China’s carbon market: Shaping climate policy cooperation for the next decade

4 August 2016

Amidst the flurry of carbon market developments around the world, the largest emitter is putting in place a national emissions trading system (ETS). Next summer China will launch the world’s largest cap-and-trade system. Considering this, China’s ETS will undoubtedly influence and shape climate policy developments worldwide. Policy harmonisation between China’s ETS and other cap-and-trade programmes – those in place or under discussion – will be key for the world to work together to address climate change swiftly and ambitiously.

China is acting on climate change. The Asian giant is moving quickly, seriously, and big. Faced with spiralling air pollution, which has created “Airpocalypses” in major Chinese cities, the country is wheeling out various policies to tackle its emissions.

China is no stranger to the concept of cap-and-trade. It helped pioneer the Clean Development Mechanism of the Kyoto Protocol and set up carbon market ”pilots” in Shanghai, Tianjin, Shenzhen, Chongqing, and Beijing, as well as in the two provinces of Guangdong and Hubei. These cities and provinces already have experience in dealing with the problem of soaring pollution. They have put in place emissions caps and engage in carbon trading, which will come in useful when they join China’s national carbon market in July 2017. Once the national ETS starts, it will be the world’s largest with a cap size of close to four billion tonnes – twice the size of the EU’s ETS which is the current mantle-holder of the largest ETS.

One of the provinces piloting an ETS is Guangdong – China’s largest population centre and the heart of the “made in China” economy. Its 105 million people now run industries and export goods that are subject to a carbon price to the US and other countries. California, which also launched a cap-and-trade system in 2013, quickly signed an agreement with Guangdong to share best practices in carbon market policy design so that the two regions can learn from and work with each other. Across China, technical agreements on ETS readiness implementation have been signed with the UK, France, Norway, Finland, Germany, Québec, the World Bank, and the European Commission. Many of the challenges with implementing China’s national ETS are being raised in government-to-government forums such as the World Bank’s “Partnership for Market Readiness (PMR)” and the EU-China Climate Programme. There are also business-to-business technical ETS dialogues such as those run by the International Emissions Trading Association’s (IETA) “Business Partnership for Market Readiness (B-PMR)” and through technical ETS trainings for Chinese businesses funded by the EU and Germany.  

But China could go further than these cooperation agreements on ETS implementation. When they are ready, China’s policymakers should look at the merits of linking China’s ETS with others in the region or joining a carbon market club that may emerge in the future. Any potential ETS linkage involving China would, however, first require that its carbon market is designed and implemented in a way that ensures environmental integrity and facilitates harmonisation with other systems in the future. This is crucial for China’s ETS to be compatible with other existing systems as well as to be consistent with the requirements on environmental integrity under Article 6 of the Paris Agreement.

China’s present and future cooperation and information sharing with other countries on carbon market design will undoubtedly help steer the process of linking in the future. Linking of carbon pricing policies can help reduce competitiveness and carbon leakage concerns and as such help countries go further in reducing emissions at lower cost, for example through the uptake of new carbon markets or greater ambition in existing ones. The UK Department of Energy and Climate Change (now merged into the UK Department for Business, Energy, and Industry) has estimated that linking could reduce costs for operators by up to 70 percent and enable global greenhouse gas reductions by an additional 40 to 50 percent at the same cost. Furthermore, with the inclusion of Article 6 in the Paris Agreement, countries, including China, now have a multilateral hook for carbon market cooperation and a permanent space for international carbon market discussions under the UNFCCC negotiations. Many developing countries and emerging economies will be watching closely how China decides to interpret and use this section of the Paris Agreement.

China is now slowly and quietly taking over the mantle of having the world’s largest carbon market once its ETS enters into force next year. The Asian economic powerhouse has sent a political signal to its trading partners that has the potential to create a dynamic towards an increasing uptake of ETSs. This, in turn, could enhance cooperation on carbon pricing through linkages and the development of a plurilateral carbon market club. China’s policymakers would be wise to consider the merits of policy harmonisation and linking with other ETSs as a way for China to help shape and influence the design of future carbon pricing policies and the ambition of climate policy in the years to come. 

Jeff Swartz is Director of International Policy for the International Emissions Trading Association (IETA). He is the author of the ICTSD issue paper China’s National Emissions Trading System: Implications for Carbon Markets and Trade.