21 November 2019
Carbon Pricing and Markets Update: Preparing Mechanisms for Rising Demand
Photo by IISD | Lynn Wagner
story highlights

The EU, Iceland and Norway extended cooperation to reduce emissions from several sectors outside the EU ETS, including agriculture and transport.

New Zealand reached agreement with the agriculture sector to price emissions from 2025.

China released a trial plan for allocating emissions allowances to the power sector.

Mexico published final regulations for a three-year pilot ETS covering energy and industry sectors.

The US Transportation and Climate Initiative released a draft framework for the transport sector ETS starting in 2022.

The ICAO Assembly listed principles for market-based measures for international aviation.

Over the last month, we saw governments work on emission pricing schemes and climate laws at the international, national and subnational level in Europe, Asia and North and Central America. The 40th meeting of the International Civil Aviation Organization (ICAO) Assembly signaled that preparations for the sector’s global market-based mechanism continue. With dozens of countries indicating that they want to use international market mechanisms to meet their Nationally Determined Contributions (NDCs) under the Paris Agreement on climate change, further negotiations on Article 6 (cooperative approaches) to take place during the Madrid Climate Change Conference in December are gaining prominence. This Update provides a reading list in preparation for these negotiations, and highlights recent developments related to carbon pricing and markets.

EU, Iceland, Norway Extend Cooperation to Reduce Emissions

In October, the EU, Iceland and Norway agreed to extend their cooperation under the European Economic Area (EEA) Agreement to reduce greenhouse gas (GHG) emissions by at least 40% by 2030 compared to 1990 levels. A press release by the European Commission explains that Iceland and Norway participate in the EU ETS since 2008, and will now align their actions to reduce emissions from sectors outside the EU Emissions Trading System (ETS) for the 2021-2030 period, including agriculture, transport, waste management and buildings, and carbon removals from land use and forestry.

New Zealand Implements Farm-level Emissions Pricing from 2025

The New Zealand government reached agreement with the agriculture sector to develop a method to measure, report and price GHG emissions at the farm level and implement the pricing mechanism by 2025. In a partnership-based approach with the indigenous Maori, they will develop a farm environment plan framework with progressive targets. Depending on a review of progress on a pricing mechanism in 2022 by the independent Climate Change Commission, the government may bring the sector into the NZ ETS even before 2025. The International Carbon Action Partnership (ICAP) reports that the decision on pricing agricultural emissions is part of a range of other planned reforms to the NZ ETS, all introduced to parliament in the Climate Change Response (Zero Carbon) Amendment Bill on 24 October 2019.

China Releases Trial Plan for National ETS Allocation

China released a trial plan for allocating emissions allowances to the power sector. It will inform the upcoming simulation phase of its national ETS. ICAP explains that the trial plan includes two allocation schemes, which are identical in most respects but differ in their benchmarks. Both schemes calculate the amount of allowances allocated to entities using the same baselines. At first, entities will receive allowances at 70% of their 2018 output multiplied by the corresponding benchmark factor. Allocation will be adjusted later reflecting the actual generation in 2019. ICAP reports that the national ETS is expected to cover some 1,700 companies accounting for more than 3 billion tons of carbon dioxide equivalent (tCO2e) per year in its initial phase and then gradually expand to other key emitting sectors, including petrochemical, chemical, building materials, steel, nonferrous metals, paper and domestic aviation.

Mexico Prepares for Three-year Pilot ETS

Mexico published final regulations for the three-year pilot phase of its national ETS starting 2020, ICAP reports. The pilot, which covers the energy and industry sectors, will help Mexico identify adjustment needs and generate an indicative value for emission allowances and offsets for the operational phase beginning in 2023. On specific sectoral scope, energy encompasses electricity generation as well as fossil fuel extraction and production. Industry includes, among others, automobiles, cement, chemicals, glass, steel, metallurgical, mining and petrochemicals, as well as the pulp and paper subsector. Only direct CO2 emissions will be regulated by the pilot, and participation is limited to entities with annual emissions greater than 100,000 tCO2. The pilot is expected to cover around 300 entities, corresponding to approximately 45% of national emissions.

US Jurisdictions Propose Transport Sector ETS Starting in 2022

Ten northeast and mid-Atlantic US jurisdictions of the Transportation and Climate Initiative (TCI) released a draft framework, outlining basic design features of a regional transport sector ETS starting in 2022. ICAP reports that the programme would cap CO2 emissions from the combustion of gasoline and on-road diesel fuel in the region, and the scheme would apply upstream with compliance obligations falling to suppliers who produce the covered fuels within the participating states as well as suppliers who import them to the participating states.

Among others, TCI Jurisdictions consider linking this ETS with programmes with similar flexibility mechanisms, such as the Western Climate Initiative (WCI), which supports the implementation of GHG emissions trading programmes of US states and Canadian provinces in western North America, and the Regional Greenhouse Gas Initiative (RGGI), a mandatory cap and trade programme in northeast US aimed at reducing CO2 emissions from electric power.

Also trying to link up with RGGI, Pennsylvania’s Governor Tom Wolf signed an executive order directing the Pennsylvania Environmental Quality Board to develop a proposal for an ETS by 31 July 2020. ICAP reports that the move aims to bypass the Republican-controlled state legislature, which opposes carbon pricing and has asserted any ETS must be approved by lawmakers.

Getting Carbon Pricing Right

Discussions on carbon pricing continued from last month, including in the International Monetary Fund’s (IMF) October ‘Fiscal Monitor: How to Mitigate Climate.’ The IMF report makes the environmental, fiscal, economic and administrative case for using carbon taxes or similar pricing schemes such as ETS, and provides a quantitative framework for understanding their effects and trade-offs with other instruments. The IMF recommends a carbon tax set to rise quickly to USD 75 per ton in 2030, lamenting current global average carbon price of only USD 2 per ton. Sweden, with a carbon tax of USD 127 per ton is an exception, prompting the Carbon Pricing Leadership Coalition to ask: should every country on earth copy Sweden’s carbon taxThe IMF report also addresses carbon price floor arrangements, and how these could be operationalized internationally, including as a complement to the Paris Agreement.

Rising Demand for Emission Reduction Credits from Aviation

Demand for international emission reduction credits from the aviation industry is expected to rise. Aiming for carbon-neutral growth from 2020, airlines need to offset part of their emissions under the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), as decided by International Civil Aviation Organization (ICAO) member countries.

The ICAO 40th Assembly convened from 24 September to 4 October 2019 in Montreal, Canada, where its 193 members adopted updated policies and practices related to environmental protection. As of June 2019, 114 member States, representing over 93% of global international air traffic, voluntarily prepared and submitted action plans to ICAO. This is further encouraged in ICAO Assembly Resolution A40-18, which specifically focuses on climate change. The Resolution requests, inter alia, that the Council, enhance appropriate standards, methodologies and a mechanism to measure/estimate, monitor and verify global GHG emissions from international aviation, and that States support the work of ICAO on measuring progress through the reporting of annual data on traffic, fuel consumption and CO2 emissions. An Annex lists 16 guiding principles for the design and implementation of market-based measures for international aviation.

ICAO Assembly Resolution A40-19 on CORSIA determines that the scheme is the only global market-based measure applying to CO2 emissions from international aviation, and recommends “ensuring that these emissions should be accounted for only once.” The Resolution recalls that CORSIA will use emissions units that meet its emission unit criteria and that emissions units generated from mechanisms established under the UNFCCC and the Paris Agreement are eligible for use in CORSIA, provided they align with decisions by the Council, including on avoiding double counting and on eligible vintage and timeframe. The Resolution requests the Council to, among other actions:

  • continue to develop and update the CORSIA emission unit criteria; and
  • establish, by early 2020, and maintain the CORSIA Central Registry under the auspices of ICAO to enable reporting of relevant information from member States.

How to Prevent Double Counting of Mitigation Outcomes

One of the biggest risks to the environmental integrity of carbon markets is double counting of mitigation outcomes. In this regard, the CORSIA Emissions Unit Eligibility Criteria require that units be only counted once towards a mitigation obligation, and measures be in place to avoid:

  • Double issuance (which occurs if more than one unit is issued for the same emissions or emissions reduction);
  • Double use (which occurs when the same issued unit is used twice, for example, if a unit is duplicated in registries); and
  • Double claiming (which occurs if the same emissions reduction is counted twice by both the buyer and the seller).

Ways to prevent these types of double counting are addressed in initial Guidelines on Avoiding Double Counting for CORSIA published in June. The October issue of Carbon Mechanism Review provides an overview of the guidelines and how they are considered by carbon-offsetting programs in the ongoing application process under ICAO.

Also in October, the EU Regulation on ICAO measures for monitoring, reporting and verification of aviation emissions for the purposes of CORSIA entered into force, to implement the CORSIA Standards and Recommended Practices for European-based operators through the EU ETS. The Regulation or reporting requirements applies to aircraft operators that hold an Air Operator Certificate issued by a member State or that are registered in a member State, and that emit more than 10,000 tCO2 on international flights in 2019.

How to Ensure Environmental Integrity in Paris Agreement Article 6

With dozens of countries indicating that they want to use international market mechanisms to meet their NDCs under the Paris Agreement, all eyes are now on Article 6 negotiations to take place during the 25th session of the Conference of the Parties (COP 25) to the UNFCCC in Madrid. Several briefs focus on these negotiations by addressing how to guide implementation of market-based cooperative approaches in Paris Agreement Article 6, with an emphasis on avoidance of double counting.

The European Capacity Building Initiative (ECBI) provides a primer and in-depth analysis of all relevant concepts, emerging features and contentious issues in a policy paper titled, ‘Negotiating Cooperation under Article 6 of the Paris Agreement.’ The authors elucidate the positions of Parties who will need to identify political compromises for technical issues related to an accounting framework for internationally transferred mitigation outcomes (ITMOs) and the UNFCCC-governed crediting mechanism.

Another article on the issue, ‘Double Counting and the Paris Agreement Rulebook,’ published in the Science, argues for: robust accounting, for example in common GHG emission metrics and over multiyear periods; corresponding adjustments applied to all relevant years; and a single set of common international accounting rules, irrespective of which carbon market mechanism is used to generate emission reductions and irrespective of whether these reductions are used by countries to achieve their Paris targets or by other entities such as airlines to achieve their mitigation obligations under ICAO.

Problems identified by the authors include the diversity of NDCs and conflicting views of Parties. Looking, for example, at how ITMOs could be transferred between countries that express targets in different metrics, the ECBI policy paper presents a landscape of different “trading clubs,” according to three different metrics are applied.

An article in the latest Carbon Mechanism Review by the Germany-based Wuppertal Institute notes “climate clubs” as an alternative strategy for ambition raising through Article 6. The authors suggest, among other benefits, that cooperating “club members” could ensure environmental integrity and foster ambition by: defining and adhering to eligibility criteria or restrictions; creating a larger and more liquid market; and assuring quality and reducing legal and reputational risks.

Still, the sum of members’ increased ambition would need to be higher than the potential weakened ambition of non-club members to meet the ultimate goal of Article 6, namely to achieve efficiency gains that translate into increased ambition. In order to achieve this goal, ECBI stresses that the rules must be: straightforward while not restricting participation opportunities to a club of industrialized countries and emerging economies; and at the same time robust and safeguarding environmental integrity to ensure both private and public trust in international cooperation.

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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.

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