Carbon Trading: Market Mechanisms

The Power of Markets

After conducting a survey and calculations, Yanshan Petrochemical found it could get a carbon dioxide discharge quota of about 3.91 million tons a year, which is expected to drop from 2013 to 2015 by 2 percent on a yearly basis, representing 70,000 to 80,000 tons of emissions. As a heavy industry, however, Yanshan needs to expand and transform its operation, as well as install new equipment to increase production, which would definitely result in increased energy consumption and carbon emissions.

In the new carbon trading market, rigid emission-reduction policies have turned into a market-driven system. Under this system, companies have two options: either pay for extra carbon quotas every year, or introduce energy-saving technologies to reduce energy consumption.

Choosing the former involves higher and higher costs; while choosing the latter means companies would need to close down outdated production facilities and improve technologies, which would give rise to expenditures, but in the long run could increase productivity as well as gain better social benefits. After researching the carbon market system over the last couple of years, Yanshan Petrochemical took the initiative to look for “black holes” in energy consumption. It has recycled waste heat, optimized the steam system, carried out technological renovations and adopted information technologies to sharply reduce energy consumption.

“Environmental protection cannot only rely on government subsidies, or administrative commands, or fines,” said Qian Guoqiang, strategy director of Sino Carbon Innovation Investments, “We should introduce a market mechanism. Nothing but the constant power of the market will provide a fundamental solution to improving company environmental awareness.”

From as early as 2005, when he worked at the Ministry of Foreign Affairs, Qian has engaged in international negotiations on climate change and domestic policymaking. He co-founded Sino Carbon in 2010, aiming to promote low-carbon development in China. In 2013 he was elected a member of the Joint Implementation Supervisory Committee (JISC) for the United Nations Framework Convention on Climate Change. Qian has witnessed the entire process of China’s construction of carbon trading markets in the last decade.

He observes that some companies are shortsighted, as they see the carbon market as a burden, rather than actively adapting to the new trend and rules. In reality, emissions reduction is directly related to a company’s efficiency and innovation capacity. “If others use only three units of resources to produce an item and you use five,” Qian said, “without competitive advantage, the market will eliminate you.”

Thus far, the EU, New Zealand, Australia, Japan and California in the U.S.A. have adopted the carbon market system. Qian believes that carbon emissions will become a key product data in the future, and once foreign markets have a relatively mature mechanism they may even set up trade barriers in the name of carbon emissions.

How the Market Operates

The over 490 companies participating in carbon trading in the Beijing market account for about 40 percent of total carbon dioxide emissions in the capital. According to Beijing regulations, if a company’s direct and indirect carbon dioxide emissions exceed 10,000 tons a year, it must meet its obligations to control carbon emissions. These companies, referred to as regulated organizations, comprise the main body for carbon emissions trading. Those with complex energy consumption of over 2,000 tons of standard coal can voluntarily participate in the market, and are known as voluntary organizations.

The whole process of carbon emission trading includes five steps – emissions data reporting, third-party verification, quota allocation, trading, and implementation. Every year, a company must report its emissions data of the previous year to the Beijing Municipal Commission of Development and Reform, and receive independent verification from third-party organizations. The commission then allocates an annual quota for carbon emissions. After receiving its electronic-certificate quota, the company may buy or sell quotas in the market, with the quota cleared every year.

“Our carbon trading center is responsible for the ‘trading’ step,” said Wang Yang, director of the Carbon Trading Center of the Beijing Environment Exchange (CBEEX). In the hall of CBEEX, successful trading information is repeatedly displayed on a giant screen. The trading parties, via a computer installed with a digital trading platform system, can directly trade by entering purchase prices and emission quantities, all accomplished quite conveniently.

This handy trading process is backed with a precise but bulky information system. To build a carbon market, most important is genuine, accurate and comprehensive data on carbon emission. The NDRC told China Today that the preparation for all the five pilot markets took several years. On the one hand, they had to carefully calculate the total control targets for greenhouse gases by 2015; on the other hand, they called for bidding to select independent third-party organizations to conduct comprehensive and in-depth examinations on trading companies, and collected a large amount of reliable firsthand basic data. The unified standards used in data collection and emissions calculation buttress companies’ trust in the carbon transaction, so they more readily accept the data.

Another key link is quota allocation, which not only relates to company costs of production, but also to the level of the carbon price. Thus far, there are two popular allocation methods used across the world – benchmarking and grandfathering. The benchmarking quotas are allocated according to the benchmark emissions of an industry, while the grandfathering allocation is based on historical level of emissions. The five pilot markets have adopted the two methods and demonstrate much flexibility in operation.