By Haibing Ma

Provinces and municipalities had been competing to establish emissions trading systems (Source: nddaily).

In an article co-authored with my colleague Alexander Ochs in September 2010, we discussed China’s interest in setting up a scheme for carbon-emissions trading in the next five years. Now, the deal is set: The National Development and Reform Commission (NDRC) recently issued an official notice to initiate pilot carbon-trading programs in seven regions. By embracing market-based approaches to mitigating climate change, China is seeking to facilitate a smooth and efficient transition to sustainable development.

The seven pilot regions are the cities of Beijing, Tianjin, Shanghai, Chongqing, and Shenzhen, as well as Guangdong and Hubei provinces. It’s no surprise that some of these regions overlap with China’s “Five Provinces, Eight Cities” pilot program on low-carbon development, initiated in 2010. Although details of the emissions trading programs have not been elaborated, designation of the pilot regions indicates that the central government has finally made up its mind to issue clearer guidance on exploring carbon markets, in order to better coordinate existing municipal and provincial interest in emissions trading.

Before the NDRC’s final list came out, a dozen provinces and municipalities had been competing to establish regional emissions trading systems. Beijing, Tianjing, and Shanghai have been trading in “environmental equities”—mainly sulfur dioxide emissions—for two to three years, and have accumulated relatively more experience than the other regions. But as reports have noted (see here and here), ever since detecting the central government’s intention to explore carbon-emissions trading (and well before the 12th Five-Year Plan officially endorsed it), some Chinese provinces, cities, and even counties rushed to declare their own carbon-trading platforms.

But none of these initiatives generated significant outcomes. Actual carbon emissions trading, in terms of both the number of transactions and the volume of emissions traded, has been insignificant if not entirely absent in most regions. The Beijing Environment Exchange tops its peers with a total of 3 million tons of carbon dioxide traded in the three years since its inception, but this is still less than the European Climate Exchange’s trade volume in a single day.

Multiple factors have contributed to the “inconvenient truth” of China’s underperforming carbon markets. A leading factor is the voluntary nature of the existing efforts. Although the Chinese government has set domestically binding targets for both energy intensity and carbon intensity, which are then broken down at the local administrative level, an absolute cap on carbon emissions remains off the agenda, at least until 2015 when the 12th Five-Year period expires. As a result, individual emitters show little urgency to curb their total emissions, and there is little incentive to join voluntary trading programs.

Although government action may be necessary to catalyze carbon markets, no market could survive, let alone thrive, by relying solely on governmental support. In fact, such reliance can lead to unprepared and ineffective carbon markets. The fact that many Chinese regional and local governments were rushing to establish their own carbon-trading schemes was therefore more of a political move than a viable economic step.

Economic and institutional reforms in China often begin with regional pilot programs, as part of the government’s strategy to contain the initial impact of these efforts before their functionality has been proven. The test regions generally receive preferential policies, which help boost the local economy, as seen with the “Special Economic Zone” in the 1980s and the “Grand Western Development Program” in the 2000s. In short, by grabbing the central government’s attention, pilot regions can garner economic opportunities, which is perhaps the main reason so many regional or local governments, no matter how unprepared they were, hoped to gain the central government’s nomination for hosting carbon markets.

Emission trading is a dish better served with balanced interests.

Some enthusiastic local officials perhaps misunderstand the merits of an emissions trading program or, at the very least, are overly optimistic about the economic benefits such a program could provide. After all, emissions trading is simply a tool to help bring down the overall cost of achieving certain low-carbon targets, and will not automatically launch green businesses or lead to a flourishing carbon market. Whether an emissions trading system will generally boost local economies is not clearly understood. Therefore, pilot programs will make sense only if the selected provinces and cities bear in mind what is required to establish a fully functional emissions trading scheme and if they have been preparing to meet the necessary conditions for some time.

I am glad to see that the Chinese government has made its decision about pilot regions for carbon trading. But this is just the beginning of a difficult road ahead, including the design of individual, locally based trading institutions; the coordination of these regional initiatives; and the timing of integration. Most importantly, the government has to decide how these pilot trading schemes will interact with another major market-based mechanism for reducing emissions: China’s carbon tax.

According to a recent report, the carbon tax will co-exist with carbon emissions trading. However, due to their different characteristics, it would be great if the government could lay out clear implementation strategies for each as soon as possible. Until then, the functionality of China’s market-oriented measures for mitigating climate change will remain uncertain, as will their impact on actual emissions reductions.

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12th Five-Year Plan, absolute cap, carbon emission, carbon intensity, carbon tax, China, emission trading, energy intensity, environmental equities, Grand Western Development Program, NDRC, pilot, preferential policies, Special Economic Zone, voluntary