Strengthening Climate Policy in China’s Private Sector

At the UN conference in September 2020, President Xi Jinping announced that China will “have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060”. Details of how this target will be achieved will probably not be released until the 14th Five-Year Plan (FYP) is announced. Nonetheless, if China fully implements a strategy to reach this goal, it will have massive implications for reaching the global 1.5 degrees Celsius target. This is because China accounts for the highest percentage of CO2 emissions worldwide, with Chinese power plants burning 25% of the world’s coal reserves and with renewable energy output only accounting for 9% of the country’s total energy [1]. Paradoxically, despite its massive energy consumption, it is also the largest producer of solar and wind energy and the leading investor in clean energy technologies worldwide [2]. Not only does China have 47% of all electric cars in the global market [3], it also refines four-fifths of the world’s supply of cobalt, an essential component in lithium ion batteries, the most common storage of clean electricity [4]. In addition to investment and manufacturing of sustainable energy technology and following several regional pilot emissions trading schemes (ETS), the Chinese government implemented a National Emissions Trading Scheme (NETS) in 2017 and enforced it in 2020, initially covering 2,267 power plants [5]. 

Challenges to reach the 2060 target

Despite China’s lead in the renewable energy race, the country still faces numerous challenges to reach the carbon neutrality target. According to two studies by researchers at Tsinghua University, electrical energy must come completely from renewable sources by 2050 and negative emissions technologies must be employed thereafter to counterbalance the CO2 emissions from cement production, agriculture and other carbon-dependent industries [6]. With the current ETS system, neither clean electrification nor carbon capture mechanisms are addressed. The cap and trade scheme only accounts for the allocation of allowances for coal and gas power plants. The first issue with this is that it excludes energy-intensive, coal-dependent sectors, which must be addressed in order to reach the 2060 target. 

Secondly, CO2 emissions from coal combustion are heavily concentrated within five state-owned power plants that account for 50% of emissions, which can lead to great unbalances of allowance surpluses and deficits. As allowances are distributed based on the amount of electricity produced, coal plants are incentivised to improve the energy intensity of existing generators rather than to transition to renewable energy generation, especially given that China has the youngest and most efficient coal plants worldwide [7]. This issue is further exacerbated by the fact that the price of allowances are determined by the State rather than through an emissions trading market. Moreover, the energy market and prices are also state regulated, deterring businesses and households from improving their own energy efficiency. In addition to this, regional governments are being further incentivized to create new coal-plants to generate employment and economic growth post-lockdown. As a result, in 2020 the number of coal-plant building permits exceeded the 2015 peak [8]. These factors all point towards the main issue of how China will manage its transition to clean energy whilst remaining competitive on the global market and attractive to foreign investment. 

Alongside this lies the broader question of whether Chinese development is compatible with  decarbonisation. Throughout the second half of the 20th century, China based its development path on an implicit social contract – the promise that everyone will benefit from this growth. Over the last 50 years, China’s unprecedented economic growth has massively increased its energy consumption, which has been met primarily by booming coal production – just under 60% of electricity was generated by coal in 2019 [9] [10]. This issue needs to be confronted in order for China to reach net-zero by 2060.

Policy Proposals

Drawing on policies and frameworks implemented in other carbon-intensive regions around the world, and considering China’s unique position as the world’s largest emitter of carbon emissions with a strong industrial reliance on fossil fuels, this paper argues for the implementation of a 2-fold policy recommendation to (1) confront the challenges facing China’s current NETS in the short-term, and (2) address the need for more radical longer-term climate policy to handle China’s seemingly perpetual energy consumption growth.

1. A new and improved hybrid NETS – carbon tax system

In order to address China’s carbon emissions in the short-term, this paper recommends establishing a renewed NETS combined with a carbon tax system as a central component to the 14th FYP.

Firstly, the current NETS is severely affected by the lack of an emissions market, its scope and the method of free allowances provision. The NETS needs to introduce an emissions trading market, with the price of allowances fixed by auctioning rather than by the state. This will incentivise firms to reduce their carbon emissions by releasing the market from state-controlled carbon prices and allow the more economically- and environmentally-effective “least-cost” approach of cap-and-trade systems to prevail. It will also encourage clean energy alternatives alongside continued economic growth and innovation [11]. In order to reduce the risk of over-allocation of quotas leading to low allowance prices that has plagued other ETS systems, the government should introduce more severe emission caps and remove any future accumulation of free allowances which may lead to prices falling below abatement costs (the costs associated with removing negative byproducts, in this case CO2 emissions, from a firm’s production process) [12].

Using the initial Hubei-province ETS structure as a reference, we propose the extension of the existing NETS to the inclusion of all companies above a carbon threshold in the six most carbon-intensive industries: power generation, ferrous and non-ferrous metallurgy, construction, chemicals production and aviation services [13] [14]. This approach will encompass the majority of emissions whilst reducing administrative inefficiency which can arise by including sectors and companies that contribute very little to the national emissions, as seen in the initial European Union ETS where 55% of carbon industries only accounted for 2.4% of emissions [15].

Secondly, drawing on the carbon regulatory system in California, this paper argues for the implementation of a hybrid NETS – carbon tax system in China, with the introduction of an upstream carbon tax on all fossil fuels applying to companies and organisations currently not contained in the NETS [16]. The aim of this hybrid system is to encourage all consumers of fossil fuels, from corporations and smaller businesses to households and government agencies, to reduce their emissions and seek renewable alternatives in an equitable fashion, with the largest pressure placed on the corporations contributing the highest emissions.

Revenues from the carbon tax could be used for a wide range of functions, such as investment into public goods, for a reduction in taxes on labour or capital to support the economy, or earmarking for future plans to mitigate GHG emissions. In light of the severe social and economic implications of the coronavirus pandemic and the current threat of the climate breakdown, the authors recommend using these revenues to support stimulus packages that invest in green technology, infrastructure and jobs to support a “green recovery” of the Chinese economy rather than a doubling-down on coal and other fossil fuel consumption. 

2. Product standards as a solution to energy consumption growth

This paper argues for the longer-term implementation of product standards on China’s domestic and imported carbon-intensive products. Here, product standards refers to uniform standards for the emissions released due to the production and energy consumption of products, applied to both domestic and imported goods. Product standards reduce energy consumption through removal of the most inefficient (in this case, the most carbon intensive) products off the market [17]. This policy recommendation has two objectives, (1) to curb China’s energy consumption growth and promote societal change in consumption patterns, thus supporting a global transition to degrowth, and (2) to mitigate any future risk of carbon leakage outside China that would undermine China’s climate ambitions and economic prosperity, and to encourage international collective action. 

The product standards should cover both production- and consumption-based emissions (the total embedded emissions over the product’s life-cycle), applied to both domestic and imported goods [18]. This allows the product standards to be non-discriminatory towards imported or domestic products, applied comprehensively to emissions across the whole supply-chain of a product, and mitigate any future risk that carbon leakage poses to unilateral climate policy [19]. The benchmark for this standard should be determined using a system mirroring the Publicly Available Specification (PAS) 2050 developed by the British Standards Institute (BSI), which allows the quantification of GHG emissions over the entire life cycle of a product, a framework also known as or “product perspective” [20] [21].

Carbon leakage will only, if ever, come to fruition in the future when unilateral carbon regulations become significantly stricter and the disparity in climate ambitions between different regions is great enough to motivate a dislocation of industry [22]. Hence, in the short-term, there is little risk of any significant carbon leakage occurring, particularly with China offering foreign investment benefits such as low labour costs, good infrastructure, a large regional market, preferential policies such as tax credits and political stability [23] [24]. However, in the long-term, product standards will prevent unsustainable low economic growth triggered by industry dislocation, and prevent an increase of consumption-based emissions from imported products offsetting domestic production-based emissions reductions through China’s climate policies – a significant risk considering the size of the Chinese domestic market [25].

Product standards encourage a longer-term societal and political shift in China away from current perceptions of energy consumption and economic growth as a prerequisite for improved quality of life. Through the introduction of stricter carbon regulations over the next five to ten years, the NETS can be thought of as a stepping-stone in China’s climate policy towards a sustainable and energy-efficient future.

Furthermore, the product standards will be an opportunity to nurture increased cooperation between China, the European Union and other regions keen on introducing environmental standards, and will apply pressure to those falling behind on their carbon reduction targets – encouraging accelerated international collective action to limit global warming to below 1.5 degrees and limiting the impacts of climate breakdown.

Assumptions

Throughout this policy proposal, we have assumed that the centralised nature of China’s political landscape means that the state will be able to implement these stricter climate policies without serious opposition from either local government, or the private sector. However, at present, there is already resistance at the local governmental level and amongst the energy industry and utility companies to stronger regulations on carbon emissions production, with continued opposition to the curtailing of new coal power station construction, and little or no action taken by the power industry to curb their own emissions growth [26] [27]. We have also assumed the willingness of the Chinese government to compromise on unchecked economic growth in the short-term in order to meet its climate targets.

Conclusion

If China is to meet the net-zero climate target, strengthened and effective climate policy needs to be introduced alongside the 14th FYP, setting China on a clear decarbonisation path and supporting its climate ambitions. 

In the short term, this policy paper has argued for the current NETS to be extended in both scope and severity, with tighter emissions caps and an inclusion of the six most carbon-intensive industries. State control on carbon allowance prices needs to be lifted and replaced with an emissions trading market that will set the price of allowances through auctioning. If sufficient steps are taken to ensure no excess accumulation of allowances occurs, this renewed NETS will incentivise decarbonisation of key carbon-intensive industries whilst allowing continued economic prosperity. To incentivise both smaller firms and households to address their energy consumption patterns, and the power generation industry to explore and deploy clean energy alternatives at an accelerated rate through the “least-cost” approach, a combined upstream carbon tax should be introduced applying to all entities excluded from the NETS. 

In the longer-term, China, like the rest of the world, will have to abandon perpetual, unsustainable economic growth in favour of a social and political shift to sustainable consumption patterns and degrowth. Product standards should be introduced with the goal of improving energy efficiency of products, reducing energy consumption, and supporting this societal shift. Product standards will also ensure carbon leakage is mitigated whilst promoting international collective action.

With the stage set and the world’s eyes on China, the government now needs to step up to the plate and deliver on a climate policy that aligns with its decarbonisation ambitions.

Policy proposal by Irene Perez Beltran, Patrick Geddis and Andrew King, members of the Energy and Environment Policy Centre at King’s Think Tank in the 2020/21 academic year.

References

 [1] OECD (2020), Renewable energy (indicator). doi: 10.1787/aac7c3f1-en (Accessed on 10 December 2020)

[2] Dominic Chiu, “The East Is Green: China’s Global Leadership in Renewable Energy”, Center for Strategic and International Studies, 2017

[3] IEA (2020), Global EV Outlook 2020, IEA, Paris https://www.iea.org/reports/global-ev-outlook-2020

[4] “What if China corners the cobalt market?”, The Economist, 2018

[5] “China says carbon trading scheme will cover 2,267 power plants in phase one”, Reuters, 2020

[6] Lauri Myllyvirta, “Influential academics reveal how China can achieve its ‘carbon neutrality’ goal”, Carbon Brief, 2020

[7] IEA (2020), China’s Emissions Trading Scheme, IEA, Paris https://www.iea.org/reports/chinas-emissions-trading-scheme

[8] Lauri Myllyvirta, “Analysis: China’s CO2 emissions surged past pre-coronavirus levels in May”, Carbon Brief, 2020

[9] Jotzo, F., Karplus, V., Grubb, M. et al., “China’s emissions trading takes steps towards big ambitions” Nature Climate Change, 2018

[10] “Q&A: How will China’s new carbon trading scheme work?”, Carbon Brief, 2018

[11] Jotzo, F., Karplus, V., Grubb, M. et al., “China’s emissions trading takes steps towards big ambitions” Nature Climate Change, 2018

[12] Mark A. Andor, Manuel Frondel and Stephan Sommer, “Reforming the EU Emissions Trading System: An Alternative to the Market Stability Reserve”, Intereconomics, 2016

[13] Shaozhou Qi, Banban Wang, Jihong Zhang, “Policy design of the Hubei ETS pilot in China”, Energy Policy, Volume 75, 2014

[14] Zhu Liu, Dabo Guan, Scott Moore, et al., “Climate policy: Steps to China’s carbon peak”, Springer Nature, 2015

[15] Egenhofer, C., “The Making of the EU Emissions Trading Scheme:: Status, Prospects and Implications for Business”, p453-463, European Management Journal, Volume 25, Issue 6 , 2007

[16] Jing Cao, Mun S. Ho, Dale W. Jorgenson, Chris P. Nielsen, “China’s emissions trading system and an ETS-carbon tax hybrid”, p 741-753, Energy Economics, Volume 81, 2019

[17] Noah M. Sachs, “Can We Regulate Our Way to Energy Efficiency: Product Standards as Climate Policy”, p 1631-1678, Vanderbilt Law Review 65, Issue 6, 2012

[18] Bastien Girod, “Product-oriented climate policy: learning from the past to shape the future”, p 209-220, Journal of Cleaner Production, Volume 128, 2016

[19] “Making trade work for EU climate policy: Carbon border adjustment or product standards”, Institute for European Environmental Policy, 2020

[20] Jong-Sung Song, Kun-Mo Lee, “Development of a low-carbon product design system based on embedded GHG emissions”, Resources, Conservation and Recycling, Volume 54, Issue 9, 2010, pp. 547-556

[21] British Standards Institute (BSI), PAS 2050, Specification for the Assessment of the Life Cycle Greenhouse Gas Emissions of Goods and Services, 2008

[22] Georg Zachmann and Ben McWilliams, “A European carbon border tax: much pain, little gain”, Policy Contribution, Issue 5, 2020

[23] K. Cheng, Y.K. Kwan, “What are the determinants of the location of foreign direct investment? The Chinese experience”, p. 379-400, Journal of International Economics, Volume 51, Issue 2, 2000

[24] K.H. Zhang, “What attracts foreign multinational corporations to China?”, p. 336-346, Contemporary Economic Policy, Volume 19, Issue 3, 2001

[25] Bastien Girod, “Product-oriented climate policy: learning from the past to shape the future”, p 209-220, Journal of Cleaner Production, Volume 128, 2016

[26] “A glut of new coal-fired power stations endangers China’s green ambitions”, the Economist, China  2020

[27] Daniel Oberhaus, “China Is Still Building an Insane Number of New Coal Plants”, WIRED, 2019

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