China's National Carbon Market - what to expect

In brief

China will soon have the world's largest emissions trading scheme (ETS), according to announcements made late last year by China's state planning agency, the National Development and Reform Commission (NDRC). According to the NDRC, China's national ETS will be operating by 2020 and it will initially cover the power sector only. Partner Jillian Button and Associate Shona Shang report on the key aspects.

Background

China's long-awaiting national ETS is an important step by the Chinese Government to meet its commitment under the Paris Agreement to reduce its carbon dioxide emissions. Since 2011, China has launched seven ETS pilot programs in two cities and five provinces.¹ By the end of November 2017, the total volume of units traded across these ETS pilot programs reached 200 million tonnes CO2 equivalent.² According to the NRDC, these pilot programs have furnished the Chinese Government with data and experience that will be drawn upon as it prepares to launch the national ETS.

Key elements of the Chinese ETS

Industry coverage

Unlike the pilot ETS programs, which cover several major high-emission industries selected by each pilot city or province, the national ETS will initially cover only the power sector. This is because the power sector generates a large volume of carbon emissions, and the NDRC was able to collect relatively complete data on this sector through the pilot programs, which provides a strong statistical foundation for a nationwide launch and test.

Based on the information released by the NDRC, the threshold for coverage by the national ETS will be 26,000 tonnes CO2 equivalent per year of direct or 'Scope 1' emissions. The scheme will affect approximately 1700 enterprises with annual emissions of over 3 billion tonnes CO2 equivalent in total. Despite covering just one sector, China's national ETS will overtake the EU's carbon market and become the world's largest.

The Chinese Government has also indicated that it intends to gradually reduce the liability threshold with an eye to including more enterprises in the trading scheme over time.

Obligations of liable entities

The national ETS will be designed to operate as a 'cap and trade' scheme. Participants will be required to either limit their emissions to avoid exceeding an allocated annual emissions limit, or (to the extent that their annual emissions exceed the allocated emissions limit), to purchase extra carbon units on the market for excess emissions.

The annual emissions limits, the overall sector emissions cap, and trading rules are yet to be released by the central government.

Timeline to a fully operative national ETS

Although the exact launch date of the national ETS is not clear, the NRDC has indicated that the ETS will be launched in three stages:

• Stage 1 – preliminary construction period, which is expected to take about one year. This stage will focus on the construction and testing of relevant systems, such as the registry system and trading system. Meanwhile, the relevant framework for the management of the national ETS is intended to be developed and made into law.
• Stage 2 – simulation operation period, which is expected to take a further year. During this stage, the national ETS will run in a simulative mode. The NRDC has indicated that the legal framework for the national ETS will be further improved during this period.
• Stage 3 – improving period, which will be the final stage during which participants will be able to trade in the national ETS market.³ 

The pilot ETS market will continue to run in parallel with the national ETS until the fully operative national ETS is in place. A mechanism for pilot participants to transfer to the national ETS will also be established to assist organisations to transition into it.

What to expect

Although a fully operative national ETS is not expected to be in place until 2020, the NRDC has set an ambitious timetable for preparatory steps, and details in relation to the legal structure of the ETS will continue to emerge in the intervening period. Enterprises participating in, or intending to participate in China's national ETS should watch these developments closely and, where appropriate, make submissions in connection with the development of the ETS. 

Consideration should also be given in the interim to the potential impact of an ETS on transactions and projects currently being contemplated, where these involve the Chinese power sector.