8.4.2 Distribution of Carbon Units
With the supply of carbon units determined, the
next step is to decide how, and how many units
should be auctioned and freely allocated. In the
learning phase of the ETS, China may choose to
allocate most units free of charge, as it seeks to
introduce liable polluters to their obligations
under the ETS and reduce the risk of carbon
leakage. In this case, the method of freely allocating permits will determine which mitigation
opportunities will be used. Figure 61 outlines in
more detail the potential sequencing of distribution methods.
Data limitations may mean that initially units
may be grandfathered or allocated according to a
company’s historical emissions. A quick movement away from grandfathered allocations will
free up a greater proportion of units to be auctioned and reduce the risk that allocations are
simply sold for profit.
Limiting allocations to those industries that
are constrained by cost pass-through can be an
effective means of avoiding carbon leakage while
reducing costs. Determining whether an industry
is constrained by cost pass-through requires
facility- and process-level data to be collected to
enable the assessment of emissions intensity and
trade exposure. These data may also be used for
benchmarking, which facilitates the movement
away from grandfathered allocations. Over time,
regular independent evaluations of cost
pass-through can be used to more closely target
assistance to those industries most at risk of
carbon leakage.
The level of assistance to industries should be
reduced over time to encourage greater efficiency
and product substitution. This can be achieved by
differentiating assistance rates by emissions
intensity and/or instituting rules-based mechanisms to reduce allocations over time. In the long
term, the market should move to 100% auctioning of units as the expansion and linking of
carbon markets negates the risk of carbon
leakage.
A revolutionary approach to allocations would
prioritise the collection of data needed to assess
cost pass-through and develop benchmarks. It
would rapidly move to more cost-effective
benchmarking methodologies and shift to the
full auctioning of units at an earlier point in time.
8.4.3 Governance of Carbon Units
The rules that govern the carbon market will
determine its cost-effectiveness and its robustness. As higher levels of mitigation are required,
movement towards more efficient governance
designs will help limit the costs associated with
China’s energy transition. Figure 62 provides
further detail on the potential scheduling of
reforms and their relationship with the allocation
and distribution of carbon units.
Over time the role of an ETS can change,
from first being a learning mechanism, to then
being one that plays a major role within a broader
policy mix, to eventually becoming the key driver of decarbonisation in an economy. This
change is facilitated through changed market
rules that act to broaden and deepen the impact of
the carbon market on decision-making throughout the economy.
There are some design decisions, like banking, where China may choose to move to the
optimal policy setting immediately or after a very
brief period. This is because there are limited
negative consequences of adopting banking early
on, and banking can significantly improve the
robustness of a carbon market.
Other decisions, like coverage, are subject to
more complex trade-offs and capability constraints. For simplicity, an ETS may first cover a
small number of high-emitting facilities in order
to incentivise those mitigation options that have
the potential to make the biggest impact. Over
time this can be expanded to include all sectors
of the economy with accurate measurement,
reporting and verification (MRV) and, as MRV
improves, can extend to all sectors.
Domestic offsets may be used in sectors that
have insufficiently robust MRV to be subject to
liabilities under an ETS, but where the mitigation
outcomes of specific projects are well known.
With a slow start to emissions trading, it may be
Special Report 4: China’s Energy System Revolution
549
With the supply of carbon units determined, the
next step is to decide how, and how many units
should be auctioned and freely allocated. In the
learning phase of the ETS, China may choose to
allocate most units free of charge, as it seeks to
introduce liable polluters to their obligations
under the ETS and reduce the risk of carbon
leakage. In this case, the method of freely allocating permits will determine which mitigation
opportunities will be used. Figure 61 outlines in
more detail the potential sequencing of distribution methods.
Data limitations may mean that initially units
may be grandfathered or allocated according to a
company’s historical emissions. A quick movement away from grandfathered allocations will
free up a greater proportion of units to be auctioned and reduce the risk that allocations are
simply sold for profit.
Limiting allocations to those industries that
are constrained by cost pass-through can be an
effective means of avoiding carbon leakage while
reducing costs. Determining whether an industry
is constrained by cost pass-through requires
facility- and process-level data to be collected to
enable the assessment of emissions intensity and
trade exposure. These data may also be used for
benchmarking, which facilitates the movement
away from grandfathered allocations. Over time,
regular independent evaluations of cost
pass-through can be used to more closely target
assistance to those industries most at risk of
carbon leakage.
The level of assistance to industries should be
reduced over time to encourage greater efficiency
and product substitution. This can be achieved by
differentiating assistance rates by emissions
intensity and/or instituting rules-based mechanisms to reduce allocations over time. In the long
term, the market should move to 100% auctioning of units as the expansion and linking of
carbon markets negates the risk of carbon
leakage.
A revolutionary approach to allocations would
prioritise the collection of data needed to assess
cost pass-through and develop benchmarks. It
would rapidly move to more cost-effective
benchmarking methodologies and shift to the
full auctioning of units at an earlier point in time.
8.4.3 Governance of Carbon Units
The rules that govern the carbon market will
determine its cost-effectiveness and its robustness. As higher levels of mitigation are required,
movement towards more efficient governance
designs will help limit the costs associated with
China’s energy transition. Figure 62 provides
further detail on the potential scheduling of
reforms and their relationship with the allocation
and distribution of carbon units.
Over time the role of an ETS can change,
from first being a learning mechanism, to then
being one that plays a major role within a broader
policy mix, to eventually becoming the key driver of decarbonisation in an economy. This
change is facilitated through changed market
rules that act to broaden and deepen the impact of
the carbon market on decision-making throughout the economy.
There are some design decisions, like banking, where China may choose to move to the
optimal policy setting immediately or after a very
brief period. This is because there are limited
negative consequences of adopting banking early
on, and banking can significantly improve the
robustness of a carbon market.
Other decisions, like coverage, are subject to
more complex trade-offs and capability constraints. For simplicity, an ETS may first cover a
small number of high-emitting facilities in order
to incentivise those mitigation options that have
the potential to make the biggest impact. Over
time this can be expanded to include all sectors
of the economy with accurate measurement,
reporting and verification (MRV) and, as MRV
improves, can extend to all sectors.
Domestic offsets may be used in sectors that
have insufficiently robust MRV to be subject to
liabilities under an ETS, but where the mitigation
outcomes of specific projects are well known.
With a slow start to emissions trading, it may be
Special Report 4: China’s Energy System Revolution
549