In light of the Paris Agreement: carbon markets, competitiveness and energy policy

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Folie

Susanne Droege

21st _{April 2016}

In light of the Paris Agreement: carbon markets,

competitiveness and energy policy

Susanne Droege

German Institute for International and Security Affairs (SWP)

Seminar, Chair for Sustainable Energy, Universitat de Barcelona 21st April 2016

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Folie Susanne Droege 21st _{April 2016}

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Outline

1. The climate regime after 2020

2. Carbon markets

3. Competitiveness issues

4. Energy policy

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1 Key features of the Paris Agreement

Signing ceremony starts tomorrow in New York (open for signature: 22nd April 2016 – 21st April 2017)

Universality

Three areas covered: mitigation, adaptation, finance Bottom-up climate policy: NDCs (pre-Paris: INDCs)

Industrial countries´ responsibilities are documented

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2 The future of carbon pricing under the Paris Agreement

Kyoto Protocol included flexible mechanisms: Emissions trading, clean development mechanism and joint implementation

Paris Agreement: Article 6, future of explicit and implicit carbon pricing

– different types of mechanisms – subject to further precision under the

COP process (2016)

– Voluntary cooperative approaches in Art 6.1 recognized when

implementing NDCs – Clubs are an option

– More explicit types

1. Transfers of mitigation outcomes (Art. 6.2 –6.3)

– internationally transferred mitigation outcomes (ITMOs)

– The CMA stipulates the accounting rules (“shall apply robust

accounting”), but the mechanisms are not under the supervision of the COP/CMA. Thus “anything goes”, JCM, REDD+,

2. Mechanisms contributing to mitigation and to sustainabily (“SDM”) (Art. 6.4 –6.7) (predecessor: CDM), subject to further negotiations, definitions not clear yet, environmental integrity issues, accounting rules, oversight (baseline and credit mechanism?)

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2 Carbon pricing clubs

Idea from game theory – how to provide a global public good

Nordhaus (2015), others: incentives and sanctions need to be included – e.g. technology transfer, trade measures

UNSG summit 2014/World Bank initiative in context with COP21:

– French Environment minister Royal and Dutch CEO of Royal DSM head

the „Carbon Pricing Leadership Coalition“

– Global goals for a broader coverage of GHG by carbon pricing

– Regular progress reporting

– Business support

Increasing the overall price level of CO2, stable and predictable pricing, drive cohesion, not competition

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EU Climate and Energy Agenda 2030 (INDC)

Greenhouse Gases

All sectors

Sectors covered by the

European Emissions

Trading Scheme

Sectors not covered by the European Emissions Trading Scheme

At least -40%

from

1990 levels

-43%

from 2005

levels

-30%

from 2005

levels

Renewable

Energy

Renewable energy share in gross final energy consumption

-27% of European

level

Energy Efficiency

Absolute reduction in primary energy

demand compared to a BAU case

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2 Carbon pricing in the EU: ETS

Target for emission reductions by the EU: „at least“ 40 percent (compared to 1990)

ETS takes over roughly 40% of this target, covering power sector and manufacturing

Non-ETS sectors: transport, buildings, agriculture – MS level, EU effort sharing decision 2016

EU target for 2050: 85-90%

Reform debate: Backloading, Market Stability Reserve, National or EU-wide floor price(s)

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2.1 CO

₂

emissions concentrated in a few sectors

(UK example)

P o te n ti a l m a x im u m g ro s s v a lu e a d d e d a t s ta k e ( M V A S ) a n d n e t g ro s s v a lu e a d d e d a t s ta k e ( N V A S ) C e m e n t B a s ic i ro n & s te e l Lime

Fertilisers & Nitrogen

A lu m in iu m Other inorganic basic chemicals Pulp & Paper Malt Coke oven Industrial gases Non-wovens Refined petroleum Household paper Hollow glass Finishing of textiles Rubber tiers & tubes Copper Casting of iron UK GDP Allocation dependent (direct) CO₂costs / GVA

Electricity (indirect) CO₂costs / GVA

Price increase assumption: CO₂= €20/t CO_2;Electricity = €10/MWh

Flat glass Veneer sheets 0% 10% 20% 30% 40% 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 4% 2% P o te n ti a l m a x im u m g ro s s v a lu e a d d e d a t s ta k e ( M V A S ) a n d n e t g ro s s v a lu e a d d e d a t s ta k e ( N V A S ) C e m e n t B a s ic i ro n & s te e l Lime

Fertilisers & Nitrogen

A lu m in iu m Other inorganic basic chemicals Pulp & Paper Malt Coke oven Industrial gases Non-wovens Refined petroleum Household paper Hollow glass Finishing of textiles Rubber tiers & tubes Copper Casting of iron UK GDP Allocation dependent (direct) CO₂costs / GVA

Electricity (indirect) CO₂costs / GVA

Price increase assumption: CO₂= €20/t CO_2;Electricity = €10/MWh

Flat glass Veneer sheets 0% 10% 20% 30% 40% 0.0% 0.2% 0.4% 0.6% 0.8% 1.0% 4% 2% Electricity cost increase (blue); cost for buying all allowances (grey) -relative to gross value added.

UK Study examined 159 subsector activities and identified a “top 20+3” for which combined cost impacts @ €20/tCO2 exceed 4% of Sector Value Added.

These activities account for 1% of UK GDP (Climate Strategies 2007: Hourcade, Neuhoff, Demailly and Sato, Differentiation and dynamics of EU ETS industrial competitiveness impacts)

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2.1 CO

₂

emissions concentrated in a few sectors

(German example)

Electricity cost increase (blue); cost for buying all allowances (grey) -relative to gross value added.

Graichen et al. 2009 , in: Grubb, Brewer, Houser & Sato, ‘Climate policy and industrial competitiveness: ten lessons from the EU ETS’, German Marshall Fund – US, Washington DC, 2009; 20€ t/CO2

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2.1 Carbon pricing in the EU

Source: CEPS, 2016 State of the EU ETS Report, based on EEA (2015, Trends and projections in the EU ETS in 2015 p. 30)

After 2020: 2.2% cap decline per year

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2.1 Reform plans for free allocation under the EU ETS

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2 Carbon pricing in China

Announcement by China in 2015: a national ETS planned from 2017

Targeted industries: 8 sectors and 18 sub-sectors which consume

>10,000 of coal equivalent per year.

– Power sector

– Petrochemicals (crude oil, ethylene)

– Chemicals (methanol, ammonia, carbide)

– Iron and Steel

– Non-ferrous metals

– Building production and materials (clinker, glass)

– Pulp and paper

– Aviation

Market stability reserve and new entrants reserve

Hybrid allocation system – full auctioning envisaged after 2020 Carbon leakage list is possible

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2 Carbon pricing around the globe

Source: Neuhoff et al. (2014): Staying with the Leaders: Europe’s path to a low carbon economy. www.climatestrategies.org DIW Berlin Calculations based on Ecofys, 2013; Sopher, P., Mansell, A., 2013; OECD, 2013; Jotzo, F. et al., 2013; Rudolph, S., Kawatsu, T., 2012; Ptak, M., 2010.

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3 Competitiveness implications

Levelling of the playing field

Drivers of EII competitiveness – China as a game changer?

Competitiveness from an environmental point of view: carbon leakage effects

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3 Concepts

Competitiveness: of firms and of countries

Carbon Leakage: emissions (re)location

Carbon Footprint: emissions associated with the chain of production, consumption and final disposal of goods

Carbon Flows/Embedded Carbon: CO2 „content“ of traded goods

Carbon leakage channels:

– Global energy markets

– Industrial competitiveness: operational and investment decisions

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3 Carbon leakage – energy markets

Energy market effects under the Kyoto Protocol, CGE modelling.

Estimated leakage rates range from -14% to 130%. However, central estimates rather range from approximately 5% to 25%.

The extreme cases with negative leakage rates or rates above 100% are due to particular assumptions.

In general, CGE modellers stick to basic assumptions of perfect competition with constant returns to scale as well as an exogenous

representation of technological change via autonomous energy efficiency improvement (AEEI) parameters.

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3 Carbon leakage – CGE model results for the Kyoto world

17 -20% 0% 20% 40% 60% 80% 100% 120% 140% GTA P-E GR EEN GEM -E3 GTA P-E GTA P-E GTA P-EG GR EEN_Light G-C ubed MIT -EPP A GTA P-EG GTA P-EG GEM -E3_n.a. GTA P-E_n.a. GTA P-EG Wor ldSc an GTA P-EG GTA P-E MS -MR T Wor ldSc an GTA P-E Wor ldSc an Wor ldSc an GR EEN MS -MR T Wor ldSc an Wor ldSc an MIT -EPP A Wor ldSc an Ligh t Wor ldSc an GR EEN MIT -EPP A Ligh t Ligh t MIT -EPP A MIT -EPP A

*share of emission reduction in Annex-I-countries that is not a global reduction, but due to an increase of emissions in Non-Annex-I countries

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3 Carbon leakage in the energy-intensive industries

„Dirty dozen“ prone to leakage if there is a competitive international market situation – cost pass-through differs across sectors

In Europe a few key sectors deserve (and get) special treatment. 8% of

manufacturing industries spend more than 6% of their revenue on energy. For some of their energy intensive processes, energy price

differentials to the rest of the world can matter. (Germany: for 92% of manufacturing, energy bills are on average less than 1.6% of revenue) However, energy price differences with competitors due to differences in natural resource endowment can only be compensated for through

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4 Energy policy and energy market trends

Questions in context with INDCs and with the global climate policy agenda:

– What drives energy policy?

Global energy markets (e.g. shale gas, coal price, oil price) Security of supply and geo-politics

Economic cycles/employment Environmental policy targets

– What drives the markets?

Demand side trends Investment options Innovation

Deployment and economies of scale Carbon pricing

energy subsidies

regulation in the power sector …

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4 Subsidies for fossil fuels – without externalities (G20)

0,0 0,0 0,0 0,0 0,1 0,1 0,2 0,5 0,8 1,4 1,7 2,5 3,3 8,6 8,8 9,6 11,3 13,3 37,2 0,00 42,8 China Italy Mexico Korea Japan France Turkey United Kingdom Australia Canada Brazil South Africa Germany EU 28 Argentina Indonesia India United States Saudi Arabia Russia

IMF Pre-Tax Subsidies in USD bn. (nom. 2015)

Petroleum Coal Natural gas Electricity

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4 Subsidies for fossil fuels – external effects (G20)

13,7 17,5 30,1 30,1 30,9 38,9 41,2 46,0 46,4 55,4 55,6 69,2 73,0 106,6 157,1 277,3 329,8 335,4 699,2 2.271,9 Italy Argentina Australia France Mexico Turkey United Kingdom Canada South Africa Brazil Germany Indonesia Korea Saudi Arabia Japan India EU 28 Russia United States China

IMF: Post-Tax Subsidies in USD bn (nom. 2015)

Pre-tax subsidies Global warming Local air pollution

Congestion Accidents Road damage

Foregone consumption tax revenue

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4 Subsidies for fossil fuels – with external effects (G20)

13,7 17,5 30,1 30,1 30,9 38,9 41,2 46,0 46,4 55,4 55,6 69,2 73,0 106,6 157,1 277,3 329,8 335,4 699,2 2.271,9 Italy Argentina Australia France Mexico Turkey United Kingdom Canada South Africa Brazil Germany Indonesia Korea Saudi Arabia Japan India EU 28 Russia United States China

IMF Post-Tax Subsidies in USD bn. (nom. 2015)

Petroleum Coal Natural Gas Electricity

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4 Energy trends in the INDCs

Special WEO by the IEA looks into 2030, considering the INDCs (end of

2015) – what would the energy sector look like if all INDCs were

implemented? Key messages

– No climate solution without changes in the energy system

– INDCs majority is about well-known agendas: efficiency

improvements.

– Only a few countries list: phase-out of inefficient coal-fired power

plants, lowering methane emissions from oil and gas production, fossil-fuel subsidy reform or carbon pricing

– Rarely mentioned: energy sector technology or policy options that are required for a long term transformation: nuclear power, CCS,

alternative vehicle fuels

– Overall energy-related GHG emission growth will slow. Electricity

demand will rise by 40 per cent. Non-fossil fuels share will rise to

25% (compared to 20% 2015)

– Decoupling: OECD electricity demand to rise by 10 per cent, CO2 emissions to drop by one third

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5 Paris Agreement – energy emission reductions

What will drive (global) emission reductions and decarbonisation of the energy sector under the Paris Agreement?

National interest and co-benefits from INDCs implementation: security of supply; cost savings / competitiveness/ comparative advantage

Review under PA – more transparency/knowledge/policy competition Deployment of technologies (via means of implementation, via markets) Investments: global context of slow growth, low interest rates, and ROI

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Thank you for your attention

Susanne.Droege@swp-berlin.org

Droege, S., Geden, O. (2016): After the Paris Agreement – New Challenges for EU‘s Leadership in Climate Policy, SWP Comments 2016/C 19, April 2016 Droege, S. (2016): The Paris Agreement 2015. Turning Point for the

International Climate Regime, SWP Research Paper 2016/RP 04