The Year in Carbon: Contemplating Brexit, Paris, and Pricing

On 10 June, the European Commission officially began the legislative process for the ratification of the Paris Agreement by presenting a ratification proposal for the European Union, aiming for the agreement to enter into force as soon as possible.

This will happen when at least 55 countries, representing at least 55% of global greenhouse gas (GHG) emissions, will ratify the agreement.

The Commission’s proposal will need to be approved by the European Parliament and the Council. After that, the Council will deposit the ratification with the United Nations Secretary General, on behalf of the European Union. Meanwhile, each EU Member States will ratify the Paris agreement, individually.

I want to review the main aspects of the Paris Agreement, describe what the EU has promised to do in Paris, and explore the possibility of having an international carbon price.

But first, I must discuss the climate ramifications of the most significant event that happened in Europe in decades: the referendum on the exit of UK from the EU.

What are the Implications of Brexit on British and EU Climate Policy?

During the past 15 years, energy and climate policy in the UK has been developed within the EU policy framework, and the UK has been one of the driving forces for the liberalisation of the European energy market and of the climate change policy.

As a result, the UK energy market is integrated with that of the rest of Europe. The UK (like all EU member states) has participated in the EU ETS, the single European carbon market.

The UK and the EU have now to renegotiate all their relations including those in the areas of energy and climate. The results of this negotiation, which will take at least two years, are still unpredictable, and it is still unclear at what level the UK will take part in the European energy and carbon markets.

What are the current commitments for the UK and EU?

The UK, with the 2008 Climate Change Act, has set the goal of achieving 80% GHG emission reduction by 2050 with respect to the 1990 level.

The main British parties are committed to this target and the result of the referendum does not imply any change in climate policy. It is probable that Brexit will impose a revision of the EU pledges submitted for the Paris Conference.

Before the conference all countries were invited to present the so-called Intended National Determined Contribution (INDC), which are voluntary commitments to reduce GHG emissions that formed the basis of the Paris Agreement. The EU presented the INDC on behalf of all the 28 Members States (at that time).

With the UK out of Europe, the EU has to recalibrate its INDC and the UK has to present its own contribution.

Implications for post-Brexit climate policy in the UK

On the one side, this means that if the UK wants to pursue stronger climate actions, the British government can potentially submit more ambitious INDC and freely decide to implement stronger climate policy.

In the fifth carbon budget, which covers emission reduction for the period 2028 to 2032 and that was presented few days after the referendum, the British government confirmed its commitment in cutting emissions and set a target of 57%, higher than the emission reduction of the EU INDC.

On the other side, Brexit might pave the way towards a weaker approach to fight climate change. The UK will probably go through a period of economic and political instability that might move climate policy down the priority list.

Moreover, with the victory of the Brexit, politicians that supported Brexit, will have a more leverage role in shaping the future national policy. Many of them are for a reduction of the effort to reduce GHG emissions; some are climate skeptics and willing to repeal the Climate Act at all. Once outside the EU, the UK will not be subjected to the EU targets on energy and climate policy, and the national legislation can be changed with a simple majority.

For example, the UK now has a target of 15% of energy consumption from renewables energy by 2020, as part of the EU 20–20–20 target. It is still unclear if, without EU pressure, the UK will maintain this commitment.

All these uncertainties could also make it more difficult for the private sector to invest in low-carbon technologies in the UK.

Lastly, on international climate policy, Brexit will probably reduce the international leverage of UK. In climate negotiations a country’s influence depends significantly on its share of global emissions and wealth. As a member of EU, the UK had access to the table of the major players, while, out if EU, it risks being moved to a secondary position.

How will Brexit impact EU climate policy and negotiations, both internal and external?

From the continental side, the EU has to recalibrate its climate policy without the UK. This may imply a delay for the forthcoming climate and energy legislation and probably also for the EU ratification of the Paris Agreement.

The EU will lose a country that has been traditionally a supporter of cutting GHG emissions. As a consequence, the opinions of those countries that are more reluctant on strong climate policy, could weigh more heavily in the EU.

The UK has also been in general a promoter a small role of the central EU government. Indeed, the UK opposed a European Carbon tax in the 90′ and supported the creation of the EU ETS; for the 2030 energy and climate package, it was among the countries not in favor to have renewable binding targets as EU has for 2020.

With the UK out on the negotiation for the 2030 EU policy, there might be also a redefinition of the renewable and climate policies. At international level, the UK generally supported the EU in promoting strong actions and helped the EU in the negotiations that lead to the success of Paris COP21.

Without the UK, the EU will be smaller and without one of the stronger voices for international actions, this could weaken the EU’s role in the international decision making process, although it will still remain one of the fundamental player.

The real significance of the Paris Agreement

On 12 December 2015, the so-called Paris Agreement was adopted by 195 countries at the 21th Conference of the Parties (COP 21) of the United Nations Framework Convention on Climate Change (UNFCCC), held in Paris.

On the 22 April 2016, with a high-level ceremony at the United Nation in New York, the agreement was open for signature by the states and it will remain open for one year.

The signatures are subject to the ratification. This means that the signature alone does not impose any obligations to the signatory state until the agreement is ratified. In many instances, the government does the signature, while the ratification needs the approval of the national parliament.

The agreement will enter into force when at least 55 countries, representing at least 55% of global greenhouse gas (GHG) emissions will ratify the agreement.

As of 29 June 2016, 178 countries, including the EU, signed the Paris Agreement, almost all did it on the 22 April. Of those, 19 countries, mostly small island countries, also ratified the agreement, they cover 0.18 % of the global GHG emissions.

The agreement was received by most of the observers (including environmental organisations as Greenpeace) as a fundamental step forward in the fighting of climate change. Many experts talked of the agreement as an historic turning point. Indeed, the agreement is important for several reasons:

It has ambitious climate change objectives:

  • Keeping the global temperature rise below 2°C above pre-industrial levels and possibly below 1.5°C.
  • Increasing the ability to adapt to the negative impacts of climate change.
  • Mobilising adequate consistent finance flows to support reduction of low greenhouse gas emissions and climate-resilient development.

It is global, requiring each country to take steps to reduce GHG emissions according to the principle of common but differentiated responsibilities.

It is a long-term agreement, that establishes a framework for the regular monitor and revision of the national climate policies of the signatory parties.

How the Intended Nationally Determined Contributions function

The agreement was reached thanks to a bottom up approach. Before the COP 21, all countries were invited to communicate to the UNFCCC their Intended Nationally Determined Contributions (INDCs). These are voluntary and unilateral commitments to reduce GHG emissions.

Before the end of the Paris conference, 188 countries, covering more than 98% of global emissions, presented their INDCs. By ratifying the agreement, the countries commit to reach the GHG peak as soon as possible and to achieve the above objectives, starting by fulfilling their INDCs.

Moreover, and here is the more innovative part, the agreement defines a regular revision process, to be done every five years starting from 2023, to take stock of the policies implemented and to increase the level of ambition.

Indeed, the UNFCCC has estimated that the global emissions reduction of INDCs, although more ambitious of voluntary targets promised after Copenhagen, are not enough to reach the 2°C target, and that, if fully applied, by the end of the century the temperature increase will be around 3°C.

In order to ensure transparency and accountability, the actions of the countries will be monitored. The goal is to create a framework to increase the ambition of the national policies through a system of “pledge and review”, with each country deciding its contribution to reduce GHG emissions.

What are the weaknesses of the Paris Agreement?

The main critique is that the treaty is only binding for the part regarding the revision process, without binding targets for emissions, since the definition of the national objectives is under the responsibility of the single countries.

As a result, the INDCs are defined in different ways such as in terms of total emission, relative emissions to GDP, year of peak of emissions, and this makes difficult to compare them. Moreover, there are no sanctions if a country sets too low objectives, or if it does not keep its commitments on emissions reduction.

Therefore, the main leverage to push the countries to fulfill their commitment is a “name and shame” system. (In this respect, however, it must be stressed that legally binding clauses in an international treaty are often very weak. In the Kyoto Protocol, for example, any party could resign from the treaty anytime, and be freed from any obligations after one year from the resignation notification. For example, Canada ratified in 2001 and left the system in 2011.)

Thus for the success of the agreement it will be essential to have a transparent and robust system of monitoring, reporting and verification (MRV) that allow tracking the efforts of the different countries.

The agreement establishes a “transparency framework” with “international assessment and review and international consultation and analysis” and with also “technical expert review” of the information provided by the different countries. However, common rules, procedures and guidelines for the framework are yet to be defined.

Upcoming challenges in making the Paris Agreement work

The Paris Agreement is an important step forward, and probably the best compromise that could have be reached, given the many existing political constraints, but it is still far from being a definitive solution.

The success of the agreement will depend on how it will be implemented (many technical but fundamental aspects, such as for the transparency framework, will be defined in the next years) and, especially, on the willingness of the countries to fulfill their commitments.

The EU INDC: An Ambitious Policy for 2030

EU Member States have reduced GHG emissions by 19% while GDP has grown by more than 44%. Currently, implemented policies have the legally binding 2020 target of 20% emissions reduction with respect to 1990.

For the COP 21, the EU presented its INDC to the UNFCCC in March 2015, being the second party to do so, after Switzerland. The EU presented a single INDC for all the 28 EU Member States, with a target of 40% reduction in greenhouse gas emissions by 2030.

This reduction covers 100% of the GHG emissions and it is fully domestic, since it does not include contribution from international credits. The target is in line with the long-term EU target of emission reduction of 80–95% by 2050, and consisting in reducing global emissions by half by 2050.

A 40% emission reduction is an ambitious target if compared with the targets of other largest GHG emitters submitted for Paris. Russia proposed a reduction of 25–30%, USA a –26–28% by 2025 with respect to 2005 (which implies a -15% with respect to 1990) and China only committed to peak in emissions by 2030.

The EU emission target as part of the Energy Union

This emissions target comes under an overall reform of the energy and climate strategy for 2030 that goes under the name of Energy Union.

Two additional key targets for 2030 will support the emission reductions: 27% share of renewable energy consumption, and 27% energy savings compared with the business-as-usual scenario.

The European Council adopted the three targets for 2030 already in October 2014, one year before the COP 21. The EC is now working on designing the policies for achieving them, which will be built on the current 2020 climate and energy package.

How the EU emissions trading system works

The main instrument to achieve the 40% target is the EU emissions trading system (ETS), which covers about half of the EU GHG emissions. The EU ETS started in 2005 and it was initially designed to comply with the Kyoto protocol.

This is a cap & trade system, where there is cap on the total emissions of the installations regulated by the system. A number of allowances equal to the cap are issued every year.

Each regulated installation has to annually surrender a number of allowances equal to their annual emissions. Those allowances can be traded in a market, which creates a carbon price that is a price on emitting GHG. The cap is annually reduced and as a result, the total emissions are reduced annually.

The EU ETS is the largest existing cap & trade system, covering more than 13.000 installations. The carbon price is increasingly considered as an important policy to reduce emissions, and we will talk more about it in the next post.

The current annual reduction of the cap was defined to reach the 2020 target of 20% GHG emission reduction with respect to 1990 level, but this is not enough for the 2030 target of 40%. Moreover, in the past years, the system was criticised, in particular, for having a too low and volatile carbon price due to an over allocation of allowances.

To face these issues and make the EU ETS stronger and in line with the proposed target, the EC undertook a reform of the system.

This was not the first modification to the EU ETS. Since its adoption, in 2005, the EU ETS has being regularly revised and improved through a learning by doing process, being the first system ever of such size and complexity.

Several measures were proposed for the post 2020 period, and a new system for allocating allowances that should create a more stable carbon price, (the so-called Market Stability Reserve), has been approved.

In 2015, the EC proposed a revision of the EU ETS directive aimed to increase the cap reduction for reaching the 2030 target. This is currently under debate at the European Parliament.

Targets for sectors not covered by EU-ETS

For the non EU-ETS sectors, which include transport (except aviation), buildings, agriculture and waste, the current legislation sets national binding emission targets for 2020, this is called Effort Sharing Decision.

The targets have been set based on the capacity of the countries and their relative wealth. Countries are responsible for the targets and for implementing policies to reach them. However, the EU has taken a series of measures, in particular to increase energy efficiency that are helping the Member States to reduce emissions in the non EU ETS sectors, such as standards for vehicles or regulation for buildings.

For 2030, the EC is proposing the same framework, with update targets and measures. The overall target for the non-ETS sectors will go from 10% by 2020, to 30% by 2030 (compared to 2005).

An international carbon price

Every time a ton of CO2 is emitted, the climate is damaged at the expense current and future generations. The carbon price system makes those who are responsible for emissions pay for them. In other words, it internalises the negative externality of climate change in the decision-making process of those creating the emissions.

The carbon price system makes those who are responsible for emissions pay for them.

The economic case for a carbon price

Carbon price gives an economic signal and disincentives to polluters who can decide when and how to reduce emissions.

From an economic point of view, this is the most efficient way to reduce emissions by incentivising the private sector to invest in low-carbon technologies. Moreover, the revenue from pricing carbon could be used for equally redistributing the cost of mitigation and adaptation to climate change.

There are two main ways of introducing a carbon price: through emissions trading systems (ETS), as described above, or through a carbon tax.

The transition towards a low-carbon economy is a complex and demanding task, which requires huge investments that cannot rely only on the public sector. A carbon price is a necessary instrument to assure a cost-efficient transition and to mobilise private investment.

This does not mean that a carbon price alone is enough to achieve the goal, and many other complementary policies are needed in different sectors, but it is an essential instrument; a view that is largely shared by economists and many climate policy experts.

Last year more than 148 experts and academics, including Nobel price laureates such as Prof. Jean Tirole, signed a Manifesto calling for an agreement on a carbon price at the COP 21.

A growing momentum at a global level to put a carbon price on emissions

There are already 40 nations and 23 sub-national regions that have carbon price mechanisms in place covering, according to the World Bank, 12% of the global emissions.

  • China now has seven ETS pilot schemes and it announced a plan to create a national ETS as from 2017.
  • The USA has two regional ETSs, in the north-east region and in California.
  • Canada has ETSs in Québec, which was linked with the California carbon market 2105, and in Alberta, and it has had a carbon tax in British Columbia since 2008.
  • Korea also instigated a carbon market in 2015.
  • Furthermore, about half of the INDC presented for the Paris conference has reference to carbon pricing.

Companies are also increasingly aware of the importance of carbon pricing

In 2015 CEOs from 43 companies and 20 economic sectors signed a letter to express support for a climate policy that included prices on carbon.

More than 1,000 companies and investors support the Putting a Price on Carbon statement led by the World Bank Group.

The Carbon Pricing Leadership Coalition, with the support of the World Bank and IMF, brings together leaders from government, the private sector and civil society to advance the carbon pricing agenda.

Companies are also increasingly considering carbon pricing in their investment decisions, in particular global companies, perceiving that in the short-medium term they might be subject to carbon price in some regions.

In 2015, more than 400 companies claimed to use an internal price, compared to 150 in 2014.

The Paris Agreement and a carbon price

Despite all this, the Paris agreement does not have any explicit reference to a carbon price. This is for two main reasons.

  • Firstly, because of the failure of the Kyoto Protocol, which created an international carbon price based on an international allowances trading system which has not functioned as desired.
  • Secondly, because some countries mistrust market-based policy measures.

Indeed, the agreement never mentions market instruments explicitly, while it recognises the importance of “non-market approaches” and promotes a framework for their development. Nevertheless, the agreement allows for the creation of market-based instruments.

Article 6 promotes voluntary cooperation among countries for the implementation of INDCs including the “use of internationally transferred mitigation outcomes”. This could take the form of exchange of emission allowances between countries and would allow countries to link their carbon pricing systems.

Moreover, Article 6 also provides the creation of a new international mitigation mechanism and of a body designated to manage it. Although the Paris Agreement may seem to dismiss a carbon price, it introduces a framework that can support countries, which already have a carbon price, to cooperate and increase their climate ambition.

This article was originally published on the Florence School of Regualtion website in 4 parts for the ‘Topic of the Month’ in July 2016.

You can see the original articles here: The Impact of Brexit on Climate Policy: The EU and the Paris Agreement; The Paris Agreement; The EU INDC: an ambitious policy for 2030; and Time for an international carbon price?

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