Commodities 2024: China's domestic carbon market set for revamp; Article 6 in limbo

China's domestic compliance and voluntary carbon markets are on track for significant upgrades in 2024, notably enforcing high-level legislation, rebooting voluntary registry, and expanding compliance market to new sectors, even as the country's Article 6 implementation plan remains in limbo.

As the world's largest compliance market by emissions covered, China's emission trading scheme is expected to be upgraded this year to better support the country's carbon peaking journey. The significant improvements in price and liquidity have laid a strong foundation for market evolution.

The annual average trading price for China Emission Allowances (CEAs) reached Yuan 68.15/mtCO2e ($9.62/mtCO2e) in 2023, up 23.24% on the year. CEA trade volume was 212 million mtCO2e for the year, jumping 316%, the exchange data showed.

Meanwhile, for domestic voluntary market, called China Certified Emission Reduction (CCER) market, a smooth relaunch is expected in 2024 after a six-year pause of new project registration.

Nevertheless, whether and how China will participate in the Article 6 market remains a wild card.

China is one of the world's largest suppliers in the voluntary carbon market (VCM), but policymakers have showed great caution towards stepping into the Article 6 market.

Compliance market's expansion

China's Ministry of Ecology and Environment, or MEE, required seven sectors to start annual emission reporting and verification -- including iron and steel, non-ferrous metals, building materials, refining and petrochemicals, chemicals, papermaking and civil aviation -- paving the way for the compliance market's expansion.

MEE asked cement, electrolytic aluminum, iron and steel sectors to follow a more stringent timeline for emission reporting, implying that these sectors will be the next participants and may start trading within 2024, some sources said.

Notably, these sectors are also covered by EU's Carbon Border Adjustment Mechanism (CBAM), which imposed carbon tax on emission-intensive commodities exported to the region, to be charged from 2026. Onboarding these sectors to China's domestic market is crucial, as it will help familiarize companies with emission reporting and waive some liabilities under CBAM.

High-level legislation

This year, China will also crack down on malpractices that damage market integrity.

State Council, the chief administrative authority of China, recently approved the interim regulations on the Administration of Carbon Emission Trading, a long-awaited, high-level legislation that governs the compliance carbon market.

The text of legislation has not been made publicly available. The expectation is that it will enable better coordination among different government bodies and introduce severer punishments to deter malpractices, especially failures to surrender CEAs by due date, data falsifications, and collusion with third-party verification agencies to commit frauds, which have happened in the past two years.

Financialization

The progress of carbon market's financialization is also in the spotlight, especially as regulatory framework gets completed and market liquidity improves.

Shanghai Environment and Energy Exchange (SEEE), which hosted the CEA trading platform, started differentiating CEA products by vintages in 2023. Besides, China Securities Regulatory Commission has approved several securities companies to trade CEAs, pending for another approval from MEE.

Introducing financial derivatives and market makers, however, is likely to intensify supply and demand fluctuations and price volatility. China's compliance market is still nascent, so most participants expected its financialization to start slowly. Hence, it remains uncertain whether any progress will be made in 2024.

Relaunching, refining voluntary market

This year, new CCER credits are expected to be issued and delivered to the market.

MEE has released four methodologies for CCER issuance in 2023, including forestation, mangrove cultivation, solar thermal power and grid-connected offshore wind power projects.

Market participants anticipated more methodologies to be released this year, such as methodologies for carbon capture, utilization and storage (CCUS), hydrogen, and methane mitigation projects. These projects are capital-intensive, so it is crucial to leverage carbon market to provide economic incentives.

Another key task is to ensure better coordination with other environmental products, especially the domestic renewable energy certificate, called Green Electricity Certificate (GEC), to avoid double counting. Currently, solar thermal and offshore wind projects are eligible for both CCER and GEC issuance.

Article 6 in limbo

Despite several countries releasing their Article 6 implementation plans, China holds a wait-and-see stance.

"We need to wait for Article 6 to be finalized. We need enough policy clarity at the UN level, before coming up with our own plan for Article 6 implementation," a Chinese government official told S&P Global on the sidelines of UN Climate Change Conference (COP28).

Article 6 negotiations failed to reach a consensus at COP28, which delays China's policymaking.

As the world's largest CO2 emitter, China also needs to ensure the fulfilment of its Nationally Determined Contributions, namely climate targets committed under the Paris Agreement, and be cautious about exporting Article 6 credits.

China may become a net importer of Article 6 credits as early as 2030, according to a recent study by Tsinghua University.