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Capless Trade: Avoiding Stumbling Blocks in China’s National Carbon Market

Jun 20 , 2019

China is the world’s largest emitter of greenhouse gases. In 2014, the nation was responsible for 30% of global CO2 emissions, double that of the second-highest emitter, the United States. In an effort to combat this issue while simultaneously working to meet the Chinese Intended Nationally Determined Contribution (NDC) from the Paris Agreement, the Chinese government has announced a national carbon market. However, rollout of this emissions trading scheme (ETS) has been slow: originally set to launch in late 2017 with eight sectors, the national ETS is now set for a 2020 launch, with only the power sector included. In the lead-up to its inception, China has already begun piloting regional carbon markets in seven of its largest cities. Each city has been allowed to design its own parameters for allocation, coverage, and compliance, within reasonable limits. One such scheme has been in operation in Beijing since 2013.

Hosted by the China Beijing Environment Exchange (CBEEX), the Beijing regional ETS involves trading permits each worth one ton of CO2 emissions. At its inception, the Beijing government issued 10,000 free permits (equivalent to 10,000 tons of CO2) to each participating corporation, with the goal of allotting fewer and fewer permits each year. Companies can make a profit by selling their permits if they emit less than their annual allotment; those that go above their emissions cap must buy more permits. New entrants to the program (excluding those that began the program at its inception) are given allowances based on benchmarking and historical emissions data. To prevent supply-demand imbalance, CBEEX withholds 5% of allowances, then auctions them off when cost containment is necessary. Beijing’s ETS also allows permits to ‘roll over’ to the next year should they be unused.

In terms of coverage, the Beijing ETS and its fellow regional programs cover enterprises as emissions sources. Indirect emissions from electricity generation in the region and emissions from imported energy are also covered in the scheme. By covering imported energy, Beijing corporations are prevented from simply ‘shifting’ the location of their energy clients without penalty or consideration of carbon emissions. This cuts down on carbon leakage, or the relocation of businesses that are driven out by higher prices in emissions trading schemes.

Compliance with the trading scheme in Beijing is enforced with fiscal penalties – if an offender exceeds 10% or less of their carbon allowance, they are fined three times the market value for each allotment. In other words, if an offending corporation exceeds their limit by three tons, it must pay three times the market value for each of the three allotments it exceeded. If the offender surpasses 20% of their allowed allotment, these fines increase to five times the market value of each permit. Based on these rules, Beijing had 97.1% compliance rates in the program’s first year.

As the Beijing ETS begins its expansion to the national Chinese ETS, challenges beyond a slow rollout may arise. Such stumbling blocks include carbon leakage, or the flight of businesses to cheaper, non-regulated areas. Another challenge is that of proper allocation - at the inception of the Beijing ETS, regulators purposely over-allocated permits to incentivize participation. As the national ETS begins, the Chinese government must be wary of the consequences of over-allocating on a national scale, namely the loss of the program’s effectiveness in controlling the amount of carbon emissions. One way this can be avoided is by moving to a system of auctioning bids as opposed to freely allocating them.

Finally, the national ETS market will likely also face a challenge currently plaguing the Beijing ETS: low liquidity. This is a result of infrequent trading and an inactive trading market. The Chinese government must consider methods of increasing trade volume on the national market; one such method is to allow non-Chinese trade firms to participate in the market. Proper allocation can also address this issue – if corporations are not given a large sum of permits, they will be forced to trade more frequently.

Emissions trading schemes such as the one currently active in Beijing and soon to be active in all of China can be a useful, pragmatic method of financially incentivizing corporations to uphold environmentally intelligent practices. As the national trading scheme begins, the Chinese government should look to its regional pilot programs to implement ‘lessons learned’ and prevent carbon market failure. By implementing practices such as proper allocation, auctioning, and increasing participation rules, the market’s liquidity and effectiveness will grow. These practices have the potential to create an ETS program that can serve as a model for other nations, such as the United States, which could expand California’s existing carbon cap and trade system into a national ETS, much like China’s expansion of its pilot programs. A thoughtful rollout of its national scheme would not only allow China to meet its NDC targets, but would also serve as a blueprint for regional-to-national ETS expansions across the globe.

 

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