A Brazilian Emissions Trading Scheme: modelling a legal framework to secure its environmental integrity and ensuring effective reduction of greenhouse gas emissions
by Rodrigo Sales
PhD Candidate
UNSW Law School
October 2017 PLEASE TYPE THE UNIVERSITY OF NEW SOUTH WALES Thesis/DissertationSheet
Surname or Family name: Sales
First name: Rodrigo Other name/s:
Abbreviation fordegree as given in the University calendar:
School: Law Faculty: Law
Title: A Brazilian Emissions Trading Scheme: modelling a legal framework to secure its environmental integrity and ensuring effective reduction of greenhouse gas emissions.
Abstract 350 words maximum: (PLEASE TYPE)
Brazil is one of the world's largest emitters of CO2. However, given its unique emissions profile, which results from its high proportion of land-use related emissions together with the potential availability of renewable energy sources, Brazil possesses enormo s potential to reduce its CO2 emissions and transit to a low-carbon economy. As part of its efforts to mitigate climate change, the Brazilian Government has developed an ambitious voluntary greenhouse gas emissions reduction target and a climate change policy, the Brazilian Climate Change Policy, which foresees that a future Brazilian Emission Reduction Market could be part of the country's efforts to reduce emissions. However, to date, there has been no fonnal adoption of such a market or any governmental indicatior f how it should operate.
This thesis examines the possible development and application of an emissions trading scheme (ETS) in the Brazilian context and analyses whether an ETS would be relevant to assist Brazil in reducing its greenhouse gas emissions. In particular, the thesis addresses the question of what is the most appropriate legal framework for securing environmental integrity in a future Brazilian ETS. To this end, the adoption or consideration of ETS as a climate change policy, both internationally and in relevant national jurisdictions, is examined and a critical analysis of emissions trading in the context of the Brazilian legal system and development dynamics is advanced. The key inherent and contingent features of emerging ETS in the EU, New Zealand and Australia are identified and �malysed, and the potential benefits of an ETS, together with the optimal conditions for its application in the context of the Brazilian greenhouse gas emissions profile and corresponding climate change legal and policy framework are assessed and evaluated. The thesis concludes with an analysis of the conditions for optimal incorporation of an ETS into the Brazilian legal framework, identifying the structural and functional elements needed for a Brazilian ETS to effectively reduce greenhouse gas emissions. By doing so, this thesis models the potential role of ETS in filling a gap in the Brazilian regulatory framework devo!ed to climate change mitigation.
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'I hereby grant the University of New South Wales or its agents the right to archive and to make available my thesis or dissertation in whole or part in the University libraries in all forms of media, now or here after known, subject to the provisions of the Copyright Act 1968. I retain all proprietary rights, such as patent rights. I also retain the right to use in future works (such as articles or books) all or part of this thesis or dissertation. I also authorise University Microfilms to use the 350 word abstract of my thesis in DissertationAbstract International (this is applicable to doctoral theses only). I have either used no substantial portions of copyright material in my thesis or I have obtained permission to use copyright material; where permission has not been granted I have applied/will apply for a partial restriction of the digital copy of my thesis or dissertation.'
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DEDICATION
I dedicate this work to Dr. Kazuo Watanabe, Professor-Doctor of Law at São Paulo University Law School, Brazil; Doctor Honoris Causa, Keio University, Japan.
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ACKNOWLEDGMENT
The experience of pursuing a PhD degree brings one’s personality to different levels of confrontation with his best and worse characteristics, and, at least, provides for a unique opportunity for self-development (if one survives his own inherent difficulties in meeting the requirements demanded by the job). In my case, the challenge was initially fuelled by a genuine desire to deepen my understanding of some aspects of climate change law, a field to which I have dedicated part of my professional lawyering time since its initial embryonic incorporation by the legal industry in the late 1990s. This apparently candid goal was then captured by the much larger demands of a PhD research and writing, and the process became an important vehicle for me to learn some of the intricacies of the complex field of climate change law and its intersection with policy, science and economics. Further, it demanded a systematic study of many important aspects of Brazilian culture, development history and law, the results of which greatly enriched my understanding of the complex and rich background we Brazilians belong to. Hopefully, the results of this intellectual effort are properly reflected in the thesis and may contribute to the studies on climate change policy alternatives, particularly emissions trading schemes, to assist Brazil in meeting the demands towards a low carbon economy. As always, possible contributions of this thesis to this goal would not be possible without the assistance and valuable support of many people, either directly involved in the academic work or by simply being around and supportive in different parts of the journey:
First of all, I express my deep gratitude to my Thesis Supervisor Prof. Rosemary Rayfuse, for believing in my potential as a researcher since our first encounter and being supportive and available through all phases of my PhD. Without her close guidance, this work would not meet the requirements of a PhD. I also thank my co- Supervisor Prof. David Freestone, for his important insights, guidance and support on key phases of the project. This PhD was also enriched by important insights from all UNSW Law School Faculty who acted as Progress Review Panel Members during all phases of the project: Profs and/or Senior Lecturers and Senior Research Fellows Andrew Byrns, Amelia Thorpe, Cameron Holley, David Leary, Jane McAdams (Panel Chair) and Sarah Waddell. Also, Prof. Theunis Roux (Associate Dean/Research) has being always supportive in providing guidance in relation to institutional matters of my candidature. My deep gratitude also goes to Ms. Jenny Jarrett, UNSW Higher Degree Research Officer, whose administrative support throughout all my tenure as a PhD Candidate, either at the UNSW campus or during the last phase of the work, which was completed from Brazil, was always unconditionally given with extreme iv
professionalism, efficiency and elegance. I also received important peer support from other PhD candidates with whom I had the pleasure to share the PhD candidate offices for some very intensive years of dedication to learning, especially Drs. Rebecca Welsh, Tamara Tulich and Wen Wei. At the final stage of this work, I received very special assistance from Luciana Carvalho, Patricia Tagnin and Claudia Guarnieri for copyediting and proofreading services, according to the guidelines laid out in the university-endorsed national ‘Guidelines for editing research theses’, and whom I thank for their attention and professionalism during a very stressful time. I also thank the Examiners who reviewed the first version of this thesis for their time and insightful comments and recommendations for the improvement of the work.
I also express my gratitude to many friends and family members who supported me in different ways during the elaboration of this work: Patricia Andrade and our beloved children Mateus and João, especially for embarking with me on a 4-year journey in Australia; Gilberto Sales, my brother, for his continuous source of inspiration in the environmental arena; my cousin-sister, Mary Aguilera, always available for inspiration in important moments of hesitation on how to conciliate the demands of the research with personal life; my Special Friend Nilce de Oliveira Nascimento Popov, for shedding light on important aspects of life that were extremely helpful in strengthening my abilities to complete this PhD journey; my friend Dr. Paulo Cruvinel, from EMBRAPA, for his continued support of my academic aspirations; my colleagues and friends of Sales & Kesselring Advogados, Ana Beatriz Kesselring, Regina Corchs and Vicente G. Oliveira Filho, for their unconditional support in my efforts to complete this work, and their generosity in filling my absence from my professional duties in many occasions due to my PhD commitments. I also express my gratitude to Anna Paula S. Souza for her lovely and supportive presence in the final sprint of completion of this thesis.
I share a special gratitude to my parents, Kalil Sales (in memoriam) and Maria Igínia Sanches, for their life examples of dedication to the law profession and academic studies, respectively. The unconditional spiritual support and continuous example of professional dedication and discipline given by mother were crucial for the completion of this work.
Finally, I thank John Coltrane, musician, for his musical and life examples that inspired long lonely hours of study and writing. v
ABSTRACT
Brazil is one of the world’s largest emitters of CO2. However, given its unique emissions profile, which results from its high proportion of land-use related emissions together with the potential availability of renewable energy sources, Brazil possesses enormous potential to reduce its CO2 emissions and transit to a low-carbon economy. As part of its efforts to mitigate climate change, the Brazilian Government has developed an ambitious voluntary greenhouse gas emissions reduction target and a climate change policy, the Brazilian Climate Change Policy, which foresees that a future Brazilian Emission Reduction Market could be part of the country’s efforts to reduce emissions. However, to date, there has been no formal adoption of such a market or any governmental indication of how it should operate.
This thesis examines the possible development and application of an emissions trading scheme (ETS) in the Brazilian context and analyses whether an ETS would be relevant to assist Brazil in reducing its greenhouse gas emissions. In particular, the thesis addresses the question of what is the most appropriate legal framework for securing environmental integrity in a future Brazilian ETS. To this end, the adoption or consideration of ETS as a climate change policy, both internationally and in relevant national jurisdictions, is examined and a critical analysis of emissions trading in the context of the Brazilian legal system and development dynamics is advanced. The key inherent and contingent features of emerging ETS in the EU, New Zealand and Australia are identified and analysed, and the potential benefits of an ETS, together with the optimal conditions for its application in the context of the Brazilian greenhouse gas emissions profile and corresponding climate change legal and policy framework are assessed and evaluated. The thesis concludes with an analysis of the conditions for optimal incorporation of an ETS into the Brazilian legal framework, identifying the structural and functional elements needed for a Brazilian ETS to effectively reduce greenhouse gas emissions. By doing so, this thesis models the potential role of ETS in filling a gap in the Brazilian regulatory framework devoted to climate change mitigation. vi
LIST OF ABBREVIATIONS
AAU — Assigned Amounts Units ABC — Agricultura de Baixo Carbono ABNT — Associação Brasileira de Normas Técnicas ABNT NBR — Norma Técnica da Associação Brasileira de Normas Técnicas ACCUs — Australian carbon credit units ANP — Agência Nacional do Petróleo APPs — Areas of Permanent Preservation ASIC — Australian Securities and Investments Commission ATS — Aviation Trading Scheme AU — Australian Units AWG — Ad Hoc Working Group BID — Banco Interamericano de Desenvolvimento BMER — Brazilian Market for Emission Reductions BM&F/Bovespa — Bolsa de Valores, Mercadorias e Futuros BNDES — Banco Brasileiro de Desenvolvimento Econômico e Social BRICs — Brazil, Russia, Índia and China BVRio — Bolsa Verde do Rio de Janeiro CAA — Clean Air Act CAR — Cadastro Ambiental Rural CDM — Clean Development Mechanism CEPAL — Comissão Econômica para a América Latina CER — Certified Emission Reduction CETESB — Companhia Ambiental do Estado de São Paulo CFI — Carbon Farming Initiative CGEE — Centro de Gestão de Estudos Estratégicos CGMC — Coordenação Geral de Mudanças Globais do Clima CH4 — Methane CITL — Community Independent Transaction Log CMI — Carbon Market Institute CNG — compressed natural gas CO — carbon monoxide CO2 — carbon dioxide CO2e — CO2-equivalent COP — Conference of the Parties COPAM — Conselho de Política Ambiental do Estado de Minas Gerais CPI — Corruption Perception Index vii
CPM — Carbon Pricing Mechanism CPRS — Carbon Pollution Reduction Scheme CRA — Cota de Reserva Ambiental CVM — Comissão de Valores Mobiliários DCCEE — Department of Climate Change and Energy Efficiency DETER — Real-Time System for Detection of Deforestation DF — Distrito Federal EC — European Commission ECL — Environmental Crimes Law EEA — European Economic Area EITE — Emissions-intensive-and-traded-exposed industries EMBRAPA — Empresa Brasileira de Pesquisa Agropecuária EPA — Environmental Protection Agency EPE — Empresa de Pesquisa Energética ERPAs — Emissions Reduction Purchase Agreements ERU — Emission Reduction Units ETP — Emissions Trading Program ETS — Emission Trading Schemes EU — European Union EU ETS — European Union Trading Scheme FGV — Fundação Getúlio Vargas FGV-Ces —Fundação Getúlio Vargas - Centro de Estudos Sustentáveis FNI — Fridtjof Nansen Institute FVA — Framework for Various Approaches GAO — Government Accountability Office GDP — Gross Domestic Product GEE — Gases Efeito Estufa GHG — Greenhouse Gases GIZ — Deutchshe Gesellschaft für Internationale Zusammernabeit GmbH GNI — Gross National Income GWP — Global Warming Potential HDI — Human Development Index HFCs — Hydrofluorcarbons IBGE — Instituto Brasileiro de Geografia e Estatística ICAO —International Civil Aviation Organization ICAP — International Carbon Action Partnership INCRA — Federal Agrarian Development Agency IPAM — Instituto de Pesquisa Ambiental da Amazônia viii
IPCC — Intergovernmental Panel on Climate Change IPEA — Instituto de Pesquisa Econômica Aplicada ITL — International Transaction Log JI — Joint Implementation LCA — Long-term Cooperative Action LDC — Least-developed countries LNG — liquefied natural gas LPG — liquefied petroleum gas MCT — Ministério da Ciência e Tecnologia MCTI — Ministério da Ciência, Tecnologia e Inovação MMA — Ministério do Meio Ambiente MRV — Monitoring, reporting and verification MSc —Master of Studies MW — Megawatt N20 — Nitrous Oxide NAMAs —Nationally Appropriate Mitigation Actions NAP — National allocation plan NBER — National Bureau of Economic Research NEPL — National Environmental Policy Law NER —New Entrant Reserve NFC — New Forest Code NGER — National Greenhouse and Energy Reporting NGER Act — National Greenhouse and Energy Reporting Act NGOs —Non-governmental Organizations NMM — New Market Mechanisms NMVOC — Non-Methane Volatile Organic Compounds NOx — Nitrogen Oxides NZD — New Zealand dollar NZ ETS — New Zealand Emissions Trading Scheme NZ ETS — ETS from New Zealand NZEUR — New Zealand Emission Unit Registry NZUs — New Zealand Units OECD — Organisation for Economic Co-operation and Development OTC — Ozone Transport Commission PAC — Programa de Aceleração do Crescimento PES — Payment for Environmental Services PFCs — Perfluocarbons PNMC — Plano Nacional sobre Mudança do Clima ix
PPCD ClCerrado — Plano de Ação para a Prevenção e Controle do Desmatamento e das Queimadas no Cerrado PPCDAm — Plano de Ação para a Prevenção e Controle do Desmatamento da Amazônia Legal RECLAIM — Regional Clean Air Incentives Market REDD — Reducing Emissions from Deforestation and Degradation in Developing Countries RGGI — Regional Greenhouse Gas Initiative RMUs —Removal Units RTTC — Responding to Climate Change SBSTA — Subsidiary Body for Scientific and Technological Advice SEC —Securities and Exchange Commission SEPED — Secretaria de Políticas e Programas de Pesquisa e Desenvolvimento SF6 — Sulfur hexafluoride SIP — State Implementation Plan SO2 — Sulfur dioxide UN — United Nations UNCTAD — United Nations Conference on Trade and Development UNDP — United Nations Development Program UNFCCC — United Nations Framework Convention on Climate Change UNTS — United Nations Treaty Series USD — US Dollar USEPA — US Environmental Protection Agency VAT Fraud — Valued Added Tax fraud VERPAs —Voluntary Emission Reduction Purchase Agreements WCI — Western Climate Initiative WTO —World Trade Organization
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LIST OF FIGURES
Figure 1: Law Nomogenesis ...... 30 Figure 1: Brazil Social-Political Division...... 208 Figure 2: Brazil Biomes...... 209 Figure 3: Demographic Density in Brazil ...... 211 Figure 4: Variation of Emissions per Sector, 2005–10...... 223 Figure 5: Spatial distribution of cattle herd across the Brazilian Territory, with an emphasis on the ten top municipalities 2005...... 227 Figure 6: Geopolitical Planning ...... 229 Figure 7: Arc of Deforestation in the Brazilian Amazon...... 231 Figure 8: Territorial Design in the 1970 Plan for National Integration...... 232
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CONTENTS
Originality Statement ...... i Dedication ...... ii Acknowledgment ...... iii Abstract ...... v List of Abbreviations ...... vi List of Figures ...... x
Chapter I – Introduction ...... 1 1.1 The Formulation of the Problem ...... 1 1.1.1 Brazil and Greenhouse Gases (GHG) Emissions ...... 1 1.1.2 Emission Trading Schemes (ETS) as a Market-Based Climate Change Policy ...... 2 1.1.3 ETS as a policy choice for Brazil ...... 13 1.2 The Objective of the Study ...... 19 1.3 The Research Question ...... 21 1.4 The Theoretical Framework for the Enquiry ...... 24 1.4.1 Challenges posed by a legal investigation of ETS ...... 24 1.4.2 Analytical Framework ...... 26 1.4.2.1 Legal Theory ...... 26 1.4.2.2 Analytical Approach ...... 31 1.5 Methodology ...... 34 1.6 Summary of Chapters ...... 39
Chapter II – The Theory and History of ETS as a Policy Instrument for Mitigating GHG Emissions ...... 42 2.1 Introduction to chapter II ...... 42 2.2 The Theory and History of Emissions Trading ...... 43 2.2.1 Some Important Conceptual Distinctions ...... 52 2.2.1.1 Price and Quantity Mechanisms: The conceptual differences between tax and emissions trading ...... 52 2.2.1.2 Two forms of ETS: cap-and-trade and baseline-and-credit ...... 55 2.3 The Historical Development of ETS: The US Pioneering Experience ...... 58 2.3.1 The USEPA Emissions Trading Program ...... 58 2.3.2 Other US Market-Based Policies ...... 61 2.3.3 The Acid Rain Cap-and-trade Program for SO2 emissions ...... 62 2.3.4 The NOx Budget Program ...... 66 xii
2.4 The Historical Development of ETS: The incorporation of emissions trading concepts into the Climate Change Regime ...... 68 2.4.1 Climate Change Economics ...... 68 2.4.2 Climate Change as a Market Failure ...... 69 2.4.3 Emissions Trading as Carbon Policy ...... 70 2.4.4 The incorporation of ETS by the Climate Change Regime ...... 73 2.4.4.1 The interplay of science, policy and economics ...... 74 2.4.4.2 The Climate Change Regime ...... 77 2.4.4.2.1 The UNFCCC ...... 78 2.4.4.2.2 The Kyoto Protocol ...... 79 2.4.4.2.3. The Kyoto Protocol Market Mechanisms ...... 80 2.4.5 Emerging Carbon ETS ...... 84 2.5 Conclusion ...... 85
Chapter III – The Major Theoretical Principles, Design Elements and Legal Aspects of ETS ..... 90 3.1 Introduction ...... 90 3.2 Guiding Principles and Major Design Options for Emissions Trading Schemes (Cap-and-Trade Schemes) ...... 91 3.2.1 Guiding Principles ...... 94 3.2.2 Major Design Elements ...... 96 3.2.2.1 Scheme Target, Cap-Setting and Stringency ...... 97 3.2.2.2 Scope, Coverage, Opt-In, and Opt-Out Provisions ...... 99 3.2.2.3 Allowance Allocations and Compliance Period ...... 103 3.2.2.4 Allowance Use Rules: Legal Nature, Transfer, Surrender, Cancellation, Validity, Banking, Borrowing ...... 106 3.2.2.5 Relationship with the Kyoto Protocol and Other Emissions Trading Schemes/Linking ...... 108 3.2.2.6 Compliance, Enforcement, Trading Infrastructure, and Governance ...... 110 3.3 The interplay of Emissions Trading with the Law ...... 112 3.3.1 Other Legal Aspects of ETS ...... 112 3.3.1.1 Mandated and Voluntary Emissions Trading Schemes ...... 112 3.3.1.2 ETS Stated Goals ...... 113 3.3.1.3 ETS Stated and Implied Principles ...... 114 3.3.1.4 Legal Nature of Carbon Credits or Allowances ...... 114 3.3.1.5 Legal Modes of Linking ETS ...... 117 3.3.1.6 Implications for Competition, Trade and Investment Laws ...... 120 3.3.1.7 Implications for Tax ...... 120 3.3.1.8 The Interplay of Emissions Trading with Other Relevant Laws and Policies ...... 121 xiii
3.4 Conclusion ...... 122
Chapter IV – Country Studies of ETS Design Elements ...... 127 4.1 Introduction ...... 127 4.2 The rationale for selecting the case studies...... 128 4.2.1 Thebasic structure of the EU ETS, the CPM and the NZ EUTS ...... 135 4.3 Analysis of ETS Objectives/Goals and Principles in Europe, Australia and New Zealand ...... 136 4.3.1 ETS Stated Goals ...... 136 4.3.2 ETS Stated and Implied Principles ...... 140 4.4 ETS Major Design Elements/Functional Features ...... 143 4.4.1 Scheme Target, Cap-setting, and Stringency ...... 144 4.4.2 Scope, Coverage, and Opt-in and Opt-out Provisions ...... 150 4.4.2.1 EU ETS Sectors, Gases and Point of Obligation ...... 150 4.4.2.2 EU ETS Opt-in and Opt-out Provisions ...... 153 4.4.2.3 CPM Sectors, Gases and Point of Obligation ...... 153 4.4.2.4 CPM Opt-in Requirements ...... 156 4.4.2.5 CPM Exempted Sectors and Activities ...... 156 4.4.2.6 CPM Re-allocation of Liability Arrangements ...... 158 4.4.2.7 NZ ETS Sectors, Gases and Point of Obligation ...... 159 4.4.2.8 NZ ETS Post-1989 Forest Opt-in ...... 161 4.4.2.9 NZ ETS Point of Obligation ...... 162 4.4.2.10 Discussion ...... 162 4.4.3 Allowance Allocations and Compliance Period ...... 166 4.4.3.1 The CPM Assistance Package ...... 170 4.4.3.2 Discussion ...... 171 4.4.4 Allowance Use Rules: Legal Nature, Transfer, Surrender, Cancellation, Validity, Banking, and Borrowing ...... 174 4.4.5 Relationship with the Kyoto Protocol and Other Emissions Trading Schemes/Linking ...... 179 4.4.5.1 CPM and The Carbon Farming Initiative ...... 182 4.4.6 Compliance, Enforcement, Trading Infrastructure, and Governance ...... 185 4.4.6.1 Penalties ...... 186 4.4.6.2 MRV and Registries ...... Error! Bookmark not defined. 4.5 Conclusion ...... 193 4.5.1 Considerations on Phased or Staged Implementation and Minimum Infrastructure ...... 202 4.5.2 Clear and Comprehensive State Objectives and Principles ...... 203 4.5.3 Environmental Integrity ...... 203 4.5.4 Cap setting and allowance allocation ...... 203 4.5.5 Linking and ETS Efficiency and International Cooperation ...... 204 xiv
Chapter V – The Brazilian Climate Change Profile ...... 205 5.1 Introduction ...... 205 5.2 Country Profile ...... 207 5.2.1 Legal Compliance and Enforcement Culture and Infrastructure ...... 214 5.3 Brazil and Climate Change ...... 217 5.3.1 Brazil GHG emissions Profile ...... 217 5.3.1.1 Brazilian GHG emissions Inventory as per the Second National Communication to the UNFCCC/ Emission Profile: 1990–2005 ...... 218 5.3.1.1.1 Aggregate Emissions and Emissions by Sectors as of 2005 ...... 219 5.3.1.2 Brazilian 2013 Annual GHG Emissions Estimates/ Emissions Profile: 2005–2010 .... 221 5.3.2 Key Dynamics of Brazilian GHG Emissions History and Trajectories ...... 223 5.3.2.1 Land-Use and Agriculture ...... 224 5.3.2.2 Energy Matrix ...... 238 5.3.2.3 Industrial Development ...... 240 5.4 Conclusion ...... 241
Chapter VI – The Brazilian Climate Change Regime ...... 245 6.1 Introduction ...... 245 6.2 Brief Overview of the Brazilian Legal System ...... 246 6.3 Brazil and the International Climate Change Regime ...... 249 6.3.1 Brazil and the Kyoto Protocol Market Mechanisms ...... 251 6.4 Brazilian Legal and Policy Approach to GHG emissions ...... 252 6.4.1 Brazil Voluntary Emissions Reduction Targets by Sector and Biome ...... 252 6.4.1.1 Projected Emissions by 2020: ...... 253 6.4.1.2 Emission Reductions by Sectors or Biomes: ...... 253 6.4.2 Brazil’s main policies aimed at implementing the voluntary emissions reductions pledge .. 254 6.4.2.1 Biome/Regional Based Programs ...... 259 6.4.2.2 Sectoral Plans ...... 262 6.4.2.3 Accounting-Based Funds and Financial Lines ...... 265 6.4.2.4 Brazilian Forest Code ...... 267 6.5 Conclusion ...... 269
Chapter VII – Applying the Emerging ETS Experience to the Brazilian Context: policy choices, design elements and legal framework that optimize emission reductions and integration with the climate change regime and the carbon market ...... 273 7.1 Introduction ...... 273 7.2 What does the ETS experience tell us? ...... 274 7.2.1 Major Advantages and Pitfalls for Adopting an ETS as a Climate Change Policy ...... 277 xv
7.2.1.1 ETS Environmental and Economic Impacts: Can an ETS provide effective GHG emission reductions? Can it do it cost-effectively? ...... 277 7.2.1.1.1 Environmental Effectiveness: ...... 279 7.2.1.1.2 Economic Efficiency: ...... 280 7.2.2 Major ETS pitfalls or perverse effects ...... 281 7.2.2.1 Lack of Credibility/Legitimacy due to loose caps and over-allocation of allowances: 281 7.2.2.2 Unfair distributional effects: ...... 281 7.2.2.3 Windfall Profits and Distributional Unfairness: ...... 282 7.2.2.4 Risks of Market Power: ...... 282 7.2.2.5 Risks of Market Fraud: ...... 282 7.2.2.6 Leakage: ...... 283 7.2.3 Other relevant aspects to be considered ...... 283 7.2.3.1 Political Acceptance: ...... 283 7.2.3.2 Enforcement and Monitoring Approach: ...... 284 7.2.3.3 Interconnectedness with other policies and jurisdictions: ...... 285 7.2.4 Implementation Lessons ...... 285 7.2.4.1 Staged Implementation ...... 285 7.2.4.2 Governance and Monitoring Infrastructure ...... 285 7.3 Is it worthwhile to include an ETS in the Brazilian response to climate change? Why? If so, how or under which conditions? ...... 286 7.4 Conclusion ...... 289
Chapter VIII – General Conclusion ...... 294 8.1 Introduction ...... 294 8.2 Structural Elements for a Brazilian ETS to Ensure Reduction of GHG emissions ...... 295 8.2.1 Brazilian ETS Major Goals and Principles ...... 295 8.2.2 Brazilian ETS Integration with the National Legal Framework ...... 295 8.2.2.1 Integration with the Brazilian Legal System ...... 295 8.2.2.2 Integration with Brazilian Climate Change Laws and Policy ...... 297 8.2.2.3 Integration with Other Relevant National Laws and Policy ...... 298 8.2.3 Brazilian Major Institutional Frameworks to govern an ETS ...... 299 8.3 Functional Elements for a Brazilian ETS to Promote Reduction of GHG Emissions ...... 302 8.3.1 Brazilian ETS Design Elements to effectively reduce emission ...... 302 8.3.1.1 Stringency of the cap ...... 303 8.3.1.2 Industrial Coverage ...... 303 8.3.1.3 Permit Allocation Methods ...... 304 8.3.1.4 Linking ...... 304 8.4 Major Legal Issues to be addressed in development and implementation ...... 304 xvi
8.5 Implications of Linking a Brazilian ETS to other National or International ETS ...... 306 8.5.1 Structural Elements for Bilateral or Multilateral Linking with other Emissions Trading Schemes ...... 306 8.5.1.1 Integration with Brazilian Commitments under the International Climate Change Regime ...... 306 8.5.1.2 Integration with other Emissions Trading Schemes – Bilateral Linking ...... 307 8.5.1.3 Integration with International Emissions Trading Schemes – Multilateral Linking ..... 308 8.5.2 Functional Elements for Bilateral or Multilateral Linking with other Emissions Trading Schemes ...... 308 8.5.2.1 Legal Nature of Linking Mechanisms ...... 308 8.5.2.2 Design Features for Linking ...... 308 8.6 The Contribution by The Thesis and Future Research ...... 309
Bibliography ...... 312 A Articles/Books/Reports ...... 312 B Cases ...... 349 1. Europe ...... 349 C Legislation ...... 350 1 Australia ...... 350 2 Brazil ...... 351 3 European Union ...... 352 4 New Zealand ...... 353 5 United States ...... 353 D Treaties and Protocols ...... 354
1
CHAPTER I – INTRODUCTION
1.1 The Formulation of the Problem
1.1.1 Brazil and Greenhouse Gases (GHG) Emissions
Brazil is one of the largest countries on the globe. Ranked fifth largest by area, it is the largest country in South America and the largest contiguous territory in the Americas. In addition to its sizeable geographical area, Brazil has been ranked among the fifth to eighth wealthiest economies in recent years,1 possessing reasonably well- developed industrial infrastructure, as well as one of the most robust agribusiness sectors in the world.2 Nevertheless, despite its size and wealth, Brazil has one of the lowest income distribution rates.3 Indeed, it has been noted that ‘Brazil combines the environmental problems of an industrialized country with all the environmental choices and challenges facing a developing one.’4
One of the environmental problems Brazil shares with the industrialized world is GHG emission. Brazil ranks as one of the largest emitters of GHG in the world.5
1 The World Bank, Country Profile, Brazil Overview,
2 Ibid.
3 The World Bank, Data by Country, Brazil,
4 Kathryn Hochstetler and Margaret E. Keck, Greening Brazil: Environmental Activism in State and Society (Duke University Press, 2007) 224.
5 Exact ranking of countries as GHG emitters may differ from time to time due to punctual changes in each country’s emission profile in a given year or due to the methodologies used by each institution that provides this kind of information. The United Nations Framework Convention on Climate Change, adopted 9 May 1992, 1771 UNTS 107, (entered into force 21 March 1994) (UNFCCC) provides for detailed emissions inventories to be submitted by each country, but does not rank them. See UNFCCC ‘Greenhouse Gas Inventory Data’
However, the profile of Brazilian GHG emissions is unique when contrasted with other large economies. The largest part of Brazilian emissions results from land-use and land- use-change activities, particularly from deforestation stemming from agriculture and forestry activities.6 Emissions from the growing Brazilian industry base are also significant, mainly in the steel and cement sectors,7 and are likely to continue to increase as the country furthers its industrialization. However, due to the high proportion of land-use related emissions, Brazil is considered to be among the five countries in the world with the largest potential to reduce such emissions.8 The question is what policies can be adopted to ensure that such emissions reductions can be achieved.
1.1.2 Emission Trading Schemes (ETS) as a Market-Based Climate Change Policy
In the light of the current needs of Brazil to mitigate GHG emissions, the consideration of market-based mechanisms9 offers important insights for identifying the
– Centro de Gestão de Estudos Estratégicos – CGEE, 15, suggests that Brazil is responsible for 3% to 4% of the global GHG emissions. See also the World Resources Institute website for consolidated emissions data from Brazil for the 1990-2011 period
6 Ministry of Science and Technology of Brazil (‘MCT’) – General Coordination on Global Climate Change, Second National Communication of Brazil to the United Nations Framework Convention on Climate Change (Brasilia, 2010)
7 MCTI,‘2013 Brazilian GHG Inventory’, above n 6; McKinsey& Company, ‘Pathways to a Low-Carbon Economy for Brazil’ above n 5, 16-7 and 20.
8 McKinsey & Company, ‘Pathways to a Low-Carbon Economy for Brazil’ above n 5, 5-6. According to this source, the Brazilian potential GHG abatement volume is huge, positioning the country behind only the US, China and India ‘in terms of absolute reduction in emission volume.’ See also Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’ above n 6, 35.
9 Market-based instruments herein defined as ‘aspects of laws or regulations that encourage behavior through market signals, rather than through explicit directives regarding pollution control levels or methods.’ Robert Stavins, ‘Market-Based 3
most appropriate policy mix for Brazil. Although the theory on the use of market-based mechanisms to mitigate pollution is not new,10 the climate change debate has reinvigorated the discussions around its foundations and policy experiences. In this context, GHG pollution is seen as an externality since those who benefit from their emissions do not bear the social costs or damage they cause to public goods.11 GHG pollution is also considered a market failure to the extent that market forces do not take into account the social costs of production and consumption of goods; such social costs are not reflected in the product price.12 Within this framework, ETS and carbon taxes, along with subsidies, are the main economic tools to inform policy by ‘pricing’ pollution.13 In the light of this theoretical framework, an ETS can be generally defined as a market-based approach to reducing emissions.
There are many variations of ETS, including baseline-and-credit, offset and ‘cap- and-trade’ schemes. Of particular interest to this study is the cap-and-trade ETS format.14 Under the cap-and-trade variation, an ETS places a limit on emissions from
Environmental Policies: What can We Learn from U.S. Experience (and Related Research)?’ in Jody Freeman and Charles D. Kolstad (editors), Moving to Markets in EnvironmentalRegulation: Lessons from Twenty Years of Experience (Oxford University Press, 2007) 19.
10 As detailed in chapter II of this thesis, the theoretical foundations for using pricing and market-based mechanisms in pollution control is credited to the following authors: Arthur C. Pigou, The Economics of Welfare (Macmillan, London, 1946, first published in 1920); Ronald Coase, ‘The Problem of Social Cost’ (1960) 3 The Journal of Law and Economics 1; T. Crocker, ‘The structuring of atmospheric pollution control systems’ in H. Wolozing (ed.), The Economics of Air Pollution (W.W. Norton, 1966); John H. Dales, Pollution, Property and Prices (University of Toronto Press, 1968).
11 T.H. Tietenberg,Emissions Trading: Principles and Practice (Resources for the Future, 2006) 2-5; Jonas Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading (MIT Press, 2011), 51-2; Fanny Missfeldt and Jochen Hauff, ‘The role of Economic Instruments’, in Anthony D. Owen and Nick Hanley (editors), The Economics of Climate Change (Routledge, 2004) 115.
12 A good summary on the application of the concepts of externality and market failure in climate change economics is given by Nicholas Stern, The Economics of Climate Change – The Stern Review (Cambridge University Press, 2008), ch 2. According to Nicholas Stern, climate change is a market failure ‘on the greatest scale the world has seen.’ Ibid, 27. See also Arnaud Brohé, Nick Eyre and Nicholas Howarth, Carbon Markets: an international business guide (Earthscan, 2009), 22-8.
13 Missfeldt and Hauff, ‘The role of Economic Instruments’ above n 11, 115.
14 As a result, ETS will be generally referred to the cap-and-trade ETS variant unless specified differently in this thesis. As it will be seen in chapter II of this thesis, some cap- and-trade schemes can encompass elements of those other variants, which sometimes are 4
certain entities (through the allocation of emission rights): the cap function. It then allows those who reduce their emissions below their individual limit to sell their excess rights to offset emissions from other sources: the trade function.15 The rationale behind an ETS is that it may create an economic incentive to companies to invest in emission reductions by allowing them to profit from credits sold to larger polluters.16 As a result, in theory, an ETS would allow companies to effectively reduce their emissions in a more economically efficient manner in comparison with other policy alternatives (especially command-and-control regulations).17 However, it is important to note that the alleged environmental and economic benefits of an ETS will largely depend on its ultimate design.18 In other words, ETS design will be key to ensuring whether, and if so to what extent, emissions reductions will be achieved, and at what level of cost.19 An ETS must provide for the right balance between the environmental integrity of the scheme (effectiveness in inducing GHG emissions reductions), and its economic efficiency (emission reductions being achieved at the lowest cost possible in comparison with other policy alternatives). If the scheme does not operate this way, it
referred to as ‘hybrid’ ETS. See Anja Kollmus et al, Handbook of Carbon Offset Programs: Trading Systems, Funds, Protocols and Standards (Earthscan, 2010), 7-10; see also Ross Garnaut, The Garnaut Climate Change Review – Final Report (Cambridge University Press, 2008) 310.
15 Judson Jaffe and Robert N. Stavins, ‘Linkage of tradable permit systems in international climate change policy architecture’ in Joseph E. Aldy and Robert N. Stavins (editors) Post-Kyoto International Climate Policy: Implementing Architectures for Agreement (Cambridge University Press 2010) 121; Jon Birger Skjærseth and Jørgen Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation (Ashgate 2008), 2; T. H. Tietenberg, Emissions Trading: Principles and Practice, above n 11, 27.
16 Jaffe and Stavins, ‘Linkage of tradable permit systems in international climate change policy architecture’ above n 15; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 15.
17 Stavins, ‘Market-Based Environmental Policies: What can We Learn from U.S. Experience (and Related Research)?’ above n 9; see also Stefan E. Weishaar, Emissions Trading Design: A Critical Overview (Edward Elgar, 2014) 12-14.
18 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementationabove n 15; Weishaar, Emissions Trading Design: A Critical Overview above n 17, 5-6; Garnaut, The Garnaut Climate Change Review, above n 14, 322; Stern, The Economics of Climate Change –The Stern Review, above n 12, 375.
19 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 15; Weishaar, Emissions Trading Design: A Critical Overview above n 17, 5-6; Garnaut, The Garnaut Climate Change Review, above n 14, 322; Stern, The Economics of Climate Change - The Stern Review, above n 12, 375.
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poses the risk of being a symbolic climate change policy with no material impact on lowering emissions. In such cases, there is no real justification for it being adopted as a climate change mitigation tool.
Admittedly, support for ETS as an effective GHG reduction mechanism is far from unanimous. Despite important studies such as the Stern Review voicing support20 for an international climate change regime centred on a global emissions trading scheme, many other scholars have questioned the efficacy of ETS as a tool to price carbon in comparison with other instruments such as a carbon tax, as discussed in more detail in chapter 2, section 2.2.1.1. Among those economists who voice a preference for tax as a price mechanism as opposed to an ETS, William Nordau’s is one of the most cited by the literature, arguing as key factor for his preference the conceptual simplicity of designing and implementing carbon tax (or even a harmonized carbon tax to be implemented internationally), its higher capacity or raising revenues to be re-distributed to low-income householders or to climate change research, and its immunity to trading prices volatility.21 Others have challenged ETS potential to effectively reduce greenhouse emissions, while others have challenged the ethics and equity of using
20 Stern, The Economics of Climate Change – The Stern Review above n 12, 543; see also Ross Garnaut, The Garnaut Review 2011: Australia in the Global Response to Climate Change (Cambridge University Press, 2011) 70.
21 William Nordhaus, A Question of Balance: Weighting the Options for Global Warming Policies (Yale University Press, 2008), 148-164 and 202-03. As an alternative to a pure price-based/ tax system, Nordhaus also explores the adoption of hybrid approaches that ‘might combine the strengths and of both quantities and prices approaches.’Ibid, 203. See also William D. Nordhaus ‘To tax or not to tax: Alternative approaches to slowing global warming’ (2007) 1 (1) Review of Environmental Economics and Policy 26; and William Nordhaus, The Climate Casino: Risk, Uncertainty, and Economics for a Warming World (Yale University Press, 2013). For a list of other authors favoring tax over ETS, see Gilbert E. Metcalf and David Weisbach ‘Linking Policies When Tastes Differ: Global Climate Policy in a Heterogeneous World’ (2012) 6 (1) Review of Environmental Economics and Policy 110, 122. Both alternatives are compared extensively in the ETS literature. For more recent concise and well-structured comparisons see Ruud de Mooij, Ian W.H. Parry, and Michael Keen (eds) Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers (IMF, 2012); see also International Monetary Fund, ‘Promising Domestic Fiscal Instruments For Climate Finance’ (International Monetary Fund, 2011)
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market mechanisms as a means of resolving the climate change problem.22 More recent accounts in the law and policy literature on emissions trading, claim that for the most part the literature has focused on promoting ETS, as opposed to providing an in-depth analysis of its main characteristics, and identifying and analysing its more critical legal aspects.23 Others point out that the ETS discussion is largely driven by a ‘quasi- ideology’ approach that glorifies price mechanisms without proper consideration of the real world context in which they should operate.24 Driesen, in particular, calls for a ‘third generation debate on instrument choice and design that goes beyond glorifying or demonizing markets by asking questions about price’s capabilities and limitations that can illuminate environmental policy and law.’25
Regardless of the criticism voiced in some of the literature, ETS have received strong support as a policy option for the ‘post-Kyoto’26 international climate change regime. Since the implementation of the European Union Trading Scheme (EU ETS) in 2005, Norway, New Zealand, Australia, Kazakhstan, and Switzerland have enacted national schemes in 2005, 2008, 2011, and 2013 respectively.27 In China, design of
22 See Clive L. Spash, ‘The Brave New World of Carbon Trading’ (2010) 15 New Political Economy, 169, 171-72 and 188; see also Vandana Shiva, Soil Not Oil: Climate Change, Peak Oil, and Food Insecurity (Pinifex Press, 2008) 16-24. See also Jutta Kill et al, Trading carbon: How it works and why it is controversial (FERN, 2010); and Larry Lohman, ‘Carbon Trading: a critical conversation on climate change, privatisation and power’ (2006) 48 Development Dialogue 1
23 Sanja Bogovejic, ‘Ending the Honeymoon: Deconstructing Emissions Trading Discourses’ (2009) 21 (3) Journal of Environmental Law 443, 447. Prof. Sanja expands her arguments in Sanja Bogojevic Emissions Trading Schemes: Markets, States and Law (Hart Publishing, 2013). Ibid, 5-12.
24 David M. Driesen, ‘Putting a Price on Carbon: The Metaphor’ (2014) 44 Environmental Law 695, 711-2.
25 Ibid698.
26 The international regime following the first commitment period of the 1997 Kyoto Protocol to the UN Framework Convention on Climate Change, adopted 11 December 1997, 2303 UNTS 148 / [2008] ATS 2 / 37 ILM 22 (1998) (entered into force 16 February 2007) (Kyoto Protocol), that ended in 2012.
27 Constanze Haug et al (editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2014’ (ICAP January 2014); Camille Serre et al (editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2015’ (ICAP February2015);The World Bank, ‘State and Trends of Carbon Pricing’ (World Bank, 2014)
seven pilot ETS programs were initiated in major provinces and cities (Beijing, Chong, Guangdong, Hubei, Shanghai, Shenzhen, and Tianjin) in the course of 2010 and 2011, in order to test the possible adoption of a national ETS as part of the GHG mitigation efforts and renewable energy targets announced in the 12thChinese Government Five- Year Plan (2011-15).28These ETS pilots commenced operating in 2013 and 2014,29 and, in 2014 the Chinese Government has published interim rules for a national ETS, originally planned to be launched in 2016.30 The Republic of Korea passed a mandatory ETS law in 2012, and the first Korean ETS commitment period commenced in 2015.31
Initiatives: Developments and Prospects’, Washington D.C., May 2013, 10-11
28 Serre et al (editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership– ICAP Status Report 2015’, above n 27 14-15; Weishaar, Emissions Trading Design above n 17, 89-96.The Chinese Five-Year Plans are guidelines approved by the Chinese National People's Congress, China’s higher legislative body, which devise key economic and development targets for the country for the next five-year period. See British Chamber of Commerce in China/China-Britain Business Council ‘China's Twelfth Five Year Plan (2011- 2015)- the Full English Version’
29 Serre et al (editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2015’, above n 27, 14. Although such pilots have been launched by 2014, only Beijing and Shenzhen have passed the legislation through their local congress by the time. Ibid.
30 ICAP News, ‘NRDC Publishes basis rules for national ETS’ (December 17, 2014)
31 Serre et al (editors) above n 27 ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2015, 53 27; The World Bank, ‘State and Trends of Carbon Pricing’ above n 27; ICAP – International Carbon Action Partnership, ‘ETS Detailed Information: Korea Emissions Trading Scheme (August 5, 2016)
Recently authorized or proposed ETS legislation has also been passed in Chile, Mexico, Turkey, Costa Rica, and Ukraine, among others, in addition to local and inter-city ETS initiatives in Japan, including a mandatory ETS in Tokyo.32
In North-America, sub-regional, regional, and local mandatory ETS schemes currently in operation include important initiatives in the US and Canada, such as the US Regional Greenhouse Gas Initiative (RGGI),33 the Western Climate Initiative (WCI),34 the California Cap-and-Trade Program, the Québec Cap-and-Trade System, and the Alberta Cap-and-Trade Scheme.35In September 2013, the California and Québec
period of the Korean ETS although it does not affect the research or reasoning of the thesis.
32 The World Bank, ‘State and Trends of Carbon Pricing’ above n 27, 49-69. See also Ed Harris, ‘China’s emissions trading scheme in line for 2020 launch’, RTTC – Responding to Climate Change, 9 April 2013
33 RGGI is an initiative by Northeast and Mid-Atlantic states to reduce greenhouse emissions. RGGI claims to be ‘the first market-based regulatory program in the United States to reduce greenhouse gas emissions.’ RGGI is a cooperative effort among the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont aiming to cap and reduce CO2 emissions from the power sector. See
34 The Western Climate Initiative planned to establish the basis for an international cap- and-trade scheme, involving initially the US and Canada. It originally included the US states of Arizona, California, Montana, and New Mexico, Oregon Utah and Washington and the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec. It also included other observer states from the US and Mexico. Different from RGGI, the WCI currently works as a non-profit organization that has proposed guidelines and given support to the affected states implementing ETS. See
35 The literature on the North American ETS regional initiatives is vast. See for example Brohé et al, Carbons Markets: An International Business above n 12, 153-197; Erik Haites and Michael Mehling, ‘Linking Existing and proposed GHG emissions trading schemes in North America’ in Andreas Tuerk (editor) Linking Emissions Trading Schemes (2009) 9 (4) Climate Policy 339, 373-388; For more recent summaries on the WRI and the Canadian ETS in Alberta and Québec, see Shaun Fluker and Salimah Janmohamed ‘Who Regulates Trading in the Carbon Market?’(2014) 26 Journal of Environmental Law and Practice 83,100-108; see also Weishaar, Emissions Trading Design,above n 17, 74-82. 9
Governments announced the linking of their two subnational mandatory ETS.36 These subnational initiatives are, in part, a reaction to the political struggle in the US in relation to passing climate legislation at the Federal level. In fact, a series of climate change bills, most of them proposing some kind of emissions trading have been discussed in the U.S. Congress over the last few years,37with at least one being approved by the House, although it did not receive enough votes to pass in the Senate.38
Although some political and economic pressures in the US, particularly from the fossil-fuel industry and their political allies, had diminished the impetus for approving a national ETS under the Obama administration, prior to the results of the 2016 presidential election,39a shift towards a more proactive approach appeared to be under way. Indeed, the momentum created by the2015 deadline for an international agreement under the United Nations Framework Convention on Climate Change (UNFCCC),40
36 Shaun and Janmohamed, ‘Who Regulates Trading in the Carbon Market?’, above n 35, 106-107; California EPA Air Resources Board and Gouvernement Du Québec, ‘The Agreement Between the California Air Resources Board and the Gouvernement Du Québec Concerning the Harmonization and Integration of Cap-and-Trade Programs for Reducing Greenhouse Gas Emissions’ (September 2013)
37 In their account of 2009, and based on previous research of the Pew Center on Global Climate Change, Brohé et al listed 10 bills of law in both the US house and senate focusing on emissions trading or related pricing instruments. Brohé et alCarbon Markets: an international business guide,above n 12, 159-183.
38 The American Clean Energy and Security (Waxman-Marckey) Bill was passed by the House in June 2009 to be further refused by the Senate. Robert Reppeto America’s Climate Problem: The Way Forward (Earthscan, 2011), 157-164. Reppeto describes in detail the process of construction of this Bill and the rejection of this and any other broad climate policy by the US Senate. According to this author, the convservative position of the US Senate is largely a result of fossilfuel industry lobbying. Ibid.
39 This thesis was submitted for examination in August 2015. In revising thethesis mention has been included of the recent U.S. election and the December 2015 Paris Agreement although neither of these affect the research or reasoning of the thesis.
40 The 2015 target was established by the UNFCCC ‘Durban Platform for Enhanced Action’ that pledge to all Parties reaching an agreement in 2015 that would bind all 10
coupled with new scientific evidence of the rising trajectory of global emissions41was hoped to ultimately push the US to revive the political agenda for a Federal Emissions Trading Scheme. The ‘Clear Power Plan’ issued by the Obama Administration on 3 August2015, which considered an ETS mechanism, was considered a sign of this trend.42While the future of a national U.S. ETS under a Trump administration remains unclear, at the international level, the outcome of the Paris Agreement does nothing to foreclose consideration of market mechanisms as part of the global response to climate change.43It is important to note, however, that the implementation of each of these existing and emerging ETS has been subject to the same intense political debate and uncertainty that has characterized much of the debate surrounding climate change policy choices.44 Indeed, to a large extent, political uncertainties relating to climate change policy are a reflection of the domestic and international clash of economic forces trying
countries by 2020 (UN Doc FCCC/CP/2011/9/Add.1, Decision 1/CP.17)
41 IPCC – Intergovernmental Panel on Climate Change, Climate Change 2014 – Impacts, Adaptation and Vulnerability – Summary for Policymakers (IPCC, 2014)
42 U.S. EPA – Overview on the Clean Power Plan: Cutting Carbon Pollution from Power Plants – Fact Sheet (August, 2015), 6- 7.
43 The pledge raised by the ‘Durban Platform for Enhanced Action’ culminated in the ‘Paris Agreement’ that advanced some major guidelines to assist countries in holding ‘the increase in the global average temperature to well below 2ºC above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5ºC above pre—industrial levels’: UNFCCC Rerport of the Conference of the Parties on its twenty-first session, held in Paris from 30 November to 13 December 2015 (‘UNFCCC COP-21’), Decision 1/CP.2, ‘Adoption of the Paris Agreement’ (UN Doc FCCC/CP/2015/10/Add.1, paragraph 2 (a)). The Paris Agreement does not maintain the Durban Plaftorm pledge to a globally binding agreement by 2020; rather it provides a more ambitious pledge on global average warming reduction and a work plan on how such reduction can be reached on an aggregate level through individual actions by each country known as ‘intended nationally determined contributions’ (INDC) which, regardless of their legal nature, count towards the achievement of the UNFCCC objectives. Even today, the final architecture of a new international climate change regime is still pending. However, the possible consideration of market mechanisms as part of such a regime remains valid.
44 The uncertainty surrounding climate change policies, including ETS, is well reflected by the Australian case where the Australian ETS legislation passed in 2011 by the Labour Party government after a long political debate was repealed in 2014 by the subsequent Liberal Coalition prime-ministership, as further discussed in chapter IV, section 4.2 of this thesis.
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to influence the path and pace of the transition to a low-carbon economy, in the light of the structural changes that may be required in production and consumption patterns.45
Given the complex political debates in most national jurisdictions and the uncertainties in the on-going international climate negotiations, the ultimate role of a global ETS in the post-Kyoto regime remains unpredictable. Nevertheless, according to some recent accounts, although a top-down harmonized global ETS (as suggested by Stern and others) has not yet materialized, a bottom-up market built from a multitude of ETS systems may be emerging.46 As noted above, ETS have increasingly become the policy of choice for many states in dealing with their respective announced emission reduction targets, and prospects for linking some of these schemes have increased in recent years, such as Quebec and California and the EU ETS and the Swiss ETS.47 Further, despite the architecture of a new international climate change regime not having been yet been defined, ‘it is widely believed that a market mechanism offers potential benefits’ and should be included in a renewed UNFCCC agreement or any other agreed outcome with legally binding force to be decided by the UNFCCC Parties.48 Not surprisingly, market mechanisms and their corresponding instruments of
45 The Global Commission on Economy and Climate, ‘The New Climate Economic Report: Better Growth, Better Climate’, Synthesis Report (Sept. 2014) 8.
46 Haug et al(editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2014’ above n 27, 4; Ecofys (By order of the World Bank), ‘Mapping Carbon Pricing Initiatives: Developments and Prospects’, above n 27, 13 and 19-20; See Jacqueline Peel, ‘Divergent Responses to Climate Change in a Multipolar World: A View from Down Under’ (2013) 107 American Society of International Law Proceedings 76. See also Sebastian Goers and Barbara Pflüglmayer, ‘Post-Kyoto Global Emissions Trading: Perspectives for Linking National Emissions Trading Schemes with the EU ETS in a Bottom-Up Approach’ (2012) 3 (3A) Low Carbon Economy 69 10.4236/lce.2012.323010; Metcalf and Weisbach ‘Linking Policies When Tastes Differ: Global Climate Policy in a Heterogeneous World’, above n 21. Regardless the approach, the World Bank has estimated that ‘over 60 countries or sub- national jurisdictions now have a carbon price in place or in development – with the world’s emissions trading programs covering USD30 billion worth of emissions.’ The World Bank, ‘State and Trends of Carbon Pricing’ above n 27, 15-6 and 48-70.
47 Haug et al(editors) ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2014’ above n 27, 4; Serre et al (editors) above n 27 ‘Emissions Trading Worldwide: International Carbon Action Partnership – ICAP Status Report 2015, 10-11 and 29-31.
48 Erik Haites, Farhana Yamin and Niklas Höhne ‘Possible Elements of a 2015 Agreement to Address Climate Change’ (2014) 8 (1) Carbon and Climate Law Review 3.
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implementation remain one of the negotiation items on the ongoing international climate change agenda49 and among the main policy options considered by the IPCC Fifth Assessment Report.50 Other important multilateral institutions, such as the World Bank51 and the International Monetary Fund,52 are also promoting the inclusion of
49 COP17 held in Durban in 2011 created a mandate for the UNFCCC Ad Hoc Working Group on Long-term Cooperative Action (AWG-LCA) to explore options for ‘New Market Mechanisms – NMM– wichshould ‘enhance the cost-effectiveness of, and to promote, mitigation actions, bearing in mind different circumstances of developed and developing countries’Decision 2/CP.17, paragraph 83. NMM options were further explored by the Subsidiary Body for Scientific and Technological Advice (SBSTA) following decisions undertaken in COP 18; Decision 1/CP.18, paragraph 50. Pursuantto this mandate, the SBSTA has explored at least three options for NMM, two confined to a baseline-and credit approach (aligned with the Kyoto Protocol flexible mechanisms of the first compliance period) and one including the incorporation of emissions trading. See UNFCCC, Subsidiary Body for Scientific and Technological Advice ‘New Market Mechanism: Technical Paper’ UN Doc FCCC/TP/2014/11 (16) to (33). (SBSTA, November 24, 2014).
Nearly half of the Parties that communicated an INDC indicated their intention to use market- based mechanisms, with some Parties identifying those instruments as a condition for the implementation of their INDCs. These Parties explicitly noted plans to use carbon credits from international, regional or domestic schemes, including some Parties that expressed an interest in using the CDM. Moreover, some Parties stated either a general interest in market-based mechanisms or an intention to further explore their use.’
UNFCCC COP-21 ‘Synthesis report on the aggregate effect of the intended nationally determined contributions.’ UN Doc FCCC CP/2015/7, paragraph 180.
50 Kolstad C., K. Urama et al, ‘Social, Economic and Ethical Concepts and Methods’ in O. Edenhofer et al (editors) Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (Cambridge University Press, 2014) 239-40
51 The World Bank, ‘State and Trends of Carbon Pricing’ (World Bank, 2014), above n 27. 13
market mechanisms in the climate change architecture being negotiated under the UNFCCC.
1.1.3 ETS as a policy choice for Brazil
Admittedly, as a ‘non-Annex 1 country’ under the UNFCCC and a ‘non-Annex B’ country under the Kyoto Protocol,53Brazil is not currently subject to any binding emission reduction requirement. However, just as other large developing countries, such as China and India, Brazil is under pressure from the international community to adopt quantifiable emission reduction targets.54 As a result, Brazil enacted legislation in 2009 establishing the Brazilian National Climate Change Policy, which included voluntary
52 See, eg,Mooij et al (eds) Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers above n 21; see also International Monetary Fund, ‘Promising Domestic Fiscal Instruments for Climate Finance’ above n 21.
53 Under the‘common but differentiated responsibility’ principle established by Article 3 (1) of theUNFCCC, developed countries and countries with economies in transition were assigned to lead the process of ‘modifying long term trends in anthropogenic emissions consistent with the objective of the Convention.’ These countries were listed in the Annex I of the UNFCCC, and are usually reffered to as ‘Annex I’ countries. Similarly, developing countries such as Brazil are referred to as ‘non-Annex I’ countries. As discussed in sections 2.4.4.2.1 and 2.4.4.2.2 of this thesis, the Kyoto Protocol established quantified emission reduction targets for the first compliance period (2008-2012) to be met by the UNFCCC Annex I countries only (as listed in the Annex B of the Protocol). See David Freestone, - ‘The International Climate Change Legal and Institutional Framework: An Overview’in David Freestone and Charlotte Steck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and Beyond (Oxford University Press, 2009), 4- 8 and 11-12.
54 This political pressure towards imposing binding emission reduction targets to large developing countries, at least those with large economies such as China, India and Brazil, is reflected in the ‘Bali Road Map’, the action plan for the international negotiations resulting from COP-13 held in Bali in 2007 (Decision 1/CP.13) that set a negotiation targed by 2009 for ‘appropriate mitigation actions for all parties.’ Freestone,‘The International Climate Change Legal and Institutional Framework: An Overview’, ibid, 29-30. Alhtough the 2009 negotiations did not produce a final agreement for the ‘post- Kyoto’ period, the need for mitigation actions by ‘all Parties’ has set the tone for the international negotiations since then. This is also clearly reflected in the ‘Durban Platform for Enhanced Action’ exhorting the conclusion of an agreement by 2015 that would bind all countries by 2020 (Decision 1/CP.17) and in the Paris Agreement itself, which, along with recognizing developed countries’s leadingrole in the implementation ofemission reduction targets, exorts developing countries to ‘move over time towards economy-wide emission reduction or limitation targets in the light of different national circumstances.’ UN Doc FCCC/CP/2015/10/Add.1 Annex, Article 4, Paragraph 4.
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emission reduction targets.55 The same statute establishes a future Brazilian Market for Emission Reductions (BMER), but without providing any further information on the definition, design, and implementation schedule for such a market. In fact, historically the Brazilian negotiation position under the UNFCCC and the Kyoto Protocol has not privileged market mechanisms, except the flexible mechanisms under the Kyoto Protocol.56 Even in that regard, Brazil has systematically opposed market mechanisms involving forestry projects.57 However, in the mid-2000s a pro-climate coalition emerged in Brazil and successfully influenced the Brazilian Government to shift towards a more pro-active position in terms of a more aggressive stance in reducing emissions in general, and towards more flexibility regarding market mechanisms (mostly in relation to land use projects) in particular.58 In addition, some Brazilian states located in the Amazon region have developed legislation including the use of carbon credits as a mechanism to protect public and private forested areas,59 trying to capture the possible advantages of market mechanisms for their region.60 Furthermore, some Amazon-basin states have joined the Governor’s Climate and Forests Task Force led by
55 Federal Law No.12.187, of December 29, 2009 (‘The Brazilian National Climate Change Policy Law’), regulated by Federal Decree 7.390 of December 9, 2010The reduction targets range from 36.1 per cent to 38.9 per cent in relation to business-as-usual projected emissions under scenarios of 5 per cent and 6 per cent GDP growth. Reductions shall occur by 2020.
56 Kathryn Hochstetler and Eduardo Viola ‘Brazil and the politics of climate change: beyond the global commons’ (2012) 21 (5) Environmental Politics 753, 758-65. The Kyoto Protocol flexible mechanisms are joint implementation, the clean development mechanism and emissions trading (Kyoto Protocol, articles 6, 12 and 17, respectively).
57 Hochstetler and Viola ‘Brazil and the politics of climate change: beyond the global commons’ above n 56, 761; see also Fernanda Viana de Carvalho, ‘The Brazilian Position on Forests and Climate Change from 1997 to 2012: from veto to proposition’ in (2012) 55 Rev. Bras. Polít. Int. (special edition) 144, 166.
58 Hochstetler and Viola ‘Brazil and the politics of climate change: beyond the global commons’ above n 56, 759-60; Viana de Carvalho, ‘The Brazilian Position on Forests and Climate Change from 1997 to 2012: from veto to proposition’ above n 57, 166.
59 Amazonas State Decree 26.581 of April 25, 2007; Amazonas State Laws 3.135 of June 4, 2007 and 3.184 of November 13, 2007; and Amazonas State Complementary Law 53 of June 5, 2007; see also Acre State Law 2308 of October 22, 2010 and Tocantins State Law 1917 of April 17, 2008.
60 Hochstetler and Viola ‘Brazil and the politics of climate change: beyond the global commons’ above n 56, 762.
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the US State of California.61 This task force seeks to advance mutual cooperation between subnational entities towards emission reductions. Other market-based initiatives have been implemented by a large number of other states and municipalities, both in the Amazon biome and in the other regions of the country,62 in addition to voluntary initiatives adopted by important forest conservation stakeholders, such as some Brazilian indigenous communities.63 As part of this more recent trend, the Brazilian Government has commissioned preliminary studies on the possible use o
61 See
62 See Celio Andrade et al ‘Iniciativas da Economia Verde no Brasil: experiências das unidades federativas em promever uma economia verde inclusiva’ (Report to Banco Interamericano de Desenvolvimento – BID and Ministério do Meio Ambiente – MMA, Brasilia, May 2012)
63 Rodrigo Sales, Viviane O. Kwon and Patricia V. Frederigh, ‘Legal Aspects of the Surui’s Carbon Project’, in Raul Silva Telles do Valle (ed) Avoided Deforestation (REDD) and indigenous people: experiences, challenges and opportunities in the Amazon context) (Instituto Socioambiental and Forest Trends, 2010), 129.
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market mechanisms64 in order to evaluate better such options in the context of the Brazilian National Climate Change Policy.65
These more recent trends on the governmental side also reflect, to some extent, a gradual increase of support from legal and policy commentators of the need for inclusion of economic instruments in the Brazilian environmental law framework in general, and forest conservation and climate change policy in particular.66 The more recent evaluation of the Brazilian anti-deforestation policies in the Amazon has claimed that, despite the success of increased command-and-control enforcement actions, market mechanisms are necessary to improve the overall performance of Brazilian climate change policies.67 These economic instruments may include an ETS for industrial
64 Under the project named ‘Elementos para um Mercado de Carbono no Brasil’ (Elements for a Brazilian Carbon Market) the Ministry of Finance commissioned a series of studies coordinated by Fundação Getulio Vargas Sustainability Centre which covered the country’s monitoring and reporting capabilities and possible elements for an ETS and other pricing instruments. See Mario Monzoni (Coordinator), Requerimentos para um Sistema Nacional de Monitoramento, Relato e Verificação de Emissões de Gases de Efeito Estufa, (Fundação Getulio Vargas/GVCes, 2013); Ibid, Elementos para a Construção de um Sistema de Comércio de Emissões (Fundação Getulio Vargas/GVCes, 2014). Those studies were published in late 2013 and 2014 and focused on the country’s infrastructure to monitor and report emissions. It also reviewed some emerging practices of ETS, and indicated some issues to be considered in the discussions about pricing mechanisms in Brazil, particularly an ETS; see also The World Bank, ‘State and Trends of Carbon Pricing’ above n 27.
65 Federal Law 12.187 of December 9, 2009 and Federal Decree 7.390 of December 9, 2010.
66 The need for market-mechanisms to complement command-and-control policies in forest conservation, particularly through mechanisms of payment for environmental services is analysed in depth by Guillermo Tejeiro and Marcia Stanton, Sistemas Estaduais de Pagamento por Serviços Ambientais: Diagnóstico, lições aprendidas e desafios para a futura legislação (Instituto O Direito Por Um Planeta Verde, 2014) 8 and 118-20. This trend is also analysed by Ana Maria de Oliveira Nusdeo, Pagamento por Serviços Ambientais (Atlas, 2012) 99-100; these more recent analyses pledging for adoption of market approaches to mitigate climate change in Brazil reinforce the ideas from some previous analyses on the necessary response of Latin American countries to the climate change challenge. See Augusto de La Torre, Pablo Fajnzylber and John Nash, ‘Low Carbon, High Growth: Latin American Response to Climate Change – Overview’ (Conference Edition Booklet, The International Bank for Reconstruction and Development/The World Bank, Conference Edition Booklet, 2009) 63-67; see also Jacques Marcovitch (coordinator), ‘The Economics of Climate Change in Brazil’ (English Executive Summary) (2009)
67 J. Börner et al, ‘Forest law enforcement in the Brazilian Amazon: Costs and income effects’ (2014) Journal of Global Environmental Change 1298 (in press, corrected proof)
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sources, Reducing Emissions from Deforestation and Degradation in Developing Countries (REDD),68 and Payment for Environmental Services (PES), and the expansion of financing mechanisms, which go beyond the project-based Clean Development Mechanism (CDM).69
However, to date, apart from the superficial consideration of a future BMER in the Brazilian Climate Change Policy Law and the studies commissioned by the Finance Ministry,70 the Federal Government has prioritized using its own funds, as well as donations from other interested parties, to finance carbon mitigation activities, usually through accounting-based funds. Indeed, a law bill proposed by the Federal Government to implement a federal policy on payment for environmental services concentrates the whole proposed system in yet another variant of accounting-based funds to directly finance conservation activities.71 In parallel, since 2007, NGOs and other stakeholders have proposed similar bills through Brazil’s Federal legislative body (the National Congress), aimed at implementing policies for REDD and PES albeit without much progress to date.72 In addition to continuous delays in advancing such bills through the National Congress, their scope is very limited in terms of establishing a truly national
68 REDD – Reducing Emissions from Deforestation and Degradation in Developing Countries is the term for the international policy approach aimed at reducing land-use based emissions in developing countries. REDD is discussed under the UNFCCC at least since the COP 16 held in Bali, in 2007 and is part of the ‘Bali Road Map’(as discussed in section 1.3.1 and above n 54), in addition to be subject to practices under other UN programs and the voluntary market. See Rosemary Lyster, ‘The new frontier of climate law: Reducing Emissions from Deforestation (and Degradation) (2009) 26 EPLJ 417. See also UN-REDD Programme
69 The Clean Development Mechanism under Article 12 of the Kyoto Protocol. In this context, a study commissioned by the Brazilian Mercantile and Future Exchange (currently BM&F/Bovespa) also considered the implementation of market mechanisms to expand the CDM market in Brazil. Such study considered a possible implementation of a voluntary platform for trading carbon credits that could evolve into a mandatory scheme in order to fulfil the Brazilian Emission Reduction Market foreseen in the Climate Change Policy. See Alexandre da Costa Soares et al ‘Organização do Mercado Local de Carbono: Sistema Brasileiro de Controle de Carbono e Instrumentos Financeiros Relacionados’ (Banco Mundial, BM&F/Bovespa e Finep, 2011)
70 See above n 64.
71 Federal Bill of Law 5487/2009 aimed at creating some kind of remuneration for the conservation of environmental assets such as carbon, water and biodiversity.
72 Including Federal Bill of Law Federal 792/2007, Federal Bill of Law 5.586/2009, and Federal Bill of Law 5487/2009 above mentioned.
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approach to the monetization of conservation measures, such as those embedded in the concepts of REDD and PES, and of rationalizing the Federal, State, and private initiatives in a coordinated manner.73 Further, such proposals simply ignore the potential synergies between monetization of forest conservation activities, such as proposed in REDD and PES initiatives, and the Brazilian Market for Emission Reduction set out in the National Climate Change Policy.
The uncoordinated development of federal and regional initiatives to fill the gap in incorporating market-based instruments into Brazilian climate change policy increases the chance of potential clashes between state and federal government policies. Further, it negatively affects the chances of Brazil optimizing its response to addressing the country’s contribution to climate change based on a balanced mix of policy alternatives more suitable to the complex Brazilian GHG emissions profile discussed in chapter V of this thesis. As pointed out by several commentators, it is thus crucial that the Federal Government work towards unifying the federal policies and harmonizing them with the states’ initiatives and with international developments.74
Moreover, in terms of carbon-pricing options within the spectrum of market- based mechanisms, additional circumstances favour the investigation of the potential application of ETS in Brazil. First, the suggested potential of ETS to be integrated internationally and drive private-sector financial flows to developing countries (either through a top-down or bottom-up approach)75 appears to complement the Brazilian social-economic and climate change profile. Second, analysis calling for the incorporation of market-based mechanisms into the Brazilian environmental and climate change policies contrast with the lack of systematic analysis on whether and how emissions trading mechanisms would fit the Brazilian legal system and effectively assist in reducing emissions.76 Third, the general scepticism of Brazilians towards tax-based
73 Caroline Almeida Souza ‘A Construção da Estratégia Brasileira de REDD: a simplificação do debate na priorização da Amazônia’ (2013) 16 (1) Ambiente e Sociedade
74 CEPAL-IPEA-GIZ, ‘Avaliação do Plano de Ação para a Prevenção e Controle do Desmatamento da Amazônia Legal – PPCDAm – 2007-2010’ (Special Joint Report, Brasilia 2011).
75 Stern, The Economics of Climate Change – The Stern Review,above n 12, 365.See also section 1.1.2 and above n 46.
76 Which are basically confined to the studies indicated on above nn 64 and 69. 19
policies suggests a high political barrier for a carbon tax: Brazil possesses one of the most complex and burdensome tax systems in the world.77 Simplification of this tax system is a recurrent topic in national elections and a repeated demand from businesses, labour unions, and households. Further, there is a prevailing public perception of a lack of efficiency and distortion of the public investment of tax revenue, particularly due to the chronic problems of governance and corruption in the Brazilian public administration.78 Thus, although some design elements of an ETS may function similarly to a tax instrument, as addressed and discussed in chapters II, III, and IV of this thesis, the political acceptance of yet another tax in the irrational Brazilian tax environment would be extremely difficult for any policy approach, a climate change policy included, to overcome.79
1.2 The Objective of the Study
Given the above, this study suggests it is imperative that ETS be critically assessed and evaluated as one of the possible policy options for Brazil, a country of strategic importance for an effective international climate change regime due to the significant volume of its emissions and the high potential to reduce them. More importantly, a critical review must consider the specific cultural, legal, and social- economic characteristics of Brazil. It must be founded on the assumption that an ETS will be a valid tool for Brazil only if it effectively assists the country in reducing emissions. The secondary objective of an ETS, which is to be an economically efficient way to accomplish the policy goal of reducing emissions, is still considered an important possible outcome (along with other secondary policy objectives), but cannot
77 See Thierry Ogier, ‘Brazil’s Tax Monster’ Latin Business Chronicle (online), August 16 2010
78 According to The World Economic Forum Competitiveness report, corruption is among the most “problematic factors” for doing business in Brazil, ranking just below taxes, inadequate infrastructure, and government inefficiency. Frederick T. Stocker, ‘Anti- Corruption Compliance in Brazil: Addressing a Daunting Challenge’ (MAPI Policy Analysis, March 2012), 5
79 Joe Harpaz ‘Brazil ranked most time consuming tax regime in the world’ (Forbes, December 17, 2013)
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sacrifice the major policy’s main goal. If it does, then the goal of emission reduction simply becomes a symbolic law or policy requirement having no material effect on climate change mitigation.
In addition, a critical analysis must identify what elements of the ETS conceptual framework are ‘inherent’ to it and what elements are ‘contingent’ on its ultimate design, and on the context of the particular jurisdiction in which it is enacted.80 This distinction will be crucial to investigate if, what, and how ETS design elements stated in the literature or present in emerging ETS can be of use within the Brazilian social, cultural, economic, and legal reality. In fact, it is clear that the ultimate design of an ETS will be the most determining factor for the environmental integrity of the scheme (meaning whether it covers the relevant sectors within a given economy and jurisdiction, and whether it induces them to reduce emissions). It will also play a determining role in setting the level of economic burden placed on the relevant affected sectors and entities, in order to achieve compliance with the primary policy objective of reducing emissions. As a result, an integrative analysis of the possible use of ETS design elements on the Brazilian climate change profile, as provided in chapter VII based on the discussions and analysis of the previous chapters, will be instrumental for the general objective of this thesis of modelling an ETS legal framework that effectively induces GHG emissions reductions, as proposed in final chapter VIII.
Within the proposed boundaries of the objective of this study, it is imperative that the analysis considers not only the economic efficiency of the scheme but also its environmental integrity. ETS, in the context of climate change mitigation policy alternatives (as opposed to other climate change policy objectives, such as adaptation), only make sense if their main objective is to reduce GHG emissions. What differentiates ETS from other policies is the argument they can engender emission reductions in an economically efficient manner in comparison with other policy alternatives. Despite their alleged economic benefits, however, the primary purpose of considering ETS in the spectrum of possible climate change mitigation policies is the climate change problem and the need for GHG emission sources to reduce their emissions. As a result, the economic benefits of ETS should be instrumental to the main policy objective at stake, that is, its environmental integrity or its capacity to actually reduce emissions, and not to be an end in itself. In other words, environmental integrity should always be the primary objective of an ETS, and cost-efficiency its main secondary objective (other
80 See Robert Baldwin ‘Regulation lite: the rise of emission trading’ (2008) 2 Law and Financial Market Review 262, 26.
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secondary objectives may include the potential benefits of inducing innovation and investments towards clean technology, or clean energy, or transfer of technology, or investments from most developed to less developed economies).
1.3 The Research Question
In order to investigate how a Brazilian ETS could balance environmental and economic objectives without jeopardizing the main policy goal of reducing emissions, this thesis asks the following central question:
What is the most appropriate legal framework for securing environmental integrity in a future Brazilian ETS?
In order to answer this central question, the following sub-questions are addressed:
• To what extent and through what legal framework can environmental integrity be secured in an ETS?
This sub question is responded trough the analysis conducted in chapters II, III and IV, the results of which are summarized in chapter’s IV conclusion (on case studies of emerging ETS) that integrates the theoretical framework and history of the ETS concept, with insights from its actual implementation in the European Union, Australia and New Zealand.
• What are the social, economic, cultural, and legal conditions prevailing in Brazil that are likely to condition the environmental integrity of a Brazilian ETS?
This sub question is responded through the analysis conducted in chapters V and VI, which examines the Brazilian climate change profile and regime.
• Given Brazil’s emissions and its social, economic, and cultural conditions, to what extent and through what legal framework(s) can environmental integrity be secured in a Brazilian ETS?
This sub question is responded through the integrated analysis and legal model of the thesis’ last chapters VII and VIII.
In answering these questions, this thesis advances a critical analysis of emissions trading in the light of the Brazilian legal system and development dynamics. To achieve this goal, special attention is devoted to an analytical approach that neither sanctifies nor 22
demonizes this policy instrument which, despite legitimate criticism regarding some of its features and scepticism as to the reach of its acclaimed benefits, is a ‘powerful idea’81 permeating the climate change policy, economics, and legal literature in the past decades ‘spreading around the globe.’82 To this end, the thesis identifies and examines the conceptual framework, guiding values and principles, essential design elements, major legal issues raised, and other important features of select emerging ETS. In particular, the thesis focuses on a case study approach involving analysis of existing and emerging ETS in the EU, Australia and New Zealand, each of which reflects different stages of implementation and design options for a major ETS. The goal of such analysis is to assess potential benefits and optimal conditions for the application of ETS in the context of the Brazilian GHG emissions profile and its respective legal and policy framework devoted to climate change mitigation.
It is acknowledged that other emerging schemes might also be chosen as relevant case studies, such as China and Korea. However, during period in which the research for thesis was being conducted (2010 to 2014), linguistic limitations and access to material aside, neither Korea nor China had an ETS in place. As noted in section 1.1.2 above, the Korean regime was adopted and entered in force only in January 201583 while the Chinese pilot schemes were comprised of provincial and local government experiments that have not yet been translated into an actual national mandated regime.84
For the same reasons, this thesis discarded other possible approaches to the selection of emerging ETS as case studies, in particular, the analysis of possible schemes in place in other developing economies (including countries falling under the UNFCCC classification of non-Annex I countries), or in jurisdictions that are considered relevant to Brazil from a trading or geopolitical perspective, such as neighbouring countries in South America or the BRICS).85 These jurisdictions also did
81 Jonas Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading (MIT Press, 2011), 192.
82 Weishaar, Emissions Trading Design: A Critical Overview above n 17, 1.
83 See also above nn 28-31.
84 As pointed out in section 1.1.2 above, the launching of the national Chinese ETS was originally planned for 2016 and was postponed to 2017. Its first phase is intended to last only until 2020. See also Swartz,‘China’s National Emissions Trading System: Implications for Carbon Markets and Trade’, above n 30.
85 BRICS is the acronym for Brazil, Russia, India and China, which was orginally forged by a Goldman Sachs report from 2001, authored by Jim O’Neill and further expanded in subsequent reports by Goldman Sachs. Such reports envisaged that those emerging large 23
not have any ETS in place at the time this research was conducted, the features of which could provide lessons for the Brazilian context.
Moreover, it is important to stipulate that the analysis here is not a comparative study of these three regimes, but rather a case study examination of how key features of the select emerging ETS are addressed in the policy discussion, decision-making, and implementation phases of the schemes, in order to identify which features should prevail in the Brazilian context to ensure attainment of the goal of maximum GHG reductions while delivering other environmental services and interoperability with national, regional and global ETS. The thesis then concludes with an analysis of the conditions for optimal incorporation of an ETS into the Brazilian legal framework, identifying the structural and functional elements needed for a Brazilian ETS to effectively attain its goals. By doing so, this thesis examines the potential role of ETS in filling a gap in the Brazilian regulatory framework devoted to climate change mitigation.
Further, in examining these emerging ETS experiences, this thesis seeks to identify the major driving forces and core values of each ETS, and to assess the extent to which the environmental effectiveness of the scheme has been prioritized in its design and implementation phase. To succeed, the analysis will be conducted with special attention to providing an integrated and systemic view of the legal aspects of ETS, both retroactively, in relation to the emerging experiences, and prospectively, in relation to its possible incorporation into the Brazilian Legal System. In doing so, this thesis will contribute to the ‘third generation’ of ETS legal scholarship, as called for in recent accounts of the literature.86
economies would ‘catch-up with the world’s economic powers by 2050.’ Recognizing some geopolitical and economic synergies, ‘BRICS’ countries (which since 2011 include South Africa as a full member) have developed some joint strategies and issued joint claims in the international relations arena, such as ‘establishing a multipolar world order, as well as to reforming the world’s financial system.’ BRICS Policy Center, ‘About the Brics’
86 See David M. Driesen, ‘Putting a Price on Carbon: The Metaphor’ above n 24.
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1.4 The Theoretical Framework for the Enquiry
1.4.1 Challenges posed by a legal investigation of ETS
The presentation of ETS as a market-based climate change policy, as indicated in section 1.1.2 above, clearly shows that apart from law and policy an ETS is forged by other disciplines such as economics, particularly climate change economics (including the presentation of concepts such as market failure and externality under climate change economics) and science (as the major source of evidence of the climate change problem and also as the basis for each country’s emission profile inventory and the respective ETS cap setting choices). As a result, the first challenge posed by ETS as a subject of legal study has to do with its multidisciplinary nature, heavily informed by other research disciplines such as economics, politics, and science. As Siems notes, ‘there is no uniform view on how exactly “multi-”, “inter-”, “trans-” and “cross-disciplinarity” are to be defined (…).’87 Recognizing this conceptual uncertainty in the literature, the approach taken by this thesis seeks to understand the ETS concepts and experiences, which is informed by several disciplines, from a legal perspective and under a legal typology. In this regard, using Siems’ own taxonomy, the research approach advanced by this thesis can be defined as an ‘advanced interdisciplinary legal research: type 1’, i.e., the one that keep disciplines separate (i.e., legal thinking from other disciplines) but that uses knowledge informed by other disciplines to better grasp the nature of the object of study.88 In this context, apart from recognizing the scientific evidence of climate change and global warming and relying on scientific and technical data regarding GHGs emission profile of countries and economic sectors (as shown in chapter IV and V, with respect to the EU, Australia, New Zealand and Brazil), the legal analysis of ETS conducted by the thesis is informed by the incorporation of economic and policy concepts that support ETS as a pricing mechanism to mitigate climate change (as shown mainly in chapters II and III, respectively).
Thus, in order to accomplish the research objectives and respond to the research questions above, it is acknowledged that this thesis requires a legal theoretical framework that readily identifies the intersection of ETS and the law. One of the
87 Mathias M. Siems,‘The taxonomy of interdisciplinary legal research: finding the way ouf of the desert’ (2009) 7 (1) Journal of Commonwealth Law and Legal Education 5, 6-8 and 12.
88 Ibid.
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primary challenges for such an analysis is precisely the adequate identification of the ETS elements belonging to the legal field, thereby enabling the legal subject of study to be captured as a distinct subject from the multidisciplinary nature of ETS. In addition, however, and in recognition of such multidisciplinary nature and intent of ETS, additional concerns must be captured by the analytical work proposed in order to meet the research objectives described above. First, the prevailing values that inform the ultimate design of emerging ETS, in particular the relevance given to the environmental integrity of the scheme, and the question of how to measure their appropriateness in light of the climate change problem caused by anthropogenic GHG emissions, must be considered. Second, the question of how to undertake such legal analysis in a systemic and integrated manner as opposed to the prevailing fragmented approach evidenced in the literature must be considered to allow the identification and proper consideration of the ‘inherent’ and ‘contingent’ elements of ETS into the Brazilian factual reality. Such approach will allow a clear distinction of inherent elements of ETS design, i.e., those that consist the nucleus of the ETS concept regardless the jurisdiction that incorporates it, from those that are contingent to the Brazilian GHG emission profile and its social, economical, legal and cultural drivers. Such an approach is needed to facilitate a better understanding of whether and how design elements of an ETS will fit the climate change regime it becomes part of, in this case, the Brazilian regime, and its further intersection with the international climate change regime.
Such a systematic approach is missing from the literature, despite its relevance to better establishing the introduction of an ETS policy in a given legal framework and allowing an adequate analysis of its efficacy as a policy option. Due to the innovative characteristics of many legal issues raised by an ETS, most of the initial legal analysis has focused on some of its most prominent emerging legal issues, such as the legal nature of the emission reduction credits or allowances.89 This initial focus on the legal nature of the tradable allowance is, of course justified by due to the key role this concept plays in defining the legal treatment of many of the other aspects of an ETS. However, more recently, many commentators have highlighted other relevant aspects of ETS, including issues related to linking of schemes, tax border issues, and others. Nevertheless, most of the analyses available provide for a more fragmented approach when focusing on the legal aspects of ETS.90
89 As discussed in chapter III of the thesis.
90 In most cases where a group of legal issues are identified in a single analysis, they are raised in connection with different options for ETS design. See, for example, Rosemary Lyster, ‘Chasing down the climate change footprint of the public private sectors: Forces 26
The systematic and integrated approach advanced by this thesis relies on two complementary analytical tools. First, it expands the concept of which are the legal aspects of ETS as opposed to the traditional legal literature, since it brings to the legal realm the major design elements that will influence the reach and performance of the ETS, as discussed in more detail in section 1.4.2.1 below. Second, to the extent possible, it clearly identify whether such legal aspects are of ‘structural’ or ‘functional’91 nature within the legal system. Thus, different from the traditional fragmented legal analysis, the systematic approach advanced by this thesis will, facilitate the integration into the Brazilian legal system of the relevant ‘inherent’ and ‘contingent’ elements of ETS that are necessary to privilege the environmental integrity of a Brazilian ETS as its most important value, reflected not only in the stated scheme’s goals but also in its overall design..
1.4.2 Analytical Framework
1.4.2.1 Legal Theory
In order to meet the challenges posed by a legal analysis of ETS, this thesis will largely rely on the ‘tridimensional theory of law’92 and the concept of ‘law as a juridical model’93 developed by Brazilian scholar Miguel Reale. It is possible to summarize, for purposes of this analytical exercise, the development of Reale’s thought into three complementary elements: the tridimensional theory - the view of Law as the interaction of fact, value and norm (labeled by him as Concrete Tri-dimensional Theory in light of other Tridimensional accounts of law, as further discussed below), the analysis of the sources of law as a condition for the validation of the norms, and the integration of the
converge – Part II’ (2007) 24 EPLJ 450, when certain legal issues are discussed in connection with a proposed ‘theoretical model for designing an ideal emissions trading scheme.’
91 See discussion in item 1.4.2 below.
92 Miguel Reale, Licoes Preliminares do Direito (Saraiva, 1983, originally published in 1973) 64-65. See also Augusto C. M. Lima, ‘A Brazilian Perspective on Jurisprudence: Miguel Reale’s Tridimensional Theory of Law’ in (2008) 10 Oregon Review of International Law, 77. Lima’s article is a very important contribution in English language for the discussion of significant aspects of Miguel Reale’s thought, particularly the tridimensional theory.
93 Miguel Reale, O Direito como Experiencia (Saraiva 1992, originally published in 1968) XXIV and XXVIII.
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sources of law with the models of law, the latter being the normative substance of the source and a condition for its efficiency (or practical application). Under this particular prism, ‘it is possible to say that the legal models represent a new language expressing the normative content of the sources of law.’94
According to Reale, the law is always formed by the interaction of three dimensions: fact, value, and norm:
a) whereas there is a legal phenomena, there is, always and necessarily, a subjacent fact (economic, geographical, demographic, technical, etc.); a value, which confers a determined significance to this fact, inclining or determining the men actions towards reaching or preserving a certain end or objective; and, finally, a rule or norm, which represents the relation of measure which integrates one of those elements to the other, the fact and the value;
b) such elements or factors (fact, value and norm) do not exist separated from each other, but co-exist in an integrated concrete unity;
c) furthermore, those elements or factors just not reciprocally demand themselves, but act as links of a process (as (…) Law is a historic-cultural reality) in a way that the life of Law results into a dynamic and dialectical interaction of the three elements that integrates it.95
Further, according to the author, the most appropriate form of identifying (and analysing) a legal phenomenon is to detect within a given legal system the ‘normative structures of the juridical experience’96 and, among them, the ones carrying prescriptive force, that is, established as mandatory prescriptions by ‘force of the law.’97 In this proposed analytical approach, which Reale calls ‘Juridical Models’,98 the normative content of a given object of legal study is not necessarily reflected in a single piece of legislation. In fact, Reale heavily relies on some aspects of the structural and, to some
94 Miguel Reale, Fontes e Modelos do Direito para um novo paradigma hermenêutico, (Saraiva, 2002) 30-31
95 Miguel Reale, Lições Preliminares do Direito (Saraiva, 1983) 64-65.
96 Reale, O Direito como Experiencia, above n 94, 163
97 Ibid.
98 Ibid. See also below n 102.
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extent, structural-functionalism sociological movement,99 and on his own criticism of some elements of Hans Kelsen’s Theory of Law100 to provide for a systematic approach to legal studies. As a result, the Juridical Model theory allows one to identify a ‘unity of meaning’101 or the ‘unitary and congruent meaning’102 of an isolated or group of legal norms103 – usually referred to as the ‘Legal Juridical Model’104 (in our case, a mandatory ETS and its main ramifications), and its interactions with the overall legal system it belongs to – usually referred to by Reale as the ‘Legal Juridical Macro- Model’105 (in our case the national and international climate change regime). This approach builds on the concepts of ‘functional’ and ‘structural’ elements of the social systems to then be applied to a systematic approach towards the objects of the legal study, including capturing the ‘operational nature’106 of most social experiences (including those pertaining to the legal realm) and the rigorous ‘typological classification’107 that shall drive the juridical modelling of a legal experience.108
99 Including contributions from Talcott Parsons, Robert Merton and Gilberto Freyre. Ibid, 147-163.
100 Ibid 170.
101 Miguel Reale, Fontes e Modelos do Direito para um novo paradigma hermenêutico (Saraiva, 2002), 87.
102 Ibid 111.
103 Ibid 29-30.
104 Ibid, In refining his theory of Juridical Models, Reale envisaged two subclasses of Juridical Models; the Legal Juridical Model (which relates to the normative substance of sources of law such as norms, court decisions and contracts, and are of prescriptive nature) and the Hermeneutic Juridical Models (which relates to the interpretation of the latter and belongs to the legal doctrine). Ibid, 37 and 63-75; Reale O Direito como Experiencia above n 93, 179-186.
105 Reale, Fontes e Modelos do Direito para um novo paradigma hermenêutico (Saraiva, 2002) above n 99, 87.
106 Reale,O Direito como Experiencia above n 93, 163.
107 Ibid 165.
108 Also significant for the distinction between structural and functional elements of law used in this thesis is the work or Noberto Bobbio, particularly his analysis on the structural and functional elements of the legal theory of Hans Kelsen, re-published in Brazil in 2007. Norberto Bobbio, ‘Estrutura e Função na Teoria do Direito de Hans Kelsen’ in Noberto Bobbio Da Estrutura à Função (Manole, 2007) 182-210.
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Although this typological classification (including the distinction between structural and functional elements of an ETS addressed in this thesis) can be arbitrary in some situations, it is a powerful tool to differentiate a given legal or policy tool and locate it within the legal system. In the case of Brazil, this approach gains a higher level of importance due to the more systematic vocation of civil law regimes
Apart from the modelled approach proposed by Reale, his tridimensional theory considers the value embedded in each norm a fundamental element of what can be considered juridical.109 This special attention to the value content of the law is an important element of analysis for this thesis, mainly in regard to the assumptions indicated in section 1.2 above, which places the environmental integrity of an ETS as the main objective of any scheme devoted to mitigate GHG emissions. In this context, environmental integrity can be labelled an ‘Axiological Invariant’ of the legal system, meaning that it belongs to the class of values that should prevail over other values informing a given norm (in our case, the prevailing nature of environmental integrity over other possible benefits of an ETS, such as economic efficiency and technological innovation).110. In support of choosing environmental integrity as ‘the axiological invariant’ of ETS, this thesis also borrows from another legal theory, the ‘Ecosystemic Theory of Law’, the notion of the importance of placing ecological values as guiding principle of environmental norms, in particular those devoted to mitigating potential impacts of global dimension, such as climate change.111
Another fundamental assumption of Reale’s theory is his conviction that the investigation of how norms are created elucidates how the tridimensional aspect of law operates and how law is interpreted and applied.112 Accordingly, the direct connection of the norm with its own ‘potential to be realized’ suggests that the act of creation of the norm (nomogenesis) is an essential part of the juridical experience, and a crucial source for one depicting its elements for purposes of its interpretation and application in real
109 Reale, O Direito como Experiencia above n 93, 25-31.
110 Reale, Fontes e Modelos do Direito para um novo paradigma hermenêutico above n 99, 115; See also Miguel Reale, ‘Axiological Invariants’ (1995) The Journal of Value Inquiry 65.
111 Richard O. Brooks, Ross Jones and Ross Virginia, Law and Ecology: The Rise of Ecosystem Regime – Ecology and Law in Modern Society (Asghate, 2002), particularly ch 10.
112 See Miguel Reale, O Direito como Experiencia, above n 84, 192.
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life. This has been expressed through one of his renowned graphic representations, showing structure of ‘juridical nomogenesis’:113
FIGURE 1: LAW NOMOGENESIS
According to Reale, the legal norm, as a ‘cultural and historical reality’, results from the combination of a set of axiological and factual factors, the exact number of which is not possible to estimate in all cases. However, in general terms, it is possible to group them for purposes of a critical analysis, in two major categories, ‘factual complexes’ (‘F’ in Figure 1 above) and ‘axiological complexes’ (V1, V2…Vn in Figure 1 above). Axiological factors include social trends or value choices of spiritual, moral, intellectual and economic orders, such as political or ideological pressures, economic interests of certain social groups, or moral, religious or juridical values prevailing in a given moment. Factual factors include natural facts and any event irrespective of human nature, in addition to those events caused by human nature, i.e., the ‘historical-cultural objects’ or social facts of economic (as opposed to economic interests or values),
113 Reale has used the same graphic representation in many of his books. See, for example, Miguel Reale, O Direito Como Experiência, above n 94,194; Fontes e Modelos do Direito para um novo paradigma hermenêutico, above n 90, 53. The English translation of the figure’s explanation comes from Augusto C. M. Lima, ‘A Brazilian Perspective on Jurisprudence: Miguel Reale’s Tridimensional Theory of Law’ in (2008) 10 Oregon Review of International Law, 77. Lima’s article is a very important contribution in English language for the discussion of significant aspects of Miguel Reale’s thought, particularly the tridimensional theory.
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technical, and juridical nature (such as the legal models or positive norms) already in place at the time a given new norm is forged. The interaction of the factual and axiological factors culminates in a series of normative proposals, and the legislative/normative authority in place (‘power’ or ‘authority’ in any given legal system, represented by ‘P’ in Figure 1 above) makes the final decision on the prevailing legal norm (‘N’ in Figure 1 above). 114
Reale’s view of the law as a historic-cultural reality, which makes it possible to understand the juridical experience (and its law models) as a cultural object, is also noteworthy. In short, he calls attention to the need for the researcher to understand not only the logical, but also the ethical and historical conditions that make the legal experience possible. In his accounting of the law within the world of culture, Reale highlights that the cultural dimension of the law experience is not confined to the formal expressions of culture, but also to the natural influences of ‘common life.’115
1.4.2.2 Analytical Approach
Based on the theoretical framework presented in the previous subsection, this thesis considers an explanatory perspective of emissions trading schemes, and particularly their legal aspects, based on a systemic view of ETS. This systemic view uses the concept of legal modelling whereby the ETS is viewed as a well-defined normative structure in each relevant jurisdiction, prescribing standards of behaviour to a pre-defined set of economic activities. Under this analytical approach, the essential ETS design elements and the resulting prevailing values they emanate will be presented under a typological qualification that will identify its driving principles and differentiate its structural and functional elements.
In terms of structural elements, this thesis considers those characteristics that are ‘inherent’ to what is defined as an ETS (thus, differentiating ETS from other emission reduction tools), providing them as a sense of unity and correspondence with its founding theoretical framework. As structural elements, such ‘inherent’ characteristics of an ETS can be viewed as the static elements of the scheme, the interrelationship of
114 Reale, O Direito Como Experiência, above n 94, 192-205.
115 See Reale, O Direito como Experiencia, above n 93, XVII and 12-3. His ‘common life’ definition relies on Edmund Husserl concept of ‘Lebenswelt.’ Ibid. See also Miguel Reale, Experiência e Cultura (Bookseller, 1999, originally published in 1977) for his in- depth analysis of ‘culturalism.’
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which is expected to (i) generate the minimum level of stability that guarantees that its identity as an ETS is maintained and (ii) provide for a clear framework for insertion of such a scheme into the overall legal system it belongs to. As discussed in more detail in chapters II and III (particularly sections 2.2.1.2 and 3.2), the basic structural elements of an ETS results from the combination of a cap on predefined emissions, and the issuance of individual allowances to certain covered entities, within the cap limits, that can be traded under certain conditions. Such basic structure is complemented by governance, enforcement and trading infrastructures that, regardless the ultimate nature of the functional elements of the scheme (for example, the legal nature of the allowances, the choice of allowance allocation methods, the level of stringency of the cap, amongst others) will provide the basic framework of the scheme that will be inserted in the overall legal system of the relevant jurisdiction.
In terms of functional elements, this thesis consider those characteristics of an ETS that are ‘contingent’ to the ultimate design of an ETS in each given jurisdiction, and which define their ultimate goals and level of ambition regarding targeted emission reductions, path of implementation, and degree of effectiveness. As functional elements, such ‘contingent’ characteristics of an ETS can be viewed as dynamic elements of the scheme, that will prescribe in well-defined terms/moments (i) the reach of the scheme vis-à-vis the most important emission sources/gases, (ii) the level of stringency of proposed emission reductions, (iii) the specific conditions to be followed by affected entities, and (iv) the ultimate balance between the goals of environmental integrity and economic efficiency. The combination of such structural and functional elements will define the prevailing values reflected in each ETS subject to such analytical approach.
Needless to say, the depiction of what is structural and functional within an ETS reflects what the author considers as prevailing characteristics of each design element in light of the systematization proposed by the current analysis. The proposed approach seek to provide for a systematic and objective identification and understanding of the ETS fundamental elements,, thereby facilitating the analysis of ETS in different jurisdictions regardless of the prevailing legal system (common law, civil law, and others). As such, it aims to provide a straightforward research tool to navigate different experiences of ETS within a minimum framework of analysis that allows its consideration as a possible alternative for other jurisdictions, such as Brazil, without loosing the perspective of the importance of specific legal culture and other social- economical characteristics of each jurisdiction.
The explicit consideration of driving principles and prevailing values in the ultimate design of an ETS taken by this thesis provides for additional benefits that go 33
beyond the crucial assessment of its environmental integrity. In fact, this approach also facilitates the consideration of historical and cultural aspects inherent to each jurisdiction that should be taken into account when a possible innovative legal tool developed in another country is considered. In the case of Brazil, this thesis looks at some aspects of the historical and development dynamics of Brazil in connection with its GHGs emissions profile and key elements of its legal culture that should be taken into account, at least as guiding concerns or principles, when the possibility of introducing an ETS into its climate change policy alternatives is considered.
To that end, and in applying Reale’s analytical approach in devising the legal aspects of ETS, this thesis assumes that every aspect of an ETS design that has normative content should be regarded as a legal component of ETS (of a functional nature), in addition to legal structural components such as the governance, compliance, and trading infrastructure. Further structural elements that should be regarded as a legal component of an ETS include the connective elements of ETS to the national legal framework it belongs, and to the international climate change regime.
In this regard, in addition to concepts or instruments of immediate reference to the legal experience, such as the legal nature of allowances and the compliance and enforcement rules, most of the ETS design features reflect a normative outcome with specific legal repercussions in the conduct and performance of affected entities, and sometimes of other social or economic actors. In the light of this, this analytical approach will support the search for integrative elements of unity, functionality, and connection of emerging ETS (and a possible ETS in Brazil) to other relevant parts of the domestic and international climate change regime.
Additionally, each principled decision or design element of an ETS reflects a dominant public culture and a value choice by the legislator that may result from more or less embattled political processes.
The consideration of the three dimensions (fact, value and norm), particularly in the case studies of emerging ETS in the EU, New Zealand, and Australia, and their depiction in structural and functional elements will inform the discussions of this thesis on emerging ETS, and whether and how an ETS should be implemented in Brazil. In examining the ETS theory and emerging practical experiences as proposed herein, particular attention will be paid to the legal nomogenisis of ETS in each jurisdiction and the extent to which environmental integrity or effectiveness is the prevailing value choice of the emerging ETS design and implementation vis-à-vis other values such as economic efficiency. An analysis seeking to cover all legal aspects of ETS would be far beyond the scope of this thesis. However, the systemic view proposed will facilitate the 34
analysis of possible incorporation of an ETS by the Brazilian legal system, and the respective design and principles that should prevail in order to effectively promote greenhouse gas emission reductions. It will also allow a consideration of the adequate positioning of a Brazilian ETS in the international climate change architecture, and the possibilities that might be explored by a Brazilian ETS that can be linked to other schemes regionally or internationally.
The application of the analytical approach advanced by this thesis will consider, whenever appropriate in each chapter, the following ‘logical categories’ of Reale’s thought in attempting to provide for a systematic and integrated view of the ETS conceptual framework and experience:
a. Environmental Integrity of ETS as an Axiological Invariant, i.e., a hierarchal superior value to be reflected in any ETS ultimate design.
b. Systematic Analysis of Emerging ETS legal nomogenesis, identifying key drivers from an axiological (values) and factual perspective and the resulting main normative proposals and ultimate legal model.
c. Identification of key social-historical and cultural elements that may be relevant for the proper insertion of an ETS in a legal system, particularly in respect to the Brazilian case.
d. Legally Modelling of ETS by identifying its main legal sources (legal sources applies only to the US experience and case studies) and depicting ETS design in structural/inherent and functional/contingent elements, identifying to the extent possible its integrative elements of unity, functionality and connection with the other parts of the climate change regime (or macromodel).
e. Proposition of an ETS legal model for Brazil considering the lessons taken from the ETS theoretical framework and experience in the jurisdictions used as case studies.
1.5 Methodology
The overall analysis of this thesis is supported by desk studies of the specialized literature and applied legislation relating to the climate change regime and economics, the use of market mechanisms in environmental policy, in particular the extensive literature on ETS design and emerging experiences, the Brazilian climate change emissions profile, and correlated legal, regulatory, and policy primary sources. Within the legal primary sources, the thesis privileged statutory and regulatory sources as opposed to case law due to the restrict availability of case law on the ETS design 35
elements of the jurisdictions object of the case studies, apart from the EU ETS-related case law and some case law from New Zealand. With respect to the EU ETS case law, the large majority of the cases are related to specific European Law matters of jurisdictional competence between the Union and Member States.116 As a result, the core legal discussions reflected in such EU ETS case law is not central for the thesis, different from the fewer cases that covered discussions on EU ETS implementation or design choices that could shed light on key elements of ETS examined by the thesis. Those cases where incorporated in chapter IV, as indicated the summary of chapter IV below, and taken into consideration in the overall analysis of the thesis.
The structure of the thesis follows the rationale of introducing the conceptual framework and history of ETS, from its initial experiences in the US to the incorporation of the ETS concept into the climate change regime. Historical and current information, and criticism of the pioneering US experience with ETS variants are reviewed from enforcement agencies to policy think-tanks to the legal scholarly literature, in which the use of market mechanisms is extensively debated in major law review and book publications. Analysis of incorporation of the ETS into the climate change regime is similarly based on the extensive literature on climate change policy and economics, as well as on the analysis of primary legal sources (mainly the UNFCCC and Kyoto Protocol and Conference of the Parties and Meeting of the Parties under the UNFCCC and the Kyoto Protocol) and the literature on climate change law and regime. As noted in the summary of chapter II below and in section 2.2 of the thesis, a ‘definitive explanation of how ETS emerged from an intellectual discussion among economists in welfare economics to a policy alternative’ in the US and a length analysis of the relevant U.S. ETS initiatives is beyond the scope of the thesis. The thesis privileged a more balanced approach to identify such important matters (and thus sacrificing a more in depth analysis of some of those important developments) in order to inform the case studies and integrated analysis of the following chapters without deviating the research from the object of the study.
The analysis of major theoretical principles, design options and legal aspects of ETS draws heavily on major studies such as the Stern Review and the Garnaut Review and other scholarly and policy literature regarding ETS design in general, and the EU ETS in particular, of predominately US and European origin, including ‘third- generation’ legal analyses published in the last four years, as well as contributions from
116 Navraj Singh Ghaleigh, ‘Emissions Trading before the European Court of Justice: Market Making in Luxembourg’ in Freestone and Steck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and Beyond above n 53, 377; Bogojevic Emissions Trading Schemes: Markets, States and Law above n 23, 119 and 125. 36
other regions such as Japan and other Asian countries. The discussion of the legal aspects of ETS relies heavily on specialized books, policy studies, and law review articles.
The thesis undertakes an incremental approach through chapters II and III to introduce the ETS conceptual framework and history and identify its main design elements and legal aspects, leaving a more in depth engagement with the primary legal sources for the following chapters, particularly through the case studies of emerging ETS (chapter IV), the Brazilian climate change regime (chapter VI) and the concluding chapters (chapters VII and VIII). Thus, in addition to analysing legal scholarly and policy literature, this thesis adopts a case study approach, analysing the issues in the context of the EU ETS, the New Zealand ETS (NZ ETS), and the (now defunct) Australian Carbon Price Mechanism (CPM). These three schemes are selected because they each represent a different stage of implementation and design options for an ETS. As of today, the EU ETS is by far the most ambitious cap-and-trade scheme implemented in the world, covering the largest number of emissions sources, and being the main driving force for the international emission reductions market. The NZ ETS is one of the first national mandatory ETS, and due to some similarities between the emissions profile of Brazil and New Zealand, in particular the role of agriculture-based emissions in both countries’ GHGs emissions profile, it offers important lessons for Brazil regarding the challenges of considering land-use emissions under an ETS. As remarked by Sartor et al, ‘New Zealand is an interesting and potentially very valuable case study for policy makers in other nations because it is a developed country, with strong governmental institutions, yet it has an emissions profile similar to a developing country.’117 Importantly, it presents an important source of analysis for design options that were clearly driven by the main goal of meeting the New Zealand commitments under the first period of the Kyoto Protocol, regardless of the corresponding actual reductions by the New Zealand emission sources. As such, the NZ ETS offers a crucial
117 Oliver Sator et al, ‘Good Shepherd or Black Sheep? Tackling Forestry & Agriculture Emissions in New Zealand’s New Carbon Market’ (Climate Research Report on the Economics of Climate Change nº 26, CDC Climat Research, November 2010) 4
‘New Zealand is an interesting and potentially very valuable case study for policy makers in other nations because it is a developed country, with strong governmental institutions, yet it has an emissions profile similar to a developing country (…) New Zealand has thus become the site of innovative and valuable policy experiments and a possible model for developing countries to aspire to emulate as institutional capacity develops.
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example of how design options may meet compliance goals under the climate change regime, and, at the same time, fail to secure the environmental integrity of the scheme.
The Australian CPM opted for a different approach to dealing with agricultural emissions, thereby enriching the options to be considered in the Brazilian case. Further, the Australian CPM, despite having been cancelled after a short period of implementation, offers a very rich body of policy discussion and legal arrangements required to implement an ETS that are extremely useful for the objectives of this thesis. Apart from the availability of sources on the Australian CPM, and the overall environment of intense public debate and political importance that surrounded the Australian CPM, two major characteristics of the Australian CPM are very important for the thesis’s object of which include the incorporation of economic, technical, ethical and policy aspects of ETS under a legal tipology: the density and level of detail of the Australian legal framework, which encompassed a legislative package comprised of 19 bills of law with a thorough and well defined set of changes in the pre-existing Australian legal system, in addition to the explicit definition and use of key legal mechanisms such as re-allocation of liability arrangements amongst entities belonging to a given economic supply chain or economic group.
In addition to specialized literature, the selected case studies rely on primary (e.g. EU ETS Directives, Australian and New Zealand statutes and regulations) and secondary legislative materials, including discussions in the European Union, particularly in the European Commission and governmental proposals and legislative tools, such as legislative impact assessments and summaries of proposed bills of laws. As well as the extensive source documents produced in the legislation public review processes, such as position papers filed by different business associations, NGOs, and other interest groups. Analysis of the environmental performance of ETS is largely based on data regarding the EU ETS, as this scheme is the first and most comprehensive emissions trading scheme devoted to greenhouse gases. Apart from independent analyses, the main source for this analysis is a technical paper published in 2013, which consolidates the results of the most important analyses regarding whether and how much abatement in EU emissions can be credited to the EU ETS.118 Official emission
118 Tim Laing et al, Assessing the Effectiveness of the EU Emissions Trading System (Centre for Climate Change Economics and Policy Working Paper No. 126; Grantham Research Institute on Climate Change and the Environment, Working Paper No. 106, January 2013)
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reductions published by the New Zealand Government in respect to the NZ ETS are also referred to.
Information and data on the Brazilian physical and social-economic reality and on major historical GHG emissions and trajectories is drawn from national emissions data reports presented to the UNFCCC and the Kyoto Protocol. The analysis is supported by a mix of classical works on Brazilian society, history, and development with the most updated analysis on Brazilian economy, development indexes, and GHG emissions data, in addition to specific works on the Brazilian compliance culture in general, and the profile of Brazilian environmental and climate change legislation, in particular. Special attention is given to the Amazon and the Cerrado biomes and the land-use emissions, due to their large contribution to the country’s emissions profile. Emissions data are primarily from the official communications by the Brazilian Government before the UNFCCC in 2010 and the subsequent annual emission inventories published in 2013. Additional analysis of the Brazilian climate change profile and emission trajectories by external sources, in particular studies by the McKinsey & Company (2009) and the World Bank (2010) are also used. Finally, primary legislative sources (mostly statutes and regulations, since in Brazil there is no case law relevant to the object of the thesis) as well as studies evaluating the most important Brazilian climate change initiatives and programs are utilized to ground the analysis of the Brazilian Climate Change regime and the major policies implemented to date. Studies referred to include those conducted autonomously by Brazilian research institutions (such as the series of robust analysis conducted by the Fundação Getúlio Vargas, the University of São Paulo, and the Federal University of Rio de Janeiro) or with the assistance and/or funding of multilateral agencies or international governments, as well as important PhD and MSc studies by Brazilian scholars.
Despite the vast literature on emissions trading schemes (both on the theoretical framework and on emerging ETS such as the EU ETS, New Zealand and Australia), an examination of possible development and application ETS in the context of the Brazilian legal system, development dynamics and cultural background and an analysis of whether it would be relevant to assist Brazil in reducing GHGs emissions is missing. This is the major original contribution of this thesis to the vast body of research on ETS. Apart from that, the thesis advances a more systematic analytical approach to the legal aspects of ETS that can facilitate the analysis of inherent and contingent aspects of ETS access different jurisdictions, filling a gap in the literature and contributing to the 39
development of ‘third generation’119 of ETS legal scholarship that examines the interface of ETS and law on a critical and careful manner.
1.6 Summary of Chapters
Apart from this introductory chapter, the thesis consists of seven chapters. Chapter II examines the theoretical and historical origins of ETS, setting the stage for the subsequent chapters of the thesis. It reviews the pioneering US debate and policy experiments, identifies the major types of ETS (cap-and-trade and baseline-and-credit) and examines the development of the ETS concept within the climate change regime (including the flexible mechanisms under the Kyoto Protocol). The chapter discusses the basic differences between carbon tax and ETS, identifies some of the major ETS elements and reveals voiced benefits and disadvantages of ETS as a carbon pricing policy.
This initial analysis is furthered in chapter III through the identification of key principles and design elements of ETS. This chapter pays special attention to the design elements that are more influential in ensuring or jeopardizing the environmental integrity of an ETS, thus addressing one of the basic elements of the central research question. The chapter then examines ETS as a legal phenomenon and its interplay with climate change law and other policies. This analysis identifies some of the key legal issues arising from the adoption of ETS as a legally mandated or voluntary market mechanism, and their potential implications when applied to a given legal framework. Such legal issues include the legal nature of emission allowances, legal implications of linking between schemes, and the interplay of ETS with international, competition, trade, and investment laws.
Chapter IV analyses the major design elements of three emerging and existing ETS regimes (EU ETS, Australia, and New Zealand) in order to identify the most significant issues that should inform a possible ETS design in Brazil that will favour the reduction of Brazil’s GHG emissions. The chapter firstly presents the rationale for the selection of ETS from the European Union (EU ETS), New Zealand (NZETS), and Australia (CPM), including the fact that such schemes present key different design options and reflect different stages of implementation, thereby offering important
119 Driesen, ‘Putting a Price on Carbon: The Metaphor’ above n 24; Bogojevic Emissions Trading Schemes: Markets, States and Law above n 23,179. See also section 1.3 above.
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insights to address the research questions. Despite the Australian scheme being repealed by the Parliament of Australia after being in force in its initial phase, the scheme constitutes an important case study, in particular, because of the sound and detailed set of legal arrangements that were devised to implement the scheme design and to integrate it into the Australian legal framework. The chapter also assesses the ultimate design of each ETS against the key principles and concepts identified in the previous chapter. In particular, it addresses the subsidiary question as to what extent and through what legal mechanisms the EU, New Zealand, and Australia attempted to secure environmental integrity in their existing and proposed ETS. Supported by the analytical approach discussed in section 1.4.2 above, the case studies also provide insights into the dynamics and major driving forces of the ultimate design of each scheme, and the most important legal issues and implementation lessons to be considered in the subsequent analysis of the thesis regarding potential application of an ETS in Brazil.
Chapters V and VI address the subsidiary research question on the social, economic, cultural, and legal conditions prevailing in Brazil that will condition the environmental integrity of a Brazilian ETS by, respectively, addressing the Brazilian GHG emissions profile and the Brazilian Climate Change Regime. Thus, chapter V situates Brazil in the global climate change context and examines the Brazilian GHG emissions profile. The chapter approaches the major drivers for Brazilian greenhouse gas emissions by sector and biomes within the context of the national development dynamics. The chapter then traces the major challenges and opportunities for GHG reductions for Brazil, taking into consideration the social, economic, and environmental characteristics of the country. This analysis includes a discussion of the legal compliance and enforcement culture of Brazil, and the key dynamics of Brazilian emissions history and trajectories. Chapter VI then situates Brazil in the international climate change regime and examines the current national legal framework and major policy options being considered for greenhouse mitigation in Brazil. It examines Brazil’s commitments under the UNFCCC, the Kyoto Protocol, and in response to the current international trend of imposing quantitative emission reduction targets on Brazil and other large developing economies. It then identifies and analyses the major mitigation policies and programs, and the key legal issues arising from the emerging Brazilian climate change regime.
Chapters VII and VIII address the final question as to whether, and if so how and to what extent, and through what legal framework(s) environmental integrity can be secured in a Brazilian ETS, given the country’s emissions profile and its social, economic, cultural, and legal conditions. Chapter VII integrates the guiding principles, design elements, and practical experiences identified in earlier chapters into the 41
Brazilian context. It considers the various advantages and disadvantages, challenges and opportunities for the optimal adoption of an ETS into the Brazilian legal system. Consistent with the central research question, it examines the main policy choices, design elements, and legal framework of a potential Brazilian ETS that would favour maximum GHG reductions, and the delivery of other environmental services. It also examines the implications and requirements of linking a Brazilian ETS to other national, regional, and global schemes in order to ensure optimum interoperability with the international climate change regime and carbon market. It concludes by examining whether and under which conditions it is worthwhile to include an ETS in the Brazilian response to climate change. Finally, chapter VIII provides the general conclusions of this thesis, examining the legal framework(s) that should be in place to secure environmental integrity in a Brazilian ETS and to fill a gap in the Brazilian climate change regulatory framework. In this final chapter, the thesis applies the analytical approach described in section 1.4.2 above, presenting a legal model of a potential ETS in Brazil, and depicting the structural and functional elements to be considered in its incorporation into the Brazilian and international climate change regime. As a result, it provides for an original and needed contribution for the research efforts on examining ETS from a legal perspective and in relation to its possible applications in developing country jurisdictions.
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CHAPTER II – THE THEORY AND HISTORY OF ETS AS A POLICY INSTRUMENT FOR MITIGATING GHG EMISSIONS
2.1 Introduction to chapter II
This chapter examines the theoretical and historical origins of ETS. It will start by summarizing the theoretical framework of ETS and its interrelation with environmental law theories, in particular the use of economic instruments in environmental policies. It will then look at the historical development of ETS – from the pioneering US debate and policy experiences to its incorporation into the global climate change policy regime.1 By doing so, the chapter will identify some of the major ETS elements, discuss the basic differences between carbon tax and ETS, and reveal voiced benefits and disadvantages of ETS, in particular as a carbon pricing policy. Such introduction of ETS concepts in light of other modes of carbon pricing will start illuminating the notion of the ‘integrative elements of unity’ of an ETS, as proposed by analytical approach devised in chapter I, sections 1.4.21 and 1.42.2. The analysis in this chapter lays the conceptual foundations and historical context of the object of study presented in the Introduction. Hence, along with chapter III, it will inform the following chapters of this thesis, which, in turn, aims at providing a case study analysis of emerging ETS and a proposal to integrate it into the Brazilian context.
This chapter will demonstrate that the use of market-based mechanisms in environmental protection, including ETS, is deeply rooted in the ‘political economy’2 and ‘public culture’3 of the United States. It contextualizes the initial development of
1 From the early discussions of the UNFCCC and the Kyoto Protocol to the prospects for a ‘post-Kyoto’ regime, that is, the international regime following the first commitment period of the Kyoto Protocol ended in 2012 and still being negotiated under the Paris Agreement. See section 1.1.2 and n 43 above..
2 Political economy is herein used as ‘the interplay between economics, law and politics’, and the corresponding studies devoted to analyze how public policy is created and implemented. Investopedia - Educating The World About Finance (2015)
3 The concept of ‘public culture’ in the context of environmental law developments herein used draws on Richard O. Brooks, Ross Jones and Ross A. Virginia Law and Ecology: The rise of the ecosystem legal regime (Ashgate, 2002) 5:
By “public culture” we mean the values implicit in our public practices – the assumptions about nature, the threats to it and the role of government and other institutions in controlling those threats – assumptions which inform our public life. 43
the ETS as a result of a clash of ideas around the best approach to deal with environmental problems in the US. This analysis is largely indebted to the works of economists, legal, and political science scholars, policymakers, and environmental and ecology scientists that have debated and shaped the development of environmental laws and policy in the US, which includes the use of market-based instruments since the late 1960s. From this historic background, the concept of ETS has been successfully exported to the climate change regime discussions. On one hand, exporting such ‘powerful idea’4 has shaped some of the major climate policies at the international, regional and national levels. On the other hand, ever since the ETS theoretical framework has been subject to a much broader level of analysis and critique. This broader debate results from the larger scale and higher level of complexity posed by the climate change problem, in comparison with the more localized US environmental problems and the respective policy responses from which ETS and other market-based mechanisms have emerged.
2.2 The Theory and History of Emissions Trading
As stated in the Introduction of this thesis (chapter I), Emission Trading Schemes (ETS) can be generally defined as a market-based approach to reducing pollution. The development of an ETS theory started from a series of welfare economics, environmental economics and environmental compliance works, and policy experiences, the foundations of which lie in the late 1920s – further developments stem from the 1960s onwards.5 As such, the integration of an economic view of pollution as ‘an externality’ and a ‘market failure’, as introduced in section 1.1.2 of chapter I of this thesis, has evolved to considering policy alternatives devoted to ‘pricing’ pollution. . It is important to note that for some authors, such as Driesen, the inclusion of ETS as one of the ‘pricing mechanisms’ is misleading, since it diverts from the original distinctions
Recognizing that such a public culture is the object of study of other fields such as anthropology, political science and others, the authors justify their brief reference to it as a ‘background to the history of ecology and environmental law.’ Ibid. 4 Jonas Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading (MIT Press, 2011), 192. See additional comments on the Introduction of this thesis (chapter I), section3.
5 T.H. Tietenberg, Emissions Trading: Principles and Practice (Resources for the Future, 2006), 2-5; Jonas Meckling, ibid, 51-2; Fanny Missfeldt and Jochen Hauff, ‘The role of Economic Instruments’, in Anthony D. Owen and Nick Hanley (eds), The Economics of Climate Change (Routledge, 2004) 115; Arnaud Brohé, Nick Eyre and Nicholas Howarth, Carbon Markets: an international business guide (Earthscan, 2009), 22-8.
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between tax and ETS as ‘pricing’ (tax) and ‘quantitative’ (cap-and-trade) mechanisms that will be discussed in section 2.1.1.1 of this chapter. According to Prof. Driesen, such evolvement in the ETS literature is a sign of a conceptual metaphor devoted to promote ETS as ‘uniquely putting a price on carbon’ vis-à-vis other policy instruments (including command-and-control or ‘traditional regulation’), reflecting a misleading tendency, of part of the literature in seeing markets and governments as antonymous instead of overlapping institutions. He names such tendency of part of the literature as a ‘quasi-ideological function of supporting market essentialism.’6 As it will be seen in section 2.2.1.1 and in other parts of this thesis, the consideration of ETS as one form of pricing mechanism has prevailed in the literature.
The conceptual framework of pricing mechanisms evolved from the pioneering work of economist Arthur C. Pigou in the 1920s. Pigou argued that an externality, such as pollution, would be better controlled through pricing mechanisms, such as a per-unit tax on emissions.7 Ronald Coase modified this approach later, in the 1960s, by introducing the concept of pollution as a factor or production that entails a ‘right to pollute’.8 According to Coase, the cost of exercising such right ‘is always the loss that is suffered elsewhere in consequence of the exercise of that right’. Such property rights should be made explicit and transferable, and the market could play a substantial role in putting a value on those rights in
6 See David M. Driesen ‘Putting a Price on Carbon: The Metaphor’ (2014) 44 Environmental Law 695, 696-9. To confront Prof. Driesden with the prevailing understanding of tax and tradeable rights as forms of pricing pollution, see T. Schelling, Incentives for Regulatory Instruments (MIT Press, 1983), reproduced in Mark Squillace, Environmental Law Volume Three: Air Pollution (Anderson, 1992), 16:
In principle there should be no difference between setting a price and letting demand determine the quantity of emissions and setting a quantity and letting demand determine the price to be paid.
7 Arthur C. Pigou The Economics of Welfare (Macmillan, London, 1946, first published in 1920), cited by Tietenberg, Emissions Trading: Principles and Practic above n 5; Meckling Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 52; Missfeldt and J Hauff, ‘The role of Economic Instruments’ above n 5, and Brohé et al, Carbon Markets: an international business guide above n 5, 25.
8 Ronald Coase, ‘The Problem of Social Cost’ (1960) The Journal of Law and Economics 1-44, cited by Tietenberg, Emissions Trading: Principles and Practice, above n 5, 3;
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contrast to tax-based pricing by the government.9 This market value would entail a more cost-effective allocation of costs among the market participants.10 The approach advanced by Coase on the advantages of using proprietary rights (and the right to trade them) to deal with the environmental externality problems at a lower cost was deemed as ‘The Coase Theorem’. As such, it became one of the most influential ideas in the environmental economics discussion, particularly in the U.S., and the debate that followed on the use of ‘proprietary rights to pollution control’ (and other forms of collectively owned resources such as land) vis-à-vis ‘social controls’ such as tax, emission standards and other forms of government direct regulation.11 The debate on proprietary rights and social controls advanced by Coase’s ideas also permeated the debate on the use of market mechanisms in environmental policy and law in the U.S., and later in the climate change regime.12 T. Croker and John H. Dales further developed Coase’s approach in the context of air pollution control in the US and water pollution control in Canada, respectively.13 Dales also emphasized that property rights were already implicit in the right to emit embedded in traditional emission standards.14 However, according to Dales, this traditional system was inefficient because those rights were not transferable, and thus potential cost-efficiencies for pollution reduction
9 Coase, ‘The Problem of Social Cost’ above n 8, 44, cited by Tietenberg, Emissions Trading: Principles and Practice above n 5, 3.
10 Coase, ‘The Problem of Social Cost’ above n 8, 44, cited by Tietenberg, Emissions Trading: Principles and Practice above n 5, 3.
11 See Steve G. Medema, ‘Of Coase and Carbon: The Coase Theorem in Environmental Economics, 1960-1979’, University of Colorado, Denver (Draft, December 2001)
12 See below in this section and nn 26-32 the discussion on the works of Garret Hardin, Elinor Ostrom and the ‘Free Environmentalism’ movement. See also Sanja Bogojevic Emissions Trading Schemes: Markets, States and Law (Hart Publishing, 2013), chapter 2.
13 T. Crocker ‘The structuring of atmospheric pollution control systems’ in H. Wolozing (ed.) The Economics of Air Pollution (W.W. Norton, 1966); John H. Dales, Pollution, Property and Prices (University of Toronto Press, 1968) cited by Tietenberg, Emissions Trading: Principles and Practice above n 5, 3-4; See also Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 51-2; and Missfeldt and Hauff, ‘The role of Economic Instruments’, above n 5, 115.
14 Tietenberg, Emissions Trading: Principles and Practice above n 5, 3.
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among polluters could not materialize. Thus, the collection of such works inspired by Coase’s theory and refined by Croker and Dales brought to the law field the theoretical foundations for mitigating environmental externalities on a more cost-effective way buy turning them into tradable proprietary rights.15 Further analysis refined the initial concepts for different applications based on the nature of the pollutant being regulated, such as ‘uniformly mixed pollutants’ (that is those for which only the level, not the location, of the emissions matters) and ‘non-uniformly mixed’ pollutants (that is, those for which both the level and the location of emission matters). According to the Tietenberg, although the ETS principles ‘hold for all pollutants’, the nature of the pollutant is important for the refinement of the ETS design, particularly the design of the permit that will reflect the actual allocation of emissions to individual sources. For sake of simplicity, this thesis will concentrate on the overall design elements of ETS that apply across all pollutants.16
The development of such environmental economic theories and proposed instruments resonated among many US theorists from the economics, law and public policy fields. In fact, as indicated in chapter I, it is beyond the scope of this thesis to propose a definitive explanation of how ETS emerged from an intellectual discussion among economists in welfare economics to a policy alternative embraced by US environmental policymakers (particularly from the US EPA), and then by the US Congress (mainly through the amendments to the 1990 Clean Air Act). However, it is necessary to present the prevailing arguments in the literature, which will point to the combination of the emergence of a prevailing political and economic environment that
15 Tietenberg, Emissions Trading: Principles and Practice above n 5, 3-4; Tamra Gilbertson and Oscar Reyes, ‘Carbon Trading: How it works and why it fails’ (Occasional Paper Series – Critical Currents No. 7, Dag Hammarskjöld Foundation, November 2009) 18-19; Bogojevic, Emissions Trading Schemes: Markets, States and Law above n 12, 30.
16 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 4-5, 27-40 and 117- 18. Tientenberg cites the following ‘classic’ works for those refining theoretical exercises: W.J. Baumol and W. E. Oates, ‘The Use of Standards and Prices for Protection’ (1971) 73 Swedish Journal of Economics 42; and W. David Montgomery, ‘Markets in Licenses and Efficient Pollution Control Programs’ (1972) 5 (3) Journal of Economy Theory 395.
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praised less government intervention in social affairs with a burdensome regulatory model for air pollution.17
Thus, for many the U.S. Clean Air Act,18 usually deemed the most complex environmental statute in the US,19 has reached a saturation point in reaching sound environmental results at bearable costs20 and, as a result, was viewed as an impediment to economic growth.21 At the time, the US air pollution control scheme was largely based on the combination of technology-based emission standards applied to individual sources of certain pollutants and designed to meet ambient air standards (that is, air quality standards based on the maximum concentrations of certain pollutants designed to protect the environment and public health) in different regions.22 Despite the heavy enforcement infrastructure in place, the environmental goals of some emission reduction
17 Errol Meindiger, ‘On Explaining the Development of “Emissions Trading” in U.S. Air Pollution Regulation’ (1985) 7 (4) Law & Policy 447, 448-52
18 Clean Air Act Publ. L. Nº 91-604, 84 Stat. 1676 (codified as amended at 42 U.S.C.A. §§ 7401-7671q (West Supp. 1991) (the ‘U.S. Clean Air Act’).
19 According to Meindiger, ‘The 1970 U.S. Clean Air Act (CAA) probably ranks as one of the more complicated statutes yet produced by a modern industrial state.’ Meindiger ‘On Explaining the Development of “Emissions Trading” in U.S. Air Pollution Regulation’ above n 17, 451.
20 Bruce Ackerman and Richard B. Stewart, ‘Reforming Environmental Law: The Democratic Case for the Market Incentives, in (1987-1988) 13 Columbia Journal of Environmental Law, 171, 172-3; Daniel J. Dudek and John Palmisano, ‘Emissions Trading: Why is this Thoroughbred Hobbed?’, in (1987-1988) 13 Columbia Journal of Environmental Law 217; The concern with the economic costs of the U.S. Clean Air Act and other command-and-control statutes was not confined to academic or business representatives, but also for some governmental officers such as EPA representatives. See the publication of a then EPA Regional Manager, Dana A. Rasmussen, ‘Enforcement in the U.S. Environmental Protection Agency: Balancing the Carrots and the Sticks’ (1992) 22 (1) Environmental Law 333, 337, citing pollution control cost estimates from 1972 to 1990 based on calculations from the EPA Office of Policy, Planning and Evaluation.
21 Wallace E. Oates, ‘From Research to Policy: The Case of Environmental Economics’ (2000) 1 University of Illinois Law Review 135, 143.
22 Meindiger, ‘On Explaining the Development of “Emissions Trading” in U.S. Air Pollution Regulation’ above n 17, 451-4; Thomas H. Tietenberg, Emissions Trading, an exercise in reforming pollution policy (Resources for the Future, Washington D.C., 1985); Tietenberg, Emissions Trading: Principles and Practice above n 5, 5-6; Inho Choi, ‘Global Climate Change and the Use of Economic Approaches: The Ideal Design Features of Domestic Greenhouse Gas Emissions Trading with an Analysis of the European Union’s CO2 Emissions Trading Directive and the Climate Stewardship Act’ (2005) 5 Natural Resources Journal 865, 885;
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goals of the US Clean Air Act were not attained in many US regions due to the fact that emissions from the different sources have been higher than the ambient standards established in the legislation.23 Thus, at the same time that ambient air standards have been on the verge of being exceeded, the regulated community had reasonable grounds to complain about the level of complexity of the requirements imposed to existing and new emission sources. In addition, this system was viewed as imposing huge costs of compliance, in part due to technology-based emission standards that were defined on a cross-industry basis, without considering the particularities of each regulated sector and corresponding firms. From the governmental standpoint, there were also claims that the regulatory and enforcement system in place had reached a point of becoming economically inefficient, demanding huge amounts of investments for very low marginal abatements, and requiring great sums of funds to bear the administrative costs imposed by the USEPA.
It was against this regulatory background that, despite initial resistance from different sides of the social spectrum, the idea of using market-mechanisms as an alternative to traditional regulation started to gain support from academia, government, and some environmental NGOs. This new pro trade coalition produced some initial policy experiments that triggered increasing political support,24 which, in turn, culminated with more sophisticated programs such as the Acid Rain Program under the U.S. Clean Air Act 1990 Amendments.25
In parallel, some powerful ideas regarding models of use of collectively owned resources (usually referred as ‘commons’ or ‘common-pool resources’) have impacted the scholarly discussions in the social and environmental sciences, particularly in law, political science, economics, and ecology.26 Largely triggered by the article ‘The
23 Tietenberg, Emissions Trading: Principles and Practice above n 5, 6.
24 According to Meckling, such initial EPA policy experiments from the 1970s and 1980s (such as the EPA Offset, Bubble and Netting programs discussed below) are the ‘First Generation’ Trading Schemes. Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 52-4.
25 Or ‘Second Generation Trading Schemes’ or ‘full-fledged cap-and-trading schemes’, such as the Acid Rain Program and the California Reclaim. Ibid 54-56. See discussion on the Acid Rain Program in section 2.3.3 below.
26 Brooks et al, Law and Ecology: The rise of the ecosystem legal regime above n 3, 25, 46 n 80 and 325.
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Tragedy of the Commons’ penned by biologist Garret Hardin,27 the discussions on how to govern common-pool resources, such as the environment, were largely driven by the opposition of those who defended the application of social controls against those who championed the use of proprietary rights. 28 According to Brooks et al, Hardin’s initial concepts were further advanced by Oran Young, Elinor Ostrom and others for the subsequent use of Harding’s notion in the Theory of Resource Regimes, which recognized the importance of ‘the institutional context in which decision makers make decisions about natural resources and ecosystems’ and envisaged governance problems related to ecosystems or common resources.29
In part, the use of market-based mechanisms in environmental protection was also captured by this interdisciplinary discussion on how to use and manage common access resources, which influenced the overall development of environmental laws in the US. From the angle of how to deal with common resources (such as the air shed or public land), the public debate tends to oppose ideas on the level of social control and property rights as the best remedies to avoid environmental problems. Within this debate, a more
27 Garrett Hardin, ‘The Tragedy of the Commons’ in 162 Science (1968), 1243-1248. Harding advanced the concept of environmental problems related to open-access resources as ‘problems of the commons’ by using a metaphor in relation to collective use of a pasture by individuals. As well summarized by Adler:
Hardin described the fate of a common pasture, unowned and available to all. As Hardin explained, in such a situation it is in each herder’s self-interest to maximize his use of the commons at the expense of the community at large. Each herder captures all of the benefit from adding one more animal to his herd. Yet the costs of overgrazing the pasture are distributed among every user of the pasture. And when all of the herders respond to these incentives, the pasture is overgrazed -- hence the tragedy. As Hardin explained it, the pursuit of self-interest in an open-access commons leads to ruin. Without controls on access and use of the underlying resource, the tragedy of the commons is inevitable.
Johnathan H. Adler, ‘Property Rights and The Tragedy of the Commons’ (The Athlantic, May 22, 2012)
28 Hardin, ‘The Tragedy of the Commons’ above n 27, 1245-1247; see also Jonathan H. Adler, ‘Taking Property Rights Seriously: The Case of Climate Change’ (Case Research Paper Series in Legal Studies, Working Paper 08-16, July 2008) 301.
29 See Brooks et al, Law and Ecology: The rise of the ecosystem legal regime above n 3, 4, 46, note 9, 325-6; See Oran Young, Resources Regimes: Natural Resources and Social Institutions (University of California Press, 1982); See also Elinor Ostrom, Governing the Commons: The Evolution of Institutions for Collective Action (Cambridge University Press, 1990), where she argues that in many parts of the world there are examples of common-pool resources managed by communities of individuals which do not fit government direct control or private property paradigms.
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radical approach on championing the use of property rights as the major approach (self- named ‘Free-Environmentalism’) to deal with environmental problems was advanced by scholars in economics, social sciences, and law.30 This more radical view, although including market-based mechanisms to deal with air pollution as part of their proposals, was clearly more focused on land use matters.31 In any event, some of the academic debate on the use of market-mechanisms in environmental policy, including ETS, has labelled ETS a ‘free-environmentalism’ approach.32 Despite the fact that the ETS concept encompasses the discussion on property rights to some extent, it is important to note that the legal theoretical framework discussed in this thesis clearly shows that the ETS debate largely belongs to the discussions on environmental policy alternatives to traditional regulation, and not as much to the ‘free-environmentalism’ debate on use of property rights to protect the environment.
The explanation offered by the literature usually also justifies the early resistance to and later acceptance of market-based mechanisms in the U.S. from a political and ideological standpoint (as a battle between free-market champions from the more liberal political spectrum, who value less government presence in social affairs, on one side, and sceptics of market use to solve social problems on the other side). According to this view, the possibility of using market-based mechanisms in environmental and natural resources legislation along with empirical analyses suggesting the cost-effectiveness of such approach appealed to those (mainly from the liberal political spectrum) who criticized the alleged economic inefficiency and poor environmental effectiveness of command-and-control and technology-based environmental protection and natural resources policies.33 According to some authors, the opposition from Democrats, who
30 For a good summary of the free-environmentalism approach, see Adler, ‘Taking Property Rights Seriously: The Case of Climate Change’ above n 28. Terry L. Anderson and Donald R. Leal, Free Market Environmentalism, revised edition (New York: Palgrave, 2001, originally published in 1991).
31 Anderson and Leal, Free Market Environmentalism above n 30, 8, recognized that ‘pollution concerns challenge the [free environmentalism] paradigm.’ Adler reinforces this point in his review of Anderson and Leal’s book, stating that it ‘is easier to use property rights to safeguard environmental values in the natural resources area than it is to control pollution.’ Jonathan H. Adler, ‘(Review) Free Market Environmentalism Revised Edition (2002) 22 Cato Journal 182, 184.
32 Peter S. Menell, ‘Institutional Fantasylands: From Scientific Management to Free Market Environmentalism’ (1992) 15 Harvard Journal of Law & Public Policy 489; see also Michael C. Blumm, ‘The Falacies of Free Market Environmentalism’ (1992) 15 Harvard Journal of Law & Public Policy 371.
33 Tietenberg, Emissions Trading: Principles and Practice above n 5, 6.
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criticized the overreliance on free market tools, counterbalanced the support of mostly Republican liberals to emissions trading.34 It is worth noting that this overall ideological debate would not mean that support and opposition to market-based mechanisms would be easily reflected in overarching support from corporations and stiff resistance from NGOs and other non-business actors. In fact, according to some sources, many firms and business associations had initially resisted market-based mechanisms due to their understanding that command-and-control regulations were more favourable to existing business vis-à-vis new market entrants.35 For different reasons, some NGOs had initially opposed market-based mechanisms due to pricing or market mechanisms being philosophically viewed by them as ‘licenses to pollute’, in addition to their meeting with scepticism the feasibility of pricing mechanisms and their ability of addressing public health and ecological well being properly.36 The same differences on the risks and benefits of ETS were found in government bureaucracy. According to the account of the Government in the period, there were those in favour of maintaining the status quo of the prevailing command-and-control regulations, so as to prevent their expertise (usually founded in legal and administrative knowledge over emission standards) ‘from becoming obsolete.’37 In this account, the same kind of ‘personal capital’ incentive by government agents drove, in a second moment, a group of EPA pro trading staff involved in the Acid Rain Program to champion the expansion of market-based mechanisms to other pollution matters
Apart from a vigorous ideological and theoretical debate on the risks and benefits of such market-based environmental policy approach, the adoption of emissions trading mechanisms in the US environmental legal framework has increased since the late
34 Robert Stavins, ‘Market-Based Environmental Policies: What can we learn from US Experience (and related research)?’ in Jody Freeman and Charles D. Kolstad (eds) Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (Oxford University Press, 2007), 33-4; Brohé et al, Carbon Markets: an international business guide above n 5, 28. In support of the argument of the ideological component of the emissions trade debate, Brohé et al and Stavins cite Steve Kelman ‘What Price Incentives?: Economists and the Environment (Auburn House, Boston, 1981), who, according to Stavins, ‘surveyed congressional staff members and found that support and opposition to market-based environmental policy instruments was based largely on ideological grounds.’ Stavins, above n 34.
35 Stavins,‘Market-Based Environmental Policies: What can we learn from US Experience (and related research)?’ above n 34, 30-32.
36 Ibid 31.
37 Ibid 32.
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1970s, particularly in air pollution control.38 Further, the idea of emissions trading has been successfully exported to the climate change policy debate, in a concerted effort driven by business coalitions, governmental officers, and some pro business NGOs who are sceptical about command-and-control policies and/or against the introduction of carbon taxes.39 Before we turn to such developments in the US and to the climate change regime, a summary of some important conceptual distinctions established by the economic theory of price mechanisms to mitigate pollution is offered together with a summary of the different types of ETS. The goal of this information at this stage is to better inform the historical development of ETS and the choices made by the policy decision makers in their time.
2.2.1 Some Important Conceptual Distinctions
2.2.1.1 Price and Quantity Mechanisms: The conceptual differences between tax and emissions trading
Among the different price mechanisms mentioned in section 1.1.2 above (tax, emissions trading, subsidies, and charges, or even hybrid approaches incorporating more than one of such mechanisms), the theoretical distinction between pollution taxes and emissions trading has driven the analytical debate and policy options involving pricing mechanisms for pollution control in general, and to a greater extent the more recent debate on greenhouse gases abatement.40 An important conceptual distinction between emissions trading and tax relates to their modes of dealing with uncertainties concerning price and quantity of the pollution being controlled.41 A carbon tax may be imposed on the total or relative quantity of pollutants emitted. It is based on the volume of emissions or on the ratio of greenhouse gas per ton emitted, or on the content of
38 Tietenberg, Emissions Trading: Principles and Practice above n 5, 6-7.
39 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 48-50.
40 Ibid 48-50 and 52.
41 This synthesis of both price and quantity concepts is derived from Lawrence H. Goulder and William Pizer, ‘The Economics of Climate Change’, (NBER Working Paper No. W119231, National Bureau of Economic Research, January 2006)
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pollutant in fuels or products.42 An emissions trading scheme involves the issuance of allowances or permits to emit a certain amount of pollution.43 A tax is deemed a pure ‘price’ mechanism since it defines the price upfront (the tax), but does not establish a predefined limit on the amount of emissions by source. In contrast, emissions trading seeks to enforce a predefined limit on the aggregate volume of emissions (the cap), and is usually defined as a ‘quantity-mechanism.44
For those who support the use of pricing mechanisms to control pollution, emissions trading, provided that the proper design and enforcement structure are in place, is viewed by many as a more dynamic incentive to cost-effective pollution abatement as opposed to tax or other instruments. It can provide companies with more flexibility to meet their compliance requirements, both in defining their control strategy and timing for control investment. It also can provide higher certainty on the amount of pollution reduction being achieved. It can also induce technological innovation, since it allows competition among different control strategies.45
Contrary views concerning ETS alleged economic benefits (and in favour of tax as a pricing option) argue that the price volatility that can arise from a quantity-based approach such as ETS can deter investments in new technologies due to price uncertainties. As a result, price certainty provided by pollution taxes is more beneficial to polluting companies planning their investments in new technologies or any other
42 Goulder and Pizer, ‘The Economics of Climate Change’ above n 41,6; Brohé et al, Carbon Markets: an international business guide above n 5, 32.
43 Goulder and Pizer, ‘The Economics of Climate Change’ above n 41, 6; Brohé et al, Carbon Markets: an international business guide above n 5, 32.
44 Goulder and Pizer, ‘The Economics of Climate Change’ above n 41, 6; Brohé et al, Carbon Markets: an international business guide above n 5, 32. The literature refers to M. L. Weitzman as the classic author for the distinction between price and quantity approaches and W. David Montgomery by delivering ‘the first mathematical proof that trading permits could minimize the cost of achieving a predetermined level of pollution reduction.’ Nicholas Stern, The Economics of Climate Change – The Stern Review (Cambridge University Press, 2008), 354-5; and Brohé et al Carbon Markets: an international business guide above n 5, 32 citing M. L. Weitzman, ‘Prices vs. Quantities’ (1974) 41 Review of Economic Studies 477; see Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 52 citing Montgomery ‘Markets in Licenses and Efficient Pollution Controls Programs’ above n 16; See also Goulder and Pizer, ‘The Economics of Climate Change’above n 41, 6.
45 Tietenberg, Emissions Trading: Principles and Practiceabove n 5, 5-6; Jon Birger Skjærseth and Jørgen Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation (Ashgate 2008) 2.
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emissions reduction strategy.46 Further, pollution taxes are simpler instruments to be managed by governments in addition to reducing the chances of rent seeking by market players.47 There are also ethical arguments, which deem the concept of emissions trading an immoral ‘right to pollute’ granted to the private sector. Such alleged ‘immorality’ includes the possibility of ETS generating ‘windfall profits’ in some sectors that benefit from generous allocations of free allowances and generate immense profits solely as a result of trading agency strategies, but without corresponding emission reductions.48 Further, particularly in the context of GHG global mitigation, there are both equity and justice concerns related to the geographic distribution of emission reduction efforts in the light of the historical responsibility of developed countries greenhouse gas emissions in the past.49 Another source of criticism relates to
46 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 48.
47 Ibid 49. For a more detailed comparison between carbon tax and ETS and also possible advangates or disadvantages of hybrid approaches, see Missfeldt and Hauff, ‘The role of Economic Instruments’, above n 5, 115-146; Stern, The Economics of Climate Change – The Stern Review, above n 44, specially ch 14 (Harnessing Markets for Mitigation – The Role of Taxation and Trading), ch 15 (Carbon Pricing and Emissions Market in Practice) and ch 22 (Creating a Global Price for Carbon); William Nordhaus, A Question of Balance: Weighing the Options on Global Warming Policies (Yale University Press, 2008) especially chapter VIII (The Many Advantages of Carbon Tax), 148-164; Ross Garnaut, The Garnaut Climate Change Review: Final Report (Cambridge University Press, 2008) especially ch 13 (An Australian Policy Framework) and ch 14 (An Australian Emissions Trading Scheme); William A. Pizer, ‘Combining price and quantity controls to mitigate global climate change’ in (2002) 85 Journal of Public Economics 409-534; Goulder and. Pizer, ‘The Economics of Climate Change’, above n 41; Warwick J. McKibbin and Peter J. Wilcoxen, ‘A Blueprint for a Realistic Approach’ (The Brookings Instituion, Washington D.C., 2002); Warwick J. McKibbin, Adele Morris and Peter J. Wilcoxen, ‘Expecting the unexpected: macroeconomic volatility and climate poicy’, in Joseph E. Aldy and Robert N. Stavins (eds), Pos-Kyoto International Climate Policy: Implementing Architectures for Agreement- Research from the Harvard Project on International Climate Agreements (Cambridge University Press, 2010) 857-86; Clive Hamilton and Frank Muller, ‘Critique of the McKibbin-Wilcoxen Hybrid Emissions Trading Scheme’ (The Australia Institute, Research Paper No. 42, March 2007); and The United States Government Accountability Office – GAO, ‘Climate Change: Export Opinion on the Economics of Policy Options to Address Climate Change’ (Report to Congressional Requesters GAO-08-605, May 2008).
48 Mike Hulme, Why We Disagree About Climate Change? Understanding Controversy, Inaction and Opportunity (Cambridge University Press, 2009), 301-02.
49 Ibid.
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the notion of transferring the governance of a huge and complex problem, such as climate change mitigation, from governments to the market.50
As indicated above, the discussions on pricing mechanisms alternatives have not gone without controversy. However, the fierce debate around it did not impede these concepts to be introduced in pollution control policies in the US, and more lately in the climate change regime, as discussed later in this chapter.
2.2.1.2 Two forms of ETS: cap-and-trade and baseline-and-credit
Another important conceptual distinction relates to the types of ETS, that is, the pricing mechanisms that incorporate trading as part of their essential feature. Thus, two basic forms of emissions trading evolved from the initial theories approached above: cap-and-trade and baseline-and credit.51 They can be implemented as part of mandated policy, or voluntarily under the rationale that they may create an economic incentive for companies to invest in emission reductions and to profit from credits sold to other polluters.
Cap-and-trade52 is based on the initial limitation of aggregate emissions of certain gases (the targeted maximum quantity of emissions) applied across the coverage
50 Ibid 301-321.
51 The distinction between cap-and-trade and baseline-and-credit concepts is largely adopted by the literature without controversy. See Matthieu Wemaere, Charlotte Streck and Thiago Chagas, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’ in David Freestone and Charlotte Streck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond (Oxford University Press, 2009) 41; Brohé et al, Carbon Markets: An International Business Guide above n 5, 42; Frauke Roeser and Tim Jackson, ‘Learning by Doing? Experiences from the UK Emissions Trading Scheme’ in Cyriel de Jong and Kasper Walet (eds), A Guide to Emissions Trading: Risk Management and Business Implications (Risk Books, a Division of Incisive Financial Publishing Ltd, 2004) 276 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementationabove n 45, 12; David Hodgkinson and Renee Garner, Global Climate Change: Australian Law and Policy (Lexis Nexis Butterworths, 2008) 244-46; Robert N. Stavins, ‘Experience with Market-Based Environmental Policy Instruments’ (Discussion Paper 01-58, Resources for the Future, Washington D.C, 2001); Abyd Karmali, ‘Observations from the Carbon Emissions Markets: Implications for Carbon Finance’ in Cary Krosinsky and Nick Robins (editors) Sustainable Investing: The Art of Long-Term Performance (Earthscan, 2008) 61; Garnaut, The Garnaut Climate Change Review: Final Report, above n 47, 309.
52 Wemaere et al, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’ above n 51; Brohé et al, Carbon Markets: An International Business Guide above n 5, 42; Garnaut, The Garnaut Climate Change Review: Final Report, above n 47, 309; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy above n 51, 56
area of the scheme (the cap component). The governing body of the scheme allocates emission rights (sometimes named permits or allowances) among sectors of the economy (usually individual corporation entities/firms within the covered area). The scheme participants who are able to reduce emissions below their individual emission rights are authorized to sell their excess to other participants, who were not able to reduce their emissions below their allocated emissions. The initial allocations and the actual emissions of each participant are monitored and verified (usually on an annual basis). The goal is to ensure that the overall capped emissions have not been exceeded by the aggregate emissions of the participants in the scheme. The overall rationale of cap-and-trade is that the allocated cap of emissions must be lower than projected business-as-usual emissions. It will then create a market scarcity and drive the scheme participants towards finding ways to reduce emissions.
Baseline-and-credit53 systems are project-based emissions trading schemes that recognize emission credits to project activities that reduce emissions against a predefined baseline scenario. The baseline scenario is usually defined as the expected emissions from business-as-usual practices in the project surrounding area. Project developers who are able to reduce emissions below the baseline are authorized to sell their corresponding emission credits to other scheme participants whose emissions exceeded the baseline. Project-based emission rights can also be used to compensate (or offset) emissions from sources located elsewhere (not necessarily in the same area where emissions reductions occurred). This offsetting practice has been the major driving force for the voluntary emission reduction market and for the linking between the Kyoto Protocol and the European Union Trading Scheme, as discussed further in this thesis.
According to the literature, both the cap-and-trade approach and the baseline-and- credit systems may be subject to absolute or relative emissions caps54 (in the case of
245; Roeser and Jackson, ‘Learning by Doing? Experiences from the UK Emissions Trading Scheme’ above n 51.
53 Wemaere et al, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’, above n 51; Brohé et al, Carbon Markets: An International Business Guide, above n 5, 42; Garnaut, The Garnaut Climate Change Review: Final Report, above n 47, 309-10; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 47, 245-6; Roeser and Jackson, ‘Learning by Doing? Experiences from the UK Emissions Trading Scheme’, above n 51.
54 Wemaere et al ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’, above n 51.
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baseline-and-credit, the cap is the sum of individual baselines). Emissions trading systems may also combine features and credits from both approaches.55 In both cases, the transactions are publicly recorded and tracked through the combination of trading platforms and registry systems or ‘transaction logs’ (comprised of individual accounts for each scheme participant, the governing body, authorized traders, among others) governed or overseen by the scheme authority.56
As in many other emerging practices, it is important to note that the terminology used to differentiate these two major forms of emissions trading is not unanimous. Some sources use the term ‘allowance-based markets’ and ‘project-based markets’ for cap-and-trade and baseline-credits, respectively.57 Others, as highlighted in the following discussion on the US pioneering experiences, use offsets as an especial form of emissions trading, which allow emissions from a new source to be compensated by reductions made in prior existing sources.58 Others use the term ‘offsetting’ to refer to voluntary approaches to compensate emissions as opposed to emission reductions from ‘mandatory compliance or emissions trading schemes.’59
In this thesis, whenever not specifically noted, emissions trading and cap-and- trade schemes will be used interchangeably. Baseline-and credit and project-based schemes will be used as a common reference for schemes recognizing credits from individual projects reducing emissions against a baseline. Offsets will be used to refer to project based emission reductions that can be used to compensate emissions elsewhere, regardless of proximity between the locations of the project and the source that seeks to compensate its own emissions.
55 Anja Kollmus, Michael Lazarus, Carrie Lee, Maurice LeFranc and Clifford Polycarp, Handbook of Carbon Offset Programs: Trading Systems, Funds, Protocols and Standards (Earthscan, 2010) 7-10; Stern, The Economics of Climate Change – The Stern Review, above n 44, 377.
56 Sefan E. Weishaar, Emissions Trading Design: A Critical Overview (Edward Elgar, 2014) 151-6.
57 See for example Booz & Company and Department of Climate Change, Assessment of the International Carbon Market (Department of Climate Change, Australia, 2008).
58 See, for example, Erik Haites (principal author), An Emerging Market for the Environment: A Guide to Emissions Trading (United Nations Publication, 2002), 9: ‘There are three basic types of emissions trading programmes: ‘cap and trade’, ‘baseline and credit’ and ‘offsets.’
59 Brohé et al, , Carbon Markets: An International Business Guide,above n 5, 274.
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2.3 The Historical Development of ETS: The US Pioneering Experience
As mentioned above the US Environmental Protection Agency (USEPA) established the first emissions trading programs in the United States by the late 1970s. The next sections will summarize and discuss some of these programs, with emphasis on the USEPA Emissions Trading Program, the Acid Rain Cap-and-trade Program for SO2 emissions, and the NOx Budget Program, due to their importance from a conceptual and empirical standpoint, mirrored extensively in the literature. Although many sources on emissions trading cite such programs in some level of depth (and the literature on this topic is immense), the following sections on the history of the US- based programs will be based on selected works whose authors have done extensive research on the matter, in addition to the USEPA’s own description of the programs. 60
2.3.1 The USEPA Emissions Trading Program
The first pioneering initiatives implemented by the US Environmental Protection Agency were the EPA Offset Policy and the Emissions Trading Program.61 The Offset Policy was created through a USEPA interpretative ruling in 1976, later incorporated to the US Clean Air Act in 1997 ‘as a means for new sources of emissions to locate in areas with poor air quality without causing additional air quality problems.’62 The USEPA encouraged sources of pollution located in regions not attaining the Clean Air Act ambient air standards (nonattainment areas) to voluntarily reduce their emissions
60 For example, Haites (principal author), An Emerging Market for the Environment: A Guide to Emissions Trading, above n 58; Stavins, ‘Experience with Market-Based Environmental Policy Instruments’ above n 51, 8-13; Tietenberg, Emissions Trading: Principles and Practice, above n 5, 6-13; A. Denny Ellerman, Paul L. Joskow and David Horrison, Jr., ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases (Position Paper, Pew Center on Global Climate Change, May 2003)
61 Haites (principal author), An Emerging Market for the Environment: A Guide to Emissions Trading, above n 58, 22; Tietenberg, Emissions Trading: Principles and Practice, above n 5, 7; USEPA, ‘Tools of the Trade: A Guide to Designing and Operating a Cap and Trade Program for Pollution Control’above n 60.
62 USEPA, ‘Tools of the Trade: A Guide to Designing and Operating a Cap and Trade Program for Pollution Control’ above n 60.
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below the legal requirements.63 The USEPA would certify excess reductions as emission reduction credits. The affected sources were able to trade such credits with new businesses looking for a permit to install their facilities within the same area. The goal of the USEPA was to try to combine environmental concerns in critically polluted areas with demands for economic growth reflected in new businesses entering the same areas.64 As a result, new sources were able to enter nonattainment regions provided they acquired sufficient credits from existing facilities and that total emissions would be lower after entry of the new businesses. To reach the goal of aggregate lower emissions, the USEPA originally demanded the new sources to acquire credits for 120 per cent of the emissions they would contribute to the regional ambient air.65
The scope of the Offset Policy was further expanded by the USEPA under a voluntary policy called the USEPA Emissions Trading Program (ETP).66 Under the ETP, the USEPA combined the offset concept with three other policy approaches: the bubble concept, banking, and netting.67 ‘Bubble’ and ‘netting’ were used by the USEPA to allow emissions trading not only between existing and new sources of pollution, but also between existing sources. The name ‘bubble’ derived from the idea of allowing multiple sources within a facility or a region to meet a single aggregate emission limit. The multiple sources could meet different emission limits by point of emission provided that total emissions within the imaginary ‘bubble’ were equal to or less than the single aggregate limit.68 ‘Netting’ applied the same ‘bubble’ concept of aggregate emissions of existing sources to sources undergoing modification or expansion. Emissions reductions occurring elsewhere in the facility could offset the increases resulting from expanded or modified operations.69 Another component of the program was the concept of
63 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 7.
64 Ibid.
65 Ibid; USEPA, ‘Tools of the Trade: A Guide to Designing and Operating a Cap and Trade Program for Pollution Control’ above n 60; Haites (principal author), An Emerging Market for the Environment: A Guide to Emissions Trading, above n 58, 22.
66 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 7; Ellerman et al, ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases above n 60, 8.
67 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 7.
68 Ibid.
69 Ibid.
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“banking”, whereby the USEPA allowed firms to hold emission reduction credits for subsequent use in the bubble, offset, or netting programs.70
It is important to note that some authors commenting on these initial experiences of the USEPA with market-based mechanisms recognize that the overall results of such pioneering programs were timid vis-à-vis the expected outcomes provided by their supporting theoretical framework.71 In summary, although emission reductions in several ‘nonattainment’ areas under the U.S. Clean Air Act were credited to the EPA Offset Program,72 the general view was that offsetting and other initial emission trading initiatives would not meet more ambitious goals due to their focus on improving existing air control programs that were not originally addressing total emissions.73 In fact, the offsetting stratagem was to allow economic growth in nonattainment areas by somehow allowing new sources to operate, provided they emit less than existing sources, which, in turn, would be shut-down or upgraded to accommodate the additional emissions brought by the new entries in the same region. Further, the design of such initial EPA ETS programs were considered a source of high transaction costs and high level of legal uncertainty resulting from, among others, the burdensome process of obtaining governmental approvals and the need of oversight for each transaction.74 At least for one source, ‘(T) the EPA ET programs constitute the first official recognition of the potential value of emissions trading, but the disappointing experience with these
70 Ibid; Ellerman et al, ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases above n 60, 8 See also USEPA, ‘Tools of the Trade: A Guide to Designing and Operating a Cap and Trade Program for Pollution Control’ above n 60, ch 2, 11 for an illustrative example of the ‘bubble concept.’
71 Ellerman et al, ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases above n 60, 8-9; Stavins, ‘Market-Based Environmental Policies: What can we learn from US Experience (and related research)?’ above n 34, 25; Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 52-3.
72 Environmental Law Institute, ‘Emission Reduction Credit Trading System: An Overview of Recent Results and Assessment of Best Practices’ (Environmental Law Institute Research Report, September 2002) i and 8.
73 USEPA, ‘Tools of the Trade: A Guide to Designing and Operating a Cap and Trade Program for Pollution Control’ above n 60, ch 2, 12.
74 Ibid; Ellerman et al, ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases’ above n 60, 8-9.
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programs is the primary reason for the early reputation of emissions trading as a theoretically desirable but largely impractical concept.’75
2.3.2 Other US Market-Based Policies
Despite the fierce debate on environmental policy alternatives in the US, the early experiences were sufficient to drive the US Government to widen the use of market- based mechanisms in environmental control, in particular air pollution.76 Thus, after the first experiences of the USEPA Emissions Trading program, the US Federal Government developed other important market-based programs allowing trading of emissions rights, including the Lead-in Gasoline Program,77 the Acid Rain Program,78 the Los Angeles Air Basin RECLAIM Program,79 and the Northeast NOx Budget Trading Program.80 The Acid Rain and the NOx Budget Programs rank among the most representative US policy experiences on emissions trading to control air pollution due to their coverage and emission reduction results. Some of their main characteristics are discussed below.
75 Ellerman et al, ‘Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases’, above n 60, 9.
76 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 8.
77 The Lead-out Gasoline Program started in 1982 to allow oil refineries to trade emission reduction rights over maximum allowed content of lead in gasoline. Merkling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading, above n 4, 53.
78 The Acid Rain Program was established in 1990 as a national cap-and-trade scheme for SO2 emissions from public utilities. Ibid 54.
79 The Los Angeles Air Basin RECLAIM Program was established in January 1994 as an alternative means of reducing SO2 and NOx emissions from different sources in the Los Angeles area. Regional Clean Air Incentives Market (RECLAIM) established by the California State South Coast Air Quality Management District in January 1 1994. Ibid 56.
80 The Northeast NOx Budget Trading Program started in 1999 as a cap-and-trade program among the District of Columbia and twelve states to reduce NOx emissions from certain electricity-generating facilities and large industrial boilers, as per provisions for ground- level ozone from the 1990 U.S. Clean Air Act Amendments. Tietenberg, Emissions Trading: Principles and Practice, above n 5, 13; USEPA, ‘Clean Air Market Programs: Cap-and-trade: Multi-state NOX programs’
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2.3.3 The Acid Rain Cap-and-trade Program for SO2 emissions81
As the concept and policy experiments on emissions trading have developed, the debate on their effective environmental and economic results persists. Despite this controversy, the Acid Rain Program (also known as the US SO2 Allowance Trading Program) is, according to many sources, the largest and most successful emissions trading program at the national level for non-greenhouse gases.82 It has also been largely cited in the literature as a strong driving force for the consideration of emissions trading in the context of global emissions of greenhouse gases, including the Kyoto Protocol and the European Union Trading Scheme, as discussed below.83 The development and implementation of the Acid Rain Program largely resulted from the concerted works of a pro trade coalition formed by representatives of academia, government and Congress political forces and some environmental NGOs.84 The nature of the acid rain problem, itself, offered a political challenge for its resolution, since it opposed the Midwest and Appalachian regions (where most of the SO2 emitters - coal and oil fired plants were located) versus the U.S. Northeast region and Canada, where the acid rain problem was
81 According to the USEPA, ‘acid rain’ is a broad term reffering to a mixture of wet and dry deposition (deposited material) from the atmosphere containing higher than normal amounts of nitric and sulfuric acids. The precursors of acid rain formatoin result from natural sources (such as volcanos and decaying vegetation) and anthropogenic sources such as emissions of sulfur dioxide (SO2) and nitrogen oxides (NOx) resulting from fossil fuel combustion. It causes damages to lakes and living bodies around them and can be spread to long distances from their emitting sources by prevailing winds across state and national borders. See USEPA, Acid Rain,
82 A. Denny Ellerman, ‘Are Cap-and-Trade Programs More Environmentally Effective than Conventional Regulation?’, in Freeman and Kolstad (editors), Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience above n 34, 50; Tietemberg, Emissions Trading: Principles and Practice above n 5, 10. For a good account on the major legal elements of the Acid Rain Program, see Brennan van Dyke, ‘Emissions Trading to Reduce Acid Deposition’ (1991) Vol. 100 (8) The Yale Law Journal 2707. For a more in depth specific assessment on the Acid Rain Program, see A. Denny Ellerman, ‘Ex Post Evaluation of Tradable Permits: The U.S. SO2 Cap-and-Trade Program’ (Working Paper 03-003 WP, Center for Energy and Environmental Policy Research, A Joint Center of the Department of Economics, Laboratory for Energy and the Environment, and Sloan School of Management, February 2003).
83 A. Denny Ellerman, Frank J. Convery and Christian de Perthuis (principal authors), Pricing Carbon: The European Union Emissions Trading Scheme (Cambridge University Press, 2010), 14.
84 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 54.
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prevalent.85 According to the literature, this political embattlement was resolved in large extent by a bipartisan group in the US Senate lead by Senators Timothy Wirth (Democrat from Colorado State) and John Heinz (Republican from Pennsylvania), who commended to a multidisciplinary group of experts lead by economist Robert Stavins, a study on market-based environmental policy alternatives to a set of environmental issues.86 This initiative, named ‘Project 88’, produced a report that presented market- based proposals for seven environmental issues (from energy efficiency to waste management), which included global air pollution problems and the acid rain problem affecting U.S. states and Canada.87 Stavins was an economist with Harvard University’s John F. Kennedy School for Government with links with pro trade NGO Environmental Defense Fund – EDF, and the latter had been working on a proposal for an emissions trading scheme to mitigate the acid rain problem.88 From a political standpoint, the strategy underpinning Project 88 was to meet then recently elected President George Bush’s political agenda in favour of marketplace solutions to policy issues; and, at the same time, it relied on EDF’s support to mitigate criticism from other environmental groups who were not favourable of promarket strategies for environmental protection.89 From a legal and policy standing point, Project 88 was largely the result of legal actions and scholar debate during the 1980s that addressed the failure of the ‘command-and- control Clean Air Act’ to mitigate air emissions, particularly interstate pollution, both from an environmental and economic standpoint.90
85 Ibid.
86 Ibid; A. Denny Ellerman et al, Markets for Clean Air: The U.S. Acid Program (Cambridge University Press, 2000), 22.
87 Robert Stavins, ‘Project 88: Harsenning Market Forces to Protect the Environment: Initiatives for the New President’ (A Public Policy Study sponsored by Senator Timothy E. Wirth, Colorado, and Senator John Heinz, Pennsylvania, Washington D.C., 1988)
88 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Tradingabove n 4, 54; Ellerman et al, Markets for Clean Air: The U.S. Acid Program, above n 86.
89 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 54-5; Ellerman et al, Markets for Clean Air: The U.S. Acid Program,above n 86, 22-3.
90 Brooks et al, Law and Ecology: The rise of the ecosystem legal regime above n 3, 234 and 236.
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Although it may not be accurate to credit the Acid Rain Program exclusively to the Project 88 initiative, it is clear that this concerted work by U.S. Senators and a pro trade coalition of business, academia and one influential protrade NGO was key to inform the final version of the legislation91 and, as it will be discussed later in this chapter, to influence the U.S. proposals for incorporation of emissions trading in the Climate Change regime.92 At least three characteristics of the Project 88 report deserve attention for the purposes of this thesis. First, although focusing on U.S. based problems, the report first proposal covered global climate change and advocated the inclusion of international emissions trading and offset of emissions from deforestation as part of the international climate change regime.93 Second, Project 88 report proposed the use of offsets from agricultural emissions to mitigate GHGs emissions from new stationary sources (such as energy and industrial plants), providing landowners with and additional source or revenues by selling credits from forest conservation activities. As discussed later in chapter IV, this approach is very similar to the Australian Carbon Pricing Mechanism and Carbon Farming Initiative, developed more than 20 years later. Third, it represented a successful model of protrade coalitions that would combine academia, government, business and pro-market environmental organizations to advance emissions trading proposals to the international and regional climate change, namely the Kyoto Protocol and the European Union Emissions Trading scheme, and in some extent the New Zealand ETS, as discussed below in chapter IV.
In summary, the Acid Rain Program is a cap-and-trade scheme with national coverage. It was devised to reduce sulphur dioxide emissions from electric utilities that were contributing to acid rain. A major innovation of the program was that it allocated sulphur dioxide allowances to existing plants, focused on their aggregate emissions instead of emissions by individual sources, and granted polluters great flexibility to implement emission reduction at specific sources, and created an auction market for allowance trading, through annual auctions conducted by the US EPA, that promoted greater transparency and lower transaction costs. The Acid Rain Program was implemented in two phases: from 1995–99, and from 2000–10. Phase I imposed a cap on emissions from approximately 260 of the largest coal-fired energy-generating plants.
91 Ellerman et al, Markets for Clean Air: The U.S. Acid Program, above n 86, 23.
92 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading, above n 4, 56-8.
93 Stavins, ‘Project 88: Harsenning Market Forces to Protect the Environment: Initiatives for the New President’, above n 87, 17-19.
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The number of allowances was progressively reduced to meet pre-specified emission reduction targets from 1980 levels by the end of Phase II in year 2010. Phase II covered more than 2260 electric-generating plants. Each allowance authorized emission of one ton of sulphur for a specific calendar year, but unused allowances could be banked to be used in future years. The program authorized transfer of allowances not only among emission sources, but also to third parties (including NGOs and individuals) who could ‘retire’ them in order to restrict future emissions. According to some authors, the Acid Rain Program provided not only reductions at a lower cost but also positive environmental results.94 The outcomes include large reduction of emissions accomplished very quickly; high level of compliance combined with low level of participants’ requests for exemptions or relaxation of requirements; and high rates of abatement by the sources contributing most to SO2 emissions.95
Some dissenting views on the success of the Acid Rain Program suggest that most of reductions resulted from over allocation of allowances in Phase I of the program. This over allocation allowed companies to establish ‘large banks’ of allowances to be used in Phase II.96 Others suggest that part of the program’s ‘over-compliance’ results from factors independent from the program design, such as increased availability of cost-competitive low sulphur coal to public utilities.97 In any event, despite dissenting views on the magnitude of the benefits resulting from the Acid Rain Program, initial reviews and subsequent periodical analysis of the program by scholars and the U.S. Government continue to show positive results from both environmental effectiveness and economic efficiency.98 Such major positive perception on the results of the Acid
94 Tietenberg, Emissions Trading: Principles and Practice, above n 5, Ellerman, ‘Are Cap- and-Trade Programs More Environmentally Effective than Conventional Regulation?’ above n 82, 52; Ellerman et al, Markets for Clean Air: The U.S. Acid Program, above n 86, 5-9.
95 Ellerman et al, Markets for Clean Air: The U.S. Acid Program, above n 86, chapter 5.. For consolidated results of the Acid Rain Program see USEPA ‘Acid Rain and Related Programs: 2009 Highlights’ (USEPA, 2009) available online
96 Lesley K. McAllister, ‘The Overallocation Problem In Cap-And-Trade: Moving Toward Stringency’ (2009) 39 (2) Columbia Journal of Environmental Law 395, 399-403.
97 Gilbertson and Reyes, ‘Carbon Trading: How it works and why it fails’, above n 15, 20– 1.
98 Ellerman, ‘Ex Post Evaluation of Tradable Permits: The U.S. SO2 Cap-and-Trade Program’, above n 82, 16-23 and 35; Douglas A. Burns (lead author) ‘National Acid Precipitation Assessment Program Report to Congress 2011: An integrated assessement’ (Executive Office of the President, National Science and Technology Council, 66
Rain Program (both in terms of actual emission reductions and in economic efficiency) was key to influence the development of other U.S. market based environmental policies (as the NOx Budget Program discussed below) and, as said before, to export the emissions trading idea to the climate change regime in a second moment.
2.3.4 The NOx Budget Program
A second example of the early US emissions trading program is the NOx Budget Program. The concern about regional tropospheric ozone problems (‘ground level ozone’) caused by NOx (nitrous oxide) emissions99 triggered a multi-state coordinated effort among the District of Columbia and twelve states in the US Northeast.100 The effort – the NOx Budget Program – was carried out through the Ozone Transport Commission (OTC) under authority granted by the 1990 Clean Air Amendments. The NOx Budget Program was a multi-phase program. Phase I started in 1995 with technology-based emission reduction targets. In Phase II, beginning in 1999, the program introduced a cap-and-trade emissions trading scheme to achieve additional emission reductions during the ozone seasons (May–September). In Phase III, beginning in 2003/4, the scope of the program was extended to include states from other regions and established a federally based central authority.101
Washington D.C., December 28, 2011), 2-17
99 According to the USEPA, ‘unlike stratospheric ozone, which forms naturally in the upper atmoshphere and protects us from the sun’s harmful ultraviolet rays, ground-level (or tropospheric ozone) is created by the interaction of antrophogenic and natural emissions and may cause health problems to human and animals. USEPA, ‘The Ozone Problem’
100 The initial state participants were Connecticut, Delaware, Maryland, Massachussets, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and the District of Columbia. Tietenberg, Emissions Trading: Principles and Practice, above n 5, 23.
101 This enlargment of the program scope is known as the NOx State Implementation Plan Call (NOx SIP Call). The NOx SIP Call added the following states to the program: Alabama, Illinois, Indiana, Kentucky, Michigan, North Carolina, Ohio, South Carolina, Tennessee, Virginia, and West Virginia. Ibid. See also Ellerman, ‘Are Cap-and-Trade Programs More Environmentally Effective than Conventional Regulation?’, above n 82, 55-6. 67
The NOx Budget Program was innovative in two major aspects. It was the first major regional cap-and-trade program in US environmental history.102 Although stimulated by a federal legal requirement, this program is generally considered to have been an authentic coordinated effort among states to meet a common objective.103 Another unique feature is that the program focused on seasonal emission reductions (May–September), taking into account the seasonal aspect of formation of ozone in the US and enhancing the chances of effectiveness.104 In addition, differently from the Acid Rain Program, the NOx Budget Program imposed some limits on banking allowances, thus putting more emphasis on early action by the regulated entities. According to some sources, this has not stopped the program from presenting better results in the first year of each phase, ‘without delays or exceptions’ by regulated entities. In other words, companies affected by the program presented a high level of adherence to its terms and did not request additional time to comply.105
The US experience of using market-based mechanisms in environmental policy continues to be subject to scrutiny and debate in the fields of economics, law, ethics, and policy. This debate has not been confined to the US national experience. In fact, the climate change problem has reinvigorated the environmental economics theoretical framework applied to ETS and other pricing mechanisms and the corresponding policy experiments on a global scale, as discussed below.
102 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 13.
103 Ellerman e al, ‘Emissions Trading in the U.S.: Experience, Lessons and Considerations for Greenhouse Gases’, above n 60,30.
104 Tietenberg, Emissions Trading: Principles and Practice, above n 5, 13.
105 Ellerman, ‘Are Cap-and-Trade Programs More Environmentally Effective than Conventional Regulation?, above n 82, 55. For consolidated resources of the NOx Budget Program, see USEPA ‘The NOx Budget Trading Program: 2008 Environmental Results’ (USEPA, 2009)
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2.4 The Historical Development of ETS: The incorporation of emissions trading concepts into the Climate Change Regime
2.4.1 Climate Change Economics
The complexity of the climate change problem has challenged well-established economic theories and triggered in-depth discussions on the prevailing economic models and social life styles. In this scenario, which became more apparent in the late 1980s and early 1990s as discussed below, the economics of climate change has had two important features. On one hand, it has exerted significant influence over major political decisions about climate change. These decisions are based on particular accounts of the economic impacts of human-induced climate change to a particular region or economic sector. On the other hand, different analytical frameworks within the field of economics can provide very different – and sometimes conflicting – advice to inform climate change policy decisions.106 Any prevailing economic analytical framework will reflect different views on the intergenerational and intertemporal aspects of climate change and on the potential magnitude of climate change risks. Within this framework, there are at least three major economic analytical frameworks informing the climate change debate: more or less conservative versions of the predominant neoclassical welfare economics and ecological or green economics.107 None of these economic frameworks are particularly well suited to deal with all aspects of climate change. Issues such as the costs of limiting carbon dioxide concentrations in the atmosphere to a certain level or controlling global warming to certain temperature limits are highly complex. Climate change falls far beyond the analytical capacity of single economic tools designed to deal with much less complex variables.108 This limitation does not preclude these economic tools from providing useful insights for policy choices and their respective legal instruments, despite the subjective value judgments implied by each analytical framework. In fact, regardless of the differences among the economic analytical models, the prominence of economics in most of the
106 Hulme, Why We Disagree About Climate Change? Understanding Controversy, Inaction and Opportunity, above n 48, 110-12.
107 Ibid. Hulme also recognizes different approaches taken by Marxian and ‘new institutional economics’ with focus on differential access to power resources between the rich and the poor or institutional reasons for climate change, respectively. Ibid 113, 124- 40
108 Ibid 113-14.
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climate policy considerations is evident. It results from the predominant recognition of climate change as an economic externality and the significant challenges of a transition to a low-carbon economy under the ‘dominant framework’109 of neoclassic welfare economics.
2.4.2 Climate Change as a Market Failure
The Stern Review110 is at the centre of major climate change economic policy discussions since it was launched in October 2006. Stern’s analysis, despite receiving a strong support from many different actors in the climate change regime, has also triggered criticism both from within the classic welfare economics realm and from ecological economics. Dissenting views from the classic welfare economics focused, in particular, Stern’s assumption of a quasi-zero discount rate. Dissenting views from ecological economists focused on Stern’s adherence to the prevailing continuous economic growth model that has driven most of the human impacts on climate change.111
The Stern Review defines climate change as ‘one example of market failure involving externalities and public goods.’112 According to the Stern Review, climate change economic analysis departures from the combined use of classic concepts of
109 Ibid 113.
110 Stern, The Economics of Climate Change – The Stern Review above n 44. The Stern Review was commissioned by the UK Government and coordinated by former World Bank chief economist Nicholas Stern.
111 The central role of Sterns’ analysis in the cimate change economics debate is recognized by Hulme, above n 48, 124-26. For criticisms on the Stern Report within the neoclassic welfare economics realm, see Nordhaus, A Question of Balance: Weighing the Options for Global Warming Policies, above n 47,165-91; Partha Dasgupta, ‘Commentary: The Stern Review’s of Economics of Climate Change’, (2007) 199 National Institute Economic Review 4; Martin L. Weitzman, ‘The Stern Review of Economics of Climate Change’, (September 2007) 45 Journal of Economic Literature, 703-24; Frank Ackerman, ‘Debating Climate Economics: The Stern Review vs. its Critics’ (Report to Friends of the Earth-UK, July 2007),
112 Stern, The Economics of Climate Change – The Stern Review above n 44, 27. See also Jason Shogen, ‘Climate Protection: What insights can economics offer?’ in Owen and Hanley (eds) The Economics of Climate Change, above n 5, 59-59.
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welfare economics – market failure involving externalities and public goods –, but demands a much broader economic analysis.113 The reason for this differentiated approach is the scale and nature of several features of the climate change problem: its global causes and consequences, long-term and persistent impacts, and pervasive uncertainties and risks.114 The Stern Review’s major conclusion about the economics of climate change is that ‘the benefits of strong and early action far outweigh the economic costs of not acting’.115 As a result, Stern argues for three elements of policy responses to global climate change: pricing carbon, supporting low carbon technology innovation and deployment, and removing barriers to energy efficiency (including educating people on how to respond to climate change).116
2.4.3 Emissions Trading as Carbon Policy
As discussed earlier in this chapter, despite the fierce debate on the comparison of pricing mechanisms, many analysts favour the use of emissions trading under certain circumstances as opposed to other emissions pricing alternatives such as a pollution tax.117 Accordingly, the quantity approach will be more efficient in establishing a price signal across countries in comparison with international or national-wide harmonized taxes.118 It is also viewed as more beneficial in terms of transferring funds and technology to developing countries and more economically efficient by allowing reductions to occur wherever they are cheaper.119 Under some of these views, a global ETS is considered a central element of any future international cooperation on climate change.120
113 Stern, The Economics of Climate Change – The Stern Review above n 44, 28.
114 Ibid.
115 Ibid xv.
116 Ibid xviii-xix.
117 Section 2.2.1.1.
118 Stern, The Economics of Climate Change – The Stern Review above n 44, 365.
119 Ibid; Missfeldt and Hauff, ‘The role of Economic Instruments’,above n 5, 142; Garnaut, The Garnaut Climate Change Review: Final Report above n 47, 308-9.
120 See Stern, The Economics of Climate Change – The Stern Review above n 44, xviii, 553, 643-44. See also Ellerman, ‘ The EU emission trading scheme: a prototype global system?’ inAldy and Stavins (eds), Pos-Kyoto International Climate Policy above n 47, 71
As indicated earlier in the Introduction of this thesis (chapter I) and in the present chapter, this support for ETS as an effective GHG reduction mechanism is far from unanimous. Thus, apart from the ‘pollution tax versus ETS debate’, legitimate concerns have been voiced concerning the efficacy and appropriateness of the use of market mechanisms in climate change policy.121 Such critiques resemble the early discussions in the US developments discussed above. They include ethical arguments against the notion of assigning emission rights to polluters, as well as equity and justice concerns related to the geographic distribution of emission reduction efforts among developed and developing countries122 and transferring to the market a central role in climate change governance.123
However, the economic intricacies of climate change suggest pricing carbon is worth being tested as a policy alternative. The Intergovernmental Panel on Climate Change (IPCC) has shared this view. According to the IPCC Fourth Assessment Report,124 market-based mechanisms are usually more cost-effective than regulations and standards if appropriate market and enforcement institutions are in place.125 The IPCC also recognized that ETS had become an important mechanism in many countries, and that a global system of international trading is emerging slowly.126 In fact, the
88-117; see also Judson Jaffe and Robert N. Stavins, ‘Linkage of tradable permit systems in international climate policy architecture’, in Aldy and Stavins (eds), Pos- Kyoto International Climate Policyabove n 47, 119-50; Garnaut, The Garnaut Climate Change Review: Final Report above n 47, 227-35.
121 See Clive L. Spash ‘The Brave New World of Carbon Trading’ (2010) 15 New Political Economy, 169, 171-72 and 188; see also Vandana Shiva, Soil Not Oil: Climate Change, Peak Oil, and Food Insecurity (Pinifex Press, 2008) 16-24. See also Jutta Kill, Saskia Ozinga, Steven Pavett and Richard Wainwright, Trading carbon: How it works and why it is controversial (FERN, 2010); Steffen Böhm and Siddhartha Dabhi (eds), Upsetting the Offset: The Political Economy of Carbon Markets (MayFlyBooks, 2009); and Larry Lohman (guest editor and author) ‘Carbon Trading: a critical conversation on climate change, privatisation and power’ (2006) 48 Development Dialogue 1.
122 Hulme, Why We Disagree About Climate Change? Understanding Controversy, Inaction and Opportunity above n 48, 301-02.
123 Ibid 301-21.
124 Sujata Gupta and Dennis A. Tirpak (coordinating lead authors), ‘Policies, Instruments and Cooperative Arrangements’ in Bert Metz et al (eds) Climate Change 2007 (Cambridge University Press, 2007), 745-807.
125 Ibid 759, 788-68 and 778.
126 Ibid 778.
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market mechanisms have constantly been an important feature of the Climate Change Regime. As discussed below, it has been advocated by many since the beginning of the discussions and negotiations on the United Nations Framework Convention on Climate Change (UNFCCC), and ultimately materialized under the Kyoto Protocol, in part due to the formation of pro trading coalitions similar to what happened in the US under the Acid Rain Program debate and approval.
A complete analysis of the driving forces for the replication of pro-emissions trading coalition formed by business, government and NGOs at the international arena is beyond the scope of this thesis. However, a thorough analysis by Meckling shows that the Organisation for Economic Co-operation and Development (OECD) and the United Nations Conference on Trade and Development (UNCTAD) had promoted studies on a possible international emissions trading to mitigate climate change in connection with the initial UNFCCC negotiations in the early 1990s.127 As discussed in section 2.3.3 above, these early discussions on market mechanisms under the UNFCCC were highly influenced by the U.S. based protrade coalition that emerged in the 1980s and 1990 debate on use of market mechanisms in environmental policy, which was particularly influential in the design and U.S. Congress’ approval of the Acid Rain Program, with some of their members participating directly in the early UNFCCC and UNCATD discussion forum.128 According to Meckling, the business side of the coalition evolved from a split in a U.S. lead global industrial lobby, largely influenced by large oil companies such as Exxon and Texaco, which systematically opposed to climate change regulation. Facing a different political pressure at home as opposed to the U.S. companies, the UK-based oil company British Petroleum changed course in relation to the international oil lobby, and partnered with protrude NGO EDF, which had already been influential in the Acid Rain Project 88, to embrace emissions trading
127 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 57. See also Gilbertson and Reyes, ‘Carbon Trading: How it works and why it fails’ above n 15, 22-3;OECD, ‘Climate Change: Designing a Tradable Permit System’, OECD Observer, Paris, 1992; United Nations Conference on Trade and Development, ‘Combating Global Warming: study on a global system for tradable carbon emissions entitlements’ (UNCTAD, RDP/DFP/1, United Nations, Geneva, 1992).
128 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 4, 57 and 75. According to Meckling the chief of the U.S. delegation in COP 2 in Geneva, in 1996, who announced the U.S. preference for the inclusion of an international trading mechanism in the climate regime, was Timothy Wirth. As discussed in section 2.3.3, Wirth was one of the U.S. senators who lead the approval of the Acid Rain Program by the U.S. Congress. Ibid, 75. 73
as the preferred climate policy. Shell also followed the same course, as well as U.S. based Du Pont. Accordingly, the common view of those companies was that the political pressure towards climate policy was unbearable and embracing emissions trading was a regulatory risk management strategy to protect their interests against a carbon tax, which was perceived as a higher risk. Under those circumstances, pro trade companies also view as advantageous to position themselves as early players in the emerging emission markets.129 This movement of large business players was naturally embraced by pro trade NGOs, and became a strong political ally to governments, such as the U.S. Clint Administration in 1996, that needed to position themselves with some kind of support to pro climate policies and resolve the divided political debate between command-and-control, carbon tax, or no regulation at all.130 As it will be seen in the next sections, this initial driving force for exporting the emissions trading idea to the climate change regime expanded the theoretical framework to a much broader application and, as discussed in chapter IV, to directly influence not only the Kyoto Protocol mechanisms but also de development of the EU ETS and the NZ ETS. In any event, as very well analysed by Meckling, it is possible to trace back the influence of the success of the Acid Rain Program as one of the key arguments for those arguing in favour of emission trading as climate policy.131 Having contextualized the foundations of the ETS conceptual framework and the history of its exporting to the climate change negotiations, we now turn to the broader theoretical discussion on the incorporation of ETS in the climate change debate and regime.
2.4.4 The incorporation of ETS by the Climate Change Regime
As anticipated in the previous section, the discussions on and experiences of ETS in the US have been an important influence in the discussions of policy alternatives to deal with the climate change problem since the UNFCCC early stages. Since evidence of human-induced climate change emerged, such discussions have permeated different levels of the scientific and policy debate, and have governed, to a large extent, the international law instruments arising from such debate. To better situate the development of the discussions on possible use of economic instruments as part of the climate change policy alternatives, it is imperative to understand how climate change
129 Ibid 80-92.
130 Ibid 75 85 and 98-101.
131 Ibid 100.
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science, policy, and economics interplay, and the importance of the latter in framing the climate change regime to date.
2.4.4.1 The interplay of science, policy and economics
Human-induced greenhouse gas emissions are primarily due to fossil-fuel use, and to unsustainable patterns of land use and land-use change,132 coupled with unsustainable rates of global economic and population growth.133 Some accounts also point out that the prevailing global economic model of continuous economic growth and its reliance on highly unsustainable consumption patterns – historically in economically developed countries and more recently increasingly achieved in some parts of the developing world – potentiate the complexity of the climate change problem and represent one of the main barriers to overcoming the problem.134
The prospect of potentially global catastrophic impacts of major variables of the human social system – mainly its energy-inefficient life style and the predominant economic and technological supporting systems – has provoked an unprecedented myriad of scientific and economic models and projections addressing the interaction of humans with the climate system. These studies include efforts to measure and project greenhouse gas emissions by country and economic sector, to correlate different
132 IPCC (Intergovernmental Panel on Climate Change), Core Writing Team, Pachauri, R.K. and Reisinger, A. (Eds.), Climate Change 2007: Synthesis Report. Contribution of Working Groups I, II and III to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC, Geneva, Switzerland, 2007), chapter 2.
133 See Jeffrey D. Sachs Common Wealth: Economics for a Crowded Planet (Penguin Books, 2008) for an account on the unsustainable ‘world’s current ecological, demographic, and economic trajectory’ caused by, among other reasons, human pressure’s on Earth’s ecosystem and climate, exponential population growth and unbalanced distribution of wealth reflected in the extreme poverty of one sixth of the world population.
134 This view is usually linked to the theory of what is generally nominated ‘Ecological Economics’ or ‘Green Economics’. A thorough account on its main concepts is provided by C. L. Spash, Greenhouse economics: values and ethics (Routledge, London 2005). See also Nirmal Chandra Sahu and Amita Kumary Choudhury (eds), Dimensions of Environmental and Ecological Economics (Universities Press 2005); Molly Scott Cato, Green Economics: An introduction to Theory, Policy and Practice (Earthscan 2009); Andrew Simms, Ecological Debt: Global Warming and the Wealth of Nations (Pluto Press, Second Edition, 2009). For the collection of some classic essays on concepts such as ‘the tragedy of the commons’, ‘steady state economics’ and a critique on the concept of ‘continued growth in a planet of finite resources’ see Herman E. Daly and Kenneth N. Townsend (editors) Valuing the Earth: Economics, Ecology, Ethics (MIT Press, 1996).
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emission scenarios and temperature increases, to project economic impacts of climate change in different global regions and economic sectors, and to assess the economic costs of different climate change mitigation and adaptation alternatives.135 An important objective of this international research effort is to devise ways of stabilizing the concentration of greenhouse gases in the atmosphere at levels that would avoid dangerous anthropogenic interference in the climate system.
As part of this effort, the scientific community has developed climate models that project different emission scenarios for the next decades (usually based on country- based estimates for CO2 or CO2-equivalent136 emissions). These models correlate each emission scenario with the volume of GHGs already accumulated in the atmosphere in order to estimate the corresponding increase in the Earth’s average temperatures. This methodological approach has led to the discussion regarding the time when the global emissions should reach its peak to allow the concentration of greenhouse gases (and corresponding average temperatures) to stabilize at levels able to avoid catastrophic consequences to the planet. In the international negotiations regarding possible emission reduction targets for each country, most of the parties have considered those same variables to quantify possible compromises of reductions in different timeframes. 137
135 The Intergovernmental Panel on Climate Change Fourth Assessment report is heavily informed by a series of those modeling studies, including emission scenarios, projections of future changes in climate, impacts of future climate changes and emissions trajectories for stabilization. See IPCC (Intergovernmental Panel on Climate Change), Core Writing Team, Pachauri et al (eds.), Climate Change 2007: Synthesis Report, above n 132, specially chapters 3, 4 and 5. See also Derek Vollmer (Rapporteur), National Research Council of the National Academies, ‘Assessing Economic Impacts of Greenhouse Gas Mitigation: Summary of a Workshop’ (The National Academy Press, Washington D.C., 2009), 8-14.
136 The use of a carbon-equivalent ratio, or index, is usually expressed as CO2-e, to express the global warming potential of all greenhouse gases is common in the climate change literature. As pointed out by Sander Simonetti and Rutger de Witt Wijnen, this index has been already used by the IPCCC in its second assessment report in 1995. An overview of the Global Warming Potentials is provided by the UNFCCC guidelines on reporting and review, FCCC/CP/2002/8. Sander Simonetti and Rutger de Witt Wijnen, ‘Emissions Trading and Green Investments Schemes’ in Freestone and Steck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond, above n 51, 158. Many economic modeling and analysis rely on those indexes, although some exceptions may ocurr under specific circumstances. See also Garnaut, The Garnaut Climate Change Review: Final Report above n 47, 609; Stern The Economics of Climate Change – The Stern Review above n 44, 5, n 3.
137 This approach will be confirmed in chapter IV by the analysis on emerging ETS.
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Many policy options for mitigating GHGs (including emissions trading schemes) usually use such models as a quantitative reference for the policy goals. Stern, for example, discusses different stabilization levels for carbon dioxide and the other greenhouse gases and the corresponding projected date of peak emissions (this model uses the goals of stabilizing emissions at 450 and 550 ppm of CO2e). He also discusses other possible policy objectives for action, such as maximum tolerable levels of impacts, global mean warming, concentration of greenhouse gases (or radiating forcing), cumulative emissions of greenhouse gases (over a given period) and reduction in annual emissions by a specific date.138
Most economic models have taken a similar approach regarding the potential impacts of climate change in the world economy and the relative costs and benefits of each policy option.139 Such models have informed the debates around the UNFCCC and the Kyoto Protocol regimes and a significant amount of alternative policy proposals and legal schemes devoted to allow the migration to a low-carbon and energy-efficient human behaviour. Not surprisingly, the potential economic costs of each policy alternative and the potential use of market-based instruments as one of them have been part of most of such discussions and policy outcomes. We turn now to the most important cluster of this debate and policy and legal results at the international level, which has brought the US ETS pioneering experiences to a much higher level of complexity and larger potential coverage: The Climate Change Regime.140
138 Stern, The Economics of Climate Change – The Stern Review above n 44,chapter 8 and chapter 13.
139 See Vollmer (Rapporteur) ‘Assessing Economic Impacts of Greenhouse Gas Mitigation: Summary of a Workshop’ above n 135, 6 for a discussion and additional references on the benefits and pitfalls of using quantitative targets such as stabilizing CO2 concentrations in climate policy design and analysis.
140 The concept of regime, although commonly used in different legal and social research works, sometimes is interchangeably used as reference for legal schemes or pieces of law, mainly in the Brazilian legal doctrine. This thesis adopts the classic definition of ‘International Regime’ used by Stephen D. Krasner and advanced by Oral R. Young in the environmental arena, which encompass not only legal frameworks but also institutions and organizations devoted to governing international relations. According to Krasner:
Regimes can be defined as sets of implicit or explicit principles, norms, rules, and decision making procedures around which actor’s expectations converge in a given area of international relations. Principles are beliefs of fact, causation, and rectitude. Norms are standards of behaviors defined in terms of rights and obligations. Rules are specific prescriptions or proscriptions of actions for action. Decision-making procedures are prevailing practices for making and implementing collective choice;
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2.4.4.2 The Climate Change Regime
The International Climate Change Regime has driven most of the climate change public debate, analyses, and legal outcomes to date. This regime is centred on the UNFCCC141 and the Kyoto Protocol,142 in addition to scientific bodies and other relevant institutions. An important pillar of the Regime is the Intergovernmental Panel on Climate Change (IPCC), a congregation of scientists from different disciplines the main goal of which is to assess and inform the international community about the state- of-the-art research on climate change and its potential environmental and social impacts.143 The assessments made by the IPCC have been one of the main drivers for
Stephen D. Krasner (ed), International Regimes, (Cornell University Press, Ithaca and London, 1983), 2.
In his account of the Regime Theory with a focus on the international environmental arena, Oral R. Young provides a similar definition, and emphasizes the dynamic character of Regimes:
Like all social institutions, environmental and resource regimes – assemblages of rights, rules, and decision-making procedures that influence the course of human-environmental interactions – are dynamic. Some changes, such as the adoption of significant amendments to an existing statute or the addition of substantive protocols to a framework convention, are developmental in character; Oran R Young, Emergent Patterns in International Environmental Governance, (MIT Press, Cambridge, Massachusetts, London, England, 2010) 1.
141 The UNFCCC ultimate objective is to achieve greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. The UNFCCC excluded from its coverage the greenhouse gases which had already been subject to control by The Montreal Protocol on Substances that Deplete the Ozone Layer (Montreal Protocol), concluded 16 September 1987, 1522 UNTS, 26 ILM 1550 (1987) (entered into force 1 January 1989) UNFCCC, Articles 2 and 4. This explicit distinction between the coverage of both Regimes (Climate and Ozone Depletion) was followed by The Kyoto Protocol. The Kyoto Protocol lists the following greenhouse gases as subject to its requirements: carbon dioxide (CO2), Methane (CH4), Nitrous Oxide (N20), Hydrofluorcarbons (HFCs), Perfluocarbons (PFCs) and Sulfur hexafluoride (SF6). Kyoto Protocol, Article 2 (2) and Annex A.
142 As indicated in chapter I, n 26, the Kyoto Protocol was adopted in Kyoto, Japan, on 11 December 1997 and entered into force on 16 February 2005. The main objective of the Kyoto Protocol was to create quantified obligations upon states to reduce their greenhouse gas emissions. Such quantified obligations were imposed on developed countries for the first compliance commitment period (from 2008 to 2012). Each country’s obligation was calculated based on historical emissions, with the goal of reducing them by at least 5 per cent of their 1990 levels.
143 See the IPCCC website
the negotiation agenda of both the UNFCCC and the Kyoto Protocol, and also for fostering the major issues still disputed by the different bodies of knowledge devoted to assess the climate system and its relation with human society. This central role of the IPCC is a natural consequence of its main role of collecting and assessing the major scientific works conducted by a whole myriad of experts in the full range of disciplines related to climate change, from “pure” climate science to the broad range of technical and social fields of knowledge.
2.4.4.2.1 The UNFCCC
The UNFCCC establishes a structure for global achievement of a common objective of GHGs emission reductions that considers the historical emissions of each country, based on emissions inventories and other related data such as the economic and scientific models indicated above. This reliance on scientific and economic models supports the principle of ‘common but differentiated responsibilities’ adopted by the UNFCCC, which puts most of the burden for the initial GHG reduction activities on developed countries.144 The UNFCCC also adopts under Article 3.1 the precautionary principle, or at least its underlying rationale, stating that scientific uncertainty should not stop the adoption of measures to anticipate, prevent, or minimize the causes of climate change and mitigation of its adverse effects. In fact, UNFCCC Article 3.1 uses the term ‘precautionary approach’, but the literature is dominant in characterizing such ‘approach’ or ‘measure’ as one of the main principles that ‘should guide the efforts toward the achievement of the main objective of the UNFCCC, namely ‘the stabilization of greenhouse gases concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.’145
understanding of the risk of human-induced climate change, its observed and projected impacts and options for adaptation and mitigation.
144 UNFCCC Article 3.1.
145 Michael B. Gerrard and Dionysia-Theodora Avgerinopoulou, ‘Development and the future of climate change law’ in David Leary and Balakrishna Pisupati (eds) The Future of International Enviornmental Law (United Nations University Press, 2010), 151. Along the same lines, David Freestone provides the following comment on Article 3 of the UNFCCC:
Article 3 then goes on to enumerate the principles by which the Parties should be guided in their actions to achieve this objective. These include a number of the 79
2.4.4.2.2 The Kyoto Protocol
The Kyoto Protocol is the first international agreement to establish a cap on greenhouse gas emissions (mirrored in the emission limits assigned to each country). In addition to establishing quantified emission reduction targets to Annex B countries (which largely reflects the Annex I countries of the UNFCCC),146 the Kyoto Protocol innovated by introducing market-based mechanisms into internationally binding efforts to mitigate carbon emissions.
As indicated earlier in this chapter, the incorporation of market mechanisms into the Kyoto Protocol is largely a result of US-based proposals in the negotiation process that led to the final text of the Protocol.147 The main objective of the US was to ensure the highest level of flexibility for developed countries complying with binding emission reduction targets.148 This approach was initially opposed by the European Union (with the exception of the United Kingdom).149 Ironically, the US has not ratified the Kyoto Protocol, yet the European Union has embraced emissions trading as its main policy to meet the EU Kyoto Protocol emission reduction requirements. Apart from the US resistance to ratifying the Protocol, the Kyoto market-based mechanisms have become
innovative principles set out in the 1992 Rio Declaration, notably the precautionary principle, and the principle of inter-generational equity.
Freestone, ‘The International Climate Change Legal and Institutional Framework: An Overview’ in Freestone and Streck, Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond (eds) above n 51, 5-6. For a good contextualization of the precautionary principle under international law, and particularly the UNFCCC, see also Rabbi Elamparo Deloso, The Precautionary Principle: Relevance in International Law and Climate Change (Master’s Thesis, International Environmental Sciences Degree, Lund University, 2005).
146 Those countries will be indistinctively referred herein as Annex I or Annex B countries.
147 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 45, 66; Merkling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading, above n 4, ch 4.
148 Michael Grubb, ‘The Economics of the Kyoto Protocol’, in Owen and Hanley (eds) The Economics of Climate Change, above n 5, 107.
149 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 45, 67.
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the catalyst for experimentation of global and regional carbon markets, and for mandatory or voluntary ETS.150 Such mechanisms will be described below.
2.4.4.2.3. The Kyoto Protocol Market Mechanisms
This section summarizes the main aspects of the flexible mechanisms of interest for this thesis.151 Although the Kyoto Protocol’s first commitment period ended in 2012, the overall architecture discussed below has been preserved through an extension of the Kyoto Protocol up to 2020, when a new international climate change regime is expected to come into force provided the Durban Platform and further commitments under the Paris Agreement are successfully implemented.152 This extension of the Kyoto Protocol was established by the Conference of the Parties serving as the meeting of the Parties to the Kyoto Protocol held in Doha, Qatar, on November to December 2012 and is referred as ‘The Doha Amendment to the Kyoto Protocol.’153 The Doha Amendment includes new commitments for Annex I Parties to the Kyoto Protocol who agreed to take on commitments in a second commitment period from 1 January 2013 to 31 December 2020, a revised list of greenhouse gases (GHG) to be reported on by Parties in the second commitment period, and amendments to several articles of the Kyoto Protocol.
150 Hulme, Why We Disagree About Climate Change? Understanding Controversy, Inaction and Opportunity, above n 45, 298; Freestone, ‘The International Climate Change Legal and Institutional Framework: An Overview’, above n 145, 18-19.
151 For a thorough analysis of the main rules and proceedings related to the UNFCCC and the Kyoto Protocol in general, see Farhana Yamin and Joanna Depledge, The International Climate Change Regime: A Guide to Rules, Institutions and Procedures (Cambridge Universtity Press, 2004).
152 As discussed in chapter I, section 1.2., in 2011 the UNFCCC, at its 17th Conference of the Parties (COP-17) established the Ad Hoc Working Group on the Platform for Enhanced Action (ADP). The mandate of the ADP was to develop a protocol, another legal instrument or an agreed outcome with legal force under the Convention applicable to all Parties, which was to be completed no later than 2015 in order for it to be adopted at the twenty-first session of the Conference of the Parties (COP) and for it to come into effect and be implemented from 2020. This resulted in the adoption of the Paris Agreement, which established the boundaries of a possible market mechanism and provided the mandate for the Parties pursuing alternatives for market mechanisms modalities and proceedings as part of the Paris Agreement workplan; UN Doc FCCC/CP/2015/10/Add. 1, Article 6.
153 For a summary of the Doha Amendments see the UNFCCC website
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It specifically referenced issues pertaining to the first commitment period and which needed to be updated for the second commitment period. Such second commitment period in fact acts as a transitional period of the Protocol to accommodate the fact that there was no comprehensive agreement on the international regime post 2012.154 In any event, the Doha Amendment provides for the second period of the Kyoto Protocol to end by 2020, coinciding with the expected initial year of application of the Paris Agreement as discussed in chapter I, section 1.1.2. The Doha Amendment requires ratification of 146 Parties under the UNFCCC to enter in force. While this has not happened, several countries, including New Zealand, have already ratified both the Doha Amendments and the Paris Agreement.155
Regardless the final outcome of such arrangements by 2020, one can expect that major elements from the Kyoto Protocol (particularly the fungibility of emission reduction credits to be used in linked schemes) and the overall trading platform of the Transaction Log be preserved,156 provided that market mechanisms are used in the next regime.157
The case study analysis of the three emerging ETS that will made in chapter IV of this thesis, particularly their relationship with the international climate change regime and linking options, cannot be made without a proper introduction of the Kyoto Protocol mechanisms, towards which we now turn:
The market-based mechanisms established by the Kyoto Protocol are Joint Implementation (JI), the Clean Development Mechanism (CDM), and Emissions Trading. They reflect the two main broad categories of emissions trading mechanisms discussed in this chapter: baseline-and-credit systems158 and cap-and-trade systems.159 The overall rationale of the Kyoto Market Mechanisms reflects the theory of use of
154
155 See New Zealand Ministry of the Environment,‘New Zealand and the United Nations Climate Change Convention on Climate Change’
156 Erik Haites, Farhana Yamin and Niklas Höhne ‘Possible Elements of a 2015 Agreement to Address Climate Change’ (2014) 8 (1) Carbon and Climate Law Review 3, item IX.
157 Ibid.
158 Such as Joint Implementation under Article 6 and the Clean Development Mechanism under Article 12. 159 Such as Emissions Trading under Article 17.
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economic instruments for environmental protection discussed above: to allow emission reductions at a lower economic cost by establishing an international price on GHG emissions. It seeks to combine the goals of changing the rising trajectory of GHG emissions, and promoting sustainable development and transfer of clean technology among the Regime participants.160
In brief, Emissions Trading, pursuant to Article 17 of the Protocol, allows Annex B Parties of the Kyoto Protocol to trade part of their Assigned Amounts Units (AAU) among each other. AAU are the unitary expressions of the emissions cap established by Article 3 of the Kyoto Protocol to each Annex B country for the first commitment period (2008–12). This cap is based on the average five per cent reductions below 1990 levels by 2012. The concept of Article 17 Emissions Trading envisages a global emissions trading scheme (in the form of a cap-and-trade scheme) between Annex I countries. Under Article 17, Emissions Trading shall be supplemental to Annex I countries’ domestic measures to comply with their respective GHG emission-reduction targets under Article 3 of the Protocol. At the end of the first commitment period, the Party must surrender emissions rights in order to show compliance with its emission reduction targets (individual cap). Where emissions in such Party’s territory exceeded the cap, the Party has to demonstrate it acquired sufficient emission rights through the flexible mechanisms to meet its targets for the commitment period.161
One important consequence of this architecture for Emissions Trading under Article 17 was the surplus of AAU to some of the Annex B countries. Article 3 has allocated AAU to all Annex B countries, including countries with economies in transition (mostly in Central and Eastern Europe) that had been through economic downturns in the 1990s after such initial allocations.162 The process created a surplus of AAU for such countries, which was named as hot air because it did not represent actual emissions reductions from their 1990 emission levels. The surplus of AAUs has been subject to criticism for lack of environmental integrity. In response, countries trading AAU in these regions have developed the concept of Green Investment Schemes in
160 See Grubb, ‘The Economics of the Kyoto Protocol’, above n 148, 72; Stern, The Economics of Climate Change – The Stern Review above n 44, 353 and ch 22; Freestone, ‘The International Climate Change Legal and Institutional Framework: An Overview’ above n 145, 12-3.
161 Simonetti and Wijnen, ‘International Emissions Trading and Green Investment Schemes’ above n 136,158.
162 Ibid 164.
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order to ensure that financial resources from the transactions are allocated to the selling country so as to produce actual reductions of GHG emissions and “restore’ the environmental integrity of the transacted credits.163 This concept is not formally linked to the Kyoto Protocol regulations under Article 17 Emissions Trading, but voluntarily included by the Parties involved in such transactions.164 The risk of over allocation of allowances, as occurred in the hot air situation under the Kyoto Protocol, persisted in the adoption of ETS at the regional and national levels, as discussed in chapter IV, at least with respect to the initial phase of the EU ETS. This fact confirms the theoretical discussions on the ultimate role of an ETS design to secure its degree of environmental integrity, regardless its coverage and scale.
Joint Implementation, under Article 6 of the Protocol, allowed Annex I Parties to implement emission reduction projects activities in conjunction with each other. It encompasses a baseline-and-credit approach where individual projects are implemented in Annex I countries and certified to achieve emission reductions against a pre- established baseline. Such projects may encompass emission reduction by sources or enhancement of carbon removals by sinks that are additional to ‘any that would otherwise occur.’165 The resulting Emission Reduction Units can be traded between the Annex I countries. The main goal of JI is to promote sustainable development and allow Annex I countries to cooperate with each other in meeting their emission reduction targets. In any event, the use of emission reduction units by Annex I countries engaged in JI projects shall be ‘supplemental’ to their respective domestic actions necessary to meet individual emission reduction targets.166
The Clean Development Mechanism, under Article 12 of the Protocol, has a baseline-and-credit approach similar to JI. However, differently from JI, the CDM allows cooperation between Annex I and non-Annex I countries. Under the CDM, Annex I parties can implement project activities in the developing countries and receive Certified Emission Reductions (CER) in exchange for such activities. The resulting emission reductions must be real and measurable, and be additional to any emission reductions that would occur in the absence of the certified project activity.167
163 Ibid.
164 Ibid 165.
165 Kyoto Protocol Art 6 (b).
166 Kyoto Protocol Art 6 (d).
167 Kyoto Protocol Art 12 (5) (b) and (c). 84
The common element of the three Kyoto Market Mechanisms is the legal recognition of an economic value for emission reductions of greenhouse gases that meet certain pre-established and verifiable requirements. This economic value is materialized by the issue of the corresponding emission reduction units that can be traded among the parties eligible to participate in the resulting market.168 The arising Kyoto-based transactions are tracked and recorded in registry systems set up by each Annex I country or by the UN. The transactions between countries or legal entities are monitored through an international transaction log managed by the UN Climate Change Secretariat.169 By doing so, this system ensures that proper accounting is kept of the transactions and of the corresponding number of Kyoto units to be assigned by each country subject to the Kyoto Protocol compliance requirements.
The interplay among all those ‘Kyoto Units’ is sometimes a complex operation to be undertaken by the regulated community and the market operators. However, it has not precluded specialized communities of international regulators, governments, and business representatives from revolving around the implementation of the Kyoto Market Mechanisms. Although these mechanisms were primarily confined to the Kyoto Protocol participants, the international experience with the Kyoto Market-Based Mechanisms has been the major driving force for the development of regional and national emissions trading initiatives, and the resulting carbon markets.170
2.4.5 Emerging Carbon ETS
The Kyoto Protocol flexible mechanisms became the catalyst for experimentation of global and regional carbon markets and the corresponding mandatory and voluntary emissions trading schemes. From all these experiments, the European Union Trading Scheme (EU ETS) has become the most successful case of an international mandatory
168 Assigned Amount Units (AAU) for Emissions Trading between countries, Emission Reduction Units (ERU) for Joint Implementation, Certified Emission Reduction (CERs), Temporary CERs (tCERs) and Long-term CERs (t-CERs) for the Clean Development Mechanism and Removal Units (RMUs) for removal by sinks under the umbrella of land- use change and forestry (LULUCF) project activities.
169 UN Doc FCCC/KP/CMP/2005/8/Add.2 Decision 13/CMP.1 (Modalities for the Accounting of Assigned Amounts) (30 March 2006), 23; See Simonetti and Wijnen, ‘International Emissions Trading and Green Investment Schemes’ above n 136, 162-4.
170 Hulme, Why We Disagree About Climate Change? Understanding Controversy, Inaction and Opportunity above n 48, 298.
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emissions trading scheme. Further, the EU ETS has become ‘the engine of the carbon market’171 and may remain as such unless the US or China embraces international emissions trading. Also, as indicated in the Introduction of this thesis (chapter I), emissions trading schemes are being considered the preferred climate change policy in many countries around the globe.172
The impetus and political support for such initiatives are in constant motion. They have been consistent with the fluctuation of the prevailing political agenda and with each country’s negotiation position in the post-Kyoto international negotiations. In any event, as indicated in the Introduction of this thesis (chapter I), emissions trading has been increasingly considered and seriously discussed in most of the countries facing pressure to adopt binding emission reduction targets. Once limited to economically developed countries, the list of countries starting to advance in-depth discussions on ETS includes developing economies such as South Korea and China. These emerging ETS (either formally adopted such as in the European Union, New Zealand and, shortly, in Australia, or in the format of more maturely proposed policy or law) entail different design options. Each of them may reflect different theoretical views and vested interests of each country that may result in significantly different outcomes. In short, a proper design will be crucial to ultimate ETS environmental integrity and interoperability, which are necessary to materialize its use in the international ‘post-Kyoto’ policy architecture.
2.5 Conclusion
This chapter laid down the foundations and history of the ETS concept and implementation. As discussed, the US has pioneered the use of market mechanisms in environmental policy in the late 1970s, and this approach was further exported to the discussions and legal outcomes of the climate change regime, such as the market-based mechanism of the Kyoto Protocol. The issues examined by the chapter offer important lessons in support for the analysis that will follow in the next chapters:
From a theoretical standpoint, the chapter demonstrated how the adoption of then innovative market based mechanism by the U.S. regulators and policy makers resulted
171 Alexandre Kossoy and Philippe Ambrosi,‘State and Trends of the Carbon Market 2010’ (Carbon Finance at the World Bank, Washington D.C., 2010) 2.
172 See section 1.2 of the Introduction (chapter I) and corresponding notes.
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from an extremely rich theoretical debate that initially emerged from pure economic analysis that were examining the most effective ways to factor in production activities of any sort the costs of the social impacts they generate. Usually named as ‘externalities’, such social costs usually were left aside any consideration of their magnitude and effects in national gross product or in products of individual firms. In this context, pollution is seen as an externality since those who benefit from their emissions do not bear the social costs or damage they cause to public goods. Pigou, one of the pioneers in this theoretical debate within the economics literature, proclaimed that such externalities should be priced in order to allow their allocation to those that caused it, and defended that taxation would work as an adequate pricing instrument for pollution and other externalities. This original idea was the object of important analysis from the 1960s onwards, mainly by Coase, who although defending a pricing mechanism to control pollution, claimed that the under certain circumstances allocation of such costs amongst several polluters through a market mechanism would be more efficient from an economic standpoint as opposed to pricing by the government; in theory, without jeopardizing the achievement of any predefined environmental outcome. Underlying Coase’s proposal was the notion that an externality as pollution was a result of a ‘right to pollute’ that in some sort was deferred to the activities that caused it (at a loss of others), and such right should be priced and transferable to allow the market to price it properly. Dales and Crocker further advanced Coase’s idea in the context of water and air pollution control in the U.S. and Canada. These developments in the North-America, particularly in the U.S., initially more confined to the economics realm, were also captured by a parallel discussion on the level of effectiveness of command- and-control regulations to curb pollution and on perceived failures of the U.S. environmental legislation in attain some of its objectives under such more traditional form of regulation. Apart from the views of scholars more devoted to legal compliance alternatives in the environmental arena and its interface with economic instruments, such as Ackerman, Dudek and Palmisano, the theoretical foundations of emissions trading and other price mechanisms were also articulated in broader discussions in the political science spectrum, such as the works of Hardin and Ostrom, and in its interface with law and policy as the works of free environmentalists such as Anderson and Leal. In this broader debate, the concepts of private-property rights and social controls have been compared in relation to their effectiveness in inducing desired changes in society with respect to managing ‘common resources’ such as the environment.
The history of ETS in the U.S. and its expansion to the climate change regime examined in this chapter show that the prevailing theoretical model of discussing the potential benefits and pitfalls of ETS and other pricing mechanisms belong to the broader debate on alternatives to traditional command-and-control regulations in the 87
context of environmental law, either domestic or as part of international regimes. It was within this framework that ETS was incorporated in the Acid Rain Program and other U.S. market-base environmental policies and laws, and further exported as an idea to be considered by the climate change regime and regional and national jurisdictions such as those examined in the chapter IV. Thus, although recognizing the importance of other theoretical models to discuss emissions trading schemes and their influence in the prevalent emission trading conceptual development,173 the thesis will, to the extent possible, exam the ETS in the context of its potential usage as an economic instrument to be incorporated into regulatory framework of climate change law and policy, and which values their ultimate adoption reflected in different jurisdictions.
The chapter also demonstrated how, from a political economy standpoint, ETS is largely a result of the concerted work of pro trade coalitions formed by sectors of government, academia, business and environmental groups which, although driven by different reasons, found a common ground in advancing ETS as the preferable emission reduction pricing mechanism both in domestic U.S. legislation and later in the climate change regime. The analysis on how these coalitions have been formed and developed allowed the identification of a pattern of behaviour of most business representatives who were involved in the debate and lobbying of carbon legislation in the U.S. and in large extent in the negotiations of the climate change regime: the first attempt of businesses, at least those most exposed to greenhouse gas emissions regulation, is to lobby against any kind of control on GHGs emissions; when the political pressure against inaction on climate change raises, business turn to emissions trading as a less risky alternative to command-and-control or a carbon tax. As this thesis will reveal in the next chapters, as soon as an ETS is inevitable, some businesses turn their efforts to influence an ETS design that favours an emphasis on economic efficiency of the scheme vis-à-vis its environmental integrity.
This chapter also demonstrated that the climate change debate has reinvigorated the original ETS theoretical framework and related policy experiments. An important feature of this debate is the analysis of ETS as a mechanism to price carbon emissions in order to internalize its economic costs and promote emission reductions. This analysis has three important components that are also relevant to contextualize the object of study of this thesis. The first component relates to the discussion on the convenience or not of pricing carbon as part of the arsenal of policies to tackle climate
173 See Bogojevic’s distinction of three different perceptions of emissions trading that refletct different ‘models’ of underlying its main principles: ‘economic-efficiency, private-property rights, and comand-and-control models. Bogojevic, Emissions Trading Schemes: Markets, States and Law, above n 12, chapter 2. 88
change. For many, the use of market mechanisms is essential to allow emission reductions at a lower cost on a global scale, favouring internationally integrated and collective action. This positive accounting on economic instruments also relies on overall scepticism about command-and-control measures to curb pollution, particularly greenhouse emissions. Contrary views sustain that creating a market value for pollution mitigation is unethical or perceives such market mechanisms as undesirable private governance over public interests. As pointed out earlier, these views also challenge the ultimate environmental performance of carbon pricing policies, including the effectiveness of a market mechanism to correct a market failure. The second component relates to the discussions on the best alternatives to price carbon. It recognizes carbon pricing as a valid route and is centred on comparing emissions trading to carbon taxes as the most economically efficient alternative. The third component relates to the discussions on emissions trading guiding principles and design options174 and how the ultimate design of an emissions trading scheme is key to realizing its potential of reducing emissions effectively.
Given the theoretical debate and uncertainty in the on-going international climate negotiations [postscript: even after the adoption of the Paris Agreement], the ultimate role of ETS in the post-Kyoto regime remains unpredictable. The prospect for using market mechanisms in the future international regime has been maintained in all Conferences of the Parties following the Copenhagen meeting, when much frustration was caused by the lack of a major international agreement at the time. However, definitions on the shape and ultimate role of the new market-based mechanisms – including a possible global ETS – were left to future negotiations.175 Some of the options considered include the expansion of Emissions Trading under Article 17 of the Kyoto Protocol to developing countries, and a market-based approach to REDD. However, such proposals are linked to the ultimate architecture of the climate change regime, which is still pending.
Nevertheless, it is clear that ETS will continue to be one of a range of tools available to states to deal with their international obligations to reduce CO2 emissions. In this context, it is imperative that ETS be assessed and evaluated as a possible policy option for Brazil. This assessment and evaluation will be conducted in the next chapters
174 Those principles and design options will be covered in subsequent chapters of this thesis.
175 See UNFCCC Draft Decision -/CP.16, Outcome of the work of the Ad Hoc Working Group on long-term Cooperative Action under the Convention, paragraphs 80-82, 12-13
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through analysis of the major ETS design elements and legal aspects, case studies of existing or emerging ETS in the EU, New Zealand, and Australia, and subsequent analysis of whether, and if so to what extent, the experience of these three ETS regimes can be useful for the Brazilian Context.
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CHAPTER III – THE MAJOR THEORETICAL PRINCIPLES, DESIGN ELEMENTS AND LEGAL ASPECTS OF ETS
3.1 Introduction
This Chapter will identify and analyse key principles and design elements of ETS derived from the developments of the theoretical framework discussed in the previous chapter. It will also identify some of the key legal issues arising from the adoption of ETS as a legally mandated or voluntary market mechanism. As indicated in chapter I, section 1.4.2.1, this thesis assumes that every aspect of an ETS design that has a normative content (that is, a prescription of behaviour with specific legal repercussions in the conduct and performance of affected entities) should be regarded as a legal component of ETS (usually of a functional nature). Such functional legal components usually provide for the greatest degree of differentiation among schemes (for example, free or auctioned allowance allocation or legal nature of the allowance), which usually operate in a more homogenous structured pattern of centralized governance, enforcement, and trading infrastructure (structural elements). If we imagine such structural elements as the ‘body framework’ of an ETS, we can expand this systematic view by adding the ETS modes of relating to the national legal framework it belongs to, with other ETS (through linking) and to the international climate change regime.
With this analytical framework in mind, this chapter will show how crucial some of the design elements are for securing the environmental integrity of an ETS. A particularly important element is adequate cap setting, which provides for effective emission reductions below projected emissions from major emitters, and ensures a minimum level of allowance scarcity in the market. Just as important are the allowance allocation rules, which avoid the political temptation of providing free allocation of allowances in large scale as opposed to auction allocations whereby affected companies must pay a price from their emission rights upfront. As we will see, other important design elements will define the contours of the scheme in relation to its sectoral coverage, level of flexibility in relation to compliance with its emission reduction goals, and modes of participation by covered entities and third parties, and liking with other schemes nationally and internationally.
Under such ETS guiding principles and design elements, a series of legal aspects emerges, inherent to this particular form of pricing mechanisms and, in many instances, dependable on the design choice for their ultimate legal contour. Some of these key legal aspects are presented in the second part of this chapter. As we will see, some functional legal features of ETS, such as the legal nature attributed to the emission 91
rights, are key to determining other important legal consequences, such as taxation of trading activities and the possibility of proprietary rights being assigned to allowance holders. Also, the possibility of liking between schemes sometimes raises rather complex legal issues of harmonization between different jurisdictions that to the extent possible should be considered upfront at the design phase of the scheme.
The analysis of the ETS principles, design, and legal aspects in the present chapter will give support to the analysis of emerging ETS that will follow in chapter IV, and will also inform the integrative analysis of the ETS experience into the Brazilian reality, conducted in the final chapters.
3.2 Guiding Principles and Major Design Options for Emissions Trading Schemes (Cap-and-Trade Schemes)
As indicated in item 1.1.2 of the Introduction to this thesis (chapter I), the ultimate design of an emissions trading scheme is of capital importance for materializing its potential of effectively reducing emissions, preferably in an economically efficient way. It is also crucial for the optimal consideration of an ETS as a legal model, since the design of an ETS will reflect the actual policy objectives and prevailing values of those in charge of its final configuration. Seen from a legal model perspective, as discussed in chapter I, section 1.4.2.1, the ultimate design of an ETS will reveal the scheme’s structural and functional features that will interact with the overall regulatory framework a given ETS belongs to (its corresponding macro model), usually as part of a broader climate change policy approach under a given jurisdiction. As a result, ideally the design of an ETS should be consistent with the legal framework and suit the political, social, and environmental circumstances of the particular region or country jurisdiction it is meant to serve.1 At the same time, the design of an environmental trading scheme shall consider the interconnectedness of the mitigation measures in a given country or region with other parts of the globe. This integrated approach is particularly important to facilitate international climate change cooperation among countries, and to influence the performance of economic sectors or individual firms that operate on a global scale. In summary, a well-designed emissions trading will be decisive in the success rate of the ETS in maximizing the potential
1 Nicholas Stern, The Economics of Climate Change – The Stern Review (Cambridge University Press, first published 2007, 2008), 351.
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environmental and economic benefits indicated in the theoretical framework supporting emissions trading as a positive tool for mitigating GHG emissions.
The ETS literature reveals series of principles and design elements that should guide and form emissions trading schemes.2 While most of the literature presents the
2 The ETS literature is vast. For a representative cross section of literature dealing with the major design elements of ETS and their most significant variations, see, eg: Ross Garnaut, The Garnaut Climate Change Review: Final Report, (Cambridge University Press, 2008), chapter 14, and specially 323-24 for guiding principles and further descritption of design elements for an Australian ETS; Josh Margolis, Andy Kruger and Curt Kaminer, ‘Critical Elements for a Market-Based Environmental Control Programme’ in Cyriel de Jong and Kasper Walet (eds), A Guide to Emissions Trading: Risk Management and Business Implications (Risk Books, a Division of Incisive Financial Publishing Ltd, 2004) 41-58, providing for 14 ‘prototypical elements’ for effective emissions trading programmes; Stern, The Economics of Climate Change – The Stern Review above n 1, 375-383; Jon Birger Skjærseth and Jørgen Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation (Ashgate 2008), 12, summarizing major design elements for further analysis of the EU ETS development and implementation; David Hodgkinson and Renee Garner, Global Climate Change: Australian Law and Policy (LexisNexis Butterworths, 2008), 244-258, providing an excellent summary of major design elements; Inho Choi, ‘Global Climate Change and the Use of Economic Approaches: The Ideal Design Features of Domestic Greenhouse Gas Emissions Trading with an Analysis of the European Union’s CO2 Emissions Trading Directive and the Climate Stewardship Act’ (2005) 5 Natural Resources Journal 865-952 also provides an in depth analysis of most design elements in the literature with focus on the EU ETS and one of the then major proposals for an US scheme -- the Climate Stewardiship Act; see also Rosemary Lyster, ‘Chasing Down the Climate Change Footprint of the public and private sectors: Forces converge – Part II’ (2007) 24 Environmenal and Planning Law Journal 450 for an excelent review on major emissions trading design issues and its application in the existent or emerging schemes in the European Union (EU ETS), the UK, USA, New Zealand and Australia; see also Dimitrios Mavrakis and Popi Konidari, ‘Classification of Emissions Trading Scheme Design Characteristics’ (2003) 13 European Environment, 48-66, proposing a classification for exisiting emissions trading schemes into four categories (objectives, target-groups, rules-influencing mechanisms and implementation network); More recent works in the context of specific jurisdictions have also focused on some design elements and principles of an ETS. See, for example, Stefan E. Weishaar, Emissions Trading Design: A Critical Overview (Edward Elgar, 2014), particularly ch 3 on major design elements and ch 5 on initial allocation of emission rights; Robert Repetto, America’s Climate Problem: The Way Forward (Earthscan, 2011), 65-81; Christie J. Kneteman, ‘Building an Effective North American Emissions Trading System: Key Considerations and Canada’s Role’ in 20 Journal of Environmental Law and Practice 127; Nicola Durrant, Legal Responses to Climate Change (The Federation Press, 2010) 104-126; Tom Tietenberg, ‘Tradeable Permits in Principle and Practice’ in Jofy Freeman and Charles D. Kolstad (eds) Moving to Markets in Environmental Regulation: Lessons From Twenty Years of Experience (Oxford, 2007), 77-86. There are also excellent reviews prepared by or on behalf of government agencies that present a good analysis of design options for emissions trading schemes. See The United States Environmental Protection Agency, Office of Air and Radiation (‘The United States EPA’), ‘Tools of the Trade: A Guide To Designing and Operating Cap and Trade Program for Pollution Control’ (EPA430-B-03-002, The United States Environmental Protection Agency, June 2003); 93
most important ETS design elements in a consolidated manner, a limited number of sources clearly segregate principles from design elements in their description of ETS. Examples of the latter approach include studies by Garnaut and the US EPA Office of Air and Radiation.3 However, in most of the other literature, the division between what constitutes an ETS principle or a design element is not clearly articulated.4 In presenting a comprehensive and consolidated description of the principles and design elements of ETS as discerned by the author, the following sections rely primarily on the work of Garnaut and Hodgkinson and Garner, as the basic initial references for the identification of the principles and design elements, respectively, while taking into account any differentiations evidenced in the remaining extensive literature. However, as analysis of this comprehensive body of literature reveals, despite differences amongst some authors regarding the conceptualization of principles and design elements, the overall structure of what defines a pricing mechanism as a cap-and-trade scheme is articulated very consistently in the literature conceptual descriptions. This basic structure results from the combination of features that establish a quantitative pricing mechanism by means of
see also National Emissions Trading Taskforce (2006) ‘Possible Design for a National Greenhouse Gas Emissions Trading Scheme (ISBN 0-97775838-0-5, State and Territory Governments of Australia, August 2006). Also, despite the date of issuance of some of those documents, the respective design elements of ETS remain valid for most of the emerging schemes under consideration internationally, including those reviewed in chapter IV of this thesis.
3 For example, before entering into the analysis of each ETS ‘[e]lementaldesign features’, Garnaut introduces five ‘[g]uiding principles for scheme design’: scarcity aligned with the emission target; credibility of institutions; simplicity of rules; tradability of permits; and integration with other markets. Garnaut, The Garnaut Climate Change Review, above n 2.The US EPA Office of Air and Radiation, by its turn, sets out four ‘guiding principles’: simplicity, accountability, transparency, and predictabilityconsistency. The United States EPA ‘Tools of the Trade’, above n 2, 3-1 to 3-2.
4 Stern, for example, sets out two major principles to be applied in the third phase of the European Union Emissions Trading Scheme – EU ETS (‘credible signal’ and ‘deep and liquid market’) and intersects them with design elements without providing a clear boundary between thetwo. Stern, The Economics of Climate Change – The Stern Review, above n 1, 383. Margolis et al adopt a similar approach, including the principles in their 16 ‘rules of thumb’ or ‘prototypical elements’ of ETS (such as fairness of allowance allocations) in the same categoryas choices of design elements, such as ‘banking.’Margolis et al, ‘Critical Elements for a Market-Based Environmental Control Programme’ above n 2, 42. For her part, Kneteman identifies seven ‘criteria for an effective trading system’ (tight emissions cap, compliance enforcement, breadth, flexibility,long-term regulatory certainty, transparency, and market liquidit),which she uses in her subsequent analysis of the European Union Trading Scheme and some North- American ETS experiences withno clear conceptual dinstinction between principles and design elements:Kneteman, ‘Building an Effective North American Emissions Trading System: Key Considerations and Canada’s Role’, above n 2, 130-142.
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the creation of a cap on predefined emissions, and the issuance of individual allowances to covered entities that can be traded under certain conditions.5 These are the basic characteristics that are ‘inherent’ to what is defined as an ETS, giving it its ‘sense of unity’ regardless the jurisdiction that it will be applied and differentiating it from other market-based instruments, the identification of which has been proposed in sections 1.2 and 1.4 of this thesis. In addition the literature reveals a fairly consistent view with respect to the overall function of each design element, although the discussions on the benefits and pitfalls on how and when to use particular elements may vary. Different opinions arise, in particular, with respect to some of the environmental and economic consequences that may be created by different design options, such as the forms of allowance allocation (free or onerous), or the adoption of price controls under certain circumstances.6 These nuances are discussed below in so far as they are relevant to the thesis, however a full analysis of the design options, particularly with respect to their economic intricacies and variations, is obviously beyond the scope of this work. What is relevant for the purposes of this thesis, and, thus, what follows, is a discussion of the identification of major design elements of ETS that are crucial for the ultimate fate of each scheme with respect to its environmental integrity and economic efficiency (emphasis added).
3.2.1 Guiding Principles
A review of the literature indicates that in order to fulfil its proposed major objectives (effectively reducing emissions in an economically efficient way) an ETS should be built on the following principles:
a. The Principle of Effectiveness: According to this principle, an ETS will only meet its stated goals of effectively inducing emission reductions if it
5 Mavrakis and Konidari, ‘Classification of Emissions Trading Scheme Design Characteristics’, above n 2, 55; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 2; Judson Jaffe and Robert N. Stavins, ‘Linkage of tradeable permit systems’ in Joseph E. Aldy and Robert N. Stavins (eds) Post-Kyoto International Climate Policy: Implementing Archtectures for Agreement (Cambridge University Press, 2010) 121; Durrant, Legal Responses to Climate Change, above n 2, 106; Stern, The Economics of Climate Change – The Stern Review,above n 1, 353.
6 See, eg, Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 909-45; Lyster,‘Chasing Down the Climate Change Footprint’, above n 2, 454-71.
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consistently provides for scarcity of permits/allowances aligned with the predefined emission reduction goals. Predefined emission reduction goals (or ‘cap’) must be stringent enough in order to provide for actual emission reductions that are below the historic and projected business-as-usual emissions of covered entities (emphasis added). Emission permits or allowances should reflect, in aggregate, a lower volume of emissions than the cap, thus creating a demand for effective reduction (or purchase of allowances from other scheme participants) by covered entities.7
b. The Principle of Transparency and Credibility: This principle requires ETS governing institutions to ensure transparent operations, clear direction of rules, and efficient monitoring and enforcement infrastructure.8
c. The Principle of Simplicity and Equality:9 ETS rules should be simple, clear, and consistently applied across scheme participants.
d. The Principle of Trading and Market Accessibility: The ETS permits or allowances trading rules should provide clear, unambiguous, and individualized trading rights consistently assigned to all scheme participants, and allow transparent and accessible trading opportunities.10
e. The Principle of Integration/Interconnectedness:11 To be effective, an ETS should be suited to linking with other markets based on appropriate exchange of information and adequate price setting policies, which reflect
7 Hodgkinson andGarner, Global Climate Change: Australian Law and Policy, above n 2, 247-8; Stern, The Economics of Climate Change – The Stern Review, above n 1, 377; Garnaut, The Garnaut Climate Change Review, above n 2, 323.
8 Garnaut, The Garnaut Climate Change Review, above n 2, 323; The United States EPA, ‘Tools of the Trade’, above n 2, 3-2; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 465; Durrant, Legal Responses to Climate Change, above n 2, 118; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 940; Mavrakis and Konidari, ‘Classification of Emissions Trading Scheme Design Characteristics’ above n 2, 58.
9 Garnaut, The Garnaut Climate Change Review, above n 2, 323-4; The United States EPA, ‘Tools of the Trade’ above n 2, 3-1; Margolis et al, ‘Critical Elements for a Market- Based Environmental Control Programme’, above n 2, 42 and 54.
10 Garnaut, The Garnaut Climate Change Review, above n 2, 324.
11 Stern is one of the strongest advocates of such principle as a key element of economic efficiency of ETS on a global scale. Stern, The Economics of Climate Change – The Stern Review, above n 1, 643.
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true scarcity of permits or allowances. This interconnectedness will increase trading opportunities among participants (particularly those who operate on a regional or global scale), and enhance the forms of international cooperation towards reducing GHG emissions.
It is important to note that some authors use the term ‘proprietary rights’ to qualify the trading rights assigned to allowances or permits as indicated in the ‘Principle of Trading and Market Accessibility’ above.12 This thesis avoids this definition since this crucial element of the legal nature of an allowance will be defined on a case-by- case basis. As such, proprietary rights expressly assigned to allowances (as it was the case of the Australian Carbon Price Mechanism – ‘Australian CPM or Australian ETS’ reviewed in chapter IV of this thesis), particularly those allocated for free, may raise issues of fairness and equity. For example, the risk of allowance holders claiming indemnification in case the government ceases the scheme or exercises some market price control mechanism to combat allowance over allocation. To avoid this risk, some ETS such as the U.S. Clean Air Act Sulphur Allowance Program have deliberately classified the allowance as ‘a right to emit’ as opposed to a ‘proprietary right’. This issue will be further discussed in subsection 3.3.1.4 below, on the legal nature of carbon credit and allowances.
3.2.2 Major Design Elements
The bulk of the literature cited in section 3.2 above identifies major design elements of emissions trading schemes that can be grouped as follows: scheme target, cap-setting and stringency (which define the form and level of stringency on the limits imposed on emissions), scope and coverage (which define sectors, gases, and locations subject to the scheme), allocations of allowances (including forms of allocation and trading rules), linking alternatives to other schemes, and the overall governance, compliance, and enforcement rules. This set is not exhaustive, but covers the major elements that will guide the case studies and integrative analysis of the following chapters. We will now look at them in more detail. Having already identified the basic structure of ETS in section 3.2 above, we will start with the ETS design functional elements (from section 3.2.2.1 to 3.2.2.4), returning to the final structural elements (linking and the overall governance and compliance infrastructure) at the end of the section. It is important to note that, in regards to liking, the characteristics of this ETS
12 See T. H. Tietenberg, Emissions Trading: Principles and Practice (Resources for the Future, 2006) 193. 97
structural design element (in terms of providing the connection of a given ETS with other legal instruments or regimes) also carry functional features that differentiate the ultimate approach of a given linking structure. This distinction will be made in the final chapter of the thesis in regards to the proposed legal model for a Brazilian ETS.
3.2.2.1 Scheme Target, Cap-Setting and Stringency
Scheme targets refer to ways of establishing the scheme emissions cap, that is, the aggregate volume or GHG intensity of emissions allowed during a given period. It may include absolute targets (which limit the total emissions during a certain period) or relative targets, or ‘emissions intensity’ (which are defined as emissions per unit of output or activity, such as production or energy consumption, calculated in comparison to a sector or firm-specific benchmark).13 The relative or intensity-based approach does not impose an initial quantity of emissions limit, but instead demands surrender of units only in cases where the GHG intensity of the participant’s activity/products is worse than the benchmark level.14 This approach allows a given firm to grow their output and emissions, and still be in compliance with their emission intensity targets.23 Relative or intensity-based targets are generally considered to be more appealing to the industry because ‘absolute emissions can continually increase as long as production of GDP, for example, increases.’15 However, such targets make the administration of the scheme much more difficult for Governments, since they require permits to be allocated not only at the outset of the scheme. Under the relative target approach, allocation of permits ex post facto is necessary when actual output has been measured, bringing one more layer of complexity to the ETS architecture and implementation.16
The scheme cap will be reflected in the amount and form of individual allowances that are distributed among scheme participants, or otherwise made available to the market. Aligned with the policy discussions and the corresponding economic and climate models abounding in the international climate change regime negotiations, the emission reduction targets (short-term and medium term) are usually related to long-
13 Hodgkinson and Garner, Global Climate Change above n 2, 246; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 100.
14 Hodgkinson and Garner, Global Climate Change, above n 2, 246.
15 Ibid 246-7.
16 Ibid.
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term ambitious or ‘aspirational’ goals, usually referred to as an ‘emissions trajectory.’17 The consideration of these quantitative emission reduction goals and the expected time for attainment are important drivers for the cap setting process of an ETS. As pointed out by the ETS theory mentioned above, the main goal of this complex task is determining caps that are stringent enough to drive emission reductions, and secure the environmental integrity of the scheme.18 The fine-tuning for achieving this optimal point is not an easy task per se, demanding a reliable set of data of emission patterns and trajectories of the different sectors of the economy and, under some ETS designs, at the facility level of each scheme participant.19 However, according to some sources, the implementation of very stringent caps from the outset has the potential of undesirable outcomes since it may harm the competitiveness of some business sectors not yet prepared to transition to a low-carbon environment in the short-term.20 Depending on the role of such sectors in a given economy, an abrupt transition to a high price on emissions may cause economic and structural problems21 or ‘uneven impact among industries.’22 In connection with these possible effects of cap-stringency resides the issue of duration of the cap.23 The cap duration has to be aligned with a minimum level of certainty to allow scheme participant investment decisions on emission reduction alternatives.24 At the same time, it has to be flexible enough to allow governments to
17 For a detailed discussion on the interactions between emission reductions targets and trajectories, and their economic implications for the design of emission trading caps, see Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, chapter 12.
18 Stern, The Economics of Climate Change – The Stern Review, above n 1, 377; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 456; Durrant, Legal Responses to Climate Change, above n 2, 106-7; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 15.
19 Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 456; Durrant, Legal Responses to Climate Change, above n 2, 106.
20 E.g., Hodgkinson and Garner, Global Climate Change, above n 2, 247-8; The United States EPA, ‘Tools of the Trade’ above n 2, 3-8 and 3-9.
21 Stern, The Economics of Climate Change – The Stern Review, above n 1, 384; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 468.
22 Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 910-11.
23 Hodgkinson and Garner, Global Climate Change, above n 2, 247-8; The United States EPA, ‘Tools of the Trade’ above n 2, 3-8 and 3-9.
24 Hodgkinson and Garner, Global Climate Change, above n 2, 247-8; Stern, The Economics of Climate Change – The Stern Review, above n 1, 369-70.
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adjust the emission limits to developments in climate change science, clean technology, or international policies.25 One possible way of dealing with this dual face of certainty and flexibility is to provide for predefined periods of the duration of the cap (for example, five years), and clear indication of conditions that could trigger changes in the scheme’s scarcity constraints.26
3.2.2.2 Scope, Coverage, Opt-In, and Opt-Out Provisions
‘Scope and Coverage’ of an ETS refers to the number of greenhouse gases, selection of sectors and installations, and geographical location covered by the system.27 It also includes the definition of the ‘point of obligation’, meaning the exact level of the supply chain of a given sector at which entities will bear the liability for demonstrating compliance with the emission reduction goals. The choice of point of obligation should consider the point at which monitoring and reporting of emissions is more reliable and cost-effective. 28 In an upstream system the installations will be responsible for the emissions that their goods will entail when consumed (consumption-based point of obligation).29 In a downstream system, the installations are held accountable for their own emissions (production-based point of obligation).30 Complementary to the definition of ‘point of obligation’ is the concept of ‘direct emissions’ (that is, emissions accounted when they occur at their source, such as emissions generated by fossil-fuel- based energy production), or ‘indirect emissions’ (that is, emissions accounted when the
25 Hodgkinson and Garner, Global Climate Change, above n 2, 247-8; Stern, The Economics of Climate Change – The Stern Review, above n 1, 369-70.
26 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 325-6.
27 Ibid, 326; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2,12.
28 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 327; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 909-11;
29 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 327; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 12 and note 3; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 909-16; The United States EPA, ‘Tools of the Trade’ above n 2, 3-6 to 3-7; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 457.
30 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 12 and note 3.
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product or service is consumed, such as electricity used by a manufacturing facility).31 Scheme coverage also may include rules on entrance of new participants (usually referred to as ‘opt-in’ requirements) and exemption of covered participants (usually referred to as ‘opt-out’ requirements) under certain circumstances.32
Ideally, the largest coverage of an ETS in relation to gases and regulated sectors will enhance the chances of higher economic efficiency (that is, abatement being achieved at the lower cost possible as per the economic theory summarized above), and environmental effectiveness (that is, maximum abatement due to broader coverage of emitting sectors) of the scheme.33 It will also ensure a higher level of equity across the sectors of the entities covered (that is, a more equitable distribution of the burden on economic sectors and/or affected entities),34 and will maximize market liquidity and stability.35
Usually GHGs covered under ETS range from CO2 only (which by far accounts for the largest portion of GHG anthropogenic emissions) to the full range of the GHGs regulated under the Kyoto Protocol.36 As pointed out by some sources, there are different views on the best approach to GHGs coverage under the ETS.37 Some argue that including CO2 only at the outset of an ETS (as was the case of the EU ETS, which foresaw the inclusion of the other gases in a later date) favours a smoother transition to
31 Ibid 12-3 and note 4.
32 Ibid 12; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 929; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 49-50; The United States EPA, ‘Tools of the Trade’ above n 2, 3-8.
33 Stern, The Economics of Climate Change – The Stern Review, above n 1, 375-7; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 326.
34 Stern, The Economics of Climate Change – The Stern Review, above n 1, 375; Hodgkinson and Garner, Global Climate Change above n 2, 248-50;
35 Stern, The Economics of Climate Change – The Stern Review, above n 1, 377; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 326; Hodgkinson and Garner, Global Climate Change, above n 2, 248.
36 As already indicated earlier in this thesis (section 2.4.4.2.1 of chapter II), the Kyoto Protocol lists the following greenhouse gases as subject to its requirements: carbon dioxide (CO2), Methane (CH4), Nitrous Oxide (N20), Hydrofluorcarbons (HFCs), Perfluocarbons (PFCs) and Sulphur hexafluoride (SF6). Kyoto Protocol, Article 2 (2) and Annex A.
37 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 250; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 456-7.
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a new regulated environment. Others favour a wider coverage of gases as soon as possible to broaden the possibility of offsets from different sectors, thus lowering compliance costs and enhancing the environmental benefits of the scheme.38 Broader coverage is also viewed as a more efficient barrier to ‘leakage’, that is, the risk of production and consumption shifting to sectors or entities not covered by the EU ETS that can operate with a lower cost due to lack of a pricing mechanism over their emissions.39 As discussed further in this thesis, ‘leakage’ may also occur between countries that compete for the production of similar emission intensive goods.40
Despite the theoretical support for broader coverage, the choice for sectors and gases to be covered by an ETS is sometimes restricted by some ‘practical constraints’41as such as lack of accurate or cost-prohibited estimation, monitoring, and verification methodologies for some sectors.42 In some cases, although reliable emission measurement exists, there are scale-related transaction costs that must be taken into account (for example, it is more cost-effective to cover under an ETS a few large emitters of a single sector responsible for the bulk of emissions (such as large utilities) than a large number of small sources within the same sector.43 In addition to practical matters, sometimes the choice of sectors is subject to pure political pressure by affected sectors and entities, which battle for milder treatment in transitioning to a ‘low emissions’ economy.44 Sometimes, the pressure from these sectors is exerted on the grounds of alleged competition impacts that a price on GHG emissions can generate over certain emission-intensive sectors of the economy, which are more vulnerable to international competition (the so-called ‘traded-exposed-and-emissions-intensive
38 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 250; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 905-8.
39 Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 456 and n 47; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 906.
40 Mohit Thukral ‘Upstream point of obligation for emissions trading in India: Lessons from New Zealand’, Presentation of August 26, 2011,
41 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 326.
42 Ibid.
43 Ibid.
44 Ibid, 326 and 331.
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industries’).45 Such impacts on competitiveness may be caused by the lower production costs of companies located in countries where there is no GHG emissions pricing policy in place. Another possible consequence in terms of sector competiveness and national economies is the risk of relocation of new plants from countries with emission pricing mechanisms, such as an ETS, to countries with less active climate policies.46 Another constraint on including certain sectors under an ETS relates to the broad geographical reach of their operations. This is the particular case of aviation and maritime transport, which, because they operate domestically and internationally, present some challenges on how to attribute their emissions across their respective jurisdictions.47
As indicated above, the ETS mechanisms that allow the unilateral inclusion of new affected sectors, entities, and gases originally not covered by the ETS are usually referred to as ‘opt-in’ provisions. ‘Opt-in’ may also refer to the later inclusion of facilities of a given covered sector, which were originally exempted due to emissions thresholds or to any other criteria.48 Under certain circumstances, the ETS design may allow the scheme administrator to accept the voluntary inclusion of some pre-exempted sectors or facilities that may have the option to choose between the ETS and other policies aimed at controlling their emissions. In turn, opt-out provisions are mechanisms that allow certain sectors or facilities originally covered by the ETS to remain exempt under certain circumstances. Sometimes opt-out provisions are temporary and designed to protect highly affected sectors undergo a smoother transition to an emissions-constrained environment. In other cases, the opt-out provisions are
45 Ibid, 341; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 175-6. This issue will be further discussed in the next chapter, particularly in connection with practical examples from allocation requirements under the EU ETS and the Australian ETS.
46 Stern, The Economics of Climate Change – The Stern Review, above n 1, 282 and 294.
47 Ibid, 388; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 248.
48 Certain facilities of covered sectors that do not emit over a minimum threshold volume are exempted and controlled under different approaches, usually due to administrative transaction costs for controlling a large number of small emitters. See Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 50; See A. Denny Ellerman, Frank J. Convery and Christian de Perthuis, Pricing Carbon: The European Union Emissions Trading Scheme (Cambridge University Press, 2010), 262.
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designed to allow flexibility of some sectors to choose between the ETS and other types of policies that are also directed to mitigate GHG emissions of same sector.49
3.2.2.3 Allowance Allocations and Compliance Period
Allowance allocation is by definition one of the most crucial design elements of an ETS, since it defines how the affected sectors and entities will share the responsibility for reducing GHG emissions within the predefined caps and compliance periods. As a result, by encompassing decisions on who bears the higher costs for compliance among different sectors of the economy, allowance allocation methods are crucial for the distributive fairness, cost-effectiveness, and credibility of an ETS.50 Not surprisingly, many authors identify them as a highly controversial issue of an ETS implementation, usually subject to heated political debate, intense rulemaking negotiations, and lobbying activities by affected sectors and other stakeholders.51
The literature reviewed by this thesis52 reports several allocation methods, mostly in connection with some US-based non-GHG ETS precedents, including lottery or random proceedings, ‘first-come, first served’, administrative rules based on eligibility criteria (the most common being free allocation or ‘grandfathering’ at the firm level
49 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, above n 49, 263.
50 Stern, The Economics of Climate Change – The Stern Review, above n 1, 379-82; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 330; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 252; According to Ross Garnaut, depending on the allocation methods and market conditions, allowance allocation can also represent to the covered entities an economic or financial benefit since the right to emit is a valuable asset. Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 331.
51 Tietenberg, Emissions Trading: Principles and Practice, above n 13, 127-8; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 2, 13; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 331; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 59 and 118.
52 Tietenberg, Emissions Trading: Principles and Practice above n 13, 128; Stern, The Economics of Climate Change – The Stern Review above n 1, 379; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy above n 2, 252; Weishaar, Emissions Trading Design: A Critical Overview, 58-9; Choi, ‘Global Climate Change and the Use of Economic Approaches’ above n 2, 916; Lytster, ‘Chasing Down the Climate Change Footprint’, above n 2, 459; Mavrakis and Konidari, ‘Classification of Emissions Trading Scheme Design Characteristics’ above n 2, 56-7; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 2, 13; The United States EPA, ‘Tools of the Trade’ above n 2, 3-14 to 3-18.
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based on historical emissions or benchmarking against a sector or industrial benchmark), and auctions. The term ‘grandfathering’ refers not only to the fact that the emissions rights subject to free allocation are based on past emissions records, but also because the word usually applies to existing sources.53 New sources usually have to purchase allowances from existing sources, or the secondary market, or be allocated permits under different rules.54
Under GHG ETS, the most commonly discussed allocation approaches are free allocation (grandfathering), auctions, or a mix of both.55 Despite the economic theory behind the ETS being supportive of auctioning as the most effective process, the prominence of free allocation in most ETS, at least in the initial phases of the schemes, is usually a result of the political bargain between governments and large polluters in order to allow the former to gain support for emissions pricing alternatives.56
Free allocation can be based on historical absolute or relative emissions (quantitative emissions or emission intensity of output, as discussed earlier in this chapter). Free allocation can apply to all participants of the scheme, or to some specific sectors deemed more vulnerable to the introduction of a carbon pricing, such as the emission-intense and traded-exposed sectors. The decision on free allocation can be made periodically, in connection with different compliance periods and based on updated emissions data.57 One of the perverse effects of grandfathering or free allocation is its potential to create distortions at the scheme outset, because it gives a premium to sources with the worst historical emission record (and which will receive a larger free allocation of emission permits), and not to sources that had already reduced their emissions prior to the scheme being put in place. Also, during the scheme implementation phase, free allocation can also perversely continue to incentivize large
53 Tietenberg, Emissions Trading: Principles and Practice above n 13, 128.
54 Ibid; Hodgkinson and Renee Garner, Global Climate Change: Australian Law and Policy, 253.
55 Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 916-20.
56 Ibid, 920; Tietenberg, Emissions Trading: Principles and Practice, above n 13, 128; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 253; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 331; Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation above n 2, 13.
57 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 253.
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emissions, since current emissions define the future allocations for the emitting source).58 Another perverse effect of free allocation is the possibility of large emitters being able to gain windfall profits by simply passing the costs of emission reduction to customers or final consumers without having any financial burden in acquiring emission permits.59 Other forms of undesirable market power (such as manipulation of the market by large emitters who become ‘price-setting’ firms able to create price distortions with negative impacts on other scheme participants – the ‘price takers’) can be built by scheme participants, who are benefited with free allocation, both at the permit market and at the output market where they compete.60 On the other hand, the arguments supporting free allocation are usually based on the recognition of the vulnerability of some sectors, which experience an abrupt transition to having to bear the financial burden of paying for their GHG emissions.61 Some also views free allocation as a more simple approach to be administered compared to auctions or other forms of allocation.62
Under auctioning, the government releases allowances by auction, and the price is determined by competitive bidding from scheme participants. According to Tietenberg, although the most common auctioning design involves the production of revenue to the government, some variations of ‘zero-revenue’ auctions have been tested in the US Sulphur Allowance Program, whereby the proceeds of the auctions are refunded to the bidders. The variations of zero-revenue auctions will not be covered by this thesis, since it has not been considered in the policy discussions regarding emerging GHGs ETS. Further, as discussed in this section, one of the most important distinctions between free allocation and auctioning under GHGs ETS is the possibility of auctions producing
58 Ibid; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 106-7.
59 As pointed out by Ross Garnaut,
Free permits are not free. Although they may be allocated freely, their cost is borne elsewhere in the economy, typically by those who cannot pass on the cost to others (most notably, households).
Garnaut, The Garnaut Climate Change Review: Final Report above n 2, 331. See also Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 917 and Stern, The Economics of Climate Change – The Stern Review, above n 1, 381-2.
60 Tietenberg, Emissions Trading: Principles and Practice, above n 13, 139 and ch 7.
61 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 253.
62 Ibid.
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revenues that can be recycled to the most impacted sectors within the economy (and not only to scheme participants).63 Similarly to free allocation, auctions can be carried out on a periodical basis, in connection with different compliance periods (even in advance of a given compliance year, as in the Australian scheme discussed below).
Auctioning is viewed by the most of the ETS theorists as the preferable form of allocation of allowances.64 First of all, auction is easily perceived by the majority of affected entities and other stakeholders as the fairest way to distribute rights and obligations under an ETS.65 It is also the most cost-efficient method in terms of distributing the costs of reducing GHG emissions among scheme participants, and within the economy as whole. In this regard, the possibility of the government recycling the revenues of the auction process within the economy is viewed as an important tool to correct distortions caused by a price on emissions, and address market failures without impacting public finances.66 Such revenue recycling alternatives include financing of low emission technologies or providing assistance to low-income households, which can be negatively impacted by higher energy prices or other inflationary effects over emission-intensive goods, or lowering some distortionary taxes, such as labour taxes, for the industry.67
3.2.2.4 Allowance Use Rules: Legal Nature, Transfer, Surrender, Cancellation, Validity, Banking, Borrowing
One important aspect of allowances under an ETS is defining its legal nature and the respective title rules of the allowances. Additionally, from an operational standpoint,
63 Tietenberg, Emissions Trading: Principles and Practice, above n 13, 130.
64 Ibid, 141; David Hodgkinson and Renee Garner, Global Climate Change: Australian Law and Policy, above n 2, 252-3; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 331; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 113.
65 Tietenberg, Emissions Trading: Principles and Practice above n 13, 139 and 141; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 920.
66 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 332; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy above n 2, 253; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 113-4.
67 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 332; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 253-4; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 11.
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the ETS design includes specific criteria on the life cycle of the allowances, from their issuance by the government and subsequent trading to their final surrender by affected entities, or to their termination by the government under certain circumstances68There are also design options regulating the duration and use of allowances across different compliance periods, usually referred to as ‘banking’ and ‘borrowing.’69 This possibility of ‘intertemporal use of permits’ is viewed, in general, as a source of economic efficiency of an ETS and of the whole economy, since it enables permit holders to decide on when and how to use their stock of permits.70
Banking refers to the possibility of scheme participants saving current permits or credits to be used or sold in future compliance periods. For some authors, banking is an important tool to manage price volatility and encourage early action emission reduction by participants.71 Banking is also seen as a source of greater flexibility to market participants deciding on the optimal use of installation of emission controls versus selling excess allowances to the market, in addition to facilitating cash flow management and responses to cyclical economic activities.72 On the other hand, it can also create some liquidity distortions in some situations. Thus, an example would be when market players use banking to wilfully restrict trading in order to induce a price increase in the short term.73
68 Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 147; The United States EPA, ‘Tools of the Trade’ above n 2, 3-19; See also Steve Drummond, ‘Trading Instruments and Risk Management’ in de Jong and Walet (eds), above n 2, 158-9.
69 Both terms are widespread in the ETS literature reviewed by this thesis. See, for example, Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 61-3; The United States EPA, ‘Tools of the Trade’ above n 2, 3-19 and 3-120; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 254; Stern, The Economics of Climate Change – The Stern Review, above n 1, 378; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 462. However, the term ‘lending’ has been introduced by Ross Garnaut more recently as a variation to ‘borrowing’, as discussed below.
70 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 335.
71 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 254; Stern, The Economics of Climate Change – The Stern Review, above n 1, 378; The United States EPA, ‘Tools of the Trade’ above n 2, 3-19.
72 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 254.
73 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 254.
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Borrowing refers to the possibility of participants using, at any time, permits or allowances that are available in a future commitment/compliance period.74 This operation may benefit participants willing to take higher risks by investing in new technologies that may trigger higher levels of reduction in the future; however, it may jeopardize the environmental integrity of the scheme, since participants will be tempted to delay emission reductions (that is, pledging current emissions with allowances to be acquired in the future) that could be triggered in case borrowing is not allowed.75 The environmental concerns over borrowing have limited its use in GHG ETS, but some sort of banking has been included in most schemes. A variation of the borrowing concept was presented in the Garnaut Review. According to Garnaut, borrowing should be rejected since it is attached to the free allocation of allowances, whereby affected entities can be entitled to advanced access to free allowances. In turn, Garnaut proposes the concept of ‘lending’, restricted to transactions between the Government and the private sector whereby the government would advance allowances under certain circumstances in the format of a loan circumvented by time restrictions, security against default arrangements, interest rates, and other risk management tools, and strict eligibility criteria.76
3.2.2.5 Relationship with the Kyoto Protocol and Other Emissions Trading Schemes/Linking
‘Linking’, or the ability of an emissions trading scheme to be linked to other domestic or international schemes, is an important design feature of ETS and can be used to expand the possibilities of cost-effective emission reduction measures through market opportunities outside the original geographical scope of the ETS.77 Linking is
74 Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 254; Stern, The Economics of Climate Change – The Stern Review, above n 1, 378; The United States EPA, ‘Tools of the Trade’ above n 2, 3-19.
75 Fanny Missfeldt and Jochen Hauff, ‘The role of Economic Instruments’, in Anthony D. Owen and Nick Hanley (editors), The Economics of Climate Change (Routledge 2004) 135.
76 Garnaut, The Garnaut Climate Change Review: Final Report above n 2, 335-6 and 360 n 9.
77 Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 337-41; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 256; Stern, The Economics of Climate Change – The Stern Review, above n 1, 377 and 543-47; Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 469-71; 109
also a key element to using market mechanisms globally in the absence of a global agreement under the international climate change regime.78 In addition to the interconnectedness between two or more cap-and-trade schemes, linking also includes the possibility of affected entities under a given ETS to offset their emissions through baseline-and-credit credits generated outside any cap-and-trade system, either abroad or in the same national jurisdiction (such as the approach adopted by Australia through the Carbon Farming Initiative).79 The use of offsets in such a context may involve associated programs such as REDD (Reduction of Emissions for Deforestation and Degradation in Developing Countries),80 the voluntary market for carbon offsets,81 and other possible carbon mitigation activities, such as payment for environmental services (the latter is being considered in the subnational discussions among the state- governments of California in the US, Acre in Brazil, and Chiapas in Mexico).82 Hence, linking may occur directly between two schemes (either through unilateral or reciprocal recognition of the allowances being traded in the linked market) or indirectly through a common third market (for example, two national schemes recognizing the use of Kyoto
Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 60; Durrant, Legal Responses to Climate Change, above n 2, 123-4.
78 Stern, The Economics of Climate Change – The Stern Review, above n 1, 544; Jaffe and Stavins, ‘Linkage of tradeable permit systems’, above n 6, 144.
79 Nicola Durrant, Legal Responses to Climate Change, above n 2, 123; Garnaut, The Garnaut Climate Change Review: Final Report, above n 2, 340; Stern, The Economics of Climate Change – The Stern Review, above n 1, 376.
80 For a good review on the REDD proposed policies and related bibliography, see Rosemary Lyster, ‘The new frontier of climate law: Reducing Emissions from Deforestation (and Degradation)’ (2009) 26 Environmental Planning Law Journal 417.
81 See Katherine Hamilton, Milo Sjardin, Molly Peters-Stanley and Thomas Marcello, ‘Building Bridges: State of the Voluntary Carbon Markets 2010’ (Ecosystem Market Place and Bloomberg New Energy Finance), for a major account on the state of the voluntarymarket
82 This possible arrangements among California, Acre and Chiapas is part of the California State funded ‘Governor’s Climate and Forests Task Force. See
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units in their respective domestic markets).83 Linking raises specific legal issues in relation to the need of harmonization of ETS design elements originated in different jurisdictions. These issues will be covered in the last part of this chapter concerning the relationship of ETS with international law in section 3.3.1.5.
3.2.2.6 Compliance, Enforcement, Trading Infrastructure, and Governance
As in any other environmental policy and enforcement approach, robust compliance and enforcement is a precondition for ETS environmental integrity.84 Further, an accurate emissions monitoring and verification system is at the cornerstone of any ETS.85 It is the reliability of the data on greenhouse gas sources emissions that will support the assessment of the global emissions by the covered sectors against the cap, and the individual liabilities of each emission source under the ETS. In most cases, ETS rely on self-monitoring and reporting by the affected entity, and verification (that is, confirmation that monitoring data are correct and that reported emissions are accurate) is performed by a third-party.86 However, variations of this pattern may exist. Non attaining the emission caps or not holding sufficient allowances to cover exceeded emissions is usually penalized with financial penalties which, according to the economic theory underpinning the ETS, shall be high enough to discourage noncompliance by scheme participants.87 In this regard, the overall financial burden imposed by noncompliance penalties must be higher than the marginal cost of abatement plus compliance costs, in order to achieve a deterrence effect.88 Despite the administrative (and civil and criminal penalties under certain circumstances),
83 Regina Betz and Ashley Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ (April 2008) Volume 27 Number 1 Australian Resources and Energy Law Journal 86, 88-89.
84 Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 466; Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 944.
85 Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 940.
86 Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 149-50; see also Marjan Peeters, ‘Inspection and market-based regulation through emissions trading: The striking reliance on self-monitoring, self-reporting and verification’ (2006) 2 (1) Ultrecht Law Review177, 193-5.
87 Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, above n 2, 466.
88 Ibid; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 255.
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noncompliant entities must acquire enough allowances/credits from the market to cover the emissions shortfall for each compliance period.89
The whole efficiency and integrity of an ETS cannot be preserved in case the collection and verification of emissions data at the source level and its consideration against the source obligations are not properly produced.90 This information must also be reported and available to other market participants on a regular and transparent basis, to allow the correct perception of market demand and supply, and the corresponding price signals that will allow trading across affected entities.91 Moreover, in aggregate, the sum of individual emission data will underpin the national calculations of attainment of the ETS’s emissions cap and the scheme’s contribution to the national GHG emission accounting vis-à-vis the country’s emission reduction targets under the international climate change regime.
Provided that adequate monitoring and reporting are in place, additional concerns are: transparency, tracking, proper accounting of the transactions, and final surrender of emission units that will take place. In this regard, an ETS requires a trading infrastructure governed by the scheme’s administrator whereby the ownership and trading of emission units is properly recorded.92 The GHG emission units register and trading infrastructure usually resembles the online electronic trading platforms for financial assets and, in many cases, is built in coordination with pre-existing Kyoto Protocol National registers and transaction logs, such as the International Transaction Log (ITL) under the Kyoto Protocol.93
89 Durrant, Legal Responses to Climate Change, above n 2,122.
90 Ibid, 118; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy, above n 2, 255.
91 Stern, The Economics of Climate Change – The Stern Review, above n 1, 382.
92 Choi, ‘Global Climate Change and the Use of Economic Approaches’, above n 2, 940; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 151-6.
93 Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 151-6; see also UNFCCC, International Transaction Log - ITL (2015)
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3.3 The interplay of Emissions Trading with the Law
Apart from the normative repercussions of each ETS design element presented above (which, in turn, carry them to the legal field), there are other legal aspects of ETS that are more readily recognized, such as the distinction between legally mandated and voluntary schemes. Other aspects also deserve special attention when an ETS is incorporated by law (for example, how ETS goals and objectives are embedded in a legal norm, and which values they represent), both from the lawmaking perspective and from the legal protection perspective in order to determine the boundaries of the protection one may expect in regard to the implementation of the scheme. Additionally, the interactions of an ETS with other relevant areas of law such as tax, competition and trade, and international law are also important. Some of these aspects are presented below.
3.3.1 Other Legal Aspects of ETS
3.3.1.1 Mandated and Voluntary Emissions Trading Schemes
A natural step in analysing ETS from a legal perspective is to differentiate emissions trading schemes mandated by law (sometimes referred to as ‘compliance ETS’ or as part of the economic instruments in the ‘compliance market’ or ‘regulated market’)94 from those established voluntarily on a national, regional, or international basis. As discussed in chapter II, apart from the pioneering emissions trading schemes mandated by US law, some subnational,95 national,96 and regional97 initiatives imposing emissions trading schemes to abate greenhouse gases have been introduced in different parts of the world. In parallel, voluntary emissions trading schemes of various scopes
94 See Rosemary Rayfuse, ‘Drowning our Sorrows to Secure a Carbon Free Future? Some International Legal Considerations Relating to Sequestering Carbon by Fertilising the Oceans’ in (2008) 31 (3) UNSW Law Journal, 919, 927.
95 Such as some state or provincial initiatives in Australia (New South Wales and Victoria), Canada (Ontario, British Columbia, Alberta) and the US (California). See J. Scott Childs, ‘Continental Cap-and-trade: Canada, the United States, and Climate Change Partnership in North America’ in (2010) 32 Houston Journal of International Law 393; Hodgkinson and Garner, Global Climate Change: Australian Law and Policy above n 2, 258-326.
96 Such as in New Zealand and, more recently, Australia.
97 Such as the European Union Trading Scheme.
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have been introduced in different spheres. Some of them are genuine voluntary corporate-driven approaches to promote efficient ways of neutralizing carbon emissions and testing compliance strategies in anticipation of potentially upcoming legislation.98 Others are driven by government initiatives either as a strategy to promote compliance or as pilot initiatives to model future mandated emissions trading schemes.99 The intersection of mandated and voluntary ETS initiatives is considered by some authors an example of a ‘new governance scheme’, which encompasses a hybrid regulatory approach that has emerged in the last two decades.100 According to this view, a mix of hard and soft regulations have been established by private and quasi-private institutions to deal with climate change issues yet unaddressed by ‘traditional state regulation.’
3.3.1.2 ETS Stated Goals
The importance of identifying stated goals of an ETS is to assess how environmental integrity and economic effectiveness are considered in the overall objectives of each mandated scheme. This identification serves both the analysis of how closely the ultimate norms are aligned with the ETS theoretical framework and to what extent the ultimate design of each scheme may have deviated from its own legislative objectives. This latter aspect defines the level of legal certainty of each scheme, that is the extent to which each ETS meets the legitimate expectations generated by its stated goals. The level of adherence of each ETS to its legally mandated objectives will, in
98 Those are the initiatives of the former Chicago Carbon Exchange, the EU Carbon Exchange and more recently some Emissions Trading Platforms in China. See Issachar Rosen-Zvi, ‘Climate Change Governance: Mapping the Terrain’ in (2011) 2 Carbon & Climate Law Review 234.
99 Into this category fall some of the proposed ETS in six provinces and major cities in China referred in the Introduction of this thesis (chapter I, section 1.1.2), which would pilot emissions trading schemes by 2013 and set up a national trading platform afterwards. For some authors this method reflects the ‘typical Chinese incremental approach to policy making.’ See Miriam Schroeder, ‘ The Road Towards China Integration into an International Emissions Trading Scheme’ (GPPi Policy Paper No. 13, March 2011) available online
100 Rosen-Zvi, ‘Climate Change Governance: Mapping the Terrain’, above n 98.
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turn, define how robust is each scheme in mitigating the risks of judicial review or political challenges that may arise.
3.3.1.3 ETS Stated and Implied Principles
Equally important to identifying the stated goals of a scheme is identifying the stated or implied principles upon which an ETS scheme is built. Identifying these principles reveals the extent to which the environmental and economic goals are balanced, and provides insights into the levels of elasticity of a scheme in terms of incorporating future changes. In many instances, the stated or implied principles also reveal how the legislator accommodated different, and sometimes conflicting, views on the ETS (usually expressed by different stakeholders in the public consultation phase of each policy).
3.3.1.4 Legal Nature of Carbon Credits or Allowances
A fundamental issue with reflexes in almost all legal dimensions of emissions trading is the legal nature of the emissions allowances or credits. The innovative aspect of an emission reduction unit provides a sui generis legal instrument,101 the definition of which may be approached differently by different legal schemes. The legal definitions established by emerging schemes or being by the literature vary. Some authors establish a basic distinction between allowances and credits, based on their public or private origin.102 The other possible distinctions include whether emissions units are a form of property, a personal right, an authorization, a permit or a license to emit under public/administrative law, a financial instrument subject to more or less formal and substantive requirements, a security, a good, or a commodity.103 The proper definition
101 Matthieu Wemaere, Charlotte Streck and Thiago Chagas, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’ in David Freestone and Charlotte Steck (eds), Legal Aspects of Implementing the Kyoto Protocol Mechanisms (Oxford University Press, 2009) 37.
102 Ibid 43.
103 Ibid; see also Mariana Parry, ‘A Property Law Perspective on the Current Australian Carbon Sequestration Laws and the Green Paper Model’ in (2010) 36 (1) Monash University Law Review 321; Jonas Monast, ‘Climate Change and Financial-Markets: Regulating The Trade Side of Cap and Trade’, (2010) 40 Environmental Law Reporter News & Analysis 10051; see also Jessie S. Lotay, ‘Subprime Carbon: Fashioning an Appropriate Regulatory and Legislative Response to The Emerging U.S. Carbon Market to Avoid a Repeat of History in Carbon Structured Finance and Derivative Instruments’ in 32 Houston Journal of International Law 459; Financial Markets Law Committee, 115
of the legal nature of emission reduction units will directly influence the contours of its legal title or ownership in a given legal system,104 and the corresponding tax and accounting treatments.105
In many cases, an allowance or credit will present more than one of such characteristics, depending on the overall treatment given to them by a given legal system.106 Thus, proprietary rights assigned to an allowance or credit may create a higher level of legal certainty regarding the trading aspect of an ETS; on the other hand, such proprietary rights may suggest that an allowance holder may claim some kind of compensation in case the government body of a mandated ETS decides to terminate or limit its use. In order to protect the government from such kind of risks, some schemes such as the U.S Acid Rain Program clearly state that the corresponding allowance ‘is a limited authorization to emit’ and ‘does not constitute a proprietary right.’107However,
‘Emission Allowances: Creating Legal Certainty: Legal Assessment of Lacunae in the Legal Framework of the European Emissions Trading Scheme and the case for Legislative Reform’ (Issue 116 – Bank of England, October 2009) 7-8, 19. For a Brazilian law perspective, in relation to the legal nature of Carbon Credits under the Clean Development Mechanism, see Haroldo Machado Filho and Bruno Kelakian Sabbag, ‘Classificação da Natureza Jurídica do Crédito de Carbono e Defesa da Isenção Tributária Total das Receitas Decorrentes da Cessão de Créditos de Carbono Como Forma se Aprimorar o Combate ao Aquecimento Global’
104 Of particular importance for the Brazilian case is the discussion around the ownership of carbon credits by Brazilian indigenous populations, which can represent around 40 per cent of the volume of credits resulting from forest conservation in the Amazon basin. See Rodrigo Sales, Viviane O. Kwon and Patricia Frederigh, ‘Legal Aspects of the Surui Carbon Project’ in Raul Silva Telles do Valle (organizer), Avoided Deforestation (REDD) and Indigenous Peoples: Experiences, challenges and opportunities in the Amazon Context (ISA and Forest Trends, 2010), 125.
105 Celeste M. Black, ‘Tax Accounting for Transactions under an Emissions Trading Scheme: An Australasian Perspective’ (2011) 1 Carbon and Climate Law Review 91.
106 Wemaere et al, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’, above n 101, 43 and 58.
107 According to the U.S. Clean Air Act, 7651b (f):
(f) Nature of allowances An allowance allocated under this subchapter is a limited authorization to emit sulfur dioxide in accordance with the provisions of this subchapter. Such allowance does not constitute a property right. Nothing in this subchapter or in any other provision of law shall be construed to limit the authority of the United States to terminate or limit such authorization (…).
Clean Air Act Publ. L. Nº 91-604, 84 Stat. 1676 (codified as amended at 42 U.S.C.A. §§ 7401-7671q (West Supp. 1991) (the ‘U.S. Clean Air Act’), § 7651b (f). 116
as noted by Manea, ‘U.S. case law has established that the allowances exhibit many characteristics of property rights as between private parties, though not against the government.’ Manea cites Ormet Primary Aluminium Corp. v. Ohio Power Co. 98 F. 3d 799 (4th Cir. 1996), where the court, despite reiterating that allowances were not proprietary rights per se, determined that a dispute between private parties over its ownership should be resolved in the federal courts ‘in the same manner as other private commercial disputes.’108 This dual treatment by the U.S. law as regards to legal nature of allowances is a good example of how this innovative right may carry more than one characteristic, as pointed out by Wemaere. Further, as pointed out by Manea, the decision in Ormet Primarium Aluminium v Ohio Power Co. shows that, although emission allowances under the U.S. Acid Rain Program are not property rights as against the government, they carry many features of property rights between private parties, such as being hold, transferred our used to emit the corresponding amounts of SO2, which creates a de facto property rights between private parties.109 Different from the U.S. approach, the conceptualization of emission allowances as ‘intangible property in which equitable interests can subsist’ has been granted by an English Court in Armstrong DLW GmbH v Winnington Networks Ltd, a case involving claims over fraudulent transactions of EU allowances.110
Also important are the legal consequences in cases where an allowance is treated as financial instrument. In such cases, this definition may trigger the jurisdiction of regulated market authorities over the allowance transactions. As a result, the overall operation of the market, including public disclosure requirements for market players and eligibility criteria for brokers and other market operators, may be conditioned to the financial market regulations.111
See also Wemaere et al, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’, above n 101, 53.
108 Sabina Manea, Instrumentalising Property: An Analysis of Rights in the EU Emissions Trading System (PhD Thesis, The London School of Economics and Political Science, 2013) 35 and 86.
109 Ibid.
110 Ibid 125; Armstrong DLW GmbH v Winnington Networks Ltd. [2012] EWHC 10 (Ch), [2013] Ch 156. See also discussion on the fraud aspects of this case in charter IV, section 4.4.6.2.
111 This was the option of the New Zealand and Australian ETS, as discussed in chapter IV, item 4.4.4.
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The discussion on the legal nature of allowance or credits will be revisited in the following chapters in connection with their treatment under the EU ETS, New Zealand and Australian ETS and Brazilian Law, in preparation for the integrated analysis (chapter VII) and general conclusion of the thesis (chapter VIII).
3.3.1.5 Legal Modes of Linking ETS
Several legal issues in connection with linking have received special attention in the literature. Some legal issues are related to the need of harmonizing different design elements of linked schemes, which, in turn, may reflect different legal treatments from each linked jurisdiction.112 Other issues are related to principles and legal mechanisms from international law, particularly in relation to the most appropriate vehicles for establishing bilateral rights and obligations, between sovereign states and with the international climate change regime.113 Also, different legal issues may arise as a result of the linking options indicated in section 3.2.2.5 above, which covered the relationship between ETS (for example, bilateral, unilateral, direct, or indirect linking).114 Specific design options will also be critical to encourage or discourage linking two or more ETS from distinct jurisdictions. Hence, design options that have been identified as potentially restrictive for the linking opportunities between two or more schemes include differences in terms of the coverage of gases or activities, stringency of the cap, or use of different types of GHG reduction targets (relative versus absolute caps, as discussed in chapter II).115 Moreover, linking opportunities will be more restrictive if there is an
112 Stern, The Economics of Climate Change – The Stern Review above n 1, 544-5.
113 Michael Mehling, ‘Linking of Emissions Trading Schemes’, in Freestone and Steck (eds), Legal Aspects of Implementing the Kyoto Protocol Mechanisms above n 101,126; Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 96.
114 Mehling, ‘Linking of Emissions Trading Schemes’, above n 112, 119-22; Jaffe and Stavins, ‘Linkage of tradeable permit systems’ above n 6,128-30.
115 Mehling, ‘Linking of Emissions Trading Schemes’, above n 112, 115; Lyster, ‘Chasing Down the Climate Change Footprint’ above n 2, 469-70; Weishaar, Emissions Trading Design: A Critical Overview above n 2, 194; Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 90- 92. See also Christian Flachsland, Robert Marschinski and Ottmar Edenhofer, ‘To link or not to link: benefits and disadvantages of linking cap-and-trade systems’ in Andreas Tuerk (guest editor) ‘Linking Emissions Trading Schemes’ (2009) 9 (4) Climate Policy 339, 358, 364; Wolfgang Sterk and Joseph Kruger, ‘Establishing a transatlantic carbon market’, in Andreas Tuerk (guest editor), ibid 389, 391; Frank Jotzo and Regina Betz, ‘Australia’s emissions trading scheme: opportunities and obstacles for linking’, in Andreas Tuerk (guest editor), ibid, 402; Richard B. Stewart, Jonathan B. Wiener and 118
asymmetry in the recognition of external trading units or inconsistency regarding types of offsets accepted by each scheme (for example, restriction on offsets from land-use projects or large hydro powers by one ETS as opposed to unrestricted offsets by another ETS).116 Other restrictive factors include differences on: allocation methodologies (for example, auctioning, free allocation, or a hybrid approach); adoption of a price cap as opposed to floating price; and different standards for monitoring, reporting and verification (MRV); and different standard for enforcement and penalty mechanisms.117 Linking may also be limited in cases of different standards for public access to information, inconsistency between rules for establishing, transferring and recording allowance ownership rights, and, finally, in cases of inconsistency or technical incompatibility between allowance registry and trading platforms.118
Of particular importance is the issue of harmonizing across jurisdictions the legal conceptualization of tradable allowance or carbon credit.119 Another challenging issue concerns the legal capacity of a given jurisdiction to recognize carbon credits issued in another jurisdiction,120 which, in some cases, may be subject to constitutional control or higher level of scrutiny by the legislative power. Additionally, linking regulations may be harmonized with policies and legislation covering other sectors or activities under a given jurisdiction, such as those on banking and financing, international trade, and tax.
Philippe Sands, ‘Legal Issues Presented by A Pilot International Greenhouse Gas Trading System’ (United Conference on Trade and Development, UNCTAD/GDs/GFSB/Misc.1, 1996), 21-2; and Juliet Howland, ‘Not All Carbon Credits are Created Equal: The Constitution and the cost of regional cap-and-trade market linkage’, (2009) 27 UCLA Journal of Environmental Law and Policy 413.
116 Lyster, ‘Chasing Down the Climate Change Footprint’ above n 2, 470; Weishaar, Emissions Trading Design: A Critical Overview above n 2, 203-4; Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 90.
117 Lyster, ‘Chasing Down the Climate Change Footprint’ above n 2, 470; Weishaar, Emissions Trading Design: A Critical Overview above n 2,198-9; Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 93-4.
118 Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 205; Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 93-4.
119 Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’ above n 84, 94.
120 Ibid 96-7.
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Apart from these legal issues, there are managerial issues (such as the constant interaction between registries of allowances in each jurisdiction) that require clear legal mandates to be given to the respective scheme governance bodies, in order to enable smooth and secure operation of the trading activities.121
Another relevant issue is defining the most appropriate legal vehicle to establish bilateral or multilateral linking (for example, political arrangement, mutual recognition in domestic law or by treaty).122 This arrangement requires the adoption of measures to harmonize a desirable consistency between the linked schemes without compromising the sovereign rights of each country in changing their own domestic scheme design over time.123 A related issue is the harmonization of linked schemes with the overall international climate change regime and with the related international emissions trading obligations. Some authors have raised concerns that linked schemes could be used to override the ‘supplementarity principle’ of the UNFCCC and the Kyoto Protocol, whereby countries shall prioritize emission reductions within their own boundaries (domestic reductions) and use emission reductions from elsewhere on a supplemental basis.124 Apart from the public international law requirements applied to ETS, the exchange of carbon credits in the international market also demands the application of legal principles and practices from private international law that will also have to be considered by market players. In fact, due to the peculiarities of carbon reduction projects a new set of principles and contractual arrangements (such as the Emissions Reduction Purchase Agreements – ERPAs and Voluntary Emission Reduction Purchase Agreements – VERPAs) have emerged since the initial projects developed under the Kyoto Protocol market mechanisms. There are a good number of literature sources on
121 Ibid 97.
122 Ibid 99, citing M Mehling ‘Bridging The Transatlantic Divide: Legal aspects of a link between regional carbon markets in Europe and the United States’ (2007) VII (2) Sustainable Development Law and Policy 46, 47.
123 Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’, above n 84, 99. See also E. Haites and X. Wang, ‘Ensuring the environmental effectiveness of linked emissions trading schemes over time’ in (2009) 14 Mitigation and Adaptation Strategies for Global Change 465.
124 Betz and Stafford, ‘The Policy Issues Arising with the Linking of International Emissions Trading Schemes’, above n 84, 100, citing E. Haites, ‘Harmonization between National and International Tradeable Permit Schemes: Concerted Action on Tradeable Emissions Permits Country-Forum Synthesis Paper (OECD, 2003), 5-6.
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such contractual arrangements, but specific analysis of contractual matters in relation to emissions trading transactions is beyond the scope of this thesis. 125
3.3.1.6 Implications for Competition, Trade and Investment Laws
Other relevant legal issues in ETS are the competition and trade aspects of the scheme’s coverage and allowance allocation rules;126 the international trade laws from the WTO and other international bodies;127 and the treatment of the emissions units under bankruptcy proceedings. Among these aspects, the principles from competition law and the requirements of a given jurisdiction are an important aspect to be considered in the design of ETS due to the possible impacts of the scheme on industries considered ‘liable entities’ to meet the emission cap, particularly in relation to the coverage and allocation alternatives discussed above.
3.3.1.7 Implications for Tax
As discussed above, the definition of the legal nature of the emission reduction credits in a given jurisdiction will define its treatment by the tax system.128 Apart from this direct outcome, the possibility of hybrid emission trading schemes129 that combine a fixed-price mechanism with a trading mechanism (including the use of the price ‘safe valve’) is the most evident example of incorporating a ‘carbon tax’ to the design of an
125 For some discussions on this matter, see Christopher Carr and Flavia Rosembuj ‘World Bank Experience in contracting form emission reductions’ (2007) 2 Environmental Liability 114; Martjin Wilder and Louisa Fitz-Gerald, ‘Carbon Contracting’ in Freestone and Steck (eds), Legal Aspects of Implementing the Kyoto Protocol Mechanisms above n 102, 296-309.
126 See Marie-Claire Cordonier Segger and Markus Gehring, ‘Trade and Investment Implications of Carbon Trading for Sustainable Development’ in Freestone and Steck (eds), Legal Aspects of Implementing the Kyoto Protocol Mechanisms, above n 101, 77- 107;
127 See Stewart et al, ‘Legal Issues Presented by A Pilot International Greenhouse Gas Trading System’ above n 115.
128 For a discussion in the Australian context, see Celeste M. Black, ‘Climate Change and Tax Law: Tax Policy and Emissions Trading’ in Rosemary Lyster (ed), In the Wilds of Climate Law (Australian Academic Press, 2010), 155.
129 See discussion on chapter II of this thesis.
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ETS.130 This aspect is of particular relevance for this thesis due to the discussion on the most efficient carbon pricing alternatives presented in the previous chapter, and the peculiarities of the Brazilian greenhouse gas emissions profile and climate change policies that will be discussed in chapters V and VI. Other relevant tax law aspects of emissions trading relate to the possibility of using cross-border taxes in a jurisdiction that adopts emissions trading scheme (or any other carbon pricing option) in order to protect its local industry from foreign competitors, which are not subject to similar restrictions in their original jurisdictions.131
3.3.1.8 The Interplay of Emissions Trading with Other Relevant Laws and Policies
As ETS are devised as part of a given legal framework devoted to climate change, they raise the issue of the ‘federalism’ dimension of their relationship with federal/national and state/regional schemes.132 This discussion not only addresses the traditional division of regulatory power and enforcement roles between different levels of state power,133 it also addresses the inference of existing legal mandates in a given legal framework that may authorize the implementation of an ETS, which, in turn, may not have to be created by a new legislative instrument.134 In addition, it addresses
130 As it will be discussed in the next chapters of this thesis, this is the model adopted in Australia, which foresaw an initial phase of a fixed price (through a ‘carbon tax’) followed by the free price floating through trading.
131 Steven Nathaniel Zane ‘Levelling the Playing Field: The International Legality of Carbon Tariffs in the EU’ in (2011) 34 Boston College International and Comparative Law Review, 199.
132 See K Russell La Motte, David Max Williamson and Laure A. Hopkins, ‘Emissions Trading in the US: Legal Issues’ in David and Steck (eds), Legal Aspects of Implementing the Kyoto Protocol Mechanisms above n 101, 406-413, who claim that because of the complexity of some of the legal issues raised by climate change in general, an emissions trading in particular, the correspondent ‘regulatory response’ will ‘undoubtedly raise unprecedented tensions in the state-federal relationships.’ Ibid 391.
133 Ibid 392.
134 See a discussion in the US context in Timothy J. Mullins and M. Rhead Enion, ‘(If) Things Fall Apart: Searching for Optimal Regulatory Solutions to Combating Climate Change under Title I of the Existing CAA if Congressional Action Fails’ (2010) 40 Environmental Law Reporter News & Analysis 10664.
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strategies to devise the optimal approach in fostering domestic law either through a centralized federal scheme or through several state-based initiatives.135
Another crucial legal aspect concerning the interplay of ETS with other policies concerns the modes of incorporation of offsets136 in a given ETS design, either from domestic projects or through linkages to other regional or international schemes.137 The use of offsets in such a context may involve associated programs such as REDD (Reduction of Emissions for Deforestation and Degradation in Developing Countries), the voluntary market for carbon offsets, and other possible carbon mitigation activities through payment for environmental services.138
3.4 Conclusion
This chapter provided a systemic view on the major principles and design elements of ETS and how they interact with law, both from a structural and functional standpoint. The analysis of the key ETS principles and design elements provided by the literature identified the basic structure of ETS resulting from the combination of the following elements:
a. Aggregate cap on predefined emissions from predefined sectors;
b. Issuance of tradeable individual emission allowances to pre-defined entities within covered sectors;
135 See Rachel Brewster, ‘Stepping Stone or Stumbling Block: Incrementalism and National Climate Change Legislation’ in 28 Yale Law and Policy Review 245.
136 Meaning emission reductions generated in individual, project-based emission reduction activities that can be used by liable entities under a cap-and-trade scheme to ‘offset’ their emission reduction targets. See discussion in chapter II of this thesis.
137 See Durrant, Legal Responses to Climate Change above n 2, 123-4; Weishaar, Emissions Trading Design: A Critical Overview, above n 2, 203.
138 Lyster, ‘Chasing Down the Climate Change Footprint’, above n 2, 470-1; Simon Hirsbrunner et al, ‘Important aspects of sinks for linking emission trading systems’ (German Federal Ministry of the Environment and German Environmental Agency, Report No. (UBA-FB) 001447/E, 2, June 2011), 7-15
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c. Entitlement to covered entities to use emission allowances to offset their own emissions or trade them in the market.
These basic structural elements are ‘inherent’ to what is defined as an ETS, regardless the jurisdiction that it will be applied, differentiating it from other market- based instruments discussed in the previous chapter. As such, it provides for the initial ‘elements of unity’ to support an integrative view of ETS, as proposed in section 1.4.2.2 of this thesis. This analysis was complemented by the depiction of complementary structural elements of and ETS as well as its functional elements, the very nature and combination of which will define the ultimate performance of the ETS vis-à-vis its stated goals and objectives. Each of those design elements was examined taking into consideration their nature, stated objectives and different forms of use. As stated in section 1.4.2.2, the analytical approach undertaken by this thesis assumes that every aspect of an ETS design that has a normative content, meaning legal mandates or repercussions to the regulated community in general or individual sectors or companies, or that is inserted in the legal enforcement or governance structures of a given jurisdiction, should be regarded as a legal component of ETS. Based on this approach, this chapter provided for a basic Legal Modelling of ETS, which will be used to frame the analysis of the case studies in the next chapter and the final proposal of a Brazilian ETS legal model presented in the final chapter of this thesis. The following elements of a basic Legal Modelling of ETS can be identified:
a. ETS Structural Elements:
(i) Sources of Law mandating ETS to certain sector and activities and stated or implied goals and principles deriving from such mandates;
(ii) Governance, Compliance and Enforcement Authority with mandate for cap setting, allowance issuance and auctions, surveillance on monitoring and verification of emissions and enforcement of penalties against violators.
(iii) Registry System and Trading Platform for allowance trading, accounting and tracking;
(iv) Structural connective mechanisms to the national legal framework (e.g., Constitution, overall climate change, environmental, tax, competition, corporate and securities, trade and investment laws and regulations and international law) and to of emissions from sources not covered by the scheme. 124
(v) Structural Elements of linking mechanisms to the climate change regime and other regional and national ETS establishing bilateral rights and obligations between sovereign states and with the international climate change regime.
b. ETS Functional Elements:
(i) Scheme Emission Reduction Target (Absolute or Relative), Level of Cap Stringency and Cap Duration;
(ii) Scheme Coverage: Pollutants/GHGs, Sectoral (Economic Sector, Point of Obligation and corresponding Individual Facilities, and Opt-in and Opt-out Provisions) and Geographical Coverage
(iii) Allowance Allocation Methods (Free/Grandfathering and Auctions), Direct Assistance Programs, and Corresponding Liability Distributional and Competition Fairness amongst sectors and/or individual facilities
(iv) Allowance Legal Nature (proprietary right, personal right, administrative permit, license or authorization to pollute, financial instrument, security, good, commodity) and Use Rules (Transfer, Surrender, Cancellation and Validity, Banking and Borrowing).
(v) Civil, Criminal and Administrative Liability Rules for Non- Compliance with emission reduction targets and other scheme violations (Monitoring and Reporting, Market Fraud, Trading Rules);
(vi) Functional Elements of Linking.
As indicated in the outset of this thesis (section 1.1.2), the ultimate design of an ETS will be crucial to define its level of environmental integrity and the effectiveness of this policy alternative from an economic stance. These two potential benefits are claimed by large part of the literature as comparative advantages of market-based mechanisms in general, and ETS in particular, vis-à-vis traditional regulations (command-and-control) and other price mechanisms, such as tax and subsidies. However, as the discussion provided by this chapter has demonstrated, it is the dynamics of structural and functional elements of a given ETS that will define how far it can go in achieving its pre-defined goals. It will also qualify most of the legal repercussions of the scheme over the regulated community, from the determination of 125
sectors and firms that will bear the liability costs or, on the contrary, be subject to some kind of compliance assistance, to the myriad of fiscal, corporate, competition and other legal ramifications it will generate to covered entities.
Thus, according to the theoretical framework reviewed in this chapter, in order to achieve the goal of environmental integrity an ETS design will have to, at least, provide for a very accurate cap setting and allowance allocation process, through which real scarcity is brought about in the corresponding market it creates. In addition, the magnitude of potential emissions reduction from an ETS will depend on other design elements such as the choice of covered gases, sectors, and entities subject to the scheme obligations. Such policy design choices also imply political decisions on the distributional and equity profile of an ETS, since it may favour some economic sectors within the spectrum of activities that generate greenhouse gas emissions in a given economy or jurisdiction. Along the same lines, the methods of allowance allocation can also highly impact the overall environmental performance of an ETS, since the stringency of the cap will only work as an emissions barrier to the extent that real prices are attached to the emissions allowances to be acquired by each covered source.
Despite legitimate concerns with respect to some sectors that may be more highly impacted in a rapid transition to a pricing mechanism attached to their greenhouse gas emissions, as the literature on ETS design discussed in this chapter demonstrates, free allocation of allowances on a large scale may create perverse effects. Said effects include avoiding real emission reductions and favouring huge profits for some sectors without the corresponding emission reduction benefits. Also, possibly unfair distribution of the scheme liability amongst sectors or individuals firms will increase the risks of litigation and jeopardize the level of compliance and schemes’ legitimacy and political acceptance. These and other examples of the major design elements show how complex and accurate the construction of an ETS must be, and how the compliance, enforcement and trading infrastructure of a given jurisdiction must be construed to accommodate this type of policy. This level of complexity also demands a careful decision process as to the legal contour of certain design elements, such as the legal nature of the allowance and the level of authorization given to the scheme authorities to procure linking with schemes from other jurisdictions. The analysis also demonstrated that some key legal aspects of ETS, such as the legal nature of the allowances, challenges traditional legal notions such as ‘property rights’, providing in some cases for hybrid approaches in regards to the extension of such entitlements vis-à-vis private and public entities. Such definitions on key legal aspects of ETS, along with a clear understanding of how an ETS policy will fit the overall legal framework of the jurisdiction it belongs to, will be extremely important for optimal implementation and 126
performance. How much of this task has been accomplished by emerging ETS in the real world is the subject of the next chapter addressing ETS experiences in the European Union, New Zealand, and Australia.
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CHAPTER IV – COUNTRY STUDIES OF ETS DESIGN ELEMENTS
4.1 Introduction
This chapter completes the analysis on ETS commenced in chapters II and III by examining the major design elements of three existing and emerging mandatory ETS regimes: those in Europe (the EU ETS),1 Australia (the Australian ETS or CPM),2 and New Zealand (the NZ ETS).3 The analysis of these case studies will assess the ultimate design of each ETS against some of the principles and concepts reviewed in the previous chapters. The analysis will also examine into the dynamics and major driving forces behind the ultimate design of each scheme, and identify a set of legal and policy issues of relevance to inform the discussions as to their applicability in the Brazilian context that will follow in chapters VII and VIII, the particular focus of which will be to assess whether and how an ETS might be adopted in Brazil as an environmentally sound climate change policy option. After discussing the rationale for choosing each of the case studies and summarizing their implementation history and respective basic structure in section 4.2, the analysis of the design elements of the EU ETS, CPM and NZ ETS will follow the analytical approach indicated in chapter I and adopted in chapters II and III, whereby the basic structure of each scheme will be summarized, followed by the depiction of each of their major goals and objectives and functional and additional structural elements. Whenever relevant, the sections will include a discussion on the major issues that are relevant for the chapter’s general conclusion and the integrative analysis that will follow in the subsequent chapters.
1 European Union Trading Scheme (as defined by the relevant European Union Directives discussed later in this chapter) (‘EU ETS’).
2 As established by the ‘Clean Energy Package’ introduced by the Australian Government in 2011 through the Clean Energy Act 2011 (Cth) and subsequent amendments. Since the major design elements of the Australian ETS was established by the Carbon Price Mechanism component of the legislative package, this chapter will use the terms ‘Australian ETS’, ‘Australian CPM’ or simply ‘CPM’ interchangeably.
3 Climate Change Response Act 2002 (2002 No. 40) as amended by the Climate Change Response (Emissions Trading) Amendment Act 2008 (2008 No. 85) (NZ) (‘NZ ETS Act’) and subsequent amendments: Climate Change Response (Moderate Emissions Trading) Amendment Act 2009 (2009 No. 57) (NZ)(‘NZ ETS 2009 Amendments’); Climate Change Response (Emissions Trading and Other Matters) Amendment Act 2012 (2012 No. 89) (NZ) (‘NZ ETS 2012 Amendments’).
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4.2 The rationale for selecting the case studies and brief history of their implementation
The main reason for selecting the EU ETS, CPM and the NZ ETS as case studies for this thesis relate to their status of emerging regional and national mandatory ETS in force at the time of the research, in addition to reflect different stages of implementation and design options for an ETS. Additional benefits for such choice of case studies are summarized below.
The EU ETS is the largest and most important ETS implemented so far. In addition to its regional scope, the EU ETS covers the largest number of emission sources and has been the major driving force for the international emission reduction market, including the Kyoto Protocol flexible mechanism during its first compliance period (2008–2012). As of today, the EU ETS is by far the most ambitious cap-and- trade scheme on a global scale, covering the largest number of emission sources from a large number of different countries. Despite diverging opinions on the level of effectiveness of the EU ETS in reducing GHG emissions and some ongoing discussions on possible structural changes, the EU ETS is clearly a well-established policy within the EU legislative spectrum. This ‘policy stability’ is another important differentiation factor between the EU ETS and the other national schemes analysed, particularly the CPM in Australia that only lasted two years as discussed below. As a result, the EU ETS presents perhaps the best case study of ETS effectiveness in reducing greenhouse gas emissions.
In general terms, the dynamics of the negotiation process of the Kyoto Protocol and the failure of previous efforts of the EU to create a harmonized EU-wide carbon energy tax in 1990 are deemed as the major driving forces for the EU embracing the creation of an emissions trading scheme as its main policy to reduce greenhouse gas emissions.4 Such interplay of EU-internal and external factors better explain the abrupt change of position of the EU towards adoption of the EU ETS and the subsequent sense of urgency that drove the EU ETS design and implementation after it had become the policy choice for the EU. Of particular importance for this outcome is the particular role played by the EU supranational institutions, the national governments and non-state
4 This summary of the EU ETS implementation history is based on Jon Birger Skjærseth and Jørgen Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation (Ashgate 2008), particularly ch 1-5; and A. Denny Ellerman, Frank J. Convery and Christian de Perthuis, Pricing Carbon: The European Union Emissions Trading Scheme (Cambridge University Press, 2010), ch 2.
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actors (major industries and non-governmental organizations) in all phases of the EUTS. In the aftermath of the Kyoto Protocol, the EU faced the challenge of finding the best approach to implement Community-wide measures that would allow it meeting the obligation to reducing emissions by 8% from 1990 between 2008 and 2012 and to demonstrate progress by 2005. An EU Commission analysis of 1998 favoured a ‘step- by-step approach’ to implementation of the emissions trading schemes which had been recently created under the Kyoto Protocol flexible mechanisms provisions (‘The EU Post-Kyoto Strategy’).5 The EU Commission further reinforced the phased- implementation approach in 2000 through the issue of the ‘Green Paper’, whereby a ‘learning-by-doing’ approach was advocated to allow the Community being ‘better prepared for the start of international emissions trading from 2008 under the Kyoto Protocol.’6 The EU ETS strategy documents were based on the previous decision of the EU and its Member States to implement their Kyoto Protocol commitments jointly through the ‘Burden Sharing Agreement.’7 The Green Paper advanced the notion that inclusion of private companies in a Community-wide emissions trading scheme would ‘represent a unique opportunity for a cost-effective implementation of the Kyoto commitments.’8 This protrade approach was enhanced by the fact that a proposed
5 Commission of the European Communities, ‘Communication from the Commission to The Council and The European Parliament: Climate Change – Towards an EU Post- Kyoto Strategy’ (Commission of the European Communities, COM [1998] 353 Final, June 3, 1998), (‘The EU Commission Post-Kyoto Strategy’) 19-21.
6 European Commission, ‘Green Paper on Greenhouse Gas Emissions Trading with the European Union’ (European Commission, COM (2000) 87 final, March 8, 2000), 10-11. (‘EU Commission Green Paper’).
7 EU Commission, ‘EU Post Kyoto Strategy’, above n 5; EU Commission, ‘ Green Paper’, ibid, 9. The Burden Sharing Agreement is expressly allowed by Article 4 of the Kyoto Protocol, and by the signature of the Protocol on April 29, 1998, the European Community declared that it and its Member States would use such prerogative of fulfilling their Kyoto Protocol jointly. For the EU internal political agreement on the distribution of emission reduction targets amongst the Member States, see Commission of the European Communities, ‘Commission Communication to the Council and the Parliament: Preparing for Implementation of the Kyoto Protocol’ (Commission of the European Communities, COM (1999) 230 Final, 19 May, 2009), Annex I. The terms of such agreement was further included in the Council Decision on the Approval of the Kyoto Protocol by the European Community. Decision 2002/358/EC: Council Decision of 25 April 2002 concerning the approval, on behalf of the European Community, of the Kyoto Protocol to the United Nations Framework Convention on Climate Change and the joint fulfilment of commitments thereunder [2002] OJ L 130/1, Preamble Paragraphs 9 and 12 and Article 3 and Annex II.
8 EU Commission, ‘Green Paper’, above n 6, 9-10.
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directive on a combined carbon and energy tax conditioned to adoption of similar tax by other OECD countries ‘led to some of the most ferocious lobby activity ever seen in Brussels’ particularly from the fossil-fuel industry.’9 It is within this context that the then recent market-based concepts successfully introduced by the US into the Kyoto Protocol negotiations offered an opportunity for the EU Commission considering an alternative approach to policy development, despite the scepticism of the EU negotiators of the time with respect to the alleged benefits of market mechanisms. In addition, the shift in the EU Commission position is also largely credited to the role played by a renewed set of officers who took charge of the Commission’s Environment Directorate shortly after the adoption of the Kyoto Protocol.10 Accordingly, this new team of EU officers were advocates of using market mechanisms in environmental policy, and played a crucial role in driving the EU Commission seizing the challenges posed by the Kyoto Protocol as an opportunity to learning and introducing a new approach that perhaps could gain acceptance as the preferred solution to promote emission reductions.11 In any event, at the same time that the Commission was building its emissions trading knowledge base, the Council of Ministers, representing the Member States, started demanding the Commission to provide for valuable alternatives to respond to the increased pressure over the EU towards addressing the commitments under the Kyoto Protocol.12 The consequent interplay between those two pillars of the EU co-decision process culminated with the Commission proposing ETS as the preferred policy approach to respond to the Council demands.13 Although the responses from Member States to the Green Paper were almost equally split between those who supported and opposed the EU ETS, the consultation process on the EU ETS Draft Directive eliminated most of the controversy regarding the EUTS adoption. The wide consultation process, which was in fact coupled with a series of capacity building initiatives headed by the Community with the help of external experts (including presentations by representatives from the US responsible for the Acid Rain and NOX cap-and-trade programs), was determinant for paving the road for consensus building around the EUTS. By the end of 2001, most stakeholders from Community institutions
9 Ibid 4.
10 Skjærseth and Wettestad, above n 4, 86.
11 Skjærseth and Wettestad refer this group as ‘Bureaucrats for Emissions Trading – BEST’. Ibid, 74-5 and 183-85. See also A. Daniel Ellerman et al, above n 4, 26.
12 Skjærseth and Wettestad, above n 4, 185.
13 Ibid.
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to Member States and non-state actors (both industry and NGOs) have agreed upon the adoption of the EUTS.
Apart from those EU-internal factors, the international climate change regime has played an additional significant role in shaping the EU decision on embracing emissions trading. At this time, the unexpected withdraw of the US from the Kyoto Protocol increased the prospects/risks of non-ratification of the Kyoto Protocol. Although the US exit from Kyoto increased the risks of EU companies being exposed to unfair competition from US companies in case of binding emission restrictions in Europe, this argument did not prevail within Europe. At the end, the US departure from the Kyoto Protocol is viewed as a significant factor to unite the EU stakeholders around the adoption of the EU ETS as a way of not just implementing a solid EU police, but also as a form of ‘saving Kyoto.’ Interestingly, the EUTS Directive and the Kyoto Protocol negotiations mutual influence at this stage created a symbiotic effect by which, on one hand, the EU ETS became the main driver for the emerging Kyoto market mechanisms in addition to maintaining the prospects of implementation of the Kyoto Protocol despite the US withdrawal. On the other hand, the climate change regime reinforced the sense of urgency in Europe for approval of the EUTS Directive as a mean of demonstrating the EU progress and compliance with the Kyoto Protocol goals.
In summary, building from the international and particularly US experience on emissions trading, the EU was able to build the largest greenhouse gas emissions trading scheme as of today. Although totally aligned with the Kyoto Protocol (particularly with respect to the Kyoto Protocol emission reduction goals and related compliance period and the fungibility of EU allowances with Kyoto project base credits), the ultimate design of the EU ETS reflected to a greater extent the internal dynamics of the European Union political system, the economic interests of the most affected sectors and the environmental concerns represented by NGOs. Clearly as a political compromise to allow the adoption of the EU ETS, the EU Commission conceded on a much more decentralized system for the trial phase that it had expected, in addition to the free allocation of allowances to please Member State concerns with the most affected industries. The Commission was able to resume its move towards a more centralized effort during Phase II implementation, which later derived in the Phase III centralized scheme from 2012 onwards, as demonstrated later in this chapter.The NZ ETS is one of the first national mandatory schemes and, given the importance of land- use based emissions for both countries’ emissions profiles, it may provide some useful lessons for the Brazilian context. The NZ ETS innovated by including the forestry sector (usually producers of planted forests) as a covered sector from the scheme’s outset, with its full obligations under the scheme commencing on January 2008, and by 132
foreseeing the inclusion of the agriculture sector’s full obligation in a second period. Admittedly, the inclusion of the agriculture land-use sector’s full obligations under the NZ ETS has been postponed continuously by the New Zealand Government; a clear sign that incorporation of agriculture activities into an ETS framework still faces important barriers including the reluctance of the agriculture sector to proactively manage their environmental externalities. Nevertheless, the New Zealand scheme offers important insights on how a national ETS can be used to assist national economies in complying with internationally mandated emission reduction targets, such as the ones imposed on New Zealand during the first compliance period of the Kyoto Protocol. Under the Labour Party prime ministership, the New Zealand ETS was introduced in Parliament in 2007 and legislated on September 26 2008 as an amendment to the New Zealand Climate Response Act 2002. However, shortly after the NZ ETS 2008 being enacted, a general election was held and the newly elected National Party introduced amendments to the original scheme in 2009, largely devoted to ‘moderate’ some of its design elements and mitigate some perceived negative economic impacts to some of the NZ ETS affected sectors, as discussed below. Lately, additional amendments were introduced in 2012, as a result of the 2011 Legislative Review Process that was foreseen in the NZ ETS Act. Allegedly, these amendments aimed at further refining some of the design elements due to the ETS first round of experience and to align the NZ ETS to the last developments in the international arena. Particular emphasis was given to the protection of the ‘long-term economic resilience of New Zealand economy at least cost. More recently, a new set of ETS reform was announced by the New Zealand Government in 2015, in part due to the criticism the NZ ETS has faced due to its lack of environmental integrity, as it will also be discussed in this chapter.
The Australian CPM offers a good case study analysis for the Brazilian case, because of the characteristics of the Australian economy and because of the rich political debate (including the eventual impermanence of the scheme after more than a decade of policy discussion and developments), in addition to the legal arrangements that resulted in the CPM framework. In fact, the Clean Energy Legislative Package that culminated with the CPM enactment comprised of 19 (nineteen) Bills exposed as Draft Bills for public comments by the Australian Government on 28 July 2011 and further developed through the parliamentary proceedings. Those Bills centred on establishing a carbon pricing mechanism in Australia and establishing the governance structure to administer the mechanism, in addition to providing for several amendments to the Australian legal framework to accommodate the legislative package innovations on, among other requirements, energy and greenhouse gas emissions monitoring and reporting, households assistance packages and certain fuel, clean energy and ozone and synthetic gases levies and taxes, and the overall tax treatment of the carbon units and 133
other carbon credits under the Scheme. The amendments also provided for adjustments in previous existing legislation, some of them enacted just months earlier than introduction of the Clean Energy Legislative Package, that, as discussed later in this chapter, are key to the overall design and operation of the scheme, such as the National Greenhouse and Energy Reporting Act of 2007 (Cth), the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) and the Australian National Registry of Emissions Act of 2001(Cth).
Similar to Brazil and New Zealand, the land-use based sector is also relevant for Australia. In particular, Australia had to deal with an important land-use based sector lobby in devising its ETS design. As a result, contrary to New Zealand, Australia opted to exclude the agriculture sector from the ETS’s direct coverage. Instead, the agriculture sector participates as a supplier of credits that can be offset by the liable entities under the ETS. As will be discussed in the next chapter, particularly in sections 5.3.1 and 5.3.2.1, both options offer potential approaches for the Brazilian scenario due to the importance of the agriculture sector in Brazil’s GHG emissions profile. Also, the significant role of the fossil fuel industry in the Australian economy is important for the ultimate fate of an ETS in the country. Due to the Australian economy’s overreliance on fossil fuels,14 the country’s attempts to mitigate climate change have been viewed by many as a major economic reform.15 This view may explain at least in part the longevity of the political debate in Australia regarding climate change mitigation and the appropriateness and desirability of using market mechanisms to achieve mitigation objectives. According to Peel, the 2011 Carbon Pricing Mechanism discussed in this chapter ‘represented the culmination of over two decades of policy debate in Australia concerning measures to address climate change and energy sector transformation’ which has a starting point the ‘the release of a series of discussion papers by the Australian Greenhouse Office in the late 1990s.’16 Clearly the subject has been raised as one of the key political issues in the last Australian elections (at least since John Howard’s defeat to Kevin Rudd in the 2007 elections).17 This debate has produced one of the most
14 Ross Garnaut, The Garnaut Climate Change Review: Final Report (Cambridge, 2008), chapter 7.
15 Ibid 313.
16 Jacqueline Peel, ‘The Australian Carbon Pricing Mechanism: Promise and Pitfalls on the Pathway to a Clean Energy Future’ (2014) 15 Minnesota Journal of Science and Technology 429, 430-1 and n 16.
17 Ibid, 458-9; Rosemary Lyster, ‘Chasing Down the Climate Change Footprint of the public and private sectors: Forces converge – Part II’ (2007) 24 Environmental and Planning Law Journal 450, 455-6. 134
comprehensive ETS policy analyses, economic and technical modelling, and comprehensive bills of law (such as the Carbon Pollution Reduction Scheme – CPRS, proposed by the Rudd Government, and the Clean Energy Package proposed by the Julia Gillard’s prime ministership) in a given country to date.18
Albeit comprehensive, the knowledge produced by climate change research, economic models, and policy proposals, have not pacified the climate debate in Australia. Indeed, even with the passing of the Clean Energy Legislation Package in 2012 the political discussions about carbon pricing have permeated the debates during the 2013 elections. Not surprisingly, the newly elected Liberal/Nationals Coalition has fulfilled its election promise and managed to repeal the Australian ETS in July 2014.19 It replaced the whole carbon-pricing package from July 2014 onwards with a ‘direct action’ set of activities largely driven by an Emissions Reduction Fund managed by the Government.20 Interestingly, the recent ups and downs of the adoption of a pricing mechanism in Australia may not have reached its end. Legal analysis on the CPM, carried out when the repeal legislation was expected to prevail, indicated that Australian large emitters expect that a carbon pricing instrument will likely ‘re-emerge’ in Australia in the medium or long-term, and only a minority would not expect this being a reality by 2020.21 Nevertheless, despite the ignominious fate of the Australian ETS, the thorough public debate, conceptual analysis, and economic modelling that were conducted during its development and adoption remain as an important case study for the analysis of an ETS as a policy alternative for Brazil. Further, the Australian CPM
18 Jacqueline Peel, ‘The Australian Carbon Pricing Mechanism’, above n 16. 18 Jacqueline Peel, ‘The Australian Carbon Pricing Mechanism’, above n 16.
19 The Clean Energy Legislation (Carbon Tax Repeal) Bill 2013 (Cth). The carbon tax repeal legislation received Royal Assentment on July 17, 2014 and became law effective from 1 July 2014. Australian Government, Department of the Environment, ‘Repealing the Carbon Tax’, available online
20 Australian Government, Department of the Environment, ‘Emission Reduction Fund Green Paper, Commonwealth of Australia, 2013’, available online
21 Jacqueline Peel, ‘The Australian Carbon Pricing Mechanism’, above n 16, 466-74.
22 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, [2003] OJ L 275/32 (‘EU ETS 2003 Directive’), Article 1: 135
presents a very sound and detailed set of legal arrangements directed to implement CPM design, as well as to integrate the CPM to the overall Australian legal framework, including the relevant environmental, corporate, tax, and administrative requirements.
Another point of potential synergies between Australian and Brazilian approaches to climate policy is their different and possibly complementary energy portfolios. Australia over-relies on its significant coal reserves, whereas Brazil presents one of the largest renewable energy portfolios, but is still over-dependent on its large hydropower base. In theory, this asymmetry could offer some potential for future collaboration between the two countries on the energy front. In this scenario, if Brazil develops an ETS and the Australia CPM is reinvigorated in the future, such complementary economic characteristics (apart from the importance of agribusiness in both countries as pointed out earlier) could favour linking opportunities between the two schemes and interesting synergies for GHGs mitigation for companies with operations in both countries.
4.2.1 The basic structure of the EU ETS, the CPM and the NZ EUTS
The EU ETS is a mandatory cap-and-trade scheme for greenhouse gas within the European Union, based on the creation of an absolute cap on emissions from certain installations. The emission cap is allocated to the covered individual installations through tradeable allowances that represent the right to release such emissions on an annual basis (namely ‘EU Allowances’ or ‘EUA’). Each affected installation has the obligation to report emissions annually, and surrender the same amount of allowances it has been granted for the same period. Those installations that emitted in excess of its allocated allowances may purchase allowances from other covered installations that were able to generate a surplus in emission reductions for the same period. As it will be further discussed in this chapter, the EU ETS cap is expected to be lowered over time in order to induce continuous reduction towards pre-established emission reduction targets.
The Australian Carbon Pricing Mechanism (‘CPM’) comprises of a hybrid approach to price carbon emissions, as discussed in chapter I and II of this thesis, which started with a three-year fixed price period from 1 July 2012 (the Fixed Price Period, which, in practice, works as a carbon tax on GHGs emissions) and foresaw an automatically transition to a full cap-and-trade-scheme from 1 July 2015 onwards (the Flexible Price Period). The CMP compliance years were set to operate on a financial year basis. As indicated in section 4.4.4, the CPM considered four major categories of eligible emission units that, subject to different requirements, could be used by the liable 136
entity to meet their carbon pricing obligations under the Scheme: carbon units (the major emission reduction unit under the CPM), Australian carbon credit units or ACCUs (issued by the Regulator as a result of offset projects under the Carbon Farming Initiative) and international emission units such as the emission reduction units under the Kyoto Protocol and other emission reduction units to be linked to the CPM.
Under the flexible price period, the carbon emissions units or permit price should float according to the market demands. The CPM focused on pricing carbon emissions from certain sectors of the economy, initially the stationary energy sector, industrial processes, no-legacy waste and certain fugitive emissions (the ‘Liable Entities’ discussed later in this chapter). Certain transport fuels and synthetic gases were excluded from the scheme, but subject to an equivalent price through changes in fuel tax credits and excises or import levies (confirm the case for synthetic gases). Under the CPM design, users of certain fuels are entitled to opt into the Scheme instead of paying the equivalent carbon price under the fuel tax system.
The architecture of the NZ ETS was aligned with the Kyoto Protocol flexible mechanisms in place for the first commitment period (2008-2012), both with respect to the adoption of the New Zealand’s Kyoto Protocol emission targets as the emissions cap for the scheme, and with the almost unrestricted eligibility of Kyoto units to be used by the scheme participants to meet their ‘core obligation’ under the scheme; i.e., to surrender to the government one emission unit to cover each metric ton of eligible emissions in a compliance year. A New Zealand Unit (NZU) was created as the primary domestic unit of trade, but, as indicated above, for the first commitment period of the Kyoto Protocol the NZUs were deemed as fully comparable to, and backed by, Kyoto units by the end of the period for determining compliance (known as the true-up period). Thus, apart from the use of Kyoto Units to meet their obligations, covered entities under the NZ ETS were able to completely rely on Kyoto Units purchased in the international markets.
4.3 Analysis of ETS Objectives/Goals and Principles in Europe, Australia and New Zealand
4.3.1 ETS Stated Goals
As originally formulated in the EU ETS Directive of 2003, the EU ETS stated goals focused on reducing emissions in cost-effective and economically efficient 137
manners; further, the 2009 amendments inserted wording giving a higher weight to the environmental integrity of the scheme.22 Similarly to the EU ETS Phase I, the
22 Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, [2003] OJ L 275/32 (‘EU ETS 2003 Directive’), Article 1:
This Directive establishes a scheme for greenhouse gas emission allowance trading within the Community (hereinafter referred to as the ‘Community scheme’) in order to promote reductions of greenhouse gas emissions in a cost-effective and economically efficient manner.
Since the 2009 amendments the EU ETS objectives expressly include the goal of promoting increased emission reductions to levels considered scientifically necessary to avoid dangerous climate change. They also include express authorization for the future consideration of a scheme cap that could be stricter than the EU international emission reduction commitments. Thus, the following paragraphs were added to the EU ETS Article 1 cited above:
This Directive also provides for the reductions of greenhouse gas emissions to be increased so as to contribute to the levels of reductions that are considered scientifically necessary to avoid dangerous climate change.
This Directive also lays down provisions for assessing and implementing a stricter Community reduction commitment exceeding 20 %, to be applied upon the approval by the Community of an international agreement on climate change leading to greenhouse gas emission reductions exceeding those required in Article 9, as reflected in the 30 % commitment endorsed by the European Council of March 2007.
EU ETS 2003 Directive, Article 1, as amended by Article 1, paragraph 1 of Directive 2009/29/EC of the European Parliament and of the Council of 23 April 2009 amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emissions allowance scheme of the Community [2009] OJ L 140/63 (‘EU ETS 2009 Directive’)
The citations hereinafter, unless indicated with the date of the original text or corresponding amendments, are from the consolidated text of the EU ETS 2003 Directive which incorporates the amendments from the following Directives and Regulations: Directive 2004/101/EC of the European Parliament and of the Council of 27 October 2004 amending Directive 2003/87/EC establishing a scheme for the greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms [2004] OJ L 338/18 (‘EU ETS 2004 Linking Directive’), Directive 2004/101/EC of the European Parliament and of the Council of 27 October 2004 Regulation (EC) No. 219/2009 of the European Parliament and of the Council of 11 March 2009, and Directive 2008/101/EC of the European Parliament and of the Council of 19 November 2008 amending Directive 2003/87/EC so as to include aviation activities in the scheme for greenhouse gas emission allowance trading within the Community [2008] OJ L 8/3 (‘EU ETS 2008 Aviation Directive’), and Directive 2009/29/EC of the European Parliament and of the Council of 23 April 2009 amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emissions allowance scheme of the Community [2009] OJ L 140/63 (‘EU ETS 2009 Directive’).
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Australian CPM23 and the NZ ETS24 centred their respective objectives in meeting each country’s emission reduction commitments under the climate change regime in a flexible and cost-effective way.
As indicated above and in the transcription of each relevant legal provision, the original wording of the EU ETS Phase I goals and the statutory objectives stated by the Australian CPM and NZ ETS, show a clear attachment to the alleged economic effectiveness of ETS to promote emission reductions at the lowest possible cost.
23 The Australian CPM objectives are stated by the Clean Energy Act 2011 (Cth), s 3, as follows:
3. Objects The objects of this Act are as follows: (a) to give effect to Australia's obligations under: (i) the Climate Change Convention; and (ii) the Kyoto Protocol; (b) to support the development of an effective global response to climate change, consistent with Australia's national interest in ensuring that average global temperatures increase by not more than 2 degrees Celsius above pre-industrial levels; (c) to: (i) take action directed towards meeting Australia's long-term target of reducing Australia's net greenhouse gas emissions to 80% below 2000 levels by 2050; and (ii) take that action in a flexible and cost-effective way; (d) to put a price on greenhouse gas emissions in a way that: (i) encourages investment in clean energy; and (ii) supports jobs and competitiveness in the economy; and (iii) supports Australia’s economic growth while reducing pollution.
24 The New Zealand ETS objectives are stated by the Climate Change Response Act 2002 (2002 No. 40) (NZ), s. 3, as follows:
(1) The purpose of this Act is to: (a) enable New Zealand to meet its international obligations under the Convention and the Protocol, including (but not limited to): (i) its obligation under Article 3.1 of the Protocol to retire Kyoto units equal to the number of tonnes of carbon dioxide equivalent of human-induced greenhouse gases emitted from the sources listed in Annex A of the Protocol in New Zealand in the first commitment period; and (ii) its obligation to report to the Conference of the Parties via the Secretariat under Article 7 of the Protocol and Article 12 of the Convention. (b) provide for the implementation, operation, and administration of a greenhouse gas emissions trading scheme in New Zealand that supports and encourages global efforts to reduce greenhouse gas emissions by assisting NewZealand to meet its international obligations under the Convention and the Protocol, and by reducing New Zealand's net emissions below business-as-usual levels. (…)
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Although achieving emissions reduction is implied in the stated objectives of the three schemes, they clearly emphasize cost-effectiveness of the policy as the main parameter for assessing fulfilment of its goals. The EU ETS 2009 amendment to Article 1 of the EU ETS 2003 Directive relativised the status of cost-effectiveness of reductions in defining the ultimate design of the scheme. It brought to the forefront of the EU ETS Directive’s regulated matter, the ecological goals of contributing to emissions reductions to a level deemed as necessary to avoid dangerous climate change, and making room for future and stricter emission reductions targets.
Although the Australian and New Zealand ETS objectives cited above include statements on the contribution of each scheme to mitigate climate change, their respective wording has been crafted very carefully to avoid interpretations of overly ambitious environmental goals. In the case of Australia, it is noteworthy that the ETS goals sought to reconcile the environmental goals of reducing Australia’s greenhouse gas emissions and contributing to global climate change mitigation, by adopting carbon pricing alternatives that support the country’s economic growth. This ambitious step was crafted in a way that carefully confined Australia’s contribution (and consequently its ETS environmental goals) to emission reduction targets being negotiated by Australia at the global level. In this regard, although the Australian Government has made reference to Australia’s short-term emissions reduction commitments in several documents supporting the Clean Energy Legislative Package,25 the Carbon Pricing Act only makes reference to the long-term commitments to be achieved by 2050.26 This long-term parameter for measuring the achievement of the Australian ETS environmental goals (even if progressive assessments are made periodically) shows how unbalanced economic and environmental results are reflected in its stated goals. This is also evidenced by the explicit reference in the Australian law to the global goal of limiting average global temperatures to no more than 2 degrees Celsius above pre- industrial levels.27 This quantitative reference does not allow the Australian ETS to
25 Ministry for Climate Change and Energy Efficiency, ‘Securing a Clean Energy Future: Implementing the Australian Government’s Climate Change Plan’ (Statement by the Honourable Greg Combet AM MP 8 May 2012), 5: The Government’s plan to move to a clean energy future will cut pollution by at least 5 per cent compared with 2000 levels by 2020. The Government’s long-term target reflected in the objects of the Clean Energy Act 2011 is to cut pollution by 80 per cent below 2000 levels by 2050. This is expected to save over 17 billion tonnes of carbon pollution being released into the atmosphere between now and 2050.
26 Clean Energy Act 2011 (Cth), s 3 (c) (i).
27 Clean Energy Act 2011 (Cth), s 3 (b).
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automatically accommodate future scientific evidence showing the need for stricter quantitative goals to avoid undesirable global warming. Therefore, because they failed to stipulate numerical targets, the EU ETS amended goals indicated above left this possibility open, providing more flexibility to accommodate more ambitious environmental goals for the EU ETS in the future.
In the case of the NZ ETS, the stated goals are even more restrictive with respect to its environmental component. The NZ ETS limits its contribution to global warming mitigation by assisting New Zealand to meet its Kyoto Protocol obligations and to reduce net emissions below business-as-usual levels. Even this timid environmental goal28 is conditional on concurrent economic flexibility, equity, and the achievement of environmental integrity at the lowest cost in the long-term.29 As discussed below, the ultimate design of the original NZ ETS and its amendments was completely framed by the weight of such economic components of its stated goals. This cost-effective approach even disregarded the Kyoto Protocol guidance to Annex I countries stating that offsetting national emissions with international carbon credits (such as those from the Kyoto Flexible Mechanisms) should be supplemental to domestic emission reductions.30 New Zealand rather opted to use its Kyoto Target as the ETS cap, and to allow unlimited use of Kyoto Units by affected entities to meet their ETS obligations, as discussed below.
4.3.2 ETS Stated and Implied Principles
The principles underlying the EU ETS are expressly or impliedly stated by the EU Commission policies and stakeholder consultation processes, and in many instances reflected in the EU ETS Directive Recitals and provisions. The EU ETS main principles include the recognition of emissions trading as the most effective way of reducing
28 As reflected in the Kyoto Protocol, Annex B, the New Zealand’s Kyoto Protocol commitment was to equal its 2012 emissions to its 1990 levels, different from most of developed countries that had to reduce emissions below the 1990 benchmark.
29 New Zealand Government, Ministry for the Environment and The Treasury, ‘The Framework for a New Zealand Emissions Trading Scheme’ (ME 810 September 2007) 5,
30 As indicated in the discussion on the Kyoto Protocol Market Mechanisms in chapter II of this thesis.
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emissions globally,31 and the establishment of ETS development parameters based on: strong compliance and enforcement infrastructure,32 binding legislation,33 stage implementation,34 periodical review,35 alternatives for linking with other schemes,36 and harmonization with other EU or member states correlated legislation.37
Differently from the EU ETS, the Australian ETS policy design documents, which informed the ultimate text of the CPM and related Acts, provided for a straightforward list of principles to govern the ETS. These principles, mostly consolidated from the work of a Multiparty Climate Change Committee established by the Government38 and subsequent supporting documents (such as the Regulation Impact Statement prepared by the Australian Government’s Department of Climate Change and Energy Efficiency),39 are almost entirely driven by economic concepts or devoted to neutralizing possible negative economic impacts of the ETS. Out of 11 principles, only two are narrowly related to environmental integrity. The ‘Environmental effectiveness’ principle is defined as the capability of the ETS to reduce emissions ‘by driving investment and innovation in clean energy and low emissions technology and processes.’ The principle of consistency means the role of the ETS in supporting
31 European Commission, ‘EU Action Against Climate Change, The EU Emissions Trading Scheme’ (Office for Official Publications of the European Communities, 2009), 13,
32 EU ETS 2003 Directive, Article 16, Paragraph 1.
33 EU ETS 2003 Directive, Articles 2 and 4.
34 EU Commission, ‘Green Paper’, above n 7, 10-11; See Skjærseth and Wettestad, above n 4,, 38; Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, above n 4, 21-2.
35 EU ETS 2003 Directive, Preamble, Paragraph 22 and Article 30.
36 EU ETS 2003 Directive, Article 25.
37 EU ETS 2003 Directive, Article 25, Paragraphs (16), (21), (23) and (24).
38 Multi-Party Climate Change Committee, ‘Communiqué, 21 December 2010’ Department of Climate Change and Energy Efficiency,
39 Department of Climate Change and Energy Efficiency, ‘Australia’s Plan for a Clean Energy Future: Regulation Impact Statement’ (Department of Climate Change and Energy Efficiency, July 11, 2011)
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Australia’s obligations to contribute to ‘effective global solution’ to climate change.’40 The majority of the remaining principles focus on economic aspects of the ETS such as economic efficiency, budget neutrality, competiveness of Australian industries, energy security, investment certainty, and fairness (meaning assistance to households and communities most affected by a carbon price).41
Similar to the Australian case, the NZ ETS architecture is based on a set of ‘in- principle decisions’42 that define the ETS objectives and the major boundaries for the system’s design and future amendments. They include operating within the Kyoto Protocol cap,43 free allocation of credits, full compatibility between New Zealand Units (NZUs) and Kyoto Units, unlimited use of international units to meet compliance obligations,44 and the continuity of the scheme even if there is a hiatus between the Kyoto Protocol’s first commitment period (which ended in 2012) and a future international regime.45
The principles implicit or explicit in each scheme are coherent with the goals and objectives that were defined by their respective legislative instruments. The EU ETS, although less systematic in defining its principles, shows a much more balanced system with respect to the incorporation of environmental and economic goals than the NZ and Australian schemes. For example, the EU ETS makes it clear that linking should be supplemental to domestic reductions.46 This UNFCCC and Kyoto Protocol harmonized approach is completely ignored by the NZ EU ETS. In fact, the listing of ‘in principle’ decisions by the New Zealand policy design documents is very clear in its choice of a
40 Ibid.
41 Ibid.
42 According to the New Zealand Government, ‘in-principle decisions means the government would need compelling reasons to adopt a different policy approach.’ New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’ above n 29, 5.
43 Leaving open the possibility of the NZ ETS not providing for any domestic emission reduction in case of favourable market conditions for purchase of international units by affected entities). Ibid.
44 Arguably to provide liquidity to the small New Zealand trading market and act as a ‘safety valve on price.’ Ibid.
45 Ibid.
46 EU ETS 2003 Directive, Article 25.
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minimalist ETS with respect to environmental ambitions. Although frustrating to many analysts, who identified tangible opportunities for New Zealand to reduce emissions domestically through an ETS, one cannot fail to acknowledge the transparency of the New Zealand policies in revealing upfront the very limited scope of the NZ ETS in regards to domestic reductions vis à vis international offsets. Admittedly, this approach was taken to assist the country in complying with its Kyoto Protocol targets in a way that is most favourable to its affected economic sectors and to the economy as a whole. A similar approach was taken by Australia, which established a series of economic principles as the main contour of its ETS, even conditioning the harmonization of the ETS with Australia’s international commitments for emissions reductions and the trade interests of the country. The overemphasis of the NZ and Australian ETS on economic efficiency (making any adverse economic impacts on covered entities or economic sectors illegal) has at least two debilitating effects. First, it jeopardizes the stability of the system, by allowing a very low threshold for affected sectors to judicially challenge or politically lobby against the scheme on the grounds of negative economic impacts. Second, it contradicts the very core of the economic theories that inspired the ETS idea, that is, pricing pollution will drive the internalization of pollution costs by polluters and consequently improve their environmental performance.
4.4 ETS Major Design Elements/Functional Features
As stated in section 1.1.2 and discussed in more detail in chapter III of this thesis, the ultimate design of an ETS is crucial to determine the level of its environmental integrity and to impose a more or less balanced policy in terms of distributional liability effects among different economic sectors. Not surprisingly, the definition of design elements may be subject to intense lobbying by affected parties and, in many instances, the result is the granting of some level of assistance to certain sectors. This can take place either in the form of free allocation of allowances or some kind of direct assistance. Depending on the outreach of such assistance, the environmental goals of the system may be deeply affected. In such cases, an ETS is only likely to survive as a relevant environmental policy if corrective measures are implemented in time to avoid the adverse effects of a symbolic policy instrument operating in a demoralized enforcement environment. With these lessons in mind, we turn to the functional design elements of the EU ETS, CPM and NZ ETS. 144
4.4.1 Scheme Target, Cap-setting, and Stringency
Initially the EU ETS adopted a decentralized method for setting the emissions cap of the scheme under ETS Phase I (2005–7) and Phase II (2008–12). Accordingly, each member state was assigned to develop a ‘national allocation plan’ (‘NAP’) establishing the total quantity of allowances (the ‘cap’ for the particular member state) and the respective method of allocation among the affected installations located in its territory.47 Under the de-centralized cap-setting approach of EU ETS Phase I and Phase II, Member States had the discretion power to define both the cap and the allocation criteria under NAPs for their respective jurisdictions, but subject to final approval by the Commission. Member States challenges to the Commission decisions on NAPs have formed the largest part of EU ETS litigation before the EU Courts,48 either in relation to the extent of discretionary power of Member States to provide for amendments to their NAPs before its final approval by the Commission49 or in respect to the Commission’s review of NAPs the cap of which have been deemed as insufficiently stringent by the Commission50According to some authors, the decentralized cap-setting and allowance allocation methods created a perverse competition among member states to protect their local industries through setting loose or timid caps.51 Along with the use of poor monitoring data to calculate historical and projected business-as-usual emissions from sectors and individual facilities, such cap-setting process contributed to the over- allocation of allowances, detected in Phase I.52 As a result, the 2009 EU ETS amendments established a centralized cap setting proceeding under the EU Commission for the EU ETS Phase III. These amendments also created a community-centred registry system because accounting of the scheme allowances ensured that more stringent caps
47 EU ETS 2003 Directive, Article 9, Paragraph 1 and Article 11, Paragraph 1.
48 Navraj Singh Ghaleigh ‘Emissions Trading before the European Court of Justice: Market Making in Luxembourg’ in David Freestone and Charlotte Streck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond (Oxford University Press, 2009), 377- 84.
49 For example, United Kingdom v Commission (T-143/05) [2005] ECR II-4431.
50 For example, Romania v. Commission (T-484/07) [2008] C51/57 and Bulgaria v Commission (T-500/07) [2008] C64/51).
51 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, (Cambridge, 2010) above n 4, 34.
52 Ibid 36-38.
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could be established under the EU ETS, as necessary.53 It also determined that the annual issuance of emissions allowances by the Commission from 2013 onwards faces an annual decrease under a linear factor of 1.74 per cent compared to the average emissions for the period of Phase II.54
Under the CPM, in the fixed-price period (2012–14) there were to be no pollution caps since the fixed price worked as a carbon tax. Liable entities would purchase or freely receive permits from the Government and would have to surrender enough permits to cover their emissions in the relevant financial year.55 However, carbon pollution caps should be set for each eligible financial year of the flexible period of the mechanism, starting on 1 July 2015, considering the country’s medium and long-term targets to reduce GHG emissions.56 Under the CPM, strong emphasis was put on the time duration of the cap to allow a minimum level of predictability to the Government and affected entities. The main goal is to ensure that a minimum of five-year certainty about the cap in order to allow better planning and budgeting by liable entities and the Government.57
The NZ ETS was set up to ‘operate within the global cap on emissions set by the Kyoto Protocol’ and within whatever cap is established under international agreement after 2012. This approach, bluntly communicated in the NZ ETS design documents58
53 EU ETS 2009 Directive, Preamble, Paragraph 4.
54 EU ETS 2009 Directive, Article 1, Paragraph 9, subparagraph 1, amendment to EU ETS 2003 Directive Article 9. The linear factor may be reviewed as from 2020, with a view for its adoption by 2025. EU ETS 2009 Directive, Article 1, Paragraph 9, subparagraph 3, amendment to EU ETS 2003 Directive Article 9.
55 Explanatory Memorandum, Clean Energy Bill 2011, 105.
56 Ibid.
57 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’ (Commonwealth of Australia, 2011), 103:
For example, in 2015-16, regulations will make setting the pollution cap for 2020-1. In 2016- 17, regulations will be made setting the pollution cap for 2020-1, and so on.
See also Clean Energy Act 2011 (Cth) Part 2 s 16.
58 According to the NZ Government ETS policy design document:
The government has decided in principle that the NZ ETS will operate within the cap on emissions established by the Kyoto Protocol (for the first commitment period) and within whatever cap is established under the international agreements post 2012). No further limit will be placed on emissions that occur within the geographic boundaries of New Zealand. 146
and stated as an ‘in principle decision’ since the ETS outset, means that up to the end of the Kyoto Protocol’s first commitment period, the NZ ETS had no cap. Even New Zealand’s reduction targets under the Kyoto Protocol’s first commitment period did not serve as a cap on national emissions, since the NZ ETS allows unlimited use of Kyoto Units by affected entities. Thus, contrary to the ETS theoretical framework that defines emissions trading as a quantitative pricing mechanism by capping emissions to a predefined limit, the NZ ETS simply demanded that emissions by affected companies be covered by NZ Units (emitted by the NZ Government in alignment with the NZ stock of Kyoto Units reflected by its Assigned Amounts Units) or offset by international Kyoto Units purchased in the international market. In practical terms, the international price of Kyoto Units acted as a price ceiling in the NZ ETS, since affected companies could freely choose between the cheapest credits by the time of complying with their surrender obligations.59 This approach had another consequence. On November 2012, New Zealand decided not to adhere to the amendments to the Kyoto Protocol that established commitments for the second commitment period (2013–20).60 Instead, New Zealand took a non-binding emissions reduction commitment under the Climate Change Convention during the transition period to 2020.61 As a consequence, New Zealand will be restricted to undertaking international trading of Kyoto Units (including bilateral linking with several regional and national schemes) after 2015, when the first commitment period’s allowed transactions coming to an end.62 In turn, the NZ ETS is
Domestic emissions that exceed New Zealand’s allocation under the Kyoto Protocol (including units issued for removals by forest carbon sinks) must be matched by emission units purchased internationally from within the Kyoto can on emissions.’
New Zealand Government, The Framework for a New Zealand Emissions Trading Scheme, above n 19, 47.
59 Geoff Bertram and Simon Terry, The Carbon Challenge: New Zealand’s Emissions Trading Scheme (Bridget Williams Books, 2010) 59.
60 For the repercussion of New Zealand’s decision, see ‘The New Zealand Herald, Editorial: Abandoning Kyoto an act of timidity’, November 15, 2012, available online:
61 New Zealand Ministry for the Environment, ‘New Zealand 1990-2011 Greenhouse Gas Inventory’ submitted to the United Nations Framework Convention on Climate Change on 12 April 2013, 3,
62 Consequently, on December 2013, the NZ Government announced that the ETS would operate with restricted access to Kyoto markets from 2016 onwards. New Zealand Government, Acting Minister for Climate Change Issues, ‘Decisions on Kyoto Protocol 147
expected to be subject to major design changes in the future, including the need for capping emissions domestically, which is more aligned with the ETS theoretical framework discussed in the previous chapter.
Setting the ETS cap is, by definition, a complex task and a crucial one for designing an effective ETS, as discussed in the previous chapter. The complexities include the need for reliable data on historical and projected emissions, the choice between absolute and relative caps, and the ultimate adoption of quantitative emissions limits that provide for actual scarcity of allowances to drive the necessary behaviour by the regulated community. Such complexities support design options that allow some sort of periodical review of ETS features and adjustments to align it with the developments of climate change science and the international regime.
The EU ETS cap-setting developments offer a good example of how the wrong choice on the level of the initial stringency of the scheme can contribute to undesired effects, such as the over-allocation of allowances detected in the EU ETS trial phase.63 However, a clear set of principles and requirements allowing a periodical review of the EU ETS, including the emissions cap, and the political will to do so, enabled proper corrections be made for the following phases.64 A clear path for the periodical cap reduction was also provided by the EU ETS amendments,65 reinforcing the environmental integrity component of the EU ETS design also reflected in the EU ETS stated objectives, as discussed in the previous sections.
In Australia, the repeal of the CPM in 2014 put an end to the possibility of assessing the level of environmental integrity of the scheme’s cap-setting rules. In any event, the design of the Australian cap-setting requirements offers a good example of how the time-duration of the cap can be regulated at the legislative and regulatory level to allow the affected entities to plan their investments and compliance strategy. The clear definition of the cap duration as reflected in the Australian scheme suggests an optimal approach for this important feature of the ETS if aligned with a consistent timetable for the overall scheme review. Thus, such programmed review should not be
emission units’, Press Release of 6 December, 2013,
63 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, (Cambridge, 2010), above n 4, 36.
64 Ibid 83-4.
65 Ibid 80.
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restricted to the cap, but should be extended to other corresponding features, such as allocation of allowances and coverage of the scheme, giving enough flexibility for the government to incorporate, whenever necessary, significant developments in the climate change science and international regime, without disrupting the ETS’s implementation process.
A much less desirable approach to cap setting was taken by the New Zealand Government. The NZ ETS design for the period ending in 2012 was a clear deviation from the theoretical framework for cap-and-trade ETS, since no cap existed for emissions within New Zealand. The environmental integrity of the NZ ETS was, thus, highly compromised by this approach and raising sharp criticism with respect to the alleged misleading role of government in branding its system an ETS.66 The approach taken by New Zealand is also a clear deviation from UNFCCC and Kyoto Protocol principles, which determined that the use of flexible mechanisms by Annex I countries for the first commitment period should be supplemental to domestic emission reductions. For both of these reasons, the approach taken by New Zealand in avoiding a national cap should not be used as a viable example for emerging ETS in other regions and countries, such as Brazil, as discussed in the last two chapters of this thesis.
However, it should be noted that the NZ option of no domestic cap appears to have had the political support of many New Zealand stakeholders from the outset, despite some criticism on the overreliance on offsets. In particular, there appears to be a total absence of any major legal challenges or other more aggressive approaches from NZ NGOs claiming the inadequacy or inappropriateness of this approach. With the exception of threatened litigation against the NZ Government by the Iwi Leadership Group ‘over the loss in value of carbon forestry’ there does not appear to have been any litigation in New Zealand or any other kind of more aggressive approach by NZ NGOs or other stakeholders the looseness of the NZ ETS approach. This view has been confirmed by both the literature review and the research before the New Zealand Higher Courts data basis conducted by this thesis. Thus, emissions trading-related cases retrieved before the Higher Courts of New Zealand (which amounted around 22 cases under the search words ‘emissions trading’, ‘NZ ETS’ and ‘Climate Change Response Act’) present only marginal discussions on the NZ ETS, not involving discussions on the NZ ETS objectives, design, implementation, or effectiveness. In fact, the most cited cases deal with the extension of the discretionary power of regional and local regulators
66 Bertram and Terry, The Carbon Challenge: New Zealand’s Emissions Trading Scheme, above n 59.
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in New Zealand to restrict development projects (such as coal mining, energy and construction) on the grounds of greenhouse gas emissions under the ‘New Zealand Resource Management Act– 1991’, followed by few cases dealing with commercial disputes between private parties over New Zealand Units (NZU) emission reduction purchase agreements under the NZ ETS. In all these decisions the New Zealand courts hold the NZ ETS as the central Climate Change Policy of New Zealand, and the disputes involved do not challenge any of the NZ ETS objectives or design elements. In any event, those cases are good examples on how the New Zealand courts are well prepared to discuss some of the technicalities of the NZ ETS on a straightforward manner: in NZ Carbon Farming Ltd v Mighty River, the court presented a very good summary on the technical aspects of the calculation of NZ Units under forest projects. In Z Energy Limited v Mighty River Power Ltd., the parties’ dispute involved alleged windfall profits by Z Energy in relation to how it calculated costs of meeting its ETS surrender liability (for fuel production), which it was entitled to pass through to Oceana Gold under a fuel supply agreement. Again, the court presented a very good grasp of the legal requirements at stake, including technical aspects in relation to the calculation of emission surrender liabilities.67 In any event, given the New Zealand Government’s decision not to support a second commitment period for the Kyoto Protocol, major changes are expected to be made to the NZ ETS (assuming it remains in place), among which, perhaps, setting a national emissions cap.68
67 For the literature sources, see Jessica Luth Richter and Lizzie Chambers ‘Reflections and Outlook for the New Zealand ETS: must uncertain times mean uncertain measures?’ (2014) 10 (2) Policy Quarterly 57, 62; See also Tony E. Moyes, ‘Greenhouse Gas Emissions Trading in New Zealand: Trailblazing Comprehensive Cap and Trade’, (2008) 35 Ecology Law Quarterly 911,923. For the case law regarding the possibility of restrictions to development projects based on greenhouse gas emissions, see Genesis Power Ltd v Greenpeace New Zealand Inc. [2008] NZSC 112, [2009] 1 NZLR 730 and West Coast Ent Incorporated v Buller Coal Limited [2013] NZSC 87 [19 September 2013]. For case law regarding interpretation of emission reductions purchase agreements, see NZ Carbon Farming Ltd v Mighty River Power Ltd [2015] NZHC 1274 [High Court judgment] and Z Energy Limited v Oceana Gold (New Zealand) Limited HC WN CIV- 2012-485-1810 [19 December 2012].
68 Richter and Chambers, ‘Reflections and Outlook for the New Zealand ETS’, above n 67.
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4.4.2 Scope, Coverage, and Opt-in and Opt-out Provisions
4.4.2.1 EU ETS Sectors, Gases and Point of Obligation
The EU ETS is the first and largest GHG cap-and-trade scheme in the world, responsible for the ‘largest emission market yet created’.69 The EU ETS covers more than 11 000 facilities from different sectors (mostly in high emitting power and heating generation, and some energy-intensive industrial sectors). It represents approximately 50 per cent of the EU’s total CO2 emissions, and nearly 40 per cent of its overall greenhouse gas emissions.70 Since its outset, the EU ETS has established the point of obligation at the ‘point of emissions’ (downstream). The EU ETS coverage was initially restricted to CO2 emissions from selected energy generation and energy-intensive sectors. 71 This initial limited coverage of emission sectors was not made without controversy. A major steel-manufacturing group judicially challenged the Directive’s scope of application as discriminatory for not including sectors in direct competition with steel manufacturers such as the aluminium and plastic industries.72 As a result of this litigation, the European Court of Justice ruled that ‘possible competition between those sectors cannot constitute a decisive criterion’ and that the differentiation taken by the Directive was justified on the grounds of the greater volume of emissions credited to
69 Denny Ellerman, ‘The EU Emission trading scheme: a prototype global system?’ in Joseph E. Aldyn and Robert N. Stavins (editors) Post-Kyoto International Climate Policy: Implementing Architectures for Agreement (Research from the Harvard Project on International Climate Agreements (Cambridge University Press, 2010) 88.
70 European Commission, ‘EU Action Against Climate Change: The EU Emissions Trading Scheme’ last update on April 4, 2014
71 The CO2 emitter sectors covered by Phase I were the following: combustion installations with a rated thermal input exceeding 20 MW (except hazardous or municipal waste installations), mineral oil refineries, coke ovens, the production and processing of ferrous metals, the production of cement (exceeding 500 tonnes per day), lime (exceeding 50 tonnes per day), the manufacturing of glass (exceeding 20 tonnes per day), ceramic products (exceeding 75 tonnes per day), pulp from timber or fibrous materials, and paper and board (exceeding 20 tonnes per day). EU ETS 2003 Directive, Annex I.
72 Société Arcelor Atlantique et Lorraine and Others vs. Premier Ministre, Ministre de l’Ecologie et du Dèveloppment Durable and Ministre de l’Economie, des Finances et de l’Industrie (C127-07) [2008] ECR I-9895 cited by Ghaleigh ‘Emissions Trading before the European Court of Justice: Market Making in Luxembourg’ above n 38, 375.
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the steel sector and administrative difficulties to regulate the more diffuse sources from the chemical and aluminium sectors.73
Further to this initially restricted coverage, the EU ETS has increasingly added emissions from other greenhouse gases (nitrous oxide and perfluorocarbons as of 2009) and a wider range of industrial installations. Those added manufacturing or production activities included primary aluminium, secondary aluminium (with combustion units with total rated thermal input exceeding 20 MW), non ferrous metals (with combustion units with total rated thermal input exceeding 20 MW), mineral wool insulation material using glass, rock or slag (with melting capacity exceeding 20 MW), carbon black (with combustion units with total rated thermal input exceeding 20 MW), chemicals and petrochemicals (nitric acid, adipic acid, glyoxal and glyoxylic acid, ammonia, bulk organic materials with capacity exceeding 25 tonnes per day, hydrogen and synthesis gas with a production capacity exceeding 25 tonnes per day, soda ash and sodium bicarbonate, and activities related to capture, transport by pipelines and geological storage of greenhouse gases from installations covered by the scheme.74 In any event, the most significant change on the sectoral coverage of the EU ETS after the scheme outset was the full incorporation of aviation activities from 2013 onwards.75 According to some sources, the inclusion of aviation under the EU ETS was partly a strategy by the EU Commission to trigger a more proactive approach for the reduction of aircraft emissions by the International Civil Organization (ICAO) in addition to pressure for the inclusion of the aviation sector under the coverage of the international climate change regime.76 It was also seen as a way of imposing a border-tax approach to traded goods, which triggered strong reactions from non-EU airlines. Not surprisingly, some US airlines challenged the Aviation Trading Scheme (‘ATS’) before the European Court of Justice in 2011, however the court ruled out the case confirming that the ATS was in
73 Ghaleigh ‘Emissions Trading before the European Court of Justice: Market Making in Luxembourg’ above n 48, 371 and 376-7.
74 EU ETS 2009 Directive, Annex I amending EU ETS 2003 Directive Annex I. See also Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, above n 24, 261-2.
75 EU ETS 2008 Aviation Directive, Article 1, Paragraph 4, amendments to EU ETS 2003 Directive, Article 3c, paragraphs 1 and 2 and Annex, Paragraph 1, amendment to the EU ETS 2003 Directive Annex 1. See also Sebastian Okinczyc, ‘European Union Emissions Trading Scheme: Phase III’ in (August 2011) 164 European Energy and Environmental Law Review 170.
76 Okinczyc, ‘European Union Emissions Trading Scheme: Phase III’, above n 75, 267.
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accordance with international law.77Nevertheless, regardless of the position of the European Court of Justice, the European Commission has continuously reduced the scope of the Aviation Trading Scheme, apparently as a result of political pressure and threats of litigation such as those brought by non-EU countries operating airline routes in the EU.78 The EU justified the suspension of the full application of the Aviation Trading Scheme as a way of providing the International Civil Aviation Organization (ICAO) Assembly with enough time to develop a global approach to reduce aviation emissions.79 In March 2014, the ATS requirements were further amended to limit the aviation coverage of the EU ETS to emissions from flights within the European Economic Area (EEA) for the period of 2013-2016. This amendment has triggered several criticisms from European environmental groups, which deemed it as a loss of sovereignty by the EU to political pressure from other countries, mainly the US, China and Russia.80
The EU ETS covers all EU countries in addition to three countries from the European Economic Area – Norway, Iceland, and Liechtenstein.81 The potential for
77 Air Transport Association of America, American Airlines, Inc, Continental Airlines, Inc, United Airlines, Inc v Secretary of State for Energy and Climate Change (C- 366/10)[2011] OJ C260/9. As summarized by the European Commission, the Court stated that:
the extension of the EU ETS to aviation infringes neither the principle of territoriality, nor the sovereignty of third countries; the EU ETS does not constitute a tax, fee or charge on fuel, which could be in breach of the EU-US Air Transport Agreement; the uniform application of the EU ETS to European and non-European airlines alike is consistent with provisions in the EU-US Air Transport Agreement prohibiting discriminatory treatment between aircraft operators on nationality grounds.
European Commission, Climate Action, ‘Reducing Emissions from Aviation’, online
78 Okinczyc, ‘European Union Emissions Trading Scheme: Phase III’, above n 75.
79 European Commission, Reducing Emissions from Aviation,
80 Ibid. See also Transport and Environment, ‘EU governments dismantle emissions trading for international aviation’, March 2014,
81 Ellerman, ‘The EU Emission trading scheme: a prototype global system?’ above n 69, 90.
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further enlargement of the geographical scope was left open by the design options in terms of linking with other schemes or offsets with baseline-and-emission projects.82
4.4.2.2 EU ETS Opt-in and Opt-out Provisions
The EU ETS has also presented a set of different approaches to opt-in and opt-out provisions during its implementation history, which provide a range of examples to be considered in addressing the case of Brazil. It includes authorization for affected installations from same sector activity to form a pool of installations in order to jointly comply with their scheme’s obligations.83 It excludes small installations and hospitals from the scheme, according to certain eligibility criteria.84
4.4.2.3 CPM Sectors, Gases and Point of Obligation
Different from the EU ETS, the CPM does not present a straightforward and positive list of covered sectors. In fact, the legislative technique85 adopted by the Australian Parliament in this case is rather complex in comparison with other environmental or climate change legislation such as the EU ETS herein discussed.
82 European Commission, Climate: The EU Emissions Trading Scheme (EU ETS) (Office for Official Publications of The European Communities, 2009) 6
83 In this case, the pool of installations should nominate a trustee that would be granted the total amount of allowances for the pool, and would carry out the obligations to surrender them according to the EU ETS requirements. The trustee would be subject to the penalties applied against violation of surrendering obligations, notwithstanding the installations subsidiary liability for surrendering allowances and paying the respective penalties in respect to their individual emissions in case the trustee fails to do so. EU ETS 2003 Directive, Article 28, Paragraphs 4 and 6. Under Phase III, pooling of activities to surrender allowances was abolished. EU ETS 2009 Directive, Article 1, Paragraph 28, amendments to EU ETS 2003 Directive Article 28.
84 In case such installation is excluded, it will no longer be entitled to free allocation of allowances upon its return, and allowances issued to such installation shall be deducted from the quantity to be auctioned by the member state. EU ETS 2009 Directive, Article 1, Paragraph 28, amendments to EU ETS 2003Directive Article 27.
85 Meaning the technique of drafting clear and well-designed laws and regulations. For a classic discussion on this topic, see Ross F. Cranston, ‘Reform Through Legislation: The Dimension of Legislative Technique’ in (1979) 73 (Northwestern University Law Review 873. See also Helen Xanthaki, ‘Dunca Berry: a visionary of training in legislative drafting’ Special Issue 1 (2011) The Loophole – Journal of the Commonwealth Association of Legislative Counsel 18.
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Under the CPM, liable entities86 and covered emissions87 are determined by the combination of a ‘threshold test’88 on the volume (the general rule being carbon dioxide equivalence of not less than 25 000 tonnes per financial year or 10 000 tonnes per financial year in case of certain landfill facilities) of directly released emissions (also referred to as ‘scope 1 emissions’) of a given facility, and the confirmation that such facility activity or sector and type of greenhouse gases are not explicit exempted by the legislation.89
The CPM covered emissions of four of the six greenhouse gases under the Kyoto Protocol: carbon dioxide, methane, nitrous oxide, and perfluorocarbons from aluminium smelting.90 The synthetic greenhouse gases (other than perfluorocarbons from aluminium smelting) were excluded from the CPM coverage and subject to an equivalent carbon price using import and manufacturing levies under the Ozone Protection and Synthetic Greenhouse Gas Management legislation.91
Under the CPM, the very definition of ‘facility’92 and the precise point of obligation in regard to ‘scope 1 direct emissions’93 (including if the liable entity is the
86 The whole of Part 3 of the Clean Energy Act 2011 is devoted to liable entities. Although the Act does not provide for a direct definition of liable entity, it provides for specific criteria for the identification of liable person or entities that operate individually or through joint ventures or that meets one of the opt-in criteria. Clean Energy Act 2011(Cth) ss 20-25, 33, 35, 36B-D and 92A. In this context, ‘person’ means any of the following: an individual, a body corporate, a trust, a corporation sole, a body politic (that is, the Australian, state and territory governments) and a local governing body. Clean Energy Act 2011(Cth) s 5 (definition of ‘person’); Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 75. See also discussion below on ‘Liable Entities and Re- Allocation of Liability Arrangements.’
87 Clean Energy Act 2011 (Cth) s 30 (1).
88 The Clean Energy Act 2011 (Cth) ‘threshold provisions’ include the following subsections: 20(4)-(5), 21(4)-(5), 22(4)-(5), 23(4)-(5), 24(4)-(5) and 25(4)-(5).
89 Clean Energy Act 2011 (Cth) Part 3, Division 2, Subdivision A – General Rules, s 20 and Subdivision E – Covered emissions from the operation of a facility, s 30; National Greenhouse and Energy Reporting Act 2007 ss 9-10 (providing the and National Greenhouse and Energy Reporting Regulations 2008 (Cth) (Select Legislate Instrument 2008 No. 127 as amended made under the National Greenhouse and Energy Reporting Act 2007) reg 2.23.
90 Clean Energy Act 2011(Cth) s 30 (11) (12).
91 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, 105-6.
92 National Greenhouse and Energy Reporting Act 2007 s 9(1). 155
facility owner, operator or financial controller) are given by direct reference to the National Greenhouse and Energy Reporting Act 2007 (NGER Act) requirements (as amended by the Clean Energy Legislative Package) and respective regulation. Provided that the emissions thresholds were met, the CPM would apply to the following sectors: stationary energy, industrial processes, fugitive emissions (other than from decommissioned coal mines), and emissions from ‘non-legacy’ waste, that is, emissions from landfills which are not treated as ‘legacy emissions’.94 According to the Government, this would result in direct coverage of around 500 liable entities under the CPM representing 60 per cent of Australia’s greenhouse gas emissions.95
The CPM also provides for specific rules regarding natural gas, synthetic gases and emissions from the transport sector, largely based on tax, tariffs and levies. In summary, the Government approach to the transportation sector was the following: a carbon price woulf be applied to domestic aviation, domestic shipping, rail transport, off-road transport use of liquid and gaseous fuels, and non-transport use of liquid and gaseous fuels. A carbon price would not apply to fuel used by households for transport, light on-road commercial vehicles, off-road fuel use by the agriculture, forestry and fishing industries, gaseous fuels used for on-road transport, ethanol, biodiesel and renewable diesel, and transport fuels, when used as lubricants and solvents.96 The CPM also applies to importer and manufacturers of liquefied petroleum gas (LPG) or liquefied natural gas (LNG) for non-transport use.97 In the case of natural gas emissions, there are also specific provisions that determine the point of obligation either to the
93 The National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER) s 10 and National Greenhouse and Energy Reporting Regulations 2008 (Cth) (Select Legislate Instrument 2008 No. 127 as amended made under the National Greenhouse and Energy Reporting Act 2007) regs 2.23-2.24.
94 Clean Energy Act 2011 (Cth) s 30 (1) (c).‘Legacy emissions’ from the operation of a landfill are defined as those wastes accepted by the landfill facility before 1 July 2012. Such emissions are excluded from the CPM coverage and included as emissions covered by the Carbon Farming Initiative for purposes of generating ACCUs that can be offset by Liable Entities under the CPM. Clean Energy Act 2011(Cth) ss 5 and 32.
95 Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 45.
96 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’), above n 47, 29 and 105-6.
97 The liability scheme for natural gas suppliers and producers or importers of liquefied petroleum gas (LPG) or liquefied natural gas (LNA) is covered by the Clean Energy Act 2011 (Cth) Part 3, Divisions 3-4.
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large users of natural gas or alternatively to the natural gas suppliers of medium or small natural gas end-users, as opposed to the natural gas direct emitters.98
4.4.2.4 CPM Opt-in Requirements
Under the CPM ‘Opt-in Scheme’99 certain purchasers, manufacturers or importers of taxable fuels (such as aircraft and maritime companies) can voluntarily adhere to the CPM in exchange of being released to pay the corresponding carbon price arising from fuel taxes. According to the Australian Government, during the public exposure for the Clean Energy Legislative Package some industry stakeholders who would be exposed to the equivalent carbon price through the fuel excise and fuel tax credit systems have expressed a desire to alternatively ‘manage their carbon liability for fuels under the carbon pricing mechanism. This was particularly a concern from the aviation industry, which in some cases preferred the option of managing its liability in Australia and elsewhere (such as under the EU ETS) under a single approach (such as ETS) other than working with different pricing mechanisms in every national jurisdiction. 100
4.4.2.5 CPM Exempted Sectors and Activities
The CPM expressly exempts some scope 1 emissions from its coverage, either as a result of the application of other forms of pricing (such as with respect to fuels subject to excise or customs), or as a result of other competing policy approaches (such as the preference for economic incentives to the agriculture sector under the CFI).101
98 Ibid.
99 The ‘Opt-in Scheme’ is covered by the Clean Energy Act 2011(Cth) Part 3, Division 7.
100 Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 100-1.
101 Clean Energy Act 2011(Cth) s 30 (2)-(12). The exempted direct emissions include the following: Fuels subject to excise or customs (including petroleum fuel, liquefied petroleum gas – LPG, liquefied natural gas – LNG or compressed natural gas – CNG); Combustion of biomass, biofuels and biogas; Fugitive emissions from decommissioned underground mines; Legacy emissions from landfill facilities; Closed landfill facilities; Synthetic greenhouse gases, except for emissions of perfluorocarbons from aluminium production; Scope 2 and 3 emissions (such as those concerning electricity use and those generated in the wider economy and not falling in the previous categories); and Agriculture and other emissions from land.
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Out of the exempted sectors, the approach undertaken by Australia in regard to the agriculture and land-use sectors deserves special attention in this thesis. Insights from the Australian experience can contribute significantly to the alternatives Brazil must consider in addressing its own land-use based emissions under an ETS or by means of any other policy approach. Besides the recognition of the large contribution of the land use sector to the Australian emissions profile (around 18 per cent of the country GHG emissions), the CPM followed previous analysis such as the Garnaut Review that recommended the land sector be excluded from the coverage of an Australian emissions trading scheme, at least in its initial phase.102 In turn, the Garnaut Review has recommended the inclusion of the land use sector through the use of incentives to reduce emissions through offsets,103 which was ultimately adopted by the Clean Energy Package through the linkage of the CPM with the CFI. 104 As discussed later in this chapter, the exclusion of the agriculture and other land use sectors from the CPM also reflects the successful political pressure made by the land use sector against being included in any form of carbon pricing initiatives. As a result of the combination of those economic and political factors, the CPM expressly exempted a set of direct agricultural or other land-use emissions from coverage: methane from the digestive tracts of livestock or from rice fields or rice plants; methane or nitrous oxide from the decomposition of livestock urine, livestock dung, the burning of savannahs or grasslands, the burning of crop stubble in fields, crop residues in fields or sugarcane before harvest; carbon dioxide or methane or nitrous oxide from soil; and emissions attributable to changes in the levels of carbon sequestered in living biomass, dead organic matter or soil or attributable to land use, changes in land use (including land clearing) or forestry activities. The CPM also excluded off-road fuel use for transportation for the agriculture sector.105
102 Ross Garnaut, The Garnaut Review 2011: Australia in the Global Response to Climate Change (Cambridge, 2011), 138.
103 Ibid 138-9.
104 The CFI will be discussed in more detail in the section covering linking with the Kyoto Protocol and other schemes.
105 The Carbon Market Institute, Australia’s Clean Energy Legislative Package: A Guide for Business (The Carbon Market Institute – CMI, 2011), 31.
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4.4.2.6 CPM Re-allocation of Liability Arrangements
The CPM provides for a detailed and well-structured process of transfer of liability among certain affected entities. This is a good example of how to incorporate into an ETS legal requirements derived from corporate law and commercial practices that enhance the flexibility of the scheme. Such arrangements, in turn, are good examples of how emerging schemes, such as the hypothetical ones covered by the last chapter of this thesis in relation to Brazil, can make a good use of the commercial practices in place in its own jurisdiction to facilitate compliance with the low emissions provisions it deems to advance.
Under the CPM, transfer of liability rules apply to facilities belonging to the same corporate structure, or as a result of contractual or joint-venture arrangements or between natural gas suppliers and large consumers.106 Transferring CPM liability to joint ventures can apply either compulsorily (mandatory designated joint venture) or voluntarily (declared designated joint venture).107 In the cases of a facility or a landfill, the liability under the CPM may be transferred from a facility or landfill operator to another member of the same corporate group or to a person who has financial control of the facility or landfill-facility (in such cases the liable entity will hold a liability transfer certificate in relation to the facility or landfill-facility).108 The facility or landfill liability
106 Clean Energy Act 2011 (Cth) ss 22 (Liable entity – holder of a liability transfer certificate), 25 (Liable entity for landfill emissions – holder of liability transfer certificate) and Division 6 – Liability transfer certificates, Subdivision A – Transfer of liability to another member of a corporate group and Subdivision B – Transfer of liability to a person who has financial control of a facility and Subdivision C – Other provisions (the latter includes requirements on the duration, surrender and cancellation of the liability transfer certificate). Such provisions of the Clean Energy Act 2011(Cth) are complemented by provisions from NGERs regarding such as ‘Reporting Obligations of holders of liability transfer certificates’ and ‘Reporting obligations of holders of reporting transfer certificates.’ See The National Greenhouse and Energy Reporting Act 2007 (Cth), Parts 3D and 3E.
107 Clean Energy Act 2011(Cth) ss 21 (Liable entity – participant in designated joint venture) and 24 (Liable entity for landfill emissions – participant in designated joint venture) and Division 5 – Designated joint ventures, Subdivision A – Mandatory designated joint venture, Subdivision B Declared designated joint venture and Subdivision C – Participating percentage determination.
108 Clean Energy Act 2011 (Cth) ss 22 (Liable entity – holder of a liability transfer certificate), 25 (Liable entity for landfill emissions – holder of liability transfer certificate) and Division 6 – Liability transfer certificates, Subdivision A – Transfer of liability to another member of a corporate group and Subdivision B – Transfer of liability to a person who has financial control of a facility and Subdivision C – Other provisions (the latter includes requirements on the duration, surrender and cancellation of the liability transfer certificate). Such provisions of the Clean Energy Act 2011 (Cth) are 159
under the CPM can also be shared amongst participants of a Joint Venture, either compulsorily (mandatory designated joint venture) or voluntarily (declared designated joint venture).109 The CPM also provides for specific provisions on liability transfer arrangements between a natural gas supplier or a LPG or LNA importer or producer and their respective end users. Such obligation transfer mechanism (referred to by the CPM as obligation transfer number - OTN) is compulsory to large users of natural gas, who will be responsible for their direct natural gas emissions. An OTN can also be voluntarily taken by other natural gas end users under certain circumstances whereby such end users will assume the liability for their share of natural gas/LPG/LNA usage.110
4.4.2.7 NZ ETS Sectors, Gases and Point of Obligation
The NZ ETS was originally designed with the ambitious goal of covering all relevant sectors of the New Zealand economy (including agriculture and forestry) and all six (6) gases covered by the Kyoto Protocol. Aligned with the principle of ‘staged implementation’, the 2008 ETS provided for different entry dates for the covered sectors, including forestry, stationary energy (including importing and mining coal and natural gas, and fuel combustion), liquid fossil fuels, industrial processes and agriculture.111
The forestry sector (including emissions from deforestation – defined under the Kyoto Protocol as conversions of forested land to other uses – and eligible removals
complemented by provisions from NGERs regarding such as ‘Reporting Obligations of holders of liability transfer certificates’ and ‘Reporting obligations off holders of reporting transfer certificates.’ See The National Greenhouse and Energy Reporting Act 2007 (Cth), Parts 3D and 3E.
109 Clean Energy Act 2011 (Cth) ss 21 (Liable entity – participant in designated joint venture) and 24 (Liable entity for landfill emissions – participant in designated joint venture) and Division 5 – Designated joint ventures, Subdivision A – Mandatory designated joint venture, Subdivision B Declared designated joint venture and Subdivision C – Participating percentage determination.
110 Clean Energy Act 2011 (Cth) ss 20(8)-(13), 21(7)-(8D), 22(6)-(11), 23(8)-(9D), 24(7)- (8D), 25(6)-(7D), 33(1)(e), and Divisions 3 and 4.
111 Moyes, ‘Greenhouse Gas Emissions Trading in New Zealand: Trailblazing Comprehensive Cap and Trade’, above n 67, 962-3; Climate Change Response Act 2002 (2002 No. 40) s. 54, 179-216 and Schedule 3.
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from afforestation) was elected as the first sector to enter the NZ ETS, with obligations starting in January 2008. One of the reasons to anticipate the entry date of the forestry sector was to neutralize a ‘perverse effect’ of the ETS by which landowners expecting the introduction of a carbon pricing scheme intensified harvesting of forestland in the years preceding the introduction of the ETS in Parliament. 112 Similarly to the Australian treatment of the agriculture sector, the NZ ETS coverage of the land-used related sectors deserves special attention when assessing the possible options for Brazil in land-use emissions, particularly in relation to emissions from the agriculture sector. As it will be discussed in the next chapter, the Brazilian emissions profile shows that the largest part of the country’s GHGs emissions results from deforestation of native forests driven by agriculture activities As a result, the arrangements under the NZ ETS for the forestry sector (usually applied to the rotation of planted forests), although extremely important for the consideration of calculations of net changes in carbon stocks of forests, are not as directly applied to the Brazilian context as those related to measures inducing restrictions to the expansion of the agriculture frontier as it will be discussed in chapter V.
Aligned with the New Zealand commitments under the Kyoto Protocol and the respective methods for accounting of forest credits (both for the 1990 emission-levels and the assigned amount units resulting there from), the NZ ETS treats pre-1990 and post-1989 forests differently. Owners of pre-1990 forests face obligations under the ETS if they deforest – remove trees and introduce a new land-use. They do not face obligations if they harvest and replant the forest, although no indication was initially given regarding the timeframe to be considered between harvesting and replanting activities in such circumstances.113 A de minimums threshold for owners of pre-1990 forest holdings of less than 50 hectares was applied, in addition to granting of a 2- hectare deforestation allowance for each commitment period.114
112 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’ above n 29, 32; Peter Sopher and Anthony Mansell, New Zealand: The World’s Carbon Markets: A Case Study Guide to Emissions Trading (Environmental Defense Fund and International Emissions Trading Association, September 2013) 2-3.
113 New Zealand Government, The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 75; Climate Change Response Act 2002 (2002 No. 40) s. 180.
114 New Zealand Government, The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 75; Climate Change Response Act 2002 (2002 No. 40) s. 183.
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4.4.2.8 NZ ETS Post-1989 Forest Opt-in
Post-1989 forest owners were not initially included under the NZ ETS coverage. However, they were allowed to voluntarily opt-in into the scheme and take responsibility for the ongoing net changes in the carbon stocks of their forests.115 The fishing sector was also granted the right to opt-in the NZ ETS as an alternative to allow certain owners of fishing quotas to mitigate potential increase in fuel prices due to the NZ ETS.116
Under the 2008 ETS, the liquid fossil fuels sector (primarily transport) was the next sector to enter the NZ ETS in January 2009, followed by stationary energy (including coal, natural gas and geothermal) and industrial processes (non-energy emissions) in 2010. Agriculture and waste were originally planned to enter into the scheme in 2013.117 The Government’s argument for the delay of entry of the agriculture sector as opposed to forest and stationary energy was based on technical difficulties associated with measuring emissions, although at the same time, it recognized that ‘there was a case for including agriculture into the ETS prior to 2013 and options were technically available.’118 The entry date of the agriculture sector was further postponed by the 2009 and 2012 amendments, which conditioned the entry date of the agriculture sector to the availability of reliable technologies to reduce agriculture emissions and to further progress on the part of New Zealand’s ‘trading partners’ in reducing their emissions in general.119 As informed by the NZ Government, these emissions come from methane and nitrous oxide. Methane emissions come from ruminant animals and animal waste, while nitrous oxide emissions come from urine, dung and nitrogen
115 New Zealand Government, The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 75; Climate Change Response Act 2002 (2002 No. 40) s. 187.
116 The opt-in alternative applied to fishing quota owners whose quotas were registered at the fishing quotas register system before September 2009.
117 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 32.
118 Ibid.
119 New Zealand Government, ‘Climate Change Information: Agriculture in the Emissions Trading Scheme’,
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fertilizer. As a result, as of January 2012, the only obligation of the agriculture sector under the NZ ETS is limited to reporting on its ‘biological emissions.’120
4.4.2.9 NZ ETS Point of Obligation
The NZ ETS also provided for different ‘points of obligation’ for different sectors. The argument was that the price signal from the ETS would flow across the supply chain and the point of obligation should not necessarily be placed on the entity that emits greenhouse gases.121 One of the key discussions under the NZ ETS involved where to place the agriculture sector’s point of obligation: on the processing activities of dairy and meat products, or at the farming activity level.122 This issue continued to be debated throughout the subsequent amendments, but its immediate interest was lost due to the continuous postponement of the date of entry of the agriculture sector.
4.4.2.10 Discussion
Although the economic theory behind the ETS suggests coverage should be as broad as possible in relation to GHG gases and emission sources, the EU, Australian, and New Zealand cases show how it can be limited by political pressure from affected economic sectors or by technical limitations. The latter is usually related to monitoring and verification of emissions. Some limitations may also be driven by the administrative burden that coverage of a large number of small sources may entail. Such experience suggest that an ETS coverage choice must be carefully constructed to find the right balance between an over-cautious approach to avoid a traumatic transition to emissions pricing and the opposite, a lenient approach to those major emitters who fight to avoid internalizing of their emissions costs.
Within these boundaries of scope choices, the EU ETS has evolved from an initial limited scope of gas coverage and sectors to an ambitious scheme, which in addition to reaching the most significant sectors in Europe, has innovated in bringing in the aviation sector from 2012 onwards. After a decade of implementation, and despite the intricacies of the European Union political and legislative process and some caveats in
120 Ibid.
121 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 33-4.
122 Ibid 96-8.
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its initial phase, the EU ETS has reached a remarkable record of sectoral and geographical coverage that has set the stage for other emerging ETS at the regional and national levels. However, as we can see from the examples of Australia and New Zealand, the political pressure from affected sectors within national economies seems to work more efficiently in the attempts to avoid ETS coverage. That is clearly the case of the agriculture sector in Australia, which, despite reasonable arguments in favour of some technical limitations to measure and monitor some of the agriculture-based emissions, has also played an important role in lobbying against it being included under the CPM. Even more powerful, according to the literature, is the fossil-fuel dependent industries’ lobbying in Australia, particularly the coal mining sector, coal-based electric utilities and emissions intensive industries, such as steel and aluminium. Despite not being able to avoid coverage under the ETS, these sectors have been among the strongest actors in influencing the carbon debate in Australia,123 and was successful in pressuring for a very generous assistance package under the CPM.124 Even if some level of assistance is justified for some sectors, there is clear evidence that there has been an exaggeration in terms of the possible negative consequences on certain economic sectors due to political pressure, thus jeopardizing both the environmental integrity and economic efficiency of the scheme.125
In New Zealand, the incorporation of land-use sectors under the ETS coverage has been an option since the NZ ETS outset, due to the emissions profile of the country. This approach has been praised by the literature as innovative and desirable, many commentators anxious to confirm that the alleged barriers of incorporation of land-use activities under an ETS has been broken by policy implementation. To some extent, the NZ Government has been successful in making the case for the incorporation of the forestry sector, for which a set of methodologies and criteria in alignment with the
123 This historical role of the so-called ‘carbon lobbyists’ is well analysed by Guy Pearse in ‘Quarry Vision: Coal, Climate Change and the End of the Resources Boom’ in (2009) 33 Quaterly Essay 1; see also Clive Hamilton, Running from the Storm: The Development of Climate Change in Australia (UNSW Press, 2001), particularly ch 6 (‘Corruption of the Policy Process).
124 See Tony Wood and Tristan Edis, ‘New Protectionism Under Carbon Pricing: case studies of LNG, coal mining and steel sectors’, (Grattan Institute, 2011).
125 Ben Saul et al, Climate Change & Australia: Warming to the Global Challenge (The Federation Press 2012), 114-15.
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Kyoto Protocol has been implemented. Further, forestry was the first sector to have surrender obligations under the NZ ETS, which signalled the confidence of the country in applying the ETS methodologies to forestry activities. Unfortunately, this has not been the case for the announced incorporation of agriculture under the NZ ETS. Although the NZ agribusiness sector has not been successful in avoiding the formal inclusion of the sector under the ETS, its entry into the scheme has been postponed through subsequent amendments. This has limited the NZ ETS experience with the agriculture sector to the development of some measurement and monitoring methodologies, and to some useful discussions on the optimal choices for the point of obligation within the different agribusiness supply-chains. This is too little for what should be an innovative approach to climate change policy, even if we consider the analysis of some authors that suggests that the largest abatement opportunities in NZ are in the agriculture sector, particularly in pastoral agriculture.126 The same authors suggest that this is a direct result of the NZ agriculture lobbying and the Government’s decision to protect its industry against potential international competition, even if this means transferring the respective costs to NZ households.127 In fact, according to such analysis, the overall NZ ETS design (particularly on free allocation to most sectors, as discussed in the next section, and postponement of agriculture entry into the scheme) resulted in a large subsidy (or ‘corporate welfare’) program with two obvious and major beneficiaries in the NZ economy: agriculture and large industry.128
From a legislative technique standpoint, the overall set of requirements of the EU ETS regarding coverage also has a positive aspect of being drafted in very clear
126 Bertram and Terry, The Carbon Challenge: New Zealand’s Emissions Trading Scheme above n 59, ch 8 (Agricultural Protection Money). According to these authors ‘[A] startling observation that emerges from any reasonable analysis of New Zealand’s abatement costs is that pastoral agriculture holds by far the biggest set of low-cost abatement opportunities.’ Ibid 136. The authors proceed citing a 2007 report by the Sustainability Council named A Convenient Untruth that put together peer-reviewed research in Australia that is worth citing:
Its conclusion defied the conventional wisdom: there were a number of options to abate agricultural emissions that were not only commercially available but profitable to undertake.
Ibid, 137, citing Sustainability Council, A Conventional Untruth, (Sustainability Council, 2007)
127 Bertram and Terry, The Carbon Challenge: New Zealand’s Emissions Trading Scheme above n 59, 137.
128 Ibid 109.
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language, thereby allowing a prompt identification of coverage sectors and gases for all its phases. This was not the choice of the Australian Government, which opted for a much more complex approach of defining covered sectors based on emissions volume and a series of criteria for identifying liable entities under each industrial sector. On the other hand, the Australian CPM provides for a very rich set of examples regarding the possibility of transfer or re-allocation of the emission reduction liabilities among businesses in the context of economic groups and joint ventures. The Australian approach on this matter was carefully drafted in coordination with the commercial and corporate law requirements already in place, showing a high-level commitment of the Government to optimizing the introduction of the scheme. The provisions on this matter presented by the CPM provides for a reasonable list of examples that may be considered by emerging national ETS. This matter will be further explored in the application of the ETS theory and experience to the Brazilian context provided in the next chapters of this thesis.
With respect to opt-in and opt-out requirements, the EU ETS sets a good list of examples of opt-in and opt-out alternatives focusing on the economic scale of the covered entities. The NZ ETS also provides for interesting arrangements allowing the voluntary adherence to the ETS by sectors that may have been affected by indirect increases in their cost due to the carbon price, such as the fishing sector; or sectors that may choose to seize the ETS as an opportunity to increase their revenues through trading of allowances, such as the post-1989 owners. One similar approach has been undertaken by the Australian ETS with respect to the opt-in alternative extended to sectors that can choose between the ETS or other pricing mechanism such as tax levies. This alternative was allegedly well received by sectors, such as the Australian aviation companies, which preferred to handle a single form of carbon-emissions management worldwide, taking into consideration the trend of including aviation under ETS coverage initiated by the EU ETS. This feature of the Australian ETS and the alleged support of the aviation industry in Australia seem inconsistent with the political pressure that the European Union has faced in relation to the inclusion of aviation under the EU ETS. The path of full inclusion of aviation under the EU ETS seems to be at a halt, but the trend of imposing some price mechanisms over aviation emissions seem to be unavoidable, due to the share of the sector in global emissions. In this regard, the very fact that the EU ETS brought the discussion to a higher level must be recognized as a very important political feature of the EU ETS in setting the agenda for some of the international discussions under the climate change regime. In particular, due to the United States not having played to date a more proactive role in the international greenhouse emissions mitigation efforts. This feature must also be considered by the climate change policy in Brazil in the medium term, since there is still no regulation on 166
aviation emissions, despite some recent enforcement actions in the state of São Paulo state.129
Finally, the political negotiation and the ultimate outcome of coverage requirements for ETS is highly affected by concerns with sectors that may be harmed in terms of competitiveness within the domestic or international markets due to a price on their emissions. However, as discussed in the following sections, the preferred government solution to this problem is usually playing with the allocation methods, rather than formally excluding emission intensive sectors from the scheme coverage.
4.4.3 Allowance Allocations and Compliance Period
The EU ETS established free allocation of allowances for 95per cent and 90per cent of the total amount allocated by each member state in Phase I (2005–2007) and Phase II (2008–2012) compliance periods, respectively.130 An important feature introduced by the EU ETS relates to provisions regarding allocation of allowances to ‘new entrants’131 and the conditions applied to allowances granted to installations that have been subsequently closed (respectively, ‘new entrant reserve/NER’ and ‘closure provisions’).132 The EU ETS 2003 Directive was initially silent about closure provisions, but its treatment was further regulated as a result of litigation between Germany and the Commission in the light of ex post133 provisions established in the German NAP. The Commission had taken the position that once the EC has reviewed a
129 The District Attorney of São Paulo State filed a collective lawsuit against air companies who operate in the International Airport of Guarulhos claiming for money damages due to the climate change impacts of the aircraft emissions. See ‘TJ acolhe recurso do MP e reconhece impacto ambiental produzido por aviões no Aeroporto de Cumbica’ (Portal de Noticias do Ministério Público do Estado de São Paulo, 25 August 2011)
130 EU ETS 2003 Directive, Article 10.
131 Installations from the covered sectors that starts their operations after commencement of the compliance period (and, by definition, after submission of the NAP by the member state to the Commission). EU ETS 2003 Directive, Article 3 (h).
132 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme above n 4, 67. A ‘new entrant reserve’ should be taken into account by member states by the time of defining allocation among facilities. EU ETS 2003 Directive, Article 11, Paragraph 3.
133 Meaning provisions allowing the member states to implement adjustments in the allocation of allowances after the NAP has been approved.
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country’s NAP, including the total number of allowances and the allocation to each covered entity, the allocations could not be revisited. Attempts to include provisions permitting such post-approval adjustments to a facility’s allocation have been uniformly rejected by the EC and were subject to judicial challenge by Germany before the European Court of First Instance134 (the NAP of Germany gave existing installations the option of choosing allocation based on historical emissions or plant-specific projected production with the Government’s option of taking back allowances if production was lower than planned). The Court ruled in favour of Germany and such provisions set out an interesting mechanism to consider new entries or exit of affected entities from the scheme.135
Under Phase III (2013– 2020), the EU ETS adopted auction-based allocation, with some rules for a transitional adjustment for most affected sectors (specially energy- intensive or traded exposed sectors).136 According to the EU Phase III Directive, the main reason for adopting auctioning as ‘the basic principle for allocation’ is because it is recognized as the ‘simplest’ and ‘most economically efficient system.’137 The adoption of auctioning was also justified as a way of helping eliminate ‘windfall profits’ from some installations, and of securing a more balanced competitive environment between new entrants and existing installations. As pointed out earlier in this thesis, ‘windfall profits’ is the term coined to explain the alleged high profit earned by some installations by simply gaining access to free allowances the amount of which was deemed as over-allocated at the end of the respective compliance period, allowing those installations to make large or ‘extra profits’ from selling the allowances without any counter-effort in actually reducing their emissions. Windfall profits were apparently earned mainly by the power sector in the EU ETS Phase I, due to the combination of free allowance allocation with the capacity of this sector to pass on the opportunity costs related to carbon pricing to its costumers.138 According to a formula for
134 Germany v. Commission (T-374/04) [2007] ECR II-4431.
135 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme above n 4, 46-7; see also Ghaleigh ‘Emissions Trading before the European Court of Justice: Market Making in Luxembourg’, above n 48, 380-81.
136 EU ETS 2009 Directive, Preamble, Paragraph 15.
137 Ibid.
138 Ibid. See also Karoline Rogge, Joachim Schleich and Regina Betz, ‘An Early Assessment of National Allocation Plans for Phase 2 of EU Emission Trading’ (Fraunhofer Institute Systems and Innovation Research and Centre for Energy and Environmental Markets at 168
‘transitional harmonized free allocation’139 the scheme shall present an annual decrease of free allocation towards achieving 30 per cent free allocation in 2020, and no free allocation in 2027.140
As pointed out above, the CPM does not provide for individual allocations of permits or carbon units at company or facility level. In fact, each company will be responsible for estimating its own emission numbers and surrender enough carbon units to cover actual emissions in relation to each compliance year. The compliance year matches the Australian financial year, from 1 July to 30 June and is usually referred by the CPM as the ‘eligible financial year’141 or simply ‘financial year.’ In both the fixed- and flexible-price periods, the general rule is that carbon emissions will be priced, despite some sectors being entitled to free allocation as part of the assistance programs aimed at certain energy-intensive and trade-exposed companies and large coal-fired electricity generators. In the fixed-price period, carbon units would be sold by government at a fixed price or allocated freely to eligible assisted entities. Liable entities would also be able to acquire and use ACCUs from the CMI to offset up to 5 per cent of their actual emissions. In the flexible period, the overall emissions of covered liable entities would be limited by the cap, which would be the sum of auctioned carbon units and units freely allocated to eligible assisted entities.
The NZ ETS staged implementation process (that is, gradual entry dates for most of the sectors) was complemented by a set of ‘relatively generous’142 allocation criteria for distribution of ETS emission units to market participants. At the scheme outset, free allocation was the major criteria used for most sectors, with the exception of electricity generators and liquid fossil fuel providers. Those two sectors were not granted free
the University of New South Wales, Working Paper Sustainability and Innovation No. S1/2006, Karlsruhe, Germany and Sydney, Australia, November 9, 2006) 26.
139 Meaning standard rules to be applied Community-wide based on benchmark criteria.
140 EU ETS 2009 Directive, Article 1, Paragraph 12, amendments to EU ETS 2003 Directive Article 10a, Paragraph 11.
141 Clean Energy Act 2011 (Cth) s 5 (definition of ‘eligible financial year’). This chapter will use the terms ‘financial year’ or ‘compliance year’ interchangeably.
142 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 66.
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allowances due to their ability to ‘pass on any extra cost imposed by the ETS to consumers down their supply chain.’143
The assistance to the forestry sector was established through quantitative allocation to the government of ‘total liability’ for deforestation emissions expressed in volume of emissions for different periods.144 Free allocation to the agriculture and industrial sectors was determined to be equal to 90 per cent of their respective 2005 emissions. Free allocation would not be granted to new emission sources (‘new entrants’). In turn, firms that would closure their operations (the text refers to ‘cease trading’) would not retain any free allocation.145. Although the Government opted for providing assistance through free allocation in the first place, it later introduced some forms of ‘progressive obligations’ under the subsequent amendments that are also a form of assistance to the covered sectors. Under those ‘progressive obligations’ introduced by the 2009 and 2012 amendments, the liquid fossil fuels, stationary energy, forestry and industrial processes sectors were only required to surrender one emissions unit for every two tones of CO2e emitted. In turn, the forestry sector would be entitled to gain one emission unit for every two tonnes for CO2e sequestered.146The phasing out of such benefits was scheduled for 2025.147 The progressive obligation would then face a steady increase over the compliance periods, in order to reach ‘full obligation’ in a given time.148
143 Ibid 61.
144 According to the principled decision: in the forestry sector, free allocation will be provided such that the Crown assumes a total liability (taking the cost of the provision of the de minimums thresholds into account) for deforestation emissions as follows: from 2008 to 2012, 21 Mt CO2-e for plantation forest, plus a relatively small allocation set aside for forest weed control (for example, wilding pines) from 2013, an additional 34 Mt CO2-e for plantation forest. Ibid.
145 Ibid.
146 Ibid 58-67; David Bullock, ‘Emissions trading in New Zealand: development, challenges and design’ (2012) 4 (21) Environmental Politics 657, 662-3.
147 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 68.
148 Ibid 67.
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4.4.3.1 The CPM Assistance Package
The design of the CPM includes an extensively and fiercely negotiated assistance package to assist certain carbon-intensive business sectors to transit towards a low- carbon regime whereby carbon emissions are priced.
The assistance package also includes public assistance to: small-business,149 economically less-favoured households (whose family budgets could be highly impacted by price increases in food and energy use due to the pass over of the carbon costs from suppliers to the end consumers),150 and indigenous Australians.151 There are also specific funds devoted to stimulating the development of clean energy technology and renewable energy.152
The CPM industry-specific assistance is largely covered by the ‘Job and Competiveness Program’, devoted to the major emissions-intensive-and-traded-exposed industries (EITE)153 and the ‘Coal-fired Generators Assistance Package’154 devoted to certain energy intensive coal-fired electricity generators, which could be initially highly impacted by the carbon price and risk the country’s energy security.155 In both cases, the major form of assistance is made through issuing free carbon units for the eligible entities.156 However, additional assistance packages in the form of grants have also been planned under the Jobs and Competitiveness Program for some sectors (for example the Steel Transformation Plan and the Food and Foundries Investment Program).157 In
149 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, 58.
150 Ibid 36-48.
151 Ibid 97. The assistance to indigenous Australians is given under the Carbon Farming Initiative discussed above.
152 Ibid 63-7.
153 Clean Energy Act 2011 (Cth) Part 7 – Jobs and Competitiveness Program.
154 Ibid Part 8 – Coal-fired electricity generation.
155 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, xv-xvi; The Carbon Market Institute, Australia’s Clean Energy Legislative Package: A Guide for Business, above n 105, 51-2
156 Clean Energy Act 2011 (Cth) ss 145 and 161.
157 Australian Government ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, 56-7.
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addition, the Government has been providing direct assistance for the closure of certain large ‘highly-emissions-intensive coal-fired generators’ and loans for emission- intensive ‘generation complexes’ to purchase future carbon units.158 Both programs also foresee a ‘buy-back mechanism’ whereby the government, upon request made by an eligible entity that received carbon units for free, must buy units back and cancel them ‘at the fixed charge for the relevant year discounted by a factor in the regulations.’159
4.4.3.2 Discussion
As discussed in the previous chapter, free allocation, per se, is considered by the most part of the literature a negative outcome of any ETS design, mainly because of the unfairness it creates in terms of distributing the cost burden of reducing emissions across the economic sectors. Additionally, free allocation refrains the government from collecting proceedings from auctions that can be intelligently recycled within the economy, in order to mitigate price or cost distortions to less favourable sectors or individuals, such as low-income households.160 Regardless of the theoretical assumption, free allocation has been part of most ETS design features, usually as a bargaining tool used by governments to buy minimum political support from affected sectors and entities. Under the EU ETS, free allocation proved to be perverse at least with respect to the possibility of windfall profits from certain sectors (usually large energy producers, although other sectors have benefited from windfall profits on a lower, but still significant, scale).161 The EU ETS transition to auctioning under Phase III clearly resulted from the recognition of windfall profits to some sectors. However, despite the EU ETS transition to auctioning, the package of assistance of the EU ETS, and the other schemes to certain sectors of the economy, is still significant. This
158 Clean Energy Act 2011 (Cth) Part 8, Division 6 – Closure Contracts and ss 303A and 303B. See also Australian Government ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’ above n 47, xv-xvi; The Carbon Market Institute, Australia’s Clean Energy Legislative Package: A Guide for Business, above n 105, 51-2.
159 Explanatory Memorandum, Clean Energy Bill 2011 above n 55, 131; Clean Energy Act 2011 (Cth) s 116. The ‘buy-back mechanism’ is one of the most unique and critical features of the assistance programs, since it adds to the free allocation of permits a second layer of subsiding the most intensive polluters by allowing them being paid for the freely allocated carbon units.
160 Garnaut, The Garnaut Climate Change Review, above n 14, 331.
161 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme above n 4, especially ch 4.
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especially applies to sectors considered the most affected by international competition from countries that do not yet price GHG emissions. This situation, still a result of the lack of harmonized GHG policies worldwide and of an international agreement under the climate change regime, offers one of the highest risks for an ETS design that ultimately do not guarantee the environmental integrity that it is expected from any greenhouse mitigation policy. The same rationale drives the CPM Assistance Package to highly-emissions-intensive electricity generators and the NZ ETS generous package of free allocation to most affected sectors. In the case of New Zealand, at least one major economic study demonstrates that New Zealand households will ultimately bear the higher costs for the emissions pricing policy under the ETS.162
It is in the case of Australia, however, that the length of the discussions on forms of assistance to EITEs and the legislation outcomes have raised important issues to be considered in future discussions on emerging ETS, such as a potential Brazilian ETS. Based on the overall structure of the Australian economy and the carbon-intensity of its largely coal-based energy matrix, it is difficult to imagine any ETS design in Australia that would not foresee some kind of transitional assistance to the most affected sectors, mainly coal-based electricity generators and coal exporters.163 However, as warned by the Garnaut Review, this ‘dreadful problem’ (particularly in relation to EITE assistance) must be dealt with caution by any ETS designers, in order to avoid the policy paradox where ‘low emitters feel the effects of the scheme, but high emitters do not.’164 In fact, the Garnaut Review sharply opposed the use of free allocation as a form of assistance because of the higher costs to the overall economy (in particular households)165 it could entail. Further, the Garnaut Review indicated that there is no basis for payment to be made to affected firms as compensation for loss of profits due to the new domestic ETS policy. It stressed a clear distinction between such compensatory payments and payments to correct a distortion in the international markets due to the ‘failure of
162 Bertram and Terry, The Carbon Challenge: New Zealand’s Emissions Trading Scheme above n 59, especially ch 3-6.
163 As highlighted by the Garnaut Review, ‘[F]for Australia, reducing emissions from coal combustion is of national importance. Under any realistic scenario, Australia’s response to climate change, both internationally and domestically, will be inextricably intertwined with the long-term future of the coal industry.’ Garnaut, The Garnaut Climate Change Review: Final Report, above n 14, 493.
164 Ibid 316-7.
165 Ibid 331.
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[Australia’s] global competitors to act on limiting their carbon emissions.’166 Recognizing the latter case as legitimate, it proposed a transitional assistance approach to the emission-intensive and traded-exposed companies combining sectoral agreements with assistance payments (through allocation of credits to be discounted from each affected company’s surrender obligations). The calculation of the credit assistance for individual companies would be based on the periodical assessment of the international market distortions on carbon-intensive product prices due to the asymmetry of carbon- pricing policies between Australia and its trading competitors.167 Along the same lines, in support of its strong arguments against generous and indiscriminate compensation to companies alleging loss or profits (apart from the transitory and limited assistance proposed to the emissions-intensive and traded exposed sectors), the Garnaut Review argued that ‘[p]olicy makers would be better off abandoning an emissions trading scheme in favour of a broad-based emissions tax without exemptions if they felt unable to resist pressures on the political process for ad hoc and overly generous assistance arrangements for these industries.’168
The confirmation of the ability of the CPM Assistance Programs reviewed in the previous section to avoid the trap of ‘overly generous assistance’ to the higher polluters in Australia would depend on the survival of the scheme after July 2014, which did not happen. Another fact that also deserves attention is the Australian arrangement of creating ‘buy-back’ alternatives, according to which government purchases, from certain entities, emission units that such entities received for free as a beneficiary of free-allocation or assistance programs. At least conceptually, this arrangement seems extremely controversial and could give rise to significant political consequences with respect to the other stakeholders’ perceptions on the scheme’s integrity, fairness, and distributional effects. In any event, the overall conceptualization of these programs, which combine free allocation of permits with direct cash payments, suggest that this issue deserves a very cautious approach by Brazilian ETS designers and policymakers, in order to avoid a major flaw in ETS design.
166 Ibid 345.
167 Ibid 342-349.
168 Ibid 317.
174
4.4.4 Allowance Use Rules: Legal Nature, Transfer, Surrender, Cancellation, Validity, Banking, and Borrowing
Similarly to the approach adopted by the Kyoto Protocol, the EU ETS Directive is silent about the legal nature of the EU allowance, leaving this definition to the domestic laws of each member state. This approach deviated from initial proposals by the Commission which sought to define the EUA as an ‘administrative authorization, but which was later rejected on the grounds of potential conflict with the EU Law ‘subsidiary principle. The subsidiary principle states that in some areas that do not fall within the EC’s exclusive competence, the EC shall not take action if the objectives of such action can be sufficiently achieved by the member states.169
Under the EU ETS Phase I, allowances (each allowance gives the holder the right to emit one tonne of carbon-equivalent) were valid for the respective compliance period170 for which they were issued.171 As a result, banking was allowed only for the years within the same Phase I compliance period.172 However, from Phase II onwards, the EU ETS expressly allowed banking of allowances from one period (for example, 2008–12) to the next (2009–2020).173 The EU ETS Directive did not explicitly allow ‘borrowing’. However, as pointed out by some sources, due to an overlap between dates assigned for the allowance issuance by the respective authority and surrender by the installation, limited borrowing was possible within the same compliance period in the cases where allowances were distributed by the member state for the whole compliance period.174 Under linking arrangements formally authorized by future agreements (as it
169 Markus Pohlmann, ‘The European Union Emissions Trading Scheme’ in Freestone and Streck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond, above n 48, 350 and n 29. See also discussion in chapter III, section 3.3.1.4 and in 4.4.6.2 below on the Armstrong DLW GmbH v Winnington Networks Ltd case.
170 Phase I (2005-07), Phase III (2008–12), Phase III (2013–20), and subsequent periods.
171 EU ETS 2003 Directive, Article 13, Paragraph 1.
172 That is, installations which emitted below their allocated allowances in a given year of the Phase I period could ‘bank’ their surplus allowances to surrender them in relation to the remaining years within the same compliance period. Ibid.
173 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme above n 4, 53 and n 8.
174 Allowances are issued by the competent authority by February 28 of a given year and are surrendered by the installation by April 30 of the following year. As a result, an installation that was short of allowances in a given year could ‘borrow’ from allowances allocated to them for the following years and placed in their registry in the beginning of 175
will be discussed below), allowances can also be transferred to persons in other countries.
Under Phase III, allowances issued from 1 January 2013 onwards will be valid for the whole eight-year compliance period, consistent with the previous phases.175 The EU ETS Phase III also contains a provision waiving the obligation of surrendering allowances in connection with capture and storage projects, which are covered through a special permit requirement.176
Aligned with previous attempts of designing and passing ETS legislation in Australia, particularly the Carbon Pollution Reduction Scheme (CPRS), the CPM defines the legal nature of the carbon unit as a personal property, which ‘is transmissible by assignment, by will and by devolution by operation of law.’177 Building on this legal definition, the CPM provides for a series of straightforward criteria aimed at facilitating the liable entities and market players’ legal certainty about the ownership of the carbon unit and fostering the trading activities it should be subject to. Thus, the CPM expressly states that the legal ownership of the carbon unit belongs to the registered holder of a carbon unit under the Registry.178
In addition to being defined as ‘personal property’, carbon units are also regulated as a financial product in order to subject providers of financial and commercial services units to the regulatory requirements of the Australian Securities and Investments
the compliance period or by February of same year where surrendering should occur. See Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, above n 4, 6 and 124. See also Environmental Defense Fund and International Emissions Trading Association, ‘The World’s Carbon Markets: A Case Study Guide To Emissions Trading – European Union’ (EDF/IETA Report, March 2014)
175 EU ETS 2009 Directive, Article 1, Paragraph 16, amendments to EU ETS 2003 Directive Article 13, Paragraphs 1.
176 EU ETS 2009 Directive, Article 1, Paragraph 15, amendments to EU ETS 2003 Directive Article 12, Paragraph 3(a).
177 Clean Energy Act 2011 (Cth) ss 103, 105-6; see also Clean Energy Act 2011 (Cth) s 5 for definitions of eligible emissions unit and eligible international emissions unit and s 94 for issuance of carbon units; and National Registry of Emissions Units Act 2011 (Cth) s 4 for definition of eligible international emissions unit.
178 Clean Energy Act 2011 (Cth) s 103A.
176
Commission (ASIC), in terms of the risk management and commercialization.179 According to this set of requirements, e carbon market service providers must obtain an ASIC license, and in theory become subject to much more stricter controls in comparison with other national and international carbon markets, where emission reduction units are not treated as a financial service.180 On the other hand, despite the noble reasons of providing greater security to the market, this kind of regulation may help to consolidate the carbon market in the hands of a few larger players. This may enhance the risks of higher costs to liable entities and exclude many capable market players, who have pioneered the carbon market development throughout project origination and secondary market transactions.
Under the fixed-price period, an unlimited number of carbon units (whose vintage year is a fixed charge year) will be available to the liable entities for purchase and immediate surrender.181 Those units will not be able to be banked for use in future years or borrowed from a future compliance year to meet the relevant year surrender obligations.182 The same banking and borrowing requirements apply for carbon units issued for free under the assistance programs.183 Under the flexible period, unlimited banking would be allowed.184 In turn, limited borrowing would be allowed under the flexible period, during which liable entities would be authorized to use carbon units from the following vintage year to discharge up to 5 per cent of their liability in the relevant financial year.185
179 This subject is covered by the Clean Energy (Consequential Amendments) Act 2011 (Cth) Schedule 11, which provided for the relevant amendments to the Corporations Act 2011 (Cth) and the Australian Securities and Investments Commission Act 2011 (Cth). See also Explanatory Memorandum (Revised), Clean Energy (Consequential Amendments) Bill 2001, 110.
180 The Carbon Market Institute, Australia’s Clean Energy Legislative Package: A Guide for Business, above n 105, 61-2.
181 Clean Energy Act 2011 (Cth) s 100.
182 Ibid s 122 (6)
183 Ibid s 122 (7). See also Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 119.
184 Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 118; Clean Energy Act 2011 (Cth) s 122 (4). See also Lisa Caripis, Jacqueline Peel, Lee Godden and Rodney Keenan, ‘Australia’s Carbon Pricing Mechanism’ (2011) 2 (4) Climate Law 583.
185 Clean Energy Act 2011 (Cth) ss 122(4) and 133(6).
177
The transmission of carbon units is authorized in the case of transactions in which the purchaser (or transferee) of the unit already holds a Registry account, or in which the transferee does not yet have a Registry account.186 In the latter case, the transferee will have to request the Regulator to open a Registry account in order for the transaction to be materialized.187 The CPM also authorizes transfer of carbon units between different accounts held by the same person,188 in addition to outgoing international transfer of carbon units to foreign accounts held by the same person or by a third- party.189 Another relevant provision aimed at the realization of the full potential of the CPM as a market mechanism is the express authorization in the Act for the creation of equitable interests in relation to a carbon unit,190 and its corresponding registration in the Registry.191 This clear and unequivocal statement suggests an effort by the legislator to ultimately incorporate the use of the carbon units into the business activities of liable entities and other market players, enhancing their ability to manage the liability and commercial risks under the Act.
Aligned with the Kyoto Protocol approach, the NZ ETS legislation has not clearly defined the legal nature of the NZU.192 However, the NZ Government issued specific requirements on the tax treatment of NZUs considering them ‘trading stock’ and ‘excepted financial arrangements’ for tax and accounting purposes.193 Since NZ has not
186 Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 118-123.
187 Clean Energy Act 2011(Cth) s 106.
188 Ibid s 107.
189 Ibid s 108.
190 Ibid s 110.
191 Ibid s 109A. Further requirements from the Personal Property Securities Act 2009 (Cth) may apply.
192 The NZU is defined as a ‘unit issued by the Registrar and designated as a New Zealand unit.’ Climate Change Response Act 2002 (2002 No. 40) (NZ) s 4 (1) ‘New Zealand unit.’
193 Income Tax Act 2007 (as amended in January 1 2009) (NZ), ss CB 36, CX 51B, DB 60, DB 61, EB 2, ED 1, ED 1B, EW 5, GC 1 and YA1. Sections EB 2 and EW5 provide the ‘trading stock and ‘excepted financial arrangements’ definitions, respectively. Other tax aspects of NZUs are covered by amendments to the Goods and Services Tax Act 1985 introduced by the Climate Change Response (Emissions Trading Amendment) Act 2008 (NZ) whereby some transactions involving NZUs were considered ‘zero-rated’ under the GST rules. GST Act ss 2 and 11A. See Inland Revenue, ‘Tax treatment of transactions in emissions units’ (8 October 2010) committed to a second compliance period of the Kyoto Protocol, one can expect that a more clear definition on the legal nature of the NZU may appear in the near future. The NZ ETS posed no restrictions to banking of emission units to be used in subsequent compliance years, but did not allow borrowing of emission units, that is, ‘use of emission units from a future period for compliance during the current period.’194 Transactions of NZUs and tracking of surrender obligations and emissions reporting would be electronically recorded in the New Zealand ETS Registry, which would be developed to be as compatible as possible with the NZ Emission Units Registry committed to by New Zealand under the Kyoto Protocol.195 4.4.4.1 Discussion The EU ETS and NZ ETS approach of not defining the legal nature of the emission units is consistent with the Kyoto Protocol. On one hand, it brings a higher level of flexibility for the gradual insertion of specific regulations in relation to the different legal aspects that emerge as a consequence of the creation and use of a new form of asset, privileging the most urgent ones or the ones more readily identified as necessary. Thus, as in the case of New Zealand, tax and accounting rules have been introduced from the scheme outset to deal with carbon unit ownership and transactions, however, other potential regulations were left to a second moment. On the other hand, this incremental approach may create legal uncertainties that may not be acceptable in some jurisdictions due to their overall legal framework or commercial practices and culture. In this regard, the Australian CPM chose to define carbon unit as a proprietary right, in addition to defining it as a financial property for purposes of imposing a regulated market similar to the financial markets. Although this approach enhances the legal certainty that many investors and other market players seek, it creates some risk of future disputes in case of cancellation of the carbon units or in the case the scheme is repealed, thus potentially giving rise to compensatory claims by emission units owners due to alleged expropriation of proprietary rights. In any event, at the CPM outset, a good legal analysis on this matter concluded that, under Australian constitutional and tax/legislation/2009/2009-34/2009-34-other-policy-matters/2009-34-op-emissions- units/> 194 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 53. 195 Ibid 50-1. 179 case law, the proprietary rights attached to the carbon unit would not generate compensation claims by carbon units holders in case of cancellation of units or repeal of the scheme, on the argument that as the Crown would not take ownership of the carbon units, the government would merely be modifying or extinguishing statutory interests with no benefit gained by the State.196 On the other hand, as indicated above, confining the emissions market to the boundaries of a regulated market may create some distortion with respect to competiveness of market players (such as project originators and traders), in addition to increasing transaction costs. Although the regulation, such as the one proposed by Australia, may enhance the level of security of the market, it may be a premature approach, since a more informal market environment may be useful for creating an ‘environmental market’ culture and enhancing the chances of liable entities complying with their obligations in a more cost-friendly form. Suffice to say that a more informal market does not mean it should not be regulated and overseen by the enforcement authorities. Under the three schemes, and aligned with the theoretical framework, banking is largely used as a mechanism for enhancing the flexibility of affected entities. Through baking, entities are able to use their stock of emission units in the most efficient manner in view of their compliance obligations. Similarly, all three schemes restrict the use of borrowing due to the perverse effect this mechanism has on ETS environmental integrity. From a political standpoint, unlimited borrowing would be very difficult for any government to cope with, mainly when this feature is added to other design flexible approaches, such as free allocation and assistance programs discussed in the previous sections. 4.4.5 Relationship with the Kyoto Protocol and Other Emissions Trading Schemes/Linking Under the EU ETS, the Linking Directive authorized member states to allow installations to use project-based Kyoto units in the EU ETS up to a certain percentage of the installation’s allocated allowances as specified by the member state in the National Allocation Plan.197 The fungibility between EUA and the Kyoto Units 196 Shona Stevens ‘The Carbon Unit”: Is It Personal Property and Would Repeal of the Clean Energy Act Demand Acquisition on Just Terms under the Constitution’ in (2011/2012) 79 (17) Queensland Environmental Practice Reporter 252, 264-5. 197 EU ETS 2004 Linking Directive, Article 1, Paragraph 2, Amendment to the EU ETS 2003Directive Article 11a, Paragraph 1. 180 (Certified Emission Reduction for CDM and Emission Reduction Units for JI projects) should take place by the immediate surrender of one allowance by the member state in exchange for one CER or EUR held by the installation in the national registry of its member state.198 The Linking Directive provided limited acceptance of certain types of projects into the scheme, particularly emission reductions from nuclear installations, land-use, land-use change and forestry activities, and large hydropower generation (generating capacity exceeding 20MW).199 Project activities from large hydropower should be in compliance with the international standards devoted to preventing social and environmental impacts, in particular standards established by the OECD and the World Bank through the World Commission on Dams and Development.200 Further regulations on post-2012 use of international credits restricted the use of CERs from industrial gas projects and limited the use of CERS from least-developed countries (LDC).201 The land-use restrictions under the ETS linking rules are one of the main barriers for full linking with schemes that cover the same kind of activities as the NZ ETS. This can also be a barrier for full linking with a Brazilian ETS in case the country adopts the NZ model on this matter. The EU ETS Phase III Directive also restricted the use of project-based credits to project participants headquartered in countries participating in the Kyoto Protocol or formally linked to the EU ETS (including subnational entities). This restriction clearly aimed at stimulating adherence to the Kyoto Protocol and subsequent agreements for those countries that want to benefit from the potential economic efficiency provided by the EU ETS.202 This approach addressed, in some extent, negotiation leverage against the US not ratifying the Kyoto Protocol, by placing project-based credits from US 198 EU ETS 2004 Linking Directive, Article 1, Paragraph 2, Amendment to EU ETS 2003Directive Article 11a, Paragraphs 1 and 2. ERU from JI projects were accepted only after Phase II onwards. Ibid. 199 EU ETS 2004 Liking Directive, Preamble, Paragraphs 8, 9 and 14. 200 EU ETS 2004 Linking Directive, Preamble, Paragraph 14 and Paragraph 2, amendment to EU ETS 2003 Directive Article 11b, Paragraph 6. 201 EU ETS 2009 Directive, Article 11(a) 4. 202 EU ETS 2009 Directive, Preamble, Paragraphs 13, amendments to EU ETS 2003 Directive Article 11a, subparagraphs 5 and 14 and Paragraph 27, amendments to EU ETS 2003 Directive Article 25, subparagraphs 1a and 1b. 181 companies out of the scheme. On the other hand, the EU ETS Phase III Directive leaves open the possibility of linking with other schemes through bilateral arrangements, either for use in Kyoto projects or in ‘other emission reduction activities’. This approach intends to address the uncertainties regarding the future of the international climate regime. These bilateral arrangements may include the US and the emerging sub-federal and regional schemes such as California’s and schemes amongst Canadian and US states (RGGI and the Western Regional Initiative),203 since the EU ETS expressly authorizes linking with subnational and regional schemes. The CPM foresaw two different kinds of linking with other cap-and-trade or baseline-and-credit schemes: the domestic linking with the Carbon Farming Initiative and the international linking with the Kyoto Protocol market mechanisms, the European Union Trading Scheme, and other emerging schemes, such as the New Zealand Emissions Trading Scheme. Such linking mechanisms would operate under different criteria in the fixed- and flexible-price periods, and some of them would be subject to future regulation or formal arrangements between the Australian Government and the relevant national and international authorities. Due to the importance of agriculture and forestry emissions to the Brazilian emissions profile, this section will discuss the CFI in more detail. The full compatibility between NZ units and Kyoto units meant, in practice, an unrestricted link between the NZ ETS and the Kyoto Protocol flexible mechanisms, that is, emissions trading between countries (Kyoto Protocol, Article 17), and the project- based flexible mechanisms Clean Development Mechanism (CDM,) and Joint- Implementation (JI) (Kyoto Protocol, Articles 12 and 6, respectively). Apart from full linkage to the Kyoto Protocol’s first commitment period, the Government highlighted that the NZ ETS design should be broadly aligned with other emission trading schemes such as the EU ETS and the then emerging Australian CPRS, despite recognizing that bilateral linking before the end of the Kyoto Protocol’s first commitment period would be remote. In fact, due to design differences between the NZ ETS and the EU ETS, mainly with respect to the coverage of forests, and the fact that the developments of possible ETS in Australia and the NZ ETS were asymmetric, the NZ ETS linking, apart from the Kyoto Protocol’s first commitment period, has not yet materialized. In addition, the New Zealand Government recently announced it was stepping out from the Kyoto Protocol for the next commitment period, thus creating 203 See item 1.1.2 of the Introduction (chapter I) for a summary on those subnational initiatives. 182 another barrier for possible linking of the NZ ETS, at least with respect to some of the linking possibilities that could be backed by the fungibility of Kyoto Units. 4.4.5.1 CPM and The Carbon Farming Initiative Under the CFI, farmers and other land managers would be able to voluntarily participate in the generation of carbon credits by storing carbon or reducing greenhouse gas emissions on the land.204 These project types are usually broadly categorized as emission avoidance and carbon sequestration projects.205 The CFI allows for the generation of Kyoto and non-Kyoto CFI Credits (Kyoto ACCUs), the former being credits generated from methodologies approved under the Kyoto Protocol and included in the Australian greenhouse accounts under the Kyoto Regime.206 Non-Kyoto ACCUs would serve the voluntary market (at least until such methodologies were not included in the Kyoto Regime or any other compliance market), and would also be subject to special funding (such as the CFI non-Kyoto USD250 million Carbon Fund announced by the Government) or purchase through tender processes by the Australian Government.207 Under the fixed-price period, the only linking initiative available to liable entities was the use of domestic offsets of some Australian carbon credit units (ACCUs) issued under the Carbon Farming Initiative (CFI) 208 land-use projects limited to 5per cent of 204 Australian Government, Department of Climate Change and Energy Efficiency, The Carbon Farming Initiative Handbook (DCCEE, 2012) 6. 205 Carbon Market Institute, Implementing the Carbon Farming Initiative: A Guide for Business (CMI, 2012), 18-9. 206 The Kyoto-approved activities and methodologies that can earn Kyoto ACCUs under the CFI include reforestation, avoided deforestation, and reducing emissions from livestock, manure, fertilizer and waste deposited in landfills before 1 July 2012. Non-Kyoto activities that may earn non-Kyoto ACCUs include soil carbon, feral animal management, improved forest management and non-forest re-vegetation. Australian Government, The Carbon Farming Initiative Handbook, above n 204, 7. 207 Ibid 8-9; this approach would also aim at promoting low carbon land use alternatives and create a demand for ACCUs Carbon Market Institute, Implementing the Carbon Farming Initiative: A Guide for Business, above n 205, 51. 208 Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth). The goal of this subsection is not cover the CFI in detail, but only point out the basic elements of the CFI linking with the Carbon Price Mechanism. 183 their surrender obligations for each compliance year. Holders of Kyoto ACCUs would also be allowed to export them to other international carbon markets under the fixed- price period. Under the flexible-price period, liable entities can use eligible ACCUs indiscriminately, and are able to discharge up to 100 per cent of their surrender obligations with CFI offsets. In addition, entities are able to use eligible international units subject to certain quantitative and qualitative restrictions. Since the outset of the CPM, the Australian Government recognized that ‘(l)inking to other credible trading schemes, including the EU Emissions Trading Scheme and the NZ Emissions Trading Scheme’ would be ‘in Australia’s national interest.’209 In 2012, the Australian Government and the European Commission announced a linking initiative between the two schemes. According to the joint-announcement by the Australian Government and the European Commission, the policy arrangements for the formal linking to be accomplished by mid-2015 should cover the following topics: measurement, reporting and verification arrangements; the types, quantities and other relevant aspects of third- party units that can be accepted into either scheme; the role of land-based domestic offsets; implications, if any, for supporting the competitiveness of European and Australian industries in particular sectors exposed to a risk of carbon leakage; and comparable market oversight.210 It should be implemented in two phases, starting with an interim link to operate from 1 July 2015, which would allow Australian liable entities to unilaterally use European allowances for compliance under the Australian scheme. A full bilateral link, by means of the mutual recognition of carbon units between the two cap and trade systems, was expected to be agreed upon by the middle of 2015 and be operational no later than July 2018.211 4.4.5.2 Discussion When EU ETS, CPM and NZ ETS linking approach are compared, it is clear that the EU ETS design incorporated most of the possibilities of linking reflected in the 209 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, 108. 210 European Union and The Australian Minister for Climate Change and Energy Efficiency, Joint Press Release ‘Australia and European Commission agree on pathway towards fully linking emissions trading systems’ (Brussels, 28 August 2012) 211 Ibid. 184 emissions trading theoretical framework. The EU ETS, since its outset, provided for a sound mechanism of linking with the then emerging Kyoto Protocol market mechanisms. By doing so, the EU ETS was particularly aligned with the UNFCCC and Kyoto Protocol’s ‘supplementarity principle’ mentioned in the previous chapters, which required that the possibility of Annex I countries using the flexible mechanisms could not jeopardize each country’s compromise of reducing emissions domestically.212 At the same time, the EU ETS’s incorporation of Kyoto market mechanisms (even if restricted to a certain percentage of the local companies’ emission reduction targets) played the dual role of assisting European companies in reducing emission reduction costs and maintaining the Kyoto Protocol alive even after the US refused to ratify.213 Furthermore, the EU ETS became the price driver for the Kyoto Units, particularly the CDM.214 The EU also stood out in using the Linking Directive requirements as a mechanism to induce its political or environmental preferences with respect to ‘qualitative restriction’ of linking with certain types of projects, such as forestry activities, nuclear energy, and large dams. It is important to note, however, that the ultimate set of qualitative restrictions for linking under the EU ETS was subject to an intense debate and political bargain among member states, the EU Commission and the EU Parliament (for example, countries over-relying on nuclear energy such as France) pushed for the exclusion of nuclear projects from the restriction list, or at least for the restriction being temporary as opposed to definitive). 215 By setting the stage for linking, the EU ETS also provided for a minimum set of criteria that other schemes should follow in order to allow linking with the largest compliance market to date. In this regard, the changes that the Australian government had to implement just after the CPM enactment to allow a possible linking agreement with the EU ETS demonstrates how important a minimum level of symmetry is between scheme designs, in order to foster the advantages of linking. The level of symmetry 212 This issue was also at the core discussions on the design of the EU ETS 2004 Linking Directive. See Karoline Hægstad Flåm, ‘A Multi-level Analysis of the EU Linking Directive Process: The Controversial Connection between EU and Global Climate Policy’ (Report to the Fridtjof Nansen Institute, 2007 Report FNI-rapport 8/2007), 7 <://www.fni.no/doc&pdf/FNI-R0807.pdf> 213 Skjærseth and Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation, above n 4, 183. 214 Ellerman et al, Pricing Carbon: The European Union Emissions Trading Scheme, above n 4, 273. 215 Flåm, ‘A Multi-level Analysis of the EU Linking Directive Process’, above n 212, 29-33. 185 between schemes cannot necessarily be determined at each scheme outset, and some design features favouring linking may not be politically feasible during the initial stages of policy implementation. As a result, some flexibility on the legislative review process of each ETS may be useful to allow necessary changes over time, in order to accommodate the dynamics of the climate change regime and the corresponding ETS developments around the globe. The potential of linking being used to ‘override the supplementarity principle’ was clearly materialized in the case of New Zealand. As pointed out earlier, the full incorporation of Kyoto Units by the NZ ETS provided for very timid emission reduction levels domestically, since New Zealand companies were able to take advantage of the low prices of Kyoto Units and demonstrate compliance with their NZ ETS obligations, without necessarily reducing their own emissions. Another important aspect of linking alternatives is the possibility of incorporation of offset credits as part of the emission units that can be used by affected entities to comply with their surrender obligations. In this regard, Australia’s decision of creating a domestic agriculture-based offset market through the CFI is of extremely significant. At the same time it creates an incentive for the agriculture sector to implement emission reduction activities, it also neutralizes the discussions on possible technical restrictions of agriculture being covered by market mechanisms. Further, it provides for a much more productive way to handle the political intricacies of dealing with the agriculture, which is a sector that markedly contributes GHG emissions and, at the same time, specifically addresses the sensitive problem of food security for an ever-growing population. The Australian approach has much more potential to address climate change aspects of the agriculture sector when compared to the New Zealand tentative inclusion of agriculture under the NZ ETES coverage, which so far has been a merely theoretical exercise due to the entry of the agriculture sector in the scheme being repeatedly postponed. 4.4.6 Compliance, Enforcement, Trading Infrastructure, and Governance Similarly to many market-based mechanisms, as discussed in the previous chapters, the EU ETS compliance assessment approach is based on the combination of self-monitoring and reporting by the affected installation, coupled with verification by a third-party.216 Under the EU ETS, the emissions allocated to each affected facility are 216 EU ETS 2003 Directive, Article 5 (d), Article 6, Paragraphs 1 and 2 (c) and (d), Article 14, Article 15, Annex IV and Annex V. 186 reflected in a GHG permit at the facility level.217 The issue of a GHG Permit to an affected facility is conditioned to satisfactory demonstration by the permit applicant of its capability to monitor and report emissions according to predefined requirements.218 In addition to penalties that may be imposed by member states, operators who do not surrender sufficient allowances to cover their emissions from the previous year are subject to ‘excess emissions’ penalty for each tonne of carbon dioxide emitted in excess of surrendered allowances.219 Payment of such excess emissions penalty does not release the operator from the obligation to surrender an amount of allowances equal to such excess emissions, when surrendering allowances in relation to the following year.220 The EU ETS compliance and enforcement framework is complemented by a system of registries developed by each member state and by the Commission to secure adequate accounting of issuance, holding, transfer, and cancellation of allowances among scheme participants.221 The Community Independent Transaction Log (CITL) is the central registry for the EU ETS system. It was integrated to the Kyoto Protocol ITL (International Transaction Log) in 2008, allowing the full integration and mutual transferability between EUA and Kyoto Units.222 Since 2012, the EU ETS Registry system has been operating under a centralized Community-wide registry.223 Its operation included security measures to mitigate the risks of fraudulent transactions, such as a Valued Added Tax fraud (‘VAT Fraud’) detected in Phase II.224 Other fraud 217 EU ETS 2003 Directive Article 5 (d). 218 EU ETS 2003 Directive, Article 6, Paragraphs 1 and 2 (c) and (d). 219 EU ETS 2003 Directive Article 16, Paragraph 1. 220 EU ETS 2003 Directive, Article 16, Paragraph 3. 221 EU Directive, Articles 19 and 20. 222 EU ETS 2003 Directive Article 20. See Arnaud Brohé, Nick Eyre and Nicholas Howarth, Carbon Markets: An International Business Guide (Earthscan, 2009), 117; Markus Pohlmann, ‘The European Union Emissions Trading Scheme’, above n 169, 359. 223 EU ETS 2009 Directive, Article 1, Paragraph 21, amendments to EU ETS 2003 Directive Article 19, Paragraphs (a) and (b). 224 EU Commission, ‘Commission Regulation (EU) No 920/2010 for a standardized and secured system of registries pursuant to Directive 2003/87/EC of the European Parliament and of the Council and Decision No 280/2004/EC of the European Parliament and of the Council’ (further amended by Regulation of 18 November 2011). See also Marius-Cristian Frunza, Dominique Guegan and Antonin Lassoudiere, ‘Missing trader 187 transactions were not related to VAT or other tax aspects of EU ETS transactions, but resulted from a ‘phishing email fraud’ whereby the fraudster obtained unauthorized access to the registered account of a given company under the EU ETS German Register (Armstrong DLW GmbH) and was able to sell the respective EUA allowances to a bona fide purchaser in the UK (Winnington Networks Ltd.), a EUA broker which then sold the EUAs to a third party (TFS Green).225 After the fraud has been discovered, the original EUA owner (Armstrong) filed action against the bone fide purchaser (Winnington) before the UK Courts seeking, inter alia, compensation for its losses.226 As discussed in chapter III, section 3.3.1.4, Armstrong DLW GmbH v Winnington Networks Ltd also deals with important aspects of UK common law issues on proprietary rights, with interesting repercussions to the discussions on whether the EU ETS should have a single definition on the legal nature of the EUA.227 Similarly to the EU ETS, the CPM compliance approach on assessing liable entities’ emissions is largely based on greenhouse gas emissions self-monitoring and self-reporting by the liable entity to the Regulator (the final volume of emissions reported to the Regulator will comprise the emissions number of the liable entity). However, differently from the EU ETS, this process is not triggered by or reflected in the facility’s environmental license or operating permit. The overall self-monitoring and reporting approach under the CPM is based on the NGER Act proceedings that, since 2007, has mandated Australian greenhouse emission sources and energy users to monitor and report their emissions and energy use to the Federal Government. In fact, despite the lack of political consensus on a the adoption of an Australian ETS at the fraud on the emission market’, in (2011) 18 (2) Journal of Financial Crime 183. According Frunza et al, the fraudulent transactions occurred as follow: The trading companies implied in the scheme allegedly imported large volumes of carbon credits VAT-free from other countries then sold the credits on French carbon market BlueNext, having already marked up the price with VAT. The market players purchasing the permits would then have been able to claim the VAT back from the French Government. But, the suspects allegedly never reported that VAT revenue, pocketing it instead. 225 Kelvin FK Low and Jolene Lin, ‘Carbon Credits as EU Like it: Property, Immunity, TragiCO2medy’, Singapore Management University School of Law Research Paper No. 52/105 (February, 2015). 226 Armstrong DLW GmbH v Winnington Networks Ltd. [2012] EWHC 10 (Ch), [2013] (Ch) 156. 227 Low and Lin, ‘Carbon Credits as EU Like it: Property, Immunity, TragiCO2medy’, above n 225.. 188 time, the NGER Act was devised and passed in 2007 as a fundamental step for a future emissions trading scheme in Australia. This was one of the expressed NGER Act objectives stated by the Government and reflected in the NGER Act original version: to ‘underpin the introduction of an emissions trading scheme in the future.’ 228 At the time of NGER legislative discussions, its main role as the precursor of an Australian ETS was clearly mirrored in the positions expressed by most of the business stakeholders who participated in the public discussions regarding the NGER’s final design.229 Self-reporting and data record-keeping of the greenhouse emissions by the liable entity will follow the NGER requirements. Failure to do so may subject the liable entity to civil penalties.230 Differently from the EU ETS, according to which an accredited third-party auditor must independently verify the emissions provided by the affected facility, under NGER the general rule is that a third-party audit is the exception. It will only be triggered by the Regulator under special circumstances of suspicious of fraud231 or as part of a random compliance assessment by the Regulator. This soft-approach on the side of the Regulator in respect to the validation of the accuracy of the information provided by the liable entity may change to a more strict enforcement system. Under certain circumstances, the civil penalties above mentioned, and even a referral to the 228 National Greenhouse and Energy Reporting Act 2007 (Cth) (taking into account amendments up to Act No. 84 of 2008) s 3. 229 Sumit Lodhia and Nigel Martin, ‘Stakeholder responses to the National Greenhouse and Energy Reporting Act: An agenda setting perspective’ (2012) 25 (1) Accounting, Auditing and Accountability Journal 126, 127 and 140. These authors also highlight the political importance of a mandatory greenhouse gas emission reporting legislation being passed even though the adoption of an ETS and its ultimate design was still under fierce debate in Australia: The successful implementation of the NGER legislation is in sharp contrast to the stalled progress on the emissions trading scheme for Australia, suggesting that the political agenda for climate change is more contentious and may require a broader community consensus, involving not only Australia but the broader international community, given the global nature of climate change. Moreover, the political agenda may need to be revised whereby a dependence on merely an emissions trading scheme could be replaced by a much broader policy instrument that has the support of the various actors. Ibid 140-1. 230 The National Greenhouse and Energy Reporting Act 2007 (Cth) ss 22A-22C and Part 5, Division 1. 231 Australian Government, Clean Energy Regulator, ‘Compliance and Education Enforcement Policy’ (Commonwealth of Australia – Clean Energy Regulator 2012) 6 189 criminal authorities for proper investigation may be triggered in case the liable entity is caught in violation of the law. 232 The CPM provided for different requirements for the reporting and surrender process in the fixed-price and flexible-price periods.233 Under the fixed-price period, most liable entities were subject to a two-part emission units surrender process: a ‘progressive surrender obligation’ (usually referred as ‘provisional’ surrender) of 75 per cent of their emissions obligations by 15 June of the relevant compliance year and a ‘true up’ surrender obligation for the remainder of the obligation by 1 February ‘following the compliance year.’234 Under the flexible-price period, emission obligations for each compliance year would be met by a single surrender date on 1 February following the relevant compliance year.235 In both periods, there were some limits to surrender certain eligible emission units, such as restrictions on offset credits from certain activities. In both cases, and apart from the civil (and sometimes criminal) penalties resulting from failure to report under NGER, noncompliance with emissions obligations would subject liable entities to pay a shortfall charge for units it has not surrendered based on specific criteria for the fixed and flexible periods.236 In case of no payment of the corresponding shortfall charge by the due date, a late payment penalty would accrue at a rate of 20 per cent per annum (or a lower rate if prescribed in the regulations).237 Differently from the EU ETS, once the liable entity pays the shortfall charge it does not have to surrender eligible units to cover the shortfall emissions for the compliance year. In other words, the amount of actual emissions that have not been covered by eligible units, which either represent a portion of the cap or an offset of emissions reduced 232 Australian Government, Department of Climate Change and Energy Efficiency, National Greenhouse and Energy Reporting: Audit Determination Handbook (Commonwealth of Australia, Department of Climate Change and Energy Efficiency 2010) 6. 233 Clean Energy Act 2011 (Cth) Part 6. 234 Australian Government, ‘Securing a clean energy future: The Australian Government’s Climate Change Plan’, above n 57, 106; Explanatory Memorandum, Clean Energy Bill 2011 above n 55, 142-5; Clean Energy Act 2011 (Cth) s. 121. 235 Clean Energy Act 2011 (Cth) s 121.. 236 Explanatory Memorandum, Clean Energy Bill 2011, above n 55, 137 and 148; Clean Energy (Unity Shortfall Charge – General) Act 2011 (Cth) s 8 (imposition of charges) and Clean Energy Act 2011 (Cth) s 114, and 125-141. 237 Clean Energy Act 2011 (Cth) s 135. 190 elsewhere. As a result, the Government should be required to devoting part of the shortfall charge to re-purchasing eligible units or somehow restrict the issuance of emission units within the same cap period, in order not to exceed the cap for the same period and comply with Australia’s emission reduction commitments. Under certain conditions, some eligible carbon units may be relinquished to the Regulator (that is, returned by the liable entity without being used), either as a result of a voluntary or mandated relinquishment.238 Mandated relinquishment would apply when units were issued as a result of false or misleading information provided by the liable entity,239 or in cases the carbon units would have been issued for free (such as in the case of the Jobs and Competitiveness Program discussed below) and the beneficiary entity ceased production prior to using all the units.240 The overall registry of liable entities and trading infrastructure of the CPM was deferred to the Australian National Registry of Emission Units. The Australian Registry has been unified to accommodate under a single Registry the emission reduction units covered by the Kyoto Protocol, the Carbon Price Mechanism, and the Carbon Farming Initiative. In theory, the Registry accounts are not limited to liable entities. Any ‘person’ meeting certain eligible requirements of the law may open one or more accounts under the Registry. Such non-liable persons or entities not participating in the CPM may have the interest of holding an account for purposes of trading in the market – subject to other requirements in case of financial advisers and professional traders – or simply to purchase and surrender eligible units as part of individual or community efforts to reduce carbon emissions. Similarly to the EU ETS Registry System, the Regulator has the power to refuse to give effect to transactions that are deemed as fraudulent or potentially criminal, or otherwise may represent any kind of abuse of the Registry or 238 Clean Energy Act 2011 (Cth) Parts 10 and 11. 239 Australian Government, Clean Energy Regulator, ‘Compliance and Education Enforcement Policy’ (Commonwealth of Australia – Clean Energy Regulator 2012) 2 and 7, 240 Clean Energy Act 2011 (Cth) s 146. The relinquishment of non-used carbon units allocated for free is deemed as a mechanism to avoid ‘windfall profits’ from beneficiaries of the assistance programs. Rosemary Lyster, ‘Australia’s Clean Energy Future Package: Are we there yet?’ in (2011) 28 Environmental Planning and Law Journal 446, 453. 191 risk to its integrity.241 The CPM Registry also presented specific provisions to prevent and punish fraudulent transactions, such as those experienced by the EU ETS.242 The overall compliance structure of the NZ ETS was also largely based on self- assessment and reporting of emissions by the covered entities for each compliance period (1 January – 31 December of each year) based on pre-approved methodologies, followed by surrender of units in respect to emissions in a given compliance year. The Government reserved the right to assess compliance, preferably through a ‘risk-based approach to verification’243 and penalties for not complying included the participant’s obligation to surrender shortfall units within a timeframe established by the administrative agency and financial penalties. Covered entities knowingly violating such requirements would be subject to higher financial penalties, notwithstanding the possibility of criminal sanctions. Civil penalties up to NZD12 000 could also be applied under certain circumstances.244 Transactions of NZUs, tracking of surrender obligations, and emissions reporting are electronically recorded in the New Zealand ETS Registry, which was designed to be as compatible as possible with the NZ Emission Unit Registry (NZEUR) undertaken by New Zealand under the Kyoto Protocol. As a result, it hosts multiple accounts (known as holding accounts). Since New Zealand signed the Kyoto Protocol, the country has allowed not only the transfer of units among NZEUR account holders but also among other registry systems maintained by parties to the Kyoto Protocol, and also ‘between holding accounts within the NZEUR itself.’245 4.4.6.1 Discussion In the last decades, -market based and even command-and-control environmental regulations have largely relied on self-assessment and reporting, at least by emitting sources that meet certain eligibility criteria, such as evidence of sound internal controls 241 Australian National Registry of Emissions Units Act 2011 (Cth).ss 28B, 36(2) and 53(2). 242 Ibid ss 23-4, 28 and 28D. 243 New Zealand Government, ‘The Framework for a New Zealand Emissions Trading Scheme’, above n 29, 54. 244 Ibid 55. 245 Ibid 50-1. See also 192 and a good compliance record.246 However, under ETS reliable individual emission data and sectoral emission inventories and projections have reached a higher level of importance, since the overall scheme integrity (including cap setting, allowance allocation and compliance verification) depends on the accuracy of emissions records. As a result, ETS design and timeframe for implementation must be carefully devised in coordination with satisfactory evidence that a sound emissions data collection and reporting system is in place.247 As discussed earlier in this chapter, the EU ETS Phase I on allocation of allowances was partly attributed to poor data collection in the trial phase. As soon as the European Commission worked on improving emissions data collection (including development of monitoring methodologies for different sectors), the accuracy of the EU ETS cap-setting and allowance-allocation procedures has improved. In part due to the long period of political struggle in Australia in relation to passing ETS legislation, the Australian approach to the ETS was preceded by development and implementation of emissions monitoring and reporting proceedings through the NGER Act. This approach was beneficial to contributing to the overall capacity building of the Australian businesses in monitoring and reporting emissions. The NGER precedent also allowed Australia to adopt a variation of the EU ETS approach of particularizing emission allowances for each source through a permit system. In fact, the two approaches seem to be adequate to provide for the necessary information gathering and reporting system, provided that sound methodologies and strong compliance and enforcement are present. In this regard, differently from the EU ETS, both the CPR and the NZ ETS do not demand independent verification of reported emissions as a standard proceeding. Both countries rely on a random system of inspections to supplement self-verification by affected entities. This soft approach appears not to be of concern in relation to its efficacy of deterring liable entities from the temptation of tampering with their emissions data to trigger a lower emission reduction obligation. For example, most of Australian authors who comment on NGERs requirements in connection with an Australian ETS do not raise any particular concern on the role of self-monitoring in the overall emissions trading scheme design, which may reflect a compliance culture 246 OECD, Ensuring Environmental Compliance: Trends and Good Practices (OECD, 2009) 69 247 This challenge of ETS programs is very well captured by Lesley K. McAllister, ‘The Enforcement Challenge of Cap-and-trade Regulation’ (2011) 40 Environmental Law 1195. 193 embedded in Australian law and policy implementation. 248 In any event, it may not be adequate in jurisdictions such as Brazil, where compliance levels for environmental regulations still depend, in many circumstances, on third-party verification or strict enforcement by the authorities, as discussed in chapters V and VI. As shown in the previous chapter, the overall allowance-trading infrastructure under ETS largely depends on electronic platforms for recordkeeping of transactions. Thus, ETS implementation will be benefited not only by pre-existing reliable data collection and reporting systems, but also by the overall trading infrastructure pre- existing prior to the commencement of the trading phase. The EU ETS was able to benefit a little from pre-existing infrastructure of Kyoto Unit registries by each member state, and the parallel development of the Kyoto Protocol International Transaction Log. This was also the case of New Zealand, which focused a significant part of its ETS architecture on full fungibility of NZ Units with Kyoto Units. As a result, the trading infrastructure to register New Zealand transactions under the Kyoto Protocol was crucial to build the minimum set of transactions recording system under the NZ ETS.249 The CPM followed the same path, and the Clean Energy Legislative Package foresaw the integration of the Kyoto Protocol, the CFI and the CPM registries. The trading platforms for ETS must also meet minimum security and technical requirements in order to facilitate liking among schemes, and mitigate, to the extent possible, the risks of fraudulent transactions such as the VAT fraud detected in the EU ETS. All of these infrastructure requirements represent one more challenge to be met by countries considering an ETS as a climate policy alternative. 4.5 Conclusion The case study of ETS in the EU, Australia and New Zealand conducted in this chapter aimed at identifying significant design and implementation issues of these emerging ETS that should inform a possible ETS in Brazil with respect to its environmental integrity. The major conclusions of this analysis is presented below under the systematic and integrated conceptual framework of ETS and its legal aspects 248 See, for example, Nicola Durrant, Legal Responses to Climate Change (The Federation Press, 2010), 118-123; See also Lyster, ‘Australia’s Clean Energy Future Package: Are we there yet?, above n 240, 446. 249 This is clearly stated in the NZ ETS Registry’s website, which also informs that NZ ETS works similarly to ‘an online bank system.’ 194 presented in the previous chapters, based on the analytical approach and corresponding logical categories advanced by section 1.4.2.2 of this thesis: 4.5.1 Environmental Integrity of ETS as an Axiological Invariant, i.e., a hierarchal superior value to be reflected in any ETS ultimate design: The EU ETS, the CPM and the NZ ETS history are directed linked to assisting the EU, Australia and New Zealand meeting the overall objectives of the UNFCCC and achieving compliance with the emission reduction commitments of the Kyoto Protocol. However, despite the evident importance of the environmental concerns and objectives of both international law instruments, the design options and implementation history of ETS in the three jurisdictions have not reflected the elevation of their respective environmental integrity to a hierarchal superior value to predominate over other scheme’s goals and objectives. This common characteristic of the EU ETS, CPM and NZ ETS was evidenced by the discussion of subsection 4.3.1 and 4.3.2 on the stated and implied goals of each ETS design, as pointed out below in the joint representation of their legal models. In any event, the important role played by the EU in supporting the Kyoto Protocol implementation despite the U.S withdraw must be credited to certain prevalence of the environmental goals vis à vis more immediate economic interests in the internal political debate of EU Members and the ultimate common position undertaken by the European Union. 4.5.2. Systematic Analysis of Emerging ETS legal nomogenesis, identifying key drivers from an axiological (values) and factual perspective and the resulting main normative proposals and ultimate legal model: The brief account of the genesis and implementation of the EU ETS, the CPM and the NZ ETS and the discussion with respect to some of their design elements allow the following systematization of their key drivers and main normative proposals that culminated in each respective legal model for an ETS: (i) Axiological Factors: predominant ideological and political support in Europe towards the importance of mitigating climate change based, preferably through multilateral arrangements such as the UNFCCC and the Kyoto Protocol; conflicting ideological views within Europe on the use of environmental taxes vis à vis other pricing mechanisms such as ETS or more traditional command-and-control legislation; conflicting political views 195 among EU Member States on the level of autonomy of each Member State vis à vis the EU Central Governmental bodies in relation to implementation of environmental and economic measures; conflicting ideological and political internal views in Australia, particularly between energy and carbon intensive industry representatives and environmental groups, regarding the importance of and best approach to mitigate climate change; unresolved confronting views on adequacy of ETS for climate change mitigation, ranging from pure economic arguments on its economic efficiency to ethical and equity discussions on “right to pollute” to intergenerational and geographical distribution of the mitigation efforts; predominant political view in Australia and New Zealand on the need to balance international commitments on climate change with the protection each country’s relevant economic sector. (ii) Factual Factors: adherence to the Kyoto Protocol by the EU, New Zealand, and in a second moment, Australia; EU leadership role in supporting the Kyoto Protocol and guaranteeing its implementation regardless the US withdrawal; formation of political pro trade coalition in the EU, embraced by the EU Commission and, in the modes of the U.S. previous experience, supported by well structured academic research, active business leadership and communication strategy towards the environmental community; replication of the same kind of pro trade coalition in New Zealand and Australia; successful implementation of some of the Kyoto Protocol mechanisms (such as the CDM) and infrastructure (such as National Registries and the electronic Transactional Log), which allowed international trade of carbon credits and cemented future consideration of ETS linking experiences (such as the subsequent EU ETS Linking Directive and the use of Kyoto Units by the NZ ETS). 4.5.3. Jointly Legally Modelling of the EU ETS, the CPM and the NZ EUTS by identifying key legal sources, structural and functional elements relevant for the integrative analysis that will follow in the next chapters: 4.5.3.1. Basic Structure The EU ETS, CPM and the NZ ETS followed, with slight differences, the basic structure of ETS identified in chapters II and III, as follow: 196 (i) Aggregate cap on predefined emissions from predefined sectors; (ii) Issuance of tradeable individual emission allowances to pre-defined entities within covered sectors; the only exception being the approach of the CPM whereby each company will estimate its actual emissions at the end of a given year and surrender enough carbon units to cover such emissions as opposed to receiving a pre-defined number of allowances in advance as under the EU ETS Phase I. (iii) Entitlement to covered entities to use emission allowances to offset their own emissions or trade them in the market. 4.5.3.2. ETS Structural Elements: (i) Sources of Law mandating ETS to certain sector and activities and stated or implied goals and principles deriving from such mandates: The EU EUTS, the CPM and the NZ ETS have been introduced as mandated ETS by the incorporation of the UNFCCC and Kyoto Protocol commitments under the EU, Australia and New Zealand legislation (the EU Burden Sharing Agreement, Mandatory EU Directives and EU Member States National Allocation Plans; the Australian Clean Energy Package comprising of 19 bills of law and the NZ Amendments to the Climate Change Response Act). Despite the crucial role of the UNFCCC and the Kyoto Protocol in driving and shaping mandate ETS in the EU, Australia and New Zealand, the goals and principles reflected in the ultimate design of such schemes prioritized the economic efficiency and other economic values as opposed to the environmental integrity of the scheme. Further amendments to the EU ETS showed a more balanced approach between economic and environmental principles and goals within the EU ETS. (ii) Governance, Compliance and Enforcement Authority with mandate for cap setting, allowance issuance and auctions, surveillance on monitoring and verification of emissions and enforcement of penalties against violators. Initial decentralized authority for cap-setting under the EU ETS facilitated political approval of the scheme by Member States but created higher legal uncertainty, triggered significant number of litigation between Member States and the EU Commission, and allowed a perverse competition between 197 some Member States to establish loose caps to protect their own industries. Evidence of such pitfalls contributed to the migration towards a EU Commission Centralized cap under the EU ETS Phase III. Australian and New Zealand schemes established clear centralized cap-setting authorities, despite New Zealand’s preference in simply not having a national cap in practice under the Kyoto Protocol first commitment period. EU ETS, CPM and the NZ ETS heavily rely on self-monitoring and self- reporting of emissions by the covered entities vis à vis governmental or external third-party inspections or surveillance Poor monitoring data in the EU ETS Phase I contributed to the over allocation of allowances in the trial period. The importance of good monitoring data was positively captured in the developments of pricing mechanisms in Australia, whereby a national monitoring and reporting system for greenhouse emissions (NGER) was established well before the issuance of the CPM, creating not only more reliable data as well as a monitoring and report culture and practice amongst companies and the regulators. (iii) Registry System and Trading Platform for allowance trading, accounting and tracking; The existence of an initial registry and trading infrastructure in the EU, Australia and New Zealand due to the requirements of the Kyoto Protocol mechanisms facilitated the incorporation of such infrastructure in the design of ETS in each jurisdiction and the proper legal amendments to accommodate the scope introduced by the EU ETS, the CPM and the NZ ETS, respectively. (iv) Structural connective mechanisms to the overall legal framework (e.g., Constitution, overall climate change, environmental, tax, competition, corporate and securities, trade and investment laws and regulations and international law) and to offsets of emissions from sources not covered by the scheme. The three schemes reviewed in this chapter provides for clear connective mechanisms with the EU, Australian and New Zealand legal frameworks, respectively. Such structural connections include clear reference to or incorporation of legal requirements established by other sources of legislation in order to situate the ETS in the overall legal framework (macro model) it belongs, or to regulate new rights and obligations introduced by 198 each ETS with repercussion in other parts of the legal system, as per the following examples: EU ETS: UNFCCC, Kyoto Protocol, EU Treaty, EU Council Decisions on Approval of the Kyoto Protocol and Joint Fulfilment of Commitments (Burden Sharing Agreement and further Communications), Member States Legislation implementing National Allocation Plans. CPM: UNFCCC, Kyoto Protocol, National Greenhouse and Energy Reporting Act 2007 (Cth), Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth), Australian National Registry of Emissions Unit Act 2011 (Cth), Clean Energy (Regulator) Act 2011 (Cth), Procedural and Related Acts on Fuel Tax and Tariff Issues, Tax Law Amendments (e.g., Clean Energy (Income Tax Rates Amendments) Act (2011)), Clean Energy (Consequential Amendments) Act 2011 (Cth) Schedule 11 with relevant amendments to the Corporation Act 2011 (Cth) and to the Australian Securities and Investments Commission Act 2011 (Cth). NZ ETS: UNFCCC, Kyoto Protocol, Climate Change Response Act (2002), Amendments to the Income Tax Act 2007, Amendments to the Goods and Services Tax Act 1985 (v) Structural Elements of linking mechanisms to the climate change regime and other regional and national ETS establishing bilateral rights and obligations between sovereign states and with the international climate change regime. ETS Linking Directive; Memorandum of Understanding between the EU Commission and the Australian Government. 4.5.3.3 ETS Functional Elements: (i) Scheme Emission Reduction Target (Absolute or Relative), Level of Cap Stringency and Cap Duration: Accurate inventorying, modelling and projecting of GHGs emissions reduction targets in support of cap setting may carry significant technical difficulties, at least for certain economic sectors and activities. However, the political barriers to the adoption of stringent caps to guarantee allowance scarcity in the market surfaced as one of the major challenges for this important design element of ETS in all three case studies. The EU ETS initial cap in the trial phase, formed by the aggregate of national caps 199 established by Member States, was clearly less stringent than necessary to force emission reductions lower than projected business-as-usual emissions for the affected sectors. The lack of a national cap under the NZ ETS phase covered by this thesis, which totally relied on emission reductions occurred elsewhere under the Kyoto Protocol project-based market mechanisms, made the NZ ETS virtually ineffective in assisting domestic GHGs emission reductions in the country. The option for a phased implementation of the EU ETS allowed the accommodation of political pressures of some potentially affected sectors in favour of loose caps for the scheme approval and subsequent corrections in the cap setting proceedings along with other major changes under the EU ETS Phase III. This phased approach, also present in the Australian and New Zealand ETS design, are important features to accommodate the pressures of avoiding extreme stringent caps from the outset of the scheme, as discussed in sections 3.2.2.1 of the previous chapter of this thesis, to prevent major harm to certain sectors of the economy without compromising the environmental integrity of the scheme, at least in the mid-term. In any event, such design options do not guarantee that the desired corrections towards a more environmentally sound ETS will happen, as evidenced by the New Zealand experience. (ii) Scheme Coverage: Pollutants/GHGs, Sectoral (Economic Sector, Point of Obligation and corresponding Individual Facilities, and Opt-in and Opt-out Provisions) and Geographical Coverage Although the ETS theoretical framework discussed in chapter III suggested that broader coverage in terms of gases and sectors would enhance the chances of higher environmental integrity and economic efficiency of the scheme, the case studies revealed that such outcomes ultimately depend on other design elements and implementation decisions. Thus, although the EU ETS initial coverage restricted to CO2 emissions, it covered significant sources contributing to large GHGs emissions in Europe. By its turn, the NZ ETS provided for broader gas coverage from the outset, but with a very generous implementation schedule for some sectors, including the still pending entry of the agriculture sector in the scheme. The inclusion of the transportation sector as part of the covered entities also revealed some difficulties, particularly with respect to including the aviation sector. The lack of a harmonized, top-down international emissions trading scheme poses significant barriers to calibrate pricing mechanisms to aviation companies operating in different jurisdictions. Apart from that, the CPM 200 presented Opt-in mechanisms to the aviation sector that, at least during the brief tenure of the Australian scheme, was well received by aviation companies which otherwise would have deal with GHGs pricing mechanisms in the form of fuel tariffs and levies. In theory, establishing the point of obligation at the source (upstream/production level) appeared to be less complex from an administrative standpoint. However, some of the legal arrangements established by the CPM in relation to allocation of liability amongst large users of natural gas suggested that, at least from a legal standpoint, it is possible to deal with both forms of demanding emission reductions in different levels of the supply chain. (iii) Allowance Allocation Methods (Free/Grandfathering and Auctions), Direct Assistance Programs, and Corresponding Distributional Liability and Competition Fairness amongst sectors and/or individual facilities In all three case studies, some level of free allocation of allowances/ emissions units or direct assistance programs to major emitters set the tone for the preferred design option in respect to allowance allocation. Despite some legitimate concerns with respect to disruptive effects that an abrupt introduction of carbon pricing may bring to certain sectors of the economy, the reality is that the theoretical concerns on the pervasive effects of free allocation with respect to the environmental integrity of ETS were confirmed in the EU ETS trial phase and under Phase II. Certainly, free allocation was deemed as a major contributor to windfall profits for the electricity generation sector, which was able to pass trough emission reduction costs to its clients and still benefit from selling to the market emission allowances they received free of charge. Similar pervasive effects can be generated by direct assistance programs, which may create significant distortions regarding the distributional fairness of the costs to comply with emission reduction targets among different sectors of the economy. Usually, such kind of assistance are deemed as unfair compensation to sectors or individual firms that are emission intensive, such as the coal and mining sectors in Australia or the agriculture sector in New Zealand, and, instead of being urged to change behaviour, are benefited by very statute that should price their emissions. (iv) Allowance Legal Nature (proprietary right, personal right, administrative permit, license or authorization to pollute, financial instrument, security, 201 good, commodity) and Use Rules (Transfer, Surrender, Cancellation and Validity, Banking and Borrowing). The emerging ETS in the EU, Australia and New Zealand demonstrated that it is possible to implement an ETS with different approaches to the legal nature of the allowance/emission credits. In fact, the experience in the three case studies showed that this innovative right is usually of a hybrid nature, and its usage entails different legal contours. Under the EU ETS and the NZ ETS, there is no previous definition on the legal nature of the allowance/emission rights in the relevant Directives and laws. The immediate goals of the EU ETS Directives and the NZ ETS were attained with the simple recognition of the fungibility of the EU Allowances and the NZ Units with the Kyoto units. The NZ ETS applied an incremental approach to define the legal contours of the NZ Units, extending to their use some tax and accounting rules already present in the NZ legal system. Australia defined the carbon unit as a proprietary right from the outset, but also covered it with the mantle of a financial asset for purposes of regulating its trading under financial market rules. Such differences do not jeopardize the essential characteristics of the allowances in representing an economic value in relation to emission rights that can be traded in primary and secondary markets. Notwithstanding the significant legal consequences arising from the definition on the legal nature of allowances, such basic characteristics and fungibility with other compatible assets that may favour linking and offsets should be prioritized in the design and early implementation of ETS. (v) Civil, Criminal and Administrative Liability Rules for Non-Compliance with emission reduction targets and other scheme violations (Monitoring and Reporting, Market Fraud, Trading Rules) The three case studies show that the relevant laws provided for standard language and legal requirements pointing to civil, administrative and criminal sanctions the stringency of which should be sufficient to deter covered entities for not complying with their emission allowance/units surrender obligations. The most critical aspect of such enforcement framework relates to possible market frauds, which are of more sophisticated nature. Some fraud precedents in the EU ETS implementation, similar in nature to other more common tax and commercial frauds in regulated markets and commercial trading platforms, raised concerns on the overall security of ETS related transactions, and, at least in the case of Australia, a 202 tendency in placing the trading components of ETS under the overall surveillance legal framework of the regulated market of financial assets. (vi) Functional Elements of Linking (qualitative restrictions to linking, legal nature and fungibility of allowances from different schemes, harmonization of tax treatment between jurisdictions) Qualitative restrictions to linking, such as the EU ETS restrictions to certain land use projects, large dams and nuclear activities, are basically of ideological and geopolitical nature. As such, it must become a barrier for certain countries, such as Brazil, exercising the full potential of linking opportunities as envisaged by the literature. 4.5.4 Key Lessons taken from the ETS experience in the jurisdictions used as case studies. This analysis of the EU ETS, CPM, and NZ ETS has also identified important theoretical and implementation issues that should be considered by Brazil. In addition to issues such as the legal nature of allowances, compliance and enforcement rules, most ETS design features mirror a normative outcome with specific legal repercussions in the conduct and performance of affected entities (and sometimes of other social or economic actors), as shown above. Additionally, each principled decision or design element of an ETS reflects a value choice by the legislator, which may result from a more or less embattled political process. The following sub-sections identify some of these elements, which will inform the integrative analysis of an emerging ETS into the Brazilian climate change policy as examined, in the following chapters. 4.5.4.1 Considerations on Phased or Staged Implementation and Minimum Infrastructure The staged implementation of ETS was a policy option of the EU ETS followed by other subsequent schemes, including the CPM (which opted for a fixed- and flexible- price phase), and the NZ ETS. The level of uncertainty of some of the design options and the constant changes in the international climate change regime (at least up to the point where a comprehensive international agreement is reached) suggest that a phased approach is recommended in many instances. However, as demonstrated by the NZ ETS, a cautious approach should not be used as an argument for unjustified delays in the implementation of the scheme, including the effective application of price 203 mechanisms to the most relevant emitting sectors. In turn, based on the importance of accurate monitoring data for a successful ETS, a staged implementation process could be used to encompass the creation of a minimum reliable infrastructure for monitoring and reporting emissions and trading of allowances. 4.5.4.2 Clear and Comprehensive State Objectives and Principles A consistent set of ETS principles and objectives should be developed through sound consultation processes and be clearly mirrored in the legislation as scheme stated objectives and goals. Beyond mere legislative technique, clear goals and objectives, to the extent that they are consistently reflected in the overall scheme architecture, are essential to ensuring scheme stability. This approach will facilitate the scheme review processes and provide for more robust legislation in case of political or judicial challenges. The NZ ETS provides for a sound example of the usefulness of clear objectives and goals, with most of the subsequent changes of the scheme, including some controversial ones, having been aligned with the principles and objectives stated from the scheme outset. 4.5.4.3 Environmental Integrity The fact that ETS are largely influenced by economic theories provides for a tendency to over rely on economic efficiency in most of the analyses and documents supporting ETS adoption as a policy choice. This trend has been clearly demonstrated in the emerging ETS reviewed in this chapter. However, unless this is a clear value choice of the community in charge of the decision-making process, this economic emphasis should not prevail over environmental concerns. Consequently, in order to make a real contribution to mitigating greenhouse emissions, ETS objectives and ultimate design must provide for an environmental integrity test for each relevant aspect, that is, decisions must be properly informed to the extent possible by the possible level of effectiveness of the scheme design in reducing emissions. 4.5.4.4 Cap setting and allowance allocation The comparison among the three schemes discussed herein shows that political pressure at the national level can be much more successful in shaping the legislation due to the importance of certain economic sectors in the overall national economy. As a result, the criteria for both cap setting and allowance allocation should not sacrifice the 204 credibility or integrity of the scheme. ETS proponents must be prepared for a political bargaining process that does not jeopardize the foundations of the scheme, which must include effective reduction of greenhouse emissions. In this regard, a careful identification of possible major players in the political process and a sound investment in responsible, transparent, and well-informed rulemaking negotiations is extremely important. 4.5.4.5 Linking and ETS Efficiency and International Cooperation The design options of an ETS should facilitate linking to the largest extent possible. In this regard, the EU ETS, CPM and NZ ETS experience shows that certain design elements must be present in order to allow future linking without demanding structural changes in the original design. Major structural changes are sometimes impossible to be achieved politically or technically. Rather, linking should be effectively and responsibly designed, in order to avoid the development of an ETS whose contribution to reducing emissions domestically is minimal, as has been the case of the NZ ETS so far. The issues considered above will inform the discussions of the final chapters of this thesis, which will confront the experience of the emerging ETS herein discussed with the Brazilian social-economic reality, greenhouse emissions profile, and the legal framework devoted to implement the country’s climate change policy. The next two chapters devoted to the Brazilian GHGs emission profile and climate change regime will cover these characteristics inherent to the Brazilian context. 205 CHAPTER V – THE BRAZILIAN CLIMATE CHANGE PROFILE 5.1 Introduction This chapter examines the Brazilian GHG emissions profile and its contribution to global climate change. Initially, it will briefly address major Brazilian social- economic and environmental indicators. The chapter will go on to examine the Brazilian greenhouse gas emissions profile and corresponding major driving forces considering the country’s main economic sectors and development dynamics. The analysis under this chapter will be complemented by the next chapter’s review of the current Brazilian climate change regime put in place to meet the country’s greenhouse mitigation challenges. Together, they provide the basis for subsequent discussions of this thesis on major challenges and opportunities for GHG mitigation in Brazil, and the national characteristics that may or may not favour the implementation of a Brazilian Emissions Trading Scheme. This chapter will show how the current Brazilian GHG emissions profile is still, for the most part, a product of the country’s early development history, in particular of the country’s occupation of the lands in the Central-West and North. This occupation has been largely driven by a mix of state development central planning (intensified in the 1960s and 1970) and large-scale exploitation of natural resources by national and international economic agents. In parallel, there was also occupation resulting from more spontaneous forms of interaction between the native population and settlers from different origins. Further, the pattern established by the late industrialization process can still be felt in the energy-intensive industry base and in the low technological innovation level of the industry and scientific community. Apart from that, the country hosts one of the most productive agribusiness in the world, formed by national groups, family-owned businesses, and the largest world commodities business groups. This unruly development pattern has produced considerable economic gains for the country, but also one of the most socially unequal societies in the world. Inequality is mirrored by the poor rates in income distribution, access to basic education, and access to healthcare. Equally alarming are the country’s high rates of corruption. Another aspect worth noting is Brazil’s legal culture, where sometimes-sophisticated laws and policies go hand in hand with low levels of compliance. It is this complex and dynamic social, economic, and ecological system, formed by a highly mixed, daring, and creative 206 population, whose unique cultural pattern is still being forged,1 that serves as a backdrop for Brazil’s GHG ‘emissions profile’ addressed below. In this approach, as indicated in chapter I, section 1.4.2 the thesis innovates by identifying the Brazilian’s emission profile beyond the traditional boundaries of simply linking the major greenhouse gases with certain sectors of the economy of a given country on a limited and static way. In fact, the thesis’ approach expands the concept of ‘emissions profile’ to include key elements of the dynamics of Brazilian development, social- environmental conditions, and legal culture. This analysis will reveal certain cultural aspects with more direct link to the legal realm, such as high rates of corruption, the pattern of still unresolved land tenure matters in vast portion of the country (particularly in the North) and a unique set of enforcement and compliance standards and culture. Those legal related matters will be identified in this chapter in the context of providing a more accurate exam of how law should address the pattern of GHGs emissions in Brazil considering the country’s inherent social, cultural and economical characteristics, in support of the integrative analysis that will follow in chapters VI, VII and VIII, particularly in sections 6.4.2.1, 6.4.2.2, 6.4.2.4, 6.5, 7.3 and 8.3.1.2. However, in depth analysis of some of those important legal issues is beyond the scope of the thesis, although the discussion herein provided will be useful to advance future lines of research. The initial analysis on the country’s GHG emissions profile will be largely based on the Brazilian Second National Communication to the UNFCCC in October 2010 and the corresponding emission inventory,2 and the last government’s update on the country’s emission inventory of 2013 and 2014,3 complemented by related studies produced by McKinsey & Company4 and the World Bank.5 The official inventories of 1 Darcy Ribeiro, O Povo Brasileiro: A formação e o sentido do Brasil (Companhia das Letras, 2011) 452–5. 2 Ministry of Science and Technology of Brazil (MCT) – General Coordination on Global Climate Change, Second National Communication of Brazil to the United Nations Framework Convention on Climate Change (Brasilia, 2010) 3 Ministério da Ciência, Tecnologia e Inovação (MCTI) – Secretaria de Políticas e Programas de Pesquisa e Desenvolvimento (SEPED) e Coordenação Geral de Mudanças Globais do Clima (CGMC), Estimativas anuais de emissões de gases de efeito estufa no Brasil (Brasília, 2013) (‘2013 Brazilian GHG Inventory’) 4 McKinsey & Company, ‘Pathways to a Low-Carbon Economy for Brazil’ (Special Report, McKinsey & Company, 2009). 5 Christophe de Gouvello (Lead Author), Brazil Low Carbon Country Case Study (The World Bank, 2010). 207 2010 and 2013 cover GHG emissions from 1990–2005, 1990–2010, respectively.6 These studies sometimes present differences in methodology and data sources, which will be highlighted when relevant for the chapter’s purposes. In any event, the technical guidelines for the GHG inventories are largely based on the reporting methodologies established by the IPCC.7 Moreover, most of the analyses on projected emissions and mitigation alternatives mirror the voluntary emission reduction targets announced by the Brazilian Government in COP-15.8 Such voluntary reduction targets range from 36.1 per cent to 38.9 per cent in relation to business-as-usual projected emissions for 2020 under scenarios of five per cent and six per cent GDP growth. The reduction targets and the corresponding proposed axis of actions to meet them were consolidated in a National Climate Change Plan9 that formed the basis of the subsequent National Climate Change Policy incorporated as a federal law in 2009,10 as further discussed in the next chapter. 5.2 Country Profile Brazil is the largest country in South America and the fifth in the world with an area of 8 514 876.6 km2.11 Brazil is politically organized as a Federal Republic with 26 states and 5 565 municipalities.12 In addition to a highly multi-racial13 population of 6 MCT, Second National Communication, above n 2; MCTI, ‘2013 Brazilian GHG Inventory’, above n 3. 7 MCT, Second National Communication, above n 2, 130. 8 Conference of the Parties of the UNFCCC held in Copenhagen, Denmark, on 7-18 December of 2009. 9 Governo Federal – Comitê Interministerial Sobre Mudança do Clima, Plano Nacional sobre Mudança do Clima – PNMC (Brasilia, Dezembro de 2008). An English version of the PNMC Executive Summary is available online 10 Federal Law No.12.187, of December 29, 2009 (‘National Climate Change Policy Law’) and Federal Decree 7.390 of December 9, 2010. 11 MCT, Second National Communication, above n 2, 66. 12 Ibid. 13 As indicated by the official website of the Brazilian Government, ‘studies show that most of the Brazilian population is genetically mixed, and even some of the population that is officially considered to be white has some African and Native Brazilian genetic lineage, 208 more than 200 million people14, Brazil also possesses an extremely diversified fauna and flora, and ‘an extraordinary mosaic of ecosystems.’15 FIGURE 1: BRAZIL SOCIAL-POLITICAL DIVISION.16 as well as the European element.’ See 14 200,4 million in 2013. The World Bank, Data by Country, Brazil, 15 MCT, Second National Communication, above n 2, 66. 16 MCT, Second National Communication, above n 2, 67 209 Known as one of the ‘megadiversity countries’ in the world,17 Brazil contains over a third of the Earth’s tropical forests in the Amazon biome, in addition to other large and important biomes: Cerrado, Caatinga, Pantanal Wetlands, Atlantic Forest, Southern Fields, and the Coastal Zones, and respective transition areas.18 FIGURE 2: BRAZIL BIOMES.19 Some of biomes have fragile ecosystems.20 A country of continental proportions, Brazil has diverse rainfall and temperature regimes, resulting in ‘great variety of 17 ‘Megadiversity countries’ is a term used to refer to the world’s top biodiversity-rich countries in the world. See R.A. Mittermeier, ‘Primate Diversity and the Tropical Forest: Case Studies from Brazil and Madagascar and the Importance of the Megadiversity Countries’ in E.O. Wilson (Editor), Biodiversity (National Academy Press, Washington, DC, 1988) 145-154; see also R.A. Mittermeier, P.R. Gil and C.G. Mittermeier, Megadiversity: Earth’s Biologically Wealthiest Nations (Conservation International, Cemex, 1997). 18 MCT, Second National Communication, above n 12, 10-11 and 106-118. 19 Ibid 365. 20 Ibid 114. 210 climates with distinct regional characteristics.’21 As such, Brazil is home to one of the most abundant basins of freshwater resources in the world.22 At the same time, around 1 million km2 of Brazil’s territory is prone to desertification.23 Most of the dry areas are located in the Northeastern semi-arid region. With nearly 32 million inhabitants, this area is the ‘most populous dry region in the world.’24 Brazil has an unbalanced demographic density. In part, the lack of balance reflects the historical colonization process: around 42 per cent of the population is concentrated in the Southeast. The Northeast ranks second (28 per cent of the population), followed by the South (14.5 per cent), the North (8 per cent), and the Central-West region (7.5 per cent).25 As many developing countries, Brazil’s population is highly concentrated in urban areas (around 85 per cent of urbanization rate).26 21 Ibid 10. 22 Ibid 71. 23 Ibid 115-17. 24 Ibid 115. 25 Ibid 66. 26 Ibid. 211 FIGURE 3: DEMOGRAPHIC DENSITY IN BRAZIL 27 These unique and diverse physical, climatic, and demographic characteristics add to the complexity and dynamics of the country’s social-economic system. With a Gross Domestic Product (GDP) of USD2253 trillion in 201228 and USD2246 trillion in 2013,29 Brazil has ranked among the world’s fifth to eighth wealthiest economies in the last years. However, despite continuous improvement in the last 15 years with respect to income distribution, in terms of access to education and healthcare, and other social development indexes,30 Brazil still has one of the worst income distribution and social 27 Ibid 67. 28 The World Bank, ‘Country Profile, Brazil Overview’, 29 The World Bank, ‘Brazil – Country at a Glance’ 30 The World Bank, Brazil ‘Country Profile’, above n 28. 212 inequality rates, with a Gross National Income (GNI) per capita (formerly Gross National Product per capita) of USD 11,690 in 2013.31 According to the United Nations Human Development Report, in 2013 Brazil achieved a Human Development Index (HDI) value of 0.744, ranking 79th out of 187 countries and territories.32 Another important measurement of the social challenges Brazil face despite its cultural and economic dynamism is the rate of perception of corruption in the country. In 2013, Brazil scored 42 and ranked 72nd out of 177 countries in the International Transparency Association’s Corruption Perception Index (CPI).33 Since the CPI scores scales go from 0 (very clean) to 110 (highly corrupt),34 the Brazilian situation in terms of corruption perception shows that much has to be done to overcoming this social problem in the lives of Brazilians.35 According to some sources, the corruption problem, 31 The World Bank, ‘Data by Country, Brazil’, For the current 2015 fiscal year, low-income economies are defined as those with a GNI per capita, calculated using the World Bank Atlas method, of USD 1,045 or less in 2013; middle-income economies are those with a GNI per capita of more than USD 1,045 but less than USD12,746; high-income economies are those with a GNI per capita of USD12, 746 or more. Lower-middle-income and upper-middle-income economies are separated at a GNI per capita of USD 4,125. The World Bank, Country and Lending Groups 32 According to the UNDP Human Development Report 2014, ‘(B) between 1980 and 2013, Brazil’s HDI value increased from 0.545 to 0.744, an increase of 36.4 per cent or an average annual increase of about 0.95 per cent. United Nations Development Program – UNDP, Human Development Report 2014, Sustaining Human Progress: Reducing Vulnerabilities and Building Resilience – Explanatory note on the 2014 Human Development Report composite indices, Brazil (UNDP, 2014). 33 The CPI ranks countries according to the perception of corruption in the public sector; it is an aggregate indicator that combines different sources of information about corruption, making it possible to compare countries. See 34 Ibid. 35 Apart from the CPI, ‘several studies indicate that corruption and bribery pose serious obstacles to doing business’ in Brazil’ including ‘The 2012 Index of Economic Freedom’ published jointly by The Heritage Foundation and the Wall Street Journal, ‘The World Economic Forum’s Global Competitiveness Report’ and ‘The World Bank / International Finance Corporation 2009 Enterprise Survey’. According to The World Economic 213 although present in every country around the world, still reaches levels considered ‘inadequate’ in Brazil in comparison with current average ‘acceptable’ international standards.36 In part, this problem derives from the combination of cultural and social structural factors. On one hand, a cultural heritage of the private-public relations of colonial times, which were construed based on personal relations and exchange of favours between public officials and landowners. On the other, a heavily bureaucratic public administrative system that contributes for the searching of shortcuts by entrepreneurs and creation of red tape obstacles by some public officials; in addition to an extremely inefficient judicial system, due to procedural hurdles raised by the laws governing judicial proceedings, and structural problems at several instances.37 This perverse combination, among other factors, has historically created a sense of impunity in many layers of Brazilian society involved in corruption, as well as a ‘lax attitude’ or resignation on the part of remaining majority of Brazilians.38 In the last decade, however, the mobilization of Brazilian civil society against government inefficiencies, the structural problems of the courts, and corruption practices, has increased steadily.39 Part of this anti-corruption sentiment in Brazil has been triggered by ‘grassroots’ movements of Brazilian civil society, which have mobilized protests and other forms of pressure against the political establishment demanding effective measures to clean the country from this social disease.40 At the same time, more organized sectors, such as the business community, have estimated the financial and Forum Competitiveness report, corruption is among the most “problematic factors” for doing business in Brazil, ranking just below taxes, inadequate infrastructure, and government inefficiency. Frederick T. Stocker, ‘Anti-Corruption Compliance in Brazil: Addressing a Daunting Challenge’ (MAPI Policy Analysis, March 2012), 5 36 Stocker, ‘Anti-Corruption Compliance in Brazil’, above n 35, 4. 37 Ibid 5. For a more detailed analysis of the major theories on possible roots of Brazilian corruption according to Brazilian social scientists, see Fernando Filgueiras ‘A tolerância à corrupção no Brasil: uma antinomia entre normas morais e prática social’, (2009) 15 (2) Opinião Pública, 386-421 38 Stocker, ‘Anti-Corruption Compliance in Brazil’, above n 35, 4. 39 Bertelsmann Stiftung’s Transformation Index (BTI) 2014 – ‘Brazil Country Report,’ 8 40 Ibid; Stocker, ‘Anti-Corruption Compliance in Brazil’, above n 35, 6. 214 economic losses that corruption has imposed on the country’s economy41 and pushed for administrative and legislative reforms. As a result, the legislation restricting political activities of candidates involved in corruption, the series of investigations against members of the judicial and political systems, and other significant legal reforms, are measures that have attracted strong support from Brazilian society.42 Legal reforms include major amendments towards optimizing the civil and criminal rules of procedure, and judicial policies incentivizing alternative dispute resolution alternatives in the court system.43 Also, a new law has been introduced establishing sanctions against legal entities involved in corruption activities and incentivizing the implementation of legal compliance management systems and more transparent accounting systems (aligned with the US and European Anti-Bribery and Foreign Corruption Acts).44 These recent legal reforms have driven a significant mobilization of corporate representatives, business associations, and legal service providers to foster good governance and compliance practices. 5.2.1 Legal Compliance and Enforcement Culture and Infrastructure Anti-corruption measures are a precondition for good climate change governance,45 as for any other kind of policy. The corruption factor is intrinsically 41 A study published by the São Paulo State Industry Federation in 2010 reported that Brazil loses between1.38 to 2.3 per cent of GDP to corruption on a year basis (between USD26 billion and USD43 billion). Stocker, ‘Anti-Corruption Compliance in Brazil’, above n 35, 3 and note 9. 42 Ibid. 43 Kazuo Watanabe, ‘Modalidade de Mediação’ (2010) 22 Série Cadernos do CEJ, 42; Federal Bills of Law 7169/2014 and 7108/2014. 44 Federal Law 12.846 of August 1, 2013. 45 This co-relation has received some special attention from policy authors and institutions in the last years. See Transparency International, ‘Corruption risks and mitigating approaches in climate finance’ (U4 Expert Answer, January 14, 2014) linked to all the other social aspects that need to be taken into account before introducing any policy in Brazil, in our case a climate change policy. The first aspect to be considered is the nature of the legal compliance culture (or ‘culture of legality’) 46 in Brazilian society, in particular in the regulated community potentially affected by an emissions trading or any other climate change policy. The second aspect is the country’s enforcement infrastructure, that is, the overall quality of the legal norms in place and the levels of effectiveness and implementation at the administrative and judiciary levels. As a result, this thesis argues that some sort of appraisal of the compliance culture and ‘rule of law’47 standards in Brazil must be carried out to inform the analyses on the best policy approach to mitigate GHG emissions in the country. Such analyses shall be used to identify the necessary ‘interconnected cluster of values’ and the most suitable ‘institutional design’48 to achieve the policy goals. The Brazilian circumstances on this front are also complex because of the country’s inconsistent pattern of quality of its legal texts, ranging from innovative, ambitious, and clear constitutional provisions to certain infra-constitutional legislation that sometimes present a very poor legislative technique.49 In other cases, the legal norms introduce legal mandates completely divorced from the institutional or administrative infrastructure that is essential to translate them into a reality.50 This situation has been interpreted as a trend of ‘symbolic legislation’ that, apart from governance/dg-publications-for-website/staying-on-track--tackling-corruption-risks-in- climate-change/Staying_on_Track_corruption_risk_in_CC.pdf>. 46 The term ‘culture of legality’ is described by Augusto Zimmermann as ‘society’s broad recognition that respect for law must become a basic standard for human behaviour.’ Augusto Zimmermann, ‘The Rule of Law as a Culture of Legality: Legal and Extra-legal Elements for the Realisation of the Rule of Law in Society’, (2007) 14 (1) Murdoch University Electronic Journal of Law, 10 quoting Herbert L. A. Hart, Concept of Law (Oxford University Press, 1961), 116. 47 As pointed out by Zimmermann, ‘regardless of which conception of the rule of law is embraced, its practical achievement may require a proper culture of legality.’ Ibid 24, citing Jazon Mazzone, The Creation of Constitution Culture, (2005) 40 Tulsa Law Review 671. 48 Martin Krygier, ‘Rule of Law’ in N.J. Smelser and P. B. Baltes (eds) International Encyclopedia of the Social & Behavioral Sciences (Elsevier 2001), 13404, apud Zimmermann, ibid, 25. 49 Celso de Barros Correia Neto, ‘Direito Ambiental Simbólico?’ (2009) 53 Revista de Direito Ambiental 127 50 Ibid. 216 introducing strict, innovative, and sometimes far-reaching concepts and mandates, has been met with poor voluntary compliance by the regulated community and little enforcement by the corresponding authorities.51 One exception to the poor enforcement is the increasing importance of the role played by District Attorney Officers in compelling observance of environmental legislation at the judicial level and through sweeping investigative proceedings. Such investigations usually culminate in consent agreements or other forms of negotiated commitments for the implementation of corrective actions by the regulated entity.52 In any event, the overreliance on judicial enforcement needs to be decreased in order to allow the country to attain higher levels of compliance, particularly because of the structural failures of the Brazilian Judiciary, which fails to provide speedy and effective responses to the millions of lawsuits filed yearly.53 Another important element to the introduction of a new policy is considering the ways to deal with the weak culture of legality in Brazil. In other words, it is crucial to deconstruct the pervasive ‘law of impunity’, that is, the socially defined rule that creates a comfort zone for those who do not feel compelled to comply with the law due to their confidence in not being penalized by the enforcement authorities because of their powerful economic position or political influence.54 This is particular important in the necessary strict enforcement of the laws curbing activities that may cause GHG emissions in Brazil, in particular enforcing the protection of native forests under the New Forest Code against the powerful agribusiness sector. The history of the low compliance levels of the Forest Code, that lead to its recent legislative reform, is a good example of how the Brazilian compliance culture of ‘impunity’ by privileged sectors may jeopardize the use of offsets from agricultural activities as part of the design of a Brazilian ETS. As stated in the introduction to this thesis, the Brazilian national circumstances highlighted above show that Brazil combines, in the same and one country, environmental challenges and opportunities of both developed and developing nations. As a result, the implementation of climate policies in Brazil (including an ETS or any 51 Ibid. 52 For a good analysis of this matter in the international literature, see Lesley K. McAllister ‘On Environmental Enforcement and Compliance: A Reply to Professor Crawford’s’ Review of Making Law Matter: Environmental Protection and Legal Institutions in Brazil’ (2009) 40 The George Washington International Law Review 649. 53 Augusto Zimmermann, ‘How Brazilian Judges Undermine the Rule of Law: A Critical Appraisal’ (2008) 11 International Trade and Business Law Review 179. 54 Zimmermann, ‘The Rule of Law as a Culture of Legality’ above n 46, 28-9. 217 other form of pricing mechanism) must master not only the elements inherent to the policy alternatives provided by the literature and also emerging experiences elsewhere but also those peculiar to the complex and rich national context of Brazil. The following sections will provide additional elements for an enhanced understanding of the national circumstances in the context of climate change, by identifying the GHG emissions per sector as provided by the national inventories. Moreover, the sections below will also contextualize the development dynamics responsible for emissions so far, which certainly will influence the country’s future emissions trajectories. 5.3 Brazil and Climate Change 5.3.1 Brazil GHG emissions Profile55 Brazil presents a unique GHG emissions profile in contrast to other large economies of the world. Brazil is ranked among the largest emitters of CO2 globally (the fourth largest emitter according to one recent account) when land-use based emissions are taken into account.56 However, the country’s GHG emissions drop dramatically when land-use based emissions are not considered, showing the critically large share deforestation and agricultural emissions represent to the country’s emission profile.57 This pattern also points out the outstanding records of Brazil in terms of the renewable energy contribution to its energy matrix. Contrary to most large economies, Brazil houses one of the highest ratios of clean electric energy sources, due to its huge 55 This sub-section will use the emissions figures from 2005 and 2010 as displayed by the Brazilian Inventories coordinated by the Federal Government. It will also rely on other sources with respect to the discussion on the main drivers of the national emission profile, particularly with respect to land-use change related activities. 56 H Damons Matthews et al, ‘National Contributions to observed global warming’ (2014) 9 Environmental Research Letters 014010 57 MCT, Second National Communication, above n 2, 136 and 147. 218 hydropower system, in addition to a very successful biofuel program based on sugarcane ethanol.58 5.3.1.1 Brazilian GHG emissions Inventory as per the Second National Communication to the UNFCCC/ Emission Profile: 1990–2005 In October 2010 the Brazilian government submitted the Second National Communication of Brazil to the UNFCCC, in accordance to its communication requirements and additional guidelines for communications by non-Annex I countries.59 The Brazilian GHG inventory presented in the second national communication (the 2010 Brazilian Inventory)60 covers the 1990–2000 period as per UNFCCC guidelines, and presents additional preliminary data on emissions of the year 2005.61 The 2010 Brazilian Inventory consolidates the works of 18 reference reports and additional expert’s contributions.62 It covers the following gases for each relevant emission or removal (when applicable) sources: carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), plerfuorcarbons (PFCs), sulphur hexafluoride (SF6) and ‘indirect greenhouse gases’, such as nitrogen oxides (NOx), carbon monoxide (CO) and other non-methane volatile organic compounds 58 MCT, Second National Communication, above n 2, 17-8. 59 Ibid 10. As per the UNFCCC guidelines, the national communication to the UNFCCC is comprised of five parts: overview of the national circumstances (country natural, social, and economical characteristics and developmental challenges and priorities), inventory of GHGs emissions, implementation strategies for mitigation and adaptation, additional measures for achievement of the UNFCCC objectives (for example, transfer of technology, research and systematic observation, education, public awareness, capacity building) and financial, technical and capacity needs for the elaboration of the national communication. UNFCCC, art 4, para 1 (a) and art 12. See also UN Doc Decision 17./CP.8, ‘Guidelines for the preparation national communications from parties not included in Annex I to the Convention.’ 60 The Brazilian Inventory of Anthropogenic Emissions by Sources and Removals by Sinks of Greenhouse Gases not Controlled by the Montreal Protocol. MCT, Second National Communication, above n 2, 130-264. 61 This set of data is a remarkable contribution for the analysis on the Brazilian profile of GHGs emissions, since most of the analysis developed up to early 2010 had to largely rely on the inventory of the first national communication of Brazil, the coverage of which was restricted to the 1990-1994 periods. This is the case of the McKinsey & Co. and the World Bank reports commented above. 62 MCT, Second National Communication, above n 2, 10. 219 (NMVOC).63 Following the reporting structure suggested by the Intergovernmental Panel on Climate Change (IPCC), the Brazilian Inventory covers greenhouse gas emissions from the following sectors: energy, industrial processes, solvent and other product use, agriculture (including livestock), land-use change and forestry, and waste.64 This chapter will discuss in more detail the emissions patterns of the following sectors: land-use, agriculture, energy and industry, because they hold the largest share of the country’s emissions pie. 5.3.1.1.1 Aggregate Emissions and Emissions by Sectors as of 2005 The Brazilian aggregate GHG emissions for 2005 were estimated at 2 192 601 Gg CO2eq based on the Global Warming Potential (GWP) 100 metrics recommended by the IPCC for national emission inventories.65 In 2013, the 2005 emissions were revised by the Brazilian Government to 2 032 260 Gg. CO2eq.66 For 2005 (Figure 5), there was a net anthropogenic GHG emissions growth of 57.84 per cent in relation to the year 1990.67 In the same period, the Brazilian population increased by 24.4 per cent, and the Brazilian GDP increased by 46.69 per cent.68 The land-use and forestry sector is responsible for the largest volume of Brazilian GHG emissions (60.6 per cent), followed by agriculture (19 per cent), energy (15 per cent), industrial processes (3.6 per cent) and waste (1.9 per cent).69 When considered in aggregate with agriculture direct emissions, land-use based emissions in 63 Ibid 11. Indirect gases are those that do not directly absorb or emit infrared radiation but influence chemical reactions that occur in the atmosphere which, in turn, result in the increase of the greenhouse effect. Ibid 130 and 143. 64 Ibid 130. 65 Ibid 16. One gigatone is equal to one thousand tons. Ibid 46. CO2e stands for Carbon Dioxide Equivalent. Ibid 44. 66 MCTI, Estimativas anuais de emissões de gases de efeito estufa no Brasil‘2013 Brazilian GHG Inventory’, above n 3, 11. 67 Ibid. 68 Ibid. 69 MCT, Second National Communication of Brazil, above n 2, 147. 220 Brazil amounts to nearly 80 per cent of the country’s emissions as of 2005.70 This classification by sector is based on UNFCCC guidelines followed by the Brazilian Inventory. However, an integrated analysis of both land-use/forestry and agriculture sectors as depicted in the same charts below (Figure 5) shows that almost 80 per cent of the Brazilian emissions are related to land-use activities, a pattern that was repeated in the emissions calculated for the 2005-2010 period.71 Apart from the critical role of land-use activities in Brazilian emissions profile, one cannot disregard the considerable role played by the high-energy intensive Brazilian industrial sector (including iron and steel, chemical, mining, and cement),72 both as direct emitters of industrial gases as well as the largest energy consuming industries (fossil-fuel sources, such as oil and natural gas, in particular).73 Likewise, the dominance of road transport and the high urbanization rates pose an additional challenge for the mitigation of the country’s GHG emissions trajectories, regardless of the success of the ethanol program.74 Added to this prospective scenario is Brazil’s challenge in meeting its increasing demand for energy, without jeopardizing the high share of renewable energy in its energy matrix. In case hydropower continues to be relied upon as the major source for increasing the country’s electricity generation capacity, this kind of growth cannot take place without affecting other important sustainable indicators (such as biodiversity and genetic resources) because significant hydropower potential are located in highly forested areas.75 However, due to the high 70 Ibid. 71 MCTI, Estimativas anuais de emissões de gases de efeito estufa no Brasil (2013 Brazilian GHG Inventory) above n 3, 12. 72 McKinsey & Company, ‘Pathways to a Low-Carbon Economy for Brazil above n 4, 16-7 and 20; Mauricio Francisco Henriques Junior, Potencial de Redução de Emissão de Gases de Efeito Estufa pelo Uso de Energia no Setor Industrial Brasileiro, (PhD Thesis, UFRJ/COPPE, 2010) 40 73 In fact, the low ranking of industrial processes in the Brazilian inventory of GHGs emissions (3.6 per cent of total emissions) masks the overall contribution of this sector to the emissions profile due to the methodology used (since industrial emissions from fossil-fuel burning from stationary sources and transportation are factored in the energy sector emissions). 74 Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’, above n 5,18-9. 75 João Leonardo da Silva Soito and Marcos Aurélio Vasconcelos Freitas, ‘Amazon and the expansion of hydropower in Brazil: Vulnerability, impacts and possibilities for 221 proportion of land-use related greenhouse emissions, Brazil is considered by many to be among the five countries in the world with the largest potential to lower its GHG emissions profile.76 5.3.1.2 Brazilian 2013 Annual GHG Emissions Estimates/ Emissions Profile: 2005– 2010 In September 2013, the Brazilian Government published the first annual GHG emissions estimate, in accordance with Federal Decree No 7390 of 9 December 2010 that imposed this annual obligation from 2012 onwards.77 The 2013 Emissions Estimates were produced consistently with the methodology used for the 2010 Emissions Inventory and covered emissions for the period between 2005–10.78 Accordingly, in 2010, the Brazilian Aggregate GHG emissions were 1 246 477 GgCO2e, decreasing by 38.7 per cent in relation to the 2005 emissions.79 The largest emissions reduction occurred in the land-use sector (particularly as a result of a decrease in deforestation rates in the Amazon Biome), and emission increases were more significant in the energy sector and in agriculture direct emissions. Accordingly, agriculture direct emissions were responsible for the largest volume of Brazilian GHG emissions in 2010 (35 per cent), followed by energy (32 per cent), land-use and forestry (22 per cent), industrial processes (seven per cent), and waste (four per cent). Based on Brazilian Government data on 2005–2010 emissions, the overall increase in the emissions of the electric energy sector is mainly a result of the combination of environmental restrictions on approval of new large hydropower plants and an increase in coal-fired thermal plants, as stated in the Brazilian National Energy Plan.80 A slight decrease in the emissions from the energy sector in 2009 reflected the impacts on Brazil caused by the 2008 international economic downturn, i.e., the adaptation to global climate change’ (2011) 15 Renewable and Sustainable Energy Reviews 3165, 3171. 76 McKinsey & Company, ‘Pathways to a Low-Carbon Economy for Brazil’, above n 4, 3. 77 MCTI, Estimativas anuais de emissões de gases de efeito estufa no Brasil (2013 Brazilian GHG Inventory) above n 3, 7. 78 Ibid. 79 Ibid. 80 Ibid. 222 international financial crisis following the outbreak of the ‘U.S. subprime crisis’ in August 2007, which caused an overall decrease in consumption of fossil fuels.81 The international crisis also led to a decrease in emissions from the industrial sector, especially from the iron and ore sector. On the other hand, emissions decrease from the chemical sector is partially credited to the development of CDM projects under the Kyoto Protocol, mainly in relation to adipic and nitric acids.82 The increase of emissions in agriculture is largely credited to the methane emissions from the enteric fermentation of bovines, the population of which faced a slight and punctual decrease in 2007 but has experienced steady growth since then.83 The more significant change in relation to the 2005 emissions came from the land-use and forestry sector. Largely due to the success of enforcement actions and other programs in the Amazon and to a lesser extent in the Cerrado biomes (as discussed in the next chapter), the 2010 emissions data presented a 38 per cent decrease in relation to the previous period (the sector’s participation in the national overall emissions dropping from 57 per cent to 22 per cent).84 As mentioned earlier, an integrated analysis of both land-use/forestry and agriculture sectors as depicted in both charts below (Figure 5) show that almost 80 per cent of the Brazilian emissions are related to land-use activities. However, in 2010 agriculture direct emissions were higher than land-use and forestry, as opposed to land-use and forestry’s largest share in 2005. 81 Ibid 14; International Monetary Fund, ‘World Economic Outlook 2009: Crisis and Recovery’, (IMF, April 2009), 2 82 MCTI, Estimativas anuais de emissões de gases de efeito estufa no Brasil (2013 Brazilian GHG Inventory) above n 3, 14. 83 Ibid 15. 84 Ibid 16-7. 223 FIGURE 4: VARIATION OF EMISSIONS PER SECTOR, 2005–10.85 5.3.2 Key Dynamics of Brazilian GHG Emissions History and Trajectories The emissions profile provided above cannot be fully captured by any mitigation approach without some level of consideration of its dynamics, that is, of the major driving forces within the country’s development history and current insertion in the global economy, and the resulting synergies. Although a thorough analysis of this sort is far beyond the scope of this thesis, it is assumed that some indication of these dynamics must be taken into account to provide support for the analysis that will follow aimed at achieving optimal approach of an ETS into the Brazilian climate change response. In particular, it is necessary to consider how (from a structural and functional level) an emissions pricing mechanism in Brazil will be able to deal with some of these development dynamics, especially in terms of defining: the scheme’s coverage, the preferred approach to deal with land-use based emissions, and the possibilities of linking with other national or international pricing mechanisms. 85 Ibid 12. 224 5.3.2.1 Land-Use and Agriculture The land-use and forestry sector emissions are largely driven by CO2 emissions from deforestation in the Amazon biome (67%) and Cerrado biome (22%). The land use and forestry sector also accounts for CH4 and N2O emissions derived from the burning of biomass left in the field after forest conversion.86 An account of the land-use emissions profile in Brazil, particularly in relation to the major Amazon and Cerrado biomes, cannot be made without a contextual analysis of the development history of these regions. Although it is beyond the scope of this thesis to provide an in-depth analysis of this complex and rich subject, the next paragraph will point out some of its major characteristics. The goal is to provide support for the further discussions on the major driving forces for deforestation in Brazil and the proposed measures to mitigate them. In particular, the goal is to enable the country’s environmental, social and economic peculiarities are identified and taken into consideration when deciding to adopt an ETS. It is understood that some economic and development models and proposed mitigation strategies that may be applied to the Amazon lack certain fundamental variables about the complex historical, ecological, and social-economic dynamics of the region. The result is usually an unrealistic portrait of the driving forces and dynamics of deforestation. As a result, some economic models supporting pricing mechanisms for reforestation or forest conservation activities rely almost exclusively on theoretical calculations of ‘opportunity costs’ of low-income activities that cause deforestation.87 In these models, deforestation activities could be easily replaced by competing financing instruments, such as carbon pricing or payment for environmental services, the costs of which would be much lower than mitigating activities in developed countries. However, the dynamics of deforestation in the Brazilian Amazon and Cerrado show a much more complex ‘social-ecological system’88 in what is considered today one of the last 86 MCT, Second National Communication, above n 2, 15. 87 See Peter May, Britaldo Silveira Soares-Filho and Jon Stand ‘How Much is the Amazon Worth? The State of Knowledge Concerning the Value of Preserving Amazon Rainforests’ (World Bank Policy Research Working Paper No. 6688, October 1, 2013) 88 Used here as systems ‘in which people depend on resources and services provided by ecosystems, and ecosystem dynamics are influenced, to varying degrees, by human activities.’ F.Stuart Chapin III, Carl Folke and Gary P. Kofinas, ‘A Framework for Understanding Change’ in F. Stuart, III, Carl Folke and Gary P. Kofinas (editors), Principles of Ecosystem Stewardship: Resilience-Based Natural Resource Management in a Changing World (Springer, 2009) 6. 225 development frontiers89 of the world. It is within this complex reality that – to the extent possible – a ‘pattern of development’ must be devised in order to enable more fruitful discussions on possible strategies to lower the current GHG footprint. The analytical approach proposed in this study is particularly important for the crucial understanding of the patterns of land use in Brazil, particularly in relation to the development frontier of the vast Amazon and Cerrado biomes which apart from accounting for a large share of land use emissions are equally extremely complex in terms of their social and ecological context. Both biomes hold one of the largest biodiversity basin and carbon stocks in the world. At the same time, they host an extremely dynamic land-use-based economy, and a consolidated population (more than 20 million people live in the Brazilian Amazon Region alone) mostly living in highly urbanized areas that still face major problems due to poor urban infrastructure and social inequalities.90 There is robust evidence supporting the prominent role of agriculture and livestock (mainly cattle grazing and soybean) and illegal logging as one of the major deforestation drivers in the Amazon.91 Since 1990, the statistics show a dramatic increase of the cattle grazing production in the Amazon, in addition to advancements of some specific crops such as soybean.92 As a result, the Legal Amazon93 hosts around 89 ‘Frontier’ is herein used as unexploited abundant land and natural resources. See Edward B. Barbier, Natural Resources and Economic Development (Cambridge, 2005) 76 and 97. 90 Bertha Becker, Amazônia, Geopolítica na Virada do III Milênio (Garamond, 2004), 29- 31; Jaqcques Marcovitch, A Gestão da Amazônia: Ações Empresariais, Políticas Públicas, Estudos e Propostas (EDUSP, 2011) 31-36; Carlos Walter Porto Gonçalves. Amazônia, Amazônias (Editora Contexto, 2001), 111-113. See also Simon Romero, ‘Swallowing Rain Forest, Cities Surge in Amazon’, The New York Times (online), 24 November 2012 91 Nobre, ‘Mudanças Climáticas e o Brasil: Contextualização’, above n 56, 12; Daniel Nepstad et al, ‘The End of Deforestation in the Amazon’ (2009) 326 Science 1350; Hilton Silveira Pinto and Eduardo Delgado Assad, Aquecimento Global e A Nova Geografia da Producao Agricola no Brasil (Embrapa/Unicamp, 2008), 21-2; Daniel C. Nepstad, Claudia M. Stickler, Britaldo Soares-Filho and Frank Merry, ‘Interactions among Amazon land use, forests and climate: prospects for a near-term forest tipping point’ (2008) Philosophical Transactions of The Royal Society, 7; Sergio Margulis, ‘Causes of Deforestation of the Brazilian Amazon’ (World Bank Working Paper No. 22, World Bank, 2004). 92 Pinto and Assad, Aquecimento Global e A Nova Geografia da Producao Agricola no Brasil, above n 91. 226 36% of cattle grazing and 39% of soybean production in Brazil. The same studies show that 73% of the more than 70 million heads of cattle herd in the Amazon occupy former forested areas.94 As shown in Figure 6 below, taken from the 2006 Agriculture Census of Brazil, the largest concentration of herds are in the centre-west and north regions, at the Cerrado and Amazon biomes and the respective transition areas. 93 The ‘Brazilian Legal Amazon’ encompasses the Amazon and large part of the Cerrado biomes. The concept of Brazilian Legal Amazon (usually referred by the national literature as Legal Amazon) was created and then expanded by a series of federal laws designed to implement development policies for the northern and part of western regions of Brazil (Federal Law 1.806 of January 6, 1953; Federal Law 5.173 of October 27, 1966; Complementary Law No. 31 of November 31, 1977). The Legal Amazon currently encompasses the states of Acre, Amapa, Amazonas, Para, Rondonia, Tocantins and a part of the states of Mato Grosso and Maranhao, corresponding to approximately 4.2 million km2. Of this total, the forest profile classes extend over 3.4 million km2. The Legal Amazon embraces the Amazon and part of the Cerrado (Brazilian Savanna) biomes. MCT, Second National Communication, above n 2, 34 94 MCT, Second National Communication, above n 2, 22, based on Instituto Brasileiro de Geografia e Estatistica – IBGE, Censo Agropecuario 2006: Dados Preliminares (IBGE, 2006). 227 FIGURE 5: SPATIAL DISTRIBUTION OF CATTLE HERD ACROSS THE BRAZILIAN TERRITORY, WITH AN EMPHASIS ON THE TEN TOP MUNICIPALITIES 2005.95 However, the development history of the Amazon Region96 suggests a much more complex scenario of ‘synergies between proximate causes and underlying driving forces’ for deforestation rather than the product of a ‘single key variable.’97 In fact, the 95 Ibid 77. 96 Unless otherwise differentiated in the text, the term Amazon Region will refer to the ‘Brazilian Legal Amazon.’ 97 Gabriel C. Carrero and Philip M. Fearnside, ‘Forest Clearing Dynamics and the Expansion of Landholdings in Apui, a Deforestation Hotspot on Brazil’s Transamazon Highway’, (2011) 16 (2) Ecology and Society 26 228 expansion of those land-use activities was a result of a concerted effort from federal public policies and programs for land occupation and social-economical integration of the Amazon Region.98 Those programs contained an entanglement of deforestation drivers such as highway and other infrastructures expansion, cattle grazing and agriculture, logging and colonization activities. Such activities were factored in sometimes-competing territorial occupation and development strategies and policies,99 implemented in a region of enormous biophysical and socioeconomic heterogeneity.100 Historically, such economy evolved from unsustainable patterns of land occupation and deforestation, constituting one of the classic examples of economic frontiers in development theory.101 As suggested above, the occupation history of these frontier lands was far from being spontaneous; it was taken since the colonial era as crucial for the formation of the country’s identity and territory unity.102 Furthermore, these lands have been subject to government geopolitical policies and planning since the mid 1950s (as illustrated by the Figure 7 below).103 98 The literature on possible driving forces for the Amazon deforestation, their underlying policies, mutual influence or allegedly leading role in the frontier occupation is robust. Some of those arguments and respective sources are discussed in the course of this chapter. For an extremely good summary of the main disputing arguments by some of the leading researchers in the region (mainly with respect to the effects of highway infrastructure vis-à-vis agricultural activities, see ‘Letters: Amazonian Deforestation Models’ in (2005) 307 Science 1043, 1043-46. 99 Bertha Becker, ‘Revisao das políticas de ocupação da Amazônia: é possivel identificar modelos para projetar cenarios? (2001) 12 Parcerias Estrategicas 135, 143. 100 The reference to the ‘enormous biophysical and socioeconomic heterogeneity’ comes from the Gilberto Camara et al, ‘Letters: Amazonian Deforestation Models’ above n 98, 1043-44. See also Ricardo Leonardo Rodrigues, ‘Driving Forces Acting on the Deforestation in the Brazilian Amazon’ (PhD Thesis, COPE/UFRJ, 2004). 101 Edward B. Barbier, Natural Resources and Economic Development above n 89. 102 Marcio Souza, Breve História da Amazônia (Marco Zero, 1994), 30, 51-69; Darcy Ribeiro, As Américas e a Civilização: Processo de formação e causas do desenvolvimento desigual dos povos americanos (Companhia da Letras, revised ed 2007) 202-3; John Hemming Tree of Rivers: The Story of the Amazon (Thames & Hudson, 2008) ch 2. 103 Golbery do Couto e Silva Conjuntura Política Nacional, O Poder Executivo & Geopolítica do Brasil – Coleção Documentos Brasileiros (Livraria José Olympio Editora, 1981) 46. The text titled ‘Geopolítica do Brasil’, where this figure comes from, was produced in 1952 by General Golbery do Couto e Silva (at the time an instructor from the Superior School of Military Studies and historically one of the main figures of Brazilian Military Government from 1964 to 1985). This study inspired the military government plans for the Amazon in the early 60s and 70s and the following 229 FIGURE 6: GEOPOLITICAL PLANNING Following the initial construction of the Belem-Brasilia highway, the most ambitious planning initiatives towards territorial occupation and regional integration of the Amazon started during the military government tenure in the mid sixties.104 Those transcription of Golbery’s thought about the Amazon summarizes one of the most important driving forces behind the major occupation plans that followed. According to Golbery, the Amazon is usually referred to as an ‘empty island’ or ‘empty desert’ that should be “inundated with civilization, starting from an advanced base established in the Centre-West, in a coordinated action with the East West progression in relation to the axis of the big river.” Ibid, 47. 104 The first major development and territory occupation plan from this era is the 1966-7 plan named ‘Operacao Amazônia e a Integracao Nacional’ (‘Amazon Operation and National Integration’), coordinated by then President General Humberto de Alencar Castello Branco. See Marcio Souza, Breve História da Amazônia above n 102, 159-162. For a detailed analysis of the implementation of the development and territory occupation plans in the Brazilian Amazon, see Daniel Monteiro Huertas, Da Fachada Atlântica à Imensidão Amazônica: Fronteira Agrícola e integração nacional (Annablume, Fapesp e Banco da Amazônia, 2009). 230 initiatives were part of a larger geopolitical plan for Brazil’s socio-economical integration. It included the construction of the new capital – Brasilia – in the centre- western region of the country, territorial occupation and defence of the country’s frontiers, and the absorption of migrants from the northeast region that had been struggling with intense droughts and extreme poverty.105 Using a range of tax incentives and credit policies,106 the government territorial occupation strategy’s centrepiece was the promotion of colonization projects and expansion of cattle production in the Region using the access and basic infrastructure resulting from the new roads construction.107 Large resources were also devoted to the expansion of infrastructure, mainly the construction of the Trans-Amazonian highway system, and later on large hydropower and mining complexes such as the Tucurui Hydro Power Plant, the Jari Agro-industrial project and the Carajas Mining Complex.108 Another important strategy of the Amazon development policy under the military government was the creation of an industrial manufacturing complex around the metropolitan area of Manaus, capital of Amazonas States, coupled with a duty-free zone for consumer goods.109 The development and territorial occupation of the Brazilian Amazon generated a pattern of heaviest deforestation in forming a band of clearer areas usually named as ‘deforestation arc’ or, as suggested by some authors focusing on the economic perspective, ‘arc of consolidated population’ (arco do povoamento consolidado)110 or 105 Souza, Breve História da Amazônia above n 102, 159-162. 106 MCT, Second National Communication, above n 2, 348; Rodolfo Coelho Prates, ‘O desmatamento desigual na Amazônia brasileira: sua evoluçãao, suas causas e consequências sobre o bem-estar’ (PhD Thesis, Universidade de São Paulo, Escola Superior de Agricultura Luiz de Queiroz, 2008). 107 Souza, Breve História da Amazônia above n 102, 161. According to this author, at the end of year 1966 around 1,000 investors had installed cattle grazing projects around the new Belem-Brasilia highway; one of the first enterprises to join the tax incentive program was the Texan Group King Ranch of Texas, which occupied a 180 thousand acres farm in Para state. Ibid. 108 Ibid, 161-2; Sergio da Cruz Coutinho e Maria Joaquina P. Pires, Jari: um banco genetico para o futuro (Monte Dourado 1996); Aziz Nacib Ab’Saber, Amazônia: do discurso a práxis (Edusp, revised edition 2004). 109 The Manaus ‘Zona Franca’ (Free Zone). Souza, Breve História da Amazônia above n 102, 163. 110 Becker, Amazônia, Geopolítica na Virada do III Milênio, above n 90, 81-82. 231 ‘arc of consolidated frontier.’111 The ‘arc’ begins in the Northeast of State of Para, going south skirting the Northeast of the States of Maranhão and Tocantins; it continues through the Northeast to the State of MatoGrosso and then through the north towards Rondônia, crossing it completely from east to west.112 The arc finally ends at the State of Acre. FIGURE 7: ARC OF DEFORESTATION IN THE BRAZILIAN AMAZON.113 One more layer of complexity to this unique development scenario is the fact that the occupation of land in the Amazon has created highly urbanized areas inserted in the vast forested country. This was predicted by some of the geopolitical exercises and planning activities, particularly from the military intellectual elite and government, as illustrated by Figure 9 below: 111 Margulis, ‘Causes of Deforestation of the Brazilian Amazon’, above n 91, 20. 112 Ibid. 113 MCT, Second National Communication, above n 2, 355. 232 FIGURE 8: TERRITORIAL DESIGN IN THE 1970 PLAN FOR NATIONAL INTEGRATION.114 It is worth noting that despite the high level of government planning and direct intervention in the occupation of the Amazon region, land tenure remains one of the most complex and unresolved issues, and, therefore, has been one of the main drivers of large and severe social conflicts.115 In fact, as discussed in the following sections, the implementation of government plans to remedy land tenure issues in critical areas prone to deforestation is an essential element of the current development and climate change policies. It could not be otherwise. Apart from being a critical element for the pacification of social conflicts in different parts of the region and a mitigation factor of 114 Reproduced by Paulo Tavares in ‘The Geological Imperative: On the Political Ecology of the Amazonia’s Deep History’ in Etienne Turpin (ed) Architecture in the Anthropocene Encounters Among Design, Deep Time, Science and Philosophy (Open Humanities Press, 2013) 220. 115 Jose Antonio Puppim de Oliveira, ‘Property rights, land conflicts and deforestation in the Eastern Amazon’ in (2008) 10 Forest Policy and Economics 303–315. 233 some of the deforestation patterns,116 clear and undisputable land tenure rights and a corresponding effective administrative and enforcement infrastructure, are preconditions to any land-use based sectoral or project based policies, including those involving price mechanisms.117 Another important feature of the Amazon scenario is that there is a Brazilian nationalist project of land occupation coexisting with a territorial and political sovereignty claim over the Amazon with the growing presence of international economic forces and agents equally influential in the development patterns that have prevailed in Brazil, and in the Amazon frontier in particular.118 In the past the international economic forces over the Brazilian Amazon was marked by the Rubber Boom,119 and later in mega land intervention projects, such as Henry Ford’s Fordland,120 Daniel K. Ludwig’s Jari Project121 and the Rockefeller’s family 116 Gabriel C. Carrero and Philip M. Feranside, ‘Forest Clearing Dynamics and the Expansion of Landholdings in Apuí, a Deforestation Hotspot on Brazil’s Transamazon Highway’ (2011) 16 (2) Ecology and Society 26. 117 Such as payment for environmental services, REDD+ and potential use of land-use based credits as offsets in the context of ETS such as the Australian model discussed in the following chapters of this thesis. See Driss Ezzine-de-Blas et al, ‘Forest loss and management in land reform settlements: Implications for REDD governance in the Brazilian Amazon’ (2011) 14 Environmental Science and Policy 188-200; J. Börner et al, ‘Direct conservation payments in the Brazilian Amazon: scope and equity implications’ (2010) 69 Ecological Economics 1272, 1282. According to these authors, 67 per cent of forests in the Brazilian Amazon under deforestation pressures are subject to unclear tenure rights. 118 Bertha Becker very well summarizes this complex development pattern, particularly from the mid-fifties to the eighties of the last century, as “a powerful geopolitical state policy associated with the national and international private capital.” Bertha Becker, ‘A Amazônia pós ECO-92: por um desenvolvimento regional responsável’ in Marcel Bursztyn (org) Para Pensar o Desenvolvimento Sustentável (Editora Brasiliense, 1994) 137. 119 The ‘Natural Rubber Production Cycle’ that drove the Amazon region to a sixty-year period dedicated to the production and export of rubber. This n economic cycle, initiated in the mid 1850s but the peak of which lasted from 1880 to 1913, pulled the region from the stagnation of the precedent eras and drove the major cities of Belem and Manaus to unprecedented period of economic growth, cultural effervesce and Faustian behaviour of its elite. Marcio de Souza, Breve História da Amazônia above n 102 127-143; John Hemming, Tree of Rivers: The Story of the Amazon above n 102 ch 6 and 7. 120 Greg Grandin, Fordlandia: The Rise and Fallof Henry Ford’s Forgotten Jungle City (Metropolitan Books – Henry Holt and Company, 2009). 121 Gerard Colby and Charlotte Dennett Thy Will Be Done: The Conquest of the Amazon: Nelson Rockefeller and Envagelism in the Age of Oil (Harper Collins Publishers, 1995) 234 ‘development plans’, and by huge investments based on experimental agriculture, large cattle ranches, and oil and mining initiatives.122 This intermingled relationship of nationalist spirit with international presence was further enhanced by the Cold War effects, and other international security influential matters (such as the ‘war on drugs’ from the 1980s onwards), all of which are usually under heavy US geopolitical and economic influence, which to a large extent inspired the military doctrine behind the integration projects from 1960–70 period.123 Nowadays the international component of the Brazilian Amazon and Cerrado social-economic dynamics is largely based on the direct correlation between the international demand for beef and soybean and the increases in deforestation rates in some areas,124 in addition to the large national and international investments in the mining and energy sector.125 Yet, international and multilateral institutions such as the World Bank and the International Finance Corporation are very active in financing significant investments in the Amazon region. Many of these projects have been the object of severe criticism by environmental NGOs 654-663; Sergio da Cruz Coutinho e Maria Joaquina P. Pires, Jari: um banco genetico para o futuro above n 108. 122 Gerard Colby and Charlotte Dennett, ibid, particularly ch 41. 123 Ibid, For a series or work focusing on this entanglement with a strong US-based view, see Joseph S. Tulchin and Heather A. Golding (eds) ‘Environment and Security in the Amazon Basin’ (Wilson Center Reports on the Americas No. 4, 2002 and 2011) 124 This correlation between the agricultural commodities marked and deforestation rates is well summarized by the following statement from the World Bank: The drivers of deforestation occur at multiple levels. In the Amazon and Cerrado regions, for example, the spatial dynamics of agricultural and livestock expansion, new roads, and immigration determine the pattern of deforestation. At a national or international scale, broader market forces affecting the meat and crop sectors drive deforestation. For specific analysis of the Cerrado biome occupation, see Paulo Bertran Uma Introdução à História Econômica do Centro-Oeste do Brasil (Codeplan e UCG, 1988). Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’, above n 5, 22. See also René Verburga et al, ‘The impact of commodity price and conservation policy scenarios on deforestation and agricultural land use in a frontier area within the Amazon’ (2014) 37 Land Use Policy, 14–26. 125 John Lyons and Paul Kiernan, ‘Mining Giants Head to Amazon Rain Forest: In Next Five Years, About USD24 Billion Will Be Invested to Boost Production in Remote, Environmentally Sensitive Region’ The Wall Street Journal (online), December 23, 2012 235 and other stakeholders in terms of their environmental performance, including their role in illegal deforestation activities.126 In parallel, the region is home to one of the most intense international networks of environmentalism thought, formed by local communities (such as the Brazilian indigenous peoples and extractive communities), international NGOs, and other social actors.127 The entrenchment of the environmentalist movement into the social and cultural fabric of the Brazilian Amazon has increased dramatically, mainly after the United Nations Conference on Environment and Development (UNCED) held in Rio de Janeiro in 1982, which triggered a significant flow of international funding to environmental NGOs in the region.128 One of the more important financing initiatives of this sort is the PP-G7 program financed by the governments of Germany, Canada, US, France, Italy, and Japan, which empowered many NGOs as project participants.129 From the above described development dynamics, emerged in Brazil one of the most powerful agribusiness industries in the world. In the early years, agriculture activities were concentrated in the Northeast, Southeast and South of the country. In the beginning of the colonization process, sugarcane was the main activity, followed by cattle grazing and other agricultures that emerged in-between the cyclical economic 126 The World Bank’ investment policies for the Amazon, particularly in the 80’s, have been under heavy criticism by environmental experts and NGOs due to their environmental impacts and had been a major driving force for important changes in the Bank’s environmental safeguard’s policies. See Robert H. Wade ‘Boulevard of broken dreams: the inside story of the World Bank’s Polonoroeste Road Project in Brazil’s Amazon’ (Grantham Research Institute on Climate Change and the Environment, Working Paper No. 55, August 2011) 127 Carlos Valerio Gomes et al, ‘Oportunidades de Apoio a Atividades Produtivas Sustentáveis na Amazônia’ (Documento subsídio elaborado no âmbito do Projeto “Cooperação com o Fundo Amazônia/BNDES” pela Cooperação Alemã para o Desenvolvimento Sustentável, representada pela Deutche Gesellschaft für Internationale Zusammenarbeit GmbHGIZ, 2012, December 2012) 62 128 Ibid 63. 129 Ibid. See also Argemiro Procópio, Destino Amazônico: Devastação Nos Oito Países da Hiléia (Editora Hucitec, 2005), 238. 236 booms Brazil experienced130. As a result, the empty spaces opened due to the territorial occupation of the Cerrado and the Amazon biomes began to be filled by agriculture.131. Nowadays, led by soybean, beef, and sugarcane production (the latter being expanded as a result of the national ethanol agro-energy program), the robust agribusiness sector faces the challenges of continuously developing under a lower-carbon footprint.132 Any successful climate change policy in Brazil will have to deal with the scenario of the consolidated presence of agribusiness in the Central-West and North of Brazil, in addition to dealing with exogenous and endogenous economic pressure due to the continuous growth of the sector and aspiring production gains.133 Apart from the antagonism between the agribusiness sector and environmental conservation actors resulting from the region’s occupation history and current state of consolidation, there are a few other aspects that must be factored into any discussion about the future of the Amazon and its potential effects in Brazil GHG emissions profile. The Amazon Region, in addition to its mega forest and rich biodiversity, is also home to the largest fresh water basin in the world,134 which translates as the country’s largest potential for increasing hydropower sources. On top of that, the region has significant mineral reserves. It is in the Amazon that the Brazilian giant mining company Vale do Rio Doce extracts iron ore from the largest mineral basin in the world. The region also has significant reserves of manganese, bauxite, gold, and tin.135 It is also in the Amazon that Petrobras exploits some of the largest onshore oil reserves in Brazil. The region also has additional potential for natural gas and other fossil fuels.136 Other significant activities in the region include a very active and organized 130 Darcy Ribeiro, As Américas e a Civilização, above n 102, 202-3. 131 Ibid. 132 Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’, above n 5, 49. 133 Ibid, 22 and 49-50; Gustavo Barbosa Mozzer, ‘Agropecuaria no Contexto da Economia de Baixo Carbono’ in Ronaldo Seroa da Mota et al (eds), Mudanca do Clima no Brasil: Aspectos Economicos, Sociais e Regulatorios (Instituto de Pesquisa Economica Aplicada – IPEA, 2011), 115. 134 Margulis, ‘Causes of Deforestation of the Brazilian Amazon’, above n 91, ix. 135 Aziz Ab’Saber, Gênese de Uma Nova Região Siderúrgica: Acertos e Distorções de Origem na Faixa Carajás-São Luís’ and ‘Da Serra Pelada à Serra dos Carajás: A Rebelião (Im)Prevista dos Garimpeiros’ in Azis Ab’Saber Amazônia: Do Discurso à Praxis (EDUSP, 2002) 113-130 and 236-285. 136 Aziz Ab’Saber, ‘O Petróleo na Amazônia’, ibid, 287-295; Sergio Margulis, ‘Causes of Deforestation of the Brazilian Amazon’ above n 91, 17. 237 criminal network engaged in illegal drug producing and trafficking, and illegal trading of ‘bio products’ (such as living animals and leather) in addition to illegal trading of diamonds and other minerals.137 Not surprisingly, this intense and complex social- economic environment stages many social conflicts, some of them extremely violent in relation to land disputes, abuse of basic rights of Brazilian indigenous population and other local communities.138 It is therefore within this very complex scenario that the set of policies devoted to reducing GHG emissions caused by deforestation in Brazil needs to be able to operate. To respond to how a pricing mechanism such as an ETS may assist in this process, one has to consider, as an initial premise, the opportunity costs for the intricate set of economic activities that cause deforestation. There is some evidence that these costs are much higher than what has been suggested by some simplistic economic models that support a very low price for the carbon credits generated by avoided deforestation activities in the region.139 Any price mechanism will have to compete with short- and long-term economic interests that so far have been very effective in producing unsustainable deforestation rates and land occupation patterns. At the same time, the legitimate aspirations of the local society in reproducing higher living standards cannot be neglected. As a result, only a truly fair and effective sustainable development project that incorporates mechanisms for the well being of the local communities (meaning more than 20 million of people, the majority living in urban areas) will be effective in producing positive results with respect to GHG mitigation. 137 Argemiro Procópio, Destino Amazônico: Devastação Nos Oito Países da Hiléia above n 129, especially chapter 5. 138 Carlos Valerio Gomes et al, ‘Oportunidades de Apoio a Atividades Produtivas Sustentáveis na Amazônia’ above n 127 provide for an update of statistics of violent conflicts in the Amazon region. Accordingly, from 2001 to 2010 2/3 of the assassinations related to land conflicts occurred in the Amazon region (usually related to dispute over land or forestry resources). Ibid, 56. See also Nikolas Kosloff, No Rain in the Amazon: how South America’s climate change affects the entire planet (MacMillan, 2010) ch 4. 139 For example, some proposals for Payment for Environmental Services have been rejected by proponent of REDD+ projects in Mato Grosso State due to the lack of capacity of the proposed programs to compensate the opportunity costs for foregone deforestation in the target region. Amy E. Duchelle et al, ‘Linking Forest Tenure Reform, Environmental Compliance, and Incentives: Lessons from REDD+ Initiatives in the Brazilian Amazon’ (2014) 55 World Development 53, 64. 238 5.3.2.2 Energy Matrix As pointed out above, GHG emissions in connection with energy production and consumption in Brazil also have a sui generis pattern when it is compared with other large economies of the world. The significant contribution of hydropower to electricity generation and of the ethanol program for transportation provide the country’s energy matrix with a substantial share of renewable energy. However, keeping this high level of renewable energy in the country’s energy matrix faces a number of constrains. Although the country has implemented several programs to increase renewable energy production from sources such as hydro, these sources are not sufficient to meet the projected growth of energy demand for the next decades. As a result, Brazil faces the challenge of either expanding its already significant hydropower base or investing in the increase of fossil fuel based sources.140 The potential for hydro expansion is huge, but is met with fierce resistance from environmental groups and other sectors due to the huge social and environmental impacts. Further, the largest potential for hydropower expansion lies in the Amazon basin, adding one more layer of complexity to the social and ecological dynamics of land use in the Amazon discussed above. The hydropower potential also creates additional sources of GHG emissions, but of a different sort: methane emissions from biomass degradation caused by the enormous flooding of forested areas to build river dams and water reservoirs in the cases of large hydropower projects.141 Other limiting factors to reliance on hydropower generation include the higher incidence of drought in the last years (in itself a potential effect of climate change), which has diminished the potential of water reservoirs and hydro generation in several regions and contributed to some energy shortages in the past years.142 Although the government still maintains the expansion of hydropower as a key element of its 140 Mauricio T. Tolmasquim, Amilcar Guerreiro and Ricardo Gorini, ‘Matriz Energetica Brasileira: uma prospectiva’ (Brazilian Energy Matrix: a prospective) in 79 Novos Estudos CEBRAP (2007) 47, 68; Antonio Dias Leite, ‘Consideracoes sobre Energia Eletrica no Brasil’ (‘Considerations about Brazilian Electric Energy’) (Texto de Discussao do Setor Eletrico No. 30, GESEL-UFRJ, February 2011), 6-28; Jose Goldemberg and Oswaldo Lucon, ‘Energia e Meio Ambiente no Brasil’, in 21 (59) Estudos Avancados (2007) 7, 10; The World Bank, ‘Environmental Licensing for Hydroelectric Projects in Brazil: A contribution to the Debate’ (Report No. 40995-BR, The World Bank, March 28, 2008) 15; Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’, above n 5, 66. 141 Soito and Freitas, ‘Amazon and the expansion of hydropower in Brazil: Vulnerability, impacts and possibilities for adaptation to global climate change’, above n 75. 142 Ibid. 239 Energy Plan for the next decades, the expansion of the fossil fuel energy base in Brazil is underway, particularly in terms of natural gas and coal.143 Considering the high- energy intensity of the most significant part of the Brazilian industry, which is by far the largest energy consumer in Brazil, and the structural problems for hydro expansion above mentioned, energy-related emissions in Brazil are expected to grow. The transport sector also plays a significant role in the GHG emissions in Brazil. Despite the enormous contribution of the sugarcane ethanol144 program,145 the emissions trajectories for the transport sectors are facing significant growth, due to the massive size of the country’s auto and cargo fleet, and the prevalence of road infrastructure at the national level. As discussed in the precedent chapters covering design elements of ETS, direct coverage of road transport under an ETS is rather complex due to the diffuse nature of the direct emissions. In any case, studies on the optimal point of obligation for emissions reduction in the fossil fuel sector in Brazil will have to factor in the significant role played by road transportation, whose GHG emission trajectory is expected to grow.146 143 EPE – Empresa de Pesquisa Energética, ‘Balanço Energetico Nacional 2014 - Relatório Síntese’ (EPE, 2014) 29 144 Ethanol, or ethyl alcohol, represented by the molecular formula C2H6O, may be used as a fuel in spark-ignition internal combustion engines (Otto cycle) in two ways, namely: 1) in gasoline and anhydrous ethanol blends; or 2) as pure ethanol, usually hydrated. BNDES and CGEE (Coordinators), Sugarcane-Based Bioethanol: Energy for Sustainable Development, (BNDES, 2008) 39. 145 MCT, Second National Communication, above n 2, 285-287. For a more detailed account of the Brazilian Ethanol Program, see BNDES and CGEE (Coordinators), Sugarcane- Based Bioethanol, above n 144; see also Paulina Calfucoy ‘The Brazilian Experience in Building a Sustainable and Competitive Biofuel Industry’ (2012) 30 Wisconsin International Law Journal 558; Juscelino F. Colares, ‘A Brief History of Brazilian Biofuels Legislation’ (2008) 35 Syracuse Journal of International Law and Commerce 293. 146 Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’ above n 5, 108; Patricia Helena Gambogi Boson, ‘Transporte Rodoviario e Mudancas do Clima no Brasil’ (Road Transport and Climate Change in Brazil’), in Ronaldo Seroa da Mota et al (eds), Mudanca do Clima no Brasil: Aspectos Economicos, Sociais e Regulatorios, above n 133 128 and 140. 240 5.3.2.3 Industrial Development The development of the industrial sector in Brazil privileged the installation of high-energy intensive industries, particularly suited for the large base of natural resources in the country.147 The development of the industrial sector also mirrored Brazil’s late industrialization process in comparison with developed countries, and the country’s subsequent low level of capacity in competing for technological excellence in the most innovative sectors of industrial production.148 Although this scenario has changed in the last decades across several sectors, the reality is that Brazil’s industrial base largely sits on production of natural-based industries (many of which are have a low level of added technological value and are highly-energy intensive).149 According to some authors, this profile of production in Brazil has been intensified by the “Dutch disease’ affecting the Brazilian economy. In other words, there was an overreliance on the high prices of mineral and agricultural commodities in the last decades, and a corresponding lack of efforts to foster technological innovation and industrial excellence in high-end products.150 Further enhanced by macroeconomic policies that have privileged the control of inflation with high interest rates and the over valuation of the Brazilian currency, the international competitiveness of the Brazilian industry has been extremely low when compared to the country’s economic size. This scenario has driven very aggressive standpoint industrial leaders in the last decades, while pursuing a larger share for industry in the national GDP and striving to gain government support for lines of financing for the sector to grow. This movement has echoed in the federal government leaders of the last 12 years, who under the Workers’ Party administrations (mainly the President Lula da Silva Administration which lasted from January 1, 2003 147 Philip Hiroshi Ueno, ‘Can Dutch Disease Harm the Export Performance of Brazilian Industry?’ (Paper prepared for the DRUID Summer Conference 2010 on Opening Innovation: Strategy, Organization and Technology’ at Imperial College London Business School, June 16-18 2010) JEL Classification: O14, O54, 19-20. 148 Celso Furtado, O Longo Amanhecer: Reflexões sobre a Formação do Brasil (Paz e Terra, 1999), 75; Luiz Carlos Bresser Pereira e Eli Diniz, ‘Empresariado Industrial, Democracia e Poder Político’ (2009) Novos Estudos 83, 84. 149 Ueno, ‘Can Dutch Disease Harm the Export Performance of Brazilian Industry?’, above n 147, 19-20. 150 Ibid, 22-3; Luiz Carlos Bresser Pereira, ‘Taxa de cambio, doença holandesa, e industrialização’ (2010) 5 (14) Cadernos FGV Projetos 68. 241 to January 1, 2011)151 have reintroduced federal plans to empower the industrial sector. Such initiatives are largely based on the direct investment of the Brazilian Development Bank in private companies likely to become ‘Brazilian Multinationals’ able to compete in the global market.152 As a result of these dynamics, GHG emissions from the industrial sectors (which in aggregate results from the combination of direct emissions with emissions from energy consumption and transportation) are expected to grow. In turn, the climate change policies to deal with such circumstances will have to face the challenges of inducing lower emissions and making investments in clean technologies or adopting energy efficiency measures that do not jeopardize the growth trajectory of the industrial output of Brazilian-based activities. And the measures preferred are the ones that support the Brazilian industry in achieving a higher standard of innovation and international competitiveness. 5.4 Conclusion The analysis conducted in this chapter focused on the Brazilian climate profile in order address the subsidiary research question on social, economic, cultural [and legal, which will be covered in the next chapter] conditions prevailing in Brazil that will condition the environmental integrity of a Brazilian ETS. The chapter presented the main drivers for GHGs emissions in Brazil by sectors and biomes, taking into consideration the country’s development dynamics and its main social, economical and ecological characteristics. This dynamic and integrated view of the emissions profile of major sectors provided for important insights on unique elements of the Brazilian economy and culture that shall be taken into account in the definition of contingent elements of a Brazilian ETS devoted to effectively reduce GHGs emissions. The analysis conducted in this chapter applied the logic category of the analytical approach presented in section 1.4.2.2 that pointed for the identification of key social-historical and cultural elements that may be relevant for the proper insertion of an ETS in a legal system, particularly in respect to the Brazilian case. 151 Biblioteca da Presidência da República Federativa do Brasil, Galeria dos Presidentes, 152 Luiz Carlos Bresser Pereira, ‘State-Society Cycles and Political Pacts in a National- Dependent Society: Brazil’ (SeriesdesiguALdades.net/Research Network on Interdependent Inequalities in Latin America, Working Paper No. 37, 2013), 19 242 As detailed in section 5.3, Brazil’s GHG emissions profile presents a unique pattern for a country whose economy size ranks among the largest in the world. This is because the country’s emission profile combines a large amount of emissions from deforestation (which is, by far the most important GHGs emission source in the country) with low emission rates from the energy sector, since Brazil holds significant contribution of electricity generation by its huge hydropower base. Yet, the country’s projected emissions show that, regardless of being able to reduce land-use emissions without sacrificing the productivity of its powerful agribusiness, emissions from energy and industrial sectors shall raise in the future. On one hand, expansion of hydropower has been limited by ecological and social factors, including ongoing changes in the hydro regime, environmental barriers for the construction of new plants in highly forested areas, and potential effects of large projects to local communities. On the other hand, the Brazilian industrial sector is historically comprised of highly energy-intensive industries with a very low record of technological innovation. This scenario has driven claims from the industrial sector for governmental support for expansion of industrial activities in the country, without a parallel development in technological innovation. Thus, to the extent possible, the industrial coverage under a Brazilian ETS will have to deal with the possible growth trajectories of industry-based emissions in Brazil, and, to the extent possible, consider design elements that favour technological innovation and less energy-intensive practices. Despite the large hydro-base electricity generation in the country, emission trajectories of the energy sector is expected to grow due to the above mentioned barriers for large hydro projects in the country, particularly in the Amazon basin. The Brazilian development dynamics also offer a great level of complexity for climate change policies that shall be taken into consideration by a Brazilian ETS, mainly with respect to mitigation of emissions from the land use sector. In particular, the coexistence, mainly in the Amazon and in the Cerrado biomes, of very primitive and violent land dispute and occupation with sophisticated economic agents and institutionalized actors, such as governmental agencies, multinational businesses, and well-informed advocacy institutions. Both regions, which hosts most of the Brazilian land-use base emissions due to the ever expanding agricultural sector, still operate as a typical development frontier, where land occupation and conversion of forests into other land uses, particularly agriculture, still drive high deforestation rates and replicates unsustainable and inefficient modes of production. This ‘frontier’ is currently inhabited by more than 20 million people, mostly concentrated in urban areas, that face the complexities of social, economic, and environmental problems, and the justified aspirations of contemporary society. These challenges in relation to land-use based emissions (which, as highlighted above, still represent the largest source of the 243 country’s emissions despite recent positive mitigation efforts) do not stand alone in the front of efforts to reduce emissions in Brazil. The country, despite its large economic base, has to balance structural changes towards transitioning to a low-carbon economy with development gains, and with lowering of the huge social and economic distortions of its population. These challenges include invigorating it’s still highly energy intensive industry, expanding the innovation capabilities of its scientific and technological production, and providing energy security solutions that reconcile a high renewable energy portfolio with protection of biodiversity resources. The latter challenge has a feedback effect on the protection of the Amazon basin, since the country’s largest potential for continuing to rely on hydropower resides in the Amazon, which also host immense oil and mineral reserves in addition to its huge genetic resources much of which still untapped. Moreover, the country has to drive its transition to a low-carbon economy at the same time that it has to overcome cultural and institutional barriers for a more efficient compliance culture and equal rule of law, all of this is still highly impacted by skyrocketing rates of corruption. Equally important is the historical tension between the Brazilian nationalist project of land occupation and territorial and political sovereignty claim over the Amazon-basin and the continuous presence of international economic forces shaping the development patterns in the region. Along the same lines, the complex and extremely dynamic development patterns in the Amazon demand a much more realistic appraisal of opportunity costs for the myriad of economic activities in the region, in order to support a carbon price policy in the region, such as an ETS, that can effectively compete with those activities driving deforestation. In this regard, the discussions conducted in this chapter demystifies certain pre-conceptions of deforestation drivers been confined to local communities conducting slash-and-burning activities for survival. In fact, the major drivers of deforestation in the Amazon are historical development plans by the Government since the early 1960s, whose most significant beneficiaries have been large international and national corporations and family businesses. Within this context, the agricultural, followed by mining, forestry, and in some extent the oil production sectors, outstand as key contenders for development activities that, directly or indirectly, are major drivers of GHGs emissions in Brazil. In the case of agriculture, calls attention the research publications referenced in this chapter that show a direct correlation between the fluctuation of international agricultural commodity prices (particularly beef, soybean and timber) and the deforestation rates in the Brazilian Amazon states. Also relevant is the historical role of governmental development plans in driving deforestation in the Amazon, in addition to other forms of tax and financial incentives with similar results. As it will be discussed in more detail in the next chapter, any possible positive result of climate change policies in Brazil, including and ETS, will also depend on full 244 integration of development and environmental policies in order to neutralize perversive effects of certain incentives to the overall GHGs emission profile of the country. Finally, the country emissions profile show that transportation has been an increasingly source of GHGs emissions, and its respective emission trajectories are expected to grow. Due to the difficulties of incorporating the transportation sector under ETS coverage, as discussed in chapters III and IV, the transportation sector deserves special attention of other policy approaches to mitigate GHGs emissions in Brazil. It is in this context of extremely complex social and ecological dynamics that climate change policies have been implemented in the last decade in Brazil, as discussed in the next chapter. 245 CHAPTER VI – THE BRAZILIAN CLIMATE CHANGE REGIME 6.1 Introduction This chapter will analyse the Brazilian Climate Change Regime put in place to deal with the GHG emissions profile presented in the previous chapter. There are different ways to conceptualize and classify the legal framework and policy instruments of a given country/jurisdiction that impact its GHG emissions profile. Also, the net results of potential impacts of a legal and policy framework in the GHG emissions profile of a given jurisdiction will depend on their interaction with policies and other state interventions that are not restricted to the climate change or environmental areas.1 The GHG emissions footprint of government plans and policies to boost economic or regional development, attract investments for infrastructure projects, stimulate growth of certain economic sectors may create impacts in the ultimate emissions profile of the country that neutralizes or reduces significantly the results of direct interventions to reduce GHG emissions. The same principle applies to any form of subsidies, tax or financial incentives to emission intensive production inputs or products, among other state-driven interventions. As a result, the ultimate success of any national GHG reduction effort will depend on a careful integration of legal instruments and policies that affect the emissions performance of the most relevant drivers of emissions. One example in Brazil of such interactions of climate change policy objectives with other government programs is the potential greenhouse emissions associated with the major economic development program of the Federal Government, the Growth Acceleration Program (PAC),2 as discussed below. However, due to practical limitations, this chapter will focus on the legal and policy interventions aimed at mitigating GHG emissions that are most directly relevant to inform the discussions on ETS adoption and design in Brazil. In particular, the legal instruments and policies integrated by the National Climate Change Policy and others with significant effects on the overall GHG profile of a particular sector or region. As this chapter will 1 E. Somanathan et al ‘National and Sub-national Policies and Institutions’ in O. Edenhofer et al (editors) Climate Change 2014: Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (Cambridge University Press, 2014), particularly item 15.7 (Synergies and tradeoffs among policies) 1179-82. 2 Federal Decree No. 6.025 of January 22, 2007. 246 demonstrate, an example of the latter case is the Brazilian Forest Code, 3 the most important legal instrument to regulate land use and native forest conservation nationwide. In order to better contextualize the discussion on the legal instruments of Brazilian climate change regime, and also in support of the analyses and conclusions of this thesis that will follow in the next chapters, this chapter offers an overview of the Brazilian legal system, in particular of the provisions of interest for environmental protection in general, and climate change mitigation in particular. This chapter will also briefly present the Brazilian negotiation approach in the context of the international climate change regime and the major climate change policies developed so far. This chapter will show that to date the Brazilian climate change policy portfolio has relied upon a series of regional and sectoral programs to implement GHG mitigating activities, usually funded by account-based funds established by law and managed by the federally owned Brazilian Development Bank (BNDES). Recent appraisals of this set of policies have pointed out that, despite relevant positive results in emissions reductions, as a result of stricter enforcement of command-and-control regulation against deforestation activities, there are claims for the incorporation of market-based mechanisms in the Brazilian climate change regime. The chapter concludes showing that, according to part of the literature on Brazilian law and policy, the Brazilian traditional regulation model needs to be complemented by pricing mechanisms or other forms of induction of behaviour change, particularly those attached to the economic and social dynamics driving deforestation. Apart from the Brazilian initiatives under the Climate Change National Policy and the Forest Code, other relevant policies and legal areas that demand attention for a fully integrated analysis of the Brazilian Climate Change legal and policy approach vis- a-vis the country’s emissions profile will be pointed out at the end of this thesis for purposes of future lines of research. This approach will take into consideration the structural and functional elements of the Brazilian Climate Change Legal Framework, in general, and of a possible Brazilian ETS in particular. 6.2 Brief Overview of the Brazilian Legal System Brazil is a civil law country of Roman law tradition, and its legal system was introduced by the Portuguese colonization.4 As a result, in addition to the Constitution, 3 Federal Law 12.651 of May 25, 2012. 247 Brazil’s legal system is based on codes and legislation enacted primarily by the federal legislature, and also by legislation from the states and municipalities. Brazil is a federal republic composed of 28 entities: 26 states, one Federal District (DF), Brasília, and the Federal Union.5 Brazil’s current Constitution was enacted in 1988 after a major political reform, which ended more than 20 years of military dictatorship. The 1988 Constitution, in part as a result of social claims aiming to give the highest voice to social rights and guarantees that had been suppressed or ignored during the military period, ended up as a complex and detailed charter of rights with more than 275 articles.6 One of the innovations of the 1988 Constitution is a special chapter devoted to environmental matters and the inclusion of environmental protection as one of the principles to inform the country’s economic order. Thus, Article 225 establishes the fundamental right of the current and future generations of Brazil to a balanced environment and the role of the government in preserving and restoring essential ecological processes.7 Article 170 establishes ‘free initiative’ as a major economic principle and ‘environment protection’ and the ‘social function of private property’ as some of its conditioning factors8. It is 4 Monaliza da Silva, ‘Update: Doing Legal Research in Brazil’ (Globalex, June 2015) 5 Ibid. 6 Keith S. Rosenn, ‘Recent Important Decisions by the Brazilian Supreme Court’ in (2014) 2 (45) Inter-American Law Review 297. 7 Article 225 of the Brazilian Constitution and its paragraph I partially reads as follows: Everyone has the right to an ecologically balanced environment, which is an asset of common use and essential to a healthy quality of life, and both the Government and the community shall have the duty to defend and preserve it for present and future generations: paragraph 1. in order to ensure the effectiveness of this right, it is incumbent upon the Government to: I – preserve and restore the essential ecological processes and provide for the ecological treatment of species and ecosystems; Brazilian Constitution of 5 October 1988, art 225, paragraph 1, I. 8 Article 170 of the Brazilian Constitution, which establishes the general principles of economic activities in Brazil, reads as follows: article 170. The economic order, founded on the appreciation of the value of human work and on free enterprise, is intended to ensure everyone a life with dignity, in accordance with the dictates of social justice, with due regard for the following principles: I – national sovereignty; II – private property; III – the social function of property; IV – free competition; V – consumer protection; VI – environment protection, which may include differentiated treatment in accordance with the environmental impact of goods and services 248 important to highlight that the Constitutional definition of the environment as an asset for common use and essential to a healthy quality of life gives this particular right a differentiated status in terms of its protection vis-à-vis individual rights under Brazilian law. As such, the Brazilian legal system also provides for ‘a sophisticated legal regime to protect ‘collective rights’,9 such as rights to a balanced environment or to fair and balanced consumer relations, particularly through ‘public civil actions’ and other legal remedies assigned to public organizations, NGOs, and to the District Attorney’s office to combat any threat or violation of ‘diffuse rights such as the right to the environment.10 The District Attorneys have also been assigned special powers to conduct investigations regarding any potential or actual environmental violation and to pursue the correction of any violation by entering into negotiated consent agreements or bringing lawsuits against polluters. The Brazilian legal system also has a complex array of individual statutes and regulations dealing with different aspects of environmental protection. At the Federal level, the basic elements of this environmental protection system is given by the National Environmental Policy Law (NEPL),11 which states the basic principles, and of their respective production and delivery processes; VII – reduction of regional and social differences; VIII – pursuit of full employment; IX – preferential treatment for small enterprises organized under Brazilian laws and having their head-office and management in Brazil. Sole paragraph. free exercise of any economic activity is ensured to everyone, regardless of authorization from government agencies, except in the cases set forth by law. Brazilian Constitution of 5 October 1988, art 170. 9 Francisco Verbic, ‘Consumer class actions in Argentina and Brazil – comparative analysis and enforcement of foreign judgments.’ in (2012) 209 Revista de Processo 44, 844. As summarized by Verbic, the ‘collective rights are divided into three basic categories, as established by Federal Law 8.078 of September 11, 1990 (‘Consumer Defense Code’), art 81: The first typified category is that of ‘diffuse rights.’ It encompasses transindividual and indivisible rights belonging to a group of undetermined individuals who are related among them by virtue of factual circumstances. The second type is labelled as “collective”. They are trans individual and indivisible rights as well, but differ from the diffuse in that they belong to a group, category or class of persons related among them or with the opposing party by virtue of a baseline legal relationship. Finally, (…) a third type of collective rights, designated as “individual homogeneous” and described simply as those “resulting from a common origin”. This last category includes individual and perfectly divisible rights, collectivized only for litigation purposes. That is why scholars referred to them as “accidentally collective”, whereas the other two categories are considered as involving “essentially collective” rights. Ibid. 10 Particularly through Federal Law 7.347 of July 24 of 1985 (‘Public Civil Action) and Federal Law 8.078 of September 11, 1990 (‘Consumer Defense Code’). 11 Federal Law 6.938 of August 31 1981. 249 instruments, and allocation of responsibility among the three levels of administration (federal, state and local) and a strict civil liability regime applied to environmental damages (meaning, responsibility regardless of knowledge, fault of intent, conditioned only to the causality between the damage and the individual or company’s activities).12 At the Federal level, another important legal instrument is the Environmental Crimes Law (ECL),13 which established criminal sanctions against individuals and legal entities for certain environmental violations, in addition to administrative fines that can reach significant amounts. 6.3 Brazil and the International Climate Change Regime Brazil has actively engaged in the negotiation, drafting and implementation of major international environmental treaties, including the UNFCCC and the Kyoto Protocol.14 The UNFCCC came into effect in Brazil on 1 July 1998.15 Brazil ratified the Kyoto Protocol on 23 August 2002, and it came into effect in Brazil in the same year.16 Since the beginning of the UNFCCC, Brazil has been an active player in the international climate change regime.17 On the one hand, Brazil’s position has been driven by a firm support of the ‘common-but-differentiated responsibilities’ principle, according to which developed countries should bear the heaviest burden of GHG mitigation efforts due to their largest share in the historical anthropogenic contributions to climate change.18 On the other hand, due to its significant land-use based emissions, Brazil has carefully, but consistently, developed a series of significant internal measures aimed at reducing the country’s GHG emissions. ‘Carefully’ means that Brazil has 12 Ibid art 14. 13 Federal Law 9.605 of February 13, 1998. 14 The Brazilian Environmental Law Practice Group, ‘Brazil’ in Baker & McKenzie Environmental and Policy in Latin America (Baker & McKenzie, 2000) 18-9. 15 Legislative Decree Nº 2.652 of 1998. 16 Legislative Decree Nº 144 of 2002. 17 Fernanda Viana de Carvalho, ‘The Brazilian Position on Forests and Climate Change from 1997 to 2012: from veto to proposition’ in (2012) 55 Rev. Bras. Polít. Int. (special edition) 144, 153-4. 18 UNFCCC, Art 3.1and the Kyoto Protocol, Art 10; ibid, 153. 250 presented its initiatives and reduction targets to the international community as voluntary commitments, thus preserving to the extent possible the country’s position in the international negotiations for the new climate change regime architecture.19 ‘Consistently’ means that the country has internalized the voluntary emissions reduction targets into the National Climate Change legislation20 and policies, the implementation of which have already presented positive results despite structural and functional problems to be solved. In short, the Brazilian negotiating approach under the UNFCCC and the Kyoto Protocol has been driven by, on the one hand, a commitment to pushing for the environmental integrity of the international regime, particularly in light of considerations of equity requiring the heaviest responsibility to fall on developed countries to reduce their emissions domestically. On the other hand, Brazil has been extremely cautious in respect of proposals that, in the view of key governmental representatives in the international negotiations (particularly some sectors of the military and foreign relations ministries), may restrict the country’s sovereign rights over its huge forest basin.21 This bi-fold approach was particularly dominant in shaping Brazil’s positions in the international negotiations at least from 1997 to 2005.22 From 2006 onwards, however, the convergence of stronger international positions relating to the inclusion of native forests in the international climate change and national developments favouring a more pro-active approach towards climate change policies has resulted in a more flexible position being taken by Brazil in the international negotiations. These developments have included the rise of the Ministry of Environment’s profile in influencing the Brazilian Government negotiation strategies at 19 Carvalho, ‘The Brazilian Position on Forests and Climate Change from 1997 to 2012’, above n 17, 155. According to this source: The year of 2009, which culminated with the unsuccessful COP-15 in Copenhagen, was especially determinant for the Brazilian position. Brazil advanced on the adoption of national voluntary commitments to reduce emissions of 36.1% to 38.9% from business-as-usual by 2020, of which reducing deforestation is a central strategy. That move has significantly strengthened Brazil’s soft power in the UNFCCC. A new informal coalition, the one formed by Brazil, South Africa, India and China (BASIC), has emerged in Copenhagen and was fundamental in negotiating the Copenhagen Accord. 20 Mainly through Federal Law No.12.187, of December 29, 2009 and Federal Decree 7.390 of December 9, 2010; see Carvalho, ibid, 165. 21 Carvalho, ‘The Brazilian Position on Forests and Climate Change from 1997 to 2012’, above n 17, 153-4. 22 Ibid 154-5. 251 the UNFCCC (which, historically has been dominated by the Ministry of Foreign Affairs and the Ministry of Science and Technology) and the raise of a pro-trading coalition formed by business sectors, some pro-trading NGOs and a group of states in the Amazon region which developed policies favouring market-based mechanisms to reduce deforestation.23 In particular, a key result of this less conservative approach was the enactment of the Brazilian Climate Change Policy in 2009.24 As discussed in this chapter, the Brazilian Climate Change Policy incorporated the voluntary emission reduction targets presented by the Brazilian Government to the UNFCCC in the Conference of the Parties (COP) held in Copenhagen in 2012 and expressly allowed the future development of market mechanisms as part of the national climate policy alternatives. It is precisely in the context of making improvements to the current set of policies under implementation that this thesis draws on an analysis of the feasibility, potential benefits, and optimal design elements of an ETS in Brazil. 6.3.1 Brazil and the Kyoto Protocol Market Mechanisms Brazil is often recognized not only as a key player in the UNFCCC and Kyoto Protocol regime negotiations but also in the implementation of projects under the Clean Development Mechanism established by the Kyoto Protocol.25 In fact, the Brazilian UNFCCC and Kyoto Protocol negotiators originally conceived the CDM as an international financial mechanism to directly fund GHG mitigation projects in the 23 Ibid, 155-63; Eduardo Viola e Matías Franchini, ‘Brasil na Governança Global do Clima, 2005-2012: A Luta entre Conservadores e Reformistas’ (2013) 35 (1) Contexto Internacional (PUC) 43, 52. 24 Viola e Franchini, ‘Brasil na Governança Global do Clima, 2005-2012: A Luta entre Conservadores e Reformistas’, above n 23, 70. 25 John C. Cole and Diana M. Liverman, ‘Brazil’s Clean Development Mechanism Governance in the context of Brazil’s historical environmental-development discourses’ in (2011) 2 (2) Carbon Management 145. According to this source: Brazil is a major international player in the carbon markets that function under the UN Framework Convention on Climate Change (UNFCCC) Clean Development Mechanism (CDM) with more than 180 registered CDM projects. In addition, Brazil ranks third after China and India in the generation of CDM certified emission reduction credits (CERs) worldwide [1]. Brazil is often seen as one of the success stories of the CDM in terms of the magnitude of carbon credits generated and the relatively rigorous application of both additionality and sustainable development criteria. 252 developing world.26 The CDM’s final conception as a market-based mechanism resulted from the US influence in the negotiations, as pointed out in chapter II. The Brazilian experience with CDM projects originated more than 180 projects duly registered under the CDM Executive Board and ranked Brazil as the third largest generator of CDM certified emissions reduction credits, behind China and India only.27 Some industries were especially benefited by the CDM as an inductor of lower emission practices and technologies, mainly the sugarcane and ethanol mills (through use of sugarcane bagasse as a biomass-based energy source), the chemical industry in relation to abatement of nitrogen-dioxide emissions from large adipic acid plants, and several projects related to displacement of fossil fuels by cleaner energy sources such as natural gas and other biomass sources. In addition, significant methane emissions were reduced through CDM projects related to urban (landfills) and agricultural (swine production) waste management projects.28 The Brazilian experience with the CDM influenced the creation of a very strong carbon project culture among government officials (particularly from the Ministry of Science and Technology and Ministry of the Environment), specialized NGOs, and service providers from engineering, business and legal fields. It also supported important initiatives for the use of market-based instruments in CDM projects such as the Carbon Platform of the Brazilian Mercantile & Futures Exchange as discussed below. 6.4 Brazilian Legal and Policy Approach to GHG emissions 6.4.1 Brazil Voluntary Emissions Reduction Targets by Sector and Biome As mentioned in item 1.1.3 of the Introduction to this thesis (chapter I), Brazil has adopted a voluntary emissions reduction target of 36.1 per cent to 38.9 per cent 26 John C. Cole ‘Genesis of the CDM: the original policy-making goals of the 1997 Brazilian Proposal and their evolution in the Kyoto Protocol negotiations into the CDM’ in (2012) 12 (1) International Environmental Agreements: Politics, Law and Economics 41. 27 Ministry of Science and Technology of Brazil (MCT) – General Coordination on Global Climate Change, Second National Communication of Brazil to the United Nations Framework Convention on Climate Change (Brasilia, 2010), 20 and 382- 4.CDM 28 MCT, Second National Communication, above n 27, 382-4. 253 reduction of Brazilian projected emissions by 2020, which are expected to total 3236 million tonnes of CO2e29 under the business-as-usual scenario.30 Overall 2020-projected emissions and reduction targets have been further individualized by sectors and or biomes as follows: 6.4.1.1 Projected Emissions by 2020:31 • Land-use-change (1404 million tonnes of CO2e) • Energy (868 million tonnes of CO2e) • Agriculture and livestock (730 million tonnes of CO2e); and • Industrial processes and waste management (234 million tonnes of CO2e). 6.4.1.2 Emission Reductions by Sectors or Biomes:32 • Reduction by 80 per cent of annual deforestation rates in the Legal Amazon region in relation to the average deforestation rates in 1996–2005; 29 Federal Decree 7.390 of December 9, 2010, art 5, caput. The methodologies for this calculation are presented in the Federal Decree’s Annex. Accordingly, the land-use- change emission scenarios were based on historical series of deforestation rates and emissions factors per hectare. The energy emission projections were based on demand forecast scenarios taking into account estimations of population and economic growth and evolution of the national energy intensity profile. The industrial processes, agriculture and livestock and waste management emission projections were based on correlations between emissions volume and economic activity levels in the period of 1990 to 2005. The resulting projections for 2006 to 2020 considered an average GDP growth of 5 per cent in the same period. It is important to highlight that the average GDP growth of 5 per cent seems to be extremely ambitious at this point due to the average growth of Brazilian GDP from the policy issuance date (2010) to date and the projections of low growth for Brazilian GDP for the coming years as reflected in recent Brazilian Central Bank, the IMF and the World Bank analysis. According to some analysts, the Brazilian economy is expected to grow 0.3 per cent in 2014 and 1.3 per cent in 2015. Focus Economics, October 14, 2014 30 Federal Law No. 12 187, of December 29, 2009, art 12. 31 Federal Decree 7390 of December 9, 2010, art 5 (I-IV). 32 Ibid art 6 (I-X). 254 • Reduction by 40 per cent of annual deforestation rates in the Cerrado biome in relation to the average annual rates for 1999–2008; • Expanded offer of hydropower, alternative renewable energy sources (notably wind, small-hydro and bioelectricity) and biofuels, and enhanced energy efficiency; • Restoration of 15 million hectares of degraded grazing land; • Increase of 4 million hectares of the integrated crop-livestock systems; • Increase of 8 million hectares of the no-till farming practices; • Increase of 5.5 million hectares of the biological N2 fixation practices in cropped areas; • Increase of 3 million hectares in forest plantation activities; • Develop waste management technology use for treatment of 4.4 million m3 (cubic meters) of animal manure; • Incremental use of charcoal from planted forests in the iron and steel industry use and efficiency gains in the carbonization processes. In aggregate between 1168 million to 1259 million tonnes of CO2e of the projected 2020 emissions will be reduced in order for Brazil to meet the 36.1 per cent to 38.9 per cent reduction by 2020.33 6.4.2 Brazil’s main policies aimed at implementing the voluntary emissions reductions pledge In summary, the Brazilian direct policy interventions to mitigate GHG emissions revolve around the following lines of action and instruments: • A cluster of regional/biome-based and sectoral action plans coordinated by the Federal Government, with focus on decreasing deforestation rates and lowering the emission profile of key economic sectors;34 33 Ibid art 6. 34 As of August 2014 the biome and sector programs already developed cover the following regions or economic activities: Amazon Biome, Cerrado Biome, energy, transport, transformation and consumer goods industry, mining, health services and agricultural and 255 • Direct funding initiatives from accounting-based funds and credit lines from federal investment banks and financial institutions;35 • Improvement of the enforcement infrastructure and monitoring technologies, in particular, satellite-based images devoted to monitoring land-use activities and detect deforestation trends in real time; • Policies towards fostering technological innovation devoted to reducing GHG emissions profile of different sectors and activities.36 As pointed out in the Introduction of this thesis (chapter I), another important feature of the architecture of the Brazilian Climate Change policy is the formal consideration of the legislation of a future Brazilian Emissions Reduction Market.37 The legal treatment of this market mechanism is extremely limited, confined to the indication that it can be operational through Stock/Securities Exchanges or trading facilities dully authorized by the Brazilian Securities and Exchange Commission (CVM).38 Further, the a federal decree issued to regulate the National Climate Change livestock. Ministry of Environment, National Climate Change Policy, Mitigation and Adaptation Sectorial Plans, 35 The most important accounting-based funds and credit lines are the following: Climate Change Fund (accounting-based fund created by Law 12.114/2009 and further regulated by Federal Decree 7343/2010 and Regulation BACEN 4.008/2011 using financial resources from oil and gas royalties transferred from the National Oil Agency (‘Agência Nacional do Petróleo – ANP) to the Ministry of Environment), Amazon Fund (accounting-based and performance-based fund created by Federal Decree 6.527/2008 using resources captured through donations, the Norway Government being the most important donator so far) and the Low Carbon Agriculture Program (Programa ABC Carbono, a low interest financial line from the Brazilian Development Bank (BNDES) and Banco do Brasil regulated by Resolution BACEN 3.896/2010 and devoted to finance low carbon technologies and practices in the agricultural sector). 36 The complete list of instruments of the National Climate Change Policy is established by Federal Law No. 12.187 of December 29, 2009 art 6 I-XVIII. 37 Federal Law No. 12.187 of December 29, 2009, arts 4 (VII) and 9. 38 Ibid. 256 Policy stated that the ‘sectoral emissions reduction targets’ resulting from the sectoral action plans for climate change mitigation can be used as ‘parameters’ for the creation of a Brazilian Emissions Reduction Market.39 Although no further reference is provided by the decree, one can assume that certain data, such as actual and projected emissions for certain sectors, can be the basis for setting an emissions cap under an ETS or an emissions baseline in a baseline-and-credit mechanism. The extremely careful language used by the National Climate Change Policy (law and decree) illustrates the predominant view of the Brazilian Government of focusing on direct interventions as opposed to market mechanisms. Such view blends the historical concerns of the Brazilian diplomacy with sovereignty issues in relation to land use (particularly in the Amazon region), as pointed out in section 6.3 above, and with the ideological view of large part of the environmental leadership of the Worker’s Party administration (particularly those in charge of the environmental and forestry management policy), which was sceptic of the role of the private sector in participating in climate change mitigation efforts, as reflected in the design of the Amazon Fund.40 On the other hand, as already pointed out in chapter 1 section 1.1.3 and in section 6.3 above, the formal recognition of a future market in the legislation is also a result of the pressure of other social actors in the political process, including a portion of protrading market players and NGOs,41 and leaders of some of the Amazonian state governments, who have developed state policy initiatives embracing market mechanisms that include subnational regimes.42 Other important subnational initiatives 39 Federal Decree 7.390 of December 9, 2010, art 4, Paragraph 3. 40 Accordingly, evidence of emission reductions from projects financed by the Amazon Fund are recognized through the issuance of a ‘diploma’ certifying the volume of carbon equivalent reduced by the project participant without entailing any right to the beneficiary or to the fund donators to trade it or use it to offset emissions occurred elsewhere. Federal Decree 6.527/2008, art 2 and para 1-5. See also Nancy Birdsall et al, ‘The Brazil-Norway Agreement with Performance-Based Payments for Forest Conservation: Successes, Challenges, and Lessons’ (CGD Climate and Forest Paper Series # August 4, 2014) 41 This kind of coalition is has produced a series of initiatives and publications supporting market mechanisms in the context of international and Brazilian climate change policy (including the Kyoto Mechanisms, REDD+, Payment for Environmental Services and ETS). This is the case of various entities belonging to the Observatório do Clima, the most important coalition of NGOs working on climate change matters. See 42 Such as the State of Acre’s jurisdictional-wide REDD+ program, and legislation on Payment for Environmental Services in the Amazon State and Tocantins State. Acre State Law 2.308 of October 22, 2010; Amazonas State Laws 3.135 of June 4, 2007 and 257 are certain state laws requiring monitoring and reporting of GHGs emissions by the regulated community. Such initiatives, although still not harmonized through common monitoring methodologies and registries, can be used as a starting point for a national system of monitoring, reporting, and verification of GHGs emissions.43 Additionally, important initiatives in the private sector included the BM&M/Bovespa’s carbon trading platform for CDM projects (launched in 2006, but not very active since the CDM market downturn)44 followed by the creation of a climate change index for public companies by the BM&F/Bovespa Exchange45 and, more recently, the launch of a private trading platform for carbon credits and other environmental assets in Rio de Janeiro (a BVRio initiative).46 The BM&F Carbon Platform was an ambitious initiative to use the Exchange credibility and trading expertise in the carbon Market, and was relatively successful during the initial years of the Kyoto Protocol’s first commitment period in relation to public sale of a major São Paulo city CDM Project. Some more recent initiatives of the BM&F aim at promoting an increased engagement of Brazilian industrial sectors in the carbon market. The BM&F Carbon Index promotes the inventory of carbon emissions (through the corresponding rating of the carbon footprint of each business). This index has also been used to create an investment fund portfolio 3.184 of November 13, 2007 and State Complementary Law 53 of June 5, 2007; Tocantins State Law 43 The main state-based GHG monitoring and reporting initiatives developed so far are present in following states: Rio de Janeiro (Regulation INEA 64/12), São Paulo (CETESB Directorate Decision 254/2012/V/I) and Minas Gerais (State Decree 45.229 of 3 December 2009 and COPAM Regulation Nº 151/2010 and Nº 160/2010). For a comparative analysis of such state monitoring and reporting initiatives, along with some federal reporting infrastructure, see Fundação Geulio Vargas-Centro de Estudos Sustentáveis (GVces)/Mario Monzoni (coordinator) Requerimentos para um Sistema Nacional de Monitoriamento, Relato e Verificação de Emissões de Gases de Efeito Estufa – Vol. 1 (FGVces, 2013). 44 BM&F, ‘The Brazilian Carbon Market’ (BM&F, 2005) 45 See ‘BM&F BOVESPA and BNDES launch Carbon Efficient Index’ (February 2, 2010) 46 BVRio – Rio de Janeiro Environmental Exchange ‘Operational Report 2011-2013 (BVRio, 2013) 258 devoted to attracting institutional investors and individuals to companies committed to disclosing and reducing carbon emissions.47 The BM&F initiatives are indirectly supported by the Federal government through the BNDES (Brazilian Economic and Social Development Bank) and can be seen as preparatory steps for a Brazilian ETS.48 The BM&F is a natural candidate to host or be an active component of a Brazilian ETS. In parallel to the CDM market, the Brazilian carbon market has followed the international trend of expansion of the voluntary market activities, particularly in the forest and other land-use activities. This gradual development of the land-use based carbon credit market is a clear sign of the overall trend of major Brazilian stakeholders, in coordination with the state initiatives on payment for environmental services discussed above, to seek business opportunities in relation to the emerging REDD+ international architecture and the embryonic emissions trading schemes in New Zealand, Australia, California and, more recently, in Japan and China. This set of initiatives in Brazil will certainly influence the emerging discussions on a possible Brazilian Emissions Reduction Market foreseen in the National Policy for Climate Change. Other initiatives include capacity awareness and capacity building clustered by the Fundação Getúlio Vargas Business School aimed at stimulating the participation of different economic sectors in climate change policy discussions and development of market base tools. These tools include emissions inventory tools and simulation of trading activities in preparation for a future Brazilian Emissions Market, the latter under a partnership agreement with BVRio launched in March 2014.49 Despite these initiatives, the legal provision on a future emissions reduction market under the Brazilian Climate Policy has not been complemented by any governmental regulation or supporting documents indicating its possible format or 47 See ‘BNDES will launch Efficient Carbon Index Fund at BM&F Bovespa’, information delivered by the Ministry of Development, Industry and International Trade of Brazil (January 19, 2011) 48 BM&F, ‘The Brazilian Carbon Market’, above n 44. 49 FGV – Centro de Estudos em Sustentabilidade (GVces) ‘Plataforma de Empresas para o Clima: Simulação de Sistema de Comércio de Emissões – SCE EPC – Relatório Analítico Semestral: março a agosto de 2014’ (FGV/GVces e EPC, Outubro 2014). 259 design.50 As a result, the rest of the this chapter will consider the main features of the policies in place and some performance reviews and proposals for improvement made by institutional external reviewers (such as the Public Accounting Tribunal), policy analysts, and the legal, policy, and science literature. This analysis of the current Brazilian climate change legal framework and policies will inform the final chapters of this thesis, which will integrate the main lessons from the emerging ETS international experience to the Brazilian context. 6.4.2.1 Biome/Regional Based Programs This policy approach consists of a cluster of an array of programs that have been implemented by different sectors of the Federal Government. As discussed in the previous chapter, among all biome-based plans, the ones for the Amazon and the Cerrado biomes are the most important to ensure the country’s commitments towards reducing deforestation and improving the carbon footprint of agriculture, forestry, and other land-use based emissions. Some of these plans, such as the PPCD-Am (Plan for Prevention and Control of Deforestation in the Amazon) precede the National Climate Change Policy and have been upgraded and integrated to the new legal framework.51 The deforestation-related plans focused on three larger topics considered critical to fighting deforestation: (i) enhancement of enforcement and 50 A few initial discussions on the contours of a Brazilian Emissions Market, including a cap-and-trade system have been provided only by think tanks and research centers. They include the studies prepared on behalf of the Brazilian BM&F/BOVESPA and a preliminary study conducted by the Getúlio Vargas Foundation to the Ministry of Finance, as indicated in the Introduction of this thesis (chapter I). See BM&F BOVESPA, ‘Estudos sobre o mercado de carbono brasileiro’ (BM&FBOVESPA, 2011) 51 One of the benefits of the incorporation of all plans aimed at decreasing deforestation rates under the same umbrella was to put the coordination of the issue under the Federal Government’s inner circle, namely the Civil Administration Cabinet (the political and administrative branch directly linked to the President of the Republic) whereas the implementation of programs would belong to different ministries and federal agencies. CEPAL-IPEA-GIZ, ‘Avaliação do Plano de Ação para a Prevenção e Controle do Desmatamento da Amazônia Legal – PPCDAm – 2007-2010’ (Special Joint Report, Brasilia, 2011). 260 monitoring infrastructure, (ii) implementation of land tenure reforms towards clearing and securing land tenure rights in large scale, and (iii) promotion of sustainable economic activities at the local level. The PPCD-Am is the most developed of such plans, comprising more than 200 initiatives at the regional level in addition to several coordinated efforts with state and municipal governments.52 Clearly, the PPCD-Am has brought very positive results. Despite some critical problems indicated below, it has been praised by recent studies as the one of the main driving forces behind the high decreasing rates of deforestation measured in the last eight years (70 per cent reduction of a ten-year average as of 2013).53 According to some studies, the improvement of environmental surveillance and enforcement actions against illegal deforestation (including the special programs ‘Operação Arco Verde’ and ‘DETER’),54 coupled with financial and fiscal restrictions applied to municipalities presenting the higher rates of land clearing, have caused a massive reduction in the land clearing rates in the most critical areas. Other positive actions contributing to decreasing deforestation has been brought from outside the PPCD-AM, by an entanglement of public denunciation and awareness campaigns initiated by NGOs,55 and correlated enforcement actions from the District Attorneys’ Office in the region.56 52 Denilson Cardoso et al, ‘Informe sobre o Estado e Qualidade de Políticas Públicas sobre Mudanças Climáticas e Desenvolvimento no Brasil’, (Plataforma Climática Latinoamericana e SPVS, May 2012). 53 J. Börner et al, ‘Forest law enforcement in the Brazilian Amazon: Costs and income effects’ (2014) Journal of Global Environmental Change 1298 (in press, corrected proof) 54 Operação Arco Verde (Green Arch Operation) is a program for enhancement of environmentally sustainable practices in the Municipalities of high deforestation rates in the Amazon Region, established by Federal Decree 7.008 of November 12, 2009 as part of the activities under the PPCD-AM; DETER –Real-Time System for Detection of Deforestation, is a satellite-base system that captures and processes geo-referenced images on forest cover in 15-day intervals developed by the National Institute for Space Research and launched in 2004. See Juliana Assunção, Clarissa Gandour and Romero Rocha, ‘DETERing Deforestation in the Brazilian Amazon: Environmental Monitoring and Law Enforcement’ (Climate Policy Initiative, Núcleo de Avaliação de Políticas Climáticas, PUC-Rio, CPI Report, May 2013). See also MCT, Second National Communication above n 27, 357-63. 55 Particularly two campaigns led by the Greenpeace against illegal deforestation in connection with the soybean and beef supply chains of major industrial and commercial players of the food industry). Daniel Nepstad et al, ‘Slowing Amazon deforestation through public policy and interventions in beef and soy supply chains’ (2014) 344 Science (6188) 1118. 56 Ibid. 261 Clearly, the PPCD-Am inspired a more effective planning process and better governance for the myriad of programs being development in the region. However, despite the positive results, some critical problems with the direct intervention model of the PPCD-Am (and to some extent with the PPCD-Cerrado which was initiated later) have been identified by external reviewers and the academia. The lack of coordination for the myriad of actions within the PPCD-Am and between the PPCD-Am and other governmental strategic plans such as the PAC has been detected as one of the most important caveats of the program at the macro level.57 With respect to enforcement actions, they have been praised as the major indicator of success of the PPCD-Am, but the current model of enforcement (focused on large properties with high levels of deforestation) has become expensive and less efficient due to the dispersion of deforestation activities affecting smaller properties and different areas outside the first targets of the enforcement efforts.58 Another caveat of the enforcement approach relates to the overreliance on administrative fines that, despite representing significant sums in some cases, have an extremely low collection rate,59 in many cases due to lengthy administrative proceedings and judicial discussions. Also, the slow progress in relation to the actions devoted to regularizing land tenure in the region has been considered a bottleneck for the Plan, since it is a crucial precondition for the success of most of the actions related to territorial governance and improvement of sustainable economic activities in the region.60 At this stage, one major concern is to confirm whether the 57 CEPAL-IPEA-GIZ, ‘Avaliação do Plano de Ação para a Prevenção e Controle do Desmatamento da Amazônia Legal – PPCDAm’ above n 45, 32-3. The PAC was launched in 2007 and encompasses a series of major projects, mainly in the infrastructure area, being the major public investment effort from the Lula and Dilma Roussef Presidencies since then. In fact, poor coordination among different Federal agencies and between federal and sate and local governments have been raised as one of the major critical problems of historical environmental and development programs for the Amazon region by the Public Accounting Tribunal in more than one occasion. See Tribunal de Contas da União, ‘Atuação do Tribunal de Contas na area ambiental’ (TCU, 2010) 58 Börner et al, ‘Forest law enforcement in the Brazilian Amazon: Costs and income effects’ above n 53. 59 Ibid. 60 CEPAL-IPEA-GIZ, ‘Avaliação do Plano de Ação para a Prevenção e Controle do Desmatamento da Amazônia Legal – PPCDAm’ above n 45, 32-3. 262 decreasing deforestation rates detected in the last years are contingent or perennial,61 and to which extent they are decoupled from the commodity markets (particularly soybean, beef, and timber) supply and demand dynamics.62 Another concern relates to the overreliance of many, if not all programs under the Plan, on the political will of authorities in all three instances of government. As with any other direct intervention policies, they are usually more prone to risks of discontinuity or radical changes due to political pressure or change in command of the executive power.63 As a result of these implementation challenges, some reviewers have argued that the PPCD-Am and other related actions must, in parallel to maintaining strict enforcement and increased presence of government agents in remote areas, invest in the so-called ‘positive measures’ such as, economic benefits and market mechanisms.64 This would result in a more balanced approach among strict enforcement action and improved enforcement and monitoring infrastructure, strategic interventions in the key supply chains (such as soy and beef production), and ‘positive’ incentives-based conservation tools (namely economic) that enhance the competiveness of low carbon and environmentally sustainable activities against the multifaceted market forces driving deforestation.65 6.4.2.2 Sectoral Plans The sectoral plans also reflect the same model of aggregating different lines of action under a common policy. By nature, sectoral plans offer a higher level of participation for affected sectors, clearly providing a forum for the consolidation of knowledge regarding each sector’s GHG profile, bottlenecks for the transition to lower emissions, and the corresponding strategies for innovation and research and financial support for achieving this. One exception to the sectoral plans is the Energy Plan, which heavily relied on the government plans for the sector, due to the regulated nature 61 Ibid. 62 Ibid 33. See also Nepstad et al, ‘Slowing Amazon deforestation through public policy and interventions in beef and soy supply chains’ above n 55, 1121. 63 Ibid. 64 Ibid 1119. 65 Ibid; See also Börner et al, ‘Forest law enforcement in the Brazilian Amazon: Costs and income effects’ above n 53, 9. 263 of the market.66 In any event, the sectoral plans present the basis for segregating and treating emissions data per sector, and generating important inputs for emissions reduction policies. For purposes of assisting in decreasing emissions from land use, one key sectoral plan is the ‘Low-Carbon Agriculture Plan’ (ABC). The ABC lines of action are directly related to the regional/biome based plans, in general, and the Amazon and the Cerrado Plans in particular due to the continuous expansion of the agriculture frontier into both regions. The ABC Plan establishes a review of the major sources of emissions in agriculture and the most important mitigation activities being considered by the government, research centre’s entities and entities representing different agribusiness groups.67 The ABC reflects the consensus of other major analyses that integrate the land-use and agriculture direct emissions in relation to the need for restricting the expansion of the agriculture frontier. Intensifying the production capacity of beans and beef production per hectare, re-using degraded lands for new cultures and activities, and improving the carbon footprint at the farm level through technological innovation and integrated land management would achieve this goal.68 The ABC benefits from the leadership of the Brazilian Agricultural Research Company (EMBRAPA) in identifying and advancing the technological innovation in all fronts of the tropical agriculture, in general, and the agriculture GHG mitigation in particular.69 However, for the implementation of the proposed mitigation activities, the ABC heavily relies on a subsided line of financing of low carbon activities offered to farmers by the Brazilian Development Bank (BNDES) and the Banco do Brasil (the federal publicly-owned commercial bank, the largest in the country), the latter being the most important 66 Rodrigo Pacheco Ribas, ‘Perspectivas de demanda e emissões de co2 no setor energético brasileiro face às políticas de mitigação da mudança do clima’, (PhD Thesis COPPE/UFRJ, 2013) 67 Aron Belinky e Mario Monzoni (Coordenadores) ‘Obvservatório ABC: Agricultura de Baixo Carbono: Análise dos Recursos do Programa ABC’ (FGV/EESP e GVAgro, Sumário Executivo, Relatório 2 – Ano 2, Setembro 2014), 3. 68 Such broad lines of actions reflect the Brazilian Climate Change Policy and the Brazilian Second Communication to the UNFCCC as well as studies such as the McKinsey and the World Bank studies regarding Brazil’s transition to a low carbon economy discussed in chapter V of this thesis. See Christophe de Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’ (The World Bank Group, Brasilia, 2010) 23-4; 69 Ministério da Agricultura e do Abastecimento, ‘O Aquecimento Global e a Agricultura de Baixa Emissão de Carbono’ (MAPA, 2012) 264 financial institution providing credit to agriculture in Brazil.70 In this regard, most criticism of the ABC plan has been directed to failure in promoting and implementing credit lines.71 In general, the ABC has a much lower budget in comparison with traditional agricultural funding (which, by definition, is a GHG source).72 The ABC credit application and analysis are highly bureaucratic and have been poorly promoted by the government in general and financial agents in particular.73 Further, the promotion of the low-carbon initiatives at the farm level has been limited in the light of structural problems of the Brazilian agriculture infrastructure in relation to ‘extension services’, meaning the availability of technical assistance or capacity-building to farmers in relation to the technological innovations developed by EMBRAPA and other agricultural research institutions.74 The result is a slow implementation of the ABC in the first years in comparison with the initial goals and in the light of the timeframe of the emission reduction targets reflected in the National Climate Change Policy.75 More recently, although funding through the ABC has increased in relation to the previous years, there has been a large concentration of delivery of funds for projects in the Southeast and Central-West, as opposed to the North (where the Amazon biome is located) and the Northeast, in large part due to land tenure insecurity and poor promotion of the program.76 Further, the governance and monitoring aspects of the ABC Program have also been subject to criticism due to poor mechanisms for monitoring and verifying the effectiveness of the financed activities in emissions reduction, and, in some cases, alleged use of the ABC credit line to financing activities 70 Belinky e Monzoni (Coordenadores) ‘Obvservatório ABC: Agricultura de Baixo Carbono: Análise dos Recursos do Programa ABC’ above n 67. 71 IPAM (Amazon Environmental Research Institute), ‘Brazil’s Low-Carbon Agriculture Program: Barriers to Implementation’, (IPAM, June 2012) 4. 72 Ibid. 73 Ibid. 74 Belinky e Monzoni (Coordenadores) ‘Obvservatório ABC: Agricultura de Baixo Carbono: Análise dos Recursos do Programa ABC’, above n 67, 11. 75 Ibid. 76 IPAM, ‘Brazil’s Low-Carbon Agriculture Program: Barriers to Implementation’ above n71. 265 that do not reduce or can even be a source of emissions increase under certain circumstances.77 6.4.2.3 Accounting-Based Funds and Financial Lines As indicated above, the major accounting-based funds under the Brazilian Climate Change Policy are the Climate Change Fund and the Amazon Fund. Similar to the problems identified in the ABC Credit line, the Brazilian Climate Change Fund (‘Fundo Clima’) and the Amazon Fund faced problems during implementation due to the highly bureaucratic proceedings for identification of projects and credit application and approval.78 The Brazilian Climate Change Fund, which is funded by oil royalties, has also been subject to delay in the transfer of money from the ANP to the Fund, and to initial lack of interest from the private sector in submitting projects for funding approval.79 It is important to note that the Brazilian Climate Change Fund has the potential of becoming a huge source of funds for GHG mitigation projects due to the expected increase in the oil royalties transfer in case the expected pre-salt oil production is confirmed in within the next 3–5 years.80 At least in relation to the Amazon Fund, there is also criticism of the lack of adequate metrics for monitoring the adequate application of funds and the environmental performance of the financed projects.81 Along the same lines, the overall 77 Aron Belinky and Mario Monzoni ‘Observatório ABC – Analise dos Recursos do Programa ABC – Safra 2013-2014 (até abril)’ (FGV e GVAgro, 2014) 4; Paulo Roque Eduardo Assad, Pesquisador da Embrapa Informática: Os desafios do Programa ABC’ Agroanalysis (online) June 2013 78 IPAM, ‘Brazil’s Low-Carbon Agriculture Program: Barriers to Implementation’, above n 71. 79 Nivaldo Souza, ‘Fundo Clima: R$ 564 milhões em caixa não atraem empresas’, IG Online June 12, 2012 80 Ibid. 81 Leandro Fraga Guimarães, ‘Fundo Amazônia – Uma visão sobre a Governança’, in Jacques Marcovitch (org.), Fundo Amazônia: Evolução Recente e Perspectivas (FEA- USP 2013) 28-9 application of the funds of the Amazon Fund in a broad array of projects has been criticized for lacking a strategy of integration of dispersed initiatives under a single or at least more a consolidated set of objectives. Further, both the Amazon Fund and Brazilian Climate Change Fund are managed by the BNDES, and carry the extra burden of a highly complex governance structure, due to the joint participation of public and private sector entities in their instances of project approval and external review.82 Although both funds are important sources of financing for many of the mitigation activities envisaged by the Brazilian government to fulfil its reduction targets, lack of coordination of the funds’ strategies (despite the common role of the BNDES in managing their financial component), higher risks of political pressure in the definition of priorities and project approvals, and the implementation failures above-mentioned have been identified as critical barriers to effective financial support of GHG mitigation activities.83 Another important aspect of the model of direct funding prioritized by the government in relation to the Amazon Fund is the fact that it is largely driven, since its launch in 2008, by a donation pledge of the Norwegian Government. Despite the positive sign of North-South cooperation embedded in the assistance provided by Norway, the importance played by this direct assistance in the overall programs and projects devoted to the Amazon region conflicts with the historical and legitimate pledges of Brazil in securing its sovereign rights over one of the most critical regions in the world in terms of preservation of biodiversity, climate regulation, and access to fresh water resources and genetic resources.84 Further, due to the uncertainties surrounding the negotiations on the climate change regime, one cannot discard the possibility of Norway and any other international donator to the Amazon Fund (such as Germany, so far under a much lower pledge) claiming emissions reduction rights over amazonia/deficiencias-na-governanca-de-fundos-ambientais-e-florestais-no-para-e-mato- grosso-1>. 82 Ibid. 83 Norad – Norwegian Agency for Development Cooperation, ‘Real-Time Evaluation of Norway’s International Climate and Forest Initiative Contributions to National REDD+ (Processes 2007-2010, Country Report: Brazil, March 2011) xiv. 84 This historical discussion has reflected in some analysis on the pros and cons of the model presented by the Amazon Fund, as well summarized by Jacques Marcovitch. See ‘Fundo Amazônia: Cinco anos de acertos e equívocos: Balanço de Uma Experiência de Apoio Externo e Gestão Brasileira’, in Jacques Marcovitch (org.), Fundo Amazônia: Evolução Recente e Perspectivas, above n 81, 9-10. 267 avoided carbon under the Amazon Fund. This would break the odd rationale adopted by the Brazilian government of not optimizing the economic results that it could gain by inserting the Amazon Fund within the context of market mechanisms under the international climate change regime. 6.4.2.4 Brazilian Forest Code The Brazilian Forest Code is the most important and long-lived legal instrument devoted to regulating the use of rural land in Brazil. The code restricts the amount of intervention in areas termed ‘Areas of Permanent Preservation’ (APPs) due to their important environmental functions (for example, contours of water sources, slopes and top of hills), and establishes a minimum quota of preservation of native vegetation in each property (the so-called ‘Legal Reserve Area’ which can range from 20 per cent to 80 per cent depending on the biome where the property is located). Originally issued in the 1930s, the longest version of the Forest Code lasted from 1965 to 2012, when a major reform took place as a result of a fierce debate in Congress between rural leaders and environmental groups.85 One of the driving forces of the Forest Code reform was its poor level of enforcement in several regions, the causes of which included the lack of enforcement infrastructure to the impossibility of meeting its ambitious goals of controlling deforestation in a country of continental dimensions, a rigid legal framework (in many cases did not offer flexible mechanisms necessary to harmonize its environmental goals with responsible land use), total lack of coordination between the environmental policies created by the Forest Code (such as the requirement of environmental license or authorization by the Environmental Agency for deforestation of native vegetation) and the policies created by the government86 which in some cases encouraged deforestation in some regions to improve indicators of productive use of the land. Evidence of lack of productiveness of the land could be used as a legal argument to take away property rights from land that did not fulfil its the ‘social function of property’ principle in favour of other potential landowners or users who need to gain 85 Guilherme Purvin de Figueiredo, ‘Capítulo I – Disposições Gerais’ in Édis Milaré e Paulo Affonso Leme Machado (eds) Novo Código Florestal: Comentários à Lei 12.651, de 25 de Maio de 2012, de 17 de Outubro de 2012 e ao Decreto 7.830, de 17 de outubro de 2012 (Thomson Reuters/Revista dos Tribunais, 2013), 33. 86 Such as the land-tenure policies implemented by the Federal Agrarian Development Agency (INCRA). 268 access to productive areas to survive.87 On top of this, the very poor level of environmental awareness of a large part of the agribusiness sector in Brazil must not be overlooked. This situation has been slowly showing signs of improvement in the last decade, but it still deserves attention and a more aggressive collaboration from the current market leaders in the commodity production and food processing markets. Two of the main issues of contention concerning the Forest Code reform was the regularization of some deforestation occurred before 2008 under certain conditions (the so-called ‘consolidated areas’) and the greater flexibility in some of the calculation criteria for the preservation of APPs. According to some sources, such changes significantly curbed the regeneration capacity (in terms of total area) of degraded land, which would otherwise be crucial for the country to meet the goals of the Climate Change policy for 2020.88 Apart from such legitimate concerns on the potential impact of the new Forest Code in the achievement of the national emissions reduction targets, a systematic analysis of the new law shows that, in aggregate it, cleared out many contingent issues (at least from the rural producers perspective) that used to impede higher levels of compliance. By doing so, it provided for a more realistic horizon for the integration of agriculture production with conservation of native forests, and emptied most of the arguments that the agribusiness sector has relied on to avoid a more proactive or conservationist approach. Thus, initiatives such as the possibility of computing APPs and Legal Reserve areas under certain circumstances and the choice of offsetting deficits in the Legal Reserve area by conserving areas in other properties, or under a joint property regime with other landowners, met historical needs of the rural sector. Another important addition was the creation of a tradeable economic instrument (‘Environmental Reserve Quota’) that represents the surplus of the Legal Reserve Area of a given property, and that may be acquired to offset corresponding deficits of Legal Reserve Areas in other areas. From the authorities’ perspective, the expansion of the Environmental Rural Registry (CAR) into a digital nationwide system for identifying and registering the environmental conditions of all rural properties in Brazil is a very promising initiative regulated by the Forest Code. This initiative aims to enhance planning, enforcement, and monitoring infrastructure of land use policies in Brazil. 87 These conflicting policies reflect in part the historical struggle of subsequent governments to deal with the ancient problem of unfair distribution of land rights in Brazil since the colonization period and the social conflicts resulting thereto. 88 Britaldo Soares-Filho et al, ‘Cracking Brazil’s Forest Code’ (2014) 344 (6182) Science 363. According to this source, the new ‘amnesty rules’ for deforestation occurred before 2008 reduced the total area to be restored from around 50 Mha to 21 Mha. Ibid, 364. 269 Another important innovation of the Forest Code was the clear definition of the legal nature of carbon credits. This filled a gap in the Brazilian legal framework in relation to climate change economic instruments. The Forest Code defines the legal nature of the carbon credit as ‘title representing rights over tradable intangible and incorporeal/immaterial goods.’ Under the Brazilian legal system, this definition allows the transaction of carbon credits under both regulated and unregulated markets. In case of transactions under regulated markets such as exchanges or any other form of public offer, the carbon credits would fall into the ‘security’ (‘valor mobiliário’) definition of Brazilian Corporate and Capital Markets laws, and would be subject to additional controls under the Brazilian SEC regulations89 This new framework provides a good basis for the consideration of land-use activities under an ETS, provided that other barriers are overcome as discussed in this chapter. 6.5 Conclusion This chapter complements the analysis conducted in chapter V, in order to address the legal portion of the subsidiary research question on social, economic, cultural and legal characteristics of Brazil that will be key to influence the development of an ETS in Brazil that will assist in securing GHGs emission reductions. The chapter presented a systematic view of the Brazilian Climate Change Regime, from an introduction to the overall Brazilian Legal System to its intersection with the international Climate Change Regime. By doing so, and following the analytical approach advanced in section 1.4.2.2, the chapter provided for a systematization of the ‘macro model’ where a Brazilian ETS Legal Model will have to operate, preferably taking into consideration the main cultural and legal aspects contingent to the Brazilian reality. Further, the analysis of the Brazilian climate change regime, including the most important mechanisms under the Brazilian Climate Change Policy and related policies and laws, complemented by the discussions undertaken by the previous chapter, provide for a systematic view on the main axiological (including compliance culture, perception of corruption and business culture of major actors in the public and private sectors) and factual factors (including the major climate change and related laws and policies) to be considered in the integrated analysis and legal modelling of a Brazilian ETS undertaken in the final chapters of this thesis. 89 Federal Law 12.651 of 25 May 2002, art 3, XXVII.. 270 Since the Brazilian National Climate Change policy was launched in 2009, Brazil has been able to demonstrate a dramatic reduction of deforestation rates in the Amazon region, which is historically the main source of the carbon emissions in the country. According to the literature used in this chapter, this relative success of the Brazilian policy is a result of a set of policies and direct investments made by the government in the enforcement infrastructure in the region. These investment efforts included investing in monitoring resources in the region (including real time satellite images) to making concerted efforts in enforcement actions in selected cities and regions that presented high rates of deforestation. Entire illegal logging networks (including timber mills) and large ranches were subject to spectacular enforcement actions that led to the imprisonment of many individuals and received great media coverage. Other actions included pressures on the municipalities with higher rates of deforestation by cutting certain public funds and conditioning their return to certain emissions reduction targets. However, also important was the role played by certain NGOs that denounced illegal deforestation in the supply chains of major soybean and meat packing industries, and forced them to implement major changes in their supply chains. Additionally, the Government has put much efforts in providing subsidized funding and lines of credit for selected industries investing in mitigation practices and low emissions technology (the most notorious being the ABC Plan for low carbon agriculture), and in funding of projects through account-based funds, such as the Climate Fund and the Amazon fund. However, despite good results on many fronts, Brazil still faces huge challenges to transition to a low carbon economy. Even the policies adopted so far, despite good results in many instances, have been subject to criticism from close observers from the academia, think-tanks, and NGOs. With respect to the enforcement efforts, particularly in the Amazon, it has been pointed out that the model of focusing on command-and-control initiatives is not enough to maintain deforestation rates below the national targets. Such policies might be complemented by other initiatives, including market-based instruments, in order to provide for a more virtuous cycle of economic activities in the region that can compete with the economic forces driving deforestation. In this regard, the link between deforestation rates and the internal and international demand for agriculture commodities (particularly soybean and beef) is still an object of concern. In this regard, Brazil cannot rest on the last good results in curbing deforestation, and the last GHG inventories show that although deforestation rates decreased, direct emissions from agriculture continue to grow. Another key factor for the effective success of any climate change policy in Brazil relates to the entanglement of government enforcement infrastructure with legal 271 compliance levels and predominant culture in the business and institutional relations90 of the GHGs emitting sectors. In this regard, the Brazilian GHG emission profile discussed in the previous chapter and the assessment of some sectoral and biome-based plans compliance and enforcement initiatives discussed above pose some specific challenges in light of the Brazilian context. First, the necessary monitoring infrastructure of GHGs emissions from stationary sources and land-use activities is not uniform in Brazil, with significant gaps amongst certain regions and states. In relation to industrial emissions, continuous monitoring in general and GHG inventory, in particular, are not common practice and there is a significant level of inconsistency amongst the enforcement infrastructure of states and regions.91 Despite some significant developments in satellite monitoring in the Amazon regions and other parts of Brazil (such as DETER, as indicated in the previous sections), the expansion of remote monitoring coverage to other regions, in particular the Centre-West that hosts the most dynamic agribusiness sector in Brazil is underway but not completed.92 Second, even if technical capabilities and administrative expertise reach adequate levels to enforce and monitor compliance with emission limits, a climate change policy will be most effective to the extent that its design incorporates mechanisms to lower the risks of vulnerability to the corruption culture that permeates several instances of the Brazilian bureaucracy and business practices, including low level of environmental enforcement in many areas,93 as discussed in the previous chapter. 90 Judith Tendler, ‘The rule of law, economic development, and modernization of the state in Brazil: lessons from existing experience for policy and practice’ (Massachusetts Institute of Technology Department of Urban Studies and Planning, Research Proposal to World Bank Office, Brazil and UK Department for International Development, 17 January 2007) 91 Lesley K. McAllister ‘On Environmental Enforcement and Compliance: A Reply to Professor Crawfords’ Review of Making Law Matter: Environmental Protection and Legal Institutions in Brazil’ (2009) 40 The George Washington International Law Review 649, 653. 92 Despite the very good coverage on daily satellite monitoring for the Amazon Biome, lack of real-time or daily monitoring for Cerrado Biome was identified as a major gap in the Brazilian environmental monitoring and enforcement infrastructure and its correction was elected as one of the priorities of the PPCD/Cerrado. Ministerio do Meio Ambiente, Plano de Ação para prevenção e cotrole do desmatamento e das queimadas: cerrado (MMA, 2011) 33-8. 93 Michael Aklin et al, ‘Who blames corruption for the poor enforcement of environmental laws? Survey evidence of Brazil’ (2014) 16 Environmental Economics and Policy Studies 241. 272 Another problem devised in the direct government interventions is the poor coordination among the various federal programs, in addition to inconsistencies between federal and state policies and legislation. As of today, major issues such as allocation of carbon stocks between states and the federal government remain unresolved, and this political inertia creates a significant level of legal uncertainty in relation to the power of states in implementing their own climate change policies (such as those promoting REDD+ and payment for environmental services in the states of Acre and Amazonas). Another major issue is the persistent uncertainty concerning legal title of rural properties, particularly in the Amazon region. Although much has been done by the government to correct this systemic failure of the Brazilian enforcement infrastructure in the Amazon, the gap is still huge and the success of any major pricing mechanism in relation to land use activities is conditioned to the effective management of the ‘legal title’ risk. In fact, pricing mechanisms can be used as another tool to promote compliance with legal title requirements, and assist in resolving this problem. Another point of concern relates to the governance of account-based funds such as the Amazon Fund and the Climate Fund. The analysis of the performance of such mechanisms has shown that there are poor accountability and tracking methods to monitor the performance of the investments approved by both funds. Also, highly bureaucratic methods for project approval and financing have been elected as one of the major reasons for the underperformance of both funds in terms of the amount of money that have been allocated for emission reduction activities to date. Despite the problems identified in the coordination of climate policies at the federal and state levels, a major development in the Brazilian legal framework, the reform of the Brazilian Forest Code implemented in 2012, brought important innovations for the overall forest conservation efforts in the country, as pointed out in the previous section. Thus, a clear definition of the legal nature of the carbon credit and the inclusion of a market mechanism (the ‘Environmental Reserve Quota’) to assist landowners in complying with the law can play an important role in linking state, regional and national efforts in reducing GHG emissions. As discussed in the analysis of emerging ETS under chapter IV, one of this possible roles is the inclusion of some land-use activities in the design of an emissions trading scheme in Brazil, either as a source of offsets to covered entities or as a regulated sector within the scheme. These options will be discussed in the following final chapters of this thesis. 273 CHAPTER VII – APPLYING THE EMERGING ETS EXPERIENCE TO THE BRAZILIAN CONTEXT: POLICY CHOICES, DESIGN ELEMENTS AND LEGAL FRAMEWORK THAT OPTIMIZE EMISSION REDUCTIONS AND INTEGRATION WITH THE CLIMATE CHANGE REGIME AND THE CARBON MARKET 7.1 Introduction The review of the literature on ETS conceptual framework and the comparative and integrated analysis of the EU ETS, CPM, and NZ ETS experiences in the previous chapters of this thesis identified a cluster of issues that are crucial for adequately considering an ETS as a climate change policy in Brazil. These issues, summarized below, are far from being applicable in a purely theoretical format or simply transplanted from one given jurisdiction and respective social-economic context to another. However, despite unique aspects of the ETS design and implementation in each jurisdiction, and the risks that any generalization of its potential benefits and pitfalls may create, it is clear that the major ETS elements, according to the conceptual framework, share a common ground, and cross every policy experience at the international and national level.1 As a result, the previous chapters dissected the driving forces for the major design options of some of the emerging legal and policy approaches to ETS, the defining elements for it to achieve environmental integrity, and its major structural and functional legal aspects. This research aimed at finding how the ETS approach as a policy option for a country as socially and economically complex as Brazil could benefit from this theoretical and practical background. By doing so, this analytical approach also paid 1 This distinction is well captured by Robert Baldwin in ‘Regulation lite: the rise of emission trading’, (2008) 2 Law and Financial Market Review 262, 26: Generalizations concerning emissions trading must accordingly be treated with care and it is important to distinguish between the inherent strengths and weaknesses of emissions trading (which are due to the trading process itself) and those contingent matters of performance which flow not from the trading mechanism but from the particular design or characteristics of the scheme (and its fit within the context of application) or the intensity of the policy being furthered – e.g., the stringency of the pollution abatement target that has been set. In fact, even the choice of some design elements contingent to each jurisdiction comes from a common set of design options established by the literature and early ETS experiences, although the final shape and ‘stringency’ of each of them will still be defined by the ‘context of application’ or particularities of each case. 274 attention, to the extent possible, to some major aspects of the ETS implementation in the covered jurisdictions, including some key facts in its political formation or early implementation phases that were significant in defining the major contours of the policy, the necessary adjustments to its initial design or even its original objectives. As such, this analysis privileged a dynamic and systemic view of the chosen object of study, the ETS, in the theory of pricing mechanisms as an environmental policy mechanism, and in practice, by looking at its empirical existence in the EU, Australia, and New Zealand. In the present chapter, this view will be confronted with the Brazilian legal framework and the relevant social-economic context for climate change mitigation; in particular with the major drivers for the GHG emissions in Brazil presented in chapter V of this thesis,2 and with the respective emission reduction goals and policies discussed in chapter VI. The main goal of the analysis conducted in the present chapter is to integrate the results of the theoretical and case study analysis of the ETS into the Brazilian context, pointing out if and how the Brazilian goals of reducing GHG emissions can benefit from introducing an ETS into the country’s arsenal of climate change policies. In doing so, the chapter will set the stage for the general conclusion of this thesis aimed at presenting a legal model for an optimal integration of an ETS in the Brazilian legal framework for climate change mitigation, considering the country’s unique GHG emissions profile and mitigation opportunities. 7.2 What does the ETS experience tell us? As discussed in the previous chapters, the idea of ETS as a climate change policy has successfully developed in major climate change academic and policy discussions in the last decade. Despite criticism of the use of price mechanisms as a legitimate and socially just instrument by many authors and policy stakeholders (as discussed in more detail in chapter II), ETS adoption on a global scale has been supported since the very beginning of the international climate change regime negotiations by a significant number of actors involved in the regime formation,3 and further by seminal studies on 2 Those emission drivers considered not only as static elements attached to different economic sectors but in the context of the social and economic development dynamics of the Brazilian biomes and regions, as summarized in chapter V. 3 Including the OECD and part of the UN bureaucracy involved in the initial negotiations of the UNFCCC in the early nineties as discussed in chapter II. Afterwards, some milestone studies on the climate change architecture and economics such as the Stern Review and the Garnaut Review and some of the background papers forming the IPCC policy studies have placed a global ETS as a policy alternative to be seriously pursued by the international climate change regime negotiators and policy formulators. Nicholas 275 climate change policy and economics. In spite of the different pace in terms of its implementation on a global scale and the uncertainties still surrounding a post Kyoto Protocol first commitment period regime, the ETS has been consolidated as the major climate change policy of the European Union since 2004 and remains in the political agenda of many countries as part of their policy options to reduce GHG emissions.4 For some authors, the spread of the ‘ETS idea’ is a successful case of an originally US- backed lobbying made by a coalition of businesses and some NGOs, further enhanced by part of the regional and country bureaucrats, such as in the case of the EU and New Zealand discussed earlier in this thesis.5 As summarized in the previous chapters, these coalitions were able to capitalize on a general sense of rejection for tax instruments as a climate change policy option,6 and found a common ground to support a market-based mechanism for climate change mitigation.7 It is in this context that the prospects of an array of national ETS forming a future international market-based regime, voiced by part of the literature, policy forums, and governments participating in the negotiations under the UNFCCC and the Kyoto Protocol, seem to regain some level of relevance. This renewed interest in ETS, both as Stern, The Economics of Climate Change: The Stern Review (Cambridge University Press, 2006); Ross Garnaut, The Garnaut Climate Change Review Final Report (Cambridge University Press, 2008). 4 Updates on the spread of ETS throughout country or subnational climate change policies include the following: Environmental Defense Fund and International Emissions Trading Association – IETA ‘The World’s Carbon Markets A case study guide to emissions trading’ available online 5 See Jonas Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading (MIT Press, 2011), 3-6 and ch 2; Jon Birger Skjærseth and Jørgen Wettestad, EU Emissions Trading: Initiation, Decision-making and Implementation (Ashgate, 2008) 33, 184 and 192. 6 Although in theory the tax-based emission pricing mechanisms have been supported by many important scholars from the economic theory pantheon of praised scholars such as the US Yale-based Prof. William Nordhaus, one of the fiercest critics of early action on climate change mitigation. See William Nordhaus, A Question of Balance: Weighing the Options on Global Warming Policies (Yale University Press, 2008), particularly ch 8. 7 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 5; Skjærseth and Wettestad, EU Emissions Trading: Imitation, Decision-making and Implementation above n 5. 276 a major policy initiative or as a form of integration with other market-based (such as payment for environmental services or REDD+) and/or as command-and-control mechanisms, reinforces the need for adequately considering how the Brazilian climate change policy will react to such international climate change policy developments. As discussed in chapter VI, the Brazilian Climate Change Policy Law recognizes this trend by considering the option of a future Brazilian Emissions Reduction Market, although there is currently no final decision on its adoption or proposed regulation. In this regard, it is submitted that the consideration of ETS as a policy alternative in Brazil can benefit from the experience of the jurisdictions that have pioneered the adoption of some sort of ETS as their major climate change policy, the EU, Australia, and New Zealand. As demonstrated by the integrated analysis conducted in chapter IV and summarized in section 4.5, three key lessons can be derived that can be considered as necessary principles or values to be taken into account in any ETS design and implementation effort. In short, the principles, identified in chapter IV and on which the following discussion is based are: • Predominance of environmental integrity over economic efficiency through clearly stated legislation objectives and principles; • Transparent and well-managed rulemaking processes that enable a political bargaining process that does not jeopardize the integrity of the scheme, particularly when determining cap stringency, sectoral coverage, and allowance allocation methods; and • Identification of linking opportunities with other international schemes, but without putting in check the real and effective domestic reduction. These principles are equally applicable to the Brazilian situation and will provide support for determining: (i) whether it is worthwhile to pursue an ETS as a policy option for Brazil’s climate policy; and (ii) if so, what is the optimal way of introducing an ETS into the Brazilian legal framework. In order to be applied to the Brazilian situation, this set of principles must be confronted with the Brazilian factual and axiological factors discussed in chapter V and VI. On one hand, these principles must be confronted with the Brazilian emissions profile, comprised of different economic activities and sectors that operate in highly 277 diverse and complex geographical regions, as shown in chapter V. On the other hand, these principles must also be tested in light of the institutional and legal framework already in place to deal with the country’s climate change problem, particularly at the level of compatibility and adequacy of the current Brazilian climate policy with a pricing mechanism as part of its policy instruments. In case the ETS principles adopted by this thesis survive the tests of its potential usefulness in reducing Brazilian GHG emissions, and prove compatibility with the country’s legal and policy framework, the next stage is to model the optimal insertion of an ETS into the Brazilian legal system. The legal model must consider the best options from a structural and functional standpoint to ensure that environmental integrity is achieved at the lower cost possible (or economic efficiency in reducing emissions is achieved without compromising the environmental integrity of the scheme). The rest of this chapter is devoted to conducting this analysis. 7.2.1 Major Advantages and Pitfalls for Adopting an ETS as a Climate Change Policy 7.2.1.1 ETS Environmental and Economic Impacts: Can an ETS provide effective GHG emission reductions? Can it do it cost-effectively? Based on the possible benefits of ETS advocated by part of the literature presented in chapters II and III, the question whether an ETS is worth adopting as a climate change policy must be answered based on two basic performance indicators: the scheme’s environmental effectiveness in inducing GHG emissions reductions, and the scheme’s economic efficiency in allowing such achievement at the least possible cost in comparison with other policy alternatives. This thesis takes the position that the environmental effectiveness or integrity of an ETS must take precedence in the ‘negotiated balance’8 between these two potential benefits: cost and environmental gain.9 8 This term is coined by Tim Laing, Misato Sato, Michael Grubb and Claudia Comberti in ‘Assessing the Effectiveness of the EU Emission Trading System’, (Centre for Climate Change Economics and Policy Working Paper No. 126, January 2013), available online at 9 Apart from those two major elements, the climate change policy and economics literature also refers to other important indicators to conduct such kind of comparative analysis between the ETS and other policy alternatives such as tax or command-and-control 278 Common sense suggests that the most reliable/sensible form of assessing ETS performance is by conducting ex post analysis covering a given period of an ETS operation/existence. This kind of analysis has been conducted for many of the US based emissions reduction schemes.10 In the context of climate change policy, only the EU ETS offers a more significant set of data for ex post analysis on the environmental effectiveness and cost efficiency of ETS, due to its almost ten-year period of existence. As discussed in the previous chapter, the NZ ETS also offers some kind of empirical data to be considered, although on a much more limited form due to its shorter life and design characteristics. Before we consider the results of the ETS ex post performance assessments that will be assumed in this thesis in support of the complementary analysis that will follow, it is important to highlight some of the difficulties that this kind of performance assessment encounters. Most importantly, the difficulties in determining the ‘counter- factual’ emissions, that is, emissions increases or reductions that might have happened without any direct interference of the ETS or any other policy being assessed. Such difficulties, inherent to any kind of similar assessment, have been addressed in the most recent analysis covering the Phase II of the EU ETS (2008–2012) as a result of the 2008 global financial crisis. The financial crisis affected the EU emissions due to a decrease in consumption and production patterns, thus affecting the estimations of EU ETS- related abatement.11 Another issue to be considered is determining which criteria should prevail in the assessment of ETS environmental effectiveness, absolute emissions reduction numbers, or a combination of these with some qualitative indicators. Examples of qualitative indicators are increase in awareness and change of behaviour instruments: transaction costs (although it might be factored under the overall cost- effectiveness indicator), administrative costs (from the government perspective in relation to governmental role in the governance, enforcement and monitoring activities) and impacts in public finances, distributional effects among the regulated community (including industrial competitiveness), political acceptance, and impacts on technological change and innovation. See a good summary and critical analysis in Robert Stavins, ‘Market-based Environmental Policies: What Can We Learn from US Experience (and Related Research)?’ in Jody Freeman and Charles D. Kolstad (eds) Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (Oxford University Press, 2007) 19-47. See also Stern, The Economics of Climate Change – The Stern Review, above n 3, particularly ch 14-16. 10 A good methodological approach and analysis for ex ante and ex post analysis of US Based programs is provided by T.H. Tietenberg Emissions Trading: Principles and Practice (Resources for the Future, 2006) ch 3. 11 Laing et al, ‘Assessing the Effectiveness of the EU Emission Trading System’ above n 8, 9. 279 that an emissions price signal from an ETS may or may not have over the regulated community in a given context.12 Despite these difficulties, which in fact apply to any policy assessment, the literature on the performance of ETS, and particularly the EU ETS (and to a minor extent the NZ ETS) discussed in the previous chapter, shows that most of the ex post analysis conducted so far recognize some level of abatement resulting from the EU ETS (although very timid in Phase I). The same set of analyses concluded for key factors for determining a more ambitious level of abatement, some of them credited to design options that prevailed throughout the early implementation phase (in particular the perverse combination of poor monitoring and political reluctance that culminated in a loose cap in Phase I, plus the free allocation of allowances that predominated throughout Phases I and II). Although the literature is vast on these ex post analyses (a number of them have already been addressed in the previous chapters covering the ETS conceptual framework and the emerging schemes), a recent compilation of the most significant ex post analyses under the EU ETS present the following results regarding environmental and cost effects of the EU ETS so far:13 7.2.1.1.1 Environmental Effectiveness: Despite over-allocation of allowances in Phase I and the economic crisis in Phase II, the EU ETS combination of enhanced monitoring (particularly in Phase II) and awareness, and a positive carbon price signal has generated emission abatement that is 12 This point is made by Denny Ellerman, Frank J. Convery and Christian de Perthuis (principal authors), Pricing Carbon: The European Union Emissions Trading Scheme (Cambridge University Press, 2010) 30-1 and 83. 13 The more limited data on the NZ ETS and Australian ETS (mostly resulting from official data, and the Australian being limited to one-year of existence only) also reinforces the more robust conclusions taken from this set of analysis covering the EU ETS, particularly with respect to the existence of some level of abatement. In any event, the few ex ante and ex post analysis on the New Zealand ETS show a very limited, if any, level of abatement in emissions as a result of the New Zealand ETS. See Geoff Bertram and Simon Terry The New Carbon Challenge: New Zealand’s Emissions Trading Scheme (Bridget Williams Books, 2010) 17; see also Jessika Luth Richter, ‘Institutional Feasibility – the end or the means in emissions trading? Evaluating the New Zealand Emissions Trading Scheme’ (Thesis for the fulfilment of the Master of Science in Environmental Management and Policy Lund, Sweden, September 2012), IV 280 attributable to the EU ETS (after discounting counter-factual emissions) in the range of 40-80 MtCO2/year annual average. Accordingly, this abatement represents 2 to 4 per cent of the capped emissions and is bigger than most of other related policy instruments in place.14 7.2.1.1.2 Economic Efficiency: The economic aspects of the EU ETS have been appraised more based on the potential for inducing investments in low-GHG technology or processes, other than on allowing emission reductions at lower costs in comparison with other policy alternatives. In this regard, the same aggregate results of ex post analysis (based on qualitative research methods other than quantitative or monetized studies) indicate that the EU ETS has contributed to investment decisions on low-carbon alternatives, although with a more limited, or short-term or small-scale investment. Anyway, the results point out that the EU ETS has definitely brought the climate change constrains to the EU businesses decision-makers and top management and, as such, helped to constrain major high-carbon investments.15 These results show that the ETS potential of reducing GHG emissions by establishing a price mechanism based on predefined emissions limits (cap) is real. However, how significant the environmental integrity of the scheme, and to which extent it will be cost-effective in comparison with other alternatives will largely depend on its final design and how optimally it is combined with other policies in place. Such design options will be crucial to achieving these results and avoiding or mitigating some of the weaknesses or perverse effects that a poorly designed ETS may cause. Some of these perverse effects are discussed below. 14 Laing et al, ‘Assessing the Effectiveness of the EU Emission Trading System’ above n 8, 25. 15 Ibid. 281 7.2.2 Major ETS pitfalls or perverse effects 7.2.2.1 Lack of Credibility/Legitimacy due to loose caps and over-allocation of allowances: The most ETS perverse effect possible is the reverse of its potential environmental effectiveness, that is, an ETS with a design that does not enable effective reduction of emissions by the covered sources. As discussed in the previous chapters, although ETS can be environmentally effective (EU ETS ex post assessments show an abatement occurs), the desired outcome will largely depend on the actual design of the scheme. Most importantly, the combination of the stringency of the cap, the adequate coverage in relation to relevant sectors and gases, and the adequate form of allocation of allowances (meaning the use of auctions instead of free allocation) will provide for real market/allowance scarcity and price signal to the affected sectors. Other perverse effects or undesirable outcomes resulting from ETS design options were also identified, and the EU ETS experience so far suggest that medium term corrections may have mitigated such effects, although further research will be necessary to confirm these assumptions. The most important perverse effects are: 7.2.2.2 Unfair distributional effects: Inadequate coverage, political lobbying of emission intensive or economically or politically powerful domestic sectors may create an unbalanced distribution of the mitigation efforts and costs among economic sectors and households. This is one of the most sensitive issues to be dealt with in the approval and implementation phases of an ETS (as in any other policy), and it can create distortions that are able to reverse the whole objective of the policy, mainly in cases where large polluters are awarded free allocation or any other kind of direct assistance that, in the end, transfer the economic costs to less carbon intensive sectors or the general public (who will bear the price increases resulting from a carbon price and/or will be impacted by the renunciation of public funds that could be earned through auction). The latter scenario has been identified by at least one major economic analysis of the NZ ETS, which modelled the 282 transfer of costs throughout the economy, and concluded that a significant portion of the costs of emissions would be borne by households.16 7.2.2.3 Windfall Profits and Distributional Unfairness: The potential of an ETS causing windfall profits for certain sectors or firms, in detriment to other economic agents or the general public, has been widely researched and confirmed under the EU ETS. Although the numbers vary, the overall conclusion is that particularly the sectors that can easily transfer the carbon costs down the supply chain to the consumer can achieve significant gains. This is widely the case of the energy sector in Europe, particularly in the first phase of the EU ETS, although some windfall profits to other sectors (such as iron and steel and cement companies) have been recognized.17 This outcome is further increased when the allowances to these sectors are freely allocated, as in Phases I and II of the EU ETS. 7.2.2.4 Risks of Market Power: Further undesirable and unbalanced profits can be achieved through exercise of market power by some sectors. 7.2.2.5 Risks of Market Fraud: As in any other market, the ETS is not fully protected against market frauds or other criminal attempts to play with the market. The detection of a VAT fraud under the EU ETS (which was actually part of a larger VAT fraudulent scheme in Europe) was crucial to alert for the need of internal and external controls in the scheme design (by including periodical controls and checks of the electronic trading infrastructure) taken into account from the outset of the scheme. 16 Bertram and Terry The New Carbon Challenge: New Zealand’s Emissions Trading Scheme above n 13, 85. 17 Laing et al, ‘Assessing the Effectiveness of the EU Emission Trading System’ above n 8, 21. 283 7.2.2.6 Leakage: The risk of GHG emission-intensive and traded-exposed companies moving to other jurisdictions due to higher production costs resulting from the price of emissions set by an ETS has been permeated most of the political debate in relation to ETS approval and implementation. As discussed in the previous chapters, although some evidence exists about such risk (and price distortions in the international market due to asymmetry in emission costs among different countries), this potential risk has been heavily relied on by some economic sectors to bargain a more favourable treatment under the ETS coverage or under any other kind of emissions control or pricing alternative. 7.2.3 Other relevant aspects to be considered In addition to the major aspects discussed above, there are other relevant characteristics of ETS that deserve attention from policy designers at the earliest stage possible: 7.2.3.1 Political Acceptance: One aspect of ETS that has created some appeal among advocates is the scheme’s alleged capacity of gaining political support, as a policy alternative to tax or command- and-control regimes, from among different stakeholders (such as industry representatives and a significant part of the environmental NGOs). However, some authors less enthusiastic about this ETS feature suggest that this appeal denotes a different standard to measure the quality and legitimacy of a regulation, namely the level of acceptance by the regulated community as opposed to other more relevant criteria.18 The political appeal of ETS in the light of previous attempts of tax reforms in the EU has been largely recognized by the literature, although other significant driving forces such as the Kyoto Protocol negotiations at the time played a major role as well. In any case, two important factors in the political spectrum of ETS adoption deserve attention. First, as detected by Jonas Meckling, the ‘carbon coalitions’ that have been organized to shape climate change policy are heavily driven by transnational business coalitions, which were able to find a common ground with business-oriented NGOs, and 18 Baldwin, ‘Regulation lite: the rise of emission trading’, above n 1, 270. 284 certain state actors, who formed a protrading coalition for climate change policy.19 This does not mean that the business community’s position is homogenous on climate policy. In fact, there has been a well-defined split in the business community, at least in the early negotiations of the Kyoto Protocol, even within the same sector (such as the oil industry).20 The discussions on risks of carbon leakage in different jurisdictions (for example the EU, Australia, and New Zealand covered in the previous chapter) and lobbying by each affected sector to avoid stricter price constraints on their emissions also show that gaining support for the ETS does not mean that the affected sectors will rest their attempts to influence the regulation design to their own individual benefit. The game goes on, and the actual design of the ETS may or may not turn it into an effective climate change policy or in a pretence scheme, which masks some subsidies to pollute to certain sectors without any guarantee of effective emissions reduction. It is within this context that the initial political acceptance of ETS must be very well managed by the relevant political actors to be translated into sound policy. An ETS design may, if necessary, entail some initial adaptation alternatives to the most affected sectors. However, experience shows that the design of a kind of initial assistance must come along with policy instruments (for example, periodical review of design options) that allow the necessary and timely changes to introduce the adequate level of emission constrains and economic scarcity that are necessary to induce a less-intensive emission profile of the covered sectors. 7.2.3.2 Enforcement and Monitoring Approach: An effective ETS is particularly dependable on the quality of emissions data (actual emissions and projections) that can be produced and verified at the source level or in aggregate (the latter with respect to sectoral or nationwide inventory and projections informing cap setting decisions). In this regard, both firm level information systems, and enforcement and monitoring infrastructure by the authorities must be evaluated and improved to minimum standards that will allow a secure and transparent management of the program. 19 Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading above n 5, 3-6. 20 BP and Shell, for example, developed intra-company ETS as part of their support for the EU ETS, in opposition to other market leaders such as US based Exxon, which invested heavily in lobbying activities against climate change policy. Ibid, 104-5 and 135; Bryan Lovell, Challenged by Carbon: The Oil Industry and Climate Change (Cambridge University Press), ch 3 (An Atlantic Divide in Big Oil). 285 7.2.3.3 Interconnectedness with other policies and jurisdictions: As discussed in chapter III, any climate change policy must be carefully designed in relation to other policies in place that may affect the ultimate goals of reducing emissions. Fuel subsidies, tax incentives, and governmental programs in support of economic growth may be evaluated before critical decisions on ETS design (such as coverage and point of obligation) are taken. 7.2.4 Implementation Lessons 7.2.4.1 Staged Implementation Staged ETS implementation has been advocated in ex ante and ex post analyses of emerging ETS, in order to preserve the potential benefits of an ETS, and deal with the uncertainties and risks inherent to its nature and, in some cases, inherent to any form of climate policy. The EU ETS experience has reinforced this assumption, as shown by the major corrections that the EU Commission has implemented during the lifetime of the scheme in order to eliminate or mitigate distortions from the original design. The concept of gradual implementation has been included in the overall EU ETS discussion since its early considerations as a policy alternative. And, this approach has facilitated the political bargain that followed, aimed to accommodate national and economic sector interests within the EU. The New Zealand and Australian political actors have taken the same approach during the long political debate in both countries for purposes of defining their climate change policy approach. 7.2.4.2 Governance and Monitoring Infrastructure In addition to a staged implementation approach, it is extremely important to assess, in any jurisdiction that is seriously considering an ETS as a climate change policy option, the level of emissions monitoring and governance, and enforcement infrastructure in place. The staged implementation process requires a previous step of the assessment and, if necessary, implementation of such infrastructure before any ETS is launched as a binding policy. A good example of sound preliminary steps to enhance monitoring and reporting capabilities before the introduction of an ETS was given by Australia through the implementation of the NGER Act years before the CPM approval, as discussed in chapter IV. Otherwise, there are great chances of the scheme being seriously flawed due to lack of reliable emissions data, as it was the case of the trial phase of the EU ETS. 286 These issues will be retaken up in the final part of this chapter and in the next chapter when the optimal insertion of an ETS into the Brazilian framework will be discussed and modelled. But before, we turn to the Brazilian GHG emission profile and address the potentiality and optimal conditions for inclusion of an ETS into the country’s climate change policy portfolio. 7.3 Is it worthwhile to include an ETS in the Brazilian response to climate change? Why? If so, how or under which conditions? Based on the analyses made in the previous sections, and within the limits of the scope of this study, it is possible to provide an answer to the research question of this thesis (namely, What is the most appropriate legal framework for securing environmental integrity in a future Brazilian ETS?) in favour of an ETS being considered as a climate change policy for Brazil. The foundations for this answer are presented below, based on the axiological and factual factors of the Brazilian GHGs emissions profile and climate change laws and polices in place, as discussed in chapters V and V of this thesis. An ETS can be effective in reducing GHG emissions, provided that its final design takes into consideration the major elements proven to be crucial for striking the right balance between its environmental integrity and cost-effectiveness. Such design elements include an accurate and responsible approach for estimating emissions inventories and trajectories, and a conservative approach to establishing emissions cap (meaning caps resulting in allowance scarcity and able to induce emission reduction from the affected sectors). Also, emission allocation policies must avoid free allocation either as the main allocation criterion or as assistance to most affected sectors under the risk of jeopardizing the core of the ETS potential benefits and demoralizing the whole policy approach supporting it. Price controls and optimal interaction with the tax system and other related policies may play a more efficient role in securing a better environmental and economic performance of an ETS, as opposed to free allocation and unbalanced assistance to some sectors, because this can create distributional injustice and economic unbalance among the different economic sectors, households, and the public finances. Provided that the basic elements of an adequate ETS are pursued and mirrored in the corresponding policies, the inclusion of an ETS in the arsenal of Brazilian climate change policies is also important to create a favourable position for the country in the emerging international climate change architecture in the post Kyoto period. The matureness of the EU ETS as Europe’s main policy approach, the movements of 287 important national and subnational jurisdictions towards an ETS (for example, China, South Korea, and California), and the US preference for market mechanisms for environmental and climate change policies, all suggest that the prospects of an international ETS formed by linking regional and national schemes cannot be discarded. Thus, countries that are better prepared will benefit from early action in case this materializes. Moreover, it is also important to expand the Brazilian climate change policy options, by adding market-based instruments to the current policy mix. Brazil has implemented a cluster of climate change policies the emphasis of which has been on improving enforcement and monitoring infrastructure, and assisting in direct financing of low carbon or emission mitigation activities. This set of policies and related initiatives in partnership with the private sector, NGOs, and the academia has significantly improved the knowledge base in terms of the GHG emissions profile of the country, the major contributions from each sector and region, and the hurdles and challenges that each sector shall face to transition to a low carbon economy. Also, at least in relation to deforestation rates, significant improvements have been detected and measured, as attested by scientific research papers published in different parts of the world. However, the analyses undertaken on the progress of Brazilian climate change policies have also revealed the weaknesses of the current policy model. This suggests that economic or market-based mechanisms can be useful to complement the current policy approach and make it more robust in the light of the highly complex Brazilian social-economic and social-ecological systems and, in the light of Brazil’s ambitious emissions reduction goals. According to the analyses of external reviewers of the Brazilian policies in place, and consistent with the history of environmental controls in Brazil (such as the Forest Code requirements), the emphasis on more stringent enforcement and corresponding infrastructure is not enough to resolve the complex array of emissions drivers, particularly in the context of land-use emissions, which are by large the most significant emissions sources in the country. In addition to the necessary and welcomed improvement of command-and-control enforcement activities, empowerment of the local economies to succeed in land conservation or more sustainable activities, as opposed to the current land clearing drivers, is necessary to maintain the gains of deforestation reduction achieved so far. The use of economic and market-based instruments as part of the policy approach towards changing social and economic dynamics is seen as an important ally, provided that some preconditions are met, and some challenges are overcome. The first precondition is that pricing mechanisms (such as tax, baseline-and-project, and ETS) must induce or impose payments and economic benefits that are real and robust enough to compete with the array of economic activities that induce deforestation, from agriculture and forestry to 288 other activities of more indirect repercussion in emissions (such mining, hydro energy and oil and gas). In other words, price for emissions reduction or any other form of monetization of sustainable activities competing with deforestation drivers must meet accurate assumptions of the real opportunity costs in each region, and be flexible enough to consider long-term opportunity costs that some groups and communities will face, in order to change the current unsustainable path of land use in large parts of the country. When considering an ETS for the land use sector, a major challenge is to implement a pricing mechanism under the still very complex and poorly enforced land tenure policies in Brazil, particularly in the Amazon region. The land tenure issue is viewed as the major bottleneck for many important policies in the region, and this challenge will not be different in the case of an ETS that encompasses land use credits, either as a regulated sector or as a credit offset source. Other sectors offer more adequate infrastructure to be considered a covered sector under a Brazilian ETS. The industrial sector, highly energy intensive and much more concentrated in terms of geographical location, is the first candidate for being targeted by a pricing mechanism such as an ETS. The global insertion of many of the active industrial sectors in Brazil (either by the massive presence of multinational corporations in the country and the exporting profile and ambitions of many Brazilian major players) suggests that market mechanisms will favour intra-company policies and potential links with international markets vis-a-vis command-and-control or other forms of emission reduction policies. In any case, the capacity of individual sectors to monitor and report emissions reliably, and of state authorities to enforce them, is controversial. Therefore, significant improvements must be made prior to a formal adoption of self-monitoring and reporting as the major source of emission information in the country. The emission profile and climate policies in place in Brazil suggest that an optimal combination of market-based mechanisms is worth trying. The unique conditions of the country’s emission profile and the challenges in place suggest that the industrial and energy sectors qualify for the first stage of a Brazilian ETS. The land use sector, including agriculture direct emissions, deserves a segmented analysis in order to define the best approach towards optimization of policies and controls towards lower GHG emissions. On the one hand, the continental size of Brazil would enable a segregation of areas that would qualify for a potential market mechanism, due to clear land tenure and proprietary rights. Areas with land tenure problems would qualify under certain conditions, and the ETS would work as an inducer of land tenure regularization in cooperation with other policies. The powerful position of many organizations in the agriculture sector (in terms of financial and management capabilities) allows them to 289 participate under an ETS at least as a source of offset credits to the other sectors. This model, adopted under the Australian framework through the Carbon Farming Initiative, seems to be more suitable for the current stage of land use policies being developed in Brazil, particularly the Payment for Environmental Services, the REDD+ voluntary and jurisdictional systems (such as in the state of Acre), and the recent innovations under the Brazilian Forest Code that created an economic instrument (the CRA) and environmental compensation mechanisms that will mirror land conservation of native species and will be tradable among other land users. In this scenario, considering the same kind of projects as offset providers under an ETS would enhance the competitiveness of such credits, and thus increase the chances of higher prices and more robust economic choices to compete with deforestation drivers. In any event, it is worth mentioning that some direct agriculture emissions are already very suitable for reliable monitoring and calculation methodologies, and including of some of them as a covered sector under the ETS should not be discarded. As viewed in the last chapter, this is the situation in New Zealand, according to some sources, which concluded that not including part of the agriculture sector under the ETS to date is more related to lobbying activities from the agribusiness than to methodological constraints as justified by the government.21 There is no legal approach immune to corruption. However, the history of implementation of Brazilian policies, in general, shows that direct investments under government programs are more suitable to corruptive practices and to the political will of the government of the day. A regulated market provides a more stable and transparent framework, with higher levels of external scrutiny by market players, the investing community, and the public. The Brazilian records for the financial and capital markets compliance standards is much higher than in other parts of the economy and the political spectrum, and problems already detected in the implementation of some of the climate change direct policies and financing indicate that a regulated carbon market is worth a try as a legitimate alternative to the climate change policy framework. 7.4 Conclusion Based on the integrated analysis conducted in this chapter, it is possible to consider under which conditions an ETS should be implemented in Brazil and identify 21 Bertram and Terry, The New Carbon Challenge: New Zealand’s Emissions Trading Scheme, above n 13, ch 8. 290 the main barriers and key points to be considered for enhancing its chances of success. This chapter ends with such reflections, which will be the foundations for the final chapter that follows, which, in turn, will propose a legal model for the consideration of an ETS in the Brazilian Legal Framework. Thus, taking into the consideration inherent strengths and weaknesses of ETS, principles derived from its adoption so far, and contingent aspects of the Brazilian reality, this thesis proposes the following conditions and strategies to be considered for the adequate implementation of an ETS in Brazil: • As clearly recommended by the ETS theoretical framework and demonstrated by the emerging ETS experiences, the adoption of an ETS in Brazil should follow a staged implementation path. In general, Brazil has a reliable emissions inventory and projections system by sectors and regions, which have been gradually improved in support of the country’s reporting system to the UNFCCC and the Kyoto Protocol as part of the internal efforts to implement the National Climate Change Policy as discussed in chapter V. This system can be used as a good starting point for the Brazilian government taking a responsible approach for to establishing emissions cap that will result in allowance scarcity and be able to induce emission reduction from the affected sectors. However, this system still needs significant improvement at the firm level in many sectors. Thus, a staged implementation of an ETS includes the improvement and selection of the sectors that already meet minimum standards for emissions self-monitoring and reporting, and efforts must be made to bring other sectors to the desired level as part of the staged implementation process. • Staged implementation must also inform the possibility of international liking of a Brazilian ETS with other systems. It is necessary to build a reliable electronic registry and trading platform, strength the overall enforcement and monitoring infrastructure of the Brazilian system and guarantee the good functioning of the market before any international linking is considered. Further, the incorporation of land-use credits into an ETS must be confined to the internal market (which is already formed by many multinationals) to avoid distortions in the price formation, and also neutralize the risks of an ETS weakening the national position before the international climate regime due to a possible loss of the stock of carbon credits to premature sales to international players at a very low price. 291 • Emissions Prices must be real, avoiding the trap of free allocation as a method for assistance aimed at affected sectors. As a result, a Brazilian ETS must consider, from the outset, auctions of allowance allocations and, if necessary, price control alternatives, including the possibility of floor price and triggers for price ceiling if necessary to avoid distortions against Brazilian business facing international competition, Also, other mechanisms of price control such as the recent strategy under the EU ETS to call back allowances to restrict the liquidity of the market and provide a scarce environment, as discussed in the previous chapter. • The land-use sector must participate as a source of credits due to its massive contribution to the country’s emissions. Also, allowing the industrial and energy sectors to participate in the novel market for conservation of native species under the New Forest Code (NFC) would translate new economic incentives translated into a highly effective tool capable of addressing the competition of the different sectors for the same credits. Thus, this approach provides for higher chances of remuneration to the agriculture sector and enhances the chances for a concrete market scarcity situation. It may increase the incentives for landowners to reduce deforestation in their own properties, without using the economic instruments in situations where the opportunity costs of deforestation are higher and more attractive when avoided. This scenario, however, will only work if at least two factors are present. First, if the prices of offset credits are high enough to compete with the numerous social and economical forces that drive deforestation, particularly in the centre-west and Amazon basin regions, which as discussed in chapter V host an extremely dynamic economy and a very complex social-ecological environment that usually are not captured by economic models that project very low prices for land conservation projects (including those under REDD and PAS). Second, if enforcement against violations of the NFC is effective, which is an aspiration of most Brazilians and one of the targets of the government’s regional and sectoral climate change mitigation plans discussed in chapter VI. • The possibility of incorporation of land-use credits as offsets of an ETS (and the competition among different players for land-use credits arising from different schemes, including the Forest Code, State REDD+ and payment for environmental services markets) will be conditioned to clear fungibility among the different credit instruments. In this regard, the legal nature of the carbon credit, as defined by the Forest Code, meets this requirement due to 292 its universality and consistency with the Brazilian legal system and nature of the market (the latter meaning the strong participation of secondary transactions as part of the market nature). On the other hand, regulated market transactions under exchange or any other form of public offer can be further regulated by the Brazilian SEC and other relevant authorities, without any major legal barrier, as already established in the CDM market. • In order to contribute to the improvement of land-tenure regularization in Brazil, a Brazilian ETS may allocate a portion of the proceeds resulting from allowances auctions to programs of land-tenure regularization in areas particularly targeted to generate offset credits for the scheme’s covered sectors. This strategy may also seek land-tenure regularization in degraded areas that are suitable to be recovered and used to accommodate the increase of agricultural production without pushing the expansion of the agricultural frontier towards currently preserved areas of native forests. • In addition to the price control policies above mentioned, the scarcity for emission allowances created by effective pricing on emissions (towards both the land-use and other sectors) might be implemented in connection with tax incentives that would be used as the main assistance tool for the most affected sectors. In this case, the government would transfer part of its tax revenues from the national treasury to effective and measured climate change mitigation, without overburdening the private sector with one more layer of transfer of private resources to the government. Along the same lines, it is necessary to review the overall policies, including tax incentives for development projects or to certain sectors of the economy and fossil fuel subsidies that may compete with the efforts of pricing GHGs emissions through an ETS. • A remaining challenge is how to incorporate, to the Brazilian Climate Change Regime, policy instruments which foster the participation of the country in the appropriation of the technological innovation that is necessary to guarantee a low-carbon development pattern. In the light of the development history of the country, technological innovation will be crucial to assist in freeing the country from the dilemma of sacrificing its social- economic development in the name of the global efforts to mitigate climate change. This huge challenge cannot be solved by an ETS alone or by any other single policy approach. However, if properly designed in alignment with other policies and practices, an ETS may assist in the expansion of low carbon practices by different industries and, indirectly, promote the 293 incorporation of emission reduction or energy efficiency technology innovation into the ‘competitive intelligence management’ of companies operating in Brazil. Based on these concluding remarks, the next chapter, as the general conclusion of this thesis, will present a model for the optimal insertion of an ETS into the Brazilian Legal Framework, from a structural and functional standpoint. 294 CHAPTER VIII – GENERAL CONCLUSION 8.1 Introduction Based on the analyses carried out in the previous chapters, and following the analytical approach advanced in section 1.4.4.2, this thesis discussed on a systematic and integrative basis the key elements of ETS conceptual framework and history, its inherent and contingent design and legal aspects, and key lessons driven from case studies related to its implementation in Europe, Australia and Zealand. This analysis, which included the incorporation of economic, technical, ethical and policy aspects of ETS theoretical framework into a legal typology, allowed a systematic depiction of ETS legal aspects on an innovative and integrated manner. It also facilitated its further consideration in regards to the Brazilian social, economical, cultural and legal reality. Taking lessons from the integrative analysis of theoretical and practical realms of ETS, which culminated in the discussion of chapter VII, this final chapter presents a Legal Model for an ETS in Brazil which incorporates the most important cultural, social, legal and policy issues to be considered in implementing an ETS that prioritizes effective reduction of Brazilian GHGs emissions. As such, the Legal Model for an ETS presented below takes into consideration the main design elements, corresponding legal mechanisms and implementation strategies that are necessary to allow the proper insertion of an ETS into the Brazilian Legal System, in particular the National Climate Change Policy. Under this approach, the proposed Legal Model adopts the creation of a government regulatory body exclusively devoted to the ETS as a point of departure (instead of employing existing government institutions that have other objectives to be pursued), in addition to an ultimate ETS design that privileges the environmental integrity of the scheme. For purposes of clarity, and consistent with the analytical approach applied throughout the thesis, the structural and functional elements of an ETS, in general, will be presented first. Then, structural and functional elements of linking alternatives will be presented in more detail. In any event, the linking alternatives of an ETS belong to its overall structure, bridging the ETS with the macro-models of the Brazilian legal framework and the international climate change regime. 295 8.2 Structural Elements for a Brazilian ETS to Ensure Reduction of GHG emissions In order to be effectively implemented in Brazil, an ETS must be introduced through a federal law and be mandatory to the selected economic sectors and facilities. However, it may be implemented in phases, and a trial period may be considered before a true period during which sanctions are applied in cases of noncompliance. Under the trial period, the current inventory and monitoring practices being developed voluntarily (such as the FGV initiative reported in chapters VI and VII1) must be implemented in larger scale across all sectors and facilities involved. Other structural elements include the following: 8.2.1 Brazilian ETS Major Goals and Principles The scheme must have clear goals and principles set out in the legislation (and not only addressed in supporting documents). Such principles must stress the predominance of the environmental integrity of the scheme over any other scheme’s objective, and assign authority to the governing body of the scheme to pursue necessary changes to the scheme’s design to achieve its objective. However, the conditions for these changes to be implemented must be clearly defined in the legislation as well, including the definition of a reasonable time for its implementation and conditioned to effective communication to the market participants and the public, with sufficient time to allow a minimum level of predictability.2 8.2.2 Brazilian ETS Integration with the National Legal Framework 8.2.2.1 Integration with the Brazilian Legal System A possible decision of Brazilian policymakers in developing an ETS as part of the country’s climate change policy is completely aligned with the major principles of the 1 Getulio Vargas Foundation - Center for Sustainability Studies (GVces), ‘Business For Climate Platform: Emissions Trading System Simulation - EPC ETS’ (FGV Centro de Estudos em Sustentabilidade da EAESP, 2014). 2 Ross Garnaut, The Garnaut Climate Change Review Final Report (Cambridge University Press, 2008), 325. 296 Brazilian Legal System. In particular, as summarized in chapter VI of this thesis, the constitutional principle of ‘environmental protection’ enshrined in Articles 225 and 170 of the Constitution. As shown in chapter VI, Article 225 of Brazilian Constitution establishes the fundamental right to a balanced environment of the current and future generations of Brazil and the government’s role in preserving and restoring essential ecological processes. Article 170 establishes ‘free initiative’ as a major economic principle, and ‘environment protection’ and ‘the social function of private property’ as some of its conditioning factors. An integrated view of these constitutional principles shows that there is no restriction on the use of market mechanisms in the Brazilian efforts to protect the environment. At the same time, it is fundamental that the instruments prioritize actual protection of the environment and the preservation and restoration of fundamental ecological processes, which, naturally, include a balanced cycle of greenhouse gases and mitigation of climate change impacts. Additionally, the combination of constitutional principles demonstrates the predominance of environmental integrity over any other additional benefit of climate change policies, such as economic efficiency, technological innovation, among others. The search for an environmentally sound policy to mitigate climate change is also totally aligned with the Brazilian National Environmental Policy principles and instruments, including the prevention of damages to the environment and public health and the government’s role in maintaining ecological stability.3 Also, the recognition of a ‘balanced environment’ and the protection of the environment as a diffuse right under 3 Federal Law 6.938 of August 31 1981, art 2: Article 2. The National Environmental Policy has the aim of preserving, improving and recovering the environmental quality conducive of a healthy life, with a view to ensuring socio-economic development, the interests of national security and the protection of human life, according to the following principles: 1. Governmental action on the maintenance of the ecological stability, the environment being considered public heritage and therefore protected for public use. 2. Rationalised use of the soil, subsoil, water and air. 3. Planned and inspected use of the natural resources. 4. Protection of the ecosystems, with the preservation of representative areas. 5. Control and zoning of polluting activities. 6. Incentives to studies and research on technologies for the rational use and protection of the environmental resources. 7. Follow up assessments on the quality of the environment. 8. Recovery of degraded areas. 9. Protection of areas likely to become degraded. 10. Environmental education at all levels, including the education of the community, with the aim of enabling its active participation in the protection of the environment. 297 Brazilian law clearly set the boundaries of a Brazilian ETS (and any other policy instrument to protect the environment) under the broad spectrum of social controls over the ‘commons’ vis-à-vis the predominance of property rights to deal with environmental problems. Thus, clearly the more radical proposals advanced by some theorists with respect to forms of dealing with environmental problems with emphasis in property- rights (particularly the ‘free environmentalism’ movement in the United States, as addressed in chapter II) does not have any resonance under Brazilian Constitutional Principles and Law. This argument is also consistent with the principle of the ‘social function of property rights’ embedded in article 170 of the Brazilian Constitution as discussed in chapter VI.4 Consequently, as pointed out below, the legal nature of a pollution allowance or permit under Brazilian law shall not be considered a ‘proprietary right’ as defined in the short-lived Australian ETS, but should fit as a ‘right’ granted by state based on a legal authorization, as defined under the US Acid Rain Program.5 8.2.2.2 Integration with Brazilian Climate Change Laws and Policy The Brazilian Climate Change Policy (PNMC) analysed in chapters V and VI provides for the possible creation of a ‘Brazilian Emission Reduction Market.’6 The development of an ETS decidedly fits this definition, regardless of the contours of its ultimate design. In addition, the voluntary reduction targets embedded in the same legislation and the biome and sectoral plans developed to mitigate emissions, as discussed in chapter VI, are totally compatible with the inclusion of an ETS able to assist the country in achieving these goals. Similarly, a Brazilian ETS design can make use of the emission reduction targets related to biomes and economic sectors, already identified in the legislation and corresponding mitigation plans, to define the scheme’s cap and identify the affected entities and the geographical reach of the scheme. It is also 4 Brazilian Constitution, art 170: article 170. the economic order, founded on the appreciation of the value of human work and on free enterprise, is intended to ensure everyone a life with dignity, in accordance with the dictates of social justice, with due regard for the following principles: I – national sovereignty; II – private property; III – the social function of property; IV – free competition; V – consumer protection. (…). 5 Robert Stavins, ‘Market-Based Environmental Policies: What Can We Learn from U.S. Experience (and Related Research)?’ in Jody Freeman and Charles D. Kolstad (eds) Moving to Markets in Environmental Regulation: Lessons from Twenty Years of Experience (Oxford University Press, 2007) 31 and n 23. 6 Federal Law No. 12.187 of 29 December 2009, art 4, VII and art 9. 298 important to note that the wording of Article 9 of the PNMC makes reference to a possible implementation of a Brazilian Emission Reduction Market under the Brazilian Exchange or another organized market under the Securities and Exchange Commission (CVM).7 This general reference, without any further qualification on the form of market organization, needs to be adequately addressed by the legal instrument chosen as the mandatory vehicle for a Brazilian ETS. In fact, this thesis argues that a Brazilian ETS must be established by a single and individualized legislation for this particular purpose, using the PNMC principles and legal authorization to do so. On one hand, the set of principles and design elements that must be part of an ETS does not fit a simple inclusion in the overall objectives and requirements of the PNMC. On the other hand, although one can argue that there is enough room of legal authorization to create an ETS by a Federal Decree (thus, simply by an act of the Executive Power regulating the corresponding legal authorizations under the PNMC law), an ETS design will interact with a broader range of legal principles and requirements (e.g., distributional aspects of emission allocation among different economic sectors and possible interface with anti- competition laws) that may not be fully covered under the PNMC. Thus, a law, and not a regulation, is the most appropriate vehicle to create and implement an ETS consistent with the overall legal treatment of its broad range of legal consequences to economic sectors and individual companies and households. Further, an ETS design created by regulation (at least its major principle and design elements) may bring a level of legal uncertainty with respect to enforcement, compliance, and market rules that would work against the necessary minimum level of legal certainty and predictability mentioned in item 8.2.1 above. 8.2.2.3 Integration with Other Relevant National Laws and Policy A Brazilian ETS must be consistent with other laws and policies that affect the greenhouse gas profile of the relevant emitting sectors. In the case of Brazil, the most important legal initiatives directly connected with a pricing mechanism such as an ETS are the Brazilian Forest Code (due to its prominent role in regulating deforestation in the land-use sectors) and the State initiatives devoted to stimulating mitigation 7 This concern is also shared by the FGVces study on possible elements for the development of a Brazilian ETS. See Fundação Getulio Vargas-Centro de Estudos Sustentáveis (GVces), Mario Monzoni (coordinator) Elementos para a Construção de um Sistema de Comércio de Emissões Vol. 1II (FGVces, 2013) 299 activities, particularly those promoting payment for environmental services and REDD+ projects. The interconnectedness of such policies must be minutely analysed in order to avoid double counting of emissions reduction efforts on one hand and legal uncertainties in relation to the ownership of emission rights on the other. The latter risk may lead to potential disputes between the federal and state governments in relation to the ownership of carbon stocks and other environmental assets embedded in forest resources, as indicated in chapters V and VI. Despite these risks, there are also important synergies that can be explored between federal and state legislation, in particular a positive competition for the purchase of emission reduction credits in rural lands, which may be used for compliance in different schemes. However, for this potential benefit to be materialized it is imperative that the legal nature of an ETS allowance and the credits generated under the Forest Code (the Environmental Reserve Quota) or in the state schemes are compatible. In this particular case, the legal definition of the carbon credit provided by the Forest Code8 is extremely flexible and enables it be used as a fungible asset among the schemes. Therefore, the corresponding federal and state legislative bodies should pursue a formal and cross-referenced authorization for such use of emission reduction credits across such federal and state schemes. The authorization should be expressly stated in a Federal law that would establish the Brazilian ETS as indicated in item 8.2 above, with a clear cross-reference to the Brazilian Forest Code provision. It should also require that State schemes (such as Payment-for-Environmental Services) provide for the same legal nature of allowances or credits in order to be eligible, among other conditions, as a source of offset-credits to be used by the ETS regulated entities. Other relevant possible integration of a Brazilian ETS with the overall Brazilian legal system relates to consideration of some arrangements of allocation of liabilities between companies of the same economic group or participating in joint ventures, similar to the Australian approach, and the corresponding references to Brazilian corporation and civil law requirements. 8.2.3 Brazilian Major Institutional Frameworks to govern an ETS As indicated above, the specific issues involving ETS implementation and operation require a dedicated entity to govern the scheme due to the multidisciplinary nature of ETS, particularly the intersection of environmental, economic and legal 8 As discussed in chapter VI, the Brazilian Forest Code defines the legal nature of the carbon credit as ‘title representing rights over tradable intangible and incorporeal/immaterial goods’. Federal Law 12.651/2002, art 3, XXVII. 300 matters. Within the Brazilian governmental architecture, it is imperative that specialists on climate change mitigation issues, using market-based tools in environmental policy, and the major corresponding legal instruments, form such entity. In this regard, it is necessary that such entity reflect a balance between environmental specialists that will secure the continuous environmental integrity of the scheme and financial and economic specialists that are able to regulate and control the market moves from the scheme participants. This balance cannot be found in existing administrative bodies, which usually reflect the predominance of a single field (for example, environmental experts under the umbrella of the Ministry of the Environment or economics experts under the Ministry of Finance). Also, existing administrative bodies responsible for the different aspects of the Brazilian Climate Change policies reflect historical predominant political influences that tend to stress particularized views of enforcing Brazilian climate change commitments in detriment of other important aspects that must be present in the implementation of an ETS. Thus, for example, ideological views against market mechanisms in the Ministry of the Environment and the Ministry of Science and Technology, as indicated in chapters V and VI, or resistance to the predominance of environmental values in the Ministry of Finance or Ministry of Agriculture. Finally, the current legal framework devoted to climate change in Brazil and the governmental bodies in support of the corresponding policies have not included the creation of an entity which could be easily adapted to deal with all the demands for the implementation and operation of an ETS. In fact, many of the current institutions devoted to certain aspects of the Brazilian Climate Change Policy are well suited to provide certain services under an ETS (particularly in relation to monitoring of emissions and approval of CDM projects), or to provide key personnel for the management of an ETS governing body that integrates all necessary fields of expertise.9 9 For a thorough analysis of the main Brazilian institutions working on the climate change policy (particularly in monitoring GHGs emissions) and their potential to lead or complement the necessary administrative and enforcement roles in a Brazilian emission reduction market (particularly on the monitoring, reporting and verification matters) Fundação Getulio Vargas-Centro de Estudos Sustentáveis (GVces), Mario Monzoni (coordinator) Requerimentos para um Sistema Nacional de Monitoriamento, Relato e Verificação de Emissões de Gases de Efeito Estufa – Vol. I and Vol. II (FGVces, 2013) 301 In relation to the legal nature of such an ETS-dedicated governing entity, there are some options under Brazilian law. The entity could be a so-called direct or indirect administrative body, including some existing entities already involved in certain aspects of climate change policy.10 In fact, this thesis takes the position that an ETS governing body should, to the extent possible, conciliate a centralized enforcement role with the flexibility of corporate structures, particularly in relation to the building of collective governance bodies, such as executive boards and directorates and implementation of operational agreements with national and international entities. This conciliatory role can be found in corporate-like institutions under government control such as mixed- capital enterprises (‘sociedades de economia mista’) or ‘public enterprises.’11 Further, such organizational model can be easily managed to avoid unbalanced direct political interventions (for example, from a given Ministry from the Federal administration) on one hand, and include representatives from the civil society without jeopardizing the governmental authority over the scheme on the other hand. At the federal and state levels, there are examples of the adoption of this organizational model for environmental protection (CETESB, the entity responsible for the environmental enforcement in São Paulo state)12 and agricultural research (EMBRAPA, the research company responsible for agricultural research under the Federal government).13 These experiences can be used as a basis for the design of an ETS dedicated institution. On the other hand, the need for a sound electronic platform for the scheme operations must be secured in advance, either by the implementation of an entirely new platform or by some kind of formal arrangement with reliable trading platforms such as the BM&F/Bovespa or others. 10 Ibid. 11 In mixed enterprises (sociedades de economia mista the state holds the majority of the voting stock; in public enterprises (empresas públicas), the state is the sole shareholder. See Mariana Pargendler ‘Governing State Capitalism: The Case of Brazil’ (2015) Columbia Law School 12 São Paulo Sate Law 118 of 29 July 1973. 13 Federal Law 5.851 of 7 December 1972. 302 8.3 Functional Elements for a Brazilian ETS to Promote Reduction of GHG Emissions 8.3.1 Brazilian ETS Design Elements to effectively reduce emission The literature on emerging ETS discussed in this thesis provides abundant examples of the deleterious effects of the implementation of an ETS, which cannot secure the basic theoretical assumptions for an ETS to function effectively, namely a cap stringency to create scarcity of allowances and allocation methods based on auctions, as opposed to free allocation. In fact, if any sector demands some kind of assistance to transition to an emissions pricing environment, it is advisable to devise some kind of direct assistance (as envisaged by the Australian CPM), as opposed to resorting to free allocation of allowances. This approach promotes a more accurate and transparent way of defining the level of assistance to be given to each sector, and of tracking its implementation in order to define the phase out.14 On the other hand, by avoiding free allocation from the outset, an ETS will be much more robust in escaping the pervasive consequences of windfall profits to selected sectors, and more just in distributing effects across the relevant economic sectors and households.15 In parallel to a stringent cap, the recent experience in emerging schemes, particularly the EU ETS and the New Zealand scheme, shows that it is important to include in an ETS design price control mechanisms to work with the inherent price volatility of an ETS. Thus, both price floors and price ceilings (or other tools with similar effects) should be considered from the outset to avoid the undesirable effect of prices that either do not stimulate any emission reduction or, on the contrary, are above reasonable values and create unnecessary economic burdens to affected sectors. In both extreme situations, there are ways to enable the scheme regulator to intervene. Therefore, Brazilian ETS should be consistent with the possibility of regulator intervention, the main objective of which is to reduce emissions. Other specific insights with respect to such matters are mentioned below: 14 See Garnaut, The Garnaut Climate Change Review: Final Report above n 2, 331-2. 15 Ibid. 303 8.3.1.1 Stringency of the cap As indicated above, the cap in a Brazilian ETS should be carefully established to create enough scarcity in the market. In this regard, an in-depth analysis of the current voluntary targets under the Brazilian National Policy should be carried out in order to confirm whether such targets are enough to create the desired effect, or whether different elements should be factored in the cap-setting process. 8.3.1.2 Industrial Coverage In principle, the issue of industrial coverage in a Brazilian ETS should not be a difficult one compared to other jurisdictions, with the exception of the decision on whether to incorporate the land-use sectors as covered entities or as providers of offset credits, and the inherent difficulties of covering the widespread emissions from the transportation sector. The overall sectoral plans developed by the government and the implementation of national emissions monitoring for the UNFCCC and the Kyoto Protocol provide a solid basis for decisions on covered sectors from industry and energy sources.16 This set of information can also be enriched by other studies on the Brazilian emission profile such as those discussed in chapters V and VI, which cover both the current and projected emissions by sector as well as the corresponding costs for emissions abatement.17 With respect to the transportation sector, it is important to consider the options for providing for its inclusion under an ETS through establishing the point of obligation over the fuel producers or to pricing transportation emissions through tax mechanisms. A hybrid approach such as the one adopted in the Australian CPM should also be considered, namely the general rule of excluding transport-related emissions from the ETS (and pricing it through tax mechanisms) and the possibility of affected companies voluntarily joining the ETS under opt-in provisions. 16 A good initial analysis on the most suitable sectors to be included in a Brazilian ETS is made by Fundação Getulio Vargas. See Fundação Getulio Vargas-Centro de Estudos Sustentáveis (GVces), Mario Monzoni (coordinator) Requerimentos para um Sistema Nacional de Monitoriamento, Relato e Verificação de Emissões de Gases de Efeito Estufa – Vol. I, above n 9, 221-6. 17 McKinsey & Company, ‘Pathways to a Low-Carbon Economy for Brazil’ (Special Report, McKinsey & Company, 2009); Carlos Nobre, ‘Mudanças Climáticas e o Brasil: Contextualização’ in (2008) 27 Parcerias Estratégicas – Centro de Gestão de Estudos Estratégicos – CGEE15; Christophe de Gouvello (Lead Author), ‘Brazil Low-carbon Country Case Study’ (The World Bank Group, Brasilia, 2010). 304 Based on the experiences of the NZ ETS and the Australian CPM design discussed in the previous chapters, and also taking into account the intricacies of the compliance culture that has historically dominated the rural sector in Brazil, this thesis concludes that the Australian model for land-use and agriculture emissions suits the Brazilian scenario better in terms of an ETS. Thus, the land-use activities should, in principle, be considered as potential providers of offset credits for the other sectors, and such role should be used as an additional incentive-based approach to assist the Brazilian agribusiness and forest sectors in complying with the Forest Code, and with other mandatory and commercial demands for a low carbon economy. 8.3.1.3 Permit Allocation Methods As discussed above, free allocation should be avoided, and the administrative fees obtained by the government in the auction process should be reinvested in programs to assist households impacted by a pricing mechanism or in developing emissions friendly technologies. If any particular industry is deemed as eligible for some kind of assistance for a transition to a carbon-pricing environment, this assistance should be considered through some kind of direct assistance package, thus avoiding the trap of creating distortions and poor environmental performance through free allocation to some sectors or to the entire scheme. 8.3.1.4 Linking A Brazilian ETS should be consistent with the possibility of linking with other national, subnational, or international schemes. However, linking should be implemented in a later phase of the scheme, after the affected national sectors and the government reach a higher level of maturity in terms of ETS implementation. 8.4 Major Legal Issues to be addressed in development and implementation Based on the structural and functional considerations above, it is imperative that the development and implementation of Brazilian ETS must be considered as a phased approach. It is elementary, though, that preliminary steps must be carefully considered with respect to the development of capabilities for accurate monitoring, reporting and verification of emissions at the source level, i.e., at each facility considered as a potential emitter of greenhouse gases. In this regard, there are important initiatives at the private and public levels that can be considered a starting point for a national initiative on greenhouse gases monitoring and reporting at the facility level. Such 305 initiatives include private initiatives, such as the FGV-lead Brazilian Greenhouse Gas Emissions Protocol18 and the voluntary rules for GHGs monitoring and reporting issued by Brazilian Technical Norms Association,19 and public initiatives, such as the Federal Registry of Potentially Pollutant Activities and a few state GHGs monitoring and reporting requirements.20 Such initiatives need to be harmonized from a methodological standpoint and coordinated from a public management standpoint, including the possible differentiation of data gathering applicable to different sectors or to different facilities within a given sector due to its size or geographical location, among other factors.21 In parallel to monitoring, reporting, and verification methods, it is crucial for a Brazilian ETS to define the best approach to building the trading platform and emission allowance registry. As evidenced in chapter VI, there are also some past and ongoing initiatives that can be used as a starting point for the creation of this fundamental pillar for an ETS, including the past BM&F experience with a carbon trading platform, the privately-owned trading platform and environmental assets exchange in Rio (BVRio) and the voluntary initiatives of simulation of trading mechanisms coordinated by FGV in cooperation with BVRio.22 18 Fundação Getulio Vargas and World Resources Institute, ‘Especificações do Programa Brasileiro GHG Protocol: Contabilização, Quantificação e Publicação de Inventários Corporativos de Emissões de Gases de Efeito Estufa’ (FGV e WRI, 2014) 19 Gases Efeito Estufa - Princípios e requisitos para a quantificação e elaboração de relatórios de emissões e remoções de gases de efeito estufa (GEE) - ABNT NBR ISO 14064:2007. See Reynaldo Galvão Antunes e Eduardo Linhares Qualharini ‘A Norma Brasileira de Mudanças Climáticas – ABNT NBR 14064’ (IV Congresso Nacional de Excelência em Gestão, 31 de julho a 2 de agosto de 2008) 20 For a comparative analysis on the Federal, state and voluntary instruments for reporting and registry of GHG emissions in Brazil se Fundação Getulio Vargas-Centro de Estudos Sustentáveis (GVces), Mario Monzoni (coordinator) Requerimentos para um Sistema Nacional de Monitoramento, Relato e Verificação de Emissões de Gases de Efeito Estufa – Vol. II (FGVces, 2013), above n 9, 16-46. 21 Ibid 46-57. 22 FGV – Centro de Estudos em Sustentabilidade (GVces) ‘Plataforma de Empresas para o Clima: Simulação de Sistema de Comércio de Emissões – SCE EPC – Relatório Analítico Semestral: março a agosto de 2014’ (FGV/GVces e EPC, Outubro 2014) The adequate design and implementation of such enforcement and trading infrastructure must be part of and inform the definition of criteria for the future selection of coverage entities and gases for a future ETS and the respective points of obligation. Enforcement and trading infrastructure should also be aligned with other elementary ETS design features such as cap-setting, allowance allocation, allowance trading and surrender rules, penalties for non-compliance, opt-in and opt-out provisions, among others. The implementation of the system should be made through a trial period followed by a series of true-periods, both with pre-defined duration (compliance terms) and cap-setting revision rules. If possible, the implementation of the ETS infrastructure and the trial period should be scheduled to allow the initial term of the first true period by 2020 or 2021. Such a schedule would coincide with the expected initial term of a new international climate change regime, at least as predicted in the last negotiating documents of the UNFCCC, and the Kyoto Protocol discussed in the previous chapters. 8.5 Implications of Linking a Brazilian ETS to other National or International ETS The major legal forms of linking mechanisms of a Brazilian ETS will, in large part, depend on the ultimate design of the scheme, the legal nature of the ETS governing body, and the level of incorporation of ETS under the future international climate change regime. Notwithstanding, some legal aspects of linking are presented below taking into consideration the legal modelling aspects adopted in the above items. 8.5.1 Structural Elements for Bilateral or Multilateral Linking with other Emissions Trading Schemes 8.5.1.1 Integration with Brazilian Commitments under the International Climate Change Regime The inclusion of a Brazilian ETS as one of the Brazilian policies to meet the country’s commitments under the UNFCCC and the Kyoto Protocol can be made without any difficulty, due to the total compatibility of the UNFCCC principles with market-based tools. One possible way to provide for such integration is the inclusion of a Brazilian ETS as one of the country’s Nationally Appropriate Mitigation Actions 307 (NAMAs) under the UNFCCC.23 In fact, the Brazilian Climate Change Policy has already been included in the Brazilian Communication regarding NAMAS24 and adding an ETS would be a simple and natural step. 8.5.1.2 Integration with other Emissions Trading Schemes – Bilateral Linking The ultimate legal forms of bilateral linking will depend on the nature of the legal mandate for liking established by the law creating an ETS. In theory, the herein proposed publicly owned company as an ETS governing body should have linking powers delegated by law and mirrored in the corresponding by-laws and other corporate documents. To the extent possible, the linking mechanisms should be pursued as part of its international activities delegated by law, provided that prior approval from and formal controls of the Government, as the single or majority shareholder, are clearly established. A complete analysis of public international law requirements applicable to liking falls beyond the scope of this thesis. However, in case the nature of liking demands formal participation of the Brazilian Government, a bilateral linking of a Brazilian ETS with other schemes may be initially pursued through memoranda of understanding or protocols between the Brazilian Government and the corresponding country,25 provided, again, that this authorization is clearly foreseen in the law that establishes an ETS. In this case, the law must provide for detailed criteria to be followed by the Brazilian Government. Such requirements include the set of criteria that Brazil cannot negotiate or change without a previous amendment to the national law. The goal is to protect the ETS framework from contingent changes that would distort the ETS goals and principles agreed upon by the legislature (the National Congress). Depending on the nature of the Brazilian obligations resulting from liking, 23 NAMAs is the nomination adopted in the ‘Bali Action Plan’ (as discussed earlier in chapter I, section 1.3.1 and n 54) for the set of GHGs mitigation plans of developing countries, which should be implemented in a measurable, reportable and verifiable manner as part of the international effort for the full implementation of the UNFCCC. The NAMAs shall be implemented in the context of sustainable development, and may entitle developing countries receiving international support though financial, capacity building and technology assistance under certain circumstances. UNFCCC UN Doc Decision 1/CP.13. 24 Formal communication of the Embassy of Brazil in Germany to the UNFCCC Secretariat 25 Ministério das Relações Exteriores, Divisão de Atos Internacionais, ‘Atos Internacionais – Prática Diplomática Brasileira – Manual de Procedimentos (Brasilia, May 2010) 8. 308 the linking instrument may be subject to international treaty formalities, including prior approval of the Brazilian National Congress through a Legislative Decree and further internalization into the Brazilian Legal system as an amendment to the original law or as a Federal Decree. 26 8.5.1.3 Integration with International Emissions Trading Schemes – Multilateral Linking In case of Multilateral linking, such as one under a potential international ETS established by the future international climate change regime, the integration of a Brazilian ETS is likely to follow the formalities adopted by the Brazilian Government in international treaties negotiation and ratification. 8.5.2 Functional Elements for Bilateral or Multilateral Linking with other Emissions Trading Schemes 8.5.2.1 Legal Nature of Linking Mechanisms The legal nature of Linking Mechanisms will depend on the ultimate design of a Brazilian ETS and the legal nature of the Brazilian ETS governing body, as discussed above. 8.5.2.2 Design Features for Linking Other design features will depend on the level of compatibility between the linking schemes, and must include to the extent possible harmonized provisions on covered gases and entities, with land-use based emissions being a point of concern due to its exclusion from some ETS (such as the EU ETS) and its importance to the Brazilian emissions profile. Also, the legal nature of the allowances between the Brazilian ETS and the linked scheme and harmonization of the tax treatment applied to transactions between affected entities from both schemes must be previously negotiated and subject to the legal formalities of both linked countries. As discussed in chapter III, other design features to be considered prior to linking include assessment of possible economic impacts of linking due to allowance price differences or existence of price 26 Ibid 16-19. 309 controls in one jurisdiction that could limit transactions, or give affected companies of one of the linked schemes unfair competitive advantage in relation to pricing forecast and agency. 8.6 The Contribution by The Thesis and Future Research The legal model herein presented provides a tentative systematization of a Brazilian ETS, signalling the major structural and functional aspects that should be present in order to enhance the chances of a Brazilian ETS effectively contributing to Brazilian GHG emissions. It takes into account the theoretical framework and experience of emerging ETS, and the Brazilian GHG emission profile and climate change regime. As this thesis demonstrated, the literature on market based mechanism, including emissions trading schemes, and its potential application to the climate change problem and regime is immense and does not stop to evolve. However, there are gaps in the literature regarding the application of the ETS conceptual framework, history and case studies of emerging mandatory schemes in certain jurisdictions, such as the case of Brazil. Thus, the first contribution of this thesis was to include as an object of study the analysis of the ETS concepts and experiences in support of the possible development of an emissions trading scheme in Brazil that actually contributes for reduction of its GHG emissions. This contribution gains another level of importance for the ETS debate because Brazil is a country of strategic importance for global climate change mitigation due to the significant volume of its greenhouse gases emissions, in general, and the role of deforestation in the country’s GHGs emission profile, in particular, considering the critical role that the immense forest reserves of Brazil play to preservation of global biodiversity and even the climate balance. The second contribution provided by this thesis is the legal analytical approach that it puts forward in order to materialize the systematic and integrated analysis of ETS and the Brazilian context. In particular, how the ETS concepts and emerging experiences from abroad and the Brazilian context were examined and integrated into the proposed legal model that incorporates the specific Brazilian needs and fits the Brazilian legal regime. Thus, the thesis advanced a systemic examination of ETS concepts, history, principles, design elements and legal aspects (from both the theory and the emerging ETS used as case studies), as opposed to usually more fragmented analysis provided by the literature. This analysis allowed a more clear depiction of inherent and contingent aspects of ETS, the identification of those that are crucial for securing the environmental integrity of the scheme, and how the combination of each 310 scheme’s objectives and principles and its ultimate design reflect the ultimate value choices that will define how relevant a particular ETS is to mitigate climate change. At the same time, the thesis advanced a more dynamic view of the Brazilian GHGs emissions profile in comparison with the usually static analysis of country’s GHGs emissions deployed by the literature, which basically quantify emissions of greenhouse gases by the relevant sectors of the economy. This was achieved by the identification and incorporation of social, cultural, economical and legal aspects of the Brazilian reality that arises from the country’s social and economic characteristics, development dynamics, and cultural aspects such as legal compliance culture that are key to allow an optimal incorporation of the ETS into the Brazilian legal system. The final integration of this analysis into the Brazilian jurisdiction made in this final chapter has taken into consideration the overall structure of the Brazilian legal system in general, and the relevant constitutional principles, laws, policies and bills of law related to the country’s climate change regime. This was also achieved through a systematic approach that conciliated the still fragmented set of Brazilian federal and state laws and relevant bills under discussion in the National Congress that ignore important potential synergies such as monetization of forest conservation activities (particularly under the New Forest Code and some REDD and PES initiatives), and the Brazilian Market for Emission Reduction set out in the National Climate Change Policy. This analytical framework based on the tridimensional law and legal model theories, which to the Candidate’s knowledge has never been applied to climate change law in general, and to ETS in particular, combined a rigorous and clear form of identifying the critical elements of ETS principles and design elements embedded in a given legal system or regime and, at the same time, unveiling and qualifying the values that drive their implementation and determine their ultimate role in securing or not GHGs emission reductions. Further, it provided for a broader conceptualization of which are the legal aspects of the ETS, to the extent that it brought to the legal realm each design element that for any reason may influence the reach and the performance of an ETS. By doing so, it expanded the concept of which are the legal aspects of ETS as opposed to the traditional legal literature. The result of this approach is that it advanced the critical legal analysis of ETS also in regards to its proposed objectives and ultimate performance, and not only in relation to certain legal aspects of more immediate reference as pointed out in different parts of this work. This innovative analytical approach in the context of emission trading schemes is also a contribution of this thesis to a more diverse scholar debate on the intricacies and complexities of possible legal modes of dealing with the challenges imposed by climate change. 311 A conclusive model covering all legal aspects of a Brazilian ETS is beyond the scope of this thesis. However, the legal model herein presented provides a sound basis for future research and a secure method for revisiting and improving the legal framework necessary to introduce this innovative policy tool into the Brazilian Legal System in an optimal way. It is possible, in any event, to envisage legal research topics that could advance the improvement and robustness of the legal model for a Brazilian ETS. They include the following topics: • Refining the legal nature of the ETS Governing Body, testing the proposal of a publicly owned company with other institutional arrangements. • Refining the proposed legal nature of the ETS allowances, including the possibility and requirements for its use as security, and the possibility of fungibility of ETS allowances with offset credits under the Brazilian Forest Code and the emerging state schemes for payment for environmental services • Defining the best legal and institutional arrangements and instruments for compliance and enforcement, including penalties for violation of ETS requirements and obligations. • Identifying the most important legal aspects of coverage and allowance allocation under anti-competition and other economic law principles. • Identifying the most appropriate legal mechanisms for periodical review of the ETS design, without compromising the ETS environmental performance and the minimum level of legal certainty and the scheme’s predictability for affected entities. • Refining the ultimate modes of linking a Brazilian ETS under bilateral and multilateral linking, taking into consideration private and public international law requirements, and proposing structural and functional design elements that would facilitate linking with existing schemes such as the EU ETS, California and emerging schemes in China and Korea, among others. 312 BIBLIOGRAPHY A Articles/Books/Reports Ab’Saber, Aziz, ‘Da Serra Pelada à Serra dos Carajás: A Rebelião (Im)Prevista dos Garimpeiros’ in Aziz Ab’Saber Amazônia: Do Discurso à Praxis (EDUSP, 2002) Ab’Saber, Aziz, Gênese de Uma Nova Região Siderúrgica: Acertos e Distorções de Origem na Faixa Carajás-São Luís’, in Aziz Ab’Saber Amazônia: Do Discurso à Praxis (EDUSP, 2002) Ab’Saber, Aziz, ‘O Petróleo na Amazônia’, in Azis Ab’Saber Amazônia: Do Discurso à Praxis (EDUSP, 2002) Ab’Saber, Aziz Nacib, Amazônia: do discurso a práxis (Edusp, revised edition 2004) Ackerman, Bruce and Richard B. 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L., ‘Prices vs. Quantities’ (1974) 41 Review of Economic Studies 477 348 Weitzman, Martin L., ‘The Stern Review of Economics of Climate Change’ (September 2007) 45 Journal of Economic Literature 703 Wemaere, Matthieu, Charlotte Streck and Thiago Chagas, ‘Legal Ownership and Nature of Kyoto Units and EU Allowances’ in David Freestone and Charlotte Streck (eds), Legal Aspects of Carbon Trading: Kyoto, Copenhagen and beyond (Oxford University Press, 2009) Whately, Marussia and Maura Campanili (organizers), Green Municipalities Program: Lessons Learned and Challenges for 2013-2014 (Programa Municipios Verdes e Governo do Estado do Pará, April 2013) Wilson Center, ‘Reports on the Americas’ (Wilson Center, 2002) Wilson Center, ‘Reports on the Americas’ (Wilson Center, 2011) White House, Office of the Press Secretary, ‘FACT-SHEET: U.S.-China Joint Announcement on Climate Change and Clean Energy Cooperation’ (November 11, 2014) Wood, Tony and Tristan Edis, ‘New Protecionism Under Carbon Pricing: case studies of LNG, coal mining and steel sectors’ (Grattam Institute, 2011) World Bank, ‘Brazil – Country at a Glance’ World Bank, ‘Country Profile, Brazil Overview’ World Bank, ‘Country and Lending Groups’ World Bank, ‘Environmental Licensing for Hydroelectric Projects in Brazil: A contribution to the Debate’ (Report No. 40995-BR, The World Bank, March 28, 2008) 349 World Bank, ‘State and Trends of Carbon Pricing’ (World Bank, 2014) World Resources Institute, ‘Consolidated emissions data from Brazil for the 1990-2011 period’ Xanthaki, Helen, ‘Dunca Berry: a visionary of training in legislative drafting’ Special Issue 1 (2011) The Loophole – Journal of the Commonwealth Association of Legislative Counsel 18 Yamin, Farhana and Joanna Depledge, The International Climate Change Regime: A Guide to Rules, Institutions and Procedures (Cambridge Universtity Press, 2004) Young, Oran R., Resources Regimes: Natural Resources and Social Institutions (University of California Press, 1982) Young, Oran R., Emergent Patterns in International Environmental Governance (MIT Press, Cambridge, Massachusetts, London, England, 2010) Zane, Steven Nathaniel, ‘Leveling the Playing Field: The International Legality of Carbon Tariffs in the EU’ (2011) 34 Boston College International and Comparative Law Review 199 Zimmermman, Augusto, ‘The Rule of Law as a Culture of Legality: Legal and Extra- legal Elements for the Realisation of the Rule of Law in Society’ (2007) 14 (1) Murdoch University Electronic Journal of Law 10 Zimmermann, Augusto, ‘How Brazilian Judges Undermine the Rule of Law: A Critical Appraisal’ (2008) 11 International Trade and Business Law Review 179 B Cases 1. Europe Air Transport Association of America, American Airlines, Inc, Continental Airlines, Inc, United Airlines, Inc v Secretary of State for Energy and Climate Change (C- 366/10) [2011] OJ C260/9 350 Armstrong DLW GmbH v Winnington Networks Ltd. [2012] EWHC 10 (Ch), [2013] Ch 156 Bulgaria v Commission (T-500/07) [2008] C64/51 Germany v. Commission (T-374/04) [2007] ECR II-4431 Romania v. Commission (T-484/07) [2008] C51/57 Société Arcelor Atlantique et Lorraine and Others vs. Premier Ministre, Ministre de l’Ecologie et du Dèveloppment Durable and Ministre de l’Economie, des Finances et de l’Industrie (C127-07) [2008] ECR I-9895 United Kingdon v Commission (T-143/05) [2005] ECR II-4431 2. New Zealand Genesis Power Ltd v Greenpeace New Zealand Inc [2008] NZSC 112, [2009] 1 NZLR 730 NZ Carbon Farming Ltd v Mighty River Power Ltd [2015] NZHC 1274 [High Court judgment] West Coast Ent Incorporated v Buller Coal Limited [2013] NZSC 87 [19 september 2013] Z Energy Limited v Oceana Gold (New Zealand) Limited HC WN CIV-2012-485-1810 [19 December 2012] 3. United States Ormet Primary Aluminium Corp. v. Ohio Power Co. 98 F. 3d 799 (4th Cir. 1996) C Legislation 1 Australia Australian National Registry of Emissions Units Act 2011(Cth) Clean Energy (Unity Shortfall Charge – General) Act 2011 (Cth) 351 Clean Energy Act 2011 (Cth) National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER) National Greenhouse and Energy Reporting Regulations 2008 (Cth) (Select Legislate Instrument 2008 No. 127 as amended made under the National Greenhouse and Energy Reporting Act 2007) regs 2.23-2.24. 2 Brazil Acre State Law 2308 of October 22, 2010 Amazonas State Complementary Law 53 of June 5, 2007 Amazonas State Decree 26.581 of April 25, 2007 Amazonas State Law 3.135 of June 4, 2007 and Amazonas State Law 3.184 of November 13, 2007 Brazilian Constitution of 5 October 1988 Complementary Law 31 of November 31, 1977 Federal Bill of Law 792/2007 Federal Bill of Law 5.487/2009 Federal Bill of Law 5.586/2009 Federal Bill of Law 7169/2014 and 7108/2014 Federal Decree 6.025 of January 22, 2007 Federal Decree 7.390 of December 9, 2010 Federal Law 1.806 of January 6, 1953 Federal Law 5.173 of October 27, 1966 Federal Law 5.851 of 7 December 1972 Federal Law 6.938 of August 31 1981 Federal Law 7.347 of July 24 of 1985 Federal Law 8.078 of September 11, 1990 352 Federal Law 9.605 of February 13, 1998 Federal Law 12.187, of December 29, 2009 Federal Law 12.651 of May 25, 2012 Federal Law 12.846 of August 1, 2013 Legislative Decree 144 of 2002 Legislative Decree 2.652 of 1998 São Paulo Sate Law 118 of 29 July 1973 São Paulo State Law 13.798 of November 9, 2009 São Paulo State Decree 55.497 of June 24, 2010 Tocantins State Law 1917 of April 17, 2008 3 European Union Commission Regulation (EU) No. 920/2010 for a standardized and secured system of registries pursuant to Directive 2003/87/EC of the European Parliament and of the Council and Decision 280/2004/EC of the European Parliament and of the Council’ (further amended by Regulation of 18 November 2011). Decision 2002/358/EC: Council Decision of 25 April 2002 concerning the approval, on behalf of the European Community, of the Kyoto Protocol to the United Nations Framework Convention on Climate Change and the joint fulfilmment of commitmens thereunder [2002] OJ L 130/1. Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, [2003] OJ L 275/32 (‘EU ETS 2003 Directive’) Directive 2004/101/EC of the European Parliament and of the Council of 27 October 2004 amending Directive 2003/87/EC establishing a scheme for the greenhouse gas emission allowance trading within the Community, in respect of the Kyoto Protocol’s project mechanisms [2004] OJ L 338/18 (EU ETS 2004 Linking Directive). 353 Directive 2004/101/EC of the European Parliament and of the Council of 27 October 2004 Regulation (EC) No. 219/2009 of the European Parliament and of the Council of 11 March 2009 and Directive 2008/101/EC of the European Parliament and of the Council of 19 November 2008 amending Directive 2003/87/EC so as to include aviation activities in the scheme for greenhouse gas emission allowance trading within the Community [2008] OJ L 8/3 (EU ETS 2008 Aviation Directive), Directive 2009/29/EC of the European Parliament and of the Council of 23 April 2009 amending Directive 2003/87/EC so as to improve and extend the greenhouse gas emissions allowance scheme of the Community [2009] OJ L 140/63 (EU ETS 2009 Directive). 4 New Zealand Climate Change Response Act 2002 (2002 No. 40) (NZ) Climate Change Response (Emissions Trading) Amendment Act 2008 (2008 No. 85) (NZ) Climate Change Response (Moderated Emissions Trading) Amendment Act 2009 (2009 No. 57) (NZ) Climate Change Response (Emissions Trading and Other Matters) Amendment Act 2012 (2012 No. 89) (NZ Goods and Services Tax Act 1985 introduced by the Climate Change Response (Emissions Trading Amendment) Act 2008 (NZ) Income Tax Act 2007 (as amended in January 1 2009) (NZ) 5 United States Clean Air Act Publ. L. No. 91-604, 84 Stat. 1676 (codified as amended at 42 U.S.C.A. §§ 7401-7671q (West Supp. 1991) 354 D Treaties and Protocols 1997 Kyoto Protocol to the UN Framework Convention on Climate Change, adopted 11 December 1997, 2303 UNTS 148 / [2008] ATS 2 / 37 ILM 22 (1998) (entered into force 16 February 2007) (Kyoto Protocol) The Montreal Protocol on Substances that Deplete the Ozone Layer (Montreal Protocol), concluded 16 September 1987, 1522 UNTS, 26 ILM 1550 (1987) (entered into force 1 January 1989) Treaty on European Union, opened for signature 7 February 1992, [2009] OJ C 115/13 (entered into force 1 November 1993). United Nations Framework Convention on Climate Change, adopted 9 May 1992, 1771 UNTS 107, (entered into force 21 March 1994) (UNFCCC)