Is Carbon Emission Trading Scheme feasible in China?

By HU Tao, WU Yanyang, ZHOU Lihuan

On November 12, a joint statement on climate change came after the presidents of the world’s two largest economies met in Beijing, following the Asia-Pacific Economic Cooperation (APEC) meetings. In this joint statement which draws applause worldwide, China and the U.S. revealed for the first time both countries’ post-2020 goals of coping with climate change. The United States has set a target of reducing its emissions by 26 to 28 percent below its 2005 level in 2025, while China has pledged to achieve the peaking of carbon dioxide emissions around 2030 and increase the share of non-fossil fuels in primary energy consumption to around 20 percent by 2030.[1] Earlier this year, during the UN Climate Change Summit in New York City, China’s Vice-Premier Zhang Gaoli pledged China would aim to cap emissions or have GHGs peak “as early as possible”.

So what kind of actions should China do? According to the views of many experts, the US experiences can serve as a template for China. About 15 years ago, U.S. EPA supported China to establish SO2 pilot emission trading programs, but almost all of the programs were failed[2]. This is an old story in last century, both China and the world have undergone tremendous changes over the next 15 years. China is now the world’s biggest-emitting nation, accounting for 28 percent of global greenhouse gas emissions. The government is putting a range of policies in place to help hit that goal. Although China has been relatively slow to jump on the carbon market bandwagon, it’s now clear a carbon market is also part of the plan.[3] Since 2011, the Chinese government has embarked on one of the largest endeavors in climate economics ever, to establish a national carbon emission trading system by 2016.[4] China has already introduced seven regional pilot markets in a bid to gain experience ahead of a nationwide program, including Beijing, Tianjin, Shanghai, Chongqing, Shenzhen, Guangdong and Hubei, to set regional caps and institute pilot programs for trading rights as part of its initiative to cut the intensity of emissions by as much as 45 percent before 2020 from 2005 levels. The success or failure of those experiments will to a large extent determine the future of climate policies in China.

China's pilot carbon trading

China’s pilot carbon trading markets. The size of the bubble represents the amount of emissions covered by each scheme. Source: CartoDB.

All the markets are experiencing teething problems. Some spurt in volumes and price occurred in the first 16 weeks in Shenzhen Emission Trading Scheme (ETS) with total transactions of more than 114,000 tons of CO2 allowances[5]. But the trading was muted in the following 6 weeks with only 16,000 tons of CO2 allowances[6]. Although Song Ranping, the Team Leader of the Climate & Energy Program in World Resources Institute’s China office, considers the ETS projects to be a strong starting point for a market-based approach to constrain emissions in China[7], it is still necessary to provide some insights about feasibility of China carbon ETS. For starters, China’s political culture and recent history means many participants have little experience of this sort of trading. But from the side of government, the scenario is slightly different. According to the data announced by the National Development and Reform Commission (NDRC), Chinese enterprises had traded over 8.56 million tons of carbon emission quotas as of June 29, and the quotas were sold for 338 million yuan, making China a major carbon trader, second only to the European Union. That’s why Chinese officials and carbon market experts urge tolerance, despite only a few trades a day with many firms struggling to understand how to trade.

Another big concern is the fierce competition between current pilot ETS regions in China for the title of “carbon financial center”, because of the allure of the huge carbon financial market. So it’s not strange to find that Shanghai, Shenzhen, Guangzhou and Beijing are all advocating the same slogans: “building China’s national carbon financial center”, while Hubei Province even goes further, whose ambitious target is “building the world carbon financial center”. Such competition is considered by LIAO Zhenliang, a scholar from UNEP, to be the biggest hurdle for NDRC to develop a nationwide carbon trading system which may be introduced as early as 2016.

Despite such issues, maybe the current biggest problem about China’s carbon ETS is governance issue. Without public information, the pricing mechanism would be opaque. In China, officials have divulged the size of the overall cap in most markets, but not always the historic emissions data on which the caps are based nor the precise number of allowances handed out.[8] Furthermore, some companies can’t provide robust records of their historical emissions, and regulators don’t have the tools to verify the companies’ estimates.[9]

Is data accurate and reliable?

Environmental data fraud is already an open secret in China. China’s Ministry of Environmental Protection (MEP) recently punished 19 corporations for last year’s desulfurization data fraud, including many state-owned enterprises (SOEs) directly controlled by the Chinese Central Government. Companies in the state-controlled and district-controlled area have all installed the pollution control line monitoring equipment, so that the local environmental protection bureaus can monitor them for 24 hours every day, but no problem can be found only from the data, said Guo Peng, the director of Ningxia Environmental Enforcement Bureau. While according to Xu Yang’s opinions, who is the chief engineer of Shandong Provincial Environmental Information and Monitoring Center, there are more than 10 kinds of data fraud methods by interfering with the normal operation of automatic monitoring equipment, and such methods can be divided into two major categories. One is by modifying the operating parameters of the device software, to make the substandard data looks good. For example, as the actual monitoring emission concentration is 1000 mg per cubic meter, adding a 0.1 coefficient into the calculating process by the software can make the final result become 100 milligrams per cubic meter. The other method is through the destruction of the sampling system to change the actual data, such as adding dilution equipment on the sampling tube, unplugging the sampling probe, or disconnecting the sampling system to make the emission samples cannot be collected by the monitoring equipment.[10]

An accurate and reliable emission data is a fundamental basis for ETS, but both properties are questioned in China for two reasons, the indirect measurement method and China’s bad reputation for data quality. The emission data in China’s ETS is indirectly calculated rather than directly monitored by equipment. The indirect calculation uses emission factors multiplied by activity data, such as gas pump receipt. As data is solely provided by companies, the accuracy of data cannot be ensured as companies can manipulate and underreport activity data within a certain range without being found.

Emission data is hardly credible if official data, which is ensured by quality framework, is not trustworthy. China’s official statistics are not as reliable as those produced in the U.S. and Europe, and manipulation remains an important cause of unreliable statistics, according to a study conducted by U.S.-China Economic and Security Review Commission[11], a commission created by U.S. Congress. For example, Henglanzhen in Zhongshan, a town located 84 miles west of Shenzhen, was discovered of providing fraud statistics[12]: the reported gross output of 71 industrial companies in 2012 was 8.5 billion RMB, but it was only 2.2 billion RMB after auditing and investigating by National Bureau of Statistics of China, only a quarter of the original statistics.

The unreliability of China’s official statistics further renders ETS ineffective, as ETS fixes the GDP emission intensity to meet its carbon emission reduction goals. Unlike European Union ETS, which fixes amount of greenhouse gases that can be emitted, China ETS will adjust the emission allowances to maintain a fixed emissions-to-GDP ratio according to companies’ Industrial Added Value (part of GDP) each year. The emission allowances cannot be accurate if emission data and GDP are not accurate.

Are validation entities capable and objective?

Emission data need to be validated to ensure accuracy and reliability after calculating by companies. The capability of a validation entity is demonstrated by relevant certificates, such as Certificate of Accreditation and Provisional Designation issued by United Nations (UN)[13]. Only two of seven validation entities designated by Shenzhen ETS obtained certificates from UN. The rest five validation entities do not have any credibility, nor experience to conduct greenhouse gas emission validation.

The validation entities also need to be independent to validate emission data objectively. If a validation entity is funded by government or affiliated to government, the validation process might be under influence of government. Five of seven validation entities in Shenzhen ETS are government’s affiliation or funded by government. If the capability and objectivity of validation entities come into question, then good data quality is not ensured.

Are there other options?

Based on our analysis above, China is still not ready for carbon ETS, and need to overcome several obstacles. But China has already established other tools to reduce carbon emissions, such as resource tax, which has included coal already.[14] When tax is placed at the beginning of the coal consumption, the abatement would include not only CO2, but also other pollutants discharged by coal-fired power plant, such as SO2, NOx, and suspended particles. This is because the higher the coal price, coal-fired power plant will make more efforts to promote the efficiency, such as upgrading to supercritical and ultra-supercritical boilers and turbines, and using more renewable energies which are cleaner. As economic instruments to encourage reductions in greenhouse-gas emissions, coal tax has its advantages and disadvantages. If a coal tax is used, then the costs of emissions reduction are fixed – but the emissions target becomes unclear, and it is difficult to know if businesses will opt to make cuts. Some may prefer to just pay the tax, which will not help reduce emissions.[15]

To control coal consumption or pollution at the beginning of industrial chain is more effective and suitable for China today than controlling pollutions at enterprises or companies level, because it reduces various pollutions in a consistent way, rather than through different individual policies. Sometimes, individual policies are contradictory. For example, China plans to cut emissions of SO2 in 2015 by 8% comparing the level in 2010.[16] However, every ton of SO2 reduced at the coal-fired power plant will increase 5.41 tons of CO2 which offsets CO2 emission reduction efforts. China should have set up coal trading programs to reduce coal consumption, rather than setting up carbon trading programs.

Conclusion

Although it’s a good start to arouse companies’ awareness of emission reduction by putting a price tag on CO2, due to a lack of reliable emissions data, inadequate capacity to integrate carbon trading into business models, and restrictions with regard to the development of derivatives and futures markets, whether the ETS pilots will be effective is still a question with such challenges in CO2 emissions reduction. As the international Clean Development Mechanism (CDM) market collapsed, China’s nascent carbon markets have attracted global attention. China must learn lessons from European failures, and the policymakers should make some changes after taking stock of this first round of ETS experiments. China should increase data quality for both official and unofficial data, and establish carbon certification system, however, these tasks are hard to accomplish in short term. From a short-term policy feasibility perspective, the coal resources tax and carbon tax might be more efficient than the carbon trading mechanism. Through the establishment of a coal tax, and setting the schedule of tax rate adjustments based on the overall emission reduction targets, government can make changes in the cost of carbon emissions become predictability, and businesses can identify future production and the corresponding energy conservation technological innovation based on their own situation. In addition, introducing coal tax can avoid the thorny issue of allocation of emissions quotas, so that the government can flexibly implement emission reduction obligations according to economic performance by adjusting the level of taxation. Thus, compared to the carbon ETS, coal tax or overall coal consumption control may be more suitable for China’s current critical situation.

[1] The White House. FACT SHEET: U.S.-China Joint Announcement on Climate Change and Clean Energy Cooperation. Retrieved from http://www.whitehouse.gov/the-press-office/2014/11/11/fact-sheet-us-china-joint-announcement-climate-change-and-clean-energy-c

[2] The development of China’s pollution rights trading faces difficulties: The effect of pilots is not good. (2011, November 8). The Economic Reference. Retrieved from http://www.cec.org.cn/xinwenpingxi/2011-11-08/73955.html

[3] Mat Hope (2014). Analysis: China’s big carbon market experiment.

[4] Han, G., Olsson, M., Hallding, K., & Lunsford, D. (2012). China’s carbon emission trading: an overview of current development.

[5] Yang L. (2013, October 9). Investors are successful in carbon market. Nanfang Daily. Retrieved from http://epaper.nfdaily.cn/html/2013-10/09/content_7231539.htm

[6] Shenzhen carbon ETS has transactions of more than 130,000 tons] (2013, November 30). Retrieved from http://www.tanpaifang.com/tanjiaoyi/2013/1130/26481.html

[7] Song R. (2013, June 21). Emissions trading in China: First steps and the road ahead. Retrieved from http://www.chinafaqs.org/blog-posts/emissions-trading-china-first-steps-and-road-ahead

[8] Pilita Clark. (May 13, 2014). The ‘black hole’ of Chinese carbon trading. Retrieved from http://www.ft.com/cms/s/0/c9b0faf8-d9e1-11e3-b3e3-00144feabdc0.html#axzz3Hz4aA900

[9] Mat Hope (Sep 2, 2014). Analysis: China’s big carbon market experiment. Retrieved from http://www.carbonbrief.org/blog/2014/09/analysing-china-carbon-market/

[10] http://news.xinhuanet.com/fortune/2014-07/06/c_1111477703.htm

[11] Weser I. (2013, January 28). The reliability of China’s economic data: An analysis of national output. Retrieved from http://origin.www.uscc.gov/sites/default/files/Research/TheReliabilityofChina%27sEconomicData.pdf

[12] Liu Z. (2013, June 14). Bureau of Statistics exposes fake data reported by Henglan Town, Zhongshan, Guangdong. Xinhua News. Retrieved from http://www.gov.cn/jrzg/2013-06/14/content_2426433.htm

[13] List of DOEs. (2014). Retrieved January 15, 2014, from http://cdm.unfccc.int/DOE/list/index.html

[14] China considers resource tax to include coal. (2013, May 9). UPI. Retrieved from http://www.upi.com/Business_News/Energy-Resources/2013/05/09/China-considers-resource-tax-to-include-coal/UPI-85641368115457/

[15] https://www.chinadialogue.net/article/show/single/en/7002-Climate-talks-will-decide-the-future-carbon-price-

[16] State Council issued statement on 12th Five-year plan of energy saving and emission reduction. (2012, August 6). Retrieved from http://www.ndrc.gov.cn/rdzt/jsjyxsh/t20120822_500736.htm

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