Creating an Emissions Trading System in ten steps

By Dr Anthony Horton

In order to move to a low carbon future and limit global average temperatures to 2°C, a number of steps are required. Decarbonising electricity production, switching to cleaner fuels, improving energy and resource efficiency, and shifting investment patterns are among them.

According to a joint handbook produced by the International Carbon Action Partnership and the Partnership for Market Readiness, published by The World Bank, carbon pricing is now a key part of the move to a low carbon future. This handbook entitled ‘Emissions Trading in Practice: A Handbook on Design and Implementation’ was produced to help decision/policy makers and stakeholders design an emissions trading scheme (ETS) that is effective, credible and transparent. It draws on lessons from ETSs around the world including the European Union, several provinces and cities in China, Quebec, California, the Northeastern United States, and New Zealand. It discusses the creation of an ETS in ten steps.

Currently operating in 35 countries, 13 states/provinces and 7 cities (and covering 40% of global GDP) an ETS is a policy tool that can achieve a range of environmental, economic and social outcomes. Before one is designed, a Government must decide how much the ETS will contribute to its emissions reductions target, the rate at which it will decarbonise its economy, and how the costs and benefits will be distributed. Other important considerations include a target area’s current and evolving emissions profile, existing regulatory environment and size, concentration, growth, and volatility of the economy.

The ‘Emissions Trading in Practice: A Handbook on Design and Implementation’ published earlier this month contends that a carbon price can direct the flow of private capital, promote actions to reduce and mitigate emissions, and inspire creativity in developing low carbon products. It further outlines ten steps for creating an ETS as follows:

Decide on the scope of the scheme

• Which sectors and gases will be covered
• Which industries and companies will be included
• What thresholds will be set

Set the emissions cap

• Creating a baseline dataset to determine the cap
• Determining the level and type of cap
• Choosing a timeline for setting the cap and provide a long term cap trajectory

Distribute allowances

• Matching emissions reduction allocation methods to policy objectives
• Defining eligibility
• Methods for free allocation and balance with auctions over time

Consider the use of offsets

• Deciding whether or not to accept offsets from industries and companies not included in the scheme from within and/or outside the geographical area covered by the ETS
• Choosing eligible sectors, gases and activities
• Deciding limits on the use of offsets and establishing a system for monitoring, reporting, verification and governance

Determine temporal flexibility

• Setting rules for banking allowances
• Defining the terms for borrowing allowances and early allocation
• Confirming the length of reporting and compliance periods

Address price predictability and cost containment

• Establishing the rationale for (and risks associated with) market intervention
• Choosing whether or not to intervene to address low prices, high prices or both
• Deciding the appropriate instrument for market intervention and the degree of delegation for market oversight

Ensure compliance and oversight

• Identifying the regulated companies and monitoring their reporting systems, plus managing the performance of emissions reduction verifiers
• Establishing and overseeing the ETS registry as well as the market for ETS emissions units
• Designing and implementing the penalty and enforcement approach

Engage stakeholders, communicate, and build capacities

• Mapping stakeholders and respective positions, interests and concerns; coordinated across departments for a transparent decision making process
• Designing an engagement strategy for consultation with stakeholder groups specifying format, timeline and objectives in view to creating a communication strategy that resonates with local and immediate public concerns
• Identifying and addressing ETS capacity building needs

Consider linking their ETS to another Government’s ETS to broaden access to lowest cost emissions mitigation

• Determining linking objectives and strategy, and identifying linkage partners
• Confirming the types of link and aligning key program design features
• Forming and governing the links

Implement, evaluate and improve

• Deciding on the timing and process of ETS implementation
• Establishing the process and scope for reviews
• Evaluating the ETS to support reviews

These ten steps to creating an ETS as outlined in the handbook are straightforward and discussed in detail. Given that this handbook is based on experiences of ETSs from around the world, I would like to think that any Government considering adopting an ETS would review the handbook and make good use of the ten steps to implement it. With each new report written and published on ETSs and the environmental, economic and social outcomes being achieved there is little excuse not to consider adopting an ETS as part of moving to an inevitable low carbon future.