ensuring environmental integrity in linking ets systems penalties, banking, borrowing,

Ensuring environmental integrity in linking ETS systems

penalties, banking, borrowing, ...

Exploring the Challenges and Opportunities for

Establishing a North American Emissions Trading System

Chicago, 14-15 November 2007

Dian Phylipsen, Ecofys

Contents

• Who are we?

• Linking

– Types of linking, types of issues– Relevant characteristics in terms of environmental

integrity– Some examples of effects of linking different systems

• Price effects• Timing effects• Overlap effects

The sustainable energy solution

provider

The sustainable energy knowledge and

innovation company

The sustainable energy

project developer

The sustainable energysystem supplier

The sustainableenergy innovation

entrepreneur

The sustainablecredits originator

Energy in the Built Environment

Energy&CLimate Change Strategy

Sustainable Power & Fuels

Innovation in Energy Systems

We are one of the leading European consultant on EU ETS & carbon market• European Commission

– Mid-term review of the EU ETS– Monitoring & Reporting

Guidelines

• Governments

– Evaluation of all 25-27 NAPs– Consequences of the Linking

Directive for domestic emission reductions

– Development of NAP Romania– Role of small installations– Feasibility of benchmarking in

Phase III EU ETS– Evaluation of NZ domestic

offset scheme PRE

• Corporates

– ETS capacity building – Development of marginal

abatement cost curves for refineries (Shell)

– Carbon management projects (GlaxoSmithKline, YAM, breweries)

– Development, verification of monitoring plans (various energy companies)

• others

– Assess of shortage in Phase II ETS and use of JI/CDM (WWF)

– Development of ideal NAP for France (Greenpeace)

– Market assessments (various financial institutions)

First agreement on linking ETS reached!• “The European Commission announced today that it

has come to an agreement with the countries in the European Economic Area on linking their respective Emissions Trading systems, making it the first international agreement of its kind for emissions trading. The newly linked systems will cover 30 countries across the European continent.”

• Announced 26 October 2007

• Linking EU ETS with Norway, Iceland and Liechtenstein

• EC will ‘assist EFTA surveillance Authority in assessment of EEA allocation plans’ using EU methodology

Linking is good, but…

• European context:

– Alternative to ETS was climate change policy without the flexibility of trading

• Objective EU ETS is ‘… emission reductions …’ + ‘..cost-effective and economically efficient way …’

• Central issue is maintaining a sufficient carbon price to drive emission reductions

• ‘Smaller’ design elements can have a big impact on this!

Environmental integrity & linking

• Direct linking

– Mutual recognition of each others currencies (allowances, credits)

• Indirect linking

– Through JI/CDM, other offset projects– Through financial markets (swaps, derivatives)

• Distinguish between

– Linking 2 or more parallel systems– Overlap of systems (regional – national)– Effects of parallel systems without linking

Important characteristics in linking

• Type of target – absolute or relative

• Price cap

• Penalties

– Financial penalty– Make-good provision!

• Banking & borrowing

• Additionality of offsets

• Overlap with project-based credits

Types of issues

• Issue of parallel systems, not linking:

– Sector coverage– New entrants

• ‘Technical issues’

– Registries– Monitoring, reporting, verification

• Other issues are political

– Certainty on environmental outcome– Limitation of impacts on/flexibility for industry

No different in North America

than in EU!

Communicating valves

• Even if systems are only linked through JI/CDM (& offsets), they will act as communicating valves, with carbon allowances/credits flowing to

– System with highest carbon price – System with highest shortage– Least flexibility in terms of type of cap, time horizon

• Not one-on-one relationship

– Longer term strategy– Transaction cost– Lack of knowledge– Uncertainty about future developments in both systems– ‘Local sentiments’

Price - Example – linking US – EU ETS

NEA c

Mc-L system: in balance

Plants in EU ETS: 100Mt short

penalty= E100/t + purchase @~ 20E/t (or $7)

$15.7 - 18 billion

Penalty =3x market price ($5-7)$2.1 billion

Emissions increase!

0

500

1000

1500

2000

2500

Av. Cap PhaseI

Ver 2005emissions

Prop cap Phase II

'Official' BaU Ecofys BaU Final cap PhaseII

max JI/CDM use

Phase I

Phase II

-370 -160-335 240

2080

shortage = 130Mt - 80Mt

NB: Phase I scope was narrower than Phase II

Aviation inclusion!

Up to 150Mt additional shortage?

Also without linking to EU ETS

• If North American systems recognise JI/CDM credits, EU ETS is likely to offer significantly higher prices for CERs

– Current prices 15-17 Euro/t (secondary CERs)– Typically 75-85% of Phase II EAU prices– Unattractive alternative in systems with expected prices

$5-7

Banking – borrowing - timelines

• System that allows banking, can become ‘dumping ground’ of excess allowances of systems that do not

• Similar effects occur when systems with different timelines are linked

Options to limit effects:

• Limited banking - quantitative, vintage

• Banking at a cost, discount

• Build in ‘grace period’?

– Not allow banking in the first period systems are linked, only after a certain period when excess/shortage is clear

Company F

Company E

Company D

Company C

Company B

Banking in part of the system

Company A

Party X Party Y

Transactions

Transaction

Excess allowances

Ban

kin

g

Re-i

ssu

e

Sell back

Transfer AAUs

Emissions increase!

Borrowing

• Borrowing postpones the need to act

• Why act now, unless:

– It happens to coincide with natural investment cycle– There is certainty that future administrations won’t

change the rules…– There is certainty that future situation will be

significantly worse– Borrowing comes at a cost

• Linking systems that allow borrowing with those that do not may lead to increase in overall emissions

Company F

Company E

Company D

Company C

Company B

Borrowing in part of the system

Company A

Party X Party Y

Transactions

Transaction

Borr

ow

ing

Sell borrowed allowances

Transfer AAUs

Emissions increase!

Offsets

• Crucial issue:

– Are (system) emissions actually reduced?

• Additionality of offsets

• Double-counting of emission reductions

Additionality of offsets

• If projects ‘would have happened anyway’, offsets

– Create emission reduction credits– Allowing more emissions in the ETS– Without (proportionally) reducing emissions outside

• Additionality is by definition difficult to assess

• Build in safety margin?

• Linking systems with different additionality requirements may lead to differences in above effects

• Risk of double-counting if cap-and-trade systems and offset systems overlap (JI or other offsets)

• In EU, distinction made between ‘direct’ and ‘indirect’ projects

Direct projects Indirect projects

Overlapping systems - doublecounting

Example indirect project

• Wind park delivers electricity to grid

• Reduces emissions from fossil-fired power plants by 50,000t/a = 50,000 ERUs

• Fossil-fired power plants under EU ETS allocated on expected electricity production excl JI project

• Lower fossil-based electricity production because of wind park results in lower emissions

• Together fossil-fired plants have 50,000 EU allowances left over

Baseline

Start Project

2008 2012

Emissions from the Project

Emissions level

time

Carbon Credits

Conclusions

• Environmental integrity issues mostly political issue, not technical issue

• Smaller design elements can have a big impact, leading to increased emissions

• Important to take into account local situation, certainly in early phase

• Avoid big differences in these elements in systems to be linked

• Think about staged linking

• Otherwise, linking may do more harm than good– Only ‘low-cost’ part of objective reached, not the emission

reduction/limitation objective

Contact details

Dian Phylipsen

[email protected]

M: + 39 340 57 92 571

M: + 31 6 520 410 15

www.ecofys.com

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