China’s Emissions Trading System May Hold the Key to Carbon Peaking Once Rolled Out Fully

China today owns the world’s most extensive Emissions Trading System (ETS), with 5.1 billion metric tons of CO2 emissions covered annually. To date, China’s ETS includes more than 2,200 companies in China’s power sector. The first stage includes only power sector companies, but the scheme will ultimately include over 6,000 production companies from different industries. In March this year, the Ministry of Environment and Ecology (MEE) announced that it is preparing to include the electrolytic aluminum sub-sector of the aluminum industry. This is the most energy- and emission-intensive part of the non-ferrous metals; the aluminum industry accounts for around 5% of China’s total CO2 emissions. The MEE has published draft guidelines for monitoring, reporting, and reviewing carbon emissions from the aluminum smelting sector. In recent months, Other sectors have been asked to become more stringent with their emissions reporting, potentially hinting at other industries, such as cement, to join the ETS within the year.

In principle, the Emission Trading Systems aims to reduce carbon emissions by assigning a fixed amount of emission quotas under a cap-and-trade system to each participating company. Companies that don’t use their quotas can trade the balance to other companies that need to emit more. Each participating company is allocated free allowances based on a national benchmarking method, whereby the average carbon intensity of critical sectors and products is calculated and compared with that of individual emitters. Each emitter will be allocated allowances equal to its verified emissions. Those companies that can reduce the carbon intensity of their production can generate a surplus of allowances to sell. The allowance price is dynamic and varies daily.  In 2023, the annual average trading price for China Emission Allowances (CEAs) reached Yuan 68.15/mtCO2e ($9.62/mtCO2e), up 23.24% on the year. The exchange data showed that CEA trade volume was 212 million mt CO2e for the year, jumping 316%.

The ETS was initially developed under the guidance of China’s National Development and Reform Commission. However, oversight has since been transferred to the Ministry of Environment and Ecology (MEE). In early January 2021, China’s ETS commenced its nationwide roll-out, with the MEE publishing key ETS policy documents and stipulating allowances and allocations for affected industries.  In mid-2021, the first trading started on the trading platform operated by the Shanghai Environment and Energy Exchange (SEEE). The trading platform also provides aggregated data, such as how many allowances were traded daily and at what price. In addition, the MEE announces an annual compliance rate, stating the aggregated emissions of all the participants.

China’s nationwide ETS has been developed over the course of seven years, including eight regions and cities designated as ETS pilots. Beijing, Shanghai, Hubei, Shenzhen, Guangdong, Fujian, Chongqing, and Tianjin were encouraged to develop unique trading systems based on local circumstances, such as prevalent industries or economic situations. The government evaluated the outcomes from different ETS to design the nationwide emissions trading system. Successful local emission trading systems have been allowed to run in parallel.

While developing the nationwide ETS architecture, China’s government has also drawn on the European Union and German ETS experience. In dialogues and collaboration sessions, lessons from establishing and running ETS examples in the EU and Germany have contributed to solving fundamental design issues or developing the structure for administration and operation. At the same time, China’s ETS had to deal with particular local conditions, such as setting up a trading system in a highly regulated power market, where additional costs for carbon pricing cannot be simply transferred to the customer. Therefore, while some aspects of China’s ETS could fit with the EU ETS, many local market particularities remain. These would pose significant challenges to a globally interconnected ETS. At the same time, if it can be demonstrated that the EU and the Chinese emissions trading systems contribute significantly to lowering carbon emissions, then the argument for the effectiveness of a carbon price may well up the pressure on countries reluctant to introduce a carbon price.

This Post was submitted by Climate Scorecard Country Manager Annette Wiedenbach.

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