European Union Emissions Trading Scheme enough for climate mitigation?

Transcription

1 Controlling Climate Change Henvi Seminar European Union Emissions Trading Scheme enough for climate mitigation? Markku Ollikainen Professor of environmental and resource economics Member of the Finnish Climate Panel

2 1. Background Kyoto protocol USA requested that emissions trading be included in the protocol Result: ideas of international emissions trading (IET), clean development mechanisms (CDM) and joint implementation (JI) mechanisms EU s target in Kyoto protocol: to reduce 8% of CO2 emissions from 1990 level EU & emissions trading was originally against emissions trading but in the end applied it as the key means of implementing the Kyoto protocol The aggregate reduction obligation was divided among member states as a national burden Emissions trading sector takes care of 45-50% of the Kyoto reduction obligation; the rest is covered by non-trading and LULUCF sectors Link directive allowed firms to introduce emissions reductions by CDM and JI mechanisms to the emissions trading program This presentation: How well does the trading system perform? What role does EU ETS have now and what role may it have as the main instrument of climate policies?

3 Theory of emissions trading 2. How to build an emissions trading scheme 1. Decide what industries are included in the trading system - emissions must be measurable with good accuracy 2. Set a binding cap on the aggregate emissions of the chosen industries, which they are not allowed to exceed - the cap is smaller than emissions in the BAU which creates scarcity and price 4. Define the trading rules - global emissions: 1:1 5. Define the principles of the initial allocation of permits - allocation for free on the chosen ground (emissions history, benchmarking) - auction 6. Create an efficient monitoring, reporting, and enforcement system - open register

4 Theory of emissions trading 3. Firm in the emissions trading market Permit prices (= price of carbon emissions) guides firms actions in the emissions trading sector Firms decide on the production of commodities and the abatement of emissions: Production: r = MC + p, the firm produces up to the point where marginal revenue equals marginal costs, including permit costs Abatement: p = MCC, the firm abates up to the point where marginal abatement costs equal permit price; for the rest of emissions the firm uses permits Emissions: emissions from production minus abated emissions Emissions account: at the end of the emissions period, the firm must have as many permits as it has released emissions to the air Buyer or seller: firm s position depends on the initial allocation of permits Role of trading: allocates permits to firms according to their abatement costs Cost-efficiency: as the permit price is the same for all firms, marginal abatement costs are equalized and emissions trading is a cost-efficient instrument

5 Theory of emissions trading 4. Production & abatement: illustration MCC, p MCC R, MC MC+ p MC P r q* abatement, q y* y 0 production, y

6 Theory of emissions trading 5. Economic insights in emissions trading Emissions trading in an instrument Price of permits depends on how tight the cap on emissions is The tightness of the cap depends in turn on political willingness and decisions to cut emissions, not on the emissions trading system As an instrument, emissions trading works well when it allocates efficiently the cap to firms Impact of emissions trading: 1. Creates a price on carbon emissions, which guides firms abatement efforts 2. Changes relative prices and favors investments in less-carbon intensive technologies not only in the emissions trading sector but all over the economy 3. Permit prices and traded amounts of carbon permits give feedback to authorities on how well climate policies are working.

7 Theory of emissions trading 6. Emissions trading versus other instruments Comparison with emission tax or constraint Both tax and quantity standards are levied on a single firm (installation); they do not restrict the aggregate emissions of the industry Emissions trading constrains aggregate emissions of the industry but let the firms to choose their individual emissions via trading Other good properties of emissions trading Inflation decreases the impact of the emission tax but does not impact emissions trading Economic growth increases emissions when taxes or constraints are used but in the emissions trading growth is possible only with no increase in emissions Administrative costs are lower than under quantity constraint

8 Experience from the EU ETS 7. EU Emissions Trading Scheme Trading to obtain Kyoto target Phase I : learning period, no binding target - Phase II : Kyoto target (8% EU reduction, Finland 0% from 1995) - Phase III : 20% reduction from 1990 level Emissions trading sector Original: electricity generators, heat & steam production, mineral oil refineries, ferrous metals production & processing, cement, lime glass, bricks and ceramics, pulp & paper New: Aviation was included in 2012 (first auction December 2012) Becoming: nitrous dioxide emissions (N 2 O), perfluorocarbons; aluminium production, carbon capture, transport and geological storage Installations - All together installations - Finland about 500 installations and more than 50% of emissions - Aviation has its own permits than cannot be sold to general permit markets

9 Experience from the EU ETS 8. Emissions and allocated EUA:s Unit 1. Trading period 2. Trading period (Kyoto period) Mt CO allocated permits verified emissions difference cumulative surplus mechanisms (CERs) cumulative surplus Comments: 1. Trading period 1: surplus was 146 Mt. This surplus was nullified and has no impact on the second trading period 2. Trading period 2: witnessed financial crises and severe recession: production dropped in This created a surplus of permits, roughly 1190 Mt, which will be transferred to the third trading period. 3. Emissions are below the cap; a reduction of emissions is achieved but at the price of a low permit (EUA) price

10 Experience from the EU ETS 9. Evolvement of EUA price 35 Phase I (EUA Dec 05 - EUA Dec 07) Phase II (EUA Dec 08 - EUA Dec 12) Phase III (EUA Dec 13) CER

11 Experience from the EU ETS 10. Explaining price development Observation: Emissions decreased roughly by 400 Mt in 2011 relative to 2008 Three explanatory variables Role of financial crisis and recession: Production in processing industries and the energy sector decreased emissions Role of renewable energy policy Mandatory requirements to increase renewable energy decreases emissions BUT it was not taken into account in the initial allocation of permits for the third period By Fall 2010 this was understood by the market and the price decreased and became independent on markets fundaments Role of Certified Emission Reduction Credits (CERs): Increased supply of EAU:s considerably Problem of the EU policy: inconsistent climate policy - The renewable energy policy should have been synchronized to setting the cap

12 EU-ETS in the future 11. Features of the third trading period Emissions cap Periods 1 & 2 ( & ) Commission accepts national targets Next period 3 ( ) Commissions sets the cap Nature of the cap Cap constant Cap decreases by 1.74%/y Length of the period 3 and 5 years 8 years Initial allocation For free almost all Auction less than 4% Auction (more than 50%) Process industry: free allocation (benchmarking) GHG emissions CO 2 CO 2, N 2 O, perfluorihiili Comments: Auctioning is an improvement: revenue from auctions can be used to finance government budgets Increase in the number of included emissions is good

13 EU-ETS in the future 12. Forecasting emissions Unit, Mt CO allocated permits predicted emissions surplus cumulative surplus Comments: - Allocated permits: decrease over time; surplus of previous EAU:s included - Predicted emissions: based on predicted economic growth and change in the structure of energy markets - Economic growth: will be low (0-1-2%) allocation of emission allowances exceeds emissions for the most part of the period - Cumulative surplus is about 375 million tons - EUA price will be very low: - while the cap is achieved, no guidance to investment

14 EU-ETS in the future 13. Forecasting emissions Unit Mt CO 2 allocated permits *) Mechanisms (CERs) Total supply Emissions surplus Cumulative surplus Set-aside Cumulative surplus *) = The total surplus is shifted from the second trading period to the first year s allocation figures Conclusion: does not look good: EU is spoiling the market Actions under consideration in EU: set-aside and delaying auctions ( the first auction) (Our worst recession scenario: cumulative surplus 2050 Mt) Not enough: more reductions are needed (buying out allowances?)

15 EU-ETS in the future 14. Good signs: EU-ETS worked as an example Australia - trading started in 2012 with a fixed price $A 23/t and from 2015 onwards price is determined at the market. - Trading covers 60% of emissions are covers (500 polluters) - Novelties: floor price, agriculture and forestry included in the scheme China - Regional pilot in 2013 and 2015 nationwide trading - Will be the world s largest trading scheme New Zealand - trading scheme in 2008 (price has varied between $NZ ). - Novelty: forestry included United States - Regional Greenhouse Gas Initiative (RGGI) 2009: ten eastern states - Western Climate Initiative 2008: USA: California Canada: British Columbia, Manitoba, Ontario, Quebec trading starts in California: state-wide trading starts by auction this Fall (trading now at price $ )

16 EU-ETS in the future 15. Integration of trading schemes Link: Australia-EU ETS Australian and EU officials announced on August 29, 2012 that EU-ETS and Australian trading scheme will be linked to each other by 2018 Interim arrangement allowing Australian businesses to begin using EAUs to meet up to 50% of their liabilities starts July first 2015 Interim arrangements will be prepared during 2013 Other links Switzerland by 2013 Norway, Iceland, Liechtenstein 2008 Creates a large blog of countries applying emissions trading schemes

17 16. Lessons to climate policies 1. Emissions trading works well as a compliance instrument: Trading is a cost-efficient way of restricting emissions below the cap 2. Allowance price, EUA, is now too low to guide investments in cleaner technology - The reason lies in too lax a cap: there are too many allowances relative to needs 3. Supply of allowance must be reduced during the third trading period - The only way of making the price high enough to guide investments 4. EU must coordinate better cap and energy policies in the future - A sufficiently high permit price introduces new technology - Energy policy entails other benefits, therefore, coordination is needed - Energy policy and increased effort in adaption complement well emissions trading 5. Experience from all trading schemes must be utilized - Australia & New Zealand: important experience from agriculture & forestry 6. Emissions trading contributes to EU s credibility in climate negotiations.