What’s next for Carbon Market in China?

By Dr Zhanfeng Dong 24 April, 2022

What is the prospect of the Carbon trading market in China in regards to achieving its carbon peak emission goal? Dr Dong explains

Under China's '1+N' policy framework to achieve peak emission & carbon neutrality, the carbon trading market faces new outlook as an important strategy to cut emissions
Recent carbon emission EIA pilot by the MEE sets a good guide to carbon market- its evaluation mgmt will help pricing of different carbon trading products & market positioning
Keeping the stability of price has been the focus for carbon market; now it needs to diversify its product types & establish local carbon markets aligned with the national market
Dr Zhanfeng Dong
Author: Dr Zhanfeng Dong
Dr. Dong Zhanfeng is currently working at the Chinese Academy for Environmental Planning (CAEP) directly under the Ministry of Ecology and Environment (MEE), acted as the associate director of the Environmental Policy Institute (EPI). He is mainly engaged in SDGs, ecological and environmental policy. He served as editor-in-chief of Progress in Environmental Economics Research and served as editorial board of some academic journals such as Ecological Economics. He also serves as the senior environmental policy consultant experts for UNEP, UNDP, ADB, GEF and other international agencies. He acted as the core expert of China Council for International Cooperation on Environment and Development (CCICED) in 2016. He has presided over about 60 international cooperation and domestic research projects in recent 10 years. The international cooperation projects were mainly funded by UNEP, ADB, GEF, etc. Domestic scientific research projects were mainly funded by the National People's Congress (NPC), the State Council, MEE, Ministry of Science and Technology(MOST), Ministry of Finance(MOF), the National Natural Science Foundation(NNSF), etc. He has made several recommendations on environmental policy to the National People’s Congress (NPC), State Council, MEE, National Development and Reform Commission (NDRC), MOF, State Administration of Taxation (SAT) in China, and were adopted by the relevant ministries and commissions. He has published more than 150 papers in academic journals, authored 9 monographs and 20 books.
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China aims to peak carbon emission before 2030 and achieve carbon neutrality before 2060. These two goals are referred to as the “Dual-Carbon Goals”. One of its major strategies is to put in place a “1+N” policy framework where “1” refers to the overarching principles of all forthcoming policies for combating climate change, while “N” refers to solutions for peaking emissions as well as policy measures for key sectors and industries.

One of the “N”s is the launch of the carbon trading market. We sat down with Dr Zhanfeng Dong from MEE’s Chinese Academy for Environmental Planning (CAEP) to talk more about the 1+N policy and what is the prospect of the “carbon market” strategy in cutting emissions.

CWR: Why is the top-level design of China’s “1+N” policy important for carbon peaking and carbon neutrality?

Dr Zhan Feng Dong (ZFD): Due to the tight time window and heavy task to reach “peak carbon emissions and carbon neutrality”, or “dual carbon” goals, China has an urgent need to strengthen the top-level design and its overall planning. The “1+N” policy system aims to achieve both goals with a series of policy measures to accelerate transformation and innovation in different areas and sectors.

1+N provides a roadmap to a complex system to achieve ‘dual carbon goals’

The first is to provide a roadmap for carbon peaking and neutrality, which is a complex system that needs to be planned holistically. It needs to set scientific targets, directions, and main responsibilities for industries.

The second is to provide sufficient support such as consolidating the responsibilities of all industries and localities, full mobilization of all parties and forming a centripetal force to achieve the “dual carbon” goals.

and accelerates in-depth industrial restructuring for carbon-intensive industries

The third is to accelerate the transition to a green, low-carbon and circular economy. This is particularly challenging for carbon-intensive industries and sectors such as energy, industry, transportation, and construction. Therefore, early action and planning are necessary for in-depth industrial restructuring for these sectors to become clean, low-carbon, safe and energy-efficient. The policies will also help improve related laws, regulations, standards as well as policy mechanisms.

CWR: The Ministry of Ecology and Environment (MEE) launched pilot programs last year to evaluate the environmental impact of carbon emission on new projects. Which industries are more under pressure, What are the possible impacts on these industries and how should they respond?

ZFD: The environmental impact assessment (EIA) or carbon emission pilot programs involve key industries such as electricity, steel, construction materials, non-ferrous metal, petrochemical and so on. The EIA can integrate the management of both pollutants and carbon emissions from fixed sources in key polluting industries.

This could help understand existing levels of carbon emissions and the potential reduction points of the whole supply chain from production to logistics (e.g. energy standards, transportation, and low-carbon technology).

It would also provide resources that accelerate the adoption of energy-efficient measures. More so, it sets carbon market standards including classification of market types, market positioning, and price setting for different carbon trading products.

Co’s are recommended to be proactive in implementing carbon reduction measures…

…for more opportunity to increase capacity

Generally, it is difficult to add new production capacity for high-emission projects but with low-carbon technologies, there is more opportunity for firms to increase capacity in pilot areas. Thus, companies in the carbon-intensive industry are recommended to be more proactive in understanding local carbon emission policies and implementing carbon reduction measures such as clean fuel replacement, energy-saving and green transportation methods.

CWR: Why is the national carbon market still not active despite the full-fledged online trading?

ZFD: One major reason is that current quotas make it difficult for carbon-market trading to balance price stability and continuous liquidity. All current quotas are free of charge, and the total quota is generally sufficient. Since it is plentiful and given the zero cost of quota acquisition, carbon prices tend to fall if oversupply occurs.

Maintaining a stable carbon price whilst managing expectations or other intervening measures will inhibit the volume of transactions. It may also result in “high-value” but “low-transaction volume” situations.

The market has only one participating party & product and it’s limited to quota allocation

Second, there is only one participating party and exchange product. The current national carbon market is only limited to emission-controlled corporates. Professional carbon companies, financial institutions and individual investors have not received admission tickets to the carbon trading market for the time being, which is not ideal for capital expansion and market activation.

At the same time, the exchange product is only limited to quota allocation. There is no entry of derivatives such as futures, options, forward, swaps, and so on, and lack of more effective price discovery tools to ensure a means of hedging risks.

CWR: What other improvements do you think the carbon market can make in terms of coverage, system design, and market operation?

ZFD: First is expanding the coverage of industries and businesses as soon as possible in the scope of transactions. Faster integration into more diverse industries such as petrochemicals, chemicals, construction materials, steel, non-ferrous, pulp, and aviation would activate trading, establish effective carbon prices, better reflect the cost of reducing emissions throughout society, and further boost the nation’s carbon market.

Construction of the rules & capabilities of the market by upgrading its existing regulation’s legal level

The second is accelerating the construction of the rules for the carbon market and improving various systems to build capabilities of the market. Upgrade the legal level of existing carbon market regulations, promulgate Administrative Measures for Carbon Emission Rights Trading, as well as formulate “carbon emission trading system”, “Act of Addressing Climate Change” and other high-level related systems to stabilize regulation and market for the trading entities.

The third is to ensure the carbon market is working properly in the carbon market operation. This includes giving full attention to the market signal of carbon price, determining a reasonable emission cost for enterprise, internalizing carbon emission cost such as to change gradually from free quota allocation to auction method, to transition from carbon intensity reduction to total carbon emission reduction.

Active development of financial products e.g. carbon futures/ options/ fund

Fourth, accelerating policy innovation in carbon finance development, such as the carbon futures market. This includes encouraging the active development of financial products and services related to carbon emission rights, seeking to operate carbon financial instruments such as carbon futures and carbon options, as well as encouraging financial agencies to establish a market-oriented carbon fund.

CWR: What will be the next step for local pilot carbon markets after the launching of the national carbon market? How can local and national carbon markets grow better together?

The local pilot carbon market has in general a good foundation and great value for reference, and some local characteristics have been explored. These experiences can still be beneficial to the national carbon market. On the other hand, in the short-term, the national carbon market may also unleash the true potential of the pilot local carbon market. Currently, the pilot local carbon market is relatively active. With the push of the “peak emission and carbon neutrality” targets, the local carbon market will need to take initiative and pursue transformation through more energy-saving innovations and so on.

Challenge ahead in unification of local & national carbon market…

… top level design of the national carbon market must be improved

Presently, there are still some problems in achieving co-development between local and national carbon markets, such as quota allocation, trading system, trading flow, and price difference. In the long-run, how local carbon market rules are unified with those of the national carbon market and how the quotas held by enterprises are carried forward will present huge challenges for the two market’s cooperative development. Therefore, there is still a lot of work to be done. For example, the top-level design of the national carbon market should be further improved.

Also, it needs to clarify the timeline for the inclusion of the eight major industries in the national carbon market, how the local carbon market continues to operate, the relationship between the local carbon market and the national carbon market and so on. Other issues such as the handling of the remaining allowances in the local carbon market, and the functional positioning of the local exchanges.

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