Navigant Research Blog

In Shanghai, Carbon Goes on the Market

Alex Lauderbaugh — August 30, 2012

This month Shanghai began an ambitious emissions trading system (ETS) intended to curb carbon dioxide emissions.  Approximately 200 local companies will participate in the program, which targets industrial firms that produce more than 20,000 metric tons of carbon annually, and non-industrial firms that produce more than 10,000 metric tons a year.  Carbon permits will be free during the program’s initial phase, but then market forces will set the price.  The scheme will be based on the mechanics of the Shanghai Environmental and Energy Exchange, with significant funding from the Asian Development Bank.

Similar programs are planned in Beijing, Chongqing, Hubei, Guangdong, Shenzhen, and Tianjin.  While the nuances of each program will vary, these initiatives will act as pilot projects for a nationwide carbon trading scheme, set to be implemented by 2015.

Shanghai’s energy demand is forecast to nearly double by 2020 and, considering the country’s vast coal reserves, a corresponding increase in greenhouse gas emissions would be inevitable without some effort at reduction.  The question becomes: by choosing an ETS, has China selected the most effective policy to combat pollution while minimizing the social impact?

The two most popular policies for emissions reductions are carbon trading schemes and carbon taxes.  They are fundamentally different, and therefore, neither is considered a “one size fits all” solution.

Carbon trading, as in the Shanghai scheme, creates an absolute maximum to the emissions of a region or company (the “cap” in “cap and trade”) and allows the market to sort out the most efficient means for achieving that goal.  Trading systems create dynamic economic efficiency by allowing companies with the lowest abatement costs (the cost of reducing their pollution) to do so, and then profit by selling their unused permits.  Companies with high abatement costs can purchase these credits if the credits costs less than retrofits required to meet the cap.  The European Union launched its Emissions Trading System in 2005.  The scheme aims to reduce total emissions 21% below 2005 levels by 2020; results so far have been mixed.  California plans to roll out a carbon ETS in 2013 that will cover approximately 85% off all carbon emissions in the state, including utility and transportation fuels.

The Tax Option

Carbon taxes, on the other hand, place a fee on every ton of carbon produced by specific industries, or on all emissions in a country, region, or state.  Taxes are simpler to implement because their mechanisms are already well understood by both politicians and the general public, and they are relatively easy to enforce.  Unlike a cap and trade system, taxes incent carbon emitters to reduce pollution as much as possible, whereas an ETS only requires reductions to a specific level.

Furthermore, some creative manipulation of the existing tax code can result in minimal economic impacts.  British Columbia has a revenue neutral carbon tax in place, which it has recently increased to $30 per ton.  Revenues from the carbon tax, levied against all the carbon from fossil fuels, are used to reduce corporate and individual income taxes; which have resulted in some of the lowest rates in the G8.  Despite economic growth, the tax has significantly reduced carbon output and fossil fuel demand.

China’s ETS is another signal of the country’s slow but steady shift to free-market capitalism.  From an economic perspective, a trading scheme may be the most logical path to curtail China’s carbon emissions, given the rapid economic expansion of the country, and the corresponding exponential demand for energy. True, the ETS introduces some complications into carbon emission compliance, but its smaller economic impact on businesses, compared to a carbon tax, should help bolster China’s continued growth.  If structured correctly, the scheme will allow China to integrate its carbon markets with Europe, Australia, and others, further incorporating the once-secluded Middle Kingdom into the world economy.

(Photo Copyright Douglas Janson)

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