by Anandita Ketkar
China has proposed the world’s largest carbon emissions trading scheme (ETS). The magnitude of the scheme’s impact will depend on the buy-in from key stakeholders and the functioning of the pricing mechanism for carbon. As the country has pledged to reach net zero emissions by 2060, this article explores the merits of the current scheme.
As the European Central Bank’s Governing Council announced its commitment to incorporating climate change considerations into its monetary policy framework, institutions worldwide are recognising the impact of the climate crisis on the outlook for price stability . In China, an ETS has been in the pipeline since 2010 . The mechanism takes the form of providing emitters of carbon dioxide with the right to release a certain amount of carbon in the format of a tradable permit. Initially, the ETS only covers the electricity generation sector and “captive” power plants that directly serve industrial sites. . There is an expectation that the scheme will expand into other sectors to ultimately bring 72% of China’s carbon emissions into the scheme . However, an iron-clad commitment to adding sectors including steel and cement in future cycles is yet to come into fruition.
The “central role” of the ETS is to achieve the country’s goal of reaching peak carbon emissions by 2030 and net zero by 2060 . 2225 sites are covered by the present scheme, constituting 40% of the nation’s total CO2 emissions . Nevertheless, the volume of emissions is substantial, at three times the amount covered in the EU scheme, translated as 15% of global CO2 emissions . In a dynamic year for tradable carbon permits, China’s announcement follows new climate targets being set by the US, Canada, Japan, South Korea and Germany. . The market uses a measure of carbon intensity, where emissions allowances are calculated relative to output and change according to the type of power plant . This contrasts with the EU, California or Canadian markets which have embraced a cap-and-trade system .
The current scheme posits an opportunity to gain buy-in from emitting companies, mirroring the European ETS’ first phase . Permits are granted to companies, rather than sold by auction . China’s ETS experienced an oversupply of 1.56bn tonnes of CO2 from 2019, conveying a need to shift towards auctioning permits to meet the objective of reducing total carbon emissions . However, the initial buy-in phase is imperative as it addresses the issue of the ETS’ expansion outpacing the ability and willingness of companies in the industrial sector to comply with it . The technological developments to induce alternative processes may require time to develop. Replacing China’s coal fleet with zero carbon alternatives incurs a net negative-abatement cost of $20/tC02, and the price mechanism may have to be reformed to ensure abatement is consistent with the net zero goal .
The process of a mature ETS is still in its early stages; the regulatory and legislative structure underpinning the ETS needs strengthening and fines for breaches are low . At the end of each cycle, regulated sites are legally bound to transfer a designated permit allocation equal to their verified emissions, which places measuring, reporting and verifying emissions accurately at the forefront of the trial run process. The penalty for non-compliance is 30,000 yuan ($4605) which is relatively low, possibly inducing paradoxical incentives for carbon emitting companies . Analysts concur that a supply adjustment mechanism will be needed to raise the carbon price and achieve the net zero objective . This would entail a market stability reserve (MSR) akin to the EU, which is activated by a predetermined threshold after which the allowances are auctioned .
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