China must broaden scope of national carbon trading market to meet climate commitments: experts

A fence is splattered with raindrops near the venue for the U.N. climate conference in Glasgow, Scotland, Friday. The U.N. COP26 conference starts Sunday. AP-Yonhap

China's carbon trading market needs some fine-tuning to help the nation achieve carbon neutrality by 2060, industry experts said ahead of the COP26 summit where global leaders are expected to discuss policies to avert the disastrous consequences of climate change.

Adjustments such as tightening quotas allocated to power plants and widening trading scope to include more emissions sectors could greatly help the "national carbon emission exchange" play a bigger role in using market forces to guide decarburization in the most cost-effective way, analysts said.

"The current design of the national ETS [emissions trading scheme], especially the intensity-based target and lax benchmarks, is hampering its effectiveness," said Yan Qin, lead carbon analyst at data provider Refinitiv. "This could be for the purpose of a soft start, but the current design has caused low liquidity and low prices in the ETS due to oversupply."

China's national ETS kicked off July 16 and is overseen by the Shanghai Environment and Energy Exchange. The trading scheme currently only applies to power generators [plants] and includes about 2,200 electricity companies which together are responsible for over 4 billion tons a year of carbon dioxide emissions, roughly over 40 percent of the country's total emissions.

"The ETS design needs to be transformed to a system with an absolute cap and also a tighter benchmark for the producers," said Qin. Auctioning should also be gradually introduced so that producers face true carbon costs, incentivizing them to switch to low-carbon generation, she said.

There is also an urgent need to tighten the generous quota allocations for power producers, according to analysts. The generously allocated allowances meant very few quotas needed to be bought and sold in the first year, and to be effective in reducing emissions, the cost of carbon needs to be higher than the cost of mitigating emissions.

"Most of the over 2,000 enterprises have rather abundant allowances for the first compliance period from 2019-2020 and the oversupply is really weighing on market liquidity and carbon price," said Qin, noting that the low price is having little impact on promoting emission reduction measures, which is what the ETS is supposed to do.

China's ETS could play an important role in the country's carbon-neutrality drive by potentially reducing carbon emissions by 30 percent to 60 percent of current levels by 2060, according to a report released in August by the Asia Investor Group on Climate Change (AIGCC) and global asset management company Schroders. But that could be realized only under the right settings, when the cost of carbon on China's ETS rises to at least $34 per ton, according to the report.

The price of carbon allowances in the ETS is estimated to rise to 71 yuan ($11.1) per ton by 2025 and 93 yuan per ton by 2030, according to a report last December by the China Carbon Forum and global consultancy firm ICF.

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Sector expansion should be speeded up to enlarge the market participants to cover non-power heavy emitters such as steel and chemicals, analysts said.

"So far only power generators are included in the ETS, although the trading volumes and prices seem normal, they are still lower than expected," said Lin Boqiang, dean of the Xiamen University's China Institute for Studies in Energy Policy.

It is also necessary to set a reasonable carbon price for China to meet its decarbonization commitments more effectively, Lin said, adding that the adjustments should be given more time and done gradually because of the huge influence of the national ETS on the overall economy.

Xue Wang, a partner at international law firm Allen & Overy, agreed.

"This is a process and the industry will need time to adapt to these changes whilst being able to maintain their competitiveness," Wang said. "We expect a period of adjustment to allow the ETS to mature before extending its application to other high emission industries, including through gradually reducing the free quotas and raising carbon prices."

The tightening of quotas should also go with mitigation plans to avoid causing energy shortages, said Gaurav Modi, Southeast Asia managing director of consultancy firm Capgemini.

The recent power crisis, which started in September and spread to more than half of China's provinces including manufacturing hubs Zhejiang, Jiangsu and Guangdong, has cast a shadow over the country's economic growth and decarburization path. Some provincial governments told factories to limit their power use, curb output or even halt production until further notice, and some regions in northeast China even experienced residential power cuts.

The crisis might cast a shadow over China's performance at COP26, raising uncomfortable questions if Beijing does deepen its decarbonization commitments at the event, climate experts told the Post.

Overall, analysts are optimistic about the influence the ETS will have on driving China's climate reduction goals.

China released a framework for its path towards peak emissions and carbon neutrality on Tuesday, less than a week before the United Nations-backed COP26 summit begins Sunday.

The new blueprint stressed promoting market-based mechanisms, which could contribute to speeding up the enhancement of the national ETS, according to Qin.

China's recent move to liberalize pricing in the state-controlled power market prompted by the power crisis could also help drive up carbon prices.

"With the costs of carbon moving to lower stream consumers after the pricing arrangement, it'll be beneficial to suppress the high power consuming sectors and improve the competitiveness of renewable energy," said Lin from Xiamen University.