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Kingston, Ontario October 17-18 Andrei Marcu IETA

Carbon Pricing and Environmental Federalism. Kingston, Ontario October 17-18 Andrei Marcu IETA. Global GHG Market. Kyoto Party-Level Entity-Level Non-Kyoto Party. Japan. USA. Voluntary targets. Canada. Projects, CDM/JI. EU25+X. European Allowances. DET. DET. Australia.

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Kingston, Ontario October 17-18 Andrei Marcu IETA

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  1. Carbon Pricing and Environmental Federalism Kingston, Ontario October 17-18Andrei Marcu IETA

  2. Global GHG Market Kyoto Party-Level Entity-Level Non-Kyoto Party Japan USA Voluntary targets Canada Projects, CDM/JI EU25+X European Allowances DET DET Australia

  3. Domestic ETS EU ETS 2100 Mt Alberta 2,6 Mt Swiss ETS 2,4 Mt RGGI 188 Mt CCX 25 Mt JVETS 0,5 Mt Australian ETS ~ 500 Mt NZ ETS ~ 70 Mt Mandatory Cap & Trade Schemes Existing Mandatory Cap & Trade Schemes To be launched Voluntary Cap & Trade Schemes Upcoming national ETS ? Source: BlueNext

  4. Carbon Market at a Glance Source: World Bank, own estimations

  5. x 10 x 2.5 x 1.0 x 2 CDM 551 x 1.3 x 3 Market Volume Growth 2007(in MtCO2e) Allowance Markets Project-Based Transactions JI 41 EU Emission Trading Scheme SecondaryCDM 2,061 240 Voluntary& Retail New South Wales Certificates 42 25

  6. The Start of Period II of EU ETSExchange Vs. Brokers • Trades made on secured platforms have increased continuously since 2005… • … especially on spot trading where 95% of contracts have been traded on exchanges in 2008 against 85% in 2007. Total volumes on European market (EUA) and breakdown between OTC and exchange trades Source: BlueNext from Reuters

  7. The Start of Period II of EU ETSSpot Vs. Futures • Spot market has become more financial in the last months: more and more players are doing arbitrage between spot and futures contract. This is due to the increasing liquidity seen on the spot market and number of members on BlueNext Spot. • In the actual context of financial crisis, investors try to diversify their investments. Carbon market, spot and futures, is a way to enlarge their product portfolio. Source: BlueNext from ECX

  8. Futures volumes breakdown by maturity • On EUA market, volumes are concentrated on first delivery (December 2008). • However, on CER market, volume breakdown is more homogeneous • This can be explained by the fact that, on CER market, market players need to cover their total number of CERs whereas on EUA market, they only need to cover the difference between emissions and allocation. Source: BlueNext à partir d’ECX

  9. The Start of Period II of EU ETSPrices Rumours on French Conection to ITL Moves in energy prices Growing Oil price Source: BlueNext, ECX

  10. Supply/demand outlook until 2012 The Kyoto Balance

  11. EU and Member State Targets for 2012 (Kyoto Protocol targets) Russia Kyoto target: + 5% EU 15: -8% 10% 0% 1% 4% -8% -8% - 21% -8% 13% -12,5% -6% -6% -7,5% -8% -21% -8% - 28% -13% -6% 0% - 8% - 8% - 8% Cyprus and Malta have no targets 27% - 6,5% 25% 15%

  12. The EU ETS – history, assessment and future developments • EU ETS – original piece of legislation was approved in 2003. • EU ETS is structured in separate phases:  • Phase I or pilot phase – ran from 1 January 2005 to end 2007. • Learning by doing phase, not linked to the Kyoto protocol, separated from following phases or trading periods. • Phase II – ongoing – 2008 to end 2012, based on existing directive, builds on experience gathered in phase I, linked to Kyoto protocol. • Phase III – under negotiation, object of review of Emissions Trading System – 2013 to…??

  13. Key features of Phase I and II • Emission permits “ EU Allowances - EUAs” distributed by Member States (MS) • Total amounts of EUAs negotiated between MS and European Commission – competitive distortions within sectors across MS • Most emission permits distributed for free – only about 3 % now auctioned • Access to Kyoto Protocol flexible mechanisms – cheaper compliance means,ensures involvement of developing countries in international negotiations • Establishment of solid Monitoring, Reporting and Verification system • High penalties – 40 €/Tonnes + “make good” provision

  14. EU ETS – blueprint for a global C+T ? • Is the EU ETS a success so far ? • Are there lessons to be learned from P1 and beginning of P2 ? • What are the key areas and how do they differ from jurisdiction to jurisdiction • How compatible must it be with other DETs ? • Can it be a docking station for global C+T ? • Lessons important in a number of areas • Allocation • Data availability • Interaction with other policies and measures

  15. Assessment of Phase I Phase I a success – although there is scope for improvement 1. Incorporated price of carbon in products – price of carbon now high on Board agendas and key for investment decisions 2. Set up MRV system: backbone of ETS, ensures that a tonne of carbon is a tonne of carbon and can be traded 3. Engine of CDM system – key for international negotiation and to rach an international agreement Main criticisms: • EU ETS a failure because price crashed - unfounded • No abatement in GHG emissions - unfounded • Windfall profits for electricity firms – partially true but addressed in EU ETS review •  Competitive distortions among sectors in the EU – partially true but addressed in EU ETS review

  16. Allocation ExperiencesLearning from Phase 1 • Working environment • Short time frames • Lack of actual data • Choices • Highest demand on power sector • Use of recent data • Little auctioning • Entrance/closure provisions • Unclear boundaries/coverage

  17. Allocation ExperiencesLearning from Phase 1 • Process • Role of stakeholders • Coordination role of the EC • Lessons Learned • Pilot phase was useful • Conditions for creating “windfall profits” • Impact of new entrance/closure provisions • Importance of actual data • Competitive impacts limited • Impact of political advocacy at local/national level • Role of EC to enforce environmental delivery

  18. Allocation ExperiencesLearning from Phase 1 • Lessons Learned • More use of ET • Use by government of CERs and ERUs • No use of post adjustment • Allocation plans too complex

  19. The Emerging Verdict on Phase 1 • The ambition level was modest and the price impact was only felt in the first half • Nevertheless, some emissions reduction from BAU took place • Impact on investment understandably slight

  20. EU-ETS Phase 2 Levels of Ambition A much tougher approach...

  21. New Guidance for P2 • Progress towards KP targets trajectory • Setting national caps according with potential • Substantiation of government purchases • Substantiation of other policies and measures • Guidance on CDM/JI • Use of benchmarking • Definition – e.g. combustion installation • Installation size

  22. Review of the EU Emission TradingScheme EU Commission proposal published on 23 January 2008. Based on unilateral EU reduction goal: -20 or - 30% agreed in March 2007 Main elements of EU ETS phase III: • Centralised cap – reduction factor set until 2028 • Longer allocation periods – 8 years • Auctioning for power & CCS sectors: 100% • ‘Suggested’ Earmarking of revenues+ some auctioning to ‘poor’ Member States • Potential Benchmarking for energy intensive sectors – 20% initial auctioning • Up to 100% free allowances for sectors exposed to carbon leakage - Broadening of scope for combustion plant, new sectors e.g. Chemicals, Aluminium, CCS and other KP gases e.g N2O, PFCs - Quantitative and qualitative limits to CDM-JI access • Banking: Specifically allowed from Phase II in Phase III • EUETS Projects to be considered, exclusion of small emitters with conditions • Linking to emerging international schemes

  23. Where were the Political Problem Areas? • Level of ambition vs competitiveness • Auctioning vs free or benchmarked • allocation • Application of auction revenues • Forestry – “something must be done” • CDM – suddenly come alive • Speculators! • Special weighting for CCS or other favoured technologies • Carbon leakage, and the international negotiations • Border adjustments diminishing • Special member-state circumstances (eg dependence on Russian gas) and ...getting it all done by December 08 Source: Mission Climat/Caisse des Depots

  24. CAP • - 21 % below 2005 emissions ( vs 10% for the non-trading sectors) • Max. cap : 1720 MT by 2020, yearly average:1846 MT • Reduction of about 11% compared to Phase II cap • From 2010 the total number of allowances to decrease by 1.74% /yr - ~37 Mt with current ETS coverage • Starting point for reductions: average quantity of allowances of cap of Phase II • Reduction factor valid until 2028 – EC to propose review by 2025 • 8-year trading periods • Total quantity of allowances to be adjusted to take account of enlarged scope in phase II and III • Cap to be strengthened if international agreement is reached Centralised cap coupled with medium and LT targets, and linear factor until 2028 give certainty in terms of environmental goal and investments- key positive aspects of the proposal

  25. How will allowances be distributed? • The power sector and CCS to be fully auctioned from 2013 – exception for heat emissions from high efficiency CHP installations • Other sectors including refining, shall receive 80% of the free allocation benchmark in 2013. This percentage will be reduced gradually - no free allowances by 2020. • Sectors exposed to the risk of leakage may receive up to 100% free allowances

  26. Allocation methods • Auctioning will be the preferred tool for allocation (“it is the simplest and most economically efficient system”) • At least 60% of allowances should be auctioned in 2013. Of these: • Member States will receive 90% of the total quantity of allowances to be auctioned according to their relative share of 2005 emissions in the EU ETS. • 10% of the quantity of allowances to be auctioned should be distributed to poorer Member States for the ‘purpose of solidarity and growth’, to reduce emissions and adapt to climate change.

  27. Revenues from auctioning At least 20% of the revenuesshould be earmarked to: • Reduce GHG emissions, to adapt to climate change and to fund R&D • To meet the EU 2020 targets for renewable energies and energy efficiency • For CCS, in particular from coal power stations; • For measures to avoid deforestation, in particular in LDCs • To address social aspects in lower and middle income households, e.g. by increasing energy efficiency and insulation • To cover administrative expenses of the management of the ETS

  28. Carbon Leakage • By 30 June 2010: EC to identify which the energy intensive industry sectors or sub sectors are exposed to carbon leakage. • Assessment based on “inability of each sector to pass through costs” ”without significant loss of market share” to other installations in jurisdictions that do not apply a price to carbon” • Specific criteria to assess leakage will cover: • (a) the extent to which auctioning would lead to a substantial increase in production cost; • (b) GHG reduction potential of individual installations in the sector concerned • (c) market structure, relevant geographic and product market, the exposure of the sectors to international competition; • (d) the effect of climate change and energy policies implemented outside the EU in the sectors concerned. • By June 2011 at the latest the EC will submit a report and propose measures: i.e. • distributing these sectors up to 100% free allowances or • setting up a “carbon equalisation system” • indirect emissions may be taken into account (recital 19):

  29. The Competitiveness Puzzle – not many sectors seriously affected but the effect is real 100% @ €45/tCO2 100% @ €45/tCO2 Cement Steel Note: Trade sensitivities estimated from range of historical variability Source: Data from CIRED, as presented in Carbon Trust (2008)

  30. Addressing Competitiveness Issues • Cross border taxation schemes • Production based allocation with benchmarking OR redistribution of proceedings • Global sectoral agreements

  31. Instruments relevant to UK business sector energy use – current and potential new ones Target segments Large non-energy intensive Energy intensive SMEs • CCL/carbon tax • CCA • UK ETS • EU ETS • Building regulations • Enhanced capital allowances • Funded programmes (CT) • Buildings - business rates / standards • Project based trading • SME White certificate trading • Product standards       Existing measures              New measures    

  32. Instruments relevant to UK generation • EU ETS & variants: • Allocation & new entrant principles • Auctioning • Renewable obligation certificates (ROCs) • LCPD • NETA balancing / other rules • Transmission charging regime • Distribution & connection charging regimes • Funded programmes (CT) • Carbon tax?? • Banded ROCs? • Nuclear incentives (insurance, disposal, etc ..?) • End-use related measures (Cogen, PV, ..?) Existing measures New measures

  33. Market research suggests a combination of business needs, regulation, fiscal and support measures drive energy efficiency uptake Derived importance of factors in influencing energy efficiency decisions Energy price and cost savings Other current regulation/Company policy Competitiveness / Investors expectations Future impact and risk of climate change Climate Change levy Customer requirements/Brand and PR Support provided by Action Energy What is the most effective combination of factors? Climate change agreements Enhanced Capital Allowances General economic outlook of the UK Environmental interest groups Increasing importance Source: NOP research and conjoint analysis June 2003; sample of 1332 organisations across industry, commercial and public sectors

  34. Avoiding Double Counting Between CCA & EU ETS • Issue • Operator reduces emissions under EU ETS • Can use that under CCA • Can be double counted under UK ETS • Double counting is avoided by adjusting CCA target

  35. Summary of the Market Sentiment Survey • Strong confidence in the longevity of the market; • Continuing strong growth in trading volumes up to and beyond 2012; • Significantly higher prices beyond 2012; • Continued significant role for project based credits, but less optimistic about growth post-2012; • A greater demand for VERs, and the appropriate infrastructure to set up a robust and reliable market. Source: IETA

  36. Full Global Trading Large Sources of CO2, CH4, N2O HFC, PFC, SF6 All Major Emitting Countries Canada Japan ? EU ETS CO2 Only ? EU ETS CO2 only, CDM: Any gas, any sector Non-EU JI: Any gas, any sector Phase 1 Phase 2 Beyond 2012 IETA Vision: Global GHG Market Post 2012

  37. Eligibility of Project-Based Instruments Post 2012 China OECD Allowances Russia India Ukraine High EmissionsHigh Wealth Brazil NIS ? High EmissionsLow Wealth Korea, Mexico,South Africa ? Asian Tigers Emissions OPEC Kyoto Protocol Annex B Latin America ? Low EmissionsLow Wealth Low EmissionsHigh Wealth Low EmissionsLow Wealth Small Island States Israel Singapore ? LDC Africa Post 2012Agreement? Wealth CDM/JI Credits 37

  38. Do you know if you are in the grace of God ? • Heavily criticized – death by a thousand cuts • They will always be more complex than C+T • Play an important role in addressing climate change for certain sectors and countries • Part of the current and likely future international & national regimes • Press & academic studies (e.g. Wara & Victor) • There are issues that can and should be solved

  39. Do Offsets Deliver ?Arguments For CDM • Lower the cost of compliance in Annex 1 – good cost control mechanism • Support SD development • Engage non Annex 1 in fighting CC

  40. Do Offsets Deliver ?Arguments Against CDM/Offsets • No environmental integrity – Chinese projects/non industrial gases projects would take place anyway • Additionality impossible to show • Cannot produce enough and on time to act as a control mechanism • HFC – a rip off • Concentrated projects • Little time in KP1, high uncertainty • Subsidy for China • Voluntary markets are full of charlatans Therefore they cannot be useful in one of its main roles and we need another mechanism – safety valve

  41. Death by a thousand cuts • Circular arguments • No desire to help reform the instrument – simple but effective remedies available • Born out of an academic view – not a practitioner’s perspective • Many good projects do not get funded • Real competition at assets allocation • Many factors – GHG will always be only one • Speed of change is critical as change itself

  42. Reality of CDM • An imperfect mechanism – offsets will always be less than C+T and a transitory measure • Added complexity due to institutional arrangements • Problems in communication • No predictatibility and precedent setting • Long lead times for projects • No clear accountability Conclusion – need for reform • More Board-like behavior • Move away from project by project • Trust DOEs • Clear accountaibility

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