Too Little, Too Cheap?
China has launched its national carbon market, but experts say it will need to increase energy prices to make it financially viable
On July 16, China's national carbon market started trading on the Shanghai Environment and Energy Exchange, after it released the rules and regulations for the much-anticipated scheme in February.
By July 30, about six million metric tons of Carbon Emission Allowances ( CEA) worth 300 million yuan (US$54.6M) had been traded. The price per ton was 54.2 yuan (US$8.36), 12.9 percent up from its initial price on July 16, when it closed at 51.23 yuan per ton ($7.92).
Efficiency-oriented
In its initial phase, the carbon market only covers some 2,200 coal and gas-powered energy firms. With combined CO2 emissions of 4.1 billion tons, China's carbon market is the largest in the world. The European Union Emission Trading System (ETS) has around 1.6 billion metric tons of circulating allowances.
Compared to carbon markets in other countries and regions, the carbon price in China is relatively low, which many say is not enough to drive down emissions. The carbon price in the EU market reached over US$60, and the price of Australian Carbon Credit Units (ACCUS) is over US$15.
The price discrepancy is largely due to the design of China's carbon market. Different to carbon trading schemes in other places, such as the EU market, which puts a cap on the total amount of carbon allowed, China's scheme adopts a so-called “cap-and-trade” model, in which emitters are allocated a certain amount of emission allowances, or cap, which they can either use or trade.
The cap-and-trade model focuses on reducing the carbon intensity of emissions generation, rather than absolute emissions. An emitter's initial emissions cap is issued based on current energy output and emission intensity, which refers to the amount of energy generated by each unit of carbon emitted.
The government is expected to restrict that over time so companies are encouraged to reduce the emissions they generate for the energy they produce. Under such a model, a company's allowance can be increased if it increases energy efficiency.
“The rationale is that as the carbon price goes up, energy companies will invest more in increasing energy efficiency and renewable energy,” said Lin Boqiang, dean of the China Institute for Energy Policy Studies at Xiamen University. Lin said that under this model, the government controls the carbon price.
“The key factor is how many free carbon allowances the authorities issue to each emitter, which is a balancing act between the need for emissions reduction and economic development,” Lin added.
According to Zhang Xiliang, executive director of the Institute of Energy, Environment and the Economy at Tsinghua University and chief designer of the carbon market, the design is in line with China's carbon emissions target of peaking carbon in 2030 and achieving carbon neutrality by 2060.
“Based on our estimate, the marginal cost of reducing emissions in China is US$7 per metric ton,” Zhong told Newschina. “The current market price of over US$8 is effective in providing an incentive for energy firms to cut emissions.” Zhang said he expects the carbon price will remain between US$8-10 up to 2025 and will reach US$15 by 2030.
A 2020 report on carbon pricing in China by China Carbon Forum, ICF International, an industrial consulting firm and sinocarbon. cn, projects that the carbon price will reach 93 yuan (US$14.4) by 2030 and 167 yuan (US$25.8) per metric ton by 2050.
Backward Step
Besides the relatively low carbon price, critics pointed out that the carbon market only covers coal and gas energy firms, which
appears to be a backward step from the pilot programs launched earlier.
In 2013, China launched pilot schemes in seven provinces and municipalities including Beijing, Shanghai and Shenzhen, Guangdong Province. These programs covered 3,000 firms in more than 20 industries including energy, iron and steel and cement. By the end of June 2021, 480 million tons of carbon dioxide were traded with a total value of 11.4 billion yuan (US$1.76B).
Many expect the national carbon market would expand rather than narrow its scope. Li Gao, head of the department for addressing climate change under the Ministry of Ecology and Environment, told Newschina the reason only energy firms are included in the initial phase is that their infrastructure to calculate and monitor the amount of carbon emissions is the most established and reliable in the sector.
Moreover, emitters in the energy sector tend to be bigger companies, often large State-owned enterprises (SOE), making it easier to implement the scheme in the initial phase. Li said that stable carbon trading in the sector will pave the way for the gradual expansion of the market to include more industries.
According to Zhang Xiliang, the national carbon market will be extended to cover other industries, such as building materials, chemicals, domestic aviation, iron and steel, nonferrous metals and paper.
“Ultimately, the carbon market will cover companies that are responsible for 70 billion tons of carbon emissions, accounting for 70 percent of China's total carbon emissions,” Zhang said. Zhang does not specify the timing of the expansion but said that companies in the cement and electrolytic aluminum industries could be included within the year.
Enforcement Challenge
For experts like Lin Boqiang, the biggest challenge for China's carbon market is enforcement. In designing the national scheme, a major focus has been on establishing a robust monitoring and reporting system to prevent falsification of emissions data.
But Lin warned that while energy firms do have robust systems, enforcement in the sector faces another challenge. Dominated by SOES, the sector is largely running at a loss due to highly-regulated electricity prices.
Data from the State-owned Assets Supervision and Administration shows that as of December 2018, among 474 coal-fired power plants owned by China's five biggest energy companies, 257 plants, or 54.2 percent, were loss-making, with a cumulative loss of 37.96 billion yuan (US$5.86B) and an average debt-to-asset ratio of 88.6 percent.
Lin said that while the carbon market scheme is designed to provide incentives for energy companies to increase efficiency, it would inevitably lead to increased operating costs.
“Ideally, as higher carbon prices lead to increased costs for energy firms, they should be able to increase energy prices and transfer the costs to consumers. But as electricity prices are largely fixed in China, energy firms will have nowhere to transfer the additional costs, which could make the market financially unviable,” Lin said, adding that it is particularly financially difficult for energy firms this year amid surging commodity prices.
Lin said that in the pilot program, some energy companies failed to pay for their carbon allowances.
“Theoretically, the government can enforce the regulations, but this would lead to bankruptcies,” Lin said. “But in reality, who will be responsible for the disruption to the power supply?”
Lin said that to make China's carbon market function in the long term, China needs to reform its energy pricing mechanism to reflect the true cost of carbon.