Applicability of market-based instruments in developing countries A case study on the SO2 emission trading system in China and lessons-learnt for a China-wide CO2 emissions trading system Miriam Schroeder University of Potsdam

Content Starting point The transferability of economic instruments to developing countries Case Study: Analysis of China’s SO2 ETS pilot projects Lessons-learnt from the SO2 pilot projects Prospects for a possible CO2 emission trading system

Starting point Challenge: CO2 emissions of developing countries with no international reduction targets

Starting point Choice of instruments at national level Command-and-control: Carbon tax Market-based: Scaled up version of CDM Emission trading Feasibility of a permit trading system for GHGs in developing countries

Starting point Research Question “Which preconditions does the instrument of emission trading require for its successful implementation in developing countries?”

Permit trading in developing countries Assumption The transferability of ETS to developing countries depends on the match between preconditions necessary for the functioning of this economic instrument and the existing framework conditions in the country under consideration. ETS ? Developed countries Developing Countries

Permit trading in developing countries IVs DV Property rights Liberalised market Successful SO2 / CO2 ETS Rule-setting capacity of state Environmental Effectiveness = Reduction of SO2 / CO2 ?? Rule-enforcement capacity of state Monitoring capacities of institutions Equity of cost distribution

Legal precondition Argument: Monetary value needs to be attached to a natural resource via the assignment of a property right to the user Hypothesis: Property rights on natural resources need to be properly defined. Indicators: strictness and legal embeddedness of emission cap eligible installations for emissison permits time frame of ETS spatial scope of ETS

2. Economic precondition Argument: In an ETS, market signals determine the most cost-efficient way of emission reduction. Market signals functions only if private (or state-owned) enterprises have incentives to follow the market signal. Hypothesis: The market in the power and energy-intensive sector needs to be liberalised and companies need to be managed independently. Indicators: ownership ratio of companies number of companies in the market

3. Political precondition Argument: State has to set rules of the game: Constitutive rules in terms of types of emissions to be reduced and business actors to participate; Regulative rules in terms of the mode of measuring, trading and accounting of emission permits. Hypothesis: The state needs to have an adequate rule-setting capacity. Indicators: - the state’s method for allocating emission permits - the interference of the emission trading system with already existing regulations for emission control

4. Political precondition Argument: Compliance with ETS needs to be credibly enforced. Hypothesis: The state needs to have an adequate rule-enforcement capacity. Indicators: the legal back-up of the emission trading system the power relations of the state institutions responsible for emission trading the state’s enforcement strategy and its imposed penalties for noncompliance

5. Political precondition Argument: Monitoring of companies’ emissions, a registration and follow-up of the tradable permits and verification of emission data of installations demand a qualified and well-equipped staff in state institutions. Hypothesis: State institutions need to have good administrative and monitoring capacities. Indicators: - the institutions’ measurement abilities for the emissions of the affected installations

6. Political precondition Argument: Distributional implications of policy instruments matter especially for developing countries. Who pays and how benefits most by emission reduction measures is a question of equity. Hypothesis: Costs and benefits of any emission trading system need to be distributed in a socially and environmentally beneficial mode among participants and affected citizens in order to ensure its acceptability. Indicators: - usage of revenues by the state - evaluation of the ETS’s distributional effects by companies and affected citizens

Case study - SO2 ETS in China Benxi City Taiyuan City Jiangsu Province Hongkong – Guangdong Province

Preliminary results of case study - 1. Definition of property rights The SO2 emission reduction target is derived from the national target, but local governemnts have relative freedom in choosing the means of how to achieve it. In pilot ETS, the eligible installations (mainly from power sector) and the scope and timeframe of the ETS is limited. -> incentives for trading or investment in abatement technology is low.

Preliminary results of case study - 2 Preliminary results of case study - 2. Existence of a liberalised market At the national level most energy companies are still state-owned enterprises (SOEs), because this sector is regarded as being sensitive in terms of national energy security. For the local level, a similar dominance of SOEs can be assumed. -> State-owned enterprises are an obstacles to any ETS implemented in China

Preliminary results of case study - 3. Rule-setting ability of state Allocation method so far only fixed in one case: Principle of grandfathering and free allocation of permits. ->In general, distributing the cost burden of the required emission reduction among companies and sectors of one jurisdiction is highly political, and thus prey to the power and interest of local actors.

Preliminary results of case study - 4 Preliminary results of case study - 4. Rule-enforcment capacity of state In most cases, the local government has initiated or at least supported the emission trading system, but operation and administration of the system are in the hands of the local Environmental Protection Bureau (EPB). -> EPB has not the authority to impose penalties and is dependent on local government for finance. Not very likely to enforce penalties against powerful interests of their local community. -> The penalty itself is seen as too low to motivate companies to comply with the reduction limits.

Preliminary results of case study - 5 Preliminary results of case study - 5. Monitoring capacities of institutions technical equipment for measuring emission is often lacking in installations data quality varies according to the data collection experience and authority of the responsible state institution no experience with allowance tracking systems for the follow up of issuance and trading operations -> low monitoring capacities

Preliminary results of case study - 6 Preliminary results of case study - 6. Equitable distribution of revenues No data on costs and benefits available from secondary literature. Chinese researchers doubt that costs for state-owned enterprises are „real costs as money is handed back to companies through back door“.

Preliminary results of case study - SO2 ETS in China Dependent variable „successful ETS“ measured in numbers of accomplished trades between companies Benxi City Taiyuan City Jiangsu Province Hong Kong – Guandong Trading situation None so far 4 trades 1 trade

Lessons-learnt from the SO2 pilot projects Some preconditions deemed necessary for a successful ETS are not yet given in China. 1. Design flaws in ETS limited spatial and time dimension, penalties for polluters are weak, interfere with the levy system on SO2 emissions. low price of non-compliance penalties has not provided incentive for trading,

Lessons-learnt from the SO2 pilot projects 2. Problem of governance capacities at local level weak power position of implementing institution, lack of monitoring equipment and experiences. 3. Transformative state of the Chinese economic system state ownership of power companies, market dominance by a small number of large companies.

Prospects for a possible CO2 ETS No national cap on CO2 emission reductions, but goal of 1) improving energy efficiency by 20% up to 2010, 2) increasing usage of renewable energies to 16% of power production. Means of achieving these targets are not further specified -> option for establishment of a trading system for CO2 emissions/ energy intensity/ green energy certificates -> introduction of coal – energy – carbon tax

Prospects for a possible CO2 ETS If Chinese government opts for a CO2 ETS, it will probably be first tested on a local scale. Fundamental problem remains: State owned enterprises are not the right addressees of a policy instrument that has its merits in reducing the costs of emission abatement.

Thank you for your attention and thank you for the workshop! Miriam Schroeder miriams@uni-potsdam.de