Carbon oversupply in China could cap price surcharges: INTERVIEW

An oversupply of emissions trading credits in China by more than 1.5 billion tonnes of carbon dioxide will likely cap carbon prices in the country, TransitionZero carbon analyst Matt Gray told Fastmarkets in an interview.

November 29, 2021

By Paul Lim

China kicked off an emissions trading scheme (ETS) on July 16, with the first phase of its carbon experiment centered on thermal coal-fired power plants. Other heavy industries such as steel, concrete and petrochemicals are likely to follow very soon.

“We found that China’s ETS was oversupplied by 1.56 billion tonnes of CO2 in 2019-2020, which means it is unlikely that trading will result in a high carbon price,” Gray said.

There is a large difference between explicit and implicit carbon prices in China and Europe, according to Gray.

“Carbon prices in the European Union [are] already trading at €60 [$69.58] per tonne, while China [they are] trading at $7 per tonne,” Gray said.

This is because China is offering generous free allocations of carbon credits, while Europe has no free allowances for power generation.

“We expect this gap to remain for the foreseeable future, as China experiments with carbon pricing and carbon markets. Without reform, carbon prices in China will likely remain under $10 per tonne,” Gray added.

The price comparison cannot be done with the United States, which only has carbon pricing in California, Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Virginia.

Differences between China and rest of world
Difference 1: China’s trading scheme hands out allowances to companies for free, rather than auctioning a portion as part of this initial phase. The first phase has been more of a trial phase, with more relaxed rules to secure buy-ins from companies. It is somewhat similar to the initial launch of the European ETS.

“Gradually, we would expect China to move away from free allocations, otherwise the scheme will have a marginal impact on decarbonization,” Gray said.

Difference 2: China’s ETS is based on carbon intensity benchmarks and focuses on reducing the carbon intensity of generation, while European, Californian and Canadian markets focus on absolute emissions.

Difference 3: China’s ETS uses a cap-and-trade model where a single industry-wide quota for emissions is allocated. Emitters can then opt to cap and then trade or buy allowances if they are below or exceed the quota.

Will ETS drive more restructuring toward electric-arc furnace-based steel production in Asia?

Electric-arc furnace (EAF)-based steel production accounts for around 30% of global steel production, but only 10% of steel production in China, 24% in Japan, 47% in South Korea and 38% in Taiwan, data from TransitionZero shows.

“However, it is widely understood that there is not enough recycled steel to meet growing demand. Currently, steel demand is being met through both the blast furnace/basic oxygen furnace and EAF production routes, all of which use recovered steel scrap. Decarbonizing the basic oxygen furnace-blast furnace (BOF-BF) production process will be key in order to meet global demand for steel, which is expected to keep growing,” Gray said.

This also means that the ETS is likely to drive a broader adoption of potential net-zero compatible end-state technologies for the BF-BOF route, Gray said.

“This may start by replacing or upgrading old installed capacity with the best available technology, to more long-term solutions like implementing abatement technologies like top gas recycling, carbon capture units and offsets,” he said.

The launch of Gujarat’s ETS will help to regulate emissions in India’s steel sector and shift the sector toward decarbonization early on, which is essential given how quickly India’s steel sector is growing.

“The adoption of net-zero compatible technologies such as replacing the current natural gas-based direct reduced iron-EAF route with hydrogen-based reductions, coupled with renewable hydrogen, offers deep emissions cuts, especially as around 60% of installed capacity in India uses EAFs. It also represents a unique opportunity for net-zero steel making in India, without the need for a significant contribution of other technologies, like offsets,” Gray said.

TransitionZero uses carbon analytics to provide information and insight to businesses. It counts ex-United States vice president Al Gore among its key backers.