House of Commons - Linking emissions trading systems - Energy and Climate Change Committee

Linking emissions trading systems - Energy and Climate Change Committee Contents

3 Linking emissions trading systems

11. In its Fifth Assessment Report on the science of climate change the Intergovernmental Panel on Climate Change (IPCC) introduced the concept of a total safe level of global emissions.[30] This concept underlines the desirability of working towards a global emissions trading system with the potential to cap global emissions. How such a global market might be achieved is open to debate. Broadly speaking there are two main approaches: "top-down" and "bottom-up".

12. The top-down approach was promoted by the United Nations Framework Convention on Climate Change's (UNFCCC) Kyoto Protocol. In theory this is one of the most efficient approaches to implementing a global carbon market. In reality it has proved unpopular because it requires countries to accept externally determined limits on their total national carbon emissions.[31] The bottom-up approach is reflected in the recent move towards wider use of Intended Nationally Determined Contributions (INDCs) as the basis for deciding what level of emissions reductions can be achieved globally as part of a new negotiation track in the UNFCCC (see chapter 5). At the same time numerous emissions trading systems have begun to be developed in regional, national and subnational jurisdictions around the world. Some witnesses argued that it was a suboptimal approach to developing a global carbon market because it is less efficient and could encourage "carbon leakage"[32].[33] This criticism applies equally forcefully to other forms of carbon pricing and is not peculiar to emissions trading. Other witnesses thought it was easier to implement because it avoided countries having to give up power to the UN.[34] In its 2014 report, Emissions trading status, the International Carbon Action Partnership (ICAP) concluded:

13. In future, disparate emissions trading systems emerging at the regional, national or subnational level will need to be "linked" in order to facilitate the development of a global market. There are economic benefits to linking.[36] Dr Luca Taschini, Dahrendorf Research Fellow at the Grantham Research Institute on Climate Change and the Environment said that the benefits included creating a "bigger market" with "broader availability of abatement options" for participants. It would also reduce overall compliance costs and make the price of emissions credits more resilient to market shocks.[37] He also highlighted non-economic benefits which included "levelling the international playing field" for market participants and "contributing to the global cooperation in tackling climate change".[38]

14. Linking also presents risks.[39] It requires one party to share control over their trading system with another jurisdiction. Pooling control can create political uncertainty especially if one party later decides it no longer wants to be linked.[40] Dr Richard Leese, who represents a range of energy intensive industries, was concerned about the potential for carbon leakage which could be exacerbated by the bottom-up development of emissions trading and could see vulnerable industries that are sensitive to the price of energy move overseas.[41] While this was a concern for some witnesses, the Government and the European Commission made it clear that there was currently no evidence of carbon leakage within the EU ETS. Vulnerable industries in the EU ETS, they argued, were protected because they had been issued with allowances which exceeded their actual emissions.[42] Indeed, the carbon price in linked systems would converge so the impact on competitiveness between systems would reduce.

15. There are a number of ways in which trading can occur in linked systems. Emissions trading systems can have direct bilateral links where participants in one or both of the systems buy or sell emissions units to the other.[43] They can also have indirect multilateral links where two or more systems have access to a common international credit.[44] Finally, several countries can integrate by joining the same system.[45] The EU ETS has been responsible for most of the linking which has been achieved to date. In 2007 the EU incorporated Norway, Iceland and Liechtenstein into its trading system and it is currently exploring the possibility of linking with Switzerland.[46] It also planned to link with Australia's Emissions Trading System but this was put on hold after the Australian government announced plans, in November 2013, to repeal its climate legislation.[47] There are two examples of linked systems in North America. The Regional Greenhouse Gas Initiative (RGGI), which held its first auction in 2008, is a cooperative effort among nine Northeastern and Mid-Atlantic States to cap and reduce CO₂ emissions from the power sector.[48] The California and Quebec cap and trade systems linked in 2014.[49]

16. Dr Denny Ellerman, a carbon-market expert based in Italy, argued that emissions trading systems "lend themselves to linking" because the allowances can be easily traded across borders. He went on to explain:

Despite this, linking has proved difficult to achieve in practice because of the political and technical challenges that must be overcome in order to link two or more emissions trading systems together. David Hone argued that there needed to be similarities between the design elements of an emissions trading system in order for them to link.[51] These include:

· How strictly the environmental integrity of a system is maintained-through monitoring, reporting and verification (MRV) standards-so that a tonne of carbon in one system represents the same tonne of carbon in another system.[52] Environmental integrity is one of the most important considerations.[53] Dr Ellerman, highlighted that, "the primary and perhaps only, criterion for linkage is the integrity of the two systems to be linked".[54]

· Whether participants in the system are able to-through registry systems and bank provisions - carry over allowances between trading periods and, in some cases, to borrow from the future trading periods to comply with a current period.[55]

· How ambitious a system is and, therefore, at what level it sets its emissions cap and how strictly it enforces this cap.[56] It would be very challenging for systems with widely differing ambitions to link because the two systems might have very different carbon prices. A price differential makes linking extremely difficult because any change in price, as a result of the link, could negatively impact the systems.[57]

· Whether a system chooses to have an absolute target versus a relative target (the latter is sometimes referred to as carbon intensity target). It would be difficult to link systems that had different types of targets. When China develops its national trading system it will probably implement a relative target at first. This would make it impossible to link to the EU ETS, at least for the time being. In the future, when China's emissions peak they may be ready and able to implement an absolute target. Adopting an absolute target would improve the prospects of linking very significantly.[58]

· The coverage and scope of the types of participants (e.g. industry, transport, land) included in the system. Respondents to this inquiry argued that linked systems should combine similar sectors, to increase emissions reduction opportunities, and different sectors to protect sectors from price shocks.[59]

· How a system decides to control the market price of allowances through cost containment measures (e.g. price floors or ceilings). Combining an emissions trading system with a price floor (or tax) is considered by some as the best way to develop a carbon market because it ensures a minimum price of carbon but still provides participants with the flexibility to choose different emissions reduction options.[60] Cost containment measures, however, have the potential to complicate linking. Actions taken to control the carbon price (such as releasing more allowances into the market to stop the price rising above a certain level) could, for example, jeopardise the environmental integrity of the system.[61]

· Whether a system will allow participants to buy offset credits (e.g. Clean Development Mechanism (CDM))[62] created in other countries or jurisdictions to use to comply with the system.[63]

During our visit to China we saw first-hand some of the pilot systems which have begun exploring the potential to link with each other. Officials in China are already grappling with these issues, despite the short time the schemes have been operating (see Annex).[64]

17. Professor Stavins highlighted that while "some kinds of harmonisation might be helpful […] less harmonisation is necessary than is commonly assumed".[65] He stressed, however, that parties looking to link have to understand the "implications" of linking and the potential impact it could have on their emissions trading system and wider economy.[66] For this reason, Miles Austin, Executive Director of the Climate Markets and Investment Association, told us that "just to link trading schemes simply to link them is not a good idea. There needs to be certain fundamental conditions that have been met".[67] The Grantham Institute on Climate Change and the Environment have developed a method by which each party is able to assess whether the other is a good match.[68] If this approach was used, Dr Taschini argued then, on average, the advantages of linking would outweigh the disadvantages.[69] DECC considered that, "the clearest way to encourage consistent design features between ETSs is for those systems that are interested in linking with others to make their intentions clear at the earliest opportunity".[70] Linking is an evolutionary process that will only occur over a long time frame.[71]

18. Currently active negotiations to develop links are limited. Professor Stavins was, however, "fairly optimistic" about linking in the future because the pressures to do so would be great from both governments and businesses. If in the future there was a robust global climate agreement (see chapter 5) all parties would want to reduce their emissions and achieve their targets as efficiently and cheaply as possible. Linking, he argued, would facilitate this.[72] As a result there would be "more and more opportunities to link".[73] Some witnesses agreed that it would be preferable for systems to link in the context of an international agreement. But even in the absence of one we may still see jurisdictions looking to link.[74] Mr Hone described how this might occur:

19. In advance of a globally linked emissions trading system there would still be considerable benefit from linking the world's largest economies: China, the US and the EU. Other countries interested in emissions trading systems such as South Korea, Mexico and Brazil could then follow on.[76] During our visit to China, Chinese officials were clear that linking any of China's pilot systems or future national system was a long way off. However, they supported the idea of linking and, if possible, did not want to preclude linking in future (see Annex). Sir David King highlighted the work between the Foreign Office and Chinese officials to develop their emissions trading system "and a big part of that was about the possibility of linkage, creating a scheme that is compatible for linkage".[77]

20. Today there are a number of organisations working to promote and support linking of emissions trading systems. These include the International Emissions Trading Association (IETA), the World Bank's Globally Networked Carbon Markets (GNCM) Initiative and the International Carbon Action Partnership (ICAP).[78] The Government also emphasised its role in promoting and supporting the development of linking emissions trading systems:

21. As emissions trading systems develop and mature around the world there will be increasing opportunity for them to grow and expand so that emissions can be reduced in the most cost-effective way. This expansion is likely to occur by the linking of systems to one another. We recommend that the Government ensure that, when supporting other countries to develop their emissions trading systems, it promotes designs that are compatible with the EU ETS. Aligning design elements will help improve the prospects of linking in the future. The Government should focus on engaging with China and the US as the world's largest economies and because they have already embraced emissions trading.

30 Intergovernmental Panel on Climate Change, Summary for Policy Makers, Climate Change 2013: The Physical Science Basis (2013), p27 Back

31 Q12 (Dr Taschini), Q52 (Mr Austin), Q175 (Mr Hone), LTS 013 (UNFCCC) Back

32 Carbon leakage describes the situation that may occur if, for reasons of costs related to climate policies, businesses were to transfer production to other countries which have laxer constraints on GHG emissions. Back

33 LTS 006 (EEF), LTS 008 (Mineral Products Association) Back

34 Q59 (Mr Austin) Back

35 International Carbon Action Partnership, Emissions Trading Worldwide, Status Report 2014 (January 2014), p4 Back

36 LTS 001 (Robert N. Stavins), LTS 009 (EDF Energy), LTS 013 (UNFCCC), LTS 015 (City of London Corporation) Back

37 Q1 (Dr Taschini), Q163 (Mr Hone) Back

38 Q1 (Dr Taschini) Back

39 LTS 001 (Robert N. Stavins), LTS 005 (DECC) Back

40 Qq1-2 (Dr Taschini), Q163 (Mr Hone) Back

41 Qq41-43 (Dr Leese), QQ55-57 (Dr Leese), LTS 006 (EEF), LTS 008 (Mineral Products Association) Back