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Researchers find benefits of China's carbon market could exceed policy costs

The national carbon-dioxide emissions trading system that China is set to launch over the next year or two could prove more expensive than a cap-and-trade-type program but could also yield environmental benefits that exceed policy costs, nonprofit research group Resources for the Future found.

China has yet to reveal all the nuances of its nationwide tradable performance standard, or TPS, but the paper said the first phase of the program will aim to lower the rate of emissions from power plants per unit of electricity produced. The paper noted that the power sector accounts for about 40% of the country's total carbon dioxide emissions and said China may later expand the TPS to cover additional sectors.

The program could ultimately grow to be the biggest in the world and would likely help China achieve its broader goals under the Paris Agreement on climate change, two of the authors of the paper said in a Jan. 14 press call. In 2016, China accounted for nearly 30% of worldwide carbon dioxide emissions followed by the U.S. with 16% of carbon emissions, according to the Union of Concerned Scientists.

"This is a big step forward for China," Resources for the Future Senior Fellow Richard Morgenstern said.

Cap-and-trade programs such as the EU Emissions Trading System or the Regional Greenhouse Gas Initiative of some U.S. states in the Northeast and mid-Atlantic typically involve setting an absolute cap on emissions for certain sectors or economywide emissions and then ratcheting that cap and related allowances down over time, known as a mass-based system. The program inherently prompts most or all fossil-fueled units to reduce total output, Resources for the Future, or RFF, explained.

But China is opting instead to set an intensity rate-based cap for its emission trading system that would allocate emissions allowances to power plants equal to the required benchmark emissions-output ratio for that plant. If the plant emits less than its quota, it can sell unused allowances to another plant. This formula would reward plants for producing fewer emissions per unit of output, instead of curbing emissions overall, which gives China the flexibility to account for shifts in economic growth, the paper said.

"In boom times, when electricity demand and production are high, the allowance allocations increase automatically," RFF said. "This prevents what otherwise could be very high abatement costs in a cap-and-trade program with a fixed cap on allowances." Likewise, the regulator will allocate fewer allowances when electricity demand, and therefore production, is lower. In comparison, under a fixed cap-and-trade program, an excessive number of allowances could be allocated in periods of lower demand.

China is also exploring whether to set varying benchmarks and is using less stringent ones for facilities that would otherwise face especially high compliance costs.

The program's general failure to encourage providers to reduce overall output "contributes to the TPS's higher costs," the paper said. In the central case simulation RFF used, which assumed a three-benchmark program, the TPS would yield a 3.1% reduction in aggregate carbon emissions for the initial phase of the program. RFF found that the same reduction could be achieved at 47% lower private cost under a cap-and-trade program that had similar allowance allocations.

At the same time, the greater reduction in electricity output under cap-and-trade would yield larger increases in electricity prices than under the TPS. The national average electricity price would increase from a baseline price of 0.372 Chinese yuan/kWh, or roughly 5.4 US cents/kWh, to 0.374 yuan/kWh under the TPS, as opposed to 0.379 yuan/kWh under the cap-and-trade program scenario RFF used.

But even with higher overall costs than cap-and-trade, the TPS can "generate significant net gains once its environmental benefits are counted," the paper said. Assuming emissions reductions are valued at 290 yuan, which is equivalent to about US$44 per ton, the environmental benefits from the TPS could exceed the policy costs by a factor of about 3, RFF said.

As of Jan. 15, US$1 was equivalent to 6.89 Chinese yuan.