Climate Change, Kyoto Protocol & Carbon Trading A Presentation by Thein Maung

1. Climate Change, Kyoto Protocol&Carbon TradingA Presentation by Thein Maung

2. Why do we have to care about climate change ? Global warming because of GHG concentration More frequent and powerful cyclones and hurricanes, intense floods and droughts Snow cover has declined by some 10 per cent in the mid- and high latitudes of the Northern Hemisphere since the late 1960s Almost all mountain glaciers in non-polar regions retreated during the 20th century Source: http://unfccc.int/essential_background/feeling_the_heat/items/2918.php

3. Fossil-fuels and land-use change  CO2 concentrations  Temperature change (Carbon emissions)

4. “How much damage will climate change do?” • Recent estimates (Tol et al., 2000)

5. Agriculture is one of the sectors most susceptible to climate change, countries with a large portion of the economy in agriculture are more vulnerable. Some Empirical Studies The Impact of Climate Change on the United States Economy (Mendelsohn and Neumann (Eds.), 1999) Cambridge University Press “The Impact of Climate on Agriculture: A Ricardian Analysis” (Mendelsohn, Nordhaus and Shaw, 1994) AER “RICE: A Regional Dynamic General Equilibrium Model of Optimal Climate-Change Policy” (Nordhaus and Yang, 1996) AER “The Damage Costs of Climate Change: Toward More Comprehensive Calculations” (Tol, 1995) Environ. Res. Econ. (Tol et al., 2000)

6. How do we solve the problem of climate change and global warming? • According to the EPA, fossil fuels burned to run cars and trucks, heat homes and businesses, and power factories are responsible for about 98% of U.S. carbon dioxide emissions, 24% of methane emissions, and 18% of nitrous oxide emissions • Carbon trading and sequestration projects offer the solutions to global warming Source:http://yosemite.epa.gov/oar/globalwarming.nsf/content/climate.html

7. Introduction to Emissions Trading • Establishment of Kyoto Protocol - For countries that would wish to participate in an international emissions trading scheme, there should be legally binding national emissions targets and timetables for reducing GHG emissions. -The participants should be committed to binding obligations. • Several emissions trading programs have been implemented (McCarl and Schneider, 2000). Example: Emissions Credit Trading, Acid Rain Program and the U.S. Lead Phase-down • Emission credit trading is a regulatory approach to pollution control that emphasizes the use of market forces rather than forced technological compliance to reduce emissions.

8. The composition of total U.S. electricity production (calendar year 2002) Coal 50.1% Nuclear 20.3% Natural gas 17.9% Hydro 6.9% Oil 2.3% Other 2.5% Source: http://www.chicagoclimatex.com/education_ccfe/

9. SO2 Cap and Trade Program • The primary emission trading program in the U.S. is the SO2 cap-and-trade program established by Title IV of the 1990 Clean Air Act Amendments. This program requires power plants to reduce their SO2 emissions by about 50% from 1980 levels. Cap and trade program has the following key features: • An emissions "cap": a limit on the total amount of pollution that can be emitted from all regulated sources (e.g., power plants); the cap is set lower than historical emissions to cause reductions in emissions • Allowances: an allowance is an authorization to emit a fixed amount of a pollutant • Measurement: accurate tracking of all emissions Source: www.epa.gov/airmarkets/trading/basics/index.html

10. The key features of Cap and trade program: • Flexibility: sources can choose how to reduce emissions, including whether to buy additional allowances from other sources that reduce emissions • Allowance trading: sources can buy or sell allowances on the open market • Compliance: at the end of each compliance period, each source must own at least as many allowances as its emissions Penalty: more than $2,000 for each excess ton of emissions Source: www.epa.gov/airmarkets/trading/basics/index.html

11. Allocation of Permits or Allowances • Auctions • Grandfathering -give away free permits on the basis of historic emissions The allocation of permits depends on the structure of national trading systems (Zhang,1998). Such systems could be modeled as, • Upstream: target fossil fuel producers and importers as regulated entities. • Downstream: applied at the point of emissions. • Hybrid

12. Fischer, Kerr and Toman (1998) argue that • The basic trading system should be an upstream, cap-and-trade program with auctioned, bankable permits. • The rules for altering permit allocations should create proper incentives for the private sector to respond to risk while also limiting opportunistic government behavior. • If permit are issued gratis (without payment), they should be taxed on market value. • The revenue from the permit auctions should be used to offset existing tax distortions.

13. Source: (Sandor, Bettelheim and Swingland, 2002)

14. Source: www.cbot.com/cbot/docs/35091.pdf

15. MAC P* Emissions permits is a fixed number of permits or allowances (in this case 125,000) is the regional demand for permits. The least cost property: Source: Hanley, Shogren and White, 1997

16. Source: http://www.chicagoclimatex.com/education_ccfe/

17. Source: http://www.chicagoclimatex.com/education_ccfe/

18. Source: http://www.chicagoclimatex.com/education_ccfe/

19. Phase I (1995-1999): 110 plants to cut emissions by 5 Mtonnes Phase II (>=2000): 800 plants to cut emissions by further 5 Mtonnes Source: http://www.chicagoclimatex.com/education_ccfe/

20. Source: http://www.chicagoclimatex.com/education_ccfe/

21. Why is SO2 cap-and- trade program successful? • The acid rain program works because it is a regional problem and multiple sources contribute to the problem. • Direct monitoring of emissions is used both to verify that the cap is achieved and to insure the value of tradable allowances. • Severe penalty – violations of SO2 air-quality standards will prevent a company from buying allowances. • The emission-monitoring protocols are clearly established by law (credibility). (Sandor, Bettelheim and Swingland, 2002)

22. The emergence of emissions trading • Experience with the U.S. SO2 market shows that a well-defined tradable emissions instrument contributes to the emergence of vigorous trading. • The price of tradable emission rights signals the value the society places on use of the environment. • Certainty as to ownership and legal title is fundamental both to the success of the market and to ensuring that the value of the resource is realized by those entitled to it. • The motivating principle behind creating emissions markets is the Coase Theorem. Coase (1960) argued that assigning property rights to public goods will yield a socially efficient use of resources, even when externalities are present (assuming low transaction costs). (Sandor, Bettelheim and Swingland, 2002)

23. Source:agecon2.tamu.edu/people/faculty/mccarl-bruce/689cc/topic9_co_effects.pdfSource:agecon2.tamu.edu/people/faculty/mccarl-bruce/689cc/topic9_co_effects.pdf

24. So, reducing transaction costs is a crucial component of enabling people to use markets to manage and optimize pollution. • Once property rights are assigned or enforced, creating markets for emissions trading is a way to decrease transaction costs (Sandor, Bettelheim and Swingland, 2002). Transaction Costs Transaction costs can arise at various stages of trading and designing. • Search and information • Bargaining and Decision • Project design • Validation • Enforcement and Monitoring • Verification and Certification In the early stages of a new permit market, participants would incur high search, information, bargaining and decision costs, but these costs should decline as the market matures and participants gain experience (Gangadharan 2000).

25. Source: www.re-focus.net

26. Effectiveness of Carbon Market • An effective carbon emissions market must have a clearly defined tradable commodity for GHG emissions – the standard measure to be traded must be agreed. • An oversight body is needed along with emissions baselines and clearly specified allocation and monitoring procedures. • Widely accepted standards will increase the credibility of the trades and help standardize the legal mechanics more quickly. • All of these steps will lower the transaction costs in the new market. (Sandor and Skees, 1999)

27. The Chicago Climate Exchange is a voluntary pilot greenhouse gas trading program for emission sources and offset projects in North America and offset projects in Brazil. Source: www.epa.gov/climateleaders/pdf/Walsh_ccx.pdf

28. THE PRICE OF CARBON “The winter has been mild and wet, which is one reason why the price has fallen” Andreas Arvanitakis, Point Carbon UK Source:http://news.bbc.co.uk/2/hi/europe/

29. The challenge for an emission trading scheme for GHGs is that there are several gases that need to be covered. • Ideally all sources of GHGs should be included in an emission trading scheme. Example, GWPMarket Price ($/ton) CO2 1 $5 CH4 21 $105 N2O 310 $1,550 HFC-23 11,700 $58,500 SF6 23,900 $119,500 GWP compares the ability of different greenhouse gases to trap heat in the atmosphere HFC-HydroFluoroCarbons SF6 -Sulfur Hexafluoride Source: Gunasekera, 1998; Sandor and Walsh, 2001; McCarl and Schneider

30. Agriculture’s Role in Carbon Trading • If a market evolves for GHG emissions, those who are now contributing to carbon emissions may be willing to pay others to sequester carbon as a permanent offset to emissions. • A buyer of carbon offset can be any entity needing to reduce/offset its GHG emission Example, a power plant facing an emission cap • The largest buyers are likely to be the largest emitters. The major U.S. sources of GHG emissions are power plant, transportation and the manufacturing industry. Source: Butt and McCarl, 2001; Sandor and Skees, 1999

31. (Butt and McCarl, 2001)

32. Who might supply in GHG offset/carbon market? - through sequestration farmers can sell carbon credits • The agricultural aspect of GHG mitigation involves, 1. Soil sequestration - Land management (changes in crop rotation and shifting from deep tillage to no tillage) - Land use practices (converting crop land to grasslands or forests) 2. Establishment of new forests (Butt and McCarl, 2001)

33. Source: www.epa.gov/climateleaders/pdf/Walsh_ccx.pdf

34. The Prospects for Farmers’ Making Money • The magnitude of the risk caused by possible implementation of GHG emission limits has drawn industry attention. • Many firms have started the quest to discover and even begin implementation of ways to reduce GHG emissions in an economically sound manner. • Almost all petrochemical and electric power generating firms now have offices with titles involving climate change or GHG emissions. (Butt and McCarl, 2001)

35. Source: www.epa.gov/climateleaders/pdf/Walsh_ccx.pdf

36. There have been two ways that carbon offset markets have been operating. 1. Direct Contracts - Some energy companies have directly approached agricultural producers to generate carbon offsets. For example, Reliant Energy is funding planting of over 150 thousand trees in an effort to capture an estimated 215 thousands tons of CO2 from the atmosphere, generating carbon credits that will be retained by Reliant. 2. The Chicago Climate Exchange (CCX) - The participants sign contracts to reduce net emissions directly or through trading. The CCX has set up guidelines for soil carbon participation. (Butt and McCarl, 2001)

37. Currently buying and selling activities in the carbon market are indicative of exploratory behavior of buyers and sellers rather than economic opportunities. • As the market develops, economics of sequestration would start to play a greater role. • Under trading, a source of GHG emission mitigation must be competitive in order to find its place in the carbon market. • Are farmers competitive suppliers of carbon offsets? (Butt and McCarl, 2001)

38. The competitive potential of farmers in supplying GHG offsets will be determined by what it might cost to sequester and sell the offsets. • Critical factor is the income change when shifting from non-sequestering alternatives. For example, shifting from conventional tillage to conservation tillage • The loss of income would form the basis of sequestration cost. • Different farmers would have different sequestration cost. (Butt and McCarl, 2001)

39. An implicit indicator of the cost ofsequestration Source: McCarl and Schneider (2001); Butt and McCarl, 2001

40. As carbon payment was raised more farmers would switch to practices that sequester carbon. • At low carbon prices, only low cost farmers might be competitive suppliers of carbon and be able to benefit from participating in the carbon market. • The price of carbon offsets may increase with the shift in U.S. mitigation policy towards tighter emission control. • Edmonds et al. show that if the U.S., acting on its own, were to meet its Kyoto Protocol target emission reduction, the cost may be as high as $250 per ton carbon. The cost may fall to around $25 per ton carbon, with the international trading of carbon offsets. Butt and McCarl, 2001

41. Other Concerns Additional factors that might influence the desirability of a sequestration opportunity to farmers, • Altering operations -Sequestering carbon often involves farmers altering tech. or management. • Middleman costs -The amount of carbon sequestered by a farmer will be small compared to buyers’ needs. -The middleman will play a role in gathering farmers and representing them to a buyer. • Market Discounts -Discounts may arise to correct for additionality, leakage, uncertainty and permanence. Butt and McCarl, 2001

42. Measurement costs - The volume of carbon cannot be directly observed. - A mechanism for verifying the quantity of carbon sequestered will be needed. • Role of government - Will the government involve in promoting carbon sequestration?

43. Future Research • Transaction Costs • Market Evolution • Technological Innovations

44. References Butt, T. A., and McCarl, B. A. “ On-Farm Carbon Sequestration: Can Farmers Employ it to Make Some Money?” Available online at: http://agecon2.tamu.edu/people/faculty/mccarl-bruce/ecomitigate.html Fisher, C., S. Kerr and M. Toman. “Using Emissions Trading to Regulate U.S. Greenhouse Gas Emissions: An Overview of Policy Design and Implementation Issues.” Discussion Paper 98-40, July 1998. Available online at: http://www.rff.org/Documents/RFF-DP-98-40.pdf Gangadharan L. "Transactions Costs in Pollution Markets: An Empirical Study." Land Economics 76(2000): 601-614. Gunasekera, D., and A.Cornwell. “ Economic Issues in Emission Trading.” Paper to Kyoto the Impact on Australia Conference, Melbourne, 12-13 Feb. 1998. Available online at: http://www.apec.org.au/docs/Gunasek.pdf McCarl, B. A.., and U. A. Schneider. “Curbing Greenhouse Gases: Agriculture’s Role.” Available online at: http://agecon2.tamu.edu/people/faculty/mccarl-bruce/ecomitigate.html McCarl B. A. and U. A. Schneider. “U.S. Agriculture’s Role in a Greenhouse Gas Emission Mitigation World: An Economic Perspective.” Review of Agr. Econ. 22(2000):134-159. McCarl, B. A.., and U. A. Schneider. “ The Cost of Greenhouse Gas Mitigation in U.S. Agriculture and Forestry.” Science, 294 (December, 2001): 2481-82.

45. Sandor, R. L., E. C. Bettelheim and I. R. Swingland. “An Overview of a Free-market approach to Climate Change and Conservation.” Published online 28 June 2002. Available online at: http://www.journals.royalsoc.ac.uk/media/LP3EF11UVM2JRVE3NG86/Contributions/U/F/9/U/UF9U3R1M017P4REJ.pdf Sandor, R. L. and Skees, J. R. “ Creating a Market for Carbon Emissions: Opportunities for U.S. Farmers.” Choices (1st Quarter 1999): 13. Sandor, R. L. and Walsh, M. J. “Kyoto or Not: Opportunities in Carbon Trading Are Here.” Environmental Quality Management (Spring 2001): 53-58. Tol, R. S.J., S. Fankhauser, R. G. Richels and J. B. Smith. “How Much Damage Will Climate Change Do? Recent Estimates.” World Economics. 4(2000): 179-206. Zhang, Z. X. “Greenhouse Gas Emissions Trading and the World Trading System.” Journal of WorldTrade, 1998. Available online at: http://130.37.129.100/english/o_o/instituten/IVM/research/efiea/zhang4.pdf