New Trading Markets to Enforce Red Lines

By Feng Hu 10 February, 2015

Hu on the latest developments in water permit trading to hold the Three Red Lines & catalyze a bigger water market

“Our environment has reached or is reaching the upper limit of its carrying capacity”, said President Xi at the year-end Central Economic Work Conference on 9 December 2014. This constraint not only refers to the worrying condition of water quality, but also relates to the sub-optimum allocation of water resources and inefficient use of water in agriculture and industrial production.

“Our environment has reached or is reaching the upper limit of its carrying capacity.”

– President Xi , Central Economic Work Conference, 9 Dec 2014

The “Three Red Lines” policy in water management was set to ensure that socio-economic development does not put the environment at risk. We have seen a tightening of environmental regulations, soaring violation costs and hiking of the wastewater discharge fee. The water fees are also going up. The NDRC just issued a notice in January 2015 to increase the wastewater treatment fee at the city level to be no less than CNY0.95/tonne for residential and CNY1.40/tonne for non-residential users by 2016.

On top of these, two new market mechanisms are being put in place to manage the Red Lines:

• Wastewater Discharge Permits: to control the total amount of wastewater discharge; and
• Water Use Permits: to manage the total water use.

Water permits trading have a dual purpose: act as both carrot and stick

These have a dual purpose, acting as both carrot and stick. Companies that operate in more water-efficient and cleaner ways, will accumulate water savings within their Water Use Permits and/or Wastewater Discharge Permits, which can then be sold; other companies that want to expand their production, may fall short of permits and buy these.

Water permit trading can be used to fine-tune water allocation across industries and pollution within an industry

By allowing companies to trade these two types of permits, the government needs to strictly control the overall permitted quantity of water use and the quality of discharged water. Accordingly, a price reflecting the level of water scarcity can be formed. The government can then use permit trading to fine-tune water allocation across industries, which could limit production capacity and push for more efficient and responsible utilization of water resources. It can also be used to rein in pollution in specific industry.

Much groundwork has been done for both markets. However, since more focus has been put on water pollution, the pilot work of Wastewater Discharge Permit trading took off earlier than that of Water Use Permit trading. This is deemed as one weapon China’s ‘war on water pollution‘.

Pollute Less = Extra $$: 11 provinces to establish pollution discharge permits trading markets by 2017

Since the late 1980s, early work on establishing pollution discharge permit systems for both air and water pollutants has been carried out in some pilot cities and provinces. Such systems were also included in the Law of Water Pollution Prevention and Control (2008). For examples of how this works in the textile industry, see “Pollution: It Doesn’t Pay to be Naughty”.

Since 2007, the State Council has selected 11 provinces, aiming to establish provincial-level pilot systems and trading markets for pollution discharge permits. These 11 provinces are Jiangsu, Zhejiang, Hubei, Hunan, Henan, Hebei, Shanxi, Shaanxi, Tianjin, Chongqing and Inner Mongolia.

Pilot trading markets for Wastewater Discharge Permits to be established in 11 provinces by 2017
Issued permits will be audited every 5 years

In August 2014, the State Council issued the “Guidelines on Further Promoting Paid Use and Trading of Pollution Discharge Permits in Pilot Areas” and set the target of establishing trading markets for pollution discharge permits (including Wastewater Discharge Permits) in these 11 provinces by 2017. According to the guidelines, the government will audit all the pollution discharge permits of existing polluting factories in these pilot provinces by 2015. Such auditing will be carried out every five years in the future. This could ensure that all the parameters of the Wastewater Discharge Permits are reasonably set based on the actual situation of the factory and regularly checked by the authority.

A first-ever national regulation is in place to manage the issuance of Wastewater Discharge Permits since 1 Jan 2015

In December 2014, to facilitate the 2017 goal, the MEP issued the “Interim Measures on Managing Pollution Discharge Permits”. It is the first national regulation for managing the issuance of such permits. Accordingly, the issued Wastewater Discharge Permit will include standardized information including type of pollutants, allowed concentration and total amount of pollutants, discharge methods, discharge timeframe, GPS location and the number of discharge points. This has been in effect since 1 January 2015.

These moves in 2014 towards transparency and regulation of the permits are necessary steps towards forming a national pollution discharge permits trading market.

Innovations in Zhejiang’s RMB2.5 billion pollution discharge permit trading market

Among the 11 pilot provinces, Zhejiang is taking the lead. The province’s Emission Trading Center was set up in February 2009. Over the last five years, the combined value of pollution discharge permit fees collected by the government and the market value of the pollution discharge permits traded in Zhejiang was RMB2.5 billion. This accounts for around two thirds of the national total of RMB4 billion.

China: RMB4 bn in permit fees & trading

Many of these trades across provinces were executed through various emission trading centers set up by the provincial governments, but new innovative ways of setting the market price and use of permits have also surfaced:

1. Online-auction of surplus wastewater discharge on Taobao

In early December 2014, a textile factory in Shaoxing sold its surplus wastewater discharge of 575 tonnes/day through three biddings on Taobao’s online auction site for a total RMB16.23 million. The whole process was overseen by the local court (see snapshot of one bidding on Taobao in the figure below).

2. Wastewater discharge permits pledged as loan security

Companies are also using their permits as pledge for borrowing money. During January to November 2014, 124 factories in Shaoxin city obtained a RMB2.39 billion bank loan by pledging their Wastewater Discharge Permits.

Wastewater Discharge Permits trading helps SMEs finance clean-up

Once the market has been established, Wastewater Discharge Permits will have a tangible market value. The trading of such permits could also help some SMEs, especially in textile industry, to recover part of the margin-swallowing cost of wastewater treatment.

Water Use Permit Trading lags and is still mainly government-led

The MWR only selected 7 pilot provinces in July 2014, aiming to establish provincial trading markets of Water Use Permits. These are Ningxia, Jiangxi, Hubei, Henan, Gansu, Guangdong and Inner Mongolia. Water Use Permit can be traded between different regions, different watersheds, upstream and downstream of rivers, different sectors or different individual water users. Each Water Use Permit, which clearly defines the amount of water assigned to the user, will be registered in a system. This could help to manage total water use provincially and nationally (read more on Water Use Permit here).

7 pilots were selected to develop trading markets for Water Use Permit in 2014

The first trade happened between two cities in Zhejiang in 2001, Yiwu and Dongyang. Yiwu city, located downstream, paid RMB2 billion for Water Use Permit of 50 million m³ of water per annum from a reservoir in Dongyang city. In addition, the two cities also shared the infrastructure and management costs for the transfer of water.

Water Use Permit helps to hold ‘Red Lines’ and ensure energy security & food security

Some other local initiatives were also carried out: Prof. Jia Shaofeng from the Chinese Academy of Science shares the example of Water Use Permit trading between agriculture and industrial water users in Ningxia and Inner Mongolia. It addresses water allocations in energy bases along the Yellow River: not only to enforce the ‘Red Lines’, but also to ensure energy security and food security.

However, these trades are still mainly government-led. The current Water Use Permit needs reform before it can be traded like the Wastewater Discharge Permit.

State Council’s dual goals: hold Red Lines & catalyze a bigger water market

Currently these two types of water permits are managed by two different ministries: Water Use Permit by MWR, and Wastewater Discharge Permit by MEP. Ideally, we should have one fully integrated water permit to regulate both water quality and water quantity. However, dispersed authority of water resources management between MWR and MEP makes such integration difficult at the moment. That said, the State Council has been pushing for development of trading markets for these two types of water permits over the last year.

Dispersed ministerial authorities hinder integrated water management
….but State Council has been pushing for permit trading to hold Red Lines & catalyze a bigger water market

In November 2014, the State Council issued the Guidance on Encouraging Social Investment with Investment and Financing Mechanism in Key Sectors to encourage water permit trading. It hopes to attract more private investment in water pollution control, water saving measures and water supply infrastructure.

With the upcoming Water Pollution Prevention and  Control Action Plan, the Year of the Goat will be an important year. We expect to see more innovative ways in the Wastewater Discharge Permit trading and also some progress in the Water Use Permit trading. Moreover, these two types of trading will possibly catalyze a bigger water market. Watch this space in 2015!

Further Reading

• China Water Risk’s 5 Trends for 2015 – As China moves to re-balance its economy and environment, Beijing will shepherd the nation towards water, food & energy security. For the Year of the Goat, it is better to be the surefooted goat than the sacrificial lamb so check out our top 5 trends in water for 2015
• 8 Game-Changing Policy Paths – There has been a fundamental shift in planning China’s future growth with changes in regulatory landscape due to multiple polices set & changes in law. Many come into full effect in 2015. Get on top of these policy shifts
• Risks Shifting Beyond the Wall – In China’s printing & dyeing sector centralised wastewater treatment brings centralised pollution, Ma Yingying of the Institute of Environment & Public Affairs tells China Water Risk. Lax supervision & vague responsibilities between factories & treatment facilities leave brands exposed

Water permits

• Water Permits: How to Get Water in China – How are water total water quotas set? How can you access water in China? China Water Risk gives an overview on these and the risks associated when China’s water permit system is reformed
• Reforming Water Permits in China – European and Chinese water policy experts Martin Griffiths & Chen Dongsheng gives an overview of their collaborative study on water permits systems as part of the China Europe Water Platform. What challenges lie ahead? What improvements are needed?
• Water Rights in China –  Professor Jia Shaofeng, Deputy Director of the Center for Water Resources Research of CAS,  shares his in-depth insights on water rights in China – what they are, who owns them, how can they be “traded” & why a market trading system should be the way forward

Water management/conservation

• China’s Hidden Water Flows – Prof Hubacek & Dr. Feng contributing authors of ”Virtual Scarce Water in China” share key findings. Find out why developed but water-scarce regions like Beijing, Tianjin and Shanghai are contributing to the country’s water depletion
• Watershed Services in China – China has embarked on an ambitious market based programme for watershed conservation. Dr Sun, the former Director at the Chinese Academy of Social Sciences explains