Ecologic Institute eco An International Think Tank for Environment and Development logic

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1 Ecologic Institute An International Think Tank for Environment and Development Berlin Brussels Washington D.C. San Mateo CA eco logic! LET S GET STARTED Ecologic Institute Matthias Duwe 26 January 2015 ETS Training Course Mexico Five days together 2 1

2 A few words about myself 3 Ecologic Institute: Who we are! Research for applied environmental research, policy analysis and consultancy! Founded in 1995! Offices in Berlin, Brussels, Washington D.C.! 140 staff in total! Private, not-for-profit, independent, nonpartisan! Among top 10 "Environmental Think Tanks in the University of Pennsylvania s Global Index in every year since 2010! Long standing experience in bridging the gap between science and environmental policy 18 September 2013 EEAS seminar on climate change 4 2

3 1/27/15 Ecologic Institute An International Think Tank for Environment and Development eco logic Emissions Trading Courses since 2009!!!!!!!!!! Alajuela Amsterdam Berlin Beijing Dublin Istanbul Madrid Paris Rotterdam Santiago de Chile By Ecologic Institute & partners under the ICAP umbrella 18 September 2013 EEAS seminar on climate change 5 Ecologic Institute An International Think Tank for Environment and Development eco logic Disclaimer! I am a political scientist, not an economist! My background is EU & DE, not Mexico 26 January 2015 Matthias Duwe: Introduction to carbon pricing. Training Course Mexico 6 3

4 Let s get to know one another! 1. Who are you? 2. Why are you here? 3. What do you like that is not work? 7 Housekeeping! 1. Sign in upon entry, please 2. Lunch 3. Sarah! 8 4

5 Ecologic Institute An International Think Tank for Environment and Development Berlin Brussels Washington D.C. San Mateo CA eco logic! INTRODUCTION TO CARBON PRICING Ecologic Institute Matthias Duwe 26 January 2015 ETS Training Course Mexico Overview of this session! Why would you want to regulate carbon?! The economic rationale for pricing tools! The climate policy toolbox! Direct and indirect carbon pricing! Main design elements of an ETS 10 5

6 Reasons for regula5ng carbon emissions? 11 Possible reasons! Avoid dangerous climate change!! Improve efficiency / reduce energy bills! Develop (a) clean technology (industry)! Improve air quality! Spur investment! Create jobs! Respond to external or public pressure 12 6

7 Economic rationale of carbon pricing Climate change, the greatest market failure the world has seen Lord Nicholas Stern 13 Economic rationale of carbon pricing! Economics: markets deliver the best result! Where markets fail, policy should intervene.! Main reasons: Externalities: polluters! impact Public good: private cost! public benefit! Solution: climate change consequences reflected in each decision by businesses, by individuals, by governments 14 7

8 Economic rationale of carbon pricing! General idea: internalise the external cost! Use the market forces to your advantage the alternative is to regulate against the market forces! Create an incentive, but leave it to individual actors (firms, households) to chose how they respond! Rationale: greater flexibility means lower cost emissions are reduced where it is cheapest! Environmental policies become more efficient environmental targets reached at the lowest cost! Information asymmetry issue not as relevant: the regulator does not have to know everything 15 Everyone familiar with MAC? 16 8

9 Economic instruments vs Command & Control Polluter 1: low abatement cost Polluter 2: high abatement cost Cost ( ) Cost ( ) Abatement effort (t CO 2 ) Abatement effort (t CO 2 ) 17 Economic instruments: marginal abatement cost Case 1: command- and- control: same level of abatement effort Cost ( ) Cost ( ) c 2 c 1 Abatement effort (t CO 2 ) Abatement effort (t CO 2 )! Both polluters have the same level of effort but different marginal abatement costs 18 9

10 Economic Instruments: marginal abatement cost Case 2: economic instruments: same abatement cost Cost ( ) Cost ( ) Tax / Permit price q 1 Abatement effort (t CO 2 ) q 2 Abatement effort (t CO 2 )! Both polluters have very different abatement efforts but the same marginal abatement costs 19 Economic Instruments: marginal abatement cost Comparing the efficiency of economic instruments vs command & control Cost ( ) Cost ( ) regula5on Tax / Permit price Comp. Company 2 1 Company Company 2 1 q 2 q 1 c 2 c 1 Abatement effort (t CO 2 ) Abatement effort (t CO 2 )! Both policies achieve the same abatement but the economic instrument at lower cost 20 10

11 Questions so far? 21 Types of (climate) policy instruments? Examples? 22 11

12 Examples of policy instruments! Taxation (e.g. on carbon)! Certificate Trading (e.g. for emissions)! Obligations (e.g. for renewables)! Standards (e.g. for energy efficiency of housing)! Grants & loans (e.g. to buy cleaner products)! Direct subsidies (e.g. for use of public transport)! Awareness raising (e.g. poster campaign) 23 ETS and its alternatives: the climate policy toolbox! Economic instruments (market-based instruments)! Regulative instruments ( command-and-control )! Suasive instruments ( soft measures )! Voluntary agreements Carrots Sermons S5cks Deals 24 12

13 ETS and its alternatives: the climate policy toolbox! Economic instruments (market-based instruments)! Tradable Permit Schemes (ETS)! Environmental Taxes! Subsidy reform! Regulative instruments ( command-and-control )! Suasive instruments ( soft measures )! Voluntary agreements 25 Some key assumptions for carbon pricing to work! Actors are informed about the abatement options that are available to them, and about their cost! Actors respond to price changes in order to maximise their profit / utility! Actors have access to finance for cost-effective abatement options! Functioning markets all along price signal passed on to consumers! No cheating and gaming actors are controlled through robust MRV, market oversight, enforcement if necessary 26 13

14 Tradeable permit schemes! Basic idea: set a quantified target ( cap ), divide the target into smaller units (permits / allowance), allocate these units to the actors (polluters) covered by the scheme, provide for trade among them, and make sure that all actors comply (i.e. report emissions, have sufficient permits). The price per unit is determined by demand and supply on the market.! Different varieties of trading schemes depending on the target:! Absolute target: absolute emissions (EU ETS) or avoided emissions (NSW)! Relative target (baseline-and-credit) per output unit, sectoral turnover...! Portfolio standards, e.g. renewable energy shares! Covered actors: upstream (fuel-based) vs. downstream (emitters) 27 Environmental taxes (including charges, fees etc.)! Basic idea: introduce a carbon price by taxing polluting activities! Different tax bases possible: Consumption of fossil fuels or electricity (e.g. tax on petrol), Activities that lead to emissions (e.g. ticket charges for flights), Emission-intensive products (e.g. cars with high fuel consumption)! For maximum efficiency, tax should be as close as possible to the actual emissions (price per ton of CO2, rather than fuel / energy use)! To achieve a quantitative target, regulator needs to know how firms and private households will probably respond ( abatement cost curve ) 28 14

15 Different types of carbon pricing! Economic instruments work by introducing a price signal that can be done by keeping either quantity or prices fixed: Quantity-based instruments, e.g. ETS:! impose quantitative limits on resource use, and establish tradable rights to use the resource price is determined through the market. Environmental effectiveness guaranteed, as the quantitative target is achieved by definition. Price-based instruments, e.g. taxes and subsidies:! set a fixed unit price for energy / emissions, but do not guarantee a specific environmental outcome.! Taxes and ETS can and do coexist, but cover different sources challenge to ensure that all are covered, ideally with same price 29 Trading and taxes compared A"ributes Emissions trading Carbon tax Price GHG target Cost- effec;veness Varies determined by market (Supply v demand) Fixed - set by government, defined as cap Fixed set by goverment Varies depends on elas5city, MA, etc.) For given climate goal, Trading is cheaper for par5cipants (for the economy as a whole? Depends on revenues ) Differen;a;on? Through alloca5on rules Through different rates MRV and compliance Revenue genera;on Both instruments require similar informa5on and processes Only if alloca5on is done via auc5oning. Depends on price and volume Key feature. May go down as reduc5ons are made, but could go up if tax is increased

16 Implicit carbon pricing: converting fuel taxes Source: CECILIA2050 project Report D Indirect carbon pricing: RES cost per ton Source: CECILIA2050 project Report D

17 Subsidy reform! Subsidies can be explicit (on-budget) or implicit (e.g. differential tax rates)! Essentially can be the negative equivalent of taxes: rather than raising taxes, first eliminate / reform subsidies?! Good subsidies vs. bad subsidies in terms of climate effects? Good subsidies : e.g. support for renewable energy sources, CCS support technology development, help cover learning costs ( technology spillover ). Bad subsidies : subsidies on activities that emit greenhouse gases (e.g. subsidies for fuel, electricity) distort the carbon price signal, lock in dirty technologies, reduce the overall efficiency / increase cost of climate policy. 33 ETS and its alternatives: the climate policy toolbox! Economic instruments (market-based instruments)! Regulative instruments ( command-and-control )! Absolute emission limits! Efficiency standards! Technology standards! Suasive instruments ( soft measures )! Voluntary agreements 34 17

18 Regulative instruments ( command-and-control )! Traditionally the workhorse of environmental policies in Europe and US, focusing on public safety and health risks (e.g. phasing out particular technologies or banning particular pollutants)! No explicit regulation on greenhouse gas emissions in the EU but many pieces of regulation with impact on GHG emissions: Energy efficiency requirements and performance standards for installations (could be done also with GHGs) Efficiency standards for products (cars (CO2), electrical appliances (energy usage), etc.) Product bans, e.g. on traditional light bulbs Absolute emission limits: common for other pollutants, not for GHGs 35 ETS and its alternatives: the climate policy toolbox! Economic instruments (market-based instruments)! Regulative instruments ( command-and-control )! Suasive instruments ( soft measures ) Providing information, labelling Awareness raising Education and training, Social recognition! Voluntary agreements 36 18

19 Suasive instruments ( soft measures )! Suasive instruments aim to change people's environmental perceptions, priorities (norms and values) and ultimately their behaviour.! Instruments include Providing information (including labelling), Awareness raising, Education and training, Social recognition.! Typically not very costly but effects are uncertain and often limited.! Ideal to support and complement other policy instruments! 37 ETS and its alternatives: the climate policy toolbox! Economic instruments (market-based instruments)! Regulative instruments ( command-and-control )! Suasive instruments ( soft measures )! Voluntary agreements 38 19

20 Voluntary agreements! Voluntary commitments by private actors to achieve a certain goal (phase out technologies or substances, establish best-practice, etc.)! Not a separate type of instrument, but a different delivery mechanism! Often established at sectoral level to avoid regulation by the state! Needs to have a verifiable target and timetable; often with state regulation as a stick if the voluntary agreement should fail! Examples in climate policy: voluntary reduction commitments by industry sectors, efficiency target of the European car industry! Flexible and easy to establish but performance is mixed (may depend on corporate or administrative culture) 08/07/2013 Benjamin Görlach: Choosing Instruments in Climate Policy. ICAP Summer School, Rotterdam, July Questions so far? 40 20

21 What choices do you need to make for an ETS? 41 Design elements of an Emission Trading Scheme! Scope and coverage! Cap-setting! Allocation! Price management! Markets and market oversight! Ensuring compliance! Legal basis and administration! Linking! Economic impacts! Interaction with other policies 42 21

22 Brief intro to some of the fundamentals now! Scope and coverage! Allocation! Price management! Ensuring compliance! Legal basis and administration 43 ETS design: scope and coverage! Which sectors & actors should be included?! Covered actors: upstream (fuel-based, e.g. refineries, mining companies, fuel importers) downstream (actual emitters where fuels are combusted) indirect emissions (electricity use)! Installation-level or company-level trading?! Some considerations: Number of actors: not too few, not too many Large enough share of emissions covered Abatement potential and abatement cost Closeness to trading MRV ability more on this tomorrow 44 22

23 ETS design: allocation! Once the scope has been set, actors identified, cap defined: How to allocate allowances to the covered actors? Selling allowances / auctioning Giving out allowances for free! Based on historical emissions grandfathering! Based on efficiency standards benchmarking! Some considerations Revenues to have or not to have them Information needs / information asymmetry Cost-pass-through, windfall profits, competitiveness Updating problem avoid perverse incentives New entrants, plant closure more on this tomorrow 45 ETS design: price stability / cost control! What is the main goal? To make sure the cap is achieved, or to set a particular price?! In theory, both should be the same in practice there are different interpretations! Different levers for price stability and cost control: Banking and borrowing Adjustment of the cap (temporary or permanent) Rules on the use of (cheap) offset credits Floor price / ceiling price more on this to follow on Friday 46 23

24 ETS design: ensuring compliance Legisla5on (MRG / MRR) Improvement sugges5ons Monitoring Plan (installa5on specific) Permihng Inspec5ons Monitoring throughout the year Competent authority Compliance checks Surrender allowances Annual report Accredita5on body Accredita5on & surveillance Verifica5on based on Fallmann 2011 more on this to follow on Thursday! 47 ETS design: legal basis and administration! How to fit the ETS legislation into the existing body of law and the existing climate policy instrument mix?! What are the administrative tasks and who should take care of them? Allocation of allowances Managing compliance, oversight for MRV Registry Market oversight! What role for private bodies in the different tasks? more on this to follow on Thursday! 48 24

25 Summary: the case for emissions trading! Highly effective and dependable but only as ambitious as the cap that has been set!! Very efficient at least for those emitters that are responsive to price signals! Relatively flexible by adapting the cap but long-term commitment needed to give certainty to investors! In general, moderate administrative burden but definitely depends on the implementation 49 Summary: the case for emissions trading! Emissions trading... is / should be considered a cornerstone for climate protection policies, since it can deliver emission reductions at reasonable cost and since working against the market is a tough battle... is most efficient where polluters are informed of their emissions and respond to the price signal... can (should be?) complemented by other policy instruments more on this to follow in the a0ernoon! 50 25

26 Any other questions? 51 THANK YOU FOR LISTENING! Matthias Duwe Ecologic Institute, Pfalzburger Str , D Berlin Tel. +49 (30) , Fax +49 (30) matthias.duwe{at}ecologic{dot}eu 52 26