MARKETS:

Cap and trade finds a new home and political traction in Asia

SHANGHAI -- When Jeff Huang hosted a visiting Chinese official in the Chicago Climate Exchange in 2011, he was impressed by the official's interest in trading carbon dioxide.

Unlike his previous experience with high-level Chinese officials who usually shake hands, exchange gifts and let their subordinates ask questions, this time it was the official himself who kept asking detailed questions during the hours-long meeting, recalled Huang. He is managing director for Greater China at IntercontinentalExchange Inc., which owns the Chicago Climate Exchange.

One year later, in southern China's Guangdong province, where the official serves as a top economic planner, a cap-and-trade system has rolled out. It limits the amount of greenhouse gases local factories can emit with a system of allowances.

Factories that emit beyond the limit are required to buy more carbon allowances; those that become more efficient can sell allowances they no longer need. When the system goes online next year, Guangdong will become the fifth largest carbon market in the world in terms of regulated emissions.

Guangdong is among seven regions China selected to pilot carbon trading. If those pilots succeed, a national carbon market will be in sight. And besides China, other Asian countries are working toward domestic carbon trading.

Already, Japan has started capping emissions from about 1,400 factories and buildings in Tokyo. While the cap-and-trade system remains only citywide, it is the first step in the nation toward carbon trading.

South Korea enacted a law earlier this year to develop its own carbon market. If all goes as planned, by 2015, the Korean carbon market will cover emitters that are collectively responsible for 60 percent of the country's annual emissions.

In other parts of Asia, from India to Thailand to Vietnam, systems associated with carbon trading are emerging. While methods and timelines vary, one strongly shared desire is to reduce emissions with a market-oriented solution.

"It's a pretty exciting time in Asia, and carbon markets are rising here in terms of policy interests," said Dirk Forrister, president of the International Emissions Trading Association, a global carbon trading group based in Switzerland. "Asia's emissions trading is alive, well, and it is growing, creating a new dynamic for carbon market professionals."

Plans to link national markets

However, this new dynamic may not translate into big money immediately. Many expect Asian countries to trade carbon credits on a small scale until they gain more confidence with the mechanism. That means a low profile for local traders and limited access by outsiders who traditionally face restrictions in Asia's financial sector.

But the buzz will come eventually. Experts say a carbon market linkage -- not only among Asian countries but also with countries outside Asia -- may emerge at the end of the decade, stirring up market demand and pushing global carbon trading forward.

"If I had to make a prediction," said Robert Stavins, a Harvard University economist and one of the early designers of a U.S. cap-and-trade system that failed to pass Congress in 2008, "it's quite possible that we're going to be seeing a bottom-up international climate policy architecture evolving around 2018 or 2020." It will be based on linkages between carbon emissions trading markets of individual countries, including many Asian nations, he said.

"It can be done purely through a series of bilateral deals. If you think about it, that's the way markets normally work, whether it be wheat or refrigerators or anything else," he explained.

The linkages, in turn, could prod international climate negotiation forward. Andrei Marcu, senior adviser at the Centre for European Policy Studies, said the carbon market linkage requires rules and providing incentives for countries to come back to the negotiating table.

It will also help remove a years-long standoff in global climate negotiations. For years, some developed countries including the United States have complained that major emitters such as China and India are not doing enough to reduce emissions.

"The buildup of carbon markets in Asia shows that developing countries are taking actions, and this will definitely help reach an international agreement," predicted Yang Fuqiang, a senior adviser at the Natural Resources Defense Council, an environmental group based in New York.

'Every nation will have to contribute'

Even countries that are not under fire during global climate negotiations see urgency for them to start carbon trading. Thailand is a case in point.

"We don't have a mandatory target [to reduce emissions], but we see this [to come] in the near future," said Sumon Sumetchoengprachya, senior official at the Thailand Greenhouse Gas Management Organization. "Every nation will have to contribute to emissions reduction. We want to set up a voluntary carbon market to prepare ourselves, our government and our industrial sector before going to this future."

One program Sumetchoengprachya's organization is working on will help industries in Thailand offset emissions starting late next year. And by 2014, she said, the nation will launch a voluntary carbon trading system that allows local emitters to trade carbon allowances among one another.

"Asian countries are starting to deal quite responsibly with climate change," said Carter Brandon, lead economist for sustainable development at the World Bank.

One reason for this new Asian desire, according to Brandon, is that the region has suffered from greater incidence of floods, droughts and typhoons -- all of which are influenced by a changing climate. So leaders are scrambling to battle climate change, and they view carbon trading as the most cost-effective solution, following earlier U.S. experience that showed market forces drove the cheapest solutions to air pollution problems, such as acid rain.

Besides that, Brandon said, Asian countries see their carbon markets as a treasure bowl once the much-anticipated global carbon trading linkage turns into a reality. As the cost of reducing carbon emissions in Asia is lower than in richer countries, factories in Europe, for instance, are likely to purchase carbon credits from Asia to meet their emissions reduction targets.

"This would bring net benefits to the developing countries," he added.

Early regional volume will be modest

Yet even as Asia's passion to develop carbon markets fires up, "it is too early to say that carbon trading has actually been taking off in Asia," said Ashok Bhargava, a carbon trading expert at the Asian Development Bank.

With few details unveiled so far, Bhargava said, it is hard to judge whether Asia's carbon trading systems will work. Even if they will, he and others predict, the trade volume will remain modest in coming years as the Asian carbon markets are still in their infant stage.

And chances for a quick market expansion appear remote. For instance, in China, which already has seven regions piloting carbon trading, "it is impossible to have an integrated market in the near future," said a lawyer who is involved with the buildup of one such pilot. He attributed this to challenges in coordination. The lawyer requested anonymity because he was not authorized to discuss the issue.

So far, Asian countries haven't been in talks with one another, nor with their distant neighbors like Europe or Australia, about connecting their carbon markets. But many believe this stage will come sooner or later.

South Korea's own carbon market is too small to generate enough trade activities, said Forrister of the International Emissions Trading Association. And for countries whose domestic carbon market is big enough to stay active, having a membership card in the global carbon trading provides other benefits.

Forrister said Chinese policymakers he had talked with "do not want to be isolated from the rest of the world, but to be linked with the rest of the world. It is a sign of Chinese leadership on the international stage."

Although Asian countries already had a whiff of the billions that can be earned through an international emissions offset program called the Clean Development Mechanism (CDM), domestic cap-and-trade ventures aren't the same story. Much work is still required to design national systems, groom carbon traders and develop needed infrastructure.

Emitters wary as tests begin

In addition, unlike the CDM, which could increase an emitter's revenue, cap-and-trade systems ask emitters in Asia to either invest in emissions reduction technology or adaptation or pay for extra credits. Few emitters like this idea. In fact, industries in South Korea responded with strong lobbies that halted the government's approval of the carbon trading plan for two years.

Sometimes, the opponents are officials themselves. When Asian countries hold elections, their plans for carbon trading are at risk, as the new ruling party may abandon the previous decision. And even if the plan survives the leadership transition, political inertia may still happen in a region that traditionally controls industries with a command-and-control style.

There is also the question of market credibility. Some scandals have marred the launch of the carbon market in Europe. The emerging Asian carbon markets will face similar trouble, if not more, due to a higher degree of corruption in the region, according to Shane Spurway, managing director of Cadogan Capital Advisors Ltd., an investment group in Hong Kong.

And if Asian countries fail to overcome those problems, Spurway said, it will hurt not only them but also carbon markets elsewhere. That's because chances for developing a global trading compact could be stymied by fears of fraud.

Carbon market professionals say the fears will soon be put to the test. The first tryouts will be in China, where five cities and two provinces are working on their final preparations and plan to trade carbon dioxide starting next year.