What You Need to Know About China's Cap-and-Trade Announcement

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We finally know what the big announcement for Chinese President Xi Jinping’s state visit to the United States is: China has announced a national cap-and-trade program designed to limit its overall emissions. The official announcement came at the Obama-Xi summit Friday afternoon; the New York Times broke the story on Thursday night, citing White House officials.

Under a cap-and-trade program or emissions trading system (ETS), a government puts a limit on the total amount of carbon dioxide emissions. This cap is set at a level that will lower the overall emissions in the target region; permits for emissions are then issued based on the cap. Businesses can then buy and sell these permits, allowing the market to regulate the cost. China’s national program, to take effect in 2017, will cover “industry sectors such as iron and steel, power generation, chemicals, building materials, paper-making, and nonferrous metals,” according to the just-released U.S.-China Joint Presidential Statement on Climate Change.

The announcement that China will institute a cap-and-trade program is a major step forward, but at the same time, a natural outreach of existing efforts. In fact, the move to a national ETS had already been announced in September 2014. At the time, a senior climate official with the National Development and Reform Commission said that China would roll out a national cap-and-trade market in 2016.

China began moving toward a national cap-and-trade program in 2011, when it announced the formation of seven regional, pilot emissions trading systems in its 12th Five Year Plan (covering the period from 2011 to 2015). Turning those pilots into a coherent national whole is the natural next step for the 13th Five Year Plan, a draft of which will be unveiled later this year.

The seven pilot ETSs were established in the cities of Beijing, Chongqing, Shanghai, Shenzhen, and Tianjin, with two provincial systems in Guangdong and Hubei. The first, in Shenzhen, opened in mid-2013; the last (Chongqing’s) came online in June 2014.

Ranping Song and Hongpeng Lei of the World Resources Institute noted that “the aggregate of all emissions regulated in China through the seven pilots” was expected to be “the second largest in the world, following only the European Union.” By July 2015, more than 38 million tons of carbon dioxide were traded in the secondary carbon markets of the seven pilot regions, according to data provided by the China Environment Forum at the Woodrow Wilson Center in Washington, D.C.

These pilots, however, are not a united whole. As Song and Lei of WRI pointed out when evaluating the pilots in early 2014, the systems have vast differences. Beijing and Shenzhen, for example, “have small industrial emissions and a large service economy” – meaning it’s easier for them to make rapid progress in curbing emissions.

But the differences in the ETS pilots are intentional. The unique systems are designed in part to account for regional variations and in part to help Chinese leaders decide which program is most successful. Jennifer Turner, the director of the China Environment Forum, told The Diplomat that the pilots “are truly laboratories for experimenting with different ways of doing cap and trade.”

“Not all are doing great,” Turner says, “but the trial and error can help them speed through the learning curve.” Turner points out that China successfully made a similar transition from pilot programs to a national ETS for sulfur dioxide in the early 2000s.

Still, it won’t be an easy to transition to a national cap-and-trade system by 2017. The pilot programs revealed some serious issues, most notably, says Turner, a “lack of transparency on emissions and pricing in some of the pilots.” Transparency – something China has often struggled with – will be vital for keeping track of the actual amount of emissions being released, where the emissions cap is set, and what prices are being charged.

China overall is making slow progress on pollution transparency. As local governments come under more pressure to halt environmental degradation, “the noose is tightening,” as Turner puts it. Guangdong’s pilot ETS could serve as a model moving forward;  according to Song and Lei, it is “the most transparent ETS pilot in disclosing not only the number of allowances allocated, but also those reserved for new entrants and government interventions to stabilize the market.”

Another challenge will be integrating the various pilots into one nationwide system. Turner suggests that the European Union’s system could be a preview of what we will see in China, with different levels of industrialization and development equating to different emission caps. Provinces that rely on heavy industry, such as Hebei, won’t face as steep of emissions cuts, while the more developed eastern provinces have more capacity to take on higher emissions standards.

Meanwhile, a nationwide ETS will be only one of many steps China’s government is taking to keep emissions down. The national ETS will work best in concert with these other efforts.

For example, new targets for lowering PM2.5 emissions are already putting pressure on local governments. The results have been noticeable: a roughly 16 percent drop in PM2.5 emissions since 2014, according to Turner – though the vast majority of cities still aren’t meeting their targets. In other words, local governments are already moving toward lower emissions; a new national ETS will only reinforce this behavior.

A concurrent push toward renewable energy will also help. The 2014 U.S.-China climate change agreement saw Beijing set a goal to have renewables account for 20 percent of its total energy matrix by 2030. China has been expanding its renewables “at a speed no other country has matched,” Turner says. Moving toward renewable energy, and away from a reliance on coal, will make the emissions reductions called for by a cap-and-trade system more feasible.

When evaluating the cap-and-trade announcement, Turner says, it’s crucial to keep in mind that “this didn’t just magically appear.” China has spent years conducting research and cooperating with international partners to lay the groundwork for a national ETS.  It’s “a very significant step for them to take and one that they have been building up to for quite a long time,” Turner concludes.

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