Since more than 40 countries have already implemented carbon pricing policies of some kind, there is much that other countries contemplating new policies could learn from their experience.
Insights from a detailed review of current emissions trading systems (ETS) indicate that institutional learning from within or outside respective jurisdictions, administrative prudence in implementing and managing ETS features, and carbon revenues spent, in part, towards additional emissions reduction measures can result in a policy that is environmentally and economically efficient.
The scope and urgency of dealing with climate change is abundantly clear. After the Paris Agreement was finalised in December 2015, nations realised that in order to meet their ambitious national emissions reduction targets, they must quickly ramp up policies, such as carbon pricing, in order to achieve decarbonisation. Momentum is clearly growing throughout the Americas, with Mexico transitioning from a carbon tax to an ETS, California extending its ETS, Ontario implementing an ETS and linking with Quebec and California. Also the EU, in phase four, aims to achieve steep reductions in emissions and China has recently launched its new national ETS for the power sector.
In our recent article in Climate Policy, we compare the experiences of implementing ETS across different jurisdictions, to identify what works, what doesn’t, and why, when it comes to implementing ETS policies. Comparing implementation of various ETS (including in the EU, Switzerland, the Regional Greenhouse Gas Initiative (RGGI) in the US, California, Québec, New Zealand, Republic of Korea, and China’s seven provinces), our research identified several characteristics that enable successful initiation and management of an ETS.
- Regimes that learn from the failures and successes of implementation, within or outside their jurisdiction, have evolved more robust carbon pricing markets with features that ensure price stability, reduced emissions leakage, and increased ambition.
- Learning from neighbouring jurisdictions can start the process of harmonising the key features necessary to link across jurisdictions (while retaining features that suit local economic structure and interests).
- Starting with free allowances (with bench-marked allocations) and a scheduled transition to full auctioning of allowances over time not only garners initial political buy-in to establish an ETS, but also generates future revenues. The revenues may then be used to encourage other green investments and/or to alleviate the distributional burden of a carbon pricing policy.
- Managing price fluctuations in an ETS market using a price collar (i.e. a price floor, to ensure environmental effectiveness and a price ceiling to control economic costs), relaxing the amount of allowances that may be banked or borrowed across ETS phases, ensuring enough reserve allowances and the ability of a regulatory body to inject or remove allowances from the market, are all methods for ensuring a predictable marketplace with stable prices and sufficient liquidity.
- A legislated timetable for reducing the emissions cap, and legal permission to adjust the cap periodically based on updated emissions data, improves environmental effectiveness in a predictable market.
- Getting firms used to monitoring and reporting emissions data prior to the rollout of an ETS not only helps them ease into the compliance process, but also helps regulators avoid inaccurate estimations of an emissions cap.
- Collecting data on the government’s cost of administering the ETS, as well as firm-level cost of compliance with the ETS, would permit evaluation of the economic efficacy of the policy.
Carbon revenue management:
- Reinvesting a part of the revenue from ETS auctions into other emissions-reduction activities can produce a double-dividend in emissions reductions. This added emission-reduction benefit can occur even in the case of low prevailing carbon prices.
- A combination of earmarking revenue towards emissions-reducing activities, reducing income taxes to address the distributional consequences of a carbon price, and recycling revenue back to the general budget would still allow for a double dividend in emissions reductions.
These key insights are intended to help policymakers structure their existing or upcoming ETS policy, to achieve substantial emissions reductions at least cost. However, knowledge gaps still exist with regards to the interaction of ETS with other climate policy instruments, as well as how governments need to manage their overall policy portfolio to achieve emissions reductions.
About the Authors
Kelly Sims Gallagher is Professor of Energy and Environmental Policy at The Fletcher School, Tufts University
Easwaran Narassimhan is a Research Fellow at The Fletcher School, Tufts University