April 7, 2014 8:00 pm JST

China promotes carbon trading

CHRISTOPHER BEDDOR, Contributing writer

BEIJING - China has opened its sixth exchange for trading carbon-emission permits, building up what might become the most powerful weapon yet in the government's declared war on smog.

     The new exchange in the central province of Hubei, which opened April 2, follows the launch of similar pilot markets since last June in the cities of Shenzhen, Beijing, Shanghai and Tianjin as well as Guangdong Province. Another will open in the city of Chongqing later this year.

     While specifics vary, the programs require companies in certain sectors to obtain permits for their emissions, with each permit covering a ton of carbon dioxide output. The Hubei program covers 138 companies, including power producers, steelmakers and ones from 10 other polluting industries.

     Around 24 million permits will be traded on Chinese exchanges this year, forecasts Hongliang Chai, emerging markets manager at Thomson Reuters Point Carbon. He expects the volume to soar to 227 million permits next year. Guangdong, one of China's largest manufacturing centers, is already the world's second-largest carbon market in volume, behind the EU.

Questions of future supply    

Yet it is unclear how much the programs will actually help China achieve its stated goal of restraining emissions and reducing carbon dioxide output, as measured against gross domestic product, by 40-45% by 2020 from 2005 levels. That's because local officials have given little indication of how much the supply of permits will grow or shrink in coming years, making it hard to know how strong a financial incentive companies will have to improve their production methods and avoid the need to buy extra permits or to profit from selling surplus ones.

     "The price needed to drive change is not well known, because we don't have experience with carbon pricing in China," said Frank Jotzo, director of the Center for Climate Economics & Policy at Australian National University.

     According to a government document obtained by Reuters, Hubei has issued the affected firms 292.2 million permits at no cost and plans to auction 7.8 million permits this year while holding 24 million in reserve. The free permits amount to 97% of what these companies emitted in 2010. Businesses failing to comply with the emissions system are expected to be fined 150,000 yuan ($24,145) and issued fewer free permits next year.

     Hubei sold 510,000 permits at 21 yuan each during its exchange's first day of trading April 2 after selling 2 million at 20 yuan in a separate auction March 31. The prices are the lowest seen yet in China.

     While prices vary widely across the pilots, most industry experts and market participants think the average across all exchanges will be 32 yuan this year, a figure that is expected to rise to 41 yuan in 2016, according to surveys conducted by Jotzo. That would be much less than Australia's fixed price of A$24.15 (US$22.4) per ton, but not far off the E.U.'s market-driven rate of around 5 euros ($6.85).

     The vast majority of respondents told Jotzo they expect the pilots will impact investment decisions, but most say the effect will be small. The current markets cover about 20% of China's total emissions.

     Shenzhen and Tianjin are allowing anyone to trade permits, while Guangdong and Shanghai limit their markets to affected companies and registered institutional investors.

Evasive emission levels    

The markets are struggling with some teething problems, notably sharp price volatility and thin liquidity. Prices in Shenzhen surged from 28 yuan last June to 130 yuan in October, before settling at around 80 yuan. Most transactions involve just a handful of permits each.

   "Some of the trades have been testing the waters," said Emelia Holdaway, principal consultant for energy and climate change at Ricardo-AEA in London. "We're not yet at the stage where the market is liquid and many parties are trading."

   Information on current levels of emissions would help market participants to better value permits. "[But] the government holds on to data around energy and emissions very, very tightly," said one analyst who works with local officials. This may relate to political sensitivity around pollution or a lack of confidence in official numbers. Much of the data is based on information provided by the companies, who may have incentives to misreport their emissions.

   In each market, affected companies are allowed to buy "offsets" to cover 5-10% of their emissions. These are generated by renewable energy projects, in proportion to their reduced level of emissions as compared with mainstream power plants.

   The National Development and Reform Commission last month approved two wind farms as the first approved sources of offsets. One, in Gansu Province, had already sold 10,000 offsets to state oil company PetroChina for 16 yuan each. Hubei's program, however, only allows for offsets from green projects within the province. 

   Chai suggested the commission will hold off registering big green energy projects to avoid flooding the market with offsets that could push down prices for credits, though he expects the supply of offsets to reach 200 million by mid-2016.

   China is expected to try to create a unified national carbon market between 2017 and 2020. The transition from the pilot exchanges could be tricky given variations between the local markets.

   The goal of the pilot phase is to gain practical experience and operational know-how. While the current exchanges could be shut later and will probably have only a modest impact on emissions reduction, they may give the development commission enough to work with to create an effective national market. "The picture may change dramatically after 2020," Jotzo said. "If we end up with a national carbon pricing scheme, and if that national carbon pricing scheme actually has ambition, then it could easily become the main instrument in China's efforts to reduce emissions intensity."