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China’s national carbon market: Mapping out the road ahead
By Meian Chen, Diego Montero | Updated: 2019-01-04 10:56
Meian Chen
Diego Montero

China’s emission trading system (ETS), which has been operating as regional pilot programs since 2013, was expanded nationwide in December 2017. At this juncture, the national carbon market covers only the power generation sector -- covering 1,700 emitters and a third of China’s total emissions. The sector was chosen because it is responsible for so much of China's carbon emissions, and because it has a relatively solid system of emission data collection. Taking a close look at the national ETS after one year is worthwhile because it is a key component of China’s effort to pursue economic development in a way that delivers growth, protects the natural environment and reduces carbon emissions.

As outlined in China’s National Carbon Market Development Plan (Power Generation Sector), the development of China’s national ETS is broken up into three phases, starting with an approximately one-year period that emphasizes market infrastructure. In this first phase, the focus has been on developing basic frameworks for emission data quality, such as monitoring, reporting and verification (MRV) systems, and allowance allocation methods. This builds on MRV work conducted in the last few years. From 2013 to 2017, China’s National Development and Reform Commission (NDRC) conducted historical emissions data collection from key emissions entities and released 24 industry guidelines on emissions accounting and reporting. The NDRC also developed a template for annual emissions monitoring plans and regulations for third-party verifiers.

Another first-phase area of work has been allowance allocation principles. Drawing on the experiences of the pilot ETS programs, allowances will be distributed mostly for free, to reduce the burden on covered entities and make it easier for them to accept the ETS. These allowances will be based on 11 benchmarks being developed for the power sector. As there are concerns with this sub-categorization of benchmarks within sectors, final allowance allocation and benchmarks will be determined in the near future.

To support MRV and allowance transactions at the national level, local ETS pilot program governments are developing unified registry, emission data reporting and trading systems. The Hubei provincial government is responsible for the construction of a unified national registry system, and the Shanghai municipal government is handling the development of a unified trading system. As China’s national ETS moves forward, these supporting systems will pave the way for allowance allocation and emissions trading in the second and third phases.

The transfer of the NDRC’s climate change department into the new Ministry of Ecology and Environment (MEE) will likely have a positive effect on the national ETS. The MEE’s pollutant emissions monitoring system can be used to help design the tracking of the national ETS’ covered entities emissions data. Most power plants are required to have continuous emissions monitoring systems (CEMS) to monitor their air pollutants emissions. Adapting CEMS to monitor carbon would improve the availability and quality of emissions data.

While China’s national ETS has made some headway with market infrastructure, there are challenges ahead.

As a policy tool for greenhouse gas emissions reduction, ETS can reshape covered industry and consumer behavior by making carbon-intensive activities and products more expensive than low-carbon alternatives. However, China’s electricity price control in the power sector has raised concerns about whether carbon prices can truly be passed on to end-users. Also, China is currently undergoing power sector reform, and its effect on the national ETS remains to be seen.

Additionally, to make carbon price signals work in the long run, it will be important to take allowance auctions and a carbon price collar into consideration. It is understandable that free allocation would be adopted in the initial stage of the national ETS, but foreign carbon markets show that it is difficult to find a reasonable carbon price or use price signals to regulate supply and demand under a free allowance regime. Auctioning a portion of the allowance would increase the market's liquidity and lead to a carbon price that reflects a natural balance between the supply and demand of allowances. Auctions can also help raise public funds for green and low-carbon development. Another improvement would be setting a carbon price collar. This would set a price ceiling and floor on the carbon price, in that way reducing price fluctuations and providing a predictable investment environment for ETS participants.

Given the complexity of ETS in both design and implementation, it will take time for China’s national ETS to mature into full efficiency and functionality. But with the right tweaks along the way, a smart learning-by-doing approach can help increase the chance that this market mechanism fulfills its promise as a pillar of China’s carbon reduction policy framework.

Meian Chen is an analyst, and Diego Montero is a strategic advisor of innovative Green Development Program (iGDP), an independent, Beijing-based think tank dedicated to identifying China-specific solutions toward a zero-emission future.

The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.
All rights reserved. Copying or sharing of any content for other than personal use is prohibited without prior written permission.

Meian Chen
Diego Montero

China’s emission trading system (ETS), which has been operating as regional pilot programs since 2013, was expanded nationwide in December 2017. At this juncture, the national carbon market covers only the power generation sector -- covering 1,700 emitters and a third of China’s total emissions. The sector was chosen because it is responsible for so much of China's carbon emissions, and because it has a relatively solid system of emission data collection. Taking a close look at the national ETS after one year is worthwhile because it is a key component of China’s effort to pursue economic development in a way that delivers growth, protects the natural environment and reduces carbon emissions.

As outlined in China’s National Carbon Market Development Plan (Power Generation Sector), the development of China’s national ETS is broken up into three phases, starting with an approximately one-year period that emphasizes market infrastructure. In this first phase, the focus has been on developing basic frameworks for emission data quality, such as monitoring, reporting and verification (MRV) systems, and allowance allocation methods. This builds on MRV work conducted in the last few years. From 2013 to 2017, China’s National Development and Reform Commission (NDRC) conducted historical emissions data collection from key emissions entities and released 24 industry guidelines on emissions accounting and reporting. The NDRC also developed a template for annual emissions monitoring plans and regulations for third-party verifiers.

Another first-phase area of work has been allowance allocation principles. Drawing on the experiences of the pilot ETS programs, allowances will be distributed mostly for free, to reduce the burden on covered entities and make it easier for them to accept the ETS. These allowances will be based on 11 benchmarks being developed for the power sector. As there are concerns with this sub-categorization of benchmarks within sectors, final allowance allocation and benchmarks will be determined in the near future.

To support MRV and allowance transactions at the national level, local ETS pilot program governments are developing unified registry, emission data reporting and trading systems. The Hubei provincial government is responsible for the construction of a unified national registry system, and the Shanghai municipal government is handling the development of a unified trading system. As China’s national ETS moves forward, these supporting systems will pave the way for allowance allocation and emissions trading in the second and third phases.

The transfer of the NDRC’s climate change department into the new Ministry of Ecology and Environment (MEE) will likely have a positive effect on the national ETS. The MEE’s pollutant emissions monitoring system can be used to help design the tracking of the national ETS’ covered entities emissions data. Most power plants are required to have continuous emissions monitoring systems (CEMS) to monitor their air pollutants emissions. Adapting CEMS to monitor carbon would improve the availability and quality of emissions data.

While China’s national ETS has made some headway with market infrastructure, there are challenges ahead.

As a policy tool for greenhouse gas emissions reduction, ETS can reshape covered industry and consumer behavior by making carbon-intensive activities and products more expensive than low-carbon alternatives. However, China’s electricity price control in the power sector has raised concerns about whether carbon prices can truly be passed on to end-users. Also, China is currently undergoing power sector reform, and its effect on the national ETS remains to be seen.

Additionally, to make carbon price signals work in the long run, it will be important to take allowance auctions and a carbon price collar into consideration. It is understandable that free allocation would be adopted in the initial stage of the national ETS, but foreign carbon markets show that it is difficult to find a reasonable carbon price or use price signals to regulate supply and demand under a free allowance regime. Auctioning a portion of the allowance would increase the market's liquidity and lead to a carbon price that reflects a natural balance between the supply and demand of allowances. Auctions can also help raise public funds for green and low-carbon development. Another improvement would be setting a carbon price collar. This would set a price ceiling and floor on the carbon price, in that way reducing price fluctuations and providing a predictable investment environment for ETS participants.

Given the complexity of ETS in both design and implementation, it will take time for China’s national ETS to mature into full efficiency and functionality. But with the right tweaks along the way, a smart learning-by-doing approach can help increase the chance that this market mechanism fulfills its promise as a pillar of China’s carbon reduction policy framework.

Meian Chen is an analyst, and Diego Montero is a strategic advisor of innovative Green Development Program (iGDP), an independent, Beijing-based think tank dedicated to identifying China-specific solutions toward a zero-emission future.

The author contributed this article to China Watch exclusively. The views expressed do not necessarily reflect those of China Watch.
All rights reserved. Copying or sharing of any content for other than personal use is prohibited without prior written permission.