Will China’s Panda Market be a Bear or a Bull for International Carbon Linking?

By Jasmine Hyman and Jonathan Smith

The Ring of Fire is ablaze with the new carbon trading schemes sweeping around the Pacific Rim. New Zealand is home to the first mandatory trading scheme outside of the EU, and the governments of both California and Australia have recently approved trading programs that will become operational in the coming years. Japan, which is pulling out of the Kyoto agreements in 2012, has been proposing the widespread adoption of bilateral carbon offset mechanisms for countries no longer part of those agreements, and at the municipal level, both Tokyo and Saitama are experimenting with urban carbon markets. Meanwhile, China and South Korea have plans to scale out national emissions trading schemes by 2015 as well.

Investors worldwide are taking note of these developments in Asia. At a recent China-sponsored side event at the climate negotiations in Durban, Henry Derwent, CEO of the carbon market’s International Emissions Trading Association, praised Asia as being the epicenter of the fastest growth in the carbon market, and noted that surveys indicate that of all the new trading programs developing around the world, participants in trading schemes have the most confidence in those that are being created in Asia.

China in particular has been the focus of attention ever since the controversial launch in 2009 of its “Panda Standard” with BlueNext, one of the leading environmental exchanges originating from the EU. This past year, the Chinese government announced that as part of the carbon intensity and energy intensity targets of its 12th Five Year Plan (2011-2015), seven pilot carbon trading schemes will be launched in provinces and cities: Beijing, Chongqing, Guangdong, Hunan, Shanghai, Shenzhen and Tianjin. Officials hope that these market-based programs will assist China in meeting its pledge to reduce nationwide carbon intensity (emissions per unit GDP) 40-45 percent below 2005 levels by 2020.

China’s domestic carbon trading scheme elicits equal parts confusion and optimism. The exact structure of the pilot carbon markets has yet to be worked out, as Tsinghua University’s Teng Fei noted in a Durban side event earlier in the week. One major point to work out is whether these pilot programs will cap emissions on an absolute basis, or per-unit of GDP basis. China is also looking at the Tokyo program, which bills itself as the “World’s First Urban Cap-and-Trade,” to see whether it should copy Tokyo’s end-user cap on building and facility owners, or follow the more traditional, EU-style cap on producers such as factories and power plants. And it is still unclear whether the pilot programs will be uniform in structure, or tailored to the specific circumstances of each province and city.

While Mr. Derwent maintains that it is “far too early to think of Chinese markets demanding international credits,” Li Junfeng of the Energy Research Institute of China’s National Development and Reform Commission did indeed indicate that the ultimate trajectory of China’s carbon markets are to eventually join a global market.

But stitching together the current patchwork of trading schemes will be challenging. On the international level, linking China’s trading schemes to its neighbors will be difficult, if not impossible, especially if the Chinese programs quantify emissions reductions in terms of GHG intensity, rather than the international norm of issuing carbon credits for reductions in absolute GHG emissions. Linking to the Australian scheme, which will likely be one of the largest sources of credit demand in the region, will also be complicated by the Australian system’s use of a floor price. It remains to be seen how carbon credits from other schemes will meet the floor price in order to circulate within the Australian market — will there be a top-up fee to the trader? A subsidy from the Aussies? Or no linking at all?

Leon Wang Liangling, Regional Manager for China and East Asia at The Gold Standard Foundation, a certification scheme for voluntary and CDM offsets, also points to internal tensions in bringing a market mechanism for pollution control to China. “Building a working, effective and efficient domestic scheme is highly challenging given the massive scale and high complexity of China’s economy. The truth is that those challenges that confront the trading scheme didn’t pop up only when the international climate talk heated up — they have been among the difficulties that China has to deal with in its market reform in recent decades.”

Worldwide interest in linking up the many regional carbon trading programs remains high. EU climate commissioner Connie Hedegaard confirmed plans to link the EU system with the what will soon be the second biggest emission trading scheme in the world: California’s. The EU has informed California that they hope to collaborate to ensure that their two programs are linkable. “It doesn’t have to be identical, just compatible,” Hedegaard notes.

With the potential of China’s scheme to be the largest in the world, pressure to make the Chinese system compatible will likely be high as well. It is up to China whether its carbon market will be a conservative bear that protects national interests, or an energetic bull pushing for global carbon market linkages.