Emitters holding surplus allowances after the first trading period in the Shanghai emissions trading scheme will only be allowed to use a third of them each year over 2016-2018, the municipal government said Monday.

The 2013-2015 trading period of the Shanghai cap-and-trade programme officially ends on June 30, when emitters must surrender allowances to the government to cover their 2015 emissions.

The government handed out around 160 million allowances annually for the first three years of the market without much ability to make annual adjustments, despite it becoming obvious after the first year that the market was over-allocated.

Emitters will be able to carry over all their surplus permits to the 2016-2018 phase, but can only use a third of them each year, the Shanghai Development and Reform Commission announced Monday.

An emitter holding 150,000 surplus Shanghai Emissions Allowances (SHEAs) from the first period would be allowed to use or sell 50,000 of those each year over 2016-2018.

The 1/3 rule will also impact SHEAs bought over-the-counter by investors between today and June 30. But non-covered entities can use any SHEAs purchased before Monday’s announcement whenever they want, as well as future allowances bought on the exchange.

Sources told Carbon Pulse that the move was aimed at providing certainty for market participants that the SHEAs would continue to hold value in the future – even though the government also encouraged companies to voluntarily cancel their surplus permits.

IMPLICATIONS

If the government is successful in creating market confidence in the future value of SHEAs, that might stem the steady tide of supply that has seen the allowances fall to around 4-5 yuan ($0.62-0.77) in recent weeks, record low levels across all China’s seven pilot markets.

But given the many uncertainties surrounding how the pilot markets will transit into the national ETS, the announcement has multiple implications for how the Shanghai scheme might operate in the future and market responses to it.

• Continued local market? The pilot markets are expected to end after 2016, when the national ETS comes in place. The fact that Shanghai will restrict the use of two-thirds of surplus SHEAs until after that date was taken as another sign that Shanghai plans to continue its municipal ETS even after the national market begins.“This is an official guarantee that there will be a Shanghai ETS in parallel to the national ETS,” one source said.
  In February, Shanghai added more than 100 participants to the scheme taking the total to over 300. Most of the newcomers would not automatically be covered by the national market, and are thought to make up the core of the future Shanghai ETS.
• No flooding. By holding back two-thirds of the historical surplus from the outset of 2016, the government would reduce the chances of lingering over-supply depressing prices in the next three-year period.
• Advantage big emitters. The bigger emitters, who will be brought into the national ETS, are likely to be left with more options than the smaller ones, according to market observers. They would likely be allowed to choose to hold on to their SHEAs and sell to smaller local emitters if demand in the Shanghai ETS is sound, or they can convert their allowances into permits eligible in the national market if that option is more profitable. “Traders can go two ways. They can cash in on the certainty in regards to entities regulated by the Shanghai ETS or they can bet on the national market. I think the market will take a few days to react,” one source said.
• More uncertainty. While Monday’s announcement should theoretically have a bullish impact on Shanghai prices, traders were unconvinced because it left questions unanswered such as what will happen to any allowances allocated to big emitters for 2016-2018 that get brought into the national scheme after the first of those three years.
• Bad for OTC? Larger transactions in the Shanghai market are often negotiated bilaterally, but as OTC deals from today onwards will be impacted by the 1/3 rule, observers expected trading OTC will become less attractive for investors as there would be restrictions on what they can do with the SHEAs they hold, although it would only impact Phase 1 allowances.

On Monday a near-record 546,000 SHEAs traded on the Shanghai carbon exchange, with the spot contract closing unchanged at 5 yuan.

By Stian Reklev – stian@carbon-pulse.com

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