China Launches Carbon Trading Market as Urgency to Cut Emissions Grows

China recently launched the world’s largest carbon trading market, a potential landmark in the country’s efforts to go green.

The market was finally launched in Shanghai on July 16, 2021, after first being announced years ago. Regional trials began over 10 years ago, but the national market experienced several delays in launching, including missing its most recent target of opening on June 30, 2021.

Carbon neutral before 2060

As the world’s largest polluter, the carbon trading market may grow to become instrumental for China’s efforts to become carbon neutral before 2060. Measured by total emissions of companies listed on the market – responsible for over 4 billion tons of CO2 – it is easily the world’s largest.

How does the carbon trading market work?

The carbon trading market gives companies financial incentives to reduce their emissions by allotting credits to those who pollute below their allowances, while requiring those who go beyond their limit to purchase additional credits. Carbon markets aim to decrease emissions by offering financial rewards and punishments in the form of credits, allowances, or quotas that can be purchased and sold in a marketplace.

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Although the market’s scope is currently limited to energy companies, its arrival adds urgency for businesses in China to integrate carbon pricing into their business and risk strategies.

China’s carbon trading market is overseen by the Ministry of Ecology and Environment, while trading is run by the Shanghai Environment and Energy Exchange.

At launch, the carbon market covers over 2,225 companies that operate coal and gas plants to produce power and heat, most of which are state-owned enterprises (SOEs). Together, these companies are responsible for about half of China’s energy-related emissions, and 10-14 percent of the world’s total.

Policymakers plan on expanding the scope of the carbon market to include other polluting industries, including steel, cement, chemicals, and aviation.

Under the carbon trading scheme, each company is allowed by the government to emit a certain amount of CO2 emissions each year. If the company ends the year beneath its allotted limit, they can sell the difference on the market as a credit. Conversely, if the company exceeds its limit, it is required to buy additional credits to compensate.

After launching, the market’s first transaction was a company purchasing 160,000 metric tons of emissions for US$1.2 million. Overall, on the first day of trading, 4.1 million tons of CO2 quotas worth RMB 210 million (US$32 million) switched hands.

This put the price on carbon at RMB 51.23 (US$7.92) per ton, a 6.7 percent increase from the opening price of RMB 48 (US$7.41).

What are the implications for China’s green economy?

China has ambitious plans to decarbonize its economy and become a leader in green technology. Most notably, Chinese President Xi Jinping committed to hitting peak emissions before 2030 and becoming carbon neutral before 2060.

The carbon market could become a key piece of the puzzle for China to hit these goals, which will require an economy- and society-wide transformation. Currently, China is the world’s largest polluter – responsible for 27 percent of global emissions in 2019 – though its emissions per capita are about half of major polluters like the US.

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At a press conference, Zhao Yingmin, the vice minister for the environment, said that the market “can place responsibility for containing greenhouse gas emissions on businesses, and can also provide an economic incentive mechanism for carbon mitigation.”

Despite China’s ambitious climate goals, the carbon market has drawn mixed reviews from experts.

TransitionZero, a financial analytics group, found that the government is allotting power companies so many credits that the number of additional credits that they will need to buy will be minimal. To start, authorities are giving companies free credits so they can familiarize themselves with the system and adapt their practices accordingly.

Further, the market sets a carbon limit per unit of power generated instead of a hard ceiling on carbon emissions, making the system more relaxed than others.

Authorities will also likely encounter challenges in accurately measuring companies’ emissions, as well as preventing companies from falsifying their own. One reason that the initial market is limited to energy companies is because their emissions are more easily measurable than companies in most other sectors.

In contrast, experts view Europe’s carbon market as more effective, because its higher prices give companies greater incentive to reduce emissions.

Added urgency to integrate carbon risks and pricing

While the immediate impacts of China’s carbon market may be somewhat limited, it offers a system that can be expanded in the future to become more comprehensive.

Eventually, China’s carbon market may cover a much broader set of companies, while the emergence of a global trading system also remains a possibility. Further, the price on carbon will likely be closer to RMB 180-200 (US$27.77-30.86) per ton by the end of the decade.

Considering the trend to put a price on carbon, companies are increasingly incorporating climate risks in their business planning. Along with factors like operational and labor costs, CO2 emissions are becoming mainstream considerations for business planning. In some industries and jurisdictions, they are expected to do so from investors and other stakeholders.

One way that companies can prepare for carbon trading requirements is to put an internal price on carbon. This can either be an internal tax to encourage emissions reductions within the company to fund green initiatives, or a shadow price that allows the company to track its emissions.

As China steps up its efforts to decrease emissions, companies operating in the country will be under greater pressure to reduce their carbon footprints across their value chains.

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