This Climate Change Bulletin is the first in a series that will be prepared periodically by BLG's Climate Change Focus Group to alert our clients of emerging issues and initiatives that are relevant to their businesses and strategic interests. Future Climate Change Bulletins will review and consider issues facing various provinces as well as different industrial sectors. Comments and questions are always welcome.
The European Union
The roll-out of the European Union Emissions Trading Scheme in January 2005 put a price on carbon; specifically it put a price on the emission of carbon dioxide, the principal greenhouse gas. All industrial installations with a generating capacity of more than 20MW were given a cap, or allowance, based on their estimated current emissions. If an installation exceeded its cap in Phase One (2005-07) it would either have to pay a €30 per tonne fine, or buy an equivalent credit from an emitter within the scheme which had emitted less than its allowance, or else buy an offset credit from within the Kyoto-based flexible mechanisms – the Clean Development Mechanism or Joint Implementation1. This type of regulation-driven market is known as a cap-and trade system.
The sectors targeted for caps are power producers, oil refiners and producers of ferrous metal, pulp and paper, cement, glass and ceramics. In all, approximately 11,500 installations were capped in the then 25 member states of the European Union. However, the burden of reduction was placed on the power producers, on the grounds that they are less sensitive to competition from non-EU suppliers. Regulators made the related assumption that if the power producers incurred significant costs in order to comply with the scheme then these costs could be passed on to their customers.
North America
As we know, neither Canada nor the United States emulated the EU's cap-and-trade experiment. In Canada, some initiatives have been taken at the provincial level, initially in British Columbia, Quebec and Alberta. Most recently, Ontario and Quebec have announced their intention to create a cap-and-trade system involving both provinces. At the federal level, interest is focussed on intensity targets, incentives for new technology (such as carbon capture and storage), and the development of a carbon offset market. In the United States several regional-groupings of states are developing carbon markets,2 and more than a dozen bills are going through Congress. Meanwhile, the Chicago Climate Exchange pioneered the development of voluntary markets for trading credits for reducing GHGs. The Chicago initiative is still active and has recently been extended with the May launch of the Montreal Climate Exchange.
These North American developments will certainly evolve dramatically over the next few months given that all three remaining contenders for the American presidency have declared themselves in favour of implementing a cap-and-trade system at the federal level. Inevitably, Canada will have to devise something that is in some way compatible with the American system3. How soon this will happen and how it will dovetail with growing provincial and state initiatives is unknown. However, it is safe to assume that 'a price for carbon' will emerge quite soon.
Thus, while European power producers are struggling with issues of compliance, for North American producers the current challenge is to respond to continuing uncertainty. Whatever does emerge is going to increase the complexity of producing power, heat and steam in a carbon-constrained world. Even when a carbon market is put in place a number of contentious issues will remain for some time to come. For example, are power producers/exporters or power users/importers 'responsible' for the carbon burden of their fuel? So far, in the EU, that burden has been placed on the producers.
Strategic Considerations
In the face of this kind of uncertainty what kind of corporate strategy makes sense? If we assume that carbon will have a price in North America within the next two years then companies owning installations which are likely to be brought into a trading scheme should consider the following steps:
- develop an inventory of its greenhouse gas emissions
(GHGs), if it has not already done so;
- identify opportunities for GHG reductions;
- analyse potential carbon offsets, domestic and
international;
- develop a green market strategy in partnership with its
shareholders, customers, suppliers and NGOs.
For electricity producers, a 'green market strategy' would include many of the technological issues that are already actively under development, such as:
- renewable energy, including managing intermittency in the
grid and developing improved storage capacity;
- carbon capture and storage;
- water availability and efficient use.
An assessment of these and related issues will provide a company with a sense of where its principal risks and opportunities lie. Future BLG Climate Change Bulletins will provide additional recommendations based on developing government policy initiatives and market responses to those initiatives.
Lessons Learned from the European Union Experience
Although the North American entry into a carbon-constrained world is still characterised by uncertainty, there are a number of key lessons that can be drawn from the EU experience over the last three and a half years. First, it is worth delaying the implementation of a cap-and-trade scheme until an independently verified baseline is in place for GHG emissions for each capped installation. (The over-allocation of allowances brought about a dramatic collapse in the price of carbon in the EU in 2006.) Second, some percentage of the allowances should be auctioned rather than issued free, as this too will control overallocation and will reward the more carbon-efficient producers. Third, the EU time horizons for compliance (three years in Phase One, five years in Phase Two), are too short for the typical corporate investment cycle.
Despite the difficulties observed in the EU scheme, we can draw mostly positive lessons from the EU experience which should assist the development of a carbon market in North America. Given that this means that carbon will have a price for all electric utilities (and other GHG emitters) in the near future we should prepare ourselves for this eventuality.
Footnotes
1 The Clean Development Mechanism allows countries which are signatories to the Kyoto Protocol, and have accepted caps on their greenhouse gas emissions (GHGs), to earn credits towards their targets by reducing GHG emissions in developing countries. Joint Implementation allows signatories to earn credits by reducing emissions in other capped countries.
2 The two largest regional agreements are the Regional Greenhouse Gas Initiative in the north-eastern United States and the Western Climate Initiative, which includes British Columbia and Manitoba. Other provinces have observer status in one or both of these groups.
3 Generally, the more participants there are in the trading system the greater the opportunities for developing markets that enjoy liquidity and transparent price discovery
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
