How will adding relevant regulations on quota carry-over and increasing the proportion of paid distribution affect carbon prices?| Rational look at carbon prices series ②

The government has recently released two important signals that are closely related to future carbon prices, namely, new regulations on quota carry-over restrictions and the clear and gradual increase in paid distribution ratios.

Not long ago, the executive meeting of the Ministry of Ecology and Environment reviewed and approved in principle the "National Carbon Emissions Trading Power Generation Industry Quota Total and Allocation Plan for 2023 and 2024"(hereinafter referred to as the "2023 and 2024 Quota Allocation Plan"). Compared with the plans for the previous two compliance cycles, the new allocation plan has made some major adjustments, including the addition of quota carry-over provisions. What does this mean? What impact will it have on carbon prices?

In addition, the "National Carbon Market Development Report (2024)" released not long ago once again proposed,"Gradually implement a combination of free and paid carbon quota allocation method, increase the paid allocation ratio, and make carbon prices more truly reflect corporate carbon emission reduction costs.".

The Beijing City Ecological Environment Bureau also recently issued the "Beijing City Carbon Emission Quota Payment and Repurchase Management Measures (Draft for Comments)"(hereinafter referred to as the Beijing Quota Issuance and Repurchase Consultation Draft) to meet the needs of carbon market development.

If the paid distribution policy is implemented, what impact will it have on carbon prices? Focusing on these issues, the reporter interviewed industry experts for in-depth interpretation.

Reverse enterprises '"reluctance to sell" behavior, increase quota liquidity, and make carbon prices more rational

The "2023 and 2024 Quota Allocation Plans" have added quota carry-over provisions to increase market transaction activity. The specific regulations are as follows: the maximum carry-over quota amount for key emission units = net sold quota amount × carry-over ratio. Among them, the carry-forward ratio is set to 1.5.

Wang Jun, author of "The Era of Carbon Neutrality" and founder of Climate Future, analyzed: "According to this plan, the quotas of this year and previous years can be used without restrictions for performance in 2023 and 2024. For wealthy enterprises with quotas, they can be carried forward to quotas for 2025 according to relevant rules and used for performance in 2025. Quotas that have not been carried forward will no longer be used for performance, which is equivalent to being voided. The amount of quotas that can be carried forward is related to the amount of quotas that companies have net sold previously, that is, the more they sell, the greater the amount that can be carried forward. Therefore, those companies that want to make carry-over need to sell quotas vigorously. But if you sell too much, you will have less holdings, and there will not be so many quotas to carry forward. I think this measure is really a 'god'. It can effectively stimulate those companies that have hoarded a lot of quotas and not sell them. If they don't sell them now, these quotas will become waste paper."

Carbon emission quota allocation is the core link for the smooth and orderly operation of the national carbon emission trading market. A scientific and reasonable quota allocation plan is of great significance to enhancing the stability and liquidity of the carbon market. Industry insiders believe that the increase in quota carry-over regulations is a reflection of the government's effective intervention in the trading behavior of the national carbon market.

Yan Gang, deputy director of the Environmental Planning Institute of the Ministry of Ecology and Environment, said in an interview with reporters that the first two cycles of the national carbon market did not clarify the use conditions and validity period of inter-temporal quotas. In actual operation, quotas can be unconditionally carried forward to the next year. The lack of carry-over restrictions and the general "bullish" expectations in the market have caused companies to "be reluctant to sell" to a certain extent, reducing the supply of market quotas and transaction activity, making it more difficult for companies with quota shortages to purchase performance quotas, which is not conducive to the stable operation of the market. The "2023 and 2024 Quota Allocation Plans" establish the principle that the maximum amount of quotas can be carried forward is linked to the net amount of quotas sold by enterprises by adding relevant provisions on quota carry-over. The higher the net sales volume of an enterprise, the greater its maximum carry-over volume, which will help encourage enterprises with surplus quotas to actively sell quotas and increase the vitality of market transactions.

Wei Wang, executive director of the Industrial Innovation Center for Comprehensive Environmental Management of Jiangsu Province, told reporters: "At present, my country's carbon price discovery process is a government-led market participation behavior. In the early stages of carbon market construction, government guidance is very necessary. If it is completely decided by market entities, it will easily appear irrational. The market has been generally 'bullish' on carbon prices for a long time, making market entities reluctant to trade. Therefore, the government stipulates that market entities must trade and carry forward carbon emission quotas within a window period, that is, within the performance period, otherwise they will be worthless, so that the carbon price will not be too high."

Paid bidding for the issuance of carbon quotas is becoming increasingly popular, and carbon prices are formed through market games

The release of the "Beijing City Management Measures for the Paid Issuance and Repurchase of Carbon Emission Quotas (Draft for Comments)" is a reflection of the growing popularity of paid bidding for the issuance of carbon emission quotas in local pilot carbon markets in recent years. Since 2022, Beijing City has tried to carry out paid bidding and issuance of quotas based on the operation of the carbon market, effectively ensuring the smooth and orderly operation of the Beijing carbon market, embodying the principle of "emissions have costs, carbon reduction has benefits", and providing key carbon emission units with a flexible way to successfully complete annual carbon emission performance and enrich market management experience.

It can be said that an important reform that may affect carbon prices in the national carbon market in the future is to gradually increase the proportion of paid allocation of carbon emission quotas.

At present, since the national carbon market adopts the method of issuing all quotas free of charge, the actual emission control costs of most participating entities are relatively low. Paid allocation of quotas can help make carbon prices more truly reflect the cost of carbon emission reduction for companies.

Wei Wang told reporters: "The purpose of gradually introducing paid distribution is not to put pressure on enterprises, but to stimulate enterprises 'ability to develop green and develop new productive forces. The water consumption and energy consumption of enterprises should be reduced, and the emission volume should be reduced, but the input-output ratio should be increased and efficiency should be improved. In addition, from the perspective of promoting exports, the EU carbon border adjustment mechanism and related bills are carbon-related trade rules. The international market requires companies to pay for carbon emissions. If Chinese exporting companies have already paid carbon costs domestically, they can offset them accordingly when exporting to the EU. Therefore, it is necessary to adopt policies to force companies to keep this part of the funds in the country to avoid outflow. From international green barriers such as the EU carbon border adjustment mechanism to relevant policies in China's carbon market to market entities, it is an orderly transmission process. The ultimate goal lies in enterprises, which require enterprises to improve quality and efficiency to achieve green and low-carbon transformation."

In what form will paid distribution ultimately be realized? As far as current local practice is concerned, all of them adopt the form of competitive bidding.

For example, on August 5, 2024, the Beijing City Ecological Environment Bureau issued a notice on the city's 2023 annual paid bidding issuance of quotas, clarifying that starting from September 2, the number of carbon emission quotas issued during this paid bidding is 1.5 million tons.

In May and July 2024, the Shanghai Environmental Exchange organized two paid bidding exercises for Shanghai carbon emission quotas in 2023, with a total amount of 1 million tons respectively.

The "Guangdong Province 2023 Carbon Emission Quota Allocation Plan" released in January 2024 clarified that the 2023 quotas will be partially distributed free and partially paid. For example, the proportion of free quotas for steel, petrochemical, cement, and papermaking enterprises is 96%, the proportion of free quotas for data center enterprises and voluntarily incorporated enterprises is 97%, and the proportion of paid quotas for new project enterprises is 6%. The paid quota for 2023 is planned to be issued of 500,000 tons, which will be distributed in two phases in the first quarter and second quarter of 2024.

The impact of this method on carbon prices can be seen from the practice of paid bidding and issuance of quotas in local pilot carbon markets.

According to analysis by industry consulting firm Intelligent Research Consulting, all eight pilot carbon markets in my country have explored paid bidding for quotas, but the proportion of paid bidding for quotas in the pilot carbon markets is low. The total quota for the carbon emissions trading market in Beijing City in 2022 is 44 million tons, of which the bidding volume is 1.5276 million tons, accounting for only 3.47%, but the proportion in the pilot carbon markets in eight places is already relatively high. The transaction price of quotas in the Beijing carbon market has the highest overall, fluctuating between 40 yuan/ton and 150 yuan/ton since 2022. The main reason why carbon prices in the Beijing pilot carbon market are "outshine" is that the restrictions on the issuance of total quotas are relatively tight, and the proportion of the total amount of paid quotas issued is relatively high.

In addition, the same is true for the international carbon market. Intelligence Research Consulting believes that the reason why the EU carbon emissions trading system can dominate global carbon pricing revenue is due on the one hand to its significant scale advantages and price advantages, and on the other hand to its high proportion of carbon quota auctions.

Wei Wang believes that bidding is an ideal way to rationalize prices. Paid distribution will be mainly completed through auction, and carbon prices will be formed through games among market entities. Companies that can successfully bid usually have better development prospects, need more quotas to support their development, are willing to pay higher costs for this, and can obtain better returns through the green development of the company. If a company does not have the potential and ability to reduce emissions, it will not spend more money to participate in the auction. The construction of a national carbon market has established a low-carbon awareness in the whole society that "carbon emission has costs and carbon reduction has benefits". However, the specific costs and benefits need to be slowly discovered through market games.