Implementing Emission trading the EU experience
Climate Change Summit, March 2009Johannesburg
Karsten NeuhoffFaculty of EconomicsCambridge University
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Outline
• The benefit of an economic instrument
• EU experience with implementing ETS– First cap setting, then allocation– Dealing with uncertainty of emission projections– Repeated free allowance allocation creates
perverse incentives– Carbon leakage – can be addressed
• Emission trading is part of the policy mix
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Companies do respond to EU ETS quotes from the submission of large EU utility
• Establishment and operation of EU ETS have successfully created a truly European market for CO2 allowances.
• concerted emission reduction policies are required.• shift to a low-carbon economy is possible. • supports the further development and wider use of
market-based mechanisms to achieve this change. • A well-functioning EU ETS is the most efficient
method to effectively incentivise companies to invest in the required cleaner technologies.
Source: E.ON submission to EU ETS review
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Price signal + institutional framework can deliver change:Dash for gas in UK power generation
Source: 1960-1997 DTI Energy statistics, Fuel consumption for power generation, transformed to output using 1998 average efficiencies, 1998-2005 DTI Energy statistics, Power generated, Projections based on Survey among participants on Futuer generation technologies workshop (asking for demand evolution and generation shares), Cambridge 2003
GWh
0
50
100
150
200
1960 1980 2000
Coal
Oil Nuclear
Gas
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After 2 bad experiences with joint cap setting & allocation -> Europe now first sets cap, then allocates
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0
500
1000
1500
2000
2500
2005 2008 2009 2010 2011 2012
MtCO2/year
Verified Emissions
NAP II + (JI/CDM range)
Avg. 2008-12
Final NAP II***
Max projection
Min Projection
20% projections60%projections
Adjustments for opt-in in Phase II
88125
Other Adjustments*
Proposed NAP II**
Emission projections are intrinsically uncertain
Source: Emissions Projections 2008-2012 versus NAP2 (2006) by Karsten Neuhoff, Federico Ferrario and Michael Grubb. Published in Climate Policy 6(5), pp 395-410.
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Several options could be explored to retain strong carbon price in a world with uncertainty
• Banking– Was excluded between phase I and phase II
– Difficult in current financial situation (in Europe)
• Reserve price in auctions– Requires significant auction volume
• Linking with other scheme– Bigger market – smaller uncertainty
– Requires scarcity in joint market
– Requires trust of all market participants in implementation
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oldcoal
gas • Energy efficiency • Low-carbon technology
Co
st
newcoal
Production
cost
The effect of carbon pricing – example power sector
CO2 Cost
efficient production
choice of the best input
appropriate use of output
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Does allocation matter for efficiency … the history
• Initially based on US experience SO2/NOx
– One off allocation to existing installations
– Based on historic reported data
– In many ways close to economic text book model
• But differences for EU scheme emerged soon– Scientific/political/economic constraints on setting targets
for more than 10-15 years
– CO2 allowances value order of magnitude bigger
-> repeated shorter-term allocation
-> (opportunity) cost pass through - free allocation?
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Au
ctio
n /
Gra
nd
fath
erin
g
Uniform updating
Un
iform
up
datin
gF
uel
sp
eci
fic u
pd
atin
g
Fuel specific updating
Em
issi
on
bas
ed
allo
catio
n
Emission based allocation
oldcoal
gas energyefficiency
Co
st
newcoal
Production
cost
Distortions from repeated free allocation … the experience
CO2 Cost
efficient production
choice of the best input
appropriate use of output
+ reduced incentives for low carbon innovation
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EU phase I, II: High level of free allocation & distortionEU post 2012 -> full auctioning in power sector
0,0
0,2
0,4
0,6
0,8
1,0
1,2
AT*
BE - WBE -
F
BE - B CY DE
ES* FIFR
HU* IE IT*
LV MT NL PL SE SK UK EE LU SI
CZ**DK** GR LT PT
mil. EUA
Hard Coal Plant
Natural Gas Plant
No detailed provisions
Analysis to be done or
No Translation available
NAP II not
available yet
Model Coal power station, 6000h,33% efficiency
Model CCGT (gas), 6000h,45% efficiency
Comparison of National Allocation Plans for the Period 2008-2012, Karsten Neuhoff, Markus Åhman, Regina Betz, Johanna Cludius, Federico Ferrario, Kristina Holmgren, Gabriella Pal, Michael Grubb, Felix Matthes, Karoline Rogge, Misato Sato, Joachim Schleich, Jos Sijm, Andreas Tuerk, Claudia Kettner, Neil Walker
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Pyramid of distortions – summary of experience from phase I of EU ETS
Excess carbon-intensive capacity
Inefficient fuel choice
Less energy-efficiency investment
Distortions
AuctionCapacity X
Capacity and technology X XHistoric output X X
Historic output and technology X X XHistoric emissions X X X X
Discourage cl
osure of p
lants
Discourage cl
osure of in
efficient p
lant
Increase
operation of in
efficient p
lants
Reduce in
centiv
es for
Efficiency
-improvin
g inve
stment
Allocation method
Distortions increase emissions and/or price impacts
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C
ost
incr
eas
e r
ela
tive
to v
alu
e a
dde
d
Ce
me
nt
Ba
sic
iron
& s
tee
l
Lime
Fertilisers & Nitrogen
Alu
min
ium
Other inorganicbasic chemicals
Pulp &Paper
Malt
Coke oven
Industrial gases
Non-wovens
Refined petroleum
Household paper
Hollow glass
Finishing of textiles
Rubber tyres & tubes manufact.
Copper
Casting of ironImpact from direct emissions
Impact from indirect emissions (electricity)
Flat glass
Veneer sheets
0%
10%
20%
30%
40%
0.0% 0.2% 0.4% 0.6% 0.8%1.0%
4%2%
Starches& starch products
Preparation of yarn
Other textile weaving
Retreading/rebuilding tyres
Identify activities with risk of leakage
Share of GDP of UK
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Basic options to address leakage for exposed sectors
Price level
CO2
costs
Price levelPrice level
CO2
costsCO2
costs
Cos
t
Cos
tC
ost
Government ledsectoral agreement
Export taxes Border adjustment
Cos
t
Export taxes Border adjustmentExport taxes Border adjustment
Conditionalfree allocationState aid
•Little substitution to low carbon products/services
•Distorts investment•Bureaucratic constraints for innovation
•Risk of lock-in
•Has to be aligned with international climate engagement
•Requires at least informal international cooperation
•Requires strong policies of developing countries
•Risk of low common denominator
Initial evaluation
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A carbon price works through the value chain. This can be supported by policies that address leakage.
Clinker Cement Concrete Building
Other building materials
LeanerstructuresLower clinker
content
Sub
stitu
tion
Clinkerimports
Cement imports
Leak
age
Efficiency
Some leakage • Without measures • With unconditional allocation
Forgone substitution/innovation• Without measures• With free allocation
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Summary
• The benefit of an economic instrument
• EU experience with implementing ETS– First cap setting, then allocation– Dealing with uncertainty of emission projections– Repeated free allowance allocation creates
perverse incentives– Carbon leakage – can be addressed
• Emission trading is part of the policy mix
Karsten Neuhoff
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Carbon pricing is one of the 3 pillars of climate policy. It internalises environmental costs and allows substitution away from Carbon intensive products towards more energy efficient and lower Carbon technologies.
1. Price CO2
2. Make credible commitments to targets
3. (Raise funds for international mechanisms)
Inte
rnal
ise
CO
2 co
sts
in
dec
isio
ns
Climate policy
Tec
hn
olog
y In
nov
atio
n
1990th : Industry self-regulation Harmonised CO2 Tax
2003 Emissions Trading
Approaches
Market pull• Future potential for renewables• Central for complex sectors
Rem
ove
non-
mar
ket
bar
rier
s
How?
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Aspects to consider
• Flexibility with off-sets
• Linking of schemes
• The role of expectations
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Stern 2006 on uncertainty
The next 10 to 20 years … transition ... to [world] where carbon pricing is universal and is automatically factored into decision making. … avoid the risks of locking into a high-carbon infrastructure … additional measures may be justified to reduce the risks."
Karsten Neuhoff
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Outline
• The benefit of an economic instrument
• Issues to consider– Repeated free allowance allocation– Carbon leakage– Emission projection
• Emission trading as part of the policy mix
Karsten Neuhoff
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Tax versus tradeTax Trade
Investment security for efficiency improvements
Policy process ?
Incentives for innovation Vision that something can happen Cap creates visibility of market shares for some low carbon options (does it suffice to have this in some regions)
Linkages of price Used as reference price Linking of trading scheme
Address inequality Revenue recycling towards groups that face higher product prices
Revenue from auction recycling
Creates leakage concerns Not if some global similar levels of carbon prices
Not if linkages with trading schemes of most regions
Options to address
leakage concerns
Revenue recycling to support low-carbon investment
Free allocation / or revenue recycling from auctions
Market power Information to set carbon tax Price manipulation creates investment risk
Required institutional capacity Existing tax structure + MRV New administrative and trading institutions + MRV
Time frame for implementation Relatively short Establishing base line for initial allocation, trading, test period?
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