Emissions trading in a policy stew: a case study on China s CDM wind power projects Yuan Xu 1, Aitong Li 1, XiuruZhou 2, Bing Zhang 2 1. The Chinese University of Hong Kong 2. Nanjing University
Research background The cost-effectiveness of the emission trading scheme (including the Clean Development Mechanism) as a mitigation tool at the global scale has been quantitatively evaluated and proved by many studies (Böhringer and Welsch 2004, Carbone et al. 2009, Fujimori 2015). The cost-effectiveness of a CDM project in a specific country involves many uncertainties, making it difficult to draw a clear-cut conclusion. Interactions between international and domestic polices (Gillenwater and Seres 2011, He and Morse 2013, Liu 2015) Institutional and technological barriers (eg. Lam et al. 2016) The influence of the CDM on investment decision-making is put under increasing scrutiny (Haya 2010, Lewis 2010, Zhao 2014).
Conventional understanding Renewable energy project With CDM Higher-thanbenchmark IRR Lower-thanbenchmark IRR To invest Not to invest Without CDM Not to invest
What we have found Renewable energy project With CDM To invest Not to Invest Without CDM Higher-than- CER benchmark prices than IRR transaction costs Lower-thanbenchmark Lower CER prices than IRR transaction costs Not to invest To To register investas CDM project Not to invest Not to register as CCM project
Research data This study conducted an empirical study of 1,461 CDM wind power projects in China over the period of 2008-2015. PDDs and related documents related to the projects were retrieved from the website of the United Nations Framework Convention on Climate Change (UNFCCC). Among a total of 1,461 projects, 1,330 projects were used for analysis. The project title, location, scale, crediting period, registration date, annual abatement in CERs, expected CER prices, and IRRs with and without CDM revenue The newly installed wind capacity for each year was obtained from the BP Statistical Review of World Energy. The CER prices for 2008 were derived from the European Climate Exchange (ECX), and price data from 2009 to 2015 were obtained from the Intercontinental Exchange (ICE).
Research methods IRR and costs To examine the investment rationale behind wind power projects in China, this study chose to focus on internal return rate (IRR), a parameter that is often used to determine the financial risk of a project. Given the period (n) which is a positive integer, the cash flow (Cn), the total number of periods N, internal rate of return (IRR), and the net present value (NPV), then NPV can be calculated as following: The acceptable level of IRRs varies across sectors. For electricity generation projects, the Chinese State Power Corporate set the benchmark IRR at 8%, while for small hydro power projects, the rate is raised to 10%.
Research methods IRR and costs To simplify the cost-benefit analysis related to the CDM projects, this study used two types of costs mitigation cost and transaction cost. The mitigation cost is defined as the minimum CER price ( /CER) for a CDM project to achieve the benchmark IRR, which is 8%. The calculation is based on the following formula: where IRR 1 and IRR 2 represent IRR without and with CDM revenues, respectively. The expected CER price indicates the price assumed in the CDM project s PDDs.
Research methods transaction cost In calculating the major components of transaction costs that relate to UNFCCC, we adopt the method as described by UNEP. At the planning phase, the following transaction costs will occur, including an initial feasibility study for submitting the Project Idea Note (PIN), the Project Design Document (PDD), validation, and the registration fee. At the operation phase, more costs will be incurred, including the UN adaptation fund fee, initial and periodical verification, and the administrative fee. Those costs were calculated by taking the averages of the costs ranges in the guidebook for financing CDM projects. The cost of periodic verification can be affected by the duration of monitoring periods and the frequency of reporting. The average span is 322 days for large projects and 508 days for small projects. In this study, to simplify calculation, we set the monitoring period of all the projects to one year.
Results: development of wind power projects
Results: development of wind power projects Three major phases the period between 2008 and the first half of 2011 (Phase 1), between the second half of 2011 and 2012 (Phase 2), and the years after 2013 (Phase 3).
Two stories: One direct story: From the perspective of eligibility criteria One hidden story Financial profitability and project sustainability Policy intervention and forced compliance From the perspective of transaction costs
CDM registration: From the perspective of eligibility criteria The up-and-down in the CERs supply in China has been first determined by two sets of eligibility criteria the additionality criteria and the Least Developed Countries (LDCs) criteria that determine which countries are eligible to be the host parties of CDM projects. Financial additionality: the project would not have been financially feasible (that is achieving an IRR of 8%) without the revenue gained from CDM. The average IRR without CERs (the baseline IRR) for all the registered projects is 6.17% while the average IRR with CERs is 9.02%. The sudden drop in the number of CDM wind power projects after the year 2013 can be partly explained by the changing eligibility criteria concerned with host countries. From 2013 onwards, the European Union s Emission Trading Scheme (EU ETS) restricts the origin of credits and only accepts CERs generated from new projects in the Least Developed Countries (LDCs).
The direct story and remaining puzzles:
The hidden story: Policy intervention and forced compliance It should be noted here that wind power investors studied here are not merely price takers in a free market because wind power investors in China are mainly large state-owned enterprises, who are not always motivated by market-based incentives. Investment decisions in wind power among those SOEs can be more sensitive to politics than profit, and politically driven losses are subsidized from the state balance sheet (He and Morse 2013) Rather than depending on a market mechanism, the Chinese government announced multiple national targets, which have a strong command-and-control element and have left limited flexibility to the SOEs. 2005 The enactment of the Renewable Energy Law 2007 The Renewable Energy Development Plan in the Medium and Long Term 2008 The 11th Five-Year Plan for Renewable Energy Development 2012 The 12th Five-Year plan for Renewable Energy Development 2014 The announcement of President Xing Jinping 2016 The Guiding Opinions on Establishing Renewable Energy Portfolio Standards
National targets and investment behaviors The Guiding Opinions on Establishing Renewable Energy Portfolio Standards has finally imposed non-hydro renewable energy quotas on regional governments and the SOEs. The policies issued in the past decade, from the enactment of the Renewable Energy Law in 2005 to the final establishment of Renewable Energy Portfolio Standards in 2016, should be seen as an interconnected policy process. Though superficially, the development of CDM wind power projects have greatly benefited from both CDM and domestic government support. It is essentially these national goals and subdivided goals that have commanded wind energy development with or without CDM.
What we have found Renewable energy project With CDM To invest Not to Invest Without CDM Higher-than- CER benchmark prices than IRR transaction costs Lower-thanbenchmark Lower CER prices than IRR transaction costs Not to invest To To register investas CDM project Not to invest Not to register as CCM project
Transaction costs ( /CER) Transaction costs vs. median CER prices (%) CDM registration: CER prices versus transaction costs 1.5 1.2 0.9 National income SOP-Admin Initial verification (incl. system check) UN Adaptation Fund Fee Registration fee (advance on SOP-Admin) Validation Project Design Document (PDD) Project Idea Note (PIN) Transation costs vs. CER price (%) 150% 120% 90% 0.6 60% 0.3 30% 0.0 2008 2009 2010 2011 2012 2013 2014 2015 Year 0%
CDM registration: CER prices versus transaction costs Three major phases the period between 2008 and the first half of 2011 (Phase 1), between the second half of 2011 and 2012 (Phase 2), and the years after 2013 (Phase 3).
Discussion: Carbon trade in a policy stew There are three important findings: (1) For Chinese investors, investing in wind power was more of a compliance act than an incentive-motived investment behavior; (2) Since CDM has had limited impacts on investment decisions, the claimed financial additionality became invalid and the traded CERs may not really contribute to emission reductions; (3) The CDM projects in China is embedded in a policy stew that evolves around command-and-control approaches, which not only compromises the cost-effectiveness of this market mechanism but also risks causing substantial financial losses.
Discussion: Carbon trade in a policy stew This study revealed the limitation of current economics-dominated evaluation models. To design a truly cost-effective global emission trading scheme, the nature of the domestic policies and their historical interactions do deserve more scholarly attention. Two types of policy instruments: Chinese government has gradually shifted its regulatory system from the conventional one centered on command-and-control instruments to a new one based on economic-incentive instruments. And this transition continues with the launch of pilot carbon emission trading schemes (ETSs) in 2013 and the scheduled implementation of a nationwide carbon trading market in 2017. This historical progress of environmental governance in China determines that the two incompatible forces of the state and market are always intertwined. Studies on emission trading should not examine the two types of instruments independently while paying little attention to their historical interactions. More 1+1 or N+1 researches in this field with a comprehensive and interdisciplinary perspective are needed.