KINGSTON, ONTARIO OCTOBER 17-18

ANDREI MARCUIETA

Carbon Pricing and Environmental Federalism

DET

DET

Projects,CDM/JI

European Allowances

EU25+X USA

Voluntary targets

Japan

Kyoto Party-Level

Entity-Level

Non-Kyoto Party

Australia

Cana

daGlobal GHG Market

Domestic ETS

EU ETS2100 Mt

JVETS0,5 Mt

CCX25 Mt

Australian ETS~ 500 Mt

NZ ETS~ 70 Mt

Alberta2,6 Mt

Swiss ETS2,4 Mt

Mandatory Cap & Trade SchemesExisting

Voluntary Cap & Trade Schemes

Mandatory Cap & Trade SchemesTo be launched

Source: BlueNext

Upcoming national ETS ?

RGGI188 Mt

4

Carbon Market at a Glance2006 2007 Estimates 2008

Volume Value Volume Value Volume Value

EU ETS 1 104 24 436 2 061 50 097 3 172 117 504

NSW 20 225 25 224 NA NA

CCX 10 38 23 72 63 315

Allowance Subtotal

1 134 24 699 2 109 50 393 3 235 117 819

Primary CDM 537 5 804 551 7 426 565 9 501

Secondary CDM

25 445 240 5 451 520 14 912

JI 16 141 41 499 219 3 681

Other 33 146 42 265 53 481

Offsets Subtotal

611 6 536 874 13 641 1 358 28 576

Total 1 745 31 235 2 983 64 034 4 593 146 394Source: World Bank, own estimations

5

Market Volume Growth 2007(in MtCO2e) Allowance Markets

Project-Based Transactions

EU Emission Trading Scheme

New South Wales Certificates

CDM

551

25

2,061

Voluntary& Retail

42

SecondaryCDM

240

JI41

x 1.0

x 2.5

x 3

x 10

x 2

x 1.3

The Start of Period II of EU ETSExchange Vs. Brokers

• Trades made on secured platforms have increased continuously since 2005…• … especially on spot trading where 95% of contracts have been traded on exchanges in 2008

against 85% in 2007.

31%

28%

24%

38%

0

200

400

600

800

1 000

1 200

1 400

1 600

1 800

2005 2006 2007 2008 (août)

Vo

lum

e e

n M

tCO

2

Volum es Brokers Volum es OTC Clearing Volum es Ecran (bourses)

Total volumes on European market (EUA) and breakdown between OTC and exchange trades

Source: BlueNext from Reuters

The Start of Period II of EU ETSSpot Vs. Futures

• Spot market has become more financial in the last months: more and more players are doing arbitrage between spot and futures contract. This is due to the increasing liquidity seen on the spot market and number of members on BlueNext Spot.

• In the actual context of financial crisis, investors try to diversify their investments. Carbon market, spot and futures, is a way to enlarge their product portfolio.

Source: BlueNext from ECX

Market Segmentation in 2008 on EUA markets

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08

Mar

ket

shar

es

Spot market Futures market (Dec08) - Screen trades

Futures volumes breakdown by maturity

• On EUA market, volumes are concentrated on first delivery (December 2008). • However, on CER market, volume breakdown is more homogeneous • This can be explained by the fact that, on CER market, market players need to cover their total number of CERs

whereas on EUA market, they only need to cover the difference between emissions and allocation.

Réparition des volum es négociés par échéances (ECX) du 14 m ars au 14 septem bre 2008

0

100

200

300

400

500

600

700

800

Vol Dec08 Vol Dec09 Vol Dec10 Vol Dec11 Vol Dec12

Mill

ion

s

Volum es EUA (ECX) Volum es CER (ECX)Source: BlueNext à partir d’ECX

EUA Spot and Futures prices (€/t) and volumes

0

5

10

15

20

25

30

Jun-

05

Aug

-05

Oct

-05

Dec

-05

Feb

-06

Apr

-06

Jun-

06

Aug

-06

Oct

-06

Dec

-06

Feb

-07

Apr

-07

Jun-

07

Aug

-07

Oct

-07

Dec

-07

Feb

-08

Apr

-08

Jun-

08

Spot EUA 05-07 prices (€/t) Spot EUA 08-12 prices (€/t) Futures EUA front settlement (€/t)

The Start of Period II of EU ETSPrices Growing Oil price

Rumours on French Conection to ITLMoves in energy prices

Source: BlueNext, ECX

Supply/demand outlook until 2012 The Kyoto Balance

1 510,0

279,8

870,0

413,0

201,0

248,0

454,0

101,0

1208,2

763,0

1325,0

8,0

4,0

189,0

0

500

1000

1500

2000

2500

3000

3500

4000

EU Gap Japan'sGap

ROE &NZ

Canada'sGap

EU PolicySteps

JapanPolicySteps

EU Sinks JapanSinks

ROE/NZSinks

EU CER &ERU

JapanCER &ERU

ROE/NZCER &ERU

CER &ERU

CreditsAvailable

Now

CurrentShortfall

EU and Member State Targets for 2012 (Kyoto Protocol targets)

-13%

-7,5%-8%

- 21%

-8%

0%

0%

-21%

25%

-6%

13%

- 6,5%

-8%

-8%

- 28%

-6%-6%

27%

15%

-8%

-12,5%

Cyprus and Malta have no targets

- 8%

- 8%

10%

1% 4%

Russia Kyoto target: + 5%

- 8%

EU 15: -8%

The EU ETS – history, assessment and future developments

• EU ETS – original piece of legislation was approved in 2003.• EU ETS is structured in separate phases: • Phase I or pilot phase – ran from 1 January 2005 to end 2007.• Learning by doing phase, not linked to the Kyoto protocol,

separated from following phases or trading periods.• Phase II – ongoing – 2008 to end 2012, based on existing

directive, builds on experience gathered in phase I, linked to Kyoto protocol.

• Phase III – under negotiation, object of review of Emissions Trading System – 2013 to…??

Key features of Phase I and II

• Emission permits “ EU Allowances - EUAs” distributed by Member States (MS)

• Total amounts of EUAs negotiated between MS and European Commission – competitive distortions within sectors across MS

• Most emission permits distributed for free – only about 3 % now auctioned

• Access to Kyoto Protocol flexible mechanisms – cheaper compliance means,ensures involvement of developing countries in international negotiations

• Establishment of solid Monitoring, Reporting and Verification system

• High penalties – 40 €/Tonnes + “make good” provision

EU ETS – blueprint for a global C+T ?

• Is the EU ETS a success so far ?• Are there lessons to be learned from P1 and beginning of P2 ? • What are the key areas and how do they differ from jurisdiction to

jurisdiction• How compatible must it be with other DETs ?• Can it be a docking station for global C+T ?

• Lessons important in a number of areas– Allocation– Data availability– Interaction with other policies and measures

Assessment of Phase I

Phase I a success – although there is scope for improvement1. Incorporated price of carbon in products – price of carbon now

high on Board agendas and key for investment decisions2. Set up MRV system: backbone of ETS, ensures that a tonne of

carbon is a tonne of carbon and can be traded 3. Engine of CDM system – key for international negotiation and

to rach an international agreementMain criticisms:• EU ETS a failure because price crashed - unfounded• No abatement in GHG emissions - unfounded• Windfall profits for electricity firms – partially true but

addressed in EU ETS review •  Competitive distortions among sectors in the EU – partially

true but addressed in EU ETS review 

Allocation ExperiencesLearning from Phase 1

• Working environment• Short time frames• Lack of actual data

• Choices– Highest demand on power sector– Use of recent data– Little auctioning– Entrance/closure provisions– Unclear boundaries/coverage

Allocation ExperiencesLearning from Phase 1

• Process• Role of stakeholders• Coordination role of the EC

• Lessons Learned• Pilot phase was useful• Conditions for creating “windfall profits”• Impact of new entrance/closure provisions• Importance of actual data• Competitive impacts limited• Impact of political advocacy at local/national level• Role of EC to enforce environmental delivery

Allocation ExperiencesLearning from Phase 1

• Lessons Learned• More use of ET• Use by government of CERs and ERUs• No use of post adjustment• Allocation plans too complex

The Emerging Verdict on Phase 1

• The ambition level was modest and the price impact was only felt in the first half

• Nevertheless, some emissions reduction from BAU took place

• Impact on investment understandably slight

EU-ETS Phase 2 Levels of Ambition

A much tougher approach...

MS 2005allowances

2005VerifiedEmissions

NAP 2As submitted

European C’ion response

CER/ERU limit(%)

Belgium 62.9 55.4 60.8 58.5 8.4

Czech R 97.6 82.5 102 86.8 10.0

Germany 499.0 474.6 482 453.1 22.0

Spain 174.4 183.6 152.7 152.3 20.0

UK 245.3 242.5 245.4 246.2 8.0

TOTAL EU27

2313.9 2137.1 2351.9 2081.3 13.7

New Guidance for P2

• Progress towards KP targets trajectory• Setting national caps according with potential• Substantiation of government purchases• Substantiation of other policies and measures• Guidance on CDM/JI• Use of benchmarking• Definition – e.g. combustion installation • Installation size

Review of the EU Emission Trading Scheme

EU Commission proposal published on 23 January 2008.

Based on unilateral EU reduction goal: -20 or - 30% agreed in March 2007

Main elements of EU ETS phase III:- Centralised cap – reduction factor set until 2028- Longer allocation periods – 8 years- Auctioning for power & CCS sectors: 100%- ‘Suggested’ Earmarking of revenues+ some auctioning to ‘poor’ Member States- Potential Benchmarking for energy intensive sectors – 20% initial auctioning- Up to 100% free allowances for sectors exposed to carbon leakage- Broadening of scope for combustion plant, new sectors e.g. Chemicals, Aluminium,

CCS and other KP gases e.g N2O, PFCs- Quantitative and qualitative limits to CDM-JI access- Banking: Specifically allowed from Phase II in Phase III- EUETS Projects to be considered, exclusion of small emitters with conditions - Linking to emerging international schemes

Where were the Political Problem Areas?

• Level of ambition vs competitiveness• Auctioning vs free or benchmarked• allocation• Application of auction revenues• Forestry – “something must be done”• CDM – suddenly come alive• Speculators!• Special weighting for CCS or other favoured technologies • Carbon leakage, and the international negotiations• Border adjustments diminishing• Special member-state circumstances (eg dependence on

Russian gas) and ...getting it all done by December 08

Source: MissionClimat/Caisse des Depots

CAP

• - 21 % below 2005 emissions ( vs 10% for the non-trading sectors)• Max. cap : 1720 MT by 2020, yearly average:1846 MT• Reduction of about 11% compared to Phase II cap • From 2010 the total number of allowances to decrease by 1.74% /yr - ~37 Mt with

current ETS coverage • Starting point for reductions: average quantity of allowances of cap of Phase II• Reduction factor valid until 2028 – EC to propose review by 2025• 8-year trading periods• Total quantity of allowances to be adjusted to take account of enlarged scope in phase

II and III• Cap to be strengthened if international agreement is reached

Centralised cap coupled with medium and LT targets, and linear factor until 2028 give certainty in terms of environmental goal and investments- key positive aspects of the proposal

How will allowances be distributed?

• The power sector and CCS to be fully auctioned from 2013 – exception for heat emissions from high efficiency CHP installations

• Other sectors including refining, shall receive 80% of the free allocation benchmark in 2013. This percentage will be reduced gradually - no free allowances by 2020.

• Sectors exposed to the risk of leakage may receive up to 100% free allowances

Allocation methods• Auctioning will be the preferred tool for allocation (“it

is the simplest and most economically efficient system”)

• At least 60% of allowances should be auctioned in 2013. Of these:

• Member States will receive 90% of the total quantity of allowances to be auctioned according to their relative share of 2005 emissions in the EU ETS.

• 10% of the quantity of allowances to be auctioned should be distributed to poorer Member States for the ‘purpose of solidarity and growth’, to reduce emissions and adapt to climate change.

Revenues from auctioning

At least 20% of the revenues should be earmarked to:• Reduce GHG emissions, to adapt to climate change and to

fund R&D • To meet the EU 2020 targets for renewable energies and

energy efficiency• For CCS, in particular from coal power stations;• For measures to avoid deforestation, in particular in LDCs• To address social aspects in lower and middle income

households, e.g. by increasing energy efficiency and insulation

• To cover administrative expenses of the management of the ETS

Carbon Leakage • By 30 June 2010: EC to identify which the energy intensive industry sectors or sub

sectors are exposed to carbon leakage.• Assessment based on “inability of each sector to pass through costs” ”without

significant loss of market share” to other installations in jurisdictions that do not apply a price to carbon”

• Specific criteria to assess leakage will cover:– (a) the extent to which auctioning would lead to a substantial increase in production cost;– (b) GHG reduction potential of individual installations in the sector concerned– (c) market structure, relevant geographic and product market, the exposure of the sectors to

international competition;– (d) the effect of climate change and energy policies implemented outside the EU in the

sectors concerned.• By June 2011 at the latest the EC will submit a report and propose measures: i.e.

– distributing these sectors up to 100% free allowances or – setting up a “carbon equalisation system”– indirect emissions may be taken into account (recital 19):

The Competitiveness Puzzle – not many sectors seriously affected but the effect is real

100% @€45/tCO2

100% @€45/tCO2

Cement Steel

Note: Trade sensitivities estimated from range of historical variabilitySource: Data from CIRED, as presented in Carbon Trust (2008)

Addressing Competitiveness Issues

• Cross border taxation schemes

• Production based allocation with benchmarking OR redistribution of proceedings

• Global sectoral agreements

Instruments relevant to UK business sector energy use – current and potential new ones

• CCL/carbon tax• CCA• UK ETS• EU ETS• Building regulations• Enhanced capital allowances• Funded programmes (CT)

• Buildings - business rates / standards• Project based trading• SME White certificate trading• Product standards

Existing measures

New measures

Target segments

SMEsEnergy intensive

Large non-energy intensive

Instruments relevant to UK generation

• EU ETS & variants:• Allocation & new entrant principles• Auctioning

• Renewable obligation certificates (ROCs)• LCPD• NETA balancing / other rules• Transmission charging regime• Distribution & connection charging regimes• Funded programmes (CT)

• Carbon tax??• Banded ROCs?• Nuclear incentives (insurance, disposal, etc ..?)• End-use related measures (Cogen, PV, ..?)

Existing measures

New measures

Market research suggests a combination of business needs, regulation, fiscal and support measures drive energy efficiency

uptake

Environmental interest groups

General economic outlook of the UK

Enhanced Capital Allowances

Climate change agreements

Support provided by Action Energy

Customer requirements/Brand and PR

Climate Change levy

Future impact and risk of climate change

Competitiveness / Investors expectations

Other current regulation/Company policy

Energy price and cost savings

Source: NOP research and conjoint analysis June 2003; sample of 1332 organisations across industry, commercial and public sectors

Derived importance of factors in influencing energy efficiency decisions

Increasing importance

What is the most effective combination of factors?

Avoiding Double Counting Between CCA & EU ETS

• Issue– Operator reduces emissions under EU ETS– Can use that under CCA– Can be double counted under UK ETS– Double counting is avoided by adjusting CCA

target

Summary of the Market Sentiment Survey

• Strong confidence in the longevity of the market;

• Continuing strong growth in trading volumes up to and beyond 2012;

• Significantly higher prices beyond 2012;• Continued significant role for project

based credits, but less optimistic about growth post-2012;

• A greater demand for VERs, and the appropriate infrastructure to set up a robust and reliable market. Source: IETA

79%April 2007

- +73%

April 2008

79%April 2007

- +73%

April 2008

IETA Vision: Global GHG Market Post 2012

EU ETSCO2 Only

CDM: Any gas, any sector

Full Global Trading

Large Sources of CO2, CH4, N2OHFC, PFC, SF6

All Major Emitting Countries

?

?

Phase 1 Phase 2 Beyond 2012

Non-EU JI: Any gas, any sector

EU ETSCO2 only,

JapanCanada

3737

Eligibility of Project-Based Instruments Post 2012

Wealth

Em

issi

ons

Low EmissionsLow WealthLow Emissions

Low Wealth

High EmissionsLow Wealth

High EmissionsHigh Wealth

Low EmissionsHigh Wealth

OECD

NIS

Russia

Korea, Mexico,South Africa

Ukraine

ChinaIndia

Brazil

LDC Africa

Small Island States

OPEC

Latin America

Asian Tigers

SingaporeIsrael

Kyoto Protocol Annex B

Post 2012Agreement?

Allowances

CDM/JI Credits

?

?

?

?

Do you know if you are in the grace of God ?

• Heavily criticized – death by a thousand cuts• They will always be more complex than C+T• Play an important role in addressing climate

change for certain sectors and countries• Part of the current and likely future

international & national regimes• Press & academic studies (e.g. Wara & Victor)• There are issues that can and should be solved

Do Offsets Deliver ?Arguments For CDM

• Lower the cost of compliance in Annex 1 – good cost control mechanism

• Support SD development• Engage non Annex 1 in fighting CC

Do Offsets Deliver ?Arguments Against CDM/Offsets

• No environmental integrity – Chinese projects/non industrial gases projects would take place anyway

• Additionality impossible to show• Cannot produce enough and on time to act as a control mechanism• HFC – a rip off• Concentrated projects• Little time in KP1, high uncertainty• Subsidy for China• Voluntary markets are full of charlatans

Therefore they cannot be useful in one of its main roles and we need another mechanism – safety valve

Death by a thousand cuts

• Circular arguments• No desire to help reform the instrument – simple

but effective remedies available• Born out of an academic view – not a

practitioner’s perspective• Many good projects do not get funded• Real competition at assets allocation• Many factors – GHG will always be only one• Speed of change is critical as change itself

Reality of CDM• An imperfect mechanism – offsets will always be less than C+T and a transitory measure• Added complexity due to institutional arrangements• Problems in communication• No predictatibility and precedent setting• Long lead times for projects• No clear accountability

Conclusion – need for reform• More Board-like behavior• Move away from project by project• Trust DOEs• Clear accountaibility