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China should add derivatives to its carbon trading market to improve liquidity and widen the pool of participants as it pushes to increase green investments and deter polluters, policy advisors told MNI.
A national carbon trading market to be launched at the end of June has become a key part of the drive to cut emissions in coal-dependent China, which so far has focused on building wind and solar power infrastructure and steered clear of taxes or penalties to encourage the switch to green energy.
But with the market initially limited to power producing companies, many state-owned, and the government handing out free emission quotas for trading, there is concern the spot market may not be dynamic enough for price discovery.
According to Ma Jun, a former member of the People's Bank of China's monetary policy committee, the market requires futures and derivatives for effective pricing. He added that more institutions, especially financial ones, should be mobilised in the effort to cut greenhouse gases as public fiscal resources are nowhere near enough for the task.
"The futures market can point to the carbon price trajectory for the next five or even 10 years so it can influence the company's preferences for medium and long-term green investment," said Ma who is the director of Center for Finance and Development at Tsinghua University.
A trial of the market in eight provinces since 2013 has yielded transactions totalling just CNY10.4 billion so far but the nation-wide rollout could lift turnover to CNY6 billion this year, the state-owned Economic Information Daily said. Once the allowances are exhausted, companies that exceed emission benchmarks will have to buy permits on the market, giving them an incentive to become more energy efficient.
According to a Tsinghua University report, China will need about CNY138 trillion in green investment, or more than 2.5% of annual GDP, to help meet the Paris Climate Agreement's goal of limiting global warming to well below 2 degrees Celsius compared to pre-industrial levels. Beijing aims to cut energy consumption by 3% per GDP unit this year, in line with President Xi Jinping's drive to achieve peak emissions by 2030 and carbon neutrality by 2060.
The country emits 10 billion tons of carbon annually with power plants accounting for about 30%, according to government data. Liu Jie, the general manager of Shanghai Exchange for Environment and Energy, said 2,225 power plants have registered with the National Carbon Emissions Trading Market and have received free emission quotas totaling 4 billion tons for the next two years.
The market has been restricted to power generating companies because the government has an effective system to monitor their emissions, said Yang Fuqiang, a senior advisor with National Resources and Defense Council and a former government official. Other industries such as steel, non-ferrous metals and the cement will be included later as and when data gathering systems are ready, Yang said. Ma forecasts China's emissions trading market will eventually cover about 8,000 companies.
Liu Ying, a research fellow at the Chongyang Institute for Financial Studies at Renmin University of China, thinks derivative products such as futures, forward contracts, options and swaps, could be introduced by 2025. The main obstacle to derivatives right now is market education, she said. Some people in China have no idea of emissions, let alone carbon trading, and that's why it's essential to have the market up and running first.
Earlier this year, the government set up a futures exchange in Guangzhou and according to many reports, carbon futures were to be included in the first product line up. However, the final plan published by the provincial government made no mention of derivatives.