China launches emissions trading system as EU and US announce big plans for carbon markets

Today, after a number of delays, China has launched its highly-anticipated national carbon market – an emissions trading system (ETS) which started trading at Yuan 52.90/mt (€8.20), according to S&P.

It adds to a big week for carbon markets around the world. On Wednesday, the European Commission announced major reforms to the EU ETS and confirmed plans to introduce a carbon border adjustment mechanism (CBAM) – a tool to impose fees on carbon emissions linked to imported goods, to level the playing field between overseas companies and those paying for their carbon under the EU ETS. The same day, the US hinted that it will follow suit with a CBAM as part of its $3.5trn budget plan. 

China’s ETS, which will start with coal and be extended over the next four years to other sectors, is expected to cover annual emissions of more than 8bn tonnes of CO2, making it the world’s largest carbon market.  

Alex Child, Carbon Markets Research Manager at Carbon Cap Management, says the announcement is good news in terms of scale, but adds there is a lot of uncertainty around the final policy design. 

“There are currently relatively low levels of transparency around policy design and market rules, but I do think this will grow,” he says. “The Chinese government is seeing this as a key part of its climate policy toolkit and a ministry higher up in the government hierarchy [the Ministry of Ecology and Environment] is now responsible for the ETS”

Child says the country will have learnt a lot from the nine regional carbon pilots it's conducted over the past eight years. 

“It’s testament to China’s ability to experiment with policy,” he says. “It’s looking like these regional pilots could become pilot markets for new sectors prior to the sectoral expansion of the national market,” pointing to the potential to roll them out into transport and manufacturing. 

David McNeil, a Lead Analyst for carbon markets at ratings agency Fitch, says he expects prices to remain low over the short term, but increase over time. This is what’s happened in Europe, where yesterday’s carbon price under the EU ETS was around €61.92/mt. 

S&P reports that in comparison to Chinese market’s initial $8.20/mt CO2 price, the EU ETS carbon price was around $61.92/mt yesterday.  

This week's proposal to update the EU ETS came in the latest instalment of the European Green Deal, the ‘Fit for 55’ package. It's what Silke Goldberg, an energy expert at law firm Herbert Smith Freehills, describes as “the most comprehensive reform of the EU ETS that there has been since its inception in 2003”. 

“This is comprehensive in terms of the burden sharing mechanism between member states,” she explains. “It comprises more sectors such as aviation and maritime, and it is a comprehensive look at the impact of carbon price as a competitive factor, through the CBAM.”

Child says that, along with protecting industrial competitiveness, the EU is using the CBAM as a bit of a “foreign policy stick” to penalise trading partners that don’t implement carbon pricing and take climate policy seriously. 

“It’s going to be hugely important – especially with the US planning their own border carbon tariff. I think at least part of the reason why it has been part of Biden’s policy agenda has been because of EU pressure, given the significance of the two regions in trade with each other. They realise if they want to avoid this carbon cost [which will spread to more products through time] they need to take greater action on carbon pricing.”

The US referred to a “polluters import fee” – code for a CBAM – in the Democrat’s budget. It was light on detail, but the move is in principle a very big deal for carbon markets. 

However, Child notes that in both technical and international-policy terms, getting CBAMs off the ground will be difficult. 

“If you’d asked four or five years ago whether it would be possible to implement a CBAM like this, most people would have said ‘no’, because people perceived it would flout World Trade Organisation (WTO) rules or potentially lead to trade wars.

“A lot has changed, and the EU has greater confidence it can be designed to be WTO-compatible and not benefit local industry or have any form of subsidy – that’s going to be key. The global trade situation is slightly different now as well, after the lengthy trade spat between the US and China and the impacts of Covid on global trade. There’s also rising global awareness of climate change and societal pressure is mounting on governments to act. I think it’ll be hard for the WTO to go against a properly designed mechanism.”

As already expected, the EU confirmed on Wednesday that shipping would be added to the list of industries covered by EU ETS, and there would be emissions trading programmes designed for housing and transport. It also announced more stringent rules for the aviation sector. 

McNeil says the addition of shipping is especially significant. “It’s less visible to the end customer, but shipping represents 80% of global trade volume, 3% of global emissions and is projected to increase to about 10% global emissions by 2050 if there’s no additional regulation introduced,” he explains, adding that stricter conditions for aviation are also important because it’s the only sector under the EU ETS to have increased its emissions in the two years leading up to the pandemic.

The Fit for 55 package still has to go through trialogue – the negotiations between the European Commission, Parliament and Council – before it can be signed off. Fitch predicts strong resistance to the Commission’s proposals, with lobbying groups already hitting back. 

EU Member States in Eastern Europe, where fossil fuels are still a key source of energy, are concerned about the impact of higher heating and transport costs on low income households, explains McNeil. But he says the Commission's legislative proposals earmark housing and transport for a fund to reimburse low-income households, as part of its commitment to a Just Transition.

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