16 May 2018: Setting up effective carbon markets, such as mandatory emissions trading systems (ETS), is a complex task that requires continuous learning and improvement to ensure that carbon markets run smoothly and result in a carbon price high enough to impact emissions levels. Over the period of April and May 2018, events, research publications, and ETS updates showed that the carbon market community is making efforts to address some of the key challenges by learning from past experiences, including the need to arrive at meaningful carbon prices, address competitiveness concerns, and advancing international cooperation.

Getting Prices Right – or when is being vaguely right no better than exactly wrong?

Carbon market mechanisms often struggle to achieve a price that is high enough to serve as an incentive for investments in mitigation technologies. “Put a meaningful price on carbon” was therefore the message World Bank and the International Monetary Fund (IMF) stressed at Carbon Pricing Leadership Coalition’s (CPLC) third High Level Assembly meeting, held in conjunction with World Bank and IMF Spring Meetings in April in Washington DC, U.S. International climate leaders discussed what an effective carbon price is and how it can be achieved. World Bank Group president Jim Kim said most carbon prices fall far below the recommendations by the High-Level Commission on Carbon Prices. According to an IMF analysis, prices must rise to over $70 per tonne of CO2 by 2030. IMF director Christine Lagarde urged countries to phase-in higher carbon prices up to 2030 and collaborate on carbon price floor arrangements. [CPLC Press Release] [CPLC Leadership Report][Carbon Market Watch Press Release]

Updating Emissions Trading Systems

Countries and regional groups regularly review and update their ETS to improve effectiveness, expand the scope of emissions covered and implement lessons learned. The EU and the Republic of Korea announced steps to upgrade their their ETS in early 2018.

‘Carbon leakage,’ the transfer of carbon intensive production activities from jurisdictions under carbon pricing to countries with laxer emissions constraints, can reduce the effectiveness of ETS. In May, the European Commission published its assessment of all relevant sectors and sub-sectors to determine their exposure to the risk of carbon leakage for Phase 4 of its ETS (2021-2030). Under the EU ETS, industrial installations deemed to be exposed to a significant risk of carbon leakage receive special treatment to support their competitiveness. Under the assessment, 44 sectors qualify directly for the preliminary 2021-2030 Carbon Leakage List. 12 sectors and 16 sub-sectors/products are eligible to apply for further assessments. [European Commission Press Release]

‘Benchmarking’ refers to a method of free allocation of carbon allowances according to performance indicators. The practice rewards efficient installations and can more easily assimilate new entrants. The Republic of Korea informed that for the second phase of its ETS (2018-2020), benchmark-based allocation will be expanded from three sub-sectors (grey clinker, refinery and aviation) to also include the power generation, group energy, industrial complex, petrochemical, and waste sub-sectors. The South Korean government also plans to release a share of the allowances held in reserve for market stabilization. In an effort to increase trade activity, the country will allow Export-Import Bank, Korea Development Bank and Industrial Bank of Korea to participate in its ETS. The government also amended its offset rules for its ETS to allow the use of international credits in the second phase (2018-2020). Currently, regulated entities can use offset credits to meet up to 10% of their compliance obligations under the ETS. In the next phase, up to 50% of these credits can be from projects developed by Korean companies under the Clean Development Mechanism (CDM). [ICAP News on Republic of Korea Rules On International Offset Credits] [ICAP News on Republic of Korea ETS Allocation Plan]

In related news, the first chamber of the Mexican Congress amended its General Law on Climate Change to establish a mandatory ETS. The Mexican Ministry of Environment and Natural Resources is tasked to set up the preliminary regulation for a 36-month ETS pilot starting August 2018. [International Carbon Action Partnership News Release]

The 10th Africa Carbon Forum convened during the Africa Climate Week in Nairobi, Kenya, concentrating on current trends in international carbon markets and emissions trading system simulation. [AfDB Press Release] [SDG Knowledge Hub Story on Africa Climate Week]

Learning by Comparing ETS Implementation

A study, published in Climate Policy Journal in May, finds the California–Québec linked ETS performs best among other ETSs in terms of environmental effectiveness with near full coverage of key emitting sectors, including transportation and a tightening of the cap by 3% every year.

ETS can yield a ‘double dividend’ even with a modest carbon price, if the emissions cap tightens over time and revenues are reinvested in other emissions-reduction activities.

The assessment also compared economic efficiency, market management, revenue management and stakeholder engagement in the implementation of eight ETSs in: the EU, Switzerland, the Regional Greenhouse Gas Initiative (RGGI) and California in the US, Québec in Canada, New Zealand, the Republic of Korea and pilot schemes in China. Findings suggest a potential for a “double dividend” in emissions reductions even with a modest carbon price, provided the cap tightens over time and a portion of the auctioned revenues are reinvested in other emissions-reduction activities.

On linking carbon markets, a Stockholm Environment Institute analysis points at potential pitfalls of linking carbon markets and assesses ways for policy makers to avoid them by use of quotas, exchange and discount rates. [Study: Carbon Pricing In Practice: A Review Of Existing ETSs] [SEI Analysis On Linking Carbon Markets]

Boosting Private Sector Uptake And Stakeholder Engagement

The third High Level Assembly of CPLC not only took stock of global progress on carbon pricing but also barriers to implementation, in particular for private enterprises in different economic sectors. Participants recognized the need for deepened dialogue around competitiveness concerns that have tended to inhibit the wider uptake of carbon pricing. According to Carbon Market Watch, CPLC will establish a new civil society working group to ensure that NGOs have both the capacity and the opportunities to engage in carbon pricing debates.[CPLC Press Release] [CPLC Leadership Report][Carbon Market Watch Press Release]

Other sectoral news included the following:

• Aggregate projections for a range of carbon prices from 2020 through 2035 including a corridor for the chemical sector can be found in the Carbon Pricing Corridors 2018 Report. The report, released by the Carbon Disclosure Project (CDP), also includes an updated corridor for the power sector. [CDP and We Mean Business Carbon Pricing Corridors 2018 Report]
• On decarbonizing maritime transport, the International Transport Forum within the OECD assessed measures to reduce shipping emissions and described possible pathways to zero-carbon shipping by 2035 that use different combinations of these measures. The case study also reviews under which conditions these measures could be implemented and presents policy recommendations. [OECD-ITF Report Decarbonising Maritime Transport – Pathways To Zero-Carbon Shipping By 2035]
• On emissions trading and electricity sector regulation, the International Institute for Sustainable Development (IISD) and the International Carbon Action Partnership (ICAP) published a conceptual framework for understanding interactions between carbon prices and electricity prices. The authors discuss the functioning of ETS in liberalized electricity markets and present options to strengthen an ETS under different regulatory settings. They also assess the effect of companion policies, such as government control of investments, setting technology-specific targets, performance targets, phasing out emission- intensive technologies or supporting innovation in low-carbon alternatives. [IISD ICAP Emissions Trading And Electricity Sector Regulation Report] [Summary for Policymakers]

Advancing International Cooperation: 2018 Bonn Climate Change Negotiations

Negotiators continued their work on the Paris Agreement during the Bonn Climate Change Conference in April and May 2018, including on the issue of cooperative approaches under Paris Agreement Article 6.

Relevant to enable national and regional instruments such as ETSs to be linked so as to create a common, cross-border carbon market are negotiations of Paris Agreement Article 6.2 (on direct bilateral cooperation concerning internationally transferred mitigation outcomes). The task remains to develop guidelines on using this cooperative approach, and negotiators in Bonn discussed:

• the difference between overall mitigation and the environmental integrity of cooperative approaches;
• share of proceeds; and
• multilateral governance and a rules-based system.

Another important task is to establish the modalities and scope for the Sustainable Development Mechanism under Paris Agreement Article 6.4, on which negotiators could not yet agree. This mechanism can be used directly by sub-national actors and could mobilize further private sector participation in climate change mitigation by providing suitable incentives. The emission reductions achieved using this mechanism can be transferred from the country in which they were achieved to another country and counted towards its nationally determined contributions. Focusing on raising ambition, the Paris Agreement requires that use of the mechanism must lead to an absolute reduction in global greenhouse gas emissions. [See: IISD Reporting Services Earth Negotiations Bulletin Summary and Analysis of the Bonn Climate Change Conference]

Lessons from Kyoto Protocol’s Clean Development Mechanism

Participants in Bonn also considered what could be learned from the Kyoto Protocol’s Clean Development Mechanism (CDM) for the creation of the Sustainable Development Mechanism. For example, the rules of procedure of the CDM Executive Board were considered for the new mechanisms’ supervisory body.

As reported by UNFCCC, the Climate Policy and Carbon Markets at South Pole Group lauded how the CDM paved the way for systems now in place or on the way, including the voluntary market mechanisms, Australia’s emission reduction fund and a national offset mechanism being considered in China.

Seeing no future for the CDM post-2020, Carbon Market Watch stresses that a zero-sum offsetting system is incompatible with the Paris spirit, and recommends a results-based climate finance scheme instead. [Carbon Market Watch Recommendations] [UNFCCC Press Release]

2018 State and Trends of Carbon Pricing Report launch at Innovate4Climate Summit

The Innovate4Climate Summit taking place from 22-24 May 2018, in Frankfurt, Germany, is the next opportunity for the international community to review experiences from carbon markets and measures for their improvement. World Bank and Ecofys will release their annual State and Trends of Carbon Pricing Report at this meeting. Workshops during the event will address, among other issues: carbon markets, GHG accounting and standardization of methodologies and metrics tools; interactions between ETSs and other climate policy instruments translating the Paris Agreement’s Article 6 for Multilateral Development Bank Operation; piloting Internationally Transferred Mitigation Outcomes (ITMOs) under Article ; and costs and Climate Impact of Offsetting Emissions under CORSIA. Look for our June Carbon Markets Update for details on this event. [Innovate4Climate Summit website] [Publication: State and Trends of Carbon Pricing 2018] [Report Abstract]

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The SDG Knowledge Hub publishes monthly climate finance updates, which largely focus on multilateral financing and cover, inter alia, mitigation and adaptation project financing news and lessons, institutional events and news, and latest developments in carbon markets and pricing. Past climate finance updates can be found under the tags: Finance Update: Climate Change; and Finance Update: Sustainable Energy.