Exploring Carbon Mitigation Instrument Choices And The Policy Implications For China

In a submission to the UNFCCC (United Nations Framework Convention on Climate Change), China has promised to cut its CO2 emissions per unit of gross domestic product by 60-65% from 2005 levels by 2030 (Ponthus,2015). Such commitment to carbon abatement is ambitious and thus calls for more concrete policy instruments. This paper aims to explore a set of policy instruments for China’s carbon mitigation pledges.In a bid to fulfill the pledge, China has been making efforts to mitigate carbon emissions. For example, the National Development and Reform Commission (2014) outlined five strategies for China’s carbon mitigation efforts:(1) adjusting industrial structure, (2) conserving energy and improving energy efficiency, (3) optimizing the energy structure, (4) controlling emissions not directly from the energy industry and (5) increasing carbon sink. These command-and-control strategies, although with good intentions, may incur unintended consequences. The unintended consequences are known as the supplier behavior induced "green paradox", and the consumer behavior induced "energy paradox" and "rebound effect".Climate policymakers should be aware of these unintended consequences because they can potentially offset carbon abatement efforts or even backfire. Factoring the unintended consequences into climate policymaking suggests that command-and-control policies should be implemented together with a market mechanism. Pricing carbon can be a more efficient approach because carbon prices are a more salient signal than returns on investments in energy efficiency. It also makes sense to pay the cost of carbon emissions at the source where choices about fuel use are made.There are two main types of carbon pricing:carbon taxes such as Pigovian tax and emission trading systems (ETS). The latter is based on the Coase theorem and is at the center of this discussion. Carbon trading systems fall into two main categories, namely the mandatory emission trading system and the voluntary carbon offset market. Under the mandatory emission trading system, there are allowance-based systems such as cap-and-trade and baseline-and-credit systems, as well as project-based mechanism such as CDM and JI.China joined the Kyoto Protocol in August 2002 and has been the main supplier of carbon emission rights through Clean Development Mechanism (CDM) projects. Through cooperation between Annex I developed countries and non-Annex Ⅰ developing countries, CDM projects assist Annex Ⅰ countries in realizing their emission limitation and carbon abatement commitments. However, CDM mechanism is project-based and relatively small in scale compared with the impacts of command-and-control regulations as well as ETS. The project-based mechanism also tends to focus on certain sectors while an ETS covers all carbon-emitting sectors.In addition to CDM projects, efforts are now under way to prepare regulations to implement the national cap-and-trade system. Starting with the Shenzhen pilot in June 2013, China’s seven cap-and-trade pilots have been up and running.At the heart of an effective cap-and-trade system is the carbon pricing issue. Ideally carbon pricing should reflect the optimal social coast of carbon in the jurisdiction. In climate studies, integrated assessment models (IAMs) are used to estimate the optimal social cost of carbon (SCC). A study by the U.S. Government Interagency Working Group on Social Cost of Carbon (2013) uses SCC values from the three IAMs and concludes the SCC estimate is $40 per ton of CO2 emitted today. However, each jurisdiction has its own features such as population, economy and natural endowment etc, and should use specific parameters to calculate its own optimal SCC. China’s current carbon pricing is at the lower end of the carbon tax range when compared to the carbon taxes in other countries and regions. The current carbon prices vary from less than$1 per metric ton in Poland and Mexico to over$130 per metric ton in Sweden (World Bank,2015). As a matter of fact, according to a World Bank study (2015), among about 40 national jurisdictions and over 20 cities, states, and regions that price carbon emission,85% of the carbon emissions are priced at less than US$10 per tC. The World Bank concludes that "the existing carbon prices are considerably lower than the price that economic models have estimated is needed to meet the 2℃ climate stabilization goal recommended by scientists"Apart from the carbon pricing issue, China is also faced with severe structural barriers that could impede the launch of an efficient national cap-and-trade system. Among the challenges,1) monitoring, reporting, and verifying carbon emissions,2) integrating state-owned enterprises into the cap-and-trade system,3) resistance from the strictly regulated power sector and 4) some major carbon emitters are not well targeted call for complementary policies to ensure the cap-and-trade systems are feasible. The monitoring, reporting, and verifying challenge come from the non-unified monitoring protocols among the seven pilot programs as well as the "statistical corruption" problem. Some strategies adopted by the pilot programs can be included in the design of a national cap-and-trade system to address "statistical corruption" in the process of monitoring, reporting, and verifying carbon emissions. For example, the Guangdong pilot program encourages compliance through a noncompliance fine, periodically publicizing the compliance status of firms, and granting priority for national low-carbon development funding to firms in compliance with the carbon market (Munnings et al., 2014). The second challenge discussed in the paper arises from the critical importance of and resistance from China’s SOEs in carbon abatement. Despite a rather small number, SOEs account for 38% of China’s total industrial assets and are mostly in carbon intensive industries such as the military defense industry, the utility and power generation industry, the oil and gas industry, the coal industry, the telecommunication industry, the civil aviation industry and the shipping industry. Thus integrating SOEs into a cap-and-trade system is likely to experience resistance from the carbon intensive enterprises. The heavily regulated power generation industry, for instance, does not provide a favorable environment for implementing a carbon cap and trade system. The main reason lies in the lack of a cost pass-through mechanism in the existing tariff structures and potential objection from the generation companies and utilities. In light of the challenges for implementing a national cap-and-trade system, the researcher proposes to enhance the legal foundation, and clarify the cap-setting process for cap-and-trade. Cap-and-trade pilots and the upcoming national system should also move from free allocation to auction so as to shift the costs of implementing carbon market from consumers to producers.*Additionally, the regulator should strengthen the compliance process by incorporating policy-enforcement experience from cap-and-trade pilots. Furthermore, complementary actions should be implemented to coordinate with the launch of a national cap and trade program.The paper also reviews the carbon abatement policies in the US, the EU, Japan and South Korea. Despite distinctive approaches, the carbon abatement efforts in all four jurisdictions address emissions in power generation, transportation, and buildings. They all provide financial incentives for renewable energy. The policy implications for China are that China should a) reform the tariff structures in the power sector; b) implement upstream trading plus efficiency standards in transportation sector; c) provide regulatory and financial incentives for adopting renewable energy.