IEA (2020), Implementing Effective Emissions Trading Systems, IEA, Paris https://www.iea.org/reports/implementing-effective-emissions-trading-systems, License: CC BY 4.0
Carbon pricing initiatives are spreading throughout the world. Over 60 countries, cities, states and provinces have implemented or are planning to implement carbon pricing schemes, with a fairly balanced distribution between emission trading systems and carbon taxes. When the emissions trading system in the power sector of China starts its implementation, carbon pricing initiatives will cover one-fifth of global greenhouse gas emissions.
Emissions trading systems present many benefits. They help to expose emitters to the external costs of emissions in the most flexible and least costly way, and as such reduce emissions cost-effectively. Trading systems can also stimulate technological innovations, support climate risk quantification and multilateral co-operation, and create synergies with energy and environmental policies. Emissions trading system are useful policy instruments that facilitate the acceleration of clean energy transitions and emissions reductions. However, the practical policy implementation of an emissions trading system needs to be designed in a way that fits with local contexts and integrates with other policy priorities in each jurisdiction.
Jurisdictions need to fully understand their own energy and low-carbon development conditions, to carefully define the expected role and functions of establishing an emissions trading system, and to discuss the system’s objectives with major stakeholders. The long-term policy predictability of an emissions trading system is an important factor for guiding private sector investment decisions. Policy makers should further consider what role the emissions trading system would play in the jurisdiction’s long-term strategy and consider how the role and functions of the system will evolve within their longer-term strategy for both climate policy and industrial and social development.
Jurisdictions should carefully assess interaction issues between emissions trading system design and other energy-related domestic companion policies, which may include air pollution control, renewable energy, energy conservation, economic restructuring and power sector reform. A top-down approach for setting the emissions trading system cap could help better align the system with national mitigation objectives, such as nationally determined contributions to the Paris Agreement or other long-term strategies.
The power sector is a major source of emissions in most jurisdictions and as such it is included in most of the operating emissions trading systems around the world. In theory, the reflection of emissions trading system allowance costs in the power sector creates various levels of incentives to reduce emissions. However, in practice power markets are often fully or partially regulated, and some power market structures can weaken the carbon pricing signal, reducing the emissions trading system’s effectiveness. Jurisdictions should analyse how the carbon signals affect the different level of potential emissions reductions in the power sector, including in investment, dispatch, and wholesale and retail markets.
How the industrial sector is included in an emissions trading system needs careful consideration because it can raise economic competitiveness concerns, such as a potential decrease in investments in industry and potential job loss. Environmental concerns can also arise, notably carbon leakage, the potential displacement of industrial production (and associated pollution) to jurisdictions with less stringent environmental controls or emissions reductions requirements. Free allowance allocation has been widely used by various emissions trading systems as a way to address competitiveness and carbon leakage concerns for the industrial sector. Gradually phasing down free allocation in favour of auctioning can help correct potential market distributional distortions, create the possibility of generating and reusing revenues from auctioning, and increase the emissions reductions effectiveness of the emissions trading system.