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Climate action 101 – The EU Emissions Trading System

We must reduce emissions of greenhouse gases (GHG) to net zero by 2050 to have a reasonable chance of limiting global warming to 1.5C. Human activities – mainly the burning of fossil fuels – are currently emitting far too much carbon dioxide (CO2) every year. One approach to reducing CO2 emissions is emissions trading –…
Writen by Investors’ Corner Team. The post Climate action 101 – The EU Emissions Trading System appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management.

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This article was originally published by BNP Paribas Asset Managment Blog ( Investor's Corner)

We
must reduce emissions of greenhouse gases (GHG) to net zero by 2050 to have a
reasonable chance of
limiting
global warming to 1.5C
. Human
activities – mainly the burning of fossil fuels – are currently emitting far
too much carbon dioxide (CO2) every year. One approach to reducing CO2
emissions is emissions trading – it is carrot-and-stick: emitters of CO2 are
given a financial incentive to cut back, while the authorities set a limit on
emissions that falls over time.

The EU Emissions Trading System –
effectively a market in carbon dioxide – sets a price on a tonne of CO2. This
GHG is pervasive: the manufacturing, agriculture, transport, waste, power
generation and other sectors release the gas that traps heat from the sun and
thus contributes to global warming.

Under the system, emitters receive a
fixed number of allowances, i.e. permits to emit CO2. These act as currencies
for the carbon market.

How does it work?

  • If a company does not have
    enough, it can either cut emissions or buy extra allowances
  • If it has a surplus, it can
    keep the allowances for next year or sell them.

Source: https://ec.europa.eu/clima/policies/ets_en

The EU calls this the smart way forward
and has branded it the cornerstone of its strategy to tackle climate change
head-on.

The system – the world’s first, largest
and longest running – has operated for more than a decade and covers almost
half the EU’s emissions.

It is seen as a flexible, cost-effective
and business friendly path to a lower carbon and greener future.

In more detail

The Emissions Trading System covers power stations, energy-intensive industries (e.g., oil refineries, steelworks, and producers of iron, aluminium, cement, paper, and glass) and airline flights within the EU and the European Economic Area – in total, more than 11 000 power plants and factories.[1] For companies in these sectors, participation is mandatory.

Geographically, it involves the 28 EU
member states plus Iceland, Liechtenstein, and Norway. It covers around 45% of the
EU’s greenhouse
gas
emissions.

Companies need to hold European Emission
Allowances (EUAs) for every tonne of CO2 they emit within one calendar year.
They are fined if they emit more CO2 than covered by their emission allowances.

Financially, a company is incentivised to
cut emissions by investing in energy efficiency because if they reduce
emissions beyond the level of their allowances they will hold excess
allowances, which they can then sell.

Participation and gases covered

The system focuses on emissions from
sectors and gases that can be measured, reported
and verified
accurately:

  • CO2 from power and heat generation, energy-intensive industries and commercial aviation
  • nitrous oxide (N2O) from production of nitric, adipic and glyoxylic acids[2] and glyoxal[3]
  • perfluorocarbons (PFCs) from aluminium production

Participation in the EU ETS is mandatory,
but in some sectors, only plants above a certain size are included, certain
small installations can be excluded if governments put in place measures that
will cut their emissions by an equivalent amount, and in aviation,
until 31 December 2023, the ETS applies only to flights between airports
located in the EEA.

Where does emission trading fit in?

The EU
is looking to tighten its emissions reduction target to at least 55% by 2030
,
the European Commission said recently, up from the current goal of 40% – both
from 1990 levels. The increase is part of a green overhaul of the European
economy, with pandemic-fighting economic rescue packages seen as an opportunity
to speed up EU ambitions for a more sustainable economy. Ultimately, the
objective is for Europe to achieve climate
neutrality
(a balance between emitting carbon and absorbing carbon from the
atmosphere in carbon sinks) by 2050.

New Commission plans will call on
European automakers to adopt tougher pollution standards, while energy will
increasingly become cleaner. Buildings will need to become more
energy-efficient and companies face stricter pollution caps in the EU carbon
market.

The carbon market can have unexpected
side effects. The pandemic-induced drop in air travel has meant that airlines
bought fewer emission allowances, causing the price of EUAs to fall (see
Exhibit 1). This has made carbon pollution cheaper in other sectors of the
economy. Such a development, if it persisted, would do little for the
decarbonisation effort, which is a declared EU priority.

In the longer run, however, the EU’s increased emissions reduction target and the (proposed) broadening of the ETS’s cover to include, for example, shipping, demand for EUA’s can be expected to rise, driving up carbon prices and enhancing the incentive for companies to cut back emissions.[4]

What is next?

For the next trading period, from 2021 to 2030, these changes are planned[5]:

  • Strengthening the EU ETS as a driver of investment by upping the pace of annual reductions in allowances to 2.2% as of 2021 and reinforcing the mechanism that reduces the surplus of emission allowances
  • Maintaining the free allocation of allowances to sectors whose international competitiveness could be threatened by carbon leakage[6], while ensuring that the rules for free allocation reflect technological progress
  • Helping industry and the power sector to meet the innovation and investment challenges of the low-carbon transition via several low-carbon funding mechanisms.

The adjustments are meant to ensure that the ETS contributes to the EU’s 2030 emission reduction targets. They are also part of the EU’s contribution to the Paris Agreement.


[1] Source: https://ec.europa.eu/clima/policies/ets_en

[2] .The main use for adipic acid is as a component of nylon-6/6. The US is a major producer accounting for about 40 % of world production. Nitric acid is used primarily to make synthetic commercial fertiliser. Source: https://www.ipcc-nggip.iges.or.jp/public/gp/bgp/3_2_Adipic_Acid_Nitric_Acid_Production.pdf Glyoxylic acid can be applied in the agro, pharma and fine chemical industries for water purificants and pesticides, an intermediate of varnish material and dyes, and the preservation of food, among other uses. Source: http://www.kat-chem.hu/en/prod-bulletins/glioxilsav

[3] Glyoxal is used in textile, paper, oil/gas, cosmetics and leather applications, disinfectants, and in special epoxy resins, among other uses. Source: http://www.intermediates.basf.com/chemicals/glyoxal/faq

[4] Also see EU carbon market shrugs off pandemic  by Mark Lewis; Financial Times 1 July 2020

[5] See https://ec.europa.eu/clima/policies/ets_en, EU ETS: ‘Key features of phase 4 (2021-2030)’

[6] Carbon leakage occurs when, because of climate-related costs, (energy-intensive) businesses transfer production to other countries with laxer emission constraints, raising their total emissions.


Any
views expressed here are those of the author as of the date of publication, are
based on available information, and are subject to change without notice.
Individual portfolio management teams may hold different views and may take
different investment decisions for different clients. The views expressed in
this podcast do not in any way constitute investment advice.

The
value of investments and the income they generate may go down as well as up and
it is possible that investors will not recover their initial outlay. Past
performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Writen by Investors’ Corner Team. The post Climate action 101 – The EU Emissions Trading System appeared first on Investors’ Corner – The official blog of BNP Paribas Asset Management.

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