China’s ETS is the Biggest Example of Carbon Trading to Date.
The new Emissions Trading Scheme (ETS) started trading carbon this July and is the first of its kind.
China has pledged to be carbon-neutral by 2060. They are not alone - countries across the globe are documenting their aim towards net-zero emissions by mid-century. Success will be achieved when the amount of carbon a country emits is offset by carbon removal techniques such as carbon capture and reforestation.
Carbon accounting is key to meeting climate goals. There needs to be an accurate way to verify how much carbon is emitted in order for emissions to be regulated and offset. Emissions Trading Schemes, specifically, are emerging as one of the most promising tools for countries to meet their net-zero goals. The European Union, California, and New Zealand are a few examples of sovereignties that have established ETSs.
China emits about 30% of the world’s carbon and is the top polluter in the world. They tested the ETS in cities such as Beijing and Shenzhen before rolling it out nationwide. While China’s ETS does not cover every industry yet (it currently covers over 2,000 coal and gas power plants), it is still the biggest ETS to date.
Carbon Taxes versus Emissions Trading Schemes
Carbon Tax
A carbon tax is a tax levied on the carbon emissions required to produce goods and services. It is an indirect tax in that it increases the price of carbon-intensive products in order to decrease their demand. Denmark, Finland, Norway, and Sweden are examples of countries that have a carbon tax. Despite being considered the simplest and most efficient way to reduce the amount of carbon going into the atmosphere, additional taxes are a hard sell to the masses and a carbon tax has proven to be exceedingly difficult to pass into law. No U.S. state has succeeded in passing a carbon tax to date.
Emissions Trading Scheme (ETS)
An emissions trading scheme is more complicated than a carbon tax, but it is proving to be more palatable to governments and citizens. For example, with China’s ETS, each company is given a certain number of free allowances based on their previous year’s emissions history. They can sell their allowances if they become more energy-efficient and don’t need to emit as much carbon, or they can buy additional allowances (within limits) at the market rate. Also called “cap and trade”, this system uses market forces to dictate the price of carbon and incentivizes polluters to reduce emissions on their own.
China’s ETS is unique to other ETSs in place because their benchmark is carbon intensity, or emissions per unit of power generation, versus absolute emissions. In other words, the Chinese companies that are members of the scheme can still increase their absolute emissions as long as they reduce their carbon intensity.
The world is watching as China’s ETS progresses.
China’s ETS is not currently challenging companies to move away from carbon, but that is expected to change. Once companies get a better handle on what they are emitting and how to correctly report the information, there will presumably be a gradual reduction of allowances to encourage the transition to carbon-neutral operations.
After China, the U.S. is the next largest carbon emitter. President Biden has been silent on both the potential for a carbon tax or nationwide ETS, but John Kerry mentioned on a visit to India in April of 2021 that President Biden is trying to determine the best way to put a price on carbon. Specifically, he said, “I think going into the next months there will be a lot more talk about whatever tools are available to us and certainly a carbon market is an important tool.”
News broke as I was writing this post that the Democrats are working on a draft plan to tax the country’s largest emitters, such as Exxon, to help pay for floods, wildfires, and other natural disasters that have been linked to climate change. We will see how far the draft gets, but for now, Washington State has recently decided to move forward with an ETS, making it the second state in the U.S behind California.
A price on carbon is coming to the United States.
Thousands of companies have started putting their own price on carbon in order to track and reduce emissions and to calculate the risk on different projects. Danone reports its carbon-adjusted earnings-per-share (EPS) in addition to regular EPS. There is also a discussion about tariffs on goods coming from countries with little to no carbon regulation to prevent “carbon leakage”. These steps all indicate that we are moving closer towards a global standard of pricing carbon and the U.S. will eventually have to comply. This is a positive for investors - increased transparency and more data will make it easier to accurately incorporate transition risks into financial decisions.
Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients nationwide and is based in San Diego. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.
Planning Within Reach, LLC (PWR) is a virtual fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.