David Hone

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. 

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 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.

At an event in Brussels earlier this week the EU Commission shared some initial thinking with business and NGOs on the consultation they have launched with regards the EU international position on climate change as we head towards COP 21 in France in 2015 where a deal is targeted for agreement. Although the EU remains very open to input on the shape of their position, it was clear to me reading the consultation document and listening to the presenter in Brussels that they are putting enormous emphasis on ambition – largely in the form of the size of national pledges.

In one sense this is hardly surprising given the world is a long way from anything that looks like a 2°C pathway, but it feels like it is becoming a distraction in itself, taking the emphasis away from the much more difficult job of putting in place the various tools and practices that might actually give us some chance of getting on a pathway that leads to some real reductions. The EU focus, like the international one, is divided into two parts, increasing global ambition to 2020 and post 2020 goals and targets.

The discussion reminded me of one I had about a decade ago with a senior policy maker in a Kyoto Annex 1 government. At that time the country had just ratified a pretty ambitious target under the Kyoto Protocol, considerably more than economically comparable countries. The government was trying to come to terms with the task of meeting the target, but the perceived difficulty of meeting the target was becoming a major distraction in itself. The conversation went something like this:

GM (government policy maker): The target is very difficult to meet.

Me: Agreed, but perhaps that shouldn’t be your primary consideration.

GM: It has to be, we have a target.

Me: Yes, but perhaps you should focus on getting a carbon price embedded in the economy first, then use that to start to drive change.

GM: But will we meet the target?

Me: You may not, but you would leave a legacy of an economy with emissions management up and running, the required capacity building done and emissions at least moving in the right direction. At the end of the day if you don’t meet the target, at least you will have made a good attempt.

GM: Yes, I understand. But what about the target?

Although this country has seen considerable regional activity (bound only by their own targets, developed as part of their policy making), the national government has struggled to this day with a target it felt somewhat helpless about. Early paralysis was almost certainly a contributing factor.

The current international discussion over a 2°C pathway is now at a similar stage and the EU appears to have fallen victim to this sort of thinking. Building a position on the need for more national ambition to meet the target, may well be a self defeating strategy. Rather, what is needed is a clear focus on two primary objectives;

1. Getting a carbon price into the global energy economy.
2. Getting CCS up and running and ready for rapid commercial deployment.

These are very specific climate objectives so play in to what the UNFCCC should be able to deliver, although they will also need to be supported by strong growth in other energy technologies, such as solar, nuclear, geothermal and the like (which shouldn’t necessarily be the objective of the UNFCCC at all). This also carves out a different role for UNFCCC, one which is related to pragmatic implementation of the tools and practices related to mitigation, rather than trying to create a frenzy of activity around targets and enhanced ambition.

Ambition will always be important, but without some clear ideas as to the pathways available, it becomes a rather empty and pointless discussion.

The first full day of 400+ ppm CO2 as recorded at Mauna Loa in Hawaii last week produced an outpouring of sentiment and grief from many, but the news has seemingly passed. Unfortunately, the arrival of such a day had become inevitable. Since the early days of the Keeling Curve at 315 ppm when it became clearly apparent that anthropogenic CO2 emissions were accumulating in the atmosphere, we have counting up the ppm to this day.

Despite an early clear warning to the Johnson Administration at 321 ppm, it wasn’t long before there was a brief worry about global cooling. Then, with atmospheric chemistry growing as a discipline (probably on the back of concerns about a cold war nuclear winter), we were distracted at 332 ppm by the first major anthropogenic global concern, the hole in the ozone layer. But with a treaty negotiated and ratification underway by 349 ppm (only 17 ppm to sort that one out), it didn’t take long for the science community to remember that another big issue was lurking in the shadows.

At 352 ppm and nearly 40 ppm on from the start of the Keeling Curve, James Hansen stated to a US Congressional Committee that;

• The earth is warmer in 1988 than at any time in the history of instrumental measurements.
• Global warming is now large enough that we can scribe with a high degree of confidence a cause and effect relationship to the greenhouse affect.
• Computer simulations indicate that the greenhouse effect is already large enough to begin to effect the probability of extreme events such as summer heat waves.

But it was another 13 ppm before the Kyoto Protocol was adopted by parties to the UNFCCC and 14 ppm more before it was finally ratified. 21 ppm later and it is a shadow of its former self, but at least with the legacy of some beginnings of a global carbon market. However, it is trading close to zero!! In the interim there was a valiant attempt at a new global deal, but even that was 12 ppm ago.

Our goal to be avoided, 450 ppm, is now feeling a bit close for comfort, given we are already at 400 ppm and 300 ppm was only passed under the previous British monarch.

Not to worry, it should only be another 15 ppm before a new global deal comes into force, although after more than 3ppm of discussion, the negotiations don’t really seem to have started. So we wait again, hopeful that someone has got a plan.

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 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.

As is well known by now, the EU MEPs voted against the specific backloading proposal that was put before the Parliament. However, the Parliament also voted against the outright rejection  of the proposal, which means that the Parliament formally has no position on backloading, possibly leaving the door open for a reformulated attempt at passage. I won’t dwell on that as it probably requires too much speculation and intrigue even for a blog.

The situation the EU finds itself in is spelled out in more generic form in the new Shell New Lens Scenarios. The scenarios tell stories about the future, but these are built around a series of paradoxes and pathways, with the latter illustrated below.

When the financial, social, political or technological capital encourage early action, it can result in effective change and reform. Room to manoeuvre exists and a new pathway forward is forged. But when such capital proves inadequate to withstand the stresses applied, behavioural responses delay change, causing conditions to worsen until ultimately a reset is forced or a collapse occurs. This is a trapped transition. 

The EU seems to be getting quite good at the latter, with the New Lens booklet giving the example of the EU handling of the financial crisis as a Trapped Transition Pathway;

The “can” keeps being “kicked down the road” while leaders struggle to create some political and social breathing space. So there is continuing drift, punctuated by a series of mini-crises, which will eventually culminate in either a reset involving the writing off of significant financial and political capital (through pooling sovereignty, for example) or the Euro unraveling.

Similarly for the EU ETS. While backloading was never the complete solution to the problems faced by the ETS, it could have given it enough momentum to see through a series of much needed reform measures, paving the way to a more robust and economically efficient climate policy framework. Instead, the Parliament has “kicked the can down the road”, setting up the conditions for further crisis later on. This in turn could do real damage to the ETS, leading to a very negative outcome, i.e. Write-off & Reset or Decay/Collapse. Many of those who opposed the backloading amendment argued that it was better to wait for the full structural reform discussion, but that discussion has no formal schedule and is unlikely to commence before the full debate on the 2030 roadmap. Even then, opposition will rear its head again and the structural reforms required could well be watered down.

The vote attracted quite a bit of media attention, with many articles and significant commentary.  Perhaps strongest of all was The Economist, which spoke of “profound consequences” that will “reverberate round the world”. The Financial Times took a different view in its editorial, effectively arguing that the backloading itself was akin to “kicking the can down the road” and instead called for the structural reform to start in earnest and “end the system’s absurdities”. This included border carbon adjustments, long term targets (of the 2050 variety) and dealing with the surplus of allowances.

I have and continue to be an advocate of emissions trading and carbon pricing, but it is looking increasingly unlikely that these systems will ever effectively trigger the one essential response to rising CO2 emissions, which is carbon capture and storage (CCS). There are too many other vested interests which continue to suck the life out of an ETS, including competitiveness concerns from participants, renewable energy targets, energy efficiency mandates, developing country needs and environmental justice to name but a few. These are all important policy desires, but they need to find their home elsewhere and not in the space occupied by an emissions trading system.

In the end if the ETS approach doesn’t deliver CCS in particular, then some form of mandated requirement could be imposed instead.

After a day in Brussels listening to European MEPs, it is clear that the Parliament vote next week on the Commission proposal to backload the auctioning timeline in Phase III of the European Emissions Trading System (EU ETS), is going to be very close. This is a policy proposal that was born out of the call by many participants in the EU ETS, as well as the European Parliament, to address the chronic allowance surplus and therefore begin to steer the CO2 price into a more useful range in terms of real action and investment. A positive vote on the proposal would also be the start of a more structured reform of the policy package designed to reduce emissions across the EU over the coming decades.

But in the frantic days left before the vote, clarity and reason are struggling to be heard over the clamour of opposition, so here are the top ten reasons why an MEP should vote to support the “backloading” amendment next week:

1. Market Confidence

The current CO2 price in the ETS is just a few euros. Even the assumption that there will be a robust price by 2030 (enough for deploying CCS in 2030s for example), but discounted back to now, should result in a higher price than the one we have. That means the market is discounting the ETS itself, in other words questioning its very existence in 2030. Nobody will invest given such an outlook. A positive vote for backloading will signal that the Parliament is prepared to act on the ETS and begin to restore confidence for energy investment decisions.

2. Low carbon Investment

Apart from its annual compliance function, which the ETS is delivering, its purpose is to provide an investment price signal. This in turn steers long term investment in the covered sector, providing support and justification for lower emission investment opportunities. The near zero price signal being seen today means the EU has returned to “business as usual” energy investment, which is even resulting in a resurgence of coal based power generation projects. This will just put upward pressure on EU emissions in the 2020s. 

3. Jobs

Rewind to 2008 and the €25-30 CO2 price, which in combination with the NER300 saw some 20+ CCS projects being considered. The construction of the world’s first CCS network was a real possibility. Today, with the exception of the UK where the necessary investment signal has been created in a national level ”carbon policy bubble“, these projects have been shelved. So too have the jobs that would have been created had they gone ahead.

4. Credibility

Investment depends as much on long term credibility of the policy structure as the policy itself. Business investment will not proceed unless there is a belief that the supporting policy framework is robust and long lasting and therefore able to deliver the necessary return on that investment.

5. Leadership

While there is an issue with the EU over leading on actual emissions reduction, this isn’t the case with leadership on policy development to reduce emissions. Today, many states, provinces and countries have implemented or are in the process of implementing an ETS on the back of the initial success in the EU. They are now watching developments here closely as the EU debates the future of the system. A decision to reject the backloading proposal will potentially undermine the implementation of emissions trading globally (see 10 below).

6. Support

There is a noisy opposition to this proposal, as there was opposition in 2003 to even having an ETS and again in 2008 to building a full policy framework for managing emissions over the longer term. But many companies, institutions, business associations and individuals see the clear merit of a functioning market based approach for reducing emissions and strongly support the proposal. The voice of some European business associations on this issue is not necessarily the consolidated view of business in Europe. 

7. Europe

The ETS was designed to build on the strength of a single EU market and deliver through the synergy that it offers. A weak ETS is leading to fragmentation of this goal as national policies are developed to fill the gaps. Just look at what the UK government is having to do to shore up investment cases which would otherwise be supported by the ETS. This only means a less effective and ultimately more expensive route to the same goal. 

8. Growth

This is all about investment in the EU energy system. Without investment guided by credible policy and clear market price signals, growth stalls.

9. Environment

The carbon price delivered by the ETS is the only mechanism in place to drive the development and deployment of carbon capture and storage. Without this one critical technology, the climate issue simply doesn’t get resolved. The demand for, abundance of and low cost of extraction of fossil fuels may well be unassailable this century, so atmospheric CO2 will continue to rise. 

. . . and most importantly at #10 (well it’s actually #1)

10. Economy and competitiveness

An emissions trading system can deliver the lowest cost emission reduction pathway for the economy, but to do this it needs to be left to do the heavy lifting. The very low price of CO2 in the EU today is not a sign of low cost abatement, but quite the opposite. Abatement is being driven by other policies, with the cost to the economy probably much higher than necessary. The ETS needs to be restored as the principle driver of change in the EU energy system. This will lower energy costs in the EU, which in turns helps competitiveness.

Supporting backloading now won’t deliver all this in one go, but it will get the wheels of change in motion and importantly, signal an intent on the part of the Parliament to correct the energy and climate policy framework and make the EU ETS central to the overall delivery of current and future emission reduction goals.

Back in the middle of last year, UNFCCC Executive Secretary Christiana Figueres tweeted:

Are you up to date with #climatechange acronyms? What is EASD? NMM? FVA? WEMA?

The answer is Equitable Access to Sustainable Development, New Market Mechanisms, Framework for Various Approaches and Workplan on Enhanced Mitigation Action. The fact that these are all linked together shouldn’t come as a surprise, given the importance that carbon markets, sustainable development and various national approaches have in developing a global approach to managing CO2 emissions. Two of these workstreams are of particular relevance to the development of a new global agreement and originated at the Durban COP under the Ad Hoc Working on Long Term Cooperative Action (AWG LCA), as outlined below:

The Framework for Various Approaches (FVA)

To conduct a work programme to consider a framework for such approaches (including opportunities for using markets, to enhance the cost-effectiveness of, and to promote, mitigation actions, bearing in mind different circumstances of developed and developing countries), with a view to recommending a decision to the Conference of the Parties at its eighteenth meeting.

 The New Market Mechanism (NMM)

Defines a new market-based mechanism, operating under the guidance and authority of the Conference of the Parties, to enhance the cost-effectiveness of, and to promote, mitigation actions, bearing in mind different circumstances of developed and developing countries, which is guided by decision 1/CP.16, paragraph 80, and which, subject to conditions to be elaborated, may assist developed countries to meet part of their mitigation targets or commitments under the Convention.

Both these workstreams continue, despite the formal end of the AWG LCA in Qatar. Although the initial focus on the NMM appeared to be solely on the development of a new crediting mechanism to provide offsets for developed countries (stemming from the text “ . . . may assist developed countries . . .”), the discussion has evolved. In particular, the FVA and NMM seem to be rapidly converging. At a recent meeting of the Climate Change Experts Group held under the auspices of the OECD, the Secretariat put up a slide which rather said it all.

Of course the two will remain different, but the integration of these two elements of the UNFCCC negotiations could be pivotal.

As part of its consultation process the UNFCCC also seeks the views of Parties and Observer organizations through a submission process. A recent call for submissions on the FVA and NMM has just closed, with the International Emissions Trading Association (IETA) submitting ideas on how FVA/NMM integration might work and the role that the NMM plays within such an approach. The IETA submission (IETA_FVA_NMM_March 2013) offers a pathway to deliver a functioning global carbon market that could then sit at the heart of the new agreement negotiated under the ADP (Durban Platform for Enhanced Action).

Much of the early debate at UNFCCC meetings focused on the specific role of a “market mechanism”. IETA defines a market mechanism as a process by which a market solves a problem of allocating resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, to having such decisions made by government. Rather, it represents the interaction of supply, demand and prices.

In the context of emissions mitigation, the trading structure within the Kyoto Protocol illustrates the part played by the market mechanism. Within its design, the functioning market mechanism is the Assigned Amount Unit (AAU), although many call the CDM the market mechanism. The AAU establishes the need for trade and creates basic supply and demand through the allocation process against national targets relative to actual emissions. This gives value to the AAU, which in turn creates demand and value for CERs under the Clean Development Mechanism (CDM). Without the AAU, the CER has no value and could not exist in a meaningful sense, as such the CDM alone isn’t a market mechanism.

IETA argues that the New Market Mechanism should be modeled on such a design, in effect replicating the role of the AAU under the Kyoto Protocol, but operating in a world of bottom up pledges, nationally designed trading systems and NAMAs – in other words, a series of various approaches operating within a common framework (the Framework for Various Approaches or FVA). This design for the core NMM instrument would give renewed value to the CER and allow the development of additional crediting mechanisms within a new framework. IETA argue that such an approach can scale-up beyond existing crediting mechanisms, such as the CDM and Joint Implementation (JI) to generate impact across entire sectors. Further, an FVA/NMM integration will enable countries to transition from project‐based crediting to real carbon pricing and economy‐wide trading of GHG emission reductions, by promoting mitigation across one or more sectors or sub‐sectors. The NMM will also embody a commitment to reduce emissions by the host country that reflects some level of aspiration across a sector or sub‐sector.

This is something of a brave new world for most countries, but it offers the opportunity for both developed and many developing countries to really embrace the idea of carbon pricing together with the operational and compliance flexibility delivered by trading of emission allowances. Without such an approach, mitigation costs are likely to be higher and less effective over the long term.

Dear ENVI Committee,

Next week you have to make an important decision on the future of the EU ETS. The Commission has proposed that 900 million allowances due to be auctioned at the beginning of this phase of the ETS be held back and returned to the market before the end of 2020. The objective is to remove a good portion of the allowance surplus that currently exists in the trading system and is putting extreme downward pressure on the resulting price of CO2 emissions. This isn’t a full solution to the problems that confront the trading system, but it is the only politically possible route forward that has been identified. It will provide the necessary breathing room for a more structural approach which must come over the next two years and which will cover the period through to 2030 and beyond.

The ETS was designed and implemented as the principal pricing mechanism to guide investment in power generation and industrial facilities across the EU such that long term CO2 reduction goals could be met at the lowest cost to society. Quite simply, it isn’t performing that role today. While Europe should be gradually shifting away from unmitigated coal and beginning to implement carbon capture and storage (CCS), coal consumption is on the rise and the CCS Demonstration Programme is on the brink of complete collapse. This is because the CO2 price in Europe today is effectively zero. The few Euros that an emissions allowance can command in the market is a reflection of future value, but even that is a cause for concern. At €4 today, this points to a price expectation in 2030 of €7, hardly an indication of a robust market based approach to managing emissions and introducing new energy technologies.

Many have argued that the market is working and delivering on the 2020 target. For this reason they have further stated that market intervention is not necessary. Unfortunately this is misguided and poorly informed thinking. While there is no doubt that annual compliance is functioning under the ETS and therefore the system will also force compliance in 2020, there is very clear evidence that longer term investment is not being guided by the ETS. Rather, investment is either not happening at all or is being driven by other factors and policies, some at EU level but many at Member State level as well. This is not leading the EU down a path of lowest cost emissions reduction, but is instead driving up energy costs in the EU. The very low price of CO2 in the EU does not represent low cost emission reduction opportunities being implemented, rather it is a very real symptom of a high energy cost pathway. This is important as it is not, or has ever been, the cost of CO2 that is impacting the competitiveness of EU industry. Even at previous levels of up to €30, in combination with the free allocation provisions for trade exposed industries, the CO2 price is a relatively benign factor.

The vote on backloading needs to be a “yes” vote. This signals the intention of the European Parliament to begin the process of restoration of the most cost effective approach to meeting Europe’s energy needs and reducing emissions over time. A “yes” vote won’t immediately restore the ETS to good health, but it is a start. Much work remains to be done. But following the advice of those who counsel for a “no” vote would mark the start of a very different pathway for meeting Europe’s energy needs – one that is less certain, more expensive and probably with much higher emissions over time.

Yours sincerely,

David Hone

Chief Climate Adviser, Royal Dutch Shell

Chairman, International Emissions Trading Association

The EU Emissions Trading System (ETS) is facing tough times. Last week saw the price fall to below €3 after the European Parliaments’ Industry & Energy (ITRE) Committee voted against the Commission proposal to amend the ETS Directive to allow for backloading of ETS allowances (a compromise mechanism which will shift the auction profile in Phase III to remove allowances in the short term). At such a price level the system isn’t really functioning, rather it is little more than a short term compliance accounting system for reporting on CO2 emissions.

In effect, this means that the EU doesn’t currently have an explicit carbon price to drive change in energy and infrastructure investment, despite 10 years of policy in place designed with that single goal in mind. The very low price level also implies that there is no expectation for a real carbon price ever developing. In theory these allowances could be bought and banked through to Phase IV. Assuming a cost of capital of 5% (and of course availability of capital to do so), a €3 allowance would only need to fetch €7 in 2030 to cover this, which would be well below the price of a market which is presumably driving investment in carbon capture and storage, surely a technology being seriously considered by then. So what is the thinking that might lead to an ~80% discount in market value? Three possible scenarios could lead to such an outlook;

1. The ETS has been stopped and the market doesn’t exist in the 2020s. In this case Phase IV would never be agreed and although there is formally no sunset clause in the system, it would effectively cease if no allowances for the 2020s were ever issued.
2. The surplus cannot be removed by then, even with tougher targets. New crediting mechanisms continue to flood the system.
3. Other policies will be doing the heavy lifting, leaving the ETS as a ”do nothing” policy instrument. The dominant policies will be ongoing renewable energy targets, CCS mandates, Emissions Performance Standards etc.

All of these are plausible, but I tend to think that the third one will be the ongoing problem. It is the problem today, as shown in the abatement curve chart below (an indicative CO2 price is shown on the vertical axis and the cumulative sum of reductions is shown on the horizontal access). The Renewable Energy Directive has brought projects forward which probably would not have happened until much later in the 2020s. This has had multiple effects within the EU energy system because of the presence of the ETS and its allowance based compliance. Whereas the 2020 goal might have been met through improvements in efficiency, fuel switching and the initial phase in of mature renewable energy technologies (all driven by the CO2 price), it has instead been met through a much less cost effective approach which forces the implementation of renewable energy projects first (including the less cost mature technologies), delays energy efficiency implementation and has the effect of pushing fuel switching and CCS into the 2020s and 2030s. The visible carbon price falls as a result, but the hidden carbon price operating in the economy is much higher.

 On top of this there was also the reduction in emissions as a result of the recession. This has had no real impact on the implementation of the renewable energy projects, but it further delays energy efficiency and pushes fuel switching and CCS into the 2030s and beyond. The resultant short term visible carbon price is near zero, but the same high hidden carbon price remains.

With a near zero carbon price, no visible sign of CCS and delays in implementing energy efficiency, policy makers may then turn to further mandates, such as the case with the Energy Efficiency Directive. This, in combination with yet another round of renewable energy targets, exacerbates the situation, leading carbon market traders to take the view that their allowances will have minimal value no matter how long they wait.

Very little of this is being discussed in the context of the backloading proposal. Rather, an emotive discussion about trade exposure, the cost of carbon for energy intensive industries and the right or not of the Commission to intervene in the market is dominating the airwaves.

The real discussion needs to be around the role of mandates when an emissions trading system is in operation. As the charts above show, backloading will have very little impact if the mandate issue is not addressed as well. Nevertheless, structural reform needs to start somewhere, so let’s hope the EU Parliament Environment Committee and the Member States will take a more positive view of the importance of the ETS and therefore the backloading proposal, when they vote in February and April respectively.

This week the organisation known as GLOBE (The Global Legislators’ Organisation supports national parliamentarians to develop and agree common legislative responses to the major challenges posed by sustainable development) met in London and launched its biannual review of national climate legislation. The GLOBE Climate Legislation Study is up to its third edition and covers the ongoing efforts in 33 countries. Of these, GLOBE claims that 18 countries have made substantial progress, 14 have made limited progress and one country has been singled out for taking a backwards step, Canada, but more on that later.

In their press release, GLOBE state that:

“The tide is beginning to turn decisively on tackling climate change, the defining material challenge of this century. In the past year alone, as described in this latest study by GLOBE International and the Grantham Research Institute, 32 out of 33 surveyed countries have introduced or are progressing significant climate-related legislation. In 2012 alone, 18 of the 33 countries made significant progress. This is a game-changing development, driven by emerging economies, but taking place across each and every continent. Most importantly it challenges how governments look at the international negotiations up to 2015 requiring much greater focus by governments to support national legislation.”

The report is a substantial piece of work and it steps through the programmes in each country in considerable detail, although the pages of tables raise the question as to what exactly is “climate legislation”. Legislation is categorised under the headings “Pricing carbon”, “Energy Demand”, “Energy Supply”, “Forests/Land Use”, “Adaptation” and so on. Of these, “Energy Demand” is largely energy efficiency measures and “Energy Supply” focuses principally on renewables (and nuclear in some countries). These two categories alone cover all but one of the countries (Nepal) surveyed, yet for the most part none of this is “climate legislation”. Rather, this is legislation that impacts the energy mix, but this does not necessarily translate into a reduction in emissions on a global basis and in many instances does not even lower national emissions. It simply augments the energy mix or lowers the energy and CO2 intensity of certain processes, which in turn can lead to greater overall use of energy and therefore increased emissions over the longer term. I have explored both these issues in previous postings, here and here.

This is not the case for the carbon pricing category, which GLOBE link to 11 of the 33 countries covered. But 4 of these are part of the EU and of the remaining countries only Australia has actually implemented the carbon price (arguably so has Japan, but the level is close to insignificant at about $1.50 per tonne). GLOBE also claim India has carbon pricing, but there is no such mechanism within the economy (there is a heavy focus on efficiency and a certificate trading system to drive it). Others include Mexico, South Africa, South Korea and China, all of which are in various stages of developing carbon pricing but none actually have.

Finally, there is the story around Canada. They are singled out as the only country to take a step backwards because of their decision to abandon the Kyoto Protocol (the same treatment is not given to Japan and Russia though) and the absence of a nationally implemented policy framework. Perversely, Canada is one country that made real and tangible advances last year, although emissions continue to rise in this resource rich economy. Quebec implemented its cap-and-trade system, carbon pricing continued in British Columbia and Alberta and the Federal Government did introduce its carbon standards for power stations, which will mean no new coal plants (without CCS) –  even the EU cannot claim such an achievement. Most importantly, Canada managed to get a large scale CCS project approved and construction started – similar attempts in the EU failed disastrously in 2012. This point is worthy of note, although GLOBE don’t mention it, given the critical role that CCS needs to play in mitigating emissions throughout this century.

The steps being taken in many countries to better manage energy supply, demand and mix are welcome, but to argue that this marks a “decisive turn” on tackling climate change and is “game changing” seems to be overly optimistic. BP released their latest Energy Outlook 2030 this week as well, which sees CO2 emissions rising sharply to 42 billion tonnes per annum by 2030, this despite non-hydro renewable energy nearly quadrupling over that time period. In total, nuclear/hydro/renewables/bio moves from 16% to 23% of the energy mix.

Finally, a P.S. to my previous post on the observation by many that “global warming has stopped”. James Hansen has just published a good analysis of this  and finds that a number of factors are contributing to the lack of change in overall global average temperature. This includes the behaviour of the El Nino/La Nina system (ENSO) and aerosol loading in the atmosphere. But he also concludes that natural variability must be playing a role. Worth a read.