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Emissions trading in China: lessons from Taiyuan SO2 emissions trading program
Zhen Lu
Faculty of Business, University of Southern Queensland, Toowoomba, Australia
Abstract
Purpose This paper seeks to investigate sulphur dioxide (SO2) emissions trading practice in China and discusses what it might reveal about the suitability of using emissions trading to achieve carbon reductions in China. Design/methodology/approach The paper explores the Taiyuan SO2 emissions trading program case through interviews with key participants in the scheme. The interview questions are developed from the literature on emissions trading practice and theory. Findings The Taiyuan SO2 emissions trading program does not seem to be functioning anything like a theoretically ideal model and this brings into question proposals to introduce emissions trading in China. Limitations would seem to be the semi-free market, the weakness of the legal system and the nature of business-bureaucracy interactions. Research limitations/implications This case study is geographically limited, as are most emissions trading schemes in China and the number of interviewees is relatively small. There was also little historical quantitative data because of the limited records kept in the enterprises and so there is a high reliance on interviewees recollection. Practical implications The evidence suggests that a national carbon trading scheme may not be suitable in China in the short run because the implementation of the program and emissions trading market are very important. Originality/value This is the rst paper investigating the actual performance of SO2 emissions trading practice in China and also the rst one discussing the suitability of using emissions trading to achieve carbon reductions in China based on the existing practice. Keywords Emissions trading, Carbon reductions, China, Taiyuan SO2 emissions trading program, Environmental management Paper type Research paper

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Received 5 January 2011 Revised 28 April 2011 Accepted 2 June 2011

1. Introduction Carbon emissions in China have increased rapidly over the last 50 years, particularly during the urbanization and industrialization periods of the last two decades (Feng et al., 2009; Guan et al., 2008). In 2006, China overtook the USA and became the worlds largest CO2 emitter (The Netherlands Environmental Assessment Agency, 2007). Thus, it is expected that China, as a large emitter, should adopt targets to mitigate carbon emissions (Environmental Resources Management, 2007). During the Copenhagen Summit 2009, China insisted on common but different responsibilities between developing
The author is most grateful for the helpful comments and suggestions from three anonymous referees. An earlier version of this paper was presented at the Academic Symposium: Leadership for Climate Change and Sustainability at La Trobe University. The author wishes to acknowledge the contributions of the conference participants for this paper.
Sustainability Accounting, Management and Policy Journal Vol. 2 No. 1, 2011 pp. 27-44 q Emerald Group Publishing Limited 2040-8021 DOI 10.1108/20408021111162119

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and developed countries but made a voluntary commitment to reduce carbon emissions per gross domestic product (GDP) to 40-45 percent below its 2005 level by 2020 (Wen, 2009). Therefore, how to achieve this ambitious carbon reduction target is becoming a top topic in China. Currently, China mainly uses command-and-control regulation to control carbon emissions (The State Council of the Peoples Republic of China, 2009), which is criticized as lacking exibility and incentives to encourage change, and this does not generate cost-effective reduction options (Armstrong, 1998; Owen, 1992; Pearce, 1991; Sandu, 2007). On the other hand, emissions trading is argued, by many researchers, based on economic theory, to be the most effective means of reducing carbon emissions, although China has little experience in applying such market-based approaches. Emissions trading was discussed and piloted in China in the early 1980s, but remained primarily conceptual because of legal and regulatory constraints (Jintian et al., 2003). It was rst used to control sewage in Jiangsu Province and Shanghai Municipality in 1987 (Lin and Feng, 2008; Zhou, 2009). Emissions trading for air pollution was rst introduced to control SO2 emissions in Taiyuan city in 2003. While the SO2 emissions trading program is the only air pollutants emissions trading practice in China, both the outcomes and experiences of the program could provide ideas as to whether or not a carbon trading program is suitable for China. This paper aims to investigate the SO2 emissions trading practice in China and discuss what it might reveal about the suitability of using emissions trading to achieve the ambitious carbon reductions target in China. The rest of the paper is organized as follows. Section 2 reviews the literature on emissions trading theory, key challenges of using emissions trading in China, and the methodology used elsewhere. Section 3 describes the case study methodology used in this paper and the results are presented in Section 4. Section 5 discusses the results of the case study and the nal section summarizes the conclusions, contributions and limitations of the paper. 2. Emissions trading theory, Chinese context, and methodology justication The idea of emissions trading was introduced by Dales (1968) and later formalized by Montgomery (1972), based on the Coase therorem. The Coase theorem suggests that:
[. . .] if there were (a) no wealth effects on demand (b) no transaction costs and (c) rights to pollute or control pollution, the allocative solution would be invariant and optimal, regardless of the initial assignment of rights (Frech, 1973, p. 254).

By creating property rights for a public good (Sterner, 2003), which in this case is the atmosphere, emission trading schemes assign private property rights to emitters and according to the Coase Theorem this should be sufcient to lead to an efcient outcome (Betz, 2006, p. 2). Meanwhile, the performance of emissions trading has been analyzed from different viewpoints, such as the emissions reductions (effectiveness) (Hidalgo et al., 2005; Kinsman, 2002; Sandoff and Schaad, 2009), cost-effectiveness (Burtraw, 2000; Gagelmann and Frondel, 2005; Kinsman, 2002), innovation and investment in clean technology (Bleischwitz et al., 2007; Kerr and Newell, 2003; Laurikka and Koljonen, 2006), leakages (production moving elsewhere) (Bleischwitz et al., 2007; Hidalgo et al., 2005) and so on. Based on the emissions trading theory and literature review of the actual practice, if an emissions trading scheme was successful, there would

be a reduction in total emissions, a functional market with trades to achieve cost saving, an increase in innovation and investment in clean technology and no leakage of investment. Emissions trading is based on the principle of the free market to ensure the possibility of trading actions (Zhang, 2004) and so far most of the successful emissions trading schemes have been implemented only in developed, market economies. The US Acid Rain Program is by now the best-known and most successful experience with emissions trading (Ellerman et al., 2003; Kinsman, 2002), while the European Union Emissions Trading Scheme (EU ETS) is the largest emissions trading system so far (Soleille, 2006). China does not have a fully developed market system, and the state-run economy holds a leading position in some key sectors including energy and transportation (Zhang, 2004). Furthermore, China has never been a mature law-based society (Zhang, 2004, p. 76), so there are doubts about the institutional capacity and enforcement regime needed to implement emissions trading in China. These are key challenges and differences for China. Much literature (Burtraw et al., 2005; Ellerman, 2005; Ellerman et al., 2003; Environmental Law Institute, 1997; Harrison et al., 2008; Kruger, 2005; Stavins, 1998; Tietenberg, 2003) has reviewed the lessons learned from SO2 trading programs in other countries to apply them to greenhouse gases (GHGs) trading. Harrison et al. (2008) discuss the important policy issues for GHGs emissions trading by studying the US cap-and-trade programs of conventional air pollutants, including SO2 and (nitrous oxide) NOX. Parsons et al. (2009) examine the performance of the European Union (EU) CO2 market and the US SO2 market when designing a US market for CO2. As the necessary data to examine the valuation implications of GHGs emissions allowances is not yet available, Johnston et al. (2008) test the valuation implications of SO2 emissions allowances instead, believing that similar characteristics between the SO2 and GHGs emissions trading markets exist though they have some different scientic and economic attributes. In practice, the SO2 programs have had a great inuence on the EU ETS, which have been noted by the EU ofcials and others (Christiansen and Wettestad, 2003; Delbeke, 2003; Dimas, 2005; Zapfel and Vainio, 2003). Therefore, there is general agreement that the SO2 program proves the concept of emissions trading for a greenhouse gas program (Kruger, 2005, p. 3). Finally, there is so little experience of large-scale programs, that the SO2 emissions trading schemes are the only existing air pollutant emissions trading in China. On the grounds that these are the best available data for carbon emissions trading in the context of China, and the extrapolation has been used elsewhere, and across jurisdictions, it is argued that this research approach is justied. 3. Methodology Given the limited application of emissions trading in China, a case study research method is adopted. The case study is a single case (Yin, 2009), which is the SO2 emissions trading program in Taiyuan city[1]. The SO2 trading program is the only air pollutant emissions trading practice in China, with Taiyuan being the most representative area among the seven regions[2] involved in this program. Taiyuan city, the capital of Shanxi Province, has always been a heavily industrialized area and one of the most polluted cities in China[3], and a forerunner in air pollutants total quantity control and emissions trading practice as well[4]. So, Taiyuan SO2 emissions trading

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program is considered typical practice in China and its experience could illustrate the emissions trading situation in China. The researcher rst collected documentations related to Taiyuan SO2 emissions trading practice from the local and professional newspaper in the Taiyuan Library and on the ofcial web sites of relevant government departments. Then, as both quantitative and qualitative data of the program are limited, semi-structured face-to-face interviews were conducted to collect the rst-hand data for the case study, with the managers responsible for SO2 trading in the enterprises covered by the emissions trading program, and the relevant administrators from the Taiyuan Environmental Protection Bureau. As mentioned in the literature review, the performance of an emissions trading program is normally evaluated from emissions reductions, cost-effectiveness, innovation and investment in clean technology and leakages and so the performance of Taiyuan SO2 emissions trading program is examined from these four aspects. An understanding of the existing problems of the Taiyuan SO2 practice could help improve the program itself and provide lessons for other emissions trading programs in China. Therefore, the overall structure of interviews was as follows: initially, a number of background questions were asked; subsequently, three main themes, performance of the Taiyuan SO2 emissions trading program, attitude toward Taiyuan SO2 emissions trading and problems of the existing Taiyuan SO2 emissions trading program, were explored by asking seven sub-questions and one open question. The sub-questions investigating the rst theme related to the degree of emissions reductions, emissions cost, innovation and investment in clean technology and direct and indirect investment outside Taiyuan city (leakages). The second theme was investigated by asking questions about the effectiveness of the Taiyuan SO2 emissions trading program, a comparison with command-and-control regulations and the functioning of the emissions trading market. The third theme explored through an open question about the problems of the existing Taiyuan SO2 emissions trading program. Based on the SO2 emissions permits allocated in 2007, the top 45 emissions enterprises were selected as the target enterprises, and their emissions allowances accounted for more than 99 percent of the total for Taiyuan city in 2007. Therefore, the managers in charge of SO2 trading affairs from each of these 45 enterprises, respectively, were considered as target participants. Of these, 20 enterprise managers were interviewed, with the 20 responding enterprises accounting for more than 96 percent of the emissions allowances allocated among the 45 target enterprises. It seemed that large enterprises were more willing to participate in the research. The participating enterprises covered 11 industries, varying from repower generator to beverage manufacturing, and most of them were state-owned capitalized enterprises. The SO2 emissions were relatively concentrated in a few industries, with repower generators the major polluting sources. Taiyuan Environmental Protection Bureau is the administrative department of the SO2 emissions trading program in Taiyuan city. It was expected that the administrators from this bureau would have a comprehensive understanding of the Taiyuan SO2 trading practice. Thus, four ofcers from this bureau, who had been in charge of the program since it was established, were chosen as the administrators target participants. Content analysis was applied to analyze the interviews (Marshall and Rossman, 1995). This examined how respondents viewed and understood certain issues (Trace, 2001).

The key, substantive statements of the interviews were identied and then put into categories according to the three main interview questions, derived from the emissions trading theory. The 20 enterprises were coded based on the emissions permits allocation in 2007 from largest to smallest, as EN1, EN2. . .EN20 (Table I). Similarly, the 20 managers from the 20 enterprises, respectively, were named MA1, MA2. . .MA20. AD1, AD2, AD3 and AD4 indicated the four administrators from the Taiyuan Environmental Protection Bureau. 4. Results The results of interviews were categorized and presented according to the three main interview themes. Some interview results were supported by data from the available documents. The performance of the Taiyuan SO2 emissions trading program Both the managers and the administrators showed relatively consistent views except on emissions costs. According to the respondents, the Taiyuan SO2 emissions trading program reduced the emissions, promoted the innovation or investment in clean technology and did not lead to leakage outside Taiyuan city but it did not obviously reduce the emissions costs (Table II). All the interviewees agreed that there was a reduction in SO2 emissions after implementing the SO2 trading program. AD2 said that:
[. . .] the SO2 emissions of Taiyuan city reduced by 8000 tons and about 4500 tons in 2008 and 2009, respectively, and the SO2 reductions were nearly 2000 tons only in the rst half year of 2010.

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The managers also indicated that they really reduced the SO2 emissions of their companies because of the caps imposed by the government. This argument was supported by the data collected from the documents as well, which is detailed in Table III. The total SO2 emissions in Taiyuan decreased steadily since the SO2 trading program was introduced in 2003. Most interviewees, 86 percent managers and three of the four administrators, said that the SO2 trading program helped the companies innovate or invest in clean technology. MA6 pointed out that his company spent around US$1.5 million on desulfurization equipments for reducing the SO2 emissions in 2009. Interestingly, 12 interviewees mentioned that their companies investing in clean technology simply to comply with the caps and ensure the company reputation. They actually did not evaluate the emission costs of different compliance strategies when choosing the compliance method. Also, most interviewees suggested that the SO2 trading program did not lead to leakage. About 75 percent of managers stated that their companies did not invest outside Taiyuan city because of the constraints from the SO2 trading program and would not do this in the future as well. But MA11 said that his company transferred part of the business to other cities where there were no strict caps on the SO2 emissions and MA17 expressed that his company had the same intention. Those enterprises that had no intention of shifting investment were all large state-owned enterprises, which heavily relied on the raw materials in Taiyuan city or had to provide the necessary life needs, such as electricity, for the people living in Taiyuan city. The other two with

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Coded enterprises owned owned owned owned 1,184 31 863 2,246 127 88 15 1,108 185 121 55 13 3 17 34 123 1,967 6,086 303 6,323 30,000 13,000 7,500 3,300 1,952 800 780 720 280 240 236

EN1 EN2 EN3 EN4

EN5

EN6 EN7

EN8 EN9 Ordinary machinery Concrete manufacturing Special purpose equipment Concrete manufacturing Rubber products Beverage manufacturing Concrete manufacturing Beverage manufacturing

EN10

EN11

EN12 EN13 EN14

EN15

EN16 EN17

EN18

EN19 EN20

Table I. Coded enterprises and managers Industry Total assets (millionUS$,1U$ 6.5RMB) SO2 emission permits in 2007 (tons) Coded managers MA1 MA2 MA3 MA4 MA5 MA6 MA7 MA8 MA9 MA10 MA11 150 135 128.65 114 110 54.3 49 42.22 35 MA12 MA13 MA14 MA15 MA16 MA17 MA18 MA19 MA20 Firepower generator Smelting and pressing of ferrous metals Firepower generator Coal mining and dressing and repower generator Coal mining and dressing and production and supply of gas Firepower generator Raw chemical materials and chemical products Special purpose equipment Smelting and pressing of ferrous metals Electronic and communications equipment Ordinary machinery Special purpose equipment

Enterprise property

State State State State

State owned

State owned State owned

State owned Joint ventures enterprise Provincial-owned enterprise Privately owned enterprises State owned State owned Joint-ventures enterprise Collective-owned enterprises State owned Joint-ventures enterprise Stated owned

Stated owned Stated owned

some intention of shifting investment were comparatively small companies engaged in concrete manufacturing and beverage manufacturing industries, which were considered more exible in facing the challenges of the outside world. As to whether or not the SO2 trading program achieved cost saving, the views varied a lot. Only three managers believed that the SO2 trading program did decrease the emissions cost, while 29 percent of interviewees thought it did not and 50 percent interviewees showed that they were unsure about this. MA13 even argued that the SO2 trading program forces the company to adopt desulfurization equipment, which in turn increases the emissions cost of the company (Table III). MA5, who was unsure about the changes of the emissions cost, explained:
The average removed cost of per unit SO2, including equipment depreciation, maintenance and operation fees, is mainly related to the sulphur content of coal and the generating capacity size. The average removed cost of per unit SO2 is positively correlated with the sulphur content of coal and negatively correlated with the generating capacity size. So the SO2 emissions cost varies a lot even in the same company but during different periods. Even though there is a reduction in the SO2 emissions cost, it cannot be attributed to the SO2 emissions trading program simply.
I do not know Refuse to answer 0 0

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Questions Reduce emissions Reduce emissions cost Innovation or investment in clean technology Direct and indirect investment out Taiyuan city

Interviewees Yes

No

20MA, 4AD 20MA, 0 4AD 20MA, 4AD 3MA 6MA (1 raise),1AD 20MA, 4AD 18MA, 1MA 3AD 20MA, 4AD 2MA 15MA, 2AD

9MA, 2MA 3AD 0MA, 1MA 1AD 1MA, 2MA 2AD

Table II. The performance of the Taiyuan SO2 emissions trading program

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total SO2 emissions (tons) 232,181 234,104 217,912 184,503 160,303 141,399 133,387 128,787

SO2 emissions reductions (tons) 21,923 16,192 33,409 24,200 18,904 8,012 4,600

Annual concentration of SO2 The number of days the air quality (mg/m3) achieving or better than level 2a 0.153 0.129 0.099 0.087 0.077 0.08 0.076 0.073 120 153 181 224 245 261 269 303 296 Table III. Taiyuan SO2 emissions from 2001 to 2009

Note: aAccording to the Environment Air Quality Standards: national level 2 standards (SO2 0.060 mg/m3) and national level 3 standards (SO2, 0.100 mg/m3) Data source: China Environment Statistical Yearbook from 2000 to 2009, Taiyuan Economic and Social Development Statistical Ofcial Report from 2001 to 2009

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Attitudes toward Taiyuan SO2 emissions trading program When the managers and administers were asked about their overall attitudes toward Taiyuan SO2 trading program, they expressed similar opinions. Both managers and administrators said that the SO2 trading program was effective in reducing the SO2 emissions. AD2 pointed out the SO2 emissions have reduced signicantly and the air quality has improved greatly in Taiyuan city after carrying out the SO2 trading program. And 54 percent of interviewees, including 45 percent managers and all the administrators, thought the SO2 trading program was better than the previous command-and-control regulations as it was much more effective in reducing and controlling the SO2 emissions. However, six managers expressed the opposite view to the SO2 emissions trading program. MA7 said that:
[. . .] even though I know the enterprise should take the social responsibility to protect the environment and achieve sustainable development, I still oppose the SO2 trading program as it constrains development and decreases the interest of the enterprise.

None of the administrators thought the Taiyuan SO2 trading market had properly developed so far. AD2 gave the details of existing situation of the Taiyuan SO2 trading market:
[. . .] except for two simulant trades in December 2002 when the program was initially piloted, there had been only 19 transactions until July 2009, involving 807 tons of emissions. And 18 of them happened between newly built enterprises or projects and the old enterprises. The other trading, which was also the rst SO2 emissions trading case, took place between enterprises in 2003 (Table IV).

Perceptions of the limitations of the Taiyuan SO2 emissions trading program In this section, 12 major problems were summarized based on the interview data (Table V) and also the reasons behind the limited trading market were especially explored (Table VI). Both AD2 and AD4 argued that the legal basis of the Taiyuan SO2 emissions trading program was not strong enough. AD4 explained that:
[. . .] the program is established on the basis of Administrative Regulation for SO2 Emissions Trading in Taiyuan City, which is a local administrative regulation published by the peoples government of Taiyuan city in 2002. While at the national level, there is no specic law or regulation for emissions trading.

The weak legal basis of the Taiyuan SO2 trading program led to uncertainty and weak enforcement of the trading program. AD2 pointed out that the design of the Taiyuan SO2 emissions trading program is half an emissions trading system and half a fee system. There was a cap in the SO2
I do not know Refuse to answer 0 0 3MA 1AD

Questions Table IV. The overall attitudes toward the Taiyuan SO2 emissions trading program

Interviewees Yes

No 0

Is it effective in reducing the SO2 20MA; 4AD 20MA; emissions? 4AD Is it better than the previous command 20MA; 4AD 9MA; and control regulations? 4AD 0 Does the SO2 trading market really exist? 4AD

6MA 2MA 3AD 0

Interviewees AD2, AD4 AD2 MA3, MA12 MA1, MA3, MA8, MA15 MA2 AD4 AD3 AD4 MA1, MA2, MA7, MA14, MA18 AD1 MA3 AD1, AD2, AD3, AD4

Limitations of the Taiyuan SO2 emissions trading program The legal basis was not strong enough The design of the program was half an emissions trading system and half a fee system The emissions allowances allocation method was unfair The allocation policy was unpredictable The linkage policy was unreasonable The continuous online monitoring equipment was too limited There was no electronic SO2 emissions allowances tracking system and transactions management system There was no xed department or person responsible for the program The information of SO2 emissions trading was not open and transparent The administrative department did not attach importance to the program The administrative intervention in the program was too strong The emissions trading market had not yet been formed

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Table V. The limitations of the Taiyuan SO2 emissions trading program

Interviewees MA8 MA2 MA7, MA14 AD1 AD3 AD3, AD4, MA10 MA9 AD2, MA16 AD2

The reasons of poor emissions trading market Insecure emissions rights Unreasonable linkage policy Asymmetric information The government administrative department lacked the enthusiasm of regulating the emissions trading market There is no emissions exchange Most enterprises did not fully understand emissions trading The alternative methods for complying with the caps were effective It was difcult to reach an agreement on the emissions trading price There were not enough participants in the program Defective design Weak implementation

Weak market structures

Table VI. The reasons behind the poor Taiyuan SO2 emissions trading market

emission trading system and the overall cap was going down year by year, but the implementation currently focused on the compensation for using the emission rights. The emissions allowances were not provided to the emissions enterprises for free, nor were they sold by auction. In practice, The Taiyuan Environmental Protection Bureau charged the enterprises 0.2 RMB/kg on the actual SO2 emissions quarterly. AD2 further said that this different design makes the enterprises managers and even some administrators misunderstand what a real emissions trading program should be like. MA12 complained that the emission allowances allocation method is unfair as it is based on the historical emissions data of the enterprises, ignoring other factors, such as production, fuel efciency. The most polluting enterprises got the most allowances. MA3 also expressed a similar view on this limitation. Four managers said the outcomes from the total quantity allocation policy were unpredictable. MA15 explained that even though the initial allocations cover ve years, the allowable emissions may be suddenly decreased as the emissions control

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from the higher levels of government gets stricter. MA8 said that insecure emissions make it difcult for them to make plans so they preferred to keep the extra emissions permits in hand rather than sell them in the trading market. The linkage policy was also criticized by MA2. MA2 said that:
[. . .] a newly built enterprise or project, which emits SO2, must get the SO2 emission allowances before being put into operation. But the current linkage policy for the newly built enterprises or projects is limited to buying allowances from the existing enterprises, without auctioning.

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Meanwhile, the decient trading information and the inactive trading market made it difcult for new enterprises or projects to get the emission allowances. AD4 argued that the total amount of emissions may be underestimated in the Taiyuan SO2 emissions trading program as only a few large and key SO2 emitters had installed the continuously online monitoring equipment due to its expensive price and maintenance fee. AD4 further disclosed that the emissions data may not be reliable as well because the continuous online monitoring equipment had not been checked since it was installed, and some might have been damaged and could not measure the emissions correctly. AD3 revealed that there is no electronic sulphur dioxide emission allowances tracking system and transactions management system in the Taiyuan SO2 emissions trading program. Both the information of emission allowances allocation and transactions were registered separately among the years by the Taiyuan Environmental Protection Bureau. Thus, the related trading information could not be provided in a timely and accurate way. AD4 pointed out that no xed department or person is responsible for the Taiyuan SO2 trading program. Overall, three departments and several administrators within the Taiyuan Environmental Protection Bureau had been in charge of the program since it was implemented in 2003. A lot of valuable original documents and data were lost due to the frequently work transition. Five managers mentioned that the information of SO2 emissions trading was not open and transparent. M14 said that:
[. . .] it promises in the Administrative Regulation for SO2 Emissions Trading in Taiyuan City that last years Taiyuan SO2 emissions and emissions trading bulletin and other related information are made known to the public in the March of each year, but actually, only a little of the information is published discontinuously.

It was argued that the efciency of markets would increase with the free ow of information. It was also suggested that the administrative department did not attach importance to this program. AD1 said that:
[. . .] the SO2 emissions trading program was promoted by the ex-director of the Taiyuan Environmental Protection Bureau who thought highly of the emissions trading. So it worked when he was in power, but this program was forgotten by the ofcers soon after when a new director, who does not pay attention to this program, comes into the ofce.

MA3 said that the Taiyuan Environmental Protection Bureau plays too much administrative intervention in the transaction process. Though few emissions trades had been done, almost all the trading cases were matched by the Taiyuan Environmental

Protection Bureau and the trading price was also suggested by the Bureau. MA3 believed that it was necessary for the administrative department to do some administrative interventions at the beginning of the program but that it should nd a good balance between intervention and supervision and act as a supervisor and let the program work by itself gradually. As few trades had taken place so far, the emissions market, it was argued by all the administrators, had not yet properly developed. AD2 said that emissions trading has faded out of peoples sight, people mention emissions reduction task instead of emissions trading when talking about sulphur dioxide. As an emissions market is the most important part of a trading program, and could be used to evaluate the success of an emissions trading practice, the reasons of why only a few tradings have taken place so far were explored and listed in Table VI. It was mentioned by some interviewees that some of the design and administrative implementation problems of the Taiyuan SO2 emissions trading program also led to inactive SO2 emissions trading. The insecure emissions rights mentioned by MA8 and the current unreasonable linkage policy criticized by MA2 made the enterprises reluctant to participate in the emissions trading market. Furthermore, both buyers and sellers were reluctant to trade because of asymmetric information. MA7 said that buying the allowances from the market is really difcult because neither the enterprises that have surplus SO2 emissions allowances, nor the administrative department announces the allowances selling information publicly. On the other hand, MA14 disclosed that his enterprise failed to sell extra allowances in some years because no buyer was found. M12 further explained that it is not worth the enterprise spending too much time and effort in nding the buyers as the allowances revenue is a relative very small amount. In addition, according to AD1, the government administrative department lacked the enthusiasm for regulating the emissions trading market. AD3 thought the most important reason why there had been a few trades so far was that there was no Emissions Exchange in Taiyuan city. AD3 said that the Taiyuan Environmental Protection Bureau, as the administrative department of Taiyuan SO2 trading program, was inconvenient to deal with and also lacked the energy to do some activities, but the trading would get much better if there were an Emissions Exchange in Taiyuan city. It could act as an independent reliable third party, organizing the trading and releasing the allowances information. Most enterprise managers still did not fully understand emissions trading. MA10 said that he knew there is an allowable emission amount for the enterprise every year and the enterprise has to control the emissions under this prohibitive amount strictly, but he has no idea of emissions trading. At the same time, AD3 complained that most of the large SO2 emission units were old state-owned enterprises, with a high average age and irregular quality of workers. Based on the requirements of the program, the Resources for the Future (RFF) and Taiyuan Environmental Protection Bureau jointly organized more than 20 SO2 emission trading training or seminars for 23 large and key SO2 emissions enterprises at the beginning and mid-term of the program, but only a few of them really understood what emission trading was. AD4 also argued that the enterprises do not know the benets that they can obtain from emissions trading, and no emissions trading expert can be found in the Taiyuan Environmental Protection Bureau. MA9 said that his enterprises considered investing in the desulphurization equipment as the rst choice when short of emission allowances, because it is much

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more convenient and the machine can work immediately. As one of the methods for complying with the caps, the desulphurization technology was quite mature so that the enterprises prefer investing in desulphurization equipment rather than trading, ignoring that the reductions cost of trading might be lower than the cost of desulphurization equipments. AD2 disclosed that some trading failed because the trading parties could not reach an agreement on the price. MA16 also complained that it is difcult to reach an agreement on the emissions trading price as there is no price for reference, neither recent trading nor guidance price. They were afraid of suffering losses and thus were cautious about trading. AD2 also emphasized the necessity of a guidance price for SO2 emissions allowance, but deciding on the guidance price turned out to be a very complex subject. AD2 called for the research in this area in China. Last but not the least, AD2 argued that there are not enough participants in Taiyuan SO2 emissions trading program. AD2 explained that the Taiyuan SO2 emissions trading program was a local emissions trading program with only about 10 key emission sources, so the participants of the emissions trading market were considered too limited, which also meant there were not many opportunities for cost saving. AD2 further suggested that the program would be much more successful if it were carried out at the provincial level or national level. 5. Discussions and limitations of the Taiyuan scheme Emissions trading, it is argued, can achieve both environmental and economic goals at the same time (Ellerman, 2005). Emissions reductions have been effectively achieved in Taiyuan SO2 emissions trading program while cost-saving does not seem to have been realised, according to the respondents in this study. As most of the cost saving is achieved by trading, and only a few trades happened. Furthermore, the motivation of innovating and investing in clean technology is found merely to comply with the caps, and the lack of leakage is mainly due to other factors related to companies structures and customer location rather than the policy. Overall, the Taiyuan SO2 emissions trading program seems not to be functioning anything like the ideal emissions trading model as proposed by the emissions trading theory. Though the allowances trading market evolved slowly at the early stage of the US SO2 trading program, the total of major allowance trades (10,000 tons or more) were 2.3 million tons and Environmental Protection Agency (EPA) auction allowances were 326,210 tons since 1992 (Rico, 1995). In comparison, the performance of the early stage of the Taiyuan SO2 trading market is really poor. If summarized, the major reasons of the poor emissions trading market in Taiyuan could be rst attributed to the defective design and weak implementation of the program. Second, the participating enterprises managers and administrators do not fully understand emissions trading. Third, other supporting measures for trading market do not follow up timely, such as emissions exchanges. All these factors make the participants afraid or hesitate to trade, which results in an inactive emissions trading market. Taking the linkage policy as an example, the enterprises in US SO2 trading program also must acquire permits to enter market, but they could buy the permits from either existing enterprises or the Environmental Protection Authority (EPA), as a small number of additional permits are auctioned by the EPA annually (Schmalensee et al., 1998). Evidence from the US SO2 trading program suggests that the early allowance

auctions can be a market starter, helping to provide a price signal on prices to the nascent market (Rico, 1995). By evaluating the SO2 emissions trading in the USA in 1998, Schmalensee et al. (1998) also argue that the permits auctions in US SO2 may have facilitated both the price discovery process and the development of the permits trading market. However, the design of Taiyuan SO2 trading program did not make good use of auctioning to enact the emissions trading market. While the enterprises covered by Taiyuan SO2 emissions trading program do not really understand emissions trading, the same kind of problem also appears in the US Acid Rain Program. Before the passage of the US Acid Rain Program, most affected units also expressed clearly that they did not understand market and would not trade allowances with other companies (Rico, 1995). However, no literature is found discussing the importance of an Emissions Exchange in other emissions trading programs, like the US SO2 emissions trading program or the EU ETS. One reasonable explanation is that the markets in USA and EU are free and mature enough for implementing the economic-based instrument-emissions trading. The market information is more symmetrical so that the affected enterprises can agree on the transactions independently. Another possible reason is the emissions exchanges in the USA and EU (Chicago Emissions Exchanges and European Climate Exchange) developed very quickly from their establishment in 2003 and 2004, respectively, and they did not block the development of the emissions trading markets. It has been conrmed by MacKenzie (2007) that allowances trading in EU ETS can take place via brokers and on a number of organised exchanges, even in the form of carbon futures by using the electronic trading platform, so the formal Emissions Exchange is comparatively not so important. Chinas semi-free market situation makes the Emissions Exchange of great signicance to the Chinese emissions trading market, and so this may be the major reason behind Emissions Exchange proposed by interviewees for the inactive emissions trading market. Zhang (2004) explores two key challenges for implementing SO2 emissions trading in China. One is whether the Chinese market is free enough for carrying out emissions trading, the other is whether the legal authority is adequate enough to ensure the implementation of emissions trading in China. He considers that the emissions trading system is feasible, in spite of the fact that the market is not totally free and the Chinese society still lacks legal regulation. After several years practice of SO2 emissions trading in China, the performance of the Taiyuan SO2 emissions trading program clearly shows that emissions trading still has some way to go because the market is still not free enough to achieve trading and the legal authority is also not sufcient enough to ensure the implementation of emissions trading in China. Therefore, when comes to the question whether emissions trading is suitable for China to achieve the carbon reductions target, questions remain. Though it is argued that CO2 is a global problem, and therefore will have more market participants, the abatement cost of CO2 is much more varied than that of SO2, and unlike the mature desulphurization technology, there has been no effective decarbonisation technology so far. Cost saving would be more likely to be achieved in carbon trading market and the affected enterprises would more probably choose carbon trading as the compliance strategy. Furthermore, the design of carbon trading program could be initially ensured and the administrative implementation could be improved step by step. Considering emissions trading market, however is the most meaningful part of an emissions

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trading program while the market situation in China is not free enough, and the development of market liberalization is a long process, so emissions trading is suggested may not be suitable for achieving carbon reductions target in China in the short run. Therefore, perhaps an initial carbon tax might be a suitable alternative choice. However, some experiences still could be learned from the Taiyuan SO2 emissions trading practice for other emissions trading programs even future carbon trading in China. The design of an emissions trading program is the rst step to success and special attention needs to be paid to the key elements of the program, including allowances allocation method, allocation policy, linkage policy and so on. Furthermore, the implementation of an emissions trading program determines the performance of the program, so the implementation should be swift, strict and strong. In addition, when using emissions trading in China, we should create an active emissions trading market and ensure the trades achieve cost-savings. As Emissions Exchange is a good organization for promoting and assisting trades in Chinas situation, and related seminars and training should be provided for the participants and make sure that they really know how to make the abatement decisions on emissions reductions. 6. Conclusions In summary, the introduction of SO2 emissions trading program in Taiyuan city effectively reduces the SO2 emissions, promotes innovation and investment in clean technology and does not necessarily lead to investment leakage, but the motivation of innovating and investing in clean technology is found merely to comply with the caps and no leakage is mainly due to other objective factors of the companies rather than the policy. It cannot be concluded from the interview evidence that cost saving has been realized. Furthermore, the Taiyuan SO2 emissions trading program is argued better than previous command-and-control regulations, but it has a lot of problems and especially a true SO2 emissions trading market has not been formed yet. Overall, it seems that the Taiyuan SO2 emissions trading program is not functioning anything like the ideal emissions trading model as proposed by the emissions trading theory and cannot be judged as a successful scheme. Based on the ndings from the Taiyuan SO2 emissions trading program, it appears that carbon trading may not necessarily be suitable for China to achieve the ambitious carbon reductions target at this stage. However, some lessons can still be drawn from the Taiyuan case, including the design and implementation of the program and the emissions trading market, which have signicant implications for other emissions trading programs even future carbon trading program in China. The ndings of the Taiyuan SO2 emissions trading program in this research not only enrich emissions trading theory in China, but also offer policy suggestions on carbon reduction problems and for directly improving the current program. In addition, the experience of the Taiyuan SO2 emissions trading program in this research can provide signicant lessons for other emissions trading programs as well as future carbon trading program in China. This research has a few limitations. The relatively small number of interviewees might be the rst limitation. The Taiyuan SO2 emissions trading program itself is a local program with limited participants and experienced people. As a result, we should be cautious about generalising the ndings from this research. Furthermore,

little quantitative data are obtained from the interviews due to limited record kept in the enterprises, and the researcher has to rely on the interviewees recollection. Future research addressing Chinas emissions trading programs could overcome these shortcomings.
Notes 1. Taiyuan SO2 emissions trading program was formally carried out in 2003 with the promulgation of the Administrative Regulation for SO2 Emissions Trading in Taiyuan City by the Taiyuan municipal government. According to the regulation, all the rms in Taiyuan city need to obtain the permits for emitting SO2 emissions. Every ve years, the yearly permits are allocated to the emissions rms. Permits can be traded and stored, but cannot be used in advance. New enterprises will not be given any permits until a new round of permits allocation for the next ve-year period, but they can obtain the permits by trading. Taiyuan Environmental Protection Bureau is responsible for the supervision and management of the Taiyuan SO2 emissions trading program. 2. The seven provinces are Tianjin, Jiangsu, Zhejiang, Shanghai, Shanxi, Henan, and Guangxi. 3. Industry accounted for 43.7 percent of provincial GDP in 2009, which was largely based on coal mining, coke production, iron and steel industries, construction cement, chemical manufacturing, and ceramics. In 2008, the annual average SO2 concentrations in Taiyuan was 0.073 milligrams per cubic meter (mg/m3), 11.5 percent more than the Peoples Republic of Chinas Class II annual standard (0.06 mg/m3) (National Bureau of Statistics & Ministry of Environmental Protection, 2009). 4. In 1990, Taiyuan was selected as one of the 16 pilot cities in implementing air pollutants emission permits system by the State Environmental Protection Bureau. In 1994, Taiyuan and other ve cities rst carried out the air pollutants emissions trading pilots. Taiyuan published the Regulation for Total Quantity Control of Air Pollutants Emissions in Taiyuan City in 1998, which was the rst local regulation on emissions trading and emissions total quantity control in China. And the Administrative Regulation for SO2 Emissions Trading in Taiyuan City in 2002 was also the rst local regulation on SO2 emissions trading in China. References Armstrong, G. (1998), Greenhouse issues, policies and positions, Kyoto 1997, National Economic Review, No. 42, pp. 23-51. Betz, R. (2006), Emissions trading to combat climate change: the impact of scheme design on transaction costs, paper presented at Conference of the Australian Agricultural and Resource Economics Society, Manley. Bleischwitz, R., Fuhrmann, K. and Huchler, E. (2007), The Sustainability Impact of the EU Emissions Trading System on the European Industry, College of Europe, Bruges. Burtraw, D. (2000), Innovation under the tradable sulphur dioxide emissions permits programme in the US electricity sector, Innovation and the Environment, June 19, pp. 63-84. Burtraw, D., Evans, D.A., Krupnick, A., Palmer, K. and Toth, R. (2005), Economics of Pollution Trading for SO2 and NOX, Resources for the Future, Washington, DC. Christiansen, A. and Wettestad, J. (2003), The EU as a frontrunner on greenhouse gas emissions trading: how did it happen and will the EU succeed?, Climate Policy, Vol. 3 No. 1, pp. 3-18. Dales, J.H. (1968), Pollution, Property & Prices, University of Toronto Press, Toronto.

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Zhang, J. (2004), Using Emissions Trading to Achieve Sulfur Dioxide Reduction in China, Roskilde Universitetscenter, Roskilde. Zhou, Z. (2009), Discussion about the status and existing problems of emission trading in China, Technology and Market, Vol. 16 No. 10, p. 45. About the author Zhen Lu is a PhD candidate in the Faculty of Business, University of Southern Queensland, Australia. Her research area is emissions trading in China. Other research interests include environmental policy, CGE model and so on. Zhen Lu can be contacted at: Zhen.Lu@usq.edu.au

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