In Depth: China’s Push to Expand Its Carbon Market

China’s national carbon market is undergoing significant changes. [para. 1] In January, the certified carbon emission reductions (CCERs) were reintroduced, and the voluntary market is set to expand beyond power plants to include major manufacturing industries. [para. 2][para. 3] Recently, the Ministry of Ecology and Environment (MEE) proposed draft rules that tighten carbon allowances for the national Emissions Trading System (ETS). This aims to boost market activity and promote the green transition of power generators. [para. 3]

These changes coincide with the European Union’s plan to implement a carbon tax on imports by 2026 under the Carbon Border Adjustment Mechanism (CBAM). [para. 4] The CBAM seeks to level the playing field by making sure that imported goods include carbon pollution costs. Zhang Xiliang, head of the technical expert group for China’s national emissions trading scheme, explained that the expansion allows Chinese companies to have a basis for dialogue with the EU, demonstrating that they have already paid carbon costs within China. [para. 5]

Domestically, companies have been hoarding carbon permits in anticipation of tighter allocations, which has led to low market liquidity. [para. 6] In 2023, while China’s carbon market covered 5.1 billion tons of CO2 (40% of national emissions), only 212 million tons were traded, a stark contrast to the EU's market. [para. 6][para. 7] Experts suggest that an expanded market will increase trading volume by attracting more participants and improving resource allocation. [para. 8]

China’s carbon prices historically surged more than 30% after the 2024 Spring Festival, with prices doubling since their inception in July 2021. [para. 11] The recent price hike is influenced not only by compliance requirements but also by companies rushing to meet emission targets and concerns over quota shortages. [para. 12] The “Interim Regulation on Carbon Emission Trading Management,” effective as of May, introduced severe penalties for non-compliance, leading to companies storing quotas for future higher prices.[para. 13]

The MEE's draft rules now require annual instead of biennial compliance reporting. [para. 19] Restrictions will be placed on carrying over unused permits and borrowing future allowances to boost market activity. [para. 20] A shift from free to partially paid quota allocations is also on the horizon, putting additional pressure on quotas. [para. 23] According to Zhang, director of the Institute of Energy, Environment, and Economy at Tsinghua University, even an initial paid allocation ratio of 1% could be significant and is expected to start soon. [para. 24]

The carbon market is set to expand to industries outside of power generation. By 2025, the electrolytic aluminum, cement, and steel industries are expected to join, followed by chemicals and civil aviation by 2026, and petrochemicals and paper by 2030. [para. 28][para. 29] In March and April, the MEE solicited public opinion on greenhouse gas emissions accounting for aluminum smelters and cement makers, indicating the government's intent to expand the market. [para. 33]

Challenges remain for steel industry inclusion due to complex production processes that make emissions accounting difficult. [para. 36] From the second half of 2024, steel companies will have to submit data for monthly certification, foundational for yearly carbon emissions. [para. 37] Major steel companies are already preparing for carbon trading, making significant purchases of alternative energy. [para. 42]

Despite their ability to pass compliance costs to consumers, industries like steel and cement may bear these costs amid weak demand and overcapacity caused by a real estate downturn. [para. 45] Financially robust firms can benefit from their carbon reduction initiatives, while smaller firms might struggle. [para. 46] Observers predict that the carbon market could lead to mergers and restructurings in high-emission industries. [para. 51]