Josephine V. Yam

The Accelerated Growth of Carbon Markets

"Right now, the carbon markets of the future are under construction in all corners of the world", enthused Rachel Kyte, Vice President of Sustainable Development at the World Bank, in a recent Huffington Post article.

According to Kyte, at least 35 countries, 18 sub-national jurisdictions in the U.S. and Canada, and 7 Chinese cities and provinces will eventually be launching their own carbon markets to reduce their greenhouse gas emissions (GHG).

For example, China has vocally expressed its resolute determination to use the "magic of the market" of emissions trading as a way of greening its robust economy. The Chinese government believes that the creation of its own national carbon emissions market will serve as a very efficient strategy to achieving a sustainable green economy.

The linking of carbon markets with one another is crucial to achieving cost efficiencies in reaching a global carbon price for carbon credits. To this end, the World Bank established the Partnership for Market Readiness (PMR) in 2011, which has brought together over 30 developed and developing countries to consolidate their efforts in creating market-based instruments for GHG emissions reduction, including the creation of emissions trading schemes. Indeed, this bottom-up approach may prove to be a more effective way to successfully combat climate change.

World's Largest Carbon Market: Linking Australian & EU Emissions Trading Systems

Last week, the Australian Minister for Climate Change and Energy Efficiency, Greg Combet, and the European Commissioner for Climate Action, Connie Hedegaard announced that Australia and the European Union (EU) will be linking their emissions trading systems.

Commissioner Hedegaard said: "We now look forward to the first full international linking of emission trading systems. This would be a significant achievement for both Europe and Australia. It is further evidence of strong international cooperation on climate change and will build further momentum towards establishing a robust international carbon market."

Minister Combet said: "Linking the Australian and European Union systems reaffirms that carbon markets are the prime vehicle for tackling climate change and the most efficient means of achieving emissions reductions."

A link between emissions trading systems allows companies in one system to use units from another system for compliance purposes. The advantages of linking include:

  • reducing the cost of cutting carbon pollution because enterprises will have access to more and lower cost emissions abatement units;
  • increasing market liquidity, which in turn offers a more stable carbon price signal;
  • increasing business opportunities to trade because companies with excess units will have access to more buyers and companies that need more units can purchase them from a wider range of sellers; and
  • supporting global cooperation on climate change.

A full two-way link between the EU and Australian cap-and-trade systems will start by July 1, 2018. Under this arrangement, private industry will be able to use carbon units from the Australian emissions trading scheme or the EU Emissions Trading System for compliance under either system.

An interim link between the two systems will be established allowing Australian businesses to use EU allowances to help meet liabilities under the Australian emissions trading scheme from July 1, 2015 until the full link is operational in 2018.

According to the EU website, this linking arrangement “represents the first step towards linking the established carbon market in Europe with developing carbon markets in the Asia Pacific. Together, the linked Australian and European emissions trading systems will be the world’s largest carbon market and a major driver of the global transition to a low carbon economy.”

Inclusion of Airline Emissions by European Union Emissions Trading System (EU ETS) triggers International Law Dispute

The brewing international controversy of airline emissions being included in the European Union Emissions Trading System (EU ETS) highlights one of the risks of the EU unilaterally imposing a carbon market on its member countries while China, US and other major economies do not have their own carbon markets.

The Law

The European initiative, effective January 1, 2012, involves folding aviation into the six-year-old emissions trading system, in which polluters can buy and sell a limited quantity of permits, each representing a ton of carbon dioxide. The law requires airlines to account for their emissions for the entirety of any flight that takes off from — or lands at — any airport in the EU bloc. While airlines landing or taking off in Europe are included in the EU ETS beginning January 1, 2012, they do not have to start paying anything until April 2013.

The goal of this European initiative is to speed up the adoption of greener technologies at a time when air traffic, which represents about 3 percent of global carbon dioxide emissions, is growing much faster than gains in efficiency.

Consequences of the Law

Airlines will have to buy 15 percent of their emissions certificates at auction. Carbon emissions from planes will initially be capped at 97 percent of the 2004-2006 levels. The emissions rules apply from the moment an aircraft begins to taxi from the gate, either en route to or from a European airport, and they cover emissions for the flight from start to finish — not just the portion that occurs in European airspace.

Why the EU went ahead with the Law

Governments and airlines have been in negotiations for more than a decade over the creation of a global cap-and-trade system under the auspices of the International Civil Aviation Organization, an arm of the United Nations. The organization’s 190 member states passed a resolution in 2010 committing the group to devising a market-based solution, though without a fixed timetable.
Impatient with the pace of those talks, the European Commission moved ahead with its own plan, which was passed two years ago with the support of national governments and the European Parliament.

Airline arguments

Some 26 countries, including China, Russia and the United States, formally showed their dissatisfaction with the European system — a move that heralds a possible commencement of a formal dispute procedure at the International Civil Aviation Organization (ICAO), a U.N. agency that handles global aviation matters. They have questioned whether this EU directive is invalid. Their arguments include the following:

  1. Why the requirements apply to emissions from the entire flight, not just the portion that occurs within EU airspace?
  2. In applying its environmental legislation to aviation activities in third countries' airspace and over the high seas, the E.U. has violated fundamental and well-established principles of customary international law.
  3. The EU's actions infringe on the notion that each nation has sovereignty over its territory, a universally recognized principle of international law.
  4. By acting unilaterally, the European Union also breached international obligations that require such matters to be resolved by consensus under the auspices of the International Civil Aviation Organization (ICAO), a U.N. agency that handles global aviation matters.

In fact, China recently announced that its carriers would be forbidden to pay any charges under the European emissions system without Beijing’s permission.

EU Response to China and the other countries

The EU posits that the ETS is not a charge or a tax but a cap-and-trade system. Its defense includes the following claims:

  1. The purpose of our legislation is to reduce emissions, not make money.
  2. Including aviation in the ETS is "fully consistent with international law" because the EU is not seeking to extend its authority outside of its airspace.
  3. However, given the complaints of China and other countries, the EU could suspend parts of a new law requiring airlines to account for their greenhouse gas emissions if countries were to make clear progress this year toward establishing a global emissions control system.

Written: 2012 February
References:

Why was there an over-allocation of allowances in the European Union Emissions Trading System (EU ETS)?

One reason why there was an over-allocation of allowances in the European Union Emissions Trading System (EU ETS) was because of national self-preservation. The EU gave its member states the authority to determine their specific allocation of allowances. In the name of protecting national economic self-interest, the member states over-allocated allowances to themselves, especially France, Germany and Italy. With no ability to bank allowances into the second phase because of their expiration dates, the allowance price of a Phase I allowance dropped to zero in 2007.

Written: 2012 February
Source: PriceWaterhouseCoopers (PWC). (2009). Carbon Taxes vs. Carbon Trading: Pros, cons and the case for a hybrid approach

What are the two main conditions that make emissions trading systems feasible in the European Union Emissions Trading System (EU ETS)?

Condition 1 - the participants covered by the program must be sufficiently varied for there to be potential gains from trading allowances. If all firms were the same, then they would all face the same abatement costs and so they would all be either net buyers or net sellers. Hence no trade would occur. In the European Union Emissions Trading System (EU ETS), the coverage includes power plants and five major industrial sectors (including oil, iron and steel, cement, glass, and pulp and paper) that together produce nearly half the EU’s CO2 emissions.

Condition 2 - there should be a sufficient number of polluters included in the scheme in order to ensure a reasonably liquid market. This increases the amount of trades that occur, hence allowing a clear price signal to emerge. In turn, this reduces the uncertainty that participants face when making long-term investment decisions because the expected gains from investing to abate are much clearer. Furthermore, the risk of any one participant holding extensive market power, which would restrict trading, is reduced. In the European Union Emissions Trading System (EU ETS), approximately 12,000 facilities in the 25 EU member states are covered.

In successfully meeting these two conditions, the EU ETS’ massive scale and breadth has enabled it to build a very robust emissions trading market in a short period of time. For example, in 2007, over 100 million allowances per month were traded. Moreover, rates of compliance amongst participants were encouragingly high.

Written: 2012 February
Source: PriceWaterhouseCoopers (PWC). (2009). Carbon Taxes vs. Carbon Trading: Pros, cons and the case for a hybrid approach”