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China’s national carbon market hits a roadblock with low liquidity, weak data quality
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.
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.
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.
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.
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