'Time not ripe' to introduce carbon futures and options in China: market experts

It is too early to introduce carbon emissions allowance futures and options in China due to the current limited level of liquidity and lack of a comprehensive legal framework, the architect of the market told state media outlet China Central Television April 16.

China's national compliance carbon market has been operating for nine months, with supply and demand dynamics still largely policy-driven. Stakeholders have called for institutional investors to be brought in to act as market makers, with the introduction of financial derivatives as soon as possible.

"There have been lots of debates in recent years about whether China's national carbon market will introduce options and futures soon. I think the time is not ripe," Zhang Xiliang, director of the Institute of Energy, Environment and Economy, Tsinghua University, said in the interview with CCTV.

"Carbon is very different from traditional commodities like soybeans. Carbon trading is a policy instrument that facilitates emissions reduction," Zhang said.

Trade volumes in China Emission Allowances saw a short-lived surge in December 2021 as power companies, pushed by the environment ministry to fulfill compliance obligations, bought allowances to cover all emissions beyond free quotas by the end of 2021.

After that, trade volumes dived and have remained at a low level this year.

From Jan. 1 to April 19, the daily average CEA trade volume was at 155,837 mtCO2e. In December last year, the daily average trade volume was 5.9 million mtCO2e, exchange data showed.

Legal framework yet to be completed

"China's national compliance market now only enrolls one sector [the power sector], and a comprehensive legal framework that safeguards the market is yet to be completed. That is to say, the foundation of our carbon market has not been fully established," Zhang said.

"The development of financial derivatives needs to rely on a solid foundation, otherwise it is just a castle in the air," he said.

Under existing rules, market penalties for malpractice were too low, he said.

For companies that fail to submit emissions reports on time or falsify reports, a fine up to Yuan 30,000 (about $4,700) applies. Similarly, a fine of up to Yuan 30,000 is applied to companies that fail to fulfill their compliance obligations on time.

"The fine is tens of thousands of Yuan, while the profit ... can be up to hundreds of millions of Yuan," Zhang said.

A healthy carbon market relied on a solid legal framework and effective implementation, with Zhang disclosing that a comprehensive set of regulations for China's carbon market was expected to be released in next one to two years, the process being accelerated under a central government call.

A marathon

Once the building blocks were in place, market liquidity coupled with financial derivatives would provide long-term price signals for risk mitigation.

"We should not overestimate the short-term impact of our carbon market, nor underestimate its long-term impact," Mei Dewen, general manager of the China Beijing Environmental Exchange, said in the same interview.

"The development of the carbon market is said to be a marathon, and the first thing is to get more people up and running. The scale of the market needs to be large enough," Mei said.

This meant diversifying market participation.

"We need people with different views of market movements, with different risk preferences and with different information on hand, so as to establish a truly fair and reasonable price of carbon," he said.

"Options and futures are all tools, not the purpose of the market. The purpose is to put a price on carbon in an efficient way."

Carbon futures would provide a price signal out to two years-plus, with institutional investors driving market liquidity, Huang Jiefu, former vice president with the Chicago Climate Exchange, said in the interview.

"Only after having that can we expect trade volumes comparable with the European or California carbon markets," he said.

CBAM sectors

The EU's Carbon Border Adjustment Mechanism is expected to impact China's steel, aluminum and cement exports.

All these sectors would be enrolled into China's national carbon market by 2025, according to the environment ministry.

"If CBAM is implemented, China's steel exports to EU member countries will reduce 11%-13%. After being covered in the domestic carbon market, steel companies will be pushed to take decarbonization measures," Zhang said.

Another driving force to accelerate carbon market development would be the ongoing power market reforms.

"After the power market becomes fully marketized, the auction scheme for emissions allowances can be introduced. This will further improve the carbon market's effectiveness," Zhang said.

"We have only eight years for carbon [emissions] to peak and less than 40 years for carbon neutrality. We cannot rush, but we can't afford to wait," Mei said.

The weighted average CEA price was Yuan 60/mtCO2e (about $9.44/mtCO2e) on April 19, exchange data showed.