Category: Emissions Trading

Articles about emissions trading

Carbon sinks and reform of the EU ETS

November 19, 2020

On Wednesday morning of this week, POLITICO held a virtual event: “Energy Visions:  Carbon removal and natural sinks in reaching climate neutrality by 2050”.

I was fortunate to have the opportunity to open the event with a few minutes of remarks to set the scene. This was followed by a discussion between the POLITICO moderator and Tina Bru, Norway’s Minister of Petroleum and Energy and then a panel session with;

  • MEP Bas Eickhout, Vice Chair of the Parliament’s Environment Committee and spokesperson for the Greens political group
  • Mauro Petriccione, European Commission Director General for Climate Action
  • Jannicke Gerner Bjerkås, CCS Director at Fortum
  • Gert-Jan Nabuurs, professor European Forest Resources, Wageningen University and Research IPCC Co-ordinating Lead Author

Although the panel couldn’t agree on how to handle the introduction of sinks into the EU as an emissions balancing mechanism, for me at least it is clear that the EU Emissions Trading System offers the simplest route forward. I have also written about this previously. See below for my opening remarks at the POLITICO event.

Good morning.
I want you to imagine for a moment that it is 2050, perhaps your autonomous electric car is already waiting in the driveway to shuttle you to the railway station, and as you step outside the house system shuts off most indoor electricity consumption. On your way to work you start thinking about an event your company had participated in a few days earlier; the last allowance auction under the EU Emissions Trading System. Now that the EU has reached net-zero emissions there would be no further allocation or auctions, in fact no more allowances.
But there is the familiar sound of planes at the nearby airport as the 787 and A350 departures continue, seemingly without pause. Although the first hydrogen fueled Boeing 808 and Airbus A500 planes can now be seen in the skies, a good proportion of air traffic still runs on jet fuel produced from crude oil. Biojet makes up the difference.
The railway station you use is in an industrial part of the city and the cement plant that was constructed there in 2030 using the most efficient process design of the day continues to operate, running on natural gas. It was built to supply concrete foundations for the gigantic 20 MW turbines in the burgeoning wind energy market.
These planes and industrial facilities are part of the 2050 EU landscape and continue to operate but do so in the absence of allowances under the EU Emissions Trading System. How will that be possible?
It is important to recognize that net-zero emissions in 2050 does not represent a point in time when there is no fossil fuel use and therefore no emissions. Today we are 70% dependent on fossil fuels for energy in the EU and although that number is clearly falling, it won’t be zero in 2050. In some cases the technologies required to remove dependence on fossil fuels don’t yet exist or are only at the earliest stages of their development. While some facilities using fossil energy should have carbon capture and storage operating by 2050, that won’t be true in all cases. Planes cannot do this and there will be regions within the EU where local at source carbon capture and storage either isn’t practical or cannot be implemented.
Rather, net-zero represents a balance between remaining emissions and the remote removal of carbon dioxide from the atmosphere. This can be achieved by 2050 in the EU, but we need the policy tools to guide us towards such an outcome. The EU Emissions Trading System is an excellent candidate for change.
Today the Emissions Trading System operates by surrendering allowances against emissions, but when the system ceases to have allowances in 2050, what happens? The Emissions Trading System needs to progress from an allowance-based system to one that manages net-zero emissions by requiring the surrender of sink based units against annual emissions. A sink unit wouldn’t be issued in the way an allowance is but would be created through projects that captured carbon dioxide from the atmosphere and permanently stored it. There are broadly three ways to do this;
One – through industrial projects that strip carbon dioxide from the atmosphere and store it geologically or use it in a way that offers near permanence, such as in making building materials.
Two – through the use of biomass to create energy but capturing and storing the carbon dioxide released in the process, which originated from the atmosphere as the biomass was grown. There is a bio-ethanol plant doing this today in the United States.
And three – by engaging in natural based projects such as rewilding and reforestation, or encouraging farmers to employ different grazing and cultivation techniques which help build soil carbon stocks.
Verified removal units from these types of projects will need to be part of the Emissions Trading System so that some parts of industry and various energy system services can continue operating past 2050. But the change to the trading system needs to be well before 2050, ensuring that enough capacity can be created by incentivising sink activity. A very early milestone would be establishing the certification process for removals within the EU.
Earlier this year Shell released a scenario Sketch illustrating a pathway forward for the EU to reach net-zero emissions by 2050. In that analysis, industrial bioenergy facilities with carbon capture and storage start to operate in the EU by 2035, which points to market signals emerging in the 2020s for project activity to start. We also showed that a gap between what can be achieved and what needs to be achieved for net-zero by 2050 also starts to emerge in 2035. This gap could be filled with nature-based sinks, at least until industrial capacity can catch up, but once again this will require a commercial carbon sink mechanism to incentivise action.
We shouldn’t forget about the period after 2050, at which point the world may require progressive regions such as the EU to extend their reductions into negative territory, in other words having more sinks than emissions. Trading of sinks could be a valuable export opportunity for the EU.
The EU Emissions Trading System is the right commercial lever to drive sink activity forwards, partly because of its carbon pricing structure but also because it must evolve to become a sinks and sources balancing system by 2050. As part of the current rethink of the trading system in preparation for 2030 and beyond, a sink mechanism should be included. Initially this could simply be the recognition of sink units from projects within the EU but should eventually be extended to global recognition of units. These would be transferred under Article 6 of the Paris Agreement along with the necessary safeguards to guarantee environmental integrity and the adjustment of trading partner carbon registries.
Without action in the 2020s to incentivise carbon sinks and subsequent follow-up in the 2030s, the EU may find itself unable to meet its net-zero emissions goal in 2050.
Thank you

An alternative to allocating removal quotas

August 12, 2020

Over the last few months I have posted a number of articles on carbon dioxide removal (CDR), highlighting the need for this set of practices and technologies in achieving the goals of the Paris Agreement. The discussion on CDR has also been growing in the academic community, as illustrated by a recent article in Nature Climate on equity considerations relating to the allocation of carbon dioxide removal quotas. Like many before it the article recognizes the necessity for CDR, but focuses on how to distribute the burden of implementing it at scale.

In calculating the required distribution of CDR quotas, the authors use a mid-range CDR cumulative allocation quota of 687 GtCO2 over the period 2018-2100  (as used in the IPCC SR1.5 P3 scenario) to 176 of the 197 UNFCCC parties following Responsibility, Capability and Equality principles. Under the Responsibility (or proportionality) principle, which relates historical emissions from a given country with responsibility to provide solutions to global warming, CDR efforts would increase with greater accumulated historical emissions. By contrast, the Capability (or ability-to-pay) principle establishes that countries better able to solve a common problem should contribute more, which implies wealthier countries are assigned a greater share of CDR efforts. Finally, according to the Equality (or environmental justice) principle, every individual should have the same right to be protected from pollution. Hence, equal per capita CDR is here enforced across countries irrespective of current (or past) emission levels and economic capability.

This is all well and good and the analysis is useful, but it falls foul of one major issue; the UNFCCC has almost no successful track record of distributing burden or enforcing compliance. The closest point that was reached in terms of targets and compliance were the requirements for developed countries within the Kyoto Protocol; unfortunately that didn’t end well. So while it is helpful to understand how the burden ought to fall, there is little chance of devising an international system of allocation to implement burden sharing. Rather, the world has settled on the architecture of the Paris Agreement which sees countries taking action according to their own nationally determined contributions (NDC) to the overall goal of limiting warming to well below 2°C. Nevertheless, within that structure there is some hope.

The Nature paper also makes the point that the capacity to implement CDR is not evenly distributed around the world. Geological storage of carbon dioxide is easier in some locations than others and the opportunity to pair bioenergy production with CCS for negative emissions may only reside in certain places. It is also clear that natural carbon storage through reforestation will only be possible at large scale in certain countries due to land availability and climate considerations. Small industrial states like Singapore are a great example of this. The country has set a course towards net-zero emissions in the second half of the century, yet its borders encompass significant hard to abate emissions and there is little or even no local capacity for CDR. What should they do?

So we have a problem of uneven supply and unclear distribution of demand, within the framework of the Paris Agreement. The solution to this problem is not one of allocation, but one of trade, making use of Article 6 of the Paris Agreement. It does of course depend on countries wanting the Paris Agreement to reach its goals, which requires that there is some sort of progressive implementation of a net-zero emissions goal within respective NDCs. The EU, UK, New Zealand and a handful of others have already set goals of 2050 for net-zero emissons. As noted above, Singapore is also on a pathway to net-zero, with current policy considerations placing that after 2050. By contrast, Bhutan is already carbon negative and Costa Rica plans to cross net-zero in the near term.

In a posting last year I showed how Article 6 and various forms of CDR could be used to reach net-zero emissions globally. The use of a trading option allows those with a clear goal of net-zero emissions to invest across borders to unlock removal potential that would otherwise remain dormant. There is no allocation or distribution of quotas, only the self-imposed requirement to reach net-zero emissions through a nationally determined contribution. We could imagine a gradation of such NDCs stretching from now (e.g. Bhutan) to 2100 (e.g. a heavily industrial emerging economy), but with all countries either investing in or delivering CDR capacity, driven by the market and its distributive capacity towards lowest cost outcomes.

The picture I developed to illustrate Article 6 starts like this, with no CDR in place;

Screenshot 2019-10-08 at 23.15.54

. . . and ends up like this, with significant CDR capacity realised through cross border trade and investment.

Screenshot 2019-10-08 at 23.17.18

While this is a simple illustration, it isn’t a world that depends on quotas and allocation, but it is a world that has a desire and willingness to get to net-zero emissions.

Shining a light on carbon dioxide removal

July 13, 2020

An important research paper emerged recently from the German Institute for International and Security Affairs (Stiftung Wissenschaft und Politik, SWP), raising the profile of carbon dioxide removal (CDR) from the atmosphere. CDR covers a set of technologies and practices that result in carbon dioxide already in the atmosphere being captured and stored, effectively removing it from the system where it is leading to surface temperature warming. This might be done for one of two reasons;

  • To balance emissions from an ongoing source of carbon dioxide, so there is no net effect on atmospheric carbon dioxide levels and therefore no warming associated with that source. This is basis for the term net-zero emissions.
  • To reduce the level of carbon dioxide in the atmosphere in an attempt to lower surface temperature warming. This might be necessary if warming has exceeded a particular goal, such as 1.5°C, and there is a need to bring the temperature back down again.

There are two categories of CDR and within each of them a subset of approaches. These are;

  1. Natural solutions, which come from increasing the total carbon held within the natural biosphere. Examples include;
    • Reforestation and afforestation.
    • Various farming practices to increase soil carbon.
    • Wetland restoration and expansion.
    • Sustainable harvesting of timber plantations to build structures such as houses, where the carbon is locked away for decades or longer.
  2. Technical solutions linked with geological storage of carbon dioxide. Examples include;
    • Direct air capture of carbon dioxide paired with geological storage (DACCS). This happens today on a very small scale in Iceland [Link], but is likely some years away from a first large scale demonstration.
    • Pairing traditional carbon capture and geological sequestration (CCS) with an energy facility using biomass as the feedstock (BECCS). This is indirect air capture in that the carbon dioxide is removed from the atmosphere when the biomass is grown. This is a scalable technology today and a major facility exists in the USA. Bioethanol production is widespread in the USA, with the fermentation step producing significant amounts of pure carbon dioxide. At such a facility in Illinois around one million tonnes per year of this carbon dioxide is captured and geologically stored, effectively removing carbon dioxide from the atmosphere. An example discussed in the EU Commission’s Hydrogen Strategy released recently notes the possibility of negative emissions from clean hydrogen production (bio-gas +CCS).

Carbon capture and storage is a version of (2) above, but the capture is directly associated with the generation of carbon dioxide, such that it is never emitted. As such, there is no removal from the atmosphere, but the geological storage step remains the same.

The paper gives a good summary of the approaches for CDR  (both natural and technology based) and picks apart the various reasons for an almost complete lack of action so far. It also makes the case for why CDR is important and notes the lack of progress so far. Two key findings are given below;

If the EU truly wants to meet its own climate policy goals, it will not be able to avoid pursuing the unconventional mitigation approach of CO2 removal from the atmosphere – in addition to far-reaching conventional emission reduction measures.

Although the European Parliament is one of the more progressive players in EU climate policy, it has so far made little progress on the issue of CDR. During the negotiations on the Regulation on the Governance System for the Energy Union, which was concluded in 2018, it was the EP which succeeded in getting the Council to explicitly mention the long-term option of a European net negative emissions pathway. However, this did not result in any noticeable action on the part of the EP with regard to CDR. In its own-initiative reports, CO2 removal has not been given priority to date. Nor has a firm CDR approach played any role in recent legislative procedures – for example, in the amendments to the Emissions Trading Directive, the Effort Sharing Regulation, and the revision of the LULUCF Regulation during the last legislative period. Currently, there is no solid evidence of how the EP in its current composition will position itself on CDR. The first indication will be the EP’s negotiation position on the EU Climate Law.

Nevertheless, the EU Commission has recognised the role of CDR in its strategic long-term vision for a prosperous, modern, competitive and climate neutral economy in 2050. They include within the report the image shown below.

Screenshot 2020-07-13 at 15.55.46

Some weeks ago, Shell released a Scenario Sketch which illustrates how the EU might achieve its goal of net-zero emissions in 2050. The Sketch made maximum use of available and expected technologies, including CCS on various industrial facilities, but a gap still remained with emissions of some 700 million tonnes per annum. This gap was filled with CDR, both nature based and artificial. In 2020 (pre-COVID 19), the EU energy system emission flows can be represented as shown below (all numbers in million of tonnes CO2 per year);

EU NZE 2020

For the most part, energy needs are met with fossil fuels, with some portion of that (~160 Mt per year) ending up in finished products such as plastics. Net emissions of carbon dioxide exceed 3 billion tonnes per annum. The use of bioenergy in the EU is also shown, but is effectively emission neutral. A much smaller portion of the energy system is non-emitting, from sources such as wind, solar and nuclear.

By 2050, the picture looks very different. The non-emitting sector has grown substantially and net emissions are zero. However, actual emissions from the continued use of fossil fuels is 670 million tonnes per year and the total potential emissions from fossil fuel use is 1.13 billion tonnes per year.

EU NZE 2050

Several factors are contributing to the overall net-zero outcome;

  • Some fossil fuel is use for making products such as plastics, as is the case today.
  • A bioplastics industry has emerged, with 50 million tonnes per year of atmospheric carbon dioxide ending up in finished products.
  • There is large scale use (240 million tonnes per year) of CCS in industry, such as in smelters and petrochemical plants.
  • There is 620 million tonnes per year of CDR, in two categories;
    • 350 million tonnes of BECCS.
    • 270 million tonnes of nature based solutions.

While the use of CDR may well decline in the ensuing decades after 2050 and might have vanished completely by the 22nd century as further substitution for fossil fuels permits, the 2050 situation is one of very large scale deployment of technologies and practices that are either non-existent in the EU today or hardly visible. The level of deployment is such that a major commercial solution needs to emerge, driving the business sector to invest in CDR.

That solution could come from within the EU ETS as I discussed in a recent post, or a new mechanism could emerge that forces deployment of CDR through mandate or encourages it through a feed-in tariff. Both have been used successfully to get the renewable energy industry going.  Whatever the approach for activating a commercial response, it needs to start soon. Building an industry on the scale shown will take many years and time is in very short supply.

The SWP paper comes to the same conclusion, i.e. start now, but it is already proposing upper deployment limits for individual sectors and overall use of CDR so as to maximise direct mitigation and the shift away from fossil fuels. This is hardly the way to unleash a commercial engine. Those who invest in CDR need to be assured that there isn’t some artificial limit put in place that may in turn limit the return on their investment, particularly if they are early adopters who take on additional commercial risk. In any case, CDR isn’t an inexpensive option that is easy to do – even large scale reforestation in the EU will be a challenge in terms of land use, maintenance, protection and longevity. The case for investing in CDR may well be a hard won battle in the boardroom, with many companies preferring to find direct mitigation options anyway.

The time for turning our minds towards CDR is now, as the EU rolls out its Green Deal and sets the rules for engagement that may well prevail to 2050 and beyond. Although the subject of CDR has been broached and by 2023 the EU Commission wants to put forward a carbon removal certification framework, CDR needs to be a priority within the immediate policy framework that emerges from the European Parliament.

 

Formulating an Article 6.2 transaction

June 1, 2020

While Article 6 of the Paris Agreement remains in negotiating limbo, the text that emerged from Madrid for Article 6.2 gives a very strong indication of how countries view this mechanism and what will be required between Parties to see transactions begin to emerge. This includes the need for a carbon budget based Nationally Determined Contribution (NDC) or an NDC for which a budget can be formulated and a corresponding adjustment of NDCs to ensure environmental integrity and the avoidance of double counting. This is clearly spelled out in the Madrid text – III. Corresponding adjustments / B. Application of corresponding adjustments, paragraphs 8 to 13.

However, the actual buyer and seller will likely be private entities operating in the two countries making use of Article 6 and while the Paris rulebook is an important consideration in their transaction, the requirements of the rulebook will not be met by the transaction itself. Rather, the transaction of units between the buyer and seller must trigger a set of actions by the respective governments such that the Paris Agreement rules can be adhered to. This means that a link must exist between the inflow and outflow of carbon units within each economy and the implementation of the respective NDCs. Without such a link, the transaction effectively sits in the global voluntary market, which in turn means that the transaction cannot be used to meet compliance obligations that are crafted to guide the economy towards the goals described in the NDC.

The simplest such link that currently exists is where two emissions trading systems are joined, such as between Switzerland and the EU. Private entities operating within these systems can trade EU ETS allowances and Swiss ETS allowances, use the allowances for compliance in their respective country and know that there is some cascade upwards to the EU and Swiss NDC accounting. The approach is very simple, transparent and effectively a non-issue for the participants in the transactions. But what happens when there isn’t an existing trading system in place?

In the case of the Clean Development Mechanism (CDM) under the Kyoto Protocol, a project could be implemented in a developing country and upon agreement of the host country, the CDM Executive Board and a verifier, certified emission reduction units (CER) were issued. Apart from the checks already mentioned, these units were issued without context in that they didn’t relate specifically to a national plan to reduce emissions or have any economic bearing on the project host country other than bringing in valuable foreign investment. In the case of the buyer, the transaction was managed through the accounting rules of the Kyoto Protocol because the CERs would be added to the national inventory of assigned amount units (AAU) and then could be used for compliance against the national target. There was still a need for a system to cause the buyer to make the purchase, which in the case of the EU was the compliance requirements of the EU ETS.

But in the case of an Article 6.2 transaction, there is an impact on the national economy where the seller resides. Firstly, the requirement for a corresponding adjustment to the NDC means that an NDC carbon budget must be established. Secondly, the adjustment means that further reductions in country must be made to compensate for the sale, so a mechanism should ideally exist to ensure that those reductions are made and that they don’t cost more to implement than the proceeds from the sale. In the case of linked emission trading systems, the inherent design of the trading system provides this mechanism. A similar problem could exist at the buyers end, but the issue is often simpler. For example, the buyer may be using the units as an allowable alternative against payment of a carbon tax, in which case the decision to buy is based on the cost of available units from the recognized sources versus the payment of the domestic carbon tax.

Without an emissions trading system in place, the host country looking to generate income through the sale of units under Article 6.2 (ITMO or Internationally transferred mitigation outcome) has the perplexing problem of both tying the sale to the NDC and establishing whether the sale is of economic interest for the country. Depending on the eventual structure and agreement on Article 6.4, the same problems could also emerge. This means that the implementation of Article 6 will have a profound impact on the shape of mitigation policy in participating countries. It may be the case that the only way of solving this problem is through the implementation of a domestic emissions trading system, which makes Article 6 a catalyst for further uptake of cap-and-trade architecture (i.e. emissions trading systems). That would be a good outcome for all concerned.

The third runway by the numbers

March 4, 2020

Last week the project proposal for a third runway at Heathrow in London was put on hold after a successful court challenge based on climate concerns. The courts sided with the plaintiffs who argued that the proposal did not adequately demonstrate how its overall emissions impact would be managed given that the UK has now adopted a target of net-zero emissions in 2050. While the emissions from the project itself are modest, with cement probably being the largest component, the ongoing emissions from aviation expansion as a result of the project could be considerable on a cumulative basis over many years.

At this point I should note that the third runway at Heathrow has been a contentious project since it was first proposed and there are many reasons put forward as to why it should or should not be built. My focus here is on the expected expansion of aviation in and out of the United Kingdom and the resultant emissions. Aviation has grown rapidly over the half century since the introduction of the widebody Boeing 747 (by which point it had grown considerably since the first intercontinental jet services some twenty years prior), to the extent that there are now over four billion passenger flights per year globally.

Of course airlines, airports and aviation companies are responding to a strong demand signal from consumers (the UK is an island). In order to drive change consumers also need to understand their own externalities and be prepared to manage them, most likely by a cost passed through with the ticket purchase.

A 2017 UK Department of Transport assessment of aviation showed growth for both capacity constrained and unconstrained scenarios, with the low constrained case showing a 60% rise through to 2050 and the high unconstrained case showing a doubling of demand.

UK Aviation Growth

Heathrow consumes about 20-25 million litres of Jet-A1 every day, so a third runway would increase this by 50%, or some 10-12 million litres per day.

A double check based on aircraft efficiency and expected distance of travel gives a similar number. If we assume that the runway operates for 18 hours per day with a flight interval of 90 seconds, with 50% of the time being used for take-off, that implies 360 additional departing flights every day. If we then assume that every flight is dedicated to longer haul, say New York or Dubai, then that means about 37,000 litres of fuel per flight based on the improved efficiency for modern aircraft of about 2.2 litres per 100 km per passenger, 300 passengers and some 5,500 km of travel, or a total of just over 13 million litres per day.

The consumption of 13 million litres of Jet A-1, 365 days a year, will result in the release of about 12 million tonnes per year of carbon dioxide when combusted. So the question that needs to be asked is how the mitigation of 12 million tonnes per year will be organised such that it has reached net-zero by 2050.

The answer lies with the sector itself, not just the airlines that own the planes or the companies that make them or the airport that is building the runway or the fuel providers that sell Jet A-1. All these parties will have to collectively own the problem and set about solving it. There are already the beginnings of some answers, but efforts will need to be accelerated such that the question posed through the court in relation to the net-zero goal of the UK can be confidently answered. For example;

All the above are still in their early stages of development and deployment, with bioJet looking to be the most promising immediate option. Nevertheless, over the coming thirty years it should be possible to bring UK aviation emissions to net-zero through some combination of the above.

But who should be responsible for implementing the strategy? Within the aviation industry, a framework already exists under which all this could be managed.

The airlines have already agreed and are now beginning to implement the CORSIA framework under the auspices of ICAO. This sets out a journey through to 2035 which will see global aviation emissions limited to current levels. It includes a facility to balance emissions through a trading arrangement where they cannot be directly mitigated through fuel changes, although the final rules of this have yet to be agreed and will involve Article 6 of the Paris Agreement. In almost any aviation scenario there will be unmitigated aviation emissions in 2050. CORSIA will need to evolve further after this first phase to be aligned with the emerging net-zero goals in many countries with major aviation hubs. The trading arrangement will eventually need to focus on removal of carbon dioxide from the atmosphere in combination with geological storage.

This form of emissions challenge to projects and development may well become more frequent, not just from campaigners but also from regulators, as the governments they represent grapple with the task of getting to net-zero emissions. There will likely be a real shift in focus from the projects themselves and their subsequent operation (i.e. Scope 1 plus Scope 2 emissions), to the broader impact they have on societal emissions (i.e. Scope 3 emissions). That will place more onus on project developers to think through and then manage the broader implications of their actions.

Getting to net-zero emissions with the EU ETS

February 3, 2020

Perhaps the biggest policy development of 2020 (possibly lasting through to 2023 or so as all the legislative requirements are agreed and put in place) will be the EU laying the foundations for its declared goal of net-zero emissions by 2050. Although the goal of net-zero was always there as an intention, the date of 2050 brings it close enough to require policy makers to give thought and then substance to the mechanisms that will deliver it. One such mechanism is the EU Emissions Trading system, which has now been operating for 15 years (but effectively 20 years from a design perspective) and covers the large emitters across the EU as well as encompassing intra-EU aviation.

The EU ETS functions by progressively reducing the number of allowances available to emitters on a linear trajectory, which means that under current plans the number of allowances issued each year will fall by about 48 million units, with 2020 allocation limited to around 1.8 billion allowances. Subsequent phases of the EU ETS, potentially including the current Phase IV, will need to see an increase in the annual reduction of allowances such that the system reaches zero in 2050. Based on a continuation of the EU ETS under the current trajectory it won’t reach zero until the late 2050s. A revision in the system could operate from the start of Phase IV, i.e. in January 2021, which means that the current 2030 goal would change. If the revision comes in from the start of Phase V, then that implies an even steeper decline for the period 2031 to 2050.

While the mechanics of the cap-and-trade architecture is very simple, the reality of 2050 is not. Under a revised EU ETS, from January 1st 2050 (or perhaps 2051) there will be no further allocation of allowances, either by auction or freely given. Yet this may not be a time in which there are no emissions – thirty years is possibly insufficient time for the complete turnover of everything in the large emitters system. Some industrial facilities, much of the aviation sector and even some power stations in parts of Europe may still be using fossil fuels as their energy source or will be emitting carbon dioxide from a conversion process (e.g. cement manufacture). Any remaining banked allowances and allowances in the Market Stability Reserve (MSR) will be quickly consumed against these ongoing remaining emissions.

The potential for remaining EU emissions can be seen in the Shell Sky Scenario, released in 2018. Even though the scenario represents a period of very rapid energy system and industrial transition, the time from now to 2050 isn’t sufficient to bring heavy industry, aviation and power generation to zero. Even in 2070 significant aviation emissions remain and require balancing with the net negative situation reached in the power sector through the deployment of bioenergy with CCS.

EU ETS Emissions - Sky

N.B. Sky aviation emissions include international aviation whereas the EU ETS does not.

So how will the EU ETS work once it runs out of allowances?

The key to the future operation of the EU ETS lies within the objective it is trying to deliver, net-zero emissions. Net-zero means that there is a balance between remaining emissions and the removal of the equivalent amount of carbon dioxide form the atmosphere, i.e. a sink. This stems from Article 4 of the Paris Agreement;

Article 4

  1. . . . . . . so as to achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century . . . . . .

However, the EU ETS is currently an allowance issuance and surrender system, which points to a change in its structure at some point in the period leading up to 2050. This would require the introduction of a unit into the EU ETS that represented a ton of carbon dioxide removed from the atmosphere and permanently sequestered. From 2050, the EU ETS would then become a system without allowances that managed the balance between remaining emissions and sinks, at least until emissions actually reached zero. Policy makers would need to define the parameters of the unit such that it could be relied upon to provide sufficient volume for the required balance. Two considerations would be key;

  1. Whether the units came from within the EU or also from outside the EU under the accounting framework of Article 6 of the Paris Agreement (i.e. the use of corresponding adjustments between NDCs to avoid double counting);
  2. The type of sequestration opportunities permitted, which could include geological (e.g. direct air capture with geological storage), natural (e.g. reforestation projects) or product based (e.g. manufacture of products used in society such as plastics).

These units wouldn’t be issued directly by the EU governments in the way allowances are today, but would be made available for sale to emitters from projects that sequestered carbon dioxide. Governments would of course be involved in issuance of units to the sequestration projects against verified permanent storage of carbon dioxide.

A further consideration would be when such a unit is introduced into the EU ETS and how sufficient removal capacity is developed prior to 2050 to ensure there is enough available when net-zero emissions is required. This will be a judgment call arrived at through transition scenario analysis. However, the point in time when the unit will first be needed is not 2050, but when the allowance decline pathway first crosses the actual decline in emissions pathway. The illustration below shows how this might happen as reductions become more challenging over time.

Notional EU ETS Pathway
To date, the actual reduction in emissions has typically been faster than the decline in allowance availability, hence the allowance surplus that developed in the 2010s and the creation of the MSR which has acted as an allowance removal mechanism (but it can also return allowances). These lines could potentially cross at some point in the 2030s, so the point of introduction could be at the start of Phase V of the ETS, i.e. 2031.

The EU Commission has developed a similar chart for their own communications, although this is for the transport sector as a whole, much of which is not currently covered by the EU ETS. However, expanding coverage is another option on the table. If such an expansion introduces more activities that may have remaining emissions in 2050, then the need for a sink unit becomes more important.

EU Transport Emissions

A provision such as described above might be seen by some as a backstop in EU ETS, but nevertheless an essential one for continuing smooth operation of the system. Without it, the EU ETS could become unstable  in the years approaching 2050 as immediate mitigation opportunities for remaining emissions become unavailable and there are insufficient allowances available to cover these emissions.

The future of carbon pricing

January 13, 2020

At this time of the year I usually review the progress in implementing carbon pricing around the world, but it seems timely to look more closely at where carbon pricing policy might be headed. That timeliness is driven by the bushfires in my home country of Australia, where the media have resurfaced the 2008 Garnaut Report. The Garnaut Climate Change Review looked in depth at the climate issue and also recommended ways in which the Australian Government might take on the task of emissions mitigation. The recent resurfacing of the report has come about due its very specific comments on bushfires, which have always been an important issue in Australia. Notably, the report says;

Garnaut Report on Bushfires

So here we are in 2020 and the effect is indeed very observable. But of equal importance are the recommendations on mitigation that Garnaut put forward. He proposed that Australia implement an emissions trading system, similar to that operating in the EU, with a view to inserting a carbon price into the Australian economy and allowing it to efficiently drive down emissions. After more than a decade of political wrangling, there is no carbon price in Australia and energy system emissions remain today at about the level they were when Garnaut penned his report.

Garnaut Report ETS

Unfortunately the Australian story is not unique. As the reality of a changing climate has become increasingly apparent and despite widespread agreement among economists that a carbon pricing system of some form is the most economically efficient way of driving down emissions, the global uptake of this policy instrument remains limited.

The World Bank compiles a detailed list of carbon pricing systems and it shows that over 50 systems exist around the world, notionally covering over 20% of global emissions. But a deeper look reveals that most of these are very light taxes, typically under US$10 per ton of carbon dioxide. Many of the other systems are still in various stages of implementation, but there are a handful of systems that stand out;

  • The EU Emissions Trading System has been operating for 15 years and trades close to €25, but spent more than six years below €10 following the 2008 financial crisis. It covers half of EU energy system emissions.
  • The British Columbia carbon tax has been in operation since 2008 and operates at CAN$40 per ton.
  • The California cap-and-trade system (also linked with Quebec) has operated since 2012 and trades at nearly US$20 per ton.
  • Korean ETS has been operating since 2015 and trades at nearly US$30 per ton.
  • New Zealand have been a stalwart of emissions trading and have an economy wide system that has operated for many years and currently trades around NZ$30.

 

World Bank Carbon Pricing

Source: World Bank

Nearly a quarter of a century into carbon trading and pricing, taking the 1997 Kyoto Protocol as a starting point, progress is muted at best and certainly not commensurate with the task at hand. In the Shell Sky Scenario, carbon pricing is a critical component for success, with implementation becoming global over the 2020s and a price range of $25-$60 developing by 2030.

Sky Carbon Prices

But the harsh reality is that there is little sign of this happening, despite the need and despite the economic efficiency of the approach. Implementation can be challenging for policy makers; in some countries even small forced price changes in goods and services, sometimes linked to carbon price implementation, have led to street protests and worse. While some governments have tried to impose carbon pricing, the outcome often ranges from tepid implementation at a very modest price level to eventual retraction (e.g. Ontario). Others just seem to be philosophically allergic to the idea. So where does that leave us?

Explicit carbon pricing through taxation and trading systems may well have seen its best days, which perhaps means a turn towards more implicit mechanisms through standards and mandates. These may well be more expensive for society to implement but are often price opaque or even price invisible. Renewable energy mandates have had considerable success, so we may well see this type of policy imposed more broadly in areas such as transport (favoring Electric Vehicles) and home heating (requiring certain technologies in new builds and renovations). Within the industrial sector, a standard that prevents emissions would force the use of carbon capture and storage, with an implied carbon price of perhaps $50-$100 per ton.

The financial markets are beginning to impose a carbon price of sorts, with finance and investment for coal technologies becoming harder to find and some equity market commentators attempting to dissuade investment in certain companies with links to fossil fuels. In the week of the UN Climate Summit last September, an alliance of several large pension funds and insurers responsible for directing more than US$ 2.4 trillion in investments and under the name Net-Zero Asset Owner Alliance, committed to carbon-neutral investment portfolios by 2050.

Some governments are looking at border tariffs based on the carbon content of imported goods, which offers another more opaque means of imposing a carbon price.

Despite the above, carbon pricing won’t go away and as emissions eventually fall (which they will) a price could well emerge as a direct cost for carbon dioxide removal. The aspiration or even requirement to be a net-zero emitter will mean the funding of atmospheric carbon dioxide removal to balance remaining emissions. This could occur through natural solutions such as reforestation, or through technical means such as direct air capture and geological storage, but probably both. Sequestered carbon could become a commodity of sorts, trading widely and imposing a form of carbon price throughout society.

At the start of this new decade, carbon pricing may well be at a crossroads. Direct implementation through taxation and emissions trading systems is looking harder, even though it remains the preferred solution from an economic efficiency perspective. While the pressure to develop carbon pricing systems should not be eased, we may nevertheless see direct carbon pricing approaches take a back seat to more opaque mechanisms. But the eventual goal of net-zero emissions implies a price to deliver on the ‘net’. That is emerging today through trade in nature-based offsets, but largely in the voluntary markets. Eventually, a regulatory approach should emerge and then carbon sink pricing will be here to stay.

What to make of Article 6 at COP25?

December 18, 2019

I spent a week at COP25 in Madrid, with great hope that the negotiators would land the Article 6 text and complete the so-called Paris ‘rule book’. Unfortunately it wasn’t to be the case and the longest COP to date was closed with little to show for the immense amount of effort that was put into it, from the Chilean Presidency, the Spanish hosts and the thousands of attendees. But the COP didn’t end with nothing, in that we do have near completed text for Article 6, albeit entirely bracketed, reflecting the lack of final agreement. Brackets are normally used to surround individual words or short passages of text that remain contentious, but in this case they surrounded the Article 6 guidance in its entirety.

In a world where there is increasing pressure (and need) to get to  an effective state of zero emissions, the ability to use the market to deliver such outcomes by “trading” emission reductions and sinks between countries and sectors, becomes critical. I illustrated this in a recent post which stepped through the transition illustrated below.

Screenshot 2019-10-08 at 23.15.54

Despite a goal of zero, 300 units of CO2 emissions still remain in hard to abate sectors.

Screenshot 2019-10-08 at 23.17.18

Article 6 delivers an overall reduction, with a net-zero emissions outcome.

The final Madrid text reflects a great deal of effort by the Parties, albeit many of the same issues resurfaced during the discussions and highlighted the differing perspectives, and understanding, of Parties on the role and application of Article 6. This will require all Parties to work hard to bridge differences to see an agreement in 2020.

The entirely bracketed Article 6.2 text looks very good in that it covers the key requirements for a transfer. The definition of the internationally transferred mitigation outcome (ITMO) is sound and importantly includes removals, a clear requirement over the longer term and a necessity for net-zero emissions (see above illustration). The guidance on corresponding adjustments adopts a carbon budget approach to the methodology, which provides the highest standard for environmental integrity of the transfer. The text also provides for Article 6.4 emissions reduction units (6.4ERs) to be transferred via this process.

The 6.2 guidance asks participating Parties to cancel some ITMOs to ensure overall mitigation in global emissions, but importantly this is not a requirement for use of the process. In some instances it may be practical for participating Parties to agree on such a step, but in others it is unlikely to happen. For example, the net flow of allowances between two linked emission trading systems (e.g. Switzerland and the EU) will be an ITMO relative to the respective Nationally Determined Contributions (NDC) within which the trading systems sit, but deciding which allowances to remove from the system when hundreds or even thousands of private entities might be involved is both impractical and self-defeating for the link, in that if there is a penalty for trading with a cross-border entity against a domestic entity, then domestic trades will prevail and the synergy of the link will be lost.

Despite the big brackets and the meeting of the Parties to the Paris Agreement (CMA) only noting the guidance on Article 6, it is very likely that the 6.2 text will be used by Parties as it currently stands. Switzerland and the EU may well be the first Parties to do so as they link their respective trading systems from 1.1.2020. Use of the current 6.2 text may also help legitimize it in the case of the CMA never actually agreeing it.

While the 6.2 guidance was largely (but not completely) without contentious points within the bracketed text, this was not the case for 6.4, where many of the issues going into the COP remained unresolved as it finally closed on Sunday, resulting in the big brackets around everything – remember, in UN parlance, nothing is agreed until everything is agreed. Unlike 6.2 transfers where Parties can simply start using the text on a bilateral basis, this cannot be the case for 6.4 because it is a centrally administered mechanism with a supervisory body, which cannot exist until all Parties agree to the text. So while there is text that looks to be complete, we are still some distance away from it being agreed and the mechanism beginning to function. This means that some countries looking for foreign direct investment through the mechanism as a means of achieving mitigation will have to wait. It may also mean that they pursue other energy infrastructure projects which could lead to lock-in of a higher emitting system. Nobody wins through such a delay.

Some of the points that remain to be agreed in 6.4 are also issues that shouldn’t really be open for debate; not in a world looking for a successful implementation of the Paris Agreement.

  • The issue of actions taking place outside the bounds of the NDC is one, when in reality the NDCs need to quickly shift to cover all emitting activities. This should be the first requirement for the agreement that was reached in Madrid that all NDCs are resubmitted next year. As such, there would be no actions taking place outside the bounds of the NDC, which makes the provision entirely superfluous.
  • A second issue is related to the transition of remaining units (CERs and AAUs) from the mechanisms of the Kyoto Protocol, with the request from some Parties that they can be utilized and transferred under the Paris mechanism. For existing projects with future issuance, this shouldn’t be an issue in that any use of the units will be balanced by the necessary corresponding adjustments required under the transfer process of 6.2, although some Parties argued that these projects are outside the scope of current NDCs, to the extent that corresponding adjustments wouldn’t be required. But for vintage units there is a clear reason not to allow future use which sits in the IPCC Special Report on 1.5°C. That report established the current level of warming and reset the carbon budgets for various levels of future warming, with a 1.1.2018 baseline. For example, limiting warming to 1.5°C with a 67% chance has a carbon budget of 420 Gt from 1.1.2018. The Paris Agreement is increasingly being formulated around the finding of the report. As such, events prior to that date are now irrelevant, including any units that may have been created.

There was still no agreement on a share of proceeds from the use of Article 6.4 or on how an overall mitigation in global emissions is determined, key issues for some Parties that reflects the importance of demonstrating the potential of trade to deliver emissions reductions. A simple analysis of the use of Article 6 shows that it alone delivers mitigation that wouldn’t otherwise occur, as I illustrated in the recent post referenced above. Unfortunately, some negotiators didn’t see this point and the call for surrender of units continued, with a minimum haircut of 2% appearing in the bracketed text. Penalties such as this will do nothing to promote the use of the mechanism, but only deter investment.

So there we have it, a fortnight of negotiation that very nearly resulted in a good Article 6 ‘rule-book’. But it didn’t and that is unfortunate for all concerned, but particularly for the successful implementation of the Paris Agreement. Let’s hope that Parties can quickly reconvene around the final Madrid text and bring it to a conclusion, perhaps even before COP26 in Glasgow, in that the formulation of mid-century development strategies and more ambitious NDCs for that COP is in part dependent on the availability of Article 6 transfers.

Article 6: A job to do at COP25

November 29, 2019

As the Parties and representatives of the many UNFCCC observer organisations gather in Madrid, there is talk of increased mitigation ambition and the need to step up the global response to the many changes now being seen in the climate system. With the release of the Gap Report, the UN Environment Programme (UNEP) noted that greenhouse gas emissions in 2018, also accounting for deforestation, rose to more than 55 gigatonnes, and have risen on average by 1.5% a year for the past decade.

UNEP Gap Report

Source: UNEP Gap Report 2019

UNEP stated that global emissions must fall by 7.6% every year from now until 2030 to stay within the 1.5°C ceiling on temperature rises that scientists say is necessary to avoid disastrous consequences.

While this is an important statement, should another clarion call be the overriding theme of COP25?

Perhaps even more important than the call to act is the creation of the economic conditions, mechanisms and processes that will facilitate the shift. The Paris Agreement itself was a critical step in that journey and we have seen in just a few years that the global focus has shifted from talk of percentage reductions to an emphasis on net-zero emissions. This has changed the landscape and given a clear long-run signal to businesses and governments, with the result that numerous countries are now either pondering a 2050 goal of net-zero emissions or have actually established such a goal. Similarly, many businesses and sectors are now thinking along such lines and some have a focus on establishing zero emission business models to grow alongside the (diminishing) legacy systems they have in place.

But the landscape required for global action is far from complete and this is what COP25 can help deliver. Article 6 of the Paris Agreement was left out of the otherwise complete ‘rule-book’ at COP24 in Poland, with the Parties unable to agree on the architecture of cooperative approaches. Superficially this may seem to be a minor issue and certainly not something that would stand in the way of progress, but cooperative approaches should be viewed in the context of global trade which is a key enabler of the global economy.

Trade underpins economic activity and offers society the flexibility to provide the wide range of goods and services that we all benefit from – not everyone can economically produce everything themselves. For example, trade in commodities provides materials for manufacturing and construction that may be unavailable domestically. Trade is often the underpinning reason for foreign direct investment. It encourages the business sector to engage in projects and activities outside their traditional base with a view to bringing goods and services into that base.

This is also true for managing emissions – not all countries can reduce emissions at the same rate and it is certainly not the case that every country can be at zero emissions when needed, so we could use trade to collectively get there through Article 6.

Article 6 is essential for the journey to and destination of net-zero emissions. Recently published research from IETA and the University of Maryland found that cooperation through Article 6 has the potential to reduce the total cost of implementing NDCs significantly, in the order of $320 billion/year in 2030, or alternatively facilitate removal of more emissions, in the order of 9 GtCO2/year in 2030, at no additional cost if those cost savings are reinvested into additional mitigation.

By channeling investment towards zero emission energy systems and expanding the use of natural and artificial sinks, Article 6 can help deliver of the goals of the Paris Agreement. For the most part, this would be pursued through projects enabled by the private sector, including their use of the provisions within Article 6 and the issuance of tradable units by host governments.

Article 6 offers the opportunity to scale the millions of tons of emission reductions that the Clean Development Mechanism (CDM) of the Kyoto Protocol delivered from a multitude of small projects to gigaton reductions from large-impact programmes featured in economy-wide NDCs. To do this, Article 6 must be fit for that purpose and not anchored to the thinking of two decades ago. We learned much from past mechanisms, but they were never designed for the long haul. Carbon would potentially trade at the scale of the commodities that underpin it, such as oil, coal and iron ore. Today, the global crude oil market is around $2 trillion per year (based on producer to end-user sale at $50-$60 per barrel); a global carbon sink market of around $1 trillion per year could be envisaged as underpinning the journey to net-zero emissions in the 2050s (Sky 1.5 Scenario with sinks trading at a notional value of $50 per ton of CO2).

Article 6 establishes a reliable framework within which carbon based trade can be efficiently and expeditiously executed between various national emission markets and projects while ensuring environmental integrity at a global level. This is analogous to the way globally established rules and institutions allow currency markets to function. Article 6 will give confidence to investors in clean energy and emissions mitigation projects and ensures that all countries access the market through a common framework. This in turn delivers cost efficiency and ultimately enhanced mitigation.

COP25 in Madrid must deliver a simple but rigorous rule book for Article 6, which is based on transparent numerical accounting, recognizes both natural and industrial sinks and supports and encourages large scale transactions.