China initiates public consultation for compliance carbon market's rules in 2024-2025

China has kicked off public consultation for the compliance carbon market's rules in 2024-2025, which moderately tightened the China Emission Allowance, or CEA, supplies and created stimulus for market liquidity, Ministry of Ecology and Environment, or MEE, said in a statement on July 2.

China's Emission Trading Scheme, or ETS, only covers the power generation sector, however, it has already become the world's largest compliance carbon market by emission volumes covered. Currently, over 5 billion mtCO2e, or 40% of the country's annual emissions, are under the ETS roof, MEE's data showed.

Earlier this year, MEE had released a draft consultation document for internal circulation among power companies. The latest consultation document, which is open to the public, has relaxed the measures to tighten CEA supplies compared with the earlier version.

In China's ETS, CEAs are allocated to companies based on carbon intensity benchmarks. In the past, the carbon intensity benchmarks were defined as the amount of emissions that a power generation unit can emit for free for each megawatt-hour of power supply to users. For this compliance period, the carbon intensity benchmarks are set based on power production volume rather than power supply to users.

MEE said in the consultation document that the adjustment was made because, compared with power supplies to users, power production volumes are directly measurable by power producers. Hence, such an adjustment can improve the accuracy of ETS emission reporting.

Caroline Zhu, senior analyst with S&P Global Commodity Insights, said such an adjustment made it difficult to compare this year's carbon intensity benchmarks with the previous year's ones and assess to what extent the market supplies have been tightened.

"It is highly likely that these benchmarks will be officially approved. If there is any adjustment, it will be a rather slight one," Duong Thi Thuy Mai, carbon market analyst with Veyt, told Commodity Insights.

She said the CEA allocation rules have been relaxed for two reasons. First, after the previous compliance period, the oversupply issue of CEAs had been addressed significantly, although not totally. Second, the proposed benchmarks in the allocation plans are enough to keep China on track to achieve its carbon reduction targets, and avoid fierce opposition from power companies.

TABLE 1: Free emissions allowed for each megawatt-hour of power output

*Note: Years refer to the years when emissions were incurred

Source: Ministry of Ecology and Environment

Stimulus for market liquidity

In the past, China ETS completely followed a two-year compliance cycle. For instance, power companies were asked to surrender CEAs for their emissions incurred in 2019 and 2020 altogether by Dec. 31, 2021, and surrender CEAs for their 2021-2022 emissions altogether by Dec. 31, 2023. As such, the market was seen to be hectic only when the final due date was approaching.

In this compliance period, despite the emission intensity benchmarks still being set on a two-year basis, companies are required to surrender CEAs for their 2023 emissions by Dec. 31, 2024, and for their 2024 emissions by Dec. 31, 2025, the consultation document showed.

Analysts expected this adjustment to improve market liquidity, especially in the first year of the compliance period.

In this compliance period, companies can still use CEAs issued in any year to fulfill their ETS liabilities. Namely, a power company can still use CEAs of 2019-2022 vintages to cover their emissions incurred in 2023 and 2024, the consultation document showed.

However, only a limited number of CEAs can be carried over and used for the next compliance period, the consultation document highlighted. A power company's entitled carry-over volume was positively correlated with its net CEA sales volume in the previous years. Hence, this new rule encouraged companies to actively sell CEAs in the market instead of hoarding them.

"The release of stricter banking rules will help stimulate trading activities, as at least market participants know that not all unused CEAs can be carried over," Veyt's Mai said.

"This design could limit the carry-over of obligated parties with surplus and unlock supplies for power plants in allowance deficits," Commodity Insights' Zhu said, adding that companies with CEA surplus can only carry over up to 60% of their surplus supplies under the current rules.

The CEA price was at Yuan 91.33/mtCO2e ($12.56/mtCO2e) on July 2, up 3.34% on the day, official exchange data showed.

Analysts also said China ETS is expected to expand to other sectors in 2024-2025, notably cement, aluminum, iron and steel. The CEA allocation plans for these sectors will be released separately in the future.