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Chinese national carbon trading scheme

The Chinese national carbon trading scheme is a cap and trade system for carbon dioxide emissions set to be implemented in July 2017. This emission trading scheme (ETS) creates a carbon market where emitters can buy and sell emission credits. From this scheme, China can limit emissions, but allow economic freedom for emitters to reduce emissions or purchase emission allowances from other emitters. China is currently the largest emitter of greenhouse gases and many major Chinese cities have severe air pollution. With this plan, China will soon be the largest market in carbon trading. The scheme will limit emissions from six of China’s top carbon dioxide emitting industries, including coal-fired power plants. China was able to gain experience in drafting and implementation of an ETS plan from the United Nations Framework Convention on Climate Change (UNFCCC), where China was part of the Clean Development Mechanism (CDM). From this experience with carbon markets, and lengthy discussions with the next largest carbon market, the European Union (EU), as well as analysis of small scale pilot markets in major Chinese cities and provinces, China’s national ETS will be the largest of its kind and will help China achieve its Intended Nationally Determined Contribution (INDC) from the Paris Agreement in 2016.

Plan Specifics

As China promised in the Conference of Parties to reduce 40-45% their greenhouse gas emissions by 2020, they decided to approach market-based mechanisms to achieve so. They developed the Clean Development Mechanism, which consists in a more “bottom up” architecture. China has learned from the European Union (which trading market is twice as big) and California in the United States, to implement mechanisms such as cap and trade. The idea behind, is to create an international market through clubs where allowances could be traded and a report on carbon is developed.

This was a long term plan for China, which will launch in July 2017. For now, the nation has implemented 7 pilot carbon markets in cities that thrive on production of cement, electricity, heat, petroleum and oil extraction. These cities are: Beijing, Chongqing, Guagdong, Hubei, Shanghai, Shenzhento and Tianjin, which represent 25% of China’s total GDP. Since the pilot plan started, it is estimated that 40.24 millions of metric tons of carbon dioxide have been traded.

These pilot cities were held responsible through the cap and trade mechanism, where a cap or limited amount of emissions are permitted, and the allowances can be traded, auctioned or even given away for free, depending the case. Through cap and trade, it is believed that the competitiveness would be reduced as well as carbon leakage. Each cap and allowance was given away to the cities according to their purpose, production rates, or ability to pass along the costs of carbon along the consumer chain. The caps of greenhouse gas emissions vary from 30-350 metric tons of carbon dioxide equivalent per year when the price for carbon varies from $1.4-$13.00 US dollars per ton of carbon dioxide. There also exists 2 types of allowances: new entry vs. governmental. The new entry allowances are for those who are in need for growth and are freely distributed, whereas the governmental allowance is a fixed, stable fraction that must be sold or auctioned.

There are also conditions that each pilot city must uphold, mainly regarding monitoring, reporting and verification. Each city has their own mechanism of doing so, but they all face the same kind of penalties. These penalties include: a reduction on free allowances, a threat on publicizing said status in order to create social pressure, a 2 year restricted access to special funds for energy research and if an excess of emission were to take place, the city or company would have to pay 3 times the original allowance price.

Difficulties

In order for China to achieve their aforementioned goals, they need to put front to certain challenges. China will have to overlook that there will no be any overlap with already existing policies from prevention, reduction and consumption of pollutants. The country will also have to strictly overlook and enforce the said regime, and make sure that there is ultimate transparency, especially on monitoring and reporting advances all the way throughout. There will also need to be special attention on carbon leakage and on price volatility. Ever since the pilot cities began this project, the price on carbon and caps have been fluctuating. The government will also need to make sure that there is an efficient trade and exchange of allowances in spot. In general, there will also need to be an existent plan on reduction of greenhouse gas emissions to achieve their Paris agreement.

On the other hand, policy makers face the struggle on allowance allocations. For the free allowance, they need to think about who to give them to. For the auctioned ones, they need to think about the type of auction that is most convenient, and the combined ones, all of the above.

Influences

Prior to the conception and design of China’s national carbon trading scheme, carbon emission trading (CET) had never been executed in China. With no CET experience to draw from, in late 2011 the National Development and Reform Commission (NDRC) approved two provinces and five cities of varying degrees of economic development as pilots. In the Notice on Launching Pilots for Emissions Trading System (ETS), the NDRC approved Beijing, Tianjin, Shanghai, Chongqing, Hubei, Guangdong, and Shenzhen as ETS pilots. Shenzhen was the first pilot to launch on June 18th, 2013 and was soon followed by the other designated pilots, which all completed their first compliance period by June of 2015. All of the pilots with compliance data had compliance rates of over 96%, with Shanghai having the highest compliance rate at 100% and Tianjin having the lowest compliance rate at 96.5%. In order to aid the design of implementation details in China’s national carbon trading scheme, each of the pilots were given the freedom to decide values for trading scheme parameters such as allowance allocation, coverage of sectors, and punishment mechanisms. They also vary in their approach to transactions, issues with price uncertainty, and managing risk. To assess the success of one pilot’s trading scheme versus another, market performance was considered.

The pilots' approach to allowance allocation were largely based on historical emissions for most sectors except the power sector, which was calculated an allowance based on benchmarks and production. Guangdong was the only pilot to implement auctioning allowances for its power sector. Additionally, all pilots except Hubei allowed allowance rollover into the next compliance period. To standardize monitoring, reporting, and verification of carbon data, the NDRC issued regulations on monitoring and reporting guidelines. Enterprises were required to monitor and report their emissions, which was compared to a report from a third-party verification agency. Discrepancies in the reports above a threshold would require a re-verification. For most pilots, this threshold was set at a difference of 10% or 100 thousand tons. Funding required for verification was supplied by the local government rather than the enterprise, in order to reduce the compliance burden.

Five of the pilot programs allowed individuals to participate in carbon trading while two only allowed enterprises to do so. Transaction formats varied slightly but were all in spot markets with no carbon futures. In all pilots, enterprises needed to pay the cost of trading, which was a two-way charging scheme. In order to ensure stability in the carbon market, each pilot set a price limit based on the closing price of carbon in the previous compliance period, as well as limits on maximum allowance holdings for enterprises. Each pilot implemented varying degrees of fines for faking carbon data or withholding data. Shenzhen was the only pilot to implement a variable fine, setting it as three times the market clearing price times the excess emissions. Other pilot programs charged a flat fee. All pilots deducted the excess emissions from the next period’s allowance for the enterprise in question.

From the pilot program’s inception to May 2015, 20.27 MtCO­2e had been traded for a total value of 720 million CNY. The carbon price for Shenzhen and Guangdong were the greatest, ranging from 60 to 80 CNY. The price fluctuated more in Shenzhen and Tianjin when compared to other pilots, especially near the compliance period deadline and near the beginning of new periods. The transitive behavior of the carbon market is a result more so of trading entities' understanding of policy and the timing of carbon data acquisition rather than market demand. From the pilot program data, China should improve on the designs of the pilot programs in order to achieve a stable and stimulated national carbon market.

Economic Analysis

The market is expected to be in the range of 3-5 billion tonnes of carbon allowances per year in the beginning, which is a lot more than the EU-ETS scheme – currently the largest carbon market in the world with two billion tonnes of allowances. The new market will only initially apply to eight sectors – petrochemicals, chemicals, building materials, steel, ferrous metals, paper-making, power-generation and aviation – as announced by the National Development and Reform Commission (NDRC). Participation in the market will be compulsory for companies in the above sectors that use more than 10,000 tonnes of standard coal equivalent (TCE) of energy each year. The launch prices will be set as the average of the prices on China’s seven trial carbon markets (about 30 yuan per tonne) – between 1.2 and 8 billion yuan ($0.17-1.16 billion) of over-the-counter trading yearly. Other products will be introduced on the new carbon market after 2020 including carbon futures, and the market trading is expected to expand to 60 to 400 billion yuan ($7-58 billion) per year.

On 21 September, the China Emissions Exchange (Guangdong), under the authorization of the Guangdong DRC, held its first auction (Chinese) for vintage 2016 allowances. Half a million allowances were on offer and cleared above the floor price of 9.37 CNY/ton (USD 1.40) with a settlement price of 9.88 CNY/ton (USD 1.48). To be launched in 2017, the Chinese ETS will be the world’s largest carbon market, covering 3-5 billion tons of CO2e with an expected trading volume of 1.2-8 billion CNY. This could expand to as much as 60-400 billion CNY when carbon futures enter the market.

Janine Young Peer Review

The background / Introduction was really good.

• For plan specifics: what do you mean by “clubs”? Are they specific organizations? A little more specific on the “conditions that each pilot city must uphold.” Maybe briefly mention what they are monitoring/reporting/verifying - are they monitoring emissions?
• For difficulties: “the price on carbon and caps have been fluctuating” - perhaps provide a value(s)?
• For influences: Briefly define what “compliance” means in this situation.

Overall, it was a really good draft. A bit too wordy when they can be simplified.