Tag Archives: decarbonisation

The case for additional actions in sectors covered by the EUETS is now even stronger

Recently agreed reforms to the EUETS mean that excess allowances in the MSR will be cancelled.  This further strengthens the case for actions such as phase-out of coal plant, increasing energy efficiency and deploying more renewables.

About a year ago I looked at whether additional actions to reduce emissions in sectors covered by the EUETS do in practice lead to net emissions reductions over time [i].

It is sometimes claimed that total emissions are always equal to the fixed cap, and by implication additional actions do not reduce total emissions.  This is sometimes called the “waterbed hypothesis” by analogy – if you squeeze in one place there is an equal size bulge elsewhere.

Although often repeated, this claim is untrue.  Under the EU ETS at present the vast majority of emissions reductions from additional actions will be permanently retained, reflecting the continuing surplus of allowances and the operation of the MSR.  Furthermore, over the long term the cap is not fixed, but can respond to circumstances.  For example, tighter caps can be set by policy makers once emissions reductions have been demonstrated as feasible.

When I last looked at this issue, the fate of additional allowances in the MSR remained necessarily speculative.  It was clear that additional excess allowances would at least not return to the market for decades.  It also seemed likely that they would be cancelled.  However, no cancellation mechanism was then defined.

This has now changed with the trilogue conclusions reached last week, which include a limit on the size of the MSR from 2023.  The limit is equal to the previous year’s auction volume, and is likely, given the size of the current surplus, to lead to large numbers of allowances being cancelled in the 2020s.

With this limit in place there is a very clear pathway by which allowances freed up by additional actions, such as reduced coal burn or increased renewables, will add to the surplus, be transferred to the MSR then cancelled (see diagram).  Total emissions under the EUETS will be correspondingly lower.

There is now a clear mechanism by which additional actions reduce total emissions

Modelling confirms that with the limit on the size of the MSR in place a large majority of reductions from non-ETS actions are retained, because additional allowances freed up almost all go into the MSR, and are then cancelled.  This is shown in the chart below for an illustrative case of additional actions which reduce emissions by 100 million tonnes in 2020.  Not all of the allowances freed up by additional actions are cancelled.  First there is a small rebound in emissions due to price changes (see references for more on this effect).  Then, even over a decade, the MSR does not remove them all from circulation.  This is because it takes a percentage of the remainder each year, so the remainder successively decreases, but does not reach zero.  If the period were extended beyond 2030 a larger proportion would be cancelled, assuming a continuing surplus.  Nevertheless over 80% of allowances freed up by additional actions are cancelled by 2030.

The benefit of additional actions is thus strongly confirmed.

The large majority of allowances freed up by additional actions are eventually cancelled

Source: Sandbag

When the market eventually returns to scarcity the effect of additional actions becomes more complex.  However additional actions are still likely to reduce future emissions, for example by enabling lower caps in future.

Policy makers should pursue ambitious programmes of additional action in sectors covered by the EUETS, confident of their effectiveness in the light of these conclusions.  Some of the largest and lowest cost gains are likely to be from the phase out of coal and lignite for electricity generation, which still accounts for almost 40% of emissions under the EUETS.  Continuing efforts to deploy renewables and increase energy efficiency are also likely to be highly beneficial.

Adam Whitmore – 15th November 2017

[i] See https://onclimatechangepolicydotorg.wordpress.com/2016/10/21/additional-actions-in-euets-sectors-can-reduce-cumulative-emissions/  For further detail see https://sandbag.org.uk/project/puncturing-the-waterbed-myth/ .  A study by the Danish Council on Climate Change reached similar conclusions, extending the analysis to the particular case of renewables policy.  See Subsidies to renewable energy and the european emissions trading system: is there really a waterbed effect? By Frederik Silbye, Danish Council on Climate Change Peter Birch Sørensen, Department of Economics, University of Copenhagen and Danish Council on Climate Change, March 2017.

Underestimating the contribution of solar PV risks damaging policy making

Underestimating the contribution of solar PV risks damaging policy making

The continuing lack of realism in projections for solar PV risks damaging policy making by misdirecting effort in developing low carbon technologies.

Solar PV continues its remarkable growth …

Electricity generation from solar PV continues to grow very rapidly.  It now supplies over 1% of global electricity consumption and this proportion looks set to continue growing very rapidly over the next decade as costs continue to fall.

Chart 1 Rapid growth of solar PV generation continues

Sources: BP statistical review of world energy [i].  1% of consumption based on data for generation with an adjustment for losses.

Many studies have underestimated this growth and continue to do so …

This growth has been much faster than many predicted.  In 2013 and again in 2015  I noted[ii] that the IEA’s annual World Energy Outlook (WEO) projections for both wind and solar PV were consistently vastly too low.  Specifically, the IEA’s projections showed the annual rate of installation of wind and solar PV capacity remaining roughly constant, whereas in fact it both were increasing rapidly.  Updated analysis for solar PV recently published by Auke Hoekstra[iii] shows that this position seems remarkably unchanged (see Chart 2).  The repeated gross divergence between forecasts and outturns over so many years makes it hard to conclude anything other than the IEA is showing a wilful disconnection with reality in this respect, though their historical data on the energy sector remains very valuable.

Chart 2:  IEA projections for solar PV capacity continue to vastly underestimate growth

Although the IEA’s projections are particularly notable for their inability to learn from repeated mistakes, others have also greatly underestimated the growth of solar PV[iv].    Crucially, as a recent study in Nature Energy[v] shows, this tendency extends to many energy models used in policy making, including those relied on by the IPCC in its Assessment Reports.

This is largely because models have underestimated both the effect of policy support on deployment and the rate of technological progress, and so have underestimated the resulting falls in cost both in absolute terms and relative to other technologies.  Where new information has been available there has often been a lag in incorporating it in models.  Feedbacks between cost falls, deployment and policy may also have been under-represented in many models.  Consequently models have understated both growth rates and ultimate practical potential for solar PV.

This damages policy making  …

Does this matter?  I think it does, for at least two reasons.

First, if policy is based on misleading projections about the role of different technologies then policy support and effort will likely be misdirected.  For example, means of integrating solar PV at very large scale into energy systems look to have been under-researched and under-supported.  Other low carbon technologies such as power generation with CCS may have received more attention in comparison to their potential[vi].

Second, there is a risk of damaging the policy debate.  In particular there is a risk of exacerbating polarisation of the debate, rather than creating a healthy mix of competing judgements.  There is already a tendency for some commentaries on energy to favour fossil energy sources, and perhaps nuclear, and for others to favour renewables – what one might call “traditionalist” and “transitionalist” positions.  Traditionalists, including many energy companies, tend to point to the size and inertia of the energy system and the problems of replacing the current system with new sources of energy.  Transitionalists, including many entrepreneurs and environmentalists, tend to emphasise the urgent need to reduce emissions, the speed of change in technologies and costs now underway, and the exciting business opportunities created by change.

Both perspectives have merit, and the debate is too important to ignore either.  The IEA provides an example of distorting the debate. It will naturally, due to its history, tend to be seen as to some extent favouring the traditionalist viewpoint.  If this perception is reinforced by grossly unrealistic projections for renewables it risks devaluing the IEA’s other work even when it is more realistic, leaving it on one side of the debate. An opportunity for a balanced contribution from a major institution is lost.  The debate will be more polarised as a result, risking misleading policy makers, and distorting policy choices.

Securing balanced, well informed debate on the transition to a low carbon energy system is quite challenging enough.  Persistently underestimating the role of a major technology does not help.

Adam Whitmore -26th September 2017

 

 

[i] http://www.bp.com/content/dam/bp/en/corporate/pdf/energy-economics/statistical-review-2017/bp-statistical-review-of-world-energy-2017-renewable-energy.pdf

[ii] For details see here, here and  here

[iii]  https://steinbuch.wordpress.com/2017/06/12/photovoltaic-growth-reality-versus-projections-of-the-international-energy-agency/

[iv] An exception, as I have previously noted is work by Greenpeace.  Some previous scenario work by Shell was also close on wind and solar, but greatly overestimated the role of CCS and biofuels.

[v] The Underestimated Potential for Solar PV Energy to Mitigate Climate Change, Creutzig et. a. Nature Energy, Published 28/08/17

[vi] CCS still looks essential for decarbonisation in some cases, and given lead times for its development continued research and early deployment is still very much needed.  This is especially so for industrial applications.  Deployment in power generation looks likely to be more limited over the next decade or more, though some may still be needed when to move to very low emissions, and eventually to zero net emissions.  However the contribution of CCS to power generation now looks likely to be much less than that from solar PV.

Overcoming the difficulty of acting to reduce emissions

Limiting climate change poses major challenges to traditional decision making, but progress is now being made.

This is the second of two posts stepping back a bit and considering why the climate change problem is so difficult to solve.  My previous post looked at some of the physical feature of the problem such as the scale, dispersion and diversity of emissions.  This post looks more at the economic, social and psychological barriers to action[1].

Perceptions

The first area of difficulty is in perceptions of the facts.  The science of climate change now one of the best established areas of human knowledge.  However a gradual change, for example with temperatures on average increasing by around a fifth of a degree per decade, may be difficult to notice.  Shifting probabilities of extreme events may be similarly difficult to perceive. Consequently, even facts well-established academically may not readily become part of acknowledged personal experience, and so will not be as readily internalised into decidion making.

This may be compounded by an availability bias.  Those regions changing most rapidly and visibly, especially the arctic, are remote and sparsely populated, so changes are less available to people despite the best efforts of reporters.

These difficulties are compounded by a framing effect due to daily or seasonal temperature variation.  A three degree rise in annual global mean surface temperatures may not sound like much if you experience day to day fluctuations of much more than that, even though in reality a change of this magnitude would lead to very severe consequences. As a result of this framing, many of the consequences of climate change may not sound so bad to those not closely involved with the issue.

On the other hand, the risks of some solution may be seen as high – “the lights might go out” – because in many ways the current system works well.  People’s subjective perception of the balance between risk and reward may therefore be quite distorted.

Finally, the perceived solutions to climate change may conflict with some value systems (see here and here), making people less willing to accept what needs to be done.

Lags

The difficulty of action is compounded by long (and uncertain) time lags between cause and effect.  Many consequences, such as the worst effects of sea level rise, are thus seen as belonging to the distant future.  They are beyond the normal planning horizons of governments, companies and most other institutions – though it is worth noting in many cases not outside the lifetime of today’s children.  It also challenges our own individual decision making.  We often have a tendency to concentrate on those problems which seem most urgent.  This makes climate change difficult for people, companies and governments to deal with.

Damage is also often seen as remote in place as well as time.  Most people will tend naturally to be less concerned with changes perceived as unlikely to affect their immediate neighbourhood.

Imperatives from existing social structures

Furthermore, career and other motivating social imperatives are not often aligned with dealing with the climate problem.  A bonus may depend on this year’s profits, or a promotion on generating local value, an election on a more immediate problem.  And social norms may encourage bigger houses, bigger cars and more air travel despite their effect on the climate.  Many people (including me) would be reluctant to live in a smaller house for the sake of the climate.

Governance of a global public good

The most pervasive barrier to action is that emissions and the benefits of the associated activity tend to be largely local, whereas the resulting damage is global.  The global nature of the climate means that a stable climate is a global public good in the economic sense[2].  However this public good must be maintained by avoiding harmful emissions.

As in all such cases, there are incentives for some to free-ride on the efforts of others to support the provision of this public good.  No one country can by itself sustain a stable climate – although China can make a huge difference – but there is no global enforcement mechanism to oblige co-operation.

The ability of any one company or any one individual in influence the outcome is smaller still.  People are right to feel that they alone cannot solve the problem.  There is a need for co-operation at a global level.

Tropical deforestation, a major source of emissions, provides a further difficulty.  It is hard to solve in part because governance is often weak even at the national level in forest countries.  This leads to weak constraints on the actions of companies and individuals, often pursuing their own incentives, which fail to reflect the wider environmental damage.

What happens when these don’t apply

The Montreal Protocol on CFCs offers an interesting contrast, in that it was achieved in part because it lacked some of the characteristics of climate change.  Although the science is complex it could be boiled down to a simple message: “chemicals we are putting into the atmosphere destroy the ozone layer.”  The lags involved were perceived as comfortably within normal human timescales.  And the consequences of failure were easy to present as scary. “If we don’t fix this problem lots more people will get skin cancer” is about as simple and relatable as messages get.

Added to this, the uses of the chemicals were limited to a few sectors of the economy, with readily available substitutes.  This made the costs appear much lower, and opposition from businesses and their allies, some of whom would benefit from regulatory change, much less strong.

The result was relatively prompt and effective action.

A way forward for reducing emissions

This also points a way forward for climate change.  The extension international agreement to limit HFCs because of their effects on the climate is an example of similar forces at work, and is a cause for optimism.  A major threat to the climate has been addressed.  Although not perfect, the agreement appears to have every chance of being successful.  This is despite having many of the barriers to action that hamper all attempts to address climate change.

What was absent was the scale and cost of decarbonising the energy system.  But even here there is progress.  Low carbon technologies are rapidly improving and falling in cost, in some cases to a spectacular degree.  This is lowering the barriers to action, and will do so to an ever increasing extent.  It is creating a powerful constituency for action.  There are now many companies invested in the transition to a lower carbon economy and jobs in low carbon industries increasingly outnumber those in high carbon sectors.  Again this will increase over time.

These trends have combined with the greater political awareness of the problem, and the increasing desire to do something about it, which is embodied in the Paris Agreement. The reactions to statements from the USA of intention to withdraw from in the agreement indicate how solid the international consensus has now become.

While the Paris Agreement provides an overarching framework, the hard work of emissions reductions is now being achieved by a vast and growing range of regulatory interventions across the world.  There is a huge diversity of regulation now in place, from carbon pricing to emissions standards to technology incentives.  Compared with the situation as recently as the beginning of this century progress has been huge.

This is a counsel of optimism, not of complacency or of naiveté about the rate of progress compared with what is needed.  Limiting dangerous climate change will still require a great deal of hard work, and quite a lot of luck.  But progress has been enormous despite formidable barriers, and there is no reason why progress should not continue.

Adam Whitmore – 6th June 2017  

[1] For further discussion of some of the issues raised in this post see file:///C:/Users/Adam/Documents/Book/Research%20material/The_Dragons_of_Inaction_Psychological_Barriers_Tha.pdf .  This is a useful review of psychological barriers, although in my view the author overemphasises the role of individual action.   See also: https://www.apa.org/science/about/publications/climate-change.pdf

[2] A stable climate is non-rival (someone can benefit from it without limiting the ability of others to do so) and non-excludable (there is no way of preventing someone benefiting).  According to the 2009 movie Star Trek this concept of a public good is sufficiently important to be included in the education curriculum on the planet Vulcan.  The reference to the definition using the terms non-rival and non-excludable occurs during the first scene on Vulcan, about 15 minutes into the movie.

Climate change: how did we get here, and why is it so hard to fix? (Part 1)

Activities that cause emissions are ubiquitous, diverse and deeply embedded in modern life.  The world’s energy system is huge and long-lived.  This makes emissions tough to deal with. 

This post is the first of two stepping back a little from the specific topics I usually cover to take a very high level look at why the climate change problem is so hard to fix.  This first post looks at how we got here and (at a very high level) the physical and engineering challenges of addressing the climate change problem.  The next post will consider some of the political and psychological barriers to greater action.

The consequence of industrialisation

The world’s climate was remarkably stable from before the birth of agriculture, some 8-10,000 years ago, until very recent times[1].  Human civilisation grew up in a stable climate, and knew nothing else, despite the calamities caused on occasions by storms, floods, drought, and so forth.

Industrialisation changed this.  There is no single year that definitively marks the beginning of industrialisation, but 1776 probably as good a reference point as any.  It was an eventful year, with the US Declaration of Independence giving history one of its most famous dates, while elsewhere the first edition of Adam Smith’s Wealth of Nations was published and the Bolshoi Theatre opened its first season.  But in the long view of history perhaps more important than any of these was that James Watt’s steam engines began to power industrial production[2].  This, more than any other event, marks the beginning of the industrial era.

In the nearly two and a half centuries since 1776, world population has grown by almost a factor of about 10.  Economic output per person has also grown by a factor of about 10.  Taking these two changes together, the world’s economic activity has increased by a factor of about 100.  This has put huge stresses on a range of natural systems, including the atmosphere[3],[4].

The increase in the use of fossil fuels has been even greater than the increase in industrial activity.  Around 12 million tonnes of fossil fuels, almost entirely coal, were burnt each year before 1776[5].  Today the world burns about 12 billion tonnes of fossil fuels each year, an increase of a factor of 1000[6].

This huge increase in the burning of fossil fuels is now – together with deforestation, agriculture and a few other activities – changing the make-up of the atmosphere on a large scale.  This in turn, is changing the world’s climate.   Within a single human lifetime – just one percent or so of the time since the birth of agriculture – changes to the climate are likely to be much greater than human civilisation has ever before experienced.  The consequences of these changes are likely to be largely harmful, because manmade and natural systems are largely adapted to the world we have, not the one we are making.

The characteristics of the systems that have led to these changes also make the problems hard to address.

The scale of emissions is huge …

The scale of CO2 emitted from the energy system is vast, around 36 billion tonnes p.a.  If this were frozen into solid form as “dry ice” it would cover the whole of Manhattan Island to the depth of about two thirds of the Empire State building.

The system that generates these emissions is correspondingly huge.  The world’s energy system cost tens of trillions of dollars to build, and is correspondingly immensely expensive to replace.

The diversity and dispersion of emissions makes the problem more challenging …

The problem is worse even than its scale alone suggests.  It would be simpler to deal with emissions if they were all in one place, whether Manhattan or elsewhere, and in solid form.  Instead emissions are dispersed across billions of individual sources around the world.  And they come from many different types of activity, from transporting food and powering electronics to heating and cooling homes and offices.  There is no single technology doing one thing to be replaced, but a wide diversity of technologies and applications.

And once emissions get into the atmosphere the greenhouse gases are very dilute.  Carbon dioxide makes up only 400 parts per million (0.04%) of the atmosphere.  Among other things this makes capture of CO2 once it has got into the atmosphere difficult and expensive.

And assets producing emissions are very long lived …

Energy infrastructure often lasts many decades, so changing infrastructure tends to be a long term process, with premature replacement expensive.  And on the whole the existing system does its job remarkably well.  Some political considerations aside, there would be little need for very rapid changes to the system if it were not for climate change and other forms of pollution.

Energy is central to modern life …

Finally it’s not possible to simply switch off the world’s energy system because it is essential to modern life.  Hurricane Sandy disrupted much of New York’s energy system, and the consequences of that gave an indication of how quickly modern life collapses without critical energy infrastructure.

These physical characteristics of the problem are compounded by the political and psychological obstacles to change at the necessary scale.  I will return to these in my next post.

Adam Whitmore – 22nd May 2017

 

[1] This climatically stable period since the end of the last ice age between 11,000 to 12,000 years ago is referred to as the Holocene.  Agriculture started not long after the ice sheets retreated and the world warmed.  Human activity has now led to a new period, referred to as the Anthropocene.

[2]   https://en.wikipedia.org/wiki/Watt_steam_engine.  The first use of the Watt engine to provide the rotary power, which was crucial for factories, was a little later in 1782 at the Soho manufactory near Birmingham.  https://en.wikipedia.org/wiki/Soho_Manufactory.

[3] http://www.scottmanning.com/content/year-by-year-world-population-estimates/

[4] http://www.ggdc.net/maddison/maddison-project/data.htm

[5]Reliable data is obviously hard to come by that far back, but See Energy for a Sustainable World: From the Oil Age to a Sun-Powered Future By Vincenzo Balzani, Nicola Armaroli .  They estimate 10 million tonnes in 1700 and 16 million tonnes by 1815.  The majority of the increase would have been in the later part of this period.  See also Socioecological Transitions and Global Change, edited by Marina Fischer-Kowalski, Helmut Haberl, who quote estimates of 3 million tonnes p.a. in 1700 in the UK, a large proportion of the world total at the time, with little increase to 1776.  This consumption included a few primitive, inefficient steam engines, used mainly for pumping water from coal mines themselves.  The Newcomen steam engine required such large quantities of coal that it was rarely economic to site it away from coal mines.  The Watt engine was more than twice as efficient.

[6] My estimate of the total mass of coal, oil and gas, based on data in BP statistical review of World Energy.

Reform of the EUETS has at last made significant progress

The effective limit on the size of the MSR proposed by Council is an extremely welcome strengthening of the EUETS.  However it will still take a long time for the EUETS to become fully effective.

This post updates last week’s post to reflect the important agreement on the EUETS reached in Council earlier this week.  On Tuesday the Environment Council endorsed more ambitious EU ETS policy changes than those agreed by the European Parliament.  This surprised many observers (including me) and is a very welcome change.

The most important change is an effective limit on the size of the Market Stability Reserve (MSR).  Allowances held in the MSR will be cancelled if the MSR contains more than the previous year’s auction volumes, although the precise interpretation of this remains to be defined.   In effect this change means that the number of allowances in the MSR is unlikely to be more than about 500 -700 million after the limit takes effect in 2024.  Indeed the volume limit is tighter than I had previously expected to be possible when I was advocating a size limit on the MSR last June (see here).

The huge size of the MSR during Phase 4 means that this reform will likely result in a cancellation of about 3 billion tonnes from the MSR over Phase 4 (see chart).  Much of this 3 billion tonnes will go into the MSR in 2019, and will be cancelled in 2024 if the reform is finally adopted.

Chart:  The proposed reform will likely lead to cancellation of around 3 billion tonnes from the MSR

chart

Notes:  Uses base case emissions (see previous post), assumes 57% auctioning, and assumes all unallocated Phase 3 allowances go into MSR in 2020.  EP MSR is the MSR under the European Parliament proposals.  New MSR is with the new proposals from Council.  Source: Sandbag

Despite this proposal the market is likely to remain weak for a long time.  Emissions will remain below the cap until the middle or the end of the next decade, and perhaps for longer.  Volumes are not in any case likely to begin returning from the MSR until close to 2030, so the size limit will probably begin to bite in the 2030s.  Tightening the cap to reflect actual emissions remains essential for a well-functioning EUETS over the next few years, and additional measures to complement the EUETS will continue to be necessary (see my previous post for more on these points).   Indeed this reform increases the value of additional action as it implies that additional surplus allowances will indeed be cancelled, leading to greater reductions in cumulative emissions.

Nevertheless, despite its limitations, this reform is a substantial and very welcome strengthening of the EUETS.  Even though the market will still take many years to tighten, this reform is likely to have some influence on earlier prices as traders anticipate a tighter market.  Indeed, in contrast to the measures coming out of Parliament, the market responded immediately to the vote (prices temporarily increased €1/tonne, about 20%).   It is highly desirable that this reform is retained through the remainder of the legislative process.

Adam Whitmore  – 3rd March 2017

Thanks to Boris Lagadinov at Sandbag for useful discussions and providing the chart for this post.

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.

Additional actions in EUETS sectors can reduce cumulative emissions

It is often claimed that additional actions to reduce greenhouse gas emissions in sectors covered by the EUETS are ineffective because total emissions are set by the level of the cap.  However this claim is not valid in the current circumstances of the EUETS, and is unlikely to be so even in future.  Additional emissions reduction measures in covered sectors can be effective in further permanently reducing emissions.

This post is longer than usual as it deals with a very important but relatively technical policy issue.

The argument about the effectiveness of additional actions to reduce emissions …

Many additional actions are being taken to reduce greenhouse gas emissions in sectors covered by the EUETS.  These include energy efficiency programmes, deployment of renewables, replacing coal plants with less carbon intensive generation, and national carbon pricing.

It is often argued that such additional actions do not reduce total emissions because the maximum quantity of emissions is set by the EUETS cap, so emissions may remain at the fixed level of the cap, irrespective of what other action is taken (see the end of this post for instances of this argument being used publicly).

However, this argument does not stand up to examination.

Assessment of the argument needs to take account of the current circumstances of the EUETS.  Emissions covered by the EUETS were some 200 million tonnes (about 10%) below the cap in 2015.  This year emissions are likely to be 13% below the cap.  The EUETS currently has a cumulative surplus of almost three billion allowances, including backloaded allowances currently destined for the Market Stability Reserve (MSR), and the surplus is set to grow as emissions continue to be less than the cap.

In these circumstances emissions reductions from additional actions will mainly increase the surplus of allowances, with almost all of these allowances ending up in the (MSR).  These allowances will stay there for decades under current rules, and so not be available to enable emissions during this time.

Indeed, in practice these allowances are unlikely ever to enable additional emissions.  The argument that they will assumes that the supply of allowances is fixed into the long term.  In practice this is not the case.  Long term supply of allowances is determined by policy, which can and does respond to circumstances.  Additional surpluses and lower prices are likely to lead to tighter caps than would otherwise be the case, or cancellation of allowances from the MSR or elsewhere.

The remainder of this post looks at these issues in more detail, including why the erroneous view that additional actions don’t reduce cumulative emissions has arisen.

Why current circumstances make such a difference

The argument that additional actions to reduce emissions will be ineffective reflects how the EUETS was expected to operate when it was introduced. It was assumed that demand for allowances would adjust so that the quantity of allowances used would always equal to the cap, which was assumed to be fixed.

This is illustrated in stylised form in the diagram below.  The supply curve is vertical – perfectly inelastic supply.  Demand for allowances without additional actions leads to prices at an initial level.  Additional actions reduce demand for allowances at any given price, effectively shifting the demand curve to the left by the amount by which additional actions reduce emissions.  This leads price to fall until the lower price creates sufficient additional demand for allowances, so that total demand for allowances is again equal to the supply set by the cap.  Because the supply curve is fixed (vertical) the equilibrium quantity of emissions is unchanged, remaining equal to the cap[1].

Chart 1: A price response to the change in demand for allowances can lead to emissions re-equilibrating at the cap when allowances are scarce …

first-chart

However, at present, large increases in emissions (such that emissions rise to the cap) due to falling prices are clearly not occurring, and they seem unlikely to do so over the next few years.  As noted above, the market remains in surplus both cumulatively and on an annual basis.  The price would be close to zero in the absence of banking of allowances into subsequent phases, because there would be a cumulative surplus over Phase 3 of the EUETS, and so no scarcity[2].

If demand were further reduced in the absence of banking there would be no price fall, because prices would already be already close to zero.  Correspondingly, there would be no increase in demand for allowances to offset the reduced emissions from additional actions.  The emissions reductions from additional actions would be retained in full. This is again illustrated in stylised form in the diagram below. 

Chart 2: With a surplus of allowances and price close to zero (assuming no banking) any reduction in demand for allowances will be retained in full …

chart-1

In practice the potential to bank allowances and the future operation of the MSR supports the present price.  It is expected that in future as the cap continues to fall allowances will become scarce.  There is thus a value to allowances set by the cost of future abatement.

Additional actions now to reduce emissions increase the surplus, and so postpone the expected date at which the market returns to balance.  This reduces current prices.  This will in turn lead to some increase in emissions.  However, this increase will be small – much smaller than if the market were short of allowances now.

Quantifying this effect 

Modelling indicates that if additional actions are taken over the next 10-15 years, then the increase in demand for allowances due to falling price will be less than 10% of the size of the reduction in emissions[3].  Correspondingly more than 90% of the emissions reductions due to additional actions are retained, adding to the surplus of allowances which, which end up in the MSR.  Modelling parameters would need to be in error by about an order of magnitude to substantially affect this conclusion.

This effect arises in part because of the low level of prices at present.  This means that even a large percentage change in price leads to a small absolute change, and thus a small effect on demand for allowances.  Even a 50% price fall would be less than €3/t at current price levels.  It also reflects that the shape of the Marginal Abatement Cost curve, with price falls only increasing abatement by a small amount.  This means that even if prices are higher than current levels the effect of price falls on demand for allowances is still relatively small.

The relatively small response to price changes is consistent with the current market, where there is a lack of sufficient increase in demand to absorb the current yearly surplus (or even to come close to doing so).

The 90%-plus of the allowances freed up by additional actions are added to the surplus end up over time in the MSR.  They then stay there for several decades.  This is because even without additional actions, and even with some reform of the current proposals for Phase 4 (which covers 2021 to 2030), the MSR is likely contain at least three billion allowances by 2030, and perhaps as much as five billion.  This will take until 2060 to return to the market, and perhaps until the 2080s, at the maximum rate written into the legislation of 100 million per annum.

Any additional surplus will only return after this.  Even if the return rate of the MSR were doubled the return time for additional surplus would still be reckoned in decades from now.

This will be even more the case if proposals for the EUETS Phase 4 are not reformed, and the surplus of allowances being generated anyway is correspondingly greater.

The implications of the very long delay in the return of allowances

It seems unlikely that allowances kept out of the market for so long would ever lead to additional emissions.  It would require policy makers to allow the allowances to return and enable additional emissions.  This would be at a time when emission limits would be much tighter than they are now, and indeed with a commitment under the Paris Agreement to work towards net zero emissions in the second half of this century.

There are several policy mechanisms that could prevent the additional surplus allowances enabling emissions.  Subsequent caps tighter as unused allowances reduce the perceived risk of tighter caps, and additional actions now set the economy on a lower carbon pathway.  Furthermore, with a very large number of allowances in the MSR over several phases of the scheme, allowances may well be cancelled.  Indeed, over such long periods the ETS itself may even be abolished or fundamentally reformed, with allowances not carried over in full.  Or a surplus under the EUETS may persist indefinitely as additional actions succeed in reducing emissions.

As the market tightens towards 2030 it is likely that a higher proportion of any additional emissions reductions will be absorbed by the market via a price effect, but it still seems unlikely to be as much as 100% given the long term trend to lower emissions and the lack of additional sources of demand, especially in the event of large scale additional actions[4].  Some of the policy responses described would still be expected to reduce the supply of allowances.

Conclusions

The argument that emissions will always rise to the level of the cap manifestly does not hold at present, when emissions are well below the cap. and there is a huge cumulative surplus of allowances.

In future, it seems likely that more than 90% of reductions in emissions from additional actions will simply add to the surplus, and eventually end up in the MSR.  They at least stay there for several decades, because of the very large volume that will anyway be in the MSR.

While there is in principle a possibility that they will eventually return to the market and allow additional emissions this appears most unlikely in practice.  Policy decisions will be affected by circumstances and this can readily prevent additional emissions, through some combination of tightening of the cap and cancellation of allowances.

Even when the market returns to scarcity these policy responses are likely to hold to a large extent, for example with lower prices enabling more stringent caps.  The hypothesis of no net reductions in emissions from additional actions thus seems unlikely ever to hold true.

Spurious arguments about a lack of net emissions reductions should not be used as a pretext for failing to take additional actions to reduce emissions now.

Adam Whitmore – 21st October 2016

 

Note:  A more detailed review of the issues raised in this post, and the accompanying modelling can be found in this report.

 

Examples of statements invoking the idea of fixed total emissions

For example, in 2015 RWE used such arguments in objecting to the closure of coal plant:

“The proposals [to reduce lignite generation] would not lead to a CO2 reduction in absolute terms.   [The number of] certificates in the ETS would remain unchanged and as a result emissions would simply be shifted abroad.” [5]

Similarly, in 2012 the then Chairman of the UK’s Parliament’s Energy and Climate Change Select Committee, opposed the UK’s carbon price support mechanism for the power sector arguing that:

“Unless the price of carbon is increased at an EU-wide level, taking action on our own will have no overall effect on emissions”[6]

Neutral, well-informed observers of energy markets have also made this case.  For example, Professor Steven Sorrel of Sussex University recently argued that:

“Any additional abatement in the UK simply ‘frees up’ EU allowances that can be either sold or banked, and hence used for compliance elsewhere within the EU ETS[7]

 

 

[1] This is analogous to the well-established rebound effect for energy efficiency measures.  Improved domestic insulation lowers the effective price of energy, so consumers take some of the benefits as increased warmth, and some as reduced consumption.  The argument here is that in effect there is a 100% rebound effect for emissions reductions under the EUETS.

[2] Such a situation occurred towards the end of Phase 1 of the EUETS (2005-7), which did not allow banking into Phase 2.  Towards the end of the Phase there was a surplus of allowances and the price fell to close to zero.

[3] The price change is modelled by assuming the price is set by discounting future abatement costs, with a later date for the market returning to balance leading to greater discounting and so a lower price.  The increase in demand for allowances is modelled based on a marginal abatement cost curve and consideration of sources of additional demand.  See report referenced at the end of this post for further details of the modelling.

[4] There are likely to be path dependency and hysteresis effects in the market which prevent a full rebound.

[5] See RWE statement, “Proposals of Federal Ministry for Economic Affairs and Energy endanger the future survival of lignite”, 20 March 2015. http://www.rwe.com/web/cms/en/113648/rwe/press-news/press-release/?pmid=4012793

[6] http://www.parliament.uk/briefing-papers/sn05927.pdf

[7] http://www.energypost.eu/brexit-opportunity-rethink-uk-carbon-pricing/