The start of trading represents a significant opportunity for businesses able to achieve meaningful reductions.

Nearly four years after China’s national emissions trading scheme (ETS) was announced in late 2017, trading of emissions quotas officially commenced on July 16. The start of trading represents a significant step in China’s adoption of market-based mechanisms for addressing climate change, while also signifying a major opportunity for businesses able to achieve meaningful reductions.

More than 4.1 million tonnes of Chinese Carbon Emission Allowances (CEAs) traded on the first day at a price of RMB52.78 (or US$7.42) per tonne — an amount that was in line with analysts’ expectations for launch. Although this price is significantly below the prices of allowances in the EU ETS (€52.89 per tonne on July 16) or California (US$18.80 per tonne at the May 2021 auction), it is close to the allowance price in the Regional Greenhouse Gas Initiative (RGGI) — a cap-and-trade program covering 11 states on the east coast of the United States (US$7.97 per tonne at the auction held on June 2, 2021). Like China’s ETS in its initial phase, the RGGI covers only power plants. Since the launch, prices have largely held steady, although volume fell significantly after the initial flurry of activity.

Despite indications that market participants (i.e., investors) will be able to trade CEAs in the future, no timeline has been given by the Ministry of Ecology and Environment (MEE) — which assumed management of the ETS from the National Development and Reform Commission as part of a restructuring in 2018. It is also unclear whether foreign investors will be able to participate. Nonetheless, investor interest in the world’s largest ETS, which currently covers slightly more than 2,200 power plants accounting for 4.4 billion tonnes of annual emissions and representing 40% of China’s emissions, remains strong.

MEE added to this interest on July 7, when it announced that the refining and petroleum sectors, representing approximately 14% of China’s greenhouse gas emissions, would be the next sectors added to the ETS. Prior to the ETS’ “soft launch” in 2017, the government had originally announced that eight industrial sectors would be covered, including electricity, refining and petrochemicals, chemicals, building materials, steel, nonferrous metals, paper, and aviation. If and when the ETS expands to cover all eight sectors, it will cover more than 72% of China’s total emissions. In the meantime, China’s nine city- and provincial-level pilot programs (two of which allow foreign participants) continue to operate and trade allowances. However, MEE is expected to issue plans for these programs, and the instruments issued thereunder, to be folded into the national ETS.

Investors in the carbon space and multinationals operating in one of the eight industries in the original scope of the ETS should watch these developments closely. With respect to the power sector, China’s ETS is structured differently than the EU ETS, California’s Cap-and-Trade Program, or RGGI in that it uses a rate-based efficiency standard rather than a mass-based standard. In a rate-based program, firms that already employ best-in-class emissions reductions may be able to generate CEAs through production and turn ETS compliance in a source of revenue. However, because a rate-based system like China’s does not include a fixed cap (that is, carbon intensity per unit of production at regulated sites is capped rather than overall emissions), MEE’s ability to adjust the rate-based targets becomes the primary tool to achieve China’s ambitious goal of peaking carbon dioxide emissions in 2030 and achieving carbon neutrality by 2060.