Emissions trading: The politics of design

Emissions trading: The politics of design • CAN EECCA General Assembly • 21 February 2014 (Tbilisi) • Sanjeev Kumar • +32 499 539731 • sanjeev@changepartnership.org • (Skype) sanjeev.kumar.1973 www.changepartnership.org

Contents • What is emissions trading? • Design elements • Politics of ETS • Post 2015

International carbon markets Clean Development Mechanism (CERs) Joint Implementation (ERUs) Kyoto: AAUs • Annex 1 countries given Assigned Amount Units (AAUs). Tradable via Track II through proven emission reduction activities e.g. Green Investment Schemes • EU main market but large surplus. EU blocked Ukrainian & Russian credits entering EU 202020 targets. • Available for transition countries who could benefit from emission reduction projects from Annex 1 countries. • Limited demand from EU. • Uncertain future due to post 2015 international treaty. • Credits made from emission reduction projects outside Annex 1 countries. • Annex 1 countries can use these allowances to meet domestic compliance requirements. • Many controversies. Possible evolution to sectoral crediting. • Demand from EU nearly over.

What is emissions trading? Cap on total volume of emissions within a given time period and from determined polluting sources. Emissions turned into tradable permits of 1 tonne CO2 Polluting installations compete to reduce emissions Or buy allowances to cover their emissions

ETS compared to other solutions? Tax Regulation ETS • Certainty on price of tax. • No certainty on volume of emission reductions to be achieved. • Know cost of decarbonisation. • Certainty on emission limit. • Everyone has to meet it at the same time. • Know cost of decarbonisation. • Certainty on emission limit. • Everyone has to meet limit but at different times. • Don’t know cost of decarbonisation.

ETS design overview Who? What? Scope Timeline Compliance rules ensure everyone takes part Target Governance rules Political commitment Distributing allowances Offsets/price control Too high vs too low Free vs buying them Verification Trust in data

Design in detail Target? CO2e by a certain date Target Base year? Crucial to ensuring target drives meaningful change EU experience: Target: Stabilise GHG emissions below 2,082 Million tonnes of CO2 (MtCO2) from 2005-2007 and reduce to 1,930 Mt CO2 between 2013-2020. Base year: Originally 2005 but this data was not correct so changed to 2008 verified emissions (real emissions in ETS sectors). From this easy to measure actual reductions. Base

Scope Sectors? Who makes reductions? Gases? CO2 only or other GHG gases? EU experience: Sectors:- power generation, heavy industry and aviation because they are large point sources of GHG emissions. - installations covered not companies. Forces investment decisions within a plant rather than being hidden within a company. - Upstream system focused on producers of emissions. Not downstream approach on consumers which is unlikely to drive change. - Defining sectors problematic: What is a power generator? CHP generators power but is paper & pulp sector… Gases: EU ETS started off which CO2 but now includes N2O and PFC

Compliance Enforcement Ensuring everyone participates. Incentivises trading or emission reductions Penalty EU experience: Enforcement:- 2 test cases: Ireland and UK. Irish company did not want to take part saying ETS was unlawful. Irish court said that they were in breech of EU law and would face a prison sentence. UK court made similar stance but threatened large fine on company. - EU ETS has highest compliance rate than any other legislation in EU history. Penalty: Automatic fine of 40 €/t CO2 (until 2007), 100 €/t CO2 (from 2008) for every tonne of CO2 that is not matched with an ETS allowance. This drives buying and selling of allowances

Distributing allowances Auctioning EU experience: Auctioning:- 100% allowances given for free during 2005-2007. Companies made mega windfall profits (money for doing nothing) and encouraged power companies to invest in coal!!- 2008-2012: Power sector in Germany and the UK given 10% allowances for free. Led to carbon price of about €30. - Difference between auctioning and selling allowances: Selling based on whatever price of ETS is on the day. Auctioning, if there is scarcity of allowances, means installations could bid up the price of allowances to much higher price. - From 2013 all power companies have to purchase ETS allowances from auctions.

Distributing allowances Free allocation EU experience: Free allocation:- Grandfathering: Giving allowances based on historic emissions. Problem is that it incentivises increasing pollution in order to get more allowances. Also, rewards the most polluting and reduces benefits to installations that have reduced emissions. - Benchmarking: introduced from 2013. 80% free allocation for industrial installations based on 10% best performing in terms of GHG (not energy efficiency). This is the threshold applied to the whole sector so more polluting installations get less allowances for free.

Monitoring, Reporting & Verification (MRV) Confidence building EU experience: Free allocation:- Key for confidence in the whole scheme. Ensures each tonne of CO2 is the same. Installations really are measuring emissions in the same way across and between sectors and that stated emissions at the end of the year are real.- Companies will only buy and sell when this data comes out. - Yearly monitoring ensures liquid market (many buyers and sellers). Data realised every May. Indicates where the market was short (undersupplied increasing demand and price for allowances) or long (over supplied so price falls).

Price management International/domestic offsets or price ceiling • EU experience: • - Relationship with target (Cap) - EU originally added CDM/JI on top of ETS cap. Increased cap by about 1 billion allowances. Reason why there is a surplus today. - From 2013, CDM/JI only 49% of ETS requirement and limited only to projects from Least Developed Countries (LDCs). From 2020 onwards virtually no demand forecast from EU.- No price ceiling in practice but this issue coming back now in post 2020 context. Price floor being introduced now. - Provision for domestic offsets and desire but currently blocked by the European Commission.

Biomass Impact on actual emission reductions EU experience: - biomass classed at GHG neutral. Big incentive to use biomass for coal-fired power generation. In real terms this increases GHG emissions and keeps coal-fired power generation capacity longer. Big mistake in EU ETS scheme.

Domestic offsets Accounting trick or real emission reductions • Likely to be an option for EECA region. Included in Kazakstan scheme. • Not used in EU ETS at present. Controversial solution. Key block is that it puts pressure on governments to make up the shortfall in emissions taken out of their management and used for compliance in the EU ETS. • Also, lack of certainty on marginal cost of abatement for these projects and whether they can be produced at scale. If they are, they increase the supply for allowances and therefore should reduce the price.

Climate decision makers Merkel Tusk Hollande Cameron Van Rompuy Barroso NGOs Economists Media Faith Health Unions Science Skeptics

Key players Economists Faiths NGOs EU ETS International offsets Power generators Trade Unions Financial advisors Steel Cement Refineries Paper & pulp Media Banks Aviation Germany Poland Academia France UK Finance ministries Industry ministries Envi ministries Scientists Developing countries Health community Institutional investors Technology developers

ETS narrative battleground Windfall profits Carbon leakage cost pass-through 186 countries legislate on climate Competitors don’t have legislation Artificial low price without externalities Burdens poorest consumers High electricity prices Makes industry uncompetitive Right price needed for EE & RES Investment out of country Needed to manage price Offsets Economy worse off in long-run Domestic offsets incentivise investment in other sectors doesn’t incentivise decarbonisation Industry view Our view

Global ETS development 2013 IETA 2013

Post 2015 confusion & chaos • No clarity on what post 2015 will look like but key questions to guide thinking: • World Bank Partnerships for Market Readiness: To continue to support establishment of carbon markets globally. • Nationally Appropriate Mitigation Acts (NAMAs): Will these generate credits? Volume, transaction costs? Crowding out by REDD+ credits? what is the demand going to be like? • CDM: What will happen to the CDM? Will it be reformed? will it be replace by NAMA credits? who will buy CDM allowances? • Deforestation and degradation (REDD+): Strong financial and political lobby for REDD+ credits. EU ETS reform to be first major test for international take up. What will this do for non-REDD+ credits? • Future of Kyoto Protocol Assigned Amount Units (AAUs) in new international treaty?

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Emissions trading: The politics of design