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The statement by President Xi Jinping in September 2020 that The People’s Republic of China (hereinafter, “China”) will “aim to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060” sets out a clear vision and timeline for a profound transformation of the country’s socio-economic development. The pace of China’s emissions reductions over the coming decades will be an important factor in global efforts to limit global warming to 1.5°C. The power sector, responsible for nearly half of the country’s energy sector CO2 emissions,1 is central to achieving China’s climate ambition. Policy makers need to set the incentives and market structures which ensure that power sector actors can capture the dynamic development and rapid cost reduction of low-carbon technologies, and improve the management of the existing fleet of fossil-based generation through retrofitting, repurposing and retirement.

Accelerating power sector decarbonisation in support of the carbon neutrality goal requires an effectively co-ordinated policy mix. This report responds to the Chinese government’s invitation to the IEA to co-operate on carbon emissions trading systems (ETS) and synergies across energy and climate policies. It explores the interactions and effects of China’s national ETS with its renewable energy policy in the electricity sector, namely renewable portfolio standards (RPS). The report demonstrates how the policy mix could be better co-ordinated and explores possible pathways that an enhanced ETS could lead the electricity sector toward an emissions trajectory that is in line with China’s carbon neutrality target.

China’s national ETS came into operation in 2021 and is the world’s largest ETS, covering annual power sector emissions of around 4.5 Gt CO2. It currently employs an intensity-based design with free allocation. This means that allowances are allocated to covered entities for free according to actual production levels of coal- and gas-fired power plants (e.g. kWh of electricity generated) and predetermined emissions intensity benchmarks (e.g. in g CO2/kWh) covering only coal- and gas-fired power plants. This is different from most ETS systems such as the EU ETS, which set a predetermined absolute cap on covered emissions. Four emissions intensity benchmarks are currently defined in China’s national ETS for coal- and gas-fired power plants, and are differentiated based on fuel, sub-technology and plant size.

Against this backdrop, this report analyses five policy scenarios for the electricity sector for 2020 to 2035, consistent with China’s 14th Five-Year Plan (2021-2025) and the Long-Range Objectives through the Year 2035 (China, State Council, 2021a). In order to test the impact of different ETS designs, assumptions regarding electricity demand growth, exogenous technology cost evolutions and the current RPS policy set-up are kept identical across all scenarios. Taking into account China’s ongoing electricity market reform, all scenarios assume economic dispatch from 2025 – an important element to effectively integrate the CO2 price signal in operational, investment and consumption decisions.

The first two scenarios establish a counterfactual and examine current policy. The RPS Scenario establishes a hypothetical counterfactual scenario with the current RPS policy set-up, including a target on the share of non-hydro renewables which is assumed to increase to 25.9% in 2030 and 36.0% in 2035, but no emissions control or carbon pricing policy.2 This scenario provides a point of comparison for isolating and evaluating ETS effects. The RPS-ETS Scenario is a current policy scenario with the same RPS policy assumptions, and an intensity-based ETS with free allocation as currently implemented. The scenario assumes moderate tightening of allowance allocation benchmarks over time.

In addition, three Enhanced ETS (ETS+) Scenarios explore different ETS design enhancements after 2025, while keeping the same RPS policy assumptions as the RPS and RPS-ETS Scenario: ETS+Benchmark (BM) Scenario maintains the intensity-based free allocation but with significantly tighter benchmarks; ETS+Auction Scenario maintains intensity-based allocation with moderate benchmark tightening and introduces partial allowance auctioning; and ETS+Cap Scenario changes ETS design significantly through a transition from the intensity-based ETS to a cap-and-trade system. The three ETS+ Scenarios are designed to achieve an electricity sector emissions trajectory after 2025 that is better aligned with China’s stated goal of carbon neutrality before 2060. All ETS+ Scenarios use the same emissions trajectory of the IEA’s Announced Pledges Scenario (APS)3 as input, and demonstrate the impact of potential future ETS designs.

The table below summarises the key ETS design features and outcomes of each scenario, excluding the hypothetical counterfactual scenario:

Key outcomes by scenario, 2035

Scenario

Key ETS design features

CO2 reduction (from 2020)

Main driver of CO2 reductions

Increase in total system costs*

Additional renewables share**

Interaction with RPS

RPS-ETS

Intensity-based;

Moderate BM tightening;

Free allocation

-20%

CCUS

-/-

-/-

Low

ETS+BM

Intensity-based;

Strong BM tightening;

Free allocation

-38%

CCUS

5.2%

1%

Low

ETS+Auction

Intensity-based;

Moderate BM tightening;

Partial auctioning

-38%

Renewables

CCUS

1.4%

8%

High

ETS+Cap

Cap-and-Trade;

Stringent cap;

Free allocation

 

-38%

Renewables

0%

12%

High

*Increase in total system costs relative to the RPS-ETS Scenario required to achieve given CO2 reduction level. **Additional share of non-hydro renewables in electricity generation mix relative to the RPS-ETS Scenario.


Implementation of the RPS-ETS Scenario can almost triple CO2 emissions reductions by 2035 relative to 2020 compared to an RPS only scenario. Together, both policies can result in electricity-related emissions falling after 2025, and decreasing to 20% below 2020 levels by 2035. In the near- and medium-term, both policies could work in tandem to successfully peak and reduce absolute CO2 emissions from the electricity sector. The two policies act on different power generation sources with limited overlaps, delivering emissions reductions that are complementary.

The intensity-based ETS enhances the efficiency of the existing coal power fleet and the RPS drives renewables generation. Implementing the RPS policy, targeting around 36% of non-hydro renewables in the generation mix by 2035, drives significant new capacity additions from mainly variable renewable energy (VRE) sources such as wind and solar PV. An intensity-based ETS with gradually tightening benchmarks covering coal and gas (RPS-ETS Scenario) drives higher coal fleet efficiency, including through incentivising retrofits and a shift in coal power generation to the most efficient plants. It also supports curbing new additions of unabated coal in favour of carbon capture, utilisation and storage (CCUS) technology deployment. However, the current ETS design provides very limited incentive for switching away from coal generation to non-fossil sources and does not lead to additional renewables deployment.

China’s intensity-based ETS design with free allowance allocation currently only permits the active participation of fossil-based generation. This is because allowances are calculated and allocated through fuel- and technology-specific benchmarks for coal and gas power plants only, while non-fossil generation sources are not covered by the benchmarks. Power generators with an emissions intensity higher than the benchmarks experience an allowance deficit. However, this can only be balanced by an allowance surplus from power generators covered by benchmarks, and that have a lower emissions intensity than those benchmarks. Generation sources that are not covered by the benchmarks – such as renewables – cannot take part in the current ETS except through the very limited route of Chinese Certified Emissions Reductions (CCERs). Switching to non-fossil generation sources could allow a generator to avoid an allowance deficit and the associated cost of needing to acquire additional allowances. However, since non-fossil sources do not receive allowances, they cannot help balance allowance deficits, nor can non-fossil generators benefit from surplus allowances that can be sold. This ETS design of fuel- and technology-specific benchmarks for only coal and gas power, therefore, mainly lowers the emissions intensity of benchmark-covered generation sources, including through CCUS, while providing very limited encouragement for fuel switching to non-fossil sources.


Stronger decarbonisation than in the RPS-ETS Scenario would better align the electricity sector with China’s carbon neutrality goal. In order to support economy-wide carbon neutrality before 2060, China’s power sector would likely need to achieve net zero CO2 emissions before 2055 (IEA, 2021a). Accelerating the transition of the electricity sector would not only further reduce CO2 emissions from the biggest source in China but also maximise the sector’s role in decarbonising end-use sectors, as growing electrification with an increasingly decarbonised electricity sector would further reduce overall emissions. Avoiding new unabated coal capacities and a faster transition also increase the chances of reaching carbon neutrality in an orderly fashion and reduce the potential burden of emissions lock-in and stranded assets (IEA, 2021a).

ETS design changes can double the CO2 reduction of the RPS-ETS Scenario and accelerate alignment with a carbon neutrality emissions trajectory. In the ETS+ Scenarios, electricity sector emissions are 38% lower by 2035 compared to 2020 – nearly double the reductions as in the RPS-ETS Scenario. Different ETS enhancements could drive these additional emissions reductions. If retaining the current design – an intensity-based ETS with free allocation – the benchmark tightening rate would need to be doubled in 2025-2030 and almost quadrupled in 2030-2035 (ETS+BM Scenario), compared to the RPS-ETS Scenario. This would reduce coal benchmarks to two-thirds of their 2020 levels by 2035. In the ETS+Auction Scenario, around a quarter of allowances would need to be auctioned by 2035 while maintaining the same tightening rate for coal benchmarks as in the RPS-ETS Scenario. A third option (ETS+Cap Scenario) is to introduce an absolute emissions cap that is aligned with a carbon neutrality pathway. 

CO2 emissions trajectory from electricity generation by scenario, 2020-2035

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Depending on its design, the ETS can drive emissions reductions through different channels. In an intensity-based ETS with fully free allocation through coal and gas power benchmarks (RPS-ETS and ETS+BM Scenarios), the ETS delivers most of the emissions reductions by transforming the coal fleet through improving unabated coal fleet efficiency and encouraging CCUS adoption in coal power from 2030 onwards. With increased benchmark stringency, the ETS+BM Scenario triples CCUS-related reductions compared to the RPS-ETS Scenario in 2035, with some very limited fuel switching from coal to gas and non-fossil technologies. The ETS+Auction Scenario generates most of the emissions reductions through fuel switching to non-fossil technologies, mainly onshore wind and solar PV, and to a lesser degree to gas, as well as through CCUS deployment. The scenario’s effect on fuel switching to gas and unabated coal fleet efficiency improvements is similar in magnitude to that in the RPS-ETS and ETS+BM Scenarios. On the other hand, transitioning from an intensity-based ETS to a cap-and-trade design with a stringent cap could significantly change how the ETS drives decarbonisation. In the ETS+Cap Scenario, emissions reductions result entirely from fuel switching away from coal power – around 90% to non-fossil and 10% to gas power. While technical efficiency improvements of the coal fleet also take place in this scenario, the average operational efficiency does not improve as all coal units see a reduction in running hours.

Additional emissions reductions by channel in the RPS-ETS and ETS+ Scenarios compared with the counterfactual RPS Scenario, 2025-2035

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The introduction of allowance auctioning and a transition to a stringent cap-and-trade considerably increase the ETS incentive for fuel switching. Partial auctioning (ETS+Auction Scenario) – leading to a reduction in free allocation through coal and gas power benchmarks – raises the effective CO2 cost for covered fossil-based generation sources. It thus makes them more expensive to run compared with non-fossil generation technologies, thereby encouraging switching to renewables. At the same time, the intensity-based design still encourages higher fleet efficiency and some CCUS deployment. Transitioning to a cap-and-trade system (ETS+Cap Scenario) with a stringent emissions cap would further change the ETS impacts on technologies. By setting a predetermined emissions cap and moving away from technology-specific benchmarks, a cap-and-trade allows the participation of all generation sources in achieving absolute emissions reductions, instead of focusing on emissions intensity reduction of coal and gas power. Its design incentivises generators to reduce CO2 emissions through the lowest-cost abatement options, thus spurring emissions reductions mainly through fuel switching to cost-competitive renewables.

Enhanced ETS designs lead to very different generation mixes, but all accelerate the phase-down of unabated coal. In all ETS+ Scenarios, unabated coal power plants would generate 2 800 TWh of electricity by 2035 compared with around 4 800 TWh in 2020; unabated coal’s share of the generation mix would also decline from more than 60% in 2020 to 24% in 2035. This is compared with a 33% generation share in the RPS-ETS Scenario by 2035, noting that in all scenarios total electricity generation increases by more than 50% between 2020 and 2035. The different enhanced ETS designs drive different low-carbon solutions. In the ETS+BM Scenario, where the benchmarks of an intensity-based ETS are significantly tightened, the share of coal power generation with CCUS increases to 11% of total generation by 2035. The shares of non-fossil technologies remain similar to those of the RPS-ETS Scenario. Introducing partial auctioning in the intensity-based ETS (ETS+Auction Scenario) results in the most diverse set of decarbonisation solutions. It encourages additional renewables and CCUS deployment, as well as some efficient gas generation and coal fleet efficiency improvement. By 2035, the share of renewables generation reaches nearly 60%, with non-hydro renewables standing for 43%. Meanwhile,
CCUS-equipped coal power contributes 3%. Transitioning to a cap-and-trade system with a stringent emissions cap (ETS+Cap Scenario) leads to a generation mix dominated by renewables. These would account for 63% of total generation by 2035, including 47% of non-hydro renewables – around 12% higher than in the RPS-ETS Scenario. This suggests that a cap-and-trade system could significantly accelerate the deployment of mature renewables. In the ETS+Cap Scenario, no coal power with CCUS is deployed by 2035. 

Electricity generation mix by technology and scenario, 2020-2035

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All three Enhanced ETS Scenarios can achieve the same emissions trajectory for the electricity sector, but at different costs. Total system cost4 increases significantly over time across all scenarios due to increasing electricity demand: in the RPS-ETS Scenario, total system cost increases from 2.80 trillion yuan renminbi (CNY) (USD 434 billion) in 2020 to CNY 4.28 trillion (USD 664 billion) in 2035. With the same electricity demand growth assumption, the ETS+Cap Scenario leads to the lowest total system cost for the electricity sector across all Enhanced ETS Scenarios. In 2035, it has the same system cost as the RPS-ETS Scenario but with almost 20% additional CO2 emissions reductions. This is followed by the ETS+Auction Scenario with slightly higher costs (CNY 4.34 trillion, USD 673 billion), and the ETS+BM Scenario which is 5% more costly than the RPS-ETS Scenario (CNY 4.49 trillion, USD 698 billion). In addition, auction revenues generated in the ETS+Auction Scenario could reach CNY 260 billion (USD 40 billion) in 2035, which can be used to address affordability or competitiveness concerns of electricity consumers, as well as to invest in technology innovation and energy efficiency to reduce future decarbonisation cost. 

Total system costs by scenario, 2035

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The cap-and-trade system achieves this cost-effectiveness by prioritising the lowest-cost abatement opportunities, especially fuel switching. By allowing power sector actors to freely choose the cheapest abatement technology, the cap-and-trade system introduces technology neutrality which, in turn, drives fuel switching from unabated coal generation to renewables. In contrast, the ETS+BM Scenario results in a much more costly generation mix as it would primarily encourage a shift from unabated coal to coal power with CCUS, a less mature and more expensive abatement option. Introducing auctioning into the intensity-based ETS (ETS+Auction Scenario), raises the effective CO2 cost that generators face and encourages both some fuel switching to renewables and intensity improvements in the coal fleet including through CCUS. Consequently, in the ETS+Cap Scenario, fuel switching to mature renewables can be encouraged already with a relatively low allowance price level of CNY 100/t CO2 (USD 16/t CO2) by 2035. In contrast, an intensity-based ETS (in both ETS+BM and ETS+Auction Scenarios) would lead to a higher allowance price of around CNY 300/t CO2 (USD 47/t CO2) by 2035 to achieve the same emissions trajectory. This is because the ETS design drives emissions reductions at least in part through CCUS deployment which requires higher financial support.


Simultaneous operation of the RPS and ETS policy mix can have important interaction effects which need to be taken into account in policy design. Where the RPS and ETS act on different electricity generation assets, as in the RPS-ETS Scenario which models the current policy set-up, both work alongside each other and with limited interaction. However, with potential changes in the ETS design, and as renewables account for a greater share in the electricity sector, overlaps between the ETS and the RPS lead to a greater need for policy co-ordination. The results of this report show that a cap-and-trade ETS (ETS+Cap Scenario), as well as partial auctioning (ETS+Auction Scenario), can help to provide the financial incentives needed to increase renewables deployment.

While these changes in ETS design can make it a key instrument in further decarbonising the electricity sector, and ensuring alignment with a carbon neutrality pathway at a lower cost, the ETS price incentive could directly interact with the green certificate price of the RPS. International experience also shows that in a cap-and-trade ETS, higher than expected renewables deployment can lead to allowance price decreases, which in turn can reduce incentives for technological innovation and increase decarbonisation costs overall. These interactions highlight the importance for policy makers to regularly assess the impacts of changes to China’s energy and climate policies. Strengthened policy co-ordination should aim to improve the effectiveness of the policy mix, and support achieving economy-wide carbon neutrality at the lowest cost possible.


As China’s carbon neutrality target shifts the policy focus from improving emission intensities towards achieving absolute emissions reductions, policy makers could consider the following insights to accelerate the alignment of the electricity sector with a 2060 carbon neutrality target through an enhanced ETS:

  • Carefully examine different ETS design options in line with the intended policy objectives, in particular with a view to the resulting costs, the carbon price and the technology mix. While different design approaches can achieve the same emissions trajectory, they could serve different policy priorities, such as supporting different technologies from renewables to CCUS. Consequently, they would also require different levels of co-ordination and companion policies (e.g. adjusting target level and RPS focus on less mature renewables, support for transport and storage infrastructure necessary for CCUS deployment).
  • Communicate future plans on China’s ETS design well in advance, including the medium-term benchmark and/or cap trajectory (e.g. for the next 5-10 years), to provide visibility and planning certainty for market participants. This will guide plant management and investment decisions (including for technology innovation), and accelerate alignment with carbon peaking and carbon neutrality goals.
  • Establish a policy co-ordination process involving all relevant government institutions that aims to analyse ex-ante the impact of different policy mixes to avoid unintended side-effects, and which regularly reviews policy outcomes. Consider introducing flexibility mechanisms such as allowance reserves or price corridors to help accommodate unexpected policy interactions and external shocks.
  • Consider gradually introducing allowance auctioning in the current 14th Five‑Year Plan (FYP) period (2021-2025) to incentivise more diversified and lower-cost emissions abatement options, encouraging renewables in addition to fossil-based generation improvement and CCUS deployment. This would also enable the use of auction revenues to address distributional impacts and competitiveness concerns, as well as to directly invest in climate actions such as low-carbon technology innovation and energy efficiency.
  • Consider transitioning to a cap-and-trade system with a stringent cap later in the decade to position the ETS as a key instrument in China’s path to carbon neutrality, to reduce the number of additional policies targeting renewables, and to lower the cost for decarbonisation. The deployment of CCUS could still be incentivised through special provisions within an ETS, such as additional free allowances, or through companion policies dedicated to CCUS uptake.
  • Swiftly implement announced plans to extend the ETS to other sectors, and consider opening market participation to non-compliance entities such as financial intermediaries. Sectoral extension would reduce costs by expanding possible options for emissions reductions, and establish a cross-sectoral carbon price signal to help achieve carbon neutrality. Opening participation would also increase the ETS’ liquidity and facilitate price discovery through a larger number of actors trading allowances.


Notes and references
  1. Energy sector CO2 emissions include CO2 emissions from fuel combustion and from industrial processes.

  2. The share target of non-hydro renewables is based on China’s National Energy Administration’s consultation draft (China, NEA, 2021a). 

  3. As presented in the IEA’s publications “An energy sector roadmap to carbon neutrality in China” and “World Energy Outlook 2021”. There is no single pathway for energy sector emissions consistent with China’s stated goals of achieving a peak in CO2 emissions before 2030 and carbon neutrality before 2060. The Announced Pledges Scenario (APS) presents one plausible pathway to carbon neutrality in China’s energy sector in line with the country’s stated goals. “An energy sector roadmap to carbon neutrality in China” also explores an Accelerated Transition Scenario (ATS) to assess the opportunities for and implications of a faster transition through enhanced climate policy ambitions and efforts to 2030.

  4. In this report, total system cost includes annualised capital expenditure as well as variable and fixed operating and maintenance costs of electricity generation, transmission and balancing costs, and costs for plant retrofits.