Pricing Carbon: Emissions Trading Schemes [Part.2]

Part 1 of this article introduced the concept of Emissions Trading Schemes (ETS), the difference between carbon tax and carbon market, and the development of ETS in China.

Other ETS around the World

According to the World Bank, by May 2021, carbon prices applied to over 20% of global GHG emissions. In total, 64 carbon pricing instruments have been in operation around the world. The map below shows countries and regions with ETS or carbon tax implemented or under consideration.

Europe

The European Union ETS (EU ETS) has been in operation since 2005 and is the oldest carbon trading market in the world. Only recently overtaken in terms of size by China’s national ETS, the EU ETS covers more than 10,000 entities, accounting for 40% of EU’s total GHG emissions. It spans 31 countries, including all 28 EU member states with the addition of Iceland, Liechtenstein, and Norway. Participants include emitters in the power, manufacturing, and aviation industries within the European Economic Area (EEA). The EU ETS has gone through several reforms, the latest of which was proposed in July 2021 as part of the European Green Deal. The new revision of the EU ETS considered extending the scope to maritime, road transport, and building sectors. The EU’s European Green Deal set a legally binding GHG emissions reduction target of at least 55% below 1990 levels by 2030 and carbon neutrality by 2050.

North America

The US does not currently have plans for a national ETS. However, several states have partnered up with one another along with a few Canadian provinces to establish regional carbon markets. One of the regional markets is the Regional Greenhouse Gas Initiative (RGGI), which nine northeastern and mid-Atlantic states commenced in 2009 and targets only CO₂ emissions from the power sector. Another regional market, the Western Climate Initiative (WCI), was launched in 2012 and comprised of seven US states and four Canadian provinces. WCI aims to facilitate the development of ETS within member states and provinces in order to reduce regional emissions to 15% below 2005 level by 2020. So far, only the US state of California and the Canadian province of Quebec have established ETS in accordance with WCI. In the absence of a US national ETS, these ETS represent regional differences in politics, resource consumption, economies, and environmental concerns.

APAC

In Asia, countries with operating ETS currently include China, South Korea, Japan, and Kazakhstan. The South Korea ETS (K-ETS) began in 2015 as the first East Asian nation to implement a mandatory national ETS. It covers power and industrial sectors along with waste and domestic aviation industries, accounting for over 70% of the country’s emissions. Between 2015 and 2017, the K-ETS reported a drop of 3.5% in emissions intensity. The country targets a 37% emissions drop below business-as-usual (BAU) level by 2030.

Meanwhile, Japan does not have a national ETS, but operates a mandatory cap-and-trade program within the Tokyo Metropolis, mandating large buildings, factories, heat suppliers, and other large fossil fuel consumers to reduce emissions below a facility-specific baseline. The city announced the Zero Emission Tokyo Strategy in 2019, which pledged a 30% reduction from 2000 GHG emissions levels by 2020 and net zero CO₂ emissions by 2050.

Kazakhstan’s ETS (KAZ ETS) launched in 2013, but ran into legislative collisions and GHG regulation gaps and resulted in no emission reduction. It was suspended from 2016 to 2017 to reform allocation rules and solve operational issues, then restarted in 2018. By the end of 2020, the KAZ ETS covered 225 installations from sectors such as power and centralized heating, oil and gas mining, metallurgy, chemicals, and material processing such as cement production.

The New Zealand ETS (NZ ETS) is now the only operating ETS in the Oceania. Launched in 2008, it is the only ETS including forestry in the covered sectors. The country has committed to a 30% reduction in GHG emissions below gross 2005 levels by 2030. Prior to the pandemic, the NZ ETS was projected to reduce 2020 emissions by 2.9m tons of CO₂ equivalent. Its more populated neighbor Australia had been planning a national ETS as well, but the project was abandoned in 2013 after a change in government.

Challenges of ETS Execution

Data Quality

One of the key challenges in ETS development is data quality. In the case of China, domestically, the maturity of corporate development and corporate management differs greatly at this stage. As a result, companies’ abilities to properly collect, organize, and store data also vary, and the collected data often lack coherence, integrity, and validity. In addition, during the pilot market phase, some companies and third-party organizations were found to have forged emissions data. Strengthening corporate governance and data management capacity is important to the long-term health and credibility of ETS.

To combat data issue, a crucial part of ETS development is the establishment a robust measurement, reporting, and verification (MRV) system. An MRV system requires companies to submit emissions data, whether directly measured by a device or calculated using emissions factors, for audit by government inspectors or official third-party experts. A legal MRV framework should couple with reliable enforcement measures, such as penalizing non-compliant entities with monetary sanctions, tightened emissions cap for the next period, even criminal penalties.

Carbon Leakage

Another common issue of ETS is carbon leakage. Carbon leakage refers to a transfer of emissions to countries with laxer climate regulations from a country with tightening emissions restrictions. As an example, California’s ETS as part of the WCI experienced severe carbon leakage due to electricity contract swapping with neighboring states. The leakage can also occur between sectors and businesses with asymmetric emission policies. For example, an ETS might lead to increased emissions in installations not covered by the ETS.

To combat carbon leakage, the European Parliament is considering a Carbon Border Adjustment Mechanism (CBAM). The mechanism imposes a carbon levy on certain imports from countries with less ambitious GHG emissions rules than the EU, starting with power and energy-intensive industrial sectors. Alternatively, China’s emissions intensity approach may also dampen the likelihood of carbon leakage. Overall, to address carbon leakage on a deeper level, strengthening emissions regulations and expanding the carbon market regionally and internationally are key to avoiding the issue from the start.

Sources:

https://climatepolicyinfohub.eu/global-rise-emissions-trading

https://www.nature.com/articles/d41586-021-01989-7

https://www.lse.ac.uk/granthaminstitute/explainers/how-do-emissions-trading-systems-work/

http://energy.people.com.cn/n1/2021/0115/c71661-32000764.html

https://www.yicai.com/news/101111692.html

http://www.nea.gov.cn/2021-07/23/c_1310079997.htm

https://finance.sina.com.cn/esg/ep/2021-07-02/doc-ikqcfnca4475787.shtml?cref=cj

https://finance.sina.com.cn/chanjing/cyxw/2021-05-19/doc-ikmxzfmm3300357.shtml

https://www.wri.org/insights/carbon-tax-vs-cap-and-trade-whats-better-policy-cut-emissions

https://www.e-education.psu.edu/geog432/book/export/html/256

https://climatechange.lta.org/midwestern-accord/