China’s carbon trading market could net positive for investors

China’s carbon trading market could net positive for investors

This week, China announced plans to launch what will become the world’s largest carbon market in 2017. While this signals long-term optimism surrounding a more environmentally responsible China, the development still presents short-term economic risks.

China, the largest carbon polluter in the world, is now preparing to establish what will correspondingly become the world’s largest national carbon emissions trading market. 

As part of a bilateral effort with the United States that aims to establish leadership against climate change, China’s incoming carbon market stands as a force of global beneficence with opportunities for the taking — though risks still extant within imply not everyone will be a winner.

Source: Statista

The World’s Largest Cap-and-Trade Program

As is often the case with policy out of Beijing, the finer points of its incoming national carbon market are at present sparse.

In a joint statement with President Barack Obama — itself notable considering the tendency of the U.S. and China to justify environmental inaction with economic rivalry — President Xi Jinping stated that the market will launch in 2017 and encompass major polluting sectors such as “iron and steel, power generation, chemicals, building materials, paper-making, and nonferrous metals.”

Beyond that, details of how the market will be implemented have yet to be released, but the general mechanism through which it will operate can be assumed based on existing emissions trading programs.

As is characteristic of all carbon markets, Beijing’s initiative will impose a legal limit, or “cap,” on the amount of carbon emissions that companies will be able to produce each year. Chinese companies brought under this program will face significant fines if found producing more carbon emissions than allowed by the cap.

Companies will, however, also be permitted to sell their own unused emissions or buy those from other companies that use less than the allotted limit, giving Chinese companies a financial incentive to reduce emissions.

Short-term risks

With this in mind, China’s impending cap-and-trade program presents a handful of clear winners and losers — both political and economic — while also contributing to an overall positive global trend.

Of the most important and influential opportunities presented by Beijing’s 2017 carbon market is growth in the renewable energy industry. The newly imposed cost on carbon emissions that will come with a Chinese cap-and-trade program will force businesses within China to seek out greener technologies.

While some of this demand will be funneled into “cleaner” fossil fuels, a large proportion can also be expected to focus investment into renewables — resulting in progressive revenue boosts for both Chinese and international renewable companies alike.

The reverse side of this impact will be an unavoidable decline, already underway, in Chinese commodity demand. As the world’s largest consumer of natural resources, any reduction in Chinese commodity imports will have clear global repercussions. In particular, the already declining coal industry — in which China is responsible for 47% of global consumption — will face accelerated loses from 2017 onward as Chinese companies are suddenly impelled to look elsewhere for energy.

Furthermore, all Chinese industries set to comprise the cap-and-trade market will face either short-term declines in output or losses in revenue while both they and the energy sector adapt to newly imposed emissions restrictions.

When combined with China’s currently slowing economy, the more immediate impacts of the new carbon market could set off the kind of market volatility first seen in Beijing this past July, breeding instability in markets worldwide.

Source: Business Insider

Long-term gains

Yet, these risks may be offset by more notable opportunities for China in the long-term. According to the World Bank, Chinese pollution-caused illnesses and premature deaths cost the country approximately $100 billion per year in 2007 — over 3% of GDP — and China’s emissions have risen dramatically in the years since.

This means that the emission reductions to come will benefit the health of Chinese citizens, and subsequently, the economy — though the scale of such an impact will depend on yet-to-be announced details regarding the strictness of the program.

If the EU cap-and-trade program is any indicator, China’s subsequent carbon market will bring economically meaningful gains and losses. The European Commission estimates that industries ushered into its own carbon market saw a reduction in greenhouse gas emissions of roughly 3% in 2013.

Considering the 1.2 billion tons of CO2 emissions from the Chinese iron and steel industry alone, an equivalently capped and regulated carbon market would reduce the sector’s CO2 emissions by 36 million tons per year — roughly equivalent to the annual carbon footprint of Hong Kong. Thus, when imagined across all Chinese sectors likely to be included in the program, the influence of a national carbon market becomes visibly consequential.

Global ramifications

Looking abroad, the announcement of China’s carbon market initiative may present risks well before its 2017 implementation.

For one, U.S. leadership will likely now be overshadowed in the run-up to the upcoming Paris Summit this November, tasked with creating a universal agreement on climate change. Environmentalism is a facet of foreign affairs where President Obama would seem inclined to assume the mantle of leadership and fortify American prestige abroad, but the failure of the U.S. Congress to adopt a similar cap-and-trade program may make China appear like a more capable and willing leader, while Washington remains all-talk and little-show.

It is unclear how other major developing countries such as India and Brazil will be impacted. Both countries may benefit relative to China in terms of growth, as Indian and Brazilian industry will continue on unhindered in contrast to their “capped” counterparts in China.

On the other hand, China’s plunge into emissions restrictions might lead to international pressure forcing New Delhi and Brazil into national carbon markets earlier than originally anticipated.

The likelihood and magnitude of these developments is reliant on the substantive details of China’s cap-and-trade commitment. Such details are unlikely to surface until the November summit in Paris, if not later — and the question also remains as to whether such a complex endeavour will even succeed.

In spite of these uncertainties, it is nonetheless clear that the incoming Chinese carbon market evokes optimism in the long-term global outlook while concurrently creating numerous short-term winners and losers along the way.

Categories: Asia Pacific, Economics

About Author

Ian Armstrong

Ian Armstrong is Commissioning Editor and Senior Analyst at GRI. He also serves as the Geostrategy and Diplomacy Fellow at Young Professionals in Foreign Policy. Previously, Ian assisted in research at Temple University, the University of Pennsylvania, Scottish Parliament, and Hudson Institute's Center for Political-Military Analysis, where he has focused on non-proliferation and international energy. Ian's analysis has been featured at prominent outlets such as Huffington Post, Business Insider, Foreign Policy Association, CBS News, and RealClearEnergy.