This report analyses the influence of the design features of China's pilot emissions trading systems (ETS) in the Province of Hubei and the Municipal City of Shenzhen and the development of the electricity markets on the quality of the carbon price signal. Based on publicly available data and expert interviews, we derive four main findings on the impact of carbon market design and the electricity market structure on the quality of the allowances price. First, the pilot ETS in Hubei and Shenzhen have adopted very different design features due to the specific local circumstances and both pilot programs are designed to strike a balance between emissions reduction and economic development. Second, despite the overall completeness of the design features, the pilot ETS in Hubei and Shenzhen and the allowance prices are affected by the lack of clarity and enforcement of certain rules, as well as limited support from the central government. Third, due to strong government regulation of China's electricity sector, including the electricity markets in Hubei and Shenzhen, carbon pricing has played a very limited role in driving low carbon investments. Finally, the electricity sector reform since 2015 has led to the adoption of some ambitious plans to deregulate electricity pricing for certain end-users and establish a more market-oriented electricity trading market, which will create a level-playing field for carbon pricing. However, there are signs that the reform process has been guided by the political agenda to reduce electricity prices in the short term and thus the effectiveness of China's ETS in internalizing the carbon cost in the future will depend on the political acceptability of electricity price increases resulting from the strong carbon price signal. This case study is part of the project “Influence of market structures and market regulation on the carbon market” that aims to investigate the interdependencies between carbon and energy markets in Europe, California, China, South Korea, and Mexico.

This report assesses the role of emissions trading systems (ETS) in electricity sector decarbonisation through analyses of carbon market designs and interactions with electricity market regulations, market structures and additional policies. We do so through the lens of four carbon price quality criteria (volatility, reflection of marginal abatement cost, predictability, and environmental effectiveness) and three abatement channels (clean dispatch, low-carbon investment, and demand-side response). The analytical framework originates from an earlier conceptual study and has been applied to five case studies comprising seven jurisdictions in the Americas, Europe, and Asia. We find that ETSs are especially effective in capitalising on shortterm abatement opportunities when embedded within liberalised electricity markets (e.g., merit order effects or fuel switching). In this context, they may also send long-term signals on fuel choices and investment decisions; however, the strength of these signals will depend on ETS design and companion policies. ETSs can also be designed to cater to hybrid electricity markets where carbon cost pass through might initially be absent. Limited pass through to industrial consumers and diluted price signals in final electricity bills can result in untapped mitigation potential and require careful assessment across systems. Moreover, path dependency in terms of previous investments in the sector to a certain extent preordain the abatement options that can be induced by the ETS in the short to mid-term. Overall, ETSs form an increasingly indispensable tool in the policy toolkit, assisting jurisdictions in their transition to net-zero electricity production.

A broad consensus exists that carbon pricing is key for cost-effective emission reductions and that it must play a major role in driving the transition to a climate-neutral economy. However, despite significant progress in wider climate policy uptake in recent years, the vast majority of greenhouse gas (GHG) emissions remain unpriced. Making a success of carbon pricing in individual jurisdictions requires a detailed and methodical understanding of their circumstances. The aim of the current report is to develop an analytical framework that contributes to such an understanding, with a view to applying it later to assess carbon pricing potential in several Asian jurisdictions. To this end, an in-depth literature review picks out over 500 relevant papers and reports published between 1975 and 2020. Their findings are used to identify the relevant conditions for the implementation of carbon pricing policies along political legal, economic, technical and regional dimensions, which in turn become the corecomponents of the analytical framework developed to assess carbon pricing readiness. For each component, the literature indicates multiple aspects that can impact carbon pricing potential and suggests variables and indicators for assessing their empirical relevance. The different components are deeply intertwined, as features of an economy can operate through multiple channels simultaneously. At the same time, each individual component of the framework, and each aspect within the components, can contribute valuable information to an empirical assessment of carbon pricing potential.