Emissions trading in a policy stew: a case

study on China’s CDM wind power projects

Yuan Xu1, Aitong Li1, XiuruZhou2, Bing Zhang2

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-than-benchmark IRR

To invest

Lower-than-benchmark IRR

Not to invest

Without CDM Not to invest

What we have found……

Renewable energy project

With CDM

Higher-than-benchmark IRR

To invest

Lower-than-benchmark IRR

Not to invest

Without CDM Not to invest

Renewable energy project

To invest

Higher CER prices than

transaction costs

To register as CDM project

Lower CER prices than

transaction costs

Not to register as CCM project

Not to Invest

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 IRR1 and IRR2 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

Higher-than-benchmark IRR

To invest

Lower-than-benchmark IRR

Not to invest

Without CDM Not to invest

Renewable energy project

To invest

Higher CER prices than

transaction costs

To register as CDM project

Lower CER prices than

transaction costs

Not to register as CCM project

Not to Invest

CDM registration: CER prices versus transaction costs

0%

30%

60%

90%

120%

150%

0.0

0.3

0.6

0.9

1.2

1.5

2008 2009 2010 2011 2012 2013 2014 2015

Tra

nsa

ctio

n c

ost

s vs

. me

dia

n C

ER

pri

ces

(%)

Tra

nsa

ctio

n c

ost

s (€

/CE

R)

Year

National incomeSOP-AdminInitial verification (incl. system check)UN Adaptation Fund FeeRegistration fee (advance on SOP-Admin)ValidationProject Design Document (PDD)Project Idea Note (PIN)Transation costs vs. CER price (%)

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).

CDM registration: CER prices versus transaction costs

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.