China wary of socio-economic impact of unregulated carbon market

The launch of China's nationwide carbon market has faced delays partly because the government remains cautious about its impacts on economic inequality between provinces, higher prices for products from carbon-intensive industries and pressure to comply with an unproven global carbon regime, according to academics and researchers at a recent industry event.

The highly anticipated launch of China's emissions trading system, or ETS, was initially slated for end-June and was postponed for undisclosed reasons. It is now expected during July, Premier Li Keqiang said on July 7.

China is reluctant to give free rein to market forces to determine a carbon price that incentivizes emissions reductions in its power, industrial and transportation sectors, which are the backbone of people's livelihoods and its economic growth.

According to the environment ministry's initial plan, the power sector will be the first sector to come under the ETS, which will eventually include steel, building materials, petrochemicals, chemicals, nonferrous metals, paper, and aviation by 2025.

"Collectively, these eight sectors contribute 89% of China's CO2 emissions. Particularly, the power sector alone contributes 44%, steel contributes 18% and building materials contribute 13%," Liu Qiao, Dean of Guanghua School of Management, Peking University, said at a forum titled Net Zero: A New Engine Driving China's Socio-Economic Development, held on June 29 in Beijing.

"The power sector is blamed for being China's biggest CO2 emitter, but who consumes electricity?" Liu said, adding that in energy transition, the role of consumers is also important.

"Net-zero pledge is not about applying a constraint that lowers economic growths but revolutionizing the way of economic growth," he said. Liu said China needs a carbon market that helps to reasonably allocate carbon emissions and capital flows in a stable manner, which cannot be achieved by developing an EU-like market with volatile prices.

Economic disparity

China's most carbon-intensive industries are also the most coal-intensive, and a single nationwide carbon price burdens provinces heavily relying on coal, as economic growth rates and industrial development vary with each province.

Heavy industries are concentrated in the northern provinces that may need to buy carbon allowances from southern provinces, Peng Wensheng, Chief Economist at China International Capital Corp, said.

In contrast, eight out of the 10 provinces with the highest GDP are southern provinces, which collectively contributed almost half of China's GDP, official data showed.

Hence, additional carbon costs will become a burden for northern provinces' economic development and exacerbate existing income inequalities.

"Among all provinces, Shanxi, Inner Mongolia and Shaanxi have much heavier dependency on coal mining and power sector for its taxation," Peng said, adding that energy transition will be more painful for these provinces while they struggle to create employment and sustain economic growth.

Price inflation

"One reason for recent commodity price surges is suppliers cut production to fulfill emission reduction targets, especially in the steel sector," Liu Shijin, Vice Chairman of China Development Research Foundation, said.

Sectors such as steel and building materials are the foundation for China's infrastructure and economic development, while the power and petrochemical sectors are directly associated with people's basic requirements in their daily life.

Higher emissions costs also increase the cost of energy consumption, especially if the energy transition is unstable, such as high oil prices impacting people's daily commute if they cannot afford new electric vehicles.

"Without handling climate targets and policies with great care, an economic problem may become a social problem," Jia Kang, President at China Academy of New Supply-side Economics, said at the forum.

Jia cited the example of coal-to-gas switching several years ago, when some local governments phased out coal stoves for household heating in winter, but later failed to provide sufficient natural gas supplies, which spiked power and fuel prices, and caused a lot of discomfort.

Global carbon regime

Wariness of global pressure to impose a uniform carbon price has made China even more cautious in designing its domestic carbon pricing mechanism.

The Carbon Border Adjustment Mechanism or CBAM proposed by the European Union has raised concerns about potential carbon taxes on imported goods currently covered in the EU's Emissions Trading System.

Infographic: EU Carbon Border Adjustment Mechanism sparks clash over free allowances

The CBAM, once implemented, will significantly impact China's steel, aluminum and cement export volumes and competitiveness, according to a recent study by Tsinghua University. Currently, 9% of aluminum products and 8% of steel imports into Europe are from China, the study showed.

Nevertheless, Dai Yande, former deputy head of Energy Research Institute at NDRC, said the CBAM can be regarded as an opportunity to drive China's economic transformation. "Now 20% of our energy consumption is directly or indirectly associated with exports," he said.

"While CBAM is controversial, it can push positive changes in China's export patterns, which currently rely on cheap resources and labor forces. China needs to transform and get rid of its position at the lower end the global supply chain," Dai added.

This article was updated on July 8, 2021, adding the expected timing of the ETS launch