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

Memorandum submitted by the Shell UK


    — Carbon markets, such as the EU ETS, are efficient mechanisms for incentivising CO2 reductions in the power and large industrial sectors.— Emissions trading schemes deliver an environmental outcome at lowest cost to the economy; the cap ensures that overall level of CO2 is restricted while trading allows the market to find the least-cost pathway to delivering the cap.


  1.  Last year, Shell published its Energy Scenarios which looked at two possible futures for energy out to 2050. In the first scenario—called Scramble—policy makers focus on security of supply and not enough on energy efficiency until supplies are tight nor on climate policy until there are major climate shocks. In the second scenario—Blueprints—growing local action along with the widespread introduction of carbon pricing leads to the development of clean energy technologies and energy efficiency measures. Blueprints leads to lower-carbon emissions than Scramble. Shell's view is that the Blueprints approach provides a better framework for moving towards a sustainable future. Copies of the "Shell energy scenarios to 2050" booklet accompany this submission.

2.  To meet the energy challenge and address climate change a range of policies will be required, including:

    — cap-and-trade systems like the EU ETS building to a global carbon market;

    — clear incentives for carbon dioxide capture and storage (CCS);

    — targets for renewable energies;

    — measured targeted at all sections of the transport sector, eg vehicle standards; consumer education and incentives for fuels based on their ability to deliver reductions in CO2 measured on a well to wheels basis (WTW); and,

    — robust energy efficiency standards for buildings and appliances.

  3.  The remainder of this submission focuses on the role that carbon markets should play in addressing climate change. Carbon markets are a key tool to address climate change, along with other the other measures outlined above.


  4.  The essential element of an emissions trading scheme is the cap which limits the overall amount of CO2 which can be emitted by the sectors covered by the scheme. A cap-and-trade scheme is designed to deliver an environmental outcome, in that the cap must be met. This is certainty that is critical for the environment. Whilst a carbon tax delivers some level of fiscal certainty in the short term, it does not necessarily deliver any particular environmental outcome. Under a carbon tax, emissions could fall, but equally they may continue to rise requiring an adjustment to the tax. It may take some years for policy makers to establish the level of tax necessary to deliver a given emissions reduction pathway. A tax does not offer long-term fiscal certainty, in that it may have to be varied substantially over time to meet the desired emissions pathway. It will only deliver price certainty in the short term.

5.  Recently, the EU allowance price has decreased in line with reduction in prices of other commodities. This change in price reflects the marginal cost of CO2 reductions in today's market conditions. If a carbon tax had been introduced, this adjustment would not have been automatic and it is possible that there would have been calls to reduce or remove the tax in light of economic circumstances. The relatively low price does not mean that the EU ETS is not effective: the cap will be delivered at the lowest cost to the economy which is particularly critical during a recession.

  6.  A cap-and-trade scheme delivers its environmental objective at lowest cost to the economy. By combining trading with a price for emitting CO2, the approach seeks out the most attractive reduction projects within the market, delivering a lowest cost outcome. Emissions trading as applied to the problem of sulphur emissions from power stations in the United States has led to the overall cost of the meeting this environmental goal being much lower than expected.

  7.  National or regional trading systems can be linked with other such systems, delivering over time a global carbon market. Developing countries initially be connected through project based crediting, such as the Clean Development Mechanism (CDM). Certified Emission Reduction (CER) unit available under the CDM which some countries use to meet their own Kyoto targets and are traded in the EU ETS. The CERs effectively links mitigation opportunities in the EU with those in other developed countries. The CER is acting as a surrogate currency, providing a bridge between different national approaches. As new emissions trading schemes are developed, it will be important that they use the same project mechanism to enhance the bridging role of the CDM. For further detail on this, and how trading systems can be linked, please see the World Business Council on Sustainable Development's "Establishing a Global Carbon Market" leaflet which we have attached to this submission.


  8.  A trading system offers both compliance and policy flexibility that is important for business. Compliance flexibility is delivered through the ability to "make or buy", ie to implement a project and make reductions (including selling allowances), or to buy allowances from other the market.

9.  Policy flexibility comes through the mechanism for distribution of allowances. For example, in Phase III of the EU Emissions Trading System some allowances will be distributed for free to deal with competitiveness concerns. This should be seen as an interim measure until a global climate deal is implemented and countries outside the EU start to have carbon prices established for their industries.

  10.  Despite this, the incentive to reduce emissions remains in that the allowances have a value. Whether or not an installation needs to buy all of its allowances in the market or gets some of them for free does not affect the incentive to reduce emissions. The decision on whether to reduce emissions will be based on the marginal cost of an allowances; ie whether the cost of investment in reducing carbon results is less than either the cost of buying extra allowances or the value of selling allowances the installation already holds.

  11.  To date, the EU ETS has delivered reductions in emissions as the cap has been met. Recent analysis by New Carbon Finance shows that emissions in the EU ETS sectors were down 3% overall in 2008. Even taking into account the recent economic downturn, its analysis demonstrates that the most significant reductions were made by the electricity generators switching to nuclear, renewables etc. While overall electricity generation was up, the total amount of CO2 emitted reduced. So far, many of the emissions reductions achieved by the EU ETS have been made in the power sectors. It should be noted that investment to make further reductions can only be made with greater long-term certainty about the emissions trading scheme. The agreement to the Directive for Phase III in December now provides that certainty as the cap is known to 2020 and mechanisms are in place to ensure that the EU ETS continues beyond 2020.

  12.  The Phase III cap will be lower than that in place today and will reduce by 1.74% per annum to meet a 20% reduction by 2020 (or a reduction of approximately 3.3% in the event of a global agreement to meet 30% reduction target). The decreasing cap means that reductions will need to be made amongst the sectors covered by the EU ETS. It is not the case that installations will be able to carry on much as normal; the reductions in allowances will necessitate that at least some make actual reductions; the trading mechanism helps to find which sector or installation can make these reductions at least cost to the economy.

  13.  The CDM provides a mechanism for developed countries to finance low-carbon technologies in developing countries. While it is recognised that there have been issues with the CDM in its early phases, this mechanism is delivering real reductions versus what would have happened and improvements in its operations are being made. It is not only cash that flows through the CDM, the projects also transfer technology, can improve local employment, and improve local environmental conditions. Most important of all is the fact that all CDM and JI project information is completely transparent and in the public domain. Not only the project design documents but all third party validation and verification reports are open for scrutiny. In addition, as discussed above, the CDM also provides a mechanism that connects different emissions trading systems, in advance of more formal linking mechanisms being put in place.


  14.  The carbon price delivered through emissions trading provides incentives for companies to invest in low-carbon technologies that are commercially available and deployed in the market. However many important technologies, such as Carbon Capture and Storage (CCS), are not yet commercially viable and will need further support.

15.  This figure illustrates a typical technology pathway consisting of three phases, Discover & Develop, Demonstrate and Deploy. The three phases are required to allow technology to progress down the cost curve. The long-term deployment of low-CO2 technologies is driven by the CO2 price in the ETS (yellow band). But for the important early stages, the cost of new technologies is typically out of reach of the CO2 market (pink band). This means that additional incentive must be found to augment the CO2 price and allow early pilot work then large scale demonstration to proceed. Shell supports the approach of the EU Parliament which has created a fund of 300 million bonus allowances for CCS (and novel renewable technologies) demonstration projects, to help bridge the cost during the demonstration phase of CCS. Once industry learns large scale demonstration projects, it is expected that the costs of CCS will decrease to the point that its deployment can be supported by the carbon price.


  16.  Shell views cap-and-trade schemes such as the EU ETS, as a key tool to delivering targets to reduce CO2. The establishment of a cap ensures that environmental goals are met while trading ensures that these reductions can be done at least cost to the economy. The agreement to the Phase III framework provides the long-term certainty required to drive investment in established low-carbon technologies, with future support required to demonstrate new technologies so that they can be deployed later once their cost is covered by the carbon price.

March 2009

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