
\newcommand{\thistitle}{Lecture 12: Carbon Markets}

\input{title.tex}


\section{Introduction to Climate Damages}



\begin{frame}
  \frametitle{Global Warming Damages}

  Global warming causes net damages to ecosystems and economies. The costs of some of these damages (and benefits) can be quantified, although uncertainties both about the climate impacts and the economic consequences are high. Damages occur over \alert{hundreds of years}.

\begin{columns}[T]
  \begin{column}{10cm}
  \alert{Direct costs}:
  \begin{itemize}
  \item \alert{Weather extremes} impact agriculture and built environment (hurricanes, heatwaves, drought, flooding, fires)
  \item \alert{Rising sea levels} increase flood damage, make large areas uninhabitable
  \item \alert{Crop/livestock losses} due to rising average temperatures
  \item \alert{Biodiversity loss} due to changing habitats
  \item \alert{Expansion of deserts} makes land uninhabitable
  \item \alert{Reduction of drinking water} due to changing precipitation
  \end{itemize}
  \end{column}
  \begin{column}{4cm}
  \alert{Adaptation costs}:
  \begin{itemize}
  \item \alert{Dams and levees} against rising sea
  \item \alert{Resilience measures} for infrastructure
  \item \alert{Air conditioning} in buildings
  \item \alert{Mass migration} from hot regions
  \item \alert{Crop changes}
  \end{itemize}
  \end{column}
\end{columns}
\end{frame}




\begin{frame}
  \frametitle{Climate Breakdown: Tipping Points}

  The 2015 Paris Agreement pledged its signatories to
 `pursue efforts to limit [global warming above pre-industrial levels] to \alert{1.5$^\circ$C}' and
   hold `the increase...to \alert{well below 2$^\circ$C}'.
  These targets were chosen to avoid potentially irreversible \alert{tipping points} in the Earth's systems.


  \begin{columns}[T]
\begin{column}{9.5cm}

  \includegraphics[width=10cm]{nclimate3013-f1.jpg}
\end{column}
\begin{column}{4.5cm}

  \vspace{.3cm}

  WAIS: West Antarctic Ice Sheet ($\Rightarrow$ 5m sea level rise)

  \vspace{.2cm}

  Greenland (7m)

  \vspace{.2cm}

  THC: thermohaline circulation (warms Europe)

  \vspace{.2cm}

  ENSO: El Niño–Southern Oscillation (extreme weather)

  \vspace{.2cm}

  EAIS: East Antarctic Ice Sheet ($>50$ m)

\end{column}
  \end{columns}

\source{\hrefc{https://www.nature.com/articles/nclimate3013}{`Why the right climate target was agreed in Paris'}, Nature Climate Change, 2016}
\end{frame}



\begin{frame}
  \frametitle{Quantifying Climate Damages}

  We can attempt to quantify the net damages
  as a \alert{Social Cost of Carbon} in \euro/tCO$_2$. These damages depend strongly on
  what damages are included, the discount rate (how we weight damages in the future), total emissions and the
  year of emission. Values in the literature range widely! Example from German Environment Agency (UBA):

  \vspace{.2cm}

  \centering
  \includegraphics[width=12cm]{uba-klimaschäden-2024.png}

  \vspace{.2cm}

  \raggedright
  0\% discount rate $\Rightarrow$ future generations weighted same as current.

  1\% discount rate $\Rightarrow$ damages in 30 years weighted by $\frac{1}{1.01^{30}} = 0.74$.



  \source{\hrefc{https://www.umweltbundesamt.de/publikationen/methodenkonvention-umweltkosten}{UBA, 2024}}
\end{frame}


\begin{frame}{Not just climate change: air pollution is a silent killer}

  Air pollution from fossil fuel burning is linked to higher mortality (deaths) and morbidity (diseases, e.g. aggravation of asthma).

\includegraphics[width=6.8cm]{who-air-2.jpg}
      \includegraphics[width=6.8cm]{air-who-1.png}

  \source{\href{https://www.who.int/health-topics/air-pollution}{World Health Organisation}}
\end{frame}

\begin{frame}
  \frametitle{Global Warming as a `Negative Externality'}

  The unabated use of fossil fuels has an unintended indirect effect on third parties: the emissions of CO$_2$ lead to climate costs for current and future generations, an \alert{externality}.

  Definitions:
  \begin{itemize}
  \item \alert{Emissions} are released by a facility into the environment; can include substances, noise, odours, radiation.
  \item \alert{External effects} are  impacts of economic activities on outsiders without compensation. In the case of damages, these impacts are \alert{negative} external effects; if the impacts are advantageous, they are called \alert{positive} external effects.
  \item \alert{External cost} is the negative external effects expressed in monetary units.
  \end{itemize}

  Examples of negative externalities: cigarette smoke in indoor spaces; oil spills; soot damage on people and buildings; nuclear accidents; noisy traffic/neighbours.

  Examples of positive externalities: keeping honey bees next to apple orchard ensures trees are pollenated; education people makes them less likely to support war.

\end{frame}

\begin{frame}
  \frametitle{Characteristics of climate problem}

  \begin{itemize}
  \item \alert{Globality}: The location of emissions does not matter (leakage problem)
  \item \alert{Timeline}: Damages affect future generations while the current generation has relatively minor impairments
  \item \alert{Cost/unavailability} of reliable abatement technologies for hard-to-debarbonise sectors (like aviation, shipping, cement and petrochemicals)
  \item \alert{Free-rider problem}: Solutions require an internationally coordinated and future-oriented approach: Who should provide what contributions? (International and intra-national distributive conflicts; developing countries against grandfathering)
  \item \alert{Measurement, reporting and verification}
  \end{itemize}

\end{frame}



\section{Strategies for Negative Externalities}




\begin{frame}
  \frametitle{Profits versus External Costs}

  Suppose a company's profits $\Pi$ depend on their emissions $Em$. There are external costs $C_{ext}(Em)$ borne by a third party.
  \begin{columns}[T]
\begin{column}{8cm}

  \vspace{.3cm}

  \includegraphics[width=8.5cm]{external_costs-absolute.png}
\end{column}

\begin{column}{6cm}
  \begin{itemize}
  \item If external costs are ignored, profits reach maximum at $\Pi_0$ with emissions $Em_0$. External costs $C_{ext}(Em_0)$ are higher than firm's profits - inefficient from a societal perspective - a \alert{market failure}.
  \item If instead we maximise for \alert{society} $\Pi(Em) - C_{ext}(Em)$ we find an optimum at $Em^*$ where external costs are lower than profits. The company can compensate the third party for their costs.
  \end{itemize}
\end{column}
  \end{columns}

  \source{Zweifel, Praktiknjo \& Erdmann (2017)}
\end{frame}

\begin{frame}
  \frametitle{Profits versus External Costs}

  Now consider the marginal costs and profits.

  \begin{columns}[T]
\begin{column}{8cm}

  \includegraphics[width=8.5cm]{external_costs-marginal.png}
\end{column}

\begin{column}{6cm}
  If we find the emissions level that maximises profits minus costs, i.e. the benefit for the whole society:
  \begin{equation*}
   \max_{Em}\left[ \Pi(Em) - C_{ext}(Em)\right]
  \end{equation*}
  then at the optimum we have \alert{marginal external costs} equal \alert{marginal abatement costs} (cost to firm in lost profits):
  \begin{equation*}
    \frac{d\Pi}{dEm} -     \frac{dC_{ext}}{dEm} = 0
  \end{equation*}

\end{column}
  \end{columns}

  \source{Zweifel, Praktiknjo \& Erdmann (2017)}
\end{frame}


\begin{frame}
  \frametitle{Strategies for dealing with negative externalities}

  There are three major strategies for dealing with negative externalities:
  \begin{itemize}
  \item \alert{Standards/norms}: Society sets voluntary or binding requirements for maximum emissions levels. Example: for 2020-2024 there is an EU fleet-wide CO2 emission \hrefc{https://ec.europa.eu/clima/eu-action/transport-emissions/road-transport-reducing-co2-emissions-vehicles/co2-emission-performance-standards-cars-and-vans_en}{target} for passenger cars of 95~gCO$_2$/km. Example: insulation standards for new/renovated buildings. Example: efficiency standards/ratings for fridges/TVs.
  \item \alert{Pigouvian tax}: Tax the externality (e.g. CO$_2$ emissions) to internalise the social costs of the externality. Example: German CO$_2$ tax on oil and gas in transport and heating. Example: cigarette tax.
  \item \alert{Cap-and-Trade System}: Set a volume limit on the externality (e.g. CO$_2$ emissions), distribute certificates for the volume and require polluters to purchase certificates. Example: EU Emissions Trading System (ETS) for CO$_2$ energy, industry and domestic aviation. Example: US sulphur dioxide (SO$_2$) Allowance Trading System.
  \end{itemize}

\end{frame}


\begin{frame}
  \frametitle{Pigouvian Tax}

  Pigou (1931) suggested to tax negative externalities so that
  producers can internalise the external costs they cause, and thereby
  reduce production to the socially most efficient level.

  Suppose we set a tax $\lambda$ on CO$_2$ emissions in \euro/tCO$_2$.

  Now the producer optimises:
  \begin{equation*}
    \max_{Em} \Pi(Em) - \lambda \cdot Em
  \end{equation*}
  So that at the optimal point:
  \begin{equation*}
    \frac{d\Pi}{dEm} - \lambda = 0
  \end{equation*}

  In other words: they reduce their emissions until the marginal
  abatement cost (i.e. the cost to the company of reducing the next
  tonne of CO$_2$) is equal to the tax.

  (NB: Compared to the socially optimal solution, we have replaced nonlinear external costs $C_{ext}(Em)$ with a linear function for the firm $\lambda \cdot Em$.)

\end{frame}

\begin{frame}
  \frametitle{Pigouvian Tax}

  Under a Pigouvian tax, the optimal solution is to reduce emissions until the marginal abatement cost is equal to the tax $\lambda$. The exact volume of emissions can be implicitly derived if you know $\lambda$ and the shape of the marginal abatement cost curve.

    \centering
  \includegraphics[height=6cm]{MAC-pigou.png}

  \source{Zweifel, Praktiknjo \& Erdmann (2017)}
\end{frame}


\begin{frame}
  \frametitle{Example Marginal Abatement Cost Curve for 2030}

  Consider this example marginal abatement cost (MAC) curve for the whole world for the year 2030. NB: x-axis is reversed compared to previous graphic, i.e. rising MAC goes to right.

    \centering
  \includegraphics[height=6.5cm]{mckinsey-mac.png}

  \source{Nauclér, T. and P. A. Enkvist (2009)}
\end{frame}


\begin{frame}
  \frametitle{Calculating the Marginal Abatement Cost Curve}

  Suppose a firm has emissions of 100,000 tCO$_2$/a based on a fossil-fueled furnace emitting 50,000 tCO$_2$/a and consuming coal of 100 GWh\th/a, and a coal electricity generator emitting 50,000 tCO$_2$/a and generating 50 GWh\el/a. Coal costs 10 \euro/MWh\th{} and coal electricity LCOE is 40 \euro/MWh\el.

  It has the following options:
  \begin{itemize}
    \item Insulate the fossil-fueled furnace at an annualised cost of 50,000 \euro/a, which reduces coal use by 20 GWh\th/a and emissions by 10,000 tCO2/a.
    \item Replace coal generator with cost including fuel of 2 million \euro/a, generation of 50 GWh\el/a and emissions of 50,000 tCO$_2$, with a solar-battery combination with cost of 3~million~\euro/a (LCOE of 60~\euro/MWh\el).
    \item Replace remaining 80 GWh\th/a coal for furnace generator with cost of 0.8 million \euro/a with green hydrogen at cost of 90 \euro/MWh\th.
  \end{itemize}

  What does the MAC curve look like?

\end{frame}



\begin{frame}
  \frametitle{Calculating the Marginal Abatement Cost Curve}

  \begin{itemize}
  \item Insulation: 10,000 tCO$_2$/a reduction at net cost of (50,000 - 200,000)~\euro/a = -150,000~\euro/a $\Rightarrow$ MAC of -15 \euro/tCO$_2$.
  \item Clean generation: 50,000 tCO$_2$/a reduction at net cost of (3-2)~million~\euro/a = 1~million~\euro/a $\Rightarrow$ MAC of 20 \euro/tCO$_2$.
  \item Clean heating fuel for furnace: 40,000 tCO$_2$/a reduction at net cost of $(90-10)$\euro/MWh\th $\cdot$ 80 GWh\th/a = 6.4~million~\euro/a $\Rightarrow$  160 \euro/tCO$_2$.
  \end{itemize}

  What would the firm do with a tax of 10\euro/tCO$_2$? 100 \euro/tCO$_2$? 200 \euro/tCO$_2$?

\end{frame}


\begin{frame}
  \frametitle{Cap-and-Trade System}

  For Pigouvian tax, price is known, volume is unknown. For Cap-and-Trade we fix known volume for emission certificates, then an implicit price is found by trading the certificates.

    \centering
  \includegraphics[height=6cm]{MAC-cap.png}

  \source{Zweifel, Praktiknjo \& Erdmann (2017)}
\end{frame}

\begin{frame}
  \frametitle{Cap-and-Trade System}

  Suppose two companies with different MAC(Em) curves are allotted allowances $Em_1$ and $Em_2$. Since $MAC_1(Em_1)$ is lower than that $MAC_2(Em_2)$, the first company has an \alert{arbitrage opportunity}: it reduces its emissions to $Em_1 - \delta$  and sells the corresponding $\delta$ emission certificates to company 2 at a cost above $MAC_1(Em_1-\delta)$. Company 2 increases its emissions to $Em_2 + \delta$. As long as $MAC_1(Em_1-\delta) < MAC_2(Em_2+\delta)$, both companies will profit from this transaction. Trading reaches equilibrium at $MAC_1(Em_1-\delta) = MAC_2(Em_2+\delta)$.

    \centering
    \includegraphics[height=4.5cm]{companies_trade_emissions.png}

  \source{Zweifel, Praktiknjo \& Erdmann (2017)}
\end{frame}

\begin{frame}
  \frametitle{Cap-and-Trade System}

  Equilibrium is found at $MAC_1(Em_1-\delta) = MAC_2(Em_2+\delta)$ for an emissions trade of $\delta$ tCO$_2$. Certificate price is set by intersection of MAC curves. Company 1 benefits since the price is higher than its abatement costs for the range it reduces $[Em_1-\delta,Em_1]$; company 2 benefits since the price is below its abatement costs for the range it increases $[Em_2,Em_2+\delta]$.

    \centering
    \includegraphics[height=5.5cm]{trade_allowances.png}
\end{frame}

\begin{frame}
  \frametitle{Coase Theorem}

  The \alert{Coase Theorem} says that in such a system, it doesn't matter how the initial certificates or emissions allowances are distributed to market participants; from the resulting trading, the system will still reach equilibrium at the socially optimum point, thus solving the problem of externalities and allocating resources efficiently.

  The main thing is to have a recognised system of allowances.

  However, benefits may be \alert{distributed differently} depending on the initial allocation.

  Relevance for EU emissions trading system (ETS): some certificates are sold by government, while others are allocated to industry for free (since they have to compete with foreign firms).

\end{frame}


\begin{frame}
  \frametitle{Pigouvian Tax versus Cap-and-Trade}


    \ra{1.1}
  \begin{table}[!t]
    \begin{tabular}{lp{4cm}p{4cm}}
      \toprule
      & \alert{Pigouvian Tax} & \alert{Cap-and-Trade} \\
      \midrule
      Price & Set by government & Determined implicitly by MAC and cap \\
      Volume & Determined implicitly by MAC and price & Set by government \\
      \midrule
      Benefits & Price certainty for industry & Allows targetting of CO$_2$ volume precisely \\
      Drawbacks & Can under- or overshoot CO$_2$ volume target & Can lead to price volatility \\
      \bottomrule
    \end{tabular}
  \end{table}
\end{frame}

\section{EU Emissions Trading System}

\begin{frame}
  \frametitle{Why an Emissions Trading System?}

  Answer: combination of advantages of Cap-and-Trade and ease of legislation.

  For tax issues all EU member states must agree, but majority vote is
  sufficient for an Emissions Trading System (ETS) $\Rightarrow$ ETS
  was easier to legislate than a carbon tax.

  The ETS is a mandatory Greenhouse Gas (GHG) Cap-and-Trade system for
  power, refinery, steel, glass, cement industries (2071 MtCO$_2$eq verified emissions in 2005, about 40\% of total).

  Included aviation within EEA from 2012. Domestic maritime included from 2024.

  Emissions from buildings, road transport, agriculture, waste and small facilities currently covered by separate \alert{Effort Sharing Regulation} (ESR). Road transport, buildings and additional industrial sectors to move into \alert{new ETS 2} from 2027, with certificates bought by fuel distributors; price should be initially stabilised below 45~\euro/tCO$_2$.

  Almost free allocation of emission rights in the first two
  trading periods 2005-7 and 2008-12 led to \alert{windfall profits}.

  System is intended to become the prototype for a global
  Cap-and-Trade system.
\end{frame}


\begin{frame}
  \frametitle{ETS in context of total emissions}

  NB: EU now has net-zero 2050 target. Most non-ETS emissions go into ETS 2 from 2027.

  \centering
  \includegraphics[height=7cm]{oeko-ets.png}


  \source{Öko-Institut, 2014}
\end{frame}

\begin{frame}
  \frametitle{Design of an Emissions Trading System}

  Trading period length of time:
  \begin{itemize}
  \item   If the trading period is too long, the incentives are weak (e.g. decades).
    \item  If the trading period is too short, there is lack of certainty for investments.
  \end{itemize}

  Allocation of emissions allowances:
  \begin{itemize}
  \item  \alert{Auctioning}, i.e. operators buy allowances in auctions.
  Government collects and redistributes auctioning revenues.
  \item  \alert{Free allocation} based on \alert{grandfathering}, i.e. industries are given free allowances based on past emissions.
  \item  \alert{Free allocation} based on \alert{benchmarking}, i.e. industries are given free allowances based on their activities (e.g. product sales) and a per-sector benchmark.
  \end{itemize}
   In past free allocation led to windfall profits, since CO$_2$
   prices are opportunity costs of power plant operators (certificates
   could be sold) and, thus, included into the product price anyway.
\end{frame}

\begin{frame}
  \frametitle{European Emissions Trading System (ETS)}

  Main features:
  \begin{itemize}
  \item   27 EU member states + Norway, Iceland and Liechtenstein (UK has own ETS since 2021)
  \item Covers around 40\% of EU GHG emissions ($\sim$ 2 billion tCO$_2$eq as of 2014)
  \item 4\% of world's GHG emissions
    \item A quantitative limit is put on the aggregate annual amount of
  emissions for all plants participating in ETS (cap).
\item A single EU-wide cap; allowances issued correspond to cap.
 \item Declining by 1.74\% annually until 2020; 2021 onwards at 2.2\% (higher from 2024).
  \end{itemize}

   \alert{EUA (EU Allowance)}: An EUA permits operators of an industry
  installation or electricity generation unit to emit 1 t of CO2 under the
  EU emissions trading system.   Each regulated operator must surrender every year the amount of
  EUA corresponding to the amount of its emissions.

\end{frame}


\begin{frame}
  \frametitle{ETS Free Allowances and Auctioning}

\begin{columns}[T]
  \begin{column}{10cm}
    \vspace{.3cm}
    \includegraphics[width=10.5cm]{free_allowances-2005-2018.png}

    NB: \hrefc{https://www.cleanenergywire.org/factsheets/understanding-european-unions-emissions-trading-system}{Backloading}, removal of 900 million allowances in 2014-6, because of surplus in years before.
  \end{column}
    \begin{column}{4cm}
  Auctioning as the main allocation principle:
  \begin{itemize}
  \item for energy utilities – since 2013
    \item for other industries – growing \%, to be fully phased in by 2027
\item free allocation to industries threatened by \alert{carbon leakage}
  \end{itemize}
    \end{column}
\end{columns}

\source{\hrefc{https://op.europa.eu/webpub/eca/special-reports/emissions-trading-system-18-2020/en/}{European Court of Auditors, 2020}}
\end{frame}

\begin{frame}
  \frametitle{Phases of ETS}


  \alert{Phase I} (2005-7)
  \begin{itemize}
      \item Pilot phase for EU energy + industry
      \item Most allowances given for free; power sector based on fuel-specific benchmarks
  \end{itemize}

  \alert{Phase II} (2008-12)
  \begin{itemize}
  \item Inclusion of EEA countries (NO, IS, LI) \& aviation inside EEA
   \item Auctioning for power sector and product benchmarking for the other sectors
  \end{itemize}

  \alert{Phase III} (2013-20)
  \begin{itemize}
    \item Move from free allowances to auctioning (particularly for energy)
    \item Linear reduction factor (LRF) for cap of 1.74\% per year
    \item Introduction of market stability reserve (MSR) in 2019 to address low prices, remove surplus certificates and stabilise prices
  \end{itemize}


\end{frame}


\begin{frame}
  \frametitle{EUA prices during Phases I-III}


  \centering
  \includegraphics[height=7.5cm]{page1-1200px-EUA_future_real_price.pdf.jpg}

\source{\hrefc{https://en.wikipedia.org/wiki/European_Union_Emissions_Trading_System}{Wikipedia}}
\end{frame}




\begin{frame}
  \frametitle{Phases of ETS}

  \alert{Phase IV} (2021-2030)
  \begin{itemize}
  \item Linear reduction factor (LRF) raised to 2.2\% per year
  \item LRF rises to 4.3\% for 2024-7 and 4.4\% for 2028-30
  \item New 2030 GHG target of -55\% will require 62\% reduction compared to 2005 (previous 40\% GHG target required only -43\%)
  \item Domestic maritime to be included: 40\% from 2024, 70\% in 2025, 100\% in 2026
  \item Waste incineration to be included by 2028
  \item Gradual phase out of free allowances by 2034 as Carbon Border Adjustment Mechanism (CBAM) phased in 2026-2034
  \item Some revenue flows to Innovation Fund and Social Climate Fund, while rest goes to member states who have to spend at least 50\% on energy and climate-related activities (e.g. subsidies for green tech, energy efficiency)
  \end{itemize}


\end{frame}

\begin{frame}
  \frametitle{ETS 2 for remaining sectors}

  \begin{itemize}
  \item Starts 2027-8, applied to upstream fuel distributors (like German BEHG)
  \item Covers road transport, buildings and additional (small) industrial sectors
  \item Trading separate from original ETS (``ETS 1'')
  \item Total reduction of 43\% in buildings and transport by 2030 compared to 2005
  \item LRF: 5.1\% from 2027, 5.4\% from 2028
  \item Price stability mechanism: if price above 45~\euro/tCO$_2$, 20 million allowances will be released (2\% of annual capacity)
  \item Exemption from ETS2 until 2030 if there is national scheme with higher price (e.g. Germany BEHG Preiskorridor 55-65~\euro/tCO$_2$, Sweden, etc.)
  \end{itemize}

\end{frame}


\begin{frame}
  \frametitle{Carbon price and coal-gas spread 2020-2}

  \centering
  \includegraphics[height=7.5cm]{eua-spread-2020-2.png}

\source{\hrefc{https://twitter.com/CarbonReporter/status/1600081427110187010}{Carbon Reporter}}
\end{frame}


\begin{frame}
  \frametitle{Carbon price and coal-gas spread 2023}

  \centering
  \includegraphics[height=7.5cm]{eua-spread-2023.png}

\source{\hrefc{https://twitter.com/CarbonReporter/status/1614962375727239168}{Carbon Reporter}}
\end{frame}


\begin{frame}
  \frametitle{Future of ETS - all sectors}

EU ETS emissions cap assuming ETS extension to buildings and transport:

\centering
  \includegraphics[height=7cm]{ets_future-agora.png}

  \source{\hrefc{https://www.agora-energiewende.de/en/publications/a-clean-industry-package-for-the-eu-impulse/}{Agora Energiewende, 2020}}
\end{frame}


\begin{frame}
  \frametitle{Market Stability Reserve}

  \alert{Market stability reserve (MSR)} is intended to address weakness of ETS:
  strong price fluctuations and \alert{waterbed effect}. The waterbed
  effect is the effect whereby it makes little sense for individual
  countries or sectors to make additional reduction efforts, since
  this only makes EUA cheaper for others.


  Market stability reserve operating since January 2019:

  \begin{itemize}
  \item  addresses the surplus of allowances
  \item improves the system's resilience to shocks (recessions, pandemics, etc.)
  \end{itemize}


It triggers adjustments to annual auction volumes
in situations where the total number of allowances in circulation is outside a predefined range:
\begin{itemize}
\item Reducing allowances from future auction volumes if the EU ETS surplus exceeds 833 million allowances
\item Adding allowances to future auction volumes provided the EU ETS surplus is below 400 million allowances
\end{itemize}
\end{frame}

\begin{frame}
  \frametitle{Carbon Border Adjustment versus Carbon Clubs}

  How to deal with the fact that European industries must pay for carbon emissions but their goods must remain competitive with imports? There is a danger of  \alert{carbon leakage}, i.e. carbon-intensive industries moving to countries without carbon pricing.

  \begin{itemize}
  \item \alert{Free allowances} for industries with products at risk of carbon leakage. This was the solution in EU until now.
  \item \alert{Carbon Border Adjustment Mechanism (CBAM)} that adds tariff on import of carbon-intensive products (like steel, electricity and ammonia) according to their emissions (based on benchmarking for each sector). This is the solution being phased in for the EU in 2026-2034.
  \item \alert{Carbon Clubs} that allow free trading between partners with similar carbon reduction schemes. Has been \hrefc{https://www.whitehouse.gov/briefing-room/statements-releases/2021/10/31/fact-sheet-the-united-states-and-european-union-to-negotiate-worlds-first-carbon-based-sectoral-arrangement-on-steel-and-aluminum-trade/}{proposed} in October 2021 for US and EU trading clean steel and aluminium.
  \end{itemize}

\end{frame}




\begin{frame}
  \frametitle{Future of ETS - all sectors}

  Currently being considered include:
    \begin{itemize}
    \item Extension to \alert{agriculture} (i.e. an ETS 3; tricky because of monitoring of CH$_4$ from enteric fermentation (e.g. cows burping), N$_2$O from soil; politically sensitive; will be implemented in \hrefc{https://www.carbonbrief.org/qa-how-denmark-plans-to-tax-agriculture-emissions-to-meet-climate-goals/}{Denmark} from 2030)
    \item Merger of different ETS to a single system (to avoid distortions, e.g. CCU in industry then fuel used in residential heating where tax is lower)
    \item Regulation of \alert{carbon dioxide removal} (CDR) and integration into the ETS
      \item \alert{2040 target} of around 90\% GHG reduction compared to 1990
  \end{itemize}


\end{frame}


\begin{frame}
  \frametitle{Carbon dioxide management}

  Most scenarios show that in 2030-50 Europe will need carbon capture from point sources, following by CO$_2$ transport, usage in fuels and materials (carbon capture and usage, CCU) or long-term underground storage/sequestration (CCS). These options are collectively known as \alert{carbon dioxide management}.

\centering
  \includegraphics[width=14cm]{carbon_management.png}
  \source{\hrefc{https://energy.ec.europa.eu/document/download/6b89e732-fea4-480b-9d2e-cf64de90247e_en?filename=Communication_-_Industrial_Carbon_Management.pdf}{COM: Industrial Carbon Management, 2024}}

\end{frame}


\begin{frame}
  \frametitle{Carbon dioxide removal (CDR)}

  E.g. afforestation, direct air capture and sequestration (DACS), bioenergy+CCS (BECCS)

\centering
  \includegraphics[height=7cm]{state_of_cdr.png}


\source{\hrefc{https://static1.squarespace.com/static/633458017a1ae214f3772c76/t/64d2223cab34856349188e07/1691492940765/SoCDR-1st-edition-2023-V9.pdf}{State of CDR, 2023}}


\end{frame}

\begin{frame}
  \frametitle{Carbon management in EU policy}
\begin{columns}[T]
  \begin{column}{8cm}
    \vspace{.8cm}
    \includegraphics[width=8cm]{eu-cms-2030-2050.png}
  \end{column}
  \begin{column}{6cm}
    \vspace{.5cm}
    \begin{itemize}
    \item EU Commission's planning for 2030 has 50 MtCO$_2$/a sequestration (in Net-Zero Industry Act), rising to $\sim$250~MtCO$_2$/a in 2050
    \item 2050: around 450~MtCO$_2$/a total capture from point sources and air
    \item 2050: around 200~MtCO$_2$/a CCU
    \item 2050: around 100~MtCO$_2$/a CDR
    \item NB: Neither DAC or BECCS have been demonstrated at scale!
    \end{itemize}
  \end{column}
\end{columns}
\source{\hrefc{https://energy.ec.europa.eu/document/download/6b89e732-fea4-480b-9d2e-cf64de90247e_en?filename=Communication_-_Industrial_Carbon_Management.pdf}{COM: Industrial Carbon Management, 2024}}
\end{frame}



\begin{frame}
  \frametitle{Carbon management in EU policy}

  %page 280
  \centering
  \includegraphics[height=7.4cm]{carbon_sankey.png}


    \source{\hrefc{https://climate.ec.europa.eu/eu-action/climate-strategies-targets/2040-climate-target_en}{European Commission 2040 target impact assessment, 2024}}
\end{frame}




\begin{frame}
  \frametitle{Why a carbon tax on its own is not enough}

  If technology were static, all financing needs could be met, and all actors rational, a carbon tax might be sufficient. However there are several \alert{market failures}.

  \begin{itemize}
    \item For cap-and-trade: \alert{fluctuating prices} $\Rightarrow$ no investment certainty. Solution: price caps/floors, carbon contracts for difference.
  \item \alert{New technologies} that are expensive but have cost reduction potential by scaling/learning, are not incentivised. Market failure: companies will not invest in hope of market share in 20-30 years. Solution: government investment incentives/subsidies.
  \item Consumers \alert{don't perceive} or calculate benefits of low-carbon technologies. Market failure: bounded rationality. Solution: information campaigns, standards/norms.
  \item \alert{Regressive impact:} poorer households pay a larger share of disposable income in carbon tax. Solution: carbon dividend, i.e. repayment of CO$_2$ revenues to citizens (Klimageld).
  \item \alert{Financing gap:} poorer households cannot or will not finance investments of $>$\euro 10,000. Solution: investment subsidies, interest-free loans, rental models for e.g. heat provision.
  \end{itemize}

\end{frame}


\begin{frame}
  \frametitle{Carbon contracts for difference}

  \alert{Carbon contracts for difference} (CCfD) are a government instrument to
  provide investment certainty for firms decarbonising, e.g. in cement
  or steel industry, particularly if their MAC is higher than the CO$_2$ price.

  CCfD guarantee a strike price in \euro/tCO$_2$ for emissions reductions.

  If the cap-and-trade price is below the strike price, the government pays the firm the price different in \euro/tCO$_2$ for each tonne of carbon dioxide avoided.

  If the cap-and-trade price is above the strike price, the company pays the government the difference.

  Further reading: ``\hrefc{https://doi.org/10.1016/j.isci.2022.104700}{Carbon contracts-for-difference}: How to de-risk innovative investments for a low-carbon industry?'' by Richstein and Neuhoff (2022)

\end{frame}


\begin{frame}
  \frametitle{Why a carbon tax is still essential for efficient decarbonisation}

  Despite the need for an \alert{instrument mix}, carbon pricing is still essential. It ensures:
  \begin{itemize}
  \item \alert{General efficiency} - abatement options with lowest costs are chosen (avoids inefficient solutions where high cost options are prioritised over low-hanging fruit)
  \item \alert{Efficiency across sectors} - if carbon is being capture here, used there and stored somewhere else, it is hard to incentivise correctly without a \alert{single uniform carbon price} (e.g. if the carbon price is higher in industry than households, could avoid high price with CCU in industry to make synthetic methane then burn it in gas boiler at home  - perverse!)
  \item We tax the problem \alert{directly} in a
    \alert{technology-neutral way}, rather than \alert{choosing
      political favourites} (e.g. politicians choose solutions for
    interest groups) - important while in many areas the best technology is uncertain (e.g. steel, cement)
  \item It provides an \alert{anchor price} for comparison with efficiency of other instruments (CCfDs, subsidies, financial help)
  \end{itemize}

\end{frame}




\end{document}
