Agriculture

Can the EU and China level their carbon markets?

The EU launched its Emissions Trading Scheme (ETS) in 2005 and now covers 11,000 emissions and almost half of European emissions. It uses a market-based restriction and trade system to reduce greenhouse gas emissions from major power plants, industries and flights to Europe.

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Since then, several other national or subnational carbon markets have been either fully launched or partially developed – in particular in Canada, Japan, New Zealand, South Korea, Switzerland and the United States. But the EU has worked particularly hard to build a cooperative relationship with China – to help develop the concept of a carbon market – because China’s size makes it a clear market leader in Asia.

China’s ETS began trading last year, and so far covers only the electricity generation sector, but “the 2,162 companies it includes produce about 4.5 billion tons of CO2 emissions annually,” writes Renato Raldao in Energy monitor. “This is comparable to the EU’s ETS limit of 20 billion tonnes of CO2 in 2021.”

In 2014, the EU collaborated with China to develop and implement China’s carbon market and support the deployment of seven regional pilot schemes across the country. Three years later, at the UN COP23 climate conference in Bonn, this collaboration contributed to the creation of the Chinese National ETS. At the event, Commissioner Arias Canette said the ETS “will undoubtedly send a strong signal to the rest of the world in support of carbon markets. That is why the EU is glad to enter into even closer bilateral cooperation with our Chinese colleagues. “

The rationale for this cooperation between the EU and China is that by sharing its experience with China, the market with the greatest potential for reducing global emissions, the most established carbon trading system, the EU, can accelerate progress in the fight against global warming.

Barbara Pongratz, associate analyst at the Mercator Institute for Chinese Studies, told China Dialogue: “The goal of the EU-China dialogue on carbon markets is to pool knowledge and improve our common understanding of the ETS.” As a world market leader in ETS, the EU has been able to share knowledge gained from its experience. However, as Pongratz says, “Regular bilateral political dialogues between the EU and China are a process of mutual learning, and given the large size and complexity of the Chinese ETS, European stakeholders also learn a lot from China’s experience. The development of the ETS is a process of constant study and improvement. “

Differences in market design

China’s STV, at an earlier stage of development, differs from the EU’s STV in a number of respects. The main difference so far, Roldao I say, is that the Chinese system has no absolute limit, but is based on carbon intensity. Under this system, the emissions of individual companies are compared with the average carbon content of the sector. Each issuer is allocated emission allowances free of charge, and if they can reduce the carbon intensity of their activities, they can sell excess allowances.

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This system is designed not so much for the phasing out of coal in favor of renewable energy as for the phasing out of less efficient coal-fired power plants, making the overall coal sector more efficient. As Raldao explains in his article: “The same total amount of electricity will be generated by coal as without ETS, but increased efficiency will reduce emissions overall.” In this way, the Chinese government can work towards its global warming goals without compromising the country’s energy security.

China, like the EU, also uses deficits as a policy tool to reduce emissions. Roldao writes: “Once the price of carbon is fully reflected in the price of energy, it will change the cost structure of power plants, which is likely to accelerate the reform of the Chinese electricity market, attract environmental funding and intensify the use of emission reduction technologies. ”

Linking carbon markets

For politicians who have faced increasing carbon markets around the world, the next step is obvious – to achieve synergies by connecting with other markets. The EU, for example, contacted Switzerland. China is also working with its neighbors to develop a regional carbon market, using trade relations that have been built over the years with the ASEAN bloc. Although regional harmonization of the ETS makes sense, analysts the Green Finance & Development Center says this is difficult to achieve in the short term as the development of individual carbon markets in Vietnam, Indonesia, Thailand and the Philippines is still at an early stage. At the moment, analysts say, “the main focus should be on helping Southeast Asian countries complete infrastructure construction. [regional] the carbon market, improving legislation to build a carbon market, creating an effective MRV system (measurement, reporting, verification) and studying the development of a pilot carbon market ”.

Jessica Green, an associate professor at the University of Toronto, writes in Nature The magazine says that “tying markets together should facilitate trade, unhindered financial flows and reduce the overall cost of reducing emissions. The world price for carbon emissions would have arisen without the need for long and capricious diplomatic negotiations. ” However, she notes that the reality is more complex: “Linked carbon markets are difficult to manage when many regulators compete. Interaction with other climate politicians causes unintended results. It is difficult for politicians to keep prices at the “right” level – neither so high that the carbon market becomes politically unacceptable, nor so low as not to change behavior. “

If the regional carbon market is complex, the global one is even more so. Pongratz says: “The introduction of a global carbon market is an ideal scenario, which, however, now seems unrealistic. First, several obstacles need to be overcome, as different ETSs, especially in China and the EU, are at different stages of development and use different approaches and mechanisms that are currently difficult to reconcile. ”

Alternatives to harmonizing carbon markets

It will be some time before China can compare with the coverage and maturity of the EU ETS, Pongratz says. The EU, as an ambitious leader in climate policy, seeks to speed up the process and exert political pressure by proposing a Carbon Border Adjustment Mechanism (CBAM). In essence, it is a tax on carbon dioxide on imports of certain products to protect climate action in Europe and prevent “carbon leakage” of European companies that transfer their production to countries with lower emission targets. She adds: “Using CBAM as a last resort, it wants other major emissions and trading partners to step up their carbon pricing efforts. The more developed carbon pricing systems in a particular country, the less they will be affected by CBAM. The CBAM should also serve as an incentive to promote the global debate on carbon prices, one of which is emissions trading. ”

Green believes that within the global system, national carbon markets should limit their links with other markets. She says China has made a wise decision to remain independent, giving the opportunity to solve problems that will inevitably arise. This should postpone any other connections under consideration. Similarly, politicians should waive offsets from other jurisdictions. ”

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Governments seek to avoid difficult political decisions. As a solution, Green advocates the creation of a central carbon bank to manage surcharges and prices. She points to the EU’s Market Stability Reserve for the ETS, which performs similar functions: “guided by detailed rules, it leaves little room for influence by member states.” Theoretically, the central carbon bank could play an equally useful, independent role as an intermediary. In practice, she says, the likelihood that this will happen on a global basis is small.

Volatility management in the EU ETS

As carbon markets are still in their infancy, a global version may still occur. When the EU was ready in 2017 to help China build its carbon market, its own ETS struggled with an excess of surcharges that lowered the price of carbon, which did not give industries much incentive to participate in the system. Now this problem is solved. Today in Brussels, discussions focused on the need to eliminate the volatility of carbon prices – the forecast was about 30 euros per tonne, but now they are about 100 euros. This volatility is due to several factors, including uncertainty caused by constant policy changes (for example, the goal of reducing greenhouse gas emissions in all EU economic sectors moving last year from 40% to 2040 to 55%; the implications of blocking Covid-19 for the global economy; and now the impact of economic sanctions on Russia for its war against Ukraine.

But one of the factors that some politicians don’t like – or maybe they can do something about – is that many market participants are financial players speculating on carbon price movements in the EU. Since 2018, the number of active investment funds in the ETS has tripled to more than 300, with non-EU financial players accounting for about a third of the market share. On the one hand, this speculation helps to develop the market by finding the true market value of carbon. On the other hand, it has also pushed up carbon prices for companies in need of surcharges, which theoretically runs counter to the ETS’s main goal – to encourage participation. However, another factor that politicians need to consider is that a higher price would help fund the development of green hydrogen, according to some as the technology of decarbonisation of the future.

One proposal is to restrict access to the EU carbon market for non-EU financial players. Other proposals include taxes on certain transactions, minimum withholding periods to reduce short-term speculation and restrictions on financial positions. The goal is greater price stability, but policymakers will also seek to balance competing needs to meet climate targets by 2030, find the right price that promotes the carbon market, and don’t stifle industry with overly expensive regulation.

A translation of this article into Chinese will be available soon.

https://chinadialogue.net/en/climate/can-the-eu-and-china-align-their-carbon-markets/ Can the EU and China level their carbon markets?

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