SHANGHAI -- When professor Chen Hongbo tried to promote carbon trading in China three years ago, he found himself under fire. As developing countries like China aren't obliged to limit the byproduct of their economic growth, opponents argued vehemently that they saw no need to motivate Chinese industries to either emit less greenhouse gases or pay for their emissions.

Today, China is still free of that obligation, but the internal dispute seems to have ended. In its proposed development plan for the next five years, the government has for the first time revealed its interest in building a domestic carbon market.

"Everybody now agrees this is a must," said Chen, an associate professor at the Chinese Academy of Social Sciences, a key government think tank in Beijing.

What silenced the dispute, according to Chen, was the recognition that carbon trading not only tightens a valve on China's greenhouse gas emissions, but also goes hand in hand with another primary concern -- energy efficiency.

To make local businesses more competitive and ensure national energy security, the Chinese government has been scrambling for ways to reduce the country's energy use. But its previous attempts -- such as simply shutting down inefficient factories -- cost jobs and couldn't be scaled up.

Carbon trading, however, may serve the mission better. In a nation where nearly 70 percent of the power supply comes from coal, a high carbon-emitting fuel, putting a price on carbon could drive businesses to use energy more wisely.

For now, China's only way to engage in carbon trading is through the United Nations' Clean Development Mechanism (CDM), a carbon emission credit system under the Kyoto Protocol. But with the clock ticking toward the expiration of the protocol in 2012, Chinese leaders appear to feel a greater urgency about building an alternative scheme at home in China.

Already, several Chinese cities are experimenting with carbon trading among local businesses, Xie Zhenhua, a deputy director from the National Development and Reform Commission, China's economic planning agency, told reporters in Beijing last November.

And looking into the next five years, "we are likely to move faster [in terms of developing domestic carbon trading]," Xie said.

This move is being watched closely by Western countries, which view it as a step forward to combat global warming, and also by other major emitters from the developing world. Aside from Europe, the United States has the most experience with emissions trading. It developed a cap-and-trade system in the 1990s that successfully reduced sulfur emissions that cause acid rain.

The greenhouse gas form of this market-based system of emissions reductions -- originally designed to appeal to businessmen and Republicans -- failed to pass the U.S. Senate last year, and Republicans demonized it as "cap and tax" in recent congressional elections.

China's use of the practice could demonstrate to other developing countries how to use carbon trading as a lever to achieve low-carbon growth, said Ashok Bhargava, a senior energy specialist from the Asian Development Bank.

Seeking another way out of a dangerous spiral
In 2010, China estimated it used 20 percent less energy for each unit of economic output than in 2005, achieving a landmark victory in its fight for energy efficiency. But that is viewed as merely one battle in a much greater war.

Simon Powell, head of sustainable research of CLSA, an Asia-focused investment group in Hong Kong, noted that China's heavy industries -- such as steel mills and cement makers -- still require more energy than their foreign peers to produce the same goods.

"So in a world where China's currency might strengthen, Beijing recognizes that some of these industries need to move to remain competitive," Powell said.

Additionally, Beijing is facing a growing threat on its energy security front. In 2009, the perennial coal exporter for the first time bought more from abroad than it sent out. And this trend continued into the first half year of 2010 at an even faster pace, according to the latest official statistics.

Improving energy efficiency, Powell said, is a key to maintaining competitiveness of Chinese businesses on the global stage and mitigating the risk of overreliance on imported fuels.

Indeed, many expect Beijing to unveil another goal for energy efficiency in March during the next annual meeting of the Congress. But what seems more urgent is finding a way to meet the upcoming goal.

To ensure the success of China's energy efficiency campaign, Beijing had urged industries to eliminate inefficient capacity during the past few years. In the last summer alone, more than 2,000 factories were shut down, which raised the question of whether such a practice could hurt social stability.

Worse yet, in order to satisfy their superiors, local officials began rushing for energy cuts by hook or by crook. One of those infamous stories came from north China's Anping town, where the local government cut off electricity supplies to factories, households and even hospitals.

As problems emerged from their previous attempts, Chinese policymakers started seeking new means to skin the cat. Then carbon emissions trading caught their eyes.

Can't depend on the CDM
Chinese policymakers and carbon trading are no strangers to each other. Policymakers first learned the economic importance of this market in 2005, when China stepped into international carbon trading through the CDM.

Overseen by the United Nations, the CDM allows companies in industrialized nations to sponsor greenhouse gas emissions-reducing projects in developing countries. As a result, the sponsor offsets emissions with a lower cost, while the host country obtains cash from implementing low-carbon technologies.

Through this system, Chinese sold nearly $1.3 billion carbon credits in 2009 alone, according to the China Beijing Environmental Exchange, a major platform that facilitates CDM transactions. And the money has helped businesses here upgrade technologies and save energy, Beijing reported happily in its 2010 annual climate change statement.

There's only one problem: China may no longer benefit from the CDM.

Carter Brandon, the World Bank's lead environmental economist in Beijing, said that if international climate change talks don't result in the renewal of the Kyoto Protocol, "the future of the CDM is very much in doubt."

"Even if the CDM continues, it isn't clear whether the buyers will want to buy credits from China," Brandon added. He pointed out that the Europeans -- dominant buyers in the CDM -- now prefer to sponsor less-developed countries rather than the world's second-largest economy, China.

His view is supported by other experts. In a 2009 report, the Copenhagen Climate Council, an international environmental group, raised doubts as to whether the proliferation of CDM projects in China has undermined the need for Chinese leaders to launch their own carbon trading scheme.

"So politically and economically, China can't depend on the CDM," Brandon said.

The Chinese carbon market is in sight
Chinese leaders appear to be aware of that problem. Last October, Beijing documented its desire to develop a domestic carbon market and high-level officials began talking about this issue openly. Meanwhile, the real question is what the Chinese carbon market would look like.

Yang Zhi, who heads the Climate Change and Low-carbon Economy Research Institute of China's Renmin University, predicted that China would cap the emissions of energy-intensive industries, as Europe has done. That is because China pledged a 40 to 45 percent cut in its emissions per unit of economic output by 2020, compared with 2005 levels. Yang said such goal could translate into the specific amounts that industries can emit.

But not everyone agrees. Other experts, like Chen, argued that even if China wants to launch a mandatory carbon trading scheme, it is far from ready.

Although several cities, such as Beijing, Shanghai and Tianjin, started testing voluntary carbon trading two years ago, the infrastructure in China is virtually nonexistent. To date, China still lacks essential legislation and third-party verifications to support domestic carbon trading.

Thus, Chinese leaders and industry players should first warm up with voluntary carbon trading, said Chen, adding that the first step is to improve the infrastructure.

That seems to match the government view. Local media cited Chinese officials as saying that the nation's first regulation on voluntary emissions trading is already drafted. And the Tianjin Climate Exchange, one of China's three major voluntary environmental exchanges, is working with Asian Development Bank to tailor a carbon trading platform.

Bhargava, who directs this project in the Asian Development Bank, said that the cooperation includes various aspects, from designing legal frameworks to developing a system for monitoring, reporting and verification of emissions data.

Despite the uncertainty over the nature of China's carbon trading scheme, Bhargava said he is optimistic regarding the development of this market.

"Whatever China decides to do, they do it very quickly," Bhargava said. "China has shown a lot of commitments, and interest now in developing domestic carbon trading. We expect something should be up and running about it very soon."

Reprinted from Climatewire with permission from Environment & Energy Publishing, LLC., 202-628-6500