Will the world’s largest carbon market reduce China’s emissions?

China’s new carbon market replicates the problems associated with the EU’s Emissions Trading System and adds a few of its own, such as its failure to impose a cap on emissions. This casts doubts on China’s ability to meet its climate targets. Andrew Marshall explains.

The world’s largest carbon market made its debut this summer. The long-anticipated Chinese Emissions Trading System (CETS) was finally launched and will include 2,225 coal and gas-fired power plants, responsible for 4-4.5 billion tonnes of CO2 emissions annually in phase one alone (12% of global emissions). 

Moreover, China accounts for more than a quarter of global emissions, which means that a comprehensive emissions trading scheme could speed up China’s climate action, enabling it to hit peak emissions earlier than the initially planned 2030 and to solidify a net-zero goal before 2060. 

Initially discussed in 2010, the proposal has been repeatedly delayed due to political infighting, the challenge of collecting reliable emissions data and a government reshuffle in 2018, but the talks have now finally come to fruition.

The scheme sets an overall limit on emissions per industry, then individual requirements for plants that emit at least 26,000 tonnes of CO2 equivalent per year (about a 5MW coal power plant). 

Capping ambition

The newly introduced Chinese system rests on the same foundation as other emissions trading schemes, with the main goal being to efficiently and cost effectively use the market to manage and reduce greenhouse gas emissions. Crucially, however, the CETS will not impose a cap on emissions, raising the risk that overall emissions could, perversely, rise rather than drop. 

Instead, the CETS will use a carbon-intensity benchmark to allocate allowances to each emitter based on fuel and plant type. Then, emitters are encouraged to reduce the intensity, rather than the volume, of their emissions. This focus on energy efficiency can even benefit companies who increase their emissions as long as their volume of emissions per unit of energy output falls. 

This absence of a ceiling means that overall emissions may fall, stagnate or, most troubling of all, continue to climb. Moreover, the carbon intensity benchmark for the power plants differs depending on numerous factors, including whether it is over or under 300MW, whether it is a gas-fired plant, how often the plant operates or whether it uses a mixture of less polluting fuels. Should a plant exceed its benchmark it will need to buy allowances from more efficient plants. This suggests that reducing carbon emissions per unit of economic output is the aim of the system, instead of achieving absolute emission reductions. 

As well as appearing ineffective for reducing carbon dioxide emissions, the CETS will only trade CO2. China currently releases more methane into the atmosphere than any other country. This greenhouse gas is 86 times more potent in terms of heating potential than carbon dioxide over a period of 20 years. As more people in China become affluent,  the country is bound to pump ever more methane into the atmosphere, unless conscious and concerted action is taken to avoid this. If the Chinese government is to be considered serious about curbing emissions, then focusing on CO2 alone is not enough. 

The polluter underpays

The scheme is likely to be expanded in the coming years to cover eight industries: petrochemicals, chemicals, building materials, non-ferrous metals, aviation, power generation, steel and papermaking. Once all sectors have been covered, the CETS is expected to cover over 8 billion tonnes of CO2, making it by far the world’s largest carbon market. 

Adding other sectors in the coming years will be crucial if China is to curb its industrial emissions. However, this system, which uses independent agencies to verify its data, is prone to exploitation, as has been the case in some parts of Europe. If the system is to make a significant impact, a more serious deterrent than the maximum current penalty for false reporting of 30,000 yuan, or just over €3,900, is necessary. Otherwise, companies may falsely report their emissions and simply pay the fine that goes with it because the profits outweigh the costs. 

Lax benchmarks and lacklustre post-pandemic recovery has led some analysts, such as Refinitiv, to forecast an oversupply of allowances during the first few years after the CETS’s official launch. This has already been demonstrated during the pilot stages, with a surplus of 184 million allowances in 2019 and 2020. Emitters are authorised to hold surplus allowances for future use, meaning that some plants may not have to curb emissions in the coming years. 

Annual governmental adjustments exist, in theory, to stop this kind of market saturation from occurring, but these are unlikely to be enforced in the near future. Somewhat more encouragingly, while overall there is likely to be an overallocation of allowances, for older, dirtier power plants emitting more CO2 per MWh of electricity generated, additional permits will have to be bought. 

Carbon profiteering

In contrast, more energy-efficient power plants currently operating under the carbon-intensity benchmark will pay a negative carbon price, meaning they will effectively receive subsidies to pollute at the taxpayers’ expense. Consequently, many Chinese coal-fired plants will likely earn enormous windfall profits from burning coal, just as their European counterparts did under the EU’s ETS.

Initially, the CETS got off to a stronger start than expected, but then fizzled out. On the first day of trading, 4.1 million allowances changed hands with a starting price of 48 yuan per tonne. The average trading price was higher than expected at 51 yuan and even reached the limit for a single-day rise of 10% at 52.80 yuan. Representing under €7 per tonne, this figure falls far short of the current European price of over €50. 

The market then slowed down considerably. In the five days following this peak, the volume of permits traded fell to just 100,000 permits a day. In subsequent weeks, the market continued its downward spiral, with many days seeing less than 20,000 trades and one day seeing just 6,001 trades. Moreover, the pilot phases in 2018 and 2019 often went multiple weeks without trades. As the system has just become operational, some see this as not being an issue. However, with the urgency of the climate catastrophe getting ever stronger, polluters need to be paying for their carbon now. 

Sink or swim

Can polluters still use offsets? Yes and no. China’s President Xi Jinping has stressed that nature-based solutions will likely be required if China is to hit its climate goals. Researchers at the Tsinghua University suggest that natural carbon sinks will need to absorb over 800 million tonnes of carbon dioxide equivalent (MtCO2e) a year to meet the country’s 2060 targets. To give some sense of the implausibility of such an undertaking, a tree can absorb approximately a tonne of CO2 per century

High polluters in China have been allowed to buy offsets, more commonly known as Chinese Certified Emissions Reductions (CCERs). In the month prior to the introduction of the CETS, 7 million CCERs were traded, down from 12 million the month prior, which went for about 30 yuan each. This suggests some companies in China have switched from using CCERs to paying for emissions allowances. Although this is a slight improvement, switching from offsetting to permits cannot be considered a major leap forward. 

The official rules state CCERs can meet up to 5% of compliance obligations, yet no new projects have been approved since 2017, when the offset programme was suspended. It is rumoured the system will begin once again later this year with forest sinks, renewable energy and methane utilisation eligible in the CCER, but details are not yet known. 

Beyond markets

Instead of using primarily market mechanisms to transform their economies towards a low-carbon future, Chinese interventions have traditionally come in the form of industrial strategies, using a combination of supply side investments and targeted regulation.

Despite China laying the foundation for the world’s largest carbon market, this trend may continue. Lauri Myllyvirta at the Centre for Research on Energy and Clean Air is not discouraged by the weak proposal, suggesting China can hit its emissions target without carbon pricing playing a significant role.  But given China’s dearth of ambition and its failure to make concrete commitments to date, it is reasonable to fear that the government will not have the appetite or stomach to impose radical reductions in emissions through state-led centralised strategies.

In the coming months, China is expected to publish a roadmap on how it intends to reach peak emissions and carbon neutrality by 2030 and 2060 respectively. China’s cabinet has set up a neutral working group that is devising initial plans before COP26 in November. President Xi has said coal will be strictly controlled until 2025, but would not indicate whether there would be an absolute cap during that time.

So far, China has only committed to halting the construction of coal-fired power stations abroad. This falls far short of the concrete deadline for the phasing out of coal many countries have been urging China to set in the run-up to COP26 in November. 

In anticipation of the mammoth task ahead at the climate conference, UN Secretary-General António Guterres has stressed more must be done to lower the current catastrophic trajectory of 2.7C warming. In this respect, China’s €7 per tonne carbon price is simply inconsequential.