Emissions Trading and Carbon Intensity Regulation in China’s Steel Sector: Environmental and Financial Outcomes from a Difference-in-Differences Analysis

This study examines how China’s carbon intensity reduction policies and emissions trading participation have affected firm-level outcomes in the steel industry from 2010 through 2024. We compile an unbalanced panel of 120 major Chinese steel firms with data on environmental metrics (CO₂ emissions per tonne of steel) and financial performance indicators, profitability, leverage, and investment. Employing a difference-in-differences (DID) framework that separately identifies two distinct policy channels, regional pilot ETS exposure and binding government-mandated carbon intensity targets, we compare treated firms against controls before and after policy implementation. To ensure causal credibility, we conduct formal event-study analyses to verify parallel pre-treatment trends, implement staggered-DID estimators to address heterogeneous treatment timing across the seven pilot jurisdictions, and cluster all standard errors at the firm level. We address endogeneity concerns by controlling for concurrent confounding policies, including output production caps, central environmental inspection campaigns, and supply-side capacity elimination, and by implementing propensity score matching DID (PSM-DID) and sensitivity bounds for unobservable selection. Our results indicate that firms subject to pilot ETS regulation achieved statistically significant additional reductions in emissions intensity, approximately 0.05 tCO₂/t steel, beyond industry-wide improvements, with firm-clustered standard errors confirming significance at the 5% level. Firms under binding intensity targets also reduced emissions, though with smaller and less precisely estimated effects. Importantly, we find no statistically significant evidence that these regulatory pressures harmed economic performance; return on assets rose modestly among pilot-ETS firms by approximately 0.7 percentage points, though this effect is only marginally significant (p < 0.10) and economically small, warranting cautious interpretation. Heterogeneity analyses reveal that state-owned enterprises and firms in eastern provinces gained more from carbon policies. A formal mediation analysis testing the hypothesized transmission channel from low-carbon innovation through efficiency improvements to profitability yields suggestive but statistically inconclusive results: while the indirect effect is directionally consistent, the Sobel test does not reject the null of no mediation at conventional levels. In light of China’s dual carbon goals and the 2025 expansion of the national ETS to include steel with the November 2025 release of the 2024-2025 allowance allocation plan, these findings imply that well-designed market-based carbon policies can reduce emissions intensity for steelmakers without necessarily undermining economic performance, though the evidence for net profitability gains remains tentative. Transitioning from intensity benchmarks to absolute caps will be necessary for deeper decarbonization.