Outdated capacity and substantial potential for energy conservation are the two main features of energy-intensive sectors in developing countries. Such countries also seek to implement market-based options to further control domestic carbon emissions as well as to promote the withdrawal of outdated capacity and upgrade production levels. This paper presents a quantitative assessment of an emission trading scheme (ETS) for China’s iron and steel industry. The diverse array of normal and outdated capacities are modeled in a two-country, three-good partial equilibrium model.