China carbon market still needs to enhance top-level design, roadmap

China is expected to take up new carbon legislation this year, which will better define the nation's high-level decarbonization targets and long-term plans for the national carbon market, as well as impose stricter punishments for malpractices like data falsification, according to policy documents and researchers.

China's national compliance emission trading scheme has been operating for one year. In its initial phase, the key focus was largely on smoothing the roll out of emission measurements and trading activities, and the mechanism is yet to evolve fully into a carbon policy tool.

On July 14, State Council of China, the highest executive body of the country, announced its legislative work agenda of 2022, which included enacting the legislation that governs China's compliance emission trading scheme.

The legislation framework, once completed, will provide better clarity to market participants on how different government bodies will collaborate and supervise the market, how emission allowances will be allocated in the long term, and how the total emissions cap will be set, carbon think tank SinoCarbon said on July 15 in its status report on one year of China's carbon market.

It said the State Council legislation will enable stricter punishments for malpractices, beyond what can be done by the environment ministry, which currently oversees the national carbon market.

In the first compliance period of the carbon market (July 16-Dec 31, 2021), slightly more than 100 companies did not surrender for carbon allowances on time to cover their excess emissions, with an overall compliance rate of 94.5%, the report said. Ningxia in northern China, Heilongjiang and Liaoning in northeast China had the lowest compliance rates, SinoCarbon data showed.

Making data reporting easier

In 2021, some third-party emission verification agencies were slammed by the environment ministry for falsifying emission reports for power companies.

The power sector accounts for about 40% of the country's emissions and is the only sector currently under the scope of China's carbon market. Power companies have been under tremendous pressure to maintain stable energy supply in the current energy crisis, and complicated emissions measurement and stringent reporting procedures have contributed to attempts to falsify data and reports.

SinoCarbon said new measures taken by the government will reduce the burden on power companies, help reduce incentives for fraud and introduce stricter penalties.

For instance, the data falsification cases were triggered by the use of a high reference value for carbon content in thermal coal (0.03356 tC/GJ).

This reference value is used to calculate emissions when companies fail to collect and submit actual coal samples to government-appointed agencies on a monthly basis. Some companies falsified coal samples or emission reports to avoid reporting high emissions levels based on this high reference value and paying more for emissions allowances.

On June 8, the environment ministry lowered this reference value by 8.1% to 0.03085tC/GJ to make it more representative of conventional coal usage and it also made the emission reporting procedures more flexible.

Low liquidity and expansion

In the first compliance period of China's national carbon market, companies were reluctant to sell their surplus emissions allowances despite oversupply because of uncertainty about whether emissions targets will be tightened over time.

In the past one year, trade volume totaled about 194 million mtCO2e of emission allowances, which translates into only 2% of the 9 billion mtCO2e of emission allowances allotted by the government, SinoCarbon's data showed.

Most companies come to the market only to fulfill their compliance obligations, SinoCarbon said, adding that some large power groups traded emission allowances between the pockets of their branch companies.

"The resulting low liquidity hinders the price discovery and resource allocation," SinoCarbon highlighted in the report.

The current price level still does not effectively reflect the market value of an emission allowance and the emission mitigation cost, it said. The low liquidity and incomplete top-level design also hinders the expansion of China's compliance carbon market, it added.

SinoCarbon said it is "almost a foregone conclusion" that China will not have new sectors enrolled into the compliance emission trading scheme this year. According to environment ministry's previous plan, new sectors to be enrolled by 2025 were petrochemicals, chemicals, building materials, steel, nonferrous metals, paper and aviation.

The official action plans have not been published to guide companies in these sectors to report their emissions, and, for these sectors, emission accounting procedures are more complicated compared with the power sector, the think tank said.

Existing emission data is insufficient for these sectors to establish a set of reasonable, industry-wide benchmarks that determine how the emission allowances will be allocated to individual companies, SinoCarbon added.

"Some of the problems cannot be solved simply by expanding the market and getting more sectors in," SinoCarbon concluded.