The problem with China’s new carbon trading market

China is still investing heavily in coal, despite high-level promises to fight climate change.
China is still investing heavily in coal, despite high-level promises to fight climate change.
Image: REUTERS/Thomas Peter
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China, the world’s top greenhouse gas emitter, also boasts one of the world’s most ambitious long-term climate goals. President Xi Jinping vowed last Sept. that the country would reach net-zero emissions by 2060. Given the scale of the country’s economy and its world-leading reliance on coal, it has no time to lose. So far, it’s not off to a good start.

On Jan. 29, environmental investigators in China’s central government published an unusually pointed public critique of their colleagues in the country’s energy planning agency. The tiff was over coal-fired electricity, the country’s main source of both power and pollution. The country’s Central Environmental Inspection Team, personally created by Xi in 2015 to sniff out climate malfeasance, accused the energy planning agency of “failing to strictly control the excess coal power capacity,” and blamed its “deteriorated political ecology” (an allusion to corruption) for the ongoing authorization of new coal power plants and mines near Beijing and in several highly-polluted industrial areas that should have been targeted for clean energy and air clean-up efforts. The country, which already consumes half the world’s coal, now has plans to add 250 GW of new coal power capacity, more than the entire installed coal capacity of the US.

Just a few days later, the country launched a carbon emissions trading market that had been grinding through the bureaucratic works since 2011. The market covers just 2,200 coal- and gas-fired power plants comprising most of the country’s power sector producing about half of its total carbon footprint. In theory, the market will force inefficient plants to buy pollution permits from more efficient ones, creating an incentive to cut carbon. But since it was opened, outside economists have called the plan toothless because an over-allocation of permits means carbon prices are too low to matter.

Even the country’s lofty climate ambitions likely don’t go far enough. China’s 2060 net-zero goal (and its interim 2030 goal to reach peak emissions) is “highly insufficient” to meet global warming targets enshrined in the Paris Agreement, according to Climate Action Tracker, a research group.

China is running out of time to alter course. The next phase of the country’s climate plan will be finalized next month as part of its latest five-year plan, the policy document that dictates the country’s near-term economic strategy. President Xi Jinping’s recent public statements on climate suggest he is keen to look like an international leader on decarbonization even as pressure builds to act domestically on pollution. Some promising signs exist, such as a $28 billion clean energy stimulus spending during the pandemic.

But Lauri Myllyvirta, a senior China analyst at the Centre for Research on Energy and Clean Air, a research organization, says the country has not yet hit the brakes on its fossil fuel economy.  ”The question has been how fast are they prepared to turn the ship,” he said. “And the country is absolutely is not on track.”

China’s coal economy makes it hard to change

China’s export-driven economy has always been powered primarily by coal. The country pursued decades of rapid industrialization with little concern for air pollution or climate change.

“They have to address years of environmental degradation,” said Rebecca Nadin, director of global risks and resilience at the Overseas Development Institute. “Under Deng Xiaoping, it was develop first and clean up later.”

That ethos has changed over the last decade or so, she said, in response to public outrage over dismal air quality and leaders’ desire to dominate the global clean energy market. Today, China is the world’s top producer and consumer of electric vehicles and solar panels. From 2010 to 2019, it invested $758 billion in renewable energy, according to the UN. In that time, it cut its rate of emissions per unit of GDP in half, according to the World Resources Institute.

But while China’s carbon emissions dropped off during the height of lockdowns in early 2020 like most countries, by May, they were already back to pre-pandemic levels.  The early resurgence of industrial activity meant by the end of the year, China was the only country to see its emissions grow compared to 2019.

As China continues its growth, it will be no small task to phase out thousands of carbon-intensive power plants and factories.

The country is still responsible for 28% of global emissions, and there are a number of structural features of the economy that are still pointed in the wrong direction, Nadin said. China remains the world’s top provider of subsidies to the fossil fuel industry, at $134 billion per year, mostly for coal. If all of the coal projects currently under development come to fruition, they would emit as much during their lifetime as the country’s total carbon footprint today. The country’s fleet of existing coal plants is already relatively young, which is a problem given that it needs to completely eliminate coal from the energy mix by 2040 in order to be in line with the Paris targets.

Meanwhile, the country is phasing out some tax incentives for renewables, and new wind and solar additions peaked a few years ago despite the fact that the total capacity of renewables needs to more than double by 2030 for the country to be on track. China also remains the world’s top financier of coal projects in developing countries; the country backs one-quarter of all coal projects currently under development outside its borders.

The pandemic isn’t helping either: China’s traditional method to boost its economy is to build infrastructure, Nadin said. The factories that produce steel, cement, and other raw construction materials are useful for fighting unemployment, but are also major sources of emissions (China alone is responsible for 60% of global emissions from the steel industry). And provincial governments often pay for infrastructure projects by selling land on their fringes to developers, which, combined with a general trend of rural-to-urban migration, leads to unsustainable urban sprawl.

How China can fix its approach to climate change

The new carbon emissions market seems unlikely to help. Pollution permits are allocated to power plants based on how much electricity the plant produces, and how its emissions compare to a state-determined efficiency benchmark. The current coal efficiency benchmark is so low that most big plants, which tend to be more efficient, already meet it, according to Morgan Stanley analysts. For many of these, the marginal cost of carbon pollution will be zero. If they have excess permits to sell to smaller, less efficient plants, they could effectively be paid to pollute. And because coal and gas plants are judged differently, there’s no incentive to switch from the former to the latter.

But some puzzle pieces are falling into place. Within China’s energy-related pandemic stimulus spending, 67%, some $28 billion, is directed toward clean energy. Much more spending is in store: The government estimates that meeting its 2060 net-zero target will cost $14.7 trillion. On Feb. 11, the same energy agency that was excoriated by environmental inspectors said that it wants to boost the share of zero-carbon electricity in the country’s mix from 28% today (mostly hydropower) to 40% by 2030. Meanwhile, state-owned enterprises, which make up most of the industrial sector, are feeling increased political pressure to set climate goals for the first time.

“Some of the oldest and least efficient of these are starting to talk about getting to net zero, and it’s directly because Xi made that [2060] pledge,” said Han Chen, manager of international energy policy at the Natural Resources Defense Council.

The biggest test will be the 14th five-year plan, due to be finalized in March, which Chen called “the most consequential thing to happen in the next year for the global climate.” The plan, which is the backbone of the country’s near-term economic strategy, is likely to include new guidance on climate issues. “They’re starting to take a more holistic view rather than not just building more coal plants,” Nadin said.

Some things China watchers expect to see in the plan include an accelerated timeline for decarbonization, a hard deadline for peak coal consumption, new pollution regulations and net-zero targets for more state-run industries, expanded coverage of the emissions market, and possibly even the cancellation some planned coal plants. Whatever is included in the plan will likely also be reiterated when China submits a new commitment under the Paris Agreement ahead of the next global climate summit in November.

Climate will be a key point of engagement between Xi and the Biden administration in the US. In their first phone call, on Feb. 10, the leaders agreed on the need to cooperate on climate action, according to a White House summary, compared to more contentious issues like China’s military aggression toward Taiwan or human rights crackdowns on the mainland and in Hong Kong. China’s newly appointed climate envoy, Xie Zhenhua, is a climate diplomacy veteran who is already close to his US counterpart, John Kerry.

Those discussions won’t be credible unless China can step up its pressure on coal. Given the country’s incremental progress on emissions in the last decade, and its deep economic interests in a carbon-free energy, there’s reason to be optimistic about the year ahead. “It’s a very big ship to turn,” Nadin said. “But that’s not to say things aren’t moving in the right direction.”