<p>Improving energy efficiency is not only the key to achieving energy conservation, carbon reduction and green development, but also the way to promote the high-quality development of China’s economy. This article measures the total factor energy efficiency (TFEE) of Chinese cities and uses the Energy Rights Trading Pilot Policy (ERTP) as a quasi-natural experiment to evaluate the impact of this market-based environmental regulation policy on TFEE using a difference in differences (DID) model. The results show that ERTP can significantly promote the improvement of TFEE in Chinese cities. This effect is more obvious in coastal cities, high-grade cities and resource-based cities. ERTP can promote the upgrading of industrial structure and enhance the ability of green technology innovation, thereby promoting the improvement of TFEE. ERTP has a negative spatial spillover effect on the TFEE of neighboring regions. This article not only provides empirical support for revealing the complex effects of market incentive based environmental regulation in developing economies, but also provides important theoretical references and practical inspirations for the nationwide promotion and differentiated policy design of ERTP.</p>