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Liquidity shriveled in China's national emissions trading scheme
(ETS), the world's largest carbon market by the amount of emissions
covered, in the first quarter of 2022 amid policy uncertainty and
data integrity issues.
After spiking to 136 million metric tons (mt) of CO2e traded in
December when the first compliance cycle ended, volume in China
Emissions Allowances (CEAs) collapsed to 7.86 million mt in
January, 1.67 million mt in February, and 709,000 mt in March,
according to market operator Shanghai Environment and Energy
Exchange.
Market participants have largely remained on the sidelines in
recent months as the Chinese government has yet to finalize the
timeframe, allowance allocation plans, and financial and tax
treatment methods for the second compliance period.
"Key policies … have still not been officially issued. The
emission control enterprises nationwide are unable to confirm the
quantity of their own trading demand and trading decisions," said
Luyue Tan, a carbon analyst at Refinitiv.
Observers said Chinese authorities could want to improve data
integrity before developing the trading scheme further, with a
series of cases of negligence and fraud in emissions reporting in
recent months.
Some companies underreported their emissions to avoid penalties,
according to government officials, and
third-party verifiers were unable to provide final checks because
they either intentionally helped falsify the data or did not
perform their duties properly due to a lack of competence.
In March, the Ministry of Ecology and Environment named and
shamed four private consultancies—Zhongtan Nengtou Tech,
SinoCarbon Innovation & Investment, Qingdao Xinuo Renewable,
and the Liaoning Dongmei Testing and Analysis Research
Institute—for failing to accurately measure and report
emissions data.
"Data integrity is the lifeline of environment management. This
is a matter of science-based market fairness and the government's
credibility," ministry spokesman Liu Youbin said during a press briefing.
At a meeting held by the National Development and Reform
Commission earlier in April, government officials reiterated
that the ETS is an important tool for achieving China's targets of
peak CO2 emissions by 2030 and carbon neutrality by 2060 and that
"data is the foundation for trade development."
"Strengthening carbon emission data quality supervision has
become the primary task" of the Chinese government, Tan said.
Coal issues
The ETS currently covers some 2,000 Chinese utilities that
reported at least 26,000 mt/year of CO2 for any calendar year from
2013 through 2019, which accounted for 40% of the emissions from
China, the world's largest GHG emitter.
Coal, the most carbon-intensive fuel, accounts for over 60% of
China's power generation, and most data integrity issues have been
linked to coal-fired plants.
"The reasons behind the falsification could be highly
individual-specific, but we did find that in most cases the problem
seems to be related to the measurement of coal carbon content,"
said Xiaonan Feng, an ENR senior research analyst at S&P Global
Commodity Insights.
Chinese reporting rules require power generators to measure the
carbon content in the coal they use consecutively on a daily or
monthly basis. In cases where no measurement was carried out, or if
the measurement failed to meet technical requirements, the emitters
must apply a default value of 0.03356tC/GJ. This is about 20%
higher than a typical coal slate.
"Using this value to calculate emissions will lead to
overestimation and large allowance deficits. This gives some
emitters perverse incentives to falsify the measurement
data/documents rather than resort to the higher punitive value,"
Feng told Net-Zero Business Daily, also part of S&P
Global.
Strong incentives
The government has only imposed small fines on misreporting
emitters during the ETS' initial stage, and many believe this
provides strong incentives to rogue players to fabricate data.
For now, those companies only face fines of CNY 10,000-CNY
30,000 ($1,509-$4,527) under the Measures for the Administration of
Carbon Emissions Trading (for Trial Implementation) and fines of
CNY 10,000-CNY 100,000 under the Administrative Measures for the
Disclosure of Environmental Information of Companies.
This means Chinese coal-fired power plants—each of which can
often emit millions of mt of CO2 per year—can earn a handsome
sum from underreporting as CEAs trade around CNY 60.
There are no clear regulations that can punish third-party data
verification agencies, and the environment ministry has promised to
work with the Ministry of Justice in addressing this in the Interim
Regulations for Carbon Emissions Trading.
"We are looking forward to the top document … The punishment so
far is insufficient," Liu said.
High-level regulation has been under discussion for a number of
quarters, but the Chinese government appears to be having
difficulty in determining how harshly the players at fault should
be punished. This is likely due to concerns about killing the
fledging industry for carbon monitoring, reporting, and
verification (MRV).
According to government-run China Environment Newspaper
Agency, verification rates can be as low as CNY 18,500-19,000
per item, and some consultants are quitting the trade amid
increasing regulatory requirements and risks.
SinoCarbon, one of the companies
named by the government for data integrity issues, said it supports
tougher regulations but admitted it "had trouble finding enough
staffers" when verifying emissions data.
Slowdown in ETS development
Beijing has announced several proposals to enhance
its ETS, but market players might need to wait some time for their
implementation.
While the market is supposed to expand to cover the building
materials, nonferrous metals, and refining and petrochemicals
sectors in the next stage, analysts said the government could take
it slow amid inflation and macroeconomic worries.
"The pace of inclusion of other sectors will largely depend on
the readiness of sectoral allowance allocation plans and MRV
guidelines, as well as the government's broader consideration to
balance emissions control with economic growth," Feng said.
There are also expectations that Beijing will not introduce
options and futures trading and allow financial institutions to
participate in the ETS before data quality improves. Currently,
power plants are the only players in the market.
Zhang Xiliang, director of the Institute of Energy, Environment
and Economy, Tsinghua University, seen by some as the ETS' chief
architect, recently told state-owned CCTV that the timing is not
ripe to usher in futures and options in China due to low liquidity
and a lack of a comprehensive legal framework.
"We expect the government to solve the data integrity issues
before initiating more changes to the ETS," Tan said.
Posted 29 April 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.