China’s carbon trading market off to slow start but the only way is up
China’s Emission Trading Scheme (ETS) marks a significant step in the country’s journey towards hitting net-zero carbon emissions by 2060, but its impact is expected to be muted at least in the short term as the policy’s scope remains limited to the power sector, experts said.
The policy will likely have a bigger impact on China’s emissions in the middle of this decade, as new industries are added to the initiative, according to a joint report by the Asia Investor Group on Climate Change (AIGCC) and asset management firm Schroders, published earlier this month.
This would help China reduce emissions by 30% to 60% by 2060 from last year’s levels, wrote the joint report titled ‘China Emissions Trading System - A new dawn’.
The world’s second-largest economy has committed to achieving net-zero emissions by 2060, and reach peak emissions by 2030. The country is currently the world’s biggest carbon polluter, accounting for a quarter of global emissions.
Still, there is significant uncertainty about the future settings of the ETS, Rebecca Mikula-Wright, chief executive of the AIGCC told AsianInvestor. Factors including the lack of timelines for sector expansion and relatively loose baselines complicate the task of forecasting the outlook and potential for direct investment, she added.
LOW INCENTIVES
The ETS was launched on July 16, requiring 2,200 companies in the power sector to submit greenhouse gas emissions reports annually.
Firms that meet benchmarks will receive free allowances while those that do not will have to buy allowances on the Shanghai Environment and Energy Exchange to cover their emissions.
Carbon emissions allowances (CEA) on the exchange closed at RMB51.2 per tonne ($7.9 per tonne) on the first day of trading after the launch of the ETS, while total turnover amounted to RMB210 million ($32.4 million), according to the report. CEA rates climbed to RMB56.9 per tonne on July 23, it added.
However, experts expect trading volume to be low in the short term, as the current incentives and benchmarks may not be enough to drive companies to action.
“Most of the emission quotas are granted to power plants for free while the emission benchmark is close to the current carbon intensity,” explained Tomomi Shimada, Asia Pacific sustainable investing strategist at JP Morgan Asset Management.
“Initial carbon trading prices may also be low given the ample allowances but we expect this to change over the coming years, as the ETS mechanism functions more smoothly, thereby enabling prices to reflect the true social cost of emissions,” Shimada said.
Yoshihiko Kawashima, head of ESG for Asia ex-Japan at Invesco agreed. “We expect the short-term impact of the scheme to be quite limited as the government needs to incentivise companies to reduce carbon without hurting the competitiveness of the industry or disrupting economic activities,” he said.
In the long run, however, the workings of the Chinese ETS market will begin to resemble its counterparts in Europe, as companies face higher financial burdens if they do not take adequate measures to contain their carbon output, Kawashima said.
Additionally, Shimada believes that China’s emissions trading endeavour will have a ripple effect globally, as it will accelerate the transformation of companies with supply chains that thread through China.
FUTURE EXPANSION
Eventually, the scheme will expand beyond the power sector to encompass petrochemicals, chemicals, building materials, steel, nonferrous metals, paper and domestic aviation.
However, the timeline for the inclusion of the other industries has not been announced.
“The timeframe for risks or opportunities to realise will depend on how the ETS will evolve, including the rate of reduction in intensity caps, expansion of industry coverage, the carbon inhibition factor and the supply of allowances,” noted Dan Chi Wong, head of ESG Integration for Asia Pacific at Schroders.
“The initial stages of the ETS are designed to test the operations and infrastructure of the carbon market,” said Wong, who added that the impact of the ETS will strengthen when the Chinese government tightens regulations, which would drive up carbon prices.
SECTOR EXPOSURE
For now, the utilities sector will remain “one of the most exposed sectors” to rising carbon costs, the report wrote.
“Unlike in most other jurisdictions with carbon pricing, China’s electricity prices are currently fixed on an annual basis by the central government, with variations by region. This means that power generation companies cannot pass the carbon price on to consumers,” the report wrote.
Chemicals from coal and cement will also be heavily impacted, followed by aluminium and steel, said the report. A carbon price of $10 per tonne would affect the 2020 revenue of these sectors by 2%-36% and the 2020 net profit of listed companies by 13%-910%.
“The ETS market essentially allows for the economy to account for the externalities of carbon, impacting both the prices of actual energy sources and the costs of end products that depend on energy in their production, in turn impacting a wide range of portfolio investments,” said Mikula-Wright.
“Overall, the scale of climate change risks to financial markets and economies, and the size of the opportunities that will be created in the transition to net-zero emissions, will be the defining investment trend of this century,” she added.