How projects from beyond the EU will affect carbon trading?

 

As the EU Emissions Trading Scheme enters its second phase, Dave Shaw of KYOTOenergy considers some of the changes – particularly how projects from beyond the EU will affect carbon trading.

 

With the price of a tonne of carbon dioxide in the EU Emissions Trading Scheme (EU

ETS) below EUR0 0.20 at the time of writing, it seems certain that the market for EU

allowances is indeed long (supply has outstripped demand) for Phase I of the scheme

(2005-2007). This is felt to be acceptable however, as the successful establishment of the worlds largest operating emissions trading market was the priority for this phase; a lack of confidence in the procedures of the scheme would have been a disaster for the European Union’s cap and trade policy.

 

As the scheme moves towards Phase II (2008-2012), revised National Allocation Plans (NAP) have been received, a new cap of 2.08bn tonnes of carbon dioxide equivalent  per year and there are new expansion sectors covered by the scheme.

 

This expansion will cover additional carbon emissions from the following industries: glass; rock wool; gypsum; flaring from offshore oil and gas production; petrochemicals (crackers); carbon black; and integrated steelworks.  Smaller emitters for whom the scheme proved to be an administrative burden could apply to be exempt from the

scheme. Fines for non-compliance will be higher, rising to EUR 100 per tonne from

EUR 40. Internally, the revised National Allocation Plans (NAPS) will have the most effect on the price of allowances within the scheme.

 

One factor that could have a significant impact on the price of carbon involves emissions from activities and projects outside the European Union.  These projects will be and have  been carried out under two  Kyoto mechanisms called Joint Implementation (JI) and the Clean Development Mechanism (CDM). These mechanisms are largely unknown to Operators in the EU ETS, and this article seeks to explain their rationale, operation and potential affect on the scheme.

 

Essentially JI and CDM offer operators in the EU ETS the opportunity to purchase carbon allowances generated by projects that offer carbon savings over traditional methods of, for example, producing electricity.  These projects are carried out in other developed and developing countries where the marginal cost of abatement is lower. Whilst being of equal value in terms of carbon, the price of allowances generated as a result of these projects is, and should remain, significantly lower than that of the EU Allowance (EUA). In Phase II where the price of EUAs is expected to be higher, this will be significant.  In the UK, up to 8% of an Operator’s annual allowance surrender in Phase II may be made up of carbon allowances generated as a result of projects carried out under CDM or JI. The reason for the cap was that the use of CDM and JI was always intended to be a supplementary measure to internal abatement within the EU, in accordance with international rules. Also, the medium and long term prospects of developing emissions solutions for the EU would be harmed if a highly significant proportion of research, development and implementation were happening outside the zone.

 

JI or CDM?

 

The distinction between CDM or JI is where the project is based. Under JI, an industrialised country can meet part of its target by carrying out a project to reduce greenhouse gas emissions in another developed (so called Annex I) country.

CDM is very similar, but project activities must be hosted by a developing country. An

example of a project under CDM might be the combustion of methane captured from a landfill site being used to generate electricity contribute toward the supply of a host country’s grid system. The use of methane from a waste stream instead of mined coal to generate electricity means that less fossil fuel is used, and there are less emissions

made to supply the country's electricity. A baseline of what emissions would have been made were the coal power station operated in a “business as usual” scenario, and the measured difference in emissions between the two methods of generation are calculated. One allowance is awarded for each tonne of carbon not produced

due to not using coal. Under JI, these allowances are called “Emission Reduction Units” (ERUs) and under CDM they are called “Certified Emission Reductions” (CERs). From2008, both of these types of allowances can be used to attain compliance, one ERU or CER is equivalent to one EUA.

 

In fact, EU Operators have had the opportunity to buy an unlimited amount of CERs to

satisfy their EU ETS obligations in Phase I, but the delay in implementation of the

International Transaction Log (ITL), the database through which CERs and ERUs are

logged, has made this difficult for most Operators. National registries are not yet connected to the ITL, although this should be possible for EU Member States by late 2007. So while the purchase of CERs before now has been possible, using them to meet an installation’s Phase I obligation may have proved to be a risk if linking to the ITL is

delayed further, as allowances or credits will need to be surrendered for compliance before April 2008. 

 

As of November 14th 2007, 844 projects have been registered by the CDM Executive Board as CDM projects. These projects should reduce greenhouse gas emissions by an estimated 216 million tonnes of carbon dioxide equivalent a year. All 2,600 projects in the pipeline, would until the end of 2012 produce over 2.5 billion tonnes of carbon dioxide equivalent reductions until 2012. For comparison, the EU-15's emissions in 2005 were about 4.2 billion tonnes of carbon dioxide equivalent per year.

 

Outlook

 

The price range of carbon dioxide in Phase II of the scheme is, naturally, an unknown. But by early June 2007, forward purchasing of carbon for December

2008 valued EUAs at over EUR20, a doubling in price from February 2007. The cost of CERs followed.  In a recent report published by Point Carbon however, one of the conclusions drawn was that because the EU member states’ NAPs were based on 2005 figures, the cap on emissions may be looser than if it were based on 2006 emissions.  For this reason, they have suggested that, like Phase I, Phase II may indeed see the market for EUAs being long.

 

However, even if the market is long, the lower cost of implementing energy and emission saving measures in developing countries and those where costs are lower will still be an attractive option for developed countries, as they will still need to meet Kyoto reduction targets (EUAs cannot be used for this purpose). This is certainly the case at the EU where late June saw the announcement that EUR2.8m was being invested in CDM in China. 

 

Nicholas Costello, first Counsellor of the Delegation of the European Commission to

China and Mongolia outlined the project objectives in a recent speech, “(The project) will facilitate the implementation of the CDM, make it easier to exchange information on CDM projects and encourage EU companies to engage in CDM projects in China and hence to tackle climate change on a global scale.”

 

 

Dave Shaw is Head of Consultancy Services  - KYOTOenergy Pte Ltd., Singapore