By David Stanway
BEIJING (Reuters) - China launched its first pilot carbon emissions exchange on Tuesday, though plans for a nationwide rollout and efforts to apply the scheme to some polluting heavy industries could be undermined by a slowdown in the world's No.2 economy.
High-emission industries such as aluminum and steel are likely to resist higher costs as they are already battling weak prices due to tepid demand and a persistent supply gut.
"It is a very big concern for Beijing and for local governments - how to strike a balance between controlling emissions and maintaining economic growth especially amid a general slowdown in the economy," said Shawn He, lawyer and carbon specialist at the Hualian legal practice in Beijing.
While the exchange in the southern city of Shenzhen will not immediately lead to a big cut in China's emissions of climate-changing greenhouse gas, now the world's highest, it does still represent a statement of intent by Beijing, campaigners said.
"This is just a baby step when you look at the total quantity of emissions, but it enables China to establish institutions for carbon controls for the first time," said Li Yan, head of environmental group Greenpeace's climate and energy campaign in China.
State oil giant PetroChina and private power generator Hanergy conducted the first two trades on the Shenzhen exchange, buying CO2 permits for 28 yuan ($4.57) and 30 Yuan per metric ton respectively, Thomson Reuters Point Carbon reported.
That is around three quarters prices on Europe's Emissions Trading Scheme (ETS). Front-year EU Allowance futures, trading on ICE Futures Europe, ended Monday down 4.8 percent at 4.54 euros ($6.06).
Under a cap-and-trade scheme, companies must buy allowances from others if they want to exceed carbon limits. But there is still a long way to go in China, and the design of its pilot platforms - as well as the national scheme that would eventually replace them - face economic and social pressures.
"Of course, decision makers have to look at the social impact - the carbon market cannot be designed in an idealistic way and you have to make sure the design of the mechanism will address such issues as social stability," said Wu Changhua, China director with the London-based Climate Group consultancy.
And the example of carbon markets overseas is not encouraging, with the global financial crisis saddling the ETS in Europe with a crushing oversupply of carbon credits and record low prices.
The Shenzhen exchange is one of seven pilot schemes due to be launched this year or next, and will involve 635 local industrial enterprises accounting for more than a quarter of local GDP and more than 30 million metric tons (33.07 million tons) of CO2 emissions. But that is still a drop in the ocean compared to the country's total emissions of around 8 billion metric tons last year
Other platforms due to start in 2013 include one in the business hub of Shanghai, where leading steel mill Baoshan Iron and Steel will participate, and Hubei province, home of Wuhan Iron and Steel.
While giant oil firms like PetroChina and CNOOC are taking part in the Shenzhen scheme, few of the companies involved will be from bloated but carbon-intensive heavy industrial sectors such as steel or aluminum, and figuring out how to include them is likely to be a bigger challenge.
Late last year, China's industry ministry told firms in sectors like steel to reduce their 2010 carbon intensity rates - the volume of CO2 produced per unit of output - by 18 percent by 2015. That was a massive burden for a sector already bruised by rising input costs and minimal returns, with the country's economy growing at its slowest pace for 13 years in 2012 and data so far this year surprising on the downside.
But while it will add to the costs of struggling firms, it could also give Beijing another tool to bring wayward industries in line with state policies and force polluting firms to close.
Carbon trade will give local governments an alternative source of revenue as well as an incentive to free up some of their CO2 allocations by closing small steel mills.
Jiang Feitao, a researcher at the China Academy of Social Sciences who has studied the impact of environmental policy on the steel sector, said smaller companies would be hit hardest by costs.
After Shenzhen, Shanghai and Hubei, four more pilot exchanges are due to open in the capital Beijing, the sprawling industrial municipalities of Tianjin and Chongqing, and the manufacturing center of Guangdong province on the southeast coast, probably next year.
The National Development and Reform Commission said the seven pilot schemes will begin a process of integration in 2015 and that a nationwide platform will go into operation some time before 2020. But the seven regions were given considerable leeway to design their own schemes and it remains unclear how they will connect together.
"My guess at this moment is that they will set up a national platform and gradually integrate the seven pilot schemes into that one, but we don't know the architecture yet - this is very new," said Climate Group's Wu.
He, the lawyer, said China still needed legislation to give legal recognition to the concept of carbon trading. It also needed to solve the longstanding problem of measuring emissions.
"I don't think it is possible to get to a national market by 2015 - there are many technical issues to be addressed to integrate these islands into one continent," He said.
China also eventually needs to set a national limit on emissions and allocate this to individual industries and provinces to establish a full countrywide trading scheme.
"Realistically, we are looking at 2025 before we have a cap - a few years ago some were saying 2040 or 2035 so we have already made progress," said Wu.
"Growth will continue to be the No.1 priority. Cap-and-trade will be one of the ways of trying to grow differently, but China is still a developing country and we have to grow."
(Editing by Joseph Radford)