In 2014, the Chinese Government declared war on the chronic pollution that was literally choking the nation’s primary industrial cities. It is a battle the world’s biggest polluter cannot afford to lose.

Chinese power plants emit around 3.3 billion tonnes of carbon dioxide (CO2) a year and will, according to International Energy Agency data, install 26% of all new coal-fired power generation by 2040.

Four years on, the Asian powerhouse is not only prevailing but also finds itself in the curious position of being lauded as a paragon of progressive environmentalism. China is now the world’s largest issuer of green bonds, fixed financial instruments issued to raise money for environmental projects.

Emissions are also expected to peak well in advance of the original 2030 deadline, the country’s new Environmental Protection Tax Law came into force on 1 January, and last November in the capital, Beijing, levels of the harmful airborne particulate PM2.5 had fallen by 40% from the peak in 2012-2013.

More was to come. In December, China unveiled the world’s largest carbon emissions trading market in an effort to force the worst polluters to clean up their acts or pay for releasing greenhouse gases.

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“The idea behind the carbon trading system is to add another policy element designed to reduce CO2 emissions in China,” explainsGreenpeace China senior climate and energy policy officer, Li Shuo.

“For a decade the country has been relying heavily on carbon control measures with binding targets, which the political parties then have to find a way to implement. New, innovative alternatives to this heavy-handed, top-down approach to began emerging a few years ago, including emissions trading.

“China has been testing this instrument since 2011, using pilot projects in several different cities and provinces. Over the next few years the idea is to implement carbon trading at a nationwide level.”

Carbon credits: the Chinese Cap and Trade system explained

Under the proposed carbon trading structure, Chinese power plants will be issued with allowances by the government detailing exactly how much CO2 they are allowed to release into the atmosphere.

If a company undershoots and emits less pollution, it can decide to sell its remaining credits to other generators as an incentive for them to become more efficient, rather than paying for their emissions.

“The Chinese system will be similar in design to the EU Emissions Trading System (EU ETS),” explains Li. “If you emit less than your allocated allowance, you are able to trade those credits with other emitters to your economic advantage, and vice versa. If you overshoot then you need to buy credits.”

The critical issue of how allowances are allocated will likely be decided later this year. Li explains that the permits should be allocated on specific power plant technology and past performance.

“The trading allowances will be based primarily on historical data from power plants,” explains Li. “Based on this information, those facilities will be given a trajectory that their emissions must take.

“In most cases that trajectory will be a downward one and in terms of emissions, there will also be different benchmarks for different power plants depending on the specific technologies employed.

“For example, gas will be included in the trading system, but the emission trajectory for gas power plants will be very different compared with coal-fired facilities.”

The Guardian reports that the mechanism will initially be applied to the heavily polluting Chinese power industry, but will ultimately cover eight sectors in total: power, iron and steel, non-ferrous metals, chemicals, petro-chemicals, paper, building materials and civil aviation.

“It is important to realise that we will not see an immediate extension of the system nationwide,” says Li. “The scheme will be heavily reliant on implementation and design and the next two to three years will be vital when it comes to deciding the overall quality of the system. Real trading will most likely start from 2020.”

Risk vs reward: will the emissions allowance system work?

China’s Environmental Protection Tax Law came into force in January. The new system replaced the Pollutant Discharge Fee, which regulators argued contained loopholes that businesses could exploit.

One unnamed analyst argues that, while the new scheme may have some effect, the worst polluters will be allowed to restart through payments to traders in the carbon market. Does Li agree and what does he make of the EU ETS on which the new Chinese carbon trading mechanism is based?

“There are genuine concerns and risks around emissions trading,” he concedes. “Even with a more advanced system like that operating in the EU, you have a real problem with over-allocating carbon emission credits. Right now, the EU model is not functioning very well.

“In a Chinese context you have even more intrinsic challenges than in Europe, in that we don’t have a culture that necessarily promotes transparency or the rule of law, so the credit allocations will be regulated by the system, which makes things more complicated. That is a cause for concern.

“The power sector in China is made up of large, state-owned players, all with a state-run DNA. They are private companies that seek profit, but at the same time they are part of the state-apparatus, which gives them some political leverage.

“The credit allocation will be a negotiated bargaining process between the central government and those state-owned power companies. If you are a company, you will of course be lobbying for more favourable credits and conditions. That’s the risk of an environmentally binding system in China.

“However, it is important to put this in context,” he continues. “There are many countries around the world where there is no political appetite or will to employ a policy instrument such as this.

“In other countries, even industrialised countries, power plants are emitting for free, but now in China there will come a point when polluting will not be free – and that is very important.”

Toward 2030: the importance of Chinese economic reforms

For now, the Chinese Government has given the green light to an exchange on which emissions permits can be traded. Other developments will take longer, but for environmental groups such as Greenpeace China the wait will be worth it only if the trading system leads to a net reduction in CO2 emissions.

“We are starting from scratch. It takes time, but what is important is that China is making that step,” says Li. “Only when the details are outlined will we be able to tell if it is a solid step,” he adds.

Li also believes that China’s wider economic reforms are of equal importance when it comes to winning the war on pollution.

“In terms of reducing carbon emissions in the near to medium term, the biggest contributing factor will be the restructuring of the Chinese economy,” he states. “Introducing more reforms to move toward a service-based economy and generating the same amount of GDP, while using less energy and relying less on heavy industry. Other instruments like emissions trading will be an added bonus.

“As for China’s target of peak emissions, the main question is to what extent will we over-achieve that or get there sooner. I think the 2030 target is already a given.”