Crunch time for emissions trading pilots

July 13, 2013 by Vaughan Winterbottom

It’s crunch time for China’s emissions trading pilot schemes. Announced in November 2011 by the country’s National Development and Reform Commission (NDRC), emissions trading scheme (ETS) pilots are being rolled out in seven municipalities and provinces starting this year. If all goes well – and probably even if it doesn’t – a national ETS will feature in the country’s 13th Five-Year Plan, to be realized in the period 2016-2020.

China is far and away the world’s largest polluter. The country is responsible for 29% of the world’s carbon dioxide emissions; the US comes in a distant second at 16%.The Chinese leadership has realized it needs to do something about runaway emissions, which have the potential to wreak climatic havoc on the country. Air pollution in general is already making life wheezy for Chinese citizens and is a source of social unrest – something the ruling Communist Party would very much like to contain.

In December 2009, China committed to cutting its carbon dioxide emissions per unit of GDP by 40-45% by 2020 from 2005 levels. The country’s 12th Five-Year Plan calls for energy consumption to decrease by 16%, and carbon dioxide emissions to fall by 17% per unit of GDP in the period 2011-2015. A nation-wide ETS is touted by the government to be crucial if China is to meet its long-term energy consumption reduction goals.

Plans for the ETS pilots have been pushed forward with a briskness characteristic of the government’s top-down decision-making process. It also ‘helps’ that the opposition parties are absent, and that industry lobbying, which has thwarted ETS efforts in other countries, is easily dealt with.

According to Bloomberg New Energy Finance, the seven pilots should regulate 800m to 1bn tons of emissions by 2015, making it the world’s second biggest cap-and-trade program after the EU’s ETS.

Shenzhen – inhabitants of which must surely be getting sick of the ‘testing ground’ epithet – was the first city to begin emissions trading under the new scheme on 18 June. A total of 635 small and medium emitters from 26 sectors are taking part, accounting for 38% of the municipality’s 2010 emissions. The overall greenhouse gas reduction target for the pilot is a 21% cut in carbon intensity by 2015 compared to 2010.

Shanghai is expected to join Shenzhen in establishing an ETS pilot by the end of June. Beijing was to introduce a pilot of its own by the end of June as well, but so far there’s been no confirmation of a start date.

Some experts maintain that China has bitten off more than it can chew when it comes to establishing the pilots. “Some schemes may be delayed. I believe the Chinese government has underestimated the challenges in developing a pilot emissions trading scheme,” said Dr. Xi Liang, a lecturer in Business and Climate Change at the University of Edinburgh. “[The ETS pilots] are a brave attempt by China… but solving all practical challenges and implementing ETS at a national level might require greater political will,” Xi added.

China’s submission in |March to the World Bank’s Partnership for Market Readiness program says a full national trading scheme will be ready for the country’s 13th Five-Year Plan. But last November Xie Zhenhua, vice chairman of the NDRC, announced there would be an extension of the piloting period to more regions in 2016-2020. This may imply a delay in the national scheme.

“The delays will be significant,” said a researcher at a Beijing policy institute that works closely with the NDRC. “In particular, the two provinces chosen to introduce ETS pilots, namely Hubei and Guangdong, are nowhere near ready to implement.”

“There remain many issues to be straightened out before the pilots can run smoothly,” said the researcher. “Shenzhen managed to launch its pilot on time thanks to its status as a special economic zone – it has more flexibility and power to enact the laws needed for ETS implementation. In other pilots, the legal base and enforcement of penalties is currently insufficient; local officials who oppose the pilots out of economic growth concerns could still undermine them through non-compliance.”

Oversight of the pilots is not yet clear-cut. Analysts point to a power struggle between the NDRC and the Ministry of Industry and Information Technology (MIIT). The ETS pilots are the NDRC’s brainchild, but traditionally the MIIT has been in the driving seat on energy-saving work.

Infighting has already resulted in another route to low emissions in China being put on the policy backburner. A Chinese carbon tax, backed by the Ministry of Finance and the Ministry of Environmental Protection and touted for implementation this year, has been put on hold. The tax is “still in internal discussions” and faces “obvious opposition,” said Jia Kang, head of research at the Ministry of Finance, speaking in March this year. Most analysts assume the NDRC, which is heavily invested in carbon markets, to be the culprit.

Another challenge in getting the pilots up and running is establishing a fair and implementable auditing, monitoring and reporting scheme. Energy audits are still uncommon in China; verifying emissions data is hard. Even when data is readily available, the permit distribution and allowance allocation methodology for the pilots is yet to be fastened down.

When a national ETS scheme is eventually introduced, problems with auditing and monitoring will be compounded. The accuracy of the national accounting measures is subject to question. In February, for instance, state media reported that 2012 saw a RMB 5.8 trillion difference between China’s national GDP and the sum figure of growth statistics from its 31 provinces and administrative regions. The statistical gap is the equivalent to the size of Guangdong’s economy.

Even if the ETS pilots manage to get off the ground as planned, there are questions about how effective they will be in reducing carbon emissions. Emissions caps are unavoidable for trading schemes to work, but so far China has resisted implementing an absolute cap. Instead, for the pilots the government has opted for ‘guiding’ caps tied to economic forecasts for the end of the 12th Five-Year Plan period.

Current estimates place peak greenhouse gas emissions in China as occurring sometime between 2025 and 2030. China may move towards an absolute cap on emission at that stage, but only, as Dr. Xi Liang says, “if other developed and developing countries adopt more ambitious targets and/or plans for emissions reduction.”

As the pilots stand at present, lowering carbon and energy intensity, rather than reducing absolute quantities of carbon emissions, is the priority. The Guangdong Province ETS pilot, for instance, plans to reduce carbon intensity by 19.5% by 2015 compared to 2010. Overall emissions will still go up, however; the provincial 12th Five-Year Plan caps 2015 carbon dioxide emissions at 660m tons, 29.4% above 2010 levels.

Concerns about forestalled economic growth seem to have ruled out absolute caps for now. As the writers of one academic paper with influence in policy circles noted, “The period from now until 2020 is a period of major strategic opportunities for China’s economic development. A good coordination between economic growth and greenhouse gas (GHG) emissions mitigation is more important than only focusing on controlling GHG emissions.”

Some of the worst polluting industries in China are dominated by state-owned enterprises (SOEs). But the participation of SOEs in the pilots – and whether they should be given favorable conditions – is still being debated.

Telecommunications giant Huawei is said to be taking part in the Shenzhen pilot scheme. But according to China’s aforementioned Final Market Readiness Proposal to the World Bank, SOEs are facing a “tremendous challenge to reach their 12th Five-Year Plan GHG emissions reduction targets.” They have “encountered issues for their effective involvement in the seven ETS pilots,” the proposal goes on to say, before concluding that another three years of research is needed to “study the characteristics of SOEs, analyze the influence of these characteristics on emissions trading and research [their] impact on allowance allocation.”

In the end SOEs won’t be exempt from energy intensity reduction targets, said Dominic Meagher, an energy analyst at China Policy, a Beijing-based consultancy. “Especially where the big state enterprises are concerned – the national champions, so to speak – China’s leaders view SOEs future as leaping to the technological frontier. If their profit margins rely on cheap coal, they’re not at the frontier.”“China wants to dominate the sectors that will provide the next 50 years’ energy supply: solar, wind and nuclear, and possibly gas. This means forcing SOEs off coal.”“This year we’ve already seen moves by the government to create an energy price signal that flows through to consumers. Getting rid of the dual track pricing mechanism for coal was a significant step. You can’t have an effective emissions trading scheme if energy prices are set by administrative decisions,” Meagher adds.

The ETS pilots and an eventual national carbon-trading scheme will ultimately be judged their ability to spur low carbon electricity investment in China. Since two-thirds of the county’s primary energy supply and more than 80% of electricity generation comes from coal, carbon capture and storage (CSS) is the obvious candidate for such investment.

However, low carbon electricity investment doesn’t only rely on emissions trading. “The impact of the carbon market on low carbon electricity investment is minor. In China, the political commitment to emissions trading has only been around for three years. There are significant uncertainties for investors in modelling carbon markets in the longer term; most low carbon electricity technologies have a long-term nature,” said Xi.

Until very recently the political will to support CCS was weak. In June, however, the NDRC issued the country’s first comprehensive policy to support the demonstration of CCS technologies. “The next stage will involve the formulation of targeted mechanisms to finance large-scale CCS demonstrations. In the longer term, if the equivalent amount of feed-in tariff for non-hydro renewables is provided for CCS, it would be deployed widely,” said Xi.

So if the market-based approach taken by the ETS pilots fails to deliver, China could always resort to its default tactics to realize energy and emissions targets: tariffs, subsidies and command economy directives. Indeed, it seems the two systems will exist side-by-side: on June 14, the State Council ordered firms in heavy-polluting industries to cut emissions per unit of GDP by 30% by 2017. The nation’s solar industry, despite being embroiled in trade disputes with Europe and rampant overcapacity, was also promised support.

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