China's compliance carbon price hits record high on stronger demand

Prices in China's national compliance carbon market hit a record high as companies moved early to buy compliance emission allowances, or CEAs, to avoid the year-end rush to meet their obligations, according to market participants.

The weighted average CEA price reached an all-time high of Yuan 70.10/mtCO2e ($9.73/mtCO2e) on Aug. 17, according to Shanghai Environment and Energy Exchange data. This was a 36.8% increase from Yuan 51.23/mtCO2e on July 16, 2021, when China's national compliance carbon market was launched, and 27.5% higher than prices at the start of the year.

On Aug. 18, the weighted average CEA price hit a new high at Yuan 72.85/mtCO2e ($10.12/mtCO2e), official exchange data showed, exceeding $10/mtCO2e for the first time. The daily CEA trade volume was 1.48 million mtCO2e.

The carbon price surge comes after months of being stagnant at around $8/mtCO2e amid concerns that China's carbon market lacked both liquidity and free market forces, raising questions about its effectiveness in enforcing emissions reductions.

China’s compliance carbon price has now exceeded the $10/mtCO2e level, which is significantly higher than prices in voluntary carbon markets, indicating that both government and companies are taking carbon pricing more seriously, and companies are starting to plan more strategically for their carbon exposure, according to market participants.

"Recent spikes are mostly due to compliance requirement that thermal generators are expected to settle their obligations before the end of 2023 for the 2021-22 compliance cycle. Higher market liquidity could last to the end of this year," said Caroline Zhu, senior analyst with S&P Global Commodity Insights.

She said many power producers were holding on to allowances with low incentives to sell, as they can be carried over into the next compliance cycle, and power generators expect free allowances to be further tightened.

"China's CEA price jumped nearly 6% in the week of Aug. 7-11 compared to the previous week. This was largely driven by the compliance requirement from some participants, with some desire to accumulate assets at a relatively more attractive price ahead of the compliance deadline," said Bai Bo, chairman and co-founder of Singapore-based exchange MetaVerse Green Exchange.

Demand pull

When China's national carbon market was first rolled out, many inexperienced companies waited until the year-end deadline to buy CEAs and ended up paying higher prices. These companies have learned their lesson and chosen to act faster this year, traders said.

Recently, the CEA registry has completed CEA issuances to individual companies for this compliance period. This has helped to boost liquidity and give companies clarity on CEA inventories, allowing them to formulate market strategies with greater confidence, analysts said.

For example, on Aug. 10, Huadian Group, one of the nation's largest power producers, said that one of its subsidiaries had fulfilled emissions obligations way ahead of the Dec. 31 deadline, assisted by its carbon asset management company.

China's compliance carbon market currently covers only coal-fired and gas-fired power generation companies, most of whom are subsidiaries of the five large state-owned groups, collectively known as the "Big 5", while there are also smaller players, such as privately-owned generation utilities.

S&P Global's Zhu said that the large state-owned groups tend to have more efficient power generation assets and find it easier to meet emissions obligations, due to which they are typically in surplus of allowances that are stockpiled for future use.

Meanwhile, the smaller players face more pressure to meet their emissions obligations as they have more emission-intensive assets and are more vulnerable to price volatility, analysts said. This resulted in more active procurement by them to secure CEAs and push up prices.

Supply constraints

China's compliance carbon prices were also supported by reluctance among the big power utilities to sell surplus credits due to uncertainty about future carbon policies, which has limited the supply of CEAs on the market.

These uncertainties include to what extent CEA supply will be tightened over time, whether financial institutions will be allowed to enter the market, the resulting price volatility, and whether large-volume CEA trading among subsidiaries of the same power group will be prohibited in the future.

Another uncertainty is around the relaunch of China's voluntary carbon scheme called the China Certified Emission Reduction scheme, expected later this year. The main compliance carbon market allows companies to use CCERs to offset around 5% of their emissions obligations.

"All CCERs currently in circulation represent issuances before the market was suspended in 2017. It is estimated that out of the 80 million mt of CCERs issued, about 76 million mt have already been retired for compliance with regional and national ETS, with another 2 million mt by the voluntary segment," Zhu said.

This leaves an extremely low volume of CCERs for use in the current ETS compliance cycle, she said, adding that while the CCER market is expected to relaunch by the end of the year and enlarged supply could ease compliance challenges, details remain unknown and it poses long-term market uncertainty.

The CEA price may continue to stay at a high level, while there are also factors that may drive a price decrease, Refinitiv analysts said in a report published Aug. 16.

They said the two significant factors are the CCER rebooting, which will bring alternative supplies for compliance entities, and the exceptions to be granted to some companies with great financial difficulties to advance next year's CEAs, which will help to relax the surging demand.