The outcome of intense negotiations between China’s central government, regional officials and industry over how to treat up to 100 million unused allowances from the seven pilot markets in the country’s national emissions trading scheme could have a huge bearing on the success of the world’s biggest carbon market, according to experts.

When the national ETS launches in 2017, the seven pilot markets will have accumulated 50-100 million surplus allowances, according to analysts at Thomson Reuters Point Carbon and ICIS Tschach Solutions.

In deciding what to do with those, the NDRC in Beijing is treading a thin line between maintaining the confidence of market participants, the goodwill of regional officials and ensuring the national market gets off to an efficient start with a meaningful carbon price.

Talks have been ongoing for months, and on Tuesday spilled over into national media, when Hong Jianwu, a deputy director at the Guangdong Development and Reform Commission (DRC), gave an interview with the 21st Century Business Herald.

“We suggest the national government consider thoroughly the overall condition of the pilot regions when converting the issued regional permits, preferably at a 1:1 ratio, especially to the regions that did not hand out all permits for free, since the liable companies and investors had paid a high cost at auctions,” Hong said.

Hong’s stance was perhaps not surprising as Guangdong is the only pilot market to have held regular allowance auctions, but is a clear indication of the opposition the central government would face from the pilot regions if it were to simply write off the surplus.

CONVERSION MECHANISM?

NDRC officials are considering a conversion mechanism that would allow pilot allowances to be eligible in the national market, but at a discounted value. However, reaching agreement on a discount rate, or on whether to use the same rate for all the pilot markets or seven different rates, has proved elusive so far.

Another option on the table is to allow the pilot permits to be used, but only for a limited period.

“This is a tough balancing task the NDRC has to undertake – to balance the effectiveness of the national scheme and satisfy participants in the pilot schemes,” Jian Wei Lim, an analyst with ICIS, told Carbon Pulse.

If Beijing rejects banking of pilot allowances, or only allows them at a very low value, prices in the over-allocated pilot markets are almost certain to collapse to near zero, which would deal a hard blow to the confidence of everyone involved in the market and cast doubt over China’s ability to operate a national scheme.

On the other hand, Lim said, with full or near-full value banking, the national market would risk carrying a severe surplus from the outset, which might bring low, inefficient prices and turn off traders.

Besides, “the NDRC was not involved in the design of the pilot ETSs, hence they should not ‘bear the consequence’ of oversupply during the pilot phase,” he added.

OFFSET VALUE

Allowing too many surplus permits from the pilots would also disincentivise developers seeking to earn offsets by launching projects that cut emissions.

“Full banking would be bad news for CCER players. The NDRC needs market confidence,” said Chai Hongliang, an analyst with Thomson Reuters Point Carbon, who predicted the NDRC would decide against it.

Chai estimated some 30-50 million tonnes of CO2e could be saved over the next couple of years through eligible offset projects, but that investment was depending on clear policy.

The NDRC recently circulated a draft law for the ETS which proposed overall rules for the market, but a number of tough issues relating to caps, allocation, coverage and the move from regional pilots to a unified national scheme were not included.

By Stian Reklev – stian@carbon-pulse.com

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