China signals shift to absolute compliance carbon market cap by 2030

Recent policy documents signaled that Chinese policymakers have decided to create an absolute cap for the national Emission Trading Scheme, likely to be introduced by 2030, when the country has committed to peaking its greenhouse gas emissions.

Notably, China's ETS has been criticized by some industry participants and observers as a "paper tiger" because it does not have an absolute cap to curb emissions under the ETS roof. Instead, it adopts an intensity-based approach, which sets maximum free emissions allowed for each unit of output, such as one megawatt-hour of coal-fired electricity or one ton of crude steel.

Without an absolute cap, annual emissions covered by the ETS increased significantly from 4.5 billion mtCO2e in 2021, when the market was launched, to 5.2 billion mtCO2e in 2024, according to statistics from the Ministry of Ecology and Environment.

In May, China's chief administrative body, the State Council, published overarching guidance on enhancing the country's environmental markets. For the first time, the State Council explicitly said the country would "gradually shift the national ETS from an intensity-based market to a cap-and-trade market."

By 2027, China's ETS is expected to cover key emission-intensive industrial sectors, and by 2030, the ETS should have an absolute cap as its foundation, with both freely allocated and auctioned emission allowances provided, according to a more detailed, non-public guidance seen by Platts, part of S&P Global Energy, on July 1.

Based on earlier plans released by the MEE, "key emission-intensive industrial sectors" include refining and petrochemicals, chemicals and papermaking, in addition to thermal power, steel, aluminum and cement sectors already covered under the ETS.

'Time is ripe'

At a press briefing in March, a MEE official said the current intensity-based ETS was initially introduced because China has not peaked its emissions, adding that the market would be transformed into a cap-and-trade one when the time is ripe.

Several market participants told Platts that "time is ripe" for making this switch even before 2030, because cutting total emissions through cutting production could be a more economically viable option for some emission-intensive sectors.

"Let's be realistic. Steel producers faced a shrinking domestic property sector and a shrinking export market due to the US tariffs and various other trade barriers worldwide. Given the market reality, cutting total production and emissions is easier than cutting carbon intensity," a Shandong-based steel industry participant told Platts.

"To cut carbon intensity for each ton of steel, we need more electric arc furnaces, CCS (carbon capture and storage), hydrogen-based direct-reduced iron ... All of them are capital-intensive, especially considering the financial difficulties that we are facing," the industry participant added.

Electrolytic aluminum producers echoed that, before being enrolled in the ETS, they had already cut production periodically to meet the government's mandatory targets to control energy consumption and emissions.

"We have shifted some manufacturing bases to hydro-abundant provinces, but that does not help us relieve ETS burdens, given that only Scope 1 emissions are ETS-liable. In contrast, if a cap-and-trade market is introduced, cutting production when needed can help us easily address ETS liabilities," according to an industry participant with smelters in southwest China.

"Setting an absolute cap and introducing auctions will also help align with the EU's practices, reducing the costs under the Carbon Border Adjustment Mechanism," the industry participant added.

Duan Maosheng, a professor at Tsinghua University, pointed out in a recent study that China could consider initiating a hybrid system around 2026, with both carbon intensity caps and an absolute control cap in place. Duan is one of China's carbon policy advisors and has represented the country in Article 6 negotiations at several COPs.

Hurdles for implementation

Despite the clear signals, several hurdles could hinder the actual implementation of a cap-and-trade system, according to a joint study published by Tsinghua University and state-owned generation utility China Three Gorges Corporation in May.

First, the study highlighted that, as a developing country with heavy industries as economic pillars, it is difficult for China to cut emissions rapidly after its carbon peaking by 2030, so the cap needs to be cautiously set and managed.

Second, the study pointed out that there are some existing administrative policies to control each province's emissions. The cap-and-trade ETS should coordinate with these policies to avoid trade barriers that impede cross-provincial emission allowance trading.

Third, the study highlighted that, in China's current power market, the compliance costs under the ETS could not be fully reflected in the end-user electricity prices, which could trigger financial burdens on generation utilities.

TABLE 1: Historical China Emissions Allowance Trade Volume Data

Source: Shanghai Environment and Energy Exchange Co. Ltd.