Background Note Index

Background Note

Emissions - who is trading what?

Online Only 15 August 2008

Contents

 Introduction

Since the United Nations Framework Convention on Climate Change and the Kyoto Protocol to that Convention, came into force in 2005, emissions trading has been the preferred approach for any international efforts to control, and eventually reduce, greenhouse gas emissions. [1]

There are several emission trading schemes already in operation and others at the planning stage. The purpose of this note is to provide the reader with a brief overview of emissions trading, the types of trading schemes and an examination of existing and proposed schemes.

What is emissions trading?

Emissions trading schemes are based around the concept of setting a desired level of emissions and issuing a number of tradeable permits or allowances, allowing this level of emissions to be made. The number of tradeable permits is fixed, in effect limiting the total quantity of emissions that can be made in any one period. Tradeable permits are quotas, allowances or ceilings on emissions levels that, once allocated to an emitter, can be traded subject to a set of prescribed rules.

The ownership of a tradeable permit allows a firm to emit up to a prescribed limit. If the firm wishes to expand production and make emissions beyond that limit, then it must either invest in pollution control equipment or purchase more emission permits. Firms which choose to emit less than their allowance may sell their surplus permits to other firms or use them to offset excess emissions in other parts of the plant. Firms with the lowest abatement costs have an incentive to control more emissions, and those with high abatement costs have an incentive to buy permits instead of investing in costly pollution control equipment. The market is left to determine the most efficient way to control pollution within a regulatory framework. [2]

In her speech of 6 February 2008 , the Federal Minister for Climate Change and Water reinforced the current government’s intention to implement an emissions trading scheme in 2010. [3]

Types of emissions trading schemes

There are two types of emissions trading schemes—the ‘cap and trade’ or the ‘base line and credit’. A third alternative is the project based markets. While emission credits from this latter market may be traded, the project based schemes are not emissions trading schemes.

Cap and Trade

With the cap and trade approach, an aggregate cap (or limit) on emissions made within a particular area is established. This overall cap is progressively reduced over time towards the long term emissions target. Individual emitters are then given a limit on their particular emissions, within this overall cap. These emitters are then allowed to trade their permits amongst themselves and third party participants in a market, to either cover their emissions above their permitted limits, or to sell surplus permits. Third parties, such as financial institutions may buy surplus permits to sell at a later date.

The cap and trade approach is by far the most popular and is the approach proposed for an Australia emissions trading scheme. [4]

Baseline and credit

An alternative approach is a baseline and credit system. The important difference with this approach is that emitters are not under a strict aggregate emissions cap. Rather, they are required to purchase offsetting emission credits. These credits are created by firms or development projects that either reduce the amount of overall emissions or destroy/absorb existing emissions.

Many of the criticisms of emissions trading are aimed at baseline and credit programs and there is only one such scheme in operation worldwide, the NSW Greenhouse Gas Reduction Scheme.

Project based markets

A feature of the Kyoto Protocol was the development of the so called ‘flexible’ mechanisms. These mechanisms are approaches designed to lower the overall cost of reducing, or offsetting, unwanted emissions.

The three flexible mechanisms are emissions trading (see above), Clean Development Mechanism and Joint Implementation Projects. Generally, use of these mechanisms is only open to countries that have ratified the Kyoto Protocol. The emission reduction credits generated by these projects are used by individual countries to offset their emissions on a national scale.

The Clean Development Mechanism (CDM) is an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment to invest in projects that reduce, or destroy emissions in developing countries, as an alternative to more expensive emission reductions in their own countries. An example would be investment in a project that, as a part of its activity, collects methane and uses it to generate electricity. [5] Currently, China hosts the greatest number of CDM projects.

A Joint Implementation Project (JI) is similar to CDM save that the investment is in another country that also has emission reduction obligations under the Kyoto Protocol. A JI project might involve, for example, replacing a coal-fired power plant with a more efficient combined heat and power plant. Most JI projects are expected to take place in so-called ‘economies in transition,’ noted in Annex B of the Kyoto Protocol. Currently Russia and Ukraine appear to host the greatest number of JI projects.

Some outstanding issues

There are several important issues for an Australian scheme, namely the method for the allocation of permits (that is whether they are allocated to emitters free of charge or auctioned) and whether any compensation will be given to certain emitters (i.e. power stations and mineral processing facilities) for the additional costs incurred as a result of the introduction of emissions trading.

Another important issue is the ability of scheme participants to save their permits/credits for later use or sale. This is often referred to as the ability to ‘bank’ an emissions permit. For example, in the first trading period of the European Emissions Trading Scheme participants could not save their emissions permits for use beyond December 2007. They could not ‘bank’ the permits beyond that date.

The recent government Carbon Pollution Control Scheme Green Paper notes their preferred position on these matters. [6] This paper simply notes the features of existing emissions trading schemes on these particular issues.

Existing Trading Systems

There are a number of emissions trading systems currently operating. To date these schemes trade permits covering only carbon dixiode (CO2) emissions or other greenhouse gases. No currently operating scheme trades permits covering all six major greenhouse gases. [7]

The United States has the largest number of current and proposed systems. The largest currently operating system is the European Emissions Trading System. However, the CDM and JI mechanisms are also large and a growing source of emission credits that may be traded. Table 1 shows the extent of trading activity of the major schemes and Table 2 in Attachment 1 outlines the basic features of these, and other, emissions trading schemes.

Table 1: Carbon markets at a glance – estimated volumes and values 2006 and 2007

Source: K. Capoor and P. Ambrosi [9]

In the above table, the term ‘secondary CDM’ refers to the emission credits generated by the CDM mechanism traded on formal secondary markets.

Voluntary Schemes

In addition to the above mentioned schemes there are a number of established emission trading exchanges. For example, the Australian Climate Exchange (ACX) commenced operation in July of 2007 and trades government accredited emission credits. Recently, emission credits arising from a CDM project have also been traded on this exchange. [10] Activity on the ACX has been limited so far, with an estimated 6300 tonnes of carbon dioxide  traded since July 2007 for an average price of $US7.42 ($A7.74) per tonne. [11] Other examples include the European Climate Exchange, the above mentioned Chicago Exchange and the Asian Carbon Market.

Further, individual companies appear to be undertaking private, over the counter, exchanges with banks or other financial institutions. For example, the Australian energy company, AGL has recently sold 10 000 ‘Australian Emissions Trading Units’ to Westpac Banking Corporation at about $A19 per unit. [12]

Together, these kinds of transactions comprise the voluntary carbon market. In Australia at least, this market is growing in the lead-up to the proposed Australian Emissions Trading Scheme’s commencement in 2010. [13]

Company based schemes

Both BP and Shell Petroleum have operated company wide emissions trading schemes since 1998. The gases targeted are carbon dixoide and some industrial gases from the operations of these companies around the world. The allocation of emissions permits is based on emission levels in 1998. Modest reductions in emissions have been achieved by these schemes. [14]

Proposed Trading Schemes

In addition to the currently operating emissions trading schemes, a number of countries, states and territories, have stated their intention to establish emissions trading schemes.

Australia

As noted above, Australia is currently in the process of designing its own national emissions trading scheme. The government intends that it will commence operation on 1 July 2010.

New Zealand

In early December 2007, the New Zealand Government introduced into Parliament the Climate Change (Emissions Trading and Renewable Preference) Bill 2008 [15] to provide the statutory framework for a New Zealand Emissions Trading Scheme and to create a preference for electricity generated by renewable sources. The Bill was referred to the New Zealand Parliament’s Finance and Expenditure Committee, which reported on 16 June 2008 . As at the date of writing, the Bill is still before the New Zealand Parliament. The Government is currently negotiating with the minority political parties (New Zealand First, United Future, the Greens and the Maori Party) to elicit support for the Bill. This process is expected to take a few weeks. [16]

United States

In the United States (US) at least 8 major pieces of legislation have been introduced in the current 110th Congress that would require greenhouse gas (GHG) reductions and establish an emissions trading program. [17] Of these, the America’s Climate Security Act (sponsored by Senator Lieberman and Senator Warner ) and the Low Carbon Economy Act (sponsored by Senator Bingaman and Senator Specter ) appear to have the most significant political support. [18] On 2 June 2008 the bill sponsored by Senator Lieberman and Senator Warner (S.3036) was considered by the US Senate. [19] The result of the vote was that this particular bill will be considered again by the US Congress in 2009. It should be kept in mind that even if the above proposed bill are passed by the US Congress they have to be signed by the US President to become law. Both presumptive US Presidential nominees are reported as supporting the Lieberman-Warner bill. [20]

The upshot of this congressional attention is that the establishment of a national comprehensive greenhouse gas emissions trading scheme in the United States is now a significant item on that country’s political agenda.

Regionally, a number of US states and Canadian provinces may set up their own emissions trading systems on either a voluntarily or mandatory basis. These proposed schemes are:

• the regional Greenhouse Gas Initative covering a number of North East US states; [21]
• six US states and Manitoba made an agreement known as the Midwestern Greenhouse Gas Accord (MGGA) which was announced on 15 November 2007, although the program’s targets will not be finalised until July 2008, [22] and
• in the west of North America , seven states and the Provinces of British Columbia and Manitoba are participating in the Western Climate Initiative (WCI), in which the aggregate emissions target, calculated on individual states’ separate GHG targets, is 15 per cent below 2005 levels by 2020. [23]

Finally, there are two mandatory US emissions trading schemes set to take effect in coming years:

• the Clean Air Interstate rule will seek to reduce nitrous oxide and sulphur dioxide emissions from the electricity generation sector in 28 eastern states from 2009 onwards, [24] and
• the Clean Air Mercury Rule will seek to reduce mercury dioxide emissions throughout the US from 2010 onwards. [25]

Just how these proposed regional and national schemes will fit with any national scheme (let alone the possible participation of Canadian provinces and possibly Mexican states) has yet to be determined.

Canada

The proposed Canadian emissions trading system for greenhouse gases that will be part of the regulatory framework will have a number of components:

• the central component will be a domestic inter-firm trading system, through which regulated firms may buy and sell emission credits amongst themselves.
• a domestic offset system will allow regulated firms to invest in verified emission reductions outside the regulated system.

In addition, Canadian firms will have access to certain qualifying credits from the Kyoto Protocol's Clean Development Mechanism for compliance with the regulations. [26]

Switzerland

In Switzerland , companies may opt for emissions trading in lieu of a carbon tax; in the event of non-compliance, the carbon-tax is to be paid. This scheme is to be introduced in mid 2008 and will be linked to both the EETS and also the United Nations Clean Development Mechanism/Joint Implementation Projects credits. [27]

Japan

Japan is reportedly finalising the details of its own national mandatory emissions trading system. [28]

Attachment 1: Table 2 – Significant operating emissions trading scheme

[1] .    A. D. Ellerman and B. K. Buchner, ‘The European Union Emissions Trading Scheme: origins, allocations and early results’, Review of Environmental Economics and Policy, vol. 1, no. 1, winter 2007, Oxford University Press, Oxford, p. 76.

[2] .    Stewart Smith, ‘Greenhouse Gas Emissions Trading’, Briefing Paper, no. 02/07, NSW Parliamentary Research Service, Sydney , 2007, p.1.

[3] .    Senator the Hon. Penny Wong, (Minister for Climate Change and Water), Climate change: a responsibility agenda, media release, Parliament House, Canberra , 6 February 2008.

[4] .    Stewart Smith, op. cit., p. ?

[5] .    For example a pig farmer in the Philippines captures the methane from animal waste and converts it into electricity. He receives finance for the development of this system from an emitting country or an emissions trader. The farmer receives ongoing payments for emissions credits generated by the methane collected and the electricity generated by this renewable low emission source. The energy trader then ‘on sells’ the credits created, or the developing country uses the credits to balance their emissions. See M. Gunther , ‘Carbon finance comes of age’, Fortune Magazine, 28 April 2008 , p. 56, http://money.cnn.com/2008/04/15/technology/Gunther_carbon_finance.fortune/index.htm accessed on 31 July 2008 .

[6] .    Senator the Hon. Penny Wong, (Minister for Climate Change and Water), Green paper on carbon pollution reduction scheme released, media release, Parliament House, Canberra, 16 July 2008.

[7] .     The main human-produced greenhouse gases dealt with under the Kyoto Protocol are carbon dioxide (C02), methane (CH4), nitrous oxide (N20), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF6).

[8] .    Mt CO2 is million tonnes of carbon dioxide

[9] .    K. Capoor and P. Ambrosi, State and trends of the carbon market 2008, World Bank Institute, Washington, D.C., May 2008, p. 1.

[10] . Australian Climate Exchange, VER+ offsets from Russian project traded within 24 hours of listing, media release, 2 May 2008 , http://www.climateexchange.com.au/Content/Publications.aspx?article=76, accessed on 4 August 2008 .

[11] . Capoor and Ambrosi, op. cit., p. 17. On 29 July 2008 the average price in $A was 7.74.

[12] . J. Breusch, ‘ AGL test drives carbon trading scheme’, Australian Financial Review, 20 May 2008 , p. 8. No information is currently available on what might constitute an ‘Australian Emissions Trading Unit’.

[13] . Capoor and Ambrosi, op. cit., p. ? and K. Walters , ‘Out of the ashes’, Business Review Weekly, v. 30, no. 15, 17–23 April 2008, p.?.

[14] . C. Boemare and P. Quiron, ‘Implementing greenhouse gas trading in Europe: lessons from economic literature and international experience’, Ecological Economics, v. 43, no. 2–3, 2002, pp. 213–230.

[15] . http://www.parliament.nz/en-NZ/PB/Legislation/Bills/c/0/4/00DBHOH_BILL8368_1-Climate-Change-Emissions-Trading-and-Renewable.htm, accessed on 4 August 2008 .

[16] .  DLA Phillips Fox, News and Publications, Progress on the NZ Climate Change (Emissions Trading and Renewable Preference) Bill, 4 July 2008.

[17] . By number these bills are S.280, S.317, S.1766, S.2191, S.3036, HR.620, HR.1590 & HR.4226.

[18] . Capoor and Ambrosi, op. cit., p. 53. See also L. Parker and B. D. Yacobucci, ‘Climate change: greenhouse gas reduction bills in the 110^th Congress’, Congressional Research Service, Washington, D.C., 24 April 2007, http://fpc.state.gov/documents/organization/84939.pdf, accessed on 4 August 2008.

[19] . See US Senate ‘vote #141’ on 2 June 2008 . A so-called ‘cloture motion’ was agreed to. A cloture vote tests whether members of Congress are ready to end debate and proceed to a vote. Failure to achieve cloture usually indicate a bill's future is dim. A vote in favour of cloture is in favour of voting on the legislation itself. A vote against is a vote to stall the bill. This bill achieved cloture on 2 June 2008 . This means that the bill in question is to be considered further, before a final vote is taken. For the first time a majority of US Senators voted to progress this issue, albeit in 2009. Sources: E. Pooley, ‘Why the climate bill failed’, Time, 9 June 2008 and GovTrack website, accessed on 29 July 2008 .

[20] . A. Duncan, ‘US Senate Climate Bill fails to get enough votes to move forward’, Platts Online Newsletter, 6 June 2008 and Environmental Defence Fund, Majority of Senate voices support for progress on comprehensive climate change bill, media release, 6 June 2008.

[21] . The Regional Greenhouse Gas Initiative (RGGI) was established in December 2005 by the governors of Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont. Massachusetts , Rhode Island and Maryland have also joined RGGI. The District of Columbia, Pennsylvania, the Eastern Canadian Provinces and New Brunswick are participating as observers. See the Regional Greenhouse Gas Initiative website, accessed on 13 May 2008.

[22] . The Midwestern Greenhouse Gas Accord (MGGA) includes Illinois , Iowa , Kansas , Manitoba , Michigan , Minnesota and Wisconsin as participants. Indiana , Ohio , and South Dakota are participating as observers. See Midwestern Governors Association, Governors sign Energy Security and Climate Stewardship Platform and Greenhouse Gas Accord, media release, November 2007, http://www.midwesterngovernors.org/govenergynov.htm, accessed on 4 August 2008 .

[23] . The Western Climate Initiative (originally the Western Regional Climate Action Initiative) was established in August 2007 by the governors of Arizona , California , New Mexico , Oregon and Washington . Utah , British Columbia , Manitoba , and Montana have also joined the WCI. Alaska , Chihuahua , Coahuila , Colorado , Kansas , Nevada , Nuevo Leon, Ontario, Quebec , Saskatchewan , Sonora , Tamaulipas and Wyoming are participating as observers. See Western Climate Initiative website, http://www.westernclimateinitiative.org/, accessed on 13 May 2008.

[24] . D. Harrison , P. Klevnas, A. L. Nichols & D. Radov, ‘Using emissions trading to combat climate change: programs and key issues’, Environmental Law Reporter, v 6, 2008, p.??.

[25] . ibid.

[26] . The Hon. John Baird (Minister of the Environment), Canada's new government announces mandatory industrial targets to tackle climate change and reduce air pollution, media release, 26 April 2007, http://www.ec.gc.ca/default.asp?lang=En&n=714D9AAE-1&news=4F2292E9-3EFF-48D3-A7E4-CEFA05D70C21, accessed on 4 August 2008 and Backgrounder: domestic emissions trading for greenhouse gases, 26 April 2007,, http://www.ec.gc.ca/default.asp?lang=En&n=714D9AAE-1&news=00A362E1-A98E-4D5C-9997-8FB7AF9ECF2C, accessed on 4 August 2008.

[27] . Point Carbon, ‘Switzerland to set up ETS from 2008’, 3 June 2005, http://www.ieta.org/ieta/www/pages/index.php?IdSitePage=698, accessed on 4 August 2008 . This is a dated report. However, Capoor and Ambrosi, op. cit., p. 49 note that this scheme is still set to commence in mid 2008.

[28] . Capoor and Ambrosi, op. cit., p. 49; Takashi Hirokawa and Shigeru Sato, ‘Japan considers launch of ‘cap-and-trade’ emission structure’, Bloomberg News, 20 February 2008, http://www.bloomberg.com/apps/news?pid=20601101&sid=aksNMTy7WtHs&refer=japan, accessed on 4 August 2008, and R. Maeda and E. Graham-Harrison, ‘Japan industry opens door to carbon cap-and-trade’, Reuters, 21 February 2008, http://www.reuters.com/article/latestCrisis/idUST20438, accessed on 4 August 2008

[29] . For further information see New South Wales Government, Greenhouse Gas Reduction Scheme, accessed on 9 May 2008 .

[30] . GGAS scheme glossary, http://greenhousegas.nsw.gov.au/documents/SchGloss.pdf, accessed on 6 August 2008.

[31] .  For further information see EurActive.com, EU Emissions Trading Scheme, accessed on 12 May 2008.

[32] . Questions and answers on the Commission's proposal to revise the EU Emissions Trading System, media release, 23 January 2008, http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/35&format=HTML&aged=0&language=EN&guiLanguage=en, accessed on 6 August 2008.

[33] . Information sources: Tomonori Sudo,  ‘Japanese Voluntary Emissions Trading Scheme (JVETS)—overview and analysis’, presentation to the US-Japan Workshop on climate actions and co-benefit, 22–23 March 2006; Seiji Ikkatai,  ‘Japans voluntary emissions trading Scheme’, presentation to the second German-Japanese workshop on economic instruments for climate protection, Berlin 31 March–1 February 2007; and Yasushi Ninomiya, ‘Recent developments in Japan's domestic carbon market’, presentation to OECC/IETA Carbon Finance Event, Bali, Indonesia, 7 December 2007.

[34] . For further information see U S Environmental Protection Agency, Acid Rain Program, accessed on 8 May 2008.

[35] . For further information see US State of Illinois, Illinois Environmental Protection Agency, Emissions market reduction system—a brief overview, accessed on 12 May 2008.

[36] . For further information see ‘Chicago Climate Exchange—Overview’, accessed on 12 May 2008.

[37] . See Harrison, Klevnas, Nichols and Radov, op. cit. and Boemare and Quiron, op. cit.

[38] . ibid.

[39] . For further information see United Nations Framework Convention on Climate Change, ‘Clean Development Mechanism’ website, accessed on 20 May 2008.

[40] . For further information see United Nations Framework Convention on Climate Change, Joint Implementation Projects website, accessed on 13 May 2008.

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