What Should We Make of China’s Announcement of a National CO2 Trading System?

On December 19, 2017, the government of China announced that it is commencing development of a nationwide CO2 trading system, that when launched will become the world’s largest carbon trading system, annually covering about 3.5 billion tons of CO2 emissions in China’s electric power sector.  That approaches twice the size of what is currently the world’s largest carbon trading system, the European Union Emissions Trading System, which accounts for about 2 billion tons per year, and is nearly nine times the size of the largest U.S. system, the California AB-32 cap-and-trade system, which covers about 400 million tons of annual emissions.

The ultimate purpose of the newly announced Chinese trading system is to help the country meets its emissions and renewable energy targets which are part of its Nationally Determined Contribution under the Paris Agreement, in particular, peaking its CO2 emissions by 2030, and achieving 20% of the country’s energy supply from renewables.  Note that coal currently accounts for 65% of China’s electricity generation.  Wind and solar capacity have been growing rapidly, but still account for only 4% and 1% of generation, respectively.

The Chinese carbon market will double the share of global CO2 emissions covered by worldwide carbon-pricing systems to almost 25 percent.  For this and other reasons, the December announcement was greeted with excited praise from climate activists (but simultaneously with disregard and skepticism from conservative opponents of climate action).  The most reasonable assessment, however, is between those two extremes, as I explain in this essay.  That said, the December announcement by China of its plan to develop and launch a nationwide CO2 trading system is an important landmark on the long road to addressing the threat of global climate change.

Some Brief History for Context

In 2011, China’s 12th Five-Year Plan (2011-2015) first included a statement about the government’s intention to develop – gradually – a nationwide carbon market.  Subsequently, in 2013 and 2014, seven pilot emissions trading programs were launched in the cities of Beijing, Chongqing, Shanghai, Shenzhen, and Tianjin, plus two provincial systems in Guangdong and Hubei.  In total, these covered some 3,000 sources, with total annual CO2 emissions of 1.4 billion tons.  The designs of the systems were intentionally varied, to facilitate learning, and allowance prices ranged from $3 to $10 per ton of CO2.

Then, in the lead-up to the Paris climate negotiations, on September 25, 2015, President Xi Jinping met at the White House with U.S. President Barack Obama, and announced that China would launch its nationwide CO2 trading system in 2017, presumably covering electricity, iron and steel, chemicals, cement, and paper production.

The announcement last month was the culmination of this brief history, as China seeks to move ahead with its “pledges” under the Paris Agreement, at the same time as the Trump administration in the United States intends to withdraw altogether from the Agreement (in November, 2020, the soonest that such withdrawal can take place under the rules of the Agreement).

What’s Known about the Chinese Carbon Trading System

China’s December announcement that it is commencing development of a nationwide CO2 trading system, beginning with the electric power sector only, provided few detailsApparently, the system is intended to eventually include electricity, building materials, iron and steel, non-ferrous metal processing, petroleum refining, chemicals, pulp and paper, and aviation, but will start with the electricity sector alone.  Like most operating systems in the world, it will regulate only CO2, not other greenhouse gases (GHGs), which in China’s case means potentially addressing more than 80% of its total GHG emissions.

The system will not be a cap-and-trade system per se (unlike the CO2 trading systems in Europe and California, for example), because there will not be an administratively set mass-based cap of some quantity of emissions.  Rather, the trading system will be rate-based, meaning that it will be in terms of emissions per unit of electricity output.  This is also called a tradable performance standard, whereby the government sets a performance standard (a benchmark emissions rate per unit of output), sources receive permits (allowances) based on their electricity output and their benchmark, and sources are allowed to trade.  Such tradable performance standards have been used previously in a variety of contexts, including the U.S. EPA leaded gasoline phasedown in the 1990s, U.S. Corporate Average Fuel Economy (CAFE) standards to regulate motor-vehicle fuel efficiency, the Obama Administration’s Renewable Fuel Standard, and California’s Low Carbon Fuel Standard.

One objective of using this approach is to insulate – or at least cushion – the (electricity) sector and the larger economy from “carbon market shock.”  By regulating the emissions rate (per unit of product output), rather than emissions per se, the rate-based approach may help mitigate the political worry about constraining economic growth, but does so by essentially rewarding (subsidizing) higher levels of output.  This relative inefficiency of China’s rate-based system, compared with a mass-based cap-and-trade approach is highlighted in a new paper by Lawrence Goulder (Stanford University) and Richard Morgenstern (Resources for the Future) and one by William Pizer (Duke University)and Xiliang Zhang (Tsinghua University).  (There is a parallel impact and concern – in cap-and-trade systems – with an output-based updating allocation, which can address competitiveness impacts but also introduces inefficiencies by subsidizing dirty production.  This mechanism – which affects only energy-intensive and trade-exposed industries – was proposed in the Waxman-Markey climate legislation and is employed in California’s system.)

The rate-based approach is intended to have a smaller impact on marginal production costs than the mass-based cap-and-trade approach, and thereby is likely to have a smaller impact on the price of products (whether electricity or manufactured goods).  This is the motivation for using this approach in an output-based updating allocation, as described above, and it carries with it the parallel disadvantage of insulating consumers from (some of) the social costs of their consumption decisions.  The problem is exacerbated in the case of China’s evolving system because the performance standards (emission benchmarks) are set not only by sector, but by various categories of electricity production within the sector.  As some categories are, in effect, subsidized by other categories, the cost-effectiveness of the overall system declines.  There is a lack of incentive for the carbon market to move energy consumption from coal to natural gas, for example, because of the multi-benchmark approach.

Finally, it appears that allowances will be allocated without charge, at least in the early stages of the program, which has been typical of emissions trading systems in other parts of the world, and may lessen political resistance while also sacrificing potential efficiency gains associated with auctioning allowances and recycling revenues.

What’s Unknown about the Chinese Carbon Trading System

Among the key design elements that are unknown as of now (at least to me) are the following:

(1)        What will the total allocation of allowances initially be and how will it change (presumably decrease) over time?  Apparently the overall “cap” will be set by adding up the expected emissions of compliance entities, based on their historical emissions.  Then, allocations will be reduced, presumably based on technology performance benchmarks.

(2)        When will trading commence?

(3)        What share of allowances will be distributed for free, and how many – if any – will be auctioned (and how will any auctions operate)?

(4)        What provisions will there be for monitoring and enforcement, and will there be fines or other penalties for non-compliance?

(5)        How will the system interact with other Chinese climate policies?  This is an important question, because so-called “complementary policies” that seek to regulate sources under the cap of a cap-and-trade system can lead to perverse outcomes, as in the European Union and California.

(6)        What is the time-path for expanding the scope of the system to include more sectors, and what sectors will be added?

(7)        When and how, if at all, will China seek to link its system with carbon-pricing and other climate policies in other parts of the world?

Given all of these open questions plus the limited sectoral scope of the announced system, it is reasonable to ask:  what should we make of all this?

How Significant was the Chinese Announcement?

The announcement, despite all the caveats, was a significant step along the road of climate change policy developments, because the Chinese system will eventually be very important, because of its magnitude and because of the importance of China in CO2 emissions and climate change policy.  However, the announcement was not a launch per se, but a statement about a forthcoming launch.

More broadly, the announcement and the eventual launch of the system will have significant effects on other governments around the world – regional, national, and sub-national.  Some will be encouraged to launch or maintain their own carbon trading systems, and to increase the ambition of their systems.  Why do I say this?

A frequently stated fear of adopting climate policies, including carbon pricing, is the competitiveness effects of those policies, due to emission, economic, and employment leakage.  This is more a political issue than a real economic one, but it is nevertheless important.  Since the greatest fear in this realm is that domestic factories will relocate to China, that concern will be greatly reduced – or at least it should be – when and if China has put in place a serious climate policy, whether through carbon markets or otherwise.

China is moving slowly and cautiously, which is wise.  Not long ago, they were considering launching a system that would initially cover 7,000 companies in several sectors, but the 2017 announcement is of a system that covers 1,700 companies in the electricity sector alone.  Of course, it is still important, given that the electricity sector (with its large coal and natural gas plants) accounts for fully a third of China’s CO2 emissions.

During the next two years, the Chinese government – apparently through its National Development and Reform Commission (NDRC), which will administer the trading system – will begin by developing systems for data reporting, registration, & trading – gathering and verifying plant-level emissions data.  This will facilitate the establishment of baselines for allocations of allowances.  Beyond this, a wide range of rules will need to be established.  Following some tests, the actual spot market may launch in 2020 (the same year the Paris Climate Agreement essentially replaces the Kyoto Protocol).

The Path Ahead

As inevitably seems to be the case, the best assessment of this new policy lies somewhere between the extremes.  The December announcement by China was neither as exciting as some of the applause from climate activists might suggest, nor was the announcement as meaningless as conservatives have claimed.

Rather, cautious optimism seems to be in order.  China is serious about climate change, and is thinking long-term.  The country appears to be methodically working to develop a meaningful carbon trading system.  What is important now is developing a robust system that can be effective, expanded in scope, and gradually made more stringent.  Among the greatest challenges will be achieving the cooperation of the provincial governments, not to mention the compliance of the regulated entities.

Development of the system has begun, with the real launch of trading likely to take place in 2020, which is a key year for Chinese climate policy for other reasons, as well.  In that year, China will release its next Five-Year Plan, and it will submit its updated Nationally Determined Contribution to the UNFCCC under the Paris Agreement.  What will the United States be doing that year?  Not much, just electing a President!

Share

If Tillerson Departs State Department, Will We Go from Bad to Worse?

On November 30th, 2017, the New York Times broke the story that the Trump White House is planning to oust Rex Tillerson as Secretary of State, and replace him with Mike Pompeo, the current Director of the Central Intelligence Agency (CIA) and former Republican member of the U.S. House of Representatives.  (Pompeo, the Times story also suggested, would likely be succeeded at the CIA by Tom Cotton, Republican Senator from Arkansas.)

What should we make of this change – in terms of climate change policy – if it does happen?

Looking Backward for Some Perspective   

On January 3, 2017, two weeks before Inauguration Day, I posted an essay at this blog on “Trying to Remain Positive,” in which I searched for any remotely positive elements of the incoming Trump administration.  I wrote:

“Remarkably, the least worrisome development in regard to anticipated climate change policy may be the nomination of Rex Tillerson to become U.S. Secretary of State.  Two months ago it would have been inconceivable to me that I would write this about the CEO of Exxon-Mobil taking over the State Department (and hence the international dimensions of U.S. climate change policy).  But, think about the other likely candidates.  And unlike many of the other top nominees, Mr. Tillerson is at least an adult, and – in the past (before the election) – he had led his company to reverse course and recognize the scientific reality of human-induced climate change (unlike the President-elect), support the use of a carbon tax when and if the U.S. puts in place a meaningful national climate policy, and characterize the Paris Climate Agreement as “an important step forward by world governments in addressing the serious risks of climate change.”

It’s fair to say that it is little more than damning with faint praise to characterize this pending appointment as “the least worrisome development in regard to climate change policy,” but the reality remains.  Everything is relative.  Of course, whether Mr. Tillerson will maintain and persevere with his previously stated views on climate change is open to question.  And if he does, can he succeed in influencing Oval Office policy when competing with Scott Pruitt, Trump’s pick to run EPA, not to mention Rick Perry, Trump’s bizarre choice to become Secretary of Energy?”

Since then, we have learned the answer to that question.  Despite Secretary Tillerson’s (apparent) support for the U.S. to remain in the Paris Agreement, the combined forces of EPA Administrator Pruitt, Secretary of Energy Perry, and – most important – former White House Chief Strategist, Steve Bannon, the President announced in June his intention to withdraw the United States from the Agreement, following on a host of moves to reverse the Obama administration’s domestic climate change policies.

Secretary Tillerson’s Record at the State Department

Perhaps Mr. Tillerson should be credited for the fact that the State Department has at least remained engaged in the climate change negotiations under the United Nations Framework Convention on Climate Change (UNFCCC), including by sending a delegation to the annual talks in Bonn, Germany (from which I recently returned), where negotiators from other Parties to the Paris Agreement personally related to me how surprised they were by the constructive role the U.S. delegation was continuing to play (in putting meat on the bones of the Paris Agreement).  However, such continued bureaucratic involvement cannot make up for the fact that the U.S. is disengaged at political levels, which must be attributed – at least in part – to Secretary Tillerson’s ineffectiveness in tilting the President toward a more sensible path on climate change policy.

It is beyond the scope of this blog (and my expertise) to comment more broadly on Mr. Tillerson’s general leadership of the State Department or on the many key areas of international relations outside of the climate policy realm.  But, I will note that my Harvard Kennedy School colleague (and former ambassador), Nicholas Burns, together with another former ambassador, Ryan Crocker, described in a scathing New York Times Op-Ed a few days ago how the Foreign Service is being virtually dismantled under Tillerson.

In another harsh New York Times Op-Ed, Antony Blinken recently assessed “How Rex Tillerson Did So Much Damage in So Little Time.”  But, as Blinken points out, the great irony is that Tillerson has had “good judgment” on many of the critical international issues facing the administration.  In addition to (apparently) asking the President to keep the U.S. in the Paris Agreement, Tillerson supported the Trans-Pacific Partnership (TPP), Obama’s nuclear deal with Iran, a calmer approach to North Korea, staying firm against Russian aggression (such as in Ukraine), and calming the Qatar-Saudi Arabia controversy, which was instigated, in part, by Trump himself.  But on all of these issues, Tillerson’s sensible, if inexperienced, diplomatic advice failed to win the day.

Out with the Bad, In with the Worse?

Enter Mike Pompeo.  What would his presence as Secretary of State mean – both broadly, and in particular, for climate change policy?

In broad terms, Pompeo is apparently smart (as is Tillerson), highly ideological (which Tillerson, a moderate, is not), and very partisan (which, again, Tillerson is not).  This does not sound like good news for the leadership of the U.S. Department of State.

On the other hand, Pompeo might be expected to slow down, if not reverse, the hollowing out of the State Department’s political leadership and Foreign Service officer corps that has occurred under Tillerson’s enthusiastic down-sizing of the Department.

Antony Blinken’s conclusion is that with Pompeo in the lead, “we can expect a focus on hard-power solutions to every problem, … and an even more aggressive pursuit of ‘America First.’”  Whereas Tillerson apparently tried to check Mr. Trump’s worst instincts, “now we may see them fully unleashed.”  Good God, what a thought!

The Path Ahead for Global Climate Change Policy

That is a rather frightening prognosis across the board.  But what about climate change policy, in particular?  Does Mr. Pompeo at least share Mr. Tillerson’s personal understanding of the reality of the problem and the importance of addressing the threat?

Sorry, but the answer does not provide cause for hope.  In the House of Representatives, before his move to the CIA, Congressman Pompeo was a consistent, long-term, and vocal skeptic of the science of climate change, and an outspoken critic of the Obama administration’s climate policies, which he characterized in 2015 as a “radical climate change agenda.”  Although he may have modified his views since his appointment as CIA Director, at his confirmation hearings last January, he stated that Obama’s view that climate change is a significant issue for national security was “ignorant, dangerous, and absolutely unbelievable.”

Secretary Tillerson’s exit from the State Department and Mr. Pompeo’s entry, if these take place, will constitute yet another sad chapter in the short history of the sorry state of governance under the presidency of Donald Trump.  During twenty-eight years of teaching at Harvard, until last year I had remained stubbornly non-partisan, but thirteen months after the election, I still find it difficult to believe that we have elected such an individual to be President of the United States.

Share

Why the U.S. Should Remain in the Paris Climate Agreement

            It was widely reported last week that a White House meeting scheduled for Tuesday, April 18th, was to consider whether the United States should remain a party to the Paris Climate Agreement.  At the last second, that meeting was postponed.  As of today, there is no public information about when it may occur.  All that is known is that the Trump Administration had indicated previously that it will make known its position on the Paris Agreement before the G7 Summit, which takes place in Italy in late May.

With that in mind – and with Earth Day being celebrated on April 22nd – I was pleased to co-author with Ban Ki-moon an op-ed which just appeared in The Boston Globe, “Why the US Should Stay in the Paris Climate Agreement” (April 21, 2017).  As you no doubt know, Ban Ki-moon was Secretary-General of the United Nations (2007-2016), but what you may not know is that he is currently my colleague at the Harvard Kennedy School, where he is the Angelopoulos Global Public Leaders Fellow.

Before the Secretary-General Emeritus and I produced the final version of our Boston Globe op-ed, we had written a considerably longer, more detailed essay on the same topic, and so in today’s blog essay, I’m pleased to provide below an expanded version of that longer essay, with hyperlinks added.  I hope you find this of interest.

++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Why the U.S. Should Remain in the Paris Climate Agreement:  An Earth Day Message for President Trump

 by Ban Ki-moon and Robert N. Stavins

In the five decades since the first Earth Day was celebrated in 1970, remarkable economic growth around the world has inevitably been accompanied by significant environmental challenges.  While tremendous progress has been made to address concerns about air and water quality, hazardous waste, species extinction, and maintenance of stratospheric ozone, leaders around the world continue to struggle to address the threat of global climate change in the face of the steady accumulation of greenhouse gases in the atmosphere.

The Necessity of International Cooperation

There is broad scientific consensus that human-based emissions of greenhouse gases – including carbon dioxide (CO2) from fossil-fuel combustion and land-use changes – will change the earth’s climate in ways that will have serious environmental, economic, and social consequences. Sixteen of the warmest years on record have occurred since 2000, including 2016 as the warmest of all.  At the same time, winter arctic sea ice is at its lowest extent in recorded history.

Increased temperatures – which might be welcome in some places – are only part of the story.  More important are changes in precipitation, decreased snowpack, glacier melting, droughts in mid to low latitudes, decreased cereal crop productivity at lower latitudes, increased sea level, loss of islands and coastal wetlands, increased flooding, greater storm intensity, species loss, and spread of infectious disease.

These biophysical impacts will have significant economic, social, and political consequences. Estimates of economic damages of unrestrained climate change vary, with most falling in the range of 1 to 3% of world GDP per year by the middle of the current century.

In order to have a 50-50 chance of keeping temperature increases below 2o C (a long-term goal acknowledged by most national governments), it would be necessary to stabilize atmospheric concentrations at 450 parts per million, which in principle could be achieved by cutting global emissions by 60 to 80% below 2005 levels by 2050.

Reducing emissions will not be cheap or easy, but the greatest obstacles are political.  The severe political challenges are due to the fact that greenhouse gases mix in the atmosphere, and so the location of damages is independent of the location of emissions. Any political jurisdiction that takes action incurs the direct costs of that action, but the climate benefits are spread globally. Hence, for any country, the direct climate benefits of taking action will likely be much less than the costs, despite the fact that the global benefits may exceed, possibly greatly, the costs. Therefore, due to the global commons nature of the problem, meaningful international cooperation is necessary.

The Paris Climate Agreement:  A Breakthrough After 20 Years

The countries of the world have been struggling to come up with a solution since they agreed in 1992 to establish the United Nations Framework Convention on Climate Change (UNFCCC). After more than 20 years of negotiations, an important, historic breakthrough came with the signing of the Paris Climate Agreement in 2015, a path-breaking approach that increased the scope of participation from countries accounting for just 14% of global emissions (in the current, second commitment period of the Kyoto Protocol) to countries accounting for 97% under the Paris Agreement!

Contrary to some claims, China, India, Brazil, Korea, South Africa, Mexico, and the other large emerging economies do have obligations under this new approach.  Far from being a “bad deal” for the United States, as EPA Administrator Scott Pruitt has asserted, the Paris Agreement is actually the answer to U.S. prayers going back to the U.S. Senate’s bipartisan (95-0) Byrd-Hagel Resolution in 1997, which rejected the Kyoto approach and called for an agreement that would include not only industrialized countries, but the large emerging economies as well. That is precisely what the Paris Agreement has finally delivered!

Will the U.S. Remain Part of the Process?

This is a pivotal moment.  President Trump’s recent executive order in which he laid out his plans to roll back much of the Obama administration’s climate policy, was silent on the Paris Agreement, reportedly reflecting disagreements among the President’s closest advisers.

During the campaign last year, the President said he would “cancel” the Paris Agreement.  But because it has already come into force, under its rules, any party must wait three years before requesting to withdraw, followed by a one-year notice period.  The United States is part of the agreement for the next four years. Any White House announcement of pulling out of the pact will have no direct effects for this Presidential term.

In theory, the President could try to bypass that four-year delay by taking the one-year route of dropping out of the overall UNFCCC — signed by President George H.W. Bush and ratified by the Senate in 1992. But that could require another two-thirds vote of the Senate, would be challenged in the courts, and would be unwise in the extreme, given that the U.S. would then be the only one among 197 countries in the world not to be a party to the Climate Convention. At a time when the United States wants cooperation from a diverse set of countries around the world on matters of national security, trade, and a host of other issues, it would be counter-productive in the extreme to willingly become an international pariah on global climate change.

Key Support Inside and Outside the Administration

Fortunately, key voices in the Administration have argued for remaining in the Paris Agreement. Secretary of State Rex Tillerson has stated that it is better for the U.S. to be at this table of ongoing negotiations. More broadly, Secretary of Defense James Mattis said in Congressional testimony that he views climate change as a national security threat.

Remarkably, support for the Paris Agreement is broad-based within U.S. private industry – from electricity generators such as PG&E and National Grid, to oil companies such as BP, Chevron, ConocoPhillips, Exxon-Mobil, and Shell, mining companies such as Rio Tinto, and a very long list of manufacturers, including giant firms such as General Motors. Even some of the largest coal producers, such as Arch Coal, Cloud Peak Energy, and Peabody Energy, have told the President about their support for the U.S. remaining in the Agreement. This broad support is due to a simple reality – leaders of successful businesses make decisions not on the basis of ideology, but based on available evidence.

True enough, there is also opposition from some especially vocal coal industry executives, and the President seems to have shaped his domestic climate policies around their interests, with his repeated pledge to “bring back coal.” But the job losses in coal mining over the past decades have been due to technological change (increased productivity) in the coal sector, and more recently by low natural gas prices, not by environmental regulations (particularly not by regulations – such as the Clean Power Plan – that have not even been implemented).

The Paris Agreement Provides Flexibility

The U.S. could stay in the Paris Agreement, and seek to revise the Obama-era numerical target of a 26% reduction in emissions below 2005 levels by 2025, an approach recommended by North Dakota Republican Representative Kevin Cramer. However, by 2016, energy-related emissions were already down by 14% below 2005, so it is not clear that the existing pledge even needs to be re-assessed. Also, state climate policies in California, Oregon, Washington, and the Northeast will remain in place, and likely be strengthened. And more than half of all states have renewable energy policies; just since election day, the Republican governors of Illinois and Michigan have signed legislation aimed at increasing solar and wind generation. At the Federal level, the important tax credits for wind and solar power continue to receive bi-partisan support in the Congress.

Putting it All Together

In summary, climate change is a serious threat, which requires international cooperation because of its global commons nature.  After twenty years of negotiations, the path-breaking Paris Climate Agreement, with its exceptionally broad participation, is the answer to long-standing, bipartisan appeals, and provides an excellent foundation for progress.

The President cannot “cancel” the Agreement, and it would take four years for the U.S. to withdraw. Pulling out of the foundational United Nations Framework Convention on Climate Change might be quicker, but would be unwise in the extreme, jeopardizing U.S. relationships with countries around the world on a host of pressing issues, ranging from national security to international trade.

Fortunately, key voices in the Administration have argued for keeping the U.S. in the Paris Agreement, and support from the business community is exceptionally broad and deep. If necessary, the U.S. can seek to revise the specific U.S. pledge under Paris made by the Obama administration, while remaining a party to the Agreement. But given the pace of emissions reductions already achieved, combined with ongoing state and Federal climate policies, it is not clear that those targets need to be changed.

Having considered this diverse set of considerations that should bear upon this U.S. decision, we find the arguments for the country remaining in the Paris Climate Agreement to be compelling. The truth is that in the 47 years since the first Earth Day, much has been accomplished.  But much of that remarkable progress could be undone in the short span of 4 years or less. We are confident – or at least hopeful – that this will not happen.

– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –

Ban Ki-moon was Secretary-General of the United Nations (2007-2016), and is the Angelopoulos Global Public Leaders Fellow at the Harvard Kennedy School.  Robert Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School, and was Coordinating Lead Author of the Intergovernmental Panel on Climate Change.

Share