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Absolute vs. Intensity-based Caps for Carbon Emissions Target Setting

A Risk Linking the EU ETS to the Chinese National ETS?

Published online by Cambridge University Press:  20 January 2017

Yingying Zeng ,
Stefan E. Weishaar  and
Oscar Couwenberg
Stefan E. Weishaar
Affiliation:
Department of Law and Economics, Faculty of Law
Oscar Couwenberg
Affiliation:
Faculty of Spatial Sciences, University of Groningen, the Netherlands
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Abstract

Linking the European Union Emissions Trading System (EU ETS) to the Chinese national ETS promises considerable economic and political benefits. However, different policy choices regarding cap setting between the systems are likely to impede a potential linking. A striking distinction is that the EU ETS relies upon an absolute cap, while the Chinese national ETS appears to apply an ‘intensity-based cap’ during the early stages. The current linking literature focuses on mapping legal barriers in general and has not yet focused on EU and China, let alone the intricacies of policy design. This article seeks to fill this gap by concentrating on (static and dynamic) efficiency and environmental effectiveness implications of linking and cap design. From the analysis of the cap we derive policy implications for a hypothetical ETS linking between the EU and China. In response, comprehensive and predictable regulation is needed to ensure the attainment of ETS targets and thus facilitate better regulation.

Type
Articles
Information
European Journal of Risk Regulation , Volume 7 , Issue 4 , December 2016 , pp. 764 - 781
Copyright
Copyright © Cambridge University Press 2016

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References

1- See, e.g., China to Launch National Pollution-Trading System to Cut Emissions, Bloomberg (Sep. 25, 2015), available at: http://www.bloomberg.com/news/articles/2015-09-25/china-said-to-plan-pollution-trading-expansion-to-cut-emissions; see also National Development and Reform Commission (NDRC), Notice on launching the national carbon emissions trading market (Jan. 11, 2016), available at: http://www.gov.cn/xin-wen/2016-01/22/content_5035432.htm Google Scholar.

2- To reduce global GHG emissions cost-effectively, the EU expects the international carbon market to develop through ‘bottom-up’ linking of compatible ETSs. The goal is to develop an OECD-wide market by linking throughout OECD countries and an even broader market by linking to other emerging markets. See European Commission, International climate policy post-Copenhagen: Acting now to reinvigorate global action on climate change (Communication), COM(2010) 86 final (March 2010), at 11-12Google Scholar. Chinese government also expressed its political willingness to link to other international ETSs. See NDRC, The fundamental conditions and operational thinking on promoting the establishment of national carbon emissions trading market (in Chinese), 1 China Economic & Trade Herald (2015)Google Scholar.

3- ‘Intensity-based cap’ is set within an ETS to impose carbon intensity targets.

4- See Tiche, Fitsum G., Weishaar, Stefan & Couwenberg, Oscar, Carbon Leakage, Free Allocation and Linking Emissions Trading Schemes, 2 CARBON & Climate Law Rev. 97 (2014)Google Scholar; see also van den Berg, Charis A., Couwenberg, Oscar & Weishaar, Stefan E., Carbon Leakage in the Regional Greenhouse Gas Initiative: Lessons Learnt for the European Union Emissions Trading Scheme, in University of Groningen Faculty of law Research Paper Series 6 Google Scholar.

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9- It bears mentioning that the EU is currently legally inhibited to link to other systems that are not based on absolute caps. See Directive 2003/87/EC of the European Parliament and of the Council establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, 2003 O.J.L 275/32, art. 25, at 1; see also Directive 2004/101/EC amending Directive 2003/87/EC establishing a scheme for greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms, 2004 O.J.L 338/18, rec. 18.

10- This article uses a Law & Economics approach to better understand the strengths and weaknesses of an instrument like emissions trading, which rests upon “incentive structures and equally complex ‘legal details’ that may be fully comprehended only if a ‘holistic view’ is taken”. See Faure, Michael G. & Weishaar, Stefan E., The role of environmental taxation: economics and the law, in Handbook of Research on Environmental Taxation (Milne, Janet E. & Andersen, Mikael Skou, eds, 2012), at 399–421 Google Scholar.

11- Better regulation is about making sure we actually deliver on the ambitious policy goals we have set ourselves. It is directly implemented by the European Commission in its own preparation and evaluation of legislation and through cooperation with the European Parliament and Council. See European Commission, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the regions: better regulation for better results - An EU agenda, COM(2015) 215 final (May 2015); see also Better Regulation Agenda: Enhancing transparency and scrutiny for better EU law-making, EUROPEAN COMMISSION (May 19, 2015), available at: http://europa.eu/rapid/press-release_IP-15-4988_en.htm

12- Offsetting, banking and borrowing are not considered in this article because they constitute different ETS design elements that are beyond the focus of this article (i.e. cap designs).

13- See Weishaar, Stefan E., Incentivizing Technologic Change in Emissions Trading Systems: The Case of Excess Supply, in Environmental Taxation and Green Fiscal Reform (Kreiser, Larry, Lee, Soocheol, Ueta, Kazuhiro, Milne, Janet E. & Ashiabor, Hope, eds, 2014), at 132 Google Scholar.

14- Ex-post adjustment is a broad term with different meanings in different contexts. See Weishaar, supra note 6, at 200. In this article, ‘ex-post adjustment’ refers to any adjustment of the pre-allocated allowances.

15- See Weishaar, supra note 6, at 54.

16- See Helm, Carsten, International emissions trading with endogenous allowance choices, 87 J. of Public Economics 2737 (2003)CrossRefGoogle Scholar.

17- See Weishaar, supra note 13, at 132.

18- See Weishaar, supra note 6, at 54.

19- See Munnings et al., supra note 7, at 33.

20- See Brussels European Council, Presidency Conclusions, 7224/1/07 Rev 1 (March 2007), para.32.

21- Directive 2009/29/EC brings about fundamental changes in the designs of the EU ETS. Additionally, the Directive 2003/87/EC was also amended in 2004 by Directive 2004/101/EC (Linking Directive) and in 2008 by Directive 2008/101/EC (aviation directive).

22- See Directive 2009/29/EC of the European Parliament and of the Council amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emission allowance trading scheme of the Community, 2009 O.J.L 140/63 [hereinafter Parliament and Council Directive 2009/29/EC], art. 9.

23- See Directive 2008/101/EC of the European Parliament and of the Council amending Directive 2003/87/EC so as to include aviation activities in the scheme for greenhouse gas emission allowance trading within the Community, 2008 O.J.L 8/3, art. 3c.

24- See Parliament and Council Directive 2009/29/EC, supra note 22, art. 15(a). Commitment to ‘better regulation’ in the EU must apply based upon full transparency and engagement (see European Commission, supra note 11, at 4).

25- See Weishaar, Stefan E. & Madani, Sami, Energy Community treaty and the EU Emissions Trading System: Evidence of an Unrecognized Policy Conflict, 2 Oil, Gas & Energy Law Intelligence 12 (2014), at 1-17Google Scholar.

26- See Market stability reserve: Council ready to negotiate with the European Parliament, European Council (Mar. 25, 2015), available at http://www.consilium.europa.eu/en/press/press-releas-es/2015/03/25-market-stability-reserve-council-ready-negotiate-ep/.

27- See European Commission, Proposal for a Decision of the European parliament and of the council of concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and amending Directive 2003/87/EC, COM (2014) 20 final (January 2014)Google Scholar; see also Parliament adopts CO2 market stability reserve, Eurepean Parliament (Jun. 8, 2015), available at http://www.europarl.europa.eu/news/en/news-room/content/20150703IPR73913/html/Parliament-adopts-CO2-market-stability-reserve.

28- See Commission Regulation (EU) No 176/2014 of 25 February 2014 on amending Regulation (EU) No 1031/2010 in particular to determine the volumes of greenhouse gas emission allowances to be auctioned in 2013-20, 2014 O.J.L 56/11; see also ETS market stability reserve: MEPs strike deal with Council, European Parliament (May 6, 2015), available at http://www.europarl.europa.eu/news/en/news-room/content/20150504IPR49654/html/ETS-market-stability-reserve-MEPs-strike-deal-with-Council.

29- See Choi, Yongrok, Zhang, Ning & Zhou, Peng, Efficiency and Abatement Costs of Energy-Related CO2 Emissions in China: A Slacks-Based Efficiency Measure, 98 Applied Energy 198 (2012)Google Scholar; see also McGrath, Matt, China’s Per Capita Carbon Emissions Overtake EU’s, BBC News (Sept. 21, 2014), available at: http://www.bbc.com/news/science-environment-29239194 Google Scholar.

30- See Guo, Xiangnan & Hao, Qianjin, Carbon Trading Market for Energy Saving and Emission Targets in China (in Chinese), 4 China Environmental Protection Industry 63 (2011)Google Scholar; see also Li, Jifeng, Thoughts on Direct and Indirect Emissions Trading in China’s Carbon Market (in Chinese), 9 Special Zone Economy 110 (2012), at 164-165Google Scholar; see also Li, Jifeng, Zhang, Yaxiong, Wang, Xin & Cai, Songfeng, Policy Implications for Carbon Trading Market Establishment in China in the 12th Five-year Period, 3 Advances in Climate Change Research 3 (2012), at 163-165Google Scholar; see also Cui, Lianbiao, Fan, Ying, Zhu, Lei & Bi, Qinghua, How Will the Emissions Trading Scheme Save Cost for Achieving China’s 2020 Carbon Intensity Reduction Target? 136 Applied Energy 1043 (2014)CrossRefGoogle Scholar; see also Zhang, supra note 8, at 4-7.

31- See Notification on the Implementation of Carbon Emissions Trading Pilots (in Chinese), NDRC (Oct. 29, 2011), available at http://www.sdpc.gov.cn/zcfb/zcfbtz/201201/t20120113_456506.html.

32- See NDRC, supra note 2.

33- For the carbon trading legislation and guidance documents promulgated in China ETSs (hereafter ‘normative documents’) referenced in this article, see Appendix 1.

34- See One Belt, One Road: Regional Carbon Markets (in Chinese), 21st Century Business Herald (Jun. 23, 2015), available at http://www.tanjiaoyi.com/article-10757-2.html; see also The State Council Will Release Regulations on Management of Carbon Emissions Trading (in Chinese), Cnrencai (Mar. 16, 2015), available at http://www.cnrencai.com/zongjie/guizhangzhidu/153017.html.

35- See NDRC, supra note 2.

36- See id.

37- See NDRC, Interim administrative measures for carbon emissions trading (Dec. 10, 2014) [hereinafter National Regulation], art. 8, available at http://qhs.ndrc.gov.cn/gzdt/201412/t20141212_652035.html Google Scholar

38- And other factors considered during cap setting include economic growth, industrial structure, energy structure and specific circumstances of covered entities. See id., art. 8.

39- See Jotzo, supra note 8, at 15.

40- See Jotzo and Pezzey, supra note 5; see also Ma, Xin, Li, Jifeng & Zhang, Yaxiong, An Important Question Before Copenhagen Meeting - BAU Scenario in the Climate Change Study and International Negotiation (in Chinese), 6 International Economic Assessment 5 (2009)Google Scholar.

41- See Quemin, Simon & Wang, Wen, Overview of Climate Change Policies and Development of Emissions Trading in China, in Paris: Climate Economics Chair Information and Debate Series Paper 30 (2014), at 31–32 Google Scholar.

42- As Appendix 3 shows, ‘industrial restructuring and development’ is an important factor considered during cap setting in most of the pilots, e.g. Shenzhen, Guangdong, Tianjin, Hubei and Chongqing.

43- See Li et al., supra note 30, at 167-168.

44- According to Xie Zhenhua, Deputy Director of NDRC, China is now researching ‘absolute cap’ as well and intends to gradually achieve ‘dual control’ (i.e. carbon intensity and absolute emissions controlling) in the future. See National Development and Reform Commission: Promoting the Establishment of National Carbon Emissions Trading Market and Implementing Dual Control of Intensity and Overall Emissions (in Chinese), Hexunnet (Aug. 30, 2014), available at: http://news.hexun.com/2014-08-30/168038731.html. Both an absolute cap and an ‘intensity-based cap’ are under consideration for the national ETS, but the latter may be preferred during the early stages.

45- See National Regulation, supra note 37, art. 15. The implementation of national reserve in China (see National Regulation, supra note 37, art. 11) is not considered as ‘ex-post adjustment’ and will not be discussed.

46- The adjustment basis in all the pilots (see the column ‘adjustment basis’ in Appendix 2) is more or less related to the actual output of covered entities.

47- It bears mentioning that not every covered entity will be issued supplementary allowances in this case, because 1) the adjustment is probably applied to limited sectors (e.g. in Shanghai and Guangdong ETS); 2) individuals’ allowances are adjusted in line with individual economic circumstances (e.g. actual output) not the overall economic growth.

48- NDRC is obligated to announce ‘on time’ to the public ‘the coverage, allocation methods, banking and etc. (see National Regulation, supra note 37, art. 6, 7, 33 & 34).

49- See the column ‘transparency of caps in practice’ in Appendix 3.

50- See China’s GDP Growth Slows to 7.4% in 2014: Govt data, Business Insider (Jan. 19, 2015), available at: http://www.businessinsider.com/afp-chinas-gdp-growth-slows-to-7.4-in-2014-govt-data-2015-1#ixzz3VNykwUG2; see also Expects Predict 2015 GDP Growth Target Will Be Decreased to 7%, Xin-Huanet (Mar. 4, 2015), available at: http://news.xin-huanet.com/finance/2015-03/04/c_127544340.htm.

51- See Queming & Wang, supra note 41, at 31-32.

52- Currently, the law or political performance evaluation test does not impose requirements regarding the transparency of cap. Political performance evaluation has been a crucial part of officials management in China’s political regime.

53- See Benwell, Richard, Linking as leverage: emissions trading and the politics of climate change, 21 Cambridge Rev. of International Affairs 545 (2008), at 550Google Scholar.

54- The European Court of Justice established that the prime goal of the EU ETS is to reduce GHG emissions in a substantial form (i.e. environmental effectiveness). See Iberdrola v. Administraciόn del Estado, Joined Cases C-566/11, C-567/11, C-580/11, C-591/11, C-620/11 & C-640/11, [2011] E. C. R. I__(delivered October 17, 2013), para. 43.

55- Namely the reduction targets is set challenging and abatement efforts are required.

56- See Starkey, Richard, Personal Carbon Trading: A Critical Survey Part 2: Efficiency and Effectiveness, 73 Ecological Economics 19 (2012), at 19CrossRefGoogle Scholar.

57- See Weishaar, supra note 6, at 46.

58- See Acworth, William, May, Nils & Neuhoff, Karsten, The Market Stability Reserve: Is Europe Serious about the Energy Union? Diw Berlin German Institute for Economic Research Series Paper 59 (2015)Google Scholar.

59- See Weishaar, supra note 6, at 54.

60- See id.

61- The reason for this is that a limit is often set on the overall amount of supplementary allowances. For instance, in Shenzhen ETS, allowances added (except for the new-entrants) should not exceed the allowances withdrawn. See Shenzhen DRC, Shenzhen Carbon Trading Regulation (Mar. 28, 2015), art. 19. Further, allowances can be adjusted upward, by no more than 10%, or downward, with no limit, in any year (see Munnings et al., supra note 7, at 18). On entity level, within the adjustment limit, it can be roughly summarized as follows: allowances surplus (after compliance) = intensity target * actual output (or added-value) - actual intensity * actual output (or added-value). Therefore, when the pre-determined target has been met (i.e. actual intensity ≤ intensity target): if the amount of supplementary allowances does not exceed the limit, there will be a surplus; if it does, no more extra allowances will be issued and there may be a shortage of allowances in this case.

62- See Benwell, supra note 54, at 555. The amount of carbon allowances could be roughly calculated from the following formula: overall allowances = carbon intensity * actual GDP. With economic uncertainty, when GDP grows fast enough, even if the intensity declines, it remains possible that the amount of overall emissions rises.

63- It has been generally believed that absolute cap and intensity targets have identical effects in the absence of uncertainty (see Ellerman, supra note 5; see also Sue Wing et al., supra note 5). However, as indicated above (see section I), this article adds to the literature the impact of the absolute cap and ‘intensity-based cap’, particularly, from a Law & Economics perspective.

64- In the standard partial equilibrium analysis, linking cap-and-trade systems could lead to significant efficiency gains when allowance prices (marginal abatement costs) across schemes are equalized. See Edenhofer, Ottmar, Flachsland, Christian & Marschinski, Robert, Towards a Global CO2 Market: An Economic Analysis, in Potsdam Institute for Climate Impact Research (2007)Google Scholar; see also Flachsland, Christian, Marschinski, Robert & Edenhofer, Ottmar, To Link or Not to Link: Benefits and Disadvantages of Linking Cap-and-Trade Systems, 9 Climate Policy 358 (2009), at 7CrossRefGoogle Scholar. However, in the case of linking the EU ETS to the China ETS, with great pre-link differences in the cap, imperfect knowledge (e.g. lack of transparency in China) and economic uncertainty, implications of linking cannot be fully comprehended only if a holistic view is taken.

65- For the definition of ‘direct bilateral’ or ‘comprehensive’ linkage, see Erik Haites & Fiona Mullins, Linking Domestic and Industry Greenhouse Gas Emission Trading Systems (2001); see also Sterk, Wolfgang, Braun, Marcel, Haug, Constanze, Korytarova, Katarina & Scholten, Anja, Ready to Link Up? Implications of Design Differences for Linking Emissions Trading Schemes, in Wuppertal Institute Jet-Set Working Paper, I/06 (2006)Google Scholar; see also Roβnagel, Alexander, Evaluating Links between Emissions Trading Schemes: An Analytical Framework, Carbon & Climate L. Rev. 394 (2008), at 396Google Scholar; see also Tuerk, Andreas, Mehling, Michael, Flachsland, Christian & Sterk, Wolfgang, Linking Carbon Markets: Concepts, Case Studies and Pathways, 9 Climate Policy 341 (2009), at 343CrossRefGoogle Scholar.

66- See Blyth, William & Bosi, Martina, Linking Non-EU Domestic Emissions Trading Schemes with the EU Emissions Trading Scheme, in IEA/OECD Information Paper (2004)Google Scholar; see also Anger, Niels, Emissions Trading Beyond Europe: Linking Schemes in a Post-Kyoto World, 30 Energy Economics 2028 (2008)CrossRefGoogle Scholar; see also McKibbin, Warwick J., Morris, Adele C. & Wilcoxen, Peter J., Expecting the Unexpected: Macroeconomic Volatility and Climate policy, in Brookings Global Economy and Development Working Paper, 28 (2008)Google Scholar; see also Carbone, Jared C., Helm, Carsten & Rutherford, Thomas F., The Case for International Emission Trade in the Absence of Cooperative Climate Policy, 58 J. of Environmental Economics and Management 266 (2009)CrossRefGoogle Scholar; see also Flachsland et al, supra note 65, at 10; see also Jaffe, Judson, Ranson, Matthew & Stavins, Robert N., Linking Tradable Permit Systems: A Key Element of Emerging International Climate Policy Architecture, 36 Ecology LQ 789 (2009)Google Scholar; see also Jotzo, Frank & Betz, Regina, Australia’s Emissions Trading Scheme: Opportunities and Obstacles for Linking, 9 Climate Policy 402 (2009), at 409CrossRefGoogle Scholar; see also Andreas Tuerk, Linking Emissions Trading Schemes (2009); see also Tuerk et al., supra note 66; see also Zetterberg, Lars, Linking the Emissions Trading Systems in EU and California, Swedish Environmental Research Institute Paper (2012), at 6 Google Scholar; see also Weishaar, supra note 6, at 191-193.

67- Different allowances (e.g. allowances issued in different years) may be transacted at different prices, which we generically refer to as ‘carbon price’ in this article.

68- See Jaffe et al., supra note 67, at 799.

69- See Carbone et al., supra note 67; see also Metcalf, Gilbert E. & Weisbach, David, Linking Policies When Tastes Differ: Global Climate Policy in a Heterogeneous World, Rev. of Environmental Economics and Policy rer021 (2011), at 5 Google Scholar.

70- See Carbone et al., supra note 67.

71- See Ellis and Tirpak, supra note 6, at 22.

72- ‘Investors’ refers to individual and institutional investors as well as the financial service institutions.

73- Theoretically, if the increased allowance price is higher than the penalties for defaulting in China, some China’s firms may fail to comply. But this remains a remote possibility in the near future considering the fact that the China ETS is double the size of the EU ETS.

74- For China’s firms who have surplus allowances after compliance, whether they will be incentivized further (compared to the prelinking scenario) depends on whether they can gain ‘net revenue’ from further abatement, i.e. the potential revenue from more allowances sales outweighs further abatement costs.

75- The ‘relative stringency ‘of targets is one critical ‘compatibility issue’ when systems consider linkage, and it may be a precondition for linking that the systems involved have ‘comparable effort’ (see Tuerk et al., supra note 66, at 347). Paradoxically, difference in abatement costs (greatly affected by different stringency of caps) is a crucial ‘economic motive’ for linking but also pose a significant barrier (see Zetterberg, supra note 67, at 8). The ‘relative stringency’ of targets will not be discussed here because the cap in China has yet to be determined.

76- See Flachsland et al., supra note 65, at 4.

77- See id.; see also Tuerk et al., supra note 66, at 344.

78- See Jaffe et al., supra note 67.

79- It bears mentioning that whether China will tighten or loosen the cap will largely depend upon the elasticity of allowances from the EU.

80- Better regulation is about making sure we actually deliver on the ambitious policy goals we have set ourselves (see European Commission, supra note 11, at 4). In this sense, ‘predictable legislation’ is needed to ensure the achievement of goals in the ETS and render more predictable the environmental and economic impacts.

81- See Queming & Wang, supra note 41, at 32.

82- See Benwell, supra note 54, at 556; see also Tuerk et al., supra note 66, at 353;

83- See Lefevere, Jürgen, Linking Emissions Trading Schemes: The EU ETS and the ‘Linking Directive’, in Legal Aspects of Implementing the Kyoto Protocol Mechanisms: Making Kyoto Work (Freestone, David and Streck, Charlotte, eds, 2005), at 511 Google Scholar.