Environment

China has finally released the plan for its first national carbon emissions trading scheme, though it only applies to the power sector for now and trading will not begin until 2020. Initially scheduled to be announced in early 2017, the scheme had hit numerous snags along the way. The plan originally called for including seven other carbon-intensive sectors, such as steel, petrochemical, and aviation, but now, their inclusion has been delayed until after 2020. Although the roll out of the carbon market is more modest than intended, the power sector alone makes up 40% of total carbon emissions in China, which will still make it the largest carbon market in the world once trading commences.

The carbon market may be formally up and running, but it will still require another two years of preparation before it is fully and properly functional. Three major causes are behind this delay.

First, current carbon emissions data quality is not good enough. China had been collecting data from seven regional carbon trading pilots since 2011, but for some pilots, even basic information such as the total amount of carbon quota or the list of carbon market participants was not publicly available. Even less is known about how emissions data is being verified. Moreoever, there are substantial regional variance in terms of standards, which need to be unified for a single national carbon market. Therefore, as a first step, Beijing plans to build the national infrastructure and implement standards for the measurement, reporting, and verification of carbon emissions, a process that is expected to take at least a year. Then an additional year will be spent on building a national carbon trading platform.

Second, even after trading officially starts in 2020, the carbon price is expected to be set relatively low at around 30 yuan ($4.5)/ton, which won’t be a sufficient incentive for industry to reduce carbon emissions. According to the Chinese government’s own estimates, the carbon price needs to be set more than six times higher at 200 yuan (~$30)/ton before it has an effect on inducing a shift in industry behavior. The main reason the carbon price is set so low initially is because, without further power sector reforms, the higher price cannot be passed through to consumers (see more below). Thus, in the short to medium term, the introduction of a carbon price isn’t likely to meaningfully contribute to emissions reduction.

Third, as alluded to above, imposing the carbon price won’t be very effective without attendant reforms in the power sector. That’s because a large part of the electricity price is still administratively controlled, which means power plants effectively have to shoulder the carbon price bill. As such, a high carbon price will translate into profit losses for power plants, not least because many power plants still abide by administrative quotas of how much electricity they need to produce, which hinders their ability to respond to a carbon price by switching to more efficient units. Finally, since there is only limited pass-through of the carbon price to end users, demand response to such a price will be weak.

Several key challenges accompany China’s effort to create its first national parks system. First, despite the fact that China currently maintains an extensive nature reserve system, its management is quite fragmented and, in practice, the management system hinders the effective protection of nature reserves. For instance, the State Forestry Administration, Ministry of Agriculture, and the Ministry of Land and Natural Resources all have jurisdiction over designated nature reserves, which can make management redundant and inefficient.

Second, China has overlapping and unclear classifications under its current nature reserve system. In fact, China now has more than 400 nature reserve areas, hundreds of national geological parks, and 244 national scenic sites, a complex and often parallel structure that needs to be streamlined. What’s more, parts of these protected areas often get coopted by the tourism industry. As many tourism sites are usually managed by commercial entities, tourism development and revenue generation usually come at the expense of ecological protection. This makes it difficult to ensure the reserve is protected if it is to also accommodate massive tourism.

In creating this national parks system, Beijing is largely drawing on the US model of national parks, which was created around the turn of the 20th century and centralized under a single federal agency. In that vein, Beijing also intends to have a single agency manage the new national parks system, though it is unclear whether it will create a new entity a la the US Department of Interior. The funding for the national parks system will also mainly come from the central government. Control of the purse strings at the center is meant to deter overdevelopment of designated national parks, and local governments will be prohibited from keeping their tourism revenue.

In other words, Beijing wants to avoid the “theme park-nization” of national parks and incentivize local governments to leave nature alone rather than manipulate it into tourist traps. To that end, a few pilot national park sites will be established by 2020, with the goal of rolling out the system nationally by 2030.

China’s first Environmental Protection Tax Law, which was passed in December 2016, took effect on January 1, 2018. While the Chinese government has long collected a pollution fee, the purpose behind elevating the fee to a tax is two-fold.

First, by changing the fee to a tax, the government hopes to significantly reduce polluter noncompliance, as many companies evaded the fee or delayed paying it. One of the problems is the fact that the previous pollution fee was collected by the weak local environmental protection bureaus, which had limited authority and lacked capacity. Now that the fee has formally become a tax, the tax bureau will be collecting it, and noncompliant behavior will be subject to harsher punishment under the new legal mandate.

Second, the previous fee was simply set too low. If a pollution fee is lower than the cost of curbing pollution, then polluters would be inclined to just pay the fee rather than invest in pollution mitigation efforts. The water pollution fee, for example, is estimated to be less than 10% of the cost of waste water treatment.

The new law introduced a much higher tax rate, which is aimed at incentivizing industries to voluntarily reduce pollution. Provinces have some latitude in deciding on the specific tax rate—the maximum rate is 10 times the minimum—to account for local economic conditions, such as struggling regions where heavy industries are concentrated. Beijing, for instance, has adopted a higher tax rate because it is suffering more from severe pollution. So far, about two-thirds of China’s provinces have adopted a higher rate, while some have not raised the rate for fear of disproportionately hurting local industrial firms.

Local officials will be measured on an 100-point system across several criteria, the results of which will be incorporated as an important part of the overall cadre evaluation that forms the basis of political promotions.

According to this system, the criteria include resource conservation, environmental protection, ranking (each region will be ranked according to its environmental quality), public satisfaction, and incidents of severe pollution. The first four criteria are weighted 30%, 40%, 20% and 10%, respectively. For the last criteria, any occurrence of a severe pollution event will lead to a deduction of five points.

Moreover, the resource conservation and environmental protection criteria are composed of 20 quantitative targets, 16 of which are binding. These targets include energy, carbon emissions, and water consumption intensity, air pollution, and water quality, with each having a weight of between three to five points.

The evaluation system is designed to encourage going above and beyond the targets, since partially meeting these targets will still earn zero points. Failure to meet three or more binding targets, on the other hand, will lead to an “F” in the evaluation. Getting such a failing grade will result in public criticism and shaming and the obligation to remedy existing problems within a limited period.

China is ramping up its effort to preserve its shrinking coastal wetlands. The government wants to keep the total area of wetlands at 132 million acres, just slightly below 2014 levels. To prevent slipping below that level, Beijing mandates that whenever any wetland is converted to other uses, new wetland of the same size should be reconstructed.

The government also aims to slow land reclamation efforts along coastal wetlands and to sustain biodiversity in existing wetlands. For instance, by 2020, wetlands should contain no less than 231 bird species and their animal and plant populations should not fall below current levels.

Existing wetlands will be classified into “key national wetlands,” “key regional wetlands,” and “regular wetlands.” The first two classifications will be strictly protected, whereas some development will be allowed on the third category of wetlands, as long as it doesn’t lead to substantial ecological damage.

Currently, the firm-level pollution quota is determined by the total regional pollution quota. That is, once the overall regional pollution quota is set, that figure is then divided among firms in that region. Such a system only takes into account the total volume of pollution but not the location and intensity of pollution. Concentrated pollution can in fact lead to more environmental damage even if annual pollution volumes remain the same.

So the new pollution control system aims to incorporate pollution intensity as a metric and will initially cover power plants and paper makers. By 2017, all major polluters and those in sectors facing excess capacity will be covered by this system.

The new system also hopes to enhance pollution monitoring and data collection capacity. Although polluters are responsible for self-monitoring and reporting real-time pollution data, if they are found to be manipulating data, the company can be fined, its production suspended, and company executives can be imprisoned. However, polluters will also be rewarded with electricity tariff subsidies if they voluntarily lower their emissions.

This plan basically reiterates China’s intent to reach peak carbon around 2030, including capping coal consumption at 4.2 billion tons and raising non-fossil fuels in the energy mix to 15% by 2020.

This means Beijing will prioritize developing low carbon sectors, including high tech and services, with each expected to account for 15% and 56% of GDP, respectively. Other efforts involve curbing nitrous oxide emissions in the agriculture sector and expanding forest coverage significantly to serve as a carbon sink. Finally, China intends to launch its first national emissions trading system in 2017 that will initially cover major carbon emitters in eight sectors.

The FYP does take a step further and details provincial level targets that are aimed at achieving an overall carbon intensity reduction of 18% by 2020. Wealthier provinces like Jiangsu and Guangdong are given a higher reduction target (20.5%), while industrial provinces, such as Shanxi, Liaoning, and Anhui, are given a lower target (17%). The poorest provinces, such as Tibet, Qinghai, and Xinjiang, only need to achieve 12% reduction.

China’s soil, much like its water, is significantly polluted, a result of decades of industrialization and over use of pesticides on crops. But the extent and scope of soil pollution is difficult to determine, as soil pollution statistics are incomplete. As part of the soil protection effort, then, Beijing will conduct a national soil survey and establish a soil monitoring network by 2020. The main goal is to ensure that by 2020, 90% of previously contaminated land will no longer be used for food production.

Key heavy industries, such as nonferrous metals, petrochemicals, and leather, will be expected to reduce heavy metal discharge by 10% from 2013 to 2020. Agricultural use of pesticides and herbicides is also expected to decline by 2020.

Protecting arable land for farming is also an important part of the plan. The government will classify arable land based on the level of contamination. Uncontaminated or lightly contaminated farmland will be deemed the “priority protection class”—meaning it will be considered permanent basic farmland so its size does not shrink further. Moderately polluted arable land will be deemed the “safe use class” and can be used with the guidance of environmental protection professionals. Finally, severely contaminated arable land will be deemed the “strict control class” and will not be used for food production.

Polluters themselves will be primarily responsible for addressing both new and legacy soil pollution. If the original polluter no longer exists, then whoever takes over the business or land will be held responsible for remedying soil pollution. In the absence of a clearly responsible party, dealing with soil pollution will fall on the shoulders of local governments.

Environmental protection tends to have positive externalities that spill over into other regions. That is, if neighboring Hebei province cleans up its air, Beijing will benefit too without having to invest in pollution mitigation. This becomes an issue of fairness and can lead to insufficient rewards and underinvestment in environmental protection, often in poorer regions.

To address this distribution of benefits issue, Beijing has called for increasing economic incentives for environmental protection. The goal is to ensure that the beneficiary also pays for the benefits of environmental protection. To that end, China hopes to establish a cross-regional compensation mechanism by 2020 that covers the protection of forests, grasslands, wetlands, rivers, and arable land, among others. In the meantime, Beijing will also experiment with a compensation mechanism as part of the national parks system it hopes to create.

Although the central government will increase fiscal transfers to regions that are considered environmentally important, such as Tibet, the majority of compensation will be cross regional. For example, regions that sit downstream from soil erosion and water pollution should compensate upstream regions for investing in tackling such problems.

Beijing will also experiment with market-based schemes for environmental compensation, such as the trading of pollution and water usage rights and carbon emissions quotas. Regions can then sell or trade extra quotas in the market to receive additional revenue.

The eight areas of environment-related reforms are as follows.

Natural resource ownership
To avoid the tragedy of the commons, the ownership and usage rights of all natural resources will be clearly defined. The majority of natural resources will be state-owned, but usage rights can be acquired for a fee. A new central agency will be established, similar to the State-owned Assets Supervision and Administration Commission, to manage natural resources.

Sustainable land development
All regions will be categorized into types of functional zones, such as residential, industrial, or agriculture. Each zone will also have different fiscal, investment, population, environmental, and development policies to help support the main functions of each region.

In addition, China aims to create its first ever national parks system to protect and preserve key ecological and cultural sites. Once established, the national parks system will replace the existing system of protected sites and will adopt higher environmental standards.

Urban planning
Urban planning will be streamlined for each region, where currently up to ten different plans exist, ranging from construction and infrastructure to environment and agriculture. These disparate plans often overlap or are in conflict with each other, making urban planning more challenging. To improve effectiveness, all plans will be merged into a single process within a region, and such plans need to be made public and approved by local legislatures.

Resource consumption caps
Energy, water, and fishery will all be subject to consumption caps. In addition, Beijing intends to experiment with a national carbon emissions cap and impose binding quotas on land reclamation.

Resource pricing
The price of natural resources across the board will better reflect market supply and demand and no longer be heavily subsidized as basically public goods. In addition, the scope of the resource tax will be expanded to cover more types of natural resources.

Environmental governance framework
Environmental regulatory bodies will be centralized and consolidated. All polluting industries and firms will need to first obtain pollution discharge permits and will be monitored accordingly. Beijing also wants to establish cross-regional coordination mechanisms to address negative externalities from severe pollution, particularly air pollution that originates in one region but ends up in non-polluting areas.

Market-based solutions
Private capital will be extensively leveraged to finance and invest in environmental protection and pollution reduction efforts. These efforts include emissions trading, pollution discharge and water usage rights, and encouraging green finance.

Local cadre evaluations
Beijing will introduce its so-called “natural resources balance sheet,” which is meant to carefully track annual change in the level of resources such as water, soil, and forest. Taking stock of natural resources will be conducted at national, provincial, city, and county levels, the results of which will form the basis for evaluating local officials’ performance on environmental protection.

With these new measures, the central government is experimenting with changing political incentives at the local level to better enforce environmental standards. Beijing has sent a stern warning to local Communist Party officials and government bureaucrats that they are now being held accountable for meeting not just economic growth goals, but environmental ones as well.

Because there is often a lag between policy decisions and observable environmental impacts that result, local officials are now responsible for environmental consequences for a lifetime.

The measures call for punishing local officials if they do not properly execute environmental regulations, allow environmental conditions to deteriorate significantly, or intervene in environmental inspections, among other transgressions. Such punishments could lead to resignation or potential imprisonment. Moreover, officials in government and party agencies that are supposed to enforce and supervise local compliance will also be punished if they do not properly deal with local officials that violate environmental regulations.

China has long dealt with its water scarcity. And that supply shortage has been exacerbated by severe pollution of available fresh water. For instance, the majority of China’s shallow underground water is polluted, yet water shortages in northern China force people to use underground water for much of their residential needs. To address this significant problem, Beijing is rolling out both demand-side curbs and supply-side measures to raise the efficiency of water usage.

According to the action plan, total water consumption will be capped at 670 billion m3 by 2020, roughly 10% higher than total water consumption in 2014 but in line with recent consumption growth. Pricing will be a key tool used to curb water consumption. By 2015, all cities should adopt a tiered pricing system for residential water consumption—meaning that the price of water will increase above a certain consumption level. A similar tiered system is expected to apply to all water consumption by 2020.

On the supply side, the government will limit water-intensive industries in areas already facing water shortages. In those shortage areas, 20% of the water supply needs to come from recycled water by 2020.

Tackling water pollution will also be an important part of boosting existing water supplies. China currently divides water quality into five classes, with V being the worst and I being the best. By 2020, the government wants 70% of the country’s seven key rivers to achieve class III water quality and for 93% of urban potable water to reach class III or better.

To achieve these targets, Beijing will continue to shut down heavy industries that are not compliant with tighter water pollution regulations, including papermaking, coking, and refining. Other sectors, such as nonferrous metals and food processing, will be subject to stricter wastewater standards.

These regulations should support increasing investment in wastewater treatment. In fact, by 2020, Beijing wants water treatment to cover nearly all large cities and 85% of small cities.

Procuring or contracting environmental management services from third-party companies can bring two major benefits: increasing efficiency and lowering cost.

When companies try to address pollution internally, they need to both own the right equipment and rely on those with specialized knowledge to implement. Such internal control has two drawbacks: one, it is usually too expensive, particularly for small and medium-size firms; and two, there’s no competitive bidding process to find the most cost-effective solutions.

Outsourcing environmental management to private service firms has the additional benefit of helping to reduce local government fiscal burdens. This is because the majority of solid waste and water treatment facilities are currently funded entirely at the local level. And the cost of dealing with this kind of pollution will only skyrocket as China continues to urbanize. So co-investing with private environmental management companies can hopefully save local governments the upfront investment needed for pollution mitigation projects and facilities.

As such, the Chinese government has rolled out various incentives to promote the development of environmental management companies. For instance, environmental services firms will have preferred access to financing through bond issuance and public listing. They will also enjoy preferential treatment when borrowing from state banks.

To ensure environmental management companies can earn reasonable returns on their projects, Beijing plans to gradually raise waste treatment fees and encourage local governments to provide subsidies to such companies.

In recent years, China has suffered from multiple outbreaks of animal-related diseases, such as avian and swine flu, that are transmittable to humans. This is in part attributable to the fact that animal farming is often co-located in densely populated areas, which can affect the water system or other natural resources.

To mitigate large-scale epidemics and environmental damage from animal waste, Beijing has prohibited breeding livestock and poultry in the following areas: 1) near potable water sources and scenic areas; 2) core areas and buffer zones of nature reserves; 3) all areas that are densely populated.

Livestock and poultry farms are required to build animal waste treatment facilities for sewage and rainwater diversion and storage, livestock and poultry manure, and comprehensive waste utilization and treatment. This is the first time such requirements have been made explicit, and if any of them is not met, the site will be shut down.

Central and local governments are expected to provide subsidies to help farms comply with these regulations. For instance, construction of pollution prevention and control systems for breeding facilities is eligible for certain environment-related loans, subsidies, and other financial support. Businesses that offer livestock pollution prevention and control, convert animal waste to organic fertilizer, and manage other types of animal waste will enjoy preferential tax policies. In addition, farmers can sell electricity generated from biogas converted from animal waste to grid companies.

China’s severe air pollution has dominated headlines and has proven to be a source of embarrassment for policymakers in Beijing, where they experience some of the worst smog in the country. The central government has sprung into action, not least because of the public outcry to deal with this problem that both threatens public health and erodes quality of life.

The plan includes a slew of quantitative targets aimed at reducing PM2.5 for China’s three mega urban clusters and the Chinese capital itself, all of which are expected to be achieved by 2017. According to the plan, Beijing’s average PM2.5 emissions should be halved from 2013 levels and be no higher than 60 µg/m3. For the Beijing-Tianjin-Hebei region (Jing-Jin-Ji), Yangtze River Delta, and Pearl River Delta regions, PM2.5 levels should drop by 25%, 20%, and 15%, respectively. Even if China achieved all these targets by 2017, however, its air pollution level would still remain far higher than the global standard of an average of 15 µg/m3.

The plan calls for ten measures to help achieve these ambitious targets, chief among them is a tougher approach toward constraining coal. By 2017, coal’s share in total energy consumption is expected to fall below 65% from the nearly 70% in 2010. Even so, this still implies absolute coal consumption growth since China’s total energy consumption is still projected to rise over the next decade. But when it comes to the three mega urban clusters, the government intends to achieve absolute reduction in coal consumption in those regions.

China has more than 55 billion m2 of buildings that together account for about one-fifth of the country’s energy consumption. As China continues to expand its cities, reducing building energy consumption is a key component of the country’s overall energy efficiency and emissions goals.

To that end, the “Green Buildings” initiative is a massive effort to improve the energy efficiency of China’s building sector, which includes retrofitting the existing stock of buildings, modernizing building codes, and integrating new technologies into new building projects. This plan only sets a broad framework for goals and targets in these priority areas, as more detailed execution policies are expected to follow.

In terms of key targets in the plan: 1) between 2013 to 2015, 1 billion m2 of new buildings will meet green building standards; 2) more than 400 million m2 of residential spaces will undergo energy efficiency retrofits in northern China from 2013 to 2015; 3) all residential buildings in northern China will undergo such renovations by 2020; 4) 120 million m2 of public and government buildings will get such renovations by 2015.

Green standards will apply to buildings larger than 20,000 m2, whether public or private. This includes, among other things, significantly raising the usage of renewable energy, such as solar and geothermal, in all new building projects. By the end of 2015, 2.5 billion m2, or around 4%, of China’s buildings are expected to have renewable energy generation capacity.

In addition, how residential heating costs are determined will be changed. The majority of Chinese apartments still use radiators for heating, and the heating bill is usually based on the size of the residence and paid by the employer as it is a standard employee benefit. Going forward, heating meters will be installed at all residential units, and the heating bill will be based on energy consumption. Although not mandatory, most employers will still provide heating subsidies to employees as additional incentive for households to invest in energy-saving measures.