Why is China's carbon price at a new high? Carbon discussion

In the past month, the national carbon market has shown a trend of "rising volume and price".

According to data released by trading institution Shanghai Environment and Energy Exchange, the national carbon market recorded a closing price of 70.07 yuan / ton on August 15, breaking through the 70 yuan / ton mark for the first time. Since then, the closing price has remained above 70 yuan / ton for many trading days, and on August 23, it hit a record high of 74.76 yuan / ton at the closing price of 74.76 yuan / ton.

Volume figures are also worth paying attention to. According to the above disclosure, the trading volume on August 17-18, August 25 and other days exceeded the order of one million tons.

According to the 2022 China Carbon Price Survey Report released by the consulting body ICF, the (potential) participants in the national carbon market are expected to be bullish on the carbon price of China's national carbon market in the long run.

Will this round of high carbon prices be the starting point for market expectations to be realized?

Does it reflect the real supply and demand relationship or is it a big order pull?

China's national carbon market, officially launched in July 2021, currently includes more than 2,000 power generation companies and captive power plants in other industries, covering about 40% of China's carbon emissions. The national carbon market is a two-year cycle, and the second cycle of compliance is now at the beginning of the compliance period.

Compared with the first compliance period in 2021, the trading peak of this round of compliance period came earlier.

On August 28, the Ministry of Ecology and Environment said at a press conference that the issuance and implementation of quotas for 2021-2022 have recently started. China Huadian Group announced that it will take the lead in clearing carbon emission allowances on August 9.

Song Yutong, an analyst at the carbon research group of the London Stock Exchange Group, told Interface News that the quotas for the first compliance period only began to be issued around October 2021, but this year's quotas were issued much earlier than that point, so companies have "goods" in their hands in the near future.

Refinitiv tracks that carbon prices have shown a trend of rising volume and price since June this year. By August, carbon prices were rising amid volatility, either due to multiple factors.

The trading price and volume of the national carbon market from August 2021 to August 2023. Image source: Refinitiv

On July 17, the Ministry of Ecology and Environment issued a notice stating that the quotas held by emission control enterprises for the first compliance cycle (2019-2020) can be used for the second compliance cycle (2021-2022).

The Center for Sustainable Development of Fudan University said at the launch of the carbon price index held on August 29 that this policy dispelled the market's doubts that retained quotas could not be carried over, and quota holders intensified their reluctance to sell, resulting in a decrease in market supply.

At the same time, the demand for quotas in other companies has not decreased in tandem. Song Yutong mentioned that the notice issued by the Ministry of Ecology and Environment on March 16 this year helped to increase the enthusiasm of enterprises to participate in transactions. The notice requires all provincial-level ecological and environmental authorities to organize emission control units to complete the current round of quota clearance as soon as possible, to ensure that 95% of key emitting enterprises in their respective administrative regions complete compliance by November 15 this year, and all units complete compliance by December 31.

Another voice believes that the current higher carbon price is caused by the increase of individual large orders. Huw Slater, an energy and climate expert at ClientEarth, told Interface News that the high carbon price and trading volume may be driven by individual transactions with large tons of transactions, rather than a large number of small transactions.

At present, there are two main trading modes in the national carbon market: listing agreement trading and block agreement trading.

Among them, the listing agreement transaction is online transaction; Block agreement transactions are bilateral over-the-counter transactions that only need to be cleared in the trading system at the end of each trading day, and some large power generation group subsidiaries choose this trading method when transferring carbon allowances internally. The price information published by the Shanghai Environment and Energy Exchange is usually the transaction price of the listing agreement.

Another industry observer told Interface News that usually listed transactions are more likely to be real market transactions, but it is not ruled out that there will be "pull-up" situations, because the scale of listed transactions is usually limited, and "it does not cost a lot of money" to drive the price.

Long-term liquidity dilemma

"Liquidity in the national carbon market remains low." Huw Slater told Interface News.

The national carbon market currently implements a system of free quotas for the power generation industry. In terms of total volume, there is no shortage of quotas in the market. According to the model of the Refinitiv Carbon Research Group, during the first compliance period from 2019 to 2020, the national carbon market included about 8.68 billion tons of carbon emissions, and issued about 9.01 billion tons of allowances, with a total of about 330 million tons of excess allowances.

The problem lies in the reluctance of some companies to sell.

Huw Slater believes that the low willingness of market players to trade is related to the many uncertainties currently facing the national carbon market, such as whether the allocation of allowances will change in the next few years, and whether other industries will soon be included in the market.

Song Yutong pointed out that some companies are bullish on carbon allowance prices and hope to hold them for a long time. In addition, a major variable this year is that some companies may choose to wait for new CCERS to enter the market to save compliance costs, as issuance of certified voluntary emission reductions (CCER) is expected to resume this year.

On August 24, 2023, the Shanghai Environment and Energy Exchange issued a notice that the national carbon emission trading system will mark the year in which carbon allowances are issued from August 28, that is, there are "carbon emission allowances 19-20", "carbon emission allowances 21" and "carbon emission allowances 22" in the trading system.

Song Yutong said that this move may lead some companies to speculate that the validity period of carbon allowances in different years in the future may be limited, such as the allowances surplus in the first compliance period will be restricted when used for settlement during subsequent compliance periods, and choose to sell carbon allowances.

So far, the Ministry of Ecology and Environment has not announced a policy similar to the above. According to Caijing, a person close to carbon market policymakers recently revealed that the allowance carry-over policy is currently being studied and expected to be released soon.

Song Yutong reminded that without any clear policy to limit it, the addition of carbon quotas to year labels will affect the price of allowances in different years to a certain extent, but the price difference will not be too large.

According to the market released by the Shanghai Environment and Energy Exchange, on August 29, the trading price and trading volume of carbon quota listing agreements in the three years were comparable; On August 30, the trading volume of carbon emission allowance 19-20 was much lower than that of carbon emission allowance 20 and 22, and its closing price was relatively low.

Another way to address the liquidity dilemma is to tighten the number of free quotas.

Although the Ministry of Ecology and Environment has tightened the carbon emission baseline for this cycle in the Implementation Plan for Setting and Distributing the Total Amount of National Carbon Emission Trading Allowances in 2021 and 2022 (Power Generation Industry), two different carbon price surveys show that the current carbon market benchmark value may not be set enough.

The baseline method is a method of calculating the amount of carbon emission allowances, which calculates the number of allowances that should be issued to an enterprise based on the actual output value of the enterprise with reference to the emission benchmark value of the industry.

On the one hand, the 2023 Refinitiv Carbon Market Survey released by Refinitiv shows that respondents believe that the above stricter baseline is likely to be insufficient to solve the current problem of over-quotas.

On the other hand, ICF's 2022 China Carbon Price Survey shows that 48% of respondents believe that carbon emissions trading in 2023 has little or no impact on companies' investment decisions. "The reason behind this is that some respondents said that the allocation standards for free allowances in the national carbon market are still relatively relaxed, and enterprises pay a certain cost, but the actual pressure to reduce emissions is not large." Huw Slater points out.

Respondents gave different answers to long-term expectations in the survey. They expect that in the future, the implementation of the dual carbon policy and the benchmark value of carbon emission quotas will become stricter, and at the same time, carbon prices will rise steadily.