Decarbonizing, the Chinese way

Leveraging the strengths of State-owned enterprises to foster the country's nascent emissions trading scheme

China, the world's largest carbon emitter, officially launched its national emissions trading scheme on July 16, 2021, marking a significant step toward peaking carbon emissions before 2030 and achieving carbon neutrality before 2060, a pledge President Xi Jinping made in September 2020.

The ETS allows companies that are covered under it to trade their emissions permits and incentivizes emissions abatement activities where the cost is the lowest. Companies that face higher costs to reduce their own emissions can purchase permits either from companies with surpluses or from an "offsets" market that is connected to the ETS.

The ETS arrangement will encourage companies with lower abatement costs to reduce their emissions so that they can sell surplus permits for revenue. Consequently, the ETS is expected to help industries with high emission to upgrade production technology, increase the share of non-fossil energy consumption, and enhance low-carbon research and development capacity. The offsets market, which grants emissions reduction activities, such as afforestation and forest management, can also promote the increase of carbon sinks in the ecosystem.

Compared to the ETS design in developed regions, such as the European Union ETS and the California ETS, China's national ETS needs to incorporate China's own characteristics in its design. One of its prominent features is that it initially only covers the thermal power sector. Once the system matures, it is expected to expand to other major emissions-intensive industries, including iron and steel, cement, aluminum, and so on. The successful operation of the ETS in the thermal power sector is critical for a full-fledged ETS in the future.

China's thermal power sector is responsible for about 4.5 billion metric tons of carbon dioxide emissions annually, accounting for about 40 percent of the country's total CO2 emissions. State-owned enterprises are dominant players in the power sector. More than 70 percent of power generation is from the SOEs, and the five largest State-owned power generation companies alone hold more than half of the total coal-fired generation capacity assets. Therefore, the ETS should leverage the strengths of these SOEs in the power sector.

First, SOEs can help set up high standards in emissions reporting and permit compliance, as they represent public interests and hold intrinsic values for fulfilling social responsibilities. As stated by the State-owned Assets Supervision and Administration Commission, the central government body responsible for supervising SOEs, the latter are required to "earnestly fulfill corporate social responsibilities to realize the coordinated and sustainable development of enterprises, society and environment in all respects".

When participating in the ETS, SOEs can help establish a norm of accurately reporting and disclosing their emissions data and submitting adequate permits for compliance, laying a solid foundation for a healthy ETS.

Second, SOEs are well-positioned to make long-term investments critical for decarbonizing the power system with the carbon price signal from the ETS. Compared to private investors, SOEs have a higher tolerance for projects with longer payback periods, which are common in the field of investment in low-carbon industries. A prime example is the China Three Gorges Dam project. It involved enormous investment and years of construction. However once built, its long-term profitability and social benefits have been proved. After the dam was built, China Three Gorges Corp successfully replicated the model and built four additional 10 gigawatt-level hydropower plants. Similarly, SOEs have played pivotal roles in building nuclear power plants, large-scale renewable energy bases, and long-distance transmission lines, all of which are important for China to achieve the target of increasing the share of non-fossil fuels in primary energy consumption to 25 percent by 2030.

Incentivizing research and development of low-carbon technologies is another important objective of the ETS. The nature of R&D also requires investors to be patient with the long payback cycle of massive investments. Hence, SOEs have been important players in China's innovation ecosystem. Many centrally administered SOEs have set up research institutes to accelerate the development and deployment of new low-carbon technologies, supporting the upgrading and restructuring of industries.

Finally, SOEs can promote common prosperity with new business opportunities created by the ETS.For example, the offset market will present a growing demand for voluntary emissions reduction credits, which are called China Certified Emissions Reductions in China's context. We anticipate afforestation and forest management will be major suppliers of CCERs in the future, raising the value of the forestry industry substantially. As most forested land in China is State-owned or collectively owned, the value appreciation would also be enjoyed by the whole society through SOEs' participation in the ETS.

China Forestry Group Corp, a centrally administered SOE and the largest forest enterprise in China, has already announced an ambitious plan of developing new large-scale afforestation projects. The revenue will improve the welfare of local communities in rural areas, which has been a key social responsibility of SOEs since 2015 when the central government stepped up its nationwide campaign to eliminate poverty.

Unlike ETS operated in Western economies, China's national ETS is a market-based carbon pricing policy with strong Chinese characteristics. SOEs, as a key pillar of China's socialist market economy, are expected to steadily foster the development of China's ETS.

Zhang Da is an associate professor at Tsinghua University. Huang Junling is a senior researcher at the China Three-Gorges Corporation. The authors are affiliated with the Tsinghua-CTG Climate and Low-Carbon Research Center.