What does the new national ETS market mean for China’s climate change objectives: So far not much but there are ways to change this

China’s bold announcements to address climate change, namely to peak emissions by 2030 and achieve carbon neutrality by 2060, have been accompanied by several policy measures so far. One that has attracted a lot of attention is the establishment of a nationwide emission trading scheme (ETS) in mid-July. With the experiences of eight regional carbon trading pilot programs, the long-awaited national market was launched on July 16th. After two months in operation, it seems important to evaluate its performance and how it may relate to China’s climate change goals down the road, let alone China’s climate diplomacy.

Starting with the performance, size is obviously a strong point of China’s national ETS market as it became the largest globally from the first day of operation. Roughly 4 billion tons of CO2 emissions can be potentially traded, more than twice the size of the carbon allowance in the EU ETS which has been in place for 16 years. This might appear as a great immediate success, but size is not all that matters. First of all, the massive size of China’s national carbon trading market reflects China’s role as the world’s largest CO2 emitter, contributing to 31% of the global CO2 emission in 2020. In fact, the 4 billion tons of CO2 emissions covered in the market are only 40% of China’s total emissions. Secondly, such a sheer amount is more nominal than real as the market remains illiquid and with a rather small number of participants in the scheme, namely 2,225 polluters for the whole China, and covering only one sector, electricity. Although as many as eight sectors are to be incorporated as the scheme rolls out, the inclusion process will take time as the quota allocation process can be complex for sectors like metals and building materials whose end-products are highly diverse. Furthermore, the market is not yet open for third-party traders, such as carbon trading companies, financial institutions, and individual investors. But even with looser entry barriers, carbon-related products still need to be developed to attract investors. The absence of both financial institutions and related products underscores policymakers’ wariness of admitting speculative activities to bolster the market. This is bound to remain the case for quite some time given the ongoing crackdown on excessive financial risks.

As regards the ultimate objective of supporting China’s goals to fight climate change, the goal is to see the pricing of carbon emissions being lifted so as to create market incentives to reduce the carbon print. Unfortunately, the new ETS market has not yet achieved this goal as carbon prices remain very low and without a clear upward trend, traded in less than USD10/ton compared to over USD60/ton in the European ETS. While there may be reasons related to industrial competitiveness for Chinese policy makers not to push for a faster increase in carbon prices, it is clearly not going to help with climate diplomacy and may even foster a speedier introduction of countermeasures from the rest of the world to avoid carbon leakage from China. The best example is Europe’s carbon border adjustment mechanism. To avert a coalition of forces to push China to reduce carbon emissions, a better functioning ETS market might be the solution. A number of measures have been identified as key to achieve such a goal, which are explored in this note.

All in all, the evolution of China’s ETS market can have important signaling effects to China’s ultimate intentions on the climate change front. So far, the message is rather gloomy but we think the message is bound to change to a more positive one soon, if anything out of peer pressure.

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