The Chinese government has approved seven pilot carbon trading schemes. These pilot regions are deliberately selected to be at varying stages of development and are given considerable leeway to design their own schemes. These schemes have features in common, but vary considerably in their approach to a variety of issues, such as the coverage of sectors, allocation of allowances, price uncertainty, and enforcement and compliance. This article examines key features and compliance of China’s carbon trading pilots, lessons learned in the pilots, and the transition from the pilots to a national carbon trading scheme. Insights offered into the design, implementation and compliance of China’s carbon trading pilots and potential pathways help make these pilots work reliably and effectively and smooth the transition from the pilots to a national carbon trading scheme.
Keywords: Pilot carbon trading schemes, Design, implementation and compliance, National carbon trading scheme, China
JEL classification: Q43, Q48, Q52, Q54, Q58
Suggested citation: ZhongXiang, Zhang, Carbon Emissions Trading in China: Features and Compliance of Pilots and their Transition to a Nationwide Scheme (July 23, 2015). Review of Environment, Energy and Economics (Re3), http://dx.doi.org/10.7711/feemre3.2015.07.002
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The National Development and Reform Commission (NDRC) in late October 2011 approved seven pilot carbon trading schemes in Beijing, the business hub of Shanghai, the sprawling industrial municipalities of Tianjin and Chongqing, the manufacturing center of Guangdong province, Hubei province (home of Wuhan Iron and Steel), and Shenzhen, the special economic zone across the border from Hong Kong.
Since Shenzhen launched its first trading in June 2013, Shanghai, Beijing Guangdong, and Tianjin, in turn, launched their first trading prior to the end of 2013. Hubei and Chongqing, launched trading in April and June 2014 respectively, marking the commencement of the pilot scheme as a whole. The seven pilots are deliberately selected to be located in regions at varying stages of development. This article examines key features and compliance of China’s pilot carbon trading, lessons learned in the pilots, and the transition between the pilots to a national carbon trading scheme.
2. Key common and varying features
All seven pilot trading schemes have some features in common. They all run from 2013 to 2015. Only CO2 is covered in all pilots except for the Chongqing pilot that considers all six gases covered under the Kyoto Protocol. Moreover, all pilots require third party verification of the emission reports of the entities covered.
In the meantime, the seven pilot regions are given considerable leeway to design their own schemes. The pilot schemes have different coverage of sectors, ranging from four sectors in Guangdong to 26 sectors in Shenzhen. The threshold to determine whether an emissions source is covered differs across pilots. A combination of the two factors leads the number of covered entities to differ significantly, from 114 in Tianjin to 635 in Shenzhen. Consequently, the share of covered emissions in the total emissions in each pilot region varies significantly, ranging from 36% in Hubei and 38% in Shenzhen to 57% in Shanghai.
Emissions sources targeted at enterprises
Differing from the emissions trading scheme (ETS) of the European Union and California, the covered emissions sources are enterprises in all the pilot schemes in China. Also unlike the EU ETS, indirect emissions from both electricity generation within the pilot region and generated from the amount of imported electricity from outside pilot regions are covered in all the pilot schemes. This design feature could help to reduce carbon leakage.
Emissions allowances and their allocation
In each pilot scheme, the majority of allowances are for initial distribution, with small portion of allowances used for adjustments, for new entrants and for auctioning, and reserved for maintaining the price stability.
While the allowances are granted to new entrants based on benchmarking, allocations to existing emissions sources are based on historical emissions or emissions intensities or benchmarking depending on sectors. In most pilots, allowances are allocated for free year by year, but in the Shanghai pilot all the emission allowances over 2013-15 are distributed for free for all the covered enterprises at one time. While all pilots allocate all or the majority of allowances for free, such allocations are based on grandfathering, benchmarking or in both. Even if allowances are grandfathered on a historical basis, the treatment of early abatement actions differs among pilots in terms of time profile of historical emissions, allocation methods, and allowance reward. In Shanghai, regardless of the methods of allowance allocation, the covered enterprises except for power plants get allowance rewards for having taken actions for energy-saving technical transformation or energy performance contracting over the period 2006-11. The pilots also allow the mandated entities to apply for adjustments in allowances in case a significant shortage of allowances occurs, but conditions and mechanisms for ex post adjustments in allowances differ across pilots.
The Guangdong and Shenzhen pilot schemes take a unique means of allocating allowances. The Shenzhen pilot has adopted an innovative competitive game-based allocation of allowances in one given sector, while in the Guangdong pilot scheme, the covered enterprises are mandated to purchase 3% of the total amount of allocated allowances during 2013-14 through auction before they get the remaining 97% for free.
Flexible provisions and cost-containment mechanisms
All carbon trading pilots in China have reserved a small portion of allowances for cost containment purposes, but the triggering conditions to use these reserved allowances, which have not yet been disclosed for most of the pilots, are expected to differ across pilots. During the pilot phase, banking is allowed, but allowances cannot be carried forward beyond 2015, the ending date of the pilot period. Borrowing is not authorized. All regimes allow to varying degrees the use of China Certified Emission Reductions (CCERs) that meet the requirements of national monitoring, reporting and verification (MRV) regulation, but regimes differ regarding the origin of CCERs (see Table 1).
Table 1 - The allowable use of CCERs in the seven carbon trading pilots
Ways to prevent market power of dominated players, or at least mitigate market power concerns differ. Some pilot regions set limits to the amount of allowances that each entity can bid, while other pilots specify the ways to handle larger order of allowances.
Shenzhen, Shanghai, Beijing, Guangdong, and Tianjin have to comply with their emissions obligations for the year 2013 before their first compliance deadlines. To enforce the compliance of covered entities with their emissions obligations, all pilots have built a variety of public disclosure and punishment mechanisms. Some pilots include non-compliance in the credit record of non-complying enterprises and make it public. Some pilots also deprive those non-complying entities for a certain period of time from applying for public energy saving funds, and from being given preferential treatment of their application for public financial support for low-carbon development, energy conservation and renewable energy projects. Some pilots go further. For example, in the Beijing pilot, depending on the extent of noncompliance, entities are subject to fines equal to three to five times the prevailing average market prices over the past six months for each shortfall allowance. Non-complying entities in the Hubei pilot are charged at 1-3 times the yearly average market prices for each shortfall allowance, with the imposed penalty capped at CNY 150,000, and two times the amount of their shortfall allowances are deducted from the amount to be allocated in the following year.
The pilots have also introduced a variety of measures and policies to enhance their compliance. Several pilots have extended the compliance deadlines. Some pilots allow the changing in status in one compliance cycle. The Shenzhen and Shanghai pilots auction additional allowances, with eligibility specified only for those enterprises of compliance gap, and the allowances received are only for compliance needs and cannot be traded on the market.
Table 2 - Five carbon trading pilots’ compliance rate in the first compliance year
As shown in Table 2, the first-year performance of the five pilots is generally good. Shanghai and Shenzhen met their commitments before the original deadline. Beijing, Guangdong and Tianjin performed well after their compliance deadlines were extended somewhat (less than one month). Guangdong achieved the compliance rates of 98.9% and 99.97%, respectively measured against enterprises or allowances. Moreover, through technical innovation, 80% of the covered enterprises are estimated to cut to a differing degree their emissions per unit of product. This is a significant accomplishment for a big manufacturing province like Guangdong. The relatively low rate of compliance in Beijing is mainly because the Beijing pilot not only covers a large number of entities, but also these entities covered are very broad in scope, ranging from Sinopec, Microsoft, universities like Peking University and Tsinghua University, hospitals, medias like CCTV, and other public service units like ministries. The lowest rate of compliance in Tianjin of the five pilots subject to compliance obligations for 2013 might be associated with the fact that the enterprises covered would not be required to pay the penalty if they failed to comply with their emissions obligations.
4. Key lessons learned from the carbon trading pilots
Experience in the pilot regions shows that they have not recognized that emissions trading is not only a means of helping the covered entities to meet their emissions obligations, but can also help them achieve that goal at low costs. Many enterprises view that governments may not be that serious in enforcing the compliance so that they only take advantage of emissions trading until the last minute. While the majority of them meet with their obligations in the end, they pay higher prices than what would be otherwise the case. For example, the total volume of traded allowances in the last month in Beijing, Shanghai and Shenzhen accounted for 75%, 73% and 65% of the total accumulated volume of trade from the first trading day to the last trading day of the first-year compliance circle. The fact could be attributed to the uncertainties over the duration of how long allowances that they hold are valid as financial assets. Consequently, not only the volume of traded allowances rose rapidly in the last month of the compliance circle, so did their online trading prices.
One key lesson derived is that educating the covered entities, strictly enforcing compliance rules, and ascribing allowances as financial assets and defining their valid duration are crucial to enabling active participation in carbon emissions trading.
Another is to seek the support of financial institutions to increase the rate of compliance. While the penalty for non-complying entities in the Shanghai pilot is not the strictest compared to peers, Shanghai achieved 100% compliance. This could be attributed to inclusion of non-compliance in the credit record of non-complying enterprises and making it public to financial institutions and the general public in the Shanghai scheme.
5. Going toward a nationwide ETS
NDRC has been preparing for launching a nationwide ETS. In January 2014, those key entities emitting 13,000 tCO2 equivalent or consuming 5,000 tons of coal equivalent (tce) or above in 2010 are required to report their carbon emissions annually. The reporting should be based on the accounting and reporting guidelines for the ten sectors issued by NDRC. In December 2014 NDRC issued guidelines for another four sectors covering oil and natural gas, petrochemical, coal, and coking, and released the interim measures for carbon emissions trading.
With all this preparation work, China has aimed to establish a nationwide ETS by late 2017. Initially China plans to include six sectors in its national ETS: power generation, metallurgy and nonferrous metals, building materials, chemicals, and aviation. The threshold for an emissions source to be covered will be set at 26,000 tons of CO2 equivalent per year. This threshold is two times that set for the aforementioned key entities required to report their carbon emissions annually, and is also higher than the threshold of 10,000 tce for those industrial and transportation enterprises included in the 10,000 Enterprises Energy Conservation Low Carbon Action Program, which covers 16,078 enterprises that also include other entities consuming energy of 5,000 tce in 2010. This implicitly suggests that the national ETS initially include about 10,000 entities. This would give China’s carbon market estimated at three to four billion tons of CO2 emissions, and establish China’s ETS as the world’s largest scheme.
To authorize emission trading at the national level, a national ETS legislation needs to be established. The aforementioned NDRC’s interim measures are not enough. The provisions governing emissions trading across regions in the form of interim measures are needed to be elevated at least to the State Council’s regulation.
The retrospective examination of carbon trading pilots and the differing timing, coverage and scope suggest two-tier management system of carbon trading. The central government sets emissions caps to level the playing field and avoid in-country carbon leakage, and is in charge of national rules setting to ensure, among others, the same rules of coverage and scope, and uniform standards for MRV, the allocation of allowances, and the rules of compliance across provinces or equivalent. In the meantime, provincial governments are assigned to take responsibility for rules implementing, but are given flexibility to go beyond the national requirements.
The aforementioned limited sectoral coverage and high threshold also suggest initially co-existence of regional and national carbon trading schemes. Until a nationwide carbon market will become fully functional, regional ETS continues to function in parallel and those entities covered in the existing regional ETS will be unconditionally integrated into a nationwide ETS if they meet the latter’s threshold. This raises the issue of striking a balance between pilots’ preferences to keep their own autonomy and characteristics and the need to have a harmonized national carbon trading scheme in order to achieve smooth interconnect of carbon pilots and a national ETS.
This article is based on the two lengthy articles by Zhang (2015a,b), which provide full references to all the data cited. This work is financially supported by the National Natural Science Foundation of China under grant No. 71373055.
Zhang, Z.X. (2015a) Crossing the river by feeling the stones: the case of carbon trading in China. Environmental Economics and Policy Studies 17(2): 263-297.
Zhang, Z.X. (2015b), Carbon emissions trading in China: the evolution from pilots to a nationwide scheme, Nota di Lavoro 38.2015, Fondazione Eni Enrico Mattei, Milan, Italy. Climate Policy, Vol. 15 (Supplement 1 on Climate Mitigation Policy in China Guest Edited by ZhongXiang Zhang).
FEEM Nota di lavoro 19.2015
FEEM Nota di lavoro 38.2015