Pricing Emissions
Keep an Eye on China’s Carbon Market

Regional carbon markets are tricky endeavors, but China hopes to succeed where Europe has failed when it unveils its own emissions pricing system. China’s ambitions are high, but as Bloomberg reports, it isn’t clear that Beijing has a solution to the problems that have plagued the European Union’s Emissions Trading System (EU ETS):

The government wants to put a cost on emissions of toxic smog to control pollution in industrial cities, starting with Beijing. The market may trade as much as 408 billion yuan ($61 billion) of certificates a year, a step toward making the economy more transparent to outsiders. And it’s good public relations, showing China is serious about climate change. Regardless of the motivation, China’s move marks the biggest yet to use a market-based approach to control pollution, exceeding the scale of Europe’s $55 billion a year system. […]

Whether China’s program forces actual emissions cuts won’t be known for years. There’s also the question of why China can make trading work when others have failed. To that, proponents say China may simply be getting in on a growing market. […]

China’s market must overcome several hurdles including “the need for emissions monitoring and reporting at the level of every major emitting facility,” said Frank Jotzo, deputy director of the Crawford School of Public Policy at the Australian National University. It also may face an oversupply of permits in the first three years of its program because allocations are based on years when industrial output and emissions were higher, said Sophie Lu, a Beijing-based analyst from BNEF.

China’s system is set to displace the EU ETS as the world’s largest carbon market, but its size is still problematic for its goals. Beijing will have to carefully monitor the price of carbon in its market—if allowances are too plentiful and the price drops too low, polluters will have little incentive to change their behaviors, but if the price of carbon becomes too expensive, businesses will up and move production outside of China. That latter possibility, called carbon leakage, is the worst-case scenario, because it hamstrings economic growth without actually addressing emissions.

Fear of carbon leakage is strong enough that most carbon markets tend to err on the side of a too-low price, over-allocating permits in the early years to ease the transition. In the EU, this initial over-allocation, combined with the bloc’s economic struggles in the aftermath of the 2008 financial crisis, has led to a much too-low carbon price, and at this point any sane observer would have to label the ETS a failure.

Beijing will hope to avoid this fate, of course, but finding that Goldilocks price is demonstrably difficult, and moreover becomes a never-ending process—you don’t just arrive at a magical price one day and declare the job done. China will also have to deal with the notoriously poor record-keeping of its local provinces, a wrinkle that the EU by and large has not encountered but will surely make life more difficult for the market’s monitors.

The more regions that adopt carbon pricing systems, the fewer options polluting industries have for relocating their more emissions intensive production. To that end, China’s impending implementation of a carbon market is a step in the right direction towards curbing global emissions, but there’s still plenty that can go wrong. We’ll be keeping a close eye as Beijing rolls this out.

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