Emissions Trading and Border “Adjustments”

Emissions trading schemes were in the news last week, and China was at the center of the news.

China’s long awaited ETS went live on Friday, after operating seven pilot programs since 2011. It covers 2,225 power plants, responsible for over 40% of China’s national emissions, and is being called the world’s biggest carbon market. Certainly in terms of sheer coverage it is. The 4,000 megatonnes of carbon encompassed in the scheme represents about 12.4% of the global total of 32,300 reported by BP in last week’s Statistical Review of World Energy.

Critics are already pointing out the holes in the scheme.

  • The maximum penalty under the scheme is around $4,600. It’s not a meaningful deterrent.
  • The scheme is unlike other “cap and trade” systems which use a declining cap to drive down emissions annually. Instead, permits are allocated on the basis of plant size and carbon intensity, and given out freely. If a plant exceeds its emissions cap then it needs to go to the market to buy additional permits. However, in practice the quantity of permits issued means that any plant operating at below 85% capacity will have excess allowances.
  • The maximum number of allowances that any non-compliant plant will be required to buy is up to 20% of their allocation. Even if operating at 50% above the allocation, they are only required to buy 20% more. It’s a free pass for the dirtiest of plants.
  • Gas plants are effectively exempt from the scheme. Analysts expect that they will always be net sellers of allowances. Some are even calling the scheme a subsidy for gas power.
  • The market price per ton is set at about $7, far below global averages.

Carbon Brief has a detailed Q&A, with many more data points. Bottom line is that “The ETS in its current form will likely have no impact” (Transition Zero, “Turning the Supertanker”, page 4). China says it’s in a preliminary benchmarking phase. Much will depend on how China enlarges it, and how carbon is priced in the future.

Separately, last week the EU released more details on it’s proposed “Carbon Border Adjustment Mechanism” (CBAM) as part of it’s “Fit for 55” initiative. The Europeans are careful to call this an adjustment mechanism, and not a border tariff. They claim that it’s neutral and will comply with current WTO rules. Essentially, CBAM requires that products imported into the EU have to meet the same emissions criteria as products produced in the EU. Imports will have to be accompanied by emissions certificates, and if they don’t comply they will have to purchase emissions credits on the open market in order to bring them into compliance. The goals are to both prevent European companies from relocating manufacturing to less stringent countries, and to encourage manufacturers in foreign countries to produce clean products for export to Europe.

CBAM is being received by European partners as a tax, and potentially an illegal tax under the terms of the WTO. It’s a headache for the US which has no emissions trading scheme in place. It’s also a headache for China, which will face (potentially) steep tariffs unless it gets its own house in order. Some believe that CBAM could be a forcing function to get global agreements on emissions trading, as it will put exporters at a disadvantage competing in large markets unless they’re willing to comply.

And that brings us back to China. The world has legitimate complaints about China. It is the world’s largest emitter. China also exports more CO2e than any other economy in the world. As the dominant manufacturing country in the world, China’s dirty power makes its way to the shores of every other nation in the world not just as air pollution, but also as scope 3 emissions in the form of the products we buy and use.

Src: WEF Net Zero Challenge: The Supply Chain Opportunity

Bottom line: CBAM, and schemes like it, are the medicine needed to clean up global supply chains, and to force emitters to mend their ways.

By Alec

Nerd, entrepreneur, adventurer, father, and enthusiastic amateur photographer, blogger, baker and cook. Aspiring yogi. Lifelong learner. Lives in the beautiful Pacific Northwest of the USA with Joanne, and the demanding feline Mr. Lucky Stripes.

Obligatory lawyer words: I'm just a climate nerd with an opinion. Although I work for Microsoft, please don't confuse my personal statements here with the company's official position.