Linking emissions trading systems

Carbon pricing, and emissions trading in particular, is an effective method for reducing emissions. Emissions trading systems are increasingly popular and spreading around the world. These systems can provide a new revenue stream for governments which can offset other taxes or support innovation. We were surprised that the Government had not yet considered the best use of revenue generated from emissions trading. We were pleased to hear that the Prime Minister thought it was an area worth examining. We recommend the Government make an assessment of current and future emissions trading revenue and report on different options for using the revenue including the potential to reduce other taxes and support new low- carbon technologies.

As emissions trading systems develop and mature around the world there will be increasing opportunity for them to grow and expand so that emissions can be reduced in the most cost-effective way. This expansion is likely to occur by the linking of systems to one another. We recommend that the Government ensure that, when supporting other countries to develop their emissions trading systems, it promotes designs that are compatible with the EU ETS. Aligning design elements will help improve the prospects of linking in the future. The Government should focus on engaging with China and the US as the world’s largest economies and because they have already embraced emissions trading.

The issue of surplus allowances in the EU Emissions Trading System (EU ETS) must be addressed urgently. We recommend that the Government focus on getting agreement in the European Parliament and Council to implement the market stability reserve (MSR) at the earlier date of 2017 rather than in 2021, as originally proposed by the European Commission. Once it has been reformed the credibility of the EU ETS will increase along with the prospects of linking it to other systems in future.

The Government’s focus in Paris at the end of 2015 will rightly be on securing a global climate agreement which will keep global average temperatures below 2°C. Carbon markets and emissions trading systems can play an important role in helping countries achieve their commitments in an efficient and cost effective way. We recommend, therefore, that the Government ensure the Agreement promotes use of carbon markets and facilitates the future linking of emission trading systems. It should also ensure that provisions which will preclude the future development of carbon markets are actively avoided.

Carbon pricing, and emissions trading in particular, is an established and well recognised policy instrument for controlling greenhouse gas emissions in a cost effective way because it provides flexibility to participants on how they want to reduce their emissions. A global carbon market would be the most favourable outcome in the long term because it is one of the most economically efficient ways to reduce emissions. However, attempting to achieve this benign outcome by means of a top-down process is extremely unlikely to succeed. Instead a bottom-up approach aimed at developing a network of regional, national and sub-national emissions trading systems, which gradually come together by linking, is much more likely. A global climate agreement that promotes carbon pricing and is favourable to linking represents the best chance of developing a global carbon market in the long term. The move towards a hybrid approach–which combines top-down elements for establishing and reviewing targets, with bottom-up elements of pledge-and-review tied to national policies and actions–in the international climate negotiations could significantly improve the prospects of linking carbon markets and is a welcome development. The world’s largest economies, which have embraced emissions trading, China, the US and the EU will be the leading players in this process. As the first pioneering adopter of emissions trading and a strong advocate for market-based carbon pricing policies, the UK Government has an absolutely vital role to play in driving forward international linkage.