As China lays down plans for a national carbon trading scheme, the world's biggest emitter of greenhouse gases risks repeating mistakes made in carbon trading in Europe by flooding its pilot markets with free permits.
The European Union's scheme, the world's largest, suffered a collapse in prices hurting its credibility when the EU gave away too many permits just as the global financial crisis was slashing demand and in turn curbing pollution levels.
Fifteen traders, brokers and consultants speaking to Reuters said that most of China's pilot markets launched last year were riddled with an over-allocation of permits, bar pockets of scarcity, such as parts of the Beijing market and the electricity generation sector in Shanghai.
Shenzhen's vice mayor said in January that the city's carbon market, China's smallest, had a surplus of around 10 percent of permits in 2013, although he later said some of the surplus would be canceled.
According to a Shenzhen-based consultant, the market could see an ever bigger surplus for 2014, as eight big power stations had asked the government to give them more permits than last year. The Shenzhen government declined to comment.
If the pilots fail it would be a blow to the credibility of carbon markets as a tool to cut emissions and could cast doubts over Beijing's plans to launch a national market later in the decade, the centerpiece of China's climate change policy.
"Based on the experiences of others it will probably take some time to get the numbers, procedures and institutions right. So a little patience is necessary," said Wettestad.
Xie Zhenhua, China's top climate change official, said in Germany last month that too many free permits and unambitious emission reduction targets had made the EU market "sluggish", and vowed that China would learn from this.
Under China's pilot schemes, companies hand over permits to the government for each tonne of carbon dioxide they are expected to emit. Most are given free, but if they exceed their quota they must buy more in the market.
Permits Trade at Record Low
None of the regional governments operating pilot schemes has released data on the amount of CO2 the companies receiving permits were estimated to have emitted last year or how this compared to the number of permits handed out.
They have published approximate numbers for how many permits they gave out then, ranging from 350 million in Guangdong to around 33 million in Shenzhen.
No information has been released on how many permits have been issued for 2014 or whether they are giving out more or fewer than last year.
But local governments under pressure from Beijing to get the schemes up and running reportedly handed out too many permits to ensure industries came on board, threatening their capacity to actually rein in emissions, according to industry sources.
"They have given out many more permits than the companies need," said one trader at a firm active in several of the markets, who declined to be named due to the sensitivity of commenting on the issue in China.
But flagging potential overallocation, permit prices fell to record lows in markets such as Guangdong and Tianjin amid weak demand in the days before a recent compliance deadline.
In a matter of weeks, prices in Guangdong fell by almost a third to 41.50 yuan ($6.75) from 60 yuan, while Tianjin's price dropped from 42 yuan to 19 yuan.
And the situation could get worse with the supply of permits set to increase further from September, when China issues its first domestic offset credits. These are handed out for projects that can reduce emissions, such as building wind farms.
The northern city of Tianjin recognized it had given out too many permits for 2013 and planned to reduce the number for 2014, although a final amount has yet to be set, said an expert involved in the city's allocation process.
"Supply will be cut this year, especially for industries like iron and steel," said the expert, who asked not to be named due to a confidentiality clause in his employment contract.
He said the Tianjin government gave away too many permits last year partly to placate industry in the area.
Officials in the pilot regions have focused on ensuring that emitters have complied with their scheme's rules and data shows this has been largely met.
But a refusal to publish data on emission is threatening efforts to improve the schemes, because few trading houses or banks would be willing to join a market where fundamentals are secret.
One Beijing-based trader said that after seeking information he was told no data would be released during the pilot period.
"I asked them, then how can we forecast the price? How can we forecast the demand and supply balance? But they said it is not their concern at the moment."