Category: Carbon price

Finally, an EU foot in the removals door

dchone March 6, 2023

As the EU continues to develop and progress legislation around its 2030 and net-zero emissions goals, one key proposal has surfaced that will be with us for decades to come. It is the EU proposal to create a certification framework for removals – i.e. measuring and certifying the amount of CO₂ that is removed from the atmosphere and permanently stored through some anthropogenic activity. Examples might include direct air capture with geological storage (DACCS) or reforesting an otherwise barren land area (nature base solution or NBS). The proposal includes the very clear reason why it is needed;

The European Climate Law provides for the EU to become climate neutral by 2050. This requires that GHG emissions are significantly reduced, and that the unavoidable emissions and removals should be balanced within the European Union at the latest by 2050, with the aim to achieve negative emissions thereafter. To achieve this objective, both natural ecosystems and industrial activities should contribute to removing several hundred million tonnes of CO₂ per year from the atmosphere. Today and with current policies, the EU is not on track to deliver these quantities: carbon removals in natural ecosystems have been decreasing in recent years, and no significant industrial carbon removals are currently taking place in the Union.

Readers of my previous posts will know that this is something of a pet subject for me and so it is pleasing to see that the EU if finally recognising the importance of removals. The need for a tradable carbon dioxide removal unit is essential for net-zero emissions, in fact it is the essence of the phrase because of the use of the word ‘net’. However, while a first step is important, time is not on the side of the EU, so they will have to move much faster.

In a 2022 post I noted that the revised EU ETS allowance decline rate built into the Fit for 55 framework would take the system to zero new allowances in 2040, but that would almost certainly be ahead of the point in time at which there would be zero emissions in the covered sectors. As such, some form of new allowance would be needed, with the obvious candidate being a carbon removal unit brought in as an external credit. That would make the EU ETS a vibrant carbon removal trading platform, creating a market for carbon removals and establishing a clear price.

But it would seem that the EU is not yet prepared to take such a step. While the certification proposal is important, it lacks one key element, a business model to encourage businesses to use it. The EU appears to be pinning its hopes on voluntary activities, or companies looking to create or acquire certified removals to use for their net-zero commitments. This will happen to an extent, but mainly at the lower cost end of the spectrum such as soil carbon projects, land use change projects and similar. These do form an important part of the EU Fit for 55 framework, but so does the need for DACCS and bioenergy with CCS (BECCS).

The voluntary market and a certification process are no match for the $180 per tonne CO₂ on offer in the USA for DACCS under the Inflation Reduction Act (IRA). In the EU there is the Innovation Fund to help drive technologies such as DACCS, but it isn’t operating on the same scale as the IRA. The Innovation Fund could provide EUR 40 billion of support over 2020-2030 for the commercial demonstration of innovative low-carbon technologies, whereas IRA is around USD 330 billion. And IRA has a specific and clearly defined incentive for carbon dioxide removal, which isn’t the case for the EU Innovation fund, although a DACCS would be considered within the framework. It’s therefore not difficult to guess where the DACCS projects will end up and which country will benefit from the investment. That being said, ETS revenues and other mechanisms could bridge this gap if directed more towards energy technology development and demonstration.

The EU could create demand for DACCS and BECCS on a large scale if it opened the EU ETS up to such units, recognising that they will be needed by 2040, but almost certainly prior to that as the ETS reaches reductions in excess of 80%, a point it will hit around 2035. That is in 12 years. The EU Commission may well have such a move in their future plans, but history would argue that if they don’t start now, time will defeat them. Major changes in direction for the EU ETS take at least 5-10 years to be developed and bed in. For example, the Market Stability Reserve (MSR) started life in about 2011 with proposals for a set-aside of allowances to remove the post financial crisis surplus, then came backloading and finally the first implementation of the MSR and some tweaks a bit later. In 2023 it operates very well.

Given the need for a clear market price signal, i.e. the €100 per tonne CO₂ price now available from the EU ETS, a clear set of implementation rules to support projects, and recognition that a functioning DACCS industry will take at least a decade to establish, if not more, the inclusion of removals within the EU ETS becomes rather urgent. Encouraging the use of Article 6 of the Paris Agreement to facilitate carbon dioxide removal technologies is another area that I have written about and is also relevant to the EU in this context. At the moment, the only signal on offer is an indication of a review of negative emissions and trading in a few years’ time.

New business models required

dchone December 6, 2022

With COP27 now behind us and no significant changes to Nationally Determined Contributions (NDC) on offer (e.g. from China), various commentators are now remarking that meeting the goal of 1.5°C may be in doubt. This means passing the 500 Gt carbon budget that the IPCC linked to the 1.5°C goal.

I have discussed this in many earlier posts, for example here and here. However, passing 1.5°C in the short term certainly isn’t the end of the story.

Many recent IPCC scenarios also show 1.5°C being breached, but deploying removals later in the century to draw carbon dioxide out of the atmosphere is then used in the scenario to reverse the balance and at least meet the 1.5°C goal by 2100. In the IPCC Special Report on 1.5°C released in 2018, all four model pathways required some form of future removal, ranging from very little in P1 to significant in P4, depending on the lifestyle and transition pathway the particular scenario embraced and the level of overshoot of 1.5°C. Both nature based and technological removals are required. In the 2018 report technological removals were shown as bioenergy processing with carbon capture and storage (BECCS), but today we could realistically envisage both BECCS and direct air capture with CCS (DACCS) playing a role. The latter has advanced considerably in just five years.

**Source: IPCC SR15 Summary for Policy Makers**

So as well as requiring CCS to get to net-zero emissions, society will almost certainly have to consider removals as a technology to deliver negative emissions globally, i.e. after the goal of net-zero emissions is achieved. Large scale removals might also offer the much longer-term prospect (i.e. in the 22nd century) of winding the atmospheric carbon dioxide levels back towards pre-industrial levels.

While global net-negative emissions on a scale that shifts the atmospheric concentration of carbon dioxide is technically possible, the contrast with the very limited scale of deployment of BECCS and DACCS today seemingly takes the task into the realms of science fiction. Yet a century ago the scale on which energy is generated now would also have seemed like science fiction, so the task should not be dismissed. Nevertheless, the longer term could require these technologies and changes in land use to scale to many billions of tonnes of carbon dioxide removal per year. The question this poses is not whether it is possible, but how can it be made to happen.

Carbon capture and storage has become a commercially available technology over the past twenty years, yet global deployment remains very limited. The technology itself isn’t the issue, it is the lack of sustainable business models for deployment. There is a carbon price in Europe, but for many years it languished at just a few Euros and other similar systems currently operating throughout the world typically maintain prices at levels well below what is required for CCS and therefore, not surprisingly, well below the levels required for a 1.5°C transition. Bespoke CCS deployment policies are almost non-existent outside the United States. In the USA a specific tax-credit mechanism exists at the Federal level and the California Low Carbon Fuel Standard will allow the use of credits based on DACCS. As a result the USA is the global leader in CCS deployment and the pipeline of projects looks impressive, largely based on the revised tax credit available through the Inflation reduction Act. There are also DACCS projects emerging and a BECCS ethanol facility has operated in Illinois for some time now.

CCS requires a very long term business model, based on some form of market pull. Today the support for CCS comes largely from direct government grants and support mechanisms for early stage technology, but there is always a limit to such incentives. However, with net-zero emissions now becoming a clear goal in most energy system policy frameworks, a more sustainable model is likely to emerge as businesses seek to mitigate their own emissions, either due to direct policy requirements or indirect consumer preference for zero carbon emission goods and services. A balance will be found between the cost of new technologies such as green hydrogen for industry and making use of CCS in industries that continue to use fossil fuels. Society will find ways to absorb these costs over time as net-zero emissions is reached and whether this results in large or small scale deployment of CCS remains to be seen, depending on the relative costs between competing pathways.

But the next stage of the CCS journey, possibly commencing as early as the 2040s for some, will be to deliver net-negative emissions via DACCS and BECCS, i.e. drawdown of carbon dioxide from the atmosphere. While this may seem like a long way off, the history of creating basic CCS business models points to the need for an early start. The journey probably commences at the UNFCCC level, where a framework for net-negative emissions would need to be established including a global goal, some form of burden sharing agreement between nations and a discussion on the role of nature versus the role of technological drawdown solutions. Unfortunately, with history as a guide, this could take some time. But perhaps the bigger challenge will be for national governments to cascade the need into the economy and find ways to spread the cost of net-negative emissions across society within goods and services and even through taxation. This may not be popular given the net cost of the task, yet with no immediate tangible benefit. Imposing deep emission reduction goals is still proving to be a difficult task in some economies today, let alone asking the population to pay for atmospheric drawdown of carbon dioxide. However, the very long term benefit can be measured in practical terms, such as avoiding metres of sea level rise.

With the prospect of a 1.5°C overshoot scenario looking likely, future biological and geological storage of atmospheric carbon dioxide becomes essential. This task may lead to the development of huge industries engaged in such activities, or very little activity at all, depending on the policy frameworks and business models that emerge.

The lesser told story of COP26

dchone November 18, 2021

The much anticipated but delayed COP26 has come and gone, with many articles and commentary focussing on whether 1.5°C is still alive. I commented on this at the start of COP26 and although some additional enhanced NDC pledges have been made since then and there is a new goal to end deforestation by 2030, the situation remains largely unchanged. Apart from one thing! COP26 delivered an agreement on Article 6 of the Paris Agreement.

Article 6 was the last piece of the Paris Agreement to be negotiated back in 2015 and true to form it has become the last piece of the rule book to be completed. So why has it proved so contentious and why does it help keep 1.5°C alive?

The Article outlines ways in which some Parties can choose to pursue voluntary cooperation in the implementation of their nationally determined contributions (NDC), but the sub-sections 6.2 and 6.4 have been negotiated primarily as carbon market instruments, designed to allow trading between Parties, through linking of emissions trading systems and cross border investment in mitigation and removals to create tradable carbon credits. Simply put, carbon markets and trading of carbon units unleashes a commercial engine that can operate on a scale far surpassing the limits of local domestic action. It helps align the energy transition with other global commercial activities, offering the potential for lower overall costs to society which in turn can enhance ambition. Trade is a powerful tool that is at the heart of the global economy and carbon trading can serve to unlock mitigation opportunities that would otherwise be neglected. As I discussed in a recent post, a potential future standstill in global emissions is brought to net-zero through Article 6 cooperative action between countries and the aviation sector developing carbon removal opportunities in various parts of the world. Trade requires price discovery, so indirectly Article 6 helps in the development of liquid carbon markets and carbon pricing, although these don’t emerge from Article 6 itself but from national systems which are open to Article 6 transfers.

The newly agreed rules behind 6.2 are simple but powerful and importantly bring clarity to the issue of environmental integrity. Article 6.2 allows transfers between counties in carbon designated units, thus impacting the NDCs of the buyer and the seller. The buyer is able to meet NDC goals more cost effectively and the seller receives an income stream for domestic mitigation activities. This may seem like a straightforward approach to mitigation, so why has it proved so difficult to negotiate?

The rule for a transfer between Parties requires an adjustment to the related NDCs which brings with it a need to account for each NDC in carbon budget terms. Over time, this drives the Paris Agreement to operate more like a rigorous cap-and-trade system rather than a collection of national mitigation activities presented as a list of actions. With national actions based on a carbon budget architecture, transparency is vastly improved and actions are increasingly focused on mitigation rather than simply supplying more clean energy. The two may align but are not necessarily the same. With so much at stake, negotiators have been careful to get the rules right. Further, carbon budgets are easy to add up and derive a global total, which then puts pressure on the Parties when that budget exceeds the available capacity of the atmosphere for a given temperature limit. Ultimately, it may also open up the highly contentious question of who can use the remaining budget. While the Paris Agreement isn’t operating like this today, widespread use of Article 6 could accelerate such a development.

Article 6 also brings with it a mechanism to assign common units to a mitigation project, carefully defining it in terms of tradable carbon credits. These would be issued by a Supervisory Body operating as part of the Paris Agreement implementation. While 6.2 is essentially a bilateral transfer approach, 6.4 is a multilateral mechanism, introducing a notional Paris carbon currency. However, transfer of these units between countries will still follow the rules of 6.2. Article 6.4 follows on from the similar Clean Development Mechanism of the Kyoto Protocol, but with a clearly quantified transfer approach.

Both 6.2 and 6.4 are voluntary in that attainment of NDCs can be realised without them, but when used they bring the power of trade to the job of mitigation. Analysis of the benefits of such an approach by the University of Maryland found that international cooperation under a well-functioning Article 6 of the Paris Agreement could save as much as $250 billion per year by 2030. Translating this back into the potential for greater mitigation becomes tangible and meaningful in the already very narrow window of opportunity for limiting warming to 1.5°C.

Glasgow doesn’t mean job done on Article 6, but it does set the stage for activities to commence. The onus is now on national governments to encourage the use of these mechanisms, by allowing their mitigation activities to be open to Article 6 transfers. This could start with well-developed systems such as the EU ETS recognizing 6.4 units, particularly if they are associated with carbon removal projects which the EU will need to meet its goal of net-zero emissions by 2050. Successful implementation could also allow the EU to consider an earlier NZE goal if required to keep 1.5°C in play. But given that the Article 6 rule book was finally agreed in the United Kingdom, perhaps the British government might be the ones to step up and allow Article 6 to flourish within the new UK ETS. After all, in the wake of Brexit trade has become the topic of the day in the UK.

Article 6 has been a hard won policy development, but it’s completion in Glasgow makes COP26 a success, even as some commentators have pronounced some disappointment with the precise wording of the Glasgow Climate Pact. We should thank the negotiators for their efforts over many years and reward their long nights at various COPs with rapid and successful implementation.

Accelerating the US energy transition

dchone January 21, 2021

Today a new energy transition is gaining pace in the US, built on the back of the falling costs of wind, solar and batteries. But what might a rapid transition to net-zero CO2 emissions look like in the US?

A Climate-Neutral EU by 2050

dchone May 5, 2020

As the EU works to reset its emission reduction goals to align more closely with the 1.5°C goal of the Paris Agreement, a question arises around the scale and scope of the energy transition required. What will it look like? How fast should it proceed? Which technologies need to be accelerated to achieve the desired outcome? To help answer these and provide a perspective on the transition, my colleagues in the Shell Scenario team have produced a scenario sketch of the journey forward, arriving in 2050 with a net-zero emissions energy system (NB: The pathway was formulated in late 2019 prior to the COVID-19 pandemic and therefore does not include the energy system disruption being seen in 2020).

From a policy perspective, the EU has been addressing the climate issue for at least 15 years, with the EU Emissions Trading System in place since 2005. The 2020 energy situation arises from the 2007 climate and energy package, which included three key targets:

20% cut in greenhouse gas emissions (from 1990 levels)
20% of EU energy from renewables
20% improvement in energy efficiency

The targets were set by EU leaders in 2007 and enacted in legislation in 2009. They are also headline targets of the Europe 2020 strategy for smart, sustainable and inclusive growth. Within this, the EU Emissions Trading System is the EU’s key tool for cutting greenhouse gas emissions from large-scale facilities in the power and industry sectors, as well as the aviation sector. The ETS covers around 45% of the EU’s greenhouse gas emissions. In 2020, the target is for the emissions from these sectors to be 21% lower than in 2005.

The year 2020 represents a halfway point from 1990 to 2050, during which 20% of the hard deployment work has been done, but with a number of key technologies available at scale that hardly existed or didn’t exist around the turn of the century. Solar PV and Electric Vehicles are two examples (although solar PV did exist in 2000, it was expensive and small scale). That leaves just 30 years for the remaining 80% reduction, which must also include bringing to scale several other technologies which are yet to be deployed in the EU. This is a tall order and the scenario sketch illustrates how extraordinarily stretching it will be.

The additional key technologies that must move quickly to scaled deployment are as follows;

Clean hydrogen production via electrolysis of water or removing and storing the carbon from natural gas;
Hydrogen fuel cell road transport for heavy goods (see chart below).
Carbon capture and storage in various industrial settings – e.g. steel, cement, petrochemicals.
Biomass power plants fitted with carbon capture and storage (as a negative emissions technology).
Air transport that utilizes hydrogen as a fuel – in the sketch first flights are imagined in the mid-2030s.
Advanced biofuels for planes, ships and heavy road transport (see chart below).
Grid scale electricity storage.
Electrification of light and heavy industry processes.
Use of hydrogen in homes for heating and cooking.
Some technologies that appear late in the sketch will need intensive development over the medium term. Hydrogen as a fuel for industrial facilities, but particularly iron ore smelting, is a good example.

On the assumption that development and demonstration of all the above proceeds rapidly, deployment kicks in for most during the 2030s. But in the 2020s the energy technologies that have been nurtured over the last twenty years must be accelerated. For example, by 2030 solar must be quadruple current deployment, wind nearly triple current deployment and nuclear must be growing again, not declining.

In the 2030s the really hard work starts, with carbon capture and storage moving from first demonstration in the EU by 2025 to 40 medium sized facilities (one million tonnes CO2 stored per annum) by 2030 and over 100 by 2035. New technologies such as hydrogen fuel cell trucks must become ubiquitous during the 2030s, with at least 600,000 vehicles on the road by the end of that decade.

All of the above will require both technology development incentives and deployment policies. The analysis assumes a rising carbon pricing mechanism – whether explicit or implicit – to more than €200 per tonne of CO2 equivalent by 2050 to deliver and sustain the emission cuts and CO2 management necessary for the EU to reach climate neutrality. But even the EU ETS will need to change, as I discussed in a recent post.

While carbon pricing is an efficient lever for reallocating resources and driving behavioural change, it will not be enough on its own. A sectoral approach to policy which brings clean technologies, fuels and products to market, as well as their deployment and diffusion at scale, must urgently be developed. It is essential that policy should help provide consumers and businesses with low-carbon alternatives to adopt.

In the sketch, 2050 marks a point of climate neutrality for Europe, helped by the development of large scale carbon sinks through reforestation. But this isn’t the end of the transition, merely a point of significance. The hydrogen economy will continue to grow, electrification of industry will expand and efficiency gains will continue to be made. As was illustrated in the Sky Scenario, Europe will likely shift to become a net-negative emission economy during the second half of the century, a necessary requirement to ensure global net zero emissions and a 1.5°C limit on warming.

Download the EU Sketch here.

Getting to net-zero emissions with the EU ETS

dchone 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.

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

. . . . . . 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;

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);
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.

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.

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

dchone 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;

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.

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.

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.

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.

How might Article 6 work in practice?

dchone October 11, 2019

This is a critical year for Article 6 of the Paris Agreement. The ‘rule book’ wasn’t agreed at COP24 in Katowice, so the focus of negotiations at COP25 in Santiago will largely be on Article 6. This is the section of the Paris Agreement that sets out the framework under which cooperative action can be organised between Parties with a view to achieving their Nationally Determined Contributions (NDC). While cooperative action could take many forms, Article 6 is being negotiated as a carbon trading framework. There are very significant benefits in doing this, as recently shown in new work from the University of Maryland.

There are a number of interpretations of how Article 6 should work, hence the lack of agreement in Katowice, but the text in the Paris Agreement is really very clear. As I recently discussed, the underlying issue is the implication of the rules. A simple illustration helps explain Article 6 and can show why it is so important, why robust accounting is essential and why it can help deliver an overall reduction in global emissions.

In the illustration below, we have three countries (A, B and C) and the aviation sector. They each have a goal of zero emissions, but that is not the current state they find themselves in.

County A still has considerable emissions (100 units) from its heavy industry sector, but with no local abatement opportunities. As such, it is stuck and unable to make further reductions.
Country B has reached zero emissions but has not developed local options to easily sequester carbon dioxide as it has no need to do so.
Country C is undeveloped and has no emissions, but needs to develop energy infrastructure.
The aviation sector still has emissions (200 units) despite efficiency improvements and perhaps some fuel substitution. It has no immediate opportunities for further reductions.

These countries and sector decide to make use of Article 6 of the Paris Agreement to achieve their goals, enhance ambition and achieve further reductions. Investors develop a large scale air capture project in Country B, with geological storage. Emissions for Country B fall to -100, but they transfer units to Country A using Article 6.2 which underpins the original investment. Both A and B adjust their inventories accordingly with each now achieving net-zero emissions.

A similar transaction is executed between Country B and the aviation sector, but this time using afforestation as a natural sink. Country B remains at net-zero emissions as it adjusts its inventory and the aviation sector emissions can now be reported as 100 units. The transfer of nature based units, again using Article 6.2, has delivered real reductions for the sector.

But aviation still needs to take further action and as such encourages project developers to implement an avoided emissions project in Country C using the mechanism under Article 6.4. The project investment delivers reduction units that are then sold to the sector, bringing emissions to net zero. However, because of the need for a corresponding adjustment to their own inventory under the rules of 6.4, Country C now finds itself with 100 units of emissions, despite having no physical emissions in the country itself. This is because of the strict accounting rules of the Paris Agreement that are designed to ensure an eventual net zero outcome.

So in this example, Country C opts for a transfer from Country B under Article 6.2, with Country B further developing its natural sink potential to allow the transfer to take place.

After making all the local reductions that were possible and then utilizing the cooperative trading approaches offered by Article 6, the overall outcome across the countries and the sector is net zero emissions, which aligns with their desired goals.

Article 6 has delivered in many ways;

An overall reduction in global emissions has been achieved, with emissions falling from 300 units to net zero.
Ambition has been enhanced, with the countries and the sector all able to confidently target a net zero emissions outcome instead of stopping short of that goal.
Economic activity across the countries has been enhanced, with jobs and investment resulting from the transfers and project activity. Importantly, no country or the sector has had to reduce its economic output to meet emissions goals.
No double counting has taken place and clear carbon emissions accounting has ensured that the actions are visible to all and pass the critical test of environmental integrity.
Project developers have made use of the capabilities of Article 6.2 and 6.4 and invested with confidence, knowing that the transaction and supporting accounting systems behind Article 6 would deliver a return on their investment, without delay and without withholding of units.
The transaction under 6.4 delivered valuable revenue to another developing country through its share of proceeds provision (Article 6.6).

While the above is a very simplified illustration, it nevertheless shows the importance of the market oriented aspect of Article 6 in delivering the goals of the Paris Agreement. In addition, there is Article 6.8 which will be used to deliver non-market oriented approaches, such as the Kigali Amendment to the Montreal Protocol. With regards the market provisions of Article 6, early and clear implementation of the rule-book, embracing the clear intent of the Paris Agreement as shown above, is the essential next step.

Looking again at carbon pricing

dchone September 23, 2019

It is Climate Week in New York and among the police barricades at the UN, the protests and traffic there is still the opportunity for new thinking and revisiting important subjects. Perhaps none is more important than the role that carbon pricing must play, yet its impact on the energy transition has been limited to date. One of the reasons for the modest uptake in carbon pricing (largely limited to the EU and a some parts of North America, but others now emerging, e.g. Singapore, South Africa and hopefully China) has been ongoing concerns relating to competition, be it for a single industry or more widely at national level compared to trading partners. By contrast, in the Shell Sky Scenario, government implemented carbon pricing emerges rapidly and robustly in the 2020s as part of a suite of critical policy measures to bend the global emissions curve and begin the long journey to net-zero emissions.

Following on from the Paris Agreement in 2015 the World Bank initiated a coalition to help usher in carbon pricing as a policy instrument. The Carbon Pricing Leadership Coalition (CPLC) brings together governments, civil society and industry and offers a forum to learn and share ideas. To that end, the CPLC created the High Level Commission on Carbon Pricing and Competitiveness and at the opening of Climate Week the Commission launched its report on the issue.

As the report discusses, those involved in the use of carbon pricing recognize the concerns that exist due to differential carbon prices between jurisdictions, currently ranging from zero (many places) to around $100 per ton of carbon dioxide (a few cases in some sectors in a handful of countries). There is the potential risk that high-carbon economic activity may move to regions without a carbon price or with a lower price. This could result in decreased profits and job losses. It could also exacerbate political push-back and undermine the intended environmental outcome of reduced GHG emissions. If this “carbon leakage” occurs, it would be a lose-lose: a loss of competitiveness or economic activity without an environmental gain.

But the report finds there is little evidence to date that carbon pricing has resulted in the relocation of the production of goods and services or investment in these products to other countries. This outcome is consistent with the economic literature assessing the competitive impact of environmental regulation more broadly. There may be several reasons for this, including the observation that carbon price levels have generally been moderate and existing programs include protection for at-risk sectors. In addition, tax rates, labour availability, and infrastructure may be more significant to investment decisions regarding location of production than environmental regulations.

While competitiveness remains a key concern for policymakers considering a price on carbon, the report argues that these concerns should not be overstated. Competitive risks exist primarily for highly emissions intensive and trade-exposed (EITE) sectors and jurisdictions that depend on such sectors. These risks can and should be addressed through a suite of locally tailored policy design choices intended to protect industry from unfair international competition even as they ensure that the incentive and support for low-carbon innovation remains.

The report points out that there are a variety of options to address competitiveness risks, including free allocation of emission rights and border measures. However, these should be based on a location-specific, data-driven evaluation of impacts. Once implemented, these measures should be periodically re-evaluated to ensure their effectiveness and usefulness. To that end, data transparency from industry, at least with government officials, is particularly important for assessing how and when intervention is necessary.

The report also revisited the broader carbon pricing subject for the sake of context and not surprisingly found that carbon pricing is an effective, flexible, and low-cost approach to reducing greenhouse gases (GHGs). Combined with other policies, carbon pricing can help accelerate and ensure a smooth transition to a low-carbon economy. Perhaps the more important context is that carbon pricing is intended to drive a shift away from high-emissions products to low-emissions products and processes. That intent may mean that some firms that compete against these low-emissions substitutes may experience a loss of market share and reduced profits even as others adapt, increase their profitability and develop new business models. That is the point of the instrument and more broadly, it is the point of the transition required to address the climate issue.

The CPLC isn’t the only organisation revisiting the basics of carbon pricing for Climate Week. The World Business Council for Sustainable Development (WBCSD) released its own report on the views of the business community on carbon pricing. The new WBCSD paper presents reasons why business supports carbon pricing as a critical enabler to raise climate ambition and calls for governments to put on a price on carbon and develop clear and consistent long-term carbon pricing policies as part of their national commitments and long-term strategies.

My own reflection on all this takes me to the movie Groundhog Day, but perhaps better phrased as Groundhog Decade when it comes to the climate issue. Ten years ago and in some cases more, I contributed to and was involved in the release of similar reports that came to the same conclusions and in some cases from the same organisations. Yet a decade later, the advance of carbon pricing as a preferred policy instrument has been modest at best and in the interim the largest implementation of carbon pricing (the EU ETS) spent much of the time languishing at very low levels and therefore having very little impact on the energy transition; fortunately in the case of the EU that has now changed. Not surprisingly, global greenhouse gas emissions have risen over the last decade.

But this time around something else has to change as there isn’t another decade to just discuss and think about the implementation of carbon pricing – in fact the decade just passed wasn’t thinking time either, it was the time during which all that had been discussed should have been implemented. Now there is no time for prevarication if the goals of the Paris Agreement are to be realised. The Sky Scenario and many other similar pieces of work make that abundantly clear.

Why is Article 6 so contentious?

dchone July 8, 2019

The Parties to the UNFCCC convened in Bonn through the second half of June to continue discussions relating to the Paris Agreement, but particularly to make progress on the rule-book for Article 6 of the Agreement that remained held over from COP24 in Katowice.

Article 6 relates to cooperative approaches, but is largely being negotiated as the foundation element of cross-border carbon trading between Parties or private entities (e.g. companies) within the jurisdiction of those Parties. Only Article 6.8, which is specifically defined as a non-market mechanism is being dealt with differently. The remainder of Article 6, i.e. provisions 6.2 to 6.7, deal with the prospect of cross border trade of mitigation outcomes, broadly defined in terms of tons of carbon dioxide.

Article 6 is simple in concept but has proven difficult to negotiate. The concept is that Nationally Determined Contributions (NDC) may be best achieved by cooperating with another Party, essentially in the same way as facilities within a cap-and-trade system trade allowances as a route to minimising the cost of compliance; i.e. facilities balance their needs by reviewing their own options to reduce emissions or purchasing allowances from other facilities that can more readily make reductions against some allocation they may have received from the government or bought in government auctions. The overall cap on the system doesn’t directly play a role for each facility, but indirectly governs the entire system and allows it to function and for reductions to proceed against a financial metric.

The challenge, is that the Paris Agreement is not based on allowance allocation, cap-and-trade architecture or carbon units, but only on a willingness to reduce emissions at national level against a nationally determined plan. However, to enter into a cooperative arrangement, some form of accounting must be implemented such that it is transparent to the cooperating Parties and others that there is no double counting of emissions and no relaxation of NDC goals. That accounting requires carbon unitization of the activities taking place and more importantly unitization of the NDCs themselves such that it is apparent to all what is going on.

While Article 6 is a purely voluntary framework and Parties are free to sidestep it and simply deliver their NDC goals, many Parties are keen to use the provisions of the Article to lower costs and attract inward investment in emission reduction activities. But it takes the cooperating Parties into the world of emissions accounting, which is where the controversy starts. Parties making use of Article 6 will inevitably be drawn into carbon budgets as the pressure on transparency and environmental integrity grows.

In Bonn the Parties spent a good portion of the time attempting to resolve numerous issues that remained from COP24. Almost all are related to accounting, issues that vanish entirely if carbon budgets begin to be applied to NDCs, as the United Kingdom has done through legislation. But a budget, however it is implemented, implies a limit of some sort, an idea that numerous Parties are not yet prepared to entertain. There are good reasons behind this, including the concern that development brings with it significant industrial activity, almost all of which is based on the use of fossil fuels, but in many cases, coal.

But a budgetary approach brings a quantitative simplicity to Article 6 that is impossible to match through qualitative assessment, as was the case for the Clean Development Mechanism of the Kyoto Protocol. Specifically, applying a clear and transparent numerical approach resolves issues related to additionality, overall reduction in global emissions, corresponding adjustments, double counting, transfer to CORSIA, NDC coverage and the handling of CERs and AAUs left over from Kyoto Protocol days.

But a robust numerical approach with carbon budget implications leads Parties into a world they sought to avoid under the Paris Agreement, yet it is one that must inevitably emerge so as to apply a climate lens to the energy transition and guide it to net-zero emissions. As Parties negotiate the terms of Article 6, there are perhaps two clear ways forward. One is to compromise on all aspects of the needed accounting regime, but risk ending up with an approach that does little to foster cooperative action and then operates at a small scale as a niche activity. It is hard to see how this serves anyone well. The other is to recognise that this is a voluntary mechanism and to implement the required accounting, which Parties will gradually adopt and use as they are ready.

The world in which carbon dioxide is meticulously and transparently accounted for also leads to carbon pricing. Little wonder it remains contentious and is taking significant time and effort to resolve.