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China to unveil national carbon market in 2016

China is poised to launch a national carbon trading market – potentially the largest one in the world - but if its seven regional pilot projects are anything to go by, there is still much to be done

As the world’s leading carbon emitter, China looms large in the climate change debate. So when a senior government official said in September that China plans to roll out a national carbon market in 2016, it raised hopes that the country is stepping up its efforts to rein in emissions. Although a move in the right direction, China’s early experiences with carbon trading show it has a long way to go. 

The scale of China’s growing carbon footprint was underscored in a report from the Global Carbon Project, a non-governmental research group. The report found that China’s per capita carbon emissions surpassed the European Union’s (EU) for the first time in 2013. The country now accounts for more than a quarter of new carbon pumped into the atmosphere, more than the US and EU combined. Moreover, recent steps by Beijing to slow its emissions growth have had little effect, as emissions grew at 4.2% in 2013 from the previous year. At its current rate, China’s emissions could exceed the combined carbon output of the US, EU and India as early as 2019, according to the report.

China has long argued that the vast majority of climate-change inducing carbon dioxide (CO2) was emitted by Western countries, so it is the West’s mess to clean up. China, Beijing argues, should be free to emit as its economy grows and it raises its citizens’ living standards, just as the West was able to. Beijing has stuck to this position, what it calls “common but differentiated responsibilities”, ahead of the next round of international climate negotiations next year. But the argument has lost some of its effectiveness in the face of the sheer scale of China’s emissions. At the same time, a confluence of factors at home has pushed Beijing to take a more proactive position on its carbon emissions. 

The centre piece of the country’s CO2 fighting effort is the planned national carbon-trading scheme. The National Development and Reform Commission (NDRC) will submit plans for the national market later this year to the State Council with an eye towards starting to put the market in place by 2016, Sun Cuiha, a senior official at the NDRC, said in Beijing in late August. If rolled out across the country it would likely be far larger than European carbon trading market, which is the largest in the world.

The government has not released details on how the national carbon market will work. He Jiankun, chairman of China’s Advisory Committee on Climate Change, said earlier this year that the next five-year plan, to be released in 2016, could include a firm cap on carbon emissions, likely in the 2030s. But he later backtracked, indicating there is still a robust debate within the government over how fast to move on committing to a carbon emissions cap. China’s environmentalists and climate scientists have pushed for more aggressive steps to cap emissions, but many in the government still reject the idea of China committing to anything that might slow its economic development.

Instead of a firm cap on emissions, most analysts expect that the market’s guiding principle will be the government’s pledge to reduce carbon emissions per unit of GDP by 40% to 45% by 2020, based on 2005 levels. That would make it very different to other trading schemes in Europe, the US and elsewhere, which have put a strict cap on total emissions and sought to achieve annual emissions reductions. The Chinese formulation would allow overall emissions to continue rising, albeit at a slower rate than without the reduced carbon intensity levels.  

The national scheme will build on China’s experiences with the seven pilot regional carbon markets that have been set up over the past 18 months. Markets have been set up in Beijing, Shanghai, Shenzhen, Tianjin, Hubei province, Guangdong province and most recently Chongqing, all of which are major industrial areas mostly in the east of the country. More pilot markets were planned, but it appears China is scrapping those in favour of a national market. 

All of the markets have been given some autonomy in how they are set up and operated, which has produced a range of different sorts of markets. For instance, only a few allow individual traders to buy and sell carbon permits, which is standard in other parts of the world in order to increase market liquidity. There are also differences in how permits are awarded. In most cases, they are given away to polluters, but some auction a small percentage of permits. They also vary in the degree to which they cover different industries. Beijing’s market covers around 50% of total emission while Tianjin’s market covers around 60% of its emissions.   

“We believe that it’s likely that the central government wants to compare the regional markets’ characteristics and results in order to establish an optimal one at the national level,” Michael Wilkins, an analyst at S&P, a credit ratings agency, wrote in a recent report on China’s carbon markets.

There have, however, been a number of difficulties all of the markets have faced that point to a long road ahead for China’s carbon market plans. Perhaps the biggest problem is the lack of activity in the market. One visitor to the Shenzhen market’s trading floor reported: “It was hardly a hub of activity. Several members of staff were asleep, one of them on a fold-out bed. It is a typical enough scene at [state-owned enterprises], where lunch breaks are often generous enough to fit in a postprandial nap, but also an accurate reflection of the state of trading.”

The pilot markets report just a few trades a day, if any at all. Chongqing’s carbon market, which opened in June this year, has yet to see a single transaction, according to the exchange’s data. The Shanghai market, touted as a promising model for the national market, saw just one trade from 1 July through late September.  

There are a number of reasons why so little trading has taken place. Most companies have little expertise in carbon trading, while others are outright hostile to the idea. Those that may want to trade carbon permits may not know how, or may struggle to find a seller. Lenient penalties and lax enforcement for exceeding allotted carbon allowances has led some companies to simply ignore the exchanges. 

Some exchanges have taken steps to encourage more trading. In early September, the Shenzhen market opened its doors to some foreign energy and utility companies as well as financial players, which hope to gain early experience in China’s carbon trading schemes. The Shanghai exchange followed suit, in the hopes that more participants will inject some life into the moribund market.

Illiquid markets have led to big disparities in carbon prices between the markets, as well as high levels of volatility. At one point in September this year, the listed market price in Shenzhen to trade a tonne (/t) of carbon was 64.08 yuan ($10.44), but was just 23.83 yuan/t in Hubei. The peak price was 122.97 yuan/t in Shenzhen in October last year, while Tianjin’s exchange has seen the lowest prices, hitting a low of just 17 yuan/t in July. Prices, though, have started to converge in recent months and the average among all the exchanges in late September was around 40 yuan/t, or around $6.52.

If the carbon price remains at such low levels when the national scheme is rolled out, it will do little on its own to convince companies to invest in lower emitting technologies. As of now, the pilot schemes do not use any of the price control mechanisms used in some other markets, such as price floors and ceilings, something that will likely be considered for the national market. 

Here, China could learn a lot from the European experience setting up its carbon market. When Brussels established its carbon market it relied on carbon emission projections from companies that proved to be far too high, thanks partly to the financial crisis. It has resulted in an oversupply of permits and low carbon prices that persists to this day.  

Beijing, analysts say, will have to carefully plan how it allocates carbon permits if it wants to see an effective market-based mechanism for controlling carbon emissions. China’s state-owned enterprises (SOEs), especially the major oil refiners Sinopec and PetroChina as well as the coal industry, are very influential within the government and will likely push for as many carbon permits as possible to reduce their costs. 

Sinopec and PetroChina, for instance, resisted efforts by the Ministry of Environmental Protection to enforce stricter environmental standards on gasoline and diesel for years before finally agreeing to make the necessary upgrading investments at their refineries. Beijing will have to persuade its powerful SOEs to get on board with the scheme. “Within the Chinese political hierarchy local governments will not be able to pull rank on [the SOEs],” the Economist Intelligence Unit (EIU) said in a recent report on China’s carbon trading efforts. “What if SOEs simply refuse to play the game?”

Beijing will also have to deal with a dearth of reliable data on emissions, especially in areas that haven’t been covered in the pilot schemes. In some provinces, less than half of the companies required to disclose their pollution emissions data online were doing so, a recent study by the Ministry of Environmental Protection found. A Bloomberg investigation found that even where emissions data was being reported it was riddled with errors and gaps. Even after the national carbon market is rolled out, it will take at least a couple years for companies to develop the personnel and technology to more accurately report data, and for the government to enforce its regulations. “A functioning scheme is unlikely to emerge until sometime towards the end of the decade,” says the EIU. 

Nevertheless, early data indicates that in some cases the regional pilot schemes have helped to reduce CO2 emissions and carbon intensity, according to the S&P report. “In Shenzhen, covered corporates have cut their CO2 emissions by 11% and their carbon intensity by 23% compared with 2011 levels. In Shanghai, covered corporates cut their CO2 emissions by 3.5%. In Guangdong, it was reported that 80% of covered corporates had reduced their CO2 emission,” the report says.

Beijing’s carbon emission efforts are closely linked to a number of other changes taking place in China under president Xi Jinping. Xi wants to move China away from the resource-intensive, investment-led growth model that has fuelled economic growth over the past three decades, but has also wrought havoc on the country’s environment, to a more consumption-focused model less dependent on heavy industry and manufacturing. 

To that end, the government has dropped GDP growth as a metric used to evaluate many local officials, with the hopes that local party members will stop pushing wasteful projects that do little more than boost their topline GDP figure. It has also started evaluating local officials in some areas based partly on meeting carbon-intensity reduction targets.

The increased focus on carbon emissions is also closely linked to the government’s efforts to clean its smog-filled skies. Above all, Beijing is pushing measures to reduce its reliance on coal, while increasing the share of gas, renewables and nuclear in the energy mix. Such a move would have positive knock-on effects for the country’s carbon emissions, which the government is keen to point out to the international community. 

In many ways the global effort to avert disastrous climate change hinges on actions taken by Beijing. China is already by far the world’s largest carbon emitter and those emissions are only going to rise. Over the next two decades, China’s energy demand is forecast to rise by around 70%. Beijing will be the world’s largest investor in renewables and nuclear, but oil and gas consumption are also forecast to double over the period. Meeting this demand while keeping a lid on pollution and carbon emissions is one of most complex and difficult problems facing Beijing.

Yet, China’s policymakers have good reason to get behind efforts to tackle the problem. A government report in 2012 warned that the country faced “grim ecological and environmental conditions” from continued climate change, including serious threats to its water and food supplies. An effective national carbon market would be a step in the right direction. 

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