Climate Change and Emission Trading - Essay Example

Climate change & Emission Trading The Green House Gases (GHG) Effect is one of the better understood features of the atmosphere; the science having been established in the 1800’s by the likes of Arrhenius, Fourier & Tyndall. Arrhenius (1896) estimated that a doubling of CO2 would cause 4.9-6.1o C increase in continental surface air temperature depending upon latitude and season, which is at the upper end of current predictions (1.4oC-5.8oC) under the third AR). The greater controversy surrounds exactly how human induced climate change will be realized at the regional level and across time, who will suffer and what should be done. Governments in many developing countries and at least two industrialized countries (the United states and Australia) have, over the years involve the implicit assumption that climate change is a nuisance, that it has little or no economic costs, while doing something about climate change would have serious negative impact on the economy. In October 2006, Nicholas Stern, head of the United Kingdom’s government economics services presented his report on the economics of climate change to the British Government [Stern, 2007]. The stern Report estimates that “if we don’t act, the overall costs and risks of climate change will be equivalent to loosing at least 5% of global gross domestic product (GDP) each year, now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more. “In contrast, the cost of action-reducing GHG emissions to avoid the worst impacts of climate change-can be limited to around 1% of global GDP each year”. These conclusions are in sharp contrast to the implicit assumptions in public statements on climate change. The stern report finds that climate change is not just a nuisance, but can significantly reduce economic growth. And that mitigating climate change is not all that expensive. The stern report concludes, “The benefits of strong, early action considerably outweigh the costs”. The impacts of climate change are, not evenly distributed. The poorest countries and people will, suffer earlier and most. And if when the damages it will be too late to reverse the process. Thus we have to look ahead. This is because the countries which have less resources to counter their impact of climate change and also because developing countries are often heavily dependent on agriculture-the most climate sensitive of economic sectors. The stern report finds that while “emission have been, and continue to be driven by economic growth; yet stabilization of GHG concentration in the atmosphere is feasible and consistent with continued growth”. The report recognizes that achieving large emission reductions will have a cost. The estimated annual cost of stabilization at 500-550 PPM CO2 will be around 1% of GDP by 2050- a level that is significant but manageable. Climate change mitigation normally involves reducing GHG emissions. Mitigation can also involve removing CO2 from the atmosphere, usually through a forestation and reforestation; such activities are called CO2 sinks. Improved efficiency in the use of fossil fuels and increased use of renewable energy sources are among the most promising option for reducing CO2 emissions. The lowest cost mitigation options generally involve energy efficiency improvement. Energy saving opportunities is often higher in developing countries and is especially large for buildings and in transport (Enqvist, Naucler & Rosander, 2007). Climate change first gained significance in 1988. Not long afterwards, the United Nations Framework Convention on Climate Change (UNFCCC) was adopted by various governments in May 1992, and came into force, in 1994, (UNFCCC, 1994). Today the UNFCCC is one of the widely supported international environmental agreements ratified by 188 states and the European community. The ultimate aim of the UNFCCC is to achieve stabilization of GHG concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. The decision making authority of the UNFCCC is the conference of the parties (CoP) which established as the supreme body of the convention. The CoP meets annually. One major agreement that was reached at the third conference of the parties (CoP3) at Kyoto, Japan in 1997 is now called the Kyoto Protocol (KP). According to KP, countries (industrialized, OECD & EIT agreed to control the emissions of the following six sets of GHG is not controlled by the Montreal Protocol; Carbon Dioxide, Methane, Nitrous Oxide, hydroflurocarbons, Perflurocarbons and Sulphur hexafluoride. Basically these countries agreed to reduce the total emissions of these gases, in terms of carbon dioxide equivalents, by at least 5.2% compared to 1990 levels, by the period 2008-2012 (Called the first commitment period) [Kyoto Protocol, 1997]. The Kyoto Protocol came into force in Feb, 2005. Most of the countries ratified the protocol important exception being the US and Australia. US is the single largest emitter of GHG’s. The geographical location of GHG emissions or the reduction of those emissions is not relevant to climate change, since these gases mix in the atmosphere. Moreover some countries may find it more expensive to achieve emission reductions than others. Therefore the Kyoto Protocol included three flexible mechanisms to allow industrialized, OECD and economies in transition, countries to undertake climate change mitigation outside their frontiers. The three flexibility mechanisms under the Kyoto protocol are: Joint implementation (JI), clean development mechanism (CDM) and emission trading (ET). In an effort to ensure collective compliance with the Kyoto protocol by all European Union (EU) member states the EU created its own cap and trade emission reduction system the EU emission trading scheme in 2003 (Directive 2003/87/EC). The EU ETS commenced operations in Jan. 2005. The scheme is based on the allocation of GHG Emission Allowances (EDA’s) which may be traded to specific industrial sectors through national allocation plan (NAP’s) with oversight by the European commission. NAP’s set out the overall emission cap for the country and the allowances that each sector and individual installation covered the directive receives. The allowances will be distributed to energy installations with a rated input greater than 20MW, plus installations greater than a certain size in the steel, minerals and paper industries. The first phase of the EU ETS covers the period 2005-2007, while the second phase coincides with the Kyoto protocol’s first commitment period from 2008 to 2012. The first phase of the EU ETS applies to some 7,300 companies and 12000 installations in six major industrial sector a cross the enlarged EU. These industrial sectors include: utility combustion plants; oil refineries; Coke oven iron and steel plants, energy intensive industry, such as cement, glass, lime brick and ceramics. The EU emissions trading scheme (EU ETS) is expected to cover 45% to 50% of the EU’s total carbon dioxide emissions and is set to create the world’s largest mandatory greenhouse gas emissions trading scheme (ECLAC, 2006). Failure by participants to meet their caps will result in a fine of euro 40 per tonnes of CO2 in excess during phase I (2005-07) rising to Euro 100 ($ 120) per tonne (equivalent) in phase II (2008-2012). And paying the fine does not remove the obligation to retire the missing certificates. The scheme allows for future extension to other greenhouse gases as well as to other sectors such as transport. It also allows for links to other national emissions trading schemes from non EU-states (EUETS, 2007). One major market analyst notes that the global carbon markets were worth 22.5billion Euro in 2006. The market saw transactions for 1.6 billion tones of CO2 emission. The EU ETS accounted for 62% of the volume and over 80% of the value. EU ETS saw 1 billion tones of CO2 transacted, worth 18.1 billion euro. This was 2.5 times higher than in 2005. As the Kyoto protocol was ratified in Feb. 2005 and the emission trading scheme of the European Union began its first phase of operations at about the same time, a couple of factors were instrumental in creating a feeling of short age in the market. By April 2006, information released from European installations revealed a severe over allocation of allowances which caused EUA prices for the first commitment period to plummet. It is worth nothing that certified emission reduction (CER) carries more flexibility than emission allowances as they are attractive to all buyers, not restricted to the EU ETS and in addition is bankable, meaning that CER’s accumulated in any year can be used to offset emissions commitments in any year 2008-2012. Between mid 2006 and early 2007 EUA (emission allowances) (2008) prices have been averaged 15 euro. The volatility level however, increased substantially as the market continued to react to news announcements related to phase II national allocation programmes (NAP’s) in Europe, indecisions in Canada and strong, Japanese procurement needs. Now Carbon market is deepening, maturing and becoming competitive and what is probably more important for sellers, more selective. Today buyers in the carbon market are looking not necessarily for access but the quality and diversity when analyzing project based emission reduction alternatives. There is a abundant supply of project based emission reduction in China and eastern Europe-primarily Russia-so it is delivery assurance that is turning into a major concern. Presently many countries have policies and programmes that help reduce or avoid GHG emission. Some are undertaken specifically to address climate change; other are driven principally by economic, energy or development objectives, but at the same time contribute to Climate efforts several voluntary GHG emission reduction schemes are running parallel to the Kyoto protocol. Among them those implemented in US & Australia are worth mentioning, since these two countries are the only developed countries are the only developed countries that have not ratified Kyoto protocol. Now several analysts have criticized emission trading in favor of a so called carbon tax (Cooper, 2004, 2005; Nordhaus, 2005). Let us first explain briefly how carbon tax is supposed to work. Imagine a world where there are no countries and there are relatively small economic differences within the society. Next imagine that this world was facing the same climate change problem that our world is facing. Obviously, in that world, there is no space for emission trading. The government could still provide a market based incentive to reduce the emission of greenhouse gases in the following way. All fuel consumed w3ould be taxed at a rate that was proportion to the carbon content of the fuel. This would encourage use of solar energy and low carbon fuels and discourage the use of coal and other higher carbon fuels. If the tax were set at the right level, the appropriate reductions of CO2 emission from fuel combustion would be achieved. As Cooper (2005) points out the carbon tax could be easily extended to process CO2 emissions such as from chemical reactions in cement production, but would be harder to apply to other GHG’s. But of course, we do not live in an imaginary one world. While recognizing that the currently developed countries have contributed much more to past GHG emissions and therefore to the current state of the climate, both Cooper and Nordhaus call for a uniform carbon tax across all countries. They argue that a non-uniform rate would cause emission producing activities to shift to low carbon tax countries. However a uniform carbon tax where developed countries do not make a greater economic contribution to mitigate climate change should never be acceptable to India and other developing countries. It would be tantamount to making countries pay to clean up a mass most of which they did not created. The ineffectiveness of a carbon-tax for non CO2 gases and the economic distributional aspects of mitigation are strong arguments against the carbon tax approach. Emission trading does not suffer from these problems. A third problem with the carbon tax approach is that in some ways, it is opposite of emission trading. The latter can be seen as perverse in the sense that the greatest emitters benefit the most. It is a reversal of the more traditional approach whereby the polluter pays. Here the polluter charges. Thus a very large landfill emitting large amounts of Methane to the atmosphere could get large revenues for reducing methane emissions than a landfill that is already capturing and burning methane. So we must propose that the advantages of emission trading and carbon tax can be combined in a system whereby emissions trading applies to transaction between Industrialized and developing countries as in the current Kyoto protocol or Michaelowa proposal beyond 2012, but that within the developing countries a carbon tax would be applied to favor low - emission project and discourage high – emission activities. For instance, India & many other developing countries promote renewable energy project through subsides. These subsides could be paid for through a tax on coal and other fossil fuels. The additional tax revenue would be allowed subsides to the renewable energy and other low energy technologies to be increased. Incidentally, this will have no effect on additionally under the clean development mechanism, unless subsides are so large that the renewable energy options become profitable without the CER revenues, which is unlikely. So in order to recognize the full trade impact of global climate change economic analysts must avoid concentration upon the potential for carbon taxes to fall heavily on industrially developed countries and go beyond the comparative safety of analyzing pollution control costs using pre – existing economics models. This requires discussing the potential benefits from avoiding damages to foreign traders due to perturbation of global environmental systems. The rising popularity of climate change as a matter for economists to consider will either force these matters for economists to consider will either force these matters into the debate or show how strong the development approach to economic assessment remains by relegating them to the sidelines. References: 1. Arrhenius, S. (1896), ‘On the Influence of the Carbonic Acid in the Air upon the Temperature OF the Ground’, Philosophical Magazine and Journal of Science, 41(251), Pp. 237-76. 2. Cooper, Richard, N. (2005), Alternatives to Kyoto: The case for a carbon tax accessed from the website http://www.economics.harvard.edu/faculty/cooper/papers/Kyoto_CT.pdf on 14th April 2008. 3. Cooper, Richard, N. (2004), ‘A Carbon tax in China’, accessed from the website http://www.economics.harvard.edu/faculty/cooper/papers/A_Carbon_Tax_in_China.pdf on 14th April 2008. 4. ECLAC (2006), Analysis of the present situation and future prospects of the clean development mechanism (CDM) in the FEALAC member countries, Study for the fourth meeting of economic and society working group of Forum for East Asia-Latin America Cooperation (FEALAC), Tokyo. 5. Enqvist, P.A., T. Naucler and J. Rosander (2007), A cost curve of greenhouse Gas Reduction, The McKinsey quarterly, no. 1, Pp. 35-45. 6. EU ETS (2007), Emission trading scheme, accessed from the website http://www.ec.europa.eu/environment/climate/emission.htm on 14th April 2008. 7. Kyoto protocol (1997), the full text of the Kyoto protocol can be seen at the website http://www.unfccc.int/resource/docs/convkp/kpeng.html on 14th April 2008. 8. Nordhaus, William, D. (2005), Life after Kyoto: Alternative approaches to global warming policies, accessed from the website http:///www.nordhaus.econ.yale.edu/kyoto_long_2005.pdf on 14th April 2008. 9. Stern, N. (2007), The Economics of climate change: The Stern Review, Cambridge, January. 10. UNFCCC (1994), United Nations Framework Convention on Climate Change, accessed from the website http://www.unfccc.int/resource/docs/convkp/conveng.pdf on 14th April 2008. Read More