On 26 March, China’s Ministry of Ecology and Environment (MEE) issued the official work plan for expanding the scope of its national ETS to include cement, steel and electrolytic aluminium. Largely adopting the draft scope expansion plan released in September last year, this final version sets a timeline consistent with the one on which Veyt’s initial demand-supply forecast is based. It reiterates that implementation of the scope expansion will take place in two phases: 2024-2026 is a start-up period, while 2027 and beyond constitutes a “deepening and improving” stage. Figure 1 below shows the timeline for China’s ETS, with the lastest update from the final work plan.
Source: Veyt’s analysis
Similar to the work plan draft, direct emissions from carbon dioxide (CO2) will be regulated from the cement and steel sectors. For electrolytic aluminium, emissions from carbon tetrafluoride (CF4) and carbon hexafluoride (C2F6) will also be regulated.
The inclusion threshold lies at 26 thousand tonnes of carbon dioxide equivalent annually, meaning companies that emit that amount or more are subject to limits on their emissions per unit of output. Those currently already covered by one of China’s regional pilot ETS will be regulated by the national ETS instead.
Chinese regulators maintain previous estimates that the scope expansion will add about 1500 entities to the 2096 power generators already covered by the program. The newly-covered entities currently emit about three billion tonnes CO2 equivalent collectively per year. About 60% of China’s total emissions will be covered following the initial scope expansion.
The September draft had been vague on the nature of compliance for emitters in the newly-included sectors – it mentioned new entities fulfilling their ‘compliance work’ by the end of 2025. The official plan, however, clarifies that 2024 allowances for newly-covered entities would be equal to their actual verified emissions per unit of output. This reflects the earlier statements by environment ministry officials that companies new to the ETS would not have to buy allowances to comply. That in turn means that the scope expansion achieves no emission intensity reduction from the newly included sectors for the year 2024 at least. In official statements, the ministry explained that this is because it prioritises giving entities time to get familiar with emission accounting, verification and market trading rules.
As of 2025-2026, however, newly included emitters will not be given enough allowances to fulfill their compliance obligation – they will receive an allocation “based on the idea of carbon emission intensity control” with the number of allowances they receive being “linked to production output.” This means that a benchmarking approach will be applied to the new sectors from the next compliance cycle (starting from 2026), such that the amount of allowances allocated to each covered emitter will depend on its actual production volume. This is different from the ‘performance evaluation method’ mentioned in the September draft, which was thought to mean the grandfathering allocation method used in China’s regional ETS pilots.
The fact that 2024 allowances for the three new sectors will be exactly equal to their 2024 emissions means the ETS is not “doing its job” of incentivising carbon intensity reduction in steel, cement, and aluminium manufacturing. However, at least it does not make for a surplus of allowances as did the over-allocation to China’s power sector during the first compliance period. In fact, the official plan specifies regulators are trying to avoid oversupply by stating that allowance surplus will be ‘reasonably controlled.’
China has delayed expanding the scope of its national ETS several times despite the original plan for the ETS back in 2016 stating that it would begin with the power sector and grow to include eight other sectors over time. The delays were due to concerns about availability of data and about the power sector’s oversupply issue repeating itself with have with these new sectors. Potential negative trade impacts from Europe’s Carbon Border Adjustment Mechanism (CBAM) may have been the impetus for nevertheless moving forward with scope expansion. Data constraints related to emission reporting and verification in the new sectors, however, make it hard for the government to adopt a benchmarking approach for allocation at this stage – hence the lack of actual targets for the newly included emitters during start-up phase (2024-2026).
The official work plan says that during this period, surplus volume and allowance shortfall will be ‘reasonably determined, so that the overall allowance profit and loss of the industry is basically balanced.” Only from 2027 will a mechanism for decreasing allowance supply based on gradually tightening benchmarks be introduced. While the work plan does not provide further elaboration on this mechanism, it does not appear to refer to a Market Stability Reserve (MSR) – like mechanism. As allowances are determined ex-post, there is no immediate need for China to introduce any MSR-like mechanism.
Tight emission intensity thresholds on the newly included sectors would make for a bullish price trajectory for allowances in the national ETS (China Emissions Allowances- CEAs), so the final workplan could have a bearish impact on Chinese carbon prices in our view. However, market participants were not expecting the Chinese government to throttle emissions per output in these critical manufacturing sectors anytime soon, so the bearish effect of lax targets on prices is limited.
Over the last one month, CEA prices consistently closed below CNY 90/t (EUR 11.5/t). CEA prices may continue their slight bearish trend in the short term, likely ranging within CNY 80-85/t (EUR 10-11/t) in the coming weeks.
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