China announced a pledge in September 2020 to be carbon-neutral by 2060. The country is the world’s largest emitter of greenhouse gases, and delivering under the pledge will be a formidable challenge. Tsinghua University calculates that China may need to spend up to $15tn in the power sector alone to achieve its carbon-neutral goal.
For China’s carbon markets, the key question will be their place in the broader regulatory framework designed to reduce the country’s emissions. China can pull many more policy levers to reduce emissions than other countries can, and a free-floating carbon price has never sat easily within the fixed pricing environment of China’s key industries. Ultimately, it may be that the carbon price itself is less important than the discovery process for emissions data generated by the carbon markets. With access to independent emissions data from the markets, regulators such as the State-owned Assets Supervision and Administration Commission (SASAC) should be able to rein in emissions more than any carbon price could.
In this article, we look at the new national carbon scheme and examine its likely development in the context of China’s broader regulatory landscape for all emissions.
A history of Chinese carbon markets
During the 2000s, China was the largest developing-market participant within the clean development mechanism under the Kyoto Protocol (the UN’s precursor to the Paris Agreement). While under the Kyoto Protocol, although China had no obligations to reduce emissions, the clean development mechanism created Chinese institutions with experience in verifying emissions and operating within an international carbon market. This experience was important for the introduction and development of the trial carbon markets that were launched in 2011 in eight Chinese provinces and cities— Beijing, Shanghai, Shenzhen, Chongqing, Guangdong, Tianjin, Hubei and Fujian.
The original concept of the eight trial markets was that they would fine-tune the development of a trading scheme to suit Chinese conditions, and a national scheme would follow in 2014. Ultimately, the trial markets never matured. They were domestically focused on a limited range of industries, including energy, petrochemicals, chemicals and materials sectors and were subject to reasonably heavy government control, and plans for a national market were abandoned.
A new injection of life
China’s carbon pledge has injected new life into its carbon markets. In late 2020/early 2021, the Ministry of Ecology and Environment (MEE) issued four sets of regulations that established a national trading scheme, launched in February 2021.
The national scheme only covers major emitters in the power sector (defined as those producing at least 26,000t/yr of carbon). While that will cover more than 2,200 generators, the significant majority of these are subsidiaries of the ‘Big Five’ state-owned power generation companies— Datang, Huadian, Huaneng, State Power Investment Corporation and China Energy Investment Corporation—meaning that the core of the obligations under the national scheme will ultimately fall upon just five state-owned enterprises. This will mean that, at least for the initial phase, fulfilling those obligations ought to be within the government’s control.
Each provincial MEE will be responsible for collecting emissions data, for setting emission limits and for allocating a free emissions allowance to each generator. Compliance with the cap will be monitored by independent third-party institutions supervised by the relevant provincial MEE, and information as to each generators’ emissions should be publicly available. Generators will be permitted to purchase allowances to offset their emissions or to use Chinese Certified Emission Reductions—broadly similar to voluntary emission reductions—to offset up to 5pc of their allowance. If, after adjusting for set-offs, a generator’s emissions exceed its allowances then the generator will face fines or may have its allowance reduced for the following years.
Looking forward: markets as just one policy lever
China has a major advantage over other countries that have pledged to be carbon-neutral. Due to its central control of the economy and its control of the major power generating emitters, it is able to pull a broader range of levers to reduce national emissions than many other states.
Chinese state-owned generators are required to achieve renewables targets, and their management face demotion for failure to achieve targets. Chinese companies in all sectors are also required to comply with increasingly stringent demand-side management requirements, and factories that do not comply can be shut down. The advancement of Chinese government officials is tied to achieving renewables and emission reduction targets. Tax incentives, subsidies and, in some cases, equity investments by government vehicles are available for clean technologies. Lending by Chinese banks is also increasingly likely to be tied to emission reduction goals and subject to renewable energy targets.
Looking forward: the role of a carbon price in changing behaviour
Some commentators have focused on the need for a sufficiently high carbon price as key for the national scheme. However, a market-driven carbon price has always sat a little uneasily within China’s largely planned industries.
In the power sector, generators face largely fixed fuel supply prices and power sale prices. A floating carbon price cannot be easily passed on to the grid and it cannot be passed back to suppliers, so it will probably need to be absorbed by generators. China’s regulators will want to ensure the carbon price does not impose too significant a burden on the Big Five. One way to protect them would be with a price cap, and although newly introduced carbon regulations do not provide for a carbon price cap, they do allow for the government to intervene in the market. In order to protect generators during the introduction of the scheme, there may well be unofficial pricing controls operating in the background.
In addition, regulators like SASAC may also play an important role. SASAC is not currently regulating emissions but, if this were to change, given the broad scope of its powers over state-owned emitters SASAC may well have more of an impact upon emitter behaviour than a carbon price.
A carbon market with Chinese characteristics
China’s carbon markets will undoubtedly be a key component of China’s toolkit to reduce emissions. Under the European Emissions Trading System, the carbon price and auctioning of allowances has been key to changing emitter behaviour. For China’s markets, the most important role may be in unlocking independent information on generator emissions. Chinese regulators, armed with independently verified information on emissions, could then take steps to change emitter behaviour. In this sense, the carbon price will be important, but the discipline around independent verification of emissions will be more important. Ultimately, regulators like SASAC, using market-generated information, may be the key to reducing China’s emissions.
Tom Luckock is a partner and Florie Sun a paralegal at Norton Rose Fulbright
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