Why China’s Nascent Carbon Market Has Long Way to Go

China, which surpassed the U.S. as the world’s biggest polluter years ago, is looking to financial markets to help restrain its greenhouse gas emissions. It plans to launch the world’s largest carbon market this year and will shortly put in place the rules that will govern trading. But it could be months before any trades occur, and years before it has any meaningful effect on the emissions speeding up climate change. Instead of starting off tough, China’s aim seems to be to get as many companies as it can on board. The question is whether it will be able to follow through on raising standards down the road.

1. What’s the plan?

The Emissions Trading Scheme was announced more than three years ago as a way to help China deliver on its climate goals. Those have since become loftier, including a plan for annual emissions to stop rising by 2030 and President Xi Jinping’s signature pledge of a carbon-neutral economy by 2060. The initial focus is on 2,225 electricity giants that are powered by fossil fuels. That industry as a whole accounts for almost half of the carbon that China spews into the atmosphere and 14% of the world’s total, according to BloombergNEF. After several delays, the rules for how the ETS will work will take effect Feb. 1. But utilities need to know their carbon allowances based on past emissions before they can trade. That could take months to determine.

2. How is it supposed to work?

The program will force utilities to pay for at least some permits to release carbon dioxide, encouraging them to invest in equipment that will use fuel more efficiently and reduce pollution. It provides a carrot because companies that can cut emissions quickly can sell spare allowances for profit. On the stick side, companies that fail to comply may be fined or have to pay for more permits to pollute.

3. When will it be ready?

The environment ministry, which oversees the ETS, has asked local governments to submit preliminary allocations by Jan. 29 based on 2018 emissions, just three days before the trading rules come into effect. Allocations will be updated once emissions figures for 2019 and 2020 have been collected, although no deadline for that has been set. Perhaps a more realistic view of when the ETS will be functional comes from the bourse that’ll host the trading, the Shanghai Environment and Energy Exchange. Lai Xiaoming, its chairman, told the the government-backed Securities Times the market’s launch will be in the middle of 2021.

4. Why so slow? Is there a strategy?

China seems to be prioritizing participation in the ETS over more stringent goals on reducing emissions as it seeks to strike a balance between its environmental and economic goals. It means allocations are likely to be quite generous and fines for non-compliance relatively benign. The upshot is that efforts to cap total emissions, or create incentives to switch from dirty coal to cleaner burning gas, will probably have to wait. The market as currently designed won’t accelerate China’s decarbonization, according to BNEF analyst Yvonne Liu. But, having a working mechanism in place offers the government a powerful climate-policy tool that it can employ in the future, she said. It’ll also help participants begin integrating emissions goals into their longer term planning.

5. What about longer term?

As it evolves, the market will expand to cover sectors beyond power generation. The Shanghai exchange’s Lai expects eight industries to be included during China’s current five-year plan, which runs through 2025, and that the ETS will eventually cover as many as 10,000 emitters accounting for about 5 billion tons of carbon. Sectors that could be next in line include cement and aluminum production, according to Huang Dafei, senior operations officer at the World Bank Group.

The Reference Shelf

  • China’s environment ministry has published its guidelines governing the carbon market here.
  • The former United Nations’ climate chief says China’s carbon market will eventually put a price on the emissions its exports.
  • Bloomberg Opinion’s David Fickling warns about China backsliding on cutting emissions, and Andreas Kluth proposes a transatlantic carbon club.
  • The European Union’s carbon market, currently the world’s largest, is perking up after years in the doldrums.

©2021 Bloomberg L.P.

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