Commodities 2022: China's carbon market to expand, build capabilities

China's national carbon market will move into a phase of expansion and capacity building in 2022, which will widen the scope of the emissions trading scheme to cover more sectors, as well as develop carbon trading infrastructure and capabilities across provinces, companies and exchanges.

The development path is important to put a price on carbon for most of China's energy intensive industries, and to strengthen the measurement and implementation mechanism for what is currently a very nascent carbon market.

The urgency of climate goals means that China may not have the decades needed for its carbon market to fully mature like the European ETS, that took many years to evolve after being launched in 2005.

The key factors to look out for will be the introduction of emissions measurement frameworks in new sectors, the re-launch of China's domestic voluntary carbon market, new regulations to strengthen implementation and new carbon-related products in increasingly sophisticated Chinese exchanges.

The challenge will be to balance top-down policymaking from Beijing, with the need to create a liquid carbon marketplace and price discovery mechanisms, while navigating a complex structure of provincial governments and state-owned enterprises with their own priorities.

New Sectors

Building materials, non-ferrous metals, and oil refining could be the next industrial sectors to be enrolled in China's national emission trading scheme. China's environment ministry had identified eight more sectors to be enrolled by the end of 2025, in addition to the power sector that it currently covers, which also includes steel, chemicals, aviation, and paper.

"We now need to expand the carbon market's coverage as fast as possible. There's a plan in place to enroll the non-ferrous metal and building material sectors next year [in 2022]," Lai Xiaoming, chairman of the Shanghai Environment and Energy Exchange, or SEEE, said at the 2021 International Finance Forum on Dec. 5. SEEE hosts the online trading platform for China's carbon market.

The refining and petrochemical sector is likely to be enrolled between 2022 and 2023, Zhang Gao, vice president of Hubei-based Carbon Emission Allowance Registration and Settlement Co, said at an event in November. The company hosts the national carbon market's registration and settlement systems.

Power generation accounts for around 40% of China's carbon emissions; 15.2% comes from steel, 13.16% from building materials, 8.16% from refining, petrochemical and chemicals, 1.17% from non-ferrous metals, 0.71% from aviation and 0.65% from paper, according to think tank SinoCarbon's data.

Roman Kramarchuk, head of Future Energy Analytics at S&P Global Platts, said a large jump in China's power demand alone means that by end-2022, covered emissions are expected to be over 10% higher than in 2019.

"China's carbon trading program by its design isn't really capping emissions and showing reductions," Kramarchuk said, adding that details implemented in other sectors "would certainly drive the value of existing allowances."

Carbon market evolution

China is expected to restart its market for China Certified Emission Reductions, which are domestically certified carbon credits that can be sold to voluntary buyers as well as companies enrolled in the compliance market to offset up to 5% of their surplus emissions.

The State Council announced on Nov. 26 that Beijing Green Exchange will host the national trading platform of CCERs and that the Beijing exchange will also be open to global investors, and upgraded to be China's green financing hub.

The relaunch of China's voluntary carbon credits, and the development of new carbon products at exchanges like China Beijing Environment Exchange, China Emissions Exchange Guangzhou and the SEEE, will be important developments to watch out for in 2022.

The wider objective is to pave the way for institutional investors to play a role in boosting market size and enhancing carbon market liquidity. China's carbon market has so far been dominated by state-owned companies' bulk transactions to meet emission targets with limited actual trading through listed transactions.

"China's environment ministry, which manages China's carbon markets, also realizes the power of institutional investors, and we have a plan to get them enrolled [in the national carbon market] as soon as possible," SEEE's Lai said.

"We hope auctions can be introduced in China's carbon market, which encourages more participation and creates a stronger market signal that we are taking decarbonization more seriously," Zhao Xiaolu, climate director at the US non-profit organization Environmental Defense Fund, said at a recent industry event.

Recently, SinoCarbon's director of finance and international business Chen Zhibin said the central government has not come up with an emissions cap for China and that there are no annual targets for emission reduction quantities. Also, sector-level emission targets have yet to be proposed.

"To make the carbon market more powerful, carbon emission allowance allocation needs to be tightened to make other decarbonization policies more effective," he said.

It remains to be seen how China's carbon market will tackle these challenges, and global pressures from COP26 and cross-border carbon trading policies like CBAM, or Carbon Border Adjustment Mechanism, will influence how the market shapes up in 2022.