Are there too many cap and trade plans?

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Source: GLOBE Foundation

The Canadian Council of Chief Executives recently noted there are too many cap and trade plans in the works and more cooperation between states, regions and countries is required.

A recent Calgary Herald article quoted the Council’s CEO Thomas d’Aquino as stating widely different approaches being adopted in provinces like Alberta, British Columbia and together, Ontario and Quebec, along with a separate approach under development by the federal government and a rival carbon tax scheme from the opposition Liberals, are weakening efforts to address climate change issues.

In the absence of a clear federal cap and trade program, the Council argued that too many emission trading options just confounds what business must do to seriously manage their emission reduction initiatives.

But the issue is far more complicated than the mere inconvenience of too many competing trading schemes. There are billions of dollars at stake, and very serious concern about whether in the final analysis emissions trading actually benefits the environment.

Part of the problem is a the confusion that exists, both in the public mind and among business executives as to what constitutes a cap and trade regime and where do emissions trading come in.

What Is a Cap and Trade Program?

As noted in an article prepared by the legal firms Perkins Coie and Fasken Martineau, a cap and trade program is a form of market based-regulation. Governments establish maximum allowable GHG emissions, and distribute or auction these emission allowances up to but not exceeding the cap.

The allowances decrease with time to meet the government’s targets with respect to future emission levels. For each compliance period, regulated emitters must remit allowances equal to their actual emissions. Emitters with excess emissions or excess allowances may 'trade' them with others in market transactions. Each program determines its own emission goals, regulated sectors, level and allocation of allowances, and methods to verify compliance and regulate markets.

The 'cap and trade' system has been used successfully in the United States to reduce the costs of meeting regulatory requirements for sulphur dioxide emissions associated with acid rain. Largely based on this success, the developed world fought hard to include such a trading scheme in the Kyoto Protocol with respect to GHG emissions.

The Kyoto Protocol allows signatory nations to purchase credits from other countries (though this is supposed to be 'supplementary' to domestic GHG emission reductions) to meet their emission reduction obligations under the Protocol.

This can be done through one of the three Kyoto mechanisms: the emissions trading mechanism, the clean development mechanism (CDM) allows developed countries to gain credit for projects with verifiable emission reductions in developing countries; and the joint implementation (JI) mechanism allows developed countries to gain credit through projects in another developed country, or in a country in transition to a market economy.

What Is an Offset?

 Again quoting Perkins Coie and Fasken Martineau, an offset is an emission reduction from a source not capped by a cap and trade program. Permitting offsets encourages reductions beyond the scope of a cap and trade program, often in sectors where emissions are more difficult to track and report (for example, mobile sources).

To provide the necessary market to encourage offset development, regulated emitters in the cap and trade program can use offsets for compliance, in the same way they use allowances. The introduction of offsets into the cap and trade program provides an additional source of compliance units that may, in certain cases, be less costly than those available to capped emitters otherwise restricted to reducing their own emissions.

Europe has the only mandatory ‘cap-and-trade’ trading systems currently in operation, the European Union (EU) Emissions Trading System (ETS). Its focus is on reducing CO2 emissions from big industrial emitters, but will be implemented in phases to include other gases and other sectors. The market is EU-wide but it taps into emission reduction opportunities from the rest of the world through the use of CDM and JI, and provides for links with compatible schemes in third countries. The clean development mechanism of the Kyoto Protocol has also begun to generate credits.

The European Commission estimates the ETS should allow the EU to achieve its Kyoto target at a cost of between €2.9 and €3.7 billion annually.

Other Emissions Trading Schemes

Many schemes are now in place or are being planned. The Regional Greenhouse Gas Initiative, or RGGI, is a cooperative effort by Northeastern and Mid-Atlantic states to reduce carbon dioxide emissions. The RGGI participating states will be developing a multi-state cap-and-trade program with a market-based emissions trading system. The proposed program will require electric power generators in participating states to reduce carbon dioxide emissions.

Other cap and trade systems include the Western Climate Initiative (WCI) a collaboration of seven U.S. states (Arizona, California, Montana, New Mexico, Oregon, Utah and Washington) and three Canadian provinces (British Columbia, Manitoba and Quebec). Last week Ontario announced that it will join the Western Climate Initiative, casting further doubt on the efficacy of the federal government’s intensity based climate plan.

The Midwestern Regional GHG Reduction Accord (Midwestern Accord) involves U.S. states (Illinois, Iowa, Kansas, Michigan, Minnesota and Wisconsin) and one Canadian province (Manitoba) in a regional program to reduce Midwestern GHG emissions. Indiana, Ohio and South Dakota participate as 'observers.' The Midwestern Accord will establish its regional reduction targets by July 2008 and plans to establish its multi-sector cap and trade program by November 2008.

These two regional initiatives may become the cap and trade models for future continent-wide regulations and as such bear close attention by the business community.

In Australia, the New South Wales Greenhouse Gas Abatement Scheme is already operating at the state level, and Australian state premiers have made initial proposals for a national cap and trade system starting in 2010.

Moving Forward on Climate Change, the Canadian climate change plan, foresees a credit trading system for large final emitters (LFEs), currently defined by the government as facilities with annual average emissions of 8 kilo-tonnes of CO2e per establishment or more; and annual average emissions of 20 kilograms of CO2e per $1,000 gross production or more. Canada will require large industrial emitters to reduce GHG emissions per unit of output by 26 percent by 2015, with emissions trading as one of the compliance options. Japan has also taken preliminary steps towards emissions trading, possibly linking to the EU market.

A huge market

The amount of money involved in emissions trading is enormous. The global carbon market is estimated to have more than doubled to USD $64 billion (2007), the largest component of which is the EU- ETS, estimated at $50 billion. Though still in development, the USA and Canada carbon markets that are expected to exceed the size of the EU ETS.

The graphic below depicts how the world currently lines up with respect to the main global cap and trade systems.

The Voluntary Carbon Market

The Voluntary Carbon market is that component that falls outside regulated regimes such as the EU-ETS. The Voluntary market is segmented by the different standards against which carbon offsets are verified. Prominent among these include ISO 14064-2, the Voluntary Carbon Standard, the Voluntary Offset Standard, the Chicago Climate Exchange, the California Climate Action Registry protocols and numerous custom standards. The sectors (forestry, renewable energy) from which an offset is generated further segment the market.

Carbon offsets can be categorized into three main types: renewable (emissions free) energy generation, energy efficiency, and sequestration. The first two avoid emissions, while sequestration projects attempt to aim to absorb or capture emissions that have already occurred.

At present, the offset process generally flows from implementing a project with emission reduction benefits, to quantifying the benefit, to passing the offset through a certification system (ending in third-party Verification), to selling the offset, to retiring (using) the offset. Various systems are being put in place to ensure the first three steps carried out honestly and correctly. However, with most cases in the market today, third-party surety of the process ends there.

Adding to the confusion is the fact that the sale and eventual end-use of an offset are completely un-monitored. There is very little way to tell of an offset is being sold twice (or more times). In the same vein, it is difficult to ensure that an offset on the market has not already been retired, or 'used' against an emission. As well, not all offsets are created equal, nor are they reported in any consistent manner.

This is one of the man reasons why the GLOBE Foundation launched a new Initiative, the GLOBE Carbon Registry. In recognition of the fact there are many excellent climate change projects not yet certified to standards such as the Voluntary Carbon Standard or ISO 14064-2, the GLOBE Carbon Registry provides a facility to display the custom standard to which an offset has been validated and verified. By clearly exhibiting all requirements for a project standard, customers in the marketplace are enabled to make informed decisions in selecting the offsets and the projects they wish to support.

In creating a mechanism for displaying quality offset projects of all types, third party validated and verified to a transparent standard, and tracking these offsets through the chain of custody, the GLOBE Carbon Registry will build trust in carbon offsetting and allow full realization of the potential of the voluntary carbon market. More information on the GLOBE Carbon Registry is available here.

Business concerns about Carbon Trading are justified

As the foregoing analysis has shown, the development of effective and reliable carbon trading mechanisms is an unfolding story. In the United States and Canada, climate change regulation is expanding rapidly, with almost weekly announcements of new initiatives and developments.

As noted in an excellent overview of the evolving climate change regulatory environment by Torys LLP, 'While the Canadian federal government prepares to set domestic GHG reduction targets, opposition parties are exerting their influence to press the government to meet its Kyoto commitments, and environmental groups are doing the same through judicial process. Moreover, various investors and concerned citizens are increasingly urging government to consider new regulations requiring companies to disclose the impact of climate change on their businesses and to help mitigate effects on the global climate.'

In response to these calls a variety of initiatives, from clean energy standards in BC to a carbon tax in Québec have been implemented and new initiatives springing up south of the border as well. The only certainty, notes the Torys review is that the regulatory climate will continue to change rapidly.

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