Power Industry and the Carbon Market: A Complex Relationship of Challenges and Opportunity

On December 19th, the NDRC (National Development and Reform Commission) officially announced the launch of China’s national carbon market under the “National Carbon Emission Trading Market Construction Scheme (Power Industry),” [1]referred to as the “Construction Scheme.” As predicted, China’s national carbon market currently only covers the power industry. REEI’s previous article discussed the reasons for piolting the national carbon market through the power industry and the power industry’s mitigation potential. This article will analyze the relationship between power market policies and the carbon market.

 

What is the effect of the power Industry reforms on the national carbon market?

China’s current power market reforms aim to restore the commodity attributes of electricity as well as construct an effective and competitive market structure, and form a system that determines the cost of electricity via the market, which is clearly indicated by the instructions of the power industry reform national leadership[2]. The objective of these measures is to improve the efficiency of the power market, improve safety, promote social fairness, and improve the quality of the environment.

Considering the national power market reform’s current state and complexity, as well as the fact that the carbon market is only just beginning to form, it is natural that the relevant policies between the two markets are not yet coordinated. For example, China’s current power dispatch mechanism does not comply with market demands. In this case, carbon trading is unable to effectively support the decarbonization of the power system.  Therefore, it is necessary for carbon market authorities to participate in the improvement of power dispatch system.

The influence of the power market’s reforms on the carbon market will chiefly be reflected in electricity prices. Compared to a higher degree of regulation in the power system, a market-based electricity pricing mechanism is more conducive to the stability of carbon allowance pricing.

 

How will China’s power industry pass carbon costs downstream?

Market-oriented electricity pricing is one of the cores of the national power system reformations. Due to the current low degree of marketization in the power industry, power generation enterprises’ costs cannot be easily passed downstream users. If the current round of power reforms restores the commodity attributes of electricity, the proportion of market-based transactions will gradually increase, leading to higher percentage of market-based electricity prices. Thus, the carbon market will have a greater potential to pass costs downstream.

Demand-side costs of electricity are reduced in highly marketized power market mainly due to the power sector reforms that improve efficiency in the industry and the equal distribution of social benefits. If these conditions are met in the future, not only are carbon market carbon costs more easily passed downstream, but there can also be significant improvement to low-carbon development in the whole of society.

Among the factors influencing electricity prices is the proportion of renewable energy, as well as power generation costs. If the power market system can accommodate more renewable energy sources, then the subsequent reduction in electricity pricing from rising efficiency in the power market could be offset by high renewable energy costs. Yet, the increase in carbon prices may adversely lead to resistance towards transmitting costs downstream.  However, this should not be an obstacle, given that the future of renewable energy will grow more and more competitive in terms of cost and that society may become more tolerant of the increased costs of clean energy.

 

How will the other power sector policies affect the carbon market?

The “Construction Scheme” explains that the carbon market’s development should  “work in accordance with the overall qualities of the supply-side structural reform, strong coordination of the relevant policy and measures among power system reforms, energy consumption and intensity ‘double control,’ and air pollution prevention and control.”  It is evident that the coordination between the carbon market and power market reform, and the relationship between energy conservation and carbon reduction policies are emphasized in the Scheme, which reflects that policy makers also expect these combined policies to put into effect better collaborations and results. However, this is not a simple matter. Some experts believe that energy system transition should follow the path of putting carbon pricing in the center and make a series of companion policies.

When the carbon market is officially launched, the market authorities must consider the effect of companion policies on carbon prices. If the allocation price is constantly at a low level, these supporting policies may decrease low-carbon technology or facilities investment, which would encourage the continued operation of high carbon facilities.

Further, how can the carbon emission trading system deal with overlapping policies, such as renewable energy goals and carbon emission intensity goals? There is a need to distinguish what portion of emissions reduction comes from carbon market versus overlapping policies (reflecting additionally). In this way, it would the manner that the carbon market can promote carbon emission reduction in the power industry would be more clear.

In summary, all policies favor low-carbon facilities and energy efficiency improvement. Further, policy development for renewable energy could have a coordination effects on the carbon market and contribute to the promotion of carbon market effectiveness. However, it would need to take into account the problem of overlapping policy.  Conversely, those policies that are against or conflict with carbon market policy should be removed or revised.

 

Conclusion

The complexity of China’s power industry causes slow advancements in the power system reformation. We must wait and see whether or not the Chinese carbon emissions trading system can promote China’s development of a more low-carbon power industry. As the power industry undergoes a step-by-step marketization process, hopefully we will see a more effective operation of the carbon market.   The power market and the carbon market mutually affect each other and have a complex relationship. This will require more diligent coordination of policies. Thus, the  coming two years will be crucial to both markets. They will face unprecedented challenges and opportunities.

 

End Note:

1.National Carbon Emission Trading Market Construction Scheme (Power Industry) by NDRC.

Link: https://qhs.ndrc.gov.cn/qjfzjz/201712/t20171220_871258.html

2.Xi Jinping presided over the Central Financial Leading Group meeting.

Link: http://www.nea.gov.cn/2014-06/17/c_133413362.htm

 

Author: Lin Jiaqiao

Translation: Kendall Tyson

 

 

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