Analysis & Reports

China faces problems with National ETS

China faces problems with National ETS

China is set to launch its long-awaited National ETS, but major uncertainties linger as the government has yet to clarify who will join the market and how it will work. Government officials have yet to finalize the design of the scheme. 

The main challenges China is facing are lack of harmonized legislation between all seven pilots, different prices and types of allowances in each pilot, oversupply, confusion among market participants, lack of liquidity and lack of derivatives (futures, forwards and options). Although China made good steps in fixing the mentioned challenges, Virtuse analysts believe that it is not enough and not fast enough to make a swift change from pilot schemes to one single national trading system.

The largest in the world

What is clear is that the Chinese ETS can’t be ignored even if the initial version ends up being limited compared to the original plan of launching a scheme that would regulate 3-4 billion tons of CO2 per year. China expects its national carbon market to attract annual trading volume of up to 500 million tons for its first three years, equivalent to less than 10% of the allowances likely to be freely allocated. A total of 3-5 billion allowances will be handed out to China’s emitters, market regulator Jiang Zhaoli told a side event at the UN climate talks in Marrakech. That could mean the total turnover in the Chinese national market would reach 9-15 billion yuan ($1.3-2.2 billion) a year, based on estimates of a 30-yuan initial allowance price. Jiang said the price likely would climb to as high as 200-300 yuan ($29-44), though he didn’t specify a timeframe.

His turnover projections would put initial liquidity in China’s national market much lower than the 11-year-old EU ETS, which has annual trading turnover of around five times the level of free allocation, according to Thomson Reuters Point Carbon data.

Nine exchanges, seven pilots

Initially 7 exchanges were approved by NDRC: Shanghai, Beijing, Shenzhen, Tianjin, Chongqing, Guangdong, Hubei. In 2016 there were 2 more added to the scheme: Sichuan and Fujian. Several of China’s regional pilot carbon markets are moving forward with 2017 allocation plans that include sectors expected to be brought into the national ETS. Shenzhen became the first of the pilot schemes to issue 2017 permits to participants in its local market. According to an official with the China Emissions Exchange in Shenzhen, V2017 permits have been issued to emitters that are set to be included in the national market as well. No changes will be applied to Shenzhen is waiting for the central government to decide on a formula that would convert pilot market allowances into national ones and would likely be based on the tightness and price levels in the local markets.

Planning problems

But while the NDRC is scrambling to finish market rules in time for the 2017 launch that President Xi Jinping promised when visiting the US two years ago, the pilots are struggling to deal with the lack of information. Trading volumes have come down as traders are uncertain which markets many of the big emitting companies will belong to by the next compliance round.

Guangdong will announce its 2017 allocation plan soon, according to a source familiar with the situation, and will opt for the same solution as Shenzhen in including companies destined for the national market.

Beijing and Shanghai have yet to decide on how to proceed with this year’s allocation, while Hubei gave out a portion of 2017 allowances last year to nurture forward trade.

When faced with problems, policymakers have a choice of action or inaction. Since action has been the major driver of the progress and innovation in China and it’s reasonable to assume that changes will be made to improve and fine tune the system soon. Virtuse realizes that focusing time, energy and resources in China’s ETS is imperative to the future of global emissions trading. That was also a reason why we became the first international broker to enter the Chinese markets.