How the thermal power sector affects carbon trading: an empirical study on China’s carbon markets

ABSTRACT

By using a dynamic panel data model, this study investigated how the production of thermal power affects China’s regional pilot carbon markets with a focus on carbon price, trading volume, realized volatility, and market liquidity. Our results suggest that the production of thermal power has slightly increased the trading volume, but has not affected carbon prices based on the existence of excessive CO${ }_2$ allowances. Moreover, thermal power production has increased realized volatility in the pilot markets. However, this impact was reduced following the announcement of the National Emission Trading System (ETS). This demonstrates that thermal power companies in pilot carbon markets tend to trade carbon credit more actively in response to policies favouring further market liberalization, rather than passively following government instructions. Furthermore, we find that realized volatility and liquidity increased in the Hubei and Shanghai pilots following the announcement. This demonstrates that the announcement of the National ETS improved the market activity and efficiency, and pricing capacity of its host pilot markets. However, this improvement could only be observed in the short term. Therefore, the government should reallocate CO${ }_2$ allowances to match its emission reduction targets and incentivize industries with high carbon intensity to participate in carbon trading.

KEYWORDS:

• Carbon market
• National ETS
• thermal power sector
• China

JEL CLASSIFICATION:

• G18
• Q38
• Q54

Acknowledgment

This work was supported by JSPS KAKENHI Grant Number 22K12482. We thank helpful comments from Kenji Takeuchi, Toru Morotomi and all the members of Research Project on Renewable Energy Economics, Kyoto University.

Supplementary material

Supplemental data for this article can be accessed online at https://doi.org/10.1080/00036846.2023.2165619

Disclosure statement

No potential conflict of interest was reported by the authors.

Correction Statement

This article has been corrected with minor changes. These changes do not impact the academic content of the article.

Notes

¹ The seven pilots launched in 2013 are located in Shenzhen, Shanghai, Beijing, Guangdong, Tianjin, Hubei, and Chongqing. Fujian province launched the eighth pilot ETS in December of 2016.

² Program for the establishment of a national carbon emissions trading market (Power Sector) (Work Plan).

³ The registration system is a cornerstone of the ETS system. It is used for registry issues, and it tracks and verifies carbon emission allowances and credits. The carbon-trading platform is where buyers and sellers trade allowances and credits.

⁴ For example, the command-and-control policies introduced innovative technologies for emissions reduction and increased energy efficiency.

⁵ The State Council issued the ‘Decision of the State Council on Accelerating the Fostering and Development of Strategic Emerging Industries’ in October of 2010 (Weng and Xu 2018). ‘The Notice on Carrying Out the Work of the Carbon Emissions Trading Pilot Program’ was announced by the NDRC in October of 2011. Based on this notice, seven regional carbon emissions trading pilots were established in Shenzhen, Shanghai, Beijing, Guangdong, Tianjin, Hubei, and Chongqing. All of the pilots were allowed to provide emissions trading services to domestic companies within their provinces. In September of 2016, the eighth regional pilot ETS was mandated by the State Council with the endorsement of the ‘National Ecological Civilization Pilot Area (Fujian) Implementation Plan’ (ICAP n.d.b).

⁶ A small share of auctions are possible in the Beijing, Shanghai, Tianjin, Guangdong, Shenzhen pilots.

⁷ The work plan for adopting the National ETS is called the ‘Program for the Establishment of a National Carbon Emissions Trading Market (Power Sector)’. The launch of this program was in accordance with the ‘Outline of the 13th Five-Year Plan for the National Economic and Social Development of the People’s Republic of China’ and the ‘Integrated Reform Plan for an Ecological Civilization’.

⁸ The National ETS was expected to regulate at most 1,700 companies, and more than 26,000 tons of annual CO${ }_2$ emissions discharge in the power sector. Both the combined thermal and power sectors, and the captive power plants of other sectors were included in this program (ICAP n.d.a).

⁹ $ThermalShar{e}_{im}$ is defined as Thermal share = Thermal power generation/Total electricity supply.

¹⁰ From the month in which the announcement of the National ETS was made by the NDRC (December of 2017) to the end of 2019.

¹¹ Detailed information regarding the launch dates for each pilot market can be found in Table 1.

¹² We did not check data stationarity including $NET{S}_m$, $Hos{t}_i$, and $EmissionCoverag{e}_i$ because these variables are either dummy variables or time-invariant variables.

¹³ Shanghai Environment and Energy Exchange (n.d.); China Beijing Emission Exchange (n.d.); China Emissions Exchange (Guangdong (n.d.); Tianjin Climate Exchange (n.d.); China Hubei Emission Exchange (n.d.); Chongqing Carbon Emissions Trading Center (n.d.); Haixia Equity Exchange (Fujian (2020).

¹⁴ The CEIC dataset on electricity generation contains various electricity power sources, such as nuclear, thermal, solar, wind, and hydroelectric power.

¹⁵ The random-effects method was selected for all models (p-value of the Hausman test $>$ 0.05) so that time-invariant variables could be estimated.

¹⁶ According to the summary statistics in Table 2, the monthly average thermal power production in the regional pilot markets is 9.372 TWh. Therefore, the 10% increase in thermal power production accounts for 0.9372 TWh, which can lead to a 0.08% increase in trading volume. Because the monthly average trading volume is 0.358 million tons (Table 2), this 0.08% increase accounts for approximately 286 tons of carbon permits.

¹⁷ According to the summary statistics in Table 2, the monthly average thermal power production in the regional pilot markets is 9.372 TWh.

¹⁸ The impact of thermal power generation on realized volatility following the announcement was calculated through the summarization of the coefficients of $Therma{l}_{im}$ (0.002) and $Therma{l}_{im}\times NET{S}_m$ (−0.002) in column (4).

¹⁹ A lower value of the illiquidity measure indicates higher liquidity in the carbon market. Therefore, the negative value suggests a positive impact on market liquidity.

²⁰ According to the policy documents of pilot markets, the verification period is typically from May to July in each year (Yang et al. 2018).