Better data is the key to the success of the Chinese carbon market

Richard L Sandor, the “father of carbon trading” and founder of the Chicago Climate Exchange, quoted Victor Hugo to explain the resilience of global emissions trading development: “No force on Earth can stop an idea whose time has come. “.

With growing concern about climate change, an increasing number of countries have committed to reducing carbon emissions by implementing one of the most cost-effective solutions, an Emissions Trading System (ETS). So far, jurisdictions that account for 55% of global GDP use emissions trading.

The newly established Chinese National ETS has attracted enormous attention around the world. It should serve as China’s primary tool for achieving its “double carbon dioxide” goals of reaching peak CO2 before 2030 and carbon neutrality before 2060. Largest ETS globally, accounts for 40% of emissions China and over 10% of global emissions, with the potential to double in size once industrial sectors are added to the already covered energy sector. It is also the first nationwide ETS in a large developing country.

How does the Chinese ETS work?

China’s National Emissions Trading System (ETS) gives each covered company the right to emit a certain amount of CO2.

The amount is based on a benchmark of the intensity of emissions and the level of production of the company.

If a company therefore issues less than its allotted quota, it can sell the surplus on the market.

If more, it has to buy allowances or offsets from the market.

Therefore, companies have an incentive to reduce emissions from production activities.

July 2022 saw the first anniversary of China’s ETS trade, when 194 million tons of carbon allowances worth over $ 1 billion were traded on the market. The first round of compliance saw over 99% compliance across 2,162 power companies.

Despite these findings, there are some key roadblocks. At the top of this list is data quality and integrity.

In July 2021, a power plant in Inner Mongolia was found to have falsified the emissions report by falsifying the test date of the carbon content of the coal it was burning, affecting at least 1 million tonnes of emission allowances worth 7 Millions of dollars. Additional cases were also found and the Ministry of Ecology and Environment (MEE) issued a notice requesting the provincial environmental departments to fully review the quality of the data. If the data is found to be false, they should make changes and impose penalties, the notice said.

194 million tons

of carbon allowances were traded in the first year of China’s domestic carbon market, worth over $ 1 billion

Some observers blamed the December 2019 announcement fraud of an extremely high default for the carbon content of the coal used in the first compliance round. This high value was intended to encourage companies to submit actual test data rather than using the default setting. But it came too late to conduct more tests for 2019 and instead attempted companies to risk falsifying test reports.

On a broader level, multiple factors have increased the risk of these types of events.

First, the penalties: the fine for fraud, ranging from $ 3,000 to $ 4,500, is insignificant compared to the potential gain from the fraud. The boundaries of responsibility for data quality are not clear enough between the different participants, including companies, verification agencies, testing agencies and consulting firms.

Secondly, verification: provincial administrations are responsible for selecting verification agencies and tend to prefer local ones. This may exclude more experienced and more qualified agencies from other provinces. In addition, provincial governments have allocated limited funds for payment of the verification and there are still no qualification requirements established for verifiers.

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Third, monitoring and reporting: regulations and guidelines are not sufficiently clear or detailed. For example, in detecting the carbon content of coal, there appears to be room for tampering with the coal samples during collection and preparation.

Data quality and integrity have been at the top of the government’s agenda. Improved reporting guidelines were published in December 2021 and March 2022; verifiers found guilty of misconduct were named and ashamed; the extremely high default value of the carbon content in coal has been replaced; and ETS legislation has been included in this year’s Council of State Legislative Work Plan, which includes tougher penalties for non-compliance the ETS needs.

Improving data quality will be the top priority of the MEE in 2022 and 2023, including accelerating further changes to the monitoring, reporting and verification (MRV) guidelines; strengthen the supervision of emissions data through periodic checks at national, provincial and municipal levels; increase information disclosure; build a system to classify organizations based on their compliance history and supervise them accordingly; and increase penalties for violations.

China should review best practices in South Korea and the European Union ETS

These are big steps in the right direction. However, it appears that China’s priorities on the absence of Covid and economic recovery may complicate efforts to address integrity issues. For example, in consideration of these priorities, the MEE issued a notice in June 2022 to adjust the MRV requirements during the second compliance cycle. It said companies with three or more months of carbon content test results per year can use the average of these results to calculate emissions for all months that have no test results, instead of using a high default value according to the previous requirements. This adjustment seems to leave room for companies to test in the months they use coal with a lower carbon content.

A key necessity for China’s national ETS is a robust MRV system. This must be supported by efficient IT systems, robust security measures and effective sanctions for non-compliance. This will foster the confidence of market participants, sector expansion and international support and credibility.

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China is making progress in improving the integrity of its MRV system, but more work is urgently needed. The ETS law must be adopted at the level of the Council of State; a robust accreditation system for verification agencies needs to be established to ensure consistent, high-quality verification across all provinces; the fees for the verification should be sufficient to carry out a complete job; and MRV regulations and guidelines need to be clearer and more detailed.

China is expected to review MRV best practices in the European Union ETS and the MRV system in the South Korean ETS, the leader in Asia. At the same time, the integrity of the system should be protected from being compromised by other criteria.

China is not alone in facing integrity issues in the early stages of an ETS. Some major cases of fraud occurred during the early stages of the EU ETS. However, lessons were learned quickly and effective controls were established. China must also quickly overcome these challenges to pave the way for the expansion of its ETS into industrial sectors, achieve significant reductions in greenhouse gas emissions, and realize its potential in helping the country meet its double carbon goals in cost-effective way.

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