Carbon trading is a legally binding scheme that caps total emission and allows organizations to trade their allocation. All these “cap-and-trade” systems have emission limit calculated by governments and policymakers according to their carbon zero target. Carbon allowances are allocated to companies proportionate to their historical emissions. Such allowances can be traded in the market at a price determined by supply and demand.
Many governments seek to reduce their emissions through carbon trading, by providing the economic incentives for businesses to reduce their environmental footprint. With China launching its own nationwide emissions trading scheme in February, people are eager to see big changes in the carbon market landscape in 2021.
The World’s Largest ETS
In September 2020, President Xi Jinping announced to the UN General Assembly that China would aim to achieve carbon neutrality by 2060, triggering global interest in China’s climate actions. Soon after the pledge, the Ministry of Ecology and Environment (MEE) committed to starting the national carbon market ‘as soon as possible’.
The Chinese national Emissions Trading Scheme (ETS) will start its trading by the end of Jun 2021. The national ETS system will first cover the power sector, which roughly accounts for 30% of China’s total emission. Trading for industries such as cement, steel, aluminium, chemicals and petrochemicals will be subsequently introduced and integrated into the market.
More than 2,200 power stations in China will be allocated allowances in the world’s largest carbon market. The first phase will cover around 4.3 billion tonnes of CO2 per year – more than twice the amount emitted under the EU ETS.
According to the 2020 China Carbon Pricing Survey, the average price expectation in the national carbon market starts at RMB 41 (USD 6.43 / EUR 5.26) per tonne of CO2 (for 2020), rises to 77 yuan for 2030. Average carbon price expectations for 2050 are RMB 140 (USD 22 / EUR 18) per tonne The actual price levels remain highly uncertain especially in the more distant future.
Reform of the Oldest ETS
Meanwhile on the other side of the planet, the EU’s benchmark carbon price surpassed EUR 50 earlier in May for the first time in the history.
Launched in 2005, the European Union’s Emissions Trading System (EU ETS) is the oldest active carbon market. It is (was) also the world’s largest ETS mandatory for all 28 EU members, plus Iceland, Liechtenstein and Norway, covering power plants, aviation and energy intensive industries. It currently covers around 40% of EU’s greenhouse gas emissions.
The EU ETS started with EUR 15 per tonne. An oversupply of carbon allowances during the 2008 financial crisis weakened their prices in the EU’s trading system, reducing the incentive for businesses to change their behaviour. As a long-term solution, a Market Stability Reserve (MSR) began operating from January 2019. MSR gives the European Commission the ability to correct the large surplus of emission. As a result, the price tripled from EUR 8 per tonne of CO2 to around EUR 25 over a year.
Prices in 2021 are expected to average at around EUR 40. Analysts at Refinitiv predicted the EU carbon trading price to reach EUR 89 by 2030.
In fact the EU is preparing to revamp its CO2 market to meet a new target of a 55% cut in emissions from its 1990 level by 2030. The proposed changes will likely include a steeper annual reduction in the overall limit on emissions, the extension of the market to cover maritime and land transport as well as buildings, and changes to a mechanism that reduces the surplus of allowances in the market.
Photo by zhang kaiyv
A Global ETS?
Would it be more efficient to have a global marketplace for carbon exchange given such a big price gap between the EU ETS and the upcoming China markets?
Currently, there are approximately 27 carbon markets in the world. However, carbon credits that are bought and sold in one market might not be eligible in another. To add in further complexity, there exist two types of carbon markets, the regulatory compliance markets and voluntary markets.
For example in New Zealand, the carbon market covers electricity generators, manufacturers of liquid fossil fuels including petrol and diesel. Some forest owners are also given free permits while others can voluntarily join the scheme.
Imagine if the New Zealand forest owner can sell credit to paper manufacturers in China to offset their carbon emissions. How would they price the deal? How would the transaction take place? Even if the transaction is feasible, would this really help China to achieve its net-zero carbon goal? On the other hand, would New Zealand be willing to give up those credits which could have contributed to its own carbon neutrality?
There remain differences of opinion as to how countries should account for transactions of emission reduction among themselves and what kind of technology would be eligible to earn carbon credits. Looming over all of the carbon market developments in 2021 will be the UN-sponsored negotiations over the future of international carbon trading.
We’re also keen to find out how would COP26 (set to 1-12 November 2021 in Glasgow, UK) help orchestrate the conversation among all countries. Till then, stay tuned and stay green.