October 16, 2017 by Ronjoy Bezbarua
CaliforniaCarbon.info, October 16, 2017: With a fourth compliance year completed in the Chinese emissions trading pilots, the highly anticipated national emissions trading scheme takes centre stage for the world of carbon markets. Expected to be the largest carbon market of its kind with a potential coverage of 2-3 GTCO2e and some estimates indicating it might be twice the size of the European Union Emissions Trading System, the Chinese National Emissions Trading Scheme (ETS) has been marred with indefinite delays and cutbacks.
Initially set for launch in 2016, the Chinese ETS may not even enter into force in late 2017 as maintained by experts and regulator, especially considering other postponements such as the nation’s Zero Emission Vehicle trading scheme which serve to emphasize that expectations for a 2017 launch date may simply be misguided. Further, crucial design elements such as allocations, caps, and offsets remain undecided as the sea of uncertainty that presently envelopes the National ETS seems to be ever expanding. Amidst this uncertainty, hope emanates from the pilot ETSs that appear to be flourishing as witnessed towards the recent end of the fourth compliance year.
The Chinese climate change policy
Tracing the origins of the ETS
In September 2015, President Xi Jinping announced the implementation of a national emissions trading scheme, a milestone for China’s climate change policy. Over the years, a host of factors, the most significant of which being an international transition to a bottom-up approach from the top-down view, have sculpted the Chinese policy towards climate change.
Intended Nationally Determined Contributions (INDCs) are bottom-up processes where countries individually determine their efforts towards combating climate change with an overall aim to reduce global emissions. China’s commitment towards the Paris Agreement was actualized in its INDC with its goal to peak its emissions around 2030 and increase its share of non-fossil fuels in primary energy consumption to around 20 percent by the same year.
Analyzing design elements
The National Development and Reform Council (NDRC) submitted a draft of ETS Regulations to the State Council this February that addressed high-level issues such as scope of the program and division of authority. While critical design elements are yet to be announced, an update to the draft regulations has long been expected which would lend more precision to the design of the National ETS.
The national ETS was originally scheduled to cover eight industrial sectors – petrochemicals, chemicals, building materials, iron and steel, non-ferrous metals, paper-making, power generation, and aviation. However, market designers are struggling to outline a sound statistical framework for all eight sectors. The NDRC is planning to exclude the steel and chemicals sectors from the initial phase. Instead, the ETS would focus on “statistically reliable” industries such as cement, power, and aluminium in its early days.
“There is a possibility that China may select some sectors other than the original eight to launch carbon trading in the preliminary stage,” said He Jiankun, director of the Institute of Low Carbon Economy at Tsinghua University, to Reuters.
Recent speculations point towards the possibility that the NDRC is considering to cover only the power sector during the initial phase of the national ETS. The reason lies in the unsatisfactory quality of historical data and a lack of consensus over the allocation method.
Reportedly, the NDRC is currently in the process of determining the free allocations for each sector. Emissions reporting and calculation issues have halted progress in some industrial sectors, which are not included in the cap. The NDRC may also introduce forward trading in the national ETS, as the International Emissions Trading Associations (IETA) and the EU governments are advocating the same.
In designing this mammoth of a carbon market, the NDRC must also be cautious to prevent a situation of surplus allowances during the initial phase of the national ETS, which may occur due to abundant free allocation in order to compensate operators for their initial participation.
Key milestones for development of the Chinese carbon market
The role of offsets in the National ETS
Offset developers fear that the national ETS would be launched sans an appended offset program as leaked documents disclosed initial plans with the absence of an o set program in the early phase. Moreover, Chinese Certified Emissions Reduction (CCER) credit issuances have been halted since last November although trading of offsets in the pilots continues.
The role of offsets becomes more ambiguous as the eligibility of CCERs to comply with the emissions reduction scheme is also being debated upon. Even in the provincial scheme, only two pilots (Hubei and Fujian) do not specifically restrict credits from hydro projects, while renewable energy projects face no explicit restrictions despite being questioned on their additionality.
With regulations being amended till date, such as the decreased coverage of the cap, it is not unreasonable to hope that CCERs would be included before the market is launched. If this were to happen, the demand between the national ETS and pilot schemes would prove to be a tremendous impetus to the offset business. Hopes are hinged on the pilot markets which are still supporting demand from offsets. In particular, Fujian and Guangdong accept forestry credits, adding viability to a significantly higher margin of projects.
As of the last issuance made in November 2016, the total CCERs issued till date stands at 67,608,607 MMtCO2e. Hydro projects witness maximum issuances, especially in Sichuan. However, under a third of these hydro credits meet eligibility criteria in any one of the nine pilots.
The Chinese pilot ETS scheme
Breeding grounds for hope
China’s seven ETS pilots were first formally announced in October 2011. Prior to that, major industrial firms in China had gained direct experience of carbon markets participating in the Clean Development Mechanism (CDM) which has undoubtedly influenced the NDRC’s policymaking, particularly regarding their offset program. The Chinese pilot emissions trading scheme accounts for 68.6 megatons of CO2, with an estimated total value of US$160 million (CNY1.1 billion). Seven ETS pilots together represent 26.7 percent of China’s 2014 GDP.
Being compliance-driven spot markets, provincial pilots display certain trends. For instance, price volatility and volumes typically peak around compliance. This has been observed notably in Hubei where the total monthly volume traded exceeded four million tonnes this July.
Despite the uncertainty engulfing the status of the Chinese national ETS, pilot ETSs in China have emerged as thriving markets that provide grounds for optimism. The incredible run of price stability displayed by Beijing all year round and also the soaring liquidity of Hubei witnessed towards the end of this compliance year bolster confidence for the success of a emissions trading scheme in China.
“Before starting to trade in any market and especially in an Emissions Trading System, it is important to have a deep understanding of the rules, the ETS law and the legal nature of the respective carbon credits or allowances. Furthermore, companies need to understand the fundamentals of the market: What drives supply and demand? Who are the main actors in the market? What is the liquidity?” says Ingo Ramming, Director at Commerz Bank.
A Comparative look at the Chinese pilots
The Beijing carbon market covers 947 entities as of 2017, more than twice the number of entities covered by the California carbon market. The sectors covered include electricity, heating, cement, petrochemicals, manufacturers, services, and public transport. In addition, Beijing has an inclusion threshold of 5000 tCO2e per year.
Beijing traded 2,205,660 tons in 2016 with the total revenue racking up to Y107,196,845. The average price per allowance as of 2017 stands at Y50.93.
Since trading is mostly restricted to the spot market and options for spreading out demand is limited, prices across the Chinese pilots typically see violent fluctuations around compliance surrender in June. However, this year prices in Beijing have displayed exceptional stability, deviating from the conventional compliance behavior and showing indications of a more experienced market.
Launched in November 2016, the Shanghai pilot ETS has a coverage spanning more than half the city’s emissions. With 368 liable entities, Shanghai accounts for 6.57% of the total volume traded across all pilots in 2017. In January 2017, the first over-the-counter emission derivatives in China were initiated in Shanghai.
Although free allocations are based on sector specific benchmarks, ex post allocation adjustments are also possible. CCER credits are limited to 1% of the total allocation whereas credits from hydro projects are not eligible.
Other prominent statistics include the 2017 average price per allowance standing at Y31.13 and the total revenue from 2016 adding up to Y32,489,073.
The second largest carbon market in the world after the EU ETS in terms of carbon dioxide emissions covered, Guangdong covers a wide spectrum of sectors from power, iron and steel, cement, and petrochemicals to aviation, paper and white cement. Guangdong achieved a 100% compliance rate for 2016, an exceptional feat considering that it covers 218 liable entities. Guangdong is one of the most energetic Chinese pilots with the 2017 average weekly trading volume amounting to 328,924 tons. Prices in Guangdong have remained stable throughout compliance this year with the 2017 price per allowance standing at Y14.27
The first Chinese pilot to be launched, Shenzhen has a diverse coverage of 824 entities that account for 40% of the city’s emissions. A distinguishing feature of Shenzhen is that it extensively trades in vintages. Along with Guangdong, Shenzhen is the only Chinese pilot market open to foreign investors. Allocation methods include grandfathering as well as benchmarking, depending upon the nature of the sector.
For 2016, the total revenue added up to Y10,578,160 whereas the average weekly traded volume remains 118,514 tons. Like most pilots, Shenzhen experiences pronounced inactivity post compliance as liquidity drops sharply.
Constituting a hefty 26.89% of the total volume traded across all pilots in 2017, Hubei remains the most active pilot ETS in China. The 236 entities, part of the Hubei ETS, include 35% of the city’s carbon dioxide emissions. With CCER credits limited to 10% of the total annual allocation, Hubei has an eligibility criterion for only rural biogas or forestry projects. In addition, Hubei uses auctioning as a complementary allocation method.
Liquidity in Hubei soars during the compliance period as the total volume traded exceeded four million tons in July 2017. The average 2017 price per allowance is measured at Y16.56
Launched in 2013, the Tianjin ETS pilot includes five sectors –heat and electricity production, iron and steel, petrochemicals, chemicals, as well as oil and gas exploration. The 109 entities are estimated to account for 55% of the city’s CO2 emissions.
The Tianjin market is characterised by sporadic outbursts of trading throughout the year with volumes spiking in June. The market remains dormant for most part of the year. However, during the compliance surrender, prices and volume react violently. For instance, more than a million tons were traded in a single week this June as prices dipped by28%. The average price per allowance for 2017 is Y11.9.
Chongqing, one of the last established Chinese pilots, consists of 230 entities making up 40% of the city’s carbon emissions. In addition to CO2, the GHG covered by Chonqing include CH4, N2O, HFCs, PFCs, SF6. CCER credits up to 8% of the total annual allocation are eligible with restrictions for hydro projects.
With the annual revenue of 2016 adding up to Y3,143,122, the 2017 average price per allowance is Y9.23. The prices in Chongqing oscillate fervently, especially during the compliance surrender.
The latest pilot ETS, Fujian, was initiated in December 2016. The first auction for vintage 2016 allowances was held on 15 December 2016 which consisted of a volume of 50,000 allowances. This ETS pilot places special emphasis on carbon sinks, given the notability of the forestry sector in Fujian.
The Fujian Development and Reform Commission reported that since its inception in December to 7 July 2017, Fujian has traded 4.016 million tons with the total turnover racking up to Y105.62 million.
China and the World
The launch of China’s national ETS will secure China’s position as the front-runner in the global climate change scenario. Unequivocally, its reverberations will be felt in global policymaking, as it will encourage other countries to establish a carbon price and concretize their commitment towards the Paris Agreement. China’s ETS will not only impact countries without an ETS, but it will also change the dynamics of existing ETSs around the world, resulting in major changes in reduction targets, cap size etc.
Participation by foreign entities would prove to boost liquidity in the national ETS, while providing necessary experiences and support in dealing with CO2 risk strategy. The IETA White Paper on China’s National ETS recommends that, “…foreign entities with deep and varied experience from participating in ETS’s around the world should be a welcome addition to the national ETS.”
The national ETS will have to improve on many aspects to inspire confidence from foreign investor, as Ingo Ramming points out “Investors need confidence in the rules and the systems. Market participants need transparency regarding verified emissions and allocations to be able to analyze the fundamentals.”
Ishana Aggarwal (email@example.com)
StillwaterScope: California Cap and Trade 101
October 17, 2018
Weekly Commentary: V2021 sees a weekly increase of 4.8 million Open Interes...
October 15, 2018
Weekly Commentary: Jan20 delivery sees 2.7 million new open interest contra...
October 8, 2018
Short-term offset forecast: Upcoming CCO issuances
October 5, 2018