Shanghai to Pilot China's First Municipal Emissions Exchange

Shanghai, often recognized for its free-market tendencies and environmental leadership, is introducing China's first municipal trading mechanism as a means to curb pollution.

Last Friday, in advance of a major carbon trade industry event taking place in Beijing this week, word began surfacing in the Chinese media that Shanghai plans to pilot an emissions trading scheme that will involve more than 300 companies' trading "pollution discharge rights."

The news comes nine months after the launch of China’s first energy and environment exchanges. That announcement – on the eve of the 2008 Beijing Olympic games – coincided with building efforts by leaders in China's premier cities to promote, at least on a rhetoric level, municipal level policies aimed at reigning in growing energy demand.

Shanghai is doing more than just talking the talk, though.

Its recent shutdowns of 500 megawatts of coal-fired generators, plans to decommission still more inefficient plants and an ordinance against the construction of any new coal-fired power plants within the municipality have earned the city of 13.7 million a reputation for leadership on environmental initiatives.

In June 2008, Shanghai’s vice-mayor and former Baosteel subsidiary Chairman Ai Baojun pledged to step up efforts to reduce emissions through industry reform and raise energy efficiency. City officials said then that new developments which did not meet specific efficiency requirements could be denied land-use approval. Now, Shanghai is taking a big first step by introduce market mechanisms.

Efforts by officials like vice-Mayor Ai to alter the local energy landscape significantly are still constrained, however, by current energy regulation. Exclusive control over energy markets, including electricity prices, rests with China's central government.

Shanghai's Pollution Discharge Right Trade will require more than 300 companies, whose emissions comprise over 80% of the city’s total, to purchase a credit that allows them only a specific allowance of discharge. Those who exceed the allotted amount will have to purchase credits from other enterprises, to be traded on the Shanghai Environment and Energy Exchange. Sulphur dioxide and chemical oxygen demand, a measurement of water pollution, will be the first two pollutants traded once the scheme takes effect later this year.

According to a report from China’s state-run news agency, the Shanghai government will set the price for the credits, instead of letting the market determine their value; and the cap will follow existing environmental requirements. These details suggest that officials hope the exchange will bring compliance, rather than extensive revenue. Enforcement of environmental regulations currently poses a significant challenge in Shanghai, and throughout China.

However, the opportunity to profit from the scheme has not been overlooked. The SEEE plans to launch an international platform for the future trade of pollution rights which would eventually include CO2. When or if that will happen depends on the central government, which retains exclusive authorization power.

While Beijing officials have not offered any clue on whether they will concede trading rights to SEEE, concerns over a fully operating exchange have already arisen within financial circles. Analysts suggest that, like the Clean Development Mechanism, verification and monitoring issues are likely to crop up. Introducing an international trade exchange into a country with still immature financial markets likewise calls into question the capability of local regulators.