Category: CDM

A link up between Australia and the EU

September 3, 2012

As Australia struggled through the ill fated CPRS legislation and finally landed with its carbon pricing mechanism, I often thought that it would be much simpler if they just joined the EU ETS. Governments don’t tend to do simple practical things like that, perhaps it makes them feel they are giving away some portion of national sovereignty or that they aren’t doing the job they were elected for (i.e. “we must invent it here” syndrome). But despite all this and having gone the very long way around to get there, Australia has, in effect now joined the EU ETS (or perhaps the ETS has joined the Australian trading system).

Last week the Australian Government and the European Commission announced that their respective emission trading systems would link up progressively over Phase III of the EU system, but for Australian entities from the start of full carbon allowance trading in 2015. This is a bold move by both parties and quite possibly one that will make others with nascent trading systems sit up and think about where they want to go. For Australia, provided the changes can be implemented by a parliament that isn’t exactly friendly towards carbon pricing (but a wafer thin majority currently is), the move cements the system into place even further, in that undoing it would likely cause some embarrassment on the international stage. For the EU, it puts the ETS back in the frame and maybe introduces some additional demand at a time of allowance oversupply, depressed prices and a consequent lack of confidence in the system. Let’s hope this move helps both sides to deliver confidence and stability in their respective systems.

A full two-way link between the two cap and trade systems will start no later than 1 July 2018. Under this arrangement businesses will be able to use carbon units from the Australian emissions trading scheme or the EU Emissions Trading System (EU ETS) for compliance under either system. To facilitate linking, the Australian government will make two changes to the design of the Australian carbon price:

  • The price floor will not be implemented;
  • A new sub-limit will apply to the use of eligible Kyoto units. While liable entities in Australia will still be able to meet up to 50% of their liabilities through purchasing eligible international units, only 12.5% of their liabilities will be able to be met by Kyoto units.

In recognition of these changes and while formal negotiations proceed towards a full two-way link, an interim link will be established enabling Australian businesses to use EU allowances to help meet liabilities under the Australian emissions trading scheme from 1 July 2015 until the full link is established.

Various Australian, EU and other websites cover all the details, so I won’t repeat them here. Rather, let me spend some time on a key issue that this move raises, namely the future design of any international framework via the UNFCCC (or other process). Both Australia and the EU have stressed that this is a bilateral linkage, to the extent that the allowance transactions will not be processed through the International Transaction Log (ITL), but CER transactions will be. However, there will still be a Kyoto AAU balancing at various times to ensure compliance in that system (although there remains considerable uncertainty with regards the issuance of Kyoto Second Period AAUs as there has been no firm agreement on the full nature of that period).

Despite this apparent distancing from the Kyoto based ITL, it must still be the case that the overarching Kyoto framework has helped this linkage – I might even go a step further here and say “allowed this linkage to happen”. Thanks to the UNFCCC architecture, these two systems grew up with enough harmony to make a linkage possible.  They “count” the same way, “track” the same way and “comply” the same way.  Both the systems have common offset arrangements through CERs under the Kyoto Clean Development Mechanism and the units created under the Australian Carbon Farming Initiative are also Kyoto compliant. This means we have the makings of a linked system with global reach.

This could be the primary goal of a new international framework, i.e. to provide sufficient tools, rules and mechanisms which countries can use in developing their carbon trading systems, thus facilitating linkage at a convenient time for those interested in doing so. Such a linkage framework could deliver the global market that we need, as shown in my illustration below (which by the way has been around for about 5-6 years now, so for me it is great to see that one of my linkage lines has finally been filled in!!).

The opportunity to devise such a framework now exists under the Durban Platform for Enhanced Action, which aims to see a new international agreement in place by 2015, for commencement not later than 2020. The agreement between Australia and the EU should be seen as a catalyst for the thinking behind what is to come.

Finally, as something of an aside, one of the major complaints by Australian companies has been that the current $23 fixed price and the future market floor price put the Australian price of carbon “out of line with the international price”. I challenged this notion in a recent post, but irrespective those who called for such alignment have pretty much got what they wanted, although obviously not in the very short term. There may be eventual irony in this, should the EU system go through something of a recovery in its fortunes. While every indicator today points to a continued depressed price through to Phase IV, stranger things have happened in commodity markets.

P.S. I still think that the simplest approach for Canada, which has been putting off economy wide carbon pricing legislation for years, would be to join the EU ETS.

A new market mechanism from the UNFCCC

May 30, 2012

While much of the focus in the recent UNFCCC meeting in Bonn was on the protracted discussion around agenda and chair for the ADP (Ad-Hoc Working Group on the Durban Platform for Enhanced Action), some progress was made in other meeting rooms. On the middle Saturday a workshop was held for initial discussions around the call for a “New market Mechanism” (NMM). A report out from the workshop can be found here.

So far, the discussion on a NMM has tended to focus on the crediting of mitigation activities in developing countries, such as the role performed by the CDM. The talk is often about up-scaling rather than having an initial discussion about the market conditions necessary for crediting to be effective or alternatively to ask what a market mechanism actually is. For some, the CDM can be represented as shown below. 

This is a very supply biased conversation, when in fact the full description of the mechanism must include both the creation of supply and the likely demand. The mechanism is much broader than the CDM and involves the core design of the Kyoto Protocol and the various elements within it. 

There are many definitions of “market mechanism”, but all talk about the process of the whole market rather than just a sub-part within it. Here are three;

  1. Means by which the forces of demand and supply determine prices and quantities of goods and services offered for sale in a free market.
  2. The use of money exchanged by buyers and sellers with an open and understood system of value and time tradeoffs to produce the best distribution of goods and services.
  3. The process by which a market solves a problem of allocating resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, to having such decisions made by government.

As the NMM discussion matures and eventually becomes part of the ADP, a much broader discussion on the need for a viable carbon market will be necessary. This cannot be limited to a discussion on crediting mechanisms because these, if standing alone, are not market mechanisms. A working mechanism requires some means of establishing price and particularly demand, a feature not inherent to the CDM.

The assumption that demand for credits will somehow be created is arguably a flawed one. The Kyoto Protocol addressed this by assigning AAUs to certain countries and making the CER (from the CDM) a fungible instrument, thereby allowing interchange for compliance. The AAU approach created demand in countries that had compliance obligations which in turn completed the market mechanism. Nations that held AAUs tended to cascade the instrument directly into their economies or if not, a proxy (e.g. the EUA under the EU ETS). Either way, the compliance obligation remained and allowed private investors to participate in the market.

There was a certain elegance in the market mechanism design of the Kyoto Protocol, one that shouldn’t be lost in the transition to a new international agreement. While it may not be smart politics in some quarters to highlight the benefits within the KP, the NMM discussion will do well to learn from what was developed in years gone by and not throw the baby out with the bathwater.