Carbon Pricing Flashcards
a. Briefly describe how a cap and trade emissions trading scheme functions (3 marks)
Market-based scheme to reduce GHG emissions by providing a financial incentive for reducing emissions. A cap (limit) is set on emissions and emitters need permits/allowance units (usually 1tCO2e each) equal to their emissions. There is a scarce supply of permits created equal to the cap, creating a price and market. The goal is to reduce emissions through the lowest theoretical price - emitters with the lowest cost abatement prefer to reduce emissions rather than use permits, and so avoid buying permits and can sell any excess. Emitters with higher cost abatement buy permits rather than reduce emissions however the net result is economically efficient reduction in emissions.
At the same time the price of products with embodied carbon rises relative to other goods, creating a demand side response that also acts to reduce emissions, prompting a shift from consumers/investors towards low-carbon technology.
b. Provide at least one advantage and at least one disadvantage to allowing the use of international carbon credits for compliance in carbon trading schemes. (2 marks)
Positives:
May provide financial incentives for developing countries with no cap under international agreements
Easier to agree on and adhere to national targets in international negotiations
Insulates market from domestic price fluctuations
Negatives:
Less control over domestic scheme design → if linked ETS schemes are not compatible will fail
Linking with flawed/incompatible schemes will threaten the integrity of the credits
Exposure to volatility in international markets → EU ETS collapse had flow on effect on the NZ ETS scheme.
c. Explain and justify the rationale behind allocating free permits to Emission Intensive Trade Exposed (EITE) industries in carbon trading schemes.
Australian industries (e.g. local refineries) have to compete against international competitors who mostly do not have to pay a carbon tax. Prices for products are based on the cost of importing (i.e. import parity) so the additional cost of emission permits impacts heavily (since they are very high emission industries). If this happens, there is no net effect on global emissions (since we would just purchase international goods/services who do not adhere to any emissions-reducing laws), however it would be very damaging to Australian industries. GHG emissions will simply come from Asia instead of Australia. This is known as leakage, where the project simply causes higher emissions outside the project boundary.
d. What is the meaning of ‘carbon leakage’ and ‘grandfathering’ in the context of an emissions trading scheme?
Carbon leakage = implementing the project causes higher emissions outside the project boundary.
For an example, read question c → countries without a carbon tax see an increase in demand resulting in a net zero effect on carbon emissions.
Grandfathering = allocating emissions cap based on historical and/or current emissions, energy use (fuel) or production (MWh).
Grandfathering subsidises polluters and gives industries an incentive to maintain their current rate of emissions rather than reducing (to avoid the risk of having a low emissions year followed by a high emissions year and high penalties). Results in technological and institutional inertia.
e. What is meant by the term “additionality” in the context of emissions reductions? Explain why additionality can be problematic for baseline-and-credit schemes.
Additionality = would the project occur anyway without the investment raised by selling carbon offset credits?
→ how to distinguish activities that are eligible to receive credits from the ones that would have happened anyway.
A project is not additional if it is intrinsically financially worthwhile due to energy cost savings or if it is performed due to environmental laws/regulations.
i.e. if it makes sense to do it anyway (or you have to), it is not additional.
This is complex for B&C schemes because they are based on reduction of intensity, not absolute emissions, creating uncertainty in whether targets are met.
f. Describe the difference between ‘cap and trade’ and ‘baseline and credit’ emissions trading schemes.
Cap and Trade
Allocated or generated permits/allowances are tradable
Permits are purchased by or allocated to regulated installations
Baseline and Credit Emissions reductions (credits) compared to baseline or target are tradable
Credits are generated after validation, verification and certification
Under a cap and trade system, an overall emissions cap is set which is divided into emissions permits that are auctioned and/or provided to participants. Restricted supply of permits creates scarcity and combined with the trading of permits creates a price for carbon, which drives liable parties to seek abatement through the most cost-effective methods.
Under a baseline and credit scheme, an emissions intensity is set for emitting activities against a baseline (usually some proportion of BAU). Credits are created for activities that achieve emissions intensities below the baseline and activities that have emissions intensities above the baseline have to buy such credits. The system incentivises participants to find lower emission production processes. There is no incentive in this system for consumers to reduce demand for emissions intensive goods (since the scheme does not necessarily penalise emissions intensive activities and goods).
Administrative costs are likely to be higher under B&C since it is a more complex scheme, requiring a baseline for each emitting activity (many of which have inadequate historical emissions data).
B&C has greater uncertainty in achieving given targets since they are based on intensity rather than absolute emissions (especially challenging when trying to meet international targets).
B&C more prone to manipulating since plant owners assist in the setting of their own baselines → can run plant in inefficient mode, then revert to efficient practices and claim an efficiency improvement against baseline and benefit financially.
g. Explain how offsets can be incorporated into ‘cap and trade’ emissions trading schemes.
Offsets give emitters a choice between reducing their own domestic emissions through the typical means (investing in or incentivising EE and use of lower-carbon fuels) or buying carbon offsets that pay for auctions elsewhere (typically in less-developed countries) that reduce or avoid emissions, resulting in the same net reduction. Examples of offset programs are the Clean Development Mechanism (CDM) and the Reducing Emissions from Deforestation and Forest Degradation program (REDD). Ideally, carbon offsets finance low-carbon energy projects like wind and solar farms. Raises uncertainty of absolute emission reduction and is prone to manipulation.
E.g. in 2009, 81 million tons of offset credits (59% of the EU’s annual CDM offsets) went to Chinese refrigerant factories to incinerate HFC-23, a chemical byproduct of refrigerant manufacturing whose potency is 11,700 x CO2. The Chinese constructed 19 new manufacturing plants solely to receive offset credits and the associated payments.
h. The Australian Government has introduced an Emissions Reduction Fund to replace the Carbon Pricing Scheme that has been removed. Describe the basic operation of the two schemes, and discuss the advantages and disadvantages of each. (8 marks)
Emissions Reduction Fund (ERF)
Voluntary scheme that provides financial incentives to organisations/individuals to adopt new practices and technologies to reduce their emissions. A number of activities are eligible under the scheme and participants earn 1 Australian Carbon Credit Unit (ACCU) for each tCO2e stored or avoided by a project. ACCUs can then be sold to generate additional income either to the government through a carbon abatement contract or on the secondary market. To prevent carbon leakage (i.e. a rise in emission elsewhere in the economy) the ERF includes a Safeguard Mechanism (SGM) which encourages 140 large polluting businesses to keep their emissions within historical levels. Note: this is only in theory. In reality, the government has already increased the emissions baselines for many of these businesses for questionable reasons. In some cases businesses have had their baseline increased simply because the business grew which is nonsensical.
Participants therefore reduce emissions in exchange for a portion of the A$2.55b fund.
For a project to be eligible it must:
- Not have started before it has been registered (the ERF register contains info including start date, location, abatement, etc.)
- Not be required to be carried out by Australian law (i.e. additionality requirement)
Not be carried out under another government program.
Problems:
- Budget has proved too small to meet commitments and is now exhausted
- Minimum bid size excludes small projects
7 year contracts for abatement are too short for many activities
- Involves a large administrative burden
- Confined to specific activities → remained of economy remains on emissions growth path
- Price is too low for industrial EE which was predicted to benefit - failure.
Carbon Pricing Scheme
Started in July 2012, was the predecessor for the ERF. Applied to Australia’s biggest carbon emitters, called liable entities. These businesses had to pay a price for carbon emissions they emitted which covered approx. 60% of Australia’s emissions. The scheme did not cover the vast majority of Australian businesses (particularly smaller businesses), households or transport.
The structure was a fixed price on carbon emissions for 3 years starting at $23/t and rising 2.5% p.a. Unlimited amount of permits were issued at this fixed price but not to be traded or hoarded for later use. Following this, a flexible cap and trade scheme with a ceiling of $20 above the international price was to be put in place for 3 years, rising 5% p.a. A limited amount of permits were to be issued at market price. It was under this scheme that the Carbon Farming Initiative was put in place, an offset scheme where farmers are rewarded for reducing emissions, carbon sequestration or change of land use (e.g. replanting native forest instead of farming). The CPS scheme was repealed in late 2014 even though it saw an average 1.5% drop in emissions from the sectors covered and a 6% drop in the electricity sector.
The problem with all of these schemes / carbon taxes is that the end-game is its own redundancy → a successful tax will not be very large in the future because emissions will be significantly lower.
The entire system of these “carbon reduction mechanisms” is premised upon letting the free market decide how Australia generates their energy - yet the Australian government props up the fossil fuels industry through ~A$11b of taxpayer money every year.
→ Turnbull himself has a 14kW array on his roof (and battery storage). Maybe promote that instead of subsidising coal.
The Australian Government has introduced an Emissions Reduction Fund to replace the Carbon Pricing Scheme that has been removed. Describe the basic operation of the two schemes, and discuss the advantages and disadvantages of each. (8 marks)
ERF
- Reverse auction scheme whereby the government uses budget money to pay for carbon-reducing projects. The cheapest wins
- Excludes the elec industry
Pros:
- Relative to Carbon tax, institutionally feasible
- Allows/rewards lowest cost abatement
Cons:
- Budget too small to meet international commitments
- Contracts require a minimum abatement amount, excluding small projects
- Contract length is too short
Carbon Tax
- Carbon tax applied a fixed a fixed price on carbon /tCO2
- Broad Coverage, excluded most of the transport sector
- Set to shift to an ETS after 3 years
Pros
- Prices the externality of carbon emissions
- Simple, easy to implement
Cons
- Price wasn’t set high enough to reflect costs of emissions
- Quantity of emissions abatement was uncertain
- Taxes are politically unfavourable
