China’s recently launched emissions trading system (ETS) is not doing enough to incentivise power generators to reduce their emissions, according to consultancy Wood Mackenzie.

China launched the world’s largest emissions trading scheme in July this year, with the initial phase of the ETS limited to emissions of power companies, with other polluting sectors such as steel and cement expected to be added in future cycles.

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The ETS sets a carbon emission quota by issuing tradeable allowances – the China Emission Allowance (CEA) – to power plants.

According to data from Wood Mackenzie, CEAs have been traded at an average price of 50.5 yuan ($7.81) per tonne of carbon dioxide equivalent.

As a result, it claimed the carbon cost accounted for only 0.5% to 0.7% of annual generation costs for a typical coal-fired plant with two 300-megawatt units, assuming generation costs ranging between 0.3 yuan and 0.45 yuan per kilowatt hour.

“Carbon prices at these levels are unlikely to incentivise generators to improve emission intensity through fuel efficiency, never mind switch to renewables,” Wood Mackenzie senior economist Yanting Zhou said.

Instead, Wood Mackenzie estimates prices need to range between $100 and $160 per tonne of CO2e in order to comply with the Paris Agreement, with Zhou noting that carbon prices in Europe were also currently only trading at about €55 (US$65.14) per tonne of CO2e.

“In the short term, we expect carbon prices determined by the ETS to remain low as the Chinese government intends to minimise the impact on power costs and economic growth,” Zhou added.

“Establishing the market lays the foundations for the government to lower the cap on total CEA issuance and achieve higher carbon prices. Only then will there be a material impact on carbon emissions.”

Policies could prove effective, but at a cost

Zhou believes policies to control carbon emissions from the industrial sector could prove more effective than the carbon market, for now, but added China would need to bear short term pain to its economic growth as a result.

China’s National Development and Reform Commission has ordered the steel industry to limit crude steel production this year, however the industry produced 563 million tonnes of crude steel in the first half of the year, a 12% year-on-year increase, according to Wood Mackenzie.

This means a steep cut in production will be needed in the second half of the year to meet the annual target, which Wood Mackenzie notes could have a tangible negative economic impact, dragging on gross domestic profit and stoking inflation.

The consultancy also highlighted slashed export quotas for refined fuels, while the tax rebate for exports of steel products was also cancelled from 1 August, resulting in excess domestic capacity in the oil refining and steelmaking industries.

While Wood Mackenzie believes limiting exports will help these industries to meet emission targets, it will also likely result in increased domestic competition and the erosion of margins.

“The pace of change is critical. Rapid adjustments to achieve emission goals quickly will inflict higher economic costs than gradual transition,” Zhou said.

“China’s policy structure and track record points to faster transition than expected, as local governments tend to set more ambitious targets than the national goals. China is laying the foundations for energy transition but to minimise the economic costs, it needs to expedite the shift from government intervention to market forces.”

China is currently the world’s largest emitter of greenhouse gases, but it has set climate goals of reaching peak CO2 emissions by 2030 on its path to carbon neutrality by 2060.