CEcover by Civic Exchange

Background Paper Emissions Trading in China Opportunities and Constraints October 2001 by Christine L. Dobridge, Tam Pui Ying and So Hoi Ying

Addiess: Room 601, Hoseinee House, 69 Wyndham Street, Central, Hong Kong Tel: 2893 0213 Fax: 3015 9713 Website: http://www.civic-exchange.org

Background Paper

Emissions Trading in China Opportunities and Constraints October 2001

limate change and increasing levels of greenhouse gases (GHGs) are worldwide concerns. China is beginning to take a strong interest in the matter and it is encouraging that it signed the Kyoto Protocol agreement in Bonn in July 2001.

Worldwide efforts will be needed to reduce GHGs and China will have an important role to play. Measures to reduce emissions may take one of two forms: first, command and control regulations, which are administratively enforced, and second, market-based regulations. The wide range of control options includes environmental clean up, the substitution of less environmentally harmful inputs in production and the prohibition of harmful products and activities. Market based-solutions, on the other hand, treat pollution as a marketable commodity subject to the laws of supply and demand and include pollution taxes and emissions trading. This paper provides the general background to the basics of emissions trading, a marketbased regulatory system that allows companies to trade air pollution permits as one way of reducing pollution. The paper looks at emissions trading initiatives carried out around the world and examines whether an emissions trading scheme could be developed for China that would reduce the impact of pollution on human health and climate change in an economically viable way. It also outlines the design elements that must be considered when developing an emissions trading program.

ACKNOWLEDGEMENTS

Acknowledgements This paper was prepared by Christine L. Dobridge, Tam Pui Ying and So Hoi Ying Civic Exchange acknowledges the help of the following individuals and organizations in preparing this report: Brian Anderson Elvis Au, HK Environmental Protection Department Angel Cheung Scott Christiansen, Adventist Development Relief Agency China (ADRA) Sean Clark, Trexler and Associates, Inc. Daniel J. Dudek, Environmental Defense Fund Robert Falls Keith Gilges, US Asian Environmental Partnership Stephen Goldman, ExxonMobil Energy Limited Christine Huang, US Consulate, Guangzhou Elizabeth Hutton Michael Liang Dick Ma Ma Xioling, South China Environmental Sciences Institute CĂŠdric Philibert, International Energy Agency Lori J. Ryerkerk, ExxonMobil Energy Limited Suzanne Skinner Dilly Tam C W Tse, Hong Kong Environmental Protection Department Adventist Development Relief Agency China (ADRA) Environmental Defense Fund Environmental Protection Administration, Guangzhou Environmental Protection Department, HKSAR Government ExxonMobil Energy Limited Trexler and Associates, Inc. 2

TABLE OF CONTENTS Background 4 China’s air quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 The cost of air pollution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Chinese efforts to curb air pollution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Global climate change initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Emissions Trading 9 What is emissions trading? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 z The cap and trade system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 z The baseline-credit system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 z Differences in the two systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Pros and cons of emissions trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Groundwork: Emissions Trading Worldwide 12 The US experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 z The US emissions credit trading programs . . . . . . . . . . . . . . . . . . . . . . . . . . 12 z The US Acid Rain Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 z Southern California’s Regional Clean Air Incentives Market (RECLAIM) program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 z The Chicago Climate Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 European initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Australian initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Pilot projects worldwide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Emissions trading in the private sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Emissions trading in developing countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 World Bank recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 A Role for China 20 China’s position in the international arena . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Air pollution control initiatives in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Would emissions trading work in China? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Emissions trading initiatives in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 z Case Study 1: The Environmental Defense Fund’s China Project . . . . . . . 23 z Case Study 2: Trexler and Associates and the Adventist Development Relief Agency China’s carbon trading project . . . . . . . . . . . . . . . . . . . . . . . 24 z Case Study 3: Resources for the future SO2 trading project in Taiyuan City, Shanxi Province . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Observation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Establishing a Regional or National Emissions Trading Program in China 26 Key criteria for successful trading regimes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Which gas should be traded? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 z Sulphur Dioxide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 z Carbon Dioxide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 z Other possibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Establishing clear boundaries for emissions permit trading . . . . . . . . . . . . . . . . 28 z Which emissions sources should be included? . . . . . . . . . . . . . . . . . . . . . . 28 z Issuing permits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 z Monitoring emissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 z Monitoring transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 z Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Establishing rules for emissions credit trading . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Conclusions and Recommendations

BACKGROUND

Background China’s air quality

hina has achieved impressive levels of economic growth in recent decades as a result of rapid industrialization and agricultural developments. This growth has led to an increase in income and an improvement in healthcare and education but has also caused serious degradation of China’s natural environment. Improving air quality is expensive but not doing it could be even more expensive in the long run

Air pollution resulting from increased manufacturing, energy production and vehicle emissions is currently one of China’s most pressing environmental problems. Although China has made significant progress during the last decade in its efforts to address environmental problems, most of the 47 cities targeted for pollution control under China’s ninth Five-Year Plan have failed to meet acceptable emissions standards.1 Today, three of the top ten most polluted cities in the world are located in China: Beijing, Shenyang and Xian. China’s environmental protection authorities recently estimated that the government would need to spend RMB78 billion (US$9.4 billion) to clean up the air and lower Beijing’s air pollution index.2

China’s air pollution levels are among the highest in the world

China’s air pollution levels are among the world’s highest. More than 500 cities in China have air quality standards below the World Health Organization’s (WHO) criteria.3 Particulate and sulphur levels that exceed WHO and Chinese standards by two to five times were registered in major Chinese cities in 1995.4 Most of these emissions result from vehicle emissions and the burning of coal. Industrial pollution accounted for over 70% of the national total in 1995, including 72% of all sulphur dioxide (SO2) emissions and 75% of all flue dust emissions (a major component of suspended particulates).5

Guangzhou suffers serious air pollution

Guangzhou, the major city in the Pearl River Delta, is one of China’s most polluted cities. In 1997, it was ranked, along with Beijing and Shanghai, as one of the cities with the highest annual nitrogen oxide (NOx) concentrations. The annual average of more than 100 micrograms of NOx per cubic meter results primarily from vehicle exhaust.6

Source of air pollution includes: vehicles, power plants, cement works, steel mills, refineries, etc.

Although the primary source of air pollution in Guangdong is vehicles emissions rather than industrial emissions, industrial plants are still a major contributor. These include power stations, cement works, steel mills, petroleum refineries, chemical factories, and other industries with fuel-burning equipment. In 1996, SO2 emissions from the electric power industry accounted for more than 68% of the province’s total SO2 emissions.7 Cement plants also remain a major source of pollution; around 500 were operating in 1996. In total, 762,500 tons of SO2, 340,000 tons of smoke and dust emissions and 1,200,000 tons of industrial fly ash were emitted in Guangdong in 1995.8 1.

2. 3. 4. 5.

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The US Embassy Beijing. “Ninth Five-Year Plan Environmental Report Card.” March 2001. http://www.usembassy-china.org.cn/english/sandt/9th5yearplan.htm. “Billion Dollars to Go.” China Daily. May 19, 2000. http://chinaenvironment.com/news/index.html. “Urban Air Pollution.” http://www.chinaenvironment.com/english/air/airpollute.html. Ibid. Hua Wang and David Wheeler: “Endogenous Enforcement and Effectiveness of China’s Pollution Levy System.” World Bank Development Research Group. 2000, p. 2. http://www.worldbank.org/nipr/work_paper/hua/levywp2000.pdf. Ibid. In world cities annual NOx averages typically range from 20-90 micrograms per cubic meter. Christine Huang: “Air Pollution Control in Guangdong.” US & Foreign Commercial Service and US Department of State. 1997, p. 2. http://www.tradeport.org/ts/countries/china/isa/isar0054.html. Ibid., p. 4. The top 12 Guangzhou industrial air polluters in 1995 were: Guangzhou Cement Works, Guangzhou Electric Power Plant, Guangzhou Steel Mill, Guangzhou Heavy Machinery Mill, Huanan Sewing Machinery Plant, People's Paper Mill, Guangzhou Copper Material Mill, Guangzhou Alloy Mill, Guangzhou Zinc Mill, Guangzhou Chemical Factory, Guangzhou Lithopone Factory, and Guangzhou Chemical Fiber Plant, emitting a rough total of 26 billion tons of exhaust fumes. Of this, roughly 16.4 billion tons were SO2 emissions, 2.7 billion tons were smoke and dust emissions, and 4.3 billions tons were industrial fly ash emissions. Guangdong's top ten cement works have a combined total annual output capacity of around 10 millions tons/year. However, Guangzhou only releases about 14% of total exhaust fumes in the province.

BACKGROUND The cost of air pollution World Bank estimated effects of air pollution cost China 8% of its 1995 GDP

A 1995 World Bank report on the state of China’s environment drew international attention to China’s air pollution problem when it estimated that the effects of air pollution on human health cost China at least US$54 billion, or nearly 8% of China’s 1995 GDP.9 A 1997 study by the Chinese Academy of Social Sciences’ Environment and Development Research Center calculated that the total cost of environmental degradation in China in 1993 equaled 10% of GDP.10 These two studies indicate the high cost of pollution in China.

Air pollution has a detrimental effect on human health and ...

Many of the most polluting industries are located in densely populated, metropolitan areas where emissions exposure can cause serious damage to human health. China is the world’s top coal producer and the combustion of coal releases SO2, carbon monoxide (CO), and respirable particulates into the air.11 Pulmonary diseases are the leading cause of death in China and occurs at a rate twice that of developed countries. Scientists have concluded that the annual death toll of 1.4 million from chronic obstructive pulmonary can be attributed to indoor and outdoor air pollution.12 High rates of disease are attributable to high ambient outdoor and indoor pollution levels. It is estimated that over 1.4 million Chinese suffer premature deaths each year because of air pollution,13 and that some 7.4 million person-work-years are lost annually because of the health impact of air pollution.14 Indoor air pollution, largely a result of burning coal and biomass for cooking and heating, is estimated to cause roughly 111,000 premature deaths every year. Blood-lead levels averaging 80% above concentrations considered dangerous to mental development have been measured in children studying in Shenyang, Shanghai, and other major cities.15

... also damages crop and forestry production and could damage arable land Air pollution also corrodes buildings

In addition to the high human health costs, air pollution also has more direct consequences in China. Acid rain in the high-sulphur coal regions of south and southwest China may have already caused an average of 3% yearly reduction in crop and forestry productivity, and also has the potential to damage 10% of arable land area. In 1996, acid rain reduced agricultural production across 10 million hectares of farmland in Jiangsu, Zhejiang and five other provinces, costing China an estimated US$400 million.16 A 1999 Georgia Institute of Technology study found that regional haze in China has resulted in a 5% to 30% reduction in crop yields in approximately 70% of the crops grown in China.17 Air pollution also accelerates the corrosion of buildings, resulting in an increased need for maintenance and a shorter structural lifespan.18

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12. 13. 14.

15. 16. 17.

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World Bank China Partner Briefing: “Clear Water, Blue Skies: China’s Environment in the New Century.” http://www.worldbank.org/nipr/china/clrwt-sum.htm. US Embassy Beijing: “The Cost of Environmental Degradation in China.” December 2000. http://www.usembassy-china.org.cn/english/sandt/index.html. US Embassy Beijing: “China Air Pollution: How Bad Is It?” June 1998. http://www.chinaenvironment.com/english/air/index.html. Ibid. Ibid. World Bank China Partner Briefing: “Clear Water, Blue Skies: China’s Environment in the New Century.” http://www.worldbank.org/nipr/china/clrwt-sum.htm. Ibid. Ibid. William Chameides et al: “Case Study of the Effects of Atmospheric Aerosols and Regional Haze on Agriculture: An Opportunity to Enhance Crop Yields in China through Emissions Controls.” PNAS 96, no. 24. November 23, 1999. US Embassy Beijing: “The Cost of Environmental Degradation in China.” December 2000. http://www.usembassy-china.org.cn/english/sandt/index.html. 5

BACKGROUND Chinese efforts to curb air pollution China’s attempts to reduce air pollution, especially vehicle emissions

In order to reduce pollution from China’s 15 million vehicles, the Chinese Government required all vehicles to meet the Euro I emissions standard by the end of 2000 and will require all vehicles to meet the more stringment Euro II emissions standard by 2005.19 Leaded gasoline production was banned at the start of 2000, and the Government began promoting the use of unleaded gasoline in summer 2000.20 In addition, the Government now advocates the use of more vehicles powered by natural gas.21 Beijing and Shanghai currently have over 80,000 gas-powered vehicles in operation.22

Guangdong’s aim is to keep environmental degradation at 1997 levels 2002

Guangzhou has recently given a higher priority to curbing pollution. The city has more than 3.85 million cars, vans and trucks, all of which contribute to air pollution.23 When Beijing banned leaded petrol, Guangzhou was one of the many cities to follow suit.24 In 2000, the municipal government announced plans to refit all Guangzhou’s diesel and gasoline buses and taxis with equipment to burn liquefied petroleum gas (LPG) before the end of 2001.25 In cooperation with Toyota, five emissions-free electric vehicles were successfully tested in Guangdong in late 2000.26 Officials in Guangdong Province have stated that reducing pollution is a priority. Xu Deli, the vice-governor of Guangdong Province, stated: “our aim is to keep the environment at the level of 1997 by 2002, while the environment will be alleviated and improved by 2010.”27 Xu added that Guangdong would increase its collaboration with Hong Kong and the rest of the world in order to protect the environment. In the past five years, more than RMB54.6 billion (US$6.6 billion) has been invested in fighting pollution in the province.28

Global climate change intiatives Intergovernmental Panel on Climate Change (IPCC)

Global climate change is among the major environmental issues facing the world today. Acknowledging the potential implications of global climate change, the United Nations Environment Programme (UNEP) and the World Metrological Organization (WMO) established the Intergovernmental Panel on Climate Change (IPCC) in 1998. The purpose of the IPCC is to assess scientific, technical and economic research and information to further understanding of the risks of human-induced climate change. The IPCC has released three assessment reports, in 1990, 1995 and 2001. The 2001 report confirms earlier findings that

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21. 22.

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“China Sets Agenda for No-Smog Autos.” China Daily. April 5, 2000. http://www.chinaenvironment.com/english/news/index.html. China is making concerted efforts to eradicate all unleaded gasoline in the country within the next few years, as outlined in the Green Fuel Plan. It is estimated that implementation will cost $2.4 billion. “Urban Air Pollution.” http://www.chinaenvironment.com/english/air/airpollute.html. Ibid. China Environmental News. January 4, 2001. http://www.enviroinfo.org.cn/Energy/Non-renewable_Energy/Natural_Gas/d010514_en.htm “Guangzhou Pushes Refitted Car to Reduce Air Pollution.” China Daily. May 25, 2000. http://www.chinaenvironment.com/english/news/index.html. “Top Ten Domestic Environmental News Stories from China Environmental Newspaper.” http://www.chinaenvironment.com/news/top10.html. “Guangzhou Pushes Refitted Car to Reduce Air Pollution.” China Daily. May 25, 2000. http://www.chinaenvironment.com/english/news/index.html. “China: Electric Option Explored to Protect Environment.” Asiainfo China Daily News. September 25, 2000. “Guangdong Vows to Upkeep its Environment Protection.” China Daily. July 20, 2000. http://www.chinaenvironment.com/english/news/index.html. Ibid.

BACKGROUND the concentration of GHGs in the atmosphere and the global surface air temperature is rising, affecting biological and physical systems worldwide.29 Kyoto Protocol saga

Several initiatives to reduce GHGs and stabilize world climate have already been undertaken and several more are now underway. The first was the Rio Summit, the June 1992 United Nations Conference on Environment and Developments regarding the reduction of future GHGs emissions. A subsequent protocol for dealing with climate change was introduced and then negotiated during the United Nations Framework Convention on Climate Change (UNFCCC) in Kyoto in December 1997. The objective of the Kyoto Protocol is to impose binding GHGs emissions targets on the world’s industrial economies and former communist economies of Europe (“Annex I” countries) by the period 2008-2012.30

“Flexible Mechanisms” to reduce emissions

Three “flexible mechanisms” established in the Kyoto Protocol to assist countries in meeting their commitment and to enable countries to deliver part of their commitment by helping reduce emissions in other countries. These are:

Joint Implementation

Joint Implementation – allows a developed country to earn credit towards its own emissions reduction commitment by funding emissions reduction projects in other developed countries.

Clean Development Mechanism

Clean Development Mechanism (CDM) – allows industrialized countries to earn emissions reduction credits by investing in abatement projects in developing countries that do not have binding targets.

Emissions Trading

Emissions Trading – provides for a system of international trading of emissions allowances among companies and countries that accept binding targets. If a worldwide standard for emissions reduction is set, international structures would be required to lay out rules, ensure fair play and keep a tally of each country’s progress and position. A worldwide system would be very hard to set up. Multilateral talks to take forward the Kyoto Protocol broke down at The Hague in November 2000 after the European Union (EU) and the United States (US) were unable to agree on the ways the standards for Annex I countries could be met. The US wanted to utilize more flexible mechanisms to meet standards, such as emissions trading, including trading between countries, and the claiming of credits through carbon “sinks” (forests and agricultural zones which absorb CO2). The EU, however, maintained that too much flexibility would compromise the Protocol’s objectives without reducing GHGs emissions sufficiently. In early 2001, the US formally rejected the treaty, maintaining that the cuts laid out in the Protocol were too drastic and the economic costs of imposing them too high. The US also disagreed with the Protocol’s lack of restrictions on developing countries, particularly relatively large polluters like India and China.31

29.

30.

31.

The IPCC Third Assessment Report: “Climate Change 2000 contains three sections: The Scientific Basis, Impacts, Adaptation and Vulnerability and Mitigation.” Summaries for Policymakers and Technical summaries of these three reports can be found on the IPCC website at http://www.ipcc.ch/ pub/reports.htm. Warwick J. McKibbin and Peter J. Wilcoxen: “Permit Trading Under the Kyoto and Beyond.” Brookings Discussion Papers in International Economics No. 150. September 1999, p. 1. “Oh No, Kyoto.” The Economist. April 7, 2001. 7

BACKGROUND Some success in multilateral negotiations to reduce greenhouse gases

At the second round of these negotiations in Bonn in July 2001, an agreement as to how to implement the treaty was reached between 178 countries, (including China but not the US) paving the way for ratification of the treaty. In the pressured final days, the EU and other important players, including Canada and Japan were able to reach a compromise on several key issues necessary for the treaty implementation. These issues included how to enforce penalties for countries that donâ&#x20AC;&#x2122;t meet targets in the first period, how much credit can be claimed through carbon sinks, what kind of forest and farmland projects count as sinks and clarification of the international carbon credit trading scheme design.32 Before becoming legally binding, the treaty must be ratified by at least 55 parties, including industrialized countries representing at least 55% of 1990 GHGs emissions. Formal adoption of the treaty is scheduled for the end of October 2001, in Marrakech, Morocco.

32.

Andrew Revkin: â&#x20AC;&#x153;Negotiators Reach Deal on Climate Treaty.â&#x20AC;? The New York Times, July 23, 2001.

EMISSIONS TRADING

Emissions Trading Several emissions trading schemes are functioning

lthough progress towards a global emissions trading scheme has been slow, emissions trading is being implemented in many places at the national and local level as a cost efficient way of reducing emissions. The US has so far done the most in this area. Although a nationwide program has not yet been implemented in the US, several regional trading projects, including the Acid Rain Allowance Trading Scheme and the Regional Clean Air Incentive Market (RECLAIM) emissions trading program in California, have been launched. Both Australia and the EU are currently examining the potential for developing emissions trading markets and some pilot projects are underway. These programs offer several potential models for an emissions trading scheme that could be adapted in China.

What is emissions trading? Emissions trading is a marketbased regulation system that helps to reduce emissions in a cost effective manner

Emissions trading is a market-based regulatory system that allows companies and countries to trade emissions permits as a way of mitigating air pollution. There are two basic emissions trading systems: “cap and trade” and “baseline and credit.” The cap and trade system In the cap and trade system, regulators determine an acceptable level of pollution, thus establishing a cap on pollution that firms will be required to meet. Rather than making all polluters reduce their emissions levels to a fixed amount, pollution permits for the total amount of the ‘cap’ are sold or granted. Under a tradable permits scheme, a company or country can achieve its emissions requirements by reducing its total output of pollution, by trading these emissions permits, or by a combination of both. In a cap and trade system, a firm that can reduce its emissions effectively at a low cost will have surplus emissions allowances that it can either bank for future use or trade with other firms for a profit. On the other hand, a firm that exceeds its emissions limits must purchase permits to avoid being penalized. It will thus be cost-effective in both cases to trade: if the marginal abatement costs are below the prevailing price of the permit, a firm would have the incentive to sell permits, and to buy if vice versa. As tradable permits provide a profitable incentive to reduce emissions more than required, the long-term goal is thus to reduce overall emissions to a level lower than the fixed cap. Through a marketbased system, firms have the flexibility to develop their own solutions to meet emissions targets by developing innovative and cost-effective pollution control strategies. The baseline-credit system Another form of emissions trading is the “baseline-credit” trading approach whereby each participant is assigned an emissions “baseline” that represents a schedule of allowable emissions over time, taking into account expected technological change, emissions growth, and/or other abatement opportunities. By undershooting its emissions baseline, firms earn “credits” which can then be sold to other participants who wish to exceed their baseline. Differences in the two systems Both cap and trade and baseline-credit systems have been the basis of previous emissions trading systems in the US. However, key differences are: Timeline for implementation – Setting up a tradable permit system (cap and trade) is time consuming as there are a large number of design elements to put in place. A tradable credit program (baseline and credit) can begin much sooner.

EMISSIONS TRADING Role of the regulator – In a tradable permit system the regulator must allocate permits, establish baselines, track trades, establish protocols and assure compliance, but would not review each transaction. In a tradable credit system, the regulator must establish rules of trading and review and approve each trade; firms are not left to undertake trading on their own. Cost per trade – A tradable permit system requires up-front expenditures but once the system is in place, the cost per trade is low. In a tradable credit program, because each trade must be reviewed thoroughly by regulators before being approved, the cost per trade is much higher. Financing the program – In a tradable credit program, the private sector, the companies benefiting most from trading, finances the costs of the program. The costs to establish a tradable permit program are paid for by the public sector. Allocation – Credit allocation is determined by emissions outcomes relative to a predetermined baseline, whereas permits must initially be allocated by a regulatory agency. Market size – The number and distribution of tradable permits is likely to exceed that of tradable credits. The thorough review of each transaction in a credit trading system may limit trading activity. Reliability – A tradable permit system focuses on achieving a specific emissions target while a tradable credit system can be implemented whether or not a specific emissions target has been implemented.33

Pros and cons of emissions trading Advantages: Cost efficient – Emissions trading reduces the cost of regulation compliance compared to other methods of reducing pollution, such as abatement or switching energy sources. Flexibility – Market based mechanisms decrease bureaucratic environmental control, giving participants the flexibility to develop cost-effective methods of meeting emissions targets. Environmentally sound – Environmental quality is not sacrificed because the overall number of permits is fixed according to the total emissions level set by the regulatory agency. Growth potential – An emissions trading program provides new business and trading opportunities. There will be a need for brokers/traders, agencies to track the transfer or permits, and a regulatory system to monitor and verify individual emissions levels of participating companies or countries. Profitable – Permit trading provides a source of profit for businesses through speculation.

33.

Australian Greenhouse Office: “National Emissions Trading: Establishing the Boundaries.” Discussion Paper No. 1. March 1999, p. 10.

EMISSIONS TRADING Disadvantages: Controversial – Some argue it is unethical to allow the trade of pollution and a global system would put poorer countries at a disadvantage. Untested – Despite its lineage, existing systems are limited in scale. Political barriers – There will be many political obstacles to implementing a scheme, as demonstrated by the long international stalemate surrounding the Kyoto Protocol. Start-up costs – It would be expensive to set up a comprehensive permit trading system that is practical and easy to operate.

GROUNDWORK: EMISSIONS TRADING WORLDWIDE

Groundwork: Emissions Trading Worldwide

here are a number of emissions trading systems in operation throughout the world today, though most are found in the US. Since 1995, the US has successfully launched SO2 and NOx permit trading schemes. Following the Kyoto conference in 1997, other governments began exploring the feasibility of emissions trading and initiatives are currently underway in a number of countries. Those countries that show particular promise include Canada, Australia, the UK and countries within the EU. The outlook for emissions trading as a viable means of mitigating air pollution is encouraging, though the political timetable for the creation of a global scheme is uncertain.

The US experience A bit of history

Emissions trading programs have evolved slowly in the US over a 20-year period. The concept of air emissions credit trading originated in the 1970s with the development of the US Environmental Protection Agency’s (US EPA) Offset Policy, a policy designed to decrease the environmental impact of new emissions sources. This policy was followed by the development of three other credit trading programs, bubble, banking and netting, and provided the foundation for the first emissions permit trading program in the 1990s. There are currently two large-scale permit trading programs operating in the US, the US EPA’s Acid Rain Program and California’s Regional Clean Air Incentives Market (RECLAIM) program. US emissions credit trading programs The US EPA’s offset policy was created in 1976 with the purpose of accommodating industrial growth while maintaining national air quality standards. Under the policy, firms can earn Emissions Reduction Credits (ERCs) by reducing emissions below required levels and applying to the government for certification of this reduction. New emitting sources can then offset their emissions by purchasing ERCs from established sources and therefore, not increase net emissions output. Of the over 10,000 offset trades that have occurred, about 10% have been between firms and the remainder have been between sources owned by the same firm.34 The offset policy was followed by the implementation of the bubble policy in 1979 and the concept of emissions banking and netting in 1980. Under the bubble policy, multiple emissions sources are treated as though they face one aggregate emissions limit. Bubbles are designed to have a neutral environmental impact and can include multiple sources owned by one firm or facilities owned by many firms.35 The concept of emissions banking evolved because under the initial offset policy, there was no provision for the banking of ERCs for future use or sale. This encouraged firms to continue operating dirty facilities until they needed credits for internal use. Since 1980, the US EPA has approved several banks for storing ERCs but the use of this provision has been limited, due to the uncertain nature of a banked ERC. Some banks, for example, have restricted the life of an ERC to five years. The concept of emissions netting allows sources undergoing modification to avoid review if the firm can prove that overall facility emissions do not increase significantly.36

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35. 36.

Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 67. Ibid., p. 68. Ibid., p. 69.

GROUNDWORK: EMISSIONS TRADING WORLDWIDE The offset policy, bubble policy, emissions banking and emissions netting are all based on the creation and certification of ERCs and the concept of emissions allowance trading or emissions permit trading evolved out of these early credit trading policies. It is estimated that the US credit-trading program has produced more than US$5 billion in savings by 1995 without sacrificing environmental effectiveness.37

The Acid Rain Program has been functioning well since 1995 The aim is to reduce SO2 emissions to 50% of 1980 levels by 2010

The US Acid Rain Program Emissions permit trading is the central component in the US EPA’s Acid Rain Program, which was created through the passage of the 1990 Clean Air Act Amendments. The purpose of this program is to reduce SO2 emissions in the US and control acid rain. The problem of acid rain was first identified in the 1980s when scientists discovered that SO2 generated by power plants and other industrial facilities was forming sulfuric acid in the atmosphere and precipitating, damaging plant life, marine life and infrastructure. The Acid Rain Program is essentially a cap and trade system designed to reduce SO2 emissions to 50% of 1980 levels by the year 2010. The program was implemented in two phases, the first began in 1995 and the second in 2000. Phase II targeted the largest, highest emitting coal-burning electric utility generating units. This phase affected a total of 445 units in 21 Eastern and Midwestern states. In Phase II, emissions limits on these larger units were tightened and smaller utility units were also required to join the program so that a total of over 2,000 units were affected.38 The Clean Air Act also set a goal of a 2 million ton reduction in NOx emissions from 1980 levels to be carried out in two phases beginning in 1996 and 2000, respectively.39 The program has been very successful since its implementation in 1995. Affected units have demonstrated 100% compliance with requirements on SO2 emissions and by 1994 utilities had reduced SO2 emissions to almost 40% below the required level.40 Firms have surpassed reduction targets at less than half the forecast cost during the period 19951997.41 Much of this success was attributed to the flexible structure of the program, of which the trading provision was one component. In the program, one pollution allowance permits a unit within a utility or industrial source to emit one ton of SO2 during a given year. Participants can choose to meet this target either by reducing emissions or by trading allowances. The US EPA enforces an Allowance Tracking System (ATS) to monitor allowance transfers and ensure that a unit’s emissions do not exceed the number of allowances it holds. Each registered participant has an account in the ATS where allowance transfers are recorded. The ATS allows the public to review all transactions and the accounts of all market participants on the Internet. At the end of each year, the US EPA penalizes those firms whose emissions exceed levels for which they hold permits.42

37.

38. 39.

40. 41.

42.

John Palmisano: “Credit Based Environmental Programs: What has Worked and Why?” A Seminar Discussion Document. Kyev, Ukraine. March 2001. “Acid Rain Program: Overview.” http://www.epa.gov/airmarkets/arp/overview.html “Nitrogen Oxides (NOx) Reduction under the Acid Rain Program.” http://www.epa.gov/airmarkets/arp/nox/index.html “Acid Rain Program: Overview.” http://www.epa.gov/airmarkets/arp/overview.html Debra S. Knopman and Megan Susman: “Trading Air Emissions for Environmental and Economic Benefits – Success Stories from the Private Sector.” 1998. http://www.dlcppi.org. “Acid Rain Program: Overview.” http://www.epa.gov/airmarkets/arp/overview.html 13

GROUNDWORK: EMISSIONS TRADING WORLDWIDE To further reduce the cost of achieving the mandated emissions targets, the US EPA’s Opt-in Program allows SO2-emitting sources that are not required by law to participate in the Acid Rain Program to participate voluntarily and receive their own SO2 allowances. This gives firms with low abatement costs the incentive to reduce emissions in order to profit from selling their allowances to firms with higher abatement costs, lowering the overall cost of emissions reduction.43 To date, the price of allowances has remained far below initial forecasts, which may be attributed to the fact that prices for virtually every form of compliance have been well below anticipated levels.44 However, prices may rise during Phase II, as more sources are involved. It is likely that newly participating sources will choose scrubbing as their method of compliance, which will increase the variation in the marginal costs of compliance across sources.45 Increased variation in marginal cost will likely lead to greater reliance on allowance trading, thereby increasing prices.46 The program has proved to be cost effective

Southern California’s experience has been successful

The US Acid Rain Program cost approximately US$1.2 billion annually in Phase I and will cost approximately US$2.2 billion annually in Phase II. These costs are offset by the estimated annual health benefits of US$10.6 billion in Phase I and US$40 billion in Phase II.47 Health benefits appear to be the dominant benefit component, surpassing earlier estimates of environmental benefits. SO2 emissions control is also reported to be far ahead of schedule. In 1995, emissions from all Phase I sources were roughly 40% below the required level; it is expected that these excess emissions reductions (unused allowances) in Phase I are being banked by utilities for use during Phase II when performance standards tighten significantly. Southern California’s Regional Clean Air Incentives Market (RECLAIM) program Since 1993, the Californian legislature has encouraged the development of emissions trading to replace the traditional “command-and-control” air pollution regulation. As part of this transition, California’s South Coast Air Quality Management District (AQMD) established the Regional Clean Air Incentives Market (RECLAIM), in 1994.48 This program includes over 400 companies and industrial facilities in the Los Angeles area that emit 4 or more tons per year of NOX and SOX. It pledged to save industries more than US$60 million per year while not contributing to increased unemployment in the region.49 By July 1999, more than 113 million RECLAIM trading credits (RTC) had been traded, generating a total of US$60 million through transactions.50 This program has been less successful in reducing total emissions than expected, however, and with the pressures imposed by the recent California power crisis, the RECLAIM program is currently being reevaluated. To date, participating businesses have reduced total emissions

43. 44.

45.

46.

47. 48.

49. 50.

Ibid. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 27. Wet scrubbing is a method of removing SO2 particles from exhaust fumes by spraying them with limestone or dolomite slurry. This chemical reaction produces gypsum, which has economic value; some power plants profit from selling gypsum to industry for use in wallboard, plaster or Portland cement. “How is SO2 Waste Recycled to Make Wallboard?” http://antoine.frostburg.edu/chem/senese/ 101/environmental/faq/so2-recycling.shtml. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 27. Ibid. The AQMD is the smog control agency for Los Angeles, Orange, Riverside and San Bernardino Counties in Southern California. “Emissions Trading Defined.” Cantor Fitzgerald EBS. http://www.cantor.com/ebs/defined.htm. Ibid.

GROUNDWORK: EMISSIONS TRADING WORLDWIDE by 16%, a much smaller reduction than was expected by this point in the program. By the end of a 10-year period, firms were expected to have reduced emissions by 13,000 tons annually. However, according to AQMD projections, only 4,140 tons have been reduced.51 Critics attribute the program’s lack of progress to excess initial credit allocations which kept credit prices low and encouraged firms to stock up on cheap credits to fund their polluting instead of making technological improvements to decrease emissions. RTC prices surged during the energy crisis as power plants rapidly acquired credits in order to ‘finance’ increased emissions as they increased production to meet the demand for electricity. A credit for one pound of NOx emissions that cost about US$0.25 in the early years of the program cost almost US$50 in late 2000.52 To reduce prices and alleviate pressure on small firms, the AQMD approved regulations in May 2001 that shifted power plants out of the credit trading market, forcing them instead to pay fees to pollute.53

A new voluntary carbon trading scheme to reduce emissions by 5% by 2005 for seven states

The Chicago Climate Exchange The Chicago Climate Exchange (CCE) is the first voluntary carbon-trading scheme to be implemented in the US. The exchange was founded after a feasibility study concluded that a voluntary pilot carbon trading market, to be started in the Midwestern US, was viable, had corporate support and could later be expanded. It is funded through a grant from the Joyce Foundation of Chicago, Illinois to the Kellogg School of Management at Northwestern University. Under the scheme, participants from seven Midwest US states (Indiana, Illinois, Wisconsin, Michigan, Iowa, Minnesota and Ohio) are issued tradable emissions permits and commit to schedule for reducing emissions by 5% by 2005. To meet this commitment, participants can either directly reduce emissions, purchase permits to cover their emissions from other participants or purchase credits from agricultural or other offset projects. The exchange will trade all six GHGs. Prospective offset projects could include the use of renewable energy sources, such as wind or solar, innovations in energy efficiency, the recovery and use of agricultural and landfill methane and carbon sequestration projects like forest expansion. As a pilot emissions trading program, the CCE has the potential to achieve several objectives other than reducing emissions at a lower cost. These objectives include: demonstrating that GHGs trading can achieve real emissions reductions across different business sectors, helping discover the price of reducing emissions and developing the frameworks needed for the operation of a successful market. The launch of the program is targeted for late 2001 and will be implemented in three phases. In Phase I, to be carried out in 2002, participants in the seven-state Midwest region will commit to emissions reduction targets. In Phase II (2003), the scheme will be expanded to include participants from the entire US, Mexico and Canada and in Phase III (2004), the system will be expanded to include international participants. A diverse group of twenty-five companies and non-profits have volunteered to participate in the earliest phase of the program, including: Ford Motor Company, DuPont, Cinergy, Suncor Energy, Inc., STMicroelectronics, Temple-Inland Inc., International Paper, Alliant Energy, Calpine, NiSource, PG&E National Energy Group, Wisconsin Energy Corporation, and the Nature Conservancy.54

51. 52. 53.

54.

Gary Polacovic: “Innovative Smog Plan Makes Little Progress.” Los Angeles Times. April 17, 2000. Ibid. David Danelski: “Energy Shortage Prompts Board to Relax Air Rules.” The Press Enterprise Co.. May 12, 2000. “Chicago Climate Exchange.” http://www.chicagoclimatex.com. 15

GROUNDWORK: EMISSIONS TRADING WORLDWIDE European initiatives UK System will start in 2002

The UK has proposed an emissions trading scheme which will begin operation in 2002. Under the Kyoto Protocol, the UK committed itself to a 12.5% reduction in GHGs emissions and set a national goal of reducing CO2 emissions by 20% by 2010 in comparison to 1990 levels. The UK scheme combines a cap and trade system with a baseline and credit system and covers only CO2 emissions. Participation will be voluntary and open to all organizations operating in the UK.55

Denmark started already although only limited to electric utilities

Denmark became the first EU member to implement a domestic carbon trading scheme with the passage of the CO2 Cap and Trade Act in July 2000. As part of its commitment to the Kyoto Protocol, Denmark has set a national goal of reducing CO2 emissions to 80% of 1988 levels by 2005. The carbon trading scheme will operate from 2000 to 2003 and the government has allocated carbon permits to electric utility facilities based on historical emissions levels between 1994 and 1998.56

EU aims to have a carbon trading scheme by 2005

The EU as a whole has aimed to establish a carbon trading scheme within the European Community by 2005 as a part of its Kyoto commitment. Under the terms of the Protocol, the EU has committed to reduce its GHGs emissions by 8% during the period from 2008 to 2012 as compared to 1990 levels.57 In March 2000, the European Commission published a Green Paper proposing the use of a GHGs emissions trading scheme to facilitate the transition from the current emissions levels to the lower levels mandated in the Protocol.58

Australian initiatives Australia has done its homework although it has not committed to any scheme

Since the introduction of the Kyoto Protocol, there has been a significant amount of interest in Australia regarding the potential for launching a national emissions trading program. In 1999, the Australian Greenhouse Office (AGO) released a series of four discussion papers analyzing Australia’s emissions trading potential and identifying the logistical issues involved in establishing new markets and allocating permits.59 However, the Australian government has not yet reached a decision about a national emissions trading scheme. It stated that a scheme would only be implemented if Australia ratifies the Kyoto Protocol and an international trading regime is established.60 Australia signed the July 2001 Kyoto agreement, but it is unclear when it would ratify it.61

55.

56.

57.

58.

59.

60.

61.

Department of the Environment, Transport and the Regions: “Draft Framework for the UK Emissions Trading Scheme.” May 2001. http://www.environment.detr.gov.uk/climatechange/ tradingscheme/pdf/trading.pdf Sigurd Pedersen: “Danish CO 2 Emissions Trading System.” October 5, 2000. http://www.ens.dk/uk/energy_reform/emissions_trading/Danish_CO2_cap_and_trade_system.pdf. Centre for the Study of Financial Innovation: “Trading Emissions Permits – A Business Opportunity for the City. – A Report for the Corporation of London.” January 1999. European Commission’s Official: “Green Paper on Greenhouse Gas Emissions Trading in the European Union COM (2000)87.” http://europa.eu.int/eur-lex/en/com/gpr/2000/ com2000_0087en01.pdf or http://europa.eu.int/comm/off/green/index_en.htm. The AGO was established as an agency of the Australian government to coordinate domestic climate change policy and be a point of contact for stakeholders. The four papers in the Australian emissions trading discussion paper series are: 1. Establishing the boundaries; 2. Issuing the permits; 3. Crediting the carbon; 4. Designing the market. These papers produced by the AGO present topics for public comment and provide a thorough and balanced treatment of the many issues and options that arise in an analysis of emissions trading. Links to the full text of these four papers can be found on the AGO website at http://www.greenhouse.gov.au/emissionstrading/paper.html. “Developing a National Emissions Trading Scheme for Australia.” http://www.greenhouse.gov.au/emissionstrading. “Editorial: Climate Change Talks Fall Short of Expectations.” The Australian. July 26, 2001.

GROUNDWORK: EMISSIONS TRADING WORLDWIDE Pilot projects worldwide International Energy Agency

The International Energy Agency (IEA) carried out an International Emissions Trading Simulation Project in June and July 2000, involving delegates from developed nations that have commitments to the Kyoto Protocol. The purpose of this simulation was to learn more about the development of an international emissions trading scheme under the conditions laid out in the Protocol. The simulation concluded that emissions trading could be a low-cost means of reaching the Kyoto targets. With international trading, all participating “countries” achieved their emissions reductions goals at a lower cost than an exclusively domestic abatement effort.62

European electricity industry

The European electricity industry association, Eurelectric, developed a Greenhouse and Electricity Trading Simulation (GETS 2) Project to simulate a European trading scheme. Forty major European companies from six sectors participated in the simulation, which ran from January to July 2000. The project had three objectives: 1) to evaluate the potential and requirements for an dual energy and tradable emissions permit scheme operating on a large scale, 2) to gain hands-on learning experience by implementing trading strategies and 3) to contribute to the global emissions trading knowledge pool. The simulation concluded that emissions trading is a viable, lower cost means of reducing CO2 emissions.63

Canadian experience

In Canada, an industry-led, multi-stakeholder environmental initiative, the Pilot Greenhouse Emissions Reduction Trading Project (GERT) was undertaken in 1996 to examine the potential role of emissions trading in reducing smog and other air pollutants in the Windsor-Quebec corridor. A think-tank on emissions trading was established and has coordinated pilot trades between American and Canadian companies. It has been working to establish a system of emissions trading in Ontario as well as on a national level.64

Emissions trading in the private sector Private deals

Aside from emissions trading schemes at the national and regional levels, there has also been participation from the private sector. Emissions reduction trading is happening on a commercial basis between companies outside permit schemes. The deals are placed privately or brokered through sizable companies like Natsource and CO2E.COM. So, as long as the trades make commercial sense, a market could be developed.

Inter-companies trades

There is also internal trading going on where companies trade emissions internally to help a company meet its own targets. Examples include: The BP Amoco PLC launched a pilot in-house carbon emissions trading program affecting 12 operating units in 1998; the program was expanded to include all 127 operating units in 2000. The goal of this program is to reduce GHGs emissions 10% by 2010, compared with a 1990 baseline.65 It is based on the cap and trade concept and by early 1999, 50,000 tons of carbon dioxide had been traded.66

62.

63.

64. 65.

66.

Richard Baron: “Emissions Trading a Real Time Simulation.” November 2000. http://www.iea.org/envissu/cop6/emistr.pdf. “GETS 2 Executive Summary.” November 6, 2000 http://www.gets2.org/visitors/download/gets2_executivesummary_0611.pdf See http://www.pert.org. Canada has a number of other schemes as well. “Greenhouse Gas Emissions Trading in BP Amoco.” November 1999. http://www.cdmcentral.org/docs/emissions-trading/15.pdf. “Biz/Ed: Company Facts.” BP Amoco. http://www.bized.ac.uk/compfact/bp/bp14.htm. 17

GROUNDWORK: EMISSIONS TRADING WORLDWIDE In early 2000, the Royal Dutch Shell Group initiated a voluntary internal emissions trading scheme called the Shell Tradable Emissions Permit System (STEPS). The Group has committed to reduce its greenhouse gas emissions by 10% by 2002, compared with 1990 levels. Businesses participating in STEPS account for 30% of the Group’s total emissions and will use tradable permits as a way to meet their contribution to the overall Group target. Shell chemicals, refining and exploration and production businesses from North America, Europe and Australia are participating in this trading initiative.

Emissions trading in developing countries The International Energy Agency thinks developing countries can benefit from emissions trading

Most of the emissions trading schemes in operation or under planning today are located in developed countries in North America, Europe and Australia. This is partly due to economic and technological advancement in these countries and their concerns about and commitment to protecting the environment. The Kyoto Protocol requires a binding commitment from developed countries to meet emissions targets. This raises the question of whether or not an emissions trading program could be implemented successfully in developing countries, like China, given their economic status and lack of a formal international commitment to controlling emissions.67

Some countries could have nonbinding targets

The IEA has examined this question and made positive recommendations for GHGs emissions trading schemes in developing countries. By giving some companies firm targets and others non-binding ones, it would be possible to mix two categories of stakeholders in a single emissions trading system. Those with non-binding targets would be permitted to sell surplus emissions, though they would not be required to buy allowances if their actual emissions exceed their limits.68 This strategy could be applied in the international emissions trading system proposed in the Kyoto Protocol. Developing countries without binding commitments are reluctant to discuss emissions trading and pollution caps because of possible constraints on economic growth. Accepting non-binding targets, however, would allow developing countries the potential to trade surplus emissions. This strategy provides a strong profit incentive for firms in developing countries to adopt cleaner, lower emissions technology as they grow. Dynamic targets, in which the assigned emissions caps are calculated with reference to economic growth, is another possible way to address concerns.69

67.

68.

69.

Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 31. At the Fourth Conference of the Parties to the UN Framework Convention on Climate Change in Buenos Aires, Argentina proposed that developing countries accept greenhouse gas emissions targets based on expected growth and that reductions be measured relative to that projection. However, the very negative reaction by China, among others, led to the proposal being dropped. Cédric Philibert: “Greenhouse Gas Emissions Trading and Developing Countries.” International Energy Agency, Energy and Environment Division. June 2000. http://www.iea.org. Ibid.

GROUNDWORK: EMISSIONS TRADING WORLDWIDE World Bank recommendations Some sensible steps to take in considering implementing an emissions trading scheme

A 1998 World Bank study reviewed economic incentive initiatives, including emissions trading initiatives, in several developing countries in Central and South America. The study concluded that the utilization of economic instruments can be an efficient and costeffective environmental management strategy if properly implemented. It recommends the following series of steps to be followed by any country considering adopting marketbased environmental management policies: 1. Identify the environmental problems. The policy is intended to address and set clear goals for reform. 2. Examine existing environmental management tools and assess their flexibility and the degree to which they internalize environmental costs. 3. Analyze the compatibility of legal institutions with market-based reforms and consider changes that may create a better legal environment. 4. Identify environmental damages whose costs are not internalized, and their relation to various economic and domestic activities. 5. Attempt to quantify the social costs and benefits of the proposed reforms. 6. Investigate the feasibility of introducing specific economic instruments in terms of their impacts on private costs, institutional costs and legal measures. 7. Recommend policy, institutional or legislative actions based on the conclusions from the previous assessments.70

70.

John Palmisano: â&#x20AC;&#x153;Credit Based Environmental Programs: What has Worked and Why?â&#x20AC;? A Seminar Discussion Document. Kyev, Ukraine. March 2001. 19

A ROLE FOR CHINA

A Role for China China’s position in the international arena China is now the world’s largest greenhouse gases emitter China signed the Kyoto Protocol in July 2001

hina now surpasses the US as the world’s largest emitter of GHGs. 71 It is encouraging that China put its name to the Kyoto agreement in Bonn. Although China has not formally approved emissions trading as an abatement measure, there is a definite interest in this area. Emissions trading is a way for China to obtain new technology as well as profit from the sale of excess credits without limiting economic expansion. Despite its current position, US organizations are looking at earning emissions credits from air pollution abatement projects in China under the Clean Development Mechanism (CDM). Clean technology, financial backing, and expertise from the US would be transferred to China, allowing China to maintain its industrial growth using new, clean technology instead of the older, dirtier technologies it might otherwise have employed. Similar strategies have been used by a number of European countries, establishing the transfer of clean technology to developing nations. Given China’s monumental energy demands and rapid industrial growth, the installation of clean technologies is essential to protecting China’s environment.

Air pollution control initiatives in China Legislative background

China’s Air Pollution Prevention and Control Law was passed in 1987, and amended in 1995 to tighten SO2 emissions regulations. The Ninth Five-Year Plan for Environmental Protection for 2010 was approved in 1996 and contained the Plan for Total Amount Control (TAC) of Major Pollutants Discharge, among other pollution control measures. Under the TAC, fixed targets for air pollutants such as soot, industrial dust, and SO2 were set and enforced.72 The levels were generally fixed at 1995 levels (the end of the Eighth FiveYear Plan), but in key acid rain and SO2 control regions, total discharge was reduced. National air pollution targets for 2000 restricted SO2 emissions to 22 million tons, and smoke and powder dust emissions to 16.5 and 17 million tons, respectively. The TAC sets specific emissions targets for different industries; in energy-related industries, the TAC sets specific targets for dust, SO2 and NOx emissions. The TAC also targets the treatment of 80% of industrial air emissions.73 Although most provinces claim to have ‘basically’ met these targets, the actual extent of pollution control remains unclear.74

Tenth Five Year Plan (20012006)

The Tenth Five-Year Plan (2001-2006) lists specific objectives for improving overall environmental quality including: capping total SO2 emissions at 19 million tons (1999 SO2 emissions were 18.6 million tons), meeting Grade II standards for SO2 emissions in areas targeted for acid rain control, targeting 100 cities for pollution control (up from 47), and installing air quality monitoring equipment in these 100 cities. Although the objectives are still undergoing revision, it is unlikely that they will change greatly. The Chinese Government estimates that the total cost of achieving these environmental targets to be US$85 billion, or 1.3% of total GDP over the five-year period.75

71. 72.

73. 74.

75.

“Urban Air Pollution.” http://chinaenvironment.com/air/airpollute.html. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 42. Ibid., p. 43. For a discussion of the results of the Ninth Five-Year Plan, please see the US Embassy, Beijing’s “Ninth Five-Year Plan Environmental Report Card.” http://www.usembassy-china.org.cn/english/ sandt/9th5yearplan.htm. US Embassy. Beijing: “Environmental Objectives and Investment Requirements for China’s Tenth Five-Year Plan.” November 2000. http://www.usembassy-china.org.cn/english/sandt/10FYP.htm.

A ROLE FOR CHINA Chinese factories have to pay a pollution levy

One of China’s responses to the air pollution problem is the institution of a pollution charge through the Pollution Levy System (PLS), provided for under China’s Environmental Protection Law. Most of the counties and cities in China have implemented the levy system, and approximately 500,000 factories have been charged for emissions since 1989.76 The PLS remains by far the largest application of a market-based regulatory instrument in the developing world and is probably the largest worldwide. In the PLS, sources that release air emissions in excess of permitted amounts are charged a fee ranging from RMB0.04/kg to RMB3.0/kg. Sources that fail to meet the standard after three years of paying this fee incur a 5% increase every year thereafter until the standard is met.

Levy funds collected are financing thousands of pollution control projects...

The successful implementation of the PLS increases the feasibility of the emissions trading system. The PLS is based on the integrity of self-reporting among polluters and monetary collection. Since its inception in the early 1980s, the total fees collected by Chinese regulators total to around RMB30 billion. Money collected from the levy has been used for pollution source control, comprehensive clean up projects and institutional development. As of 1994, about RMB4.5 billion of levy collections had been used for development of environmental institutions, RMB3.1 billion for purchasing monitoring equipment, and RMB1.4 billion for projects such as environmental education and environmental staff training.77 However, the bulk of the levy – approximately RMB11.8 billion as of 1994 – has been used for pollution abatement. This represents about 15% of China’s total budget for industrial pollution control, and as much as 30% - 40% of the local budget for some cities. As of 1995, levy funds have financed or co-financed about 220,000 pollution control projects.78

... although the existing system has flaws

The design of the PLS does have several flaws that limit its effectiveness as a pollution control instrument. Problems encountered include: System design – Emissions sources are encouraged to meet environmental standards and fees are only levied on discharge above the standard; a large portion of these fees are then returned to the sources to help control pollution which weakens the incentive effect. In most cases, a source can be assured to get back most of the fees that it pays. Inadequate fees – Charges bear no relationship to the cost of environmental damage because the pollution discharge fees are low and inflation further devalues the fees. Poor infrastructure – Environmental supervision and monitoring must be improved and law enforcement must be strengthened to ensure full collection of the fees.79

76.

77. 78. 79.

Hua Wang and David Wheeler: “Endogenous Enforcement and Effectiveness of China’s Pollution Levy System.” World Bank Development Research Group. 2000, p. 3. http://www.worldbank.org/nipr/work_paper/hua/levywp2000.pdf. Ibid., p. 6. Ibid. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 46. 21

A ROLE FOR CHINA Would emissions trading work in China? Emissions trading has potential for China

Emissions trading is an excellent potential tool to help China reduce its effect on climate change.80 It could greatly offset the cost structure of pollution abatement, as well provide a source of profit through speculation. New business and trading opportunities would also occur through a Chinese emissions trading program, thus encouraging economic growth while addressing a pressing environmental problem.

China should ratify the Kyoto Protocol as a first step

One possible step for China to take in reducing its GHGs emissions would be to ratify the Kyoto Protocol. This international collaboration would provide China with the international support and infrastructure to make a considerable impact in fighting its current environmental degradation.

Emissions trading initiatives in China China has several pilot projects The results will help to guide policy-maker in the future

Although emissions trading is a relatively new concept and has so far only been implemented on a regional level in the US, the mechanics of the ‘cap and trade’ system have spread quickly to China and several credit trading initiatives have been undertaken in recent years. Since 1991, various emissions trading programs have been established in six cities in China. These programs include: Fluoride emissions trading in Baotou City, Inner Mongolia; Atmospheric pollutants’ emissions trading in Taiyuan City; Shanxi Province; SO2 dust, and smoke emissions trading in Kaiyuan City, Yunnan Province; Dust and suspended particulates emissions trading in Pingdingshan City, Henan Province; SO2 and dust emissions trading in Guiyang City, Guizhou Province; and SO2 emissions trading in Liuzhou City, Guangxi Province.81 These programs have reduced emissions in some areas, greatly improving ambient air quality, and in some cases facilitating economic development and providing social benefits through new job opportunities.82 However, these permit systems have yet to be fully implemented in China and still require improvement and finalization. Although most of these initiatives are local, the fact that the central government has welcomed a new market-based strategy as an alternate means to combat air pollution is encouraging. With rapid industrialization and monumental energy demands, there are enormous opportunities for emissions trading in China.

80.

81.

82.

Chinese industries are already operating under a unique pollution control system. A market-based instrument combining emissions charges and abatement subsidies has given firms incentive to invest in wastewater treatment facilities, and the pollution levy, although low, has significantly improved investments in abatement. Hua Wang and Ming Chen. “How the Chinese System of Charges and Subsidies Affects Pollution Control Efforts by China’s Top Industrial Polluters?” World Bank Working Paper Series 2198. October 1999. http://www.worldbank.org/nipr/work_paper/wps2198.htm. Since 1991, the State Environmental Protection Agency (SEPA) has established pilot programs for air emissions permit systems in 16 cities, of which six (Baotou, Kaiyuan, Liuzhou, Taiyuan, Pingdingshan and Guiyang) tested emissions trading. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 108. Ibid., pp. 103-4.

A ROLE FOR CHINA Case Study 1: Environmental Defense Fund - China Project83 In 1997, the Environmental Defense Fund (EDF), a US non-profit, and the Beijing Environment and Development Institute (BEDI) established a joint research project to tackle China’s air pollution problem. The focus of this project was Total Emissions Control and emissions trading. The Plan for Total Emissions Quantity Control for Major Pollutants (TEC), like the TAC, was a pollution control initiative introduced in 1996 in the Ninth Five-Year Plan. TEC established limits on the total annual discharges of a number of pollutants including SO2, similar to the US national cap on SO2 mandated in the 1990 Clean Air Act Amendments. Other parties involved in this project include the State Environmental Protection Administration, the State Economic and Trade Commission, the Benxi Environmental Protection Bureau, and the Nantong Environmental Protection Bureau. In 1999, China and the US signed a bilateral agreement for joint action on acid rain and emissions trading. A two-day workshop was held under the bilateral agreement, featuring work by the EDF, BEDI and other local partners. The EDF and the BEDI are jointly responsible for the pilot trading projects to be conducted by China under the agreement. Local emissions trading projects were carried out in Benxi and Nantong. Benxi, in Liaoning Province, was chosen to represent of one sector of the Chinese economy that is targeted for economic reform. The main industries in Benxi are steel and cement production, largely state-owned enterprises in which coal is the dominant energy source. Nantong is located in Jiangsu Province at the mouth of the Yangtze River. Nantong is a rapidly growing region in which there is a substantial amount of foreign investment and a large number of joint ventures. Light manufacturing and textiles dominate its economy. Previous emissions allowance experiments in China traded credits for substances including air pollutants, water pollutants, and manufacturing quotas.84 This project, however, is the first to link emissions trading directly to the pollution caps established in the TEC initiative. While few locales have the diversity of SO2 sources required to create a broad-scale market, these cities offer the opportunity to test the capacity of local agencies and institutions to implement emissions trading. Currently, the EDF is working on the development of local legislation in Benxi, one of the few cities in China with the power to enact its own legislation. The proposed legislation will create a legal basis for TEC, coordinate existing environmental policies, establish emissions measurement and reporting protocols, and impose consequences for noncompliance. In Nantong, the EDF is focusing on the development of a bilateral emissions trade between two emitting facilities. Since Nantong is located in both the SO2 and deposition control zones, an emissions trading scheme would be a practical resolution of the transboundary SO2 problem. The Chinese presently have no mechanism to solve inter-provincial environmental problems other than direct intervention by the central government.85

83. 84.

85.

Daniel Dudek: “Environmental Defense’s China Project.” Environmental Defense Fund. 1999. Daniel Dudek and Ma Zhong (translation): ”Total Emissions Control and Emissions Trading (Chinese).” China Environmental Science Press. 1999, p. 154. Personal communication, Daniel Dudek, Environmental Defense Fund. 1999. 23

A ROLE FOR CHINA Case Study 2: The Trexler and Associates and Adventist Development and Relief Agency carbon trading project Trexler and Associates, Inc. (TAA)86 has a carbon trading project in China cooperating with the Adventist Development and Relief Agency China (ADRA), a non-profit organization that is active in development projects in China.87 In colder Northern China, coal is the primary residential energy source and is typically burned inefficiently in small tin stoves with short chimneys. Most homes in the region are made of clay bricks and mud mortar, materials with only one-fourth of the insulation capacity of modern walling. So to improve energy efficiency, ADRA has worked to introduce straw-bale technology for home construction in this region to reduce the amount of coal needed for heating, thus reducing CO2 emissions. ADRA has projects in Mongolia and has targeted Northern China as an ideal region to implement a larger program involving 10,000 to 20,000 homes.88 In the first phase of this program, TAA and ADRA launched a small pilot project in the fall of 1999, constructing 18 houses in northern China in order to test the potential for straw bale as a viable housing alternative and a CO2 emissions reduction strategy. The goals of this phase were to test the feasibility of straw bale technology, to train workers, to quantify the coal savings likely to result and to develop the monitoring and verification systems necessary for expansion.89 ADRA is currently constructing 1,000 straw bale houses and, contingent on funding, is planning on substantially increasing that number. The coal used by newly constructed houses (the baseline against which the straw bale houses are measured) is between five and six tons per winter; straw bale houses are reducing this coal consumption by about 60%. Thus, each new house mitigates more than three tons of coal use, or about four tons of CO2 emitted, per winter and, figuring on a 30-year lifespan, about 120 tons of CO2 total per house.90 Each house currently costs about RMB18,000, although ADRA’s goal is to reduce that cost to about RMB14,000. At this time, ADRA, the Chinese government and the occupant share the cost of each house equally, however, it is expected that the Chinese government will withdraw financial support as the project expands. By marketing the CO2 reductions around the world, under the CDM, the ADRA can continue to subsidize construction and provide technical assistance and monitoring of the project. With the price of carbon in the world market currently at US$8 a ton, the projected income for each house over 30 years is US$960. So it is projected that in the future, the out-of-pocket expense per house for the occupant will be RMB8,000, substantially cheaper than the current outof-pocket expense of building a new brick house: RMB24,000.91

86. 87.

88.

89. 90.

91.

See Trexler and Associates, Inc. http://www.climateservices.com. Personal communication, Scott Christiansen. Adventist Development and Relief Agency. July 24, 2001. “Developing Mitigation Projects: Top Available Offsets – Straw Bale Home Construction Project.” http://www.climateservices.com/proj_avail_straw_bale.htm Ibid. Personal communication, Scott Christiansen. Adventist Development and Relief Agency. July 24, 2001. Ibid.

A ROLE FOR CHINA With the ratification of the Kyoto treaty, ADRA expects that there will be increasing interest from international sources in purchasing CO2 credits and hopes to complete funding by the end of 2001.92 This program has the support of organizations in China including the Center for Environmentally Sound Transfer, the Ministry of Science and Education, the State Development and Planning Commissions, and the Chinese Academy of Sciences.93 Case Study 3: Resources for the future SO2 trading project in Taiyuan City, Shanxi Province Resources for the Future (RFF), is a non-profit based in Washington D.C. that conducts research on environmental and natural resource issues. In cooperation with the Asian Development Bank (ADB), researchers with RFF are currently working with regulatory officials in Taiyuan City, Shanxi Province to create a pilot SO2-permit trading program. A 1998 World Bank report listed Taiyuan as the most polluted city in China. The overall goal of this project is to develop an emissions trading system that will work within the China’s existing legal and regulatory infrastructure. RFF researchers began by studying Shanxi’s existing legal, regulatory and administrative bodies and assessing their potential to implement an emissions trading system.94 At a concluding meeting in July 2001, RFF, the ADB and Shanxi officials decided to implement a cap and trade system consistent with China’s TEC policy. The pilot project will run from September 2001 to September 2002 and the evaluation is expected to finish by the end of 2002.95

Some observations about the potentials for expansion in China

Observation China currently has no commitment to the Kyoto Protocol. The government thus lacks the formal incentive to cooperate with the international community in meeting emissions reduction targets. China lacks a comprehensive regional or national emissions regulatory system. The effectiveness of the PLS is limited by design flaws and although the TEC set clear goals, it did not establish an implementation mechanism. Corruption in and ineffective monitoring by local environmental protection bureaux are commonplace. The lack of funding and human resources also impedes monitoring. Many power plants themselves do not have an internal emissions monitoring system. Economic obstacles and planning limits a lot of the existing air pollution initiatives.96 Trades can take place outside permit schemes as they are taking place elsewhere in the world provided they make commercial sense.

92.

93.

94.

95. 96.

Ibid. Several private sector companies have invested in the carbon reductions generated by the pilot scheme. “Developing Mitigation Projects: Top Available Offsets – Straw Bale Home Construction Project.” http://www.climateservices.com/proj_avail_straw_bale.htm. “RFF Team to Help Chinese Province Develop Air Pollution Permit Trading System.” Resources. Winter 2001. http://www.rff.org/resources_archive/pdf_files/142_goings_on.pdf. Personal communication, Xueha Zhang. Resources for the Future. July 31, 2001 Personal communication, Elvis Au. 25

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA

Establishing a Regional or National Emissions Trading Program in China The next step up could be a regional scheme for several provinces

Regional or National Emissions Trading Program in China has the potential to achieve environmental management goals efficiently and cost-effectively. Before a substantial program can be established however, there must be a strong policy commitment by the central government to the system with broad based support among the povincial authorities and the industry participants. If a national scheme is too complicated to consider, the Chicago Climate Exchange initiative for seven US states may provide an example for provinces to group together to create a regional scheme as the next step up from the current small scale pilot schemes in various cities and areas.

Key criteria for implementing successful trading regimes Factors to consider when designing a system for China

Drawing from the US experiences with SO2 trading and other emissions trading initiatives worldwide, there is a general consensus on the most important issues that need to be addressed for a successful trading regime. Realism – Policies and instruments must be implemented within the available institutional capacity in order to be effective. Simplicity – A simple system is more likely to succeed, because it implies minimal restrictions on trade and streamlined administration and enforcement procedures. Gradualism – National or regional projects can be implemented gradually through the establishment of pilot programs or experimental programs. Establishing clear and enforceable norms, standards and guidelines is an important starting point. Commitment – There should be strong policy and political commitment to the system and its objectives from participating parties and the overseeing agency. Leadership – Those responsible for environmental management must lead the reform process by identifying stakeholders, constraints and the means for building consensus. Legal flexibility – Legislation must allow for potential low-cost policy revisions. Verification – There must be accurate and reliable systems of emissions monitoring and permit accounting. Compatibility – The scheme must be compatible with existing regulatory requirements, which should not restrict the scope for trade. Participation – Participation by stakeholders must be based on sharing information openly. Potentially contentious issues should be identified and avoided. Cultural specificity – To be successful, a regulatory program must take into account the culture in which it will be operating. Not all cultures, particularly in developing countries, have the same value system or the same historically market-based approach as the United States, where emissions trading was founded.97, 98

97.

98.

See Green Paper on Sustainable Energy. Annex 5: Potential Operation of a Tradable Permits Scheme. http://www.adnet.ie/gpse/a0501.html. John Palmisano: “Credit Based Environmental Programs: What has Worked and Why?” A Seminar Discussion Document. Kyev, Ukraine. March 2001.

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA Which gas should be traded? As a result of a State Council decision in January 1997, a national Air Pollution Index (API) was created and many large Chinese cities have begun making weekly – and, in the case of Dalian and Shanghai, daily – air quality reports.99 The API weights the concentration of a single pollutant by the health effects of that pollutant at varying concentrations in order to provide a good air quality guide. The API is not directly comparable with indexes used overseas, where several pollutants are combined into a single index.100 Weekly APIs for the three major pollutants, SO2 and NOx, and total suspended particles (TSP) are now published in many Chinese cities. These pollutants, in addition to the GHGs targeted for trading under the Kyoto Protocol, are all possible candidates for trading. Sulphur Dioxide could be traded regionally and carbon dioxide internationally

However, the two with the most potential are clearly SO2 and CO2 trading. They are the ones with the greatest interest and for which there is past experience from other countries as well as pilot projects already on-going in China. The status of the various gases are listed below: Sulphur Dioxide The US experience with SO2 trading provides a good example for China; the US program could serve as a template; existing projects by EDF and RFF should provide useful insight; Certain areas in China are already targeted for acid rain control and, thus, there is an incentive for authorities and industry to lower SO2 levels. The dispersion of SO2 in the atmosphere and acid rain is a trans-boundary problem, thus an environmental security issue. China has already set a tonnage cap on SO2 in the Tenth Five-Year Plan. SO2 levels are easy to measure. Carbon Dioxide In the international arena, priority is given to concerns about global warming and GHGs. Most of the emissions trading initiatives outside of the US in progress today are opting for carbon permit trading. The Kyoto Protocol specifically targets GHGs emissions trading. China will have to reduce its GHGs at some point in the future. Estimates of the global CO2 market are in the range of US$100 billion per year. The international environmental community may provide more financial support for carbon emissions trading, and countries with experience and a sound system will be the ones to attract carbon funds. Thus, the sooner China begins to gain experience, the better positioned it will be to take advantage as the market develops.

99.

100.

US Embassy Beijing: “PRC Air Pollution: How Bad Is It?” June 1998. http://www.chinaenvironment.com/air/index.html. Ibid. 27

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA Other possibilities NOx: Guangzhou has some of the highest NOx levels in China and NOx is the main component of smog and a main precursor in the formation of ground level ozone. Weekly monitoring in Guangzhou has indicated that NOx, mostly from motor vehicles emissions, is the major pollutant 94% of the time.101 Other GHGs: Methane (CH4), Hydrofluorocarbons (HFCs), Perfluoro-carbons (PFCs), and Sulphur Hexaflouride (SH6).

Establishing clear boundaries for emissions permit trading It is not easy to design a system

The development of a comprehensive national emissions permit trading system in China would require consideration of all design aspects of the initiative including how permits or credits should be issued, to which GHGs should be monitored, to how to ensure compliance with the system. These design elements for a successful permit-trading program are summarized in the following questions: What sources should participate in the scheme? How will permits be allocated? How will emissions be monitored? How will transactions be monitored? What penalties will be set to deter non-compliance?

Which emissions sources to include?

Which emissions sources should be included? Some of the main polluters in China today are electric utilities and cement factories. Other industries with fuel burning equipment include steel mills, petroleum refineries and chemical factories. Regulators must consider if small emissions sources should be included or if only large industrial sources will be included. The benefits of including an opt-in option, under which any emitting source has the option to participate voluntarily, should be considered. Geographic issues must be taken into consideration when deciding which emitters should be involved in the program. The concentration of industries in certain regions may affect emissions transport within the region, so that downwind areas will be more affected by pollution.

Fairness is important

Issuing the permits The initial distribution of permits is one of the most important design considerations in a tradable permits scheme. When many industries and companies are involved, one major issue in establishing an emissions trading system and determining its potential for success is the perceived fairness of the system and the major equity concern is the distribution of permits.

101.

US Department of State, China Embassy: “China’s Development of Alternative Fuel Vehicles.” 8 December 1998.

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA One option for initially distributing permits among emitters is “grandfathering,” which involves allocating permits to emitters in proportion to their historical emissions levels. This approach implies that emitters would only purchase permits to support emissions requirements over and above their initial permit allocation, rather than purchase permits for all the emissions they release. By minimizing the amount of change that current emitters face in adapting to emissions restrictions, this option has the benefit of cushioning the transition period. Grandfathering would work where there are sufficient historical records, which may be difficult in China. However, the grandfathering option raises a number of efficiency and environmental effectiveness concerns. Grandfathering may give incumbent firms an artificial advantage over newcomers or international competitors, may provide inducements for firms to delay abatement action or increase emissions levels and may not provide an incentive to develop innovative ways of reducing emissions. In addition, because of the high cost of building new units, older power plants may continue to emit pollutants at much higher rates, and operate for far longer than their original design lives.102 Auctioning permits is another option

Permits may also be allocated by auction, a method of distribution likely to pose fewer efficiency concerns than administrative allocation methods. However, auctioning would entail a more radical change for the bulk of emitters, who are currently not subject to any explicit emissions charge or restrictions on GHGs output. Industries with limited ability to absorb cost increases would be hardest hit by a requirement to pay for emissions and might be less competitive as a result. In order to achieve equity objectives, auctioning would need to provide for supplementary assistance mechanisms.103

There are also other ways to issue permits in a manner acceptable in China

In establishing an emissions permit trading system for China, permits would not have to be allocated exclusively by grandfathering or auctioning. Other possible approaches to distribution might involve a combination of grandfathering and auctioning, so that part of the stock of available permits would enter the market through free or concessional allocation, and the remainder would enter through auctions. Permits could also be allocated as a reward for early abatement action on the part of emitters, reserved for future periods to assist in long-term planning, or negotiated in binding industry agreements.104

Monitoring could be expensive though

Monitoring Emissions Perhaps the main concern affecting the success of any emissions trading system is the means that will be used to ensure compliance with targets and timetables. To verify compliance with emissions limits, pollution emitted by each source must be measured accurately. China’s PLS is based largely on the integrity of self-reporting among polluters. In this system, the local environmental authorities check polluter reports in several ways: through internal consistency of reported data, consistency with material balance models, historical data from the facility, direct monitoring, and surprise inspections.105

102.

103.

104. 105.

In the US, coal-burning electric generating units built after 1970 were limited to 1.2 pounds of SO2 emissions per million British thermal units (Btu), and by 1977 new plants were forced to meet a percent reduction requirement in addition to the 1.2 pound limit. However, older coal-burning units continued to operate far beyond their original design lives because of the cost of building new units, and consequently emit pollutants at much higher rates – up to 7 pounds of SO2 per million Btu. Asian Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 22. Australian Greenhouse Office: “National Emissions Trading: Issuing the Permits.” Discussion Paper no. 2. June 1999, p. 8. http://www.greenhouse.gov.au/emissionstrading/paper_2.pdf. Ibid., p. 9. Hua Wang and David Wheeler: “Endogenous Enforcement and Effectiveness of China’s Pollution Levy System.” World Bank Development Research Group. 2000, pp. 9-10. http://www.worldbank.org/nipr/work_paper/hua/levywp2000.pdf. 29

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA The US Acid Rain program has implemented a Continuing Emissions Monitoring (CEM) system that keeps track of the quarterly reports of hourly emissions data. CEM systems include SO2 pollutant concentration monitors, NOx pollutant concentration monitors, monitors for other gases including O2 and CO2 and a computer-based data acquisition and handling system for recording and performing data calculations. All CEM systems in the US are in continuous operation and must be able to sample, analyze and record data at least every 15 minutes.106 A CEM system must be certified before it can be used in the emissions trading program. The equipment must be acquired, certified and operational by the dates set for the start of the program and must undergo performance testing throughout the life of the equipment. In the US, emissions data is then reported on the Acid Rain Program website. More than 90% of hourly emissions data for affected units is received electronically, and the US EPA tracks compliance by correlating the data with the allowance record for each unit. Formulas based on technology and fuel use are another common method for determining compliance with environmental regulations. Across the industry, however, 1995 emissions measured with CEM systems averaged 7% higher than emissions calculated with formulas.107 The cost of monitoring this type of system in China would be substantial. In the US, the total cost of installing and maintaining the CEM system could approach the savings attributable to emissions trading.108 Although CEM systems are the accepted industry standard for measuring emissions levels and provide accurate accounting of emissions in the US, cheaper models for use in China should be investigated, including using formulas to calculate emissions. An emissions trading scheme in China would not require total accuracy of inventory data in order to assess compliance with emissions targets, though removing systematic biases would be important.

Tracking permits is crucial to a trading system

Monitoring transactions Tracking permits is crucial to the integrity of the permit trading system. In order to track allowance transactions and the status of allowance accounts, the US EPA has instituted an Allowance Tracking System (ATS). This electronic record keeping and notification system is the official tally of allowances that the US EPA uses to determine compliance with emissions targets. Any party participating in the trading system opens an ATS account by submitting an application. The account contains information on unit account balances, account representatives (which must be appointed by each trading party), and serial numbers for each allowance. The computerized nature of the ATS expedites the flow of data and assists in the development of a viable market for allowances.109 Currently, the US system requires a paper form to be signed by both the buyer and seller of the allowances but a monitoring system to be implemented in China could allow utilities to submit allowance transfers electronically with just the signature (or electronic equivalent) of the seller. The US EPA has two staff members processing most allowance transactions within one day of receipt.110

106.

107.

108.

109. 110.

“US EPA Acid Rain Program CEMs Factsheet.” http://www.epa.gov/airmarkets/monitoring/factsheet. html. Asia Development Bank: “Emissions Trading in the Energy Sector: Opportunities for the People’s Republic of China.” September 1999, p. 25. Ibid. The projected savings from the overall design of the US Acid Rain Program are about $2.5 billion per year. Savings that can be attributable to allowance trading have not been estimated directly, and the contribution of allowance trading may be less important than some other features. When the acid rain program is fully implemented, it will include 2,000 units, each of which must have a continuous emissions monitoring system installed. The annual cost of a single system is about $125, 000, so that the total cost of these systems will be about $250 million annually. As a developing country, China should preferably investigate acceptable but less costly means of measuring emissions. “US EPA Acid Rain Program.” http://www.epa.gov/acidrain/overview.html#princips. Ibid.

ESTABLISHING A REGIONAL OR NATIONAL EMISSIONS TRADING PROGRAM IN CHINA Consistent enforcement remains difficult in China

Enforcement In any pollution regulation scheme, penalties must be set to deter non-compliance and both the US Acid Rain Program and the PLS impose penalties for excess pollution. In China, for the monthly/quarterly levy, polluters have a 20-day grace period to pay the calculated levy, after which the required payment increases by 0.1% per day. However, regional enforcement practices vary greatly.111 Inaccurate reporting and/or non-cooperation with government inspections incurs penalties, and irreconcilable disputes are taken to local courts or to higher-level environmental authorities. To deter non-compliance in a tradable permits scheme, the penalties imposed must be greater than the marginal abatement cost for a firm. In the US Acid Rain Program, firms whose emissions exceed the number of permits held must pay a US$2000 fine per ton of excess SO2 or NOx emitted. In addition, the source must purchase allowances for the excess pollutants.

Establishing rules for emissions credit trading In implementing a national credit trading system in China, there would be fewer design features to consider because regulators must review each potential trade. For the program to be successful however, clear rules for trading must be set. In the US credit trading programs, emissions reduction credits (ERCs) are the “currency” of emissions trading. In order to be certified as an ERC by the regulatory agency, a reduction must meet four criteria: Surplus – The reduction cannot be required under current regulations. Permanent – The reduction cannot be temporary or periodic. Enforceable – The reduction must be legally binding and enforceable by the regulatory agency. Quantifiable – The reduction must be measurable and/or quantifiable. Closing an emissions source or decreasing production are the most common ways to create ERCs, however, ERCs can also be created by modifying production processes or installing new, pollution reduction technology. A credit trading system in China could be modeled after the US ERC system.

111.

Polluters are required to report increased discharges, and rebates are possible when pollution reductions are verified. The levy can be reduced or even eliminated at the discretion of local regulators after appropriate inspections. The levy may also be postponed if the polluter cannot afford to pay it, although reductions or exemptions are not allowed in such cases. Hua Wang and David Wheeler: “Endogenous Enforcement and Effectiveness of China’s Pollution Levy System.” World Bank Development Research Group. 2000, p. 10. http://www.worldbank .org.nipr/work_paper/hua/ levywp2000.pdf. 31

CONCLUSIONS AND RECOMMENDATIONS

Conclusions and Recommendations

More experimentation would be useful

ince the 1980s, China has stepped up efforts to deal with the ever-increasing problem of worsening GHGs. However, programs targeting large reductions in emissions are unlikely to be achieved through the current PLS. Most of the cities targeted for pollution control in China have failed to meet targets. A tradable emissions permit system may be a better solution that reconciles the desire to significantly reduce emissions with the desire to minimize the cost of emissions reduction. Attention should also be given to trading possibilities outside permit schemes.

The Kyoto Protocol set the stage for opportunities

There appears to be an undercurrent of support for the concept of emissions trading in China, hence the ability for non-profits to engage in trials. Over the next two years, the rules for emissions trading, Joint Implementation and the CDM will be established as part of the Kyoto Protocol. The CDM has the potential to both attract foreign direct investment as well as mitigate China’s GHGs emissions. It is important for Chinese policy-makers to explore opportunities since the potential market for CO2 especially, and SO2 to a lesser extent, should be attractive.

Civic Exchange makes the following recommendations: Encourage regional partnership

Take a strong interest – The Chinese Government should recognize emissions trading as a viable, cost effective means of reducing the impact of climate change and take a strong interest in its development by encouraging regions to collaborate.

Explore an appropriate CO2 pilot as it will have greater international interest

Identify a CO2 scheme – It would be useful to also identify an appropriate CO2 trading scheme since this will have more financial potential for international community.

Beijing Olympics 2008 is a chance to showcase Chinese efforts to environmental protection

Consider a scheme with Beijing at the center – With Beijing hosting the Olympics in 2008, this may offer an exciting opportunity for China to showcase its various efforts to clean the environment.

Shanghai’s role

Consider Shanghai’s role – Shanghai is China’s foremost domestic financial center. It should have a role in any eventual inter-provincial or national scheme.

Hong Kong’s role - a South China pilot scheme

Consider Hong Kong’s role – China’s Special Administrative Region of Hong Kong should consider what role it can play in the international developing emissions trading market. It is the country’s most sophisticated international financial center and should be well-placed to consider possibilities once it focuses on the matter. Hong Kong should be able to explore commercial trades that do not have to be a part of a permit system as well but few people at this moment understand enough about these developments. To enhance its role as Asia’s World City and premier financial center, exploring a strategic role for itself is just the sort of challenge Hong Kong should adopt. Hong Kong may wish to examine what it can do with the provinces in South China in developing a regional pilot trading scheme.