Category Archives: international comparisons

Can emissions trading produce adequate carbon prices?

Prices under emissions trading schemes have been low to date.  Sometimes this may be because systems are new, but the EUETS is long established and needs to demonstrate that it can now produce adequate prices. 

Prices under emissions trading systems around the world have so far remained low.  The chart below shows carbon pricing systems arranged in order in increasing price, with prices on the vertical axis shown against the cumulative volume covered on the horizontal axis.  Carbon taxes are shown in purple, emissions trading systems in green.  It is striking that all of the higher prices are from carbon taxes, rather than emissions trading systems.

Prices under Emissions Trading Systems and Carbon taxes in 2016

capture

Source:  World Banks State and Trends of carbon pricing report[1].  Prices are from mid-2016.

Prices in the largest emissions trading system, the EUETS have been around $5-6/tonne, and prices in the Chinese pilot schemes have been similar and in some cases even lower, although with little trading.  The price under the California and Quebec scheme (soon to be joined by Ontario) is somewhat higher.  However, this is supported by a floor set in advance and implemented by an auction reserve price.  If this price floor were not present a surplus of allowances would very likely have led to lower prices.  The Korea scheme has had very low trading volumes, so does not provide the same sort of market signal found under more liquid schemes.

In contrast, a wide range of carbon taxes are already at higher levels and in some cases are due to increase further.  The French carbon tax, which covers sectors of the economy falling outside the EUETS, is planned to reach €56/tCO2 (US$62/tCO2) in 2020 and €100/tCO2 (US$111/tCO2) in 2030[2].  In Canada a national lower limit on carbon prices for provinces with an explicit price-based system (not shown on the chart) is due to reach $50 per tonne in 2022[3]. The UK carbon price floor, which covers power sector emissions, was due to rise to substantially above current levels, but is currently being kept constant by the Government, mainly because the price under the EUETS is so low.

Increases such as those due in France and Canada will bring some carbon taxes more in line with the cost of damages, and thus to economically efficient prices.  The cost of damages is conservatively estimated at around $50/tonne[4], rising over time (see here for a discussion of the social cost of carbon and associated issues).  The increases will also bring prices more into line with the range widely considered to be necessary to stimulate adequate low carbon investment[5].

Low prices under emissions trading systems have been attributed to a range of factors, including slower than expected economic growth and falling costs of renewables[6].  However these factors do not explain the consistent pattern of low prices across a variety of systems over different times[7].

While it is difficult to derive firm evidence on why this pattern should be present, two factors seem plausible.  The first is systematic bias in estimates – industry and governments will expect more growth that actually occurs, costs will be overestimated, and these tendencies will be reflected in early price modelling, which can often overstate likely prices.

But the second, more powerful, tendency appears, based on anecdotal evidence, to be that there is an asymmetry of political risk.  The political costs of unexpectedly low prices are usually perceived as much less than those of unexpectedly high prices, and so there will always be tendency toward caution, which prevents tight caps, and so leads to prices being too low.

This tendency is difficult to counteract, and has several implications for future policy.

First, it further emphasises the value of price floors within emissions trading systems.  Traditional environmental economics emphasises the importance of uncertainty around an expected level of abatement costs or damages.  If decision makers are not in fact targeting expected average levels, but choosing projections of allowance demand above central expectations then the probability of very low prices is increased, and the case for the benefits of a price floor is stronger.

Second, it implies that it is even less appropriate than would anyway be the case to expect the carbon price alone to drive the transition to a low carbon economy.  Measures so support low carbon investment, which would in any case be desirable, are all the more important if the carbon price is weak (see here for a fuller discussion of the value of a range of policy measures).   While additional measures do risk further weakening the carbon price, they should also enable reduced emissions and tighter caps in future.

Third, it requires governments to learn over time.  Some low prices may reflect the early stage of development of systems, starting slowly with the intention of generating higher prices over time.  However this does require higher prices to eventually be realised.

The EUETS has by some distance the longest-established system, having begun eleven years ago and with legislation now underway for the cap to 2030, by which time the system will be 25 years old.  The EU should be showing how schemes can be tightened over time to generate higher prices.  However it now looks as though the Phase 4 cap will be undemanding compared with expectations (see previous posts).  The recent vote by the European Parliament’s ENVI committee failed to adopt measure that are adequate to redressing the supply demand balance, with tweaks to the market stability reserve unlikely to be enough.  This undermines the credibility of cap-and-trade systems more generally, rather than setting the example that it should.  Further reform is needed, including further adjustments to supply and preferably auction reserve prices.

The advantages of cap-and trade systems remain.  Quantity limits are in line with the international architecture set by the Paris Agreement.  They also provide a clear strategic signal that emissions need to be reduced over time.

However there is little evidence to date that emissions trading systems can produce adequate prices. The EU, with by far the most experience of running an ETS, should be taking the lead in substantially strengthening its system.  At the moment this leadership is lacking.  Wider efforts to tackle climate change are suffering as a result.

Adam Whitmore – 23rd January 2017

[1] https://openknowledge.worldbank.org/handle/10986/25160

[2] World Bank State and Trends in Carbon Pricing 2016.  See link in reference 1.

[3] http://news.gc.ca/web/article-en.do?nid=1132169  Canadian provinces with volume based schemes such as Quebec with its ETS must achieve emissions reductions equivalent to these prices.

[4] $40/tonne in $2007, see https://www.epa.gov/climatechange/social-cost-carbon, escalated to about $50 today’s dollars.

[5] See this recent discussion: https://www.weforum.org/events/world-economic-forum-annual-meeting-2017/sessions/the-return-of-carbon-markets

[6] Ref: Tvinnereim (2014) http://link.springer.com/article/10.1007%2Fs10584-014-1282-1#page-1

 

[7] The South Korea ETS may be a partial exception to the pattern.  However it is unclear due to the lack of liquidity in the market.

Carbon prices around the world are consistently too low

Carbon pricing is spreading rapidly around the world [i].  However prices almost everywhere are far too low at the moment to price emissions efficiently.  The chart below summarises carbon prices in those jurisdictions with pricing.  The horizontal axis shows volumes, the vertical axis shows prices, as in a conventional commodity supply curve.  The vast majority of priced emissions – about 90% of the total – are priced below $14/tCO2.  Higher carbon prices are invariably for small volumes, and are found only in Europe and British Columbia.  They include prices under the French carbon tax, which covers sectors outside the EUETS, the UK carbon price floor, where the EUA price is topped up, and longstanding carbon taxes in Scandinavia.

The chart also shows the social cost of carbon – which represents the cost of the environmental damage caused by emissions – as estimated the US EPA.  This is almost certainly an underestimate[ii] of the true cost, and the concept has other limitations that imply it is no more than a lower bound to what it is worth paying to avoid emissions.  Carbon prices are thus too low even compared with a likely underestimate of the cost of emissions.  Taxes are too low and caps are too loose to price carbon adequately.  Consequently efficient abatement is not happening[iii].

Prices and volumes of carbon pricing around the world

Carbon supply curve

Price data is from May 2015.  I have excluded the Mexican carbon tax on the grounds that it does not apply to natural gas and so does not fully tax carbon.  The Chilean carbon tax is included although it does not come into force until 2018.  The South African carbon tax is scheduled to be introduced next year, but may be postponed, or may not be introduced at all.  The EUETS price would be somewhat higher but for the weakness of the Euro against the dollar at the moment.   The Social Cost of Carbon is the US EPA estimate at a 3% discount rate and converted to $2015 – see reference 2.

Prices may increase in future.  However this process looks likely to be too slow in most cases.  For example, under the California and Quebec scheme prices are currently at the floor set by the auction reserve.  This escalates at 5% p.a. real terms.  However at the present rate this will take until around 2050 to catch up even with the EPA’s estimate of the social cost of carbon[iv], which also shows increases in real terms over time.  Prices elsewhere in North America are mostly lower still.  In the EU there is little evidence from forward markets that allowances will reach significantly closer to the social cost of carbon over the next few years, and it seems unlikely that China will seek to price emissions at much above levels that prevail in the EU and North America.  It therefore seems likely on present trends to be a long time before prices in major jurisdictions reach levels that reflect the cost of damage from climate change, or are sufficient to limit temperature rises to two degrees.

This implies that further action is needed to make higher prices more politically acceptable.  Doing this will be a huge challenge, but two strands of any solution appear clear.  Ensuring that industry that is genuinely vulnerable to carbon leakage is appropriately safeguarded from competitive distortions will help mitigate political obstacles to higher pricing.  And efficient carbon pricing may further be helped by more explicit recycling of revenue to citizens, including ideas such as cap-and-dividend, in which the proceeds of sale of allowances under a cap-and-trade scheme are returned directly to citizens.  This in effect defines citizens as owners of the right to emit and so gives everyone a stake in higher prices (more on this in a future post).  Elements of such an approach are evident in British Columbia and were part of the former Australian scheme.

Measures other than carbon pricing are in any case necessary to bring about the required transformation of the energy sector[v].  And while carbon prices remain too low there will be an even greater need for such approaches, even if these may sometimes themselves help keep the carbon price low.  Funds to subsidise deployment of low carbon technologies may come from the proceeds of carbon pricing, especially in jurisdictions such as North America where earmarking of revenues is common.

The spread of carbon pricing is a success story, but a limited one in view of the prices prevailing to date.  Efforts both to strengthen the carbon price and enhance complementary policy approaches are needed if climate change is to be limited to acceptable levels.

Adam Whitmore – 2nd June 2015

 

Notes

[i] See  here

[ii] See  here

[iii] The marginal price signal is at too low a level, so some economically efficient abatement is not being signalled.  It is possible that an inefficient mix of abatement is being purchased, even though the level of abatement is efficient.  This could be the case if, for example, there was too much expensive abatement through renewables programmes.  However for a number of reasons this does not seem plausible.  For example, abatement is currently insufficient to meet the agreed 2 degree target, and support for renewables globally is clearly not excessive in view of their present share of generation and the required speed of reduction (although it may well be desirable for more of the support to be in the form of a higher carbon price on fossil fuel use).

 

[iv] Escalating the current carbon price at 5% real terms to 2050 gives a price of about $74/tCO2, roughly in line with the EPA’s central estimate of the Social Cost of Carbon at that date of 2011$76/tCO2.

[v] See here

The continuing spread of carbon pricing

Carbon pricing continues to spread around the world, with major schemes in Chinese provinces now in place.

For my first post this year it seems timely to review progress on implementing carbon pricing around the world.  As I’ve previously noted, the spread of carbon pricing during the past decade has been remarkable.  Once confined to a few small economies in northern Europe, it has become a worldwide phenomenon, with more than a dozen major carbon pricing schemes either in place or under development around the world.  The major step forward in last year has been the start of five regional pricing schemes in China, although trading in these markets remains relatively illiquid.  The expansion of carbon pricing in China is set to continue this year as two more trial schemes go live.  A year from now, assuming current programmes run to schedule, carbon pricing will be in place in jurisdictions that together account for between a fifth and a quarter of total global CO2 emissions from energy and industrial processes. 

Not all emissions in these jurisdictions are priced, as governments use other policy instruments to reduce emissions in particular sectors, for example surface transport in the EU.   Nevertheless, by next year over 10% of the world’s energy and industry CO2 emissions are likely to be priced.

On the Chart below the top (blue) line shows how the percentage of emissions in jurisdictions with pricing has grown over the last decade.  The total includes all energy and industry CO2 emissions taking place in each jurisdiction with carbon pricing.   Thus, if all jurisdictions in the world had carbon pricing in place the total coverage would be shown as 100%.  The lower (green) line shows the percentage of energy and CO2 emissions that are actually priced.  For example, the EU accounts for around 11% of emissions, but only a little under half of these are priced by the EUETS.  The gap between the blue and the green lines is the proportion of emissions covered by other policies, or by no policy.  Even if carbon pricing were to be extended to 100% of jurisdictions it is likely that some emissions would remain unpriced. 

CO2 emissions from land use and emissions of other greenhouse gases are excluded from the calculations.  Including these would reduce the proportion of emissions in jurisdictions with pricing, in part because of a large volume of emissions from deforestation in countries without national carbon pricing, notably in Brazil and Indonesia.  Nevertheless the trend is remarkable, and implies that any country considering carbon pricing is very much part of the worldwide policy mainstream.

Coverage of carbon pricing is increasing …

Coverage chart January 2014

By far the most significant new development over the next few years is likely to be the extension of carbon pricing across all of China, which the Government has indicated it wishes to see in the next few years.  This alone would raise global coverage of carbon pricing to over 40%.  Indonesia is also looking at carbon pricing with a prospective voluntary market potentially leading to a compulsory market in due course. 

We may also see somewhat more widespread carbon pricing in the USA.  EPA regulation of existing power plants under the Clean Air Act will oblige states to put in place implementation plans.  This may lead states to establish emissions trading schemes, or (more likely) join the Regional Greenhouse Gas Initiative (RGGI), which covers the power sector only.  Indeed some states are understood to have already expressed an interest in doing so, although it is not yet clear in which states interest is strongest.  Expansion of Western Climate Initiative trading schemes beyond California and Quebec also remains possible.

There also appears to be a trend towards carbon pricing in Latin America.  Mexico may strengthen its currently very limited carbon tax (excluded from the chart) over time.  Provinces in Brazil have looked at emissions trading schemes, and discussions on an ETS are now underway in Chile.

Future trends are, however, far from clear, and the commitment by the Australian government to repeal its carbon pricing legislation is an indication that consistent progress is far from guaranteed.

For those involved with carbon pricing day-to-day it is often easy to forget just how recent it is, and just how much progress has been made in a short time. There is still only a single decade of experience, compared with many decades, and in some cases centuries, for other types of regulation.  As a regulatory “technology” large scale carbon pricing remains more recent than the ipod, and there is still much to learn and a long way to go.  But the achievement to date is both substantial and encouraging.

Adam Whitmore – 16th January 2014

Notes on inclusion and exclusion from the chart:    The small carbon tax introduced in Japan in 2012 by modifying energy taxes is excluded, as is the carbon tax in Mexico, which is small and has limited scope.   The Tokyo emissions trading scheme is excluded as its current status is unclear.  The Swiss scheme is included in the total for the EU.  The status of the Kazakhstan scheme is currently uncertain and I have allowed for a year’s delay to 2015.  For simplicity the California and Quebec schemes are shown with full coverage from their introduction in 2013, although they do not reach this in practice until next year.  Question marks indicate measures which have yet to be enacted. 

Comparison with World Bank study:  The results here are similar to those from a World Bank Study of carbon pricing from 2013, but on a slightly different basis.  The World Bank study quotes just over 10Gt out of 50Gt of emissions taking place in jurisdictions with pricing.  This is for all GHGs.  The total shown here is around 8Gt out of 34Gt (2012 data) for carbon dioxide emissions from energy and industry.  The main difference in the total Gt of emissions in jurisdictions with pricing appears to be due to the inclusion in the World Bank study of a number of jurisdictions where pricing is at an earlier stage than shown here, notably Turkey, Ukraine and Brazil.  However South Africa is excluded from the World Bank total, as is British Columbia.  The total emissions actually priced is quoted by the World Bank as 3.3 Gt, which is 10% of carbon dioxide from energy and industry and 7% of total GHGs, but this excludes some of the China pilots for which no data was available.  I have included estimates in these cases.  If the other pilot Chinese schemes were included  in the World Bank totals their estimates of coverage would likely increase by about a percentage point (to 11% of energy and industry and 8% of total GHGs), roughly in line with the totals quoted here.  The World Bank study can be found at

http://documents.worldbank.org/curated/en/2013/05/17751166/mapping-carbon-pricing-initiatives-developments-prospects.

 

Data: Emissions data is for 2012, from the EDGAR database, with no adjustment for changes in relative volumes over time.  Shares at subnational level are estimated based on a range of data.  Data sources include  http://edgar.jrc.ec.europa.eu/  and Zhao et. al., China’s CO2 emissions estimated from the bottom up: Recent trends, spatial distributions, and quantification of uncertainties  Atmospheric Environment, Volume 59.

The EUETS stands alone in not managing price – time to change?

The EUETS stands alone in currently excluding any element of price management from its basic design.  In this respect it can learn from other schemes.

The current debate on whether the backload the sale of EU allowances is in many ways a distraction from the more important issue of structural reform.  The Commission’s review of the EUETS published last year mentioned price management as an option for structural reform (Option f in the document)i.  I have previously talked about the way in which carbon pricing lies on a spectrum between pure emissions trading and pure taxes (27th March 2013), and looked at the role of floor prices in emissions trading schemes (2nd May 2013).  In the context of the current debate on EUETS reform it seems worth further emphasising how exceptional the EUETS is in not already including some element of price management in its design.

Every other carbon pricing scheme in the world contains some element of price management or fixed pricing, or (for those schemes still being designed) seems likely to put something in place, with the only possible exception I am aware of being Kazahkstan.  The measures that have been introduced or are being considered – floors, ceilings, market interventions, and carbon taxes – are summarised in the table at the end of this post.

There are many reasons why governments may wish to introduce such mechanisms.  They may be concerned about the economic damage of very high prices, or that low prices will fail to stimulate the necessary long-term investment, or that they do not wish to see the price fall below the range plausible estimates of the likely cost of the damage due to additional emissions.  In any case, pervasive uncertainties in advance about both the effects of climate change and the cost of mitigation imply that simultaneous attention to both prices and quantities is appropriate.  (A review of the reasons for this will need to await another post, but it is a well-established principle.)

There will of course be political challenges in negotiating the form and level of any price thresholds in the EUETS, with some eastern European member states likely to favour lower values than some in western Europe.  But whatever form and level of price containment in the EUETS proves achievable, the presence of such mechanisms in every other scheme in the world surely at least warrants a close look at how such mechanisms might benefit the EUETS.

The EUETS was a pioneering scheme, and other schemes have learnt much from it.  Now other schemes are up and running, and the EUETS can learn from them in return.  And one of the things it can learn is that price containment mechanisms are an appropriate component of emissions trading schemes.

Adam Whitmore – 25th June 2013

Scheme Price floor Price Ceiling Notes
California, $10 + 5% p.a. real escalation auction floor $40/45/50 + 5% p.a. real. Reserve tranche volume increasing over time. The floor appeared to influence the first auction and some future tranches
Quebec C$10 + 5% p.a. real escalation, auction floor c$40/45/50 + 5% p.a. real Linked to California as part of the WCI
RGGI c. $2 constant real, auction floor price Increased offsets at price thresholds.  Moving to Cost Containment Reserve, at $4 in 2014 rising to $10 by 2017, 2.5% p.a. nominal  increase thereafter The floor has been effective in sustaining prices despite chronic oversupply
Alberta No $15/tonne buyout price, may rise to $30-40/tonne following review A hybrid baseline and credit scheme and tax
British Columbia Carbon tax fixed at C$30 May adopt emissions trading in future as part of WCI, but does not appear likely at present.
Australia (pre EU link) A$15 + escalation (abolished with EU link) $20 above EU price, rising annually Fixed price of A$23 rising at 5% nominal p.a. for first three years
New Zealand No Price ceiling at NZ$25 Effective ceiling lower due to 2 for 1 surrender provisions
Prospective schemes
China pilot schemes Likely to have some kind of price management through buying/selling of allowances, perhaps in a “central carbon bank” type model
South Korea Understood to be examining a wide variety of options, including a review committee with powers to implement measures such as increased supply and price floors
South Africa Carbon tax at Rand120/tonne

 

[i] The State of the European Carbon Market in 2012 Com (2012) 652 final, Brussels 14.11.2012 http://ec.europa.eu/clima/policies/ets/reform/docs/com_2012_652_en.pdf

Will carbon pricing in China be regional or national?

Regional differences are already an important feature of carbon pricing in China.  These differences seem unlikely to stop the emergence of carbon pricing across the country, but prices and scheme designs may continue to vary between regions for many years.  Something may emerge with characteristics between the complete integration of the EUETS and the diversity of provincial schemes in Canada.

Policy developments in China, the world’s largest greenhouse gas emitter, are critical to global prospects for limiting climate change.  The trial emission trading schemes being implemented in seven provinces and cities, accounting for around a quarter of the economy, are, taken together, by far the world’s largest carbon pricing system, after the EUETS.  However wealth and economic structure are very different across China.  The seven trial schemes are in the richer eastern and central parts of the country, with as yet nothing equivalent in poorer provinces.  This raises the question of whether economic diversity will be a barrier to establishing national carbon pricing in China.

A unified emissions trading scheme might prove possible despite differences in wealth.  The chart below compares the percentage variation in GDP per capita across the twenty-seven countries in the EU with the thirty-one provinces in China in 2030 (see note below chart for details).   The variation between rich and poor countries in the EU is substantial. The three richest countries (Denmark, Sweden and the Netherlands) have per capita incomes around 4.8 times those of the three poorest (Bulgaria, Romania and Poland).  The range of incomes among China’s provinces is slightly smaller, with the three richest provinces, the cities of Tianjin, Shanghai and Beijing, having incomes around 4.5 times those of the three poorest (Gansu, Yunnan and Guizhou).  However the variation in the middle of the income range is greater in China.  Thus, very broadly, the variation in incomes across China is comparable to that across the EU.  As it has been possible to establish and maintain a unified emissions trading scheme across the EU with its diversity of income then it may be possible to establish something similar in China.

Relative wealth chart

The countries/provinces are arranged in order of increasing GDP per capita.  The horizontal axis shows the cumulative proportion of the population in countries/provinces with GDP per capita below a certain level, relative to the national mean per capita GDP (population weighted average across provinces/countries).  The vertical axis shows the relative GDP per capita of countries/provinces.  The blue arrows indicate the positions of the Chinese provinces with trial ETSs.  Data sources are World Bank and China NBS Database.  Data for China is for 31 provinces (taken to include the 22 provinces – Taiwan being excluded – 5 autonomous regions and 4 municipalities). Hong Kong and Macau are excluded.  Data for the EU is for the 27 Members States.  Data is for 2011 in both cases. 

Furthermore, emissions trading creates the potential for transfers of wealth from richer to poorer provinces.  If richer provinces in China have more demanding emissions caps they may buy in allowances from the less prosperous provinces, transferring funds in the process.  Such differences in stringency may to some extent resemble the EU’s burden sharing agreements.  Wealth transfer may stimulate further economic integration and convergence, especially if there is also a transfer of administrative infrastructure and capabilities to less developed provinces as part of the process of building a national scheme.

These considerations lend credibility to a scenario in which there is a single national scheme with uniform prices, but different stringencies of cap in different provinces, and perhaps different allocations of allowances to industry and other sectors across different provinces.  Coverage of sectors and facilities may also vary between provinces.

Nevertheless, even in the EU diversity of economic circumstances is proving an obstacle to reform of the EUETS, with poorer countries in eastern Europe more resistant to reform than more prosperous countries in western Europe.  China’s provinces remain economically diverse and politically distinct, and this may form a barrier to establishing a national trading scheme.  A scenario in which there are separate regional schemes, each having its own rules and prices, with prices generally lower in poorer regions, seems at least as plausible as a fully national scheme, and perhaps more so.  There might be some linkage and trading between schemes, perhaps in the form of offsets, but this might not be enough to fully equalise prices.  Over time schemes might converge, and perhaps eventually merge, but this may take many years.  (Alternatively, differing regional carbon taxes might be introduced.)

Canada is the clearest example of distinct regional pricing in a single country.  Despite total 2011 emissions in Canada being only about 6% of China’s, Canada has three separate provincial carbon pricing schemes (British Columbia, Alberta and Quebec), with other provinces currently considering what, if anything, they might implement.   Any unification of these schemes seems a distant prospect.   Although British Columbia is, like Quebec, a member of the Western Climate Initiative it does not currently appear to be moving towards introduction of an ETS.

Among the barriers to unification of carbon pricing are the different economic structures and resource bases of Canadian provinces, for example hydropower rich Quebec contrasting with fossil fuel rich Alberta.  Similarly, differences in the economies and resource endowment of provinces across China may create persistent barriers to full integration of emissions trading schemes, although there may be greater commonality of design than between the Canadian carbon pricing schemes, which are notably diverse in their approaches to pricing.

Whichever model it chooses it seems clear that China is pursuing carbon pricing as an important component of its emissions reductions programme.  Carbon pricing will surely spread across the country.  And there may well be much in common between regional schemes, and increasing linkage.  But although a national price may emerge in the next few years it also appears possible that pricing could remain diverse for many years to come.

Adam Whitmore  –  17th June 2013   

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A spectrum of possibilities for carbon pricing

Carbon taxes and emissions trading are two ends of a spectrum of possibilities for carbon pricing.  One or other end of the spectrum may not be the best place to be.

As carbon pricing spreads around the world (see post from 7th March) governments are differing in whether they choose to pursue emissions trading or carbon taxes.  For instance, South Korea is getting ready to implement its emissions trading scheme, for which legislation was passed last year, while the South African Government has recently reaffirmed its commitment to a carbon tax.   There many reasons for these differences in approach, which I’ll return to in future posts, but for the moment I want to look at how existing schemes illustrate that the distinction between the two types of instrument is not absolute.  Emissions trading schemes can have fixed price components or limits to price ranges, which introduce an element of price certainty, while taxes may allow a degree of trading in the form of offsets or credits generated from outperforming a baseline.  Emissions trading and carbon taxes are thus at two ends of a spectrum of possibilities.  The best policy choice is not necessarily at either end.

The chart shows major carbon pricing schemes around the world on a spectrum from pure emissions trading on the left to pure carbon taxes on the right.  The first thing that’s apparent is that there is a clear preponderance of emissions trading schemes, especially by volume of emissions covered.  But many ETSs contain some element of price certainty, and taxes may include elements of trading, so many schemes do indeed in practice lie somewhere between the two extremes.

A spectrum of possibilities between an emissions trading schemes (ETS) and a carbon tax

spectrum chart

The EUETS and the Regional Greenhouse Gas Initiative (RGGI) in the Northeastern USA are almost pure emissions trading scheme, with minimal limits on price, although RGGI does have a low reserve price in its auctions (currently $1.98, indexed to inflation), and there are also some very limited auction reserve provisions available in the EUETS.  The prospective Beijing ETS appears to likely to follow this model quite closely, although there appears to be a possibility that the regulator will seek to exercise some influence on the price by buying and selling allowances centrally, rather analogous to the role a central bank might play in currency markets, or by some other means.  However, the Beijing scheme remains to be finalised and it is not yet clear what form this or the other trial Chinese schemes will take in practice.

Several other schemes diverge from the model of a pure ETS by having elements of fixed pricing.  The Australian scheme includes an initial 3-year fixed price period.  Before the link to the EU ETS was established late last year it was intended that after the 3-year fixed price period it would include a floor price in the auction and a ceiling related to the international carbon price.  (The price ceiling remains in principle following the EU linkage, but in practice will never be triggered).  This made its original design much closer to the California and Quebec schemes, both of which contain reserve prices in the allowance auctions to give a price floor, and also price ceilings in the form of reserve tranches of allowances.  Floor prices are currently just over $10/tonne, well above the levels found in RGGI, and indexed to rise at above the rate of inflation.

The Alberta scheme is a hybrid between a tax and an ETS.  It sets a baseline for emissions from an entity per unit of output (emissions intensity), rather than a fixed emissions cap.  If emissions are below this baseline then credits are generated.  If emissions are above the baseline then the entity has several options: it can buy credits from those in surplus, it can purchase offsets, or it can pay a fixed price of $15/tCO2 which goes into a fund for clean technology investment.  It thus resembles a carbon tax payable above a threshold level of emissions intensity, but with some element of trading allowed.

The proposed South African carbon tax would, if introduced in its currently proposed form, allow some of any remaining obligation to be met through offsets.

At the other end of the spectrum the British Columbia carbon tax is a solely a tax, with no element of trading at present (and only very minimal provisions for offsets).

Political processes introduce dynamics which may ultimately limit the extent to which a carbon pricing scheme focus is exclusively on price and quantity.  Decisions about the level of the cap are likely to be influenced by expectations of the prices that will result.  And if a surplus of allowances leads to low prices a tightening of the cap may be considered, as in both the EUETS and RGGI at present.  Similarly the level of a tax may be adjusted over time to meet an environmental goal, or other policy objectives such as raising revenue.

So policy debates should perhaps be less about a preference for taxes or emissions trading in their pure form, and more about where a scheme should be positioned on the spectrum of possibilities, and how outcomes can be managed over time as the scheme develops.  And even if a scheme starts at one end of the spectrum, events may force changes that recognise that in practice there is always a balance to be struck between prices and quantities.

Adam Whitmore        27th March 2013

The continuing spread of carbon pricing

Within the next two or three years some form of carbon pricing will be in place in jurisdictions accounting for nearly a quarter of the world’s CO2 emissions from energy and industry (although not all emissions in those jurisdictions are priced).  This will have been put in place in little more than a decade, a remarkable achievement.

For the first post on this blog, it seems appropriate to take a look at how far carbon pricing, a central tool of climate change policy, has spread.

There are now more than a dozen major carbon pricing schemes either in place or under development around the world.  Two or three years from now, assuming current programmes run to schedule, carbon pricing will be in place in jurisdictions accounting for just under a quarter of total global CO2 emissions from energy and industrial processes.

This will have been achieved in little more than a decade (see chart).   In the early 2000s carbon pricing was in place in just a few jurisdictions, mainly in northern Europe, accounting for less that 1 % of world emissions.  The first major increase in the coverage of carbon pricing was the introduction of the EUETS in 2005.  Since then several countries and provinces have introduced pricing.  Schemes in Australia, California and Quebec have all gone live in the last year.  The next big step up in coverage is just beginning, with seven trial emissions trading schemes being introduced in China, in provinces and cities which account for around a sixth of China’s emissions.   The South Korean scheme, for which legislation was passed last year, will go live two years from now.  If South Africa implements a carbon tax, as announced in the recent national budget statement, this will add about another 1% of world emissions, bringing the total proportion of emissions in jurisdictions with pricing to around 24%.  If China were to introduce a national emissions trading scheme or carbon tax the proportion of world emissions in jurisdictions with carbon pricing would rise to over 40%.

The proportion of world energy and industrial carbon dioxide emissions taking place in jurisdictions with carbon pricing is increasing rapidly

Chart of emissions coverage revised May 2013

Source:  Emissions data is for 2010, from the EDGAR database[i], with no adjustment for changes in relative volumes over time.  Data for North American states and provinces is taken from official statistics.  Data for China is from Zhao et. al.[ii] Timings for regional schemes in China are estimated.  The Tokyo scheme is excluded as its current status is unclear.  The small carbon tax introduced in Japan last year by modifying energy taxes is also excluded.   The Swiss scheme is included in the total for the EU.  There is also some uncertainty around the Kazakhstan scheme, although this is included.

The percentages on the graph include the total energy and industry CO2 emissions for each jurisdiction with carbon pricing, although not all of the emissions in these jurisdictions are priced.  For example, the EUETS prices a little under half of its energy and industrial CO2 emissions, focusing on large point sources, with other sectors targeted by other policies.  Thus, if all jurisdictions in the world  had carbon pricing in place the total coverage would be shown as 100%.  A chart showing the proportion of world CO2 emissions that are priced would show a lower percentage.  A recent study by the World Bank estimated around 3.3 Gt of GHGs will be priced, around 10% of world energy and industry emissions, although this total appears to exclude some of the regional Chinese schemes for lack of data [iii].

Also, CO2 emissions from land use and other greenhouse gases are excluded from the calculations.  Including these would reduce the proportion of emissions in jurisdictions with pricing, in part because of emissions from deforestation in countries without national carbon pricing, notably in Brazil and Indonesia.  There are also issues to be resolved with some of the schemes, and it remains to be seen how effective the Chinese and Korean schemes, which have yet to go live, will prove in practice.  Nevertheless the trend is remarkable, and implies that any country considering carbon pricing is very much part of the worldwide policy mainstream.

The picture of increasingly widespread action extends beyond carbon pricing.  The legislators’ policy network Globe International recently published the third edition of its climate legislation study recently [iv].  It found significant progress on climate legislation in countries as diverse as Chile, Indonesia, Mexico, Pakistan and Vietnam.  Indeed, examining policy in 33 countries, it found substantial progress 18 countries and limited progress in a further 14.

Policy was found to have regressed in only one country, Canada.  And even this was because the methodology looked at the national level only.   There has been significant progress in Canada with carbon policy at the regional level, with three separate provinces having introduced carbon pricing, one of which (Quebec) is new this year and another of which (British Columbia) has a higher carbon price than found anywhere else, at C$30/tCO2.  Even at the national level Canada has now finalised a national emissions performance standard for new power plant at 926lb/MWh (420 kg/MWh), similar to that in place in California and being legislated in the UK, which effectively prevents new unabated coal plant from being built [v].

The challenge for the future will be to maintain this momentum, but the extent of progress on climate change policy to date, although falling far short of what is needed to prevent dangerous climate change, gives a cautiously hopeful perspective with which to start this blog.

Adam Whitmore      7th March 2013  (Updated 30th May 2013)


[ii] Zhao et. al. China’s CO2 emissions estimated from the bottom up: Recent trends, spatial distributions, and quantification of uncertainties  Atmospheric Environment, Volume 59.

[iii]  The World Bank Study quotes just over 10Gt out of 50Gt of emissions in jurisdictins with pricing.  This is for GHGs.  The total shown here is 8Gt out of 33Gt (2010 data) for carbon dioxide emissions from energy and industry.  The main difference in the total covered appears to be due to the inclusion of a number of jurisdictions where pricing is at an earlier stage than shown here, notably Turkey, Ukraine and Brazil.  However South Africa is excluded from the World Bank total.  The total emissions actually priced is quoted as 3.3 Gt, which is 10% of carbon dioxide from energy and industry and 7% of total GHGs.  If the other pilot Chinese schemes were included this coverage would likely increase by about a percentage point (11% and 8% respectively), and thus a little under half the emissions in the jurisdictions with carbon pricing on average are estimated to be priced.  The World Bank study can be found at: http://documents.worldbank.org/curated/en/2013/05/17751166/mapping-carbon-pricing-initiatives-developments-prospects

[v] http://ghgnews.com/index.cfm/canada-unveils-softened-final-ghg-performance-standard-for-coal-units/

This post deliberately does not say much about the current status of the UNFCCC process, which must await future discussion.  In the meantime coverage of this can be found on other forums, for example see http://climatestrategies.wordpress.com/