Three months after launch, carbon trading market aims for efficiency
China’s national carbon emissions trading market has been operating for about three months since it started operating. Compared to the rise of the European Union Emissions Trading System (EU ETS) set up in 2005, the Chinese national carbon market has just taken its first steps. As carbon traders now number only 2,225 coal-fired electricity emitters, the expected contribution of the market to reducing carbon emissions is still limited, as is total market capitalization.
How can the commercial market become more efficient?
First, most large issuers should be included in the trading system. About 90 percent of China’s carbon emissions come from the combustion of fossil fuels. The contribution of emissions from the power generation sector is around 42 percent, while other energy-intensive industrial sectors such as steel and cement account for around 30 percent of the total. If other energy-intensive sectors than electricity producers were engaged in the market, it would make a big difference in reducing greenhouse gas emissions.
Second, improving the allocation and surrender of emission allowances is essential. Every company involved in the market should get a suitable allowance for free at the start to trade in the market. If the allowance is not properly set, it will be of no use in reducing the carbon emissions of related companies. The development of the EU market from 2006 to 2008 has already demonstrated such a failure. During this time, the negotiation price was almost zero. How to manage the cap and trade market is a complicated and systematic question. It is not only a question of the number of participating traders, but also of the systematic conception of market regulation.
Third, standardization of emissions calculations is important for allowance allocations. It depends on the standardization of the methodology for calculating emissions for each industrial sector according to the production process. From 2016 to 2017, the National Development and Reform Commission issued 24 technical regulations on the calculation of emissions for various industries, including power generation and steel industry. Yet only half of them have been published as national standards so far.
Fourth, it is necessary to set up a data processing and communication system. The allocation of quotas is based on the benchmarks for each sector. To establish a benchmark, the government must have a good understanding of the emissions situation of emitters through calculations based on their production and emissions data. For example, before the power generation sector was included in the national quota market, the government collected related data from 2019 and 2020 from power plants. For the steel industry, based on the national carbon emission standards for steel production, which were published by the national standards commission in 2017, this data would include the amount of energy consumption, the equipment oxidation rate, carbon content of by-products and waste use, among others. . To ensure the validity of the data, monitoring and reporting systems should be in place and also be involved in third-party accreditation institutions.
Like the EU ETS, a Chinese emissions trading system is also a complex cap-and-trade system. Once the reduction caps are set, the system must take into account regulations, data analysis and the diversity of transactions and traders.
The Chinese government is aware of the complicated nature of carbon emissions trading. Since 2007, seven local pilot carbon exchange centers have been set up in some provincial regions, including Beijing, Tianjin, Chongqing, Shenzhen and the provinces of Guangdong and Hubei. Not only are the carbon emission allowances of selected sectors in these regions affected, but local Chinese certification emission reductions (CERs) have also been traded in these different markets. According to the CER, carbon emissions accumulated through renewable energy programs can be traded. With the involvement of financial institutions, several types of carbon financial products have been provided in these pilot markets.
For example, several carbon finance products debuted on the Shanghai Environment and Energy Exchange. The Shanghai government has also released a municipal plan to become the national carbon finance center, and carbon funds, carbon bonds and carbon trusts are being developed.
Over time, China’s carbon emission reduction performance has improved. China reduced emissions intensity per unit of GDP by 48.4% in 2020 from 2005 levels. The Ministry of Ecology and Environment said China has become the second largest market carbon exchange in 2020, with 2,837 key emitters, 1,082 institutions and 11,169 people enrolled in pilot exchange programs. Last year, the total amount traded was 1.267 billion yuan ($ 197.05 million), a record. But the prices of the exchanges were not very high. In the seven provincial regions, the average price in Beijing was around 89.4 yuan per ton, and for other provinces it was less than 40 yuan per ton, in Fujian, even 17 yuan per ton. Carbon trading was not economically feasible for some provinces to actually reduce emissions. Given the low prices, financial institutions cannot really be motivated to participate.
As we all know, China has the largest carbon emissions market in the world. But why are local carbon exchange transactions not yet attractive? And when is the right time for financial institutions to enter?
Besides what has been mentioned above, systematic management is also essential for the market to flourish. Establishing the allocation benchmark for each sector suggests that legislation plays the most important role in market prosperity. In addition, regulations on the carbon emissions trading system are expected to be a very motivating factor for emitters.
This year, a series of measures have been taken by the Chinese authorities to honor China’s climate commitments. As an important market tool for carbon reduction, the domestic commercial market is expected to develop stably on a solid foundation.
In July, the Ministry of Ecology and Environment asked related companies in the main carbon emitting sectors to report related data. Later, the NDRC announced the creation of a working group focused on statistics and verification of carbon emissions. Unlike other trading markets, data is the basis of this massive emissions trading system.
On October 10, the State Council released a national plan for the development of standards. It is expected that by 2025, systematic, multi-tiered low-carbon standards will be established for sectors, companies and products.
With this foundation, the Chinese carbon quota market will gradually prepare for the involvement of financial institutions. Once financial institutions participate, the market will become more dynamic.
However, the cap and trade system is not the only effective way to reduce carbon emissions. Compared to other emission reduction measures, such as reducing energy consumption by using clean energy or reducing the capacity of high-emission industries, the carbon market needs a relatively longer time. to become effective. But once it is ready, it will be stable and its effect on the commodity market will be more noticeable.