House of Commons - The role of carbon markets in preventing dangerous climate change

The role of carbon markets in preventing dangerous climate change - Environmental Audit Committee Contents

5 Global carbon markets

Latest international developments

93. The UK Government has been at the forefront of international debate on creating and expanding global carbon markets. In Emissions Trading: UK Government Vision, published in October 2006, it argued that an international carbon trading system was "the UK's carbon price instrument of choice and a key component in a comprehensive UK policy framework to effectively mitigate climate change", and that "the more we can trade emissions reductions across international borders, and the more emissions that are covered, the more cost effective for all it will be to achieve challenging emissions reduction targets".[187]

94. Lord Stern has argued that international emissions trading should be a key element of any successor to Kyoto, because it embodies the three principles on which any global deal must be founded:

i. Effectiveness: "a cap imposes an absolute limit on emissions, and therefore clarity on reductions";

ii. Efficiency: "competition and the market will seek out the cheapest ways of reducing emissions"; and

iii. Equity: "the structure of quotas, together with the exploitation of some low-cost emission reductions options in developing countries, can generate private-sector finance to developing countries to support low-carbon growth […] These financial flows can provide part of the 'glue' for a global deal".[188]

95. Internationally emissions trading is becoming an increasingly popular mechanism for tackling greenhouse gas emissions. The US is at an earlier stage in this policy area than the UK and EU and does not have an equivalent to the EU ETS but various regional schemes are being developed and these could be extended to create a federal scheme. The United States Congress is considering draft legislation for a federal emissions trading scheme, to come into operation in 2012.[189] In addition, one regional scheme (the Regional Greenhouse Gas Initiative, covering 10 states in the US northeast) began operation in January 2009, and two more proposed schemes (including Canadian provinces as well as US states) are currently being developed.[190] A Bill for an Australian cap and trade scheme, set to come into operation in 2011, was recently defeated in the Parliament's Senate, but may be reintroduced later this year.[191] Japan has developed a voluntary emissions trading scheme, and Taiwan and South Korea are considering following suit.[192]

96. In June 2009 the Government published The Road to Copenhagen, setting out why securing a deal at the Copenhagen conference was so important and the details of the kind of deal the UK Government would be seeking.[193] Launching it, the Prime Minister said: "More and more developed countries, including the US, Canada, Australia, New Zealand and Japan, are now planning to introduce emissions trading systems similar to the EU's, and our goal is to establish links between these schemes by 2015 to create a global, liquid market in emissions reduction".[194] However, the role of emissions markets was given only brief attention in the Accord agreed in Copenhagen in December (paragraph 5).[195]

Linking cap and trade systems

97. The European Union has said it is committed to encouraging the creation of a single US federal scheme that can be linked to the EU ETS.[196] The EU has also issued proposals for an OECD-wide carbon market to be established by as early as 2015 and to be extended to economically more advanced developing countries by 2020.[197] The proposals envisage "mandatory cap and trade systems, with an absolute cap on greenhouse gas emissions".[198] In practice that means merging different schemes together so that there is only one overarching cap. DECC expressed the Government's strong support for these efforts and the "economic and environmental benefits" they will bring. Global Carbon Trading: a Framework for Reducing Emissions, a report by Mark Lazarowicz MP (the Prime Minister's Special Representative on Carbon Trading, and a member of our Committee), said linking schemes would aid international co-operation on emissions reductions, reduce price volatility, help to address competitiveness concerns, and reduce costs by increasing access to low cost abatement opportunities.[199]

98. As DECC acknowledged, however, there would be practical constraints on linking trading systems.[200] Mark Lazarowicz's report stressed the need for different schemes to harmonise their rules, for instance on the use of offset credits. It argued that price floors and ceilings would make it difficult to link schemes, but that reserve price auctions could still work provided that each scheme could agree to set similar reserve prices.[201]

99. In Emissions Trading: UK Government Vision, the Government argued in 2006 that "the EU ETS can become the basis of a global carbon market".[202] The CBI argued that price intervention would make it more difficult to link the EU ETS to any future US emissions trading market;[203] a similar point was made in Mark Lazarowicz's report.[204] Barclays Capital favoured linking the EU ETS with other emissions trading systems, but cautioned: "While linking is desirable in practice, it is imperative that schemes that do not have a binding absolute cap are not allowed to corrupt those schemes that do have binding caps".[205] They argued that the most important issue in linking the EU ETS to a future US scheme was that the level of ambition embodied in the caps had to be compatible, and thought it ambitious to aim to achieve a link by 2015.[206] A US scheme, they believed, was likely to start with soft targets and high offset use in the period to 2020, followed by more aggressive targets once the scheme was established. In practice, Barclays Capital argued, there would be structural difference in prices between Europe and the US in 2015, and linking the systems would cause a convergence that would entail US prices rising and European prices falling.[207] (The US Environmental Protection Agency considered that the legislation currently before Congress would set a carbon price of only $12/tonne in 2012, rising to $20/tonne in 2020.[208]) Barclays Capital did not think that this would be politically feasible on either side of the Atlantic.[209]

100. Jill Duggan, Head of International Emissions Trading at DECC, thought the EU's proposal for an OECD-wide set of linked cap and trade systems by 2015 was "probably optimistic and ambitious", and stressed that, overall, the UK was envisaging that a global carbon market would take forty years to be built.[210] Mike O'Brien MP, then Minister of State at the Department of Energy and Climate Change, conceded that "developing this system by linking up various [emissions trading schemes] that have been created is not of itself going to be an easy process" and suggested it could take decades to complete.[211] He believed any differences between schemes could be overcome through various "technical fixes", and told us that "the view generally from talking to other countries is that they envisage a link up […] of course always on their own terms".[212]

101. We recommend that the Government encourages the EU to prepare for linking the EU ETS and other emissions trading systems together, whilst ensuring that the effectiveness of the EU ETS and the price signal it provides is not weakened as a result.

102. Looking further ahead, Lord Stern suggests that towards 2050 there will be limited scope for trading, because countries should by then have taken significant action and there will be fewer cheap abatement opportunities to sell: "In this sense, we would expect the volume of trade to rise over the next twenty years or so, and then start to fall. That would be a feature of success".[213] We asked a number of witnesses whether they agreed with this analysis. The Government, the Carbon Trust, and traders and investors[214] all agreed that the volume of trading ought to decline, but that it would be hard to see it disappearing for many decades. The Minister told us:

215

Dr Tom Counsell of the Carbon Trust foresaw that a carbon market would have an important role to play until the point at which CO₂ emitting activities were phased out.[216]

103. The Government needs to set out how the global carbon market can expand, when it may contract, and to what extent emissions trading will deliver the emissions reductions that will meet the world's needs.

104. There are significant benefits available from a wider emissions trading system. Apart from providing better and more extensive co-operation on emissions reduction action, there are the benefits that flow from a wider market, in particular a more efficient allocation of resources. In that wider market, the 'customer' is a world view of what action is needed to avoid dangerous climate change. As with expanding any market, there are practical hurdles to overcome, particularly in harmonising the rules and parameters of the merged schemes, and—perhaps most importantly—the rigour or ambition implicit in each scheme. If the EU ETS is merged with other emissions trading systems with more generous allowances and greater access to offset credits from other countries, or more generous subsidies for low-carbon emitters, then terms of trade—some sort of carbon 'exchange rate'—will be needed to put all participants of the wider trading system on a level playing field. This would not be a requirement simply of fairness; without it, the greater efficiencies of the expanded system would be jeopardised. The Government, with its European partners, should ensure that schemes are not merged without a well-founded 'exchange rate' in place. Provided such a mechanism can be devised, and periodically adjusted to take account of initiatives or interventions of individual countries or regions, then initial differences in schemes' carbon prices should present a less significant hurdle. In the context of a balanced wider carbon market, such price differences would signal the most efficient way (and location) for reducing emissions.

187 Defra, HM Treasury and DTI, Emissions Trading: UK Government Vision, October 2006 Back

188 Nicholas Stern, A Blueprint for a Safer Planet, 2009, p 162 Back

189 The American Clean Energy and Security Act 2009 (Waxman-Markey bill). The Bill seeks a 17% emissions reduction below 2005 levels by 2020, or 4% below 1990 levels. Back

190 Ev 127 Back

191 The Economist, 5 December 2009, p 68 Back

192 Ev 127 Back

193 DECC, The Road to Copenhagen, Cm 7659, June 2009 Back

194 DECC website: News, 26 June 2009 Back

195 Copenhagen Accord, 18 December 2009, para 7 Back

196 Ev 127 Back

197 Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, COM (2009) 39, pp 11-12 Back

198 Ev 127 Back