Carbon Taxes and Regulation

With anthropogenic greenhouse gas (GHG) emissions building up in the atmosphere at alarming rates, governments have turned to pricing carbon as one tool to help reduce GHG emissions and avoid the risk of dangerous climate change having catastrophic impacts on human livelihoods. Pricing carbon can be done via carbon taxes or Emissions Trading Schemes (ETS). Economists generally believe that emissions trading is more effective than taxes because the market should be better placed to achieve emission reductions at lower marginal abatement cost. By putting a price on carbon, projects which reduce GHG emissions such as methane avoidance (coal mines, landfills), renewable energy and energy-efficiency become more economically viable, and incentives are provided for investment into research and development in low carbon technologies.

In 2005 the EU started the European ETS which regulates CO2 emissions at over 12,000 installations, or close to 50% of Europe’s emissions. The scheme is a cap and trade programme, which means that there is an absolute cap on emissions for each country. So far the scheme has been effective in reducing emissions and the EU has seen a 40% increase in gross domestic product (GDP) since 1990 while experiencing a 17% decrease in total emissions. The scheme covers energy generation (above 25MW installed capacity) and industrial sectors, and is set to expand to include the aviation sector from 2012. Installations have their own targets set by National Allocation Plans (NAPs), which have been set by national governments, and from 2013 will be set by the EU. Emission permits are allocated to companies as European Allowances (EUAs) and traded between companies to ensure they meet their cap under their NAPs. If the cap is exceeded then this needs to be met with offsets from other companies’ EUAs, Certified Emission Reductions (CERs) from Clean Development Mechanism (CDM) projects, or Emission Reduction Units (ERUs) from Joint Implementation (JI) projects.

There are limits on the amount of CERs or ERUs that can be used for compliance. Failure to comply results in significant penalties of 100 euros per tonne. The CDM is run by the United Nations Framework Convention on Climate Change (UNFCC) through a CDM Executive Board, which is responsible for approving new CDM methodologies, approving and registering CDM projects and issuance of CERs to projects. All CDM projects must be in developing countries and all projects must mitigate GHG emissions. Projects must prove additionality, which means that the project would not take place unless carbon credits are available to make it financially viable. The JI programme is also managed by the UNFCC through the JI Supervisory Committee and emission reduction units are allocated to carbon mitigation projects in countries that are in Annex I Parties (developed countries, such as eastern European countries, Russia, Ukraine, New Zealand, etc). The difference between CDM and JI projects is that JI projects are in developed countries. As these countries have targets under the Kyoto Protocol, when an ERU is issued an AAU (Assigned Amount Unit) is surrendered at the same time.

An extension of the EU ETS legislation that is of particular importance for countries outside of the EU is the plan to introduce aviation into the scheme starting 1 January, 2012. Under the proposed legislation companies will be required to pay for their emissions resulting from aviation activities occurring over EU land. So for example, if there was a flight from Sydney, Australia to Frankfurt, Germany, the aviation company will be required to meet targets for emissions, but only for the kilometers travelled within EU borders. Flights are only covered under the scheme if they land or depart at EU member airports. Aviation companies will receive 85% free allocations in 2012 and 82% free allocations from 2013-2020. The emissions cap for 2012 will be set at 97% of the average emissions during the period 2004-2006, and the 2013-2020 cap will be set at 95% of the 2004-2006 average. This will drive emission efficiency in aviation fuel and equipment and subsequently result in reduced emissions from the sector. Asian airlines will be included and will need to understand their obligations and liabilities under the programme. All airlines globally are well on their way to being prepared for the scheme.

The EU ETS sets a clear cap which limits the GHG emissions from all sectors covered by the scheme and aids in setting the price for carbon. This in turn drives the development of renewable energy and energy efficiency within the continent. The New Zealand Emissions Trading Scheme (NZ ETS), however, does not set an absolute cap on emissions and has a price cap of NZ$25 per tonne. The scheme has come under scrutiny for being a ‘watered down’ ETS that isn’t fully committed to making noticeable cuts in emissions. Despite the lack of an absolute emissions cap, the programme has been effective in incentivising emission reduction after only one year of operation. The net increase in forestry planted in New Zealand increased from 500 hectares in 2009, to 4700 in 2010, to 5,700 in 2011 and 7,700 is expected in 2012. New Zealand also saw 1.34 GW of consented renewable energy plants in 2013, which is a five-fold increase compared with the previous 10 year average. The New Zealand ETS works with offsets rather than an allowance programme like the one in the EU. Foresters are awarded one tonne of CO2 per tonne sequestered and emitters currently pay one tonne of CO2 for every two tonnes emitted. This is simple Pigouvian economics, as it economically incentivises activities that take emissions out of the atmosphere and economically disincentivises activities that put CO2 into the atmosphere. If companies fail to offset their emissions they will pay a NZ$30 fine per unit and are also required to purchase the required offsets. If companies give false data regarding their emissions they will be liable for up to NZ$50,000 in fines.

There are also new ETS under consideration in other countries and some have started implemenation. Australia has recently passed its Carbon Tax Bill through the House in October 2011. It is likely that it will enter into force by the end of 2011 and be in operation as of 1 July 2012. The Californian ETS is set to begin on 1 January 2013, and with possible links to the EU ETS this should greatly increase the size of the international carbon market. A Chinese ETS may be established in 2015 by the National Development and Reform Commission (NDRC). Currently China is preparing pilot projects in six states, including Beijing, to begin in 2013. This is starting in the state of Guandong, which has already selected its exchange for trading emissions. Japan and South Korea are also considering implementing domestic ETS. With more carbon markets appearing globally, emissions trading is likely to become more important in the future. While it appears that in the short term, the prospects of a global carbon market with one global price for carbon is a long way off, it is clear that more and more countries are going to choose to regulate carbon and choose an ETS as one of the policy tools to achieve this goal.

In order to be compliant under an ETS, it is important that companies and organisations understand the legislation and how this will impact on business decisions. In order to do this, organisations can seek legal advice from lawyers, expert consultants in the field of emissions trading or advice from accountants in relation to tax issues. The ins and outs of carbon legislation can be quite daunting, so for companies that have a high risk exposure to an ETS or carbon pricing it is recommended that professional advice is sought. If your company is small or operates in a field that is not directly affected by the carbon legislation, then free advice can often be sought from government agencies. The New Zealand government, for example, has been very helpful in providing free information and advice to all parties that are interested in the NZ ETS by organising seminars and providing information via the internet, phone and mail.

So the first and most important element of making sure that your company or organisation is compliant is to thoroughly understand the legislation and its relevance to your operations. The next important element, if your company is directly affected by the ETS, is to understand the market and the drivers of carbon pricing so that your organisation can make informed decisions regarding the purchase of carbon credits, whether they are NZUs from projects in New Zealand, CERs or ERUs from projects in other countries. Larger companies may wish to appoint a carbon procurement manager within their company who buys on a monthly basis. Smaller companies may decide this is not necessary and work with a broker, or choose to make one transaction once a year. Understanding in the risks and opportunities is an important first step for emitters in reducing the cost of their compliance under the scheme. As with many things, information is key, and the more information a company has at a finger tips the better it will be able to plan for the future in an increasingly carbon constrained world.

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