Chinese Carbon Trading Pilots – Progress and Current Status

Stephen Zhao

1. Overview

The People’s Republic of China currently operates seven pilot carbon emissions trading schemes (ETS) in Beijing, Shanghai, Guangdong, Tianjin, Shenzhen, Hubei, and Chongqing. These pilot ETS are being implemented in preparation for the rollout of a national ETS. While initially planned for implementation in 2020, Vice-Director of the NDRC’s Department of Climate Change, Sun Cuihua, announced in August 2014 that implementation will begin in 2016. Entry of provinces and cities into the National ETS will be staggered under the new schedule, though it will be expected to cover 40% of Chinese emissions by 2020, a total of 3-4 billion tons of CO2.

The seven pilots encompass a wide variety of situations: Guangdong is comparatively rich, while Hubei is one of the less developed provinces in China; over half the pilots are being implemented in directly controlled municipalities, but the Shenzhen pilot is not and must be integrated with the provincial Guangdong ETS. The coverage of the seven pilots encompass 18% of China’s population and account for 28% of its Gross Domestic Product (GDP). (Shen 2013, 241) Together, these pilots will be expected to cover 700 million tons of carbon dioxide emissions in 2014, which would make them one third the size of the European Union ETS and the second-largest emissions trading system in the world. (International Emissions Trading Association 2013, 4) Despite this, the pilots themselves only cover an estimated 7% of China’s total emissions. (Zhang et al. 2013)

graph1

These pilots and the proposed national ETS are part of China’s efforts to improve its environmental record, specifically in the area of climate change. China plans to reduce carbon intensity (emissions per unit of GDP) by 40 to 45% of 2005 levels by 2020 – a target first issued at the 2009 United Nations Climate Change Conference in Copenhagen. (Zhang et al. 2013) Since 2008, there have been voluntary ETS schemes in China. (Shen 2013, 236) China’s State Council first made mentions of plans to establish a mandatory carbon ETS in October 2010 and the Outline of the Twelfth Five-Year Plan for National Economic and Social Development of the People’s Republic of China (2011-2015) also announced the gradual establishment of an ETS to reduce greenhouse gas emissions in November 2010. (Xinhua 2011)

One year later in November 2011, the National Development and Reform Commission (NDRC) officially approved the seven pilot projects. The seven pilot projects were designed over the course of the 2012-2013 period and actual operations were expected to take place in the 2013-2015 period. (Zhang et al. 2013) During the design phase, each pilot was obligated to: compile an implementation plan, define objectives and key tasks, establish safeguards and project schedules, study and formulate regulations, and create emissions targets as well as plans for distributing them. (The National Development and Reform Commission 2012). Design and implementation are both done at the local level under the auspices of Local Development and Reform Commissions (LDRC), which means that the NDRC does not have a common implementation standard for the pilots and does not handle responsibilities such as the assignment of emissions credits. (Shen 2013, 248)

All seven ETS pilots have now completed their implementation plans and begun operations. The Shenzhen ETS was the first to begin operations on June 2013, followed by Shanghai on November and Beijing in November, then Guangdong and Tianjin in December, Hubei in April 2014, and lastly Chongqing in June 2014. The pilots are intended to reduce the carbon intensity of their respective regions, with all setting their intensity reduction target to between 17% and 21%. (Greenovation Hub 2013, 10-11)

 

2. Setup and Construction:

Commonalities: The seven pilot projects share a number of common traits. The pilots schemes are carbon dioxide ETS, and, with the exception of the Chongqing ETS, do not cover any greenhouse gas (GHG) other than carbon dioxide. In terms of industry coverage, all the pilots include firms involved with heat and electricity production, iron and steel, nonferrous metals, petrochemicals and chemicals, pulp and paper, and glass and cement sectors. (Zhang et al. 2013) Moreover, all seven pilots require that participating firms hand over emission credits for indirect emissions that come from areas such heating and electricity consumption. (Zhang et al. 2013) The pilots all use freely allocated credits, though to varying degrees. Moreover, all the pilots also allow for excess credits to be saved for surrender in future years, but none allow borrowing of credits to be assigned in future years. (Greenovation Hub 2013, 10-11) All seven pilots also accept limited amounts of Chinese Certified Emissions Reduction credits (CCER credits come from China’s voluntary emission trading schemes) as substitutions for credits generated within the pilots. (Greenovation Hub 2013, 10-11) There is also a large number of shared traits between the different schemes that are not common amongst all seven pilots. This is to be expected. Despite the pilots being locally designed, many of the pilot regions are in common economic and industrial situations. Monitoring, reporting, verification (MRV) setup for all the pilots uses government selected third party verifiers, with varying consequences for parties that do not comply.

 

Beijing ETS: The Beijing ETS features coverage of almost every polluting sector of the economy, including a total of 40 different industry sectors, with mandatory participation by all firms within those 40 sectors that have released over 10,000 tons of carbon dioxide per year from 2009 to 2011. (Shen 2013, 244; Zhang et al. 2013) This translates into coverage of over 600 installations over the pilot period. (Greenovation Hub 2013, 10) Firms consuming the energy equivalent of 2,000 tonnes of standard coal must report their emissions. (Environomist 2014, 6) Beijing is considered to have one of the best set of officials overseeing the program. Unlike most other pilots, the department responsible for climate change, and thereby the pilot program in Beijing is also responsible for energy efficiency. Since energy efficiency is the greatest factor in reducing carbon emissions, a key understanding of energy efficiency policies help these officials implement carbon reduction policies as well. (Ni 2014)

The Beijing ETS allocates emissions credits once a year, starting with December 2012 for the 2013 year and then in May of 2014 and 2015 for the respective years. (Shen 2013, 249) Credit assignments are based on historical emissions as well as historical carbon intensity and industry benchmarking. (World Bank 2014, 122) The amount of CCER credits that may be used by a firm to substitute for its emission credits is capped at 5% per year. (Greenovation Hub 2013, 10) The trading platform for the Beijing pilot is the China Beijing Environment Exchange, with trading between participating firms conducted through public trading, negotiated trades, over-the-counter trading (OTC trading), and other methods. (Environomist 2014, 8) Firms in Beijing report emissions and relevant data for a given year to the LDRC on April 15th for MRV purposes and credits must be surrendered two months after emissions are reported on June 15th of the year in question. (Environomist 2014, 10) If a firm does not comply with the ETS, it will be forced to pay a penalty equal to 3-5 times the market price of its excess emissions. (World Bank 2014, 122)

 

Shanghai ETS: The Shanghai ETS requires compliance for firms in iron and steel, petrochemicals, chemicals, non-ferrous metals, electricity, building materials, textiles, pulp and paper, rubber and chemical fibre that show higher than 20,000 tons of direct and indirect carbon dioxide emissions in the 2010-2011 period as well as firms in aviation and airports, ports, railways, commerce and finance, and hospitality that possess direct and indirect emissions higher than 10,000 tons in the same period. (Shen 2013, 245; Environomist 2014, 7) During the planning phase, Shanghai’s LDRC investigated every single participating firm for historical emissions regardless of what emissions these firms reported. (Ni 2014) All firms in Shanghai are obligated to report their emissions if they emit more than 10,000 tons of carbon dioxide per year. (Wu et al. 2014) Altogether, the ETS covers about half of Shanghai’s economy in terms of emissions and gross domestic product (GDP). Regulated entities in the Shanghai ETS account for about 61.7% of Shanghai’s total carbon emissions and 37.8% of Shanghai’s total GDP. (Wu et al. 2014) Like Beijing, Shanghai’s LDRC also has the same department handling climate change and energy efficiency. (Ni 2014)

The Shanghai ETS allocated its credits only once for the 2013-2015 period, but assigns years to the credits so that a credit may not be used before its assigned year: 2015 credits cannot be surrendered for 2014 emissions, but 2014 credits may be banked for surrender in 2015. (Wu et al. 2014) These credits are assigned based on historical emissions and benchmarking for power usage. (World Bank 2014, 122) The amount of CCER credits that may be used by a firm in the Shanghai ETS is, like the Beijing ETS, also 5%. (Greenovation Hub 2013, 10) Trading for the Shanghai ETS occurs on the Shanghai Environmental and Energy Exchange (SEEX), where credits may be traded via OTC trading and other means. (Environomist 2014, 8) Allowances may be traded ahead of their assigned year if 50% of them stay within their original account. (Wu et al. 2014)

MRV in the Shanghai ETS is similar to Beijing, with firms reporting emissions to the LDRC on April 15th, followed by third-party verification. (Environomist 2014, 10) Shanghai assigns one-third party verifier group for each sector so that they can develop sector specific rule-sets for greater effectiveness, since each industrial sector has different methodologies for emissions verification. (Zhou 2014) When a firm’s emissions cannot be fully deduced, Shanghai sets a minimum requirement of credits that the firm must surrender at the end of the compliance period. (Zhou 2014) To improve verification performance, Shanghai’s LDRC conducts supplementary verification for 60 randomly selected firms participating in the pilot. (Zhou 2014) The Shanghai ETS also uses both soft and hard penalties to ensure compliance. The Shanghai ETS imposes a fine of 10,000 to 30,000 CNY for failing to report emissions, 10,000 to 30,000 CNY for hiding information or false reporting, 30,000 to 50,000 CNY for “unreasonably resisting verification”, and a fine of 50,000 to 100,000 CNY for failing to surrender allowances. (Environomist 2014, 9) In addition, Shanghai also instituted a list of violators in the spring of 2014 to create reputational repercussions for non-compliant firms. (Zhou 2014)

 

Guangdong ETS: The Guangdong ETS is exceptional amongst the Chinese pilots as it is the only one to possess three phases in its design. Its first phase resembles all the other pilots, ending in 2015. (Shen 2013, 243) However, Guangdong continues beyond 2015 with two additional phases. The second “perfecting” phase of the Guangdong ETS will last from 2016 to 2020, after which the pilot will move onto its third phase of continuous operation. (Shen 2013, 243) As such, the Guangdong pilot is also the only Chinese pilot scheme that plans to continue operations indefinitely.

For its first phase, the Guangdong ETS covers the electricity, cement, iron and steel, ceramics, petrochemicals, textiles, non-ferrous metals, plastic, as well as pulp and paper industrial sectors for firms that have annual emissions of over 20,000 tons of carbon dioxide in the 2011-2014 period. (Shen 2013, 247) In addition, firms in these sectors emitting over 10,000 tons of carbon dioxide must report their emissions. (Environomist 2014, 6) The Guangdong ETS also intends to include tertiary sectors such as transportation and construction at the end of the twelfth five year plan (2011-2016), about the time when it would move onto its second phase. (Shen 2013, 247) The Guangdong ETS is the largest of the Chinese ETS, covering 830 installations with a total emissions cap of 388 million tons of carbon dioxide in 2013. (Zhang et al. 2013; World Bank 2014, 64)

Guangdong allocates emissions credits annually based on historical emissions and benchmarking, but will also use auctions as a means of distributing emissions credits. (World Bank 2014, 122) For the first phase, this means 95% of credits will be provided for free and the rest subject to auction. (Environomist 2014, 8) Auctions after September 2014 will also include foreign buyers. (Li 2014) The amount of CCER credits that may be used by a firm in the Guangdong ETS is capped at 10% of total emissions. (Greenovation Hub 2013, 10) Trading for the Guangdong ETS takes place on the China Emissions Exchange in Guangzhou. (Environomist 2014, 8) Credits may be saved for later years, but become invalid after 2015. (Shen 2013, 253) Guangdong also possesses a reserve mechanism to release credits should a shortage arise. There are 38 million credits on reserve for 2013. (Environomist 2014, 7) To put this figure in perspective, Guangdong emitted 508 million tons of CO2 equivalents in greenhouse gases in 2007, which was 28 million tons more than the entirety of Germany. (International Emissions Trading Association 2013, 4) MRV in Guangdong is conducted by third party verifier trained by the government and an electronic information system will be created for MRV purposes as well. (Shen 2013, 255) Firms that do not comply with the ETS will face a penalty of triple the market price for excess emission. (World Bank 2014, 122)

 

Tianjin ETS: The Tianjin ETS requires participation from firms in the iron and steel, chemicals, electricity, heating and power, petrochemicals, oil and gas, and civilian construction sectors that emit over 20,000 tons of carbon dioxide per year since 2009. (Shen 2013, 261) Firms in the aforementioned sectors emitting over 10,000 tons of carbon dioxide must report their emissions, though they are not obligated to surrender credits for them. (Environomist 2014, 6) Not only does the Tianjin ETS cover inland firms, but oil and gas operations in Bohai are also included in the Tianjin ETS. (Zhang et al. 2013)

The Tianjin ETS allocates emissions credits annually based upon historical emissions, historical intensity, and benchmarking in power usage. (Zhang et al. 2013) The amount of CCER offsets that may be used in the Tianjin ETS is capped at 10% of total credits surrendered. (Greenovation Hub 2013, 11) Trading for the Tianjin ETS takes place on the Tianjin Climate Exchange and is done so through the use of online spot transactions, negotiated transfers, and auctions. (Environomist 2014, 8) Like the Guangdong ETS, the Tianjin ETS also includes a reserve mechanism to alleviate credit shortages. (Environomist 2014, 7) MRV in Tianjin is conducted by government assigned third parties. Tianjin has the only ETS that does not impose any sort of penalty for non-compliance out of the seven pilots.

 

Hubei ETS: Hubei is the least economically developed region of the seven pilot regions and has the highest carbon intensity, at 1.4 tons of carbon dioxide per $1,000 GDP. (Zhang et al. 2013) As such, the Hubei ETS possesses a number of unique qualities amongst the seven pilots. Hubei is the only pilot ETS to base its coverage entirely on energy consumption, with required participation from all firms in the province that consume over 60,000 tons of standard coal equivalent and reporting obligations for firms that consume over 8,000 tons of standard coal equivalent. (Environomist 2014, 6-7) Hubei’s coverage extends to 12 sectors, including pharmaceuticals and food and beverage, which are not covered by any of the other pilots. (World Bank 2014, 65) Hubei is China’s second largest ETS with an allowance of 324 million tons of carbon dioxide for 2014. (World Bank 2014, 66)

The Hubei ETS allocates credits based upon past emissions, but also includes auctioning in its credit distribution. Allocations are made annually, based on the historical emissions of individual firms and benchmarking for power usage. (World Bank 2014, 124) Like the Tianjin ETS, the Hubei ETS limits the CCER offsets to a maximum of 10% of total emissions. Trading on the Hubei ETS is done on the Hubei Carbon Emissions Exchange through electric bidding and online matching. (Environomist 2014, 8) About 5% of the total emissions credits in the Hubei ETS are reserved for interventions, which can help manage price fluctuations. (Environomist 2014, 7) Reporting of emissions in Hubei must be done at the last working day of February every year and credits must be surrendered by the last working day of May; firms who do not comply must pay fines three times the average market price of their non-surrendered allowances, which will also be deducted from their credits twice in the next year. (Environomist 2014, 9-10)

 

Shenzhen ETS: The Shenzhen ETS extends its coverage over 800 entities in the transportation, industry, and public building sectors and accounts for over 40% of Shenzhen’s carbon dioxide emissions. (Jiang et al. 2014) The Shenzhen ETS has the lowest threshold for the inclusion of polluting entities of all seven pilots. All entities emitting over 5000 tons of carbon dioxide per year, any large public buildings over 20,000 m2, government office buildings over 10,000 m2 must fully participate in the Shenzhen ETS and entities emitting over 3000 tons of carbon dioxide per year must report their emissions under the trading scheme. (Environomist 2014, 6-7)

For industry, the Shenzhen ETS allocates 95% of its credits by free allocation, 3% by auction, and retains 2% of the credits as a price stabilization reserve. (Jiang et al. 2014) The free allocations are made annually by benchmarking, with 85% out of the 95% allocated before the compliance period and 10% reserved for new entrants and allocation adjustments. (Jiang et al. 2014) For buildings under the Shenzhen ETS, all credits are freely allocated based on benchmarking. (Jiang et al. 2014) The Shenzhen ETS also accepts an upper limit of 10% for CCER offsets and allows for credits to be banked until 2015. (Greenovation Hub 2013, 11) Trading for the Shenzhen ETS takes place on the Shenzhen Emissions Exchange through spot electronic auctions, fixed price transactions, block trades, and negotiated transfers. (Environomist 2014, 8) In 2014, foreign investors have also been allowed entry into the Shenzhen carbon credit market. (Cai 2014) The Shenzhen ETS uses a dual MRV system. Both GHG emissions and economic output of the installations of the Shenzhen ETS are monitored, each by its own third party agency. (Jiang et al. 2014)

Relevant data must be reported by March 31st of every year and the corresponding credits must be surrendered on June 30th; non-compliant entities are obligated to surrender any owed credits in the following compliance period and must pay three times the market price for any credits owed. (Environomist 2014, 9-10) Other penalties include a fine of 10,000 to 50,000 CNY for failing to report emissions and a fine of 50,000 to 100,000 CNY for more serious issues. (Environomist 2014, 9) Shenzhen is unique among the pilots as its LDRC is the only one that does not possess the ability to affect legal changes, which creates problems should Shenzhen need to modify its laws to improve the effectiveness of its ETS pilot. (Cai, 2014)

 

Chongqing ETS: The Chongqing ETS is the only ETS to cover greenhouse gases other than just carbon dioxide. As a June 2014 Reuters report noted, the Chongqing ETS covers six other GHG including methane, nitrous oxide, and artificial fluorinated gases. The Chongqing ETS intends to cover over 300 entities mainly in cement, iron and steel, ferrous alloy, electrolytic aluminum, calcium carbide, and caustic soda production. (Greenovation Hub 2013, 11) The threshold for mandatory participation lies at 20,000 tons of carbon dioxide emissions per year in the 2008-2011 period. (Greenovation Hub 2013, 11)

Due to its later start in June 2014, all of the Chongqing ETS’ credits are allocated at once. The allocations were free and based on historical emissions. (World Bank 2014, 122) The Chongqing ETS also allows for the usage of CCER offsets, which is capped at 8% of total emissions. (Greenovation Hub 2013, 11) Trades are made at the Chongqing Carbon Emissions Exchange, via methods that include negotiated trades. (Environomist 2014, 8) The ETS also holds penalties for non-compliant participants, charging a fine of twice the market price for any credits owed. (World Bank 2014, 122)

 

3. Operation and Performance:

Commonalities: Once they began operations, the seven pilot projects faced challenges similar to other ETS around the world. Low carbon prices and unsatisfactory trading volumes plague the various pilot ETS. Of course, given the different attributes of the seven pilots, some have experience more success than others and each have their strengths and weaknesses. The average credit price ranges from $4.1 USD in Hubei to $12.4 USD in Shenzhen. (World Bank 2014, 64) In the area of pricing, the Chinese pilots perform at similar levels when compared to other ETS and even outperform some of their predecessors. However, the trading levels of the pilots are very low, especially considering how much emissions are covered by the pilots.

An August 2014 China Network Television report, however, revealed that progress in reducing carbon intensity in China as a whole is progressing smoothly, exceeding expectations with a 5% reduction in carbon intensity just between January 2014 and June 2014. Compliance rates across all pilots that began operations in 2013 exceeded 90% in their first compliance period, with most having nearly complete compliance rates. (Zhang 2014b; Zhang et al. 2014)

The pilot programs have generated enough success to warrant, it would seem, for the apparent decision to advance the implementation of the National ETS from 2020 to 2016. If the ETS pilots are indeed responsible for the 5% reduction in carbon intensity during the first half of 2014, then the implementation of a national program would make the Chinese carbon intensity reduction goals more attainable. A reduction of 5% in China’s carbon intensity every year would bring it very close to the upper limit of the government’s intended goal of reducing carbon intensity to 40-45% of 2005 levels by 2020.

graph2

 

Beijing ETS: The Beijing ETS began operations on November 28, 2013. From this period until April 18, 2014, credits equivalent to a total of 96,000 tons of carbon dioxide were traded in the Beijing ETS. (World Bank 2014, 125) This volume is the lowest out of all the ETS pilots, though Beijing is one of the smaller ETS pilots in China with a total emissions cap of 50 million tonnes of carbon dioxide for 2013. (World Bank 2014, 122) Its price is still relatively high for an ETS, with an average price of $8.7 USD over the aforementioned five-month period. (World Bank 2014, 64) This price is about the same as the EU ETS, the largest and most extensive ETS today. (World Bank 2014, 32)

Prices were generally stable in Beijing and emissions declined by 4% from 2012 to 2013. (Hong 2014) Compliance in Beijing exceeded 90%, but was relatively problematic due to its broad spectrum of coverage. (Zhang 2014b) This may show that very broad sectorial coverage like that in the Beijing ETS is in fact detrimental to the effectiveness of an ETS. To enhance technical competence, the Beijing ETS provided various forms of training to a total of five to six thousand officials. (Hong 2014)

 

Shanghai ETS: The Shanghai ETS began operations in November 26th, 2013. From this date until April 18, 2014, credits equivalent to a total of 239,000 tons of carbon dioxide were traded on the Shanghai ETS. (World Bank 2014, 125) This is actually a lower proportional trading volume than the Beijing ETS as the Shanghai ETS had an emissions cap of 160 million tons of carbon dioxide in 2013. (World Bank 2014, 66) This lack of trading has presented significant issues in the market. As firms complained in a May 2014 Shenzhen Daily report there are no bulk sellers of credits that they can purchase from, leaving these firms unable to meet their compliance requirements. The Shanghai ETS also has one of the lower prices amongst the pilots, with an average price of $5.2 USD over the five-month period. (World Bank 2014, 64) Still this gives the Shanghai ETS a higher carbon price than the Mexican carbon tax, the Japanese carbon tax, the New Zealand ETS, and the Regional Greenhouse Gas Initiative (RGGI). The Shanghai ETS has a comparable price to the South African carbon tax. (World Bank 2014, 32)

 

Guangdong ETS: The Guangdong ETS began operations in December 18, 2013. In 2013, participants were required to purchase a minimum of 3% of their total allocation on auction, with a floor price of CNY60 (~US$10) before the remaining 97% of allowances can be traded. (Guangdong Province Reform and Development Commission 2013) The first four auctions had 10.7 million credits sold at the reserve price of CNY 60. (World Bank 2014, 123) This reserve price is fairly close to the average price of the Guangdong ETS in the period between December 18, 2013 and April 18, 2014, which was CNY 61.8 or $10.2 USD. (World Bank 2014, 64) The Guangdong ETS is priced highly compared to other ETS in existence. The Guangdong ETS has a similar carbon price to the Quebec Cap and Trade scheme and the Icelandic and French carbon taxes; only the Shenzhen ETS, California Cap and Trade, and Tokyo Cap and Trade significantly exceed the Guangdong ETS in price. (World Bank 2014, 32) However, trading volume in the Guangdong ETS is quite low. Despite being the largest ETS in China, the Guangdong ETS only traded credits worth 126,000 tons of carbon dioxide during the four-month period. (World Bank 2014, 125)

 

Tianjin ETS: The Tianjin ETS began its operations on December 26, 2013 and had traded 140,000 credits by April 18, 2014. (World Bank 2014, 125) The average price of carbon in that period was $5.7 USD per tonne of CO2 emissions. (World Bank 2014, 64) In terms of both carbon pricing and trading volumes, the Tianjin ETS has one of the lowest performances of the seven pilots. In its initial year, the Tianjin ETS issued credits equivalent to 160 million tons of carbon dioxide emissions. (World Bank 2014, 122)

 

Hubei ETS: The Hubei ETS began trading on April 2, 2014 and over about 1.6 million credits had been traded by the end of 16 days. (World Bank 2014, 125) The first auction in Hubei on March 31 also managed to auction off 2 million credits at the price of 20 CNY per ton. (China Hubei Emissions Exchange 2014) In comparison, the average carbon price from April 2 to April 18, 2014 in the Hubei ETS was 24.7 CNY or $4.1 USD. (World Bank 2014, 64) The Hubei ETS may have the lowest price out of all the ETS pilots, but Hubei also has the least developed economy of the ETS regions and has lower costs compared to the rest of the country in general. With this in mind, the Hubei ETS seems to be one of the better performing pilots, as its carbon price is comparable to ETS of more developed regions and has the highest trading volume by far of all the pilots. The Hubei ETS had an allowance of 324 million tons of carbon dioxide for its initial year. (World Bank 2014, 122)

 

Shenzhen ETS: The Shenzhen ETS was the first pilot to operate and began its trading on June 18, 2013. In the following ten months, the Shenzhen ETS had a total trading volume of 250,000 credits. (World Bank 2014, 125) In 2014, Shenzhen issued credits for 33 million tons of carbon dioxide emissions. (World Bank 2014, 66) Along with its low trading volume, the Shenzhen ETS also has over-allocation issues. CNBC reported in March 2014 that the Shenzhen ETS had a 10% excess of credits in its first year of operation. Yet despite this excess volume, the Shenzhen ETS still maintains an average price of $12.4 USD. (World Bank 2014, 64) This means carbon in the Shenzhen ETS is priced significantly higher than all other ETS except the California Cap and Trade, which is priced at around the same level, and the Tokyo Cap and Trade. (World Bank 2014, 32)

Compliance at the end of Shenzhen ETS’ first compliance period was 99.4% and every firm had either surrendered the required number of credits or paid their fines. (Cai 2014) Over 360 firms in the ETS were assigned too many credits and over 150 firms had insufficient credits assigned. Shenzhen experienced a 33.5% decline in carbon intensity from 2010 to 2013. (Cai, 2014) Vice Chairman of Shenzhen’s LDRC, Cai Yu, believed the ETS to be a big contributor to this decline, though he qualified that Shenzhen also experienced a decline in manufacturing, power use, and coal use. (Cai, 2014)
Chongqing ETS: The Chongqing ETS began its operations on June 19, 2014. Reuters reported in June 2014 that 16 deals were signed in the Chongqing ETS’ initial launch, which totaled 145,000 credits at a price of 30 to 32 CNY (roughly $5 USD). To put these figures in perspective, a total of 125 million credits were issued to participating firms for them to cover their 2013 emissions. Trading volumes in Chongqing are especially bad. While the Hubei ETS is the only Chinese pilot that trades almost every day and other pilots only trade on rare occasions, Chongqing basically never has any trades in its carbon market. (Ni 2014)

 

Pilot Project Summary

Pilots Start Date Current Coverage Emissions (initial year cap) Average Price Trading Volume
Beijing ETS Nov. 28, 2013 Carbon dioxide only.
Sectorial coverage: over 40 different sectors
50 million tons of carbon dioxide $8.7 USD (all trades up to April 18, 2014) 96,000 tons
(all trades up to April 18, 2014)
Shanghai ETS Nov. 26, 2013 Carbon dioxide only. Sectorial coverage: iron and steel, electricity, petrochemicals, pulp and paper, chemicals, non-ferrous metals, rubber and chemical fibre, building materials, textiles, aviation and airports, ports, railways, commerce and finance, and hospitality 160 million tons of carbon dioxide $5.2 USD (all trades up to April 18, 2014) 239,000 tons (all trades up to April 18, 2014)
Guangdong ETS Dec. 18, 2013 Carbon dioxide only.
Sectorial coverage: electricity, cement, iron and steel, ceramics, textiles, non-ferrous, pulp and paper, metals, plastic, petrochemicals
388 million tons of carbon dioxide $10.2 USD (all trades up to April 18, 2014) 126,000 tons (all trades up to April 18, 2014)
Hubei ETS April 2, 2014 Carbon dioxide only.
Sectorial coverage: 12 sectors, including pharmaceuticals and food and beverage
324 million tons of carbon dioxide $4.1 USD (all trades up to April 18, 2014) 1.6 million tons (all trades up to April 18, 2014)
Shenzhen ETS June 18, 2013 Carbon dioxide only.
Sectorial coverage: industry, transportation, and public buildings
33 million tons of carbon dioxide $12.4 USD (all trades up to April 18, 2014) 250,000 tons (all trades up to April 18, 2014)
Chongqing ETS June 19, 2014 Carbon dioxide, six other GHGs including methane, nitrous oxide, and artificial fluorinated gases
Sectorial Coverage: cement, iron and steel, ferrous alloy, electrolytic aluminum, calcium carbide, and caustic soda
125 million tons of carbon dioxide equivalent 30 to 32 CNY /~$5 USD (trades on launch day: June 19, 2014) 145,000 tons (trades on launch day: June 19, 2014)

 

 

4. Strengths and Opportunities:

Indirect Emissions Coverage: The Chinese pilots cover indirect emissions, an ambitious trait which is unique amongst the world’s ETS systems and may serve as a best practice for other ETS to follow. (Shen 2013, 244) This is particularly important in China for administrative regions that often source electricity from outside the region. For example, 60% of Beijing’s electricity comes from outside the administrative region. (Shen 2013, 244) Covering indirect emissions generated through electricity and heating allows an ETS to target polluting actors better than it would otherwise by preventing carbon leakage generated by outsourcing of energy. This happens to a lesser degree in Shanghai, which still sourced a significant 11.43% of its electricity from outside the jurisdiction of the ETS in 2010. (Wu et al. 2014) The benefits of Chinese coverage of indirect emissions is also compounded by state control of the electricity market, which eliminates windfall profits created in privatized electricity markets when power producers pass on costs directly to consumers. (Zhang 2014a)

High performance in price compared to other ETS: The various Chinese pilots maintain high levels of carbon prices compared to most of their ETS counterparts, which is still a relative strength despite the low prices of ETS in general. Higher prices makes it worthwhile for firms to invest in low carbon technologies and practices as they could be rewarded financially by selling the credits they no longer have to surrender due to lower emissions. Though a significant obstacle exists in the illiquid nature of the market, the high price of the Chinese pilots may serve as a buffer for the reduction in prices that an increase in liquidity will yield.

Successes show ETS to be feasible in low-income environments: On a per capital basis, China is the least developed state to have instituted an emissions trading scheme. This feature is more apparent in the Hubei and Chongqing ETS, where both have a GDP per capita of under $7,000. However, despite this, the Hubei ETS has proved to be quite successful so far, with a comparatively acceptable carbon price. Its trading volume may not be ideal, but it still far outclasses that of the other Chinese schemes in absolute terms. With this in mind, these pilots could hold potential best practices and lessons that may be imparted to other developing economies should they wish to pursue more proactive climate change policies.

 

5. Weaknesses and Challenges:

Prices: Carbon prices in the seven Chinese pilots are low like their international comparators. Despite some pilot ETS possessing higher prices than the EU ETS, they are still not at optimum levels. (World Bank 2014, 32) This even applies to the Shenzhen ETS, which has the highest performing price out of all the pilots. According to a study published in the Journal of Biology and Engineering, the abatement cost required for the reduction of 5% of Shenzhen’s total emissions is about $20 USD per ton of carbon dioxide emissions. (Jiao et al. 2013, 331) Considering that the average price of carbon in Shenzhen is only a little bit over half this amount, the market environment does not seem conducive to investments by firms in reducing emissions.

The main goal of the ETS is to reduce carbon intensity. It suggests that the emissions caps are not stringent enough to warrant such high prices. However, there is, at least in Shenzhen, a clear issue concerning the over-allocation of emissions credits. If this was not simply a case of the local planners managing expectations, than there could be a potential mistakes in future credit assignments, particularly when the NDRC moves onto implementing a national ETS. One method to increase prices in the Chinese pilot markets is to institute greater auctioning of credits in the pilots. Only Guangdong, Hubei, and Shenzhen auction credits and its effects are clear. Guangdong and Shenzhen both have comparatively high prices among the pilots and the Hubei ETS, despite being the least economically developed region of the seven, maintains prices not that far off from the Shanghai and Tianjin ETS.

 

Liquidity: Liquidity in Chinese pilots is exceptionally low. Since all the pilots only use spot trading, it is difficult to facilitate transactions and liquidity is hampered. (World Bank 2014, 125) Only Hubei has traded volumes over one million credits – in this case by April 18, 2014. In comparison, ETS like the California Cap and Trade and the RGGI all possess multimillion monthly trade volumes. (World Bank 2014, 57-58) There is a lack of funding and resources for the trading exchanges as well as insufficient market confidence amongst participating firms due to a lack of information regarding emissions trading. (Ni 2014; Li 2014) In addition, credit trading initially occurred exclusively among participating firms and did not involve financial institutions that may have been able to facilitate additional liquidity in the market. As an ETS is based upon a market logic to create efficiency, it is vital that credits are traded in a manner to ensure the most cost-effective abatement options are taken. The lack of trading in the pilots enlarges the economic cost of reducing emissions, which may also lead to less ambitious targets for fear of suppressing growth. The liquidity issue holds implications for the pricing of the Chinese pilots. The prices in the Chinese pilots may actually be artificially heightened due to the illiquid nature of the market, which is why the Tokyo ETS is priced so highly compared to other ETS. (World Bank 2014, 17) Fortunately, the Shenzhen and Guangdong pilots have allowed foreign firms to participate in the carbon markets, which might remedy the liquidity situation and support carbon prices with additional demand. (Cai 2014; Li 2014)

 

Ambition: The various ETS in operation are pilot programs and are intended to merge into a national system in the coming years. When a national ETS is established, the system could go further in terms of targets and coverage than the pilots. All the ETS pilots, except Chongqing, only take carbon dioxide emissions into account, which leaves many pollutants unaccounted for. Moreover, cap setting in the pilots could be more stringent. There are other structural reasons for the illiquid emissions credit market, but there were definitely be more incentive for firms to trade their credits if prices were driven higher by more stringent emissions in schemes with excess supply like Shenzhen. There is also uncertainty to whether the pilots are affecting significant change, or if the reductions are largely unrelated to the ETS programs. Nationally, the greatest source of emissions reduction is energy efficiency, which may have been mostly driven by China’s energy efficiency programs rather the ETS pilots.

 

MRV: The Chinese pilots face a number of challenges regarding MRV. There are no laws supporting third party verifiers in their work, leading to the current phenomenon of companies refusing the verifiers entry into their facilities for inspection. (Zhang 2014b) Moreover, corruption and ethical issues are concerns that burden any government program in China. Beyond that, officials managing the pilot and third party verifiers also lack the technical expertise to properly oversee the pilots. (Zhang 2014b; Zhou 2014) Statistical methods and frameworks in China remain insufficiently advanced for effective MRV. (Zhang 2014a) Both of the ethical and technical deficiencies of government officials and third party verifiers in the pilot programs need to be mitigated to ensure strong oversight of compliance. Additional time also needs to be given for the verification process as current circumstances mean third party verifiers in some of the pilots need to complete their tasks in only a month’s time. (Zhou 2014) Ongoing efforts are being implemented to raise compliance. Deputy Director General of NDRC’s Climate Change Department, Sun Cuihua, stated that ten new measures to improve compliance have been implemented in 2014 with more to come. (Sun 2014)

 

6. Conclusion:

With the Chinese pilot programs have been in operation for just over a year (some for even less than half a year), there are numerous lessons to be taken away for the future development of a national scheme. The pilots have shown that international best practices such as auctioning are effective even in the Chinese context. The Chinese pilots have also created a best practice of their own, with the innovative measure of including indirect emissions. This initiative demonstrated that it is possible to implement ETS in even low-income environments with less than $10,000 GDP per capita. The pilots have also served their presumed purpose in producing lessons that could be implemented with the future national ETS. The pilots have revealed planning errors – over-allocation and structural deficiencies such as the illiquidity issue.

Improvements in the competence of the state apparatus as well as the MRV framework are integral to the desired success of the upcoming national scheme. The Chinese government has made positive steps in identifying key problems with their pilot programs and increasing efforts to train officials and other relevant staff. Overcoming these challenges, however, will not be an easy task. Additional efforts are needed to enhance technical competency as well as the ethical conduct of officials managing the pilot programs. Moreover, a legal framework to give verifiers the authority to do their jobs is necessary to ensure the trading schemes are effective.

Another important step moving forward would be to resolve the stagnant trading markets. The liquidity issue must be resolved if the future national ETS is to see success. The national ETS will raise the stakes for a successful ETS involving, as it will, a much more complex and varied national carbon market. Differentiated targets produce more liquidity and this should definitely be considered when setting targets during the implementation of the national ETS trials in 2016. (Environomist 2014, 49) More work is definitely required on to expand the secondary credit market. The most effective step is ikely to move beyond spot transactions between firms and carefully examine the role of financial institutions in facilitating the trading of carbon credits in China. The involvement of financial institutions is likely to provide paths to increasing the liquidity of these markets.

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