Background

1. EUSTAFOR WORKSHOPBrussels, 26 June 2008Forestry and land uses: should sequestration be included in the EU ETS?Matthieu WEMAËREResearch Associate Climate and Energy Programme – IDDRIPermanent Representative of IDDRI at EU institutions in Brussels

2. Background • Member States’ emission removals from LULUCF are accounted for under art. 3.3 (mandatory) and 3.4 (optional) of the Kyoto Protocol • Linking Directive 2004/101/EC: exclusion of JI/CDM credits generated by LULUCF activities • Shift in the discussion since Kyoto entered into force: LULUCF is important to combat climate change • EU Summit and ENV Council conclusions (9/3/07 and 28/6/07), and EP Resolution (15/11/07) asked the Commission to explore options to include LULUCF, road and ship transport in the EU ETS • Council has already agreed that auction revenues from the aviation sector should be used to finance measures to avoid deforestation, EP not focussed on this

3. What is it all about? • Should LULUCF be included as a sector in the EU ETS? • Bearing in mind that LULUCF in the EU is not included at this stage in the EU Effort Sharing proposal • Should emission reduction credits from possible future international mechanisms to avoid deforestation be used in the EU ETS = RE(D)D debate pursuant to the Bali Action Plan • Would address forestry activities outside the EU • Should credits from JI/CDM and Domestic Offest Projects (DOPs) generated by LULUCF activities be allowed to be used by operators in the EU ETS for phase III? • Would cover LULUCF in and outside the EU

4. I. Should LULUCF be included as a sector in the EU ETS (1)? • Not the case in Phases I and II, mainly because: • Temporary sequestration v. permanent reductions: EU ETS is first designed as a technological driver for long term emission abatement improvements from energy and industrial sources within the EU • Coverage of LULUCF vary in Member States (art. 3.4) who have chosen different reporting requirements (art.3.3) under the Kyoto Protocol • Including LULUCF would increase coverage but would require harmonized rules and special provisions: • As EU ETS is mandatory, special provisions would be needed, including authorization for enforcement purposes, at the level of land owners, holdings and Member States • Harmonizing requirements for monitoring sequestration at holding level would be much more complicated to elaborate than for other candidate sectors (e.g. ship transport) • Would entail major administrative costs, • …and undermine simplicity and efficiency of the EU ETS

5. I. Should LULUCF be included as a sector in the EU ETS (2)? • Experience in other Annex I countries show that including LULUCF in an ETS requires special features (voluntary participation of land owners in New Zealand who can receive free allowances) • How to deal with land owners liability in case the carbon stock would be converted into a carbon source? • To surrender allowances only when the carbon stock falls down? • Buying allowances through auctions or on the secondary market, as for CCS in case of leakage? • Inclusion of LULUCF in Phase III would need to be consistent with international rules for LULUCF accounting which, at the very best, will not be agreed before end 2009 • Including it now would prejudge the outcome of post 2012 negotiations • There is no basis for setting now a sequestration target for LULUCF

6. II. Avoiding Deforestation (1) • Not addressed under the Kyoto Protocol, even through CDM • Roughly 20% of global GHG emissions, 28% of global CO2 emissions: major source of emissions from land use change, hardly compensated by A/R activities (IPCC 2007) • Tackling emissions from deforestation is a crucial element in the overall EU Strategy to limit global warming to 2°C max above pre-industrialized levels (COM(2007)2) = EU credibility at stake! • Bali Action Plan recognizes the need for “policy approaches and positive incentives” but leaves open the door for various solutions • Opportunity costs may range from 5 to 8 billion $/annum in 2030 • Need to raise funding: Commission proposal suggests to use a portion of 20% of the proceeds from auctioning (US Liebermann Warner Bill: 2,5%), including for measures to avoid deforestation – Aviation precedent!

7. II. Avoiding Deforestation (2) • Using RE(D)D credits raises fundamental questions: • What is the role of the carbon market…and of the EU ETS? Deforestation is not just a climate issue… • What is the exact scale of transfers likely to be involved (annual emissions from deforestation could account for 6 billion T CO2/year)? • Crucial to look at supply and demand: What demand might be from industrialised countries, and what action developing countries can undertake? • What impacts of using RE(D)D credits in the carbon market ? - Price collapse? Incentive for technological improvement in the EU? - Should Annex I targets be increased in proportion of the volume of RE(D)D credits that can be used? • Liability concerns related to non permanence are just the same than for tCERs if such commodity is used… • What about supplementarity? • Would it help or impede linking trading systems?

8. II. Avoiding Deforestation (3) • Is it appropriate to signal now that RE(D)D credits may be used in the EU ETS in the absence of an international framework? • Any decision would prejudge the outcome of international negotiations and would not, as such, stimulate early action • Introducing a commitment to use revenues to tackle deforestation and/or to consider use RE(D)D credits directly in EU ETS via the review clause would give a strong signal to other Parties • What matters is to finance action in tropical countries in order to gain experience in avoiding deforestation in an integrated manner towards sustainable forest management practices: • Use/fix (10%?) a portion of auction revenues to support early action and avoid competition with other areas = no displacement of emission reductions from the EU! • Additional funding will be necessary: establishment of an EU Fund? • Review clause to decide (in 2015?) if and what role the EU ETS can play in providing incentives to halt deforestation

9. III. Use of credits from LULUCF (1) • In 2004, Council and Parliament agreed not to allow the use of JI/CDM credits from LULUCF activities in the EU ETS, because: • ETS: “technological” driver for “permanent” reductions in the EU • Temporary and reversible nature of LULUCF: liability risks • Creation of “tCERs” was an attempt to respond to the non permanence issue of CDM A/R projects, but nothing for JI (which allows more than A/R) • Experience with LULUCF activities under JI/CDM is limited • Marrakech Accords limit the use of A/R CDM credits up to 1% of Parties’ emissions in the reference year, while JI starts in 2008 only • Impact of “no linking”? • Commission proposal maintains the exclusion of credits from LULUCF, mainly because of the liability risks • But Effort Sharing proposal is independent of Member States' obligation to replace tCERs used towards Kyoto commitments, for up to 60 years

10. III. Use of credits from LULUCF (2) • Reliable methodologies arebeing developed by the CDM Executive Board, based on IPCC GPG LULUCF, which help address some concerns (additionality, monitoring, leakage, accurate accounting…etc). • But some concerns remain to be solved on a project by project basis, especially environmental and social impacts (biodiversity, carbon ownership taking account of land tenure and land use rights, including indigenous people’s customary rights) • Domestic Offset Projects (e.g. France) show how difficult it works in practice for forestry activities under current JI rules : • ILT rules prevent ERUs for LULUCF to be converted from AAUs • ERUs converted from RMUs (capped under art. 3.4 of KP) cannot be carried over = uncertainties given the long lifetime of LULUCF projects • France chose annual inventories for LULUCF…but will not know whether it is a source of carbon or a carbon sink before 2014 • Specific provisions are required to address non permanence and guarantee the State against liability risks in case of loss of carbon

11. III. Use of credits from LULUCF (3) • The “liability” issue: distinction between JI and the CDM • CDM: “buyer (company/Gvt) liability” = tCERs expire at the end of their validity period (e.g. 5 years), and have to be replaced by permanent credits if there is a loss in carbon and/or at the end of a project’s crediting period • JI: “seller (country) liability” = ERUs are permanent credits, transferred without passing any liability to the buyer, which rests on host country that must account for the loss in carbon • Both lCERs and tCERs are not easily compatible with a company based trading system: • May give a perverse incentive to sell first permanent allowances • Liability is transferred to the Member States, if the plant closes down • Difficulty lies with the management of 2 different commodities • Noteworthy that there is very little demand for lCERs on the market. New Zealand, while keen on forestry, has ruled out tCERs from the NZ ETS.

12. Conclusions (1) • Including the LULUCF as a sector in the EU ETS is not desirable, at least until accounting rules are agreed upon at international level for the post 2012 period. • Action must be taken to tackle deforestation. Using RE(D)D in the EU ETS is one option to be further explored, but early action to learn and gain experience can be financed through the use of auction revenues. Draft Report from Mrs Doyle calls for a Coalition of the Willing of Member States to transfer to a Community Fund one quarter of 50% of auction revenues to take action to avoid deforestation and increase A/R in “Parties” to the future climate agreement

13. Conclusions (2) • Linking forestry credits from offsets still raises liability concerns. But EU harmonised rules for offset projects may offer a window for issuing fully fungible allowances to forestry activities in the EU while providing robust rules to deal with non permanence issues and associated liability risks that are directly supervised by Member States . • Forthcoming Commission Communication on Forests (September 2008?) should pave the way for a better defined strategy on REDD at international level, foster policies and measures to increase carbon sequestration through A/R, forest conservation and sound forestry and land use management practices as well as mobilizing biomass potential in synergy with renewable energy targets within the EU.