Carbon Markets and New Market Mechanisms - Ernst & …€¦ ·  · 2015-07-28Carbon Markets The adoption of the Kyoto Protocol in 1997 created a new commodity in the form of a carbon

Carbon MarketsThe adoption of the Kyoto Protocol in 1997 created a new commodity in the form of a carbon credit used both in compliance based and voluntary carbon markets. The Kyoto Protocol is an international agreement linked to the United Nations Framework Convention on Climate Change. The Clean Development Mechanism (CDM) created under the Kyoto Protocol is the most well known generator of carbon credits traded in what is the largest carbon trading platform, the European Union Emissions Trading System (EU-ETS).

The underlying principle of a carbon market is, as with any commodity market, a platform for the exchange of goods. Carbon, in the context of carbon markets, is a blanket term for six greenhouse gases, the most ubiquitous of which is carbon dioxide. The defining feature of carbon markets is that unlike most commodity exchange platforms, carbon trading is a key policy tool created specifically to address the pressing issue of climate change. Carbon markets have the potential to stabilise current concentrations of atmospheric greenhouse gas at levels that would prevent dangerous climate change. The stated aims of a global carbon market are threefold. The primary purpose of global carbon markets is to give carbon an economically quantifiable value; the second is to ensure that this economic value is reflected and accounted for in the pricing of goods and services in which carbon is embedded; and finally to incentivise the economy-wide adoption of low carbon technologies and practices.

Compliance based carbon markets, such as the EU-ETS, are created and driven by international policy implemented on a national and regional scale. The demand for approved carbon credits has been created as a result of mandatory national, regional or international carbon reduction regimes such as a carbon cap-and-trade system in which sectors or individual companies are allotted a carbon budget, one which they cannot exceed without a penalty of some sort. The unused portion of an entity’s carbon budget may be sold to another entity company, which has exceeded its own allotted budget or merely wishes to purchase credits for use at a later date. In the case of voluntary carbon markets, participation is not driven by carbon budgets or legal regulations.

Unlike China, Brazil and India; South Africa has been exceptionally slow to take advantage of CDM. By July 2011, China had a total of 1,560 Chinese projects successfully registered with the CDM Executive Board. This is effectively almost 50% of the world’s total registered projects and accounts 64% of annual compliance based carbon credits issued globally. South Africa in sharp contrast had only

21 registered projects as of June 2012 1. South Africa, along with developing countries such as China, has effectively been shut out of the largest compliance-based market, the EU-ETS as of 2013 because of its classification as an advanced developed nation. Though the opportunity still exists to use programmatic CDM, this form of CDM is better suited to small scale projects in less developed countries or regions. South Africa has missed an exceptionally significant opportunity to reduce the carbon intensity of economic activity on the scale needed to make any strides towards reducing the country’s carbon emissions 2.

Carbon Markets and New Market Mechanisms By Reitumetse Molotsoane

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Where did it all begin?Climate change is an economic issue, brought about by the disturbance of the carbon cycle and consequent destabilisation in the global climate. It was in the pursuit of economic development during the industrial revolution, that climate change arose and; it is in the current pursuit of economic development, steeped in the intensive utilisation of fossil fuels and extensive deforestation that climate change will continue to be the defining feature of our time. The continued dependence on fossil fuels as the main driver of economic growth and changes in land use serve only to exacerbate the severity of climate change impacts and accelerate the onset of a climate tipping point 3.

The regulation of climate by the global carbon cycle is one of the most important ecosystem services. The distribution of carbon throughout this cycle determines the degree and speed of climate change. The historic and continued removal of the carbon stored in forests and soils into the earth’s atmosphere through deforestation and other forms of land use change including the extraction and combustion of fossil fuels is the main driver of current and future climate change.

Payment for an ecosystem service, such as climate regulation, requires the user of the service, irrespective of the form in which it is provided or how oblique and tortuous the connection between the final good and the underlying system is, to take on the costs of ensuring that all the elements essential for the maintenance of that system in the state required for the continued provision of the services in question are present. Society, from the time of the industrial revolution to the present, has incurred tremendous debt for the climate regulation services provided by various ecosystems. Climate change is essentially the result of a default on the debt owed to all the ecosystems that regulate the carbon cycle. The challenge of valuing ecosystems coupled with what has been a systemic disregard of the importance of ecosystems as providers of indispensible services, has resulted in what has been described as ‘the greatest and widest-ranging market failure ever seen4.

The Key IssuesCommon but differentiated Responsibilities and the Polluter Pays Principles

The principles of common but differentiated responsibilities (CDBR) and the polluter pays are the two most important principles underpinning current efforts to draw up a legally binding climate change treaty post 2020. Common but differentiated responsibilities in the context of climate change places the bulk of the responsibility for climate change mitigation on developed countries with the expectation that these countries will take the lead and provide the

majority of funds needed to mitigate the levels of climate change and the degree of impact particularly so for vulnerable countries and communities.

In keeping with this principle, developed countries were expected to take on legally binding carbon emissions targets, a condition not extended to developing countries. The financial and economic implications of legally binding emissions targets are significant and several developed countries, of which the United States of America is most prominent, have refused to take on legally binding carbon emissions targets without the advanced developing countries, China and India in particular, doing the same.

The Clean Development Mechanism (CDM) is driven by such a policy, where carbon credits generated by the CDM are used to limit carbon emissions in line with binding emissions targets. A second level of the application of CDBR is imbedded in how CDM works in compliance markets: the purchasing of carbon credits generated under CDM by a developed country is equivalent to investing in the developing country hosting the emissions reduction projects. Expecting developing countries, advanced or otherwise, to purchase carbon credits along the same lines as CDM, is effectively changing the CBDR principle to one of common responsibility.

South Africa has traditionally aligned itself with China and other major economies such as India and Brazil in its view that the principle of ‘common but different responsibilities’ should underpin any negotiations as a starting point for a global treaty which sets legally binding obligations on countries to reduce carbon emissions. However, in recent months, a significant shift away from the strict adherence to the principle of common but differentiated responsibilities has occurred. COP17, held in South Africa in 2011, represented a watershed moment in that for the first time, widespread consensus was reached, that a global climate change treaty with legally binding targets for all countries would be in place by 2015 and come into force by 2020.

The question that comes to mind is whether developing countries, particularly the advanced developing countries are being held equally liable for current climate change as is with the developed countries? How much do developed countries need to contribute to begin to pay off the carbon debt incurred over the past two centuries and for how long? Has the application of the CDBR principle changed from retrospectively allocating the responsibility for current climate change and the duty to pay off the carbon debt accrued over the past two hundred years to the developed countries; to allocating the responsibility for future climate change to both developed and developing countries?

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It is at this point that the CDBR principle morphs into that of the polluter must pay principle. A legal interpretation of the polluter must pay principle allocates the cost of prevention of pollution and holds the polluter liable for the environmental damage caused by his actions as well as binding the polluter to compensate for the environmental damage caused by his actions or business practices.

Future generations will attribute climate change and associated impacts in their time to present business practices, resource utilisation and consumption as well as large-scale deforestation. Present society will be held accountable for the climate change experienced by future generations. But unlike the present, where developed countries were the major emitters, this position is being taken over by key advanced developing countries such as China and India.

While it appears that the introduction of a post Kyoto international climate change treaty in 2015 affective from 2020 will focus less on the hotly contested CBDR principle, surely some acknowledgement of the environmental damage caused by the developmental pathway followed by today’s developed economies over the past 200 hundred years is necessary, and recognising this damage some compensation for the environmental damage is necessary; and equally, all countries will be liable for the environmental damage caused by continuing on a carbon intensive economic growth path.

AdditionalityAdditionality is one of the most important criteria for the certification of carbon credits generated using the CDM; and it is upon this certification that carbon credits are allowed into an emissions trading scheme such as the EU-ETS. Additionality is context specific; it is a judgment call on whether the financial or technological hurdle of introducing or switching to low carbon technology relative to a business as usual scenario is sufficiently large as to merit assistance in the form of carbon revenue.

1. To protect the economic interests of the party purchasing carbon credits: It is generally the case that technology used to generate the emission reductions in which a developed country has invested on behalf of the host party carries a premium. The technology is more modern and efficient than established technology, accelerates the host party’s transition to a low carbon economy and leaves it well-positioned to compete in a carbon constrained world.

Additionality as a qualifier for carbon credits is meant to draw that very fine line between assisting an emissions reduction project host party to transition to low carbon economy through the sale of credits

rather than enabling the host party to invest in technology it should and would have otherwise invested in even in the absence of revenue gained from the sale of carbon credits.

2. To ensure that emissions reduction project is sufficiently ambitious and bold as to make a significant contribution to long term climate change mitigation, and have sufficient impact to direct an economy onto a low carbon development trajectory.

The conceptions of additionality and principles of common but differentiated responsibilities are inextricably linked; each identifying and building in some measure of who is responsible for climate change and who will lead efforts to mitigate climate change and associated impacts.

Carbon TaxSouth Africa will be introducing a carbon tax to be operational in 2014. The South African government has indicated that it regards the use of a carbon tax as the most appropriate market-based mitigation tool and is unlikely to introduce a compliance based cap and trade system in the short term due to the nature of the South African economy which is dominated by relatively few companies especially those that are carbon intensive.

The use of carbon offsets, particularly those from voluntary carbon markets does not preclude the introduction of a carbon tax, both systems can work in tandem but to a very large extent have a different focus. A voluntary carbon market promotes ownership of specific projects, thereby empowering buyers and enabling them to identify and monitor the direct impacts on communities or ecosystems of their actions. A carbon tax, on the other hand, tends to be impersonal; the National Treasury has indicated that it is unlikely to earmark the revenues generated from carbon tax and instead these revenues would go into the general fiscus.

The private sector and corporate in particular could become the most important buyers of voluntary carbon credits, and therefore an extremely important part of an effective voluntary carbon market. The voluntary carbon market allows buyers of credits to exercise choice in the types of projects they support. They have the opportunity to support and align the development of specific offset-generating projects with their corporate social responsibility mandate, thereby driving significant improvement of the socio-economic conditions of a large number of South African communities.

Carbon Markets and New Market Mechanisms Implications for South Africa and Africa

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Reitumetse Molotsoane Senior Manager / Climate Change & Sustainability Services

Reitumetse has extensive experience undertaking and providing assurance of greenhouse gas inventories having worked on the greenhouse gas inventories of local and international companies with operations worldwide. She is a technical assessor for the accreditation of carbon accounting verification and validation bodies in South Africa.

What are the implications for South Africa in relation to carbon markets?Of the major advanced developing countries, South Africa has made the least use of the international mechanisms such as the CDM to reduce carbon emissions, particularly in the energy intensive sectors so dominant in the South African economy. In addition, when compared to its peers, South Africa lags far behind countries such as China and India on the levels of climate change related innovation and in the manufacturing of renewable energy equipment and infrastructure. In many ways the countries with whom South Africa shared a common position and benefited substantially from its association, such titans as China, have made better use of opportunities to prepare themselves for an increasingly carbon constrained world. This shift has essentially resulted in a misalignment of the climate change agenda of South Africa relative to other advanced countries.Although considered to be very influential relative to its size, a common stance with the likes of China, India and Brazil has certainly enhanced South Africa’s negotiating power. Without a direct alignment with powerful allies, South Africa is highly exposed and vulnerable to punitive climate change related measures and regulations at an international level, as well as a compromised ability to compete economically.

In truth South Africa for the most part shunned the CDM, a tool to reduce global carbon emissions while entrenching sustainable and low carbon technologies into the South African socio-economic landscape. In so doing, the country missed a stellar opportunity to convert the carbon intensity of the economy into an asset rather than a liability. There is still an opportunity to make better use of the future market mechanisms as a host of them are proposed as alternatives to the CDM. New market mechanisms such as sectoral and regional emissions trading and nationally appropriate mitigation actions (NAMA) have the potential to achieve economy-wide carbon emissions reductions.

There are lessons to be learned particularly from China, in the way that government and business have aligned and focussed themselves to ensure that tools arising from international treaties designed to support low carbon economic development are used to the fullest. China has been able to use the CDM to modernise and increase efficiency in carbon intensive sectors and has made great strides in turning carbon liabilities into assets to give rise to a strong renewable energy manufacturing sector.

The South African business sector needs to position itself now to benefit from the mechanisms available or those being developed to reduce industry related carbon emissions or risk being left behind. There is considerable potential for the private sector to align investment with large scale emission reduction projects, typically those related to energy generation with NAMAs initiated by government. In the past the business sector has looked to the national government to give clarity and direction on climate change related issues. The relative infancy of new market mechanisms, coupled with a growing appreciation of the importance of responding to climate change strategically by business places South Aafrica in a strong strategic position to actively shape market mechanisms designed to spur investment in low carbon technologies in a cost efficient way.

1 Department of Energy. South Africa’s CDM Projects Portfolio 19 June 2012. Available at South Africa’s CDM Projects Portfolio 19 June 2012

2 Programmatic CDM is a form of the CDM which allows the addition of an unlimited number of component projects to a registered programme of activities (PoA) without undergoing the complete CDM project cycle

3 Lenton, T. 2011. Early Warning of Climate Tipping Points. Nature Climate Change (1): 201–209

4 Stern Review: The Economics of Climate Change. Executive Summary

5 http://www.treasury.gov.za/public%20comments/Discussion%20Paper%20Carbon%2Taxes%2081210.pdf