As NDRC pushed back the launch of the national ETS in 2016, the seven existing pilots at the time finished their originally planned term of three years. These three experimental years of the Chinese carbon pilots have provided regulators, covered entities, and others involved with valuable learnings ahead of the national scheme. A recently published study by Dr. John Fan and his colleagues tested the empirical link between crude oil and carbon prices in the Chinese pilots during their nascent years*. ChinaCarbon.net.cn interviewed Dr. John Fan to learn about his findings and pick his thoughts about the sensitivity of carbon prices to macroeconomic activities in China.
– Rahul Rana (email@example.com)
ChinaCarbon.net.cn: Pleasure to be interviewing you, Dr John Fan. Could you start us off with an introduction to your recent research about the impact of macreconomic activities on carbon prices in the various emissions trading pilots in China?
Dr. John Fan: Certainly. This was a joint research conducted by me and my colleague, Dr. Neda Todorova, from Griffith University, under the guidance of Professor Shiqiu Zhang from Peking University. In this study, we examine the empirical link between carbon prices and macroeconomic risks in China’s cap-and-trade pilot scheme for CO2 emissions. Using the trading data of four pilot markets in Beijing, Guangdong, Hubei and Shenzhen from October 2013 through to February 2016, we show that the carbon price in Beijing is weakly linked to Daqing crude oil prices but not to international crude oil price levels.
Furthermore, our results indicate that energy, utilities, industrial, and materials sectors stock indices are positively related to the allowance prices in Hubei and Shenzhen. Our main findings suggest that the Chinese carbon market is currently immature. The carbon price fundamentals are weak and the markets are not efficient in an informational sense. Thus, policy makers have much preparations to complete before the launch of the national trading scheme in the second half of this year.
CC.net.cn: You explored correlations between crude and carbon prices in your study. Was there a particular reason to choose crude oil prices over coal which accounts for much of the power sector emissions in China?
JF: You are absolutely right, coal-fired power accounts for more than 70% of the energy mix in China. This presents a monumental challenge not only for the emerging Chinese economy, which is undergoing a structural shift, but also for the long-term sustainability of our environment. If you look at Europe, it is apparent that a fuel-switching behaviour between coal and gas exists among power generators, which clearly helps to reduce the pollution intensity in the continent. However, in the case of China, the vast majority of coal power plants are not capable of switching to natural gas; though this is also changing.
To answer your question, we primarily looked at crude oil prices as the data on both the domestic and the international crude oil is available at a better quality compared to coal. The coal price data that we have access to exhibits large staleness which could distort our results and hence the conclusion of the study. Nevertheless, given the significant role that oil plays in any economy, oil price as a fundamental input contains rich information about the Chinese economy. Thus, we think it is important to study the relationship between carbon price and oil.
CC.net.cn: Do you think that the National ETS might also be weakly correlated to Daqing crude prices (and none at all to the international market), as your study on the pilot schemes suggest?
JF: We don’t know for sure at this stage. More data is required to draw a conclusion. However, we expect that when trading volume ramps up and market liquidity improves, carbon prices should reflect the economic fundamentals, i.e. macroeconomic activities, business cycle, energy prices and weather conditions. However, the current state of the market presents a significant challenge for the policy makers in Beijing to design and implement the national scheme. We still know very little about the detailed mechanics i.e. allowance allocation, national carbon pricing and compliance. I think more clarity will be beneficial for a smooth launch of the national market. Even after the launch of the national scheme, there is still a lot of learning waiting for the policy makers and market participants, given how differently these pilot markets behaved from 2013-2016.
CC.net.cn: Data transparency in the Chinese pilots has been touted by many analysts as a key barrier for in-depth research. Did your study face any limitations because of the need of data?
Dr. John Fan: Yes. We thought long and hard about overcoming the large number of missing values in our dataset. The missing prices may reflect the lack of trading activities and/or transparency issues in the reporting process. The carbon prices are published by each regional exchanges separately. In order to draw meaningful conclusions, we focus our analysis on four markets – Beijing, Guangdong, Hubei and Shenzhen. We conducted a regression analysis based on raw data with missing values, a daily time series with missing values excluded, and a daily series containing simulated value for days of no trading activities. To ensure the study was robust, we also examine the observed relationships by constructing weekly returns series (both time and volume-weighted). The findings suggest that the allowance price in the pilots trading phase is only weakly linked to a number of macro factors, although the results are somewhat mixed from one market to another.
CC.net.cn: We have been tracking the pilot markets since they began trading in the 2013-14 period and we have observed that both liquidity and price volatility always increase around the compliance deadlines. This and other observable trends suggest that trading in the spot markets is driven by compliance rather than macro-economic factors. How much would you agree with this?
JF: At this present stage, the data indicates trading volumes generally spike around July each year across exchanges, which coincides with the compliance events. This implies that Chinese carbon markets are inactive most of the time outside of the compliance events. Given this behaviour, the empirical evidence suggests that domestic crude oil still plays an important role in determining the carbon prices. Nevertheless, this market behaviour is not specific to China. In the EU-ETS markets, studies have reported that trading is relatively calm on the days before the compliance event but trading volumes are significantly higher on compliance days, as the market incorporates the emission permit option prices. Overall however, we would still like to see more liquidity in the market, especially institutional capitals from those of investment banks and asset managers. As this would help improve the efficiency and price discovery process of these markets.
CC.net.cn: The Chinese government cut the quotas for both exports and imports of crude oil for the current year, thus impacting the production from the nation’s refineries this year. Do you see this impacting emissions or carbon prices in China?
JF: Our findings suggest that carbon price in Beijing is weakly linked to Daqing crude oil prices but not to international crude oil price level. Based on this evidence, we expect that shocks to domestic crude oil prices will be transmitted into carbon prices. However, as market liquidity and transparency improve, we expect more economic fundamentals to influence carbon prices. Although at this stage, when trading volumes and market interests are low, we think the price discovery process is rather immature.
CC.net.cn: Thanks again for the interview John. Before we leave I would like to know how you plan to follow up on your study?
JF: We are currently examining the potential cross-market linkages during the pilot phase. However this could soon change, as the NDRC spoke of averaging the allowance prices from regional markets for determining the national carbon price. We are waiting for more information to become available.
Dr John Fan is a Lecturer in Finance at Griffith Business School. His research interests include empirical asset pricing, behavioral finance, alternative investments, sustainable finance and investments in superannuation. John’s current research focuses on the construction of investment strategies for institutional investors. He has provided consultations to asset management and advisory firms in Brisbane, Sydney and China.
*ChinaCarbon.net.cn is proud to have assisted Dr. John Fan’s study by providing historical price data for all of the seven Chinese pilots