Price stabilization mechanisms in China’s pilot emissions trading schemes: design and performance

Abstract

ABSTRACT Following the experience of high price instability and unpredictability in the European Emissions Trading Scheme (ETS), the management of carbon prices is a key concern for Chinese authorities. The objective is to avoid excessive price volatility in daily trading and stabilize the intrinsic price trend. Building on environmental economics and financial market theories, this study reviews the design of carbon price stabilization mechanisms in China’s seven pilot ETSs and assesses their performance. The pilot ETSs have incorporated most price stabilization mechanisms recommended in the literature, including price ceiling–floor, intensity-based allocation, ex-post adjustment of allowances, intertemporal flexibility, and daily trading risk management. By examining this wide range of mechanisms, our analysis helps understand the different design options available to stabilize carbon prices. Furthermore, by decomposing carbon price data in the different pilot ETSs, our analysis helps evaluate the effectiveness of these mechanisms. Price ceiling–floor and intertemporal flexibility (update of ETS cap) are the most effective mechanisms for stabilizing the intrinsic price trend. Daily trading risk management mechanisms help control price volatility but have little impact on the intrinsic price trend. However, we are cautious about the desirability of regulatory intervention for influencing carbon market prices. Depending on the institutional context and their design, price stabilization mechanisms can cause regulatory uncertainty. KEY POLICY INSIGHTS The Chinese pilot ETSs provide unique input for understanding ETS regulations concerning price stabilization mechanisms and their effectiveness in achieving price stability. The details and sophistication of carbon price stabilization mechanisms can influence the performance of ETSs. Cap updates and price ceiling–floor mechanisms most significantly impact intrinsic price trends. To ensure the effectiveness of price stabilization mechanisms, it is important to separate mechanisms aimed at intrinsic price trends and at daily volatility. Excessive and unexpected regulatory intervention to stabilize prices may disturb market expectations and create uncertainty for investors.