The complete guide to the world’s largest carbon market that just launched in China

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Last month, China announced the initial details of its much-anticipated emissions trading scheme ETS. The new scheme will have a more cautious rollout than set out in initial draft plans, starting with the power sector alone in a national pilot phase.

It burns more coal than the rest of the globe put together. Alongside other policies to cut emissions, China has long had plans to create a national carbon market. In Januarya notice to industries set out the steps they should take to prepare for the national scheme.

Draft plans covering three sectors were then set out for consultation with industry and other government departments in May Note that Carbon Brief is relying on an unofficial translation of this framework plan, published by crowdsourced translating website China Energy Portal.

Initially set to cover more than 3bn tonnes of CO2 from the power sector, the carbon market will be the largest in the world and close to double the size of the next largest, the EU ETS. Once operational, it will mean around a quarter of global CO2 emissions are covered by carbon-pricing systems. Map of explicit carbon prices around the world in In developing its plans, China has reportedly been very conscious of the issues affecting other emissions trading schemes. It has conducted extensive discussions with representatives from schemes in California and the EU, in an effort to learn from their mistakes.

According to Jeff Swartzdirector of climate policy and carbon markets at the South Pole Group and previously director of international policy at the International Emissions Trading Association IETAthese include the need to have good emissions data and to set a conservative emissions benchmark from historical data.

He tells Carbon Brief:. They have understood the mistakes in Europe. Carbon leakage is the idea that emissions-intensive industry could relocate production to another jurisdiction, to avoid paying the same level of carbon prices. Emissions would fall in the country where CO2 is priced but might not change on a global level, or might even increase, if overseas industry is less efficient, more coal-powered or further away, necessitating extra transport of goods.

A study for the UK government says: If it manages to implement an effective carbon price, it could also reduce fears in the EU of carbon leakage to China. Environmental policy has become a priority in China, in part due to widespread concerns over air pollution and climate change caused by cars and coal-fired power plants. It has also moved to cap its coal capacityban petrol and diesel cars albeit without a firm dateincrease industrial energy efficiency and improve air quality.

Other goals include a decrease in the carbon intensity of its economy and an increase in forest stock volume. However, CAT also notes that these targets are far from being in line with the Paris Agreement, which commits countries to limit global warming to well below 2C and pursue efforts to limit it to 1. One comparison of the potential for 35 environmental policies in China to drive down emissions found carbon pricing would be the most effective.

However, with little confirmed about how it will work see belowit is hard to judge its possible impact. Yep, there are lots of things to get excited about in terms of China's energy, climate and innovation policies. Its ETS really isn't one… https: Li Shuoan energy and climate policy analyst for Greenpeace East Asiatells Carbon Brief the real question is how much the country will overachieve its goals and if the ETS plays any role.

As is the case for the EU ETSthere will be debate over whether the China ETS itself drives emissions reductions, or merely mops up after all the other related policies. Max Dupuysenior associate at the Regulatory Assistance Projectsays other policies may have more of an influence on carbon emissions in the near term, as the ETS develops over time.

Perhaps the most significant part of the announcement in December was that it scaled back the sectors the ETS would cover. This would have covered around 6, companies. However, the December launch confirmed that only the power sector will be included at first. Plants emitting more than 26, tonnes of CO2 per year or more — covering almost all coal and gas-fired plants — will be included, the government plan says.

This will still almost double the amount of emissions worldwide covered by emissions trading schemes. The scheme will, therefore, only involve around 1, power companies at first.

It is expected to eventually include the other seven sectors previously proposed. Others have argued it is important for China to move cautiously and take the time to get the emissions trading scheme right, with the power sector a reasonable place to start.

For example, policymakers need reliable data on historic baseline emissions from different plants, to set the right target levels and allocate allowances. Some observers have noted that the large state-owned enterprises that dominate electricity generation in the country have relatively complete emissions data, at least compared to other parts of the economy.

Chinese officials have similarly expressed concern that including other sectors at the outset would require constant testing and adjustments, given they are still in the process of establishing their emissions datasets. The typically large size of power plants, which might emit tens of millions of tonnes of CO2 each year, also means relatively few points of emissions compared with other industries.

Carbon markets aim to provide incentives for polluters to reduce emissions by allowing firms to trade the right to emit. In the EU and Californiathis has involved putting an absolute cap on emissions, which is reduced over time.

However, China has generally resisted setting absolute emission caps in its climate pledges, instead opting for intensity-based targets to cut emissions per unit of GDP. Therefore, it appears China will use a rate-based limit for its ETS. This would see a limit put on the amount of CO2 allowed per unit of output. Each power company would be allocated a certain number of credits, depending on how much electricity it produces.

If it emitted less than this set quota, it could then sell that surplus to another firm. This would reward firms for producing less emissions per unit of output, rather than less emissions overall, which could help alleviate political worry about constraining economic growth. But it would mean that even if power producers become more efficient, emissions could in theory still rise, if power production increases overall.

Once payments begin in the power sector, it is companies that would foot the bill, not consumers. This is because power prices are set by government regulators in China.

However, a process to reform electricity pricing in China see next sectionalready underway for several years, could allow the carbon price to be passed on to consumers in future. Dupuy tells Carbon Brief:. Prices for other industries are set by the market rather than government regulation, so once the ETS expands outside the power sector, it could have an impact on consumers.

In theory, carbon pricing should encourage a switch from higher emitting power sources, such as coal. While prices in the EU have generally been too low to achieve this, the contribution of a carbon price to the rapid fall in coal-fired power in the UK shows it is possible.

If China does set a rate-based limit of allocating permits rather than an absolute cap, this would mean the setting of benchmark emissions rate per unit of output from each fuel. It also appears the scheme may set different benchmarks for different parts of the power industry, depending on the size of the producer and type of fuel used. This would mean coal-burning plants would only compete against each other, rather than against cleaner gas plants. Some experts have warned this means the ETS would struggle to move electricity consumption towards cleaner sources.

Lauri Myllyvirtaa clean air and clean energy expert working with Greenpeace in Beijing, similarly says an intensity-based allocation would not encourage a cleaner fuel mix, but could help to push power plants to increase their efficiency.

Myllyvirta tells Carbon Brief:. Myllyvirta points out, however, that even if such an intensity-based method is used, it is not known whether this would just be the approach for an initial period, or more permanently. A man works at the control room of No. Unlike most other jurisdictions, China does not traditionally change the order in which its power plants are turned on based on their operating costs. The power sector reform effort currently underway in China could address this, says Dupuy.

The process of developing this reform is long. While China has a commitment to get to national competitive electricity markets byDupuy says he is not sure if this timetable will be met. However, some progress has already been seen. China launched regional pilot carbon trading projects in four cities, two provinces and the special economic zone of Shenzhen during and Two more local schemes were launched in and in Fujian, a southeastern Chinese province near Taiwan, and Sichuan in southwest China, although these are not usually counted as pilot schemes.

ETS prices are mean values observed between March and March Percentages are of total greenhouse gas emissions for the region. I4CE Global panorama of carbon prices in The initial seven pilots were developed by local governments with intentionally different designsto help inform the development of the national scheme.

They cover more than 3, firms in a variety of sectors depending on the scheme, including power, steel, cement and aviation. Compliance with the various rules of the pilots is reportedly high. The schemes have run into some issues, however, including a lack of transparency and a low trading volume. One criticism has been that they have mainly avoided using financial derivativessuch as futures trading.

Some argue this has made the markets ineffective in providing a clear price signal for big emitters. However, some of the pilot regions are now experimenting with such mechanisms. They were a de facto university for a generation of emissions-market traders. The rest of the world has pretty much lost a decade.

The pilots have also allowed the government to test how trading systems could work with very different profiles. For example, says Swartz, the cities generally have high emissions in the buildings and transport sectors, while in Hubei province, the largest emissions source is iron and steel. Leaders have emerged among the pilots, helping to establish best practices for the national market, according to ChinaDialogue. Guangdong province and Hubei have experimented with auctioning allowances, for instance, Swartz tells Carbon Brief, while the Beijing market has maintained the highest and most stable carbon price.

As of the beginning ofthese covered around 3, sources, with total annual CO2 emissions of 1. He added that he does not expect this to happen until after Transaction values since the pilot schemes began reportedly reached around 4. Data from our annual — Year in Review publication pic. Power-sector emissions now under pilot schemes will shift into the national ETS, once it is launched. The pilot projects will continue for sectors not yet included in the national carbon market, such as chemicals, oil and gas.

The government plan released in December is hazy about the exact timeline for the rollout of the ETS. Instead, it sets out the next few stages of implementation and makes clear that any and all parts of this plan could be adjusted. In the first stage, over the next year or so, China will focus on the basic infrastructure of the scheme: Companies will be required to monitor and report their emissions to the NDRC and other relevant local regulators.

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China is set to introduce its equivalent of U. EPA's Clean Power Plan next week, even as the Trump administration prepares to discard its electricity rule for the carbon sector. China will debut an emissions trading system as soon as today that will begin by covering coal- and natural-gas-based power production. The program will eventually expand to a variety of manufacturing and industrial sectors. He stressed those could change before the launch. The plan initially will include 11 different emissions baselines for power plants based on whether they run on coal or gas, their size, and other details, Li said.

It's unclear what the starting price for emissions allowances will be. It's a slower start than the Chinese government initially promised, but environmentalists say that's prudent.

The world's second-largest economy and largest global emitter of greenhouse gases has limited monitoring and verification capabilities. China must also build the legal infrastructure that will allow it to hold companies accountable for noncompliance. So greens say it makes sense for China to focus first on the power sector, which is its largest single source of emissions, before expanding.

The limited rollout "is a sign that China is taking this seriously and wants to make sure they're doing it right," she added. A quarter of a century ago, China was still a poor country, he noted.

Chinese President Xi Jinping announced plans for the program in September during a bilateral summit with former President Obama. China's ambitions narrowed over time Climatewire , Aug. Earlier this year, officials said they planned to start with three sectors—electricity, aluminum and cement—but next week's plan is expected to include only electricity.

The announcement builds on the seven regional pilot emissions trading systems that were first approved in Those regional programs will continue for other sectors, like steel and aluminum, until those industries are deemed ready to be incorporated into the nationwide program.

It will also work in tandem with the country's cap on coal use, renewable energy targets and a nationwide efficiency standard on coal plants. That means China's entire continuing coal fleet could be more efficient than any existing U. Hart said a key question next week would be how the program would seek to avoid advantaging provinces with substantial renewable energy resources over those that are more dependent on coal-fired power, like Liaoning in northeastern China, which is known as the country's Rust Belt.

Eventually, the program should give an advantage to provinces that ramp up their clean power, but "they don't want to do it like flipping a switch," Hart said. Some of the poorest regions of China also use the highest-emitting energy, she said, and a sudden shift could exacerbate that problem.

Reporter Debra Kahn contributed. Sign up for our email newsletter. Discover Foolish Ideas that Changed the World.