Technical n o Te 13 | May 2016 Carbon Credits and Additionality Past, Present, and FutureAcknowledgments This technical note was prepared for the Partnership for Market Readiness PMR by Pedro Martins Barata Get2c with , review, and oversight by Felicity Spors, Pauline Kennedy, Alexandrina Platonova-Oquab, and Harikumar Gadde PMR Secretariat. Please direct any comments and questions about this draft brief to the PMR Secretariat pmrsecretariatworldbank.org.Carbon Credits and Additionality Past, Present, and Future Technical Note 13 | May 2016 2016 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone 202-473-1000; Internet www.worldbank.org Some rights reserved 1 2 3 4 19 18 17 16 This work is a product of the staff of The World Bank with external contributions. 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All queries on rights and licenses should be addressed to the Publishing and Knowledge Division, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax 202-522-2625; e-mail pubrightsworldbank.org. Cover photos B. Used with permission. Further permission required for reuse. Cover design Bill Pragluski, Critical Stages LLC.iii Carbon Credits and Additionality Past, Present, and Future Contents 1. Background and Terms of Reference 1 2. AdditionalityWhy It Matters .2 2.1. A Word on Terminology .2 3. AdditionalityHow to Define It .7 3.1. Emissions or Environmental Additionality 7 3.2. Financial Additionality .8 3.3. Technological Additionality .9 4. Additionalitys for Determining It .11 4.1. Checklists of Criteria 11 4.2. Barrier Analysis 13 4.3. Common Practice, Best Practice, “First-of-Its-Kind,” Perance Benchmarks .14 4.4. Conclusions on Additionality Testing .15 5. The Development of Carbon Offsets and Additionality 19 6. Conclusions.25 Appendix. Rules/Ination on Additionality Determination in Different Offset Schemes 27 Boxes Box 1. The Combined Tool .4 Box 2. Additionality, Non-additionality, and Markets 5 Box 3. Investment Additionality in the CDMEarly Criticism .9 Box 4. Technological Additionality .10 Box 5. Checklists in Different Offset Schemes .11 Box 6. Eligibility in California .12 Box 7. Programmatic CDM 13 Box 8. Barrier Analysis in the CDM 13 Box 9. The Regional Greenhouse Gas Initiative and the Use of Perance Standards 15 Box 10. Wind Power in China 21 Figures Figure 1. Approaches to Additionality and Baseline CalculationThe Two-Step Approach .3 Figure 2. Approaches to Additionality and Baseline CalculationThe Combined Approach 4Carbon Credits and Additionality Past, Present, and Future iv Figure 3. Typical “Bell Curve” of Technological Development .15 Figure 4. A Broad Overview of the Evolution of Additionality Criteria among Different Systems .25 Tables Table 1. Use of Additionality Tests in Selected Existing Programs .16 Table 2. Concepts and Determination s for Additionality .171 Carbon Credits and Additionality Past, Present, and Future 1. Background and Terms of Reference The World Bank’s Partnership for Market Readiness PMR brings together developed and developing countries to build readiness for carbon market instruments to support cost-effective reductions in greenhouse gas emissions. As part of the PMR’s Technical Work Program, the PMR Secretariat asked Get2c to develop a technical briefing on the issue of additionality. The PMR’s offset and crediting working group identified the topic as an area of particular relevance to in countries about the consideration of additionality in the context of new crediting mechanisms that they are exploring. The terms of reference identify three key objectives, as follows, to clarify the concept of additionality and its significance for crediting mechanisms; describe the different approaches that have been used to demonstrate or test additionality; and explore the implications of the evolving carbon markets on the application and importance of additionality. The analysis is based on desktop research and consultation with relevant experts, including with the PMR’s Offsets and Crediting Working Group.Carbon Credits and Additionality Past, Present, and Future 2 2. AdditionalityWhy It Matters Key Messages Additionality matters for two separate reasons Cost effectiveness Additionality is a prerequisite to a socially and economically efficient allocation; and Environmental integrity If offsets are generated in an uncapped situation, a nonadditional offset implies a violation of the cap undermining the environmental integrity of the system. Additionality testing improves environmental integrity at a cost, including through excluding viable actions that do not cover the transaction costs involved. Most countries or constituencies considering climate mitigation policy instruments have considered the role of baseline-and-credit schemes. In a baseline-and-credit scheme, an incentive is provided to an action that is deemed to reduce emissions from a reference scenario. The units generated“credits”represent emissions reductions and are mostly sold to buyers in compliance or voluntary markets 1to compensate for emissions which would be more expensive to mitigate than the price of the credit. Crediting schemes have both been considered and developed at an international level and, increasingly at a domestic level see section 4, below. 2.1. A Word on Terminology Carbon market instruments fall essentially into two categories cap-and-trade C-T and baseline-and- credit B-C instruments. Under the er, units are issued to installations or entities included under the cap by an administrator, and entities are meant to surrender a specified quantity of units to offset/ compensate their emissions. Units represent therefore an “allowance” to emit that is usually denominated in metric tons of CO 2 e. In a B-C scheme, units are earned from a calculation of the difference of emissions between a baseline scenario that is, that which would have occurred in the absence of the scheme itself and the actual prevailing or “project” scenario. If that calculation yields a reduction between baseline scenario emissions and project emissions, these emission reductions accrue to the entity responsible for the action. They represent therefore a “credit.” It is important to understand that “offset” refers to a particular use of either “allowances” or “credits.” If an allowance is used to offset emissions elsewhere in a cap-and-trade scheme, it becomes effectively an “offset.” If a “credit” coming from a B-C scheme is used to demonstrate achievement of emission reductions under a payment-for-results scheme, emissions credited may indeed end up failing to offset any emission increase elsewhere. Instead, most professionals tend refer to “offsets,” which are effectively the products of baseline-and-credit schemes. 1“Compliance markets” refer to markets created through legal obligations or mandates on entities to cover their emissions with carbon assets, such as offsets or allowances. Voluntary markets which have often preceded compliance markets refer to voluntary compensation or offsetting undertaken by corporate entities, the social sector, or individuals looking to compensate their carbon footprint, without any legal mandate. 3 Carbon Credits and Additionality Past, Present, and Future Additionality is an essential criterion for credits in all standards and schemes. 2All existing standards and schemes apply a common definition of additionality A credit is considered additional if the emissions reduction that underpins the credit would not have occurred in the absence of the activity that generates the credit the BAU scenario. Additionality is, however, a complex concept. It is essentially a question of causation. What causes a particular policy intervention or mitigation action Can one relate the emission reduction to a particular incentive In the case of credits, a credit is additional if, in the absence of the incentive provided by the crediting scheme, that mitigation action likely would not have occurred. The incentive provided by the unit relates to the price, which results, in turn, from supply and demand for units that demonstrate a credible emission reduction. As the word “offset” indicates, the typical use for this unit is to allow companies or individuals to compensate for their emissions by supporting reductions elsewhere. With this rationale, an action cannot be certified as an offset, merely because it reduces emissions, but rather because it is motivated by the incentive provided by the scheme. Once one determines the link between the incentive and the action undertaken, it is then possible to proceed to the elaboration of the reference scenario for example, what would have been the emissions outcome without the incentive. A common approach in credit certification is to have as a first step the determination of additionality and as a second, to calculate baseline emissions figure 1. 2In what follows, an “offset standard” is a required procedure that stipulates what level of quality is expected in the generation of an offset unit. These procedures include ologies, calculation protocols systems, and validation and verification requirements that must be followed to achieve certification under an offset. An “offset scheme” represents the set of institutions that assist in the development and operation of an offset standard, encompassing usually a standard setting body, a regulatory board, and a validation/verification system typically autonomous institutions. Figure 1. Approaches to Additionality and Baseline CalculationThe Two-Step Approach Proposed action Is the action motivated by the incentive What is the most likely action without the incentiveCarbon Credits and Additionality Past, Present, and Future 4 Alternatively, some protocols for example, the combined baseline selection and additionality demonstration tool of the Clean Development Mechanism see figure 2 and box 1, below incorporate the determination of additionality into the step calculating the baseline Additionality is key in crediting schemes for two separate but related reasons. Carbon crediting schemes have as a stated goal the certification of emission reductions from a baseline. If these emission reductions would have occurred anyway, their certification and later use as offsets, that is, compensating for somebody else’s emissions, causes a net increase in emissions in that such emissions have not in reality been compensated. There is a direct impact on environmental integrity from such “non-additional” credits. Figure 2. Approaches to Additionality and Baseline CalculationThe Combined Approach Proposed action What are the likely baseline scenarios Does the likley scenario lead to lower emissions than the projest scenario Box 1. The Combined Tool The combined tool for the determination of additionality and baseline can only be applied to ologies for which the potential alternative scenarios to the proposed project activity available to project proponents cannot be implemented in parallel to the proposed Clean Development Mechanism CDM project activity. For example, the combined tool may be used for an energy efficiency CDM project where the possible alternative scenarios are the retrofit of existing equipment, replacement with new equipment, or the continued use of the existing equipment without any retrofits. Only one of the above scenarios could be implemented at any one time cutive Board meeting 70, Annex 9, paragraph 5. 5 Carbon Credits and Additionality Past, Present, and Future A related argument is that of the cost-effectiveness of policy intervention. A non-additional unit generated and used as an offset implies a redistribution of the social cost of reducing emissions, as follows If a non-additional unit is used as a means to offset a carbon tax liability, the government will see its carbon tax intake reduced, while the social goal of emission reduction is not met. Meeting the initial goal will require emission reductions elsewhere; in essence, there is a transfer of value from the treasury to the entity generating the non-additional units. If a non-additional unit is used to offset emissions of agents under a cap-and-trade system, the cap will be violated, and m