COMMENT: Financing carbon dioxide removals – what role for ETS in the race to net zero?

Published 12:40 on May 18, 2021  /  Last updated at 12:40 on May 18, 2021  /  Americas, Asia Pacific, Canada, China's National ETS, Conversations, EMEA, EU ETS, International, New Market Mechanisms, New Zealand, REDD, South Korea, Switzerland, UK ETS, US, Views, Voluntary Market  /  No Comments

Carbon pricing and specifically emissions trading systems can play an important role in incentivising removals necessary for achieving Paris Agreement emissions targets, according to the ICAP Secretariat.

By Baran Doda, William Acworth, and Mary Hellmich of the ICAP Secretariat

As the COP26 UN climate conference in Glasgow approaches, there is a sharpening focus on how to achieve net zero emissions by mid-century. In fact, by March this year, 124 countries have implemented or are considering implementing net zero targets — countries that collectively represent 61% of global emissions, 56% of the global population and 68% of global GDP. While the target is abundantly clear, the policy frameworks, business models and technologies required to achieve it are difficult to pin down. One unresolved question that obscures the future pathways to net zero is the appropriate balance between future abatement and carbon dioxide removals from the atmosphere. Simply put – the more we abate sooner, the less we will need to remove later.

Essentially all scenario pathways delivering the Paris Agreement targets, as assessed by the IPCC in the Special Report on 1.5C, involve some level of carbon dioxide removals (or “removals” for short). This has again been confirmed by analysis from the IEA including a Net Zero Emissions by 2050 (NZE) Scenario, released today. The analysis by the IEA requires significantly fewer removals (1.9 bln tonnes CO2 in 2050) than comparable IPCC scenarios (3.5-16.1 bln tCO2 in 2050), with differences across scenarios being driven in large part by variations in policy and technology assumptions. However, in all cases financing a large volume of removals alongside a fundamental transformation of our energy and economic systems will be necessary.

The International Carbon Action Partnership (ICAP) has also released an important report today that considers what role carbon pricing and specifically emissions trading systems (ETS) can or should play in incentivising removals. The way an ETS works will be familiar to most Carbon Pulse subscribers. The government creates emission allowances, and the covered entities receive these as free allocations or purchase them in primary or secondary markets to meet their compliance obligations.

The removals market is more like a traditional market. On the supply side, removal units are produced using negative emission technologies (NETs) which differ in market readiness, cost and scalability. Several technologies are currently being explored, including afforestation and reforestation (AR), soil carbon sequestration (SCS), biochar (BC), bioenergy with carbon capture and storage (BECCS), direct air carbon capture and storage (DACCS) and enhanced weathering (EW). The demand side for removals can include direct purchases by the government, voluntary measures by private citizens and firms, as well as mandatory removal obligations established through regulation. Of course, removal units must be underpinned by a robust certification and governance mechanism just like the market for dairy products or financial advice to ensure minimum quality standards.

The ICAP Secretariat report outlines four possible models of interaction between the market for removals and an ETS. Each has its own opportunities and risks. The models range from one where the two markets operate in complete isolation, to another where NETs supply removal units are fully fungible with allowances issued by the government under the ETS cap. In between these extremes, the government can purchase units in the removals market which can later be allocated freely or by auction in the ETS. In that model the government connects the two markets. Alternatively, the two markets could be connected via private channels but with restrictions, much like offset provisions in many existing ETSs.

Distinctions between these models revolve around the level of government control over the balance of abatement and removals in the system; the flexibility on cap-setting and how to deal with residual emissions; impacts on market expectations; avenues for additional demand and finance for NETs and the resulting fiscal and administrative burden on governments aiming to achieve net zero. Choices will likely be jurisdiction specific, and governments may opt to treat different NETs differently.

Beyond these models a number of more technical questions remain. First, a benefit of cap-and-trade policies is the strong signal that an absolute and declining emissions cap sends to covered entities – namely, that high-emitting facilities will not be part of the future economy. Net zero targets reframe the long-term prospects for an ETS with different conceivable options: caps could be maintained at a non-zero level to accommodate some level of residual emissions, fall to zero or even become negative if the responsibility of covered entities shifts from abating emissions to removing them from the atmosphere. Negative caps raise practical questions surrounding instrument design as well as larger ethical considerations as to who should bear the responsibility of financing removals that are required to compensate for overshooting temperature targets.

Second, carbon capture and storage is a fundamental component of a number of NETs. Therefore, some provisions will likely need to be adjusted if ETSs are to accommodate significant shares of removals units. Finally, despite the clear need for a large volume of removal units, deep abatement will always remain fundamental to our chances of achieving the goals of the Paris Agreement. Before adjusting ETSs to accommodate for removal units, the short- and long-term impacts on the incentive to abate must be carefully assessed.

 

The International Carbon Action Partnership (ICAP) is an international forum for governments and public authorities that have implemented or are planning to implement emissions trading systems (ETS).  ICAP facilitates cooperation between countries, sub-national jurisdictions and supranational institutions that have established or are actively pursuing carbon markets through mandatory cap and trade systems. This comment and associated report were prepared by the ICAP Secretariat. The findings and opinions expressed in this report are the sole responsibility of the authors. They do not necessarily reflect the views of ICAP or its members.

Comment