Metrics, Uncertainty, and a Legal Framework
Steps Toward a Global Emissions Trading System
by Michelle de Leon, mad354@cornell.edu
Atmospheric carbon dioxide (CO2) concentrations historically — and continuously — fluctuate, and so we observe that earth systems are dynamic. As the environment changes, much climate policy debate centers around whether recent trends of accelerated accumulation of CO2 and associated global warming are anthropogenic or not. These trends draw on the global carbon budget in which there is a finite stock of carbon stored among different pools, namely the ocean, forests, and fossil fuels, that cycles between different pools via different processes. For one, many studies observe a rise in CO2 concentrations since the Industrial Revolution around the 1750[1], and thus while climate fluctuations are “natural,” human activity or accelerates climate change.
These changes already have real consequences: rising sea-levels challenge small island nations and their water systems, and biodiversity within critical ecosystems is declining. As such, the change in the carbon budget has an international impact, calling on humans, nonhuman life, and landscapes to be stakeholders on climate issues, irrespective of national identity. The United States Department of Defense recognizes that “Global climate change will aggravate problems such as poverty, social tensions, environmental degradation, ineffectual leadership and weak political institutions that threaten stability in a number of countries” [2]. Recognizing these threats, the United Nations Framework Convention for Climate Change drafted the Paris Agreement in December 2016. This Agreement calls on Parties to reduce greenhouse gas emissions by “nationally determined” mitigation and adaptation strategies that will have international impacts. Strategies must “(a) Promote mitigation and adaptation ambition; (b) Enhance public and private sector participation in the implementation of nationally determined contributions; and © Enable opportunities for coordination across instruments and relevant institutional arrangements” [3]. Therefore, Article 6 supports the creation of a global emissions market, given it meets the aforementioned criteria.
A Global Emissions Market
Since the Kyoto Protocol of 1990, emissions trading has become a key policy tool in greenhouse gas abatement through a market-based approach. An emissions market involves caps, allocations, regulations, and the “flexibility” of permits. First, caps are limits on emissions as measured by a unit of emission per output. Emissions trading systems (ETS) vary by (1) type of greenhouse gas and (2) metric for amount emitted. With respect to these caps, permits are distributed to emitters, typically by three main ways: grandfathering, using benchmarks, or selling permits through auctions.[4] Grandfathering permits is the most common allocation approach; emitters are granted credits proportional to their historical emissions, oftentimes using the Kyoto Protocol (1990) as the baseline. Benchmarks are granted for each sector or sub-sector based on a particular factor, whether it is technology or emission factors, among other options. Lastly, through auctions, generally held by governments, sales demand emitters to consider the entire cost of emissions and to reveal abatement costs. Moreover, revenues from auctions may be “recycled” by the seller to fund climate change actions. Whether government involvement is through sales or other mechanisms, emissions markets charge the state with creating the framework for trading.
Giving way to trading, the flexibility of permits comes in three primary forms: banking, borrowing, or offsetting. Banking and borrowing primarily concern the storage and future use of permits, and these mechanisms incentivize emitters to invest in “early emissions reductions when industries know the constraint will increase over time.”[5] This article focuses more on offset credits, “carbon assets that reward emissions reductions undertaken by installations outside of the scope of carbon markets, and hence not required to surrender permits.”[6] For example, an emitter in Germany may invest in wetland restoration in Bolivia. In turn, “allowing offset credits in permit markets increases the scope of the abatement possibilities and thus allows participants to buy emissions reductions at a lower cost.”[7]
Afterwards, permit pricing depends on supply and demand. Supply, to a large extent, depends on “parameters set by policy makers, be it directly by the level at which the cap is set, or indirectly through the rules set relating to offsets, banking and borrowing, or linking.”[8] Demand, however, “depends largely on the behavior and characteristics of market participants” and also shocks independent of the ETS design, such as the level of emissions relative to the cap and abatement costs [9]. Therefore, the price of a permit — and thus the price of a tonne of carbon — fluctuates with the market. “Because underlying economic activity is a main driver of energy demand and thus emissions, allowance prices tend to be lower during economic recessions and higher during periods of economic growth.”[10] As a market-based tool, changes in pricing must be considered when encouraging a demand and managing a supply, particularly when trade occurs across markets. Linking ETS supports global cooperation and coordination for greenhouse gases abatement by engaging more emitters and governments than a single system would. Policymakers gain an avenue to learn from each other and provide assistance. International ETS has begun, and a popular model is the European Union Emissions Trading System (EU ETS): “The EU ETS is the largest emissions trading system in the world. Its coverage of GHG emissions, scale, and market value far exceed other carbon markets currently in operation. The EU ETS was the first multi-national installation-level cap-and-trade system that set up a market for CO2 and other GHGs.”[11] Within EU ETS, each EU state submits monitoring plans and self-reports emissions, verification, and improvement.[12] This market covers about 45% of the EU’s greenhouse gas emissions, and the EU aims to link with other ETS such as China.[13] The EU-China link would likely create a market between 5 and 7 billion tonne carbon per year.[14]
Measuring Ambiguity
In considering a large scale, market-based solution, logistical questions arise. First, the trade frames emissions as a product, but what are emissions and how do we measure them? There are six primary greenhouse gases are CO2, methane (CH4), nitrous oxide (N2O), and three fluorinated gases (PFCs, HFCs and SF6).[15] Given the variety, a cap can include all six or just some: “the first option was chosen in the Kyoto Protocol, and the second in the European CO2 allowances markets or in the RGGI [Regional Greenhouse Gas Initiative] in the North-East of the United States” [16]. Linking ETS targeting different emissions can become problematic, leading emitters to prefer cheaper forms of emissions rather than a comprehensive emissions reduction.
Moreover, to further conceptualize the endeavor of creating a metric, we must recall that atmospheric gases are difficult to contain, especially for measurement. In turn, a variety of metrics appear for a tonne of carbon. A tonne of carbon dioxide emissions is approximately 2,200 pounds CO2 and functions as the standard for comparing greenhouse gases as contributors to a warming climate. Metrics recognize other greenhouse gases, or CO2 equivalents (CO2-e) such as CH4 and chlorofluorocarbons, on the pollutant’s respective ability to trap heat in the atmosphere. Such conversion depends on a strong scientific understanding of greenhouse gases, and we must consider how climate science continues to develop. Likewise, scientific instruments for measurement vary: because greenhouse gases vary in their anthropogenic sources, metrics become industry specific. For example, measuring CO2 emissions from vehicular activity depends upon a surrogate method of measuring miles driven, as opposed to a system monitoring flue gases for CO2.[17] Surrogate methods depend on a host of assumptions, such as how much the average driver travels and how many drivers are there on how many days of the year, and because data is the foundation of ETS, inaccuracies can distort carbon market conditions and different (carbon) products by sector and country. Without commensurable products, linking carbon markets becomes increasingly difficult, especially in the context of a single global carbon budget.
Another metric issue occurs when considering how reductions are measured. Government bodies generally aim for reductions relative to a baseline. The EU ETS pushes for a reduction relative to 1990 (Kyoto Protocol). China, however, places current year output as a baseline.[18] Moreover, reductions may not be accurately reported. The current mode of ETS requires self-reporting (i.e. EU ETS), and while the Paris Agreement calls on countries to use internationally-accepted Intergovernmental Panel on Climate Change methodologies [19], accuracy depends on the country. The global carbon market looks forward to China’s participation because of its position as the largest emitter, but ETS depends on data transparency, the opposite of China’s “politicized and often secretive industrial system.” [20,21]
Whether in terms of emissions or reductions, ETS are not standardized, though this is intentional in the Paris Agreement’s call for “nationally determined” plans: “each country decides its own appropriate contribution to reduce emissions and keep global warming below 2 degrees Celsius.” [22] While this discourse respects a nation’s capabilities and sovereignty, different mechanisms to achieve reduction within a single, international market may prove problematic. The Regional Greenhouse Gas Initiative in the U.S. Northeast and Mid-Atlantic voluntarily focuses on the energy industry: “The target is to reduce carbon emissions in the power sector by 10 percent until 2018 compared to the year of 2009 by establishing a market-based mechanism. The RGGI was launched in 2009 and consists of individual cap-and-trade schemes for electricity generation facilities, which are all linked.” [23] As a mitigation approach, targeting one sector supports its climate adaptation strategies over that of others, which may lead to a privilege to pollute.
Similarly, how do policymakers distribute permits in a way that effectively, and fairly, mitigates and adapts to climate change? To whom should, and will, permits go? These questions illuminate the various allocation types, and for one, grandfathering gives historically large polluters leeway to continue polluting. With emission levels related to economic productivity, these emitters may have the capital to purchase more permits, and in turn, large emitters do not ambitiously approach climate change as called for by Article 6. Also, even if a country nationally determines an ambitious ETS, carbon leakage may occur, a scenario in which businesses relocate activity to countries with laxer emissions constraints because of the costs related to carbon policies. [24] In light of a single global carbon budget, leakage may encourage an increase in businesses’ total emissions, a policy outcome disagreeable with emissions reductions.
A Legal Framework
Consequently, ETS must establish a clear legal framework that specifically outlines who is accountable. The voluntary participation can put individual companies and entire countries at a competitive disadvantage, and this risk can be moderated through a global framework that mandates emissions abatement strategies. The voluntary, bottom-up approach struggles to address emission because large, wealthy polluters can buy up credits and offset: however, stakeholders intuitively understand that planting trees is not the same as cutting coal use. If a legal framework holds companies, sectors, and countries accountable for emissions through its permits, then this can lead to real emissions reductions.
Furthermore, a legal framework must define what a carbon unit is: it is a grant to pollute, a license to emit, or property? If it is property, how will it be secured, as are other forms of private property? “If a carbon unit is legally considered property, specific rights become associated with it, potentially allowing its owner to use it in transactions other than selling/purchasing or surrendering for compliance (e.g., as a collateral for a loan).” [25] Permits may become a popular trade commodity not intended for climate policy, and stakeholders will not observe real emissions reductions.
To avoid such framework issues, policymakers and industries must take lessons learned from pilot and already established programs. EU ETS introduced a phase plan in which the price of carbon collapsed multiple times: Phase 1 (2005–2007) saw the price as 0 EUR, and it was thought that as the economy recovered, the price of carbon would, too [26]. This failure was due to monitoring and accountability mechanisms not yet set, and “the total cap on the emissions was decided using best estimates, which led to too many permits being available in the market. In addition, neither aviation nor maritime transport was included in the scheme, and the installations that were included consisted of just power generations and energy-intensive industrial sectors (with plenty of exceptions).” [27]
The EU made adjustments and encouraged China to learn from ETS failures: China considers its best strategies, such as how China, as aforementioned, looks to current year output rather than how the EU references pre-1990 values. This collaboration demonstrates that success will depend more on just market health: capacity building exercises such as conferences for policymakers and trainings for emitters will foster the ability to effect tangible climate mitigation strategies.
A focus on deliberation highlights that an attitudinal change is necessary for long term abatement strategies. ETS are only one tool in the climate change adaptation and mitigation toolbox. As such, findings highlight that markets only address some greenhouse gases, and greenhouse gases are not the be-all-endall of climate issues. In turn, we must continue to have a variety of tools, namely those that discourage all emissions, as opposed to encouraging emissions reduction. For example, heavier investment in alternative energy proves to be a strong mitigation strategy. [28]
Moreover, another attitudinal change asks to be mindful of how policy outcomes may interplay. Environmental issues are dynamic and complexly-intertwined, and thus strategies may have unanticipated outcomes. When planning ETS, policymakers must consider how reducing greenhouse gas emissions may impact other climate policies (i.e. clean air initiatives) or economic policies (i.e. international trade).
Because ETS have broad, market implications and require investment and coordination, governments must make a political commitment. We cannot ignore the political implications of climate policies: the economic health of a country is closely-tied to its energy sector. Poland, for example, depends on coal for 85% of its electricity needs, and thus it asks for permits to keep its coal industry competitive. [29] However, we find that free permits for Poland subsidizes, not limits, the growth of its coal industry. [30]
All parties to the Paris Agreement and governments participating in ETS adopt responsibility in mitigating and adapting to climate change, and according to the agreement, developed countries have financial obligations to assist developing countries. This rationale comes from the assumption that since developed nations are more industrialized — and thus able to produce more greenhouse gases — they have more financial capital. Therefore, developed nations must be leaders financially and by example.
Since the 1970s, the U.S. leads in environmental policy, particularly given the National Environmental Policy Act (NEPA) for environmental assessment. Many states, countries, and multilateral institutions (i.e. World Bank) adopted NEPA mechanisms. Given this historic leadership, the future of a global carbon market could become problematic if the Trump Administration does not take action. There exists much ambivalence within the USA and abroad about the Administration’s climate policy commitment. Trump has illuminated to withdrawing from the Paris Agreement early in his presidency, but this rhetoric is empty: the Agreement, with USA as a Party, entered into force 4 November 2016 and explained that at “any time after three years from the date on which this Agreement has entered into force for a Party, that Party may withdraw from this Agreement by giving written notification to the Depositary.” [31] Consequently, the Trump Administration cannot withdraw from the Agreement, but it may neglect to fulfill its Agreement responsibilities. Without American leadership and participation, especially given its large economy and levels of emissions, we begin to question the level of confidence we can put in a global ETS.
As such, the success of a product depends on market participants’ confidence. Given that governments will have the legitimate ability to manage key parameters, and policies, of an ETS, “changes, or anticipation of these changes, can also lead to considerable price changes, as well as uncertainty, which increase the risks of investments in abatement. For example, policy deliberations over postponing (“back-loading”) the auction of allowances to temporarily tighten the EU ETS’s cap led to considerable price movements during the third phase of the program and may have increased the perceived risk from banking allowances.” [32]
Stability in policies and prices can begin to be articulated through an unambiguous legal framework. Until then, carbon trading emulates trading uncertainties. What are the policies? What are emissions? What are reductions? The current emissions market pushes past these central questions and attempts to commensurate emissions. “Commensuration of place is built into its design; redistributing pollution around the landscape to ‘maximise cost-effectiveness’ is part of its structure.” [33] In turn, trading permits can be considered synonymous with trading mixed-emissions. Without knowing what the commodity actually is, the carbon market may find itself in an economic bubble, similar to the 2008 Housing Crisis driven by trading housing loan uncertainties.
In the case of ETS, institutions are selling nature to save it and striving to link markets for global coordination. Such cooperation is necessary to effectively mitigate and adapt to climate change, but given the variety of ETS designs, institutions must begin to harmonize — not just link — markets. Moreover, government intervention must be mindful so as to not create distortions in the market: its role should be to create an international, legal framework. ETS and the Paris Agreement are starting points on a long journey toward responsible environmental stewardship.
Notes
1 “Causes of Climate Change,” U.S. Environmental Protection Agency, accessed 19 December 2016, https://www. epa.gov/climate-change-science/causes-climate-change.
2 “DoD Releases Report on Security Implications of Climate Change,” U.S. Department of Defense, 29 July 2015, accessed 19 December 2016, http://www.defense.gov/News/Article/Article/612710.
3 United Nations Framework Convention on Climate Change, “Paris Agreement,” United Nations, November 2015, Art. 6.8a-c, http://unfccc.int/files/essential_background/convention/application/pdf/english_paris_agreement.pdf.
4 Anaïs Delbosc and Christian de Perthuis, Carbon Markets: The Simple Facts (United Nations Global Compact, 2009), https://www.unglobalcompact.org/docs/issues_doc/Environment/Carbon_Markets_The_Simple_Facts.pdf.
5 Delbosc and Christian de Perthuis, Carbon Markets: The Simple Facts.
6 Ibid.
7 Ibid.
8 The World Bank Group, Emissions Trading in Practice: A Handbook on Design and Implementation (Washington, D.C.: The World Bank, 2016), https://openknowledge.worldbank.org/bitstream/handle/10986/23874/ETP.pdf?sequence=11&isAllowed=y.
9 Ibid.
10 Ibid.
11 Environmental Defense Fund, European Union: An Emissions Trading Case Study, May 2015, http://www.edf.org/ sites/default/files/eu-case-study-may2015.pdf.
12 “Monitoring, reporting and verification of EU ETS emissions,” European Commission: Climate Action, last updated 20 December 2016, accessed 20 December 2016, https://ec.europa.eu/clima/policies/ets/monitoring_en.
13 “The EU Emissions Trading System (EU ETS),” European Commission: Climate Action, last updated 20 December 2016, accessed 20 December 2016, https://ec.europa.eu/clima/policies/ets_en.
14 Kieran Cooke, “Fuzzy Data Poses Problems for China Carbon Market,” Climate Home, 5 December 2016, accessed 18 December 2016, http://www.climatechangenews.com/2016/12/05/fuzzy-data-poses-problems-for-chinacarbon-market/.
15 Delbosc and Christian de Perthuis, Carbon Markets: The Simple Facts.
16 Ibid.
17 Hannah Hoag, “The Problem with Emissions Trading,” Nature, 25 November 2011, accessed 18 December 2016, http://www.nature.com/news/the-problems-with-emissions-trading-1.9491.
18 China Carbon Forum, “Executive Summary: China’s National ETS,” China Carbon Forum, 24 April 2016, accessed 18 December 2016, www.chinacarbon.info/wp-content/uploads/2016/07/Executive-Summary-Chinas-National-ETS-20160427.pdf.
19 United Nations Framework Convention on Climate Change, “Paris Agreement,” Art. 13.7(a).
20 Hoag, “The Problem with Emissions Trading.”
21 Craig Hart, “Craig Hart: Doubts Swirl Over China’s Carbon Trading Plan,” Nikkei Asian Review, 13 October 2016, accessed 20 December 2016, http://asia.nikkei.com/magazine/20161013-Asia-s-new-vanguard/Viewpoints/CraigHart-Doubts-swirl-over-China-s-carbon-trading-plan?page=2.
22 Kelly Levin and David Rich, “INDCs: Bridging the Gap between National and International Climate Action,” World Resources Institute, 19 February 2015, accessed 19 December 2016, http://www.wri.org/blog/2015/02/indcs-bridging-gap-between-national-and-international-climate-action.
23 Deutsche Gesellschaft fur Internationale Zusammenarbeit GmbH, “Global Carbon Markets,” Deutsche Gesellschaft fur Internationale Zusammenarbeit GmbH, accessed 18 December 2016, http://ets-china.org/emission-trading-schemes/global-carbon-markets/.
24 “Carbon Leakage,” European Commission: Climate Action, last updated 20 December 2016, accessed 20 December 2016, https://ec.europa.eu/clima/policies/ets/allowances/leakage_en.
25 The World Bank Group. Emissions Trading in Practice: A Handbook on Design and Implementation.
26 Darius Mikulenas, “The Unclear Future of EU-ETS: Is there still a chance of success?” European Public Affairs, 5 Feburary 2016, http://www.europeanpublicaffairs.eu/the-unclear-future-of-eu-ets-is-there-is-still-a-chance-of-success.
27 Ibid.
28 European Environment Agency, “Renewables Successfully Driving Down Carbon Emissions in Europe,” European Environment Agency, 16 February 2016, accessed 19 December 2016, http://www.eea.europa.eu/highlights/ renewables-successfully-driving-down-carbon.
29 Mikulenas, “The Unclear Future of EU-ETS: Is there still a chance of success?”
30 Megan Darby, “EU Carbon Market is Subsidizing Polish Coal Plants — NGO,” Climate Home, 26 April 2016, accessed 20 December 2016, http://www.climatechangenews.com/2016/04/26/eu-carbon-market-is-subsidising-polish-coal-plants-ngo.
31 United Nations Framework Convention on Climate Change, “Paris Agreement,” Art. 28.1.
32 The World Bank Group. Emissions Trading in Practice: A Handbook on Design and Implementation.
33 Larry Lohmann, When Markets are Poison: Learning about Climate Policy from the Financial Crisis (Dorset, UK: The Corner House, 2009), 37
