China kicks off consultation for compliance emission trading rules in 2024-2025

The Chinese government has kicked off an internal consultation for the compliance emission trading rules to be implemented in 2024-2025 among power companies, according to a consultation document seen by S&P Global Commodity Insights

If implemented, the recommendations could significantly cut emission allowance supply and push up prices, but draft rules are typically still open to changes depending on industry feedback. China owns the world's largest compliance carbon market by emission volumes covered. The market currently only includes the power generation sector, accounting for about 5.1 billion mt or 40% of the country's annual CO2 emissions.

Since its launch in July 2021, China's national compliance market has been criticized for oversupplies and ineffective prices, especially by policymakers and stakeholders in other countries that have much higher prices on emissions. The recent consultation, however, sent a strong signal that the Chinese government plans to take countermeasures to address these concerns.

There are multiple reasons behind the oversupply issue, including loose regulations in the first year, lack of measures to prevent companies from hoarding previous year's allowances, and generous offering for some companies to advance future year's allowances to relieve their financial difficulties. All of these have been addressed in the latest consultation document.

Addressing oversupplies

When the market was initially launched in 2021, companies were required to surrender China Emission Allowances, or CEAs, by Dec. 31, 2021 to cover their annual emissions in 2020. Many companies were unfamiliar with emission reporting and carbon trading at that time. Consequently, the government supplied too many free CEAs to the market due to the lack of actual emission data.

In the consultation document, the government adjusted the number of allowances assigned to companies for their emissions in 2020. When assigning allowances to companies this year, the surplus allowances assigned in the past will be deducted.

For instance, a conventional coal-fired generation unit with above 300 MW capacity and an annual power supply of 1,000 megawatt-hours received 877 mt of CEAs from the government for free in 2020. However, after the adjustment, only 865 mt of CEAs should have been allocated, so 12 CEAs will be deducted from the current year's quota.

Following the trend in previous compliance periods, free emissions allowed for each megawatt-hour of electricity supply and the respective CEAs supplied to companies will continue to decline on the year, the consultation document showed.

TABLE 1: Free emissions allowed for each megawatt-hour of electricity supply

*Years in which emissions were incurred

Source: Ministry of Ecology and Environment of China

Last year, the government allowed some companies to advance future allowances to cover their emissions incurred in 2021-2022, considering their financial difficulties and soaring fuel prices during that period. Such arrangement will no longer be allowed from 2024 onwards, and the advanced CEAs should be deducted from this year's quota for these companies, the consultation document showed.

To stop hoarding

In 2023, the national carbon exchange has started differentiating CEAs issued in different years by vintages. For instance, a CEA of 2022 vintage was issued based on a company's emissions incurred in 2022. However, market participants currently are allowed to surrender CEAs of all vintages to cover their emissions in a specific year, so many companies are hoarding previous year's allowances.

Companies are still allowed to surrender CEAs of all vintages to cover their emissions incurred in 2023-2024, however, they are only allowed to use CEAs of 2025 vintage to cover their emissions incurred in 2025, the consultation document showed.

This vintage requirement is expected to remain effective for future compliance periods after 2025, analysts said, adding that this move will prevent companies from hoarding CEAs and enhance market liquidity.

The requirement will trigger demand for financial derivatives, such as vintage-specific carbon futures, to provide hedging tools and nurture long-term price signals in the market, analysts added.

Other details

Companies are required to surrender CEAs by Dec. 31, 2024 for their emissions incurred in 2023, and surrender CEAs by Dec. 31, 2025 for their emissions incurred in 2024, according to the consultation document.

There's no official timeline in terms of when the rules will be finalized. Some power companies are expected to propose changes for the government to consider, such as relaxing some of the rules and increasing market supplies, especially companies that still face financial difficulties and are relatively inefficient.

The consultation document only covers the thermal power generation sector, and gas-fired power generation utilities do not need to meet any compliance obligations for now. Earlier this year, separate consultation documents have been released for including aluminum and cement industries in the national compliance carbon market.

Daily weighted average CEA price was Yuan 89.57/mtCO2e ($12.37/mtCO2e) on April 16, official exchange data showed.