EMISSIONS TRADING

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EMISSIONS TRADING

• Minna-Maari Harmaala

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CONTENTS

• Background and history to emissions trading
• The economics of international emissions trading
• The Kyoto Protocol
• Emission trading in Finland
• Business effects of emissions trading

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WHAT IS EMISSIONS TRADING?
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What is emissions trading?

• Emissions trading is
• A market-based approach used to control
  pollution by providing economic incentives for
  achieving reductions in the emissions of
  pollutants (Stavins. 2001)
• Market-based instruments are aimed at encouraging
  behavior through market signals rather than
  through explicit directives or regulations
  regarding the levels of pollution or the allowed
  methods and means for reducing them
• Overall goal is to reduce emissions with minimum
  cost!

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Emissions trading in a nutshell

• Some authority sets a limit on the amount of a
  pollutant that can be emitted (cap)
• This limit is allocated/ given/ sold to companies
  as emissions permits. The total level of permits
  must equal the cap.
• The permit allows the company to emit the amount
  of the pollutant specified in the permit.
• If the company can not meet its quota it will
  either have to buy permits from others, or engage
  in pollution prevention measures.
• Theoretically those who can reduce emissions most
  cheaply will do so, achieving pollution
  reductions at the least societal cost

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Basic principle of emissions trading

• In year 1 both companies A and B emit 100 tonnes
  of CO2. The following year, company A emits 110
  tonnes and company B 140 t.
• The emissions are being reduced by emission
  reduction measures each has to reach 90 t. For
  company A the cost of reducing emissions is 10
  EUR/t and for company B 40 EUR/t
• If both reduce to 90t, total emissions are 180t.
  It will cost A 200 EUR (20t10e) and B 2,000 EUR
  (50t40e). This is not the COST efficient
  solution!

Source Jussi Nykänen 2006
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Basic principle of emissions trading, cont

• The most cost efficient solution is for A to
  reduce emissions to 40 tonnes with the cost of
  (70t10e) 700 EUR. B does not reduce emissions at
  all but instead pays A 700e-200e500e in effect
  buys emission reductions. Total emissions stay at
  180t but total costs are one third of the
  previous total costs.

Source Jussi Nykänen 2006
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Market mechanism? Or almost?

• Market mechanisms vs. the command and control
  approach
• Command and control often viewed as rigid and
  inefficient providing little incentive for
  innovation
• However, the government sets the cap (regulatory
  measure) after this its a market mechanism
  until
• A company fails to comply with the cap/ limit and
  may be hit with another regulatory measure, fine
  for example
• Regulatory measures often increase the cost of
  production firms will opt for the least-cost way
  to comply

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History and background

• Rather surprisingly emissions trading development
  can be traced back to the US
• First simulations were made in the late 60s
  institutionalized for the first time in The Clean
  Air Act (1977)
• First cap-and-trade system 1990 Clean Air Act as
  part of the US Acid Rain Program. The paradigm
  shift
• Later shifting from the US clean air to global
  climate policy, global carbon markets and the
  carbon industry

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The IPPC

• The Intergovernmental Panel on Climate Change
  (created 1998 under UNEP)
• Purpose to give the world a clear scientific
  view on the current state of climate change and
  its potential environmental and socio-economic
  consequences
• Massive debate on global climate change more
  uncertainties than truths!
• Policy recommendations included
• Energy pricing strategies through taxes and
  subsidies
• Phasing out existing distortionary policies
  (certain subsidies regulation,
  non-internalisation of externalities)
• Tradable emission permits
• Energy efficiency standards
• Market pull and demonstration programs
• Etc.

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An externality? What?

• Economics dictionary An externality is an effect
  of a purchase or use decision by one set of
  parties on others who did not have a choice and
  whose interests were not taken into account.
  Classic example of a negative externality
  pollution, generated by some productive
  enterprise, and affecting others who had no
  choice and were probably not taken into account.
• In a competitive market, prices do not reflect
  the full costs or benefits of producing or
  consuming a product or service, and too much or
  too little of the good will be produced or
  consumed in terms of overall costs and benefits
  to society. For example, manufacturing that
  causes pollution imposes costs on the whole
  society, the good will be overproduced by a
  competitive market, as the producer does not take
  into account the external costs when producing
  the good.
• The tragedy of the commons (Hardin 1968)

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THE ECONOMICS OF EMISSIONS TRADING
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The economics of emissions trading

• Different countries have a differently sloping
  Marginal Abatement Cost Curve (MAC) ? the cost of
  eliminating an additional unit of pollution
• For example, countries which have already
  invested heavily in pollution prevention will
  have a much higher price tag on further emissions
  reductions than countries which have invested
  less
• ? International/ global emissions trading was
  created precisely to exploit these differences ?
  air emissions especially know no boundaries!

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MACs and international emissions trading example
Market price of emission allowance
Total amount of required reductions
Efficient allocation (as a result of trade)
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MACs in an individual business

• Any individual company can and should calculate
  its own MAC.
• Simplified Net Present Value of investment/
  saved CO2 emissions
• Example A cookie manufacturer is considering an
  upgrade of its factory lighting. The project will
  involve changing existing lamps, installation of
  time-delay switches, occupancy sensors, etc. For
  an investment of 17,000 EUR to buy and install
  the new lighting system, the cookie manufacturer
  will save 2,000 EUR per annum in electricity. The
  project will save 400 tonnes of CO2 across an
  investment time frame of four years. Calculate
  the NPV and MAC.

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Cookie example continued

• NPV 17,000 (investment) 2,000 4 (total
  savings)
• 9,000 EUR
• MAC 9,000 EUR/400 t CO2
• 22,50 EUR/tonne CO2

Source EPA Victoria
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Another cookie example

• The same cookie manufacturer identifies that some
  of its equipment can be shut down completely
  during the weekend. This will have no cost to the
  business and will save 6,000 EUR and 300 tonnes
  of CO2 over four years.
• NPV 0 6,000 EUR -6,000 EUR
• MAC -6,000 EUR/ 300 t CO2
• -20,00 EUR/t CO2

Source EPA Victoria
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THE KYOTO PROTOCOL
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The Kyoto Protocol

• An international treaty drafted in 1997 and came
  into force 2005.
• The US and Australia are the only industrialised
  countries in Annex 1 that have not ratified the
  treaty ? not bound by its obligations.
• Intention to reduce emissions from 1990 levels by
  2012.
• Introduces three mechanisms (1) emissions
  trading (2) joint implementation JI and (3) clean
  development mechanisms CDM.
• These aim to reduce costs and promote technology
  transfer to developing and underdeveloped
  countries.

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Annex I

• There are 40 Annex I countries and the European
  Union is also a member.
• Australia, Austria, Belarus, Belgium, Bulgaria,
  Canada, Croatia, Czech Republic, Denmark,
  Estonia, Finland, France, Germany, Greece,
  Hungary, Iceland, Ireland, Italy, Japan, Latvia,
  Liechtenstein, Lithuania, Luxembourg, Monaco,
  Netherlands, New Zealand, Norway, Poland,
  Portugal, Romania, Russian Federation, Slovakia,
  Slovenia, Spain, Sweden, Switzerland, Turkey,
  Ukraine, United Kingdom, United States of America

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Joint Implementation

• Allows a country with an emission reduction or
  limitation commitment under the Kyoto Protocol to
  earn emission reduction units (ERUs) from an
  emission-reduction or emission removal project in
  another Annex B Party, which can be counted
  towards meeting its Kyoto target.
• Joint implementation offers Parties a flexible
  and cost-efficient means of fulfilling a part of
  their Kyoto commitments, while the host Party
  benefits from foreign investment and technology
  transfer.
• A JI project must provide a reduction in
  emissions by sources, or an enhancement of
  removals by sinks, that is additional to what
  would otherwise have occurred. 

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JI

• Most JIs in former Soviet states and transition
  economies in central and eastern Europe.
  Currently most projects in Russia and Ukraine.
• CO2 reductions are generally cheaper in these
  countries.
• The total emissions or emission allowances stay
  unchanged with a JI.
• JI takes place between two countries, which each
  have an emissions reduction target!
• Examples are windpower, and combined heat and
  power production.

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Clean Development Mechanism, CDM

• Allows a country with an emission-reduction or
  emission-limitation commitment under the Kyoto
  Protocol to implement an emission-reduction
  project in developing countries. Such projects
  can earn saleable certified emission reduction
  (CER) credits, which can be counted towards
  meeting Kyoto targets.
• The mechanism is seen by many as a trailblazer.
  It is the first global, environmental investment
  and credit scheme of its kind, providing a
  standardized emissions offset instrument, CERs.
• For example a rural electrification project using
  solar panels or the installation of more
  energy-efficient boilers.
• The mechanism stimulates sustainable development
  and emission reductions, while giving
  industrialized countries some flexibility in how
  they meet their emission reduction or limitation
  targets.

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(No Transcript)
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EMISSIONS TRADING IN FINLAND
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Emissions trading in Finland

• Finland has adopted laws and regulations
  concerning emissions trading.
• Energy market authority (Energiamarkkinavirasto)
  is the national emissions trading authority.
• EMV is responsible for issuing and monitoring
  emission permits, maintaining the emissions
  trading register, monitoring the emissions
  trading scheme and adherence to regulation and
  accepting emission trading auditors.
• The Emissions Trading Act is applied to carbon
  dioxide emissions of combustion installations
  with a rated thermal input of more than 20 MW and
  of the smaller combustion installations connected
  to the same district heating network, of mineral
  oil refineries and coke ovens, as well as of
  certain installations and processes of the steel,
  mineral and forest industries.

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Emissions trading in Finland 2009

• In Finland, the number of installations needing a
  permit is around 530.
• Combined emissions in 2009 from Finnish
  installations were 34,4 million tonnes CO2.
  Emission permits allocated free of charge were
  enough to cover this and in fact permits for 2,7
  million tonnes CO2 were left over.
• The global recession decreased the need for
  emissions permits a little, except in the energy
  industry which needed permits for 1,8 million
  tonnes CO2 more than it was originally
  allocated

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What does an emission permit cost?

• Cost of en emission permit (EUADEC-10) 15.9.2009
  14.9.2010 (EUR/t CO2)

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EFFECTS OF EMISSION TRADING ON BUSINESS
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Emissions trading in practice

• Emissions trading brings some additional issues
  to the business agenda
• Emissions permit must be applied for much in the
  same way as an environmental permit
• Emissions registry company must open an account
  in the national emissions registry
• Emissions monitoring and returning emission
  allowances company must monitor and verify
  emissions and return the required emission
  allowances to EMV
• Evaluate emission reduction possibilities
• Emissions trading and trading strategy
• Emissions trading in accounting

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Emissions trading in accounting

• Emissions trading sets certain requirements for
  the accounting department!
• IFRIC (International Financial Reporting
  Interpretations Committee) withdrew an
  interpretation on this issue in 2005 due to
  conflicts in measurement and reporting. It is now
  being worked on again and in the initial stages
  of completion
• In Finland there are interpretation for
  accounting and taxation purposes
• Emission allowances are to be treated as
  intangible rights in the companys fixed assets
  (aineettomia oikeuksia käyttöomaisuudessa)

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KILAn lausunto 1767 (15.11.2005)

• Hyvän kirjanpitotavan mukaista on perustaa
  päästöoikeuksien kirjanpitokäsittely ns.
  nettomenettelyyn. Jos toteutuneet päästötonnit
  ylittävät saadut oikeudet, tehdään ylimeneviä
  tonneja vastaava kulukirjaus tilinpäätöshetken
  markkinahinnalla ja pakolliset varaukset
  vastatilinä.  Kuitenkin siinä tapauksessa, että
  puuttuvien päästöoikeuksien hankinta on sidottu
  sopimuksella tai muuten tietyn hintaiseksi,
  kulukirjaus tehdään lähtökohtaisesti sen
  mukaisena. Jos taas toteutuneet tonnit alittavat
  saadut oikeudet, kirjanpitovelvollisella on
  taseen ulkopuolista varallisuutta, joka tulee
  ilmoittaa liitetietoina. Toisaalta
  päästöoikeuksien ostot ja myynnit kirjataan
  liiketapahtumina suoriteperusteisesti.Jotta
  nettomenettely antaisi oikean ja riittävän kuvan
  päästöoikeuksien vaikutuksista,
  kirjanpitovelvollisen tulee lisäksi
  tilinpäätöksen liitetietona kuvata
  päästöoikeuksiensa, toteutuneiden päästöjen ja
  käymänsä päästökaupan kokonais- ja hintatilanne
  sekä vaikutus tulokseen ja taloudelliseen
  asemaan.Vastaavalla tavalla menetellään myös
  osavuosikatsauksen tai muun välitilinpäätöksen
  laadinnassa ottaen kuitenkin koko tilikauden
  arvioidut päästöt huomioon olennaisuuden
  periaatteen mukaisesti.

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Some Finnish examples

• Ruukki annual report

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• Ruukilla ei mainintaa päästökaupasta varauksissa

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Ruukki annual report
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UPM annual report
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UPM
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UPM
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UPM annual report
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Päästöoikeudet Suomen verotuksessa

• Maksutta jaettujen päästöoikeuksien hankintameno
  on 0 euroa.
• Arvonlisäverotuksessa päästöoikeuden myynti on
  palvelun myyntiä, johon sovelletaan
  arvonlisäverolain 68 n immateriaalipalveluja
  koskevia säännöksiä. Elinkeinonharjoittajille
  myydyt immateriaalipalvelut verotetaan Suomessa,
  jos ne luovutetaan ostajan täällä olevaan
  kiinteään toimipaikkaan.
• Päästöoikeus ei ole varainsiirtoverolain mukainen
  arvopaperi, jonka omistusoikeuden luovutuksesta
  luovutuksensaajan olisi maksettava
  varainsiirtoveroa.
• Päästöoikeuden ylitysmaksu on luonteeltaan
  elinkeinotulon verottamisesta annetun lain 16 n
  5 kohdan mukainen sanktioluonteinen
  maksuseuraamus, joten päästöoikeuden ylitysmaksu
  ei ole tulon hankkimisesta tai säilyttämisestä
  johtunut vähennyskelpoinen meno. Päästöoikeuden
  ylitysmaksua käsitellään verotuksessa siten
  vähennyskelvottomana eränä