The Role of Emission Allowance Allocation in China's New

The Role of Emission Allowance Allocation in China’s Cap and Trade Carbon Market: A General Equilibrium Analysis

Hancheng Daia, Yana Jinb, Xiaorui Liua a Peking University, Beijing, China; b College of William & Mary, USA

1 Background: China’s NDC and the new ETS

• China’s NDC reflects strong political will and rigorous enforcement

• By or before 2030, China will peak CO2 emissions, reduce CO2 per unit of gross domestic product (GDP) by 60%-65% from 2005 and increase the share of non-fossil fuels in primary energy consumption to 20%

• Although “intensity target”, this NDC implies substantial emission reduction efforts • by plausible projections with, e.g., IAMs • Jiang 2018, Jiang et al 2019

• To achieve the NDC • National Emission Trading System (ETS) is chosen as a key market based instrument

2 Seven Pilots: Carbon Market Starting Day

Bei Jing November, 2013 Tian Jin December, 2013 Hu Bei April, 2014 Shang Hai November, 2013 Chong Qing June, 2014

Guang Dong Shen Zhen December, 2013 June, 2013

3 Carbon Trading Price

Average Carbon Price of 7 Pilot Market ( 2014.4 – 2018.8 )

Apr May Jun Jul Aug Sep Oct Nov Dec Jun Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 80

60 GuangDong 50 BeiJing 40 ShangHai ShenZhen 30 ChongQing 20 TianJin

10 HuBei

4 The 2017 new ETS: “concerned” features and possible future directions

• Covering only the power generation • Covering multiple sectors industry • Rate based, output-based allocation of emission allowances • Still output based • Based on “sectoral emission intensity allocation, but becomes benchmarks * output” and update “mass based” dynamically • ETS participants are incentivized to influence allocation • The OBA allowances across • Not clear, overall emission cap of the sectors are predetermined ETS by an emission cap implied • Goulder et al., 2018; Pizer et al., 2018 by the NDC

5 The 2017 new ETS: “concerned” features and possible future directions

• What difference will be if China’s ETS covers multiple sectors and uses mass-based OBA? • Carbon price formation • Trading behavior in carbon market • Macroeconomic impacts

6 Background: Producer’s incentives

base case Grandfathering

Output-Based Allocation

If s updates based on each year’s output: rate-based OBA. Producer have incentive to change output therefore s If a planner can make “perfect” projection for the future, set the s, and producer takes it as given: mass-based OBA 7 What if China’s ETS covers multiple sectors and use mass-based OBA?

• We set up such an ETS and to examine its impacts and underlying mechanisms • Multi-sectoral recursive dynamic computable general equilibrium (CGE) model

8 IMED model Peking University

9 Multi-sectoral recursive dynamic computable general equilibrium (CGE) model

10 Scenarios in this study

Total carbon Sectoral emission Carbon Scenario name mission allowance emission trading constraints allocation BaU No emission cap Not allowed None CAP SHR07 A fixed carbon Grandfathering emission cap Not allowed Output-Based CAP SHRbau implied by China’s Allocation ET SHR07 NDC of reducing Grandfathering 65% GDP-CO2 Cross-sectoral ET SHRbau intensity by 2030 emission trading Output-Based (similar to future ETS) compared to 2005 Allocation

Data includes the input–output table, energy balance tables, carbon emission factors of different fossil fuels, energy prices of coal, oil and gas for the year of 2007. 11 Initial allowance allocation and emissions in 2030

When changing from Grandfathering to OBA, carbon allowances would:

• Increase for power generation, aviation and non-ETS sectors, • Decrease for non-metal, chemicals and metal smelting sectors.

12 OBA vs Grandfathering

Grandfathering Output-Based Allocation

• All participating sectors make significant abatement effort • Carbon price is more converged

13 “Inside” factors: autonomous technology improvement

Grandfathering Output-Based Allocation more difficult to abate, their marginal abatement costs would be more sensitive to allocation changes

• Bubble size is the percentage of allowance allocation

more difficult for sectors which autonomously become less energy intensive to further reduce extra emissions

Capital substitution rate (CSR): the ratio of capital input over energy input

in the production function 14 Intuition: OBA is based on projections of future, therefore the sectoral impacts are “closer” to sectoral original development paths

• Sectoral specific impacts are associated with their autonomous emission intensity reduction and technology improvement potentials • Detailed discussions in the paper • Findings in line with theories

• After allowing emission permit trading • ETS trade volume smaller under OBA • equilibrium conditions under OBA is not significantly different from Grandfathering

15 Reduced total trade volume

Grandfathering Output-Based Allocation

• Relatively dirtier sectors are buyers of permits • ETS trade volume smaller under OBA

16 Which are net subsidized by ETS?

Grandfathering Output-Based Allocation

• The accumulated trading revenue and the accumulated variance of value added are smaller under OBA versus Grandfathering • Avoiding massive buying or selling emission permits in OBA in Grandfathering

Bubble size is the share of traded emission volume over the total sectoral emission.

17 Sectoral economic output changes in 2030

• Fewer losses in sectoral output under OBA • ETS reduces output loss • Under ETS, losses under OBA and Grandfathering are not significantly different

Grandfathering Output-Based Allocation

18 Macro-economic impacts

• Fewer losses in GDP under OBA • ETS reduces GDP loss • Under ETS, losses under OBA and Grandfathering are not significantly different.

Grandfathering Output-Based Allocation 19 Discussion

• The proposed ETS is not a silver bullet for NDC • non-ETS sectors also need a clear carbon emission constraint (we did) • Other practical concerns • Only a few years remain before 2030, not sure if it is feasible to quickly expand the sectoral coverage in the national ETS • Beyond ETS, there are many other “planning-based” policies

20 Conclusion: the main OBA ETS scenario

• In 2030, the equilibrium emission permit price 95 USD/ton • NDC is achieved with modest welfare losses • losses of GDP and consumption would be 2% and 4% respectively. • Multi-sectoral coverage is the key determinant for equilibrium conditions • In the long run, to make the carbon pricing policy work • sectoral coverage (either by ETS or combining carbon tax) + clear cap + mass based OBA

21 Case studies of IMED|CGE Model: Economic impacts of carbon cap

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Related articles: [32, 33, 34, 35, 36, 37, 38, 39,40, 41] 25/35 26/38 Subscribe to our public blog on Wechat Thank you for your attention! Questions? Hancheng DAI Assistant Professor · Doctoral Supervisor Peking University · China [email protected] University Homepage / Researchgate / Google scholar

Electric vehicles’ health and climate benefits in China and India 27/38 Bibliography

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30/35 “Outside” factors affecting carbon price

△ = Output-Based Allocation - Grandfathering Relationships between carbon price change and:

allowance allocation technology improvement emission intensity capital substitution rate (CSR): the ratio of capital input over energy input in the production function 31 Fisher: OBA compared to grandfathering

Smaller output price increase and more output planners and participants are happy For the same emission target (cap) More emission intensity reduction Higher carbon permit price (higher MAC at equilibrium) Thus caveats of OBA: “efficiency loss”