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:
It is becoming clear that contrary to the expectations
of policy-makers and analysts in the 1990s and early 2000s, a
global carbon market is unlikely to come about in a harmonized,
top-down fashion. Rather, it will emerge from the bottom up, building
on a multitude of systems that do not follow one blueprint, but
have found different answers to questions like cap-setting, allocation,
scope, and flexibility provisions, based on their own local needs
and conditions.[35]
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:
The means to accomplish such trades and the practice
of doing so with analogous financial products is already in place.
All that is needed is agreement of the relevant parties to trade
the allowances that each has created within their own domestic
or local systems.[50]
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:
Over the longer term the expansion of these systems
is going to be through linkage, and that is probably the area
where there is most opportunity. We have seen it already: the
California emissions trading system expanded by, in effect, linking
with the proposals in Quebec. [
]. You could imagine perhaps
other jurisdictions in that area that are looking at emissions
trading deciding to join that system rather than creating their
own from the get-go. I think that sort of expansion is probably
the direction these systems will go inlinkage between very
big systems.[75]
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:
The Government has been active in encouraging
the linking of ETSs. The UK has been positively engaged in all
linking negotiations involving the EU's ETS, including those with
Australia and Switzerland.[79]
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
42
Q45 (Mr Pibworth), Qq186-187 (Mr Meadows), Q195 (Ms Rudd), Q200
(Ms Rudd) Back
43
LTS 003 (Grantham Institute on Climate Change and the Environment),
LTS 005 (DECC), LTS 007 (A. Denny Ellerman), LTS 008 (Mineral Products Association) Back
44
LTS 001 (Professor Stavins), LTS 007 (A. Denny Ellerman), LTS
008 (Mineral Products Association) Back
45
LTS 017 (EU Commission) Back
46
LTS 016 (IETA) Back
47
LTS 016 (IETA), LTS 017 (EU Commission) Back
48
LTS 016 (IETA), RGGI, 'Welcome,' accessed 10 February 2015 Back
49
Q2 (Mr Forrister), Q4 (Mr Forrister), Q9 (Mr Forrister), Q22 (Mr
Forrister), Q159 (Mr Hone), LTS 015 (City of London Corporation),
LTS 016 (IETA) Back
50
LTS 007 (A. Denny Ellerman) Back
51
Q164 (Mr Hone), LTS 003 (Grantham Institute on Climate Change and the Environment) Back
52
Q72 (Professor Stavins), Q144 (Mr Svenningsen), LTS 007 (A. Denny Ellerman) Back
53
LTS 015 (City of London Corporation) Back
54
As above Back
55
LTS 003 (Grantham Institute on Climate Change and the Environment) Back
56
As above Back
57
Qq14-15 (Mr Forrister, Dr Taschini), LTS 003 (Grantham Institute on Climate Change and the Environment) Back
58
Qq4-5 (Mr Forrister, Dr Taschini) Back
59
Q164 (Mr Hone), LTS 003 (Grantham Institute on Climate Change and the Environment) Back
60
Q70 (Professor Stavins) Back
61
LTS 003 (Grantham Institute on Climate Change and the Environment) Back
62
The Clean Development Mechanism (CDM), defined in Article 12 of
the Kyoto Protocol, allows a country with an emission-reduction
commitment under the Kyoto Protocol (Annex B Party) to implement
an emission-reduction project in developing countries. Such projects
can earn saleable certified emission reduction (CER) credits,
each equivalent to one tonne of CO2, which can be counted towards
meeting Kyoto targets. Back
63
LTS 003 (Grantham Institute on Climate Change and the Environment) Back
64
LTS 016 (IETA), LTS 018 (Project Team of EU-Guangdong ETS Linkage Study) Back
65
Q76 (Professor Stavins) Back
66
Q76 (Professor Stavins) Back
67
Q54 (Mr Austin) Back
68
LTS 003 (Grantham Institute on Climate Change and the Environment) Back
69
Q1 (Dr Taschini), LTS 005 (DECC), LTS 016 (IETA) Back
70
LTS001 (Robert N. Stavins), LTS 005 (DECC) Back
71
Q55 (Mr Austin), Q90 (Professor Stavins), Q159 (Mr Hone) Back
72
Q88 (Professor Stavins) Back
73
Q71 (Professor Stavins), LTS 016 (IETA) Back
74
Qq140-143 (Mr Svenningsen), LTS 013 (UNFCCC) Back
75
Q159 (Mr Hone) Back
76
Q12 (Mr Forrister), Q97 (Sir David) Back
77
Q107 (Sir David) Back
78
Q12 (Mr Forrister), LTS 005 (DECC), LTS 014 (World Bank Group),
LTS 016 (IETA) Back
79
LTS 005 (DECC) Back
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