David Hone

This week I managed to stay a bit closer to home and met up for lunch with Dr. Myles Allen of the Department of Physics (Atmospheric, Oceanic and Planetary Physics) at the University of Oxford.

Although we have probably all understood the bit about the “area under the curve” when it comes to CO2 emissions, Myles and his team have brought a whole new dimension to the issue with a recent article in Nature. The core of the arguement is that simply emitting carbon dioxide slower will not address the  issue of climate change unless it involves phasing out carbon dioxide emissions altogether, before we reach an upper limit of one trillion tonnes of carbon.

According to Myles the risk of exceeding the EU stated target of 2 degrees Celcius is primarily determined by the accumulation of carbon dioxide emissions over time, not by short-term emission rates. He has shown that total cumulative emissions of one trillion tonnes of carbon (1 Tt C, or 3,670 billion tonnes of carbon dioxide) over the entire ‘anthropocene’ period 1750-2500 causes a most likely peak warming of 2 degrees Celsius above pre-industrial temperatures. Of this budget, emissions to 2009 have already consumed approximately half (0.5 Tt C).

You can track the “progress” (hardly seems the right word for this) of global carbon emissions on his website. As of today 532 billion tonnes of the trillion tonne budget have been consumed. Extrapolating emission rates forward leads to the forecast that the trillionth tonne will be emitted sometime in the late first quarter of 2045 (although the website shows this moving forward all the time). All this means we have 468 billion tonnes left – which might sound alot, but carve that up amongst 200 countries with populations ranging form 1.4 billion down to a few thousand and it presents quite a problem.

The EU and the USA are already in the process of carving their bit out. Have a look in Waxman-Markey and add up the number of allowances to be issued into the US economy between 2012 and 2100 (from 2050 onwards one billion tonnes of CO2 per annum are allowed) and it comes to 50 billion tonnes of carbon (which doesn’t even account for the whole economy, but most of it). This represents nearly 11% of the total remaining carbon emissions for some 5% of the global population.

Whilst this is a huge reduction from current US emissions (which, according to the IEA, account for some 20% of global energy related CO2 emissions), it of course raises the difficult question of equity. Add to this the fact that US and EU economies will be able to emit more as they purchase offsets from other countries. This in turn raises the issue as to the nature of offsets. In order to keep this system whole all offsets should really only be sequestration based – i.e. a tonne stored away for every tonne emitted. That means forestry and carbon capture and storage and that’s all, although GHG destruction should probably also qualify. By 2050 of course we may also be talking about a tonne removed from the atmosphere, but that will still have to be sequestered somewhere as well. There is a certain irony here in that neither forestry nor CCS qualify as offsets under the EU-ETS today – in the case of forestry it is because the EU doesn’t want to allow it and in the case of CCS because the international community won’t allow it to qualify under the CDM.

Another aspect to all of this is that very long tails of low emissions can’t be allowed. Waxman-Markey does an excellent job of driving down US emissions to very low levels by 2050, but then has a billion tonnes of CO2 remaining indefinately, i.e. a very long tail. Over time that continues to accumulate which just adds to the problem. As I have noted in a previous posting, the last 20% is indeed problematic, but under a trillion tonne scenario it cannot be. As it will be extraordinarily difficult for an economy to get to zero emissions, the solution will doubtless be net zero emissions, which could mean sequestering a tonne of CO2 from the atmosphere for every tonne emitted, either by direct removal or by gasification of biomass to produce electricity with the resultant CO2 being stored.

This will indeed be a brave new world.

After a short telephone interview yesterday, I was quoted in the Guardian newspaper today, but unfortunately completely out of context. Based on the interview, The Guardian chose to position Shell as opposing action in Copenhagen, which couldn’t be further from the truth. In fact the conversation was about the application of a floor price for the EU-ETS.  You may be interested in my reply which I hope will be published on Monday.

Dear Sir,

In today’s article “Shell opposes moves to reform carbon trading”, you chose to open with the assertion that Royal Dutch Shell is opposing moves to overhaul Europe’s carbon trading scheme at the crucial climate change summit in Copenhagen in December. This statement is incorrect on several counts;

1. Copenhagen is not and will not be a forum for discussion on the detail of the EU Emissions Trading System (EU-ETS). Copenhagen is a United Nations Framework Convention on Climate Change (UNFCCC) meeting where we, along with many others, hope that our political leaders can agree a broad, workable framework within which nations and regions can seriously address the issue of climate change. The EU-ETS is one element of the domestic policy arrangements that the EU have put in place to meet their proposed goal of a 20% reduction in emissions by 2020, in comparison with 1990. Its structure and design is a domestic discussion, not a discussion for UNFCCC meetings, although elements of how it may link to other domestic approaches (such as that being developed in the USA) could possibly be discussed at the UNFCCC.
2. Shell, initially as almost a lone voice but now with others, has supported the EU emissions trading approach since the first draft Directive was circulated for consultation in 2001. In 2008, when the EU-ETS was overhauled as the EU Commission crafted Phase III of this legislation (to run from 2013-2020), Shell maintained its strong support for the development of the system. Whilst we have not agreed with every part of every article within the Directive, we have maintained the view that industry should engage in a constructive dialogue with the EU Commission on this legislation.
3. There are no moves to overhaul the EU-ETS as this has just been completed. The legislation was passed by the EU Parliament in December 2008 and was published in the Official Journal of the EU Parliament only four months ago.

However, the quote that you did include from me was correct. Shell does not support a floor price within the EU-ETS. This is a market based system and the market needs to be left to find the price that is required to deliver the necessary reductions to meet the clear environmental objective of the system. Today, as a result of the financial crisis and a consequent reduction in emissions across the EU due to lower industrial activity, the market is telling us that it can meet the 2020 20% reduction objective at a price of around EUR 15. We should respect this and allow the market to do its job. The lower price is coming at a time when EU consumers are tightening their belts so they may welcome this reduction in price, which feeds primarily into their cost of electricity.

 We also note that there is no specific mechanism within the design of the EU-ETS to set a floor price. However, EU governments do auction allowances into the system so they could choose to set a reserve price at those auctions. But the majority of allowances are still provided free of charge to EU emitters and that practice will continue for three more years. By then, we may be seeing quite a different set of market conditions and even a different overall 2020 target, as the EU has a provision to shift this to 30% should it be a signatory to a new international agreement.

 Yours sincerely,

David Hone

Senior Climate Change Adviser

Shell International

One of the less discussed and least used features of the Kyoto Protocol is the tradability of the Assigned Amount Unit or AAU. This is the instrument that national governments use for compliance and it functions in pretty much the same way as allowances do in a cap-and-trade system. If a Kyoto signatory country emitted 500 million tonnes CO2e in 1990 and agreed to a 10% reduction, then the UNFCCC would grant that country 5*(500-50)=2250 million AAUs for the period 2008-2012. The country can of course emit whatever it wants, so long as it can surrender sufficient AAUs or related units such as CERs from the CDM. The AAU is backed by a certain set of definitions that establish the measurement and reporting protocols for the emissions they represent.

One option open to a country is to buy from or sell AAUs to another country, depending on its overall position, i.e. in surplus or deficit. But the AAU can also transfer through other means. The EU-ETS is underpinned by the AAU, such that if an EU allowance was bought by a participant in a linked ETS, say the upcoming Australian system, then an AAU would quietly make its way from the EU account to the Australian one on the International Transaction Log (ITL) to keep everyone whole at the international level. Of course there is only one AAU backed ETS today and nobody is linked to it, so none of this has actually happened yet, but the principal is important to the long term goal of building a global carbon market.

I am in Bangkok this week at another round of UNFCCC talks in the lead-up to Copenhagen and one issue that has suddenly leapt out of the dark is the often ignored AAU. The US delegation has made the point that as they are not a signatory to the Kyoto Protocol and don’t intend to be, the AAU will not feature in the US view of a future agreement. By contrast, the Kyoto signatories whose (future) emissions trading systems are built around the AAU see this as the undermining of their hopes for a growing market. Other nations simply saw it as a brazen US attempt to tear up the Kyoto Protocol and said so in no uncertain terms – so the negotiations go on!

Despite this, the US delegation made it clear that they see linking to the EU-ETS (and others) as an important goal for the future. I for one can’t see this happening whilst the AAU is still part of the system, or at least part of some of the system. The problem is that there are a finite number of AAUs that represent the cap on those countries with targets on the basis of a certain measurement protocol. Typically, a national emissions trading system (cap-and-trade) is a cascade down into the economy of the AAU, but with a name change and revised legal definition on the way such that trading rules can be crafted for particular national circumstances. Nevertheless, there remains a one-to-one alignment between the two. When two trading systems are linked the AAUs move back and forth as described above. But if a US system were to link, trade between the two would be very limited. Certainly EU allowances could flow to the USA as this would be the same as retiring AAUs from that part of the system and just lowering the defined cap. But US allowances couldn’t flow back as this would bring unknown allowances into the system, raising the cap by the same amount. The exception would be if the US registry had a bank of AAUs from previous trades from the EU or if both recognised the same project mechanism and the US had a bank of these instead – but once the bank ran out that would be it, no more trade.

There are probably constructions around this, such as special recognition of US allowances (given that their cap is known and presumably agreed), but perversely the US is then effectively recognising AAUs within its system, which it didn’t want to do at the outset. The systems would also have to adopt the same definitions throughout, such that allowance arbitrage did not take place, which means that any change in the US system (and vice versa) at any point in time would have to be internationally ratified, which isn’t that different to recognising AAUs in the first place. The sensible thing to do is to back all the national targets with a single underpinning currency but this looks impossible from the discourse in Bangkok – for the US it would mean recognising some aspect of the Kyoto Protocol, which it just can’t do or for the Kyoto countries it would mean dismantling the Protocol, which is a non-starter for most participants.

A further casualty of an AAU free agreement could be a cap-and-trade approach for sectors such as shipping and aviation. The approaches described in my previous posting both rely on a carbon currency exisiting in the international agreement. The units are used as the basic building block of the shipping approach.

So, is the notion of a future global carbon market under threat? Perhaps not, but it will be quite a bit more difficult getting there given the current sentiment. The irony of the situation is that apparently some time back in 1997 it was the US delegation that invented the AAU in the first place!!!

Late last week a significant development came from an equally significant slice of the global shipping community – support for action to reduce CO2 emissions from international shipping in the form of a global cap-and-trade system. International marine and aviation bunkers were excluded from the Kyoto Protocol, but if there is one thing I can be sure of seeing from Copenhagen is that this exclusion will no longer be the case. Shipping emissions will almost certainly be included and the shipping community will either grasp the opportunity to shape its future in terms of policy or it will have its future shaped for it by national governments and the UNFCCC.

The announcement comes in the form of a discussion document released by the British, Australian, Belgian, Norwegian and Swedish ship owners associations. The document clearly outlines the issue and challenges, spells out the advantages of a trading approach and then outlines two different constructions for a possible system. At this stage the document doesn’t discuss the scale of reductions, but I don’t think that is important right at this moment. Rather, the industry is taking a major step into the policy arena with a view to charting its own course foward (pun intended, sorry).

What really differentiates the two models in the document is the flow of money. In the “sectoral” approach, the industry pretty much creates its own allowances (although they originally come from the UNFCCC in the form of AAUs), auctions them, manages the revenue from the auctions and establishes registries and compliance mechanisms. Revenue management is not discussed in great detail, but it is clear that some portion is directed towards technology development. By contrast, the “distibuted” approach sees national governments being issued additonal AAUs to cover international marine bunkers (but only those governments with national targets also underpinned by AAUs)  and the shipping market buying either CERs from developing country projects or AAUs from government auctions. The industry maintains its important role in the compliance process but has little control over the money flow. That rests largely with governments.

The flow of money is bound to be a divisive issue, with many shippers, as with big emitters in land based systems, arguing that they should be in control of the auction revenue raised. It is difficult not to be sympathetic with this, but the reality of our world is that governments control the money flow, not sectors or industry associations or even banks. This is almost certainly a subject for further postings.

I will certainly write more about shipping in the weeks ahead, but in the meantime I would recommend reading this document. The shipping community that put it together deserves a round of applause for taking on a difficult subject at a pivotal moment for the industry.

A tectonic shift may be underway in Japan, but not of the sort normally associated with this country and its frequent earth tremors. Rather, a new era in climate politics may dawn as a result of the recent win by the DPJ in the national elections. This is because within the manifesto pledges of the DPJ sit two key policy choices, now (Monday September 7^th) formally announced by incoming Prime Minister Yukio Hatoyama;

1. A commitment to reduce national emissions by 25% by 2020, relative to 1990 – this compares with the proposal by the LDP of an 8% reduction, one which was heavily criticised internationally as being insufficient support for the developed country contribution to an agreement in Copenhagen.
2. A commitment to implement a cap-and-trade system within the Japanese economy. Although the previous government had talked about this policy instrument, little progress was made in implementing it given the negative position that some business groups took towards it.

Whilst much domestic “nemawashi” is still to take place, this shift could be critical for the success of an agreement in Copenhagen.

But Japan already finds itself an international leader in energy management, given the energy legacy inherited from the previous administration. However, the CO₂ story in Japan, whilst positive, has not delivered an overall drop in emissions. Whilst energy diversity and efficiency have been key policy objectives for many years now, absolute CO₂ emissions have risen by nearly 15% from 1990 (to 2006, IEA). At the same time emissions in the EU-27 have fallen, but only slightly. Over the same time period CO₂ emissions in the USA have risen by just over 19%. 

A big difference lies in the power sector, with Japanese power emissions staying at around 430 gms CO₂ per kWh over a 20 year period, but EU power emissions falling from over 430 gms per kWh to some 350 gms per kWh in the same period. This is due to the continuing rise of nuclear power in the EU, the influx of natural gas and the more recent aggressive build of renewables in countries such as Germany and Denmark.  By contrast, Japan has seen emissions from coal grow by 45% over the same period, much of that in the power sector.

With a transport sector already one of the most CO₂ efficient in the world and an efficient manufacturing base, the power sector will become a particular area of focus.  But efficiency alone is not going to deliver the necessary change, so fuel switching (i.e. more natural gas), renewables and international offsets will all play important roles.

The last item above will be critical to the strategy. But to be truly effective, the tougher target must be backed by an emissions trading system, which is also a preferred policy position of the DPJ. A Japanese emissions trading system, with very open access to international markets will allow the domestic target to be met but importantly will direct significant funding to developing countries.

Some quick numbers – let’s assume domestic emissions in 2013 are down to 1100 MT (with the Kyoto target met through CER and AAU purchases) and that the country can reduce this to 1000 MT by 2020 (i.e. a ~20% reduction from 2006 to 2020). Therefore, meeting a 2020 target of 810 MT CO₂ (i.e. 25% lower than 1990) could mean the purchase of over 800 million tonnes of international credits from projects between 2013 and 2020.

Between Japan, the USA, the EU, Canada, Australia and New Zealand, six cap-and-trade systems could be buyers of some 10 billion tonnes of international reductions in the period 2013-2020, giving rise to not only a very large and liquid global carbon market but also an ability to fund very significant step changes in developing country emissions. In tandem, new avenues of supply would have to be rapidly developed, including a mechanism that supports some kind of sectoral crediting, although this will likely be more successful as an outgrowth of the CDM through the creative use of methodologies rather than an entirely new approach.

The announcements by the new government in Japan, if put into practice over the next three years, could have very far-reaching effects. Rather than facing the prospect of a lone EU-ETS struggling to hold the fort for this powerful market instrument, we instead head rapidly into the brave new world of a global carbon market.

Last week saw the launch of a new initiative in the United States, “Energy Citizens”, which aims to create a significant lobby against the passage of climate change legislation in the USA and most specifically the recent House bill, the American Clean Energy and Security Act of 2009, or “Waxman-Markey” as it is more widely known. “Energy Citizens” kicked off with a well attended rally in Houston last Tuesday, has its own website and is strongly supported by an organisation that Shell US belongs to, the American Petroleum Institute. More rallies, events and advocacy initiatives are planned.

Whilst I am not an American, nor do I have any issue with the democratic process in the USA, what is at stake in this debate goes far beyond American shores and will have a profound impact on the global response to climate change for at least a decade and possibly a great deal longer. So, as an employee of the energy sector for nearly 30 years this “world Energy Citizen” also wants a word.

The clutch of EU Directives that were passed last year (ETS Phase III, CCS, Renewables) or are in the pipeline (Buildings) pretty much resemble the totality of what is proposed under Waxman-Markey. The two sides of the Atlantic are learning from each other as they move forward with ambitious plans to address energy use and begin the tough task of managing greenhouse gas (GHG) emissions. A key element in both programmes is a GHG cap-and-trade system (a mechanism originally developed and successfully deployed in the USA to reduce sulphur emissions).

Cap-and-trade legislation is now under development or in place in many parts of the developed world (including of course the USA on both counts) and if implemented could cover nearly a third of global fossil fuel CO2 emissions by 2013. In the EU it has been in place since 2005 and although it took a while to establish itself has given rise to a robust and growing carbon market with stakes in many countries through linked projects. It is working, it is beginning to drive change, it is creating new businesses and business models and there is no sign that the EU economy is suffering as a result. New wind projects are appearing across the continent, nuclear power is being given a new life, biofuel investment is rising and there is a major push to bring new technologies such as carbon dioxide capture and storage into the energy mix. A wide range of new financial and service organisations are also being created, including verifiers, (offset) project developers, CO2 consultancies and market participants.

It is also true that electricity prices across much of the EU have risen as a result of the EU-ETS – in the UK this is about 1 pence per kWh (or one and a half US cents) – but equally this is helping drive the new investment that is now taking place. This and the overall hike in electricity cost as a result of generally higher energy prices are also making families more conscious of the need for energy efficiency measures which in turn has led to a wide range of consumer initiatives in response, some developed by government but many created by business to meet that new demand.

I agree that Waxman-Markey is still some way from the right solution, but equally it is not headed in the wrong direction either. For example, it still needs to find a better balance between free allocation and auctioning in the face of international competition, but so too did the EU-ETS as Phase III was thrashed out by the European Parliament last year. There were times last year when stakeholders looked at what was on the table and thought “You must be joking!!”, but reason prevailed in the end and the necessary deals were struck – industry accepted the provisions for trade exposure, the power generators are facing up to the reality of auctioning and individual member states walked away from Brussels happy with the deal they had secured in terms of national burden and state aid provisions. Importantly, the cap-and-trade approach has been shown to be flexible enough to accomodate all of this without underminig the overall environmental goal being sought.

But is the “Energy Citizens” oganisation helping the rally attendees and signatories learn about this or recognise the importance of developed countries taking the lead on emissions mitigation?? Probably not – which of course is the unfortunate side of all this.

There have been similar concerns about jobs and  energy prices in the EU, but this is a two way street – and that is now being recognised. Whilst there will be some shift in energy prices, the resultant investment in efficiency and new energy infrastructure will have a positive benefit for consumers and in the longer term the new industries that are created should offset any job changes that may occur in existing sectors.

What is really required now is positive and proactive bipartisan engagement by industry and others in the development of this relatively new instrument.

In the early days of the development of the EU Emissions Trading System (EU-ETS) a number of industry groups, particularly in the energy intensive sector (e.g. cement, metals) put forward an alternative design known as “baseline-and-credit”. This was widely discussed and strongly advocated by some, but never gained traction with the EU Commission and was ultimately rejected as a viable way forward.

Baseline-and-credit is fundamentally different to cap-and-trade, in that no cap exists within the system. Rather, individual facilities are assigned a benchmark CO2 per unit of production (or it could be against some other specific production related metric) and must either buy credits in the market if the facility is short for the compliance period or are awarded credits by the government if the facility exceeds the benchmark. Offset project credits may also form part of the mix as they often do in traditional cap-and-trade approaches.

Since then, baseline-and-credit has been applied in a limited way in Alberta, Canada and did actually run for a few years in the United Kingdom in some sectors. Otherwise, the focus has been on cap-and-trade. But baseline-and-credit keeps rearing its head and has done so again in Australia very recently as the debate over the CPRS (Carbon Pollution Reduction Scheme) continues.

This then raises the question, yet again, as to whether such an approach can be the basis of a workable emissions trading system. Whilst baseline-and-credit seems to have all the components necessary for a viable market, (i.e. a tradable unit, supply, demand), the reality of trying to build such a system is very different. A number of obstacles present themselves:

• Of primary importance is that there is no overall cap on emissions. This is what really drives demand and creates the necessary scarcity to see a price develop. Whilst individual facilities may have a benchmark target, actual emissions from the system remain unknown until the level of production is known. If production is high, total emissions from the covered sector may even rise, even though the intention of the government is to drive emissions down. This means that delivering a specific environmental outcome cannot be guaranteed.
• A linked issue to the lack of a cap is that the government probably has one, perhaps in the form of a pledged reduction target for the nation as a whole. If production is high and emissions rise, the government will be forced to rachet down the benchmark, creating uncertainty for the scheme participants. Alternatively, the performance risk for the nation as a whole could rest with the government, which might then have to step in and buy international allowances to meet a cap such as that pledged under the Kyoto Protocol.
• The approach is built on the assumption that benchmarks are available and easy to establish. Whilst this may be true for some sectors, it is far from true for others. Chemicals is a good example, where one site may be comprised of many different processes and as such unlike any other single chemicals site. A related issue comes from attempting to find equality between sectors – i.e. how do I know that my benchmark for the cement sector is equivalent in difficulty to achieve as my benchmark for the steel sector?
• The world is progressing towards absolute numbers and developed countries are taking the lead in this respect. This means that national obligations must all eventually be in the form of absolute numbers and developed countries today are now targeting between 15 and 20% reductions in absolute emissions by 2020 from 2005. As discussed above, governments would rather not have to manage compliance, so they will cascade the obligation down into the economy as much as possible. This means that many nations will use cap-and-trade and will seek to link these with other cap-and-trade systems to increase flexibility and lower overall compliance costs. But a baseline-and-credit system cannot fully link with a cap-and-trade system given that one has an overall cap and the other doesn’t. The UK tried to link two such systems some years back and had to implement a complex gateway. Whilst the baseline-and-credit system can always buy from the cap-and-trade system, the reverse is not the case. A supply of credits from a baseline-and-credit system that has overall emissions rising due to increased production may undermine the environmental objective of the cap-and-trade system it is linked to (hence the UK gateway).
• A cap-and-trade system works its way progressively along the abatement curve, always implementing the next best reduction opportunity. This may be an efficiency measure, a CCS project or possibly a reduction in demand for a given product as a cheaper alternative (lower carbon footprint) is found. By contrast, the baseline-and-credit system may distort this progression along the abatement curve, driving up the overall cost of compliance for the economy as a whole. Whilst the system favours production and encourages efficiency measures, the hard truth may be that the most effective way to reduce emissions is through demand destruction and replacement of certain products and not through improved efficiency of existing production capacity.
• Lastly and perhaps most importantly, a trading system must deliver a liquid market. The ensures efficient price discovery, sufficient depth to execute large trades and the development of a forward curve – all important criteria to support investment. But the development of a liquid carbon market is hampered by the very design of baseline-and-credit. This has been seen in practice in systems that have come and gone, where trade was negligible and the price feeble at best. Up front allocation of allowances delivers a tradable commodity into the market early on, allowing future prices to develop – a critical component of overall trade in the energy sector. By contrast, baseline-and-credit delays crediting until after the event, which limits future trade. Many companies will simply not even entertain the notion of trading something they don’t yet have.

Cap-and-trade is the proven performer. It has delivered successfully in the US Acid Rain Program and has created a robust and growing carbon market in the EU. We need to create more systems of this design if we want to reduce emissions at lowest overall cost to the economy and have any chance of a global market in the years to come.

This week has seen a report produced for the British Government which details pathways towards a global carbon market and the benefits of doing so. A series of policy recommendations are put foprward in the report along with supporting analysis. The report makes excellent reading.

A fully functioning global market for carbon is essential for many reasons. First and foremost, it will drive the reduction of emissions globally in an organised and equitable manner, always picking off the next best project along the abatament curve and therefore giving us a lowest cost solution to meeting reduction targets. The resulting carbon price will also act as an incentive to spur the development of a range of new technologies, such as carbon carbon and storage. The overall global cost of meeting, say, a 2050 target can be reduced significantly with a fully fungible global market, compared to the alternative of many separate stand alone systems.

But such a market will not be something that policy makers will ever be able to create in one swoop, rather it will evolve as individual systems are linked together, as sectoral approaches mature and begin to deliver credited reductions and as new policy mechanisms are introduced in areas such as land use and forestry. Today, we have just the beginnings of such a system, with the EU-ETS buying certified reductions via the CDM, thereby projecting the EU carbon price into many developing countries.

We can already see the dawn of other approaches, such as in the USA, Australia and New Zealand. But whilst both the Australian and New Zealand systems are underpinned with Kyoto AAUs, as is the EU, this is clearly not the case in the US Waxman-Markey case. The USA system, whilst architecturally very similar to the other systems, does not immediately recognise the same project mechanism nor present the possibility of fungible (AAU based) allowances, so discontinuities are already appearing. What is missing is the notion of a common currency for carbon.

This then brings into focus one of the key deliverables from Copenhagen – somehow merging the Kyoto negotiating track and the Long Term Cooperative Action track. Unless this can be achieved we may end up with emission trading systems that simply can’t link together because they are built on different platforms. Although Waxman-Markey does offer an open door for recognition, it won’t be possible to use it as it will present an unrecognised source or sink for allowances within the other systems.

Such a discontinuity will drive up the overall cost of compliance for everyone. Alternatively, we can ensure that the various systems are built on a common platform, recognising the same underlying units, thereby ensuring the shift towards a global market.

Towards a global carbon market

One of the features of cap-and-trade legislation is that it typically includes a variety of supporting standards – for example, a renewable portfolio standard in the power sector or a vehicle efficiency standard in the transport sector.

But shouldn’t we just trust the cap-and-trade system to deliver the lowest cost outcome for the economy?

With its tradable allowances, cap-and-trade is designed to move progressively along the abatement curve, driving the implementation of the next best project – which then delivers the lowest cost solution overall. Introducing standards into this mix does two things;

• It lowers the overall carbon cost within the cap-and-trade;
• It raises the overall cost of the system to society.

This is because the standard is interfering with the progression along the abatement curve and may be forcing the implementation of projects that are not the next best in terms of cost. Because these projects are then executed, the need to move up the abatement curve to meet the CO2 target is reduced, therefore lowering the overall carbon cost in the cap-and-trade system.

Despite knowing this, we persist in setting such standards. Why do this?

In the case of the transport sector, we (Shell) advocate for the use of standards and I have had input into that thinking. In fact we started from the perspective that cap-and-trade isn’t really the ideal tool in the personal road transport sector at all, but given that inclusion is a reality of US, Australian and New Zealand cap-and-trade policy, we came to the view that supporting standards were still necessary.

With the point of regulation shifted from the emitter to the supplier in the road transport sector, the only signal the emitter (i.e. the driver) sees is a change in price of gasoline. There is plenty of evidence that shows this sector isn’t very price responsive and certainly not at the level of a $50 CO2 price – i.e. about 50 cents a gallon on gasoline. But cost effective “projects” do exist at this price, for example switching to diesel fuel or even choosing a different vehicle when a purchase is made. So if the sector doesn’t respond very well, additional pressure is put on the other sectors, raising the overall CO2 price and of course delaying action in the transport sector itself. Of course the overall reduction is still achieved, but has the cap and trade system delivered the lowest cost outcome – possibly not?

Supplementing the action of cap-and-trade in the road transport sector with a set of standards can redress this balance – at least that is the view we came to. For example, a vehicle efficiency standard can start delivering reductions in the sector at very low cost, at least initially, as vehicle manufacturers may initially try to meet it simply by promoting different types of cars. These are things that should happen anyway under a cap-and-trade and probably would if the vehicle purchase decision was made entirely on financial grounds.

There is a similar arguement in the buildings and commerce sector – standards to drive more efficient appliances and force insulation into homes may be more effective than cap-and-trade at doing this job.

But what about the power sector? Arguably the cap-and-trade system should deliver an outcome balanced between efficiency, renewables, CCS, nuclear and fuel switching, so why have a Renewable Portfolio Standard or, as some have advocated, a CCS standard. This is where other policy objectives come in and the soluiton starts to get messy. Governments are keen to see a shift to renewables for security reasons so they add in a Renewable Power Standard – but it is important to realise that this is potentially undermining the cap-and-trade system and reducing its effectiveness in driving technologies such as CCS.

It may be costing us all more money as well!!

At the end of last week I was in Bonn, where another round of UNFCCC negotiations was taking place in the lead-up to Copenhagen. I happened to catch the Greenpeace show, which involved the sounding of an incredibly loud air-raid type siren from within a locked steel cage on the back of a truck. The German police didn’t take kindly to this and proceeded to cut them out.

But the point made by Greenpeace isn’t without merit. My own “alarm moment” comes from looking at the text which the negotiators are deliberating over. Although much was apparently added during the Bonn talks, the starting point (the AWG-LCA text) says little about how to actually address this problem, but rather presents fifty three pages of arcane language about process. It talks of “appropriate action”, but doesen’t define what this might actually entail, other than in the loosest terms. Take a technology such as carbon capture and geological storage – it doesn’t even get a mention. The word “renewable” appears once, “nuclear” doesn’t appear at all and “energy efficiency” twice. Even the notion of a carbon market to drive large scale deployment is barely touched upon.

Short of a document which clearly spells out a forward emissons profile for every country, perhaps it is time to replace abstraction with clarity and focus. There are five, and only five things we can do to address the mitigation side of climate change. We have to do all of them, we have to do them at huge scale and we have to do them very quickly. They are;

• Using energy much more efficiently;
• Increasing the use of renewable and nuclear sources of energy;
• Rapidly commercialising and deploying carbon dioxide capture and geological storage in tandem with the use of fossil fuels [or with the chemical conversion of fossil derived materials for the provision of various manufactured products];
• Containment, destruction and reduced usage of greenhouse gases other than carbon dioxide;
• Reducing emissions through land use, land use change and forestry, including reducing emissions from deforestation and degradation.

At the very least, the text should be driving these specific solutions forward, for example through properly funded large scale demonstration programmes and targeted mechanisms to hasten deployment. Carbon capture and storage provides a good example. Three policy initiatives are required to support this technology;

• An underlying price for CO2 must be in place;
• A clear recognition of the demonstration nature of the technology, which means funding, objectives, timelines and focus on delivery of projects;
• A robust approach to CO2 storage certification (and MRV) based on 2006 IPCC GHG Inventory Guidelines.

The EU has nearly reached this point, but it has taken eight years to do so. Whilst this represents a landmark in policy creation, the rate at which it has happened is hardly commensurate with the gravity of the issue that we are trying to address. We need to focus our efforts on bringing this technology to developing countries, particulalry those with large coal reserves. A policy framework similar to that in place now in the EU is needed, but on an international scale. First and foremost, this means recognising CCS within the an international project mechanism. We will also need to underpin this with an internationally recognised CO2 storage certification, again based on the 2006 IPCC GHG Inventory Guidelines. Finally, we need a mechanism within which large clusters of projects can be identified, funded and implemented against defined deadlines. Most importantly, we need all this now, in Copehagen, with a view to starting implementation in 2010.