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Emissions trading milestone


China's carbon market needs a development roadmap and further support

Emissions trading systems--carbon pricing policy instruments for carbon emissions reduction--have become very popular in recent years. Under a typical ETS, a central authority allocates emissions permits to enterprises and requires them to submit permits equal to their emissions for compliance at the end of a "compliance cycle".

Enterprises that are short of permits can purchase them from the permit market, creating a carbon price signal that is crucial to reducing emissions cost-effectively.

The development of its ETS is an important policy move by China, marking a significant shift from command-and-control environmental policy instruments to market-based approaches. It will play a key role in meeting China's carbon peaking and carbon neutrality targets. China has been constructing its ETS since 2011, starting with seven regional ETS pilots launched between 2013 and 2015. In a joint US-China climate statement in 2015, President Xi Jinping pledged that China would introduce a national carbon market.

A plan for developing the national ETS to cover the power generation sector initially was first released in 2017, marking a significant milestone. China's national ETS finally started trading on July 16, 2021. In the first compliance cycle, the only covered sector is power and heat generation. However, this single sector accounts for more than 40 percent of China's national carbon dioxide emissions, making China's national ETS the largest in the world.

Unlike a typical ETS in the developed countries that imposes a hard emissions cap, the main feature of China's national ETS is its permit allocation rules that guarantee carbon policy stringency without introducing strong adverse shocks to economic growth. China's national ETS is so far a rate-based system--the permit allocation in each sector is based on the companies' actual output levels and a corresponding "benchmark" (emissions-output ratio) that matches an appropriate emissions intensity reduction target in that sector.

For example, if a plant's emissions intensity exceeds its predetermined benchmark, it will face an allowance deficit and need to buy permits for compliance.

Conversely, a plant with relatively low emissions intensity can sell surplus permits.

China's national ETS has been in operation for a year now. It has made progress on multiple fronts.

First, the institutional framework has been formed. The National Measures for the Administration of Carbon Emission Trading (Trial), released in December 2020, has provided a regulatory basis. It has been supplemented by additional technical documents for permit registration, trading, settlement, permit allocation, and emissions reporting for the power generation sector. All these directives have gradually formed a "1+N emissions trading policy system".

Second, infrastructure for the system has been established. The National Carbon Emissions Permits Registry in Wuhan (responsible for recording permit holdings, modifications, payments, and retirements) and the National Carbon Emissions Exchange in Shanghai (serving as a permit exchange) have been operating smoothly.

Lastly, for the monitoring, reporting, and verification of emissions, enterprises have been encouraged to take "on-site" measurements of their coal consumption, significantly improving the integrity of China's carbon emissions data.

In the last year, a resilient carbon price has emerged from the system. The transaction price of carbon permits fluctuated in the range of 40-60 yuan (about $6-9) per metric ton, and the average transaction price was 43 yuan per ton. The cumulative trading volume hit 179 million tons with a turnover of 7.7 billion yuan by December 2021, surpassing the ETS in the European Union during the same period. The compliance rate (measured in terms of permits submitted divided by total emissions) was 99.5 percent, suggesting most enterprises complied with the regulation. Overall, the operation and carbon price in the first year was stable and aligned with expectations.

Although there have been important milestones for China's national ETS in its first year, several challenges were also encountered. There is still no official roadmap for future sectoral coverage. Trading was very much concentrated just ahead of the compliance date, which reveals a less active market which limits price discovery. Risk control regarding data quality still needs to be improved, given that some data manipulation cases were detected.

Building a mature and effective ETS in China poses comprehensive challenges that require great effort and patience. In the early stage, most existing carbon markets have experienced issues such as permits oversupply and market fluctuations. Therefore, China's national ETS needs to learn the lessons from those in developed countries, such as the EU ETS and California's carbon market in the United States, and improve strategies for setting emissions caps, permit allocation, market stability mechanism, and data management.

Specifically, a medium- and long-term development roadmap is very much needed for China's ETS.Higher-level legislative support to strengthen market supervision and penalties for non-compliance are also necessary. With regard to the permit allocation, China's national ETS needs to continuously tighten the benchmarks under a rate-based design and carefully plan a transition to a mass-based system to introduce a clear cap for covered emissions. Moreover, auctioning needs to be introduced to reduce free permit allocation and facilitate price discovery. In the next few years, China's national ETS is expected to expand from the power sector to multiple industries and eventually to cover more than 8,000 companies, whose emissions account for 70 percent of China's energy-related emissions. We are confident that a full-fledged national ETS can help China achieve its "dual-carbon" goals and lead the development of a global carbon pricing regime in the near future.

Zhang Xiliang is the director of the Institute of Energy, Environment, and Economy at Tsinghua University. Huang Junling is the director of the International Clean Energy Research Office at the China Three Gorges Corporation. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn