Environmental Law

30/06/2021

The Challenge of Meaningful Comparisons of ETS Systems: How Canada and the EU Price Emissions

By Michael Leach

Introduction

Scholars and policymakers have been considering emissions trading systems ever since at least the 1960s when Ronald Coase imagined pollution and emissions as factors of production that could be converted into transferable legal rights.^[1] Although it took a number of decades yet before the first markets for emissions trading took off, there are now a relatively limited pool of functional examples of emissions trading systems (ETS) around the world that provide some grounds for comparison and lesson learning as these systems continue to evolve and future ones are imagined. There is tendency among scholars to treat the puzzle of emissions trading as a kind of multi-case engineering design process that searches for optimally efficient mechanisms, system architectures, forms of regulatory market oversight. From such a perspective, the few examples of ETSs around the world can be mined for evidence about what models and practices work best, and then plugging them into existing systems in processes of technical refinement. What is less discussed, however, are the boundaries of what can be learned from such inter-system comparisons, something that becomes evident once ETSs are appreciated more as regulatory systems in and of themselves rather than as a specific kind of markets that are subject to regulatory oversight. This blogpost will draw attention to these limits through a very focused and cursory comparison of the EU ETS and the Canadian emissions reduction scheme under the Pan-Canadian Framework on Clean Growth and Climate Change along the narrow comparator of how the two are structured to produce prices on emissions.

ETS Comparisons

Comparative studies of ETSs are relatively few and far between, largely because the number of actual functioning ETS in the world is quite limited.^[2] Of those that exist, ETS comparisons have largely been done to evaluate the effectiveness of different ETSs in creating a functioning market and achieving actual emissions reductions goals.^[3] Other types of comparative studies have compared the experiences of different industrial sectors within single ETS systems to evaluate how well or poorly a given ETS incentivizes them to reduce their emissions and innovate cleaner technologies.^[4] Still others have compared different specific features of ETS systems,^[5] or have compared the relative effectiveness of ETS systems versus across-the-board carbon taxation to induce emissions reduction behavioural changes.^[6] In almost all cases, the metric of comparison is the same, namely how effectively a given ETS achieves its respective goals.

By framing ETSs as forms of regulatory technology, however, much is missed about how contingent the designs of such systems are on the socio-political and legal environments in which they are created. By focusing on the technical pursuit of optimal models for ETS system designs, scholars sometimes forget to ask why it is that those few ETS systems that exist currently in the world differ from one another in the ways that they do. In 2013 Sanja Bogojevic argued that the EU ETS system was sui generis and unique because of the EU’s unique supranational legal environment. In so doing, Bogojevic challenged the notion that transferring ETS design and technologies from one jurisdiction to another is technical and straightforward.^[7]

In the brief EU-Canada comparison offered below, the argument follows Bogojevic’s line of thought, not only to point out that the two achieve emissions prices differently, but also to argue that the reason for this difference is that both ETS frameworks are products of their respective idiosyncratic political contexts and constitutional legal regimes.

Comparing Europe and Canada

Both the EU ETS and the Pan Canadian Framework are based on a logic that markets can achieve prices for emissions in ways that will produce incentives for affected industries to reduce their emissions. Despite the similarity of their goals, the two systems achieve those prices in quite different ways, however. The reasons for these differences are not simply a matter of better or worse technical choice-making, but rather are intimately connected to the natures of the political and legal orders within which they are created. Indeed, any accounting for the differences between the Canadian and European ETS systems will always circle back to the constitutional natures of Canada and the EU as political unions, one being a national federation, the other a supranational federation.^[8]

The EU ETS is structured to achieve prices by centrally determining and limiting permissible levels of emissions throughout the EU though establishing a cap on a restricted number of emissions allowances. Regulated industries are permitted to emit provided within the limits of the allowances that they own. By creating increasing scarcity of allowances as the cap is lowered annually, the ETS achieve prices on emissions as increasingly scarce allowances are traded among affected industries. Emission caps are determined centrally by the EU Commission and allocated by a combination of an open auction as well as some given freely to Member States to allocate as they feel is important. How many emissions allowances should be produced and auctioned or distributed is calculated according to both environmental considerations as well as the relative economic development of the different Member States, where some poorer countries are receive relatively more allocations to emit than richer ones). Over the course of its existence, the ETS has produced considerable fluctuations in emissions prices, but generally has been criticized for prices ending up too low, creating insufficient incentives on industries to reduce emissions accordingly.^[9]

The Canadian system achieves emissions prices quite differently. The method for achieving emissions pricing proposed in the Pan Canadian Framework and promulgated with the 2016 Greenhouse Gas Pollution Pricing Act (GGPPA)^[10] sets a basement benchmark price for all of its subnational provinces and territories to either match or surpass, using whatever means they choose, whether through a straight carbon taxes or by using market-based trading systems. In contrast to the EU ETS, the structural logic employed here is to rely on market forces (in those provinces that choose to establish a price through a trading system) to achieve an efficient sub-national emissions reductions within a framework that is centrally constrained by a basement emissions price setting. The Canadian federal system does not centrally determine emissions caps like the EU does because the point is not to intervene by controlling scarcity, but rather to set an outer framework for achieving at least a minimal price and then relying on the cost of emissions as the mechanism to structure how emissions are efficiently allocated throughout the economy. While sub-national provinces and territories that choose to set up their own ETSs are entitled to set their own cap and allowance allocation mechanisms to provide sufficient scarcity in order to achieve that price (or higher), unlike the EU Commission, it is not the Federal Government in Ottawa that does this.

Now, one can spend time wondering whether the European or Canadian ETS as they are structured will better achieve behavioural and emissions reduction goals. There is considerable debate in Europe, for instance, about whether or not to include a basement price equivalent (often referred to as an ‘auction reserve price’), while discussions in Canada have debated the value of a single national trading market instead of a sub-nationally variable one. To date, such a study has not been done, but its utility would be limited because the differences between the two systems are quite significant. The question of interest here, however, is not which system works better, but rather why it is that they are different to begin with. The choice of how a given political order will design its ETS to achieve prices is as much a political and structural question as it is a technical and economic one.

The fact that emissions prices in Canada and the EU are achieved through different forms of state intervention to manipulate prices, as well as the different roles and purposes that each system gives to the market to allocate resources and costs reminds us that both are fundamentally market-based regulatory systems, rather than merely emissions markets that are subjected to regulation. This framing nuance is important because whereas the latter suggests that achieving optimal prices should be possible through tinkering with forms of regulatory oversight to get the right fit, the former appreciates how the systems that produce prices are contextually sensitive and structurally determined by the political and legal frameworks in which they are created.^[11]

Although Canada and the EU are both forms of federations, the manner by and purposes for which power and legal authority is distributed within each is critically important for understanding why the ETS systems that each designed look the ways they do. The most obvious difference between the two is that the EU ETS is a single system for the whole union, while the Pan Canadian Framework holds together a patchwork of different provincial approaches to pricing emissions, united by a common benchmark price floor. While the EU ETS was originally designed specifically to avoid the prospect of a balkanization of different national emissions trading markets within the union,^[12] under the principle of subsidiarity that trading was more effectively done on a union-wide basis,^[13] the legal and political logic of Canadian federalism precludes the possibility for the central federal government to construct a single carbon market for the entire country in the same way.

The Canadian form of federalism is based on a series of historical agreements that united British colonial provinces under a single federal government on the condition that provincial autonomy was protected from interference by the centre within certain designated areas of governance, including economic activity.^[14] Section 92 of the Constitution Act of 1867 confers jurisdiction to provinces over much of the trade, industry, and resource extraction that are responsible for GHG emissions.^[15] It is because of this that it would constitutionally difficult, if not impossible, for the Federal Government in Ottawa to play the same regulatory role that the EU Commission does when it determines emissions quota for Member States. Similarly, because the EU is historically a federal project to create a supranational, liberal, internal market among sovereign Member States, it would face a different constitutional legal challenge if the Commission were to impose a single price floor or benchmark (in EU ETS literature this is often referred to as an ‘auction reserve price’)^[16] on the internal market in the way that the GGPPA does in Canada. While some scholars have argued that EU law would be permissive of such an action, they have also reported hesitancy on the part of economists in the Commission to consider it, concerned that if it were interpreted as a fiscal measure then passing it would be politically difficult, requiring a unanimous vote within the European Council.^[17]  In the absence of a centrally mandated basement price for emissions, however, the early phases of trading in the ETS is generally considered a failure for not producing high enough prices to sufficiently incentivize affected industries to reduce their emissions, helped in large part by giving too much discretion to Member States to freely allocate allowances through their National Allocation Plans (NAP) in ways that created competitive distortions and undesirably large windfall gains for some industries.^[18]

Conclusion

The point here is not to argue that comparing ETS systems is not possible, nor that regulatory tinkering with ETS systems cannot be inspired by other examples around the world. Rather, the aim is only to emphasize the challenges that are involved in making comparisons between ETS systems. Indeed, in order for comparisons to be meaningful requires going well beyond technical considerations of economic and regulatory cause and effect. Just because a particular mechanism successfully structures a market in ways that do induce emissions reductions in one place does not necessarily mean that it will be feasible elsewhere.

Understanding the socio-legal embededness of ETS systems is important because if we assume that all of them (both those that currently exist and any future ones) differ in how they are politically, legally, and economically embedded, or, alternatively how the legal, political and economic contexts of each delimit the range of technical options available to their designers to a bounded set of technical options, then this poses certain difficulties when imagining the transplantation of ETS technologies from one place to another.

Furthermore, by viewing ETS systems as sui generis and embedded regulatory systems, rather than as differently regulated markets, one can also appreciate how difficult it will be to achieve any future integration of ETS markets globally, as some have called for.^[19] Again, this is not to say that cross jurisdictional integration is impossible, and the case of the Western Climate Initiative that links the ETS markets of the state of California and Quebec proves its feasibility. At the same time, however, any such cross-border integration will require creating new sui generis ETS frameworks, as the EU did in 2003, but which will likely not be possible within Canada on a national scale.

This research is made possible through funding from the Netherlands Research Council NWO under grant number 406.18.RB.004.

29/06/2021

Setting Up Carbon Offset Farming in the EU: Identifying Benefits and Risks

The Intergovernmental Panel on Climate Change (IPCC) has estimated that the international community has until 2030 to cut human-caused carbon dioxide (CO2) emissions in half to maintain a 50% chance of avoiding the worst effects of climate change. By 2050 CO2 emissions will need to reach ‘net zero’ – where emissions are in balance with removals – to meet this challenge. The urgency is clear: States, organizations and business will need to use every tool at their disposal to achieve these ambitious emission reduction goals. At the EU level climate action is at the heart of the European Green Deal – an package of measures. This includes importantly  the European Climate Law that was this week adopted by the Council to enshrine the 2050 climate-neutrality objective into EU law and a 2030 Climate Target Plan to further reduce net greenhouse gas emissions by at least 55% by 2030. Just like the Paris Agreement (Article 6 of the Paris Agreement explicitly recognizes the possibility for international cooperation through the transfer of emission reductions) and national policies, the EU Climate action framework is an transitional path towards climate net neutrality rather than a response to calls in climate science for a more radical transformation. This means that a lot of the current debate revolves around ‘negative emissions’ and ‘carbon offsets’ as a tools for speedy action to avert dangerous climate change.

Carbon offset credits are used to bring a net climate benefit from one entity to another, and the theory goes that as GHGs enter the global atmosphere, it does not matter where exactly they are reduced. These carbon offset projects could also produce so called co-benefits such as social and environmental benefits; improved air or water quality and biodiversity. An offset project needs to be adopted, implemented, monitored and verified to determine the quantity of emission reductions it has generated. Carbon offset credits can be produced by wide range of national and international projects that reduce GHG emissions or increase carbon sequestration. These carbon offset projects can include agriculture. For example, the agricultural sector can enhance the capability of its land to be used as a sink, so that CO₂ from the atmosphere is naturally removed and stored in the soil or in above-ground biomass. While the contribution of agriculture to the GDP is relatively small (approximately 1.1% of the EU’s GDP), its direct contribution to EU GHG emissions is high, approximately 15% , but is also indirectly responsible for significant additional emissions. Agricultural emissions include those resulting from the growing of crops, the rearing of livestock and the management of soil to maximise production.

The agricultural sector has however long escaped environmental regulation, especially regarding agricultural emissions. Only as of 2021, agricultural GHG emissions have to be balanced under Regulation 2018/841/EU on Emissions from Land Use and Forestry (LULUCF Regulation). However, emissions from livestock are for example not included. Last week, The European Parliament and EU governments agreed on a reform of the Common Agricultural Policy (CAP). One of the biggest challenges is the alignment of the CAP with the Green Deal, the Farm to Fork strategy and  Biodiversity strategy. The problem remains that the CAP is not a climate instrument and there is no GHG-MRV connected to CAP funded projects. This was also the outcome of a recent report of the Court of Auditors : during the 2014-2020 period, the Commission attributed over a quarter of the Common Agricultural Policy (CAP)’s budget to mitigate and adapt to climate change. It was found that the €100 billion of CAP funds attributed to climate action had little impact on agricultural emissions, which have not changed significantly since 2010. In the new reform for the period 2023-2027  sealed this week a compromise was reached that 25% of the direct payments should be dedicated to eco-schemes that shift farmers toward environmentally friendly methods. However, it is not clear how these eco-schemes are defined and they depend on implementation by member states. The compromise has therefore been received with fierce criticism from the EEB and other NGOs for having too many loopholes and potential for ‘greenwashing’ EU farm policy.

Meanwhile, the Farm to Fork Strategy establishes that a new EU Carbon Farming Initiative will be launched in 2021, in order to reward climate-friendly farming practices, via the Common Agricultural Policy (CAP) or through other public or private initiatives linked to carbon markets. Carbon farming refers to the management of carbon pools, flows and GHG fluxes at farm level, with the purpose of mitigating climate change. This involves the management of both land and livestock, all pools of carbon in soils, materials and vegetation plus fluxes of CO2 and CH4, as well as N2O. It includes carbon removal from the atmosphere, avoided GHG emissions and emission reductions from ongoing agricultural practices. The Strategy establishes that the Commission will develop a regulatory framework for carbon credits but this is currently in its infancy and one of the questions is if and how market based approaches like carbon offsets or emission trading can and will be deployed.

Market-based approaches to climate change such as carbon offsets have also raised concerns and criticism.  Several studies have identified serious credibility issues with some carbon offset credits due to lacking ‘environmental integrity’. For example, studies of the two largest offset programs – the Clean Development Mechanism (CDM) and Joint Implementation (JI), both administered by the United Nations under the Kyoto Protocol – established  that the majority of their offset credits may not represent valid GHG reductions. It is not easy to measure and ascertain the quality of carbon offset credits. There are several conditions that must be met for the GHG reductions or removals to be real and effective: Carbon offset credits must be additional, meaning they would not have occurred in the absence of a market for offset credits. They should be accurate and overestimated (measurable), not be doubly accounted for and they should be permanent. Effects of CO2 emissions are very long- lasting, and once a GHG reduction or removal is reversed it obviously loses its offset function. Lastly, they should not be the cause for social inequality or other environmental harms.

To oversee that the quality is reached offset programs have been developed, usually by independent non-governmental organization. These programs develop standards that set criteria for the quality of carbon offset credits; third-party verifiers review if these standards are met, and there is a registry for transfer. Assessing the abovementioned quality criteria is however ambiguous and complex, and it is here where much of the debate is being played out, and where science and law meet. Article 6 of the Paris Agreement states that double counting will be avoided through ‘robust’ accounting methods. Nevertheless, the EU has phased out participation in CDM projects under the EU ETS, and  Participants in the EU ETS could only use international credits from CDM and JI towards fulfilling part of their obligations under the EU ETS until 2020. The EU ETS, currently, does not include agricultural emissions nor has it used the potential to acquire allowances from offsets in agriculture, either via avoided emissions or increased sequestration.   This is different in other carbon markets, such as those in California, Canada and Australia. Even though most of these offset programs have not yet generated huge volumes of offsets it is clear from the above that their relevance will become more prominent – as was also recently announced by the Biden Administration.

Looking forward to this, the EU already has already a rich experience with monitoring, reporting and verification (MRV) under the EU ETS on which it can built  for carbon offset projects. It can also learn from the successes and failures of existing protocols of agricultural offsets to identify design elements that can create or reduce barriers to effective mechanisms. For example, the EU can gain from Australian experiences with its extensive methodologies on a range of carbon farming methods since 2011. See our earlier blogpost here and here.   California and the provinces of Alberta and Quebec in Canada also offer interesting case studies: all offer the agriculture sector opportunities to sell offset credits and protocols for this are adopted (e.g. for dairy digesters). The programs in these different jurisdictions vary in (economic) design, functioning and compliance – making them interesting to study and compare. Fascinating as well, California’s program is linked with Quebec’s program since 2014 (and briefly to Ontario’s program in 2018) meaning that offsets and allowances can be traded across jurisdictions.   In two follow-up blogposts we will zoom in on the experiences with the offset carbon markets for agricultural emissions in California and Canada with a focus on the identified challenges above.

This research is made possible through funding from the Netherlands Research Council NWO under grant number 406.18.RB.004.