The marketplace for emissions trading that is widely expected to take off in China in a few months will force polluters and inefficient energy consumers to fall in line over time through economic disincentives, though challenges to implementation remain.
Fitch Ratings sees the Emission Trading Scheme (ETS) as key for China to achieve President Xi Jinping’s pledge to achieve carbon neutrality by 2060, with the scheme’s impact expected to increase progressively as coverage expands and rules tighten, and also as emission allowances that are currently allowed are reduced over time.
“The initial impact of the ETS is likely to be limited,” the ratings agency said in a non-ratings action commentary this week. But rules will become stricter as policy makers step up efforts to meet emission pledges over time and as they use the “initial phases of the ETS to explore the market mechanism and test the market infrastructure.”
China launched the operational phase of the national ETS on Feb. 1, and actual trading is expected to begin around mid-2021, with some media reports suggesting a start as likely in the second quarter.
Initially, the scheme covers entities in the power sector. Once trading starts, companies operating coal plants with excessive emissions will be required to buy emissions permits from the open market. Such economic costs are expected to force the operators to lower their emissions intensity over time.
Yan Qin, a lead analyst at Refinitiv, noted the Ministry of Environment as saying in the past that the coverage of companies will be expanded to other industry sectors beyond the power sector by 2025.
With China’s power sector emissions at 4.4 giga tonnes in 2020, the country’s carbon market already covers at least 40% of its total carbon dioxide (CO2) emissions, and would rise to 80% by 2025, as coverage is expanded beyond the power sector.
That would make carbon pricing an effective market-based policy instrument, Qin said, although she added that the role of the carbon market goes beyond carbon pricing, as it would also help authorities collect emissions data, build an effective monitoring system and enhance awareness among energy-intensive companies.
Still, the lack of carbon market competencies at the local enterprise and environmental authority level could be an obstacle, as would the absence of an established commodities market. She cited the example of Europe, saying the carbon market there benefited from a well-established power and fuel-trading market, as well as a variety of financial instruments facilitating both energy and carbon trading.
Overlapping policies facing the carbon market also presented a challenge, she said, creating the need for coordination among different authorities or ministries.
In the beginning, carbon allowances will be allocated based on four carbon intensity benchmarks, which in turn are based on the generator’s size and type of fuel. This requirement differs from the absolute emissions cap used in Europe, and should help to “improve efficiency rather than substitution across fuel sources,” according to Fitch.
“We expect an eventual shift to a single benchmark and the introduction of absolute emission constraints,” Fitch said.
