【Eco-China: How Carbon Emission Trade Nurtures Low-carbon Economy】
Recently, the emerging carbon market in China has gradually gained its popularity in private sector. Alibaba Group, the China’s largest IT giant, has been paving the way to carbon emission trade since 2016. In April 2019, Alibaba announced that 500 million users of Ant Forest, an afforestation project, have jointly plant 100 million tresses in desert regions of China by practicing low-carbon behaviors. Alibaba is anticipated to make a huge profit if they sell emission-reduction amount produced by Ant Forest in carbon markets. As the Chinese national market is about to operate since 2020, what opportunities and challenges will the market bring to organizations and individuals involved?
If you are institutions in eight listed high-emission industries*or you are eco-friendly organizations and individuals, this article can be helpful to you, where we are going to discuss about the carbon emission trade (CET) market in China and how it impacts different stakeholders in the market.
*At the first development stage of national CET market, the Chinese government plans to cover eight high-emission industries (power, petrochemical, chemical, building materials, steel, nonferrous metal, papermaking, aviation).
Guangdong is emerging as an international market and Shanghai is the most popular market for voluntary market players.
The national CET market is at initial development stage and largely driven by government regulations.
As the industry scope expands, key emission institutions will still take the lead in CET, whereas voluntary players are very likely to play an equally important role as their compulsory counterparts in the national market, thanks to cheaper market price and flexible trading rules.
The enlarging national market will bring opportunities to companies and individuals that show interests in carbon neutrality and carbon finance in China.
【Provincial/Municipal CET Markets】
Prior to the national market, China launched seven pilot markets of carbon emission trade (CET) in 2013 and 2014 as a key measure to peak carbon emission and reduce carbon intensity*1 by 60%-65% compared to 2005 by 2030. By May 2019, accumulated transaction of Emission Allowance (EA)*2 in all pilot markets reached 310 million tons carbon dioxide equivalent, worth around 6.8 billion RMB.
Seven pilot markets have operated in Beijing, Shanghai, Guangdong, Tianjin, Shenzhen, Hubei and Chongqing, while another two provincial markets are located in Sichuan and Fujian. In 2016, Jiangsu also launched a provincial CET market, yet it is still under development (Fig. 1).
Fig. 1 Locations of nine provincial/municipal CET markets
In total, nine markets in operation has traded over 600 million tCO2e. As shown below (Fig. 2), EA takes the majority of total transaction, except that in Shanghai and Sichuan, the amount of Chinese Certified Emission Reduction (CCER, see below for explanation) outweighs that of EA.
Fig. 2 Total traded amount of nine provincial/municipal CET markets by 31 Dec. 2019
Guangdong (excluded Shenzhen) overtook Shanghai in 2016 and has become the largest market with 854 million RMB worth of EA transaction in 2019. Guangdong is emerging as an international carbon market. Through 2019, foreign institutions account for 1.6% of total transaction happening in the Guangdong market. To attract more foreign investors, Guangdong market (Guangzhou Emission Exchange) has cooperated with EU carbon market (The European Energy Exchange) to promote joint businesses since March 2019. More importantly, the Chinese government plans to allow foreign investors to trade carbon products via RMB or foreign currency in Guangdong market as a financial support policy for the development of Guangdong-Hongkong-Macao Greater Bay Area.
Shanghai has the most traded CCER among nine markets, accounting for 69% of total traded amount in Shanghai market. Reasons can be 1) trading methods for CCER in Shanghai (majorly negotiated transfer) is more flexible than other provinces/cities, so voluntary participants prefer Shanghai market for speculative investment; 2) Shanghai owns the biggest financial market in China, attracting lots of investors to Shanghai CET market as well.
Chongqing will be the only city operating CET market in west China after the national market starts operation in 2020. It can be assumed that the Sichuan market will be merged with the Chongqing one for trading CCER produced in Sichuan.
*1. Carbon intensity refers to carbon emission amount per GDP unit (10000 RMB)
2. Emission Allowance is a major carbon product in current CET markets. 1 EA unit represents that entities can emit 1 ton of CO2 equivalent (tCO2e) GHG into the atmosphere. Please see following sections for detailed explanations.
【National CET Market】
After the trial operation of seven pilot provincial/municipal markets (detailed explanations are provided in the last section), National Development and Reform Commission (国家发展改革委员会) launched the first-ever national CET market for power-generation industry in 2017. Yet, it is under development and predicted to start operation since 2020.
The market mechanism is shown as followed (Fig. 3). Simply put, enterprises and individuals are allowed to sell or purchase carbon products to meet their demands in the CET market. However, the market is largely driven by national regulations.
Fig. 3 Simplified market mechanism
Two types of carbon products are available in the market:
Emission Allowance (EA) refers to carbon credits allocated annually by governments to key emission institutions. Currently, it can only be traded in provincial/municipal CET markets for deducting excessive GHG emission or obtaining by voluntary entities. 1 EA unit represents that entities can emit 1 ton of CO2 equivalent (tCO2e) GHG into the atmosphere.
Chinese Certified Emission Reduction (CCER) refers to carbon credits issued by governments for voluntary entities based on project-based emission reduction amount. CCER serves as an offset mechanism for insufficient EA supply in the market, but the amount of CCER purchased by listed institutions is limited by the proportion of EA, project type, geography and starting time. In pilot provincial markets, voluntary participants can resell CCER.
To control total emissions, every year governments would allocate EA to every key emission institution based on different allocation methods (e.g. benchmarking*). Key emission institutions shall purchase carbon products (EA & CCER) if they emit greenhouse gas (GHG) more than allocated EA, otherwise they should pay for non-compliance fines or even accept administrative penalty. This leads to that those institutions with excessive emissions are major buyers in the markets. Institutions with emissions less than allocated allowance can choose to sell surplus EA to other market players (majorly other key emission institutions) or save it for next-year emission settlement.
Key emission institutions in current national market refer to entities that meet two following qualifications.
Enterprises and other economic organizations in power-generation industry or other institutions with self-owned power generators.
Greenhouse gas emission amount reaches 26,000 tCO2e above. (comprehensive energy consumption is about 10,000 tons standard coal equivalent) in any year from 2013 to 2019.
【Voluntary market player: other organizations and individuals】
In addition to key emission institutions, organizations and individuals that want to trade carbon products also can join CET markets. On seller side, voluntary market players can only own and sell CCER, because they are not qualified for EA allocation. To obtain CCER, qualified organizations and individuals* can invest in carbon-reduction projects that absorb GHG more than emit. Two major types of CCER projects are carbon sink (natural and artificial sequestration of CO2 from the atmosphere to offset GHG emissions) * and carbon inclusion (an incentive mechanism for encouraging low-carbon behaviors of small and medium enterprises, communities and individuals) *.
*Detailed information of qualifications will be provided in our incoming report
【Analysis on Chinese CET markets】
China has witnessed a significant drop in its carbon intensity between 2000 and 2018, which has been accelerated after seven pilot CET markets started operation in 2013 (Fig. 4). Specifically, national carbon intensity of 2018 has decreased by 45.8% compared to 2005, equal to carbon reduction amount of 5.26 billion tCO2e. The national market will continue to contribute to carbon reduction while bringing business opportunities to investors.
Fig. 4 Trend of Power Carbon Intensity by Country/Region from 2000 to 2018 (unit: gCO2/kWh)
References: IEA, 2020.01.30. Power carbon intensity in key regions in the Stated Policies Scenario, 2000-2040
The future national market will not only cover high emission institutions but attract more voluntary organizations and individuals to join CET.
In terms of compulsory market players, the market coverage is expected to expand from power-generation industry to another seven high-emission industries (petrochemical, chemical, building materials, steel, nonferrous metal, papermaking, aviation). According to the criteria of key emission institutions, approximately 1700 power-generators will join national market. The future market will cover 7000-8000 key emission institutions in aforementioned industries after the industry scope expands.
With regard to voluntary market players, the promising carbon economy and trending environmental-friendly culture incentivize corporations and individuals to trade CCER in CET markets. By August 2019, CCER of around 490,000 tCO2e have been retired or used for carbon-neutral activities and this number is trending high. This is mainly because an increasing number of corporations tries to purchase CCER to offset GHG emissions produced by their daily operation and business campaigns.
Simultaneously, some companies invest in carbon-reduction projects and sell CCER in CET markets. For example, Alibaba Group has been devoted to carbon sink and carbon inclusion. They have incentivized users on Alipay (Alibaba’s online payment platform) to conduct low-carbon behaviors through rewarding green credits, which can be used to plant trees in desert regions. The afforestation projects, called Ant Forest, can be used to issue CCER and sell in the national market in the future. Individual participants of Ant Forest project will be possible to operate their own carbon accounts for CET practices as well.
The enlarging national market indicates huge potential for companies and individuals from home and abroad that show interests in carbon neutrality and carbon finance in China.
Comparison of two carbon products (EA & CCER)
In the case of seven pilot markets, although CCER has an edge in price competition, the demand of CCER is still lower than that of EA. However, CCER is anticipated to gain its popularity in a mature national market thanks to cheaper price and flexible trading rules.
On average, the prices of EA in seven pilot markets fluctuate between RMB 20 and 30 Yuan per tCO2e, except for Beijing market that has the highest price ranging from 48.4 to 87.48 (unit: Yuan/ tCO2e) based on 2019 data. By comparison, the prices of CCER show a slightly dramatic fluctuation under 20 Yuan per tCO2e, which is comparatively lower than EA price.
However, total transaction amount of CCER (170 million tCO2e) is around half of traded EA (330 million tCO2e) based on data by June 2019. One root is that governments control CCER transaction in emission settlement. Key emission institutions are only allowed to purchase CCER of at most certain percentage of allocated EA, ranging from 1% to 10% in different pilot markets. Instead, they can purchase EA from other compulsory market players or from governments which organize auction to sell reserved EA, whose price is normally higher than market price. Given that key emission institutions are leading market players in seven pilot markets, market demand of EA is driven higher than CCER mainly due to aforementioned rules.
Yet, specific rules of the national market have not been released. It can be assumed that regulations similar to pilot market rules would be applied to the national market. However, the emerging voluntary market cannot be neglected. Compared to EA, CCER is advantageous in flexible transaction and cheaper prices. By July 2018, total traded amount of CCER outnumbered that of EA in Shanghai market thanks to flexible trading rules. The Shanghai scenario can be anticipated to happen in the national market given that the Shanghai Environment and Energy Exchange* will be the operator of national CET system. Following expanding CCER transaction, one possible risk that voluntary market players will face is speculator behaviors, which can disturb the market.
*Shanghai Environment and Energy Exchange is the operator of Shanghai CET market
Relationship with international carbon market (CDM)
From 2020 onward, CERs issued in China will continue to decrease, particularly after the national CET market starts to operate and become mature with diversified traded products.
China has been the largest CER suppliers under Clean Development Mechanism (CDM)*, accounting for 54.12% of total CERs issued in all involved countries. However, CERs issued in China demonstrates a declining trend since 2016, one year before the Chinese national CET market was launched.
Fig. 5 Annual CERs issued in China (2007-2020)
As shown above (Fig. 5), the amount of CERs issued by Chinese projects peaked in 2012 majorly due to the improvement of international CET market and the lack of national CET market in China. After 2012, CER issued from Chinese projects decreased dramatically, probably due to that seven CET pilot markets launched in 2011 have encouraged the transaction of domestic carbon products since then. Moreover, NDRC is the national administration of CER and CCER in China, so a Chinese project cannot obtain CER and CCER at the same time.
* Clean Development Mechanism (CDM) is introduced in Kyoto Protocol as a measure to counter global warming. It allows listed developed countries purchase Certificated Emission Reduction (CER) from carbon reduction projects that they invested in developing countries, which shall be conducive to the sustainable development of developing countries. The money paid by developed countries will be shared between Chinese government and project owners based on related regulations.
In conclusion, key emission institutions will still be the leading market players in the next few decades, whereas voluntary players are very likely to play an equally important role as their compulsory counterparts in the national market, thanks to the trending social culture of environmental-protection, cheaper price and flexible trading rules. Likewise, carbon-reduction project owners are very likely to issue CCER instead of CER for joining the promising Chinese market.