The Road Towards China’s Integration
Into an International Emissions
Trading System

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Executive summary

Learning for the future

The international debate on how to integrate China – the world’s biggest greenhouse gas (GHG) emitter – into the global effort to fight climate change has intensified. Because China has become the world’s largest host country for the clean development mechanism (CDM), there is mounting pressure on China to commit to GHG emission reduction. While international climate negotiations hardly show signs of progress, China’s domestic climate-related policy landscape is changing rapidly. The latest plans to establish local carbon trading programs has aroused policymakers’ curiosity. If China has gained capacities and positive experiences in the international carbon market as a CDM host country, and if it is now designing its first local carbon trading programs, is the long-term integration of China into an international emission trading scheme (ETS) promising? Based on the assumption that the emergence of an international ETS is a thinkable scenario, this paper reviews China’s experiences with the CDM and with initial SO2 emission trading experiments in order to deduce strategies for European policymakers to prepare for China’s long-term integration into a potential international ETS.

Building on common interests

Any future cooperation to establish an international ETS with China’s participation should build on this vast CDM experience. China’s experience with the CDM shows that an attitude of initial skepticism toward a policy instrument can change into strong support. Wary of the CDM at first, China has become host to the world’s largest number of CDM projects and has turned into an ardent advocate of the CDM and supports its continuation in the post-2012 commitment period. Under the current CDM architecture, the European Union (EU) and China have clear roles and share many interests as CDM market players.

Short-term options

However, prospects for developing CDM in China under the current project-based framework are less promising than they used to be due to a high degree of political uncertainty about a Kyoto successor treaty, possible changes to the CDM setup and the European shift in its CDM policy with respect to least developed countries. Short-term options of keeping up momentum for GHG mitigation in China are noregret policies, which are in line with its own interests in ensuring energy security, reducing energy import dependency and tapping into green technology markets.

Long-term options for post-2020

Introducing carbon trading in China at the national level and ultimately integrating China into an international ETS becomes thinkable as a long-term option. An appropriate strategy to enable the introduction of ETS in China should pay tribute to the typical Chinese incremental approach to policymaking: Once policy experiments prove to be successful at the local level, they are likely to be scaled up to the national level. Currently, ample local policy experimentation is occurring in China: The first carbon trading programs have been announced, low carbon development zones are planned, and several pilot projects in SO2 ETS provide good learning devices for a future nationwide ETS in China. Deciding on ETS design issues such as cap setting, timeframe and trading rules remain problematic, as do implementation issues such as administrative structures and enforcement capacities. Lessons learned from China’s experiments with SO2 emission trading reveal that problems arise, for example, from restricted competition between state-owned enterprises (SOEs), where monetary incentives lack vigor. In addition, the monitoring and enforcement capacity of local administrations are in need of improvement. Consequently, the pilot ETS have so far delivered few successful trades, whether in permits or in actual emission reductions. The major challenge remaining is thus the adaptation of ETS designs used in the United States and Europe to better fit Chinese circumstances.

The road ahead for Sino-European cooperation

If the international community wants to ease the integration of China into an international ETS, China’s interest in doing so must be heightened and its capacities strengthened. The following observations could serve as starting points for closer Sino-European cooperation on the road towards establishing an international ETS:

1. Sustaining China’s positive experience with the CDM is a prerequisite for Chinese support for the subsequent use of market mechanisms in the fight against climate change.
2. Joint Sino-European research programs need to systematically review China’s past and present experiments with local emission trading pilots in order to learn how to adapt ETS designs to Chinese circumstances.
3. International support is needed for capacity development of the regulatory institutions of any pilot ETS in China.
4. Close cooperation with the Chinese government is needed to make use of the opportunity to design the modalities of China’s first local carbon ETS, which might then be more easily integrated into a national or even international scheme.

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