Transcript Slide 1

Implementing Emission trading
the EU experience
Climate Change Summit, March 2009
Johannesburg
Karsten Neuhoff
Faculty of Economics
Cambridge 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
Karsten Neuhoff
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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
Karsten Neuhoff
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Price signal + institutional framework can deliver change:
Dash for gas in UK power generation
200
GWh
Coal
Gas
150
100
Oil
Nuclear
50
0
1960
1980
2000
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
Karsten Neuhoff
generation technologies workshop (asking for demand evolution and generation shares), Cambridge 2003
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After 2 bad experiences with joint cap setting & allocation
-> Europe now first sets cap, then allocates
Karsten Neuhoff
Emission projections are intrinsically uncertain
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MtCO2/year
2500
Proposed
NAP II**
125
88
2000
Final
NAP II***
Other Adjustments*
Adjustments
for opt-in in
Phase II
1500
NAP II
+ (JI/CDM range)
Max projection
1000
60%
projections
500
20% projections
Verified
Emissions
Min Projection
0
2005
2008
2009
2010
2011
2012
Avg.
2008-12
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.
Karsten Neuhoff
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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
Karsten Neuhoff
The effect of carbon pricing – example power sector
CO2 Cost
Cost
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Production cost
old
coal
new
coal
gas
• Energy efficiency
• Low-carbon technology
efficient production
choice of the best input
appropriate use of output
Karsten Neuhoff
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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?
Karsten Neuhoff
Distortions from repeated free allocation … the experience
old
coal
new
coal
gas
energy
efficiency
Emission based allocation
Uniform
Emission
Fuel specific
updating
based
updating
allocation
Auction / Grandfathering
Uniform updating
Fuel specific updating
CO2 Cost
Cost
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Production cost
efficient production
choice of the best input
appropriate use of output
+ reduced incentives for low carbon innovation
Karsten Neuhoff
EU phase I, II: High level of free allocation & distortion
EU post 2012 -> full auctioning in power sector
Natural Gas Plant
mil. EUA
1,2
Model Coal power station, 6000h,
33% efficiency
1,0
0,8
Model CCGT (gas), 6000h,
45% efficiency
0,6
Analysis to
be done or
No
Translation
available
0,4
0,2
NAP II
not
available
yet
No detailed
provisions
PT
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K*
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LT
LU
U
K
EE
SE
SK
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PL
LV
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FI
FR
H
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C
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0,0
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BE W
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Hard Coal Plant
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
Karsten Neuhoff
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Pyramid of distortions
– summary of experience from phase I of EU ETS
Allocation method
Auction
Capacity
Capacity and technology
Historic output
Historic output and technology
Historic emissions
X
X
X
X
X
X
X
X
X
X
X
X
Distortions increase emissions
and/or price impacts
Excess carbon-intensive capacity
Inefficient fuel choice
Distortions
Less energy-efficiency investment
Karsten Neuhoff
Lime
Casting of iron
40%
Impact from direct emissions
Preparation of yarn
Copper
Impact from indirect emissions (electricity)
Other textile weaving
Other inorganic
basic chemicals
30%
Household paper
Non-wovens
Industrial gases
Coke oven
Fertilisers & Nitrogen
4%
2%
0%
0.0%
Malt
Starches& starch
products
Flat glass
Veneer sheets
Retreading/
rebuilding tyres
Rubber tyres &
tubes manufact.
Hollow glass
Finishing
of textiles
Refined petroleum
0.2%
Aluminium
10%
Basic iron & steel
20%
Cement
Cost increase relative to value added
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Identify activities with risk of leakage
Pulp &
Paper
0.4%
0.6%
Share of GDP of UK
0.8%
1.0%
Karsten Neuhoff
Conditional
free allocation
State aid
Initial evaluation
•Little substitution to low
carbon products/services
•Distorts investment
•Bureaucratic constraints
for innovation
•Risk of lock-in
Export taxes
Border adjustment
•Has to be aligned with
international climate
engagement
•Requires at least
informal international
cooperation
Cost
Cost
CO costs
2
Price level
Cost
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Basic options to address leakage for exposed sectors
Government led
sectoral agreement
•Requires strong policies
of developing countries
•Risk of low common
denominator
Karsten Neuhoff
Forgone substitution/innovation
• Without measures
Substitution
• With free allocation
Leakage
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A carbon price works through the value chain.
This can be supported by policies that address leakage.
Other building materials
Leaner
Lower clinker structures
content
Efficiency
Clinker
Cement
Concrete
Building
Clinker
Cement imports
imports Some leakage
• Without measures
• With unconditional allocation
Karsten Neuhoff
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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
Carbon pricing is one of the 3 pillars of climate policy.
Internalise CO2
costs in decisions
Remove
non-market
barriers
How?
Technology
Innovation
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It internalises environmental costs and allows substitution away from Carbon intensive products towards
more energy efficient and lower Carbon technologies.
1.
2.
3.
Price CO2
Make credible
commitments to targets
(Raise funds for
international mechanisms)
Approaches
1990th : Industry self-regulation
Harmonised CO2 Tax
2003
Emissions Trading
Market pull
• Future potential for renewables
• Central for complex sectors
Karsten Neuhoff
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Aspects to consider
• Flexibility with off-sets
• Linking of schemes
• The role of expectations
Karsten Neuhoff
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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 trade
Tax
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 lowcarbon 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
Karsten Neuhoff
allocation, trading, test period?