Archive for the ‘Emissions Trading’ Category

Emissions Trading via Direct Action in Australia

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The Australian Government recently released a Green Paper describing in more detail its proposal for an Emission Reduction Fund (ERF), the principle component of its Direct Action climate policy. The ERF will sit alongside renewable energy and reforestation policies, but is designed to do the bulk of the heavy lifting as the Government looks for some 430 million tonnes of cumulative reductions (see below) over the period 2014 to 2020. The ERF will have initial funding of about AU$ 1.55 billion over the forward period, with the money being used to buy project reductions (as Australian Carbon Credit Units or ACCUs) from the agriculture and industrial sectors of the economy by reverse auction. These reductions will be similar to those that are created through the Clean Development Mechanism (CDM) available under the Kyoto Protocol.

 Australia Reduction Task to 2020

Although the fund and reverse auction process are discussed in some detail and appear as central to the policy framework, this may not be the case as the system is rolled out and the full framework developed. The issue that comes from such an approach to emissions reduction is that despite buying project reductions from the economy, the overall emissions pathway for the economy as a whole still does not follow the expected trajectory. The ERF may also encounter a number of issues seen with the CDM, all of which are some form of additionality;

  1. Determining if there would have been higher emissions had the project not happened. Perhaps the reduction is something that would have happened anyway or the counterfactual position of higher emissions would never have actually happened. For example, an energy efficiency gain is claimed in terms of a CO2 reduction but the efficiency gain is subject to some amount of rebound due to increased use of the more efficient service, therefore negating a real reduction in emissions. Further, the counterfactual of higher emissions might never have existed as the original less efficient process would not have operated at the higher level.
  2. Double counting – the project presumes a reduction that is already being counted by somebody else within the economy as a whole. For example, an energy efficiency gain in a certain part of the supply chain is claimed as an emissions reduction, but this is already intrinsic to the overall emissions outcome for another process.
  3. Rent seeking – project proponents seek government money for actions already underway or even construct an apparent reduction.

The Australian emissions inventory will be measured bottom up based on fuel consumption, changes in forest cover and land use and established estimates / protocols for agriculture, coal mine fugitive emissions, landfill etc. It will not be possible to simply subtract the ERF driven reductions from such a total unless they are separate sequestration based reductions, e.g. soil carbon. This is because the ERF reductions are themselves part of the overall emissions of the economy.

The Green Paper clearly recognizes theses issues and proposes that the overall emissions pathway through to 2020 must be safeguarded. In Section 4 it discusses the need for “An effectively designed framework to discourage emissions growth above historical levels . . . “, with associated terminology including phrases such as “covered entities”, “baseline emission levels”, “action required from businesses” and “compliance”.  The safeguarding mechanism, rather than being a supplementary element of Direct Action, could end up becoming the main policy measure for decarbonisation if significant CO2 reductions are not achieved under the ERF. While this may not be the objective that the Government seeks, it does mean that the implementation of the safeguard mechanism needs to incorporate the design thinking that would otherwise be applied to the development of intended emission trading systems, such as the Alberta Specified Gas Emitters Regulation.

As currently described, the safeguarding mechanism looks like a baseline-and-credit system, with the baseline established at facility level either on an intensity or absolute emissions basis (both are referred to in the Green Paper). Should a facility exceed the baseline it could still achieve compliance by purchasing ACCUs from the market, either from project developers or other facilities that have over performed against their own baselines. Although the Government have made it very clear that they will not be establishing a system such as cap-and-trade that collects revenue from the market, facilities will nevertheless face compliance obligations and may have to purchase reduction units at the prevailing market price.

The level of trade and the need for facilities to purchase ACCUs will of course depend on the stringency of the baselines and this remains to be seen, however in setting these the Government will need to be mindful of the overall national goal and its need to comply with that. The development of a full baseline and credit trading system also raises the prospect of the market out-bidding the Government for ACCUs, particularly if the Government sets its own benchmark price for purchase, as is indicated in the Green Paper.

As Australia moves from a cap-and trade system under the Carbon pricing Mechanism (CPM) to the ERF and its associated safeguarding mechanism, the main change for the economy will be distributional in nature, given that a 5% reduction must still be achieved and the same types of projects should eventually appear. However, the biggest challenge facing any system in Australia could be around speedy design and implementation, given that the time remaining before 2020 is now very limited and the emission reduction projects being encouraged will themselves take time to deliver.

The US Submission on Elements of the 2015 Agreement has recently appeared on the UNFCCC website and outlines, in some detail, the approach the US is now seeking with regards “contributions”. Adaptation and Finance are also covered, although not to the depth of the section on Mitigation.

The submission makes it very clear that the US expects robust contributions from Parties, with schedules, transparency, reporting and review. There is also a useful discussion on the legal nature of a contribution. None of this is surprising as the US delegation to the recent COPs and various inter-sessional meetings has made it very clear that real action must be seen from all parties, not just those in developed countries.

But the submission makes no reference to the role of carbon markets or carbon pricing. Only in two locations does it even refer to market mechanisms and this is only in the context of avoiding double counting. This is coming from the Party that gave the world the carbon market underpinning of the Kyoto Protocol, which in turn has given rise to the CDM, the EU ETS, the CPM (in Australia) and the NZ ETS to name but a few, so perhaps reflects the current difficulty Parties are having keeping carbon price thinking on the negotiating agenda. 

I would argue that without a price on carbon emissions, the CO2 emissions issue will be much more difficult to fully resolve. Further to this, while individual countries may pursue such an agenda locally, the emissions leakage from such systems could remain high until the carbon price permeates much of the global energy system. This then argues for an international agreement that encourages the implementation of carbon pricing at a national level. The Kyoto Protocol did this through the Assigned Amount Unit, which gave value to carbon emissions as a property right. While there is no such “Kyoto like” design under consideration for the post 2020 period, the agreement we are looking for should at least lay the foundations for such markets in the future. The question is, how??

In the post 2020 world, carbon pricing is going to have to start at the national level, rather than be cascaded from the top down. Many nations are pursuing such an agenda, including a number of emerging economies such as China, South Korea, South Africa and Kazakhstan. Linkage of these carbon price regimes is seen as the key to expansion, which in turn encourages others to follow similar policy pathways and join the linked club. The reason this is done is not simply to have carbon price homogeneity, but to allow the transfer of emission reduction obligations to other parties such that they can be delivered more cost effectively. This allows one of two things to happen; the same reductions but at lower cost or greater reductions for the expected cost. The latter should ideally be the goal and is apparently the aspiration the USA has, given it states that the agreement should be “designed to promote ambitious efforts by a broad range of Parties.” The carbon price is simply a proxy for this process to allow terms of trade to be agreed as a reduction obligation is transferred.

All of this implies that the post 2020 agreement at least needs a placeholder of some description; to allow the transfer of reductions to take place between parties yet still have them counted against the national contribution. As it stands today, it is looking unlikely that explicit reference to carbon pricing or carbon markets will make its way into the agreement, but perhaps it doesn’t need to at this stage. On the back of a transfer mechanism, ambition could increase and a pricing regime for transfers could potentially evolve. If that happens to look like a global carbon market in the end, then so be it.

The EU ETS isn’t out of trouble just yet

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On January 22nd the EU Commission launched its White Paper which lays out the major components of its energy and climate policy through to 2030. This is the first major step in what could well be a lengthy debate and parliamentary process before a new package of measures is finally agreed. The Commission has proposed a 40% EU wide greenhouse gas reduction target for the year 2030, an EU wide target of 27% renewable energy by the same year and a supply side mechanism to adjust the overall number of allowances in circulation within the EU ETS.

The latter component is clear recognition by the Commission that the ETS has been awash in allowances for some time now and with a price of just a few Euros is doing nothing to drive emissions management across the EU. There are multiple reasons for the situation the ETS currently finds itself in, but one major contributor has been overall energy policy design in the EU. This has imposed renewable energy targets to the extent that further emission reductions under the ETS are not required once the former have been met. Hence the near zero CO2 price. There are two parts to this particular story – the first is the overall level of the renewable energy target and the second is the reality that transport (oil) and commercial / residential (natural gas) sectors hardly contribute to this, so it forces a much higher renewable energy penetration in the power sector, which is under the ETS.

But with a 2030 reduction target of 40% and a new renewable energy goal of 27%, is the problem now remedied?

This of course depends on how the renewable energy target is met. Importantly, it will not be imposed on Member States as it was in the period to 2020, but is only binding at EU level. This could mean that the Commission expects to be at 27% renewables based on the impact of policies such as the ETS, rather than requiring that Member States guarantee a certain level of renewable energy use and therefore effectively forcing them to enact policies to deliver such goals. But many Member States are likely to continue their support of renewable energy and may force it into the overall energy mix right through to 2030.

The worst case outcome for the ETS would be one that sees the whole 27% renewable energy goal met with explicit policies at Member State level. The chart below shows this – note that this is a simple model of the EU for illustrative purposes. Assume that at the end of 2012 EU power generation and industry sector emissions are at 2000 million tonnes CO2. By 2020, with a 1.74% annual reduction under the ETS, they need to be at ~1730 million tonnes. But with renewable energy being forced into the power generation system (although not quite reaching the 20% across the EU) and the EU easily meeting its overall 20% CO2 goal, sector emissions are below the ETS cap, which implies nothing else need be done, hence the low CO2 price. Projecting this out to 2030 with the proposed 2.2% annual reduction and meeting the 27% renewable energy goal across the EU energy system, shows that sector emissions are only slightly above the cap (about 50 million tonnes), which again implies a low to modest CO2 price. Assume further that a CCS programme is actually running and delivering 50 mtpa storage (through direct incentives) and no further action is required – so a zero CO2 price once again! The model also assumes about 30% growth in electricity generation from 2012 to 2030.

 EU ETS RET impact to 2030

This very simple model doesn’t account for the large allowance surplus that exists in 2012 (> 1 billion allowances), which would therefore be unlikely to vanish through normal growth in electricity demand, industrial production and so on. This makes it imperative that the EU also implements the supply side mechanism within the ETS, which would then remove much of the surplus through the early 2020s. Ideally, implementation of this should be immediate and also with immediate effect, rather than waiting until post 2020.

Should Member States not implement specific renewable energy policies and the supply side mechanism is active and functioning, we might just have an ETS that actually drives change in the large emitters sector, but there are two big “ifs” here. Otherwise, expect continued price weakness and probably a higher overall cost of energy as a result.

What to make of 2013?

It’s difficult to sum up 2013 from a climate standpoint, other than to note that it was a year of contrast and just a little irony. Overall progress in actually dealing with the issue of global emissions made some minor gains, although there were a few setbacks of note along the way as well.

  • The IPCC released the climate science part of their 5th Assessment Report and that managed to keep the media interested for about a day, after which it was back to issues such as health care, economic growth, Euro-problems and assorted regional conflicts. Importantly, the report introduced into the mainstream the much more challenging model for global emissions, which recognizes that it is the long term accumulation that is important, rather than emissions in any particular year.
  • The global surface temperature trend remained stubbornly flat, despite every indication that the heat imbalance due to increasing amounts of CO2 in the atmosphere remains in place and therefore warming the atmosphere / ice / ocean system somewhere, although where exactly remained unclear. The lack of a clear short term trend became a key piece of evidence for those that argue there is no issue with changing the concentration of key components of the atmosphere, which further challenged the climate science community to provide some answers.
  • The UNFCCC continued to put a brave face on negotiations that are being seriously challenged for pace by most of the worlds declining glaciers while the world’s largest emitter, China, often thought of as blocking progress at the international level kicked off a number of carbon pricing trial systems in various parts of the country.
  • Australia elected a government that proudly announced on its first day in office that the carbon pricing system which was finally in place and operating after eight years of arguing would be dismantled, only to be confronted by the fact that the country sweltered under the hottest annual conditions ever recorded in that part of the world.
  • Several very unusual global weather extremes were reported, including what may be the most powerful ever storm to make landfall, yet there was a distinct lack of desire by scientists and commentators to attribute anything to the rising level of CO2 emissions in the atmosphere, except perhaps for the UNFCCC negotiator from the Philippines who went on a brief hunger strike in response to devastation that hit parts of his country.
  • The EU carbon price remained in the doldrums for the entire year, although did show a few signs of life as the Commission, Parliament and various Member States teased, tempted and taunted us with the prospect of action to correct the ETS and set it back on track. In the end, the “backloading” proposal was passed by the Parliament and will likely be adopted and implemented, but the test will be whether or not the Commission now has the backbone to propose and unconditionally support the necessary long term measures to see the ETS through to 2030 as the main driver of change.
  • For the first time that I had seen, a book was released that finally got to grips with the emissions issue, yet somewhat alarmingly failed to find any clear route out of the dilemma we collectively find ourselves in. “The Burning Question”, by Mike Berners-Lee and Duncan Clarke recognized how difficult the emissions challenge has become and questioned those who trivialize the issue by arguing that more renewable energy and better efficiency is all that is needed to solve the problem. Clearly a book for those who designed the hallway posters [Link] at COP19 in Warsaw to read. Closer to home, new Shell Scenarios released in March [Link] 2013 did chart a pathway out of the emissions corner that Mike and Duncan painted themselves into, but the much discussed 2°C wasn’t quite at the end of it.
  • The IEA put climate change back in the headlines of their World Energy Outlook, with a special supplement released in June outlining a number of critical steps that need to be taken to keep the 2°C door open. Unfortunately they hadn’t taken the time to read “The Burning Question” and consequently positioned enhanced energy efficiency as a key step to take over this decade.
  • In North America both the US and Canadian Federal governments continued to head towards a regulatory approach to managing emissions, while States and Provinces respectively continued to push for carbon pricing mechanisms. California and Quebec linked their cap and trade systems to create a first cross border link in the region.
  • The World Bank Partnership for Market Readiness continued its mission of preparing countries for carbon markets and carbon pricing, with numerous “works in progress” to show for the efforts put in to date. But the switch from early trials and learning by doing phases to robust carbon trading platforms underpinning vibrant markets remains elusive.

 These were all important steps, particularly those that tried to broaden or strengthen the role of carbon pricing. On that particular issue, 2013 saw both positive and negative developments, with progress best described as “baby steps” rather than anything substantial. With a change in the European Parliament, mid-term elections in the US and Australia in the process of unwinding, it is difficult to see where the big carbon pricing story in 2014 will come from. Perhaps the tinges of orange (see below) now beginning to appear in South America will flourish and green with COP20 being held in that region towards the end of the year.

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While there was plenty of talk at COP 19 about financing, national ambition, increasing pre-2020 ambition and adaptation, another core subject that struggled for high-level attention (the other one being CCS) was the idea of carbon pricing, specifically delivered through carbon markets. This is one of those subjects that an observer of the process would expect to see appearing in almost every discussion, yet it didn’t make it out of the SBSTA working group meetings. This meant that the high level discussions towards the end of the COP (when the national delegations are typically bolstered by the presence of a Minister) didn’t get to hear about carbon pricing at all (or CCS).

There is no doubt that carbon pricing appears on many national agendas, with of course the EU leading that trend through the 2005 start of the EU ETS. Parts of the US and Canada, New Zealand, Kazakhstan (pilot phase) and a few others have already incorporated carbon pricing within parts of their energy systems and China, South Africa and others are in various stages of preparing for it. These are positive developments, but carbon pricing really only works at its most efficient when coverage is both widespread and coordinated, otherwise leakage (in various forms), arbitrage and rent-seeking can undermine local implementation. Further to this and as I have discussed in previous postings, if carbon pricing isn’t a core element of the eventual climate policy framework, then emissions may not go down at the necessary rate or if they do decline it will likely be at a much higher cost than would otherwise have been necessary.

Carbon pricing is also the potential lever for large scale financing of mitigation projects, as has been seen to some extent with the CDM. By far the largest flow of finance to projects in developing countries has come through the application of the CDM and subsequent sale of CERs on international markets, not through public financing of projects through funds, development aid and the like. While these latter approaches are also important, they will never be sufficiently large or aggressive enough to underpin the scale of global mitigation required. Well over a billion CERs have been created since the start of the CDM, which equates to some $10 billion in carbon financing and possibly $30-$70 billion in underlying project financing.  But even discussions on the CDM in Warsaw were lacklustre, with some CDM negotiators continuing to think and operate as if the year was 2006 and demand for CERs was on an rise. At the beginning of the Warsaw talks, there was some discussion amongst negotiators about having the Green Climate Fund (GCF) utilise the CDM as a results-based financing tool, and allowing the CDM to become a ‘net mitigation tool’ for non-Annex 1 countries to utilise as they prepare for tabling contributions next year and in 2015. In the end, no such language emerged from Warsaw, which raises the prospect of even this mechanism struggling to survive in the post 2015 world.

One could argue that carbon pricing is simply part of national implementation and therefore shouldn’t feature at the UNFCCC level, but as noted above, that is not an efficient approach. There is a potential role for the UNFCCC to create a framework which both encourages the use of carbon pricing and coordinates its implementation through linkage, leading eventually to the much desired “global carbon market”. Within the current negotiations, the only place a UNFCCC role might be created is through the New Market Mechanism (NMM) within the Framework for Various Approaches (FVA). Some thoughts on this can be found here (Carbon Pricing, the FVA and the NMM), where the FVA/NMM is proposed to include a linking framework for all countries to use.

 NMM and FVA

There is also a second argument that linkage can be achieved bilaterally, such as California and Quebec have negotiated and Australia had proposed with the EU (presumably now defunct given the repeal of carbon legislation now underway in Australia). But bilateral linkage runs its course very quickly before multilateral discussions are required. For example, if Quebec now reached out to another party to link to, California would have to be involved given the existing link, so a trilateral discussion would be needed. This would quickly get very complex and large potential linking partners such as the EU would have to shift to a multilateral approach of some description.

So what happened to carbon markets in Warsaw? The short answer is not much.

The FVA and NMM discussions ground to a standstill in the first week. Concerns about basic form and function of the FVA dogged the discussion, compounded by other concerns relating to whether these were pre or post 2020 mechanisms. In the end, the FVA and NMM discussions were postponed until the regular SBSTA meetings in June. The UNFCCC posting on the FVA and NMM in Warsaw shows nothing more than the input documents that were available prior to the COP, with no conclusions whatsoever.

On a positive note this delay at least offers more time to develop FVA and NMM thinking along the “carbon market” lines outlined above, rather than have a weak agreement that precludes such a possibility and leaves them languishing as information sharing bodies – an entirely possibly outcome from this process. But the lack of attention to carbon pricing and carbon markets in the context of a global deal that is meant to rapidly drive down global emissions is worrying. There remains of course the sterling efforts of the World Bank and their Partnership for Market Readiness, but initiatives such as these won’t be sufficient without some overarching policy action to create the markets in the first place.

Linking discussions continue

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With the election of a new government in Australia and their promise to discontinue the “carbon tax”, the much discussed link between the Australian ETS and the EU ETS looks to be in doubt. As this is the highest profile example of bilateral linking, one might then think that the subject would die. Quite the contrary if you attended Carbon Forum North America last week, where linking continues to be a major preoccupation with carbon market aficionados.

The scene was set at CFNA when the Quebec Environment Minister used the conference to officially announce the link between cap-and-trade systems in California and Quebec. Although this has clearly been in the works for a while, the deal is now done. There were various other discussions about linking, but a particularly interesting panel session involved the World Bank where they tabled a completely new idea that could either be impossibly difficult to implement or could revolutionise the global carbon market – at this stage it is hard to assess which end of the spectrum we might be at. Nevertheless, it is an idea with real merit and worth thinking about or even piloting.

The World Bank takes the view that despite the best of intentions, market based emissions management systems (such as cap-and-trade or baseline-and-credit) will only rarely be close enough in design and underlying ambition to cleanly link and that as countries with existing bilateral links try to link with others (and therefore link the system that they are already linked with to another one by default), progress will grind to a standstill. Therefore, something else is needed. Their idea is to introduce a ratings system into the mix, with individual market based instruments being rated in a similar way to sovereign ratings by the likes of Standard and Poor’s.

For example, a tight cap-and-trade system with limited offset use and high ambition (i.e. a sharply declining cap) might have its allowances rated at 0.9 (like a national AAA  or AA+ rating), compared with a baseline-and-credit system with credits rated at 0.3 because such a system is not as environmentally tight due to its inherent intensity basis. Trade between the two would be possible, but three external credits would be needed for compliance instead of one internal allowance in the cap-and-trade system. Many different systems could then link without the need for perfect design alignment. Ratings applied in this way could solve the problem that the EU Commission has had with its on / off approach to CERs from the Clean Development Mechanism.

In the World Bank model the ratings would be handled by a private agency and the decision to use them would be a sovereign one, both by the country hosting a market based system that wishes to import other instruments for compliance and by any country that creates carbon instruments deciding that they can be exported for external use.

The World Bank proposed two other legs to a three part system, a settlement platform and an international carbon reserve. The latter would be a pool of carbon instruments that could be drawn on by any participating nation and would be created by a standardised contribution by all participants. This latter point is important in that if a nation’s carbon market compliance instrument is downgraded, they would need to contribute more of them to the pool to maintain the same standardised amount within it.

This idea was proposed as something that could commence today, outside the UNFCCC process. The alternative of waiting for some 190 countries to agree a common methodology when some don’t even recognise the idea of a market based approach has a high risk of failure (at least to the extent that it would deliver the infrastructure required for a global carbon market).

A lot of water will pass under the bridge before something like this gets going, but it was good to see new and original thinking in this area.

A rewind back to 2007 reveals an EU Parliament that was very keen on carbon capture and storage (CCS) and gave it tremendous support through the CCS Directive and the NER300 financing mechanism. Five years on and for all the reasons discussed in recent posts, only the UK looks likely to see any near term CCS development and this is entirely due to its own additional policy development.

In March 2007, the Presidency Conclusions of the Brussels European Council stated;

 Aware of the huge possible global benefits of a sustainable use of fossil fuels, the European Council:

    • underlines the importance of substantial improvements in generation efficiency and clean fossil fuel technologies;
    • urges Member States and the Commission to work towards strengthening R & D and developing the necessary technical, economic and regulatory framework to bring environmentally safe carbon capture and sequestration (CCS) to deployment with new fossil-fuel power plants, if possible by 2020;
    • welcomes the Commission’s intention to establish a mechanism to stimulate the construction and operation by 2015 of up to 12 demonstration plants of sustainable fossil fuel technologies in commercial power generation.

CCS couldn’t have had a much harder push out of the starting blocks, yet none of this project activity has happened and CCS is virtually at a standstill in the EU. This has led the EU Parliament to look more closely at the issue and in the very near future we should see the Environment Committee release a report on CCS. In the meantime the Committee on Industry, Research and Energy (ITRE) has posted a short draft opinion on CCS on the EU Parliament website. This may give some early insight into the likely direction of the more critical Environment Committee report. Key findings from ITRE are as follows;

    • Failing to include CCS within a long-term energy strategy will severely hamper national, Union and global efforts to address climate change;
    • Believes that the EU’s mandatory renewable target has undermined investment in CCS, and calls, therefore, for a technology-neutral approach to the Union’s 2030 energy goals, in line with Article 194(2) of the TFEU, in order to create a level playing field and ensure effective competition amongst varying low-carbon energy technologies;
    • Calls on the Commission and the Member States to address the main barriers to the deployment of CCS, such as the granting of permits and funding, the establishment of a CCS skills base and the development and testing of technologies for effective capture, transport and storage;
    • Believes that incentives and policy measures should target both CCS demonstration as well as subsequent longer-term operational projects and must provide greater certainty for private sector investment; believes, furthermore, that incentives and measures should be split efficiently both within the power-generation sector and CCS within industrial production processes;
    • Considers that the low carbon price delivered through the EU’s Emissions Trading Scheme (ETS), and subsequent revenues generated from the sale of allowances under the New Entrants’ Reserve of the ETS (NER300), has failed to deliver an attractive business case for early long-term private sector investment in CCS;

This is all solid stuff and it would appear that ITRE have got to grips with both the important role that CCS must play and the challenges that CCS faces to deploy. Perhaps one surprise is the reference to Article 194(2) of the Treaty of the Functioning of the European Union (TFEU). It is difficult to see how this particular part of the treaty actually supports the need for CCS. Rather, it tends to support the set of actions that have contributed to the problems that CCS is having, namely the focus on renewable energy.

ENERGY

Article 194

  • In the context of the establishment and functioning of the internal market and with regard for the need to preserve and improve the environment, Union policy on energy shall aim, in a spirit of solidarity between Member States, to:
    •  ensure the functioning of the energy market;
    •  ensure security of energy supply in the Union;
    •  promote energy efficiency and energy saving and the development of new and renewable forms of energy; and
    • promote the interconnection of energy networks. 
  • Without prejudice to the application of other provisions of the Treaties, the European Parliament and the Council, acting in accordance with the ordinary legislative procedure, shall establish the measures necessary to achieve the objectives in paragraph 1. Such measures shall be adopted after consultation of the Economic and Social Committee and the Committee of the Regions. Such measures shall not affect a Member State’s right to determine the conditions for exploiting its energy resources, its choice between different energy sources and the general structure of its energy supply, without prejudice to Article 192(2)(c).  

Many will argue that support for renewable energy is the right approach to address climate change, but as I have discussed in numerous posts, it’s not quite that simple. There is little doubt that renewable energy is part of our future and in the next century it may well be the major component, if not all, of our energy system. But in the meantime we are using fossil fuels to power pretty much everything and that is going to take a century to change. If we don’t capture the majority of the CO2 associated with that ongoing use (even with it declining throughout the century) then 2°C isn’t achievable, but nor for that matter is 3°C.

The TFEU doesn’t really give much guidance to help solve this, although Article 191 states;

. . . promoting measures at international level to deal with regional or worldwide environmental problems, and in particular combating climate change.

This then comes down to interpretation of the phrase “combating climate change”. A hardnosed analysis of the global emissions  issue leads to the necessity for a CCS strategy, irrespective of any personal views on whether we should or shouldn’t power the world with fossil fuels. The fact is that we currently do and this existing reality won’t change anytime soon.

 

In conjunction with its request for submissions on the 2030 policy framework, the EU Commission posed a series of questions on carbon capture and storage (CCS) to be answered separately. This follows on from the failure of the NER300 policy framework to deliver an EU CCS demonstration programme.

One question within this new consultation is of particular interest in that it opens up the possibility of a dedicated instrument designed specifically for the deployment of CCS. The Commission asked;

Should the Commission propose other means of support or consider other policy measures to pave the road towards early deployment, by:

a.      a support through auctioning recycle or other funding approaches

b.      an Emission Performance Standard

c.       a CCS certificate system

d.      another type of policy measure

One of the leading CCS focused industry / society groups (European Technology Platform for Zero Emission Fossil Fuel Power Plants, or ZEP) responded to this and argued for consideration of a CCS Certificate system should its preferred Feed-in-Tarrif approach not be acceptable. Such a system would require a certain (and annually increasing) amount of CO2 storage for each tonne of CO2 emitted, but the storage could take place in another location with proof of such storage coming in the form of a tradable certificate. But ZEP noted that;

Any system of certificates should be designed in such a way as to avoid any negative interaction with the existing ETS. Measures to ensure this could include making CCSCs fungible with a certain number of EUAs, or retiring EUAs, as CCSCs are supplied into the market.

While a robust carbon market is the preferred approach for driving investment in technologies such as CCS, frustration with price development is leading policy makers and some CCS proponents to consider targeted policies. The ZEP caveat is important in that overlapping policies have been a real problem for the EU ETS. With other polices taking away the need for the carbon price to trigger investment,  higher overall  costs of mitigation result, but at the same time weakening the visible CO2 price.  The same would be true of a CCS policy instrument. However, an EU wide CCS Certificate mechanism which operates for all the same facilities as the ETS could be designed as follows, delivering a first round of CCS projects but working within the ETS to at least mitigate the overlap issue to some extent:

  • For the period 2021-2025, each 100 tonnes of CO2 emitted would require the surrender of 99 EUAs (EU ETS Allowances or equivalent instruments) and 1 CCSC (carbon capture and storage certificate).
  • The CCSCs are tradable instruments and would be granted for each tonne of CO2 stored in the EU from 2015 onwards. This would give the EU some lead time to build up a modest bank of CCSCs.
  • From 2026 onwards, the CCSC requirement would increase by 1 in 100 each year, i.e. by 2030 the minimum compliance requirement for each 100 tonnes of CO2 emitted would be 6 CCSCs and 94 EUAs (or equivalent).
  • A facility that generates CCSCs would be deemed as emitting one tonne of CO2 for each CCSC sold into the market.
  • CCSCs could be banked for future use.
  • The initial 2021-2025 period would require about 20 million CCSCs in each year across the EU, therefore underpinning a number of projects.
  • As a “relief valve” mechanism for the period 2021-2025 only, an EUA could be converted to a CCSA for a fee, for example at the current ETS non-compliance penalty level (€100), with the money being placed in a CCS technology fund for disbursement to CCS projects.
  • Total EU allowance auction / allocation for the period 2020-2030 would be adjusted downwards on the basis of the creation of a certain number of CCSCs.
  • The approach could also inspire the EU to lead the development of an international CCSC at the UNFCCC which could also be used for compliance in the EU.

A CCS Certificate approach has a very modest price impact on the consumer (of electricity). Under an ETS, the marginal cost of compliance is reflected in the cost of everyone’s electricity and this must rise to levels above €50 per tonne before any CCS project activity is firmly triggered. This equates to quite an increase in electricity prices. But the CCSA not only ensures delivery but quickly socializes the cost of CCS, in that each electricity purchaser pays a fraction of the cost of the first CCS facilities. If a CCSC was trading at €80 per tonne of CO2 stored, then in the period 2021-2025 the consumer would see a cost per tonne of CO2 of only 80 € cents, or for coal fired power generation at 900 gms CO2/kWh, a price increase of less than a tenth of a €-cent per kilowatt hour.

So should we opt for CCS Certificates? Although they will deliver CCS, the approach isn’t as economically efficient as the carbon market left to its own devices. But as already noted, carbon markets aren’t being left to their own devices as other policies continually encroach on their turf (e.g. renewable energy targets), which means that CCS may be significantly delayed.

One further thought. Arguably, the increasing requirement to provide CCSAs could continue past 2030 until the ETS is fully replaced later in the century. This would at least align any use of fossil fuels with the long term requirement to store all the resulting CO2.

Can a (second) global carbon market emerge?

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At the very end of May Carbon Expo was held in Barcelona. It was an excellent event, overall attendance was good and there were still quite a few exhibitors at the Expo hoping for life in the project mechanism market of the current “global carbon market”. But this is an area of trade that is clearly struggling. 

Carbon Expo

The conference also offered an opportunity for the World Bank to release a new review of carbon market activity, which showed that there is at least quite a lot, even if price development is far from the levels required to ever make any discernible difference to global emissions.

 Carbon Markets (world Bank)

 

Carbon Expo consists of many events, plenary panels and side meetings and through these one of the subjects that attracted plenty of attention is the ongoing desire to see a global carbon market take shape. This seems like a rather odd desire since we have had something along these lines for the past decade under the Kyoto Protocol, but nobody really wanted to discuss that, even though it is clearly the approach that makes the most sense, is most robust in terms of compliance and has all the necessary bits and pieces actually up and running. Equally, it is withering on the vine. 

The desired alternative to a Kyoto style global market has yet to be specified, but it builds on the reality of the World Bank report which shows that there are lots of carbon market systems in various stages of development, implementation or operation and that if they could somehow be linked together a global market would coalesce. This follows from the excitement around the proposed link between the EU and Australian Emission Trading Systems.

Both the EU and Australia have called their proposed linkup a bilateral arrangement. That may well be the case, but it would have been an order of magnitude more difficult were it not for the fact that both systems were designed under the Kyoto Protocol framework, recognized the same types of offsets, counted carbon the same way etc. I discussed this back in September last year after the linkup was first announced.

So here we are in a world that has started once down the pathway towards a global carbon market, built all the required institutions and instruments necessary to run it, balked at using them but perversely still wants the market to develop. As such, discussions continue on how a global market might catalyze, with four models now in the picture. They are:

  1. The creation of an international compliance unit and a standard set of offset mechanisms. This is effectively a spinoff of the Kyoto Protocol, using the CDM, but creating a new international unit to replace the AAU (the KP “glue”). Such a unit would underpin national ETSs that voluntarily opt-in to the global market. An international registry would exist to keep track of the market and manage national compliance.
  2. A set of “exchange rates” evolve between national compliance units and project mechanisms, akin to currency exchange rates. This then supposedly solves the problem of different levels of national ambition, quality of offset projects and so on. The problem here is that CO2 is more like a fixed commodity type instrument, whereas currency (where exchange rates exist) is not a commodity but effectively a security (like a company share). The value of a security is set by the value of the whole that it represents (e.g. a company, a country). By contrast, a tonne of CO2 will always be a tonne of CO2.
  3. Bilateral arrangements continue and linkages simply evolve over time. The challenge comes when A links with B then B talks to C but A doesn’t want to link with C. Also, some very different designs may never be suitable for linking.
  4. International Measurement / Reporting / and Verification rules are expanded to cover the necessary requirements for linking. This is effectively like (1) above, but without the international unit or internationally regulated compliance.

The most robust approach exists in (1), but this is currently looking like the least likely outcome – many nations seem to be opposed to such an approach, at least for now. The opposition appears to extend from the idea of the UN managing national sovereignty in any form, such as evaluating national programmes and allocating international units against them, even though this is positioned as a voluntary opt-in process.

The exchange rate approach has instant appeal, simply because it allows the market to decide. But so far, I have not seen an explanation as to how it might actually work.

Evolution through bilateral agreement appears to be the most likely path forward, so the question remains if there is any role for the UNFCCC in such an approach. Perhaps it’s role is limited to maintaining offset mechanisms such as the CDM.

This remains a nascent discussion, with much thinking to be done.

 

Whether it is via the auction of allowances or the taxation of carbon emissions, climate policy is increasingly being seen as a source of revenue into the national treasury. For example, the Australian carbon pricing mechanism will raise several billion dollars per annum in its fixed price period (currently $23 per tonne CO2) and EU member state revenues from the ETS have risen as power generators in particular now face full auctioning of allowances, rather than the mainly free allocation that has existed since the system started in 2005.

The issue that the collection of revenue raises is what to do with it. Government already has a long established process for this. Money flows into the national treasury, with spending set through the Budget process that occurs on an annual basis. The principal link between revenue collection and spending is the political agreement on the size of the deficit or surplus, otherwise the two are largely independent. But carbon revenue challenges this model. For example, although the EU ETS Phase III Directive doesn’t (nor can it) dictate how auction revenue should be spent by Member States, it does suggest that it is used as follows:

Member States shall determine the use of revenues generated from the auctioning of allowances. At least 50 % of the revenues generated from the auctioning of allowances referred to in paragraph 2, including all revenues from the auctioning referred to in paragraph 2, points (b) and (c), or the equivalent in financial value of these revenues, should be used for one or more of the following:

    1.  to reduce greenhouse gas emissions, including by contributing to the Global Energy Efficiency and Renewable Energy Fund and to the Adaptation Fund as made operational by the Poznan Conference on Climate Change (COP 14 and COP/MOP 4), to adapt to the impacts of climate change and to fund research and development as well as demonstration projects for reducing emissions and for adaptation to climate change, including participation in initiatives within the framework of the European Strategic Energy Technology Plan and the European Technology Platforms;
    2. to develop renewable energies to meet the commitment of the Community to using 20 % renewable energies by 2020, as well as to develop other technologies contributing to the transition to a safe and sustainable low-carbon economy and to help meet the commitment of the Community to increase energy efficiency by 20 % by 2020;
    3. measures to avoid deforestation and increase afforestation and reforestation in developing countries that have ratified the international agreement on climate change, to transfer technologies and to facilitate adaptation to the adverse effects of climate change in these countries;
    4. forestry sequestration in the Community;
    5. the environmentally safe capture and geological storage of CO2, in particular from solid fossil fuel power stations and a range of industrial sectors and subsectors, including in third countries;
    6.  to encourage a shift to low-emission and public forms of transport;
    7. to finance research and development in energy efficiency and clean technologies in the sectors covered by this Directive;
    8. measures intended to increase energy efficiency and insulation or to provide financial support in order to address social aspects in lower and middle income households;
    9. to cover administrative expenses of the management of the Community scheme.

A new report out recently from the International Council on Mining and Metals (ICMM) provides a detailed look at the current revenue recycling practices around the world. These include areas such as the following;

  1. Compensating trade exposed industries
  2. Support for lower income people to offset the carbon price.
  3. Support for Research and Development on low carbon technologies.
  4. Investing in low carbon / low emission projects and energy efficiency schemes.
  5. Adaptation to climate change.

ICMM Report

ICMM have built the report around a core principle which they extol, namely “apply climate change related revenues to manage a transition to a low carbon future”. The report is excellent and well worth reading, but it does raise a very fundamental issue around the direct hypothecation of carbon revenue. This is isn’t just a governance issue though.

Australia serves as an interesting recent example. The decision to link the Australian ETS with the EU ETS followed by the precipitous drop in EU carbon prices has caused Australian government carbon revenue projections to be adjusted (down) accordingly. Recent headlines in Australia suggest that those relying on government support for various energy initiatives are now concerned about the certainty of that support and the overall level of it going forward. This concern stems from the fact that carbon revenue has been earmarked against certain objectives, such as in the categories listed above.

The alternative approach is to largely delink the collection of revenue and its use, which is the standard practice for most government expenditure. After all, why should we imagine that the collection of carbon revenue and the needs of the economy to make the transition to a much lower emission state should follow the same path. In the very early years, expenditure on R&D and demonstration projects (e.g. CCS, solar thermal etc.) may require funding far in excess of the available carbon revenue, which is often low at this stage as governments introduce a new tax at a modest level or give the bulk of the ETS allowances away for free. Further, at this time the need for guaranteed support for those first tentative investments is critical for long term deployment pathways.

Some years down the road carbon revenue may be very large and probably in excess of the transitional needs, which then argues for the bulk of the money to flow to general revenue. This will lead indirectly to reductions in other taxes, but the linkage would be unspecified. In this case, forcing the use of a large revenue stream on specific objectives may become a market distortion in itself. It is the job of the underlying mechanism (e.g. carbon tax, cap-and-trade, energy pricing) to drive deployment of a new set of energy technologies, not government against the need to spend earmarked revenue.

This is an issue that will likely run and run, assuming carbon prices ever recover to some meaningful level. The ICMM report is a useful contribution to the discussion and certainly gives an excellent overview of current practices. However, it does enter the discussion with the somewhat myopic view of ongoing hypothecation.