How Can Carbon Markets Limit Climate Change?
Carbon markets are advancing on a global level, following the first country-to-country trades at COP27. The Energy Podcast investigates how carbon pricing works and examines what role it can play in the race to reduce greenhouse gas emissions.
Presented by Julia Streets. Featuring Dr Hasan Muslemani from the Oxford Institute of Energy Studies, Andrea Bonzanni from the International Emissions Trading Association and Shell’s senior carbon pricing policy advisor, Dr Malek Al-Chalabi. With additional contribution by Stephen Kansuk, Head of Environment and Climate Change at the United Nations in Ghana.
The Energy Podcast is a Fresh Air Production for Shell, produced by Annie Day and Sarah Moore, and edited by Molly Lynch and Sophie Curtis.
00:00Julia Streets: Today on The Energy Podcast...
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Andrea Bonzanni: Emissions must be reduced globally irrespective of where they take place. The atmosphere is one at the end of the day. Article VI allows reducing emissions where it’s more efficient.
Dr Hasan Muslemani: We have solutions that are being praised as the holy grail of net- zero… The issue is that we need all the solutions that we can get because in the fight against climate change, we are really in a race against time.
Julia Streets: The cost of climate change. It's a phrase commonly used by governments, companies, and campaigners across the world when discussing the need to limit global warming to well below two degrees Celsius. Quantifying the exact cost of far- reaching effects of climate change is not an easy task. But putting a price on emissions is viewed by many as an effective means to help drive down levels of CO2 in the atmosphere. The idea is simple. Putting a price on carbon emissions creates a financial incentive to reduce them.Carbon markets have existed for decades. There are many carbon pricing systems around the world, but at present, it is estimated that only a quarter of emissions are priced. That could soon change. At last year's COP27 climate conference in Egypt, the first country- to- country carbon trades took place. Could this pave the way for further uptake of carbon trading and what impact could that have in the fight against global warming?
Hello, I'm Julia Streets, and today on The Energy Podcast: How can carbon markets limit climate change?
With me to discuss this are Andrea Bonzanni, who's the international policy director at the International Emissions Trading Association, who you may well remember from a previous episode of The Energy Podcast. He is joined by Dr. Hasan Muslemani, who is the head of Carbon Management Research at the Oxford Institute for Energy Studies. And our third guest is Dr. Malek Al- Chalabi, who is a senior carbon pricing policy advisor at Shell.
Hasan, perhaps I could start with you. For the benefit of the audience, would you just mind explaining what we mean when we talk about carbon markets?
02:18Dr. Hasan Muslemani: The fundamental concept behind a carbon market is really to put a price on carbon, or in other words, to quantify the cost of damages that emissions will cost our society over time. To do this, we have, at the heart of carbon markets, what is called carbon accounting or greenhouse gas accounting. This represents a set of standards and methods that help us quantify but also verify the impact that each business creates on the environment, and this impact is reported in terms of tons of CO2 emitted. Now, something that I really want to emphasize here is that today, we speak of carbon markets, but we need to differentiate between two different types of markets. The first is what we call a compliance market, which is a market that is heavily regulated and corresponds to a specific region or jurisdiction, and where companies within that jurisdiction have to take part in the market. The other one is a voluntary one. This is a lot less regulated and where participation is voluntary, as the name implies. The voluntary carbon market is based on the concept of offsetting. That is where a company wishes to mitigate or neutralize its own emissions. So, it goes out and invests in projects which are reducing equivalent amounts of emissions elsewhere in the world.
03:30Julia Streets: Can you talk to us a little bit about how they work in practice in everyday terms?
03:36Dr. Hasan Muslemani: Starting on the compliance markets, and the objective is really to put a price on carbon, there's two different ways to do this. The first one is carbon taxation, which should be a simple concept. We have countries like Norway and Denmark, which would impose a specific tax on every ton of CO2 that a company would produce within those countries. The key here, really, is for that carbon tax to be high enough to incentivize businesses to change behavior or to move to greener production. This is essentially a stick form of regulation where businesses have to lower their emissions or face an additional cost. The other mechanism, which is a cap and trade mechanism, which is the more familiar one, and in this system we have an authority, say, the European Commission, which sets a cap on how much emissions can be generated as a whole within the continent, within Europe, and then allocates a number of allowances or carbon credits to European countries and companies for them to trade amongst each other. Here, each carbon credit or allowance is representative of one ton of CO2. This allocation process, what I want to note, is done using the historical emissions of each one of these companies. This is a process that we call grandfathering. The overall cap is reduced each year in order to meet a certain European climate target in the future. The way this works is where companies that have lowered their emissions below their targets, now they have surplus of allowances, which they can go into the market and sell to companies that did not do so well and will require to buy credits. So, this mechanism really is sort of a carrot but also a stick sort of regulation.
05:12Julia Streets: Thank you for explaining how they work. I suppose my next question, is how effective are they proving to be?
05:19Dr. Hasan Muslemani: The longest running and actually the biggest ETS in the world, that is the EU ETS or emission trading scheme. This has started in 2008 and has gone through different phases over the years. But I do want to mention that it has suffered from a number of setbacks over those years. To give an overview, the carbon price at the beginning was around 30 euros per ton, but that price has crashed to less than 5 euros around the financial crisis of '09. This was most likely because of two main reasons. The first one is that companies had to report their emissions in such a regulated manner that they have not done before, and so they might have overestimated how much emissions they emit and hence how much allowances they eventually received from the system. But also, because of the financial crisis itself, it meant that business offices aren't lit, emissions aren't as high as usual, so they did not need to surrender as much allowances at the end of the compliance phase, which eventually meant there's an oversupply of credits in the market, and so the price has crashed. The good news is the EU ETS has gone through sort of a recovery mode over the past 10 years, and today the price has not only recovered but reached the level which is believed to incentivize most sectors to lower emissions, and that level is around 100 euros per ton.
06:41Julia Streets: It's been so helpful to get a sense of progress, thinking about the dynamics of the market since launch, and also to think about the market share. Andrea, let me bring you in here because this is about the world's attempts to limit global warming to well below two degrees Celsius, in line with the Paris Agreement. Are we likely to see the growth of carbon markets in pursuit of this great ambition?
07:03Andrea Bonzanni: Well, we know that meeting the goals of the Paris Agreement requires a radical transformation of many areas of our economies and our lives, and for the reason outlined by Hasan, carbon markets and carbon pricing in general are one of the tools that governments are increasingly considering. Carbon markets are spreading from a core of rich runs economies such as the EU, California, South Korea, and New Zealand, to middle- income and emerging countries. This year, we had Mexico and Indonesia launching their emission trading systems, and the two schemes are expected to expand and evolve over time. There are other countries in Southeast Asia and Latin America that are implementing carbon markets, and even some African countries are starting to consider them.
07:45Julia Streets: Andrea, when we last spoke, you would just at COP27. As I mentioned in the introduction, that's when the first country- to- country carbon trade took place. Could you tell us a bit more about that and what happened at COP27?
07:58Andrea Bonzanni: Sure. At COP27, Ghana authorized the transfer to Switzerland of certified emission reductions. This transaction was the first of its kind under Article VI of the Paris Agreement. There were emission reductions generated in Ghana thanks to the implementation of enhanced rice production techniques that avoided CO2 and methane emissions. These emissions will be counted towards the climate target of Switzerland. In turn, Ghana commits to apply a corresponding adjustment to its emission account. Mechanisms like this have vast potential to generate investment flows in climate change mitigation and sustainable development from the Global North to the Global South. Article VI is still a small, nascent market, but we expect it to grow and countries are looking to buy and sell emissions to each other. In addition to Ghana and Switzerland, after COP27, another transfer was authorized, this time from Thailand to Switzerland. A country like Japan has 26 bilateral agreements with countries around the world and is looking to import emission reductions in the near future. Countries like Singapore, South Korea, New Zealand and Canada are all looking to purchase carbon reduction from abroad. Many countries around the world, mostly developing countries, are preparing and getting ready to become sellers in this market.
09:20Julia Streets: Andrea, just picking up on one of the comments you made there. One project being implemented under the Ghana- Switzerland, Article VI carbon pricing deal is a UN initiative that aims to reduce greenhouse gas emissions from rice cultivation by training local farmers in sustainable agriculture practices. Rice cultivation currently accounts for over 10% of global methane emissions, and this is because the main method of rice farming involves flooding the fields, which prevents oxygen from penetrating the soil, causing a buildup of bacteria. This bacteria emits methane into the atmosphere, contributing to global warming. The United Nations Development Program aims to promote climate- smart rice cultivation for Ghanian farmers, leading to a significant reduction in methane emissions. Stephen Kansuk, Head of Environment and Climate Change at the United Nations in Ghana, speaking from the capital Accra, told us more….
10:18Stephen Kansuk: In Ghana, rice is cultivated as both food and cash crop. Research shows that in 2020, Ghana's total rice consumption was about 1. 4 million metric tons. To support rice farmers to reduce methane emissions in Ghana, the United Nations Development Program, the Ministry of Environment Science Technology Innovation, the Ministry of Food and Agriculture, and the Environmental Protection Agency, all in Ghana, and the future office for the environment in Switzerland are implementing a climate- smart rice project. The project is supporting over 7, 000 rice farmers across Ghana to adopt an alternate wet and drying technology in rice cultivation to reduce methane emissions. This project is one of the initiatives under a partnership between the government of Switzerland and Ghana. The agreement is to allow public and private institutions to collaborate to invest in climate change mitigation interventions in Ghana and exchange carbon credits with Switzerland for payments. In terms of benefits with this climate smart rice project, our target is to achieve about 1. 1 million tons of carbon dioxide equivalents, emission reduction targeted by 2030. The project will also provide extra incomes for the farmers as a carbon revenue through a performance bids payment system, and this will help increase their resilience. The project is also helping to create a number of jobs at the rural level so that they will be able to adapt effectively to the impact of climate change.
12:14Julia Streets: Andrea, I wonder if I could bring you in because there has been some reaction that has accused governments of rich countries of outsourcing their emissions reductions to governments of developing countries. Is that fair?
12:27Andrea Bonzanni: Emissions must be reduced globally irrespective of where they take place. The atmosphere is one at the end of the day. Article VI allows reducing emissions where it's more efficient, deploying capital where it can abate or remove more emissions. Researchers have quantified the cost savings of meeting climate targets used in Article VI will be up to 250 billion US dollars a year by 2030. There is a perception out there that projects reducing emissions abroad replace strong climate action at home. But I don't think there is evidence supporting this thesis. In the longer run, achieving net- zero means that every ton of CO2 emitted must be compensated by a ton of CO2 removed from the atmosphere. It is not rational to believe that all countries, especially European ones, can get to net- zero without using international carbon market mechanisms. International carbon markets deploy investments in things like natural climate solutions or emission removal technologies, such as direct air captures, bioenergy with CCS, and then deploy the capital where these projects are feasible. Not all geographies, not all jurisdictions have the potential to scale these solutions and achieve net- zero within their borders. Rich countries need strong climate action both at home and abroad, and we need carbon markets. We need well- designed one. 80% of countries in their nationally determined contributions said that they're planning to use carbon markets to meet their goals. So, we should start implementing carbon markets soon and let investment flows from rich countries into developing countries.
14:02Julia Streets: So we've explored this from the point of view of what are carbon markets. We've thought about this from an international global sort of point of view, and whether or not this is fair from a jurisdiction point of view. We've also heard about a real case study and its application of where some of this collaboration comes in. Malek, could I ask you, from a corporate point of view, why does this particularly matter to a company like Shell?
14:25Dr. Malek Al-Chalabi: Yeah, thanks. Thanks, Julia. At Shell, we've set a target to become a net- zero emissions energy business by 2050, and our policy positions on climate and energy transition serve as a global framework for Shell's advocacy with governments, international organizations, and associations. This includes supporting government policies that will help the world to achieve net- zero emissions by 2050. A variety of policy tools are required, one of which is carbon pricing, and at Shell, we advocate to put a direct price on carbon emissions as part of a broader policy framework to achieve net- zero emissions. The carbon price, whether through tax, cap and trade, or hybrid system, should apply to as many sectors of the economy as possible and increase over time. Additionally, Shell advocates for greater international cooperation through systems that transfer carbon credits between countries and ensure that international carbon credit transactions have environmental integrity by avoiding double- counting across national inventories. In summary, a carbon price can be an effective mechanism, and success depends on it being part of a comprehensive energy transition policy framework that incentivizes innovation and encourages commercialization of new and clean technologies.
15:33Julia Streets: You talked there about the importance of collaboration. I'm curious, what needs to happen to get more countries trading carbon?
15:41Dr. Malek Al-Chalabi: If we look at the data from the World Bank and look back 30 years, the first carbon prices took place in the 1990s. If we fast- forward today, there's approximately 70 carbon pricing initiatives and, as you've said, covering 25% of the world's emissions, which represents a sizable improvement. But this still means that 75% emissions are still unpriced, and more work needs to be done in this space. I think it's important to recognize a tremendous amount of work to operationalize carbon pricing policies has taken place. The International Chamber of Commerce at COP26 focused on global carbon pricing principles that are needed to help deploy carbon markets, and at COP27, a business review was also done to highlight opportunities for decarbonization. There are 10 principles which include, but are not limited to, focusing on greenhouse gas reduction as a prime target, creating a reliable and predictable overall framework, promoting the linkage of carbon pricing instruments, and ensuring cooperation for greater consistency globally.
16:49Julia Streets: Hasan, earlier you were talking about some of the market dynamics at play. I would love to get your thoughts on what do we need to do if we want to have an ambition for a global price on carbon?
17:01Dr. Hasan Muslemani: First off, I would say it's probably not easy and may not even be possible to have one carbon price that fits all jurisdictions in the world. This is because what may work for a country or a region or a jurisdiction might not work for another. We might have some that prefer a carbon tax mechanism, but others which might prefer a cap and trade, or an emission trading scheme, or ETS for short. Not only that, but the sectors which are included within these different ETSs in the world that we have today are not the same sectors. Some of them might include cement or steel or oil. Some others might include different sectors. To give an example from my own background, which is in steel production in China, specifically. Producing steel in China is much cheaper than in Europe. That's the first thing. The second thing is measures which we have that we can take to lower emissions from steel production in China versus in Europe are different and their costs are different. So, that means that the abatement costs for each company and each country are different. The problem with not having a global price becomes important when trading happens between these regions, so if you're importing or exporting steel into and out of Europe. For that reason, I think carbon prices should be complemented with what we now call carbon border adjustments. The EU has already introduced such a mechanism that will come online as of October of this year. Under these adjustments, what happens is any steel that would be imported from China into the EU will have to face the same carbon tax based on its carbon footprint. In that way, the steel manufacturer is now subject to the carbon price in Europe, the EU ETS price, creating what I would like to call an implicit global carbon price.
18:47Julia Streets: Andrea, I'd love to get your thoughts, if you would, about some of the risks and some of the opportunities for Article VI? And what do skeptics say about its limitations?
18:57Andrea Bonzanni: Well, the opportunities generated by Article VI are obvious. They go down to basic economic theory. We have to reduce or remove emissions where it's more efficient because that will allow us to do it faster and to do more at lower cost. So, we need an international mechanism that brings together countries with access to capital and technologies, but without access to cheaper emission abatement options, and on the other hand, countries without capital and technology, but with plenty of opportunities for reductions. So that's, to me, very clear; it's a mechanism that can work. Some of the risks around Article VI are related to the complexity of these mechanisms, and this is where the skeptics are coming from. Critics have magnified, in some instances, the cases where carbon markets have not delivered what they promised. They highlighted cases where methodologies to calculate carbon reductions were not robust, or measurements overstated the impact of certain projects. However, the industry is aware that markets need to improve, and there are many initiatives to address market integrity.
20:06Julia Streets: Malek, I'd love to get your thoughts about what are your hopes for the carbon markets in the future?
20:12Dr. Malek Al-Chalabi: I think if I build on what Andrea has said, I believe further operationalization of Article VI country- to- country trades increasing in the future would be a welcome development to take place. I think also, as some may know, Article VI. 4, which is the globally led carbon market by the UN, looking to operationalize in the next one to three years would also be another welcome development to help facilitate carbon markets. But also, as Hasan has mentioned, the growth of compliance and voluntary markets would also be a welcome development where countries can continue to use implicit or explicit carbon pricing mechanisms to help further incentivize low and clean technologies at a price that is helping assist decarbonization efforts.
21:07Julia Streets: Gentlemen, I'd love to come to each of you with your closing thoughts for our listeners.
21:12Andrea Bonzanni: Carbon markets need to grow. Growth, growth, growth is what we need. We need to shift gears, scale up markets, both in terms of coverage and in terms of price levels. We said that about a quarter of emissions are priced nowadays, but the World Bank estimates that only 4% are priced at the level that will allow us to achieve the goals of the Paris Agreement. So, whatever the economic and geopolitical situation, we cannot afford to put carbon markets on hold.
21:40Julia Streets: And Malek, what would be the one thing that you think that the audience should hang onto and really take away?
21:45Dr. Malek Al-Chalabi: I think our message would be that to put a direct price on carbon emissions as part of a broader policy framework to achieve net- zero emissions, and whether it's through a carbon tax, cap and trade, or a hybrid, they should apply to as many sectors of the economy as possible and increase over time.
22:04Julia Streets: Hasan, would you agree with that? What would be your message?
22:07Dr. Hasan Muslemani: I think markets have already picked up momentum, and they are here to stay. The next step is really to ensure integrity of what's being traded and sold in the market. That word integrity has really become the buzzword in the carbon market space lately, where we're seeing a lot of quality frameworks being developed to define what is integrity. We have solutions that are being praised as the holy grail of net- zero solutions, such as capturing CO2 directly from air or other solutions, and they're sort of being put in competition with each other. The issue is that we need all the solutions that we can get because in the fight against climate change, we are really in a race against time. Because this task is so critical to us as a human race, if anything, it's much better to be vaguely right than precisely wrong.
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23:00Julia Streets: It's been a wonderful conversation because in such a short period of time, we've thought about the dynamics of the carbon markets; we've thought about some real use cases of how there's been some international collaboration; we've thought about why this matters for different people. But we've also been very considerate in terms of where are some of the limitations and perhaps some of the things that skeptics are talking about. But this is about integrity. This is about momentum, and this is about growth. Exactly as you say, this is all about us using all the tools at our disposal to drive change at pace and at scale. Andrea Bonzanni, Dr. Malek Al- Chalabi, and Dr. Hasan Muslemani, thank you very much for being with us today. You've been listening to The Energy Podcast, brought to you by Shell. Listen and follow for free wherever you get your podcast so you don't miss a single episode. The Energy Podcast is a Fresh Air Production, and I must remind you that the views you've heard today from individuals not affiliated with Shell are their own and not Shell, PLC, or its affiliates. I'm Julia Streets. Thank you for listening, and until next time, goodbye.
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