Climate policy and emissions trading

1
Climate policy and emissions trading Asbjørn
Torvanger CICERO Center for International
Climate and Environmental Research Website
www.cicero.uio.no Seminar at TotalFinaElf,
Stavanger, 28 May 2002
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• Topics
• Is there climate change, and if so is it
  man-made?
• Climate policy and the Kyoto Protocol
• Quota system or tax
• The workings of a quota market
• Emissions trading early systems, harmonization
  of systems, and trading under the Kyoto Protocol
• Verification of quotas
• The role of an international oil company

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Climate change Driving forces on many time scales

• External forces
• Variations in solar output (all time scales)
• Variations in the orbit of the Earth (relatively
  slow)
• The form and positions of the continents (slow)
• Vulcanic activity (all time scales)
• Internal forces and feedbacks
• Changes in the Earths albedo (all time scales)
• Changes in the Earths biosphere (all time
  scales)
• Changes in the composition of the atmosphere
• ? gases (fast and relatively slow)
• ? particles (fast)
• ? clouds (fast)

Source IPCC (2001a) and CICERO
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• The atmosphere and climate
• Composition of gases in the atmosphere is a main
  driving force for the climate system
• If the composition of gases changes the climate
  will change
• Humans influence the climate through the release
  of greenhouse gases (GHG)
• Tendency to over-exploitation of the atmosphere
  (emissions of GHG) and thus the climate system,
  leading to climate change (global warming)

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CO2 concentration in earlier times
a)
b)
c)
d)
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Radiative balance
Source NILU
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Radiative forcing
Source IPCC (1996a)
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IPCC Third Assessment Report Summary (2001) An
increasing body of observations gives a
collective picture of a warming world and other
changes in the climate system. The global
average surface temperature has increased over
the 20th century by about 0.6C. There is new
and stronger evidence that most of the warming
observed over the last 50 years is attributable
to human activities.
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Global annual temperature variations relative to
19611990
Source http//www.cru.uea.uk/cru/climon/data/them
i/17.htm (14.02.01)
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IPCC Third Assessment Report Summary (2001)
-Human fingerprint The attribution of climate
change to anthropogenic causes involves
statistical analysis and the careful assessment
of multiple lines of evidence to demonstrate,
within a pre-specified margin of error, that the
observed changes are - unlikely to be due
entirely to internal variability - consistent
with the estimated responses to the given
combination of anthropogenic and natural forcing
and - not consistent with alternative,
physically plausible explanations of recent
climate change that exclude important elements of
the given combination of forcings.
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Does human activity have an effect on our climate?
Source IPCC (2001a)
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Projected global anthropogenic CO2 emissions
Source IPCC (2001a)
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The global climate of the 21st century
Source IPCC (2001a)
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Potential climate changes impact
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• A cost-effective climate policy
• Minimization of abatement cost
• implementing policy options and investment
  options according to increasing cost per unit of
  greenhouse gas (independent of national borders)
  until the target is met. Thus options with lowest
  cost per ton of CO2 equivalent should be
  implemented first.

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• Greenhouse gas abatement options
• Increase energy efficiency - new and more
  efficient (energy) technologies
• Substitute high-GHG energy sources for low-GHG
  energy sources coal -gt oil -gt gas -gt heat pumps
  -gt hydropower/solar/wind
• Develop renewable energy sources biomass, solar
  (heating, thermal and photovoltaics), wind and
  wave, geothermal, etc.
• Substitute high-GHG goods and services for
  low-GHG goods and services
• Change production processes
• Reduce transportation needs through area planning

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• Climate negotiations and treaties since 1994
• The Climate Convention (UNFCCC), Rio de Janeiro,
  Brazil, June 92 entered into force in 1994
• COP1 Berlin, Germany, March/April 1995
  Berlin-mandate
• COP3 Kyoto Protocol (KP), Kyoto, Japan, December
  1997
• COP4 Buenos Aires, Argentina, November 1998
  Buenos Aires Plan of Action
• COP6 den Haag, Nederland, November 2000 failure
• March 2001 the USA pulls out
• COP6-2 Bonn, Germany, July 2001 agreement
• COP7 Marrakech, Morocco, Oct./Nov. 2001 KP
  finalized
• Per May 2002 84 countries signed and 54
  countries ratified the Protocol

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• The Kyoto Protocol
• The Kyoto Protocol is a historical treaty first
  legally binding climate policy treaty, but only a
  first small step in a process towards more
  ambitious targets later.
• Only a small step towards stabilization of
  greenhouse gas concentrations in the atmosphere
  at a level that would prevent dangerous
  anthropogenic interference with the climate
  system. (FCCC, Art. 2) the global warming is
  only reduced by some 0,1 degree C by the end of
  next century. Effect depends on reductions after
  2012.
• According to IPCC, greenhouse gas emissions must
  be reduced by some 70 to avoid a doubling of the
  atmospheric concentration of carbon dioxide.

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Main features of theKyoto Protocol

• Industrialized countries are to reduce their
  aggregate GHG emissions by 5.2 in the period
  20082012 compared to the base year 1990.
   Differentiated reduction targets ranging from
  8 to 10. Possibility to participate in a
  bubble to jointly reduce emissions. Six gases
  or groups of gases are included CO2, CH4, N2O,
  HFC, PFC, and SF6.  There is an opening for
  including sequestration of CO2 in forests and
  soils. Three flexible mechanisms are specified
  International emissions trading (IET), Joint
  Implementation (JI), and the Clean Development
  mechanism (CDM).

Source CICERO
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Differentiated reduction targets
Source CICERO
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• Compliance
• Establishment of a Compliance Committee with a
  facilitative branch, an enforcement branch, and a
  bureau
• Restoration of non-compliance plus 30 deduction
  rate in the next budget period
• Suspension of eligibility to sell quotas until
  compliance is restored
• The legal form of procedures and mechanisms
  postponed until first Meeting of the Parties
  (MOP) to the Kyoto Protocol
• Source CICERO

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• The flexibility mechanisms
• Cap and trade emissions trading
• Baseline and credit JI and CDM
• No specified ceiling on trade (domestic action
  shall thus constitute a significant element of
  ...)
• A 2 fee on the CDM mechanism (transferred to
  the KP adaptation fund)
• Refrain from nuclear power
• Host party to confirm whether a CDM or JI
  project contributes to sustainable development
• Fast-track for small-scale CDM projects
• CDM crediting from January 2000
• Fungibility between the mechanisms
• AAUs, JI and CDM quotas can be banked (up to
  2.5 of Kyoto target for JI/CDM)
• Commitment period reserve for all quota/credit
  types
• Source CICERO

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Flexibility mechanisms and units for greenhouse
gas emissions trading
Source CICERO and Natsource (2001)
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Prospects for the Kyoto Protocol

• Will Australia, Canada, Russia, and Japan ratify
  the protocol?
• In the best case the protocol could enter into
  force late next year (the World summit Rio plus
  10 takes place in South Africa in September
  2002)
• The parties are to show demonstrable progress in
  meeting the protocol commitments by 2005 and
  they must engage in negotiations on targets for
  new budget periods by the same year
• Source CICERO

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Policy tools benefits and drawbacks
Policy tool Tax Emissions trading Joint
implementation and CDM
Benefits Cost-effectiveness Well-known policy
tool Replacement of other taxes may give
additional benefits Cost-effectiveness Emission
reduction target achieved with certainty Inexpen
sive projects in other countries
Drawbacks Uncertain emission reduction The state
may have fiscal objectives ? reduced
cost-effectiveness Unilateral use can lead to
migration and carbon leakage Uncertain quota
price Not much experience with use Could conserve
industry structure reduce rate of technological
progress? Unilateral use can lead to carbon
leakage Information and verification problems
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Illustration of emissions trading between two
countries
Emissions 2010
CO2 equivalents
Quotas purchased
Kyoto target for both countries
Quotas sold
Emissions 2010
Country ALow abatement cost
Country BHigh abatement cost
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• An illustration of emissions trading at national
  level. A tool for achieving cost-effectiveness
• Determine total national emissions climate
  policy target
• Divide into quotas of suitable size (1 ton of
  carbon dioxide equivalent)
• A plan and time schedule for introduction of the
  system who/sources to participate what gases
  up-stream or down-stream, etc.
• Initial quota allocation auction/sale, or free
  quotas according to reference year/period
  emissions (grandfathering) or mixture
• Quota market companies and others buy and sell
  quotas
• Companies that can cheaply reduce their emissions
  sell and companies with high abatement cost buy

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Key findings of studies on the Kyoto Protocol and
the fossil fuels markets

• Significant reductions in coal demand, less
  impact on oil and gas demand
• Demand reductions are generally smaller with free
  international emission trading
• Producer prices of fossil fuels do not fall
  dramatically
• Emissions trading can reduce national
  implementation costs by up to 70

Source Holtsmark and Mæstad (2000)
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Harmonizing quota trading systems

• There are initiatives to launch quota trading
  systems before 2008 in the EU (from 2005),
  Denmark (from 2001), the United Kingdom (from
  2002), the Netherlands (from 2005), Norway (from
  2005), and Australia, Canada, Sweden and some
  other countries
• A number of features of the national and
  regional initiatives differ
• Harmonization of trading rules is required to
  reduce transaction costs between countries before
  2008 (e.g. linking national systems with the EU
  trading scheme)
• Transaction costs are lowest when all quotas and
  credits can be regarded as one commodity (i.e.
  high fungibility between emissions trading, the
  CDM, and Joint Implementation), and there is no
  need for risk adjustments of the price according
  to origin (i.e. seller liability)
• Source CICERO

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Important features for harmonization of quota
trading systems to reduce transaction costs
Source CICERO
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• White paper no. 15 (2001-2002)(tilleggsmelding
  til St.meld. nr. 54 (2000-2001))
• National quota system 2005-2007
• Industries that today are exempt from the carbon
  tax shall participate (with some consideration to
  feasibility)
• Aim at 20 reduction in emissions compared to
  1990
• Fee if emissions are above the volume of quotas
  obtained
• Free quotas (restrictions on sale apply)
• All industries to participate from 2008 (trading
  under the Kyoto Protocol)
• Quota Commission (1999) broad system from 2008
  (90)

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• Verification of Kyoto mechanisms fundamental
  challenges
• Baseline determination and additionality
  abatement effect (leakage, technological
  progress no-regrets/profitability)
• Largest problem for CDM smaller for JI small
  for ET (KP target)
• Geographical level project (carbon leakage
  spillover effects), local, region, national
• CDM baseline present emissions/BaU
  benchmarking emissions of economically
  attractive investment
• CDM/JI incentives for host and investor to
  exaggerate abatement
• Likely to be highest transaction costs (and
  risks) for CDM projects

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• Verification of Kyoto mechanisms Rules
• A Party to report on establishment of AA by 1
  January 2007 a set of national inventories of
  gases from 1990 volume of AA
• The national reporting system in place well
  before 1 January 2007 quality assurance plan
  procedure for official approval of the inventory
  preferably undergo third party review
• Reviewed by international expert review team
• Reporting requirements fulfilled to have KP
  mechanism eligibility
• True-up period of 100 days. The final report
  contain complete account of AAs (ET), ERUs (JI)
  and CERs (CDM) (and RMUs (sinks))
• National registry Party holding account legal
  entity holding accounts
• CDM approval of project design, verification,
  monitoring, certification

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• The role of an international oil company
• The Kyoto Protocol is a political reality and
  is likely to be followed by more stringent
  targets after 2012
• Price penalty on fossil fuels and stimulus for
  low-carbon energy sources (sun, wind, biomass,
  etc.)
• The KP mechanisms/emissions trading is a vital
  part of the treaty
• The benefits of early participation in emissions
  trading learn about new markets, influence
  design?
• Internal trading national/regional trading
  2002-2007 KP trading 2008-2012
• CDM, joint implementation and emissions trading
• Direct participation or investment in funds
  (e.g. WB/PCF)
• Trading for a company with branches in many
  countries/developing countries

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Quota trading blocks
ET, JI orUS-ET, US-JI
The Kyoto block
The USAAmerican firms situated in the USA
OECD
ET, JI orUS-ET, US-JI
ET, JI
CDM or US-CDM
CDM
Economies in transition
G77/China
CDM
Source CICERO