On December 19, China formally launched its national carbon market. By setting a carbon price on the country’s largest greenhouse-gas emitters, China has launched a new, crucial endeavor in its efforts to tackle pollution and climate change, write Hal Harvey and Hu Min of the San Francisco-based think tank Energy Innovation.
While the first phase of the market only covers power generation, this step will still have major climate benefits. China’s power sector generates 65% of its electricity from coal and accounts for more than 3.5 gigatonnes (GT) of annual carbon dioxide (CO2) emissions, so this new cap is almost double the European Union’s carbon market, and ten times the size of California’s cap and trade system.
If designed correctly, a carbon cap-and-trade system is a powerful policy to cost-effectively cut carbon pollution. This early phase is a promising start, but there is room for improvement, and Chinese policymakers are keenly studying the performance of other existing carbon markets to ensure continuous improvement.
President Xi fulfills commitment
China’s carbon market began its countdown to launch two years ago, when President Xi visited President Obama in September 2015. President Xi promised to launch a national carbon market in 2017; this commitment was then included in China’s pledge to the Paris Agreement on climate change.
But preparation for the national carbon market started earlier than that: Five cities and two provinces (including Beijing, Shanghai, and Guangdong) launched regional carbon market pilots in 2013 and 2014, with encouragement from the central government. The seven pilots cover over three thousand emitters with total annual emissions of 1.4 GT CO2.
The average price on carbon across these seven markets in 2017 was between $3-10 per ton of CO2, raising roughly $680 million in total transactions. The pilots have worked out carbon allowance allocation, emissions monitoring and verification issues, and are driving toward more market liquidity. These regional pilot programs helped policymakers develop market design experience and implementation ability, and helped build confidence to expand the carbon market nationwide.
The carbon cap aligns with the China Policy Solution study (conducted by Energy Innovation, China’s National Center for Climate Strategy and International Cooperation, and the Energy Research Institute of China’s National Development and Reform Commission), which found that a $10 carbon price would help reduce national emissions by a quarter or more below business-as-usual in 2030.
Just like the California cap-and-trade system, which started slow and expanded over time, China’s national carbon market is expected to expand to cover eight high-energy intensive sectors across the Chinese economy. Because of its economy-wide importance, launching with a carbon market covering 1,700 emitters across the power sector makes sense, and will cover about a third of China’s total emissions.
China has been the world’s leading renewable energy investor for years, has the world’s largest installed renewable energy capacity, and is the biggest clean energy economy with 3.5 million green jobs, but its power sector still depends upon high-carbon sources.
Electricity generation from wind and solar electricity, while growing at an astounding rate, is still marginal (4% from wind and 1% from solar in 2016) and, renewable power generators face the world’s worst curtailment rates, at 17% for wind and 10% for solar in 2016. Thus, a carbon market starting with China’s power sector should help both reduce coal burn and boost the growing clean energy industry.
Cap-And-Trade economic strategy as much as environmental policy
As with many new policy changes in China, the carbon market can develop incrementally, reflecting Deng Xiaoping’s phrasing to, “cross the river by feeling the stones.” Phase one of China’s national carbon market is just a starting point. For instance, allowances to emit carbon are expected to be distributed to power generators for free when the system launches, and allowance auctions are not expected to be introduced in phase one. This runs contrary to most economists’ recommendations, but gives China’s power companies time to adapt without economic shock.
The system should evolve to be more effective. Allocating too many permits has plagued other existing carbon caps—from Europe’s Emissions Trading System to the Northeast U.S. Regional Greenhouse Gas Initiative. It remains to be seen whether China’s initial design will get the permit allocation right, but several good tools can obviate this worry.
Our organization has championed allowance auctions and establishing allowance price collars for cap-and-trade systems, which insure them against both under- and over-allocation of permits. We also recommend policymakers be vigilant against allowance oversupply by steadily tightening the cap over time.
Hal Harvey is CEO at Energy Innovation in San Francisco and Hu Min is Senior Fellow at Energy Innovation in China.
This articles was first published by Forbes.com and is republished here with permission.