Why does China want carbon trading?

With the calendar turning to 2013, the long-awaited next phase in a campaign to reduce greenhouse gas emissions will soon take place in China.

Five Chinese cities and two provinces will begin pilot programs to cap the amount of carbon dioxide key polluters can emit with a system of tradable allowances. Polluters that emit beyond the cap are required to buy more carbon allowances; those that become more efficient can sell allowances they no longer need. Besides trading allowances among each other, polluters can also offset a small amount of emissions by sponsoring emissions reduction projects outside these regions.

Such emissions trading may sound familiar to many Americans, since the United States adopted a similar scheme in the 1990s to reduce sulfur dioxide, a precursor of acid rain. But when it came to carbon trading, the bill failed in the U.S. Senate amid concerns by some that it would hamper an already troubled economy.

Funny enough, decision makers in China drew the opposite conclusion.

It’s the economy, stupid

To be sure, Beijing’s intention to use carbon trading against climate change is real, given that China is among the world’s most vulnerable countries. But if its goal is to combat climate change, reducing emissions anywhere helps achieve the mission, so why do these Chinese carbon trading pilots limit the amount of carbon offsets polluters can use?

The recently unveiled Chinese carbon trading plans all stress reducing emissions inside the pilot regions. The reason, China’s senior climate official Xie Zhenhua said in a speech: Restructuring the economy through carbon trading.

Because China gets the majority of its energy from coal, a high carbon emitting fuel, putting a price on carbon could incentivize transitioning from power-hungry manufacturing industries to more service-oriented businesses. And even for existing manufacturers, carbon trading can lead to innovation and efficiency improvements motivated by financial incentive to save energy, and that in turn improves their competitiveness. Ultimately, the connotation of the Made-in-China label could change from “low end” to “low carbon.”

Yet another even bigger game is on the horizon. With carbon markets mushrooming worldwide, many predict that a global linkage could take place by 2020. Chinese experts have advised Beijing to be proactive in helping form this multibillion-dollar global trade pact so that they might influence the formulation of rules favorable to China instead of following terms set by others.

Evolving plans

But for now, China’s own carbon trading rules remain unclear. Beijing, Tianjin, Chongqing and Hubei have yet to unveil their plans. Although Shenzhen, Shanghai and Guangdong have given a general frame (see table), they lack crucial details like what penalties, if any, will be imposed if regulated polluters exceed their emissions caps yet refuse to pay the fees. Designers of the pilots say that they are still working on details, but no one knows the timeline for any further releases.

What is clearer is a modest trading volume in coming years as policymakers here hope to first get polluters familiar with carbon trading. The roles of foreign players in China’s carbon trading might be limited to consultants or emissions reduction solution providers, as Beijing has traditionally restricted the participation of outsiders in its financial sector. There is also little expectation of a quick market scale-up, as integrating regional carbon markets could take years. In fact, the Chinese official Xie reportedly said in a conference last year that a Chinese national scheme may not emerge in 2015 as planned since more small-scale tests will be needed.

Still, a tiny step by China may be big enough to turn the tables in global climate talks.

China’s move may help get other top polluters like the U.S. to do more. And when carbon barriers to trade emerge, as was the case with the EU scheme which charges carbon emissions from flights into and out of Europe, Chinese industries will be better positioned in negotiations if they have already reduced emissions at home.

Uncertainties with China’s carbon trading

A question remains: can China make enough progress so other countries trust China’s carbon trading?

In September, when China sealed its first carbon trading deal, with four cement producers buying 1.3 million carbon allowances from the Guangdong government at 60 renminbi ($9.65) per unit, there was no explanation on how the price tag was set. That has raised questions about how transparent China’s carbon market operations will be.

China’s carbon trading has also encountered other snags. One problem planners are wrestling with is that determining where to set emissions caps requires historical data, but few facilities have complete records on what they have emitted. Another tricky issue is that because electricity prices are government-controlled, power generators can’t pass costs associated with carbon trading on to energy consumers and also hesitate to absorb them themselves. Additionally, China is new to cap-and-trade and therefore it may face other technical challenges in scheme designing and market operation.

So, what will the Chinese do? A clue came at a 2010 TEDx talk, in which Peggy Liu, a veteran in China’s green revolution, said that “they (the Chinese) are able to quickly throw spaghetti on the wall to see what clean-tech models stick, and they have the political will to scale them quickly across the country.”

Chinese policymakers may use the same strategy to seek a suitable carbon trading model, just hoping those that fail to stick wouldn’t leave too many unsightly marks on the wall.

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Table reproduced with permission from International Emissions Trading Association (IETA) report, “Greenhouse Gas Markets 2012: New Markets, New Mechanisms, New Opportunities.”

Photo Credit: Wikimedia Commons