International Carbon Markets: a Case Study on Chinese Emissions Trading Schemes

Kathryn A. Walker

Research Project Placement for Ndevr Environmental Consulting

3rd February 2014

Ndevr Pty Ltd Suite 6, Level 3,499 St Kilda RdMelbourne, VIC 3004P +61 3 9865 1400W www.ndver.com.auE ndver@ndver.com.auA.B.N 72 084 281 836

List of Abbreviations......................................................................................................................3

Executive Summary.......................................................................................................................4

Climate Change Policy and Carbon Trading................................................................................6Climate and Carbon Policy……………..…………………………………………………….6Table 1. Current carbon emission reduction policies.…………………………….…….…6Table 2. Complimentary schemes in climate change policy..………………………….…7Emissions Trading Schemes…………………………………………………………………7

Drivers for Carbon Trading in China.............................................................................................8Development of Carbon Markets……………………………………………………………..8Drivers of China's Climate Change Policy..................................................................…9Implications..................................................................................................................10Services Offered..........................................................................................................10

Current ETS projects....................................................................................................................12Who will the policy target?...……………………………..……………………………...…..12Table 3. Summary of pilot scheme components………………………..……………...…13

Scheme Intricacies……………………………………………………………………….…..16 Controlled Market…………..…………………………………………..………………...…..17Uncertainties………………..………………………………………………..…………...…..18

Table 4. Summary of China's emissions reduction targets…………………..……..…....18Future Directions………....…………………………………………………..……….……...19

Market Entry and Future Directions............................................................................................20Needs analysis.............................................................................................................20

Table 5. Disciplines required for carbon market function…………………………………20Future Directions..........................................................................................................21

Figure 1. Timeline of expected international ETS commencement…………….……….21Barriers to Entry...........................................................................................................21

Table 6. Barriers to carbon market entry…………………………………………………...21Funding Opportunities..................................................................................................23

Australian links with Chinese policy………………………………………………………...23 India's climate change policy…………………………………………………………...……24

Conclusion....................................................................................................................................25

References.................................................................................................................................... 26

Table of Contents

Research Project: International Carbon Markets

List of Abbreviations Abbreviation Full name

ABE The Asian Business Engagement Plan

CCER Chinese Certified Emissions Reduction

CDM Clean Development Mechanism

CER Certified Emissions Reduction

CFI Carbon Farming Initiative

CO2 Carbon dioxide

CO2e Carbon dioxide equivalent

EPs Equator Principles

EU European Union

ETS Emissions Trading Scheme

FYP Five-Year Plan for Economic and Social Development

GDP Gross Domestic Product

GHG Greenhouse gas

MEP Ministry of Environmental Protection

MRV Monitoring, reporting, verification

NDRC National Development and Reform Commission

UNFCCC United Nations Framework Convention on Climate Change

US United States

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Research Project: International Carbon Markets

Executive Summary

This report was conducted as part of a research placement on behalf of Ndver Environmental Consulting. It is intended to provide an informative summary, for internal purposes, on the state of carbon markets with particular examination into the Chinese Emission Trading Scheme.

The development of emissions reduction schemes, including the Emissions Trading Scheme (ETS), has increased globally in response to predicted threats to the economy and environment associated with anthropogenic warming of the climate. In an attempt to combat rising greenhouse gas emissions, climate change mitigation policies are being adopted by many countries. Carbon trading markets have developed over the last decade and are being increasingly undertaken as part of climate change policy.

China has developed their own climate change policy: they want to avoid the economic, environmental and social consequences of climate change and reduce their dependency on fossil fuels. The country is attempting to convert to a ‘low carbon economy’, using a number of strategies, including the ETS. The recent adoption of the Chinese carbon market, developed through positive experiences with the Clean Development Mechanism.

China is currently trialling the ETS domestically, through seven pilot schemes. If successful, they intend to develop a national scheme, by 2020. The pilots vary in design characteristics, such as emissions budgets and sectors encompassed. The regions chosen also vary in terms of economic status. The reason for this is to assess how the ETS is likely to run under different conditions and economic contexts. The most successful design features will be selected to develop the national system, and any weaknesses abandoned.

Companies will have to comply to set emissions caps or will face a hefty fine. They also may not be allocated a share of their permits the following year. It is likely that some administrative measures will also be employed, to reach set targets on emissions intensity reduction.

There are a number of uncertainties and risks associated with the Chinese scheme and carbon markets generally, which will need to be managed through time. Risks include;

Volatile market prices, where permit prices have the potential to crash Lack in behavioural change if prices are too low ETS related crime

It is uncertain whether quickly-approaching emissions targets will be met using the pilot schemes, and whether regulatory measures will continue to be used now and into the future. Transparency is also an issue, with some governments withholding information on permit pricing and allocation, and methodologies used to calculate emissions levels.

Despite the risks, carbon markets provide a lot of opportunities and services to local economies, communities and the environment. Not only do these markets create a large number of jobs, across a broad range of areas, they also help fund offset programs and energy efficiency research. The reduction in emissions levels will aid air pollution mitigation and be beneficial to health. There is also the potential for

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carbon markets to expand and operate on a global scale. If the Chinese scheme is successful, it may encourage other countries to adopt the ETS and help develop the global climate change policy.

Based on a needs analysis, a number of essential skills and professionals are needed to create and maintain a carbon trading market. Among these, important disciplines include, financial advisors, lawyers and auditors. In order for Australia to develop an ETS and link to the Chinese system, it is quite likely they would need to employ Chinese professionals or employ a team of climate policy experts at the Australian embassy in Beijing.

Market entry is currently challenging - a number of barriers to entry exist and need to be managed as the market develops. Some examples include;

Existing knowledge gaps on pricing mechanisms and other methodologies Methods of funding Bipartisan political agreement Lack of transparent mechanisms to monitor and verify emissions levels

The Chinese and the European ETSs are employing a ‘learning-by-doing’ approach to their schemes; they will working through problems and learn from mistakes as they arise.

A potential funding opportunity for carbon market development in Australia is Austrade’s Asian Business Engagement Plan, and internationally, the Equator Principles are encouraging financial institutions to invest in green projects, including emissions reductions schemes. Carbon markets are yet to become wholly cost-efficient and creating funding to combat climate change will remain one of the greatest financial challenges of our time.

In the upcoming UNFCCC convention in Paris, 2015, the progress of a global agreement on climate change mitigation is anticipated, to be in force by 2020. It is likely the conference will influence the execution and timing of international strategies, including the development of the global carbon market. The timing and direction of Australia’s climate policy is likely to be influenced by this conference. The EU, US and China will be major players in international negotiations.

China has managed to relatively quickly implement their own ETS, which in comparison took Europe and Australia years of debate and arranging to pursue. If China manages to successfully run a carbon market and implement a national scheme, there is potential to lower global emissions levels, trigger innovations in clean energy technology and encourage other countries to adopt similar emissions reductions mechanisms.

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Climate Change Policy and Carbon Trading Climate and Carbon Policy

The potential environmental and socio-economic impacts associated with anthropogenic greenhouse gas (GHG) production, have been cause for international concern. The current rate of climatic change is not sustainable and will pose a number of threats not only to the environment, but also the functioning of modern economies.

Mitigating GHG emissions will affect a range of industries, such as agriculture and materials production, as well as influencing electricity consumption, fuel use and heating. If not managed, likely changes to natural systems will include a rise in temperature extremes, sea level rise and exacerbated biodiversity loss.

Carbon dioxide (CO2) is the largest GHG contributing to climate change: it represents approximately two thirds of human-produced GHGs (DSE 2013). A single, standard unit for measuring the combined impacts of all GHGs is the carbon dioxide equivalent, CO2e. This is a measure of the equivalent amount of warming each GHG would cause, in terms of CO2 (a calculation of each gas’ ‘global warming potential’).

Carbon emissions are hence generally used as the ‘target’ GHG, and the terms can be used interchangeably. They are also generally more readily measureable - CO2 emissions sources can be identified directly (US EPA 2012). The development of emissions mitigation strategies, is a core component of climate change policy. Various carbon emission reduction strategies have been trialled and implemented globally, as summarised by Tables 1 and 2.

Table 1. Current general carbon emission reduction policies.

Scheme DescriptionCarbon Tax The government sets a price polluters will pay per tonne CO2 released to the

atmosphere – known as permits. The price per tonne increases annually to promote a reduction in carbon emissions (Energy Action 2013). Pro: permit price is controlled. Con: amount of emissions reduced is uncertain.Examples: many exist worldwide, including in India, Japan and local taxes in the US.

Emissions Trading Scheme (ETS)/ Cap and Trade

Market-based approach to CO2 emissions reduction. Permit price is floating (affected by market fluctuations) however a cap on the total amount of emissions is set by the government. Unused permits can be traded on the market; hence it is in business’ best interests to reduce carbon emissions. Pro: emissions reductions are controlled. Con: price of permits is uncertain.Examples: mandatory EU ETS, the Australian Carbon Pollution Reduction Scheme (the proposed ETS under the Labour government).

Direct Intervention (including ‘command-and-control’ policy)

Government-implemented activities that directly target companies to reduce emissions. Can include financial incentives to implement emissions-reducing projects or forced compliance of national emissions targets. Pro: less uncertainty involved. Con: can be costly to local economies, e.g. may force closure of companies. Examples: China’s top-down administrative measures to reach targets during the 11th Five-Year Plan. The Emissions Reduction Fund of Australia’s current climate change policy, the Direct Action Plan.

Table 2. Complimentary schemes for climate change policy. Page 6

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Scheme DescriptionOffset Schemes Projects that reduce GHG emissions, such as sequestering CO2 from the

atmosphere. They are designed to compensate for emissions produced. Offsets should be used in conjunction with a policy designed to reduce GHG emissions at the source (Greenfleet Australia). Offsetting may be required as part of another scheme or can be voluntary.Examples: Certified Emissions Reductions issued by the Clean Development Mechanism (an offset strategy in the EU ETS). In Australia; the Carbon Farming Initiative – where abatement activities (e.g. revegetation) can generate offset credits (Department of Environment 2013). Both strategies generate tradeable carbon credits.

Energy efficiency research and development programs

Involves research into energy efficiency improvement. Includes research into new and existing clean energy projects. Can promote investment into new technologies, including renewables. The Chinese government has funded extensive research into energy efficiency improvement.

Investment in clean energy and energy efficiency targets

Government or private sectors may choose to voluntarily invest in clean energy technologies. ‘Clean energy’ includes renewables and non-fossil fuels such as nuclear power. A growing industry, particularly in China. Various countries within the EU have adopted these technologies. Energy efficiency targets can be set by local governments to encourage energy-saving activities. Subsidies can be provided to incentivise the uptake of projects. Examples include the Victorian Energy Efficiency Target and the Energy Savings Scheme of NSW.

A holistic approach may be needed (i.e. multiple policy use) in climate change mitigation, as policies can fail. Climate change policies will differ between countries and their circumstances.

Emissions Trading Schemes

Of particular interest, is the Emissions Trading Scheme (ETS). The ETS is a market-based approach to lowering GHG emissions. It involves the commodification of carbon, where emissions are turned into tradeable units that can be transferred or sold.

The schemes vary in size and scope. Some are mandatory (e.g. EU ETS) whilst others are voluntary and may be conducted in countries that have not ratified the Kyoto protocol. The goal of the ETS is to reduce GHG emissions at the lowest possible cost to the economy (Perdan & Azapagic 2011).

The typical ‘cap and trade’ system is a market-based instrument, where the selling and trading of emissions allowances is conducted. There is potential to create a larger, international market for emissions trading, which makes this scheme appealing.

Recently, China has implemented a number of pilot ETSs with the eventual target of a national ETS. China is the world’s largest emitter of GHGs - the implementation of a carbon reduction scheme will contribute to global emissions reductions. If successful, the Chinese ETS could pave the way towards a global strategy.

China is committed to becoming a ‘low-carbon economy’. As well as the development of carbon markets, the country is adopting a range of strategies to reduce emissions, including projects to improve energy efficiency and increase the use and research into renewable energy.

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If a national Chinese ETS is established, there is a prospect of linking it with other markets in the Asia-Pacific region, including Australia.

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Drivers for Carbon Trading in China

As part of China’s climate change policy, the nation is committed to becoming a ‘low-carbon economy’ and are attempting to achieve this by developing a national carbon market. The idea of this strategy is for China to reduce their GHG emissions at least cost –whilst still allowing economic development.

There are two ways of setting emissions caps; absolute caps or intensity targets. Notably, China has chosen to target the growth of emissions, rather than net quantity of emissions produced. This type focuses on reducing energy intensity (carbon emissions produced per unit GDP). Although this type of cap may not result in a reduction in total emissions produced, the trajectory will be below what it would have been if left unmitigated.

Development of Carbon Markets

Historically, the domestic carbon trading market developed as a result of positive experiences with the Clean Development Mechanism (CDM) in overseas markets. The CDM is a means of implementing emissions-reducing projects in Annex 2 countries (includes China) of the Kyoto Protocol (UNFCC 2014). These projects can earn saleable Certified Emissions Reductions (CERs) – which equate to offsetting one tonne of CO2e – the level in a regular carbon permit (UNFCCC 2014). CERs can be traded and sold to parties bound to the Kyoto Protocol, and can count towards their emission reduction targets (UNFCCC 2014).

The CDM is a standardised emissions offset instrument, meaning projects must meet strict rules to qualify for CERs (UNFCCC 2014). There are three types of projects:

Renewable energy projects Energy efficiency improvement projects Other projects that reduce sources of anthropogenic emissions

The stringent requirements the CDM meant China developed a capacity to manage robust carbon markets. Through the CDM process, the National Development and Reform Commission (NDRC) devised valuable pricing tools, which aided the development of an ETS (e.g. baseline emissions calculations).

Of the 4,200 projects registered under the CDM, over 2,000 are based in China (UNEP Riso Centre 2012). The revenue generated from CERs funds CDM projects, of which have been so successful in China they have created a thriving renewables export industry. The positive experiences of the CDM endorsed the opportunities carbon markets can create, inspiring authorities and encouraging banks to invest a domestic carbon market (Scotney et al. 2012).

Currently, the price of CERs in the EU ETS is very low and carbon permit prices are volatile, resulting in little funding for CDM projects. The use of CDMs in higher-level emissions reductions is hence limited. If China is to reach its target of reducing emissions intensity by 40-45% by 2020, they need to involve an alternative strategy, such as a carbon market. By developing their own ETS, China can potentially curb its emissions by encouraging businesses to improve energy efficiency, and not rely on funding from CERs alone.

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Drivers of China’s Climate Change Policy

China’s main policy planning document, the Five Year Plan for Economic and Social Development (FYP) is a periodic document that states national agendas and provides guidelines on how to meet objectives. Local governments and major administrative units use these guidelines to produce their own FYPs (Lo 2013).

The 12th FYP (covering 2011-2015), describes the initiation of environmentally-aware economic growth through ‘low-carbon development’ (Department of Industry). It sets energy and emissions targets, and commits to trialling mechanisms to reduce energy and carbon use, including a domestic carbon trade market (Department of Industry). Key targets of the 12th FYP include:

A 16% reduction in energy intensity (consumption per unit GDP) A 17% reduction in carbon intensity (emissions per unit GDP) An increase of renewable and non-fossil fuel energy to 11.4% of total energy use (currently

8.3%) (Lewis 2011)

Although absolute emissions are not likely to be reduced in the near future, the emissions trajectory will be below what it would have been if left unmitigated.

China’s climate change policy is a macroeconomic-based means of addressing energy security and conservation (Lo 2010a, 2010b, Qi et al 2007, Richerzhagen and Scholz, 2008). It is largely a result of addressing socio-economic concerns associated with future climate change, including risks to food security, reductions to regional economic growth and involuntary migration (and associated social impacts) (Lewis 2009).

International competition and collaboration, most notably in the research and production of green technologies, is also a driver. Renewable energy technologies have relatively recently created a major export market in China; the country is the world’s largest manufacturer of wind turbines and solar panels (Schreurs 2012, Bradsher 2010). The economic profits and jobs creation associated with the export trade offers a great service, but also important, is the reduction in dependency on fossil fuels. In a global sense, it is in China’s best interests to adopt a climate change policy, as it strengthens China’s position in UNFCCC international climate negotiations.

Purely environmental benefits are not recognised as a primary target of this policy, but rather a contributing factor. China’s climate change policy document, the National Climate Change Program, released white papers in 2007 and 2008, with neither referring to the Ministry of Environmental Protection (MEP) or the national environmental agency (NDRC 2007, State Council 2008). That being said, environmental effects that are linked to the economy, such as water security and air pollution mitigation are highly motivating reasons for adopting a climate change policy.

China’s leading economic agency, the NDRC, manages the pilot ETSs. In comparison, the MEP has little formal involvement. Lo (2013) concluded that therefore, Chinese carbon trading is not an environmental policy, but rather is predominantly an economic policy with some beneficial environmental outcomes. Low-carbon economic growth is incentivised, whilst simultaneously curbing emissions (Yu and Elsworth 2012).

The present choice not to adopt mandatory emissions targets, or other commitments that could jeopardise the national economy is notable and consolidates the main priority of the nation; maintaining economic development.

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Implications

The introduction of a carbon market to China reflects the country’s current transition from a centrally-planned economy to a socialist-market economy. The pilot schemes are a major mechanism aiding this transition. As China has not used carbon markets before, this trial phase may encounter various problems, yet this is not unexpected.

The ultimate ‘success’ of the pilots, will be determined by whether the involved companies and the carbon market is correctly and efficiently run by the end of the first phase (2013-2015) (known as Phase 1 or the ‘trial phase’) (Cassisa 2014). It is less likely that emissions reductions will be obtained during this phase, and additional regulatory methods may have to be undertaken to reach assigned intensity targets (Cassisa 2014).

The nature of the cap-and-trade policy means that although emissions levels can be controlled, the price of the pollution cannot. On a free market, there is potential for permit prices to rise and fall dramatically and this is one of the major concerns with ETSs. For example, the EU ETS has had problems with pricing; polluters were paying very little for emissions - a consequence of over-supply of permits. When the European Parliament advisory committee advised against back-loading (removing) permits, the price per permit crashed to just €2.81 (Hope 2013). This is an example of the sensitivity of carbon markets to external pressures, such as political uncertainty.

Another risk of carbon markets is the possibility of ETS related crime. As outlined by INTERPOL (2013), carbon markets are vulnerable to;

Fraudulent manipulation of measurements to claim additional carbon credits than were actually allocated from an activity

Theft of credits by computer hacking Selling of credits that either do not exist or do not belong to the seller Exploitation of the weak regulations in the market to commit financial crimes, such as tax fraud and

money laundering

The lack in understanding about the buying, selling and trading of unconventional commodities (i.e. not physical commodities) such as carbon permits, makes carbon markets particularly vulnerable to crime (INTERPOL 2013).

With these challenges in mind, the NDRC will attempt to reduce risk and manage potential problems the pilot schemes may face in Phase 1. The mistakes made in the early phases of the EU ETS are likely to be avoided, but just like the EU scheme, Phase 1 of the pilots will be used as a ‘learning-by-doing’ manner of developing of a carbon market in China.

In any new scheme of this level, complications will be inevitable, but that is precisely why China is running these seven pilot schemes initially. The goal of these schemes is to tease out any flaws now, to develop a less risky, more efficient national ETS in the future.

Services

There are a number of services offered from carbon trading markets, including:

Providing a means of reducing emissions, by defined amounts, at the lowest cost to economiesPage 11

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Jobs creation, in a range of fields (e.g. lawyers, engineers, IT, auditors etc.) Investment opportunities for private entities and individuals Funding of offset projects such as renewable technology development, can be generated from

Chinese Certified Emissions Reductions (CCERs) Potential to hasten breakthroughs in energy efficiency, by encouraging companies to consume less

energy (and reduce emissions) Advances in air pollution mitigation and improved health associated with reduction of particulate

matter

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Chinese ETS pilot projects

The domestic trial of emissions trading has recently commenced, with China initiating a number of pilot programs around the country. Combined, the pilot schemes will produce the world’s second largest ETS, in terms of emissions capped, second only to the EU ETS.

It is estimated the program will cover approximately 700million tonnes of CO2e emissions; larger than the scope of the South Korea, California or the (proposed) Australian schemes (Scotney et al. 2012). If the nation is to succeed in producing a national ETS, it would be the world’s largest and have the potential to affect climate outcomes.

As China is not considered an Annex 1 party under the Kyoto Protocol, hence does not have binding commitments to emissions reductions, their ETS policy is internationally considered ‘voluntary’ (Jackson 2013). For the cities and provinces involved however, the schemes are domestically legally binding and mandatory (Jackson 2013).

China has not previously used a market-based mechanism to manage pollution. In the past, they have used top-down regulatory methods to reach emissions reductions targets. Their choice to trial an ETS program reflects their transition from an authoritarian-style government to a socialist-market economy. Phase 1 of the program, known as the ‘trial phase’, will run between 2013 and 2015 and will involve the set-up of seven pilot schemes across the country.

Who will the policy target?

Presently there are seven proposed pilot schemes, five of which are in operation. Five cities, Beijing, Tianjin, Shanghai, Chongqing, and Shenzhen and two provinces, Guangdong and Hubei were nominated. The schemes in Hubei and Chongqing are to be commenced in the near future.

The cities vary in population and economic development; ranging from the affluent, global cities of Beijing and Shanghai to the relatively poor province of Hubei. Trialling ETSs in contrasting regions allows the government to assess the progress and success of carbon trading under varying economic conditions (Scotney et al. 2012).

The programs are designed and regulated differently (see Table 3), to help examine which design features are most successful. Differences in design include:

Cap size Sectors and extent of industries covered Allocation of emissions allowances Trajectories (level of cap reduction per year) Methods used to monitor, report and verify (MRV) emissions produced Amount of CCER allowances

(World Resources Institute)

As part of compliance requirements, companies can typically cover 5-10% of their emissions permits by purchasing offsets, known as Chinese Certified Emissions Reductions (CCERs) which are issued by the NDRC (World Resources Institute). The program is based on the CDM and rules are similar (Carbon

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Market Watch 2013). Companies in Beijing and Shanghai are allowed to cover 5% of their compliance requirements using CCERs, and Guangdong 10% (Chen & Reklev 2013).

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Table 3. Summary of Chinese ETS pilot project components

Launch Date

ETS Type Cap Type Total Regional

GHG Emissions

Emissions Reduction Target

set in 12th FYP (per unit GDP)

Estimated Scheme

Coverage

Sectors Covered Permit Allocation

Shenzhen June 2013 Mandatory Absolute cap

83.4 MtCO2e (2010)

21% 31.7 MtCO2e

26 sectors (over 600 entities) Initial free allocation. Gradual increase in auctioning.

Beijing November 2013

Mandatory Absolute cap

100 MtCO2e (2011)

18% 40.8 MtCO2e

Industrial and non-industrial sectors (490 entities). Include electricity providers, major public buildings, heating and cooling manufacturers.

Free allocation for 2013-15. Small number of permits auctioned.

Shanghai November 2013

Mandatory Absolute cap

240 MtCO2e (2010)

19% 110 MtCO2e

197 entities. Energy-intensive industries, airports, railways, commercial buildings.

Free allocation for 2013-15.Considering auctioning. Grandfathering with performance-based correction.

Guangdong December 2013

Mandatory Absolute cap

510 MtCO2e (2010)

19.5% 214 MtCO2e

Nine energy-intensive industries including power generation, textiles, ceramics, plastics and paper production, plus public transport and buildings.

Free allocation for 2013-15. Grandfathering auctioning complimentary.

Tianjin December Mandatory Absolute 130 MtCO2e 19% 78 114 entities (initially). Five Free allocation for Page 15

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2013 cap (2010) MtCO2e energy-intensive industries: iron, steel, power and heat production, chemical production, petrochemical, oil and gas exploration, as well as large buildings.

2013-15. Grandfathering and benchmarking permitted. May be updated.

Hubei TBC Mandatory Absolute cap

N/A 17% 35% total regional emissions

High emissions industries (over 150 entities), including cement, iron, steel, chemicals, power generation, glass, pulp and paper, car manufacturing, non-ferrous metals etc.

80% free allocation, remaining 20% allocated based on sectorial benchmarks. 10% auctioning after three years. 100% auctioning by 2030 (unless domestic carbon market in place).

Chongqing TBC 17% N/A Six energy-intensive industries, including cement, steel, calcium carbide, aluminium ferroalloy and caustic soda.

N/A

Source: CMI 2014

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Scheme Intricacies

Scheme Differences

Some notable individual scheme differences are;

The cities of Beijing and Shenzhen have large service and manufacturing economies, yet small industry emissions (World Resources Institute). Their emissions productions are likely peak soon, as the cities plan to replace coal power sources (Beijing will convert to natural gas by 2017) (World Resources Institute). To compensate for this, their ETSs will involve more companies in the service sector.

Companies involved in the Beijing ETS will have to reduce their absolute emissions by greater amounts each year; in 2013 they will have to reduce emissions by 2% (from average emissions from 2009-2012) and by 4% for 2015 (World Resources Institute).

Shenzhen and Tianjin will allow entities and individual investors (such as financial institutions) not involved in the ETS, to participate in trading (World Resources Institute). This may result in higher trading frequencies and greater price fluctuations. This is already being seen in Shenzhen, where the price has fluctuated between RMB 28 to RMB 130 ($4.5-$20) over the past six months.

Shanghai’s scheme will encompass six Shanghai-based airlines, which will have to surrender permits for their domestic commercial flights (World Resources Institute). In addition, they will allow retrospective recognition of companies’ energy-saving efforts. If businesses can demonstrate an implementation of energy-conserving projects between 2006 and 2011, they will be offered extra carbon permits (World Resources Institute).

Cap Allowances

In the Chinese scheme, the total emissions cap is considered an intensity cap, rather than an absolute cap, as it focuses on reducing carbon intensity (emissions per unit GDP). China does not want to accept an absolute cap, as they want to continue expanding the economy (Vas 2014). Absolute caps are more binding and require a net reduction in emissions (as opposed to reducing growth of emissions), which China believes may compromise economic productivity (Vas 2014).

Caps are set by estimating the likely growth in GDP each year. This estimate is used to calculate the cap’s total allowable emissions, to a level that will theoretically reduce the growth (intensity) of emissions that year (Cassisa 2014). However, because this method uses estimates, the cap is allowed to be adjusted, depending on the real growth in GDP (Cassisa 2014).

Unlike other schemes, adjustments are permitted in China, as, for the first time, the country is attempting to reach emissions targets using a market-based mechanism – and adjustments will allow for error. In the past they have used command-and-control methods to reach targets. The launch of the pilot schemes and methods used to calculate their caps reflect the country’s transition from a central commanding body, to a socialist-market economy.

Effect to Consumers

Electricity prices are strictly regulated in China, and the costs to power manufacturers associated with mandatory emissions reductions, will not be passed onto consumers (World Resources Institute). Although this may be helpful for individuals, it does however mean, that this policy is unlikely to alter social behaviours, as it will have little influence on curbing electricity demand (World Resources Institute), which should be encouraged if climate change mitigation is to be successful.

Enforcement

Research Project: International Carbon Markets

Each year, companies are mandated to comply with surrendering enough permits to cover their emissions. If they do not, they face a fine, up to three times the average market price for permits (ICAP 2014). There is however currently some legal limitation to this (revision of the environment protection law and the draft on climate change policy is ongoing) (Cassisa 2014). Also, depending on the pilot program, over-emitters may not be allocated permits the following year, to the equivalent level of CO2e they did not cover (Cassisa 2014).

Other incentives to comply include the public publication of lists of noncomplying companies, and the removal of the right to apply for loans for noncomplying companies.

Controlled Market

Predicting the responses to pricing and regulating the market will be one of the greatest challenges of the Chinese scheme, now and into the future. There is large uncertainty about permit pricing, and in a free market, there is the potential for prices to fluctuate considerably.

This, combined with China’s dynamic economic growth, will make it difficult to formulate an absolute cap (number of available permits) for a future national scheme. Periodic adjustment of the absolute cap may therefore be necessary in future, when creating targets for emissions intensity (Jotzo 2013).

Methodology of permit pricing in the initial phase of the scheme, is not currently publically released. Critics advise that some form of price regulation should be implemented, to prevent a dramatic drop in price, as occurred in the EU ETS when permits were over-allocated. Multiple methods exist;

Fixed-price model: permits are sold at a set price Carbon tax Price floor and ceiling: permit price can vary within set maximum and minimum prices

ranges Moderated permit supply: supply of permits altered depending on market prices

(Jotzo 2013)

In the long-term, using a floating market price would be ideal (Jotzo 2013), as it complements carbon markets in other countries and encourages global market interaction.

In addition, permit allocation needs to be considered wisely; especially the allocation of free permits. In a sense, these problems can only be managed through ongoing research and by learning from mistakes - from both the Chinese pilots and international schemes. This will improve future program design and market efficiency and robustness (Jotzo 2013).

Uncertainties

There are a number of uncertainties concerned with the Chinese pilots, which are affecting the transparency of the carbon market. Information on a number of methodologies is being withheld by some governments (e.g. Beijing and Tianjin), which may be due the desired avoidance of public scrutiny. This includes;

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The number of emissions permits distributed to participants The methodology used to calculate caps The price of permits (Reklev 2014)

Without this transparency, it is very difficult to assess the state-of-play and success of these pilots (Reklev 2014). It also makes transactions and assessing market risks difficult for the parties involved. There may be more information released on this as markets become more active; at present, there are few transactions and volumes are very low (Cassisa 2014).

Like the early phases of the EU ETS, the outcome of Phase 1 of the Chinese ETS, will probably have little impact to emissions reductions (Cassisa 2014). In the early stages, companies will learn how to use carbon trading and integrate costs of CO2 emissions into their business strategies. This will involve a ‘learning-by-doing’ approach. Phase 1 will show China what challenges need to be overcome in setting up an ETS and whether a national ETS, or even a link-up of the domestic strategies, will be possible (Cassisa 2014).

The targets set in the 12thFYP (Table 4) are “ambitious”, and some question whether a 17% reduction in carbon intensity will be possible through pilot ETSs alone, at least in Phase 1 (Cassisa 2014). In order to achieve the targets, the pilot zones may need to supplement emissions reductions with ‘command-and-control’ policy instruments (Cassisa 2014). This is not hard to imagine, with the level of emission and air pollution reduction that needs to be covered to reach targets, with only two years to go before end of the 12th FYP period (Cassisa 2014). Regulation is already planned for Beijing, which is to replace all coal-fired power plants with natural gas by 2017 (World Resources Institute).

China is well-known for using top-down regulation to achieve targets. During the 11thFYP, China managed to reduce its energy intensity by 19.1% (against a target of 20%) largely through direct regulation; which included ordering large emitters to close down completely during 2010 to meet assigned targets (Han et al. 2012). If carbon trading is to become a viable policy in China, the limits of command-and-control mechanisms need to become clear (Wu 2011).

The ability to reach targets will be tested further in the future, with a high goal of 40-45% reduction in carbon intensity by 2020.

Table 4. Summary of emissions reduction targets for China’s climate change policy. Targets are set against 2005 levels.

11th FYP Target (2006-2010)

11 FYP Actual result (2006-2010)

12th FYP Target (2011-2015)

2020 Targets

Energy Intensity (% reduction)

(energy consumed per unit GDP)

20% 19.1% (achieved top down methods – forced closure of plants etc)

16% No target

Carbon Intensity (% reduction)

(carbon emissions produced per unit

N/A N/A 17% 40-45%

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GDP)

Primary Energy consumption (growth) 4% 6.3% 3.75-5% No target

Electricity generating capacity (growth) 8.4% 13.2% 8.5% 5.5%

(Scotney et al. 2012)

If the schemes do not succeed in their trial phase, it is likely China will scrap the ETS and employ a different method of emissions reduction, such as a carbon tax (Vas 2014). This is option is easier for China than other countries trialling carbon markets, because they have no legally binding commitment to the Kyoto Protocol. With that being said, China is serious about attempting to convert to a low-carbon economy and reduce their dependence on fossil fuels. In addition, adopting a climate change action plan will provide China with the power to influence negotiations at international UNFCCC conferences (Vas 2014).

Future Directions

If the pilot schemes are successful, the Chinese government plans to implement a national ETS by 2020, according guidelines that will be set in their 13th FYP (2016-2020). At this stage, the most successful components of the pilot schemes will be cherry picked to design the national ETS, and theoretically, any detrimental components should have been eliminated through the trial phase.

In the longer term, there is the potential to trade internationally, particularly within the Asia-Pacific region. Bi-lateral trades between China and Australia would be possible in future.

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Market Entry and Future Directions

Carbon markets present optimistic opportunities for multidisciplinary services and sector involvement. It is still considered a relatively new and developing market, but with potential to expand globally. Due to the complex, challenging nature of the industry, market entry can be difficult, and a number of barriers will need to be worked through over time to make the market more accessible.

Needs Analysis

The introduction of this policy instrument in China and around the world has provided opportunities for a variety of individuals and organisations. The implementation and management of a carbon market is a multidisciplinary field – requiring a number of integrated disciplines and specialist skills. Table 5 describes the disciplines most needed to create and sustain an ETS and carbon market.

Table 5. Analysis of disciplines required in the running of a carbon market.

ETS Need/Characteristic Needs Analysis and Potential Partners

Policy-driven management tool. May contain legally-binding commitments (e.g. domestic absolute emissions caps). Implemented by the government.

Requires: lawyers, politicians, government bodies and Non-Government Organisations.

Market-based mechanism Requires: Business and trade experts as well as financial institutions for market entry and investment.

Development of methods to improve energy efficiency, improve air quality and reduce emissions

Requires: scientists and engineers (particularly environmental engineers).

Development of clean energy technologies Requires: engineers/environmental engineers.

Baseline emissions calculations and ongoing emissions monitoring

Requires: scientists; including statisticians and environmental auditors (essential for MRV processes).

Creation and implementation of the carbon market Requires: business professionals and computer programmers, as well as accountants and financial advisors. Financial auditors, lawyers and IT professionals also needed for MRV and to prevent criminal activity.

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Future Directions

If China can produce a successful and robust ETS framework, it would be a significant step in developing the global carbon trading market. If the domestic Chinese schemes succeed, this may encourage other nations to adopt similar policies.

The national ETS is aimed to be running by 2020, and theoretically is likely to dovetail with other carbon trading schemes (Figure 1), such as the South Korean and Californian ETS, hopefully motivating the way towards a global climate change policy (Scotney et al. 2012).

It is unlikely that complete global link-up of markets will occur, due to the vast variation between the design of schemes. Schemes would still be linked to a degree though; CDM, bi-lateral and multi-lateral trades will continue to be possible, and potentially on a larger scale – particularly in the Asia-Pacific region (Vas 2014). Bi-lateral trades between Australia and China would be likely, made easier with the common time-zone (Vas 2014).

The international political environment will significantly shape the evolution of the market (CMI 2012). International negotiations, particularly during the upcoming UNFCCC convention in Paris, 2015, will influence the timing of projects and direct new objectives. At this conference, the UNFCCC hopes to finish negotiation on a global agreement on climate change policy, to be in force by 2020 (Scotney et al. 2012). China is considered a major international player, as the implementation of their climate change strategy will strengthen their own negotiation position at UNFCCC (Vas 2014; Scotney et al. 2012). The EU and the US are also major players.

Barriers to Entry

The carbon market is a relatively new and dynamic market, and has many challenging components. This makes it difficult to enter and there are a number of barriers to entry, as summarised by Table 6;

Table 6. Barriers to carbon market entry.

Barrier to Entry Effect

Knowledge gaps The carbon market is complex and contains a number of uncertainties, and with imperfect information, it can be difficult for new players to enter the market. An example; the lack of an ideal pricing mechanism for permits. It is uncertain whether regulatory balance should be employed.

Methodologies and lack of effective regulatory agencies

There are no universal methodologies to;

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Calculate permit price Allocate permits MRV methodology (making companies potentially liable during audits)

This makes it difficult to predict likely risks of market entry and difficult to assess whether the market is competitive.

Private sector The market will predominately feature trades between private companies, which can be difficult to monitor and gather information on.

Transparency between markets

Carbon markets between countries can vary dramatically. This will make market link-up challenging, and will take time to establish. Within markets, there is need for: transparent mechanisms to investigate fraud, independent auditing and methodology free of political interference.

Language barriers and time zone difference

Emissions trading is being conducted on a global scale and managing specific details and transactions will be a challenge with language and cultural differences. Differences in time zones may present a slight issue if markets are to trade internationally, although this is of little concern if an Asian-Pacific market were created.

Government and international (UNFCCC) influence

Thorough negotiation will continue to be required within governments and between nations if the carbon market is to be securely established. Not all major players are involved with the ETS, which dis-persuades other nations to adopt the policy. Bipartisan agreement on a national climate change policy is also important; the disagreement on Australia’s carbon policy, may cause one of the world’s first repeals of a major carbon pricing scheme (Morton 2013).

Confidence in investment

Investors need to have sufficient confidence in carbon markets, as projects may have long payback periods. They need to be confident that projects will not be affected by changes in government policy.

Infrastructure Compatible infrastructure for the development of markets is still lacking. Currently, most trades are ‘over-the-counter’.

Cultural differences and expectations in business practice

Business is conducted differently among nations and opening markets to foreign players can cause difficulties (as was the case when South Korea opened its insurance industry to foreign companies).

Funding Huge costs are involved in setting up national schemes; banks need to support the idea of a carbon market and be able to outweigh risks –a major challenge.

Source: Vas 2014

To overcome some of these barriers there must be the development of:

Robust systems for trade settlement, transfer of ownership Robust processes for releasing market-sensitive information (e.g. permit pricing) Centralised management of counterparty credit risk Bipartisan political agreement and stable policy arrangements

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(CMI 2012)

Funding Opportunities

There is an opportunity for Australia to link with Asian trading markets, including the carbon market, through the Asian Business Engagement Plan (ABE). This program, funded by the Australian Trade Commission (Austrade), will provide grants to small-medium sized Australian businesses to harness commercial opportunities in Asia (Austrade 2014). Up to 50% of the cost of an eligible project can be funded by the ABE, with grants being between $20,000 and $300,000 (Austrade 2014).

The idea behind the plan is to encourage new business initiatives within Australia and link Australia with Asian markets (Austrade 2014). Projects that exhibit to potential for long-term links, are particularly encouraged and such an opportunity presents itself with carbon trading.

Another Australian opportunity lies through the Department of State Development, Business and Innovation’s ‘Trade Mission Program’. This program provides financial support to Victorian companies willing to engage with international markets. The program prioritises grants to activities involved in certain Asian markets, including China (DSDBI 2013). Grants up to $3,000 will be issued to business involved (DSDBI 2013). The department also provides scholarships to Victorian individuals who undertake intensive language studies at institutions in China, with the aim of boosting Asia-focused skillsets, and developing business and cultural relationships (DSDBI 2013).

An international initiative, to encourage financial institutions to see the environmental and social issues associated with financing development projects, are the Equator Principles (EPs). Banks in China and around the world have been encouraged to sign up to the framework. The EPs are a global risk-management framework that advises financial institutions about the risks to the environment and the community associated with funding projects, and how to help manage them (The Equator Principles Association 2011). This framework could have the effect of encouraging banks to support environmentally-beneficial projects, including emissions reductions strategies. As China is in the process of converting to a low-carbon economy, this will be central in its development.

The financing of climate change policies is central to mitigating, and hence avoiding dangerous climate change (Buchner 2013). A global climate fund to finance climate change mitigation was estimated, by examining how much money is currently flowing, its sources and where it is going. In 2011, global climate finance flows were estimated to be on average $364 billion per year (Buchner 2013). The International Energy Agency however, estimates the world needs to average $1 trillion each year between 2012 and 2050 to be able to finance a low-emission transition (Buchner 2013). This concludes that currently, global funds are not large enough to finance climate change. Financing long-term gain (i.e. a transition to a ‘green economy’) will prove extremely challenging against the desire for short-term economic growth (Buchner 2013).

Australian links with Chinese policy

Under the Labour government, Chinese and Australian officials spent considerable time discussing the structure of carbon markets. In July 2013, funding was granted for joint research on market-based mechanisms for climate change policy between Australian and Chinese universities (Slater 2013). This

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program has the added benefit of strengthening the bi-lateral relationship, proving advantageous in a market where international co-operation is mutually beneficial (Slater 2013).

Although the Liberal government is choosing to repeal Labour’s carbon pricing policy, they have admitted it is likely to be reintroduced in future (most likely by 2020) (Slater 2013), as there is a global trend towards developing carbon markets. For the time being however, the current government is likely to remain focussed on the implementation of their Direct Action Plan, and little on development of carbon pricing with China (Vas 2014).

Given the direction of carbon markets towards a global trading scheme, suggestions have been made for Australia to re-establish the collaboration with China in helping develop their carbon pricing policy (Slater 2013). This would not only strengthen the relationship but would aid in the complex development of ETS transparency, such as permit pricing (Slater 2013), both of which will be of extreme benefit if Australia does reinstate an ETS in future.

Either the employment of a Chinese national or the establishment of a permanent team at the Australian embassy in Beijing (working on carbon market policy development) would be recommended if Australia is to establish market entry with the assistance of China (Slater 2013). This would be more efficient than continuous travel between countries and is more likely to aid Australia’s influence to developments (Slater 2013). The annual base salary (2013) of an accountant, in global market sales, with 8-10 years of experience, is $113-151K AUD and for a commercial market director (Asia Pacific region) with 15+ years of experience, is $151-283K AUD (Hudson 2013).

India’s climate change policy

India is Asia’s third-largest consumer of energy (Pearson 2010) and is a rapidly growing nation in terms of population, economy and importantly, emissions. Their voluntary climate change policy has many differences, but also some similarities to China’s strategy.

Like China, India has set targets to reduce emissions intensity (carbon emissions per unit GDP) by 2020. It aims to reduce the growth in emissions by 20-25% from 2005 levels by 2020 (Pearson 2010). The targets are not legally binding and do not represent a reduction in net emissions produced.

In July 2010, India implemented a carbon tax, applying to coal only, which is used to generate over half of India’s electricity (Pearson 2010). Coal is the major energy source used to power India. A tax of 50 rupees per tonne (the AU equivalent of less than $1) of coal was placed on coal both imported and exported from the country (SBS 2013). The revenue created was used to finance clean energy technology research and environmental remediation programs, conducted by the National Clean Energy Fund (SBS 2013).

India is considering commencing a domestic carbon market, to start later in 2014 (The Guardian 2011). The market-based mechanism used is called Perform, Achieve and Trade (PAT) (Mukherjee 2011). It will set ‘emissions budgets’ for 563 of India’s high-polluting businesses in sectors such as power generation, cement and steel production (The Guardian 2011). If companies exceed their energy budget, they can purchase energy-saving certificates (Escerts) from companies consuming less energy (Mukherjee 2011) - forming a market similar to the trading of emissions permits.

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There is concern for the feasibility of the scheme however, due to the weak enforcement measures (i.e. low penalties for non-complying companies) and the lack of information and experts in this area (The Guardian 2011).

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Conclusion

Carbon markets and the ETS will be a monumental component of climate change policy. The market-based nature of the ETS means there is potential to reduce global carbon emissions at low costs.

As part of their climate change policy, China is attempting to convert to a ‘low-carbon economy’, and is trialling an ETS scheme to help achieve this. Internationally, this is a voluntary scheme and will therefore boost China’s power to influence negotiations on global climate change policy.

The ETS will be trialled initially, by implementing several domestic pilot schemes. The seven pilots are designed differently, with differences in emissions caps and targets, sectors targeted and allocation of allowances. The design features that work most successfully in the pilot schemes, will be cherry-picked to theoretically create an efficient, regional or national ETS in future.

The ETS will focus on reducing emissions intensity, not absolute emissions, which will permit China to commece GHG pollutant mitigation, without compromising its economy.

If the ETS trial is successfully developed in China, the country plans to implement a national scheme by 2020, which will hopefully link with foreign schemes. A Chinese national ETS may encourage other countries to develop their own schemes, hence act as a catalyst for international development of the carbon market.

Emissions trading is a relatively new and challenging market. There are a number of barriers to entry that need to be resolved to facilitate market entry and make it an efficient, less risky system.

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