The merit of sectoral approaches in transitioning towards a global carbon market

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.COM Ltd.

Providing potentially the strongest link between the EU's emissions trading scheme and sectoral approaches, sectoral benchmarks can be used for setting caps and free allocations, or can become a catalyst for linking the world's carbon markets, writes Noriko Fujiwara, head of climate change and a research fellow at the Centre for European Policy Studies (CEPS), in a May special report.

This report was authored by Noriko Fujiwara of CEPS, with contributions from Anton Georgiev and Monica Alessi.

''The term 'sectoral approaches' means different things to different people. There are at least three main models of sectoral approaches: industry-led transnational initiatives linked to the deployment of sector-specific technologies; bottom-up developing country commitments, possibly combined with 'no-lose' targets; and a sectoral Clean Development Mechanism (CDM) or sectoral crediting with implications for carbon finance.

There are a number of industry-led transnational initiatives, including the Cement Sustainability Initiative (CSI) under the World Business Council for Sustainable Development as well as activities by the International Aluminium Institute and worldsteel (formerly the International Iron and Steel Institute). Each sector has developed parameters or formulae for the coverage of sub-sectors.

There are also different stages involved in benchmarking: i) setting sector boundaries, ii) documenting current industry performance based on agreed metrics or key performance indicators, and iii) identifying best practices.

Consideration of the complexity in setting the sector boundary and the feasibility of operation would be preconditions for allowing the future inclusion of a relevant sector in a cap-and-trade system. Datasets collected at an installation level throughout multinational corporations could be integrated in each sector. The sharing and diffusion of best practices among companies would increase operational efficiency.

Similarly, the diffusion of technology within the sector could contribute to improving the performance of the least-efficient installations.

Sector no-lose targets aim at encouraging emission reductions in a given sector through a form of non-binding targets in developing countries, especially in emerging economies. A sector-crediting baseline would be established by a host country. Credits for reductions below that baseline would be issued and could be sold on the international carbon market. A sectoral crediting mechanism is seen as an instrument for scaling up financial flows to and investment in developing countries.

The transition from sectoral crediting to sectoral trading is usually considered the halfway point on the evolution path towards a flexible mechanism, starting from the current CDM and going through the programmatic CDM, then eventually moving to a cap-and-trade scheme.

These sectoral approaches are not necessarily assumed to be the best option but can be considered part of a transition towards a global carbon market. They could coexist with other policies or mechanisms. Unlike transnational initiatives, sectoral crediting or sectoral trading is to be implemented domestically in developing countries. Proponents of these approaches put more emphasis on the electricity and heating sector than those of industry-led transnational initiatives.

Sector-specific benchmarks form the potentially strongest link between the European Union's Emissions Trading Scheme (EU ETS) and sectoral approaches. First, sectoral benchmarks can be used for setting caps. In a subsequent phase (2013–20), the European Commission will be in charge of setting an EU-wide cap. The cap will decrease annually by a linear factor compared with the average annual quantity of allowances issued by member states.

Second, sectoral benchmarks can be used for free allocation. The benchmarks will be set Community-wide ex ante, and calculated for products.

Third, sectoral benchmarks can become a catalyst for linking carbon markets.

One option is to link carbon markets through agreements to provide for the recognition of allowances between the EU ETS and 'compatible mandatory' emissions trading schemes with absolute caps in any non-EU country or in sub-federal or regional entities.

Another option is to link carbon markets through non-binding arrangements to provide for administrative and technical coordination in relation to allowances in the EU ETS or other 'mandatory' emissions trading schemes with absolute caps.

The EU calls for the creation of a carbon market across the OECD through linkages by 2015, which will be extended to include major emerging economies by 2020. As a step towards developing the global carbon market, it envisages a gradual phase-out of the project-based CDM for advanced developing countries in a move towards a sectoral crediting mechanism. This move would pave the way for introducing and developing cap-and-trade schemes in these countries.

There would be at least three ways to strengthen the effectiveness of sectoral approaches: through the choice of performance metrics, reporting and compliance. One approach to performance metrics is to use a composite index system. A rough framework, possibly adopting the index approach and based on what would be possible to measure, could be negotiated.

Measurability would be essential for making sectoral approaches operational as part of a post-2012 framework and is likely to require a common scientific scale of measurement, including performance indicators and boundaries.

For this purpose, the process underway through the UN Framework Convention on Climate Change (UNFCCC) could be complemented by the work of the International Organisation for Standardization/International Electrotechnical Commission and the International Energy Agency.

An example of a functioning compliance system can be found in the EU ETS; compliance systems are much weaker when based on an effort-sharing decision that requires member states to reduce emissions from non-ETS sectors.

Some preliminary thinking points to the possibility of an increase in decentralisation and flexibility in the post-2012 architecture. Decentralised or 'bottom-up' approaches would rely heavily on the correct conduct of measurement, reporting and verification of mitigation actions in developing countries to ensure that the resources provided by developed countries are spent effectively.

Sectoral approaches could work together with the targets-and-timetables approach or with a pledge-and-review model.

Otherwise, an 'action-based' strategy, which covers sectoral approaches, can be regarded as a way of integrating targets and timetables, as they are agreed, with consistent and comparable policies and measures.

Since the UNFCCC is a framework agreement with a longer time horizon as well as a wider coverage of participating countries, its scope allows a broader range of issues, including mitigation tools, under a single umbrella. Hence, sectoral approaches could have a better chance of developing into part of the post-2012 framework under the UNFCCC than under the Kyoto Protocol.

There will be a hybrid range of agreements and mechanisms to make sectoral approaches operational. The simplest option is to have only intergovernmental agreements, such as a reporting protocol, as an extension of the UNFCCC requirements.

The other option is to have both intergovernmental agreements and agreements negotiated between the government and industry in each entity. Moreover, intergovernmental agreements would provide not only for guidelines for domestic legislation and regulations but would also set up international mechanisms to reduce the unevenness of distributional impacts or increase access for those with less resources to implement policies and measures. This combination would make the implementation of domestic measures more enforceable.

In conclusion, the research shows that sectoral approaches could contribute to the development of a method that could optimally set a cap on GHG emissions and allocate emission allowances, especially (but not exclusively) through benchmarking. Sectoral benchmarking could be built upon improvements in boundary setting and data collection, along with best practices.

Yet, views over the costs associated with and the capacities for sectoral benchmarking differ from country to country, especially between developed countries and emerging economies or developing countries that are 'economically more advanced'.''

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