When China, the world’s largest emitter of greenhouse gases, launched its first national emissions-trading scheme (ETS) for the electricity sector in mid-July, it did so with the goal of achieving net-zero CO2 emissions by 2060.
China’s ETS is not a cap-and-trade system like most other ETSs around the world, because it does not impose a cap on total CO2 emissions. It is more accurately understood as a tradable performance standard.
Under the system, companies are incentivized to reduce the intensity of their carbon emissions by a system of government-allocated emission allowances that can be bought and sold, ultimately raising costs to inefficient, high-emitting producers while rewarding efficient, low-emitting ones. The freely allocated allowances act as output subsidies to emitters. The ETS is designed to minimize the cost of emission reductions for the sector as a whole.
Now, a team of economists from Harvard University, Tsinghua University, and Beihang University have explored the effectiveness of China’s pilot carbon markets—operated in seven regions since 2013 to lay groundwork for the national program—in reducing emissions in the electricity sector.
Using firm-level evidence, their research, published in the Journal of Public Economics, shows that while coal use in power plants in the pilot areas fell and there was a shift from less efficient to more efficient plants, these were unlikely due to the market incentives directly from the rising carbon prices.
This result highlights the challenges of implementing carbon trading in a highly regulated sector such as power generation in China, compared to the more market-driven ones slated for future phases of the national ETS, such as iron & steel production.
“As the largest carbon-emitting industry in the world, the electricity sector is an obvious target for an emission reduction policy,” explains Mun S. Ho, co-author and Research Associate with the Harvard-China Project on Energy, Economy and Environment at Harvard University. “But power sectors are often highly regulated, as is the case in China, which can limit the effectiveness of a market-based emission control policy.”
“We set out to explore whether the pilot markets led to a reduction in CO2 emission intensity or total emissions, capitalizing on unique firm-level data to conduct our analysis,” says co-author Jing Cao, of the Tsinghua University School of Economics and Management.
The micro-level dataset encompassed nearly all power plants in China including very small ones, totaling over 10,000 both within and outside of the pilot regions. This allowed the authors to compare ETS and non-ETS plants.
The new national ETS covers roughly 2,200 of the largest coal- and natural gas-fired power plants, emitting approximately 4 billion metric tons of CO2 annually.
Although the research shows that the pilot ETS did not raise the coal efficiency (grams of coal per kWh) of regulated coal-fired power plants during the study period, the authors did find significant reductions in electricity output and coal consumption associated with ETS participation.
“In such a highly-regulated industry, the ETS operates differently from an unregulated, marketized one,” explains Rong Ma, an alumnus of the Harvard-China Project. In some countries there are spot markets where generators bid to sell their electricity, but there were none in China during the period. “The prices that generators receive are regulated. Since the cost of the emission allowances are very small relative to both the cost of coal and the regulated electricity prices, the changes in power output of each plant were likely driven by government dispatch decisions and not by profit-maximizing decisions.”
In another notable finding, the study, co-authored also by Fei Teng of Tsinghua University, found no evidence that China’s ETS pilots induced carbon emission leakage to other regions, possibly due to the strict regulatory hierarchy of the electricity sector. And the study did find a significant increase in the production of non-coal-fired power plants in the ETS pilot regions, compensating for the reduction in coal plant output.
Paper cited: Jing Cao, Mun S. Ho, Rong Ma, and Fei Teng. 2021. “When carbon emission trading meets a regulated industry: Evidence from the electricity sector of China.” Journal for Public Economics, https://doi.org/10.1016/j.jpubeco.2021.104470.
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The Harvard-China Project on Energy, Economy and Environment, based at the Harvard University John A. Paulson School of Engineering and Applied Sciences, conducts rigorous, peer-reviewed studies with partner institutions in China of the global challenges of climate change, air quality, energy systems, and economic development. It provides natural, applied, and social scientific evidence for the design of innovative and effective policies to confront these challenges in China and beyond.
Tsinghua University’s School of Economics and Management (SEM), located in Beijing, China, is consistently ranked among the best business schools in China. The school is committed to advancing knowledge and cultivating leaders for China and the world, and currently enrolls more than 3,000 students in its undergraduate, master’s, doctoral, and executive education programs.