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Economic Focus May Hamper Success of New Chinese Carbon Market

China’s climate pledges put it on a tight schedule to cut emissions, but whether a new carbon market will help the country reach its targets depends on how it balances its ambitious commitments with economic growth. 

“China’s leader, Xi Jinping, has sought to cast his country as an environmentally responsible world power, and has pledged to tackle climate change,” reports The New York Times. “The new carbon market, whichis immediately the world’s largest by volume of emissions, is the latest of Beijing’s efforts.” 

The new Chinese carbon market puts into action plans for a national emissions trading scheme (ETS) first announced in 2017, writes Carbon Brief. But while the market will play an integral role in the country’s climate policy, China’s leaders are hesitant to prioritize its success above what they declare as their right “to do what Western countries have done in the past, releasing carbon dioxide in the process of developing [their country’s] economy and reducing poverty,” reports BBC. 

Why It Matters

Reducing emissions through the ETS will be a major step both for China and globally. As the world’s largest producer of greenhouse gases—accounting for 27% of total global emissions, according to BBC News—China increasingly faces pressure from other nations to initiate effective climate actions.

President Xi addressed the United Nations General Assembly in September 2020, announcing ambitious commitments to reach peak emissions by 2030 and become carbon neutral by 2060. (“Peak” as a target identifies when annual emissions will start declining, while a “carbon neutral” system will use carbon storage projects to offset any emissions that are still being produced.) 

However, past failures in China’s environmental track record cast doubt on whether the country has the political will to fulfill its carbon neutrality pledge, says the Times. In one instance, China reversed course on its campaign improve air quality by cutting coal consumption and instead invested heavily in coal-burning facilities to counter economic troubles in 2017. And when the pandemic caused another stall in economic growth in 2020, China again increased fossil-fuel investments to stimulate industry growth despite its involvement in ongoing global climate discussions, reports Carbon Brief.

Analysts also point out that Xi’s announcement did not include any clear, specific details, and that he only “stated that China will aim to have emissions peak by 2030—not reduced by 2030—and he did not elaborate on whether China’s long-term emissions pathway will be consistent with a 1.5°C target,” notes the Center for American Progress. China also maintains that it should not be bound to a 1.5°C target because the initial Paris Agreement aimed to only keep the global temperature rise below 2°C. 

“While China has pledged carbon neutrality in mid-century, which is great, it has not so far announced plans to do enough in the 2020s in my judgment,” said Todd Stern, the lead U.S. climate negotiator at the 2015 Paris conference.

Under its newest five-year plan, China may not be acting as quickly as it could to meet its emissions commitments, and the published details are modest considering the time frame laid out by Xi. Drawing particular concern is the plan’s stated intent to maintain GDP growth at pre-pandemic rates, which could mean that China’s trajectory will “do little to curb emissions growth in the near term,” says the Center for American Progress.

How China’s ETS Works Differently from Western Markets

China’s emissions trading scheme will delegate emission rights to 2,225 participating coal- and gas-powered facilities by issuing “allowances” that can be traded through the Shanghai Environment and Energy Exchange (SEEE) as needed. In theory, the expense of additional allowances will create an incentive for plants to reduce emissions, explains Carbon Brief. 

Officials cut back from the initial plan to include eight industrial sectors in the ETS, to ensure that authorities could better enforce market regulations across China’s “sprawling industrial base,” the Times writes. 

The ETS now only covers the mostly state-owned power-generating sector, where many facilities already have established emission tracking systems in place. But even considering its current limited scope, the market could still make a significant impact in a country where power generation accounts for 40% of carbon dioxide emissions (and 15% of all global emissions).

The country is already preparing to expand the market over the next five years, and is requiring the seven unregulated sectors to start tracking and reporting annual emissions now, reports Carbon Brief.

While the ETS is similar to carbon cap-and-trade markets in other countries, China’s formula for issuing allowances is unique. China has for years developed environmental policy that regulates industries based on “how much energy [the country] needs to consume to create a unit of GDP” instead of on overall outcomes. By focusing on production efficiency, rather than the amount of pollution, the country is trying to reach its environmental objectives without limiting economic growth, says Bloomberg.

To that end, the ETS issues allowances according to “carbon intensity” rather than emission volume. Generally speaking, this means that “a regulated power plant will receive more permits if it generates more electricity,” and it can profit from that efficiency by selling allowances to less productive facilities, says Carbon Brief. 

Importantly, a carbon-intensity based ETS does not ensure a national reduction of emissions unless an overall cap is set on national allowances. China has not yet imposed a cap and has not committed to any plans to, so emissions can continue increasing so long as facilities keep improving their carbon intensity. Whether or not the market succeeds in reducing emissions therefore relies on whether regulators impose “gradually tighter benchmarks over time,” writes Carbon Brief. 

China’s reluctance to limit development by setting a cap weakens the market’s power to drive down emissions, but this policy may not be as harmful as it would be in other countries. Emission caps are western markets’ main incentive for decarbonization, raising the cost of emissions by limiting demand for emitting rights. However, China’s authoritarian government has greater power to encourage large decarbonization investments “by direct policy intervention”, and does not need to rely as heavily on market mechanisms, reports S&P Global. And since the central government maintains control over electricity prices, power companies cannot alter prices to pass on allowance expenses to consumers. 

A Slow, Strategic Start

In its early days, this attempt to target carbon efficiency seems to have undercut China’s ETS. Trading started off strong and moved more than four million tonnes of CO2 allowances on the SEEE’s opening day, with prices closing at US$7.56 and analysts predicting an upward trajectory from there. However, that continued momentum did not appear, and, by August 31, market activity tapered down to a record daily low of 23 tonnes and prices closing at $7.02, writes Bloomberg News.

The price recorded in the EU carbon market that same day was $70.83 per tonne.

Various factors contributed to this slow start, including a low emissions cap for facilities and weak penalties for failing to accurately report emissions data, says Forbes. Many facilities already have enough allowances to cover their emissions and have no further need for trading.

But despite these apparent failures, Forbes adds, the ETS is in fact achieving Chinese regulators’ short-term goals of establishing industry cooperation and “[encouraging] emitters to accurately document and report their past emissions.”

“A high priority is on getting the system up and running, getting companies to understand how much they’re emitting, and to understand what carbon is,” said Carnegie Mellon University professor Valerie Karplus, who has studied China’s emissions reporting systems.

What’s Next

Wielding the ETS to fulfill the carbon neutrality pledge will require “a complete transformation of the Chinese economy,” writes the Times, citing Greenpeace China policy advisor Li Shuo. According to a recent study, China will “need to reduce its carbon emissions by more than 90% and its energy consumption by almost 40%” to maintain its role in keeping global warming below 1.5°C.

“Think about it: The way we eat, the way we consume energy, the way we produce our food, the way we commute to work will need to be completely rearranged,” said Li. 

Part of this transformation will include a transition to alternative energy production, which could be hastened if China’s ETS succeeds in pressuring the country’s facilities to avoid emissions. The declining costs of renewable technology—solar power prices have fallen 82% in the past decade, and wind power prices by a third—now offers a cheap alternative to coal that could let China continue its economic expansion while also working toward climate targets, says Forbes.

A transition to renewables is one of several recommendations recently issued by the China Council for International Cooperation on Environment and Development, which also cites improving the carbon pricing system, electrifying transport, and capping absolute emission levels as important policies for reaching carbon neutrality, reports Reuters.

But China will have a hard time cutting back its use of coal, the country’s main power source for decades and a major component of the national economy. So far, there are no signs of a strong will to make that step, despite research showing that climate commitments require China to “stop using coal entirely for generating electricity by 2050,” reports BBC.

In light of that looming deadline, China’s continued investment in new coal facilities casts doubt on whether any such change will take place. However, “there are signs—including the halting of a $19 billion coal-to-chemicals plant in July—that [China is] serious,” writes Bloomberg.

Meanwhile, the watchful eye of the global community does not seem to be adding much haste to China’s actions. Chinese officials talking with U.S. Special Envoy for Climate John Kerry have stated they will not treat climate policy as a “standalone” issue that can be separated from other international negotiations, and they are unwilling “to be seen buckling to overseas pressure on the coal consumption cuts.”

“The best way to propel Chinese climate action is to align it with China’s self-interest,” Li Shuo told Reuters.

However, that position is considered a “non-starter” by U.S. officials, who seem disinclined to elicit Chinese climate action by compromising on other policy issues, says analyst Nikos Tsafos, in a commentary for the Center for Strategic and International Studies. As officials prepare to meet at the COP 26 climate summit this November, the U.S.-China climate agenda will have big implications for how quickly China embarks on its climate strategy, which will in turn affect the success of global efforts to cut carbon emissions.