China's carbon price was steady at $7.88-$8.76/mt since the launch of its carbon market on July 16, which is too low to drive significant decarbonization of the power sector, or incentivize a large-scale fuel switching away from coal.
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Any material increase in China's carbon prices is constrained by many factors, ranging from concerns about its economic impact to whether it has sufficient confidence in market-based mechanisms to reduce emissions.
These issues are reflective of events in commodity financial markets and the technology sector in recent weeks, where running afoul of the central government's objectives prompted a crackdown that rattled markets and raised questions about whether market-based systems can be allowed to function independently in China.
Concerns over the high cost of carbon are hardly restricted to China. The European Union's "Fit for 55" plan to cut average greenhouse gas emissions by 55% by 2030 and reach net zero emissions by 2050, has sparked resentment in some member countries, and countries like the US, Japan and India are still miles from setting a national carbon price.
The recent spate of extreme weather events, such as the devastating floods in central China, and the associated public backlash are also likely to feed into decisions around carbon pricing, similar to the evolution of anti-pollution and coal-to-gas switching policies over the years.
While high carbon prices are key to incentivizing investment in high capital expenditure technologies like carbon capture and storage, or CCS, and green hydrogen, this can also be done by direct policy intervention in China's context.
Clear pricing signals
True carbon price discovery needs a variety of free market forces to operate, so that supply and demand can meet in the middle. This requires diverse market participants, liquidity, fair trading systems, efficient regulation and clear price signals.
Many of these prerequisites have yet to fall in place in China.
China's carbon market starts with the power sector, which by nature, is controlled by incumbents such as large state and provincial government companies, despite ongoing reforms.
For instance, China's five largest state-owned generation utilities, collectively known as the Big 5, include Huaneng Group, Huadian Group, China Energy Investment Corp (CEIC), State Power Investment Corp (SPIC) and Datang Group, which accounted for 44% of China's total installed generating capacity of 2.2 TW in 2020.
Many power companies enrolled in compliance carbon trading are subsidiaries of the Big 5, according to the environment ministry. Many carbon allowances are likely to be traded internally between subsidiaries within the same government-owned parent company, according to a joint study by Shanghai Environment Energy Exchange and the US' Environmental Defense Fund, or EDF, dated July 20.
The study said if carbon trading remains passive and exists solely for companies to meet their emissions targets, demand would surge near deadlines causing short-term spikes in carbon prices, but fail to provide valid price signals for the rest of the year.
Despite a successful launch, the future development roadmap of the carbon market is still unclear, and it will be difficult to generate an effective pricing signal if there are no clear expectations of near-term, medium-term and long-term emission reduction targets, the joint study said.
Data transparency around trading volumes, bids and offers, and trades will be critical to price discovery.
The design of China's carbon market does allow for tightening supply-side fundamentals to increase carbon prices.
The current system allows an average emission of 0.877 mt of CO2/MWH for conventional coal units above 300 MW, and 0.979 mt of CO2/MWH for conventional coal units equal to, or less than 300 MW. A sub-critical low efficiency coal-fired plant will have a higher-than-average emissions intensity.
A recent study by the research institute under Huadian Group, one of the Big 5 utilities, showed that a 300 MW subcritical power unit using low-quality coal has a profit margin of Yuan 60/MWH without carbon costs and an emission intensity of 1.015 mt of CO2/MWH, which means its profit margin will shrink by 3.3% at current carbon prices, and this loss widens as carbon prices rise.
The regulator can tighten permitted emissions intensity, cut free allowances, auction allowances at higher prices, and tighten penalties as coal-fired power plants only need to buy 20% of emissions above permitted levels.
Only 34% out of 133 power companies said they needed to buy additional emission allowances to meet their targets, according to a survey by non-profit China Carbon Forum, or CCF, in December 2020. It forecast carbon prices will hit Yuan 93/mt ($14.31/mt) in 2030 and Yuan 167/mt ($25.70/mt) in 2050.
Others like Zhang Xiliang, director of the Institute of Energy, Environment and Economy at Tsinghua University, who helped design China's carbon market, said the carbon mitigation cost, and hence carbon price, will reach $300-$350/mt by the end of 2060, as cheaper technologies get adopted first.
The emissions intensity of China's overall power sector has been in long-term decline, and policy tools to ramp up renewables have been maxed out. The government will need to widen its decarbonization arsenal to include carbon price discovery to get to the next level of emissions cuts at some point, which is where the future of China's carbon market lies.
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