Emission Trading Schemes, Interlinking can Curtail GHG Emissions

A street level view of smog in Chongqing, PRC.
A street level view of smog in Chongqing, PRC.

By Virender K. Duggal

ETSs have enormous potential to help countries achieve their national climate goals, and reduce emissions in a cost-effective manner if interlinked with each other.

The Carbon Expo held on the banks of the Rhine at the Messe Köln last month in Germany echoed optimism for the resurgence of carbon market mechanisms after the Paris Agreement was adopted at the COP21 in Paris last year.

The Paris Agreement signifies hope at the domestic, regional, and international levels. Enshrined in Article 6, the agreement establishes both a cooperative approach to facilitate international transfer of mitigation outcomes between countries on a voluntary basis, and a centralized international market mechanism.

Article 6 therefore lays the groundwork for carbon market mechanisms such as emission trading systems (ETS) as an effective instrument to achieve emission reductions in a cost-effective manner, and to potentially raise countries’ ambitions beyond existing domestic emissions reduction targets.

By now more than 185 countries have submitted their Intended Nationally Determined Contributions (INDCs), which were prepared in consideration of their respective national circumstances, covering approximately 95% of global greenhouse gas (GHG) emissions. 122 countries have indicated interest in using market mechanisms to reach their respective national ambitions on GHG emission reductions. In tandem with this, many subnational governments are either already using or considering using domestic carbon markets as a tool to achieve GHG emission reduction in their jurisdictions.

When contemplating policies to reduce GHG emissions, countries often consider carbon-pricing instruments like ETSs and carbon taxes. Across the globe, more and more ETSs are being planned or implemented each year and the instruments are increasing playing an important role in jurisdictions’ climate policies.

Currently 35 countries have established ETSs. Since 2005, the EU has operated the EU ETS, which was ground-breaking in establishing the world’s largest multinational carbon market and offers a host of lessons for new ETSs. Now, ETSs are being introduced in Asia, where the People’s Republic of China has seven regional pilot systems working and is advancing plans to launch a national ETS in 2017, covering sectors such as power generation, iron and steel, petrochemicals, chemicals, building materials, paper making, non-ferrous metals, and aviation. Another example is the first nationwide ETS established by the Republic of Korea in 2015, accounting for around 68% of national GHG emissions.

Given the positive signal from the Paris Agreement, market mechanisms such as ETSs have enormous potential to help countries achieve their national climate goals set out in their NDCs, and play an important role in reducing GHG emissions in a cost-effective manner while supporting the mobilization of finance together with the deployment of innovative technologies.

As we explain in our recent publication Emissions Trading Schemes and their Linking - Challenges and Opportunities in Asia and the Pacific, countries should make well-informed decisions in order to use carbon markets effectively, and must have a long-term strategy for designing their ETSs. It highlights how robust policies on ETS can be an important tool for the cost-effective reduction of GHG emissions, together with mobilization of finance and deployment of innovative technologies.

We have learned from the experiences of existing ETSs that the political commitment and robust policy framework are fundamental for the development of domestic ETSs, while target setting, legal framework and its enforcement besides flexibility to deal with market dynamics hugely contribute to the successful implementation of ETS. Given this, it is rather pertinent to draw lessons from the existing ETSs, and closely examine how such issues have been dealt with and how emerging ETSs can be designed to avoid the same pitfalls.

As a logical progression, domestic ETSs  should eventually interlink with national/regional ETSs to enhance the market liquidity and economic efficiency of carbon markets. The blueprint of such progression should however be drawn taking into account particular regional priorities and circumstances under a strategic approach wherein pilots lead to the development of national ETSs, which in turn results in a regional carbon market and potentially a global system. The choices made while designing ETSs on the basic building blocks such as caps, MRV systems, use of offsets, and the legal framework etc. can set preconditions for its linking with other ETSs in the future.

By virtue of their design to meet national priorities and the timing of their development, domestic ETSs in various large and emerging economies will present diverse and fragmented markets for carbon assets, which will need to be interlinked across jurisdictions through innovative mechanisms to achieve economic efficiencies and contribute to the climate action in the region.