Lec. 12: Carbon markets Flashcards
(21 cards)
What is missing?
Quantifying Climate Damages
- We can attempt to quantify the net damages as a “…” in €/t_CO2. 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!
“Social Cost of Carbon”
How can global warming be represented a negative externality?
- The emissions of GHG/CO2 lead to climate costs for current and future generations
- These external costs are an externality
What is missing?
Characteristics of climate problem
- “…”: The location of emissions does not matter (leakage problem)
- “…”: Damages affect future generations while the current generation has relatively minor impairments
- “…” of reliable abatement technologies for hard-to-debarbonise sectors (like aviation, shipping, cement and petrochemicals)
- “…”: Solutions require an internationally coordinated and future-oriented approach: Who should provide what contributions? (International and intra-national distributive conflicts; developing countries against grandfathering)
- Measurement, reporting and verification
“Globality”
“Timeline”
“Cost/unavailability”
“Free-rider problem”
True or false?
Profits versus External Costs
If external costs are ignored…
- External costs are higher than firm’s profits
–> This is inefficient from a societal perspective: market failure
True!
True or false?
Profits versus External Costs
If instead we maximise for society…
- External costs are lower than firm’s profits
–> The company can compensate the third
party for their costs.
True!
What is missing?
Profits versus External Costs
If we find the emissions level that maximises profits minus costs, i.e. the benefit for the whole society:
max_Em [Π(Em) - Cext (Em)]
then at the optimum we have “…”:
dΠ/dEm - dCext/dEm = 0
or
dΠ/dEm = dCext/dEm
“marginal external costs equal marginal abatement costs (= cost to firm in lost profits)”
(“Grenzkosten des Externen Effekts” = “Grenzvermeidungskosten”)
What is missing?
Strategies for dealing with negative externalities
There are three major strategies for dealing with negative externalities:
- “…”: Society sets voluntary or binding requirements for maximum emissions levels. Example: for 2020-2024 there is an EU fleet-wide CO2 emission target for passenger cars of 95 gCO2/km. Example: insulation standards for new/renovated buildings. Example: efficiency standards/ratings for fridges/TVs.
- “…”: Tax the externality (e.g. CO2 emissions) to internalise the social costs of the externality. Example: German CO2 tax on oil and gas in transport and heating. Example: cigarette tax.
- “…”: Set a volume limit on the externality (e.g. CO2 emissions), distribute certificates for the volume and require polluters to purchase certificates. Example: EU Emissions Trading System (ETS) for CO2 energy, industry and domestic aviation. Example: US sulphur dioxide (SO2) Allowance Trading System.
“Standards/norms”
“Pigouvian tax”
“Cap-and-Trade System”
What is missing?
Pigouvian Tax
Pigou (1931) suggested “…”
Suppose we set a tax λ on CO2 emissions in €/tCO2.
Now the producer optimizes:
max_Em Π(Em)−λ·Em
So that at the optimal point:
dΠ −λ=0 dEm
- In other words: they reduce their emissions until “…”
- (NB: Compared to the socially optimal solution, we have replaced nonlinear external costs Cext (Em) with a linear function for the firm λ · Em.
“to tax negative externalities so that producers can internalise the external costs they cause, and thereby reduce production to the socially most efficient level.”
“the marginal abatement cost (i.e. the cost to the company of reducing the next tonne of CO2) is equal to the tax.”
What is missing?
Pigouvian Tax
- The exact volume of emissions can be implicitly derived if you “…”.
Draw the graph.
“know λ and the shape of the marginal abatement cost curve”
Graph: slide 12
How do you calculate marginal CO2 abatement costs (MAC)?
Present a formula.
MAC [€/(t_CO2*a)]=
(CO2 abatement costs [€/a] - potential savings (e.g. saved fuel costs like coal) [€/a])
/
Abated CO2 emissions [t_CO2]
What is missing?
The “…” 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 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).
“Coase Theorem”
Compare Pigouvian Tax and Cap-and-Trade with each other.
Pigouvian Tax
- Price: Set by government
- Volume: Determined implicitly MAC and price
- Benefit: Price certainty for industry
- Drawback: Can under- or overshoot CO2 volume target
Cap-and-Trade
- Price: Determined implicitly by MAC and cap
- Volume: Set by government
- Benefit: Allows targetting of CO2 volume precisely
- Drawback: Can lead to price volatility
What is the EU ETS?
EU ETS
- Includes all 27 EU countries plus Iceland, Liechtenstein and Norway
- Includes the following sectors
–> Electricity and heat generation (plants > 20 MW)
–> Energy-intensive industry (e.g. cement and steel production, refineries, glass, paper, etc.)
–> Intra-European air traffic
–> Since 2024: maritime transport - Certificate trading system
–> Basic principle: cap and trade - Downstream approach
–> CO2 emitter must buy certificates
What is missing?
Design of an Emissions Trading System
Trading period length of time:
- If the trading period is too long, the incentives are weak (e.g. decades).
- If the trading period is too short, there is lack of certainty for investments.
Allocation of emissions allowances:
- “…”, i.e. operators buy allowances in auctions. Government collects and redistributes auctioning revenues.
- “…” based on “…”, i.e. industries are given free allowances based on past emissions.
- “…” based on “…”, i.e. industries are given free allowances based on their activities (e.g. product sales) and a per-sector benchmark.
In past free allocation led to “…”, since CO2 prices are opportunity costs of power plant operators (certificates could be sold) and, thus, included into the product price anyway.
“Auctioning”
“Free allocation” ; “grandfathering”
“Free allocation” ; “benchmarking”
“windfall profits”
What is missing?
“…” (MSR) is intended to address weakness of ETS: “…”. The “…” 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.
“…” operating since January 2019:
- Addresses the surplus of allowances
- Improves the system’s resilience to shocks (recessions, pandemics, etc.)
- It triggers adjustments to annual auction volumes in situations where the total number of allowances in circulation is outside a predefined range:
–> Reducing allowances from future auction volumes if the EU ETS surplus exceeds 833 million allowances
–> Adding allowances to future auction volumes provided the EU ETS surplus is below 400 million allowances
“Market stability reserve” ; “strong price fluctuations and waterbed effect”
“waterbed effect”
“Market stability reserve”
What is missing?
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 carbon leakage, “…”
- “…” for industries with products at risk of carbon leakage. This was the solution in EU until now.
- “…” 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 proposed by the European Commission in 2021.
- “…” that allow free trading between partners with similar carbon reduction schemes. Has been proposed in October 2021 for US and EU trading clean steel and aluminium.
(carbon leakage): “carbon-intensive industries moving to countries without carbon pricing.”
“Free allowances”
“Carbon Border Adjustment Mechanism (CBAM)”
“Carbon Clubs”
What is missing?
Most scenarios show that in 2030-50 Europe will need carbon capture from point sources, following by CO2 transport, “…” or “…”. These options are collectively known as “…”.
“usage in fuels and materials (carbon capture and usage, CCU)”
“long-term underground storage/sequestration (CCS)”
“carbon dioxide management”
True or false?
Carbon dioxide removal (CDR)
E.g. afforestation, direct air capture and sequestration (DACS), bioenergy+CCS (BECCS)
True!
What is missing?
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 market failures.
- For cap-and-trade: “…”. Solution: price caps/floors, carbon contracts for difference.
- 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: “…”. - Consumers “…”.
–> Market failure: bounded rationality.
–> Solution: information campaigns, standards/norms. - Regressive impact: “…”.
–> Solution: carbon dividend, i.e. repayment of CO2 revenues to citizens (Klimageld). - Financing gap: poorer households cannot or will not finance investments of >€20,000.
–> Solution: investment subsidies, interest-free loans, rental models for e.g. heat provision.
(cap-and-trade): “fluctuating prices ⇒ no investment certainty”
“government investment incentives/subsidies”
(Consumers): “don’t perceive or calculate benefits of low-carbon technologies”
(Regressive effect): “poorer households pay a larger share of disposable income in carbon tax”
True or false?
Carbon contracts for difference
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 CO2 price.
CCfD guarantee a strike price in €/tCO2 for emissions reductions.
- If the cap-and-trade price is below the strike price, the government pays the firm the price different in e/tCO2 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.
True!
True or false?
Why a carbon tax is still essential for efficient decarbonisation
Despite the need for an instrument mix, carbon pricing is still essential. It ensures:
- General efficiency - abatement options with lowest costs are chosen (avoids inefficient solutions where high cost options are prioritised over low-hanging fruit)
- Efficiency across sectors - if carbon is being capture here, used there and stored somewhere else, it is hard to incentivise correctly without a 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!)
- We tax the problem directly in a technology-neutral way, rather than 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)
- It provides an anchor price for comparison with efficiency of other instruments (CCfDs, subsidies, financial help)
True!
