China’s carbon market: a trader’s view

Carbon trading is a divisive issue, especially with regard to China. In the final part of our series on the emissions market, Leigh Fitzgerald says it’s time to open up the discussion on a new footing.

So, what do you do?

That inevitable question.

PR; investment banking; consulting; journalism; IT: my friends’ answers usually get a pleasant smile and a nod.

My answer, “carbon trading,” rarely gets that reaction. I always wince a little before I throw it out there. Most people ask me what on earth carbon trading means. Others are horrified that I am paying Chinese companies to pollute. Once, a particularly pugnacious (and intoxicated) compatriot threw a fist at me. It’s not often that I hear, “Wow, carbon trading, that’s great.”

In a carbon market, an entity sets or is given a limit on how much greenhouse gas it can emit. If it isn’t able to meet this target in-house, it can buy emissions reduction credits from somewhere else. Carbon trading is the buying and selling of those reduction credits, known as carbon credits. Here in China, we develop emissions-reducing projects that generate carbon credits used to offset emissions elsewhere.

Most of the time, I dig myself in deeper with that follow up. Buying and selling emissions reductions? Outsourcing to China? It just doesn’t go over well. Still, I have learned that most of the upset surrounding the carbon market is based on common misconceptions that can easily be talked through.

The scientific community has come to a consensus that climate change is real and its effects catastrophic. The carbon market is a very active response to the problem. According to Point Carbon, the leading carbon market news provider, the market traded 1.6 billions tonnes of CO2 or equivalent in 2006, worth about 22.5 billion euros (around US$30.6 billion or 231 billion yuan). That’s a lot of money in the name of climate change. So where is it going?

Here in Beijing, day in and day out, I see firsthand what that carbon money is doing. China, with the world’s fastest growing economy and largest population, is poised to overtake the United States as the world’s greatest emitter of greenhouse gases. It is crucial that China build the infrastructure needed to curb its greenhouse gas emissions growth. Nonetheless, despite stellar year on year economic growth rates, China’s per capita GDP is still only one-sixth that of the United States.

In 1997, when the Kyoto Protocol was being negotiated, parties were concerned that specific emissions caps would handicap economic growth for developing nations. Therefore, they did not give developing country signatories specific limits on their greenhouse emissions. To encourage the reduction of emissions in these developing countries, the Protocol established the Clean Development Mechanism, or CDM. This mechanism gives China, and all other developing countries, the practical assistance it needs to stop emissions without unfairly hindering economic growth.

The Clean Development Mechanism, and the carbon market in general, is based on the fact that the gases warming our planet are all being dumped into the same place, our atmosphere, regardless of where they come from. Abatement is abatement, regardless of where it happens. Therefore, under CDM, stakeholders from developed country signatories to the Kyoto Protocol, like the UK, invest in and transfer technology to greenhouse gas abatement projects implemented in developing country signatories like China. If these projects prove that they could not have been implemented without CDM support, they are issued carbon credits that can be used by developed countries to stay under their emissions caps.

CDM, simplified, works like this: I am a utilities company in the UK, a developed country signatory to the Kyoto Protocol, and am allowed to emit 10 tonnes of carbon dioxide (CO2) this year. I emit 11. It costs me 50 euros to reduce a tonne of CO2 at home. I pay a company in China, a developing country signatory, 20 euros to help build a wind power project. The project generates electricity that would have otherwise been generated by burning coal. Less coal is burned and the project reduces the amount of CO2 that would have been emitted into the atmosphere by one tonne this year. The project would not have happened without my financing, so the worldwide net reduction in CO2 emissions is still the same. This CDM funding gives China real incentives to develop the technology and training needed to that wind project off the ground. Once it is up and running, companies gain valuable experience, which can be reapplied to more clean energy projects.

At the center of the mechanism is an intricate regulatory system that ensures the project quality. Getting projects registered through the CDM process requires the support of both the developed and developing country host parties, verification by a certified third-party standards body and the ultimate approval of the United Nations. Baseline emissions, what would have been emitted without CDM, must be clearly measurable and the project must be able to be strictly monitored. Finally, combinations of financial, investment, technological or common practice barriers must be strong enough to block the implementation of a project without CDM support.

So what is being done in China? One type of project far and away gets the most attention: the highly profitable HFC-23 destruction. Although the environmental benefits of destroying this highly potent refrigerant are unquestionable, HFC-23 factory owners to make a great deal of money off CDM. HFC-23 projects, because of their profitability, were developed first and tend to be the poster child for CDM.

Such a strong focus on HFC-23 presents a seriously skewed picture of CDM’s impact. China does hold a greater share of HFC-23 CDM projects than any other country in the world. Yet, of the 85 projects in China that have passed through UN registration, only eight are HFC-23 destruction projects. HFC-23 project development has all but trickled to a halt; 488 new projects in China are preparing registration applications, of which three are HFC-23 projects; 261 are renewable energy projects.

The vast majority of CDM projects will make long term contributions to curbing China’s emissions growth. Many projects generate electricity through renewable sources, such as hydropower and wind power. The electricity generated by these sources displaces the electricity produced from fossil fuel burning power plants, which, in China, tend to burn coal. Less coal is burned and greenhouse gas emissions are thus reduced. Other projects generate electricity from waste heat recovered from industrial processes. Others capture methane gas emitted from working coal mines and utilize it to generate electricity. The owners of these projects, regardless of how committed they are to the issue of climate change, aren’t able to implement them without financial support. The carbon market, through CDM, provides that. The fate of CDM after 2012 is unknown. Regardless of what happens, the infrastructure created by CDM projects will still be in place.

The impact of the carbon market extends beyond curbing Chinese emissions, and there isn’t space in a short article to fully argue the merits and flaws of the carbon market. However, by opening the conversation I hope we can correct some misconceptions and start a real discussion on how to do it better. Rather than destroy one of most important schemes we’ve devised to seriously tackle climate change, let’s keep the dialogue going.

Leigh Fitzgerald is senior specialist at Arreon Carbon UK, a firm that develops carbon credits in China then trades them on the international market.

Homepage photo by sheilaz413

See the other articles in chinadialogue’s carbon trading series:

Briefing: carbon trading

Mr Wang’s chemical factory

The limits of free-market logic