A passenger flight from Hong Kong to Dalian had to drop more than 6,500m (21,000ft) due to a sudden loss of cabin pressure.
Investigators said it was caused by one of the pilots smoking an e-cigarette.
The civil aviation body fined the airline and cut the carrier's flights with Boeing 737 models by 10%.
It also ordered Air China to undertake a three-month safety review.
The mid-air drama unfolded when one of the pilots, who was vaping, tried to turn off a fan to stop his smoke reaching the passenger cabin. Instead, he turned off the air-conditioning unit, causing a drop in the cabin's oxygen levels.
Emergency measures were triggered, and oxygen masks dropped.
The plane was forced to descend rapidly.
If a plane loses cabin pressure, the pilot has to bring the aircraft to a lower altitude to keep crew and passengers safe.
Once the crew saw that the air conditioning had been turned off, they reactivated it and brought the flight back to its normal altitude.
The plane went on to complete its flight as scheduled, and none of the 153 passengers or crew were injured.
A third pilot on board, who was not involved in the incident, had his licence revoked for six months and was banned by Air China for two years, the South China Morning post reports.
Chinese flight regulations prohibit all flight crew from smoking, and banned passengers from using e-cigarettes on board in 2006.
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