Higher carbon prices in China may tighten commodity supply, impact customers: UBS

Higher carbon prices in China could result in tighter supply of commodities like metals and energy, resulting in higher prices that will eventually be passed on to consumers, according to analysts from Swiss investment bank UBS.

UBS has projected that China's carbon price is likely to exceed Yuan 200/mtCO2e (about $31/mtCO2e) in the next few years, more than three times the current price level, given stronger demand and tightening supply.

"Bear in mind, commodity price is always defined by demand and supply. At the end of the day, if the carbon price results in tightened commodity supplies, I think it will be passed on to consumers," James Kan, head of Asia basic materials research at UBS, said at a press briefing on the sidelines of the UBS Greater China Conference held in the week starting Jan. 10.

Kan said per ton of aluminum production results in around 13-14 tons of CO2 emissions due to which the aluminum cost curve is probably affected the most, while traditional steel making generates 2 tons of CO2 per ton of steel, which translates into a 10% increase in the cost curve.

Peter Gastreich, head of Asia oil, gas and chemicals research at UBS, said a significantly high level of carbon price will be required to drive the transition to low-carbon technologies in China's hard-to-abate sectors like steel.

However, unless the carbon price increase is very dramatic, it will be very similar to any types of taxes that are ultimately passed on to customers, he said. "Ultimately, I think it is how this system is meant to work. Creating higher prices will also enhance customers' transition to low-carbon alternatives," he said

"Within China, how companies are impacted by carbon prices ultimately will depend on how the benchmark evolves with the government," Gastreich said, adding that currently UBS was looking at only low single-digit impacts to earnings very broadly within oil, gas, refining and chemical companies.

High prices incentivize transition

China's national carbon market was launched on July 16, 2021, and the daily weighted average price of a China Emission Allowance was at Yuan 57.99/mtCO2e ($9.11/mtCO2e) on Jan. 12, official exchange data showed.

In 2022, carbon trading will start to become an essential market tool to carry out the difficult process of decarbonizing industrial sectors in China, and the carbon market size could grow to Yuan 500 billion ($77 billion) with more carbon-related financial products in a few years, UBS said in a report in early January.

The bank expects the majority of China's carbon trading volume to come from a carbon futures market to be formed in the next few years, similar to EU's Emissions Trading Scheme.

"In our bull case, we estimate the market size could reach Yuan 2 trillion, bringing potential commission fees of hundreds of millions to trading exchanges and market makers. Furthermore, new carbon financial products could evolve with ample market sizes, bringing new business to Chinese financial institutions," the report said.

"Our very long-term upside carbon price estimates are around Yuan 650/mtCO2e ($100/mtCO2e), while downside carbon prices may be flat at Yuan 50/mtCO2e ($7.70/mtCO2e)," UBS said.