Where's the world going on carbon trading?

Over 2000 visitors from more than 100 countries attended the Carbon Expo in Barcelona last week. Carbon Market Institute CEO Peter Castellas reports on some of the key takeaways for Australia.

1. A new generation of carbon markets are progressing at pace.

The transition toward a new generation of carbon markets includes a range of domestic or regional initiatives that will become the cornerstone of the global growth of the carbon market in the coming years. Over 40 national and 20 sub-national jurisdictions have either implemented or are considering market mechanisms that place a price on carbon.

The World Bank Partnership for Market Readiness Program (PMR) – in which Australia plays a major role – is a key initiative that is helping to support the introduction of market mechanisms to cut emissions in 16 developing countries including emissions powerhouses China, India, Brazil and Indonesia.

Carbon pricing now covers approximately 21 per cent of global emissions. If you include countries that have or are considering carbon pricing between now and 2020, carbon pricing will cover 50 per cent of global emissions. This builds on over 6800 projects registered with the UNFCCC in 88 countries, representing $215 billion of investment.

As the EU ETS stutters, the new domestic and regional markets, like China, will be increasingly important for Australian companies to follow as they will be the markets that will impact future carbon pricing, influence international climate negotiations, establish opportunities for possible future linkages and create new business opportunities for carbon market participants.

2. Newer schemes can learn from older schemes.

The first generation of market-based instruments is informing what will constitute the future landscape of carbon pricing. There is a strong appetite for learning from countries developing carbon pricing mechanisms. The governance model which underpins the Australian CPM is well regarded in international markets. And, so, just as Australia learned from the EU in the design of our scheme, now others, from both the public and private sector, can learn from Australia.

Australia has had a leading role in the PMR with the Australian government opening up new dialogues and transferring regulatory and policy insights to key new potential markets. The International Emissions Trading Association has a complementary initiative – the Business Partnership for Market Readiness – which has engaged industry in developing carbon markets and involved the private sector with experience in carbon markets in the development of public policy.

The foundation has been laid for individuals and companies with experience in the development, design and implementation of the Australian scheme to potentially capitalise on the relationships established by initiatives such as the PRM to participate in further knowledge exchange and commercial interaction as these new markets evolve.

3. Eyes are on Australia.

As one of the most advanced carbon pricing schemes in the world, the development of the Australian market featured in many of the Carbon Expo sessions. There was strong interest in the proposed linking of the Australian and EU markets as a model for other markets to emulate. Due to the apparent structural weakness in the EU ETS impacting on confidence in the European market, many carbon market participants have been closely watching developments in Australia. Some are weighing up the possibility of establishing operations in Australia. However, the political uncertainty regarding the future of the scheme is impacting that commitment.

The views of a strong contingent of Australians at Carbon Expo Barcelona were also constantly sought out regarding this political uncertainty and to get a better understanding of the federal opposition’s policies. At a well-attended workshop session on the Australian market, chaired by CMI, the international audience was informed of the status of the current scheme as well as the possible scenarios and implications of how the politics may play out if there is a change of government in September, and the impact on the carbon market.

It was clear that many international delegates hoped that whatever the election result, that there be some forward momentum in the development of the Australian carbon market, in part to give confidence to other markets that are developing.

4. China is a powerful force in the ‘next generation’ of carbon markets.

A key Chinese representative from the National Development and Reform Commission presenting at the expo stated that China views market-based instruments as the most cost effective way to address climate change.

China plans to use market-based instruments to show progress to climate change goals and to demonstrate their international obligation and responsibility. In addition to the seven major emissions trading pilots schemes beginning this year, China will be actively piloting different approaches such as energy efficiency crediting similar to what is being employed nationally in India.

China aims to encourage Chinese enterprises to be active in the market and aims to create a new significant business sector around carbon finance to create commercial opportunities for Chinese companies. However, the capability in China is not equal to capacity and so the rapid evolution of the Chinese market will open up opportunities for international businesses to help establish the governance, infrastructure and efficient operation of the Chinese schemes such as accountancy firms, banks, exchanges and other carbon market service providers.

5. Structural reform of the EU ETS is needed.

In addition to a short-term adjustment, the EU ETS is likely to face some longer term structural adjustment to ensure the viability of the scheme. The current surplus of permits in the EU, which has resulted in a low carbon price, is likely to be addressed again in June with another vote on the ‘backloading’ proposal which involves delaying the auction of 900 million EU allowances.

Results of an IETA survey released at Carbon Expo highlight that the membership backed a short-term fix (backloading) if combined with structural reform. Such reforms could include the setting of an ambitious 2030 target before 2015 or the permanent cancellation of surplus units. In regard to the EU ETS, it is not easy to change the rules mid-game, but the survey respondents suggested this structural reform is necessary.

Overlapping energy and climate policies, at both EU and national level, are also suppressing the demand in the EU ETS and they will need to be somewhat harmonised if there is to be a recovery of the carbon price to levels that will support long term investment.

It is important for Australian liable entities to understand these international policy developments especially Australian companies looking to purchase cheap carbon certificates from the EU beyond 2015, as some analysts expect that the EUA price may increase by as much as 50 per cent if a short term adjustment is made. As a ‘price taker’ under a linked market, more substantial structural reform in Europe will have a potentially more significant impact on the long term Australian carbon price.

6. Markets are an important response to climate change, but not the only response.

Although a robust price on carbon is a key global response to avert dangerous climate change, it is not the only response. Markets are stronger if they are part of a broader suite of financial efforts. This includes innovation of new climate funds and financial instruments, technology innovation and deployment and economic and industry policies that will lead to a transformation to a low carbon economy.

A low carbon growth model will be the new global norm, and it can be enabled by markets as a price on carbon can stimulate investment in low carbon technologies.

7. The private sector needs certainty to invest.

The private sector voices at Carbon Expo stressed that carbon markets need to provide a clear price signal for investment predictability. Business needs confidence in the longevity or ‘term’ of market mechanisms in order to gear up to respond efficiently. Price certainty can be impacted through overlapping policies measures such as renewable energy subsidies.

Many carbon abatement projects require large upfront capital and projects need a revenue stream. Carbon pricing provides an avoided cost, not a revenue stream. The private sector investment needs to be de-risked and one way is through some price sharing between public and private funding.

8. It is not clear how a globally connected market might emerge.

We are already in a world with many different types of carbon units and we are not going to get identical, homogenous units across different markets. At the international level it is important that markets create tradable instruments. We face a risk of silos of markets can’t speak to each other.

In order to link markets there must be measurable, definable units across jurisdictions with common accounting standards to link cap and trade schemes, carbon tax schemes and other non-CO2 schemes such as India’s energy efficiency trading scheme.

The trend now is for bottom-up linking of carbon markets at both a sub-national and national level, for example Australia and Europe, and California and Quebec. Market linkage leads to a harmonisation of the carbon price which can lessen competitive distortions, but does involve giving up some degree of sovereign control, as in the Australia/EU ETS linkage. It can also result in a lower cost of compliance in aggregate.

Australia is recognised as a benchmark in the development of standardised methods to generate domestic credits under the Carbon Farming Initiative. It is a long process to develop the CFI methodologies but those methodologies can potentially be leveraged in to emerging market development activities to ensure future alignment and harmonisation.

Similarly, methodologies that have been through a robust approval process in other jurisdictions could be ‘imported’ to Australia to expand the range of eligible domestic abatement projects.

Even if there are only a few examples of linked markets, we are seeing a gradual alignment of market design features. This is already producing some of the benefits that linked markets provide. It is important that we develop harmonised rules which ensure that ‘a tonne is a tonne is a tonne’ to assist in fungibility of units across jurisdictions.

This is an important precondition to market linkage which can lead to the creation of a global carbon market. We can still progress to a common framework to enable carbon offset development, even if we don’t have a common global scheme.

9. It’s a long journey.

Messages at Carbon Expo reflected a strong sense of the enviable evolution of an interconnected market of carbon pricing schemes. The top down approach for developing a global carbon market through the UNFCCC process may either be replaced or enhanced by regional, national and sub-national schemes, but either way, forward momentum will continue. Capacity will continue to be built in new markets and market evolution enhanced by increased international participation.

The major milestone for the international community will be the negotiations at COP 21 in Paris in 2015 where an agreement for a global market and emissions reductions target by 2020 will be the aim of the negotiations. Although there is a high degree of scepticism with regard to achieving a global climate agreement in Paris in 2015, rapid progress is being made and important new alliances such as between the US and China are being created.

The practical experience in the evolution of the Australian market positions Australia with a potential leadership role in the lead up to 2015 and beyond, if we desire it. There is a key seat at the negotiating table if we want it.

If we have the political will and ambition we can open up significant commercial opportunities for Australia’s carbon market professionals, investors and clean technology companies as the trend to a low carbon economy continues apace.

Peter Castellas is CEO of the Carbon Market Institute, an independent membership-based not-for-profit organisation. 

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