Climate talks will decide the future carbon price

A new climate deal in 2015 would rejuvenate the struggling carbon market, argues Cao Mingde

This week, negotiators are gathering in Bonn for the next round of climate talks. China University of Political Science and Law professor Cao Mingde spoke to chinadialogue about the influence the global carbon price and climate negotiations have on each other.

Xu Nan (XN): Is the lack of progress at international climate talks to blame for the crisis in the carbon market?

Cao Mingde (CM): There are some shortcomings in the design of the EU's emissions trading scheme: these include the fact that too many allowances were given away for free, which has resulted in many companies being able to comply without reducing their emissions. Another factor is the economic downturn since 2008; many companies naturally reduced their emissions—this is because of the market.

Another important reason is the uncertainty in the carbon market. A new carbon emissions reduction deal was never agreed upon. How the Kyoto Protocol will be followed is an unresolved issue. Therefore investors have no incentive.

XN: Do you think there will be a climate deal in 2015 and will China commit to mandatory cuts?

CM: In 2013, the combined emissions of China and the US accounted for 47% of the global total. The accumulated greenhouse-gas emissions of the US and its emissions per capita are both extremely high. If the US does not participate, then developing countries have no reason to commit to any kind of mandatory emissions reductions or targets.

However, if China and other major emitters do not participate, then the US will also not join. By looking at negotiation tactics, the US will definitely request the BRICS countries to pull their weight. Any country that does not take part will face political and diplomatic pressure.

China and other developing countries will be asked to commit to a clear timetable for peaking their emissions, such as 2025 or as early as 2020. They will also be asked to commit at some point to take on mandatory greenhouse-gas emissions reduction targets, but these targets should differ from those of developed countries. This should be determined by a number of different factors such as the developing country's capacity, its stage of economic development, cumulative emissions, per capita emissions and per capita cumulative emissions.

I think that whether emerging economies can take on mandatory emissions reduction targets is an issue that cannot be avoided at the international climate-change negotiations. Developed countries will propose that the BRICS countries should take on mandatory emissions reduction targets. In contrast, emerging economies will put forward some additional conditions, such as needing more time to determine a value for their peak emissions, and a longer deadline. And then from a certain point of time in the future they will take on mandatory emissions reductions, for example, from 2025 or even as early as 2020. Further, these emissions reduction targets should be adjusted to the developing country's capacity.

In the past, there have been some misunderstandings about China in the international climate negotiations, for example that it was in China’s best interests not to accept any kind of responsibility. Actually, in many cases, that’s not the situation at all. The international community is also a community. When the US refused to ratify the Kyoto Protocol, the international community and even local environmental activists heavily censured them. When Canada announced its withdrawal from the Kyoto Protocol, this also damaged its national image. Neither of these actions was consistent with those countries' national interests.

Therefore, China should draw on the lessons learned from the Copenhagen climate talks, avoid becoming the focus of public criticism and build a national image of a country that dares to take on responsibilities and obligations, but not to the extent that it is taken advantage of or assumes a burden disproportionate to its capacity. This requires that the negotiating team has both profound professional expertise, excellent negotiation skills and also a vision for diplomatic tactics and national strategy.

XN: What impact will the talks have on the carbon market?

CM: If a new international agreement on carbon emissions reduction can be reached by 2015, this will undoubtedly have a major impact on the carbon price.

The Kyoto Protocol is coming to an end, and there is nothing to follow it. There are many other reasons that have caused the carbon price to decline, including the global economic downturn, but that really doesn’t mean that carbon is not worth investing in. The current situation is that the carbon bear market has bottomed out, and investors have lost confidence in it, even to the extent of giving up all hope. They don’t even trust positive news. This is the definition of hitting the bottom.

Essentially, the carbon price is the same as stocks, securities and futures, which reflect market expectations, and are a barometer for the economy. The carbon market is expected to determine the carbon price, rather than the other way around. Whether the market has any prospects, whether it’s worth investing in depends on the international community’s level of consensus and will to cut emissions, and whether an enforceable emissions-reduction agreement can be reached will be decided by many important factors such as the international economic situation. If these factors are all favourable then the carbon market will be rejuvenated.

XN: What will happen to China's carbon market?

CM: China's carbon market is currently in its pilot phase, its future is not yet clear.

A fundamental question is: will China have a self-contained trading scheme, or does it have its sights set on some point in the future when it will integrate it with the rest of the world? China has not committed to any mandatory global emissions reduction obligations. However, over the past few years China has been committed to reducing its domestic carbon emissions, and it has not excluded in the near future introducing legislation to deal with climate change and to making a clear-cut carbon emissions trading scheme. In that case, the carbon market in the country will have a legal basis, and so investors will stand to gain.

China has a long way to go to establish a unified domestic carbon market and to prepare properly for its future integration with rest of the world. This includes having a trading platform, trading programme, regulatory body and so on. The three main parts of a carbon market — control of total carbon emissions, carbon emissions allowances and a carbon emissions trading scheme – are inter-related, and they also rely on a unified national market. As regards the current pilot projects in China’s province and cities, it is hoped that they will gradually form a unified national carbon market.

XN: Is the carbon market or a carbon tax more practical for China?

CM: Carbon markets and carbon taxes are the two prevailing global market mechanisms and they can both act as additional bargaining chips for China at the international negotiations. If we introduce a carbon tax or implement carbon emissions trading, it means that companies internalise the externalities produced by greenhouse-gas emissions. This is a levelling factor in the global competition of corporate emissions reduction. In China, both of these mechanisms have made some progress – that of the carbon emissions trading pilots is a bit more obvious and efforts to promote them are now more bullish than before.

Carbon markets and carbon taxes can progress in parallel, but we must consider how to coordinate them. Some countries overseas have both carbon taxes and emissions-trading schemes.

As economic instruments to encourage reductions in greenhouse-gas emissions, both of these have their advantages and their disadvantages. The advantage of a carbon tax is that the price of emissions reduction can be determined, but the disadvantage is the environmental benefit cannot. We really don't know if a company will cut its emissions as the emitter may prefer to pay the carbon tax, and then continue to emit greenhouse gases. People who aren't price sensitive don't change their driving habits just because the price of petrol goes up.

The characteristic of a carbon market is that the environmental benefit can be determined, but the social cost of carbon emissions reduction cannot. The market fixes the cost of carbon emissions reduction but the market is constantly fluctuating. For example, the initial planned carbon price for the EU emissions trading scheme was around 10 euros, but now it has dropped a little over three euros. The price has changed a lot, and the reason for this change is complex – there are market factors, institutional design factors and also factors arising from the uncertainty in the outcome of the international climate talks.