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China turns to free markets to tame fossil-fuel pollution

[BEIJING] There are at least three good reasons why China is likely to succeed in starting the world's biggest carbon-trading market when its efforts to limit pollution kick in next year.

The government wants to put a cost on emissions of toxic smogto control pollution in industrial cities, starting with Beijing. The market may trade as much as 408 billion yuan (S$82.5 billion) of certificates a year, a step toward making the economy more transparent to outsiders. And it's good public relations, showing China is serious about climate change.

Regardless of the motivation, China's move marks the biggest yet to use a market-based approach to control pollution, exceeding the scale of Europe's $55 billion a year system.

It's the latest example of Asian nations turning to finance to govern electricity instead of relying on direct controls. Banks including China Everbright Bank Co and Industrial Bank Co as well as China Energy Conservation & Environmental Protection Group are assessing how to profit from it.

"As the world's largest carbon emitter, China recognizes it has an important role to play in global climate policy," said Lee Levkowitz, a Beijing-based analyst at IHS Markit Energy.

"The Chinese government is also keen to slow down fossil fuel consumption growth to better manage its energy security." Designed to provide economic incentives to cut pollution, carbon trading has lost momentum in the past decade as prices failed to hit the level of at least US$30 a ton that industry says is needed to spur real change.

In Europe, the cost of a metric ton of carbon offsets has fallen about 80 per cent from its peak in 2008 to an average 5.52 euros (S$8.40) this year as politicians failed to mop up a surplus created when industrial output and pollution plunged.

China's authorities are assuming a similar price for their credits, estimating the size of their market based on a cost of 40 yuan a ton (S$8.10).

Whether China's program forces actual emissions cuts won't be known for years. There's also the question of why China can make trading work when others have failed. To that, proponents say China may simply be getting in on a growing market.

"Carbon trading is part of the government's broader effort to tap into the power of markets to address economic, social and environmental challenges," said Song Ranping, developing-country climate action manager at the World Resources Institute. "It demonstrate China's commitment to take action."

Chinese officials are optimistic the system will become the world's leading carbon market. Spot trades could reach 8 billion yuan, resulting eventually in 400 billion yuan in derivative trades a year, said Chai Qimin, deputy director of strategy at China's National Center for Climate Change and International Cooperation.

China is learning from other's missteps. It established pilot systems in seven regions starting in 2013 to guide what's coming next year. Industrial Bank, based in Fuzhou, China, has started developing trading and clearing systems for the market and financing for low-emissions projects, Xinhua News Agency reported in March, citing Fang Zhiyong, general manager of the environmental finance department.

The government in Beijing is following the trend toward markets across Asia. South Korea and the European Union earlier this year initiated a three-year project to support the the Asian country's emissions trading system, which started last year.

Japan will consider more measures including carbon trading to ensure 44 per cent of its power comes from zero-emission sources by 2030.

In China, authorities have previously ordered factories closed and cars off the street to combat smog. Trading will cover eight industries, including areas such as papermaking, aviation and power utilities. They will buy credits covering their emissions and can sell any surplus. A link to overseas markets may also be possible, giving another way to profit.

For China, carbon trading is part of President Xi Jinping package of emissions cuts promised in a deal with US President Barack Obama that revived the global climate talks and led to the deal in Paris in December.

China, the world's biggest energy consumer, has pledged to cap its emissions around 2030. The nation aims to derive 20 per cent of the energy it uses from clean sources then, while it seeks to also reduce its reliance on coal power.

China's market must overcome several hurdles including "the need for emissions monitoring and reporting at the level of every major emitting facility," said Frank Jotzo, deputy director of the Crawford School of Public Policy at the Australian National University.

It also may face an oversupply of permits in the first three years of its program because allocations are based on years when industrial output and emissions were higher, said Sophie Lu, a Beijing-based analyst from BNEF.

The difference between the amount of permits to be given and historical data will be "a good sign to show how serious China is in cutting emissions," she said.