Module 3 provides a review of international agreements and domestic policies for mitigation climate change. In particular the Kyoto Protocol and the Paris Agreement under the United Nations Framework

CERs • No explicit cap on the scheme but an implicit cap to meet the Kyoto target • Government would purchase emissions reduction units to meet target 19 The NZ ETS • The NZ ETS is unique as it was the first to allow forest based sequestration of carbon to be credited in the scheme • Afforestation (newly planted forest) sequesters carbon and reduces the atmospheric concentration so offsets emissions • Deforestation releases the carbon stored back into the atmosphere (typically with a lag depending on the final use) • Before the scheme commenced in (2008) an incentive to bring forward deforestation (See Figure 4, source: NZ Ministry for Environment, 2016 p. 23) • Post 2008 the incentives under for forestry stimulated afforestation, reduced deforestation and on net the forest sector made a significant contribution to NZ meeting Kyoto targets 20 21 The NZ ETS • The other unique aspect of the NZ ETS is that it allowed unlimited trade in the Kyoto flexibility mechanism e.g. CERs and ERUs. • In the period 2011 – 2013 the international price of ( e.g CERs) drove the price of permits in the NZ market (see Figure 1, source: NZ Ministry for Environment, 2016 p. 13 ) • That is the NZ is relatively small so it is a “price taker” in international terms • From 2013 NZ changed the eligibility of the international credits and the prices between the NZ emission reduction units and the international price diverge. 22 23 Carbon markets • There are many other national, sub national markets for carbon as shown in Figure 2 (see Slides 7 & 8) • In the U.S., the Californian cap and trade market from 2013, is now linked to the Quebec market in Canada: • Reducing emissions to 1990 levels by 2020 (20 per cent reduction) • Has a price floor on auctioned permits • Also in the U.S. the Regional Greenhouse Gas Initiative (RGGI), is a cap and trade scheme that includes 9 states. • Japan, China and Canada also have regional or sub -national markets 24 Increase in Global emissions covered by an ETS Source: International Carbon Action Partnership (ICAP) 2016, p.26 25 Voluntary Carbon markets • Voluntary carbon markets operate outside of a legally mandated reduction in emissions • Trades are generated as firms, or events seek to offset emission or claim carbon neutrality (see Bayon , Hawn and Hamilton, 2009): • In 1989 the American Electricity Company (AES) invested in an agroforestry project in Guatemala to offset emissions • In 2005 HSBC announced they would be carbon ‘neutral’ and purchased 170,000 tons of carbon offsets credits from projects in Australia, New Zealand, India and Germany. • In 2006 the FIFA offset World Cup emissions through a voluntary 100,000 ton carbon offset program, called the Green Goal Initiative 26 Voluntary Carbon markets • However these markets lack regulation and transparency have generated some concerns over: • Additionality of the offsets compared to business as usual • Risks of non -delivery • However, attractive to firm as lower transaction costs compared to Kyoto CDM and JI projects • From 2003 – 2010 the Chicago Climate Exchange traded legally binding voluntary carbon offsets • Figure 1, shows the historical volumes traded as reported by the State of Voluntary Carbon Markets 2016 and Figure 2 the value of these 27 28 29 Global c arbon markets • Summary • The development of pricing, through carbon taxes and emissions trading • The Kyoto Protocol flexibility mechanisms ̶ CDM – Certified emission reductions (CERs) ̶ JI – Emission Reduction Units (ERUs) • The Paris Agreement and National Determined Contribution (NDC) from countries should increase trading • E.g. China has announced the development of an national ETS in 2017 30 C arbon leakage • Carbon prices are intended to favor innovative, clean firms and improve production efficiency • However a concern with carbon pricing and, in particular fragmented prices, is the risk of carbon leakage • Carbon leakage (World Bank 2015): • A carbon price on a firm in one jurisdiction increases it’s costs that firms in other jurisdictions do not face, such that they lose either market share, a decrease in profits or both. • If it leads to a relocation of production – to the jurisdiction without carbon pricing emissions leakage occurs 31 C arbon leakage • Likely to impact on firms that: • Produce relatively homogenous (the same) products • Have emissions intensive production • Are trade exposed, i.e., operate in international markets • Examples of such firms include commodities, steel, cement and electricity . • For such firms, price competition is crucial – so if carbon pricing increases costs this will lead to a fall in competitiveness and as a consequence a risk of carbon leakage 32 C arbon leakage Positive impacts of carbon pricing • Carbon pricing supposed to increase costs of carbon intensive activities and promote low emissions activities that contribute less to climate change • Porter hypothesis: • Properly designed environmental policies enhance competitiveness of firm by inducing technological innovation offsetting costs of compliance • Evidence of weak version that it enhances innovation and does not impact on competitiveness • However no evidence that it completely offsets the cost of compliance 33 C arbon leakage Positive impacts of carbon pricing • Evidence suggests that carbon pricing has a more robust impact on productivity compared to less flexible alternatives • Environmental regulation promotes innovation in green technologies • Economy -wide gains stem the exit of the least productive firms • Much of the evidence is based on industrialised countries (developed) – so may not directly transfer to developing countries 34 C arbon leakage Adverse impacts of carbon pricing • The risk of carbon leakage is the most important concern for the introduction of carbon pricing • Carbon leakage can occur through three channels 1. Short -term – firms facing a carbon price risk losing market share or profits 2. Long -term – new investments preferred in locations without a carbon price 3. Fossil fuel pricing – drop in demand – fall in price of fossil fuels stimulates increase in demand elsewhere (not considered) 35 C arbon leakage Adverse impacts of carbon pricing • Assessing the risk of carbon leakage • Ex -ante (before the fact) modelling suggest that potential carbon leakage in the region of 5 -20 per cent. • For every 1,000 kg of reduced emissions in jurisdictions with a carbon price – 50 -200kg increase in emissions in jurisdictions without a carbon price • Ex -post (after the fact) indicate very little evidence of carbon leakage (studies mainly in Europe) • Potential reasons – emission costs of firms relatively small, low carbon prices, free allowances and difficulties in inferring the results of econometric estimation 36 C arbon leakage How to assist exposed and vulnerable sectors • Free allocations (of permits) based on: • Grandfathering (e.g. EU ETS phase I & II) • Fixed sector benchmarking – free allowances related to historical production and emissions • Output -based allocation – allowances based on actual production and benchmarking of sector emissions intensity • Administrative exemption e.g. sectors exempted from a carbon tax • Rebates – subsidies to exposed sectors (E.g. Australian carbon tax) • Border carbon adjustments – imposing emissions costs at the border on importers of carbon intensive goods 37 C arbon leakage How to assist exposed and vulnerable sectors • The various measures have advantages and disadvantages in terms of political support, administrative costs, effectiveness in preventing leakage and as an incentive to reduce emissions. For example: • Administrative costs higher for benchmarking approaches • Exemptions increase the costs of abatement as less emissions covered • Border carbon adjustment best in terms of environmental integrity but may face political challenges • Can overcome this with one global carbon price. But how? 38 Linking of emissions trading schemes • T he cost effectiveness of market based policies to mitigate climate change can be improved through: • Increasing the coverage of the tax or ETS, that is, the number of polluters covered • Increasing the size of the market by linking carbon pricing instruments or markets • In the extreme the most cost effective measure is a global harmonised tax on carbon or global ETS • A global pricing approach exploits a larger range of abatement options, which is estimated to allow for 40 -50 percent reduction in emission at the same cost (see Adelphi, 2015) 39 What is the rationale for linking?

• Linking to other credible trading schemes is in Australia’s national interest ( CoA , 2011) • Economic rationale ̶ Improves economic efficiency o Discover and exploit different costs of abatement o Provides access to more “low hanging fruits” ̶ Improves the efficiency of trading o A larger market should be more liquid and competitive ▪ Political rationale? ̶ Pooling regulatory risk provides greater certainty 40 40 Linking of emissions trading schemes • In Australia the former carbon tax, to be incorporated into an ETS, was scheduled to be linked to the EU ETS in 2015 • As stated earlier the California and Quebec cap and trade scheme have been linked • The NZ scheme allowed trading of Kyoto flexibility mechanism and was therefore linked to this global market • Linking is defined as a way of connecting policies with aim of harmonising carbon prices • While a global price remains the ideal, in the medium term the linking of various markets and/or taxes or even with regulatory approaches is examined 41 Linking of emissions trading schemes • Following the Adelphi report (2015) three scenarios for linking are examined 1. Linking of ETS (only) 2. Linking of ETS and carbon tax schemes 3. Linking an ETS and /or carbon tax with regulatory approaches • The advantages and drawbacks of these approaches is discussed, including the political feasibility of each 42 Scenario 1: Linking of ETS only • This involves the acceptance of emissions reduction credits (permits) from one scheme to another • As illustrated this can be: 1. Direct • Unilateral – trading in one direction • Bilateral – trading in both directions • Multilateral - > 2 systems 2. Indirect • Systems can be indirectly linked through a separate 3 rd system 43 Scenario 1: Linking of ETS only • Direct linking - Mutual recognition of allowances • E.g. In a linked EU -Aus ETS scheme, a company in Aus can use both European allowances and Aus allowances for compliance • If a large ETS establishes an unilateral link with a smaller ETS could cause a price rise in the smaller system • Indirect linking or mutual recognition of offsets • E.g. If offsets in Australian from the carbon farming initiative are allowed for compliance in both EU ETS and in Aus ETS • With no limits on the use of offsets in either system and unlimited supply, the price in the 2 systems will be the same → 2 markets but 1 price • With limits (quantity or quality) → 2 markets and 2 prices 44 39 Scenario 2: Linking of ETS and carbon tax • Here an ETS and a carbon tax co -exist. This involves linking a flexible price (ETS) with a fixed price (Tax) • Options include direct two (one) way or indirect linking (See diagram • The would involve creating carbon tax credits – in the tax regime to be tradable in the ETS • See figure 4 for an illustration of possibilities • However: • Unlimited tax credits into the ETS could inflate the cap • This would turn the ETS into a de facto tax scheme • Quantitative limits would be required for both schemes preventing full price harmonization 46 41 42 Scenario 3: Linking of ETS (Tax) with regulatory approach • This involves the linking the explicit price instruments of an ETS or tax with implicit price emitters face from a regulatory approach • Implicit price implies there is still cost to reducing emissions in t/CO 2-e terms to comply with a regulation, however it is not explicit • Efforts to link these types of scheme would require political coordination to link the implicit price with the explicit price • Could be that firms that overachieve on regulatory standards, earn emission reduction credits to sell in a market based system 49 44 Assessment of linking options Single carbon price • It is argued that only a fully linked ETS -only scenario can lead to a single carbon price • An ETS -tax scenario always requires quantitative limits Environmental effectiveness • Depends: • Stringency of cap or tax rate • The accuracy of the monitoring, reporting and verification (MRV) system • Enforcement measures 51 Assessment of linking options Cost effectiveness • Direct linking in an ETS -only or ETS -tax increases cost effectiveness as a result of a larger market • Increase in liquidity and as a result less price volatility Risk of carbon leakage • Linking reduces the risks (incentives) for carbon leakage • Levels the playing field as prices converge • The greater the price convergence the lower the risks of carbon leakage 52 Assessment of linking options Distributional effects • Direct linking in an ETS -only or ETS -tax have distributional effects if prices are initially different. E.g. for an ETS -only • Net buyers in the more expensive system benefit (pay less for permits) • Net sellers in the less expensive system profit (from higher permit prices) • E.g. for an ETS -tax scenario • If the tax rate is initially lower – net buyers in the ETS benefit by using tax credits • Tax credit sellers benefit • How are government revenues impacted? 53 Assessment of linking options Political feasibility • An ETS -only scenario is the easiest but involves harmonising key design features, e.g. units traded, MRV • Linking an ETS -tax is harder – smaller gains, requires more compromises and the establishment of quantitative limits • A ETS -regulatory scenario – even harder as it involves even more compromises 54 B arriers to bilateral linking of ETS System differences unlikely to create significant barriers • MRV rules for permits • Banking provisions • Rules governing new entrants and closures • Compliance periods • Allocation methods Significant barriers: • Relative stringency of targets • Stringency of enforcement • Eligibility of offset credits 55 Summary • Carbon pricing is a cost effective policy for mitigation of GHG emissions • Carbon pricing mechanisms, both ETS and taxes are spreading • A concern if the potential risk of carbon leakage • The next step is linking of markets to achieve greater efficiencies and reduce the risks of carbon leakage • An ETS -only linking scenario delivers the greatest benefits as it provides the greatest likelihood of achieving a single carbon price 56 This weeks reading • This week focus on: • World Bank, (2015), State and Trends of Carbon Pricing, Washington DC, Chapters 1 & 3 • Adelphi , (2015), Towards a global price on carbon: Pathways for linking carbon pricing instruments, Report commissioned by German Federal Ministry for the Environment 57 Thank you