Carbon economics
from A to Z
The economics of climate change
-Clean Development Mechanism (CDM)
An Annex B country, or the developer of a project based in an Annex B country, can obtain Certified Emission Reductions (CERs). These reduction
units correspond to emissions avoided through emissions reduction projects funded in non-Annex B countries. CDM projects result in the net creation of reduction
units and contribute to the liquidity of the market while reducing actors’ compliance costs, thus making emissions targets easier to reach.
- CDM projects promote investment flows from developed to developing countries as well as the transfer of low-emissions technology. All projects must be approved and registered
by the UNFCCC Secretariat.
-Joint Implementation (JI)
JI projects take place between two Annex B countries. They generate GHG Emission Reduction Units (ERUs). JI projects do not create credits, but
rather transfer reduction units from one country to another.
The European market for tradable CO2 emission quotas
The central tool of the European approach is a CO2 emissions trading market called the European Union Emissions Trading Scheme (EU ETS). It caps the CO2 emissions of
over 11,000 installations of the industrial sectors with the highest GHG emission levels in the 27 member countries: energy production, mineral industries (cement,
lime, glass, ceramic), metallurgy (steel, iron), and paper. The ETS is based on the 2003/87/CE
Directive.
The principle is to set an emissions cap for each country. This cap results in an annual allocation of credits divided among installations (1 credit = 1 ton of CO2).
The allocation method is detailed in each National Allocation Plan (NAP) and amended by the European Commission, in charge of the scheme.
The compliance of installations is verified each year before the 30th of April: each installation must surrender to the European Commission a number of permits corresponding
to their emissions over the previous year. A system of national and Union level (Community International Transaction Log) registries
enables the accounting of allowances and emissions.
Two periods have been established for the market: 2006-2007 as a test phase, and 2008-2012 corresponding to the Kyoto engagement period. The European Council in
March 2007 set reduction objectives as far out as 2020, so the market will likely continue at least until that date.
About 6.3 billion tons of CO2 equivalent (tCO2e) have been allocated over the 2005-2007 period. During the second period,
the annual allocation will be 2.1 billion tCO2e.
The auctioning of permits was possible during the first period up to a limit of 5% of total allocations. This limit has been raised to 10% for the second period but few countries
have chosen to take advantage of this opportunity.
If emissions exceed available allowances, the installations in the ETS can buy credits from the Kyoto project mechanisms (CERs and ERUs) for compliance needs, as these were made fungible
into the ETS by Directive 2004/101/EC.
A “domestic offset projects” system is also under development to make emissions credits available
for trade on the basis of abatements realized in sectors not yet covered by the ETS. It is intended to make the flexibility of project mechanisms available within one’s own
country.
The price of CO2
The EU ETS is the main indicator of global carbon finance, as until the beginning of the Kyoto market for states in 2008, it is the only mandatory international market for GHG emissions
permits.
In the European system, trades between buyers and sellers occur either face to face, through bilateral contracts which are generally confidential, or through
marketplaces, electronic portals which publicly release the price and amounts exchanged.
Two prices are currently observed on the European Market.
-The allowance price for the first period is the spot price, or the price for immediate delivery.
-The allowance price for the second period is the forward price, the price for allowances to be delivered in the future. For example the Dec.08 vintage
represents the current price for credits for delivery in December 2008 (for more market information see “Tendances Carbone”).
During the first period, the number of allowances allocated exceeded the emissions of covered installations. As the European Commission had forbidden the
banking of credits from one period to another, the price of first period credits collapsed, converging near zero. The consistently higher second period price can be accounted
for by the cancellation of this rule and more stringent allocations to installations. (See APREC’s “ex-post assessment of
the EU ETS”)
Unlike the EU ETS, American emissions permits markets such as the Chicago Climate Exchange or RGGI are
not regarded as international indicators. The price of CO2 on these markets is different because they are based on voluntary commitments by market participants.
In the future, linking different regional initiatives within a large global CO2 market will necessitate a consideration of common allocation and trading rules.
The stakes of adaptation
Adaptation must complement GHG mitigation because, even if states reduce their emissions, GHGs already in the atmosphere will cause temperatures to increase.
One must therefore find and implement strategies to cope with the unavoidable consequences of climate change, which will include increased risk of water and food
shortages, floods, spread of disease (for instance malaria) and species extinction.
Adaptation requires changes in behaviors (water use, farming practices, etc.), infrastructures and policies (management of new risks). The new technical
(sea defenses, improved forecast systems…) and natural resources management choices will involve local communities as well as national and international organizations.
What priorities for action in uncertainty?
The Kyoto Adaptation Fund has been established to help developing nations –that will bear the most negative consequences of climate change – to
implement measures to protect themselves (see the United Nations’ Human Development report 2007-2008).
Reflections on new risks and needs are being carried in industrialized countries as well.
New economic instruments must now be developed to ease the implementation of adaptation programs. Like mitigation tools, these instruments must integrate the consequences of climate
change into economic expectations and prove efficient enough to get the broadest possible support, not only at the political level but also from private economic actors and
individuals. (See APREC’s « adaptation » research program)
For more information:
- Dales J.H. 1968. Pollution, Property and Prices, An Essay in Policy Making and Economics. University of Toronto Press, Toronto
- DGEMP - Observatoire de l’Energie, Caisse des Dépôts - Mission Climat « CO2 and Energy, 2007 », (download)
- Kiehl & Trenberth, National Center for Atmospheric Research, 1996
- IPCC, report of the 2nd working group, 2007
- IPCC, 4th report of the 1st working group, 2007
- Pigou A., The economics of welfare, 4th edition, London, Macmillan, 1932
- Samuelson P., « The Pure Theory of Public Expenditure », Review of economics and Statistics, novembre 1954, pp. 387-389
- Stern, The Economics of Climate Change, 2006
- Weitzman, M.L., « Price versus Quantities », Review of Economic Studies, 41 (4), pp.477-491
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