Last month, China announced the initial details of its much-anticipated emissions trading scheme (ETS).
The new scheme will have a more cautious rollout than set out in initial draft plans, starting with the power sector alone in a national pilot phase.
However, it will still be by far the world’s largest carbon market.
Carbon Brief takes an in-depth look at what is known about China’s ETS, the remaining gaps and how it will fit in with China’s wider climate policy landscape.
How did China’s ETS come about?
China’s greenhouse gas emissions are the highest in the world and are estimated to have risen by around 4% last year, halting several years where they flatlined. It burns more coal than the rest of the globe put together.
Alongside other policies to cut emissions, China has long had plans to create a national carbon market. First floated in the country’s 12th Five-Year Plan in 2011, plans to roll out a nationwide scheme in 2017 were confirmed by Chinese President Xi Jinping in a US-China joint climate statement in the run-up to the Paris climate summit in 2015.
In January 2016, a notice to industries set out the steps they should take to prepare for the national scheme. This notice was circulated by China’s National Development and Reform Commission (NDRC), the state agency tasked with developing the ETS. Draft plans covering three sectors were then set out for consultation with industry and other government departments in May 2017.
On 19 December 2017, China released an initial framework for the first nationwide phase of the ETS, just inside the deadline set by the president’s 2015 pledge.
This was the first document with final approval by the state council, the country’s chief administrative authority. (Note that Carbon Brief is relying on an unofficial translationof this framework plan, published by crowdsourced translating website China Energy Portal).
Initially set to cover more than 3bn tonnes of CO2 from the power sector, the carbon market will be the largest in the world and close to double the size of the next largest, the EU ETS. Once operational, it will mean around a quarter of global CO2 emissions are covered by carbon-pricing systems.
In developing its plans, China has reportedly been very conscious of the issues affecting other emissions trading schemes. It has conducted extensive discussions with representatives from schemes in California and the EU, in an effort to learn from their mistakes.
According to Jeff Swartz, director of climate policy and carbon markets at the South Pole Group and previously director of international policy at the International Emissions Trading Association (IETA), these include the need to have good emissions data and to set a conservative emissions benchmark from historical data. He tells Carbon Brief:
“The government in China has studied this clearly: there are traces in the plan to make sure the cap is set appropriately. They have understood the mistakes in Europe.”
According to the New York Times, China’s ETS could serve as a laboratory for other carbon markets developed in the future. If it manages to implement an effective carbon price, it could also reduce fears in the EU of carbon leakage to China.
Will the ETS help China hit its climate targets?
China’s government has begun to put a strong emphasis on curbing CO2 emissions. The country plans to spend $363bn on renewable power capacity by 2020 and has a leading presence in renewables investment abroad.
Its climate pledge ahead of the Paris Agreement included a goal to peak CO2 emissions by “around 2030”, and make “best efforts” to peak earlier. It also plans to source 20% of its energy by 2030 from non-fossil sources (this stood at 13% in 2016). Other goalsinclude a decrease in the carbon intensity of its economy and an increase in forest stock volume.
China is already set to overachieve on its aim to peak emissions by 2030, according to Climate Action Tracker (CAT). However, CAT also notes that these targets are far from being in line with the Paris Agreement, which commits countries to limit global warming to well below 2C and pursue efforts to limit it to 1.5C.
China’s trading scheme, therefore, comes in the context of a wide range of climate policies. One 2016 comparison of the potential for 35 environmental policies in China to drive down emissions found carbon pricing would be the most effective.
However, with little confirmed about how it will work (see below), it is hard to judge its possible impact.
Li Shuo, an energy and climate policy analyst for Greenpeace East Asia, tells Carbon Brief the real question is how much the country will overachieve its goals and if the ETS plays any role. As is the case for the EU ETS, there will be debate over whether the China ETS itself drives emissions reductions, or merely mops up after all the other related policies.
For example, Swartz says coal plant closures will result from other regulations. He says:
“The ETS is a transitory policy tool that sends a market signal for companies and investors to shift away from heavily polluting sources.”
Max Dupuy, senior associate at the Regulatory Assistance Project, says other policies may have more of an influence on carbon emissions in the near term, as the ETS develops over time. He tells Carbon Brief:
“There are a lot of things that are going on and they all have interlocking effects and they will, in turn, interact with the emissions trading scheme.”
What will be covered by the trading scheme?
Perhaps the most significant part of the announcement in December was that it scaled back the sectors the ETS would cover.
Early plans for the scheme, circulated in January 2016, had included firms consuming more than 10,000 tonnes of “coal equivalent” in eight sectors: petrochemicals, chemicals, building materials (including cement), iron and steel, non-ferrous metals (such as aluminium and copper), paper and civil aviation. This would have covered around 6,000 companies.
However, the December launch confirmed that only the power sector will be included at first. Plants emitting more than 26,000 tonnes of CO2 per year or more – covering almost all coal and gas-fired plants – will be included, the government plan says. This will still almost double the amount of emissions worldwide covered by emissions trading schemes.
The scheme will, therefore, only involve around 1,700 power companies at first. This will be gradually expanded “when conditions allow…to other industries with high energy consumption, high pollution and high resource intensity”, the plan says. It is expected to eventually include the other seven sectors previously proposed.
Swartz argues this vastly diminished ETS, compared to the original plan, is the big story of the release in December, arguing it “won’t have any bite in it” with the power sector alone. He tells Carbon Brief:
“After studying the market for years and conducting pilots, how much delay do you need when you know what needs to be done?”
Emissions have already levelled off in China’s power sector, while even with the other seven sectors included the ETS would by no means cover all of China’s emissions. Swartz estimates it would reach perhaps half of China’s CO2 emissions because key emitting sectors are excluded, including land transport and agriculture.
Others have argued it is important for China to move cautiously and take the time to get the emissions trading scheme right, with the power sector a reasonable place to start.
For example, policymakers need reliable data on historic baseline emissions from different plants, to set the right target levels and allocate allowances. Some observers have noted that the large state-owned enterprises that dominate electricity generation in the country have relatively complete emissions data, at least compared to other parts of the economy.
Chinese officials have similarly expressed concern that including other sectors at the outset would require constant testing and adjustments, given they are still in the process of establishing their emissions datasets.
The typically large size of power plants, which might emit tens of millions of tonnes of CO2 each year, also means relatively few points of emissions compared with other industries.
In an article for Vox, David Roberts argues the key thing to remember is that China’s government thinks long term. He writes:
“The most important thing is getting the baselines, rules and procedures right, creating a functioning system that can be used as a ratchet for decades to come.”
The plan itself says China wants to avoid “affecting…stable and healthy economic development” by including too many industries at the outset.
How will China’s carbon market work?
Carbon markets aim to provide incentives for polluters to reduce emissions by allowing firms to trade the right to emit. In the EU and California, this has involved putting an absolute cap on emissions, which is reduced over time.
However, China has generally resisted setting absolute emission caps in its climate pledges, instead opting for intensity-based targets to cut emissions per unit of GDP. While the precise methodology for the cap-setting in China’s national carbon market has not yet been released, government sources have indicated it will take a similar approach.
Therefore, it appears China will use a rate-based limit for its ETS. This would see a limit put on the amount of CO2 allowed per unit of output. Each power company would be allocated a certain number of credits, depending on how much electricity it produces. If it emitted less than this set quota, it could then sell that surplus to another firm.
This would reward firms for producing less emissions per unit of output, rather than less emissions overall, which could help alleviate political worry about constraining economic growth. But it would mean that even if power producers become more efficient, emissions could in theory still rise, if power production increases overall.
Who will pay for emissions?
In an initial “simulated” trading period of the ETS, companies will be issued free emissions permits. Under the plan’s loose timeline, auctions for permits would begin around 2020.
Once payments begin in the power sector, it is companies that would foot the bill, not consumers. This is because power prices are set by government regulators in China.
However, a process to reform electricity pricing in China (see next section), already underway for several years, could allow the carbon price to be passed on to consumers in future. Dupuy tells Carbon Brief:
“There’s still quite a way to go before we can say that the power sector’s been reformed and transformed to a model where the true costs, including emissions costs, are really flowing through to end users.”
Prices for other industries are set by the market rather than government regulation, so once the ETS expands outside the power sector, it could have an impact on consumers.
How will the ETS affect the power sector?
In theory, carbon pricing should encourage a switch from higher emitting power sources, such as coal. While prices in the EU have generally been too low to achieve this, the contribution of a carbon price to the rapid fall in coal-fired power in the UK shows it is possible.
If China does set a rate-based limit of allocating permits rather than an absolute cap, this would mean the setting of benchmark emissions rate per unit of output from each fuel.
It also appears the scheme may set different benchmarks for different parts of the power industry, depending on the size of the producer and type of fuel used. This would mean coal-burning plants would only compete against each other, rather than against cleaner gas plants.
Some experts have warned this means the ETS would struggle to move electricity consumption towards cleaner sources. Zhang Junjie, director of the Environmental Research Center at Duke Kunshan University, told the South China Morning Post:
“The focus will be on improving efficiency of existing plants, rather than improving the energy structure by replacing coal with gas or other cleaner energy sources.”
Lauri Myllyvirta, a clean air and clean energy expert working with Greenpeace in Beijing, similarly says an intensity-based allocation would not encourage a cleaner fuel mix, but could help to push power plants to increase their efficiency. Myllyvirta tells Carbon Brief:
“Improvements in thermal efficiency are much easier to predict than the combination of electricity demand, mix of energy sources and thermal efficiency. Of course, this would at the same time mean that the role of emissions trading in China’s overall climate efforts is more limited than if an overall [emissions] cap was set.”
Myllyvirta points out, however, that even if such an intensity-based method is used, it is not known whether this would just be the approach for an initial period, or more permanently.
In addition, even if the ETS makes polluting plants more expensive, it may not affect their “dispatch order”. Unlike most other jurisdictions, China does not traditionally change the order in which its power plants are turned on based on their operating costs. Dupuy tells Carbon Brief:
“That means, effectively, that one of the normal channels through which we’d expect to see emissions trading work is not functioning well in the current power system in China.”
The power sector reform effort currently underway in China could address this, saysDupuy. First launched in 2015, this is perhaps the most overlooked of the country’s other climate policies. It promises to address each of the major “pain points” for clean energy and could have far bigger implications for China’s emissions than the ETS. Dupuy tells Carbon Brief:
“One of the major thrusts of the power sector reform is for each of the generators to compete, based on its relative operating costs and relative efficiency, for the number of hours that they’re going to operate on an hour-by-hour, day-by-day basis.
“These new markets should allow the power sector to be more flexible, to be more efficient, and to transmit the cost associated with carbon in a more fluid way to users throughout the system.”
The process of developing this reform is long. While China has a commitment to get to national competitive electricity markets by 2020, Dupuy says he is not sure if this timetable will be met. However, some progress has already been seen.
In the meantime, a shift to cleaner energy may also be driven by China’s other power sector targets, such as goals for the increasing the share of low-carbon sources in the energy mix, and coal plant closures driven by other regulations.
What will happen to China’s pilot ETS projects?
China launched regional pilot carbon trading projects in four cities, two provinces and the special economic zone of Shenzhen during 2013 and 2014. Two more local schemes were launched in 2016 and 2017 in Fujian, a southeastern Chinese province near Taiwan, and Sichuan in southwest China, although these are not usually counted as pilot schemes.
The locations of these nine local schemes are shown in the map below.
The initial seven pilots were developed by local governments with intentionally different designs, to help inform the development of the national scheme. They covermore than 3,000 firms in a variety of sectors depending on the scheme, including power, steel, cement and aviation.
The schemes have run into some issues, however, including a lack of transparency and a low trading volume. One criticism has been that they have mainly avoided using financial derivatives, such as futures trading. Some argue this has made the markets ineffective in providing a clear price signal for big emitters. However, some of the pilot regions are now experimenting with such mechanisms.
“China had 10 years to train people and let them learn the ropes of carbon trading. They were a de facto university for a generation of emissions-market traders. The rest of the world has pretty much lost a decade.”
The pilots have also allowed the government to test how trading systems could work with very different profiles. For example, says Swartz, the cities generally have high emissions in the buildings and transport sectors, while in Hubei province, the largest emissions source is iron and steel.
Leaders have emerged among the pilots, helping to establish best practices for the national market, according to ChinaDialogue. Guangdong province and Hubei have experimented with auctioning allowances, for instance, Swartz tells Carbon Brief, while the Beijing market has maintained the highest and most stable carbon price.
Prices averaged $2.27/tonne, according to the Partnership for Market Readiness, an international platform backed by the World Bank to foster carbon markets instruments. For comparison, over the past five years EU ETS emissions allowances have hovered between €4 and €9 ($5-11) per tonne, itself well short of most estimates for the social cost of carbon.
Jiang Zhaoli, deputy head of NDRC’s climate change department, has said companies will not feel real pressure to cut emissions until the carbon price hits 200-300 yuan/tonne ($31-47/tonne). He added that he does not expect this to happen until after 2020.
Transaction values since the pilot schemes began reportedly reached around 4.5 billion yuan ($706m) in September last year and the value of trades in the pilots has been rising over time. However, this is far below the €49bn ($61bn) of allowances or their derivatives that were traded in the EU ETS in 2015 alone.
Power-sector emissions now under pilot schemes will shift into the national ETS, once it is launched. The pilot projects will continue for sectors not yet included in the national carbon market, such as chemicals, oil and gas. China’s plan says these will gradually be moved into the national scheme “when conditions allow”.
When will the ETS start?
The government plan released in December is hazy about the exact timeline for the rollout of the ETS. Instead, it sets out the next few stages of implementation and makes clear that any and all parts of this plan could be adjusted.
In the first stage, over the next year or so, China will focus on the basic infrastructure of the scheme: setting up emissions monitoring, reporting and verification systems, alongside the administrative aspects of the trading system. Companies will be required to monitor and report their emissions to the NDRC and other relevant local regulators.
Power companies will start to receive ETS allowances in this time and the legal basis for the ETS is also likely to be strengthened, according to Energy Foundation China.
The second step will be a year-long “simulated” trial of the market, the plan says, expected to start in 2019. This will see free credits allocated to companies with mock trading, but with no money changing hands. It aims to test and develop the reliability, market risks and management of the trading platform, the plan says.
Source: Carbon Brief. Reproduced with permission.