Navigating China's Carbon Market Imbalances: Strategic Opportunities Amid Policy Evolution

China's carbon market, the world's largest emissions trading system (ETS), is at a critical juncture. While its expansion into high-emission sectors like steel, cement, and aluminum signals a bold step toward decarbonization, the market faces persistent imbalances-including a 400 million-ton surplus of carbon emission allowances (CEAs) as of 2023 and volatile pricing dynamics. For investors, these challenges present both risks and opportunities, particularly as policy reforms and international pressures reshape the landscape.

Policy Slippage and Structural Imbalances

The national ETS, launched in 2021, initially focused on the power sector but expanded in 2025 to cover 1,500 additional companies in steel, cement, and aluminum, adding 3 billion tonnes of CO2e to the system, according to the China Carbon Market Weekly Update. However, this growth has been accompanied by systemic oversupply. As of late September 2025, CEA prices plummeted to 55.50 yuan ($7.80) per tonne-the lowest since May 2023-due to surplus units being sold under relaxed banking and conversion policies, the update noted. Meanwhile, the voluntary China Certified Emission Reduction (CCER) market, relaunched in 2025 with new credits from renewable energy projects, saw trading volumes drop to 62.8 thousand tonnes, with prices stagnating below 80 yuan, the same update reported.

The root of these imbalances lies in overallocation and outdated cap-setting mechanisms. A 2024 study highlighted that the ETS's benchmark values for allowance allocation remain higher than the average carbon intensity observed in covered sectors, creating an excess supply of annual allowances exceeding 600 million tonnes. This oversupply undermines the market's ability to drive meaningful emission reductions, as prices remain far below the 186 yuan/ton threshold required to align with the 1.5-degree pathway, the study argued.

Policy Reforms and Investor Implications

To address these issues, China has introduced several reforms. The transition from two-year to one-year compliance cycles, stricter allowance banking rules, and plans to shift from intensity-based to absolute emissions caps by 2027 aim to tighten the system, according to Invezz. These changes, modeled partly on the EU ETS's Market Stability Reserve (MSR), could stabilize prices by reducing surplus and enhancing market discipline, analysts say.

For investors, the immediate risks include asset devaluation in sectors reliant on low-carbon pricing and regulatory uncertainty. However, long-term price projections-averaging 100 yuan in 2025 and rising to 200 yuan by 2030, per the 2024 study-suggest a potential re-rating of carbon assets. Sectors poised to benefit include renewable energy (via CCER demand) and carbon management technologies, as companies seek compliance solutions.

Strategic Positioning for Investors

1. Sectoral Diversification: Investors should prioritize sectors directly impacted by ETS expansion, such as steel and cement, where carbon pricing is expected to rise as absolute caps take effect. Conversely, energy-intensive industries with weak abatement incentives may face margin compression.
2. CCER Market Exposure: The relaunched CCER market offers a niche opportunity. Companies with renewable energy assets (e.g., wind, solar) can monetize offsets, as CCERs now cover up to 5% of ETS obligations, according to the weekly update.
3. Policy Arbitrage: The EU's Carbon Border Adjustment Mechanism (CBAM), set to apply to Chinese exports in 2026, creates a dual pricing dynamic. Investors could hedge by allocating to firms that align with both China's ETS and CBAM requirements, such as aluminum producers adopting low-carbon technologies.

Conclusion

China's carbon market is a work in progress, balancing ambitious decarbonization goals with structural inefficiencies. While oversupply and policy slippage pose near-term risks, the 2025–2027 reforms and international alignment with CBAM create a framework for long-term value creation. Investors who position themselves in sectors aligned with tightening caps, CCER demand, and cross-border compliance will be best placed to capitalize on the market's evolution.