Upcoming Mallesons seminarsThe scheme directly affects power generation units currently operating in Hong Kong. Fuel suppliers and future entrants to the electricity and energy market in Hong Kong and Guangdong Province should also be aware of the proposed new law.
What do you need to do?Affected power companies should carefully consider the effect and impact of the scheme on their operations. They, as well as potential participants in the PRD emissions trading scheme and potential entrants to the market, should seek specialist technical and legal advice to understand the obligations and opportunities created by the proposed scheme.
Christopher Tung (董彥華)
Partner
Kate Trumbull (沈沛琪)
Solicitor
Christopher Tung
(董彥華)
Partner
T +852 3443 1082
Beijing
John Shi
(史衛)
Sydney
Dominic Bortoluzzi
Melbourne
Louis Chiam
Facing growing pressure to address Hong Kong’s air pollution crisis and meet the emission reduction targets agreed with neighbouring Guangdong Province by 2010, the Hong Kong Government has stepped up its efforts to regulate emissions from the power sector.
The Air Pollution Control (Amendment) Bill, introduced into the Legislative Council on 22 January 2008, caps total emissions from the power sector while providing the power companies with some flexibility in achieving these caps.
It is a significant move away from Hong Kong’s traditional “command and control” approach to environmental law towards market-based instruments. Given the structure and small size of Hong Kong’s power sector, it remains to be seen whether the proposed scheme will be effective in reducing emissions in practice.
The objectives of the scheme set out in the Bill are:
- to cap emissions of sulphur dioxide (SO2), nitrogen oxides (NOx) and respirable suspended particulates (RSP) from power plants in Hong Kong by 2010, and
- to facilitate the use of emissions trading as a means to comply with these caps.
Key elements of the scheme
- A total cap will be set on emissions of SO2, NOx and RSP from power generation in Hong Kong.
- Allowances to emit these pollutants will be shared amongst the four power plants in Hong Kong. Three of these are operated by CLP Power Hong Kong Ltd (CLP), and owned by ExxonMobil Energy Limited (60%) and CLP Power ( 40%). These power plants supply the bulk of Hong Kong’s electricity. They generate power for Kowloon and the New Territories, as well as most of the outlying islands. The other power plant is operated by the Hong Kong Electric Company (HEC), and supplies electricity to Hong Kong Island and Lamma Island. The allocation will be based on each plant’s historical share of electricity generation for the territory.
- Allowances may be traded locally between power plants.
- Credits may still be created through emissions-reduction projects in accordance with the Implementation Framework of the Emissions Trading Pilot Scheme for Thermal Power Plants in the Pearl River Delta Region (Pilot Scheme), released in January 2007.
- At the end of each year, all power plants in Hong Kong will have to surrender enough allowances or credits to cover their total emissions for the year.
- Failure to surrender sufficient allowances or credits will mean that the operator is in breach of its operating licence, and therefore subject to prosecution under the Air Pollution Control Ordinance. In addition, the operator will be required to make up the deficit in the following year.
- If the failure to surrender enough allowances or credits was caused by a force majeure event, the operator will be issued additional allowances to cover the deficit at no cost.
A hybrid emissions trading scheme
Emissions trading schemes are generally of the “cap and trade” type, where the tradable units are allowances allocated by a regulator, or “baseline and credit” types, where the tradable units are credits created by reducing emissions below a business-as-usual baseline. For further description of these types of schemes, please see our publication What is emissions trading?.
The proposed scheme allows for trading in both allowances and credits.
Allowances
Allowances will be issued to individual power plants in Hong Kong on a pro-rata basis, calculated in accordance with their share of the total electricity generation for local consumption. Initially, each power plant’s share will be based on its historical generation between 1999 and 2003. The allocations will be updated at least once every three years, with reference to each power plant’s generation over the preceding five years.
This means that each power plant will receive the same number of allowances per unit of electricity generated, whether it is generated using coal or natural gas. The combustion of natural gas releases substantially less SO2 and NOx than burning coal, and almost no particulate matter. Power plants operating with natural gas are likely to have excess allowances, while those that are predominantly or entirely coal-fired may be short of allowances.
This is a significant difference from the current system of caps under the power plants’ operating licences, which are based on the expected emissions from units in operation, and so differ widely according to fuel used. For example, in 2007, the natural gas-fired Black Point power station was allowed to emit only 520 tonnes of SO2, while the predominantly coal-fired (and larger) Lamma Island station was allowed to emit 29,500 tonnes.
Allowances will be allocated to individual power plants, as opposed to power companies. This means trading may take place between plants owned by CLP, as well as between CLP and HEC. Local trades will be effected by joint written notification to the Director of Environmental Protection. Trading of allowances for an emission year (1 January to 31 December) can only take place within the first three months of the following year.
If power plant operators have excess allowances, they will be able to “bank” up to 2 percent of the initial allocated quantity of allowances for use in the following year.
Credits
Power generators subject to a cap will also be able to meet their obligations by purchasing emissions credits from a power generator in the Pearl River Delta under the Pilot Scheme. For every credit purchased under this scheme, the operator’s allocated allowances will be increased on a one-to-one basis. Credit trades will be subject to the approval of the Director of Environmental Protection.
This arrangement is similar to the European Union Emission Trading Scheme for greenhouse gases, which allows credits from the Clean Development Mechanism of the Kyoto Protocol to be converted into EU Allowances and used for compliance with emissions caps.
The risk of a credit trade failing is mitigated to some extent under the Bill. If a power plant in Hong Kong arranges to do a trade with a power plant in the PRD, but the latter fails to deliver the contracted credits despite the Buyer’s due diligence, the Hong Kong power plant will be able to purchase additional allowances, up to the amount that they had expected to receive under the trade, at a cost of HK $20,000 per tonne.
Will the scheme make a difference?
In the short term, the Bill is unlikely to have an effect on the amount of pollution emitted by power generators in Hong Kong, because:
- the scheme will not come into operation until 2010,
- the 2010 caps had already been agreed upon and disclosed to the two Hong Kong power companies in 2005, and
- emissions caps already apply to all of the power plants, and are progressively being reduced to meet the 2010 emission reduction goals.
The ability of certain power plants to meet the caps by 2010 is still uncertain, meaning that the option of purchasing allowances or credits to cover any shortfall may be welcomed. In addition, the setting out of a clear regulatory basis for emissions trading is a significant step forward from the Framework for the Pilot Scheme last year.
By addressing some of the uncertainties under that Framework, the proposed amendments may help to kick-start emissions trading in the region. It remains to be seen whether the caps have been set at a level that will create a demand for credits.
In the longer term, the scheme may help to bring about more substantial reductions in emissions of pollutants from power generation. Overseas experience shows that the opportunity for power plants to meet emissions caps in a flexible manner through trading may enable the territory-wide caps to be tightened more rapidly than would otherwise have been politically or technically feasible. The Bill also indicates that the overall emissions cap may be revised in future, although any change in the allocation of emission allowances would require advance notice of at least four years to the power companies.
Closing observations
The Bill contains some important clarifications and safeguards to the cross-border emissions trading scheme envisaged in last year’s Pilot Scheme Framework. There have been no trades to date under that scheme. This may be partly due to uncertainty about:
- how the credits would be recognised under Hong Kong’s power plant licensing scheme, and
- what would happen if a planned trade fell through at a late stage, leaving the purchaser exposed to the risk of non-compliance with its operating license.
The establishment of a clear legislative basis for the use of cross-border credits for compliance with licensing obligations in Hong Kong may help to stimulate trading.
At this stage it appears unlikely that there will be any liquidity in the market for the allowances created under the new scheme. Although the Bill treats individual power stations as separate entities, from the perspective of ownership and control rather than operating licences, there are really only two players in the market.
The scheme does not provide for any trading in greenhouse gas (GHG) emissions, as these are not subject to control under Hong Kong law. It would be difficult to extend the proposed regime to cover GHG emissions, as the Air Pollution Control Ordinance and the system of specified process licences that it establishes are designed for control of local air pollutants.
A local trading scheme for GHGs would most likely require new legislation. While this is not likely in the current political climate, and the interaction with the Clean Development Mechanism would need to be examined, control of GHG emissions from Hong Kong’s power sector and potential trading opportunities should be brought onto the policy agenda sooner rather than later.
In the meantime, a PRD power plant that participates in the pilot cross-border emissions trading scheme may be able to create GHG reductions for trade in international carbon markets through the same activities that generate SO2, NOx and RSP reductions for the pilot scheme.
Fuel switching from coal to natural gas, replacing fossil fuels with renewable energy for electricity generation, and improvements in generation efficiency are examples of projects that reduce both local pollutant and GHG emissions. These have the potential to bring in multiple revenue streams from different emission trading markets, if planned and executed carefully.
The Bill will now be debated by the Legislative Council, and will be subject to amendment before the Council votes on whether to enact it into law. No timeframe has currently been set for this process.