Research on China ETS’s Grand Opening and impact from the upcoming CBAM

Carbon Border Adjustment Mechanisms is expanding and the world’s largest carbon market (China) starts trading last week



Under its commitment to combat climate change and align with the Paris Agreement, China’s emission trading scheme (ETS) commenced on the Shanghai Environment and Energy Exchange on July 16, 2021, covering emissions from 2,225 power companies.


On the other side of the world, to account for asymmetric in carbon pricing policies across different countries, the Carbon Border Adjustment Mechanisms (CBAM) are generating discussion over its impact on global trading markets. Our insights focus on the two underlying topics, ETS and CBAM and their impacts on carbon pricing and market trends. Carbon pricing has emerged as a key policy mechanism to curb and mitigate the dangerous impacts of greenhouse gas pollution and drive investments towards cleaner, more efficient alternatives. (CDP)


CHINA’S NATIONAL EMISSIONS TRADING SCHEME


Following by China’s Interim Rules for Carbon Emissions Trading Management, which came into effect on February 1, 2021. Marking the start of spot transactions within the quotas of the national carbon market. The rules specify that the MEE (Ministry of Ecology and Environment) shall organise a registration system and trading system for domestic carbon emissions, including agencies for registration and trade, in accordance with national regulations. The national carbon emission registration agency will be responsible for the centrally unified carbon emissions trade. The grand opening of China’s National Emissions Trading Scheme (CN ETS) starts trading on July 16, 2021.


The carbon price is trading at ¥52.08/mt (around €6.9/mt) on CN ETS the first day (July 16, 2021), up 6.7% from the opening price of ¥48/mt. In its initial phase, the CN ETS will regulate entities from the power sector, retrospectively handing pollution allowances for the market’s first compliance cycle covering carbon dioxide (CO2) emitted during 2019-2020. There are plans to extend the trading coverage to seven other sectors: petrochemicals, chemicals, building materials, iron and steel, non-ferrous metals, paper and domestic aviation eventually.





MRV (Monitoring, Reporting, and Verification)


On March 29, 2021, “the Guidelines for Verification of Corporate Greenhouse Gas Emissions Reports (Trial)” has finalised the verification procedure with eight steps: 1) verification arrangements, 2) the establishment of a verification technical working group, 3) document review, 4) establishment of an on-site verification team, 5) implementation of on-site verification, 6) issuance of "verification conclusions", 7) notification of verification results, and 8) preservation of verification records for at least 10 years. The new CN ETS is expected to be one of the crucial instruments in helping China achieve its goals of peak emissions before 2030 and net-zero by 2060. A more rigorous greenhouse gas emission inventory accounting system shall be expected to come before further expansion of the sector coverage for the carbon trading market. As the MRV process is consequential for baseline setting for the trading entities.


CEAs (Carbon Emission Allowances)


China’s Interim Rules for Carbon Emissions Trading Management denotes key emitters being entities covered in the trading sectors (primarily being the 2,225 companies in the power generation sector) with an annual GHG emission over 260k CO2 equivalent. The CN ETS market aims to reduce GHG emissions by requiring these entities (key emitters) to pay for at least some permits to emit their emissions, encouraging them to invest in technologies that will improve fuel efficiency and reduce pollution. With the allocated carbon emission allowances, these key emitters are incentivised to cut emissions and trade spare CEAs in the carbon market.


For the current trading sector, the power generators’ CEAs are assigned freely based on operating size and fuel type and measured by their carbon intensity (mtCO2e/MKWh), where a limit is applied for every unit of electricity generated. This entails a growing potential for GHG emission as production grows while limiting carbon intensity for the power generated. The benchmark for such allocations of CEAs is at 70% of the 2018 output multiplied by the corresponding benchmark factor. Offset by trading CCERs (China Certified Emission Reduction) is limited to 5% of verified GHG emissions. A maximum fine of ¥30,000 (~USD$4,600) could be penalised upon any non-compliance.


Multilateral Collaboration and CBAM


As the world’s largest carbon market (China) starts trading last week, connecting the global carbon market is necessary to avoid freeloading and “carbon leakage”. According to PRI, carbon markets link to CBAM in two ways:

EU CBAM and the ‘Fit for 55 Package’


To deliver on the GHG emissions reductions in line with the European Climate Law, the European Commission proposes to revise where necessary all relevant policy instruments by July 2021 in a ‘Fit for 55 Package’, which covers, in particular, the review of sectoral legislation in the fields of climate, energy, transport, and taxation. The ‘Fit for 55 Package’ aims to reduce emission allowances under the EU ETS in the coming years, to achieve an overall reduction of at least 55 % by 2030 and beyond, so as to ensure a balanced pathway to reaching climate neutrality by 2050.


A carbon border adjustment mechanism (‘CBAM’), announced in the European Green Deal, is part of that package and will serve as an essential element of the EU toolbox to meet the objective of a climate-neutral EU by 2050 in line with the Paris Agreement by addressing risks of carbon leakage as a result of the increased Union climate ambition. The European Parliament adopted in March 2021 a resolution advocating for the introduction of a WTO-compatible carbon border adjustment mechanism.


The long-awaited proposal for an EU Carbon Border Adjustment Mechanisms (CBAM) was published by the European Commission on July 14, 2021, alongside 12 other legislative proposals in the "Fit for 55" package. The CBAM will commence in 2023 and apply to the importation of electricity and certain goods into the EU Customs Union. The goods covered are aluminum, cement, fertilisers, iron, and steel. The CBAM is expecting to be fully implemented in 2026.


Impacts on Supply Chains


The general objective of the CBAM was to address climate change by reducing GHG emissions in the EU and globally. The European Commission assumes that, while revenue generation is not an objective of CBAM is expected to generate additional revenue, which for 2030 is estimated at above EUR 2.1 billion. A penalty against false information or misconduct related to the CBAM regulations is expected and details on the application of penalties will come with the implementing acts.


The inclusion of aluminum, cement, fertilisers, iron, and steel, makes sure the carbon price burden does not just fall onto the construction and heavy industry, but the everyday consumer goods such as cans made out of aluminum.


Complexities for companies’ supply chains, and additional costs both in administration to comply and in the underlying carbon price are coming soon with the CBAM.


Carbon Pricing


Measuring the cost of nature (climate cost and environmental cost) is at the heart of carbon pricing. According to the World Bank, carbon pricing is an instrument that captures the external costs of greenhouse gas (GHG) emissions—the costs of emissions that the public pays for, such as damage to crops, health care costs from heatwaves and droughts, and loss of property from flooding and sea-level rise—and ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted. A price on carbon helps shift the burden for the damage from GHG emissions back to those who are responsible for it and who can avoid it. Instead of dictating who should reduce emissions where and how, a carbon price provides an economic signal to emitters, and allows them to decide to either transform their activities and lower their emissions or continue emitting and paying for their emissions.


Policy makers’ intentions for putting a price on carbon is to transit to low carbon economy by incentivising innovation and expansion of new low-carbon technologies and phasing out fossil fuels reliance. However, the methods to deliver that remain testing.


Concerns over protectionism and retaliatory measures across trading borders are rising. Assumptions over the cost of CBAM would eventually fall upon consumers and the revenue gains through CBAM are also questioned if it is really directing to combat climate change and a transition to a low-carbon economy.


EU’s key trading partners that fall within the range of CBAM restrictions are worried about their exposures and competitiveness. This will incentivise these key trading partners to consider building their own ETS or carbon tariffs to at least gain from the carbon price linked to goods that they produce rather than see the levy simply being paid to the EU, said by Energy Voice. The cost for imposing the same (or close to) the CBAM or comply by calculating and decarbonising the goods are adding to this complexity for developing countries.



(written by Yitong Yuan)



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