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Forest conservation can supply 25% of climate solutions through 2020

Section: News
Category: Emissions
2010-05-27 04:10:03

Brazil, Indonesia, and nations in the Amazon-Andes and Central America are poised to be key players in an emerging market for forest carbon that could reach $20 billion annually through 2020 according to a detailed analysis released today by Resources for the Future. The Forest Carbon Index, developed by RFF and Climate Advisers, provides governments, development agencies, NGOs, and private investors with geospatial data on global, national, and local forest carbon supply, explicitly taking into account country-specific economic, biological, and risk factors-such as governance and ease of doing business. The Index brings together for the first time 21 datasets at the national scale and six datasets at a gridded subnational scale, integrated and mapped across approximately one and a half million locations at a resolution of 85.5 square kilometers.

Background of emissions trading and the Kyoto Protocol

The EU member states must reduce their CO₂ emissions to on average 8% below their 1990 levels as part of the commitments of the Kyoto Protocol. This reduction has to occur in the period 2008-2012. Each country has been allocated a fixed number of emission rights, and may not emit more than the number of rights it possesses. The European Union is responsible for about 22% of global CO₂ emissions. A reduction will be useful to fight climate change, but one has to realize that quite a few important countries (most notably, the third world, India, China, the United States and Australia) have not committed themselves to similar emission caps.

Each country can achieve emissions reductions in several ways. Energy savings, reforms in the transport sector and stimulating renewables energies are often-mentioned examples. In addition, governments propose energy standards to bring down emissions. The likelihood of success is currently still an open question. There are conflicting stories about the achievements of the EU so far. To further fight carbon emissions, the EU member states have done something special in their industry sector (including power generation). The larger companies in this sector have been allocated a number of emissions rights. Again, they cannot emit more than the number of rights they own.

Both companies and countries have an additional degree of flexibility. They may buy and sell rights to each other. Imagine that saving a tonne of CO₂ in Poland costs €5, but in the Netherlands a similar saving would cost €50. In a situation like this, Poland may choose to emit less than the amount of emissions rights it has. The excess credits can then be sold to the Netherlands, which may now emit more than its initial allocation. If the selling price of the credits is between €5 and €50, both countries have gained from this transaction.

Why is a sound system? The total amount of CO₂ emissions in Europe is still bounded by the same cap. But, trading enables companies and countries to implement the reduction exactly at those locations where it can be done in the cheapest way. This means achieving the same total carbon savings at the lowest possible costs for the economy. A solution like this is called cost efficient.

Carbon trading also has its problems, though. Firstly, the decision how many credits to allocate to each country or company is a highly sensitive and political choice. Should a government decide to allocate emissions rights very generously, the solution will be cost efficient but the overall effect on mitigating climate change will be negligible. The CO₂ price will be very low as a consequence. In practice, there is mixed evidence about possible overallocation of credits, but the CO₂ price in the second half of 2005 and first half of 2006 has been significantly above zero.

Reducing emissions in foreign countries

Another complication is the possibility in the Kyoto Protocol to realize a part of the emission reductions abroad. For example, if an EU member state invests in a CO₂ mitigation project in another country within the Kyoto framework (e.g., Germany investing in Poland), Germany will receive credits while the Polish total will be reduced by the same amount. This mechanism is called "Joint Implementation" (JI). JI is not debated so much, because it does not affect total emissions.

Germany could instead finance a carbon reduction program in the developing world. This means lower emissions in e.g. Bolivia, allowing Germany to emit more at home. In addition, Germany exports clean technology to the third world. This is called the "Clean Development Mechanism" (CDM). The key problem is that it is hardly measurable if Bolivia really emits less than it would otherwise have done. This led many countries to argue that the use of CDM credits should be restricted more such that reductions should be realized within the ETS.

These rules apply both to countries and firms. We now analyze how the EU has imposed carbon trading on its industrial and power generation sector.

How does the European Emissions Trading Scheme work?

The Emissions Trading Scheme started on January 1st, 2005. Although it is the first international market place for carbon, the idea of emissions trading has been implemented much earlier in the United States to cap SO₂ and NO_x emissions. Each country has allocated a certain fraction of its Kyoto credits to its industry sector in the so-called "National Allocation Plan" (NAP). This has to be approved by the European Commission. A total of 12,000 firms, constituting 46% of total EU emissions, participate in the ETS. It remains important to realize that 54% of emissions do not fall within the rules of the ETS. This means that governments must ensure to realize emissions reductions in other sectors as well, or alternatively become a net buyer on the international carbon market. For instance, the Netherlands has a yearly allocation of 212 million tons (Mt), of which it distributed 95.5 million to the industrial sector.

The ETS is split in two stages. The first stage, from 2005 - 2007, is now ongoing. Stage 2, from 2008 - 2012, exactly coincides with the Kyoto commitment period. At the moment, it is permitted to shift emissions rights from one year to the next within one stage, but not between two stages. A firm that, at the end of a certain stage, has emitted more than the number of rights it owns must pay a penalty of €40/tonne (stage 1) or €100 (stage 2). On top of that it must purchase the deficit in the next stage.

In stage 1, the rights were allocated for free. This still means that companies - in general - incur additional costs, since the allocation is less than a company's historical emissions. This means a firm must choose between mitigation and buying credits in the ETS. In stage 2 it is expected that a small part (5 - 10%) of the rights will be auctioned off by governments as opposed to the current system of 100% grandfathering. In addition it is considered to include a wider range of industries in stage 2 of the ETS (most importantly, airlines) and smaller companies.

What's the price of CO₂?

The price of CO₂ is very volatile. Early 2006 showed prices in the range of €21 - €27, but prices have fallen recently to the mid-2006 level of €15. The reason for this change can be found in announcements by several governments that actual emissions were much lower than expected, reducing the need for CO₂ credits. For the most recent price information, click here (http://www.pointcarbon.com). Carbon credits are traded at several trading platforms. Interestingly, the European Commission announced prior to the launch of ETS that it would favor prices in the range of €25/tonne, to give firms a serious incentive to invest in energy efficiency technology. Most analysts had expected prices much lower than the prices actually observed in the current market place.

The environmental economics literature prescribes that emissions trading works optimally if the price of a carbon credit is exactly equal to the damage of one additional ton of CO₂. This is of course hard to estimate. There exists a very wide range of estimates, with $50/tonne often being mentioned as a reasonable mid-range approximation. That means the current prices are too low from an economist's point of view. This argument is complicated by the large number of "free riders": countries not committed to reduce emissions under the Kyoto Protocol, but at the same time enjoying the benefits of other countries reducing their carbon pollution.

In 2005, roughly one million tonnes CO₂ were traded on a daily basis. All in all, some 2,200 million emissions rights were distributed among companies in the ETS. The average 2006 price of about €20 implies a total trading volume of about €7 billion per year. EnergyPortal published in an earlier news post that CO₂ has become a billion dollar business. The traded volume in 2006 will highly likely exceed that of the year before. We may conclude that carbon trading has become an important financial market.

Future developments and conclusion

No one knows how the carbon market will evolve. Stage 2 of the ETS still has a number of uncertainties attached to it, such as the status of air traffic. But the main source of uncertainty is the future of the Kyoto Protocol after it expires in 2012. If the protocol turns out to be a success and more countries will commit to compulsory emissions reductions, the market will grow and prices may increase further. On the other hand, the possibility remains that Kyoto will die after 2012. That is mainly a political choice, and as such hard to predict.

The most recent political developments lead one to believe that regulations will be tighter rather than weaker. Some European governments talk about aggressive targets for 2050. The British Ministry for the Environment, for instance, has formulated the ambition to emit 60% less CO₂ in 2050 than the country did in 1990. Another important development is the Asia-Pacific Partnership for Clean Development in Climate, ratified in January 2006. This indicates that the United States, Australia, China, Japan, India and South Korea are regarding climate change as a serious issue that deserves policy attention. While this is arguably a major shift in thinking, the partnership focuses on technology and does not force the participants to cap emissions to pre-specified levels. The future participation of these countries, responsible for over 50% of global emissions, is crucial for the future of carbon trading. Will it become an enormous global market with a real potential to reach significant milestones to reduce climate change, or will it enter the books as just another failure of global environmental policy?