Coal Shortage Causes Short Supply of Power in China

China’s highly anticipated pilot carbon markets are up and running, with the notable exception of Chongqing, but already the lack of transparency, pressure from big business and government-owned enterprises, manipulation of data and over allocation of allowances are proving to be hurdles for success. High levels of liquidity are not the end-goal for a carbon market – that is just a tool to reduce carbon emissions over the long term – but the low levels of trading seen in China point to a bigger problem.

The hurdles – an unwillingness to share data and a preponderance of data manipulation by those trying to game the system – are ubiquitous in China. In a play on Beijing’s attempts to qualify their economic system as capitalism with Chinese characteristics, many in country have taken to using the term “Chinese characteristics” as a sort of catch-all phrase, tying in inconsistencies in method with a stated end result. The term is aptly applied to China’s seven pilot emission markets, with long-term implications on the success for a national market (expected to be announced sometime during the next five-year plan, 2016-2020).

Pilot Project

To much fanfare, in 2009 China announced it would cut its carbon intensity – a measure of pollution by GDP growth – by 40% by 2020. To realize that plan, two years later Beijing directed key cities and provinces to pilot carbon emission markets. Together these markets – Beijing, Guangdong, Tianjin, Hubei, Shanghai, Chongqing with Shenzhen opting in later – cover a population of 250 million and 27% of China’s 2010 GDP. The results from these pilot exchanges are set for review at the end of 2015.

carbon map

Huge Progress, but Hurdles Remain

Local governments have done an extraordinary amount of work getting their pilot projects up and running, but the market seems tepid at best. It’s not hard to fault Chinese companies for not having more enthusiasm for the program; the pilot programs are designed to morph into a national one during the next 5-year plan. This breeds uncertainty in the market and the lack of transparency adds just one more hurdle.

Control of establishing and running the market was handed over to the local governments, which Jeff Schwartz, international policy director at the International Emissions Trading Association (IETA) points out is a big task for bodies that don’t have the best environmental track records. Still, Schwartz adds that the local government bodies “have done a very good job of getting all of the right ingredients there.”

Over allowance has been a big dampener for trading; companies that have 100% of their pollution allocations for free have no reason to go to market. Beijing, Shanghai, Shenzhen, Tianjin and Chongqing all offer free allowances based on past levels, with Guangdong offering free allocations for 97% this year and Hubei offering 92% of allowances for free.

The lack of transparency in the markets is dampening market interest, according to Schwartz. Unlike in more mature emissions markets, in China companies only know the emission levels for their sector, not for others in the exchange. This makes it nearly impossible for them to estimate whether it’s a smart financial move to reduce emissions in order to sell permits on the market. Or what the penalty would be if a company needed to buy extra permits for over emitting. Data that is shared freely in the west is often coveted in China, and it’s likely the NDRC (China’s top economic body) has not given local governments permission to dole out this information.

With the lack of liquidity, prices for carbon haven’t been terribly exciting. IETA’s data shows that the average price for emissions ranges from 27 yuan per ton ($4.33/ton) in Tianjin on the low end to 70.5 yuan per ton ($11.31) in Shenzhen on the high end.

Furthering complicating matters is that carbon offsets – in the form of government approved projects – are typically only allowed within the confounds of the market. That means a Shanghai-based company that wants to use carbon offsets must find a project in the city, whereas most of the projects are located outside of major hubs. For a country that benefited from CDM projects with European investors, this is a curious regulation.

The localized nature of the exchanges adds another layer of complications. National companies, especially power producers, are dealing with regulations in six different areas, but are aware that none of the plans is likely to last more than a few years.

The combination of these characteristics will make evaluating what works difficult, meaning a national exchange will be built on what Beijing knows doesn’t work.

A Bigger End Game

While establishing a national market for emissions, where transparency is built into the system, would seem like the best move to ensure the market works, Beijing may have other motivations. The current system is not only giving Beijing a more nuanced view of where emissions are coming from, but also a way to manage them both centrally and locally. For China, emissions almost always come down to coal use, and the pilot projects will allow Beijing to better anticipate future coal demand. Any reform to the energy sector requires dealing with massive state-owned energy companies as well as the country’s politically connected coal barons. A reduction in emissions is a straight line to a reduction in coal use, but while the populace may back that measure, politically connected industries may balk.

While Beijing may have unstated goals beyond emission reductions, measuring the success of this initiative may be years off. For now, according to Schwartz, “It all comes back to this challenge; will the regulation change after 2015? That cloud of uncertainty is affecting people’s investment decisions.”