European Climate Summit, 2019

Introduction

The 2019 European Climate Summit (the Summit) took place on April 15 – 17 in Lisbon. The event was organised by the International Emissions Trading Association (IETA) and was attended by representatives of governments, development organisations, energy companies, traders and financial institutions.

Over three days, participants discussed the progress made in achieving carbon reductions, how countries can collaborate on meeting their emission reduction targets, challenges to industrial decarbonisation and potential new ways of reducing greenhouse gas emissions. The key areas of focus are set out below.

The Paris Agreement and Article 6

By way of background, at the Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC) in 2015 in Paris (COP21), an agreement was made which committed Parties to legally binding climate change action.

As part of this agreement, the State Parties are required to set national emission reduction targets (Nationally Determined Contributions or NDCs) and regularly submit these to the UNFCCC. However, the detailed “rulebook” for reporting greenhouse gas emissions and regulating voluntary market mechanisms, such as carbon trading, was left to be finalised at COP24 in Katowice, Poland. At COP24 negotiators managed to reduce the list of potential options from hundreds to a few dozen, but significant disagreement between countries still exists. Despite the progress at COP24, guidance for market cooperation (Article 6 of the Paris Agreement) was left out and there is now pressure to agree a way forward at COP25 which will take place in December 2019 in Santiago, Chile.

There are a number of challenges to getting agreement on the detail of Article 6 rulebook: Parties’ differences in approach, with developing countries favouring centralised mechanisms whereas more developed countries prefer market-based mechanisms; the need to agree on accurate accounting to prevent double-counting of emission reductions; lack of trust; the need to secure new investments; and lack of overall approach to carbon policies in different jurisdictions. That said, the cooperation mechanisms in Article 6 enable enhanced ambition and allow Parties to achieve more than if each country complied with its NDCs independently.

An important means of raising ambition to take on more challenging targets are the market-based climate change mitigation mechanisms for which Article 6 sets a legal framework. However, market mechanisms must be complemented by a wider suite of policy responses to address climate change. For example, policy has a key role to play in mobilising the private sector which is vital in the success of NDC implementation. Pension funds, bonds and other investors will be looking for transparency, stability and certainty.

Considering the importance of finance, Article 6 should not be looked at in isolation from Article 9 of the Paris Agreement which obliges developed countries to provide financial resources to assist developing nations with respect to mitigation and adaptation in continuation of their obligations. Getting finance right will help meet the NDCs.

A related topic to be considered is transition from the Clean Development Mechanism (CDM). Under the CDM, established under the Kyoto Protocol in 1996, emission reduction projects in developing countries are able to earn certified emission reduction credits which can be traded and used by industrialized countries to meet a part of their emission reduction targets under the Kyoto Protocol. An overlap between the mechanisms under the CDM and the Paris Agreement could jeopardize the accounting of emission reductions towards the Paris Agreement’s goals, but how can countries with running CDM projects start with Article 6?

To broaden the Article 6 discussion further, the NDCs and action in this space should be linked with the Sustainable Development Goals (SGDs) adopted by the United Nations member states in 2015 which also call for tackling climate change and promoting sustainability.

It remains to be seen what progress on agreeing Article 6 guidance will be achieved at COP25.

Natural Climate Solutions (NCS)

NCS is a fairly new area which has been growing in importance. Deforestation, land use, agriculture, oceans, biodiversity and conservation all play a role in maintaining global temperature and, despite being only a small part of the problem, could provide a significant contribution to the solution at a reasonable cost. According to studies, natural climate solutions could offer up to 37% of the emission reductions needed between now and 2030 to limit global warming to 2°C.

As key emitting industry sectors become regulated and reduce their emissions, the numbers of green certificates supplied by them will drop over time, with NCS becoming an important source of emissions to be traded.

So far, investment in this space has been driven by demand from voluntary players, but now long-term institutional capital is needed. To encourage investment, NCS needs a standardised set of methodologies, scale and investment vehicle to create consistent long-term demand. Public policy will be important to mobilise private sector.

Currently, IETA is working on rules for measuring and certifying emission reductions to incorporate NCS on a scale needed; it is hoped that this will encourage investments to flow.

How Europe can lead the world in the Climate Change

The EU has set itself a long-term goal to reduce greenhouse gas emissions by 80% – 95% (when compared to 1990 levels) by 2050. The EU is on track to achieve this aim, yet there is potential for it to be even more ambitious - by increasing collaboration between the public and private sectors, including additional industry segments in the EU Emissions Trading Scheme (EU ETS) and promoting investment in research and development and technical innovation.

For example, heating and cooling alone represents 50% of the EU’s energy consumption, yet 75% of heating is still based on fossil fuels. Some participants estimated that if emissions from decentralised heating were included, the volume of EU ETS could increase by 35%.

Another suggestion put forward was to increase the withdrawal rate of allowances from the market, moving to a full auctioning over time, thus putting more pressure on industry players to decarbonise.

Currently, the overall number of allowances is declining at an annual rate of 1.74%. This will be stepped up to 2.2% from 2021 onwards. In addition, the Market Stability Reserve (MSR) established in 2015 in order to reduce the oversupply of allowances, will be reinforced, so that between 2019 and 2023 the rate at which allowances will be placed in the MSR will be doubled from 12% to 24%. From 2023 onwards the number of allowances held in the MSR will be limited to the auction volume of the previous year. Holdings above that amount will lose their validity, unless otherwise decided in the first MSR review in 2021. This is intended to encourage companies to lower the quantity of their greenhouse gas emissions further.

The next challenge for Europe will be to achieve industrial decarbonisation while at the same time growing business. Emissions trading will play an important role in promoting competitiveness, but significant investment will be required too, since low carbon technologies can be expensive to develop and implement. In some sectors, the carbon component currently represents as much as 20% of a product’s sale value. In order for the EU to remain competitive, particularly against China, this has to be reduced. Regulation and clear policy tools will encourage investment in innovation, technology and digitalisation, helping transition towards a climate-neutral Europe.

As well as being ambitious, EU energy regulation must recognise regional differences and ensure that climate mitigation action is affordable and fair, so as to continue having support of the community. This was highlighted by the recent “gilets jaunes” protests in France that accompanied a carbon tax rise. 

At the Summit, participants concluded that the EU should continue being a “laboratory” for policy development and technological and market innovation, and setting an example for developing countries.

Emission trading schemes (ETS)

This space was dominated by two topics – the case for linking (and de-linking) ETS and the emergence of a Chinese ETS.

Linking ETS

Over the past two decades emission trading schemes have emerged in many countries and regions of the world, with the EU ETS being the world’s largest carbon market. Since a larger market creates more cost-effective carbon reduction opportunities, linking ETS, whereby a participant in one system can use allowances from another ETS in satisfaction of its obligations to surrender allowances, can be an attractive proposition.

An example of successful linking is the California–Quebec joint carbon market which has been operating since 2014. Particularly noteworthy is how quickly and painlessly the California-Quebec ETS managed to de-link from Ontario after Ontario ended its provincial cap-and-trade system in 2018. Despite concerns that demand would dry up, the joint market avoided volatility and remained stable.

One lesson learnt from this is that for a link to be successful it is important that the emissions trading systems being linked are relatively comparable, so that neither system is importing weakness from the other. Also important are mutual trust and close political contact.

At the Summit participants contemplated the possibility of linking the EU ETS with North America’s cap-and-trade system, and discussed risks and benefits of doing so.

An important difference in the two market designs is the approach to price. In the case of North America’s cap-and-trade system, governments cap total emissions output, letting market forces decide the price of carbon. This is contrasted with the EU ETS, where significant amount of allowances continue to be allocated for free to eligible installations. One of the reasons for free allocation is to reduce the risk of companies transferring production to third countries with laxer constraints on greenhouse gas emissions (carbon leakage).

Other concerns with linking the two systems are political risks, maintaining competitiveness, lack of trust, risk of litigation in different jurisdictions and risk of market instability resulting from different pricing systems or disorderly exist of one of the parties.

That being said, a larger market has potential to be more liquid and stable, helping reduce emissions at a lower cost. This is one of the reasons why linking compatible emissions trading systems with each other is a long-term goal for the EU.

Currently underway is linking of the EU ETS with the Swiss emissions trading scheme. A linking agreement was signed in November 2017 and approved by the Swiss Parliament in March 2019. It must now be ratified by Switzerland and the EU before coming into force on 1 January 2020. When the linking agreement is implemented, participants in the EU ETS will be able to use allowances from the Swiss emissions trading system for compliance, and vice versa.

De-linking ETS

A potential example of de-linking ETS is the UK leaving the EU.

Theoretically, there is a possibility of a stand-alone UK ETS, although it is questionable whether such a market could have sufficient liquidity. A better alternative would be a UK ETS linked with the EU ETS.

The Political Declaration on the future relationship between the EU and the UK after Brexit envisaged cooperation on carbon pricing by linking a UK national greenhouse gas emissions trading system with the EU ETS. The establishment of a UK ETS linked to the EU ETS was stated as a preferred option in a joint consultation on the future of UK carbon pricing issued on 2 May 2019 by the UK Government, the Scottish Government, the Welsh Government and the Department of Agriculture, Environment and Rural Affairs in Northern Ireland.

Technically, linking a UK emissions trading system with the EU ETS should be straightforward since both would start from a position of complete compliance. But there are, nevertheless, important issues to settle for which political will is key.

Emergence of China ETS

In China, preparations for a national emissions trading scheme are being completed this year, with launch expected to take place in 2020. Initially, this will include the power sector only, with other major industries being added in the later years. Upon completion, China’s ETS is expected to be the largest in the world, nearly four times the size of the EU ETS. Participants in the Summit felt that it is a positive development in climate change that China is now pursuing ambitious emission reduction policies.

Conclusion

Participants in the Summit were confident that not only is it possible to achieve emission reductions necessary to keep global warming below 2°C, but that this target can and should be exceeded.

The Summit concluded with a celebration of IETA’s 20th birthday which was marked by champagne and a birthday cake. Having started in 1999 as a small organisation, IETA now counts almost 200 members. This is a testimony to how important climate change issues have become over the past 20 years and how much effort is being put in combatting global warming.