By Sieren Ernst1 and Dr. Nicholas Linacre2
1Principal and Founder, Ethics & Environment, email: firstname.lastname@example.org
2Fellow, Faculty of Science, University of Melbourne, email: email@example.com
On his trip to the United States in September, President Xi Jingping announced that China would implement a national emissions trading system by 2017. The announcement was a part of a joint statement with U.S. President Barak Obama that reaffirmed the two countries’ interest in curtailing global climate change in the lead- up to the Paris Climate Conference known as COP21.
The joint Sino-American announcement specifically avoids using the term ‘cap-and-trade’ to describe China’s envisaged national system, though it has been reported as such in the English language press. Linguistic ambiguity is common for high-level Chinese government announcements in order to allow for leeway in implementing regulations. Despite foreign reporting of ‘cap-and-trade’ we believe, in this case, that the term ‘emissions trading’ more accurately describes what has been and will unfold in China.
As a part of the announcement, China reiterated its 2030 climate goals, released in preparation for COP21, of reducing the energy intensity of industrial and power emissions as a percentage of GDP by 60 to 65 percent by 2030, and increasing the non-fossil fuel power generation to 20 percent of the national total, a policy that extends and improves upon the existing targets of 40 to 45 percent energy intensity improvements by 2020 and 15 percent non-fossil fuel energy generation by 2020. China’s 2030 targets represent an improvement on the baseline trajectory. The key points are summarized in Box 1.
The announcement of a national emissions trading system in China has prompted commentary that China is implementing a policy that could not pass through the U.S. Congress. Such claims exaggerate Chinese actions and are based, in part, on the idea that China is implementing a cap-and-trade scheme in the manner that often exists in other countries, with a steadily declining cap.
We believe that a California or EU style cap-and-trade emissions trading system, or even national targets that produce real reductions in total emissions are still a prospect for the future. China’s existing sub-national or regional schemes are often described as cap-and-trade schemes, but this is at best problematic and at worst potentially misleading. We therefore go into some detail on the operations of these schemes later in this document and explain how current Chinese sub-national schemes differ in important details from cap-and-trade schemes as popularized by California and the EU ETS.
China’s choice of a policy—emissions trading—requires a robust, transparent, consistent and accurate monitoring, reporting, and verification (MRV) system for greenhouse gas emissions and their associated regulatory oversight. This is something China lacks. This weakness, when coupled with the existing patchwork implementation of emissions reduction policies at the regional level, and the leeway that is built into the national targets, means that any international comparison or even internal analysis of China’s targets must be considered to have a wide margin of error. This has been the case for many years in China, and we do not see recent developments as changing the fundamental dynamic of uncertainty in China’s level of effort to reduce emissions.
In the following sections we discuss: (i) potential evolution of China’s national emissions trading scheme from the regional schemes, (ii) emissions trading design elements, (iii) the problem of transparency, (iv) model development and assessment of impacts of announced emissions policies, (v) new and prospective policy initiatives, and finally we provide conclusions in section (vi).
(i) Evolution of a National Scheme from the Regional Schemes
China already has several existing regional or sub-national pilot emissions trading schemes that began operation in 2013 and 2014 as a part of the of the 12th Five Year plan in the cities of Beijing, Shanghai, Tianjin, Shenzhen, Chongqing and the provinces of Hubei and Guangdong. Established at the impetus of the State Council, the regional schemes are designed and implemented at the provincial level, which results in differences in their targets, coverage, and monitoring and verification plans.
There is not yet a clear indication from the Chinese government if the national scheme will replace the sub-national schemes and, if so, how these sub-national schemes might be grandfathered into the national scheme. Despite this uncertainty, it is our view that it is likely that any national emissions trading system will continue the existing pattern of development—not with a national system of uniform rules being announced in 2017—but with national targets informing the development of sub-national trading schemes that will continue to evolve through the 2017 period and beyond with some form of linkage between the sub-national schemes.
Some evidence for this view comes from the recent announcement that Zhejiang approached the Hubei Development and Reform Commission to join its market, and Gansu and Anhui announced intentions to launch a joint pilot carbon exchange in 2015. The national government will likely continue to introduce rules and guidance for specific sectors, or even cities, but with each system continuing to have different targets, rules, and monitoring protocols for each jurisdiction. We believe that this unevenness between schemes will create challenges for linkages domestically, let alone internationally.
There is also some indication that the national system might be sectoral in nature, perhaps providing unified guidelines in key industry sectors such as iron and steel, power generation, chemicals, building materials, papermaking, and nonferrous metals. In this situation it is plausible that the sub-national schemes will continue to operate and expand in concert with additional, nationally controlled schemes governing specific sectors of the economy, and that a complex system of rules and monitoring and verification protocols will link these systems together.
The subnational schemes share unifying features that set them apart from cap-and-trade systems that exist in the United States and Europe. The most striking difference is the nature of caps in Chinese regional schemes. Cap-and-trade systems typically work by setting a cap that declines in each subsequent compliance period. While China’s regional trading systems do have gross emissions limits, called caps, these emission limits are allowed to expand depending on the region’s economic growth. , As such, the caps do not cause a decline in absolute total emissions as would normally be expected. Instead the caps work more like a managed quota system that keeps gross emissions within regional energy intensity targets. Cap allocation in China is determined at the provincial level, but is informed by the regional intensity target that is, in turn, devolved from the national target. We expect this hierarchy to continue to be manifest in any national scheme.
(iii) Emissions Trading Design Elements.
There are many aspects to the development of a national emissions trading scheme, but in this section we limit the discussion to seven key elements that are important for modeling scheme prices: scheme greenhouse gases, sector coverage, compensation for emissions intensive industries, offsets, linking, managing price volatility, and caps.
The proposed national scheme appears to only covers CO2. The following Kyoto Protocol gasses are not covered: Methane (CH4), Nitrous oxide (N2O), and Sulfur hexafluoride (SF6), but HFC, including HFC-23 appear to be controlled separately. PFC’s do not appear to be covered at all, and as yet, the Chinese government has no comprehensive methane policy, though there exist numerous international cooperation projects to improve methane management.
Sector coverage appears limited to industrial and power enterprises covering industry sectors such as iron and steel, power generation, chemicals, building materials, papermaking, and nonferrous metals. Transport fuels will be covered using new fuel efficiency standards for heavy-duty vehicles and the introduction of a policy to promote improved low-carbon motorized travel reaching 30 percent of transport in big and medium-sized cities by 2030, but what is meant by ‘low carbon motorized’ travel is undefined at this stage. Further, it is not clear how transport fuels are counted in national intensity targets.
Emissions Intensive and Trade Exposed Industries
China has long protected key industries by subsidizing power prices for major emitters. Protection of key and state-owned industries will likely continue under the emissions trading scheme through the majority free allocations that have characterized the pilot schemes.
Domestic Chinese offsets (CCERS) are currently allowed in regional emissions trading schemes, with the proportion of total offsets allowable varying between 5 to 10 percent of total emissions differing depending on the scheme. It is expected that CCERS will continue to be allowed in expanded local schemes as well as in any national expansion of the rules. It is by no means obvious that international offsets will be allowed in China’s trading schemes. China is a country with a long history of protectionist policies and local content rules, and there is a considerable likelihood that this will continue to extend to its allowable offsets.
Managing price volatility
To date, there are no transparent rules available governing mechanisms for smoothing out market prices. Generally, this may be limited to rules governing banking and borrowing of allowances, but might also include price caps and collars or other mechanisms to reduce price volatility.
China’s regional trading systems do have gross emissions limits, called caps. These emission limits are allowed to expand depending on the region’s economic growth. , As such, the caps do not cause a decline in absolute total emissions as would normally be expected. Instead, the caps work more like a managed quota system that keeps gross emissions within regional energy intensity targets.
There is currently no linking between China’s emissions trading systems. It is likely that China will start to develop internal linkages as a part of the development of a national system. However, in order for this to be an effective process, it will require considerable standardization in terms of the rules between existing systems. We believe that because of transparency issues, international linkage is a prospect of the distant future.
In summary, given the current lack of scheme details, it is difficult to assess the likely price trajectory of any carbon allowances issued under the proposed national scheme, as no specific caps or emissions reduction trajectories have yet been set. As more details become available, it may be feasible in conjunction with China’s marginal abatement cost curve to develop an idea of likely carbon prices.
Transparency continues to be a major challenge for China in three areas: (i) China’s national emissions inventory, (ii) facility-level monitoring, reporting, and verification (MRV) system, and (iii) GDP based intensity targets. Further capacity development and transparency are needed in these areas before a national emissions trading scheme can be objectively assessed as reducing emissions. Until this is accomplished, any international comparison or even internal analysis of China’s actions must be couched within a wide margin of error.
National Emissions Inventory
China’s emissions inventory was last published in 2005, which is the base year used for both its 2020 and 2030 intensity targets. The 2005 emissions inventory is now a decade out of date. China committed, as part the 2009 Copenhagen accord, to creating a statistical monitoring system for greenhouse gasses and further agreed to providing a national GHG inventory every two years. This pledge has not been met. More frequent publication of reliable data is an important element of building international confidence.
Uncertainty around China’s emissions inventory has led analysts to estimate carbon dioxide emissions for the power and industrial sectors from China’s published energy use data and estimates of its constituent fuel types and their carbon content. Comparing assessments from the International Energy Agency (IEA), U.S. Energy Information Administration (EIA) and World Bank provides widely differing estimates of Chinese carbon dioxide emissions, which can vary by over a gigaton for the same year (see Table 1). Such wide variations from credible sources is concerning, but is also a useful guide to the level of the potential uncertainty in China’s underlying emissions inventory.
Table 1: Estimates of Chinese CO2 Emissions (Gt) from U.S. EIA, IEA, and the World Bank
Additionally, there are often discrepancies between regional and central government reporting of carbon dioxide. While China is taking steps to improve the institutional capacity of its Environmental Protection Agency, problems persist. A paper published in Nature earlier this year points to official estimates of national emissions that have differed from reporting at the provincial level by as much as 20 percent.
China needs a robust, transparent, consistent and accurate monitoring, reporting, and verification (MRV) system for facility-level greenhouse gas emissions and associated regulatory oversight. International confidence in China’s achievement of its stated goals will depend to a significant extent on China’s implementing such a system. There are few published independent assessments of China’s MRV capacity. This means that international observers must rely on Chinese statements, anecdotal evidence, and sparse academic literature.
Publicly available Chinese commentary on MRV, such as the World Bank’s Partnership for Market Readiness Program, provides superficial coverage without any real analytical rigor on China’s MRV capacity. A more useful perspective is gained from recent academic work by Auffhammer and Gong. This suggests that monitoring and verification protocols for different emissions trading pilots are at different stages of development, with only Shanghai at a relatively advanced stage of methodological development. MRV development has lagged behind the launch and operations of emissions trading system pilots in China. Auffhammer and Gong also highlight that most regions do not have a sufficient number of qualified verification entities or individuals. This situation should be of concern to the international community as well as China, as it calls into question the data quality of reported emissions.
China’s lack of transparency over its MRV and the sparseness of high quality independent analytical work mean that international observers must rely on anecdotal evidence. While such evidence is inconclusive, it should inform the need for a systematic, rigorous, and independent analysis of China’s MRV system. It is the experience of the report’s authors that technical capacity in monitoring and verification in China is generally weak. This evidence comes both from personal experience and engagement with the Clean Development Mechanism (CDM) community working in China. Some specific concerns center around monitoring and verification.
Monitoring plans primarily rely on a combination of estimation and physical monitoring of emissions. Appropriate estimation of emissions depends on robust methodologies and high quality data, while physical monitoring depends on appropriate, properly installed and maintained equipment. It is the experience of one of the authors working directly on facility-level monitoring in China that physical monitoring of data for MRV purposes is of inconsistent quality across facilities. China has been working to improve capacity in this area, but numerous sources indicate that calibration and maintenance of monitors continues to be problematic.,
Another area for concern is independent verification of emissions. This is a problem for all emissions trading schemes (e.g. EU ETS, CDM, and California), but we argue that this is particularly so in China. Objectively China has issues with corruption. China currently ranks 100 out of 175 countries on Transparency International’s Corruption Perception’s Index. A potential conflict of interest exists for verifiers who are appointed by local governments officials who are, in turn, judged by the central government for their progress in meeting their provincial energy intensity targets. Based on personal experience, sparse academic work on the topic, and anecdotal evidence, we believe it is reasonable to question the legitimacy, robustness, and transparency of China’s existing MRV system. This problem is further compounded by a lack of transparency in reporting emissions data on registries.
For example, in the EU-ETS all data is publically available through the European Union Transaction Log (EUTL), through which the users can access information down to the facility level. Each emissions trading scheme in China has its own registry system, however the data on facility emissions, allocated or surrendered allowances, allowance transactions, and offset usage is not publically available, making it impossible to perform an independent assessment of the functionality of the emissions trading systems.
In summary, a trustworthy MRV system underpins any emissions trading scheme. Currently the measurement, reporting and verification of facility-level carbon dioxide emissions in China lack quality, transparency, and consistency resulting in uncertainty about data quality. This situation could be addressed by a systematic, rigorous, and independent analysis of China’s MRV system and other specific actions to address gaps. This is in the interest of both the international community and China.
GDP based Intensity Targets
China needs a more realistic measure of energy intensity. The framing of China’s intensity target in terms of GDP introduces a level of subjectivity that would not exist if the intensity target were defined, for example by a genuine efficiency measure such as tons of carbon dioxide per MWh—as is used by the United States for its intensity targets under the Clean Power Plan—or tons of carbon dioxide per ton of output from heavy industrial production.
China’s GDP numbers are controversial. China’s Premier Li Keqiang told the U.S. ambassador in 2007 that their GDP numbers were ‘for reference only’, and that in order to assess the growth of the economy of his own Liaoning province he used numbers such as electricity consumption, rail cargo, and loan disbursement. The situation has not improved since Li assumed the Premiership, with independent analysts reporting that official GDP numbers may be off by as much one to four percent., Currency and exchange rates further complicate the GDP calculations and impact the assessed intensity reductions. Discrepancies in GDP and associated carbon dioxide numbers create a wide margin of error for the official targets.
In summary, China’s GDP and CO2 estimation methodologies are not transparent and the use of GDP means that China can rely on economic restructuring, rather than real improvements in energy production and efficiency to meet its goals. Instead of using GDP for the denominator of the national intensity target it would be more realistic to use a measure tied to energy generation, such as megawatt hours (MWh). Using GDP allows China to meet its target through measures that have nothing to do with energy efficiency or zero emissions energy production.
(iv) Model development and assessment of the impacts China’s Emissions Policies
To understand the potential impact of the China’s National 2030 intensity targets of 60 to 65 percent reductions on 2005 emissions, we modeled the impact of major announced policies on the business-as-usual (BAU) scenario that will reduce energy intensity, namely the increase of non-fossil fuel energy use to 20 percent of the total, and the increase of the services sector to 55 percent of GDP. We projected GDP using constant 2005 RMB and derived an energy to carbon dioxide conversion function correlating average data from the World Bank, EIA, and IEA. The model results are shown in table 2. We validated our model against China’s claimed reduction in energy intensity of 28.5 percent from the 2005 baseline in 2012 using published data.
Table 2: Real and Project Chinese GDP, Emissions, and Energy Intensity reduction from 2005 baseline
The results in Table 2 show that using the publically available data we were unable to exactly reproduce China’s claimed reduction in energy intensity of 28.5. Our model instead suggests that China achieved an emissions intensity of 27.9 percent in 2012 from 2005 levels, but this is likely within the uncertainties inherent in the model and data. The projections in table 2 are based on extrapolating existing growth rates from the business-as-usual (BAU) scenario, and then estimating the impacts of announced emissions-reduction policies that China intends to use to reach its 2030 energy intensity targets.
Our results suggest that that existing policy measures—renewable targets and development of the service sector, are enough for China to comfortably meet its 2020 targets of 44 percent reductions below the 2005 baseline. Even in the business as usual scenario, China is still on track to meet 2020 targets. Absent the boost in zero-energy generation and extending baseline trends, China would still be at 39.5 percent below 2005 energy intensity levels by 2020.
The service component of the target—55 percent by 2020—represents only a slight departure from the business as usual growth rate of services in the economy and, contrary to current commentary, our modeling suggests that the services impact on the Chinese economy is over-hyped. Certainly, rebalancing is occurring, but current policy promoting services growth as a percentage of GDP appears to be consistent with services growth built into the data and continues the existing trend. Any additional policy effects of the 55 percent target appear minimal. The growth of China’s service sector, from 41 percent of GDP to 48 percent in 2014, has created a decarbonized GDP growth, which has done a great deal to bring down China’s energy intensity. By 2014, service sector growth accounted for about 50 percent of total GDP growth.
While China can safely meet its 2020 targets, with or without additional policies, the picture for 2030 may be starkly different and depends on China’s ability to maintain high–7 percent plus–future GDP growth rates. If Chinese GDP growth declines in line with our model assumptions–GDP growth declining from 7 to closer to 3 percent in the later years of the 2020s,–the Chinese government will need to take significant additional policy measures to meet its 2030 decarbonizing targets, which may in part be achieved by realizing the goal of 20 percent non-fossil fuel energy by 2030.
The ‘20 percent by 2030’ non-fossil fuel energy use policy scenario represents about a 70 percent increase above the current growth trajectory in non-fossil fuel energy generation over the period of 2020 to 2030. This non-fossil fuel policy also covers China’s planned rollout of nuclear power. Any support that countries are able to give in this area, in terms of the nuclear fuel cycle, is likely to have a disproportionate and positive impact on reducing global emissions.
In an early measure to boost renewable energy production in the mix, the Chinese government announced—in conjunction with the 20 percent non-fossil fuel target—measures to ensure the availability of renewable energy on the grid. This is expected to boost the contribution of renewable energy in the energy mix, which continues to struggle with a decade-long problem of idle capacity. To illustrate the problem, between 20 to 30 percent of wind power and approximately 9 percent of solar were intermittently unable to access the grid in 2014 and the first half of 2015.,
China currently uses a quota system for each type of energy coming onto the grid, rather than using a least-price dispatch system. This has resulted in a significant under-utilization of wind power. The pricing impacts of reorganizing the dispatch system are unclear, but it is likely that China will continue to subsidize trade-exposed industries in rural areas to protect them from the price effects of any increases in power costs due to the non-fossil fuel power generation policy.
In a declining GDP scenario, even with achieving the goal of 20 percent non-fossil fuel energy by 2030, our model projects China’s energy intensity will still be only 46 percent below 2005 baseline by 2030, well short of the goal of 60 to 65 percent reductions. In such a situation, the Chinese government may be tempted to rely on additional structural shifts in its economy beyond increasing services, namely increasing personal consumption of durable and non-durable goods combined with decreasing use of energy intensive investment (i.e. construction) for stimulus.
Despite the fact that the Chinese government does not have official consumption targets, changing the investment/consumption ratio is an explicit goal of the 13th Five Year Plan. An indication of unofficial goals comes from the Development Research Center of the State Council, which has put forth a vision statement that includes projections of a GDP comprised of 66 percent consumption in 2030. This goal, combined with any offshoring of heavy industry from China to lower production cost countries could result in decreasing energy intensity through carbon leakage–exporting of Chinese emissions–rather than by genuine global emission reductions.
Should China be successful in raising consumption to 66 percent of GDP, it would have the potential to eliminate the need for further policy in the areas of renewable energy, energy efficiency, or carbon pricing in order to meet its 2030 goals. However, such an increase would represent a significant departure from the historical situational in which personal and total final consumption have held steady at around 36 percent and 50 percent of GDP respectively for the last decade.
(v) New and prospective policy initiative
There are a number of other potential policies that could have an effect on China’s emissions trajectory. China is evaluating the possibility of putting a hard cap on coal in the 13th Five Year Plan, starting in 2016. To date, a coal cap has not been codified in law. Unofficial planning documents suggest a possible cap of 4.2 billion tons of coal in 2020, but this values seems low as the Chinese National Bureau of Statistics (CNBS) recent upwardly revised China’s coal consumption data for 2013 to 4.2 billion metric tons. Our modeling also suggests that implementing the 4.2 billion cap is unlikely as China exceeds this level in 2015 and future years.
Some reports suggest that Chinese coal consumption is leveling off or even contracting. If this is true, then it is likely partly a sign of an economic contraction. Under such circumstances the 4.2 billion metric tons cap for 2020 may be a realistic objective. It seems more likely that Chinese coal use will continue to grow out to 2020 and any future coal cap is likely to be higher than 4.2 billions tons, unless some additional action is taken on the part of central government to constrain coal use.
China announced at COP21 new coal use intensity targets for power plants of 310 grams of coal per kWh for existing plants and 300 grams for newly built plants. For existing plants, this represents about a 2.5 percent efficiency improvement on the national average the coal fleet of 318 grams of coal per kWh. In general, China’s coal-fired power stations are relatively inefficient by global standards, making efficiency improvements and associated emissions reductions an obvious emission reduction measure.
The introduction of the intensity standard is a positive change. Until this announcement industrial and power sector efficiency measures in China were largely voluntary. Despite the positive impact of this policy, the Chinese government estimates the reduction in emissions as 180 million tons of carbon dioxide annually due to lower coal use. Using our modeled emissions, this represents a reduction of 1.5 percent on 2020 level of emissions. In its current form this policy appears unlikely to be sufficient on its own to reduce coal usage to a level where minimal economic impacts will be felt from a 2020 introduction of a 4.2 billion ton coal cap.
Examining China’s national targets and the trajectory of the economy, it is unlikely that there will be a need for significant downward pressure on emissions from a national emissions trading system before 2020, as the Chinese government is on track to meet its targets without a significant shift in current policy. However, to meet targets beyond 2020, the government will need new policy measures. Likely, the most significant policy measure for reducing emissions intensity and real emissions growth is China’s non-fossil fuel policy of 20 percent by 2030. This policy covers China’s planned rollout of nuclear power. This policy alone appears insufficient for China to meet its 2030 intensity targets, but it is likely to have a significant and positive impact on reducing global emissions.
The gap between the current policy scenario and the targets indicates the scope that might exist for reductions through carbon pricing, efficiency, or additional policies to support zero emissions technologies. A further policy option could be measures that devolve national energy-intensity targets to regional energy intensity targets, which could signal tighter emissions trading targets past 2020 and generate more activity to reduce emissions in the lead up to 2020. If the government is to take the route of reducing emissions through its carbon trading schemes, we believe that Chinese emission trading market would have to evolve significantly beyond its current state of development.
The development of a functional carbon market in China requires transparency at the sub-national and national levels. A great deal of work is required to address the problem of opacity in MRV, intensity targets, and national emissions inventories. Specific suggestions include continuing support for improved transparency and capacity of China’s MRV systems, publishing emissions data held on current registries, publishing current emissions inventories and methodologies, and using measures of energy intensity that are directly tied to reducing emissions, instead of GDP. Opacity in China’s methods of calculation and measurement of emissions and emission reductions creates considerable uncertainty in the behavior of a major emitter. Whatever governments can do to continue to clarify these numbers will have a positive impact on the security of the world’s low carbon future.
If the world continues to accept China’s use of GDP based energy intensity targets, then China might be able to meet its emissions reduction commitments largely through structural adjustments such as increases in consumption or higher than expected GDP growth. None of these measures represent real emissions reductions that affect the amount of greenhouse gases going into the atmosphere. Failure to address this issue at COP21 will further delay the actions we need to take, resulting in deeper and more expensive actions later in the century.
The world would do well, in the midst of its enthusiasm for China’s new climate leadership, not to forget that real, verifiable emission reductions matter. We lull ourselves into thinking margins of error don’t matter much for the politics of climate change, but it is nature with which we will have to reckon in the long run.
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 The exception is where coverage of emissions expands. Subsequent to expanded coverage emission caps decline. This is a characteristic of the Californian scheme, EU ETS, Australian Scheme (nowdefunct), and the proposed 2010 Waxman-Markey Scheme.
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