EMISSIONS TRADING SCHEMES AND THEIR LINKING: CHALLENGES AND OPPORTUNITIES IN ASIA AND THE PACIFIC ASIAN DEVELOPMENT BANK EMISSIONS TRADING SCHEMES AND THEIR LINKING: CHALLENGES AND OPPORTUNITIES IN ASIA AND THE PACIFIC ASIAN DEVELOPMENT BANK Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO) © 2016 Asian Development Bank 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 632 4444; Fax +63 2 636 2444 www.adb.org; openaccess.adb.org Some rights reserved. Published in 2015. Printed in the Philippines. ISBN 978-92-9257-372-0 (Print), 978-92-9257-373-7 (e-ISBN) Publication Stock No. RPT167931-2 Cataloging-In-Publication Data Asian Development Bank. Emissions trading schemes and their linking - challenges and opportunities in Asia and the Pacific Mandaluyong City, Philippines: Asian Development Bank, 2016. 1. Emissions Trading 2. Climate Change I. Asian Development Bank. 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Notes: (i) In this publication, “$’ refers to US dollars. (ii) ADB recognizes “China” as the People’s Republic of China, “Korea” as the Republic of Korea, “Russia” as the Russian Federation, and “Vietnam” as Viet Nam. iii Contents Tables and Figures v Foreword vii Preface ix Acknowledgments x Abbreviations xi 1 Context: Carbon Pricing Instruments for Developing Member Countries 1 Carbon Pricing Options 2 Choosing the Right Carbon Pricing Approach 4 Emissions Trading Systems in Asia and the Pacific 6 2 Existing Emissions Trading Systems—Theory and Practice 8 Theory—Building Blocks of Emissions Trading Systems 8 Practice—Existing Emissions Trading Systems 16 Theory—Possible Linking Arrangements 30 Linking Experiences 32 3 Key Challenges and Lessons Learned from Existing Emissions Trading Systems 34 Overview 34 Political Desirability and Legal Frameworks Play Decisive Role in Emissions Trading Systems 35 Flexibility to Address Oversupply 36 Consequences of Offsets for Allowance Surpluses and Emissions Trading System Abatement 39 Framework to Incentivize Long-Term Investment 41 Allocation as a Fair System that Supports Long-Term Competitiveness 44 Banking May Have Longer-Term Implications for Future Emission Reduction and Carbon Price 46 Institutional Setup and Operation 47 Prefecture-Level Trading (Tokyo Cap-and-Trade Program) 48 Summary on Lessons for the Future Development of Emissions Trading Systems 48 4 Emissions Trading Systems in Developing Member Countries 49 People’s Republic of China Emissions Trading System 50 Kazakhstan’s Emissions Trading System 52 Emerging Initiatives: India, Indonesia, Thailand, Viet Nam 53 iv Emissions Trading Schemes and their Linking - Challenges and Opportunities in Asia and the Pacific 5 Key Challenges Faced by Developing Member Countries and a Blueprint for the Future 55 Political Commitment and Uncertainty 55 Policy Interactions 56 Target Setting and Flexibility 58 Legal Framework and Enforcement 60 Institutions and Monitoring, Reporting, and Verification Capacity 63 Allocation Mechanisms 65 The Functioning of the Market 66 Enabling Conditions 67 Summary—A Staged Approach 68 6 Linking: Key Challenges and What Can Be Learned from International Experience 69 Lessons Learned from International Experience of Linking 70 Linking Enablers and Barriers in Developing Member Countries 71 Strategic Approach toward Linking Emissions Trading Systems in Asia and the Pacific 79 Appendices 1 Track Record of Existing Emissions Trading Systems 86 2 Advantages and Disadvantages of Linking Emissions Trading Systems 93 3 Energy, Greenhouse Gas, and Renewable Energy Policy Instruments 97 References 100 v Tables and Figures Tables 1.1 Existing and Emerging Emissions Trading Systems 6 2.1 Emissions Trading Systems Examined in Section 6 17 2.2 Overview of the European Union Emissions Trading System 17 2.3 Overview of the Regional Greenhouse Gas Initiative 19 2.4 Overview of the Western Climate Initiative 21 2.5 Overview of the Alberta Greenhouse Gas Reduction Program 23 2.6 Overview of the New Zealand Emissions Trading System 24 2.7 Overview of the Australian Carbon Pricing Mechanism 25 2.8 Overview of Japanese Prefecture Level-Based Emissions Trading Systems 27 2.9 Overview of the Republic of Korea Emissions Trading System 28 2.10 Experiences of Linking Emissions Trading Systems 32 3.1 Experience and Lessons from Existing Emissions Trading Systems 35 3.2 Phase III Cap and Change of Emissions Outlook 46 4.1 Overview of Emissions Trading Systems in the People’s Republic of China 50 4.2 Overview of the Emissions Trading System in Kazakhstan 52 4.3 Overview of Emissions Trading Systems in India, Indonesia, Thailand, and Viet Nam 54 5.1 Average Annual Growth Rate in Gross Domestic Product and Carbon Dioxide Emissions 58 5.2 Compliance to the Emissions Trading Systems in the People’s Republic of China for the First 2 Years 61 5.3 Trading Volume of Emissions Trading Systems in the People’s Republic of China for the First 2 Years 66 6.1 Trading Relationships between the Largest Economies in Asia and the Pacific 72 6.2 International Carbon Action Partnership Research on the Relative Importance of Emissions Trading System Design Elements on Linking 74 6.3 Summary of Reduction Targets and Trading System Implementation by Country 75 A1.1 Aggregated Compliance Outcome of the Alberta Greenhouse Gas Project, 2007–2014 91 A2.1 2011 Key Economic Indicators and Carbon Emissions Indicators in the Countries with Carbon Trading Potentials in Asia and the Pacific 94 Figures 1.1 Visual Guide of the Sections 1 1.2 Existing and Emerging Emissions Trading Systems in Asia and the Pacific 7 2.1 Visual Guide of the Sections 8 2.2 Key Elements of an Emissions Trading System 9 2.3 Direct Linking between Three Systems 30 2.4 Indirect Linking 32 vi Emissions Trading Schemes and their Linking - Challenges and Opportunities in Asia and the Pacific 3.1 Visual Guide of the Sections 34 3.2 Evolution of European Union Allowance from 2005–2015 37 3.3 Regional Greenhouse Gas Initiative Power Plant Emissions Compared with their Caps 37 3.4 Oversupply of Allowances in the European Union Emissions Trading System 39 3.5 Freely Allocated European Union Allowance vs. Emissions in Industrial Sectors 45 4.1 Visual Guide of the Sections 49 5.1 Visual Guide of the Sections 55 6.1 Visual Guide of the Sections 69 6.2 Approach to Harmonization and Linking of Systems 80 6.3 Steps to Approach Linking 81 A1.1 Evolution of Gross Domestic Product (in Real Terms), Greenhouse Gas Emissions, and Emissions Intensity 86 A1.2 Greenhouse Gas Emissions by Main Sector in EU-28, Change 1990–2012 and 2012 Shares 87 A1.3 Aggregate Change in Total CO2 Emissions from Fossil Fuel Combustion in the EU-28, during Phase I and Phase II of the European Union Emissions Trading System 88 A1.4 Regional Greenhouse Gas Initiative: Emissions and Economic Growth 89 A1.5 Distribution of Auction Revenues 90 A1.6 Changes in Emissions 92 vii Foreword A successful policy response to the challenges posed by climate change will be critical to the future development of Asia and the Pacific.