The world number three was below par throughout in a scrappy match that featured few breaks of note.
Higgins led 2-0 but Cao fought back in spectacular fashion to take the next five.
The one spark of form shown by Scot Higgins was in the penultimate frame, when he was on a 147 but missed the 11th red.
With the score 5-3 Cao, who turned 22 two days ago, clinched the match with a fluked final ball and apologised to the four-times world champion.
Higgins said: "It's a big tournament so I'm gutted to go out in the first round. I started well but then I missed a lot of chances and I didn't deserve to win. Cao is definitely one to watch."
Mark Allen or Robert Milkins, who play on Tuesday afternoon local time, lie in wait for Cao in the last 16.
In the other match completed on Monday afternoon in China, world number one Mark Selby beat Ali Carter 6-3.
Selby will face either Ricky Walden or Lu Ning in the last 16 after the Chinese earned a place in the first round by beating Barry Pinches 6-5.
Monday's evening session saw Dominic Dale defeat former world champion Graeme Dott 6-3 while Matthew Stevens edged Zhao Xintong in a final frame decider.
John Higgins 3-6 Cao Yupeng
Mark Selby 6-3 Allister Carter
Matthew Stevens 6-5 Zhao Xintong
Graeme Dott 3-6 Dominic Dale