Linking certificate trading schemes for greenhouse gas emissions, renewable energy and energy efficiency

Diploma Thesis 2008 106 Pages

Environmental Sciences



1 Introduction
1.1 Problem description
1.2 Goal of the master thesis

2 The reasoning for climate protection
2.1 Global Warming and anthropogenic CO2
2.2 Sources of Greenhouse Gas Emissions
2.3 The UNFCCC Agreement on Climate Protection
2.4 The cost of combating climate change
2.5 European energy policy and the 2020 / 2050 targets
2.6 Overview of ways for reducing greenhouse gas emissions
2.6.1 Greenhouse gas abatement
2.6.2 Increase of renewable energy
2.6.3 Increase of Energy Efficiency
2.6.4 Implementation of Carbon Capture and Storage

3 Certificate trading schemes for climate protection
3.1 Background of Market based instruments in environmental policy
3.2 The evolution of trading schemes in environment policy
3.3 Deployment of Environmental Trading Schemes
3.4 Design characteristics of Emission Trading Schemes
3.4.1 Cap setting
3.4.2 Allocation of allowances
3.4.3 Coverage
3.4.4 Offsets
3.4.5 Cost control measures

4 Greenhouse Gas Emissions Trading (Grey Certificates)
4.1 Overview and Functioning of GHG Emission Trading Schemes
4.2 The global market for Greenhouse Gas emissions trading
4.3 GHG Emission Trading Schemes in place or proposed
4.3.1 European Emission Trading Scheme
4.3.2 Norwegian ETS
4.3.3 Chicago Climate Exchange
4.3.4 New South Wales Greenhouse Gas Abatement Scheme (Australia)
4.3.5 Japanese Voluntary Emissions Trading Scheme
4.3.6 Alberta´s Climate Change and Emissions Management Act (Canada)
4.3.7 Swiss Emission Trading Scheme
4.3.8 Australian ETS (announced)
4.3.9 Canadian ETS (announced)
4.3.10 New Zealand ETS (announced)
4.3.11 Proposed initiatives in the United States of America

5 Linking GHG Emission Trading Schemes
5.1 Types of Links
5.1.1 Direct Linking
5.1.2 Indirect Linking
5.2 Impacts of Linking
5.3 Examples of links between GHG ETS
5.4 Prospects and near-term opportunities for linking GHG ETS

6 Renewable energy trading (Green Certificates)
6.1 Options for promoting renewable energy production
6.2 Overview and Functioning of Tradable Green Certificates
6.3 The Guarantees of Origin system in the EU
6.4 Implementation of TGC Systems
6.5 Voluntary TGC schemes - the example of RECS
6.6 The proposed EU-wide Guarantees of Origin Trading Scheme
6.7 Possibilities of Linking Green Certificate Schemes

7 Energy efficiency trading (White Certificates)
7.1 Overview and Function
7.2 White Certificate Systems in place
7.2.1 Tradable White Certificates in Italy
7.2.2 Tradable White Certificates in UK
7.2.3 Tradable White Certificates in France
7.3 Opportunities and barriers for White Certificates
7.4 Outlook for White Certificate Systems within the EU
7.5 Possibilities for Linking TWC Systems

8 Interaction of Grey, Green und White Certificate Trading Schemes
8.1 Linking Emissions Trading with Green Certificates
8.2 Linking Emissions Trading with White Certificates
8.3 Linking White and Green Certificates

9 Summary

10 References
10.1 Literature
10.2 List of Figures
10.3 List of Tables
10.4 List of Abbreviations

1 Introduction

1.1 Problem description

Scientific research clearly evidences that global warming is influenced by the concentration of carbon dioxide (CO2) in the atmosphere, which increased significantly since industrialisation due to the burning of fossil fuels by mankind (anthropogenic CO2 emissions). Many governments, especially the European Union, have agreed to ambitious CO2 reduction targets in order to avoid global warming by more than 2°C compared to pre-industrial times.

In order to achieve those greenhouse gas (GHG) emission reductions, governments can either use regulatory approaches (like rules, bans, norms and standards) or chose market based instruments that include the external costs of greenhouse gases in the prices which leads to reduced demand of GHG emission intense goods.

The most prominent market based instrument in the area of climate policies are GHG Emission Reduction Trading Schemes (ETS), which are established in the EU but also in other countries around the world. Besides that, Certificate Trading Schemes have also evolved in the area of promotion of renewable energy generation (Green Certificates) and energy efficiency (White Certificates). Each of the three systems has different target, policies and design characteristics. To date, there are hardly any links between trading schemes in different countries or between different system types. As all three systems are targeted towards combating climate change by finally reducing greenhouse gases and since a global market would increase liquidity, participants and options to reduce GHG emissions cost effectively, some kind of linking the schemes together should be analyzed and introduced if possible.

1.2 Goal of the master thesis

Goal of the master thesis is to illustrate the rationale behind using market based instruments in environmental policy and to give an overview of Certificate Trading Schemes in climate policy around the world.

Characteristics of the different instruments and trading schemes (Grey, Green and White Certificates) shall be described, and major design parameters shall be identified with a focus on compatibility and potential for establishing links between schemes of the same type or among the different types of trading schemes. Implications of establishing links, which can be planned and wished but may also conflict with other goals, shall be discussed. As greenhouse gas emissions trading schemes are the most developed and experienced trading schemes in climate change policy, the focus of this paper will lie on the analysis of the different trading schemes of this type. For compatibility analysis of ETS, the EU ETS will be chosen as the reference system.

As more and more environmental policies and instruments emerge around the world due to rising awareness for the problem of climate change, this thesis shall give an overview but will not cover all different certificate systems in place and planned.

An outlook for near-term linking options and a summary shall conclude the analysis based on the findings of the work.

2 The reasoning for climate protection

This background chapter will illustrate the necessity for climate protection by quoting scientific evidence that anthroprogenic (man-made) emissions of CO2 and other Greenhouse Gases lead to an increase in earth´s temperature with the subsequent consequences on resources, mankind and nature. International agreements, especially the UNFCCC with the landmark "Kyoto Protocol" show that the international community is taking the threats of global warming serious and is willing to do the necessary to halt global warming by not more than 2° Celsius compared to pre-industrial times temperatures. The European Union has committed itself to act as the forerunner in combating climate change and therefore has set ambitious targets for reducing CO2 emissions and increasing renewable energy usage. This leadership by the EU shall encourage other countries and regions to follow the example.

A short overview of means how to reduce CO2 emissions completes this chapter.

2.1 Global Warming and anthropogenic CO2

Since many years, scientists have been telling that excessive CO2 content in the atmosphere will harm the global climate by increasing the mean temperatures.

Leading on the front of providing scientific evidence for this have been the scientists convened under the Intergovernmental Panel on Climate Change (IPCC).

The IPCC is a body for the assessment of climate change, established by two United Nations Organizations, the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP), in 1988 to provide to the public a clear, balanced view of the present state of understanding of climate change. IPCC reviews and assesses the most recent scientific, technical and socio-economic information relevant to understanding climate change. The IPCC does not carry out research, nor does it monitor climate or related phenomena.

In regular intervals, IPCC provides reports that summarize the current knowledge and future projections of climate change.

The findings of the first IPCC Assessment Report of 1990 played an important role in leading to the United Nations Framework Convention on Climate Change (UNFCCC), a framework treaty which was opened for signature at the Summit in Rio de Janeiro in 1992.

One of the key aspects of IPCC assessments is finding out to what extent and how natural processes and anthropogenic factors cause Climate Change.

Taking into consideration the work and the impact being reached by the IPCC reports, the Nobel price committee decided to award the Nobel Peace Price 2007 to IPCC, together with former US vice president Al Gore.

With the IPCC 4th assessment report (AR 4), which was finalized in early 2007, the latest climate change science was compiled and several key findings were identified (IPCC, 2007):

- Warming of the climate system is unequivocal, as is now evident from observations of increases in global average air and ocean temperatures, widespread melting of snow and ice and rising global average sea level
- Observational evidence from all continents and most oceans shows that many natural systems are being affected by regional climate changes, particularly temperature increases.
- Global GHG emissions due to human activities have grown since pre-industrial times, with an increase of 70% between 1970 and 2004.
- Global atmospheric concentrations of CO2, methane (CH4) and nitrous oxide (N2O) have increased markedly as a result of human activities since 1750 and now by far exceed pre-industrial values determined from ice cores spanning many thousands of years.
- Most of the observed increase in global average temperatures since the mid-20th century is very likely due to the observed increase in anthropogenic GHG concentrations.
- There is high agreement and much evidence that with current climate change mitigation policies and related sustainable development practices, global GHG emissions will continue to grow over the next few decades.
- Continued GHG emissions at or above current rates would cause further warming and induce many changes in the global climate system during the 21st century that would very likely be larger than those observed during the 20th century.
- Anthropogenic warming could lead to some impacts that are abrupt or irreversible, depending upon the rate and magnitude of the climate change.

The impacts being caused by global warming do vary but are significantly increasing with a stronger increase in temperature, especially regarding water systems, ecosystems, food, coasts and health. For example, impacts can be demonstrated by the effects on coasts: with rising temperature, damages from flood and storms increase. At a temperature increase of more than 3°C, already 30% of global coastal wetlands could be lost and millions of more people would suffer from coastal floodings (see Figure 2.1).

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Figure 2.1: Examples of impacts associated with global average temperature increase (IPCC, 2007)

The dominant factor for the temperature on earth is the incoming energy from the sun and the amount of reflection, absorption and emission of energy within the atmosphere and the surface. Greenhouse gases play an important role in changes of the balance of incoming and outgoing energy in the atmosphere system: an increase in greenhouse gas concentration increases the atmospheric absorption of outgoing radiation and therefore keeps more energy within earth´s atmosphere. Aerosols do have a contrary effect: as they absorb and reflect incoming solar radiation and change cloud radiation, the mean temperature on earth decreases.

"Radiative forcing" (RF) is the term being used for describing the magnitude of influence a factor has in changing this balance, and there are positive (temperature increasing) and negative (cooling) factors. The impact of radiative forcing is expressed by its ability to change energy contents in Watt per square meter (W/m2; IPCC, 2007).

The total net anthropogenic RF since 1750 is, according to analysis conducted by IPCC, 1.6 Watt/m2. This is already the balance of warming effects mainly from Greenhouse gases like CO2, CH4 and N20 and cooling effects from aerosol effects (see Figure 2.2).

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Figure 2.2: Global mean radiative forcing (RF) in 2005 with respect to 1750 for CO2, CH4, N2O and other important agents and mechanisms (IPCC, 2007)

The Global Warming Potential (GWP) compares the potential climate warming impact (radiative force) of the emissions of different greenhouse gases over a specified period (e.g. 100 years). The GWP is expressed in a multiple of the radiative force of the same amount of CO2. As illustrated in Table 2.1, the GWP of CH4 is 21 times higher than CO2, N20 even nearly 300 times as harmful as CO2 (ACCC, 2008).

This standardisation of GWPs enables a simplified terminology by using the term of CO2-equivalents (CO2e) for showing overall greenhouse gas concentrations.

Table 2.1: Global Warming Potential of major greenhouse gases (ACCC, 2008)

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Greenhouse gases do play an important role for keeping energy coming from the sun within the atmosphere, being the precondition for enabling live on earth.

However, by increasing the greenhouse gas concentration rapidly through burning fossil fuels in a short time which have taken millions of years to be generated, the temperature rises above the usual level.

In pre-industrial times, the global atmospheric concentration of CO2 was at about 280 parts per million (ppm). In 2005, mainly as a consequence of burning fossil fuels, CO2 levels had already reached 379 ppm and had by far exceeded the natural range over the last 650,000 years which was between 180 and 300 ppm (see figure Figure 2.3).

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Figure 2.3: Atmospheric concentrations of important greenhouse gases (IPCC, 2007)

The scientists working together under the IPCC have put together all available modelling and analysis tools and found out, that greenhouse gas concentrations have to be stabilized at a long term level not above 445-490 ppm CO2e in order to avoid global average temperature increase at not more than 2°C.

As a comparison: the GHG concentration 2005 was 379 ppm and thus below the stabilization goal. However, as GHG emissions are rising sharply as more and more energy is being used (especially by developing countries catching up economically) and the fact that greenhouse gases are long-living gases, the concentration in the atmosphere will rise for the next years, even if emissions would totally stop today.

To show the entire dimension of GHG emission reductions necessary: for a 2° C Target, CO2 emissions in 2050 would need to be 50-85% below the emissions level of 2005. Not reaching these targets will probably mean to have higher temperature increases (3-6° C), which will cause severe impacts in socio-economic systems (IPCC, 2007; see Figure 2.4).

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Figure 2.4: Stabilisation scenarios and resulting long-term temperature and sea level rise (IPCC, 2007).

Reaching these ambitious emission reduction targets will not be easy and will require emission reductions in all sectors causing emissions: Energy supply, transport, buildings, industry, agriculture, forestry and waste. These emission reduction measures will cause significant costs and investments in new and diverse technologies.

2.2 Sources of Greenhouse Gas Emissions

Most anthropogenic GHG Emissions are caused by the burning of substances containing Carbon, which set free CO2 during their combustion. Since the start of industrialisation, these emissions are set free by burning fossil fuels like coal, gas or oil in order to produce energy.

According to sectoral analyses of CO2 emissions from burning fossil fuels in 2004, done by the International Energy Agency (IEA) in 2007, 41% of emissions were caused by electricity generation, followed by transportation with 20% and industry being responsible for 18% (IEA 2007b, see Figure 2.5).

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Figure 2.5: Emissions from burning fossil fuels 2004 (IEA, 2007b)

The highest share of GHG emissions therefore are resulting from activities in industrialized countries. According to data compiled by the Carbon Dioxide Information Analysis Centre for the UNFCCC, in 2004 about 27,250 million tonnes of CO2 have been emitted worldwide from the consumption and burning of fossil fuels (not including CO2 emissions from other activities like deforestation). The United States of America were in this data collection the largest emitters of CO2 with 20.2%, followed closely by the People´s Republic of China and Taiwan with 18.4%. The ten largest emitter countries in 2004 were responsible for 64.6% of global CO2 emissions. Compared to these figures, the CO2 emissions from the European Union with 11.4% of global CO2 emissions appear relatively low (see Table 2.2).

Table 2.2: CO2 emissions of largest 10 emitting countries 2004 (CDIAC, 2005)

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The trends of emission amounts show that developing countries are catching up fast in their emissions. Several sources, e.g. the Netherlands Environmental Assessment Agency and the University of California, recently published articles that CO2 emissions from China have been underestimated and that China already overtook the US in 2007 in being the world´s largest CO2 emitter with 6,200 million tonnes of CO2 in 2007, compared to 5,800 million tonnes from the US.

Growing attention is being given to anthropogenic carbon dioxide emissions from land use land use change and forestry (LULUCF), as these sources are contributing about 20% to global CO2 emissions. The Greenhouse Gases are emitted mainly through deforestation of former rainforest (i.e. conversion of forest into agricultural land).

The largest emitters of GHG emissions from LULUCF are developing countries, especially Indonesia (700 million tonnes CO2e in 2000, i.e. 34% of worldwide CO2 emissions from LULUCF), Brazil (375 million tonnes CO2e, i.e. 18%) and Malaysia (190 million tonnes, i.e. 9%). Further major emitters are Myanmar, Democratic Republic of Congo, Zambia, Nigeria and Peru (see Table 2.3, Houghton, 2003).

IPCC states that from 1850 to 1998, about 160 Gigatonnes carbon have been emitted as a result of land-use change, predominantly from forest ecosystems. In comparison, 285 Gigatonnes carbon have been emitted in the same period as carbon dioxide into the atmosphere from fossil fuel burning and cement production (Watson et al., 2000).

Table 2.3: CO2e Emissions from Land-Use Change and Forestry in Top Ten Countries in 2000 (Houghton, 2003)

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2.3 The UNFCCC Agreement on Climate Protection

Climate change induced by global warming is considered one of the most serious threats of our age. It will have negative impacts on environment, human health, food security, economic activity, natural resources and physical infrastructure.

There is common political understanding, that climate change will be a major threat for international security. By global warming, the competition for resources will intensify, and especially countries which are already fragile and conflict prone will be affected by climate change (European Commission, High Representative, 2008).

The international political response to climate change began with the adoption of the United Nations Framework Convention on Climate Change (UNFCCC) in 1992. The UNFCCC, which has 192 parties, entered into force in 1992 and sets out a framework for stabilizing greenhouse gas concentrations.

A milestone in UNFCCCs actions was the agreement to a "Protocol" on the 3rd Conference of Parties in Kyoto, Japan. In this Protocol, developed countries and economies in transition committed themselves to reducing emissions. All countries which committed to these reductions were outlined in the Annex I of the Kyoto Protocol and agreed to lower their emissions by 5.2% below 1990 levels between 2008-2012 (with specific targets for each country). The European Union volunteered for a higher reduction of 8% in the same period.

In order to bring the political decision of reducing emissions to live, further negotiations were necessary in order to define the rules on how to reach these reductions. Finally, in November 2001 at the 7th Conference of Parties in Marrakesh, Morocco, the rules and operational details how countries will reach the emission reductions were finalized in the "Marrakesh Accords". The Accords contain, besides reporting and compliance rules and methodologies (including LULUCF), already detailed distinctions for the three flexible mechanisms under the Kyoto Protocol: Joint Implementation (JI), Clean Development Mechanism (CDM) and Emissions Trading (ET).

In a UNFCCC working session in June 2007 in Vienna, Austria, the "Ad hoc Working Group on Further Commitments for Annex I Parties under the Kyoto Protocol" adopted conclusions including that global greenhouse gas emissions need to peak in the next 10-15 years before being reduced for at least 50% below 2000 levels by the middle of the 21st century. In order to achieve this stabilization level, Annex I parties (i.e. the developed countries and economies in transition, see above) as a group would be required to reduce emissions by a range of 25-40% below 1990 levels by 2020 (UNFCCC, 2007).

During the past Conference of Parties, COP 13, which took place in December 2008 in Bali, Indonesia, a "Bali Roadmap" with the focus on reaching a Post-2012 agreement by the end of 2009, was agreed on.

Following this roadmap, several negotiation rounds in 2008 and 2009 are scheduled in order to design a global agreement between not only Annex I countries, but also developing countries. The distinct target for Annex I countries is to agree on binding commitments for emission reductions or at least emission limits from developing countries, which increase their amount of greenhouse gas emissions at a very high speed.

As the European Emission Trading Scheme (EU ETS) is a successful means for reducing emissions, a major part of such a global agreement could be formed by means of a global certificate trading scheme. The topic of linking already existing certificate trading schemes (with certificates for Greenhouse Gas Emissions, Renewable Energy and Energy Efficiency) is the core of the following analyses.

2.4 The cost of combating climate change

In 2006, Sir Nicholas Stern, former Chief economist of the World Bank, published a highly noted report called "The Economics of Climate Change", analyzing the economic impact of global warming.

The main conclusions from his report were that global warming could have very serious impacts on growth and development and that urgent global response is needed to avoid this.

Sir Stern shows that the cost of inaction, i.e. not reacting now to this challenge, is several times higher than taking action now by mitigation of greenhouse gases and adaptation to the effects which cannot be avoided anymore. The review estimates that it could cost on average more than 5% of global GDP each year if no actions are taken, whereas the cost for reducing greenhouse gas emissions to avoid the worst impacts of climate change would be about 1% of global GDP per year.

These costs would not be distributed evenly: developing countries would have to carry the cost of inaction, whereas mainly developed countries would need to finance actions (Stern 2006).

The review also postulates that delaying actions would lead to a sharp increase in costs for combating climate change, and that strong political action is needed in order to fight global warming. Stern emphasizes the need for a global framework on action, where emissions trading, technology cooperation, actions to reduce deforestation and adaptation would be the key levers for success (Stern, 2006).

In June 2007, consulting company McKinsey published a report called "A cost curve for greenhouse gas abatement", where it evaluated the cost of measures to be taken in order to reduce global warming (McKinsey, 2007). According to the authors, the cost will vary between 500 and 1,100 billion Euro in 2030. This represents 0.6 to 1.4 % of the total GDP.

In the McKinsey cost curve analysis of CO2 abatement measures, the most economic solutions to reduce greenhouse gases were seen in the building area and vehicle sector (see Figure 2.6).

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Figure 2.6: Global cost curve for greenhouse gas abatement measures beyond business as usual (McKinsey, 2007).

The economic dimensions of impacts from climate change and the very high cost of abatement measures show how important it is to choose the most cost efficient way of reducing greenhouse gases, which most probably is done by giving a value to the commodity greenhouse gas and make it tradeable.

2.5 European energy policy and the 2020 / 2050 targets

As a result of the growing awareness of the tremendous impact which greenhouse gas (GHG) emissions most probably do have on climate and in addition through the binding commitments for the EU and its member countries under the UNFCCC Kyoto Protocol, plans, commitments and measures to reduce GHG emissions are playing a central role in EU energy and environmental policies.

Under the UNFCCC Kyoto Protocol, the European Union has agreed to reduce its greenhouse gas emissions by 8% in the period 2008-2012 compared to 1990 levels (see Chapter 2.3). Within the EU, the total reduction target was distributed between the Member States via a burden sharing, adding up in total to the EU 8% reduction target from the Kyoto Protocol (compared to 1990 values).

In the EU strategy for sustainable development, further priorities have been adopted by the European Council in June 2001 in Gothenburg, including several goals regarding demand-side energy efficiency and an increased development of renewable energy sources.

Major milestones from these Council conclusions were the agreement on the following targets for 2010 (European Council, 2001):

- Realizing the potential for energy-efficiency improvements as far as economically possible and reducing energy consumption by 1% per year to achieve 18% energy savings
- Double the share of electricity production from combined heat and power to 18%
- Develop the potential of renewable energy production and increase consumption of RES (electricity, heating and biofuels) from 6% to 12% of EU gross energy consumption by 2010 (target for renewable electricity: 22.1%)

In the light of increasing scientific evidence of the growing need for a quick reduction in GHG emissions, the European Council defined in its conclusions from the March 2007 meeting even more ambitious targets for 2020: the EU´s greenhouse gas emissions shall be reduced by 20% in 2020 compared to 1990 levels, and the share of renewable energy (electricity, heat and cold, fuels) shall reach 20% of EU´s final energy consumption (European Commission, 2008).

In order to bring these ambitious goals closer to implementation, the European Commission presented in January 2008 the so-called "Integrated package for climate and Energy policy" which consists of proposals for four new directives:

- Directive to improve and extend the greenhouse gas emission allowance trading scheme of the Community (COM (2008) 16)
- Decision on the Effort Sharing of Member States for the Reduction of Greenhouse Gases in the Community (COM (2008) 17)
- Directive on the geological storage of CO2 (COM (2008) 18)
- Directive on the promotion of the use of energy from renewable sources (COM (2008) 19)

These proposals are currently under discussion in the various working groups of the European Council and the European Parliament. In the March 2008 Council Conclusions, the target line for political agreement on the package was set with end of 2008, which is a highly ambitious plan and most probably hard to stick to.

Meeting the 2020 targets will be a tough challenge for Europe: Starting from a share of energy consumption in electricity, heating and biofuels from renewable energy in 2005 of 8.5%, there is a gap of 11.5% or the need of more than doubling the renewable energy consumption in the years until 2020 (European Commission, 2008). Considering the long history of renewable energy in Europe, especially the usage of large hydro power, this is a very high target, taking into account the constantly growing energy consumption (IEA, 2007b; see Figure 2.7).

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Figure 2.7: World Primary Energy Demand in the Reference Scenario (International Energy Agency, 2007)

The CO2 reduction goals for Europe are challenging as well: The European Commission proposes, that the sectors covered by the Euopean Emission Trading Scheme, which are the European energy producers and the energy intense industry sector, shall reduce their emissions by 21% compared to their 2005 figures. The other sectors not covered from the European Emission Trading Scheme (households, transport, agriculture, waste management), which are responsible for 60% of the EU´s emissions, need to reduce their emissions by comparably modest 10%.

The Energy and CO2-intensity for production processes in Europe is already quite low, and achieving further increases will be more difficult and more costly than achieving increases in countries starting from a low level.

Prominent examples for different starting points in energy and CO2 efficiency are the production of steel and cement, two very energy intense products.

Following the analysis quoted by Mr. Lakshmi Mittal, the CEO of Mittal Steel (one of the largest steel producers worldwide), producing one tonne of steel from iron ore in Europe or the USA causes - depending on the age of the plant and other factors, CO2 emissions of 1-1.5 tonnes of CO2. In some emerging markets the average CO2 emissions for the production of one tonne of steel could be almost double (Mittal, 2007).

Similar figures are being published for the cement production: whereas the production of 1 tonne of cement causes about 660 kg of CO2 in Europe (642 kg CO2 in Austria as the CO2 emissions from energy consumption are lower due to the high proportion of renewable electricity), 830 kg in China and 925 kg of CO2 in the United States of America for the same output amount (IEA, 2007a; see Table 2.4). This means, that cement production in the USA can cause up to 44% more CO2 emissions than in Austria.

Table 2.4: CO2 emissions per tonne cement in 2004 (based on analysis by IEA, IEA, 2007a)

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The large differences in CO2 effectiveness in different countries show that there is significant potential to reduce CO2 emissions, but that the potentials are not spread evenly across the world. It would not be wise to urge all companies to reduce the same amount of CO2 emissions (i.e. by setting a reduction target of 20% for all companies), as it is more difficult and costly to reduce GHG emissions in an already efficient process. In order to avoid such excessive costs, it is of high importance to provide flexible mechanisms to companies which enable them to reduce emissions at least cost - either by implementing reduction measures themselves or by purchasing reduction credits from other companies which have lower abatement costs (see chapter 4).

2.6 Overview of ways for reducing greenhouse gas emissions

The reduction of greenhouse gases is high on the political agenda in most of the industrialized countries. However, as greenhouse gas emissions do come from many sources, various sectors and most economic actors but also private households, abatement measures must be taken in many fields.

2.6.1 Greenhouse gas abatement

Greenhouse gas abatement measures can be realized in many areas, from households to industries, from private to public sector. Examples with a high potential of reducing greenhouse gases are the buildings sector, where a lot of energy is wasted by insufficient insulation or old heating technology, or the transport sector, where rail transport could be an alternative to road transport in some areas.

High abatement potential is especially given for projects that reduce greenhouse gases with a high global warming potential like methane, nitrous oxide or hydrofluorocarbons (see GWP in chapter 2.1).

The levers to encourage these abatement measures are in the private sector mostly through national environmental policies, subsidies or taxes. In the business and energy industry sector, emission trading schemes with limited amounts of emission rights force companies to make use of their reduction potentials or to buy emission rights via an appropriate market. In most of the emission trading schemes, abatement measures in other countries are partly allowed to offset the reduction obligation within the trading scheme (see chapter 4).

2.6.2 Increase of renewable energy

The major source of CO2 emissions is the burning of fossil fuels. By generating and using more energy from renewable sources, these emissions can be reduced substantially.

Many countries have put legislation or measures in place in order to increase the share of renewable energy in the energy generation or consumption.

The European Union adopted in the March 2007 council conclusions defining the target of 20% renewable energy in 2020 (European Union, 2007). Even the People´s Republic of China passed a Renewable Energy Law in 2005 fixing a 10% target of renewable energy in 2020.

Methods to promote renewable energy production are done via a support scheme for the producers (guaranteed feed-in tariffs higher than the market price, tax exemptions or market based instruments like tradable green certificates) or an obligation (mostly quota obligations) for the energy producers or consumers (see also Chapter 6).

2.6.3 Increase of Energy Efficiency

Increasing energy efficiency can be regarded as a win-win situation: energy efficiency can help in reducing energy consumption and emissions from energy production (greenhouse gases but also other pollutants), it can reduce the need for investment in energy infrastructure, cut fuel costs, increase competitiveness of companies and improve consumer welfare. Another important aspect for energy efficiency is that by decreasing the reliance on imported fossil fuels, security of energy supply can be improved by national and decentral production.

Energy efficiency can best be increased by implementation of standards and norms but also raising awareness for this topic.

Improvements in energy efficiency can be reached in all areas of consumers daily life and industries, from household appliances to production equipment.

One of the recent examples which got international attention was the decision taken by Australian government in February 2007 to phase out light bulbs by 2010 as they were not energy efficient.

In the automotive sector, the European Union is planning to implement legislation that average CO2 emissions for new cars on average of the manufacturers production portfolio shall not exceed 130 g CO2 per km, otherwise they would face penalties (European Council, 2008). The decision about the details for the new directive will probably be decided in the European Parliament in Autumn 2008.

Many more examples and initiatives do exist, and further increase in energy efficiency will be a key issue for increasing security of energy supply and stabilizing greenhouse gases.

2.6.4 Implementation of Carbon Capture and Storage

Carbon capture and storage (CCS) is a novel technology which aims at mitigating global warming by capturing CO2 from large sources like fossil fuel plants and storing it subterraneous instead of releasing it into the atmosphere.

Ideal places for storage are geological formations where previously oil or gas was stored for millions of years, as these formations are regarded as relatively safe. However, no experience has been made with long term storage of CO2 so far.

The technology for capturing the CO2 from emission streams is already commercially available but still very energy intense: the process of capturing CO2 from the emission stream might reduce efficiency factors of coal plants from currently about 40-45% to 30-35%, which means that about 10-15% points additional fuel is needed in order to produce the same amount of energy.

However, as other technologies to reduce greenhouse gas emissions are still not mature enough in order to reduce GHG to the extent needed in the short term, many countries do regard CCS as a suitable and important bridge technology in order to combat global warming.

Strong proponents of the CCS Technology are countries with many coal fired plants like China, USA and Germany, but also countries with large GHG emissions from other single point sources like oil sands in Canada.

Until CCS is ready for the market, high investments in research and development are needed, and it will take several years to have enough experience in order to implement this technology in the large scale.

3 Certificate trading schemes for climate protection

Trading Schemes are a market based instrument which can be also used for environmental goals like climate protection. Trading follows different reasoning and criteria than regulatory measures like taxes. The first trading schemes in environmental policy were successfully implemented in the United States of America with permits for certain amounts of pollution. Other examples of trading systems in environmental policy are described and typical system design parameters for trading schemes identified.

3.1 Background of Market based instruments in environmental policy

Economic theory tells that treating resources as common goods that are shared jointly by many users brings the risk of over-exploitation of the good as long as there is no regulation to the access. Environment is a classical example of such a common good: air quality, atmosphere, landscape etc. are goods without clearly defined ownership and usage rules. The answer to the question of how to set up and define these access rules is not so simple.

Since the late 1950s, economists with Professor A.C. Pigou as a prominent representative, have taken the approach that in the face of an externality such as pollution, the solution would be to impose a per-unit tax on the emissions from a polluting activity (Pigouvian Tax). The tax rate should be equal to the marginal external social damage caused by the last unit of pollution and therefore internalize the external effect. As firms and private persons would strive to minimize their costs, they would either pay the tax or reduce the pollution.

The opinion group of policy makers, however, did not follow the ideas of Pigou, as they thought the information burden imposed on the bureaucracy by design of efficient taxes was unrealistically high. In their point of view, the proper way to control pollution was through a series of legal regulations which should define amounts, access rights, spatial distribution and other aspects of emissions (Tietenberg, 2006). Ronald H. Coase, a british economist, argued in 1960 in his article "The problem of social cost", that well-defined property rights could overcome the problems of externalities (University of Berkeley, 2008). This theory became well-known as the Coase Theorem.

Coase was convinced that, when property rights are clear and enforceable, all economic agents have full information and transaction costs are low, there is no need for government intervention to correct externalities, because the economic agents can bargain to achieve a Pareto optimal allocation of resources - no matter which economic agent is given the property rights (University of Berkeley, 2008; see Figure 3.1).

If the polluter has the right to pollute, he will pollute the entire length 0A until his Marginal Benefit (MB) is 0. The pollutee welfare will be negative. After a negotiation, where the pollutee agrees to pay the polluter an amount of F per unit pollution reduction, the polluter will pollute the length 0N. An equilibrium will be reached in point C.

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Figure 3.1: Illustration of the Coase Theorem (University of Berkeley, 2008)

Coase received the Nobel Price in Economics in 1991 for his work.

This so-called "Coase Theorem" is the root idea of using a market based trading mechanism for removing market failures of public goods, and it has found prominent examples in environmental protection and emission trading programs.

Market failure means that there is no market (e.g. no payment for clean air) or that the market price is not sufficient for the real or social cost of economic activity. In these cases, public intervention is needed in order to correct these failures. Unlike regulatory or administrative approaches, Market Based Instruments (MBIs) have the advantage of using market signals to address the market failures. They give flexibility to companies on how to reach their targets and therefore can substantially reduce the costs of environmental improvements. MBIs give price signals through giving a value to the external costs and benefits of the economic activities which influences the behaviour of actors.

Frequently used types of MBIs in environmental policy are tradable permits (e.g. emission rights), environmental taxes or charges, environmental subsidies and incentives and liability and compensation schemes (EEA, 2005).

Tradeable permits are quantity based instruments, i.e. they fix a quantity of permits (e.g. emission rights), whereas taxes, charges, subsidies and incentives are price-based instruments.

3.2 The evolution of trading schemes in environment policy

The first trading schemes in environmental policy evolved from air pollution control measures in the United States of America, especially from the Clean Air Act. The main substances to be controlled via this market based instrument were air pollutants like nitrogen oxides and Sulfur oxides. Trading Schemes for greenhouse gases like CO2 entered the markets in the new millennium.

Clean Air Act

Ground level ozone and nitrogen oxides have been two of the most difficult pollutants to control and triggered new mechanisms in environmental policy.

Early pollution programs starting in the 1960s and 1970s required sources of emissions to install specific technologies or achieve defined emission rate levels or concentrations. But with growing economies the total number of installations and the number of production hours increased and pollution control did not work as planned. The air quality deteriorated.

A major problem of this scheme was that the scarce resource of emission rights was distributed to the installations already in place; new installations could not start operation and existing ones could not expand without harming the environmental target (Emissions Trading Education Initiative, 1999). More flexibility in reaching the required emission levels was necessary.

The first approach to this flexibility was to allow a regulated facility with multiple sources to combine the total emissions under a "bubble" and achieve the reductions in those emission sources where it was most efficient (Emissions Trading Education Initiative, 1999). Bubbles, which were introduced in the Clean Air Act Amendment of 1990, allowed for the first form of emissions trading via intra-facility trading. However, this mechanism was only possible on a case-by-case agreement between the facility and the regulator.

The next step in evolution of Emission Trading Schemes was the offsetting mechanism. Offsets are created when a source implements voluntary, permanent emission reduction measures that were legally recognized by the regulator. Existing sources could trade their emission rights with new facilities based on an approval by the regulator. These offsets were called Emission Reduction Credits. Similar to the bubble mechanism, also offsets caused high transaction costs through the requirement of a case-by-case consideration.

Regulators recognized that flexibility mechanisms need to be standardized into tradable commodities following clear and fixed rules in order to guarantee cost-efficient and attractive flexibility mechanisms.

This required the regulator and the emission sources and facilities to negotiate and agree on a number of key elements for the trading scheme, like baselines, emissions monitoring and reporting rules, future utilization rates for credit generating and receiving sources, validity time of credits and trading possibilities, and an assessment criteria if the reduction measure would have happened also without the trading option (Emissions Trading Education Initiative, 1999).

This mechanism was more flexible than its predecessors, but still had high requirements on negotiation times and transaction costs, therefore the number of trades remained restricted to cases where clear and substantial economic benefits could be expected. Furthermore, the total amount of pollutants emitted could not be regulated with this mechanism.

US Acid Rain Program

In the 1990s, a market mechanism for Sulfur dioxide emission allowances was created under the Clean Air Act Amendments. This "Acid Rain Program" (as SO2 is the main cause of Acid Rain) followed a new principle, the "cap and trade" principle. Cap and trade systems have fixed and permanent limits of emissions and thereby ensure the maximum overall amount of harmful or dangerous substances.

In the US Acid Rain Program, power plants were given clear limits for emissions of SO2, but the plant operators had the freedom how to achieve these limits under clearly defined rules. The reductions can then be sold on the market for these allowances. By this market mechanism, competition between plant operators evolved on the most cost effective pollution reduction system and appliances to reduce emissions, which gave ground to speeding up innovation and rewarded efficiency.

Although the cap in the Acid Rain Program was ambitious with setting a firm cap at half of 1980 levels by 2010, the mechanism managed to proof success. In 2007, the program has cut about 40% of Sulfur dioxide emissions compared to 1980. The Acid Rain Program also seems to be financially very successful: the US Environmental Protection Agency estimates that complying with the law will cost utilities and consumer about $ 1-2 billion per year, which is about one quarter of the original forecasts (EPA, 2007).

Regional Clean Air Incentives Market (RECLAIM)

Smog, which is caused from the air pollutants nitrogen oxides (NOx) and sulfur oxides (SOx), is a major problem in the urban area of the Los Angeles Basin (USA). In 1993, local governments created a market-based policy tool for achieving reductions in these emissions. This was the first emissions market for urban areas.

A market for NOx and SO2 was created, as the program established a cap and trade system to reduce emissions of NOx by 75% and SO2 by 60% in 2003 compared to 1994. All facilities emitting more than 4 short tons (one short ton is equal to 0.907 metric tonnes according to Wikipedia) of NOx or SO2 per year had to participate in the market. They received free RECLAIM Trading Credits (RTCs) for their emissions based on historical emissions, but had to reduce their emission continuously.

At the start of the program in 1994, about 400 facilities had to participate in the RECLAIM programme, which covered about 65% of NOx and 80% of SO2 emissions.

From 2000-2001, an electricity crisis with subsequent black-outs hit California. Due to ambitious but not fully working deregulation of energy policy, since the 1990s no new power producing plants were built, and some of the power producers in place faced financial difficulties. Government had set price caps for electricity, and ambitious environmental policies like RECLAIM made it expensive for energy companies to produce electricity in California.

After a heavy storm in 2000, increased energy demand caused older and more polluting local power plants in California to produce more energy for which they had to purchase RECLAIM Trading Credits (RTCs) for NOx on the market. As demand grew, prices for RTCs soared and peaked at more than 40,000 USD per short ton of NOx, about 8 times as much as in most other years (see Figure 3.2).

As the extra cost for the RTCs could not be covered by the sales of electricity, many power plants decided not to produce energy - which (besides other factors) led to a veritable energy crises and black-outs (EPA, 2006).

As a consequence, the power sector was released from the obligations from the RECLAIM program.

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Figure 3.2: Average Annual NOx RTC Prices (per short ton) from RECLAIM Inception to 2000 (SCAQMD, 2001)

The example of the RECLAIM NOx case shows, that trading schemes also have their limits and are not suited for all kinds of substances in all circumstances.

The lessons learned from the US examples have been incorporated into emission trading schemes which are in place now in different countries all over the world.

UK Emission Trading Scheme (ETS)

The UK Emission Trading Scheme installed in 2002 was the world's first economy-wide greenhouse gas Emission Trading Scheme, created as a pilot prior to the mandatory European Union Emission Trading Scheme. Denmark had installed a pilot greenhouse gas trading scheme between 2001 and 2003, but it only involved eight electricity companies and therefore is not described here in detail.



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University of Applied Sciences Burgenland – Nachhaltige Energiesysteme




Title: Linking certificate trading schemes for greenhouse gas emissions, renewable energy and energy efficiency