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China is putting a price on carbon

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A price on carbon is crucial for China’s energy transition

China is on the verge of announcing its national carbon emissions trading system. Creating disincentives for carbon intensive energy production will be critical in China’s transition to a clean, green, and efficient energy system. The new national carbon emissions trading system creates a national carbon market and with it a carbon price, but in the short-term this will not be enough to bring down emissions. The analyses in the 2017 edition of the China Renewable Energy Outlook (CREO2017) from CNREC shows that a reasonable price on carbon will successfully bring down emissions from the energy sector in the medium to long-term. Other action is needed to quickly cut emissions and allow China to contribute to limiting global warming in line with the intent of the Paris agreement.

Carbon markets are playing a more central role

There are several emission rights trading systems in operation around the world, including China’s seven pilot programs. They encompass a range of valuable insights for China to make sure its national emission rights trading system will successfully achieve its purpose. Carbon markets are further expected to become an increasingly important tool worldwide. Most counties will use carbon markets to curb carbon emissions as they implement their national determined contributions towards the Paris agreement. The Paris agreement itself further supports international cooperation on carbon markets and allows for markets to be linked.

Supporting energy efficiency and renewable energy

Carbon markets can successfully support energy efficient practices and renewable energy development as increased energy efficiency and a high share of renewable energy can displace carbon intensive energy production. There are high societal costs associated with burning fossil fuels. A carbon market is one way of internalizing some of these costs and thus discourage use of fossil fuels. Higher costs for energy based on fossil fuels make renewable energy comparatively cheaper. This requires a significant carbon price. However, there is an imminent risk of declining carbon prices as a result of over allocation of emission credits. Since renewable energy development can be greatly affected by the carbon market, it is essential to make sure that renewable energy and carbon market policies are closely coordinated. It should be made sure that the carbon market supports energy efficiency and renewable energy development.

Limited short-term effects

In the initial phase, leading up to 2020, the national carbon market is expected to have a small influence on curbing carbon emissions. The carbon price is expected to be low, around 30-50 RMB/tCO2, based on experience from China’s seven carbon trading pilot projects. This would only account for about 0.2% of the coal power average on-grid tariff and thus only marginally influence coal power operations. Depending on allocation method, the coal power industry could even increase its profitability in the short-run. As a benchmark method is employed in allocation, this will benefit highly efficient coal power plants. However, the overall effect will be determined through combination with other effect, e.g. power sector reform, total power demand, and coal price.

In the medium term, from 2020 to 2030, the carbon price is expected to increase and for the national carbon market to play a central role in cutting China’s carbon emissions. For this to be true, the carbon price must be high enough to motivate the power industry to invest in a low-carbon power system. This is expected to be achieved with a carbon price around 100-200 RMB/tCO2. Between 2025 and 2030 the carbon price level, along with cost reductions, is expected to make wind and solar power competitive with coal, as shown in Figure 1.

New wind and solar compete with old coal

Carbon emitting activities have been free in the past. This has created an advantage for fossil fuels and need for renewable energy subsidies. Due to China’s coal power overcapacity, new wind and solar generation will compete with existing coal plants. This highlights the need for support for wind and solar to be cost competitive with coal power generation. As the carbon market matures, and emission control gets stricter, the carbon market could level the playing field for fossil and renewable power generation. The carbon market has the prospect for becoming a key driver for renewable energy development and replace the need for renewable energy subsidies in the medium to long-term.

This year’s CREO covers a number of policy actions and measures needed to enable a low-carbon energy system in China, including a specific chapter designated to analyzing the role of carbon markets. For more information please see Part 3 of CREO2017.

 

Author:Xiong Xiaoping and Sara Shapiro-Bengtsen