Since 2013, China worked on establishing a national carbon trading scheme that would dwarf the prominent EU emissions trading system (EU ETS) market. China is one of the world’s largest carbon emitters, much of which is produced from the burning of coal. Although the country has emerged to become a global leader in the renewable energy space, its power sector remains reliant on coal. In 2019, coal accounted for 51.2% and 64.2% of the total capacity installed and power generated in China.

China’s environmental policy has for many years encompassed ambitious plans to improve air quality and lower the dependence on coal. A key proponent for the establishment of a carbon market was the provisions laid out in the 12th Five Year plan (2011–2015). Over the years, several pilot projects were developed and studied with the aim of establishing a national carbon trading market by the end of 2020. Now, with Covid-19 causing severe market disruption in China, several new challenges have emerged that could derail the nation’s aim to reduce carbon emissions and establish a national emissions trading market in the short term.

Initial Stages

The cornerstone for a nationwide carbon market was the creation of seven regional pilot programmes in 2013. In China, the National Development and Reform Commission (NDRC) is the incumbent government planning authority responsible for climate policy. The NDRC selected five major cities – Beijing, Chongqing, Shanghai, Shenzhen and Tianjin and two provinces Guangdong and Hubei, which have different economic structures and development levels, as part of their pilot programme. Each location covered the primary heavy industries of electricity and steam, petrochemicals, iron and steel, nonferrous metals, pulp and paper, glass and cement, but other industries were included that differed between the locations.

Shenzhen is a major financial and high-tech centre and it included commercial buildings and road transportation in its pilot programme, Shanghai included commercial buildings, railways, ports, airports and aviation, and Beijing included hotels, universities and medical facilities. The diversity among the programmes was to obtain useful information that could help establish a national trading programme for the whole of China and not just the more developed regions of the country. In 2017, the government initiated national rollout, which would take place in phases and be fully implemented by the end of 2020.

National rollout and market structure

A three-step process was outlined for the creation of the nationwide market. The first phase would focus on developing systems for data reporting, registration and trading. The second stage would focus on mock trading of carbon credits to test the effectiveness and reliability of the market. Spot trading would follow in the third and final step. Under the policy, the government gives or sells companies a limited number of carbon credits. Companies that produce less than their allotted emissions can sell the excess to other businesses.

Meanwhile, those that exceed their limits must buy surplus credits from other companies or typically face some kind of penalty. On 30 September 2019, 360 million tonnes of credits have been traded since the markets began with a total value of CNY7.8bn. The nationwide ETS aims to cover eight billion tonnes of carbon dioxide emission a year from approximately 100,000 industrial plants when the trading scheme is fully launched.

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Covid-19-related challenges

With coronavirus spreading across the world, several sectors have been impacted, which has caused economic contractions and carbon emissions to plummet worldwide. The consequent crisis could weaken the demand for carbon offsets, in favour of economic revival, risking the scheduled rollout of the carbon market in China. Not only is the carbon market likely to be impacted, but the country’s green transition could also be set back due to the market disruptions caused by C-19.

  • Economic headwinds: Prior to the outbreak, the economy in China suffered as a consequence of a trade war with the US and weakening consumer demand. Now, with the country’s economy reeling under the influence of the coronavirus outbreak, the economy is likely to slow down even further. According to the International Monetary Fund (IMF), China is one of the few economies expected to grow in 2020 by 1.2%, which is a sharp drop in economic performance from previous years. Moreover, with global trade expected to slow, China’s industrial sector is set for a lean period in the short term. Historically, the growth of China, as an industrial superpower was fuelled largely by state spending and similar support is expected to revive the industrial sector and achieve President Xi Jinping’s goal of doubling per capita gross domestic product (GDP) in 2020 from 2010. Much of the spending is facilitated by local provincial governments with the central government supervising proceeding. Provinces such as Beijing, Shanghai, Fujian and Anhui have ratified several infrastructure projects and will accelerate projects under construction in a bid to mitigate the impact of Covid-19. Increased activity is likely to raise the carbon intensity of the respective sectors and, consequently, push back the integration of non-power carbon-intensive sectors into the national carbon market in the short term, delaying the establishment of a comprehensive national market.
  • Changes in industrial regulations: The government has established several industrial-friendly measures such as relaxing environmental rules for industries and lowering credit costs to spur activity revival. According to the environment ministry, deadlines for companies to meet environmental standards have been extended and some companies have been exempted from on-site checks. Short-term need to shore up the economy could see emission control priorities take a back seat, impacting the pace and timing of the market rollout.
  • Slowdown in compliance: The MEE’s objective for 2020 was to establish spot trading and regulations, covering market allocation, emissions data reporting and data verification. The process to finalise institutional regulations, activate market trading and establish supervisory mechanisms have been affected by the coronavirus epidemic. Earlier in the year, the central government has already ordered companies from eight industrial sectors – oil, chemicals, construction materials, steel, nonferrous metals, papermaking, electric power and shipping to submit their carbon emission data before the end of March, in preparation for the ETS launch but the pandemic prevented participating industries to begin calculating and reporting emissions data, according to the protocol. This, in turn, has restricted officials from carrying out their verification process as part of the third phase objectives. In April, the province of Guangdong has pushed back its annual compliance deadline for companies by two months in its emissions trading scheme, giving companies more time to finalise their 2019 data verification. Other pilot markets such as Beijing, Fujian, Shanghai and Shenzhen had already delayed their annual compliance deadlines.

The national carbon market in China could potentially become the largest carbon market in the world and could significantly drive down emissions in the country. Although several institutional delays were witnessed during the implementation phase, the outbreak of Covid-19 will give rise to additional political and regulatory hurdles that are expected to affect the pace and timing of the national market implementation.

The government seems to be taking a softer stance on environmental accountability to lower the cost burden on business and spur economic activity, which could see a delay in the integration of businesses into the carbon market. With the 14th FYP for 2021–2025 yet to be published, it is likely that new market structures would be established to accelerate the national rollout with flexible measures introduced to not compromise on economic growth.