THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS Delivering environmental, economic, and social benefits July 2019. Berlin, Germany Marissa Santikarn, Christopher Kardish, Johannes Ackva, and Constanze Haug – ICAP Secretariat THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 2 Cite as Santikarn, M., Kardish, C., Ackva, J. this includes California and Qubec3, as well as the Regional Greenhouse Gas Initiative RGGI4 and Switzerland5 all hold regular allowance auctions. Over time, total auctioning revenue has increased as systems have either introduced auctioning or increased their share of auctioned allowances, alongside uneven but generally upward-trending allowance prices across the different systems. This paper focuses on these systems and how they manage and use any revenue raised. The Republic of Korea just started auctioning a small share of 1 This paper draws on and builds upon a paper prepared, in cooperation with the European Commission, as to a Carbon Market Workshop held in Florence in May 2018. 2 For 2019 the European Energy Exchange auctions general allowances three times a week Mondays, Tuesdays and Thursdays, as well as six auctions for domestic aviation allowances. A separate calendar is available for Poland and Germany for 2019. 3 California and Qubec hold joint quarterly auctions. 4 RGGI allowances are distributed through quarterly, regional auctions. 5 Switzerland auctions only an allowance reserve of 5 auctioning only what remains of the reserve after first providing free allocation to new or growing entities and any allowances that were freely allocated to entities that have since reduced or ceased operations. The Federal Office for the Environment of Switzerland can hold auctions several times a year through the Swiss Emissions Trading Registry EHR. On average, four auctions are held each year. All revenue from the Swiss ETS flows into the general budget. Given that ETS revenue is not allocated to a particular purpose, Switzerland is not considered in detail in this paper. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 7 allowances for some subsectors in January 2019. The Canadian province of Nova Scotia will start auctioning allowances in 2020. The New Zealand government is also preparing for the introduction of an auctioning mechanism by 2020 for its national ETS. The proposed design for the pilot phase of the national ETS in Mexico foresees setting aside a reserve equivalent to 5 of the cap for auctioning. Figure 1 Share of auctioning across ETSs Notes * Auctioning is the only RGGI-wide allocation approach, but the actual percentage is less than 100 because some states have small dedicated “set-aside” accounts. ** While entities in the Korea Emissions Trading Scheme are generally required to purchase 3 of their allowances at auction, sub-sectors that are considered vulnerable to international competitiveness and carbon leakage are mpted. This means auctioning system-wide is currently below 3. *** Mexico is yet to launch its pilot ETS. Sources ICAP Status Report 2019 and EHR. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 8 Figure 2 Auctioning revenue USD per ton of emissions capped by system over time Sources EC, ICAP Status Report, MELCC, CARB, RGGI, EEX, and ICE By the end of 2018, the EU ETS6 as well as the systems of Switzerland, California7, Qubec, and RGGI had raised revenue totaling just over USD 57 billion see Figure 4. Total auctioning revenue raised by each system is a function of a number of variables including, among others, the cap number of emissions covered, share of allowances auctioned, allowance price, as well as any market stability mechanisms in place e.g. auction floor price. Figure 2 highlights how much auctioning revenue has been raised in each system annually per ton of emissions capped, whereas Figure 3 tracks the allowance prices in each system over time. As prices and auctioning shares have increased, so too has the total revenue raised by the ETS see Figure 5. 6 Auctioning revenue figures for the EU ETS exclude revenue from the domestic aviation sector. 7 For the California cap-and-trade system, the estimated percentage of auctioned permits and total auction revenue account for state-owned permits only. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 9 Figure 3 Price USD of allowances in each system over time Source ICAP Allowance Price Explorer Figure 4 Auctioning revenue by system until end of 2018 THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 10 Notes ***Eight EU member states held auctions during phase 2 of the EU ETS 2008-2012, but there is no consolidated and comprehensive source of data available. For some member states, the auctioning revenue generated during this period was substantial. Germany for instance raised about €3.2 billion, according to the German Emissions Trading Authority DEHSt. Sources Own calculation with figures from the EC, CARB, MELCC, RGGI, EXX, ICE, and EHR Figure 5 Auctioning revenue by year and system8 Sources EEX, ICE, RGGI, ARB, MELCC, and EHR 3 Management and use of auctioning revenue How auctioning revenue is used depends on the jurisdiction’s priorities and circumstances9, which may also shift over time. In many cases, stakeholder consultations have helped to identify or tailor funding needs. ETS revenue can be earmarked for specific purposes. In practice, it is often used to further climate action or to compensate particularly vulnerable groups. While some jurisdictions have created separate funds to collect and distribute auctioning revenue according to an overarching investment plan or spending priorities , revenue can also go into the general budget with no earmarking, as is the case with Switzerland for more details on the management of revenue by jurisdiction, see Table 1.10 In the EU, California, Qubec, and the RGGI states, the main rationale for revenue expenditure is to fund additional climate and energy programs. Supporting households and communities that are disproportionately 8 Ibid. 9 There may also be legal limitations. For instance, the state of Oregon, which is considering a cap-and-trade program, is restricted by its constitution in how freely it can use revenue from transportation fuels. 10 Nine member states in the EU direct their revenue to the general budget, and California authorized a one-time loan from a portion of its auction proceeds to the state’s General Fund. Around 4 of total RGGI proceeds since 2009 have also been directed to the public budget of the participating RGGI states USD 90 million by New York State in 2009 and USD 3.1 million by New Hampshire in 2010. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 11 affected by carbon pricing has also been a key consideration in how auctioning revenue is used. Spending focuses not only on sectors covered by the ETS but those outside its scope as well. One consideration for earmarking auctioning proceeds for specific programs or purposes is accounting for year-to-year variability in revenue generated because of external factors, particularly fluctuations in allowance prices Vaidyula ii clean energy and energy efficiency; and iii natural resources and waste diversion. Figure 7 California’s use of auctioning revenue CARB, 2018 Source California Climate Investments 2018 Annual Report 4.3 Qubec Green Fund for the low-carbon transition Qubec’s auctioning revenue goes to the Green Fund, which has helped launch a wide range of climate change projects outlined in the province’s Climate Change Action Plan CCAP. This Plan emphasizes crosscutting initiatives that reinforce the necessity to reduce GHG emissions and increase Qubec’s resiliency to the effects of climate change. 79714Transport ii clean and renewable energy; iii mitigation; and iv direct bill assistance e.g. energy bill rebates. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 14 Figure 9 Use of auctioning revenue by the participating states RGGI Inc., 2018 Source The Investment of RGGI Proceeds in 2018 5 Climate and energy programs Investing revenue into additional climate and energy programs can strengthen the impact an ETS has on reducing emissions and help jurisdictions reach their mitigation targets. Auctioning revenue can help fund programs that address other market failures or stimulate behavior that the allowance price cannot achieve on its own. Spending on sectors outside the ETS could also encourage reductions among entities that otherwise face no cap or carbon price. Revenue use linked to the broader rationale for the instrument reducing emissions to fight climate change is intuitively easy to understand for the general public, such as using tolls or gasoline taxes for road maintenance and highway construction Esch, 2013. Such expenditure can help build public support to turn carbon pricing from “burden to benefit” Vaidyula Carl advanced, on-farm waste-to-fuel-generation projects; and low carbon intensity fuels research. 6 Compensating households, communities, and industries The costs and benefits that come with the introduction of a carbon price are unevenly distributed across different groups in society. Auctioning revenue is an important tool to achieve a fairer distribution and to protect vulnerable groups from potentially negative effects Haug, Eden however, this is not done through the use of auctioning revenue. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 17 households while other states provide a general credit on consumers’ electricity bills.18 Within the EU, France directs almost all of its revenue to the National Housing Agency to retrofit social housing, delivering both energy efficiency gains and supporting lower-income households. California is required to direct at least 25 of its revenue to benefit disadvantaged and low-income communities as outlined in the legislation AB 1550 and SB 535. In practice this means that California’s climate programs and policies that are funded by the auctioning revenue also aim to improve the lives of people in these communities. Examples include lowering local air pollutants through cleaner transportation options; increasing quality of life by planting trees and providing active transportation options; reducing energy bills by installing rooftop solar; and locating affordable homes near jobs, reducing commute times and household expenses. As of November 2017, about half of California’s projects are benefiting disadvantaged communities and over 30 are located within those communities CARB, 2018. 6.2 Regional disparities Revenue can also be directed to ease the transition to a low-carbon economy for lower-income regions. In the EU, 10 of auctioning revenue is distributed to lower-income member states, where they can be used for the purposes of solidarity, growth, and interconnections. Additionally, a new Modernisation Fund starting in phase four of the EU ETS funded by 310 million allowances will support the transition and modernization of energy systems in lower-income member states.19 In addition to efficiency improvements, it will fund investments such as worker-retraining programs to help facilitate a socially just transition to a low-carbon economy. This may be particularly important for fossil-fuel intensive sectors, which will find such a transition particularly challenging given the reduction in fossil fuel resources and demand for labor as the economic base shifts ILO it is also funded by proceeds from other statewide and federal programs. 19 Bulgaria, the Czech Republic, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovakia. 20 EU rules on State aid were put in place to ensure that state-owned resources are not deployed to distort competition or create unfair advantage in the European single market. State aid is an advantage given by a government that may provide a company with an unfair competitive edge over its commercial rivals. EU rules generally prohibit state aid unless it can be justified under certain circumstances related to general economic development. The European Commission is charged with ensuring that State aid rules are applied and observed equally across all the member states. 21 The Commission is currently revising the Guidelines for the next trading period. 22 The maximum amount of eligible costs is 85 from 2013-2015, decreasing to 80 for 2016-2018 and 75 for 2019-2020. 23 These schemes operate in Belgium, Finland, France, Germany, Greece, the Netherlands, Lithuania, Luxembourg, Slovakia, Spain, and the UK. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 18 adaptive solutions that reduce climate vulnerability, including water resource management, soil conservation, and pest surveillance. Regional vulnerability analyses are being conducted to in tourism businesses, alongside recommendations for adaptation solutions. Finally, a similar approach is being taken toward the mining industry in Northern Qubec, where risk analyses will play a key role in understanding the vulnerabilities of the industry to better target adaptation solutions. 7 Conclusion The primary purpose of an ETS is to reduce emissions in a cost-efficient manner. Auctioning is the most straightforward way to achieve this because it holds polluters accountable for their environmental costs while creating the clearest incentives for efficient abatement decisions. The additional income stream governments can generate by auctioning a share of the allowances can deliver additional co-benefits to the environment and the economy. How jurisdictions use this revenue stream will likely vary on a case-by-case basis. Most jurisdictions have used the revenue to fund additional climate and energy programs as part of a comprehensive approach to climate change that strengthens the positive climate impact of an ETS and also tends to mitigate carbon prices. A smaller share of revenue has gone to assist low-income households or disadvantaged communities. In this way, an ETS works not only to reduce emissions but can also increase economic opportunities and public health outcomes across the jurisdiction. Stakeholder involvement in shaping these spending priorities, alongside transparent and clear accounting of how such proceeds are spent, can also help build up public support and the acceptability of ETSs. THE USE OF AUCTION REVENUE FROM EMISSIONS TRADING SYSTEMS 19 8 Bibliography AB 1550 2016. Greenhouse gases investment plan disadvantaged communities. Available at https//leginfo.legislature.ca.gov/faces/billTextClient.xhtmlbill_id201520160AB1550 AB 32. 2006. California Global Warming Solutions Act. Available at http//www.leginfo.ca.gov/pub/05-06/bill/asm/ab_0001-0050/ab_32_bill_20060927_chaptered.pdf California Air Resources Board. 2018. California Climate Investments 2018 Annual Report. Available at https//ww3.arb.