China's Emissions Trading Scheme
Overview of Scheme
The Chinese Emissions Trading Scheme (ETS) was released in 2021 and currently covers the country's power sector, particularly coal generation. During its first cycle, it will regulate the carbon dioxide emissions of 2,225 entities. The scheme covers nearly all coal plants above 50 megawatts (MW), as well as some gas plants. An ETS functions by giving each entity an allowance for how much carbon dioxide (CO2) they can emit in a given timeframe (typically a year). These allowances are usually based on an overall 'cap,' or maximum level of emissions, that the regulatory body has set; however, China's ETS is different in that, currently, there is no overarching cap or limit on emissions. Companies who do not use up all their allowances can sell or trade their leftover allowances with others. The goal of an ETS is to make it economically harder for carbon-intensive companies or industries to continue operating, thus leading them to reform their operations or shut down.
History and Timeline
China's Emissions Trading Scheme (ETS) has been in the works since 2010, when the government announced its intention to launch an ETS that would help regulate their carbon emissions. This intention was confirmed by the government in 2015 with the plan to introduce an ETS in the country's 12th Five-Year Plan (2011-2015); however, the launch of the ETS was delayed several times the following years until 2021. In the meantime, from 2013 to 2016, China launched eight provincial ETS pilots in Beijing, Fujian, Guangdong, Shanghai, Shenyang, and Tianjin to test the feasibility of the pilots. These pilots all continued to operate until the launch of the national ETS, after which they were merged with the national ETS. In September 2020, China announced its goal of becoming carbon-neutral by 2060. Following this announcement, action on producing and finalizing the national ETS increased significantly.
In January 2021, China's Ministry of Ecology and Environment (MEE), the government body in charge of regulating the country's greenhouse gas emissions, released several key documents explaining the processes behind an upcoming national ETS.
In March 2021, the MEE released a document titled 'Interim Regulations for the Management of Carbon Emissions Trading.' This new ETS legislation defined the first national scheme and its measures in detail. According to this document, compliance for the first cycle began on January 1, 2021, and came into effect on February 1, 2021. A list of 2,225 entities that would be regulated by the ETS soon followed.
The official launch of the ETS was planned for June 2021. However, the launch was delayed again without explanation until July 16, which was confirmed by the Shanghai Environment and Energy Exchange.
Currently, a new draft regulation is undergoing a consultation period. Expected to be stronger than the previous 'Interim Regulations for the Management of Carbon Emissions Trading,' this document will likely be finalized by the end of 2021.
The national ETS currently covers 2,225 entities in China, covering 40% of national emissions and around 12% of global emissions (4.5 gigatons of CO2). To be considered eligible for the ETS, an entity must have produced over 26,000 tonnes of CO2 in any year between 2013 to 2019. Currently, the ETS only regulates companies in the power sector. It encompasses nearly all coal plants over 50 MW in China, including 770 captive power plants, which account for more than a third of the 2,225 entities included in the ETS' first cycle. Gas plants are also included in the first ETS cycle, but face different compliance measures - they can sell their allowances, but don't face additional costs if they emit more than their allowances.
Regulated firms are relatively concentrated in just three provinces in China: Shandong, Jiangsu, and Inner Mongolia. The Chinese energy sector currently emits 9.6 gigatons (Gt) of CO2 annually out of China's total 12.3 Gt of annual emissions. Other carbon-intensive sectors in China include industrial processes (1.7 Gt of annual CO2 emissions), agriculture (830 megatons), and waste (195 megatons). The ETS is expected to expand to include other sectors in the future (see 'Plans for Expansion').
Impacts on Carbon Emissions
A lead analyst from Refinitiv (an energy consultancy) modeled the ETS's impacts on emissions and found that it would result in a modest reduction of 200-300 megatons CO2 per year under its current design.
Compliance Measures and Obligations
Allowances and Benchmarks
Allowances in the current ETS equal 70% of an entity's 2018-2020 emissions, multiplied by a 'benchmark factor' that depends on the type of power plant being regulated. There are four categories of power plants in the current iteration: conventional power plants over 300 MW (where the benchmark factor is 0.877), conventional power plants below 300 MW (benchmark factor of 0.979), unconventional coal (1.146), and natural gas (0.392). Allowances are currently given to entities for free, although auctioning the allowances may become a possibility in the future (see 'Plans for Expansion'). If a coal plant does exceed its allowances, it will need to purchase only 20% of its surplus from the market, which some critics point out as a flaw of the model.
In the current iteration of the ETS, entities can cover up to 5% of their emissions in their compliance obligations for the cycle by using offsets from Chinese Certified Emissions Reductions (CCER) projects, which are carbon sequestration/reduction projects in renewable energy, carbon sinks, methane utilization, and more.
While most ETSs have a price per ton of carbon dioxide, pricing for China's ETS is yet to be determined, due to several factors that make the pricing hard to calculate, such as a flexible cap. During the previous pilot schemes (2016-2020), one ton of CO2 ranged from 9.5 to 29 RMB (5 Euros) as opposed to the EU ETS average price of 50 Euros (~383 RMB). According to China Carbon Forum, most experts expect the average price to start at 49 RMB ($7.6 USD) per ton of CO2, which would put it on par with an ETS in the eastern United States, but nowhere near the EU ETS prices. According to the Carbon Pricing Corridors initiative, a carbon price of $30-100 USD per ton of CO2 is needed to decarbonize the power sector. The group Refinitiv expects the price to go up to 156 RMB ($24 USD) by 2030.
A price stability mechanism on the carbon market trading platform will be implemented to limit any daily price swings to 10%. China's carbon market is expected to reach 2.5 Gt in 2021, representing around 6 billion RMB ($925 million USD) in value.
The document laid out by the MEE outlines the fees and penalties for not complying with the national ETS. If an entity fails to report data (or falsifies data), they will be subject to a fine of 10,000-30,000 RMB ($1,449-$4,347 USD); if they fail to keep their emissions below their allowances, they are subject to a fine of 20,000-30,000 RMB ($2,898-$4,347 USD). All emissions that are over the entity's allowances/compliance obligation will be deducted from the next year's allowances.
To ensure proper data collection and enforcement, the ETS is structured and supervised within three levels of government. The federal MEE body acts as the rule-setter and oversees the overall system, as well as the trading platform. The MEE's provincial subsidiaries oversee entities in each province and are more responsible for communicating with entities and administering adherence with the ETS' rules. Lastly, the municipal-level authorities also help with adherence and verifying data.
China's Carbon-Neutrality Commitment
Following on the heels of China's commitment to carbon neutrality, the ETS comes at a pivotal moment in the nation's timeline of climate governance. In September 2020, President Xi Jinping announced China's target of becoming carbon neutral by 2060, with a peak of emissions in 2030. Although the commitment is considered 'highly insufficient' by the Climate Action Tracker to keep global temperature rise within 1-2 degrees Celsius, this pledge prompted faster action on the ETS as the energy sector in China is responsible for a large percentage of carbon emissions.
China's Current Coal Fleet
China's coal fleet is the largest in the world — the country's capacity has increased fourfold from 2000 to 2018. Its total installed capacity, at around 1050 GW, is larger than all other countries' coal fleets combined. One out of every four tons of coal used globally is burned in China for electricity. The average age of China's plants are also younger; the majority of existing coal plants have operated for less than 15 years but are estimated to be retired in the near future as well. Although the coal fleet is one of the most efficient in the world, nearly half of the country's capacity is created by subcritical, less-efficient and more pollutive units. As of 2018, coal represented around 61% of China's energy mix.
As of early 2021, a further 100 GW of coal plants are under construction; meanwhile, 160 GW of coal projects have been proposed (but suspended by the central government) since 2016, and another 106 GW are proposed this year. The total of these represents more than the capacity of the next biggest coal country, the United States.
The enormous size of China's coal fleet means that decarbonizing their power sector and introducing various incentives for early retirement is essential. The country currently has an overcapacity of around 400 GW. In 2019, plants were only producing at an average of 49% of their total capacity. China's coal plants are also decreasing in profitability: in 2019, over half the country's plants were loss-making.
According to a model and study by Cui et. al., meeting a 2°C scenario would soon require China's coal fleet to be almost entirely used for peaking service only, when electricity demand is extremely high. It would also imply that coal power plants' annual operating hours would have to be reduced from 4350 to 3750 by 2030, and under 1000 hours per year by 2050. In a 1.5°C scenario, coal plants would have to stop all operations by 2045. According to a 2021 report by analytical group TransitionZero, meeting the Paris Agreement goals would mean that China's coal plants would have to all be closed or put into reserve capacity around 2040. Put into real time, this closure would mean retiring two or three coal units every week until 2040. TransitionZero also stated that converting China's coal fleet to renewables could save the government up to $1.6 trillion (USD) as the cost of carbon dioxide emissions grew.
China's Future Energy Mix
Plenty of estimates and forecasts for China's future energy mix exist. According to TransitionZero, China's solar and wind capacity is expected to reach 1,800 GW by 2030 (from the current 535 GW), representing around $1.4 trillion of capital investment. If the trend continues as such, the coal fleet would be dramatically reduced and pollution levels would decrease significantly to meet Paris Agreement levels.
For more on China's coal fleet and energy mix, please see China and Coal.
Plenty of energy experts and environmental economists see China's ETS as lacking in several regards. First and foremost, people argue that the carbon price is too low. TransitionZero argues that without a stronger price signal from the government, the carbon price will crash or be close to zero, which will not create an effective trading scheme or economic incentive.
Many people also argue that the penalties and fines are also too low; for most energy companies in China, the non-compliance fee is negligible. Some critics also point out the fact that coal plants only have to buy 20% of their surplus emissions if they exceed their allowances limits the strength of the ETS and does not provide enough incentive.
Secondly, the lack of an absolute cap or limit on emissions is concerning for many. Currently, based on the allowances given to entities covered by the scheme, China's ETS will be oversupplied by 1.56 billion tons of CO2 (which amounts to the EU's annual ETS emissions). Given that carbon neutrality in China will require the energy sector's carbon intensity to halve by 2030, the oversupply and lack of cap imply very slow progress towards this goal. This situation of allowances being too high is further exacerbated by the fact that half of the "unconventional coal" sites (which include coal waste-fired plants, mixed fuels with biowaste, etc) are allocated more generous benchmarks than their regular coal peers, meaning they are able to emit more.
Lastly, data regarding emissions that come from coal plants and energy companies can easily be falsified. Most local governments do not have sufficient resources to validate all the data, meaning that many power plants can bypass the ETS laws.
Plans for Expansion
The national ETS is set to grow and change after a short trial period. In March 2021, draft MEE legislation to expand the scope of the ETS (which had just been released) was filed to go through the State Council, which would also guarantee stricter oversight and supervision of the ETS' processes. The draft ETS suggests a cap on emission permits based on China's carbon emissions targets, it also increases the fines/penalties - which critics argue are too low - to five hundred thousand to one million RMB (up from twenty thousand to thirty thousand). The draft regulation will be reviewed for several months and will likely only be approved or rejected in late 2021.
The ETS is also scheduled to cover other sectors besides power, including petrochemical, chemical, building materials (cement), steel, nonferrous metals, paper, and domestic aviation. In 2016, all these sectors had been included in a previous ETS document; however, the final ETS was scaled back to just power when it was released in 2021. According to Yan Qin, a lead analyst at Refinitiv (an energy consultancy), the two sectors likely to be covered first are aluminum and cement.
Other types of emissions trading may also occur, such as auctioning and stop futures. According to ICAP, “rules on banking and borrowing are not yet specified in the published policy documents. The system is expected to allow for banking but not for borrowing." Auctioning is included in the draft ETS, but no timeline is specified.
Recommendations from Experts
With regards to phasing out coal power in China, many experts agree that gradually lowering allowances and setting an absolute cap for carbon emissions, which is proposed in the draft ETS legislation for the end of 2021, is essential to making the ETS effective. In a 2021 study, the IEA highlights how introducing an auctioning system (that will cover 50% of the ETS allowances) will be effective; in their model, auctioning would reduce annual power generation emissions by 10% more than under the current scenario. They also demonstrate that under moderate auctioning, the share of coal power in China's energy mix would be reduced to below 40%, while under the current ETS, the share of coal would only reduce to around 50%.
Other policy recommendations for decarbonizing China's energy sector include cancelling all new proposals for coal power plants immediately and developing a national phase-out plan for coal power plants. A paper by Cui et. al outlines a three-step algorithm that measures coal plants' technical attributes, profitability, and environmental impacts (using various criteria and metrics), providing a score for all coal plants in the country that ranks them for retirement. After ranking most coal plants in China, they found that the plants set to retire first were older, smaller, less efficient, self-use plants in polluted and water-scarce regions. This ranking provides the government with an easy agenda for coal power phase-out which would prioritize retiring more pollutive plants.
TransitionZero has also developed a simple phase-out plan; they state that by identifying a pathway aligning with the Paris Agreement and using a Risk Index System (RIS) to rank China's power units, China can annually phase out the plants with the highest RIS scores to stay within national climate targets. TransitionZero also recommends that, to avoid data misreporting, the MEE should explore using a system of onsite continuous emission monitoring systems (which includes satellite imaging) which could be more cost-effective.
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