China's ETS may remain powerless in decarbonizing thermal power sector

China's national compliance carbon market may not evolve into the country's primary tool to decarbonize its coal-fired power sector, due to the government's reluctance to give free rein to market forces and resistance from influential bodies in the thermal power sector.

This is likely to mean that China's national emission trading scheme, or ETS, which was launched on July 16, 2021, is unlikely to tighten its rules significantly, until its main regulator, the Ministry of Ecology and Environment or MEE, is given more enforcement authority.

Operating in a two-year retrospective manner, the ETS has put a price on emissions from coal-fired power plants since calendar year 2019. Yet numbers show that the world's largest emissions trading scheme by emissions covered, has yet to make a dent in deincentivizing coal burn.

The carbon intensity of China's thermal power, namely CO2 emissions per megawatt-hour of electricity generated, has only been reduced by 2.38% from 2018 to 2023, according to an MEE report in July 2024.

The absolute volume of annual CO2 emissions regulated by the ETS totaled 5.1 billion metric tons of CO2 equivalent in 2023, MEE's data showed, 13% higher since the market was established. This was equivalent to around 40% of the country's total GHG emissions.

Furthermore, in 2023, coal-fired power still accounted for 57.9% of the country's power generation mix, merely reduced by 0.6 percentage point year on year, despite rapid growth in solar and wind capacity, according to data from China Electricity Council or CEC.

In July's report, MEE said building China's ETS was like a sophisticated engineering project, which needs to improve on many fronts to become an effective marketplace.

Paper tigers

There are several reasons behind the ETS market's ineffectiveness.

Firstly, MEE remained conservative when setting annual carbon intensity caps for coal plants, which resulted in excessive supply of China Emissions Allowances and kept companies from cutting their emissions.

In the last compliance period ended Dec. 31, 2023, 5.096 billion tCO2e and 5.104 billion tCO2e of CEAs were given to ETS participants, for emissions incurred in 2021 and 2022, respectively, MEE said in July.

Actual emissions, however, were 5.094 billion tCO2e in 2021 and 5.091 billion tCO2e in 2022, which means that there was a surplus of 1.47 million tCO2e and 12.98 million tCO2e CEAs in 2021 and 2022 respectively, the report showed.

Secondly, MEE allowed ETS participants to borrow CEAs from the next compliance period to cover their liable emissions. They said this was a one-time policy that only applied to the compliance period ended in December 2023 to address financial difficulties of power companies amid soaring fuel prices.

A total of 202 companies or 9% of ETS participants, chose to borrow future CEAs, MEE's report showed. If energy prices surge again due to economic and geopolitical turbulence, it remains uncertain whether MEE will allow more concessions.

Finally, in the longer term, MEE's ambitions to curb coal sector emissions face resistance from incumbents.

Earlier this year, MEE had come up with an emission allowance allocation plan for 2023-2024 emissions, to significantly cut oversupplies, progressively increase ETS prices and boost market liquidity, however, this plan was not welcomed by stakeholders due to higher costs and impacts on economic development. After consultations, the final version became stringent.

The ministry lacks authority to enforce its regulations and has been called the proverbial paper tiger – which appears ferocious but has no teeth.

Decarbonizing power

One of the stakeholders pushing back against further tightening of China's ETS is the quasi-official CEC, which represents the largest thermal power producers.

"We should not define the success of an ETS solely based on its market liquidity or carbon prices," Wang Zhixuan, deputy director of CEC's expert council, said at an industrial forum in late July.

He said the government should be cautious in introducing new measures like CEA auctions which would gradually restrict supply of allowances and increase costs for companies.

Wang argued that an aggressive ETS may not be the best solution to decarbonize power in China, adding that the country has one of the world's youngest fleets of coal plants and a significant amount of sunk capital that requires more nuanced solutions to finance coal plant decommissioning than most countries.

"In developed countries, coal-fired generation units will only be dismantled after around 40 years of operation. Some units can even operate for over 60 years," he said. "In China, the average age of coal-fired generation units is only 12 (years)," he added.

Wang suggested gradually reducing operating hours of coal plants as renewables grow, instead of outright closures, allowing them to be used as backup in the transition phase.

"By the way, don't expect ETS to solve all problems," Wang said.

Unlike EU ETS that serves as a cornerstone of Europe's energy transition, China's ETS is just one of many climate policy instruments at Beijing's disposal.

Experts at the forum said top-down action plans and mandatory goals set by the economic planner or energy administration can be more efficient to support renewables, carbon capture and ammonia or biomass co-firing. Wang said the ETS is not obliged to duplicate such efforts.

Wang's speech reflected the collective mindset of many powerful stakeholders in Chinese government and power industry that is likely to blunt MEE's ETS ambitions.