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

Abstract

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 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 allowances to match its emission reduction targets and incentivize industries with high carbon intensity to participate in carbon trading.