99533 State and Trends of Carbon Pricing Washington DC September 2015 2015 2 State and Trends of Carbon Pricing Washington DC September 2015 2015 This report was prepared jointly by the World Bank and Ecofys. Alexandre Kossoy and Grzegorz Peszko led the World Bank team, also consisting of Klaus Oppermann and Nicolai Prytz, which conceptualized this report. The Ecofys team consisted of Noémie Klein, Kornelis Blok, Long Lam, Lindee Wong, and Bram Borkent. © 2015 International Bank for Reconstruction Translations – If you create a translation of this work, please add and Development/The World Bank the following disclaimer along with the attribution: This translation 1818 H Street NW, Washington DC 20433 was not created by The World Bank and should not be considered Telephone: 202-473-1000; Internet: www.worldbank.org an official World Bank translation. 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ISBN (electronic): 978-1-4648-0725-1 Attribution – Please cite the work as follows: Alexandre Kossoy, DOI: 10.1596/ 978-1-4648-0725-1 Grzegorz Peszko, Klaus Oppermann, Nicolai Prytz, Noémie Klein, Kornelis Blok, Long Lam, Lindee Wong, Bram Borkent. 2015. Photo credits: page 15: Mr.Lukchai Chaimongkon/iStock/ State and Trends of Carbon Pricing 2015 (September), by World Thinkstock; page 19: Mike_Kiev/iStock/Thinkstock; page 51: Bank, Washington, DC. Toa55/Shutterstock.com; page 63: omihay/Shutterstock.com Doi: 10.1596/ 978-1-4648-0725-1 License: Creative Commons Attribution CC BY 3.0 IGO Design: Meike Naumann, Visuelle Kommunikation 2 Reflecting the growing momentum for carbon pricing worldwide, the 2015 edition of the State and Trends of Carbon Pricing report targets a wider audience of public and private stakeholders who are engaged in carbon pricing design and implementation. This report also provides critical input for the negotiations leading up to the Conference of the Parties (COP) in Paris. As in the previous editions, the report provides an up-to-date overview of existing and emerging carbon pricing instruments around the world, including national and subnational initiatives. Furthermore, it gives an overview of current corporate carbon pricing instruments. To better reflect the plethora of topics being considered in the climate dialogue, the report also analyzes competitiveness and carbon leakage, and their impact on the development of carbon pricing instruments. The ­ task team responsible for this report intends to select new relevant topics to be explored in future editions. These topics could include, for example, the effectiveness of existing and emerging carbon pricing instruments, and how to measure it. international Finally, this year’s report gives the audience a forward-looking assessment of the advantages of ­ cooperation in reaching stringent global mitigation targets. A review of existing modeling work provides a qualitative and quantitative assessment of cost saving potentials and the magnitude of financial flows ­ inherent to international cooperation aimed at reducing greenhouse gas emissions to a level consistent with the 2°C climate stabilization goal. climate The report benefited greatly from the valuable written contributions and perspectives of our colleagues in the ­ and carbon finance community, ensuring the quality and clarity of this report: Emilie Alberola, Carter ­ Brandon, Marcos Castro, Alyssa Gilbert, Andries Hof, Pauline Maree Kennedy, Thomas Kerr, Grant Kirkman, ­ Benoît Leguet, Alexios Pantelias, Jayoung Park, Ian Parry, Paul Steele, Massimo Tavoni, Adam Whitmore, and Peter Zapfel. We wish to extend our gratitude to those who offered their cooperation and insights during the development of this report: Marion Afriat, Soffia Alarcon-Diaz, Marco Aurélio dos Santos Araujo, Adrien de Bassompierre, Nils Axel Braathen, Stefanie Bradtner, Pieter van Breevort, Kurt van Dender, Guy ­ Dundas, Maxime Durande, Jane Ebinger, Monica Paola Echegoyen Lopez, Marianne Fay, Shari Friedman, Camille Funnell, Daniela Goehler, Guigon, Thomas Forth, Shari Friedman, Isabel Hagbrink, Ferry van Hagen, Kelley Hamrick, Takashi Hongo, Pierre ­ Matthieu Jalard, Maria Kolos, Franck Lecocq, Pedro Martins Barata, Frank Melum, Sarah Moyer, Samantha Mullender, Christian Nabe, Meike Naumann, New Zealand Ministry for the Environment, Norwegian Ministry of Finance, Inge ­Pakulski, Baptiste Perrissin-Fabert, Simon Quemin, Ulrika Raab, Venkata Ramana Putti, Kate Rich, Juan ­ Pedro Searle, Igor Shishlov, Bianca Sylvester, Manasvini Vaidyula, Detlef van Vuuren, Jessica Wade Murphy, Xueman Wang, John Ward, Carsten Warnecke, Vikram Widge, Qian Wu, Liu Ying, and Menggeng Zhu. We also acknowledge the support from the Partnership for Market Readiness and Vivid Economics, who produced the upcoming technical report on carbon leakage, from which Grzegorz Peszko has drawn generously to write section 3. 3 LIST OF ABBREVIATIONS AND ACRONYMS °C Degrees Celsius A AAU Assigned Amount Unit ADB Asian Development Bank ADP Ad Hoc Working Group on the Durban Platform for Enhanced Action ARB Air Resources Board B BCA Border Carbon Adjustment C CCER Chinese Certified Emission Reduction CCR Cost Containment Reserve CCS Carbon Capture and Storage CDM Clean Development Mechanism CDP Carbon Disclosure Project CER Certified Emission Reduction Ci-Dev Carbon Initiative for Development CMP Conference of the Parties serving as the Meeting of the Parties to the Kyoto Protocol CO2 Carbon dioxide CO2e Carbon dioxide equivalent COP Conference of the Parties CP1 First Commitment Period under the Kyoto Protocol CP2 Second Commitment Period under the Kyoto Protocol CPM Carbon Pricing Mechanism D DNA Designated National Authority E EBRD European Bank of Reconstruction and Development ERU Emission Reduction Unit ETS Emissions Trading System EU European Union EU ETS European Union Emissions Trading System F FCPF Forest Carbon Partnership Facility FSB Fixed Sector Benchmarking FVA Framework for Various Approaches 4 G GDP Gross Domestic Product GHG Greenhouse gas Gt Gigaton GtCO2e Gigaton of carbon dioxide equivalent I ICAO International Civil Aviation Organization ICAP International Carbon Action Partnership IEA International Energy Agency IET International Emissions Trading INDC Intended Nationally Determined Contribution IPCC Intergovernmental Panel on Climate Change J JI Joint Implementation L LIMITS ­ trategies Low climate IMpact scenarios and the Implications of required Tight emission control S LPG Liquefied Petroleum Gas M MRV Monitoring, Reporting and Verification Mt Megaton MtCO2e Megaton of carbon dioxide equivalent MW Megawatt N NAMA Nationally Appropriate Mitigation Action NDRC China’s National Development and Reform Commission NMM New Market-based Mechanism NZ-AAU New Zealand-originated Assigned Amount Unit NZ ETS New Zealand Emissions Trading System NZU New Zealand Unit O OBA Output-Based Allocation OECD Organisation for Economic Co-operation and Development P PBL Planbureau voor de Leefomgeving (Netherlands Environmental Assessment Agency) PMR Partnership for Market Readiness PoA Program of Activities ppm Parts per million 5 List of abbreviations and acronyms R RBF Results-Based Finance REDD Reducing Emissions from Deforestation and Forest Degradation REDD+ Extends REDD by including sustainable forest management, conservation of forests, and enhancement of carbon sinks RGGI Regional Greenhouse Gas Initiative S SBSTA Subsidiary Body for Scientific and Technological Advice sCER Secondary Certified Emission Reduction T t Ton (unless specified otherwise, ton in this report refers to a metric ton = 1,000 kg) tCO2 Ton of carbon dioxide tCO2e Ton of carbon dioxide equivalent U UK United Kingdom UN United Nations UNDP United Nations Development Programme UNEP United Nations Environment Programme UNFCCC United Nations Framework Convention on Climate Change US United States US EPA United States Environmental Protection Agency V VCS Verified Carbon Standard Y y Year 6 CONTENTS List of abbreviations and acronyms 4 Executive summary 10 1 Introduction 15 2 Existing and emerging carbon pricing 19 instruments around the world 2.1 Overview, recent developments, and emerging trends 20 2.1.1 Global overview of carbon pricing instruments 20 2.1.2 Recent developments and emerging trends 26 2.2 International carbon pricing instruments 31 2.2.1 International carbon pricing under the UNFCCC 31 2.2.2 International carbon pricing outside of the UNFCCC 37 2.3 Regional, national, and subnational carbon pricing instruments 40 2.4 Corporate carbon pricing 48 3 Competitiveness and carbon leakage 51 3.1 Analyzing carbon pricing’s impact on competitiveness 53 3.2 Positive carbon pricing impacts on competitiveness 54 3.3 Adverse impact of carbon prices on competitiveness; 56 carbon leakage 3.4 How to assess the risk of carbon leakage? 58 3.5 Which firms need assistance to prevent leakage and when? 59 3.6 How to assist exposed and vulnerable sectors? 60 3.6.1 Integrated assistance measures 60 3.6.2 Complementary leakage mitigation measures 62 3.6.3 Ensuring targeted and effective leakage assistance measures 62 4 International cooperation on mitigation 63 4.1 Incentives for cooperation on climate mitigation 65 4.2 Realizing the benefits of cooperation 69 Annex I – Conversion rates 73 Annex II – Integrated assistance measures 74 to mitigate the risk of leakage Glossary 80 7 Contents Tables 1 Market and policy update of mechanisms under the Kyoto Protocol 36 and new mechanisms under the UNFCCC 2 Literature overview of global cost savings from international 67 ­ cooperation 3 Currency conversion rates as of August 1, 2015 73 4 Pros and cons of various leakage assistance measures 74 5 Free allocation approaches and their relationship to a firm‘s output 75 and emission intensity Figures 1 Overview of existing, emerging, and potential regional, national, 11 and subnational carbon pricing instruments (ETS and tax) 2 Regional, national, and subnational carbon pricing instruments 12 already implemented or scheduled for implementation: share of global GHG emissions covered 3 Prices in existing carbon pricing instruments 13 4 Overview of existing, emerging, and potential regional, national, 22 and subnational carbon pricing instruments (ETS and tax) 5 Regional, national, and subnational carbon pricing instruments 23 already implemented or scheduled for implementation: share of global GHG emissions covered 6 Prices in existing carbon pricing instruments 24 7 Carbon price and emissions coverage of carbon pricing instruments 25 8 INDCs submitted 32 9 Potential supply of CERs until 2020 35 10 Annual and cumulative CER and ERU issuance, secondary 37 CER prices (left), and voluntary offset issuance and prices (right) 8 11 Carbon pricing instruments implemented or scheduled for 41 implementation, with sectoral coverage and GHG emissions covered 12 Price range of the average internal carbon price, as disclosed by 48 companies to CDP 13 Three channels of transferring emissions leakage 57 14 Ex-ante and ex-post assessments of carbon leakage 58 15 Illustration of cost savings from international cooperation relative 68 to mitigation costs without cooperation for ten regions by 2030 16 Illustration of approximate regional financial flows required to 72 achieve GHG mitigation in line with a 2°C target at global least costs by 2030 Boxes 1 Carbon pricing in numbers 21 2 Emissions trading systems and carbon taxes 27 3 Carbon taxes and ETSs as tools to support public budget 30 4 A global market-based measure for a global industry 39 5 Summary of selected changes in regional, national, and 47 subnational carbon pricing instruments 6 Highlights from Caring for Climate survey on carbon pricing 49 7 Different channels of carbon leakage 57 8 Linking of carbon pricing instruments 70 9 Executive summary W  ith the countdown on to the Paris climate change conference, there is clear evidence of growing momentum to put a price on carbon. The form the largest national carbon pricing initiative in the world in terms of volume. The European Union Emissions Trading System (EU ETS), which covers growth of carbon pricing around the world has been 2 GtCO2e of emissions, remains the single largest substantial. Since January 2012, the number of carbon international carbon pricing instrument. pricing instruments already implemented or scheduled for implementation has almost doubled, jumping from So far this year, the Republic of Korea launched 20 to 38. Moreover, the share of emissions covered by an ETS, and California and Québec’s cap-and-trade carbon pricing has increased threefold over the last programs expanded their GHG emissions coverage ­decade. from about 35 to 85 percent by including transport fuel. Also, Ontario announced its intention to implement Currently, about 40 national jurisdictions and over an ETS linked to California and Québec’s programs. A 20 cities, states, and regions—representing almost a major structural reform in the EU ETS was approved quarter of global greenhouse gas (GHG) emissions—are ­ for implementation starting in 2019, and a proposal putting a price on carbon (Figure 1). ­ Together, carbon to revise the EU ETS after 2020 has been put forward. pricing instruments cover about half of the emissions in These changes should make the EU ETS more resilient these jurisdictions, which translates to about 7 gigatons of to sudden changes in macroeconomic conditions and carbon dioxide equivalent (GtCO2e) or about 12 percent help ensure that the EU ETS enables cost-effective of global emissions (see Figure 2). emission reductions in the decade to come. To date, China and the United States are the two The advances in 2015 follow on the heels of 2014 countries with the largest volume of emissions covered milestones such as the implementation of two new by carbon pricing instruments. In China carbon p ­ ricing subnational ETSs in Hubei and Chongqing (both instruments cover 1 GtCO2e, while in the U ­ nited Chinese jurisdictions), the implementation of carbon States they cover 0.5 GtCO2e. China has announced its taxes in France and Mexico, and the adoption of new intention to move to a national emissions trading system tax legislation in Chile. The year has also seen more (ETS). It currently has seven pilot ETSs, which ­combined companies using an internal price on carbon. 10 Figure 1 Overview of existing, emerging, and potential regional, national, and subnational carbon pricing instruments (ETS and tax) ALBERTA MANITOBA ONTARIO ICELAND KAZAKHSTAN REPUBLIC BRITISH EU UKRAINE OF KOREA COLUMBIA QUÉBEC WASHINGTON OREGON JAPAN CALIFORNIA RGGI TURKEY CHINA MEXICO THAILAND BRAZIL RIO DE JANEIRO SÃO PAULO NEW CHILE SOUTH AFRICA ZEALAND NORWAY SWEDEN REPUBLIC DENMARK FINLAND OF KOREA UK ESTONIA IRELAND LATVIA BEIJING KYOTO POLAND SAITAMA TIANJIN TOKYO HUBEI PORTUGAL SHANGHAI CHONG- GUANGDONG QING TAIWAN FRANCE SLOVENIA SHENZHEN SWITZERLAND Tally of carbon pricing instruments ETS implemented or scheduled ETS and carbon tax implemented or scheduled for implementation Carbon tax implemented or scheduled ETS implemented or scheduled, tax under consideration 14 for implementation ETS or carbon tax under consideration Carbon tax implemented or scheduled, ETS under consideration 4 1 39 21 22 23 ­ epresentative of the size of the carbon pricing The circles represent subnational jurisdictions. The circles are not r instrument, but show the subnational regions (large circles) and cities (small circles). Note: Carbon pricing instruments are considered “scheduled for implementation” once they have been formally National level Subnational level adopted through legislation and have an official, planned start date. 11 Executive summary Figure 2 Regional, national, and subnational carbon pricing instruments already implemented or scheduled for implementation: share of global GHG emissions covered 14% 37 38 12% 36 35 10% 31 8% 23 6% 18 20 14 15 Share of global GHG emissions 10 4% 9 Number of 2% implemented instruments 2 4 5 6 7 8 0% 1991 2001 2011 1997 2007 2017 1994 1995 2004 2005 2014 2015 1992 2002 2012 1993 2003 2013 1999 2009 1998 2008 1996 2006 2016 1990 2000 2010 Finland carbon tax (1990 ) Switzerland carbon tax (2008 ) Shenzhen Pilot ETS (2013 ) Poland carbon tax (1990 ) RGGI (2009 ) Shanghai Pilot ETS (2013 ) Sweden carbon tax (1991 ) Ireland carbon tax (2010 ) Beijing Pilot ETS (2013 ) Norway carbon tax (1991 ) Iceland carbon tax (2010 ) Tianjin Pilot ETS (2013 ) Denmark carbon tax (1992 ) Tokyo CaT (2010 ) Guangdong Pilot ETS (2013 ) Latvia carbon tax (1995 ) Saitama ETS (2011 ) Hubei Pilot ETS (2014 ) Slovenia carbon tax (1996 ) Kyoto ETS (2011 ) Chongqing Pilot ETS (2014 ) Estonia carbon tax (2000 ) California CaT (2012 ) France carbon tax (2014 ) EU ETS (2005 ) Australia CPM (2012 - 2014) Mexico carbon tax (2014 ) Alberta SGER (2007 ) Japan carbon tax (2012 ) Korea ETS (2015 ) Switzerland ETS (2008 ) Québec CaT (2013 ) Portugal carbon tax (2015 ) New Zealand ETS (2008 ) Kazakhstan ETS (2013 ) South Africa carbon tax (2016 ) BC carbon tax (2008 ) UK carbon price floor (2013 ) Chile carbon tax (2017 ) Note: Only the introduction or removal of an ETS or carbon tax is shown. Emissions are given as a share of global GHG emissions in 2012. Annual changes in global, regional, national, and subnational GHG emissions are not shown in the graph. Data on the coverage of the city-level Kyoto ETS are not accessible; its coverage is therefore shown as zero. 12 Figure 3 Prices in existing carbon pricing instruments The combined value of the regional, national, and subnational carbon pricing instruments in 2015 is US$140/ estimated at just under US$50 billion globally, of which ­ tCO2e almost 70 percent (about US$34 billion) is attributed to ETSs and the remainder (about 30 percent) to carbon taxes. 130 Sweden carbon tax The existing carbon prices vary significantly—from less than US$1 per tCO2e to US$130 per tCO2e (see Figure 3). The majority of emissions (85 percent) ­ are priced at less than US$10 per tCO2e, which is … considerably l models ­ower than the price that economic ­ … have e ­stimated is needed to meet the 2°C climate 64 Finland carbon tax (transport fuels) ­ ­ ecommended by scientists. stabilization goal r 62 Switzerland carbon tax US$60/ tCO2e 52 Norway carbon tax (upper) 48 Finland carbon tax (heating fuels) Note: Nominal prices on August 1, 2015, shown for illustrative purpose only. The figures given in the Carbon Pricing Watch 201516 have been updated to August 1, US$40/ 2015. The differences with the Carbon Pricing Watch are due to the daily changes tCO2e in prices and exchange rates. Prices are not necessarily comparable between carbon pricing instruments because of differences in the number of sectors covered and allocation methods applied, specific exemptions, and different compensation 36 Tokyo CaT methods. US$/tCO2e 28 UK carbon price floor 25 Denmark carbon tax Switzerland ETS, 23 BC carbon tax Korea ETS, 9 22 Ireland carbon tax EU ETS US$20/ 8 Iceland carbon tax tCO2e 19 Slovenia carbon tax Beijing Pilot ETS, 7 RGGI 16 France carbon tax 6 Portugal carbon tax 13 California CaT, Québec CaT Shenzhen Pilot ETS, 5 12 Alberta SGER New Zealand ETS Hubei Pilot ETS, 4 9 Latvia carbon tax Mexico carbon tax (upper), 8 Norway carbon tax (lower), 3 7 6 Tianjin Pilot ETS Guangdong Pilot ETS, 5 2 Chongqing Pilot ETS, 4 Kazakhstan ETS, 3 Estonia carbon tax, 2 Mexico carbon tax (lower), <1 Shanghai Pilot ETS, US$0/ <1 Poland carbon tax Japan carbon tax tCO2e 13 Executive summary Carbon pricing is increasingly being used internally eliminate the need for protection of firms. Under these by firms as a tool to analyze business and investment circumstances, carbon prices can be used to enhance strategy. Some of these carbon prices are substantially the performance of economies—specifically benefiting higher than current price levels in mandatory carbon innovative, low-carbon firms, and promoting the pricing instruments. Internal carbon pricing is part of technical upgrade or exit of the least efficient firms in a risk management strategy to evaluate the current or emissions-intensive industries. This would improve the potential impact of a mandated carbon price on business overall efficiency of the economy. operations. It is also used as a means to identify and value cost savings and revenue opportunities in low- In addition to reducing the risk of carbon leakage, carbon investments. cooperation between countries can significantly reduce the overall cost of achieving a 2°C climate stabilization In a world of fragmented carbon pricing instruments, goal compared to domestic actions alone, as countries the potential impact of carbon pricing on the international have more flexibility in choosing who undertakes competitiveness of some domestic industrial sectors has emission reductions, and who pays for them. Moreover, been a concern. The risk of carbon leakage is real as long such cooperation could drive low-carbon growth in as carbon price signals are strong and the stringency of lower-income countries, some of which might lack the climate policies differs significantly across jurisdictions. resources to modernize their economies, create jobs in low-carbon sectors, or reduce poverty in a sustainable However, the report finds, based on available manner. Through international cooperation, the global research, that carbon leakage—the phenomenon of costs associated with a given emission reduction target companies moving their production and/or redirecting can be lowered or a larger mitigation target can be their investments to other jurisdictions where emissions achieved at a given cost, and development gaps can be costs are lower, thereby increasing emissions there—has narrowed. not materialized on a significant scale. This risk tends to only affect a limited number of exposed sectors, namely According to estimates from economic models, those that are both emissions- and trade intensive. This financial transfers through cooperation could reach risk can be effectively managed through policy design up to US$100–400 billion annually by 2030, possibly components, such as free allocations, exemptions, increasing to over $2 trillion dollars by 2050. The size rebates and border adjustment measures, as well as of the transfers will be beyond the level of public sector specific complementary measures, for example, financial spending, and will need to be channeled through a blend assistance. of instruments. These include carbon pricing instruments such as ETSs, carbon taxes, offsets and a combination The risk of carbon leakage declines as more countries thereof and linkages between them, as well as innovative take concrete actions to prevent climate change. hybrid instruments, such as variations of results-based International cooperation through carbon pricing climate finance. Climate finance and carbon pricing instruments and climate finance can help redress the instruments will be essential in leveraging these financial existing asymmetry in carbon pricing signals, reduce transfers and enabling cooperation to mitigate climate concerns about their impact on competitiveness, and change. 14 section 1 Introduction 1 Introduction T  he year 2014 proved to be the warmest year since record keeping began1 and temperatures are now 0.8°C above pre-industrial levels.2 From heat faces a huge challenge in raising the ambition expressed by countries so far to the level actually needed to avoid dangerous climate change. and ­ precipitation to drought and cyclone activity, the ­frequency of extreme weather events has increased,3 with Over the next 35 years, approximately US$40 t­ rillion damaging effects on settlements, crops, food, w ­ ater, of additional investment will be needed to transition people’s lives and energy security. The risks this poses to ­ to a global, low-carbon energy system.5 Beyond the and well-being are expected to be even higher if the official climate negotiations under the United Nations global greenhouse gas (GHG) emissions trend r ­ emains Convention on Climate Change (UNFCCC), support ­ unchecked. Experts agree that the most severe climate for the necessary changes is coming from a v ­ariety impacts can be avoided if the mean g ­ lobal temperature of actors,6 public and private sector finance ­ playing rise is lower than 2°C. an ­ increasingly important role. Current ­ financial flows ­ associated with climate change mitigation and Keeping this goal within reach requires significant adaptation amount to about US$343–385 billion/year ­ cuts in emissions of all GHGs. Compared with the globally, with most of this going to mitigation efforts.7 2012 overall level of 54 gigatons of carbon dioxide However, to stabilize the climate, these resources need equivalent (GtCO2e), GHG emissions need to be cut to be scaled up and investment patterns need to change. by 32 GtCO2e by 2050.4 The international community 1 Temperature record keeping began in 1880 (source: NOAA National Climatic Data Center, Global Analysis - Annual 2014, accessed April 28, 2015, https:// www.ncdc.noaa.gov/sotc/global/2014/13). 2 World Bank, Turn Down the Heat: Confronting the New Climate Normal, 2014. 3 Ibid. 4 The UNEP says that the median emission level required for this target is 42 GtCO2e in 2030 and 22 GtCO2e in 2050. Source: UNEP, The Emissions Gap Report 2014. According to the IPCC, global emissions need to be reduced by 40–70% in 2050, compared to 2010 levels, in order to have a likely chance to keep the temperature change below 2°C. Source: IPCC, Climate Change 2014: Mitigation of Climate Change – Summary for Policy Makers, 2014. 5 The additional investment is relative to the US$318 trillion that is expected to be invested in a business-as-usual scenario. Source: International Energy Agency, Energy Technology Perspectives 2015, 2015. 6 UNEP, Climate commitments of subnational actors and business: A quantitative assessment of their emission reduction impact, 2015. 7 IPCC, Climate Change 2014: Mitigation of Climate Change - Summary for Policy Makers, 2014. 16 There is a growing consensus among both govern- by companies. Bearing in mind this scope, ­ other policies ments and businesses on the fundamental role of c­ arbon that implicitly price GHG e ­missions—such as the pricing in the transition to a decarbonized economy. taxation, support removal of fossil fuel subsidies, energy ­ Placing an adequate price on GHG emissions helps for renewable energy, and energy efficiency c ­ertificate ­ mobilize the financial investments required to support trading – are not included. diverse actions, such as fuel switching from coal to natural gas, renewable energy deployment, the adoption ­ The carbon prices observed in these instruments of energy efficiency measures and the use of low-carbon vary significantly, from less than US$1/tCO2e to technologies in industry. $US130/tCO2e. The majority of emissions (85 percent) are priced at less than US$10/tCO2e, which is For governments, carbon pricing is an instrument considerably lower than the price that economic models to achieve emissions mitigation and also a source of have estimated is needed to meet the 2°C climate ­ revenue, which is particularly important in the ­ current stabilization goal recommended by scientists. As carbon economic environment of budgetary constraints. ­ pricing is not implemented uniformly around the world, Businesses use internal carbon pricing to evaluate the ­ one of the key issues facing the affected industries is impact of mandatory carbon prices on their operations carbon leakage—the situation where production and and as a tool to i ­ dentify potential cost savings and associated emissions shift to jurisdictions that do not revenue o ­ pportunities. Finally, long-term investors use have equivalent policies in place. Section 3 examines carbon pricing to analyze the potential impact of climate this issue and suggests policy provisions that could change policies on their investment portfolios, allowing alleviate it. them to reassess investment strategies and reallocate capital toward low-carbon or climate-safe activities. Finally, to optimize the emission reductions that c ­ arbon pricing and other policy instruments can d­ eliver, Over the past year, new carbon pricing i ­nstruments cooperation is needed on all levels. Section 4 focuses on have been launched, and existing ones have been ­evolving the rationale and potential economic gains of a joint in response to the lessons learned from ­ operational mitigation effort. The report concludes by examining ­experience. These existing and new ­instruments, as well as carbon pricing instruments and their crucial role in carbon pricing trends, are discussed in section 2. For the mobilizing the resources needed to achieve cost savings purpose of this report, carbon pricing refers to ­ initiatives through international cooperation. that put an explicit price on GHG emissions. These 8 initiatives include not only emissions trading s ­ystems (ETSs), carbon taxes, offset mechanisms, and ­ results- based finance (RBF), but also internal c ­ arbon prices set 8 In other words, a price expressed as a value per ton of CO2. 17 1   Introduction » Climate change poses great dangers to us all. This means that we need to limit harmful greenhouse gas emissions effectively. Economic incentives are a good way to achieve this goal. Carbon pricing makes investments in low-carbon or carbon-free technologies attractive and ensures that fossil fuels are used efficiently. This helps us to adhere to our common two-degree climate goal. […] Our country’s positive economic development shows that technological progress and growth can go hand in hand with climate protection. […] The emission of harmful greenhouse gases must come at a price. This is the only way that we will make any tangible progress on climate protection. And it is the only way to ensure that we will not have to pay a far higher price in the end. Fortunately, many governments and companies are already using carbon-pricing instruments. Our hope is that all countries will perceive the opportunities that economically efficient and low-carbon development offers them. « Angela Merkel, Chancellor of Germany 18 section 2 Existing and emerging carbon pricing instruments around the world 2 Existing and emerging carbon pricing instruments around the world 2.1 Figure 5 shows three distinct periods since the intro- OVERVIEW, RECENT DEVELOPMENTS, duction of carbon pricing instruments: (i) the period AND EMERGING TRENDS 1990-2005, which was dominated by early movers intro- ducing carbon taxes; (ii) the period 2005-11, which saw 2.1.1 the start of the Kyoto Protocol, and a rapid expansion Global overview of in the coverage of GHG emissions, largely because of carbon pricing instruments the implementation of the European Union Emissions Trading System (EU ETS);11 and (iii) the period from A  national s of August 31, 2015, 39 national and 23 sub­­ jurisdictions are putting a price on carbon through ETSs and taxes (Box 1 and Figure 4). Together, these car- 2012 to the present day, which is mainly defined by the decline in the mechanisms under the Kyoto Protocol and the emergence of new, national and subnational, carbon bon pricing instruments cover some 7 GtCO2e, about pricing instruments in both developed and developing 12 percent of the annual global GHG emissions.9 This economies. represents significant progress: the number of carbon pricing instruments has expanded by 90 percent since 2012. More specifically, since January 1, 2012, the » The number of carbon number of carbon pricing instruments implemented and scheduled has increased from 20 to 38. In addition, ­ pricing instruments has the share of global emissions under a carbon pricing in- expanded by 90 percent ­ strument has increased threefold over the past decade (Figure 5).10 since 2012. « 9 The EU ETS operates in the 28 EU member states and the other three members of the European Economic Area (Iceland, Liechtenstein, and Norway). 10 These numbers are revised on a regular basis to reflect updated figures on GHG emissions in each jurisdiction, changes in the design and coverage of existing carbon pricing instruments, the inclusion of new instruments, and the availability of new data. Thus, these figures and the ones from previous State and trends of carbon pricing reports are not necessarily comparable. 11 In 2005, carbon pricing instruments covered 4 percent of annual global GHG emissions; in 2015, this figure stands at 12 percent. 20 Box 1 Carbon pricing in numbers 39 NATIONAL 23 SUBNATIONAL JURISDICTIONS JURISDICTIONS with carbon pricing instruments 38 CARBON PRICING 90% INCREASE INSTRUMENTS already implemented or in number of instruments scheduled for implementation with respect to January 1, 2012 COVERING ANNUAL GLOBAL GHG EMISSIONS OF ~12% = 7 GtCO2e 8% ETSs 4% CARBON INCREASE 3x TAXES over 2005-2015 in share of global emissions covered PRICES IN THE INSTRUMENTS IMPLEMENTED US$ 1-130/tCO2e 85% of emissions covered are priced at 50 MW) in developing countries amounted to US$671 billion over the period 2006–14. Source: REN21, Renewables 2015 Global Status Report, July 2015. 53 UNFCCC, “What the CDM Can Offer the Emerging Market Mechanisms?” (presented at the Global CDM DNA Forum, Bonn, November 13, 2014); UNFCCC, CDM Has Wide Role to Play Before and After 2020, June 1, 2015, http://newsroom.unfccc.int/financial-flows/cdm-has-role-to-play-in-pre-and-post-2020-world/. 35 2   Existing and emerging carbon pricing instruments around the world Table 1 Market and policy update of mechanisms under the Kyoto Protocol and new mechanisms under the UNFCCC Market update Policy update CDM –– The number of projects and PoAs registered in 2014 was 160, –– Procedures for voluntary deregistration of projects were 53% lower than in 2013. adopted in 2015.e –– The number of CERs issued in 2014 was 104 MtCO2e, 61% –– An online platform for voluntary cancellation of CERs will lower than in 2013. This continues the declining be launched on September 22, 2015.f trend of the CDM market, as shown in Figure 10. –– Efforts continue to streamline CDM procedures through –– In the primary CER market, a total of 60 million CERs were digitalization of forms, simplification of methodologies, and ­ traded, a 70% drop with respect to 2013.a Over half of these simplified registration for projects that automatically qualify transactions were made by the governments of Norway and as additional.g ­ Sweden through their CER purchase programs.b –– The CDM Executive Board and the UNFCCC Secretariat –– 25 million primary CERs are expected to be traded in 2015.c are actively investigating alternative uses of the CDM –– The average CER price on the secondary market was €0.17/ infrastructure beyond an offset mechanism under the Existing mechanisms tCO2e (US$0.19) in 2014, more than 50% lower than in 2013.d Kyoto Protocol, to increase the demand for the CDM and strengthen its ability to enhance mitigation activities.h JI –– No project was registered in 2014.i –– The UNFCCC Secretariat produced a technical paper on –– The number of ERUs issued in 2014 was 31 MtCO2e, 83% how the JI can achieve cost savings and efficiencies, based less than in 2013. This continues the declining trend of the on lessons learned from the CDM. The findings of this JI market, as shown in Figure 10. paper may be taken into account in future deliberations.l –– In 2014, no primary ERU contracts were closed and only 17.8 MtCO2e of trading took place on the secondary market.j –– The ERU price fell to €0.03 (US$0.03) in December 2014.k IET –– The true-up period for the first Kyoto Commitment Period –– Little progress has been made, as the Doha agreement (CP1) ends on November 18, 2015. Before the end of this has not been ratified. period, countries need to retire sufficient eligible units to –– No further decisions have been made since Doha, 2012, cover their CP1 emissions.m on the carry-over of Assigned Amount Units (AAUs) from CP1 to CP2. NMM and FVA New Approaches –– Not operational –– Progress has been limited. The role of the mechanisms in the post-2020 agreement and their technical design remain open. –– No conclusion has been reached and the issues were placed on the preliminary agenda for SBSTA 43, to be held in Paris, in December 2015.n Note: The true-up period refers to the additional period given for fulfilling commitments. a Thomson Reuters, 2014 Year in Review and Outlook: Asia on the Rise, i UNEP DTU Centre on Energy, Climate and Sustainable Development, UNEP Carbon Market Analyst, January 2015. DTU CDM/JI Pipeline Analysis and Database, August 1, 2015, http://www. b Ibid. cdmpipeline.org/; UNEP DTU Centre on Energy, Climate and Sustainable c Ibid. Development, JI Pipeline, August 1, 2015, http://www.cdmpipeline.org/ d Intercontinental Exchange ICE, Daily Future sCERs. publications/JiPipeline.xlsx. e UNFCCC, CDM Executive Board Eighty-Second Meeting Report, February j Thomson Reuters, 2014 Year in Review and Outlook: Asia on the Rise. 20, 2015. k Ibid. f UNFCCC, Online Platform for Voluntary Cancellation, accessed September l UNFCCC, Opportunities for Cost Savings and Efficiencies in Joint Implementa- 4, 2015, http://customers.meta-fusion.com/wcm/150720_5051_UNFC- tion, Learning from Experience with the Clean Development Mechanism While CC_CDM-EB_85_Bonn/download/2.2_4%20EB85_VC_tool.pdf. Recognizing the Respective Mandates of the Two Mechanisms, April 21, 2015. g UNFCCC, Decision 4/CMP.10, Guidance Relating to the Clean Develop- m UNFCCC, SIAR - True-up Period Report Procedure, October 8, 2014. ment Mechanism. n IISD, Summary of the Bonn Climate Change Conference 1-11 June 2015, h UNFCCC, CDM Executive Board Eighty-Fourth Meeting Report, May 28, Earth Negotiations Bulletin Vol 12, Issue 638 (2015). 2015. 36 Figure 10 Annual and cumulative CER and ERU issuance, secondary CER prices (left), and voluntary offset issuance and prices (right) CDM and JI credit issuances and CDM credit prices Voluntary offset issuances and prices 1,600 40 1,600 1,400 35 1,400 1,200 30 1,200 1,000 25 1,000 800 20 800 600 15 600 Volume (MtCO2e) Volume (MtCO2e) 400 10 400 200 5 200 0 0 Unit price 0 (US$/tCO2e) 005 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 pre-2 Annual CER issuance Cumulative CER issuance Annual voluntary Cumulative voluntary offset issuance Annual ERU issuance Cumulative ERU issuance offset issuance Annual average voluntary credit prices Secondary CER prices Source: UNFCCC for CDM and JI data on issuances, Intercontinental Exchange ICE for CDM data on prices, Forest Trends’ Ecosystem Marketplace for data on voluntary offsets. 2.2.2 Reducing Emissions from Deforestation, International carbon pricing Forest Degradation, and the role of con- outside of the UNFCCC servation, sustainable management of forests, and enhancement of forest carbon ­ Voluntary carbon market In 2014, carbon offsets stocks (REDD+) On June 9, 2015, an agreement worth US$395 million were purchased, representing a was reached on the outstanding items on the agenda for volume of 87 MtCO2e, up 13.6 percent with respect to the UNFCCC’s REDD+ mechanism: safeguards, non- 2013. However, the annual issuance volumes and prices market-based approaches, and non-carbon b ­enefits.55 of carbon offsets continue to fall, as shown in Figure 10. Draft decisions on these issues have been forwarded for This trend can be attributed to the policy uncertainty consideration and adoption at COP 21. If these deci- and the diminishing number of new corporate offsetting sions are adopted in Paris, there will be adequate guid- programs.54 Yet the issuance and price decreases seen ance for implementation of REDD+, c ­omplementing in the voluntary market are less substantial than in the the Warsaw Framework on REDD+ adopted at CDM market. COP 19.56 Countries are making progress on e ­ stablishing 54 Forest Trends’ Ecosystem Marketplace, Ahead of the Curve: State of the Voluntary Carbon Markets 2015, June 2015. 55 UNFCCC, Methodological Guidance for Activities Relating to Reducing Emissions from Deforestation and Forest Degradation and the Role of Conservation, Sus- tainable Management of Forests and Enhancement of Forest Carbon Stocks in Developing Countries, June 9, 2015. 56 Gustavo A. Silva-Chávez, Surprising Development at UN Climate Meetings: REDD+ Is Finished, Forest Trends, June 9, 2015. 37 2   Existing and emerging carbon pricing instruments around the world the national REDD+ infrastructure and REDD+ projects The PAF provides project developers with a ­guaranteed have already been launched, primarily through financing minimum price for reducing methane emissions through from donor countries rather than carbon markets.57 For ­ uction the auctioning of tradable put options. The first a example, the Forest Carbon Partnership Facility’s (FCPF) for the PAF was held on July 15, 2015, and was ­ attended Readiness Fund provides technical guidance58 and the by 28 bidders from 17 countries. There were 12 ­ winners BioCarbon Fund’s Initiative for Sustainable ­ Forest Land- from developing countries. The clearing price in this scapes will purchase significant portions of verified emis- auction was US$2.40/tCO2e and 8.7 MtCO2e of put sion reductions from successful programs. These large options were sold. The PAF currently has ­ capitalization forest carbon operations are essential ingredients for of over US$50 million through contributions from low-carbon development in many countries. Germany, Sweden, Switzerland, and the United States, ­ and aims to reach US$100 million.62 Another two or The New York Declaration on Forests estimates emis- three auctions are planned over the next year and a half. sions could potentially be reduced by 4.5–8.8 GtCO2e per year by 2030.59 These numbers assume country-­ International Aviation The international a ­ viation specific policy reforms to be successfully adopted and industry’s commitment to limit its emissions was certain strategies aimed at reducing forest emissions affirmed by the 2013 Assembly of the International ­ to be implemented, for example, land use planning, Civil Aviation Organization (ICAO), which resolved to ­ increased transparency, and law enforcement. Many of ­ cap net carbon emissions at 2020 levels.63 The ICAO has the ­ technical concerns about REDD+ can be addressed identified four pillars of climate action, which it intends today, for instance, by managing risks through buffers. to use to meet its emission reduction target: ­technology, operations, infrastructure, and a global market-based Results-Based Finance The RBF approach measure (MBM). The 2013 Assembly decided to finalize ­ provides a mitigation activity with financial support once the MBM by 2016, and set into motion several actions its ­emission reductions have been duly verified. Some to accomplish this task: RBF programs purchase compliance emission ­ reduction –– Finalize work on the technical aspects, environmental units, including CERs and ERUs, ­ 60 helping bridge the and economic impacts and modalities of the p ­ ossible ­ current lack of d­ emand for these units. O ­ rograms ­ ther p options for a global MBM scheme, including its not ­specifically designed for ­ compliance ­ markets use feasibility and practicability; ­ RBF as a direct funding mechanism.61 ­ Elements of –– Organize seminars and workshops on a global scale the existing c ­arbon market infrastructure, such as the for international aviation officials and experts of CDM m ­ onitoring, reporting and verification (MRV) member states as well as relevant organizations; and ­requirements, have been incorporated into some ­programs, –– Identify the major issues and problems, including including the Carbon Initiative for Development (Ci-Dev) ­ those expected to affect its member states, and make and the Pilot Auction Facility for Methane and Climate recommendations for a global MBM scheme to be Change Mitigation (PAF), which purchase CERs. Other implemented by 2020. current programs, such as the Performance Based C ­ limate Finance Facility (PBC) in Latin America, were built from Further details on the development of the MBM are the ground up. provided in Box 4. 57 Gustavo A. Silva-Chávez, On the Road to Paris. Next Stop: Bonn, June 2015, Forest Trends, June 10, 2015. 58 Key outcomes include national REDD+ strategies, effective stakeholder participation, safeguard instruments, reference levels and national forest monitoring systems. 14 countries are developing large-scale emission reductions programs to implement their national strategies combining high climate impact potentials and development benefits. These programs range from supporting communities in establishing new agricultural production schemes to encouraging the supply of deforestation-free agricultural commodities and managing protected areas. 59 Climate Summit 2014, FORESTS: Action Statements and Action Plans, September 23, 2014. 60 Examples include the Carbon Initiative for Development (Ci-Dev) and the Pilot Auction Facility for Methane and Climate Change Mitigation (PAF). 61 Examples include the Energy+ Partnership, the Nordic Climate Facility and the Facility for Performance Based Climate Finance in Latin America from the Development Bank of Latin America (CAF). ­ 62 World Bank, First Pilot Auction to Capture Methane a Success, July 17, 2015, http://www.worldbank.org/en/news/press-release/2015/07/17/first-pilot-­ auction-to-capture-methane-a-success. 63 ICAO, Consolidated statement of continuing ICAO policies and practice related to environmental protection – Climate change, 2013. 38 Box 4 A global market-based measure for a global industry By Paul Steele, Senior Vice-President, Member and External Relations & Corporate Secretary national Air Transport Association (IATA) Inter­ The global air transport sector links economies and societies. It provides connectivity to over three billion passengers a year, supports US$2.4 trillion in global GDP, almost 60 million jobs, a third of world trade by value and half of all international tourists. It is also growing fast, particularly in emerging economies. Recognizing the need for the sector to both foster this growth and also play its part in meeting the climate ­ change challenge, the aviation industry has set comprehensive short-, medium-, and long-term climate goals. Coordinated by the industry-wide Air Transport Action Group, the goals are to: 1. Improve the fuel efficiency of the world fleet by an average 1.5% per annum, a goal it is already exceeding; 2. Stabilize net aviation CO2 emissions at 2020 levels through carbon-neutral growth; 3. Halve aviation’s net CO2 emissions by 2050, compared with a 2005 baseline. Significant work is underway to meet the first and third goal through new technology, alternative fuels, better operational methods and improved infrastructure such as air traffic management reforms. However, the mid-term goal of capping CO2 at 2020 levels will be achieved through a global market-based measure (MBM), currently being developed through the sector’s specialized UN agency, the International Civil Aviation Organization (ICAO). ­ The industry itself has taken the unusual position of calling for such a measure and is actively involved in its ­ design, arguing that a global standard scheme is favourable to a patchwork of disjointed regional or national measures that would increase compliance complexity, reduce environmental integrity and lead to market dis­ tortion. ­mplementation Airlines are fiercely competitive businesses, operating in an international environment. Whilst the i of such a measure will place a financial burden on airlines, it is fairly modest compared with the costs of fuel (around a third of airline operating costs) and the competitive impact that unaligned schemes will bring. In order to have a global MBM in place in time for the 2020 start date (which neatly now coincides with the start of the next UNFCCC commitment period to hopefully be agreed upon at COP 21), the industry has called for a simple offsetting scheme as the best option to fulfil its criteria. The ICAO Assembly (a meeting of 191 government representatives) in 2013 supported the development of such a global MBM, to be presented at the next ICAO Assembly in September 2016. In the three inter- vening years, both political and technical design elements are being debated, analyzed and discussed by representatives of governments, industry and civil society. Political questions include how to take account of ­ the need to reflect maturity of developed and developing markets, whilst maintaining a level playing field for airlines. Technical discussions have centered on the eligibility criteria of offsets (does the scheme use CDM, VCS, REDD+, etc?); and the MRV requirements for such a scheme. Progress is extremely encouraging and the industry is putting all of its efforts into achieving a final agreement in September next year. This is not a process without challenges, but it is also the first time such a global mechanism for an individual sector has ever been attempted. For further information about aviation’s climate action, see www.enviro.aero. 39 2   Existing and emerging carbon pricing instruments around the world 2.3 Canada and the United States In the absence REGIONAL, NATIONAL, AND of national carbon pricing instruments in Canada and SUBNATIONAL CARBON PRICING the United States, ETSs are continuing to develop and INSTRUMENTS mature in California, Québec, the RGGI states, and ­ other states and provinces. The California and ­ Québec Cap-and-Trade programs officially linked up in J ­ anuary Carbon pricing has been implemented or is ­ scheduled 2014, and the first shared auction took place in ­November for implementation in 39 national and 23 subnational 2014. The scope of both programs was ­ enlarged in 2015 jurisdictions. Together, these carbon pricing instruments to include transport fuels. This ­ extended the coverage cover some 7 GtCO2e, or about 12 percent of annual to 85 percent of California and Québec’s total GHG global GHG emissions.64, 65 ETSs cover 8 percent of emissions. Continuation of the California Cap-and- annual global GHG emissions, while a further 4 percent ­ Trade Program post-2020 is currently in the ­ legislative are covered by carbon taxes. As highlighted in Figure 11, process.67 This follows California’s ­ announcement the sectoral coverage of carbon pricing instruments of a 2030 target to reduce GHG emissions by ­ varies per jurisdiction, but typically includes the power 40 percent with respect to the 1990 emission l ­evel, and industry sectors. a target that has been incorporated into a bill for consideration in the legislature.68 ­ Further details on the key developments in carbon pricing over 2014–1566 are presented by jurisdiction Since reaching the 2014 US$4/short ton of ­ below, in alphabetical order. This convention will be CO2 (US$4.4/tCO2) ­ trigger price for RGGI’s cost used throughout this section. It should be noted that containment reserve (CCR)69 at the first auction held in rather this section is not intended to be exhaustive, but ­ 2014, the auction clearing price has steadily increased. a summary of the most recent developments in the At the most recent auction, held in March 2015, the ­ instruments implemented and currently being designed auction clearing price reached US$5.5/short ton of or proposed. CO2 (US$6.1/tCO2),70 ­ below the 2015 CCR trigger price of US$6/short ton of CO2 (US$6.6/tCO2). A comprehensive review of RGGI is expected no later than 2016; it will consider potential additional reductions to the cap post-2020 and other program design elements.71 64 These numbers are revised on a regular basis to reflect updated figures on GHG emissions in each jurisdiction, changes in the design and coverage of existing carbon pricing instruments, the inclusion of new instruments, and the availability of new data. Thus, these figures and the ones from previous reports are not necessarily comparable. 65 It should be noted that 100 percent coverage of GHG emissions by carbon pricing instruments is neither desirable nor realistic. 66 This report covers the period from January 1, 2014 to August 31, 2015. 67 Environmental Defense Fund, Carbon Market California, 2015. 68 Office of Governor Edmund G. Brown Jr., Governor Brown Establishes Most Ambitious Greenhouse Gas Reduction Target in North America, April 29, 2015, http:// gov.ca.gov/news.php?id=18938; State of California, California Global Warming Solutions Act of 2006: Emissions Limit, SB-32, 2015. 69 RGGI, Summary of RGGI Model Rule Changes: February 2013, n.d. 70 RGGI, Auction Results, accessed May 19, 2015, http://www.rggi.org/market/co2_auctions/results. 71 RGGI, RGGI 2012 Program Review: Summary of Recommendations to Accompany Model Rule Amendments, 2013. 40 Figure 11 Carbon pricing instruments implemented or scheduled for implementation, with sectoral coverage and GHG emissions covered ALBERTA QUÉBEC EU* BEIJING SHANGHAI 21% 13% 41% 40% 43% 25% 55% 60% 50% 70% 66% 85% BRITISH SWITZER- REPUBLIC OF COLUMBIA RGGI LAND 7% KAZAKHSTAN TIANJIN KOREA 4% NEW MEXICO SOUTH AFRICA HUBEI SHENZHEN ZEALAND 1% 42% 40% 35% 40% % 48% 60% 54% 85% 80% 66% CALIFORNIA CHILE CHONGQING GUANGDONG JAPAN** ­ espective Note: The size of the circles reflects the volume of GHG emissions in each jurisdiction. Symbols show the sectors and/or fuels covered under the r carbon pricing instruments. The largest circle (EU) is equivalent to 4.8 GtCO2e and the smallest circle (Switzerland) to 0.05 GtCO2e. * Also includes Norway, Iceland and Liechtenstein. Carbon tax emissions are the emissions covered under various national carbon taxes; the scope varies per tax. ** ETS emissions are the emissions covered under the Tokyo CaT and Saitama ETS. No coverage information was available for the Kyoto ETS. The scope shown is for the Japan carbon tax and the ETS scope is more limited. ETS implemented or scheduled for implementation Industry Buildings All fossil fuels (tax only) Carbon tax implemented or scheduled for implementation Power Waste Solid fossil fuels ETS and carbon tax implemented or scheduled Transport Forestry Liquid fossil fuels 40% Estimated coverage Aviation Agriculture 41 2   Existing and emerging carbon pricing instruments around the world In addition, another two U.S. states are actively will increase to CAN$20/tCO2e (US$15/tCO2e) on c ­ onsidering the implementation of an ETS: ­ Washington ­ January 1, 2016, and to CAN$30/tCO2e (US$23/tCO2e) and Oregon. After the Washington State legislature on January 1, 2017. British Columbia’s ­ carbon failed to pass the ETS bill on June 28, 2015,72 Governor tax r­emains at the 2012 level of CAN$30/tCO2e Inslee announced on July 28, 2015 that his government (US$23/tCO2e). would implement a regulatory cap on GHG emissions, which may allow emitters to trade among themselves.73 The United States Environmental Protection A ­ gency’s Oregon is currently debating bills in both the House and (US EPA)—through its Clean Power Plan, finalized on Senate. One pair of bills (SB965 and HB3250) would August 3, 2015—has set an emission reduction target ­ introduce a cap-and-dividend program to reduce GHG of 32 percent of 2005 levels by 2030 for the country’s emissions.74 This program would essentially o ­perate power sector.79 This represents a 7 percent increase in like an ETS, except that the auction revenue would be the targeted emission reductions with respect to the ­ distributed to tax payers in the form of a “­ dividend.” draft regulation released in 2014. The Clean Power Another bill (HB3470) sets a cap on Oregon’s GHG ­ Plan ­reduces power sector emissions through a range emissions and mandates the implementation of an ETS.75 of measures. States have the flexibility to choose their own c ­ompliance mechanisms, including emissions On April 13, 2015, the Canadian province of O ­ ntario trading, efficiency measures, and increased deployment announced its intention to implement an ETS linked of renewable energy. This will enable California and the to California and Québec’s Cap-and-Trade programs.76 RGGI states to use their existing ETSs to meet their Ontario also signed a Memorandum of Understanding emissions target. The Clean Power Plan has received with Québec to collaborate on market mechanisms and ­ upport from officials representing the California overall s harmonize GHG emission reporting. Alberta amended Cap-and-Trade Program and RGGI.80 the Specified Gas Emitters Regulation, in June 2015, to extend the scheme through 2017.77 Under the previous nationally, The United States has also been active inter­ rules, facilities with annual emissions of 0.1 MtCO2e or signing a bilateral agreement with China on e ­mission more were required to reduce their emissions i ­ ntensity by reduction targets on November 12, 2014. In this agree- ­ 81 12 percent with respect to the average emissions i ­ ntensity ment, the US and China announced their ­ respective in 2003–05. Under the amended rules, the ­ required ­post-2020 emission reduction targets, which are ­reiterated emissions intensity reduction will be raised to 15 percent in their INDCs (see section 2.2.1 for more details). on January 1, 2016, and to 20 percent on ­ January 1, 2017.78 Also, facilities that choose to meet their Chile In September 2014, the Chilean Parliament compliance by contributing to the Climate Change and ­ approved the implementation of a national carbon ­ Emissions ­ Management Fund will face higher costs. The tax. The tax will put a price on emissions from 2017 current carbon price of CAN$15/tCO2e (US$11/tCO2e) onward.82 The tax applies to all stationary sources with 72 Washington State Legislature, HB1314 – 2015-2016 Implementing a carbon pollution market program to reduce greenhouse gas emissions, August 12, 2015, http://app.leg.wa.gov/billinfo/summary.aspx?bill=1314&year=2015. 73 Governor Jay Inslee, Inslee Directing Ecology to Develop Regulatory Cap on Carbon Emissions, July 28, 2015, http://www.governor.wa.gov/news-media/­ inslee- directing-ecology-develop-regulatory-cap-carbon-emissions. 74 State of Oregon, Relating to Climate Protection; Prescribing an Effective Date, SB 965, 2015; State of Oregon, Relating to Climate Protection; Prescribing an Effective Date, HB 3250, 2015. 75 State of Oregon, Relating to Greenhouse Gas Emissions; Declaring an Emergency, HB 3470 B, 2015. 76 Ministry of the Environment and Climate Change, Ontario Government, How Cap and Trade Works, April 13, 2015, http://news.ontario.ca/ene/en/2015/04/ how-cap-and-trade-works.html. 77 Province of Alberta, Alberta Regulation 139/2007, Climate Change and Emissions Management Act: Specified Gas Emitters Regulation, 2015. 78 Alberta Environment and Parks, Greenhouse Gas Reduction Program, accessed August 10, 2015, http://esrd.alberta.ca/focus/alberta-and-climate-change/­ regulating-greenhouse-gas-emissions/greenhouse-gas-reduction-program/default.aspx. 79 EPA, Carbon Pollution Emission Guidelines for Existing Stationary Sources: Electric Utility Generating Units, 2015. 80 RGGI, RGGI States Comments Support EPA Proposed Clean Power Plan, November 7, 2014; California Environmental Protection Agency Air Resources Board, “Letter to Ms. Janet McCabe RE: Docket Number EPA-HQ-OAR-2013-0602,” November 24, 2014, http://www.arb.ca.gov/cc/powerplants/ca-comments-2014-clean-power-plan.pdf. 81 The White House, Office of the Press Secretary, U.S.-China Joint Announcement on Climate Change, November 12, 2014, https://www.whitehouse.gov/the- press-office/2014/11/11/us-china-joint-announcement-climate-change. 82 Tax payments for the 2017 calendar year will be due in April 2018. 42 a thermal input capacity greater than 50 m ­ egawatts while 70 percent of the p ­ hongqing, and ­ articipants in C (MW).83 The value of this tax is denominated in 80 percent of the participants in Hubei90 met the first ­urrency U.S. dollars. The level of this tax is the local c ­ compliance in June 2015. The amount of ­ Chinese equivalent of US$5/tCO2e, which means that tax ­ offsets has also been growing, ­ number bringing the total ­ liabilities in the local currency will depend on the ­ of offsets issued to about 25 million by the end of July ­ prevailing exchange rate on the day of payment.84 2015.91 Most Chinese offsets are l ­ocation-specific and restricted to the compliance m ­ arket of the region in China The seven pilot ETSs combined form the largest which the offset project is located. national carbon pricing initiative in the world in terms of volume, putting a cap on 1.3 GtCO2e.85 Since the Over the past year, China has focused on ­ extending start of the pilot ETSs in Beijing, Guangdong, Shanghai, e ­ missions trading beyond the seven pilot regions. G ­ uangdong Shenzhen, and Tianjin in 2013, and in Chongqing and and Shenzhen are exploring a more c approach to ­ oordinated ­ Hubei in 2014, the designs of some of these systems have their respective ETS ­ pilots,92 while Beijing is ­exploring an been rapidly evolving – their scope has been expanding inter-regional ETS with C ­ hengde city in Hebei province.93 and their stringency has been increasing. For example, Furthermore, ­ Shanghai is c ­ onsidering regional c­ ooperation Shenzhen is planning to expand its ETS to include with ­ Zhejiang, ­Jiangsu, Anhui, ­ Jiangxi, Shandong, and the transport;86 Guangdong is considering including more ­ Fujian p ­ rovinces to exchange ­ information and ­ discuss ETS industrial sectors, buildings, and transport; and Hubei is ­design and ­operation.94 In addition, Gansu, Q ­ ingdao,95 adding 49 new companies to its pilot ETS.87 In addition, Hangzhou, and Anhui96 are investigating the implementation Chongqing has reduced its cap at a greater rate than of their own ETSs. F ­ inally, Beijing, Tianjin, and the Hubei ­ cipated, lowering the number of allowances freely anti­ ­ provinces have signed an agreement to ­ cooperate on GHG allocated by 7 percent with respect to the 2013 level.88 ­mitigation activities.97 For the compliance year 2014, which ended in On June 15, 2015, Taiwan adopted the Greenhouse June or July 2015 (depending on the jurisdiction), Gas Reduction and Management Act.98 This law sets ­ illion allowances were traded in all systems 24.7 m an emission reduction target of 50 percent below 2005 ­combined.89 In Beijing, Guangdong, Shanghai, levels by 2050 and indicates that one of the major means ­ ­ Shenzhen, and Tianjin, between 99 and 100 percent to achieve this target will be an ETS. However, the of the companies met their compliance ­ obligations, schedule for launching the ETS is unclear. 83 Ministry of Finance, Chile, Ley Nº 20780, accessed August 12, 2015, http://www.leychile.cl/Navegar?idNorma=1067194. 84 Ministry of Finance, Chile, 2014, Tax reform to amend the system of income taxation and introduce various adjustments in the tax system, http://www.leychile.cl/ Navegar?idNorma=1067194. 85 Authors’ calculation, based on cap for 2015 or the latest year for which information is available. 86 Carbon Pulse, Shenzhen Set to Broaden out Emissions Scheme, March 16, 2015, http://carbon-pulse.com/shenzhen-set-to-broaden-out-emissions-scheme/. 87 Carbon Pulse, Hubei to Expand Emissions Trading Scheme, December 3, 2015, http://carbon-pulse.com/hubei-to-expand-emissions-trading-scheme-state-media/. 88 Chongqing Municipal Development and Reform Commission, Chongqing Municipal Development and Reform Commission issued a notice of 2014 annual Chongqing carbon emissions quotas, March 19, 2015, http://www.cqdpc.gov.cn/article-1-21088.aspx; Carbon Pulse, Chongqing Cuts Allocation by 9 Million Permits in 2014, March 10, 2015, http://carbon-pulse.com/chongqing-allocates-115-7-million-permits-for-2014/. 89 Carbon Pulse, China Sees Six-Fold Increase in Carbon Trading Volumes despite Teething Issues, July 21, 2015, http://carbon-pulse.com/china-sees-six-fold-in- crease-in-carbon-trading-volumes-despite-teething-issues/. 90 ICAP, Second Compliance Period Ends in Chinese ETS Pilots, July 28, 2015, https://icapcarbonaction.com/news/news-archive/294-second-compliance-period- ends-in-chinese-ets-pilots. 91 Carbon Pulse, China Issues Fresh Batch of 5.1 Mln Mostly Ineligible Carbon Offsets, August 3, 2015, http://carbon-pulse.com/china-issues-fresh-batch-of-5-1- mln-mostly-ineligible-carbon-offsets/. 92 Carbon Pulse, Guangdong close to Launch 600 Million Yuan Carbon Fund, March 17, 2015, http://carbon-pulse.com/guangdong-close-to-launch-600-million- yuan-carbon-fund/. 93 Beijing Municipal Commission of Development and Reform, Regional Committee Held in Beijing and Hebei on Emissions Trading, December 19, 2014, http:// www.bjpc.gov.cn/gzdt/201412/t8594655.htm. 94 Shanghai Municipal Development and Reform Commission, Regional Cooperation Seminar Held on Emissions Trading, accessed April 28, 2015, http://www. shdrc.gov.cn/second.jsp?colid=551&top_id=316&artid=24800. 95 Qingdao Municipal People’s Government, Notice on the Organization and Implementation of Low-Carbon City Qingdao Pilot Carbon Emissions Trading Market Embodiments, September 24, 2014, http://www.qingdao.gov.cn/n172/n68422/n68424/n30259215/n30259219/140924163750977834.html. 96 Anhui People’s Government, Anhui Provincial People’s Government Office on the Issuance of Anhui 2014-2015 Annual Energy Saving and Emission Reduction Carbon Development Action Programs, September 24, 2014, http://www.ah.gov.cn/UserData/DocHtml/1/2014/12/9/6417463050796.html. 97 The White House, Office of the Press Secretary, U.S.-China Joint Announcement on Climate Change, November 11, 2014, https://www.whitehouse.gov/the- press-office/2014/11/11/us-china-joint-announcement-climate-change. 98 Government of Taiwan, Greenhouse Gas Reduction and Management Act, 2015. 43 2   Existing and emerging carbon pricing instruments around the world At the national level, China has committed to reach shifted to the need for greater price stability and its peak in GHG emissions around 2030,99 with best ­predictability through flexibility of allowance ­supply in the efforts to peak earlier. In addition, details are ­ gradually EU ETS. The proposed MSR is designed to achieve this being revealed on a nationwide ETS, which may be goal by removing allowances from the m ­ arket if s­ upply is launched by the end of 2016 and fully implemented much higher than demand, and injecting ­ allowances into in 2019.100 The general rules of the national ETS were the market if the market is u ­ ndersupplied. At the May published by the National Development and Reform 5, 2015 “trilogue” meeting of the ­ European Parliament, Commission (NDRC) in December 2014.101 The ­European Council, and European ­Commission, ­consensus national ETS should cover power generation, metallurgy ­ was reached on a 2019 start date for the MSR. The agree- and non-ferrous metals, building materials, chemicals, ment further specifies that the 900 million back-loaded and aviation.102 The importance of the national ETS for EU allowances will be placed in the MSR, instead of China to achieve its GHG emission objective is high- returned to the market in 2019–20. The MSR p ­ roposal lighted by the ETS’s inclusion in China’s INDC.103 The also includes provisions for the fate of the ­ so-called latter also includes its post-2020 emission reduction unallocated” allowances – leftover a “­ ­ llowances available at ­target, announced on November 12, 2014104 ­after a ­bi­lateral the end of EU ETS Phase III in 2020 that were intended agreement with the United States had been reached on for new and expanding installations, and allowances that emission reduction targets. ­ China also ­continues to seek were returned by ­ installations after (­partially) shutting cooperation with the EU on c ­ arbon markets, as specified down. Barring special measures, these a ­ llowances would in the EU-China Joint ­ Statement on Climate Change, come onto the market in 2020, ­ thereby undermining through, among o ­ apacity-building activities in ­ thers, its c the operation of the MSR.107 The E ­ uropean Parliament preparation for the ­ national ETS.105 approved the MSR on July 8, 2015.108 Formal adoption of the MSR is expected in September 2015, following EU In the course of 2014, the price of allowances in approval by the European Council. The ­ significant other ­ the EU ETS has increased from less than €5/tCO2 change to the EU ETS was the approval of a new carbon (US$5/tCO2) to just below €7/tCO2 (US$8/tCO2). The leakage list for the period 2015–19 on O ­ ctober 27, 2014. average price in 2014 was €6/tCO2 (US$7/tCO2), with a total trading volume of 6.1 billion allowances.106 As of The EU has committed to reducing emissions by at August 1, 2015, the EU allowance price stands slightly least 40 percent with respect to the 1990 baseline level below €8/tCO2 (US$9/tCO2). by 2030 through domestic actions.109 The EU ETS will target, be the main instrument to achieve this mitigation ­ In February 2014, the European Union decided to corresponding to a 43 percent emission reductions by temporarily postpone the auctioning of 900 million 2030 compared with 2005 emissions in the sectors EU allowances from the period 2014–16 to the period covered by the EU ETS.110 The above target will help ­ 2019–20, a process known as backloading. Following ensure that the EU is on a cost-effective track toward this change, the focus of the EU ETS structural reform meeting its objective of cutting emissions by at least 99 Department of Climate Change, National Development and Reform Commission of China, Enhanced Actions on Climate Change: China’s Intended Nationally Determined Contributions, 2015. 100 ICAP, China to Cap Emissions from Six Sectors, ETS to Launch 2016, February 9, 2015, https://icapcarbonaction.com/news/news-archive/268-china-to-cap- emissions-from-six-sectors-ets-to-launch-2016. 101 National Development and Reform Commission, People’s Republic of China Order: No. 17, October 12, 2014, http://qhs.ndrc.gov.cn/gzdt/201412/ t20141212_652035.html. 102 ICAP, China to Cap Emissions from Six Sectors, ETS to Launch 2016, February 9, 2015, https://icapcarbonaction.com/news/news-archive/268-china-to-cap- emissions-from-six-sectors-ets-to-launch-2016. 103 China, Intended Nationally Determined Contribution, 2015. 104 The White House, Office of the Press Secretary, U.S.-China Joint Announcement on Climate Change, November 11, 2014, https://www.whitehouse.gov/the- press-office/2014/11/11/us-china-joint-announcement-climate-change. 105 European Union-China, “EU-China Joint Statement on Climate Change,” June 29, 2015, http://ec.europa.eu/clima/news/docs/2015062901_statement_en.pdf. 106 Thomson Reuters, Big Emitters Promise Cuts, but Pledges Are Hard to Compare, Carbon Market Monitor, January 15, 2015. 107 European Union, Decision of the European Parliament and of the Council Concerning the Establishment and Operation of a Market Stability Reserve for the Union Greenhouse Gas Emission Trading Scheme and Amending Directive 2003/87/EC, 2015. 108 European Parliament, Parliament Adopts CO2 Market Stability Reserve, July 8, 2015, http://www.europarl.europa.eu/news/en/news-room/con- tent/20150703IPR73913. 109 European Union, Intended Nationally Determined Contribution of the EU and Its Member States, March 6, 2015. 110 European Council, European Council (23 and 24 October 2014) Conclusions, http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/145397.pdf. 44 80 percent by 2050. On July 15, 2015, the European Other elements of work on the ETS are efforts to i­ mprove Commission put forward a proposal for a revised EU ETS electronic reporting, develop and support the ETS ­registry, for the period after 2020.111 The key proposed changes implement benchmarking rather than g ­ randfathering as are increasing the annual cap reduction from 1.74 to the free allocation methodology, and explore the potential 2.2 percent, adopting better targeted rules for the free to link with other existing carbon markets. ­ allocation of allowances (to guard against carbon leakage risks), and establishing funds using ­ allowances to finance Mexico In February 2014, the Mexican Ministry of low-carbon innovation in industry and ­ modernization Energy announced the possible development of an ETS of the energy sector in the lower-income member states. in the energy sector. This would complement Mexico’s The proposal does not include any provisions for the use tax on fossil fuel sales, excluding natural gas, which went of international offsets after 2020. into effect on January 1, 2014. France France’s carbon tax came into effect on April 1, New Zealand As of June 1, 2015, Kyoto credits, 2014, putting a carbon tax of €7/tCO2e (US$8/tCO2e) with the exception of New Zealand-originated Assigned on the use of fossil fuels not covered by the EU ETS. Amount Units (NZ-AAUs), are no longer allowed for The carbon tax rate increased to €14.5/tCO2e compliance under the NZ ETS. As of that date, only (US$16/tCO2e) in 2015 and will rise to €22/tCO2e domestic units, New Zealand Units (NZUs), and NZ- (US$24/tCO2e) in 2016. On July 22, 2015, France AAUs can be used to meet compliance obligations.116 formally adopted its Law on the Energy Transition to This decision was motivated by changes in international Green Growth. This law sets a trajectory for the country’s rules and the oversupply of Kyoto markets. New Zealand carbon tax level to rise to €56/tCO2e (US$61/tCO2e) will reassess this decision once i ­nternational market in 2020, and €100/tCO2e (US$110/tCO2e) in 2030.112 ­ ircumstances. ­conditions are better suited to its domestic c This augmentation in the carbon tax rate will be revenue-­ A comprehensive review of the NZ ETS is scheduled neutral, as other taxes will be lowered.113 The afore­ in the second half of 2015. The exact scope, objective, mentioned law also sets the objective to reduce GHG process, and timing of the review are yet to be decided. emissions by 40 percent with respect to 1990 levels by However, the review will look to set a long-term 2030, consistent with the EU target. ­ direction for the NZ ETS so that it is fit for p ­ urpose and can evolve to assist in meeting New Zealand’s Kazakhstan Full enforcement (of regulations) post-2020 commitments. and trading in the Kazakhstan ETS started in 2014. Total trade volume over 2014 was low, with only Norway In May 2015, the Norwegian government 35 ­ actions, totaling 1.3 MtCO2e. The average price trans­ proposed several changes to the carbon tax rates, which allowances in 2014 was KZT406 (US$2).114 Although of ­ entered into force on July 1, 2015.117 These changes the pilot phase was completed in 2013, the Kazakhstan include an increase in the tax rate for natural gas and ETS is still facing challenges with the MRV of GHG liquefied petroleum gas (LPG)—from NOK337/tCO2 emissions, in particular regarding the v ­ erification p ­ rocess. (US$41/tCO2) to NOK412/tCO2 (US$50/tCO2) and The Kazakh government is looking to develop ­ clearer NOK410/tCO2 (US$50/tCO2) respectively—bringing guidance, f ­ormats, and templates for ­ monitoring.115 carbon it in line with the tax rate for petrol. The higher ­ 111 European Commission - Climate Action, Revised Emissions Trading System Will Help EU Deliver on Climate Goals, July 15, 2015, http://ec.europa.eu/clima/ news/articles/news_2015071501_en.htm. 112 French Senate, Bill on the Energy Transition to Green Growth, July 24, 2015, http://www.senat.fr/espace_presse/actualites/201406/engager_la_france_dans_ la_transition_energetique.html. 113 French National Assembly, Bill on the Energy Transition to Green Growth, July 22, 2015, http://www.assemblee-nationale.fr/14/ta/ta0575.asp. 114 Caspy Commodity Exchange, Stock Trading in Quotas Are on the Increase, September 8, 2014, http://comex.kz/ru/press/news/42- %D0%B1%D0%B8%D1%80%D0%B6%D0%B5%D0%B2%D1%8B%D0%B5-%D1%82%D0%BE%D1%80%D0%B3%D0%B8-%D0%BF%D0%BE-%D0 %BA%D0%B2%D0%BE%D1%82%D0%B0%D0%BC-%D0%B8%D0%B4%D1%83%D1%82-%D0%BD%D0%B0-%D1%83%D0%B2%D0%B5%D0%B- B%D0%B8%D1%87%D0%B5%D0%BD%D0%B8%D0%B5. 115 Aigerim Yergabulova, Kazakhstan Emission Trading Scheme (KAZ ETS): Status and Challenges of MRV, http://www.thepmr.org/system/files/­ documents/18.0-%20KAZAKHSTAN%20presentation-kaz.pdf. 116 New Zealand Environmental Protection Authority, “The New Zealand Emissions Trading Scheme: NZEUR Account Holders Access to Kyoto Units,” accessed August 10, 2015, http://www.eur.govt.nz/how-to/guides-hmtl/guides-pdf/NZEUR%20account%20holders%20access%20to%20Kyoto%20units.pdf. 117 Ministry of Finance, Norway, Changes in Tax, Royalty and Interest, Prop. 120 LS, 2015, http://www.statsbudsjettet.no/upload/Revidert_2015/dokumenter/pdf/prp120.pdf. 45 2   Existing and emerging carbon pricing instruments around the world tax has been linked to the delay in implementing a Sweden The Swedish government is considering road tax on natural gas and LPG, which was intended changes to the Swedish carbon tax. Under current rules, stimulate the use of biogas. The government has also to ­ the carbon tax covers all fossil fuels used for heating that exempted the share of hydrogen gas in natural gas and are not covered by the EU ETS and motor fuels. How- LPG from the carbon tax. ever, non-EU ETS installations, as well as the agriculture and forestry sectors receive tax rebates for their use of Portugal A carbon tax of €5/tCO2e (US$5/tCO2e) fossil heating fuels.122 Under the new rules considered for was approved in November 2014, as part of a w ­ ider introduction in the 2016 Budget Bill, to be presented package on green tax reform. The carbon tax e ­ntered on September 21, 2015, the aforementioned tax rebates into force on January 1, 2015. It applies to all ­ energy would be abolished as of January 1, 2016. The Swedish products used in non-EU ETS sectors and covers government argues that the removal of these tax r ­ ebates approximately a quarter of the country’s GHG e ­ ­ missions. would better align its policy with the polluter pays The tax rate will be determined annually, based on principle, lead to a more cost-effective instrument, and ­ the average EU allowance auction clearing price in improve the transparency of the taxation system.123 the preceding years. The 2015 tax rate of €5/tCO2e (US$5/tCO2e) is e ­xpected to yield approximately Switzerland In Switzerland, the first auction of €95 million (US$104 million) in revenue. The full green tax ­ allowances under its ETS was held in May 2014. As of revenues reform package aims to be fiscally neutral and the ­ showing August 1, 2015, four auctions had taken place, ­ from the carbon tax and other taxes will be r ­edistributed a wide price range for emission allowances—ranging lower-income families. in the form of income tax relief to ­ from CHF40/tCO2e (US$42/tCO2e) at the first auction of May 2014 to CHF12/tCO2e (US$12/tCO2e) at the Republic of Korea The Republic of Korea’s ETS auction held in February 2015. Switzerland and the EU entered into force on January 1, 2015, and covers continued negotiations on linking through a seventh 23 subsectors, including steel, cement, petro-­ chemicals, round of talks, which took place in March 2015.124 refinery, power, buildings, waste, and aviation. In the first phase (2015–17), the affected installations will r ­eceive Switzerland’s carbon tax on thermal fuels (that is, a free allocation of 100 percent based on their ­ average e ­xcluding fossil motor fuels) will be raised from the 2011–13 GHG emissions and the national GHG r ­ eduction current rate of CHF60/tCO2e (US$62/tCO2e) to ­ target. No auctioning is foreseen in the first phase. There CHF84/tCO2e (US$87/tCO2e) on January 1, 2016.125 is a perception that the Korean market is undersupplied, This increase follows a 2015 review of Switzerland’s resulting in Korean companies being ­ reluctant to sell their GHG emissions trajectory, which found that the ­current allowances. The latest trading was reported on January 16, emission level lies above the targeted level. The next 2015.118 Companies can also use Korean offsets, including review of the tax rate will be based on emissions from Korean CERs,119 for up to 10 percent of their compliance 2016, and tax rates may have to be adjusted again as of obligation. Given that the price of CERs is much lower 2018, depending on the evolution of Switzerland’s GHG than that of Korean A ­ llowance Units (KRW10,300 or emissions trajectory. The maximum level of the tax rate about US$9), some demand for CERs issued for projects is 120 CHF/tCO2e (US$125/tCO2e). in the Republic of Korea is to be expected.120 As of early July 2015, around 780,000 Korean offsets had been ­traded Selected changes in the instruments are summarized on the Korean exchange.121 in Box 5. 118 Carbon Pulse, South Korea’s Hanwha Corp. to convert 286,000 CERs to Korean offsets, August 18, 2015, http://carbon-pulse.com/south-koreas-hanwha-­ corp- to-convert-286000-cers-to-korean-offsets/. 119 CERs need to be canceled first before they can be converted to Korean offsets. 120 Carbon Pulse, UN Cancels First CERs Bound for Korean ETS, March 14, 2015, http://carbon-pulse.com/un-cancels-first-cers-bound-for-korean-ets/. 121 Carbon Pulse, Korean Market to Get Offset Infusion, Simpler Rules, July 6, 2015, http://carbon-pulse.com/korean-market-to-get-offset-infusion-simpler-rules/. 122 Ministry of Finance, Sweden, Certain Point Tax Issues Before the Budget Bill for 2016, June 25, 2015, http://www.regeringen.se/contentassets/50c- 71588b22043e6ac47acbad136919f/vissa-punktskattefragor-infor-budgetpropositionen-for-2016.pdf. 123 Ibid. 124 Swiss Federal Office for the Environment, 7th Round of Negotiations for Switzerland-EU Linking of Emissions Trading Systems, March 26, 2015, http://www.bafu. admin.ch/klima/13877/14510/14882/15415/index.html?lang=de. 125 Swiss Federal Office for the Environment, Imposition of the CO2 Levy on Thermal Fuels, July 3, 2015, http://www.bafu.admin.ch/klima/13877/14510/14748/index.html?lang=en. 46 Box 5 Summary of selected changes in regional, national, and subnational carbon pricing instruments Instruments implemented in 2014: Hubei and Chongqing (ETS), Mexico and France (tax) Instruments implemented in 2015: Korea (ETS), Portugal (tax) New instrument scheduled for implementation: Chile (tax), as of 2017 ETS under consideration or development: Washington and Oregon (US); Ontario (Canada); Mexico; Taiwan and nationally (China) Scope expansion: 2014/2015: California and Québec included transport fuels, Hubei added new companies Future developments: Shenzhen plans to include transport, Guangdong is considering the inclusion of additional sectors ­ Price rate changes (tax only): 2014/2015: Norway’s carbon tax rate for natural gas and LPG increased in 2015, from NOK337/tCO2 (US$41/tCO2) to NOK412/tCO2 (US$50/tCO2) and NOK410/tCO2 (US$50/tCO2), respectively; France’s carbon tax rate increased from €7/tCO2e (US$8/tCO2e) in 2014 to €14.5/tCO2e (US$16/tCO2e) in 2015 Future developments: France’s carbon tax rate to be raised to €56/tCO2 (US$61/tCO2) as of 2020 and to €100/tCO2 (US$110/tCO2) by 2030; Sweden’s carbon tax rebates to be removed for non-ETS, agriculture, and forestry as of 2016; Switzerland’s carbon tax to increase to CHF84/tCO2e (US$87/tCO2e) from 2016 Price/market stabilization mechanisms (ETS only): 2014/2015: RGGI’s cost containment reserve triggered in 2014 Future developments: EU ETS to implement a market stability reserve as of 2019 Offsets: 2014/2015: New Zealand’s ETS restricted use of offsets to domestically generated offsets only; growth in offsets for use in Chinese ETS pilots and the Republic of Korea’s ETS Future developments: The European Commission’s proposal of July 15, 2015 foresees no use of inter­ national offsets in the EU ETS for the revised EU ETS after 2020 Linking: 2014/2015: California and Québec Cap-and-Trade Programs linked up in 2014 Future developments: Ontario intends to join the California and Québec Cap-and-Trade Programs, Beijing is exploring linking with Chengde city, Shanghai is seeking regional cooperation on ETS Instruments under review: 2014/2015: EU ETS started review for post-2020 Future developments: Review of the New Zealand’s ETS to start in second half of 2015, RGGI in 2016 for post-2020, and Switzerland’s carbon tax in 2017. 47 2   Existing and emerging carbon pricing instruments around the world 2.4 CORPORATE CARBON PRICING » Globally, at least 150 companies use an Carbon pricing is spreading beyond the domain internal carbon price, with of government policy and becoming an increasingly ­ common tool in business decision making. Private disclosed prices ranging from ­ sector firms are adopting internal carbon prices, even in US$6 to US$89/tCO2e. « jurisdictions without legislated carbon pricing. Internal carbon pricing can be implemented in various forms: some companies incorporate it into the business case for investment, while other companies use it to transfer the For many businesses, using an internal carbon price costs of emissions offsetting to individual business units. is part of a risk management strategy to evaluate the current or potential impact of a carbon price obligation ­ Globally, at least 150 companies use an internal carbon on their operations. Furthermore, it is used as a means to price, as reported by the Carbon Disclosure ­ Project identify and value cost savings and revenue opportunities (CDP), with disclosed prices ranging from US$6 to in low-carbon investments. Corporate carbon pricing US$89/tCO2e126 (Figure 12). These companies represent can also help companies demonstrate their support for diverse sectors of the economy, including the ­ consumer ­ effective carbon pricing policies. Governments designing goods, energy, finance, industry, manufacturing, and a carbon pricing instrument can benefit from the lessons utilities sectors. learned through corporate carbon pricing initiatives such Figure 12 Price range of the average internal carbon price, as disclosed by companies to CDP –– Microsoft –– BRF –– TD Bank –– Westpac Banking –– Google –– Walt Disney –– Mars –– Devon Energy –– Conoco Phillips –– TransAlta –– Ameren –– British Sky –– Cairn Energy Broadcasting –– Cenovus Energy –– Marshalls –– BP –– Teck Resources –– AzkoNobel –– National Grid –– Xcel Energy –– Royal Dutch Shell –– Encana –– Exxon Mobil –– Pennon Group $0 $20 $40 $60 $80 $100 Note: Some companies report that a price range is applied as part of a sensitivity analysis, or to Source: Authors, based on CDP data. differences in carbon prices. take into account projected price increases and regional ­ 126 CDP, Global Corporate Use of Carbon Pricing: Disclosures to Investors, 2014. 48 as the Business for Climate Platform (EPC-ETS), which Long-term investors are also beginning to realize that operated an ETS simulation with the engagement of climate change can undermine the financial returns of 20 of the largest Brazilian companies. Further details on their portfolio and have started rethinking their invest- ­ corporate carbon pricing in practice are provided in Box 6. ment strategies and practices. A recent study confirms that climate change will inevitably affect returns and that In the lead-up to COP 21, seven oil and gas prudent investors could realize net gains by positioning ­companies127 have called on governments and the across and within sectors and asset classes.130 Leading UNFCCC to introduce carbon pricing instruments in ­ financial institutions are responding to climate risk by jurisdictions where they do not yet exist and to ­ create allocating capital and steering financial flows toward an international framework that could e ­ventually link low-carbon and “climate-safe” activities. For example, ­domestic instruments.128 This initiative adds weight to the Swedish pension fund AP4 is decarbonizing its ­ equity the growing number of private sector ­ representatives portfolio by tilting it toward more carbon-­ efficient who have signaled their support for carbon ­ pricing. ­companies.131 Also, the Norwegian Government Pension At the 2014 New York Climate Summit, over Fund Global will cease investing in coal companies as of 1,000 ­ companies and investors voiced their support for January 1, 2016.132 carbon pricing policies in a public statement.129 Box 6 Highlights from Caring for Climate survey on carbon pricing By United Nations Global Compact As far as many leading companies are concerned, internal carbon pricing does not need to be ­ complicated. While thorough analysis is needed to identify a meaningful price for carbon, complex modeling or ­ projections internally often creates confusion and delay in implementation. This is a key insight shared by the respondents of a global survey of nearly 100 companies that are creating internal carbon pricing systems ­ and engaging governments to advance effective market-based climate policies. Companies at the forefront are aligning with the UN Caring for Climate Business Leadership Criteria on Carbon Pricing.133 They are working to: (1) value carbon internally; (2) advocate for carbon pricing policies externally; and (3) report publicly on these activities.134 UN Caring for Climate initiative (C4C) together with the World Resources Institute (WRI) took a closer look at companies’ approaches in 2015. The objective was to gather perspectives and experiences of individual companies confronting the challenges and maximizing the opportunities related to carbon pricing. To do this, C4C and WRI interviewed senior staff from nearly 20 companies and received further input through a global survey from approximately 100 companies across multiple sectors and geographies.135  127 BP, BG Group, Eni, Repsol, Royal Dutch Shell, Statoil and Total. Source: Bloomberg, Repsol Signs Up to European Oil Group’s Stance on Climate Change, June 9, 2015, http://www.bloomberg.com/news/articles/2015-06-09/repsol-signs-up-to-european-oil-group-s-stance-on-climate-change. 128 BG Group plc et al., May 29, 2015, http://www.statoil.com/en/NewsAndMedia/News/2015/Downloads/Paying%20for%20Carbon%20letter.pdf. 129 World Bank, We Support Putting a Price on Carbon, 2014. 130 Mercer, Investing in a Time of Climate Change, 2015. 131 Global Investor Coalition, with support from UNEP-FI and the World Bank Group, Financial Institutions Taking Action on Climate Change, 2014. 132 The Storting, The Storting Has Made the Unanimous Decision to Pull the Government Pension Fund Global (GPFG) out of Coal, May 28, 2015, ­ https://www.stortinget.no/en/In-English/About-the-Storting/News-archive/Front-page-news/2014-2015/hj9/. 133 Caring for Climate is a joint initiative of the UN Global Compact, UN Environment Programme, and UN Framework Convention on Climate Change. The Business Leadership Criteria form one of the workstreams of the Carbon Pricing Leadership Coalition, led by the World Bank Group. Partners on the Leadership Criteria include: WRI, CDP, The Climate Group, Principles for Responsible Investment, and UN Foundation. 134 For the full criteria, see: www.caringforclimate.org/carbonpricing. 135 The input received is informing the Executive Guide to Carbon Pricing Leadership, to be released in draft form in September 2015 and launched at COP 21 in December 2015. For more information, visit www.caringforclimate.org/carbonpricing. 49 2   Existing and emerging carbon pricing instruments around the world The effort yielded results that are consistent with general expectations. Companies from sectors or regions that are already subject to carbon pricing policies were largely ahead of others in terms of internal awareness and support at senior levels. Building internal capacity and engagement ranked among the most common benefits cited by companies that are pricing carbon internally (see the table below). Most common benefits of carbon pricing Most common challenges of carbon pricing 1 Helps translate carbon into business- relevant terms Lack of common method or guidance to set a and engage internally carbon price 2 Increases support and investment for energy Lack of clarity and long-term certainty in countries’ efficiency projects climate policies 3 Helps company achieve ambitious GHG Prices (internally or externally) too low to shift reduction targets investment decisions Interestingly, some 40 percent of the companies that responded to the survey noted they had no plans and no interest in creating internal carbon pricing programmes. Most of these companies expressed one of two reasons for not pursuing carbon pricing: (1) they did not see carbon pricing as material or practical for their company/industry (i.e., not from regulated or energy-intensive sectors); or (2) they could not identify a clear methodology to create an internal carbon pricing programme. Nonetheless, more than half of these companies still noted a desire to see an external carbon price and are actively engaging governments to ­ advance such policies. Those companies that have successfully established internal carbon pricing programmes tend to take a ­ simple, straightforward approach. They adapt carbon pricing to fit their own internal investment needs, market interests, and outlooks (rather than trying to create complex formulas for predicting market prices ­ and policy changes). Most companies do one or more of the following: –– Treat carbon pricing like any other effort to evaluate and account for financial risks, costs, and market opportunities. –– Establish a modest carbon price as a means of creating internal awareness, funds, and incentives to support GHG reduction goals. ­ –– Build internal expertise on the topic and find influential channels (e.g., trade groups, leadership coalitions) to share their views and experiences. In each case reviewed by C4C and WRI, champion companies are not waiting or trying to make guesses about the future. Instead they are accepting that eventually carbon costs will be reflected in market prices and taking prudent steps to ensure their business is “market-ready”. Based on insights in the draft Executive Guide to Carbon Pricing Leadership. For more information, visit www.caringforclimate.org/carbonpricing. 50 section 3 Competitiveness and carbon leakage 3 Competitiveness and carbon leakage C  arbon prices are intended to have an efficient and fair impact on the relative competitiveness of firms. They are expected to favor innovative, clean So far, carbon or a broader emissions leakage has not materialized on any significant scale, at least not in the more advanced industrialized countries. However, as firms, and facilitate the exit or upgrade of the least long as climate policies and carbon prices significantly ­ thereby efficient firms in emissions-intensive industries, ­ differ between jurisdictions, the risk of carbon leakage ­ improving the overall efficiency of the economy. seems real. This risk is nevertheless localized in a few ­ Carbon prices are particularly effective at achieving such exposed economic activities (not the whole economy) an ­intended and efficient outcome if they are broadly and can be effectively managed through policy design, similar across jurisdictions. as discussed in this section. However, as demonstrated in this report, current The risk of carbon leakage declines as more countries efforts to put a price on GHG emissions around the take concrete action on climate change. International world remain fragmented. Both the coverage and carbon cooperation and coordination of climate policies is an price vary significantly between jurisdictions. In such an ultimate remedy for the risk of leakage. It would help asymmetric world, countries are legitimately concerned redress asymmetry in carbon pricing signals, thereby that their ambitious climate action may undermine eliminating the need for protection of firms, although the international competitiveness of some domestic more research may be needed to understand the impact sectors, which may lose market share and profit margins of similar carbon prices on firms in countries with very to competitors who do not face similar emission costs different income levels. abroad. A phenomenon known as carbon leakage occurs if such differences in emission costs lead to the relocation This section unpacks the concerns over carbon leakage of carbon-intensive activities and related emissions from and reviews how they can best be addressed, drawing on jurisdictions with stringent climate policies (including a experience and literature. high price on carbon) to jurisdictions with less stringent climate policies (low or no price on carbon), resulting in higher emissions at the latter jurisdictions.136 In this way, climate policy in one country would favor inefficient, carbon-intensive firms abroad. 136 The Intergovernmental Panel on Climate Change defines emissions leakage as “the increase in CO2 emissions outside the countries taking domestic mitigation action divided by the reduction in the emissions of these countries.” Source: IPCC, 2007, Fourth Assessment Report: Climate Change 2007, Climate Change 2007: Working Group III: Mitigation of Climate Change, section 11.7.2. 52 3.1 Often, production of these relatively homogenous goods ANALYZING CARBON PRICING’S is also emissions-intensive and carbon pricing could have IMPACT ON a significant impact on companies’ production costs, COMPETITIVENESS leading to loss of their international competitiveness and, as a consequence, emissions leakage. In lower- income countries, an increase in production costs may Legitimate concerns over carbon pricing’s potential have challenging social and distributional consequences impact on competitiveness arise when a different price also for domestic consumers, which would need to be is charged (or expectations about future prices differ) managed with a range of policies and institutions. The for firms’ or sectors’ GHG emissions in different social and income distribution impacts are not the main jurisdictions, possibly causing emissions leakage. Holding focus of this section but may deserve special attention all other things constant, if firms in one jurisdiction face in future editions of the State and Trends of Carbon a new cost that their competitors in another jurisdiction Pricing report. do not face, they will fear either a loss of market share or a reduction in profit margin, or both. If it leads The cost impact of carbon pricing must be seen in the to relocation of emissions-intensive production and context of other business costs and risks, even in the case associated emissions to a jurisdiction where emissions of homogenous products. Production and investment costs are lower, emissions leakage occurs. decisions are influenced by a wide range of factors, such as proximity to product markets and low-cost inputs, In reality, things are not that simple. Making firms construction costs of new facilities, transport costs of pay for emissions does increase their costs, but this does reaching key markets, exchange rate fluctuations, labor not necessarily affect their competitiveness. In many costs, and overall business risks, as might be captured sectors, companies do not compete mainly on costs, but in a firm’s cost of capital.140 Factors, such as other taxes, rather on overall efficiency in converting complex input the quality of institutions and infrastructure, are often costs (energy, material, labor, land, knowledge) into far more significant in a company’s decisions than a high-value products and services.137 This is especially carbon price.141 Besides, explicit carbon prices (carbon true in the more advanced markets where the product taxes and ETSs) are not the only instruments that make and consumer preferences are of a highly dynamic nature emissions-intensive firms internalize their emission and very sophisticated. An increase in energy or labor costs. Firms are also affected by implicit and indirect costs often goes hand in hand with increased profits and carbon prices embedded in other policy instruments, productivity.138, 139 such as energy taxes, emission standards, or support systems for renewable energy and energy efficiency.142 However, for sectors producing relatively homogenous These implicit and indirect carbon prices should also be products—such as commodities, steel, cement, and considered when comparing carbon prices across firms electricity—cost competition is crucial. Such firms find and jurisdictions.143 it difficult to gain market share by differentiating their end products from those of their competitors. They The traditional notion of cost competitiveness is of must increase market share and profit margins mainly little relevance at the national level.144 Countries do through production-side innovation and cost reduction. not compete with one another like firms do.145 Most 137 Porter, M. E. “How Competitive Forces Shape Strategy.” Harvard Business Review 57, no. 2 (March–April 1979): 137–145. 138 lbrizio, S., T. Ko luk and V. Zipperer, “Empirical Evidence on the Effects of Environmental Policy Stringency on Productivity Growth”, OECD Economics D ­ epartment Working Papers, No. 1179, OECD Publishing, 2014. 139 Productivity is understood to be the value of output per unit of production inputs. 140 Oliver Sartor and Thomas Spencer, An Empirical Assessment of the Risk of Carbon Leakage in Poland, Working Paper (IDDRI, 2013). 141 Julia Reinaud, Issues Behind Competitiveness and Carbon Leakage: Focus on Heavy Industry (IEA, 2008). 142 Vivid Economics (2010), The implicit price of carbon in the electricity sector of six major economies, London. 143 OECD (2013a), Effective Carbon Prices, OECD Publishing, Paris. 144 Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review Vol 68, Issue 2 (1990): 73–93; Josef T. Yap, “A Note on the Competitive- ness Debate,” Philippine Journal of Development Vol XXXI, Issue 1 (2004). 145 Paul Krugman, “Competitiveness: A Dangerous Obsession,” Foreign Affairs, 1994. 53 3   Competitiveness and carbon leakage economists argue that “the only meaningful concept of Even fragmented carbon pricing may sometimes support competitiveness at the national level is productivity.”146 the competitiveness of certain firms and productivity of In a similar vein, the World Economic Forum’s Global the economy. The so-called Porter hypothesis suggests Competitiveness Report defines national competitiveness that properly designed environmental policies may— as “the set of institutions, policies, and factors that under certain conditions—enhance the competitiveness of determine the level of productivity of a country.”147 The firms by inducing technology innovation and increasing competitive economies worldwide are usually not the productivity, thereby partly or fully offsetting the additional economies that have the lowest labor or energy costs, but cost of compliance.149 This hypothesis has been widely those that are able to generate the highest value from the tested since it was first formulated 20 years ago, at least total portfolio of its resources, skills, and other assets, and for high-income OECD countries. Generally, there is clear increase the sustainable prosperity of its population, as and well-established empirical evidence for the “weak” demonstrated by high-income countries. version of the Porter hypothesis, that is, that environmental regulations indeed stimulated innovations and had no significant adverse impact on competitiveness.150 The 3.2 evidence seems to be less conclusive for the “strong” version POSITIVE CARBON PRICING of the hypothesis, namely, that this innovation led to cost IMPACTS ON savings, which more than compensated for the additional COMPETITIVENESS costs of compliance, and enhanced business performance.151 Environmental policies were found costless only under rare conditions of significant prior market barriers and It needs to be stressed at the outset that putting where policy was designed as very efficient and market a price on GHG emissions is meant to change the friendly.152 Certain studies even found some negative relative competitive position of firms. Carbon pricing impact of stringent environmental policy on productivity is supposed to increase the financial costs of emissions- and exports.153 However, this impact was small, and only intensive activities, as they inflict climate change affected a few sectors when the policy targeted production- damages on society, and promote low-emission activities related emissions. Tightening environmental standards that do not contribute to climate change.148 This result did not seem to reduce international competitiveness is an economically efficient and socially fair impact on when pollution was generated by consumption. And the relative competitiveness of firms, which makes them where depletion of natural capital was at stake, effective face the truer economic cost of production. It levels environmental policy was found to contribute to the playing field between the emissions-intensive and developing long-run international competitiveness.154 relatively “clean” firms. The expected macroeconomic Interestingly, the more recent studies tend to provide result is a shift in the structure of the economy toward clearer empirical support for the “strong” hypothesis that low-carbon activities. environmental regulations improve business performance, although the impact may differ by sector.155 146 Michael E. Porter, “The Competitive Advantage of Nations,” Harvard Business Review Vol 68, Issue 2 (1990): 73–93; Robert D. Atkinson, Competitiveness, Innovation and Productivity: Clearing up the Confusion (ITIF, 2013). ­ 147 Klaus Schwab, Global Competitiveness Report 2012–2013. (World Economic Forum, September 2012). 148 Alex Bowen, The Case for Carbon Pricing (Grantham Research Institute on Climate Change and the Environment and Centre for Climate Change Economics and Policy, December 2011). 149 Porter, Michael E. (1991), “America’s Green Strategy,” Scientific American (Apr. 1991), 168; Michael E Porter and Claas van der Linde, “Toward a New ­ Conception of the Environment-Competitiveness Relationship,” Journal of Economic Perspectives Vol 9, Issue 4 (November 1995): 97–118. 150 Lanoie. P., J Laurent-Lucchetti, N Johnstone, S Ambec. “Environmental policy, innovation and performance: new insights on the Porter hypothesis”. Journal of Economics & Management Strategy 20 (3): 803-842. 151 Jaffe, A., and K. Palmer (1997), Environmental Regulation and Innovation: A Panel Data Study, The Review of Economics and Statistics, Vol. 79, No. 4 (Nov., 1997), pp. 610-619, MIT Press 1997. 152 Brannlund, R., and T. Lundgren. 2009. “Environmental policy without costs? A review of the Porter Hypothesis”. International Review of Environmental and Resource Economics 3 (2): 75–117. ­ 153 Jug, Jerneja, Mirza, Daniel (2015), Environmental Regulations in Gravity Equations: Evidence from Europe, in: World Economy, Vol. 28, Blackwell Publishing Ltd 154 Copeland, Brian R., International Trade and Green Growth. World Bank, Washington, DC, (2012). 155 Ambec, Stefan, et al., “The Porter Hypothesis at 20: Can Environmental Regulation Enhance Innovation and Competitiveness?,” Review of Environmental Economics and Policy Vol 7, Issue 1 (2013): 2–22. ­ 54 However, it is important to note that the empirical firms with dynamic incentives for innovation and evidence is based mainly on studies in the advanced efficiency improvements, although some environmental industrialized countries, which have relatively few barriers performance standards can also be designed to foster to information and innovation. A recent OECD review such dynamic efficiency, for example, the EU’s Industrial also found that the tightening of environmental policies Emissions Directive or the United States’ Corporate led to improvements in production efficiency, but mainly Average Fuel Economy (CAFE) vehicle standards. in already technologically advanced industries and firms, while less productive firms saw their productivity fall There is growing evidence that environmental even further.156 This finding may have an important regulations do promote innovation in green technologies.159 implication for extending carbon pricing to less Even more important, green innovation appears to entail developed countries where firms, particularly domestic stronger growth benefits than traditional innovation in fossil firms in energy and labor-intensive sectors, are often less fuel sectors. Clean technology research and development technologically advanced and not as productive as their has economic benefits that spill over to the rest of the foreign competitors; moreover, it is precisely these firms economy through diffusion of new knowledge, in a way that account for a major share of the jobs and incomes of that is comparable to the spinoff of “frontier” technologies low-income households. Symmetric carbon pricing may such as robotics, IT, and nanotechnologies. Fossil-based have asymmetric impact across countries at different technologies tend to find narrower, more traditional income levels. Some emerging research indicates that applications in mature, slower growing sectors.160 the longer-term effects on productivity and export can be positive, even in developing countries.157 However, As the aforementioned OECD review of existing more research is needed to better understand the impact evidence demonstrated, a large part of the economy-wide of climate policies on the performance of firms in productivity gains from environmental policies stem from developing countries, especially of those traditionally the exit of the least productive firms from the market. dependent on fossil fuels. This is akin to other market transformations, which cause both losses and gains in different industries, even without Another consistent finding is that market-based climate policies, releasing workforce, land, and physical mechanisms (such as carbon pricing) tend to have a assets for a more productive use in other sectors.161 more robust positive effect on productivity than their less flexible alternatives.158 Firms also tend to prefer flexible For sectors and regions that have been affected economic instruments of environmental policy over by firms’ exits, the government may assist in shutting command-and-control alternatives because the former down the least efficient facilities and in retraining and offer companies greater flexibility regarding the means reemploying workers in other, growing, sustainable and timing of reducing emissions. They also provide sectors. Social protection provides additional safety nets 156 Albrizio, S., T. Ko luk and V. Zipperer (2014), “Empirical Evidence on the Effects of Environmental Policy Stringency on Productivity Growth”, OECD Economics Department Working Papers, No. 1179, OECD Publishing. 157 Zhu, J., and M. Ruth (2015), “Relocation or reallocation: Impacts of differentiated energy saving regulation on manufacturing industries in China,” Ecological Economics, 110, 119–133. doi:10.1016/j.ecolecon.2014.12.020. 158 Silvia Albrizio, et. al, ibidem. 159 Raphael Calel and Antoine Dechezleprêtre, “Environmental Policy and Directed Technological Change: Evidence from the European Carbon Market,” Review of Economics and Statistics (2012). 160 Antoine Dechezleprêtre, Ralf Martin, and Myra Mohnen, Policy Brief: Clean Innovation and Growth (Imperial College London Business School, n.d.). 161 Samuel Fankhauser, Friedel Sehlleier, and Nicholas Stern, “Climate Change, Innovation and Jobs,” Climate Policy Vol 8, Issue 4 (2008): 421–429. 55 3   Competitiveness and carbon leakage for those who find it difficult to transition to a new job. of domestic firms, such asymmetric carbon pricing will Public assistance can also facilitate skills development benefit emissions-intensive firms abroad. The price through national education systems. For example, signals may force specific sectors to shift their output and Chile introduced its carbon tax with the explicit aim of eventually also their investments to other countries, so- providing additional resources to improve its education called “pollution havens,”where firms face lower GHG system.162 Countries and regions where many people emission costs.164 Policy makers and environmentalists rely on emissions-intensive industries for jobs and are worried that this relocation could be followed by where incomes are lower and institutions weaker will an increase in emissions at the new jurisdiction— be more vulnerable to an increase in carbon prices. This the carbon leakage discussed above. These concerns vulnerability can be reduced, for instance, by supporting over the adverse impact on competitiveness and the innovation and energy efficiency improvements in the possibility of carbon leakage are probably the single industrial sector (for example by providing access to most common concern challenging the introduction of information about new technologies and access to finance carbon prices around the world. for SMEs). This enhances workforce capability to pursue new, “cleaner” business opportunities.163 Technology and If carbon leakage occurred, it would have two main resource transfers and institutional strengthening will knock-on effects on environmental policy objectives: be crucial to manage structural transformations in less it would reduce the environmental effect of emission advanced low-income countries. reduction efforts and increase the cost of meeting specific climate targets. An increase in emissions in jurisdictions with low or no carbon prices would 3.3 require additional efforts in the jurisdictions with ADVERSE IMPACT OF CARBON carbon pricing policies in place to achieve the same net PRICES ON COMPETITIVENESS; global emission reduction. CARBON LEAKAGE Carbon leakage can occur through three main channels (Box 7); the short-term output channel, the long-term The likelihood of a positive impact of carbon pricing investment channel, and thirdly, global fossil fuel prices on firms’ productivity and their competitiveness channel. While global economic models show the third is seriously challenged when asymmetric climate channel may actually be very important, this subject is policies significantly differentiate price signals between not discussed in this report because it does not originate jurisdictions. Industry and policy makers are often from the distorted international competitiveness of firms concerned that rather than enhancing the productivity due to asymmetric carbon prices. 162 PMR, Chile, accessed August 10, 2015, http://www.thepmr.org/country/chile-0. 163 World Bank, Decarbonizing Development: Three Steps Toward a Zero Carbon, 2015. 164 Arik Levinson, “Offshoring Pollution: Is the United States Increasingly Importing Polluting Goods?,” Review of Environmental Economics and Policy Vol 4, Issue 1 (2010): 63–83; Josh Ederington & Arik Levinson & Jenny Minier, 2005. “Footloose and Pollution-Free,” The Review of Economics and Statistics, MIT Press, ­ vol. 87(1), pages 92-99.; Levinson, A., and Taylor, M.S. (2008), Unmasking the Pollution Haven Effect. International Economic Review 49: 223-54. 56 Box 7 Different channels of carbon leakage The output, or short-term competitiveness, channel operates when higher carbon emission costs force firms to reduce the utilization of their production facilities in jurisdictions covered by carbon pricing, to the benefit of plants located elsewhere that are not covered by carbon pricing.165 The investment, or long-term competitiveness, channel operates if different carbon prices in different jurisdictions affect investment decisions relating to choice of location (country). Existing plants in jurisdictions with a carbon price may first reduce investment in maintenance to sustain output levels, and eventually close. Companies may prefer to relocate to jurisdictions without a carbon price. Figure 13 Three channels of transferring emissions leakage 1. Output: short-term ­ firms facing a carbon price lose market share to those without competitiveness channel 2. Investments: new investment is preferentially located in long-term regions without a carbon price competiveness channel carbon price causes drop in domestic demand for fossil fuels 3. Fossil fuel  lower fossil fuel prices pricing channel  increase in demand for fossil fuels elsewhere in the world The third channel of carbon leakage, the fossil fuel pricing channel, operates if climate policies in some countries were to reduce global demand for fossil fuels, which would in turn depress their global prices, thereby leading to a rebound in demand elsewhere and a subsequent increase in emissions.166 165 Julia Reinaud (2008), Issues Behind Competitiveness and Carbon Leakage: Focus on Heavy Industry. International Energy Agency. 166 Burniaux, J.-M.; Martins, J. Oliveira (2000). “Carbon Emission Leakages: A General Equilibrium View”. OECD Working Paper No. 242.; Sinn, H. W. (2008). “Public policies against global warming” (PDF). International Tax and Public Finance 15 (4): 360–394; Elliott, J., I. Foster, S. Kortum, T. Munson, F. Pérez Cervantes, and D. Weisbach (2010), “Trade and Carbon Taxes,” American Economic Review 100 (May): 465–469. 57 3   Competitiveness and carbon leakage 3.4 The risk of carbon leakage is often debated even before HOW TO ASSESS the implementation of carbon pricing instruments. THE RISK OF The risk of carbon leakage can be assessed before a CARBON LEAKAGE? certain policy is introduced (“ex ante”) or a few years after its implementation, allowing empirical evidence to be collected (“ex post”). These two complementary Carbon leakage only exists if the decision to relocate approaches to assessing leakage are illustrated in Figure 14. output and/or investment can be directly attributed to differences in carbon prices and, in turn, leads to an Ex-ante modeling suggests a wide range of potential increase in emissions somewhere abroad where carbon leakage rates.167 Economy-wide models tend to find prices are lower. In other words, causality needs to leakage rates in the region of 5–20 percent (meaning that be established. Carbon leakage therefore needs to be for every 1,000 kg of reduced emissions in jurisdictions assessed against what would have happened if carbon with a carbon price, emissions are expected to increase by prices had been similar. 50–200 kg in other jurisdictions)— still yielding a net reduction. The results were found for a blend of sectors, In reality, firms change location of production more and less heavily exposed to carbon leakage. However, and investments every day, motivated by a variety of in the economy, when some sectors lose market share and idiosyncratic factors discussed above. It is difficult employment, others gain. Leakage rates for individual to attribute such decisions to a single factor—like sectors therefore differ. The range of leakage rates the increase of a carbon price. Furthermore, the real estimated by single-sector, partial equilibrium models is reasons for shifting production or investments are a much wider: rates vary from just a few percentage points to firm’s private knowledge. Firms always strategically rates even exceeding 100 percent (meaning that emissions select the information they share with governments and in other jurisdictions are expected to increase by more than the public. the emission reduction achieved in a jurisdiction with a Figure 14 Ex-ante and ex-post assessments of carbon leakage Assessments of carbon leakage Theoretical (ex-ante) Empirical (ex-post) Economy-wide (CGE) Sector-specific (PE) Econometric Wide range (0-100%+); No causal relationship Typically 5-15% but typically higher than between CO2 price and loss ­ GE studies of market share Significant differences within and between models Source: Authors, based on Vivid Economics Note: CGE = Computable General Equilibrium (model); PE = Partial Equilibrium (model). 167 See the comprehensive review of the ex-ante and ex-post studies on carbon leakage in the forthcoming: Partnership for Market Readiness, Carbon leakage: theory, evidence and policy design, World Bank. 58 carbon price). However, such models tend to focus on the 3.5 sectors that are particularly vulnerable to carbon leakage. WHICH FIRMS NEED The different findings of the various modeling approaches ASSISTANCE TO PREVENT are also explained by the diversity of the underlying LEAKAGE AND WHEN? assumptions and data, meaning that the results can only be duly compared if they are presented in a transparent way. In the presence of fragmented policies and different Ex-post studies are based on empirical assessments carbon costs, the risk of carbon leakage justifies giving of existing schemes (mainly carbon taxes in individual assistance to the exposed firms and sectors. Policy makers EU countries and the EU ETS), using econometric usually face strong pressures from affected vested interest approaches to try and establish a causal relationship groups to shield them from the impact of carbon prices, between carbon pricing and leakage. The results of ex- and need to ascertain whose claims are legitimate and post assessments consistently indicate that so far there who is just seeking windfall gains. is very little evidence that carbon prices have caused any significant carbon leakage and, least in Europe.168 Three criteria are typically used to identify the sectors However, it is important to recognize that the absence of that are exposed to the risk of carbon leakage: evidence to the contrary does not necessarily indicate that carbon leakage has not occurred and will not occur in the 1. Level of carbon price (capturing the impact of carbon future. Several factors could explain the above results: prices), which determines the magnitude of costs associated with emissions; –– The risk of leakage is negligible because emission costs 2. Emission intensity (another measure of the impact represent only a small fraction of production costs of carbon prices), which determines the cost increase and/or other factors are more important determinants that can be attributed to carbon pricing, including of a firm’s production and location decisions; direct on-site emission costs and indirect emission –– Carbon prices in the existing schemes have been too costs passed on through electricity price increases; low to have an impact; 3. Trade intensity (capturing the exposure to carbon –– Mitigation measures worked—free allowances, for prices), which is a proxy for the ability of a firm or example, have successfully neutralized the leakage risk; sector to pass on a cost increase to consumers without –– Methodological challenges have distorted the losing significant market share. Absent trade, or the results because of the relatively short period that potential to trade, firms covered by carbon pricing are carbon pricing has been in existence and the limited insulated from uncovered competitors and the risk of geographical coverage of the schemes that could carbon leakage should be small. be studied for a longer period of time (almost all empirical studies focus on the EU countries). The next section discusses when it may be justified to provide assistance to firms to mitigate the risk of leakage. 168 Johanna Arlinghaus, Impacts of Carbon Prices on Indicators of Competitiveness: A Review of Empirical Findings, OECD Environment Working Papers, 2015; Abrell, J., G. Zachmann andA. Ndoye (2011), “Assessing the impact of the EU ETS using firm level data,” Bruegel Working Paper, 2011/08; Silvia Albrizio et al., Do Environmental Policies Matter for Productivity Growth? Insights from New Cross-Country Measures of Environmental Policies; Ralf Martin et al., “On the Empirical Content of Carbon Leakage Criteria in the EU Emissions Trading Scheme,” Ecological Economics Vol 105 (September 2014): 78–88; The New Climate Economy, 2014; Florens Flues and Benjamin Johannes Lutz, Competitiveness Impacts of the German Electricity Tax, OECD Environment Working Papers (May 2015); Sartor, O. (2012), Carbon leakage in the primary aluminium sector: what evidence after 6 ½ years of the EU ETS? CDC Climate Research Working Paper 2012-12; Sartor, O. and T. Spencer (2013), An Empirical Assessment of the Risk of Carbon Leakage in Poland; Barker, T., S. Junankar, H. Pollitt and P. Summerton (2007), “Carbon leakage from unilateral Environmental Tax Reforms in Europe, 1995–2005,” Energy Policy, 35(12), 6281–6292, Chan, H. , S. Li, and F. Zhang (2012), “Firm competitiveness and the European Union Emissions Trading Scheme,” World Bank Working Paper; Cummins, M. (2012), EU ETS market interactions: a multiple hypothesis testing approach, Mimeo, Dublin City University Business School; Ellerman, A., F. Convery, and C. De Perthuis (2010), Pricing Carbon: The European Union Emissions Trading Scheme, Cambridge University Press; Graichen, V., K. Schumacher, F. Matthes, L. Mohr, V. Duscha, J. Schleich, and J. Diekmann (2008), Impacts of the EU Emissions Trading Scheme on the industrial competitiveness in Germany: final draft report prepared under the UFOPLAN, Berlin; Lacombe, R. (2008), “Economic Impact of the European Union Emission Trading Scheme : Evidence from the Refining Sector,” Thesis for the Degree of MTech, Massachussetts Institute of Technology. 59 3   Competitiveness and carbon leakage The full picture can be obtained when these three 3.6 criteria are considered together rather than in isolation. HOW TO ASSIST EXPOSED AND In the California Cap-and-Trade Program, leakage VULNERABLE SECTORS? assistance is determined by a combination of emission intensity and trade intensity, and, in the period 2018–20, sectors will receive different levels of leakage assistance Once the risk of leakage has been determined to be according to their level of exposure to leakage. However, significant for certain sectors, governments can assist some instruments, such as the EU ETS (in its current the affected firms in several ways. They can assist in phase) and the proposed carbon tax in South Africa, mitigating the social and economic impact of the sector’s offer support to entities that are deemed trade exposed, decline, for instance, by retraining workers. Alternatively, even if they are not carbon-intensive. governments can lower the risk of leakage through special measures— including integrated assistance measures that It is best to assess the carbon leakage risk exposure are included in the design of a carbon pricing instrument of entities at the sector rather than the firm level. This and complementary measures, which are not part of the approach avoids rewarding firms that are more emissions- carbon pricing instrument’s design. intensive than their competitors and prevents firms from changing sales patterns in order to satisfy trade exposure 3.6.1 tests. Integrated assistance measures The impact of carbon and trade intensity can be Integrated measures have been the generally preferred further fine-tuned by considering: (i) the price sensitivity approach to date. Directly incorporating measures that of consumers; (ii) the degree of competition within the protect against leakage in the carbon pricing legislative industrial sector in question; (iii) the availability and package transparently addresses leakage concerns and cost of abatement options; (iv) carbon pricing (implicit can help secure the necessary political support for the and explicit) in other jurisdictions (the main trading policy. Broadly speaking, six distinct types of integrated partners), and (v) the carbon intensity of production in measures can be observed, three of which involve free other jurisdictions. In sum, exposed sectors are those that allowance allocations: are carbon-intensive, burdened with costly abatement –– Free allowance allocations, based on: options, and exposed to international trade with –– Grandfathering: firms receive free allowances jurisdictions that do not charge their firms for emissions. directly related to their historical emissions (e.g., However, the lack of data and the accompanying EU ETS Phases I and II, the Republic of Korea’s administrative burden often prevent the use of these ETS in all but three sectors, Kazakhstan ETS criteria for more targeted assistance. Phases I and II, and most sectors in the pilot ETSs of Beijing, Chongqing, Guangdong, Hubei, Assistance should be narrowed over time, as it Shanghai and Tianjin); can otherwise have undesirable fiscal and economic –– Fixed sector benchmarking (FSB): firms receive free consequences and possibly undermine the core objective allowances related to their historical production of a policy by maintaining support for carbon-intensive and a product-specific benchmark of emission firms. However, when carbon pricing is introduced for intensity of the whole sector (EU ETS Phase III) the first time, providing broad support to all sectors –– Output-based allocation (OBA): firms receive is sometimes necessary to gain public and political free allowances related to their actual production acceptance. It can be gradually limited and better and a product-specific benchmark of emission targeted over time as acceptance increases and more intensity of the whole sector (e.g., California, relevant data become available. New Zealand, the Republic of Korea in three sectors, and Shenzhen); 60 –– Administrative exemptions: exempting some Of the free allocation approaches, those that use emissions or sectors/firms from the carbon pricing benchmarking (either OBA or FSB) generally perform instrument, or setting reduced rates for them (e.g., better by most criteria than those that provide free a number of carbon taxes in EU countries and South allowances on a grandfathered basis. By breaking the Africa’s proposed carbon tax); link between a firm’s own historical emission levels and –– Rebates: providing subsidies to industry (direct its free allowance allocation, the risk of rent-seeking is rebates) or reducing other taxes paid by the exposed reduced. The additional administrative costs incurred to industry (indirect), often by an equivalent amount calculate the benchmarks, and in the case of OBA also (e.g., the U.K. climate change levy and the Swedish to update output data, are higher for the benchmarking Nitrogen Oxide charge); approaches, but are manageable. –– Border carbon adjustments (BCAs): imposing emission costs at the border on importers of carbon- There is a trade-off between the two benchmarking intensive goods and/or providing a rebate to firms approaches. OBA may be more effective at preventing exporting to third countries, unless those countries leakage but may also compromise the environmental have an equivalent carbon pricing regime. integrity of the carbon pricing instrument, unless it is designed with additional environmental safeguards. This The various assistance measures each have their own is particularly true if OBA is applied to sectors that are relative merits and weaknesses in terms of administrative not exposed to leakage. feasibility and costs, effectiveness in leakage prevention, and usability as an incentive to reduce emissions. They BCAs arguably perform best in terms of environmental are sometimes combined in one legislative package, where integrity, but face political, administrative,169 and possibly different forms of assistance are given to different sectors. also legal challenges. BCAs effectively extend the carbon pricing regime to entities outside the implementing Exemptions perform most poorly in terms of jurisdiction. Legal considerations will influence any abatement incentives, but are easy to implement. They design170 but many commentators suggest that these may be appropriate to ensure political support so that considerations will not represent an insurmountable carbon pricing survives the infancy stage. barrier.171, 172 World Trade Organization requirements might possibly be met if BCAs demonstrate their Grandfathering may be appropriate when a scheme effectiveness at reducing emissions, rather than at is in its early stages, where the need to tackle other addressing carbon leakage.173 The political challenges administrative challenges may make benchmarking may be as great, or greater, than any legal constraints, as approaches complex, or where there is a desire to provide demonstrated by the experience of the EU in seeking to one-off compensation to firms, even if they are not at risk establish a regime that would have extended its ETS to of leakage. Grandfathering entails perverse incentives to cover emissions from all international flights from and to increase emissions, unless firms expect that it will be Europe. Application of trade measures to climate change soon replaced with benchmark-based assistance. 169 Davie, Bruce F. (1995), Border tax adjustments for environmental excise taxes: the US experience, Mimeo Washington DC, US Treasury Department. 170 Laborde, D. and S. Msangi (2011), “Biofuels, Environment, and Food: The Story Gets More Complicated,” International Food Policy and Research Institute, Wash- ington, DC, www.ifpri.org/node/8439. 171 Condon, M. and A. Ignaciuk (2013), “Border Carbon Adjustment and International Trade: A Literature Review”, OECD Trade and Environment Working Papers, No. 2013/06, OECD Publishing, Paris. DOI: http://dx.doi.org/10.1787/5k3xn25b386c-en. 172 Cosbey, A., S. Droege, C. Fischer, J. Reinaud, J. Stephenson, L. Weischer and P. Wooders (2012), “A Guide for the Concerned: Guidance on the elaboration and implementation of border carbon adjustment,” ENTWINED/International Institute of Sustainable Development, Stockholm. 173 Stéphanie Monjon and Philippe Quirion, “A Border Adjustment for the EU ETS: Reconciling WTO Rules and Capacity to Tackle Carbon Leakage,” Climate Policy Vol 11, Issue 5 (September 2011): 1212–1225. 61 3   Competitiveness and carbon leakage regulation remains largely untested and risky. Trade 3.6.3 disputes can spill over to many areas of international Ensuring targeted and relations, making BCA a very expensive policy for all effective leakage parties concerned. Border adjustment measures appear assistance measures more feasible when introduced by a coalition of partners who account for a significant share of world trade.174 Experience suggests that to successfully address Moreover, considerable administrative challenges arise competitiveness and leakage concerns requires that from the fact that the legislator introducing BCA has assistance be targeted at those sectors where the risk no jurisdictional access to third-party companies to of leakage is significant. The assistance measures ensure accurate measurements of emissions. Adequate implemented should be chosen after considering multiple monitoring, reporting, and third-party verification of criteria, such as effectiveness in leakage prevention and emissions has proved essential for the proper functioning administrative feasibility, as indicated in Table 4 in of carbon markets. Annex II. If this is a politically difficult process, assistance measures should be reviewed periodically and adjusted as A more technical discussion of the integrated more jurisdictions apply similar policies, and additional assistance measures is presented in Annex II. knowledge is gained on this subject. 3.6.2 Studies suggest that leakage prevention assistance has Complementary leakage not always been necessary to maintain the competitiveness mitigation measures of firms affected by these policies.175 A number of analyses found no difference in output or employment between Complementary measures tend to have a less firms that faced the full carbon price and those that were immediate impact on leakage and are more challenging fully or partially exempt.176 However, this finding may to design in a way that flexes in value with the carbon not necessarily apply to higher carbon prices. price. They can reduce the carbon cost burden faced by sectors exposed to leakage through grants; tax incentives; The ultimate solution to carbon leakage is and financial assistance for emission reduction projects international cooperation, which would harmonize for firms in leakage-exposed sectors or for R&D of low- carbon price signals across all jurisdictions. It would emissions technologies applicable in leakage-exposed remove the underlying cause of leakage and therefore sectors. For example, under Phase III of the EU ETS, reduce the need for assistance measures. Nonetheless, as member states can compensate firms for indirect emission pointed out above, more empirical evidence is needed costs using national resources via state aid schemes. on the impact of internationally harmonized but high Both the EU and New Zealand provide research and carbon prices in less developed, low-income countries. development funding to affected sectors. However, the The benefits of international cooperation and the link between these measures and leakage prevention may fundamental role of carbon pricing instruments are not be strong. discussed in the next section. 174 Nordhaus, B. (2015), “Climate Clubs : Overcoming Free-riding in International Climate Policy,” American Economic Review, 105(4), 1339–1370. 175 Johanna Arlinghaus, Impacts of Carbon Prices on Indicators of Competitiveness: A Review of Empirical Findings, OECD Environment Working Papers, 2015. 176 Niels Anger and Ulrich Oberndorfer, “Firm Performance and Employment in the EU Emissions Trading Scheme: An Empirical Assessment for Germany,” Energy Policy Vol 36, Issue 1 (2008): 12–22; Ralf Martin, Ulrich J. Wagner, and Laure B. de Preux, The Impacts of Climate Change Levy on Business: Evidence from Microdata, CEP Discussion Paper, 2009; Ralf Martin et al., “Industry Compensation under Relocation Risk: A Firm-Level Analysis of the EU Emissions Trading Scheme,” American Economic Review Vol 104, Issue 8 (2014): 2482–2508; Flues and Lutz, Competitiveness Impacts of the German Electricity Tax, OECD Environment Working Papers (May 2015). 62 section 4 International cooperation on mitigation 4 International cooperation on mitigation A  s outlined in section 2, new national and subnational carbon pricing instruments have emerged since 2012 in a bottom-up process. Countries are defining development opportunities, but lack the resources to harness them. Carbon pricing and climate finance instruments are important facilitators of cooperation, their mitigation efforts in INDCs. These INDCs will as these are the primary mechanisms through which inform future action on carbon pricing. Section 3 has international finance can be transferred between shown that competiveness and carbon leakage are serious countries. Through carbon pricing instruments, a concerns in a world of uncoordinated, fragmented action portion of the resulting cost savings in countries that on carbon pricing. Policy tools are available to manage avoid the most expensive abatement measures can these risks but ultimately international cooperation be converted to financial transfers and drive low- will be essential to realizing the full potential of carbon carbon growth in the lower-income countries, which pricing. might otherwise lack the resources to modernize their economies, create jobs in low-carbon sectors, and reduce This section explores the broader role of international poverty in a sustainable manner. Rewards such as these cooperation in achieving the 2°C mitigation target financial transfers between countries and penalties, in a cost-efficient manner. Because of the unequal for example, border carbon adjustments, are necessary distribution of wealth and abatement potential around instruments to overcome incentives to “free-ride” on the the world, all countries would benefit from cooperation. efforts of others, something that prevents a cooperative Some countries can afford to reduce GHG emissions but solution. They align incentives between countries, avoid have already exploited most of their low-cost abatement fragmentation, and enable harnessing of the common options, while others have many low cost low-carbon benefits from cooperation.177 177 Nordhaus, W., “Climate Clubs: Overcoming Free-riding in International Climate Policy”, American Economic Review, 105(4): 1339–1370, 2015. 64 The natural starting point to estimate the potential cost savings through cooperation and associated » The main reward for financial transfers would be the INDCs. However, as some INDCs have not yet been submitted, it is too global cooperation on soon to model the cost savings that could be achieved climate change lies in the on the basis of INDCs. Therefore, this section follows an alternative approach that illustrates a possible range savings that can be gained of INDCs using so-called effort-sharing scenarios. Based on the costs of limiting on the modeling of these scenarios from various leading literature sources, ranges of cost savings and associated the global temperature resource transfers are presented. While these ranges are increase to 2°C. « broad, reflecting different impacts from the various effort sharing scenarios and models used, the possible savings and resource transfers are nonetheless large in all cases, The distribution of mitigation efforts among across a diverse range of assumptions. This demonstrates countries reflects national circumstances, political the robustness of the conclusions of this section and realities, economic possibilities, and strategic interests. highlights the indispensable role of international International climate negotiations recognize that countries cooperation, through carbon pricing and climate finance should participate in climate mitigation in accordance instruments, in mobilizing resources at the scale needed with their common but differentiated responsibilities to stabilize the climate. and respective capabilities, taking into account their specific social and economic circumstances.178 Once all INDCs have been submitted, they will reveal the de facto 4.1 initial distribution of mitigation efforts. INCENTIVES FOR COOPERATION The INDC effort-sharing outcome can be compared ON CLIMATE MITIGATION with the outcome of a process purely based on the principle of efficiency: a least-cost approach, which calls for emission reductions to be achieved wherever it is The magnitude of cost savings that can be achieved cheapest to do so, without regard for political or other through cooperation depends mainly on the initial constraints. As the INDC process is still underway, it distribution of mitigation efforts among countries, is too early to make such a comparison. However, the stringency of the emission reduction targets, the regardless of the distribution of mitigation efforts that differential of mitigation costs between countries, and will emerge from the INDCs, it is likely that the cost the size of the coalition of countries pursuing climate burden of climate change mitigation can be reduced. action. Although all countries ultimately benefit from This is because the actual emission reductions can be cooperation, each country will benefit to a different achieved either through domestic actions alone or extent—some will be recipients of resource transfers, through a combination of domestic and cooperative while others will transfer resources to other countries. actions undertaken jointly by several countries. 178 United Nations Framework Convention on Climate Change, 1992. 65 4   International cooperation on mitigation Academic literature can give an insight into the extent mitigation effort among countries compared to a least- to which cooperation can help reduce the cost burden. cost scenario, as discussed above. In general, the largest It compares effort-sharing outcomes based on the least- global cost savings are expected if the distribution of cost approach with effort-sharing approaches based on effort is not based on low-cost mitigation options. This normative principles, reflecting different stakeholders’ is highlighted in Table 2, which shows that cooperation preferences on how the effort should be distributed is more valuable if the initial effort-sharing approach according to principles such as fairness and equity. Some is based on the per capita convergence principle rather examples of these normative effort-sharing approaches than on effort-sharing approaches that take global are equal costs per GDP, per GDP convergence, and mitigation opportunities into account (that is, the equal per capita convergence.179 By definition, these effort- costs per GDP and per GDP convergence approaches). sharing approaches are more expensive than (or at least Moreover, a study by Clarke et al. (2009), which is as expensive as) the least-cost approach. quoted by the IPCC, estimates that the potential cost savings are larger under a scenario where only a few The cost savings that can be achieved by moving from countries take mitigation action, as delayed mitigation various initial effort-sharing approaches to a least-cost by the other countries results in higher global mitigation scenario through cooperation are presented in Table 2. costs (see Table 2).181 Furthermore, research has found Although these estimates are based on effort-sharing that lower relative cost savings are obtained for more approaches that may be different from the outcome of the ambitious global emission reduction targets, such as INDC process, they can be considered as a proxy of the the 450 ppm CO2e scenario,182 compared with less cost savings that can be achieved through cooperation. ambitious targets, such as the 550 ppm CO2e scenario This is justified because the normative principles used (Table 2). The main explanation for this finding is that in in the academic research presented in Table 2 are also, order to achieve substantial global emission reductions, implicitly or explicitly, adopted in the INDC process. both developed and developing countries have to use relatively expensive abatement measures. As the costs According to this academic research, cooperation can of achieving emission reductions in industrialized and reduce the global costs of meeting a long-term climate developing countries converge, the benefits of shifting target by about 6–67 percent.180 The magnitude of these the mitigation effort from one country to another are cost savings depends on the assumed distribution of the lower. 179 Equal costs per GDP – this approach assumes that the mitigation effort is divided among countries so that all countries have equal mitigation costs as a share of GDP. This burden differentiation model takes into account countries’ mitigation opportunities and their ability to pay for mitigation. Per GDP convergence – this approach is based on the convergence of emissions per unit of GDP, which is an indicator of the carbon efficiency of a country. Under this burden differentiation model, countries with lower carbon efficiencies (that is, higher emissions per unit of GDP) are required to make deeper emission reductions than countries with higher carbon efficiencies (that is, lower emissions per unit of GDP). Typically, these deep emission reductions can be achieved at a relatively low abatement cost, as countries with low carbon efficiency generally have numerous low-cost mitigation opportunities. Per capita convergence – this approach distributes the ­ mitigation effort among countries so that the emissions per capita of countries converge over time to a common level. This model is based on the egalitarian principle, where all citizens have equal rights to “use” the atmosphere. 180 Savings are reported on a net basis, i.e. are calculated as a sum of avoided mitigation costs in some countries after transfers plus a sum of surplus of other countries resulting from transfers after additional mitigation costs have been incurred. ­ 181 Leon Clarke, Kejun Jiang, Keigo Akimoto, Mustafa Babiker, Geoffrey Blanford, Karen Fisher, J. Vanden, Jean-Charles Hourcade, Volker Krey, Elmar Kriegler, Andreas Loschel, David McCollum, Sergey Paltsev, Steven Rose, Priyadarshi R. Shukla, Massimo Tavoni, Bob van der Zwaan and Detlef P. van Vuuren, “Assess- ing Transformation Pathways,” Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change, Chapter 6 (2014): 413–510, quoting Leon Clarke, Jae Edmonds, Volker Krey, Richard Richels, Steven Rose, and ­ Massimo Tavoni, “International climate policy architectures: Overview of the EMF 22 International Scenarios,” Energy Economics, Vol 31 (2009): 64–81. 182 A long-term 450 ppm CO2e target is “likely” (>66%) to limit the global temperature rise to 2°C. 66 Table 2 Literature overview of global cost savings from international cooperation Distribution of ­ Global cost savings Regional Target mitigation efforts Long-term ­ from international Source scope year across countries climate target cooperation (in %) Global, Equal costs per GDP 450 ppm CO2e 16%b Hof et al. (2012)a 2030 26 regions Per capita convergence 450 ppm CO2e 32% 450 ppm CO2e 16%d Per capita convergence Global, 550 ppm CO2e 35% Fujimori et al. (2015)c 2050 17 regions 450 ppm CO2e 6% Per GDP convergence 550 ppm CO2e 19% Global, 450 ppm CO2e and Clarke et al. (2009)e 2100 Fragmented actionf 33–67% 10 regions 550 ppm CO2e Böhringer and Welsch Global, 25% below 1990 2050 Per capita convergence 59%h (2004)g 12 regions levels EBRD and Grantham Research Institute on Economies Uniform: 80% below 2005 2050 500 ppm CO2e 47%k Climate Change and the in transitionj countries levels by all ­ Environment (2011)i Uniform: 20% below 1990 2020 n/a 13%n Annex I levels by all Annex I countries OECD (2010) l onlym Uniform: 50% below 1990 2050 n/a 7% levels by all Annex I countries Note: a Costs are expressed as share of GDP in the target year. h Costs are expressed as welfare changes. b Source: Andries Hof, Corjan Brink, Angelica Mendoza Beltran, Michel den Elzen, i Source: EBRD and Grantham Research Institute on Climate Change and the Greenhouse Gas Emission Reduction Targets for 2030. Conditions for an EU Environment, The Low Carbon Transition, 2011. Target of 40%, PBL Netherlands Environmental Assessment Agency, 2012. j Eastern and South-eastern Europe, Baltic countries, Russia, former Soviet c Source: Shinichiro Fujimori, Toshihiko Masui, and Yuzuru Matsuoka, Union, Central Asia (excluding China) and Turkey. “Gains from Emission Trading under Multiple Stabilization Targets and k The mitigation cost without cooperation was calculated in this study using ­ Technological Constraints,” Energy Economics, Vol 48 (2015): 306–315. a “limited trade” scenario, in which 20% of the emission reductions can be d Costs are expressed as welfare changes. imported from other regions and 80% needs to be achieved through domestic e Leon Clarke, Jae Edmonds, Volker Krey, Richard Richels, Steven Rose, and actions. Costs are expressed as share of business-as-usual GDP in net Massimo Tavoni, “International climate policy architectures: Overview of the ­ present value for period 2010–50. EMF 22 International Scenarios,” Energy Economics, Vol 31 (2009): 64–81. l Source: OECD, Towards Global Carbon Pricing, 2010. f This scenario assumes that Annex I countries (without Russia) take imme- m As the scope of this study is limited to Annex I countries only, the cost increase diate mitigation actions, Brazil, Russia, India and China participate in 2030 ­nclude relates to linking Annex I countries. If the scope would be extended to also i and the rest of the world participates in 2050. non-Annex I countries, the cost increase would most likely be much higher. g Source: Heinz Welsch and Christoph Böhringer, “Contraction and n Costs are expressed as welfare changes measured by income equivalent ­ Convergence of Carbon Emissions: An Intertemporal Multi-Region CGE variation in target year. Analysis,” Journal of Policy Modeling Vol 26, Issue 1 (2004): 21–39. Cost savings from cooperation on a regional level vary important to highlight that Figure 15 presents the regional significantly, as demonstrated in Figure 15, which shows cost savings calculated on the basis of a single model study by the absolute and relative cost savings for an approach where Hof et al. (2012) and on only one effort-sharing approach. the effort-sharing uses equal costs per GDP (chosen for The cost savings calculated by other studies may not be illustration only). In this figure, the largest circle represents identical, as these other studies may use different models, a 45 percent reduction of mitigation costs in South Asia.183 based on different underlying assumptions and different The largest $ sign represents US$39 billion in absolute cost effort-sharing approaches. However, in general, studies show savings in Europe. While the size of the cost savings varies that all countries benefit from international cooperation as widely, all regions nonetheless benefit from cooperation. It is it leads to a more efficient use of global resources. 183 The exact definition of this region depends on the calculation model used. South Asia includes India, and may include, among other countries, Afghanistan, Bangladesh, Nepal and Pakistan. Source: Tavoni, M., Kriegler, E., Aboumahboub, T., Calvin, K., De Maere, G., Jewell, J., Kober, T., Lucas, P., Luderer, G., McCollum, D., Marangoni, G., Riahi, K., and van Vuuren, D., Limits Special Issue on Durban Platform scenarios: The distribution of the major economies’ effort in the Durban platform scenarios, 2013. 67 4   International cooperation on mitigation Figure 15 Illustration of cost savings from international cooperation relative to mitigation costs without cooperation for ten regions by 2030 Note: Circles represent the relative cost savings, while $ symbols represent Source: Authors, based on Andries Hof, Corjan Brink, Angelica Mendoza the size of the absolute cost savings. Absolute cost savings are expressed in Beltran, Michel den Elzen, Greenhouse Gas Emission Reduction Targets for US dollars and represent the difference between the global mitigation cost in 2030. Conditions for an EU Target of 40%, PBL Netherlands Environmental a scenario without international cooperation and the global mitigation cost in Assessment Agency, 2012. a scenario with international cooperation based on an equal costs per GDP effort-sharing approach. Relative cost savings are the absolute cost savings expressed as a percentage of global mitigation costs without cooperation. For example, the mitigation costs in South Asia without cooperation amount to US$9.3 billion, but drop to US$5.1 billion with cooperation. This represents absolute cost savings of US$4.2 billion, or 45 percent in relative cost savings. The regions were based on the model and do not imply any judgement concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Values are in 2005 US$ per year. It is important to note that these studies only of mitigation that are not quantified in these studies take into account the direct costs of GHG emission include improvement in human health, energy access, mitigation and the resource transfers that enable cost and energy security. Cooperation can also strengthen savings. The global benefits of avoided climate change trust between countries, reduce the potential for damages are not considered. Furthermore, co-benefits184 conflicts, and facilitate knowledge sharing. 184 Parry, I., Veung, C., and Heine, D., How much carbon pricing is in countries’ own interests? The critical role of co-benefits, 2014. 68 4.2 costs and identify optimal mitigation strategies, REALIZING THE BENEFITS these models are based on assumptions made with OF COOPERATION limited information available to modelers at the time the model was built. By contrast, the cost discovery function of carbon pricing facilitates innovation that Carbon pricing instruments can mobilize the resources uncovers mitigation options and costs. needed to achieve cost savings from cooperation in the form of financial transfers between countries. Such –– Flexibility: This is needed to provide policy makers instruments include carbon taxes, ETSs, carbon offset with the ability to deal with uncertainties in future instruments as well as different forms of climate finance economic development and emission trajectories. In that can be funded by the revenues derived from carbon particular, permitting the use of mitigation outcomes pricing or regular taxes. achieved abroad can provide comfort to policy makers who set an ambitious emission reduction target. Climate finance involves financial transfers between, for example, countries or international investors. It –– Resource mobilization and private finance leveraging: can take the form of direct investment in low-carbon Achieving ambitious and cost-efficient mitigation technologies through grants or concessional loans globally requires significant international financial and tax rebates, among other instruments. It can also transfers that cannot be mobilized through public fund readiness activities such as capacity building, budgets only. The leveraging of private sector institutional development, and policy design.185 financial flows is therefore important, especially for Climate finance can help economies prepare for the developing countries, where low-carbon, capital- introduction of a carbon price signal by providing the intensive technologies often struggle to compete with upfront funds needed to set up the infrastructure for cheaper, traditional, carbon-intensive technologies. a carbon pricing instrument or by phasing in carbon Developing countries also have higher sovereign risks, pricing in the form of carbon RBF. which reduce the attractiveness of investments in low- carbon technologies. Carbon pricing helps overcome Furthermore, carbon pricing instruments (carbon these issues by providing an economic incentive for taxes, ETSs, and carbon offset instruments) have features investors to assume the additional investment risk that complement climate finance instruments: and shift resources from carbon-intensive to low- carbon technologies. –– Cost discovery: Carbon pricing instruments can engage private sector actors to actively search for and Combining and linking up different carbon pricing discover the lowest-cost mitigation options. While instruments can facilitate financial transfers even further models can be used to estimate emission mitigation (see Box 8). 185 While climate finance is often considered to be a resource flow from developed to developing countries, climate finance can also flow between developing countries or between developed countries. Moreover, climate finance includes financial resources from both the public and private sectors. ­ 69 4   International cooperation on mitigation Box 8 Linking of carbon pricing instruments There are various ways to combine and link different carbon pricing instruments. For instance, offsets have commonly been used under ETSs. A well-known example is the use of CERs and ERUs in the EU ETS. The import of offsets up to about 6% of the cumulative cap is allowed under the EU ETS in the period 2008–20. Offsets can also be used in carbon taxes. For example, offsets are expected to be permitted for use in the scheduled South African carbon tax and CERs can be used in the Mexican carbon tax. Several countries mention the use of international credits in their INDCs. The use of a common offset standard by various ETSs and carbon taxes indirectly links the instruments and helps carbon prices converge. Common offset standards such as the CDM, recognized by a wide range of countries, can help facilitate this indirect link of instruments and cooperation between countries. Another example of an indirect link is the international emissions trading under the Kyoto Protocol, where the trading of AAUs between countries creates implicit links between the countries’ domestic mitigation policies.186 Directly linking carbon tax instruments may involve different jurisdictions agreeing on (minimum) tax rates. Furthermore, it would require a consensus on the rules for transferring tax revenues across borders. ETSs and carbon taxes can also be linked directly. An example of a direct link between ETSs is found in the California and Québec Cap-and-Trade programs. Another linking variant is where ETS allowances are accepted under a carbon tax. Similarly, ETSs can also accept tax credits, which entities liable under a carbon tax would receive when paying taxes beyond their obligations. These types of links can be two-way, where units from one instrument are accepted in the other instrument and vice versa, or one-way, where only one instrument accepts units from the other.187 While harmonization of key design elements can help facilitate direct linking, this can be a challenge. Jurisdictions are currently designing and implementing carbon pricing instruments that reflect their national circumstances and that are, therefore, not harmonized. The concept of “networking” carbon pricing instruments is an alternative to direct linking which reflects this political reality. Networking accepts differences in the design and ambition of instruments, and seeks to facilitate cross- border trade by assigning a value to these differences.188 Another alternative to direct linking is to establish quantitative limits on the flows of units between instruments. While this option may restrict overall efficiency gains, it is recognized as an important mechanism to ensure that linking supplements domestic action. 186 Daniel Bodansky, Seth Hoedl, Gilbert Metcalf, Robert Stavins, Facilitating Linkage of Heterogeneous Regional, National, and Sub-National Climate Policies Through a Future International Agreement, Harvard Project on Climate Agreements, 2014. 187 Adelphi (on behalf of the BMUB), Towards a Global Price on Carbon: Pathways for Linking Carbon Pricing Instruments, 2015. 188 The World Bank Networked Carbon Markets (NCM) initiative supports international cooperation. It has a long term vision that is focused on how a future international carbon market could accommodate a ‘patchwork’ of different, domestic climate actions. It is collaborating with a wide range of stakeholders to ­ explore the post-2020 services and institutions that might be needed to achieve this, including: an independent assessment framework to establish a shared understanding of the climate change mitigation value of a wide range different climate actions; an International Carbon Asset Reserve to support and facilitate carbon market related functions; and an International Settlement Platform to track cross-border trades and provide a possible clearing house function. Further information is available at: http://www.worldbank.org/en/topic/climatechange/brief/globally-networked-carbon-markets. 70 The magnitude and direction of financial transfers other jurisdictions under the convergence per capita through economic instruments depend on the initial approach, as this approach involves high reduction distribution of mitigation efforts. The LIMITS project189 targets for these countries. However, under the equal found that under a scenario compatible with a 2°C costs per GDP approach, these regions would be target,190 the net annual flow of financial resources will receiving international finance, as the relatively large be US$100–400 billion/year by 2030. By 2050, this net impact of climate mitigation on fossil fuel trade flow is estimated to increase to approximately US$400– reduces their GDP. As a consequence, this lowers 2,200 billion/year. their emission reduction targets. An illustrative example of the magnitude and direction Financial transfers need to take place even in a future of the financial transfers in 2030 for two different effort- where net global GHG emissions will be nil. It is expected sharing approaches (equal costs per GDP and per capita that some countries will reach zero GHG emissions convergence) are presented in Figure 16. Similar to the through the achievement of net negative emissions (or analysis of cost savings from cooperation, the size and emission removal) by, for example, reforestation, or direction of financial transfers depend on the effort- biomass with CO2 Capture and Storage (bio-CCS), sharing approach adopted, the specific model used, and which balances other countries’ positive emissions. the underlying assumptions. It is important to note that Financial flows are therefore needed to facilitate these financial transfers are net flows, which take into cooperation between these two groups of countries to account the difference between inflows and outflows. The achieve the net zero emissions target. value of these flows is directly related to the size of the cost savings: a large flow (in either direction) is associated In summary, the long-term, global costs of reaching with a high level of cost savings to a particular region. the 2°C target can be reduced by cooperation between countries. The corollary of this result is that, for a The analysis shows that, in general, developing regions given cost figure, countries can achieve larger emission are recipients of net financial inflows. However, for some reductions through cooperation than through domestic regions or countries—such as East Asia191, the Middle actions alone. East and North Africa (MENA), and the former Soviet Union—the direction of financial transfers depends on The large-scale international resource transfers will the effort-sharing approach selected: be beyond the level of public sector spending, and will need to be channeled through a blend of instruments. –– Under the convergence per capita approach, East Asia These include carbon pricing instruments such as ETSs, would be transferring finance to other regions, as its carbon taxes, offsets and a combination thereof and per capita emissions are relatively high (currently larger linkages between them, as well as innovative hybrid than the EU), while under the equal costs per GDP instruments, such as variations of results-based climate scenario, East Asia would be a recipient of finance. finance. Climate finance and carbon pricing instruments –– Energy-exporting regions such as the MENA and the will be essential in leveraging these financial transfers former Soviet Union would be transferring finance to and enabling cooperation to mitigate climate change. 189 The LIMITS project is one of the most complete studies to date of regional resource transfers. LIMITS compares six different models that, among other outcomes, evaluate financial transfers under various scenarios. Financial transfers are calculated as the volume of emission reductions transferred multiplied by a carbon price. For further details, see Massimo Tavoni, Elmar Kriegler, Keywan Riahi, Detlef P. van Vuuren, Tino Aboumahboub, Alex Bowen, Katherine Calvin, Emanuele Campiglio, Tom Kober, Jessica Jewell, Gunnar Luderer, Giacomo Marangoni, David McCollum, Mariësse van Sluisveld, Anne Zimmer, Bob van der Zwaan. (2015) “Post-2020 climate agreements in the major economies assessed in the light of global models”. Nature Climate Change 119–126 (2015) and http://www. feem-project.net/limits/. 190 This scenario assumes a GHG concentration of 450 ppm CO2e by 2100. 191 The exact definition of this region depends on the calculation model used. East Asia includes China, and may include, among other countries, Cambodia, ­ Mongolia, North Korea and Vietnam. Source: Tavoni, M., Kriegler, E., Aboumahboub, T., Calvin, K., De Maere, G., Jewell, J., Kober, T., Lucas, P., Luderer, G., McCollum, D., Marangoni, G., Riahi, K., and van Vuuren, D., Limits Special Issue on Durban Platform scenarios: The distribution of the major economies’ effort in ­ the Durban platform scenarios, 2013. 71 4   International cooperation on mitigation Figure 16 Illustration of approximate regional financial flows required to achieve GHG mitigation in line with a 2°C target at global least costs by 2030 UNDER A CONVERGENCE OF PER CAPITA EMISSIONS APPROACH UNDER AN EQUAL COSTS PER GDP APPROACH Net outflow Net inflow Source: Authors, based on LIMITS database Note: Regional mitigation contributions are determined by either convergence of per capita emissions (top map) or equal costs per GDP (bottom map). The area of the triangles scales with absolute resource flows. The largest triangle (Sub-Saharan Africa in top map) depicts a value of US$95 billion and the smallest triangle (Latin America in bottom map) corresponds to a value of US$0.4 billion. Values are in 2005 US$ per year. 72 ANNEX I CONVERSION RATES Table 3 Currency conversion rates as of August 1, 2015 Currency Symbol US$ equivalent British Pound £ 1.5574 Danish Krone DKK 0.1470 Canadian Dollar CAN$ 0.7664 Chilean Peso CLP 0.0015 Chinese Yuan CNY 0.1635 Euro € 1.0967 Icelandic Krona ISK 0.0074 Japanese Yen ¥ 0.0081 Kazakhstan Tenge KZT 0.0053 Korean Won KRW 0.0009 Mexican Peso MXN 0.0622 New Zealand Dollar NZD 0.6577 Norwegian Krone NOK 0.1218 Polish Zloty PLN 0.2637 South African Rand R 0.0790 Swedish Krona SEK 0.1159 Swiss Franc CHF 1.0392 Source: International Monetary Fund, accessed August 6, 2015, https://www.imf.org/external/np/fin/data/param_rms_mth.aspx. 73 ANNEX II INTEGRATED ASSISTANCE MEASURES TO MITIGATE THE RISK OF LEAKAGE Table 4 Pros and cons of various leakage assistance measures Leakage Demand-side prevention Administrative Incentives to efficiency measure feasibility/cost Leakage prevention ­ reduce emissions incentives Other issues Free allocation: Relatively easy to Relatively weak, relying Diluted by strategic May be Risk of windfall profits Grandfathering implement if his- on periodic updates of gaming by firms ­ preserved and rent-seeking by firms torical emissions free allowances data are available Free allocation: Relatively complex Relatively weak, relying Preserved by using May be Low risk of rent-seeking Fixed sector and risks being on periodic updates of firm-independent ­ preserved by firms benchmarking subject to lobby- free allowances benchmarks ing, but this can be overcome Free allocation: Relatively com- Strong, due to the Preserved by None if Low risk of rent-seeking Output-based plex and risks clear and explicit link benchmarks, but applied too by firms allocations being subject to between output and lower predictability broadly lobbying, but this allocations, depending of overall environ- can be overcome on which benchmarks mental impact have been set Administrative Easy to Strong, but inefficient None None No risk of windfall profits exemptions implement ­ firms will be artificially shielded from competi- tion from efficient ones Rebates Depends on the Strong if rebates Strong if rebates Stronger for choice are linked to output are not linked to lump-sum (like output-based emission intensity rebates than ­ allocations), but weaker for those if rebates are in the form linked to of lump-sum transfers output Border carbon Very complex Strong Preserved and may Yes Significant political and adjustments and also be extended possibly legal challenges; (BCAs) administratively to firms outside the lower risk when costly direct scope of the introduced by a coalition policy with market power Source: Vivid Economics: Technical note for the World Bank Partnership for Market Readiness 2015. 74 Free allowance The most common policy mechanism that policy makers have used to address allocations leakage to date is the provision of free allowances under ETSs.192 This reduces the financial cost of emissions for firms and is thus expected to reduce the risk of leakage. Free allowances can be allocated in many different ways, but the following two questions best characterize design efforts so far: –– Does the amount of free allowances vary with the output of the individual firm? –– Is the amount of free allowances linked to the emissions of the individual firm? Combining the two questions offers four conceptually distinct approaches to assistance (Table 5). Table 5 Free allocation approaches and their relationship to a firm‘s output and emission intensity Does allocation vary in proportion to a firm’s output? No: Fixed allocation based on a firm’s Yes: Output-Based Allocation historical output with periodic updating Yes, allo- This would effectively eliminate carbon Grandfathering: Allocations are directly linked to cation is price.193 To date, this approach has not been a firm’s historical emissions. Examples include directly adopted. the EU ETS Phases I and II, the Republic proportional of Korea’s ETS (for all but three sectors), to a firm’s Kazakhstan’s ETS Phases I and II, and most emission sectors in the pilot ETSs of Beijing, Chongqing, Is allocation intensity Guangdong, Hubei, Shanghai and Tianjin. linked to the emissions of individual No, allo- Output-Based Allocation: Allocations Fixed sector benchmarks: Allocations firms? cation is are proportional to sector-wide product are proportional to sector-wide product bench- benchmarks and a firm’s current output levels. benchmarks and firm-specific, historical marked to Examples of its implementation include the activity levels. Output adjustments take the emission California Cap-and-Trade Program, New place between phases. An example of its intensity of Zealand’s ETS, Australia’s former carbon pricing implementation is Phase III of the EU ETS. the sector in mechanism (CPM), the Republic of Korea’s question ETS (in three sectors), and the Shenzhen ETS. Source: Authors, based on Vivid Economics: Technical note for the World Bank Partnership for Market Readiness 2015. Note: Some schemes use grandfathering for the majority of their allocations but adopt benchmarking approaches for new entrants or capacity expansions. These schemes are categorized as grandfathering for simplicity. The Shanghai ETS pilot involves a hybrid approach that combining combines some elements of grandfathering and benchmarking, and so thus is not included in this typology. ­ 192 Economic impacts similar to those of free allowances under a cap-and-trade scheme can be achieved by transferable tax exemptions under a carbon tax. For example, carbon tax equivalents of free allowance allocations have been described in Pezzey (1992) and Pezzey & Jotzo (2012). Source: John C. V. Pezzey, “The Symmetry between Controlling Pollution by Price and Controlling It by Quantity,” The Canadian Journal of Economics Vol 24, Issue 4 (1992): 983-991; John C. V. Pezzey and Frank Jotzo, “Tax-versus-trading and efficient revenue recycling as issues for greenhouse gas abatement,” Journal of Environmental Economics and Management Vol 64, Issue 2 (2012): 230–236. ­ 193 If a firm were allocated allowances on the basis of both its actual output and actual emission intensity, the volume of allowances granted would move in direct proportion to its carbon cost, and therefore the firm would effectively be exempted from some or all of the carbon cost. 75 Annex II  – Integrated assistance measures to mitigate the risk of leakage Some countries provide different types of free allowance allocation for different sectors. Under the Republic of Korea’s ETS, the majority of sectors receive free allowances through a grandfathering approach in the first phase. However, the clinker, refineries, and aviation sectors have obtained assistance through output- based allocation. This reflects the perceived relative ease of creating benchmarks in these three sectors. Policy makers have expressed a desire to shift increasingly toward the use of benchmarks in future phases. These different leakage risk mitigation measures are discussed in turn below, skipping free allocations that vary both with output and emission intensity, as this would effectively cancel the impact of carbon pricing. Grandfathering Under a grandfathering approach, firms receive free allowances directly related to their historical emissions, and the amount does not automatically change with their future output. This ensures that incentives to reduce emissions are retained because even allowances received free of charge have a market value that can be cashed out through abatement investments. This feature, combined with administrative simplicity, has made grandfathering a popular method of providing assistance in the initial stages of many carbon pricing schemes. Prominent examples include the first two phases of the EU ETS, the first phase of the Republic of Korea’s ETS (for most sectors), Kazakhstan’s ETS, and various Chinese ETS pilots. Existing grandfathering schemes periodically adjust free allocations to the changes in production levels. Free allowances are usually also canceled if firms do not maintain a minimum level of production. This normally takes place every three to seven years, as under the EU ETS and the Republic of Korea’s ETS, as well as under the various Chinese pilot ETSs. These adjustments weaken some of the incentives that grandfathering can provide to reduce output and can even shut down emissions-intensive facilities if the sale of unused allowances generates a higher profit than maintaining production. Another reason for reducing allowances with output is to prevent windfall profits. In particular, in Phase II of the EU ETS, unexposed firms, especially energy utilities, passed on the cost of their allowances to their customers, even though they did had not even had to pay for them. Furthermore, such adjustments, if not managed properly, create a temptation for “rent-seeking” by firms. When firms expect that updates to the volumes of allowances will be linked to the level of their emissions-intensive activities, they tend to increase their current emissions- intensive output to receive more free allowances for the next period.194 These rent-seeking incentives disappear when firms expect that grandfathering will be replaced by an allocation scheme in which the volume of free allowances cannot be “gamed” so easily by individual firms. 194 Frédéric Branger et al., EU ETS, Free Allocations and Activity Level Thresholds, the Devil Lies in the Details (Centre for Clima te Change Economics and Policy Working Paper No. 190, Grantham Research Institute on Climate Change and the Environment Working Paper No. 169, October 2014). 76 Fixed Sector Like grandfathering, this approach breaks the link between the emission intensity Benchmarking (FSB) of an individual firm and the allowances this firm receives. However, in contrast to grandfathering, the level of assistance is determined not by reference to the current or historical emissions (intensity) of each individual firm, but by reference to a product-specific benchmark of emission intensity of the whole sector. This is the approach adopted in Phase III of the EU ETS. The benchmark for free allowances is based on industry emissions performance, so that only the top 10 percent performers receive free allowances to, in principle, cover 100 percent of their emissions. Other firms receive the same volume of free allowances as the best performers, but have to purchase additional allowances at the market price to cover their actual emissions.195 It provides an ongoing incentive for firms to outperform others in their sector in terms of emission efficiency. Benchmarks are also periodically updated, but opportunities for strategic gaming that increases emissions and windfall gains by individual firms are much weaker because the benchmark is derived from the performance of several firms. Output-Based OBA is similar to the benchmarking scheme, except that the changes in a firm’s Allocation (OBA) ­ output (upwards or downwards) lead to rapid, almost automatic, changes in allowance allocations. Variants on this basic model are used for providing assistance to firms in California, New Zealand, some sectors in Korea, and in Shenzhen. OBAs preserve the incentives to reduce emission intensity, as do the other free allocation approaches, and give a competitive edge to emissions-efficient firms. More importantly, OBA offers stronger leakage protection than FSB and grandfathering. Under OBA, an increase of production by an extra unit will directly result in additional free emission allowances. The level at which a benchmark is set affects the level of protection against leakage. A stringent benchmark will offer weaker leakage protection, as most firms will have an emission intensity that is worse than the benchmark and, hence, will have to purchase many extra allowances to produce an extra unit of output. Conversely, a higher benchmark will better protect against leakage but could have a negative effect on the environmental outcome. The benchmarks are also often tightened over time. The key downside of OBA is that it could make the total environmental outcome of a carbon pricing scheme less certain, because the overall emissions cap can increase with the output of the industry. Without careful design, the environmental integrity of an emissions pricing scheme with OBA may be compromised. 195 European Commission - Climate Action, Free Allocation Based on Benchmarks, accessed August 10, 2015, http://ec.europa.eu/clima/policies/ets/cap/­ allocation/index_en.htm. 77 Annex II  – Integrated assistance measures to mitigate the risk of leakage Exemptions The design of carbon pricing schemes may include exempting some emissions (for example, by implementing carbon tax–free thresholds), exempting some sectors/firms from the scheme (for example, the Swedish carbon tax196), or setting reduced rates for them. Sometimes these exemptions are driven by practical difficulties, political sensitivities, or the high transaction costs of covering certain sectors. For example, small and dispersed emitters in transport, agriculture, forestry, and municipal waste are often exempt from an ETS. However, sometimes these exemptions are also motivated by concerns about leakage. While exemptions are effective in addressing leakage and administratively easy to implement, they fundamentally undermine the abatement incentives of carbon pricing. Reducing the effective carbon price means that abatement incentives are reduced as well. Exemptions, like grandfathering, may be useful when establishing a carbon pricing regime for the first time but should be accompanied by a credible plan for their eventual replacement with more targeted assistance. This thinking underpins the proposed South African carbon tax. Rebates Sometimes policymakers aim to reduce the leakage risks associated with carbon prices by reducing other taxes paid by the exposed industry, or providing other subsidies to industry, often of an equivalent amount. This is an approach most commonly adopted in countries pursuing a carbon tax. Often, rebates are funded by recycling a portion of the emissions tax revenue. Tax rebates preserve an incentive for firms to reduce their emission intensity, provided the rebates are not in proportion to emissions. They favor less emissions-intensive firms, without reducing the overall tax liability faced by the industry, although they may slow down the structural transformation marked by shifts in the shares of emissions-intensive and cleaner firms in the industry in question. Output-based rebates, such as in the case of the Swedish Nitrogen Oxide charge, have very similar properties to OBA and provide strong leakage protection, without compromising environmental integrity (OECD, 2013c).197 Alternatively, lump-sum rebates resemble grandfathering and FSB approaches. Border Carbon BCAs involve imposing an emission cost at the border on importers of carbon- Adjustments (BCAs) ­ intensive goods and/or providing a rebate to firms exporting to third countries, unless those countries have an equivalent carbon pricing regime. BCAs can be introduced either as a border tax or, under an ETS, by requiring importers to surrender allowances for the GHG emissions associated with producing the imported goods or resources. The fundamental difference between BCAs and standard free allowance approaches is the effective extension of the carbon pricing regime to entities outside the implementing jurisdiction. This, in turn, dramatically changes the economic, environmental, and political effects of such a policy. 196 Over the years, carbon tax exemptions have increased for installations under the EU ETS, with the most recent increase in exemption starting from 2014 for district heating plants participating in the EU ETS. 197 The coverage has subsequently been expanded to all plants producing more than 25MWh of useful energy. Source: OECD, 2013. 78 BCAs have been widely modeled and discussed, but not often implemented. Article 10B.1 of the EU ETS Directive opens the possibility of applying BCA in the EU. Bearing some resemblance to a BCA, the emissions associated with imported electricity have to comply with the California Cap-and-Trade Program in the same way as emissions from electricity generated in California. In another example more broadly on border tax adjustments, the United States imposed a tax on imports whose production relied on ozone-depleting chemicals but also provided a tax rebate to manufacturers or exporters of those very same products.198 The modeling of BCAs generally suggests that BCAs would be effective in reducing leakage. However, the administrative difficulties associated with border adjustments may be substantial.199 Accounting for emissions embodied in the products and services imported from different places can be complex,200 although some say it is “administrable.”201 Considerable administrative challenges can arise from the fact that the legislator introducing BCAs has no jurisdictional reach to assure accurate measurement of emissions in third party companies, while practical experience has shown that accurate monitoring, reporting and third party verification of emissions is absolutely crucial for a well-functioning carbon market. BCAs may be easier to introduce in sectors with relatively homogenous products, such as cement.202 An alternative, simpler approach has been proposed: to impose a blanket tariff on all goods imported from non-participating countries without linking these tariffs to embedded emissions, to encourage third countries to join the “climate policy club.”203 Legal considerations will influence any design but many commentators suggest these considerations will not represent an insuperable barrier. World Trade Organization requirements might possibly be met if BCAs demonstrate their effectiveness at reducing emissions rather than at addressing carbon leakage.204 Yet the political challenges may be as great, or greater, than any legal constraints, as demonstrated by the experience of the EU in seeking to establish a regime that bore some resemblance to a BCA in the civil aviation sector. Trade disputes can spill over to many areas of international relations, making BCA a very expensive policy for the affected parties. Some experts suggest that the larger the market power of a coalition of countries applying border adjustments, the more feasible the BCA will be. 198 J. Andrew Hoerner, The Role of Border Tax Adjustments in Environmental Taxation: Theory and U.S. Experience, Working Paper, March 19, 1988. 199 IFPRI, “Biofuels, Environment, and Food: The Story Gets More Complicated,” in 2011 Global Food Policy Report, 2012; Madison Condon and Ada Ignaciuk, Border Carbon Adjustment and International Trade: A Literature Review, OECD Trade and Environment Working Papers, October 31, 2013; WTO, European Union and Certain Member States – Certain Measures on the Importation and Marketing of Biodiesel and Measures Supporting the Biodiesel Industry: Request for Consultations by Argentina, WT/DS459/1, G/L/1027, G/SCM/D97/1,G/TRIMS/D/36, and G/TBT/D/44, 2013; Persson, 2010. ­ 200 IISD, A Guide for the Concerned: Guidance on the Elaboration and Implementation of Border Carbon Adjustment, November 21, 2012. 201 Bruce F. Davie, Border Adjustments for Environmental Excise Taxes: The U.S. Experience, January 8, 1995; J. Andrew Hoerner, The Role of Border Tax Adjustments in Environmental Taxation: Theory and U.S. Experience. ­ 202 Dieter Helm, Cameron Hepburn, and Giovanni Ruta, “Trade, Climate Change, and the Political Game Theory of Border Carbon Adjustments,” Oxford Review of Economic Policy Vol 28, Issue 2 (2012): 368–394. 203 Nordhaus, W., “Climate Clubs: Overcoming Free-riding in International Climate Policy”, American Economic Review, 105(4): 1339–1370, 2015. 204 Stéphanie Monjon and Philippe Quirion, “A Border Adjustment for the EU ETS: Reconciling WTO Rules and Capacity to Tackle Carbon Leakage,” Climate Policy Vol 11, Issue 5 (September 2011): 1212–1225. 79 GLOSSARY Annex I (Parties) The industrialized countries listed in Annex I to the UNFCCC were committed to return their GHG emissions to 1990 levels by 2000. They currently include Australia, Austria, Belarus, Belgium, Bulgaria, Canada, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Monaco, the Netherlands, New Zealand, Norway, Poland, Portugal, Romania, the Russian Federation, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, Ukraine, the United Kingdom, and the United States, as well as the European Union. Assigned Amount Annex I Parties are issued AAUs up to the level of their assigned amount, Unit (AAU) corresponding to the quantity of GHG they can release in accordance with the Kyoto Protocol (Article 3), during the first commitment period of that protocol (2008–12). One AAU represents the right to emit one metric ton of carbon dioxide equivalent. Backloading The European Commission’s temporary postponement of the auctioning of 900 million allowances from 2014–16 to 2019–20 by changing the auctioning timeline to rebalance supply and demand of emission allowances in the EU ETS in the short term. Banking or Carry over Compliance units under the various schemes to manage GHG emissions in existence may or may not be carried over from one commitment period to the next. Banking may encourage early action by mandated entities, depending on their current situation and their anticipation of future carbon constraints. In addition, banking brings market continuity. Banking between Phase I and Phase II of the EU ETS is not allowed; it is allowed between Phase II and further phases. Some restrictions on the amount of units that can be carried over may apply; for instance, EUAs may be banked with no restriction, while the amount of CERs that can be carried over by a Kyoto Party is limited to 2.5% of the assigned amount of each Party. 80 Baseline The emission of GHG that would occur without the policy intervention or project activity under consideration. Benchmarking Benchmarking is used to compare the operations of one company with those of others, with the industry average, or with best practice, to determine whether they have opportunities to improve energy efficiency or reduce GHG emissions. In the EU ETS, for example, free allocation is carried out on the basis of ambitious benchmarks of GHG emissions performance. These benchmarks reward best practice in low-emission production. Cap-and-Trade Cap-and-trade schemes set a desired maximum ceiling for emissions (or cap) and let the market determine the price for keeping emissions within that cap. To comply with their emission targets at least cost, regulated entities can either opt for internal abatement measures or acquire allowances or emission reductions in the carbon market, depending on the relative costs of these options. Carbon Dioxide The universal unit of measurement used to indicate the global warming potential Equivalent (CO2e) ­ of each of the six GHGs regulated under the Kyoto Protocol. Carbon dioxide—a naturally occurring gas that is a by-product of burning fossil fuels and biomass, land use changes, and other industrial processes—is the reference gas against which the other GHG are measured, using their global warming potential. Carbon Finance Resources provided to activities generating (or expected to generate) GHG emission reductions through the transaction of such emission reductions. Carbon Leakage Shift in CO2 emissions from countries taking stringent actions to countries taking less stringent mitigation actions. Carbon tax A tax that explicitly states a price on carbon or that uses a metric directly based on carbon (that is, price per tCO2e). Cost Containment A pool of CO2 allowances, established by the RGGI states and replenished at Reserve (CCR) the start of each calendar year, which creates a fixed, additional supply of CO2 allowances that are only available for sale if CO2 allowance prices exceed certain prices levels. Certified Emission A unit of GHG emission reductions issued pursuant to the Clean Development Reduction (CER) Mechanism of the Kyoto Protocol and measured in metric tons of carbon dioxide equivalent. One CER represents a reduction in GHG emissions of one metric ton of carbon dioxide equivalent. Chinese Certified The NDRC issued rules to regulate the voluntary emission reduction credits Emission Reduction market in China, in the form of CCERs, in June 2012. These will be issued in (CCER) units of tCO2e, and will include CO2, CH4, N2O, HFCs, PFCs, and SF6. 81 Glossary Clean Development The mechanism provided by Article 12 of the Kyoto Protocol, designed to assist Mechanism (CDM) developing countries in achieving sustainable development by allowing entities from Annex I Parties to participate in low-carbon projects and obtain CERs in return. Conference of the The supreme body of the UNFCCC. It currently meets once a year to review the Parties (COP) UNFCCC‘s progress. The word „conference“ is not used here in the sense of „meeting“ but rather of „association,“ which explains the seemingly redundant expression „fourth session of the Conference of the Parties.“ Conference of the The UNFCCC’s supreme body is the COP, which serves as the meeting of the Parties Serving as the Parties to the Kyoto Protocol. The sessions of the COP and the CMP are held Meeting of the Parties during the same period to reduce costs and improve coordination between the (CMP) UNFCCC and the Kyoto Protocol. Emission Reduction The measurable reduction of release of GHG into the atmosphere from a specified activity, and a specified period. Emission Reduction A unit of emission reductions issued pursuant to Joint Implementation. One ERU Unit (ERU) represents the right to emit one metric ton of carbon dioxide equivalent. Emissions Trading Emissions Trading Scheme (ETS): See cap-and-trade. Scheme (ETS) European Union The allowances in use under the EU ETS. An EUA unit is equal to one metric ton Allowance (EUA) ­ of carbon dioxide equivalent. First Commitment The 5-year period, from 2008 to 2012, during which industrialized countries Period under the ­ committed to collectively reduce their GHG emissions by an average of 5.2% ­ Kyoto Protocol (CP1) compared with 1990 emissions under the Kyoto Protocol. Framework for Defined at COP 17 in Durban, general framework at the UNFCCC level that allows Various Approaches ­ various approaches—including opportunities for using markets to enhance the (FVA) cost effectiveness of mitigation actions and promote their use, bearing in mind the different circumstances of developed and developing countries—which must meet standards that deliver real, permanent, additional and verified mitigation outcomes, avoid double counting of effort, and achieve a net decrease and/or avoidance of GHG emissions. Greenhouse Gas Both natural and anthropogenic, GHGs trap heat in the Earth’s atmosphere, (GHG) causing the greenhouse effect. Water vapor (H2O), carbon dioxide (CO2), nitrous oxide (N2O), methane (CH4), and ozone (O3) are the primary GHGs. The emission of GHGs through human activities (such as fossil fuel combustion and deforestation) and their accumulation in the atmosphere are responsible for an additional forcing, contributing to climate change. 82 ­ ationally Intended N Sets the climate actions (mitigation and adaptation) that a country intends to take Determined under the new international agreement to be negotiated under the UNFCCC in Contribution (INDC) ­ Paris in December 2015. Internal carbon price A price on GHG emissions that a company uses internally to guide its business decisions. Joint Implementation Mechanism provided by Article 6 of the Kyoto Protocol whereby entities from (JI) Annex I Parties may participate in low-carbon projects hosted in Annex I countries and obtain Emission Reduction Units (ERUs) in return. Kyoto GHGs The Kyoto Protocol regulates six GHGs: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6). Kyoto Mechanisms The three so-called flexibility mechanisms that may be used by Annex I Parties to the Kyoto Protocol to fulfill their commitments. These are Joint Implementation (JI, Article 6), the Clean Development Mechanism (CDM, Article 12), and International Emissions Trading (Article 17). Kyoto Protocol Protocol that commits industrialized country signatories to collectively reduce their GHG emissions by at least 5.2% below 1990 levels on average over 2008–12 while developing countries can take no-regret actions and participate voluntarily in emission reductions and removal activities through the CDM. It was adopted at the third Conference of the Parties to the UNFCCC held in Kyoto, Japan, in December 1997, and entered into force in February 2005. Appropriate Nationally ­ Refers to a set of mitigation policies and/or actions a developing country Mitigation Action undertakes aimed at reducing its GHG emissions and on which countries (NAMA) report to UNFCCC on a voluntary basis. NAMAs were defined in 2007 under the UNFCCC Bali Action Plan as “Nationally Appropriate Mitigation Actions by developing country Parties in the context of sustainable development, supported and enabled by technology, financing and capacity building, in a measurable, reportable and verifiable manner.” New Market-based New market-based mechanism to promote mitigation actions and enhance their Mechanism (NMM) cost effectiveness, bearing in mind different circumstances of developed and developing countries (as guided by decision 1/CP.18, paragraph 51); operating under the guidance and authority of the COP; defined at COP 17 in Durban. It may help developed countries meet part of their mitigation targets under the UNFCCC but should consider the principle of supplementarity. Offset Designates the emission reductions from project-based activities that can be used to meet compliance or corporate citizenship objectives vis-à-vis GHG mitigation. 83 Glossary Primary Transaction A transaction between the original owner (or issuer) of the carbon asset and a buyer. REDD Plus (REDD+) All activities that reduce emissions from deforestation and forest degradation and contribute to conservation, sustainable management of forests, and enhancement of forest carbon stocks. Registration The formal acceptance by the CDM Executive Board of a validated project as a CDM project activity. Results-Based Funding approach where payments are made only after predefined outputs or Finance (RBF) ­ outcomes, such as emission reductions, have been delivered and verified. Second Commitment The 8-year period, from 2013 through 2020, in which Annex I Parties to the Period under the Kyoto Protocol committed to reduce GHG emissions by at least 18% below Kyoto Protocol (CP2) ­ 1990 levels. The composition of Parties in the second commitment period is different from that in the first. Secondary A transaction where the seller is not the original owner (or issuer) of the carbon Transaction ­ asset. Supplementarity Following the Marrakesh Accords, the use of the Kyoto mechanisms shall be supplemental to domestic action, which shall thus constitute a significant element of the effort made by each Party to meet its commitment under the Kyoto Protocol. There is no quantitative limit, however, to the use of such mechanisms. Supplementarity also needs to be considered in the development of modalities and procedures for the UNFCCC NMM (Draft decision -/CP.18, para 51, February 28, 2013). Union Registry An online database that holds accounts for stationary installations that have been transferred from national registries, as well as accounts for aircraft operators, which have been included in the EU ETS since January 2012. The Union registry replaces EU member states’ national registries. Nations United ­ The international legal framework adopted in June 1992 at the Rio Earth Summit Framework ­ to address climate change. It commits the Parties to the UNFCCC to stabilize Convention on ­ ­ Climate human-induced GHG emissions at levels that would prevent dangerous, man- Change (UNFCCC) made interference with the climate system, following “common but differentiated responsibilities” based on “respective capabilities.” Validation The process of independent evaluation of a project activity by a Designated Operational Entity (DOE) against the requirements of the CDM. The CDM requirements include the CDM modalities and procedures, subsequent decisions by the CMP, and documents released by the CDM Executive Board. 84 Verification The review and ex-post determination by an independent third party of the monitored reductions in emissions generated by a registered CDM project or a determined JI project (or a project approved under another standard) during the verification period. Verified Emission A unit of GHG emission reductions that has been verified by an independent Reduction (VER) auditor. Most often, this designates emission reduction units that are traded on the voluntary market. Voluntary Carbon The market that caters to the needs of those entities that voluntarily decide Market to reduce their carbon footprint using offsets. The regulatory vacuum in some countries and the anticipation of imminent legislation on GHG emissions also motivates some pre-compliance activity. 85 Notes Notes 1818 H Street, NW Washington, DC 20433 USA www.carbonfinance.org