Striving to Keep ETS Simple Current practices to manage complexity in emissions trading. 05.08.2019, Berlin, Germany Alexander Eden, Mariza Montes De Oca and Constanze Haug STRIVING TO KEEP ETS SIMPLE 2 Background In line with the 2016-2017 work program of the International Carbon Action Partnership ICAP, the Secretariat facilitated a discussion among ICAP Members and Observers as to how emissions trading systems ETSs can be designed in a way that is easy to administer and lowers costs. The aim of this discussion paper is to promote a dialogue among ETS policymakers and operational staff by mapping options for ETS simplification, highlighting experiences and good practice from existing systems around the world. The paper is based on a survey of ICAP Members conducted in November 2016. The survey was structured based on the ETS design elements outlined in the ICAP-PMR Handbook ‘Emissions Trading in Practice’. The paper also draws on published discussion papers and the academic literature dealing with administrative transaction costs of ETSs. Respondents to the survey included policymakers and operational staff of seven official departments, representing five ETS jurisdictions – The European Union Emissions Trading System EU ETS – represented by Netherlands, Spain and Italy, California Cap-and-Trade Program, Qubec Cap-and-Trade System, the Regional Greenhouse Gas Initiative RGGI, the Tokyo Cap-and-Trade Program, and the New Zealand Emissions Trading System NZ ETS. Acknowledgements The ICAP Secretariat would like to thank the following government officials and experts for contributing to this paper through their insights and experiences, or by providing valuable comments on an earlier draft of the paper Tamarah Andriessen, Jean-Yves Benoit, Mary Jane Coombs, Giulia Dramis, Hubert Fallmann, Jason Gray, Alexander Handke, Peter Heindl, Ted Jamieson, Bill Lamkin, Sachiko Nakamura, Machtelt Oudenes, Kim Ricard, Ignacio Snchez Garcia, Mark Sippola, Will Space. STRIVING TO KEEP ETS SIMPLE 3 cutive Summary Setting up and operating an emissions trading system ETS involves both technical and administrative complexity. Policymakers and administrators need to navigate trade-offs between the procedures and requirements needed to ensure the environmentally sound operation of the system, and the resulting administrative burden both for the regulator and for covered entities. The question of how to keep ETS simple yet robust has therefore attracted significant interest among policymakers, experts and stakeholders. The present paper identifies general and transferable lessons for simplification in ETS design and operation, based on a review of experiences and best practices from existing ETS around the world. These insights are relevant to existing systems, which may consider options for ETS simplification as part of a review process. Yet they are perhaps even more crucial for the next generation of ETS, many of which will be implemented in emerging economies facing additional challenges in terms of institutional capacity. Against this background the paper finds that considering simplicity as one objective among others already at the inception stage can yield important benefits. Once legislation or ination systems are in place, making changes can require significant administrative effort. Key determinants of complexity in ETS design revolve around the choice of allocation , point of regulation, scope setting, and a potential offset component of a system. Most of the opportunities for ETS simplification, however, lie in the realm of ETS operations. Policymakers have implemented a variety of measures to reduce the administrative burden and increase user-friendliness. This includes threshold setting for small emitter exclusion, monitoring, reporting and verification MRV and data management techniques, options for streamlining the administration of free allocation, and secure but simple registry operation. Several ‘soft’ approaches to simplification are also explored. One key focus for these efforts is small emitters in an ETS, who face disproportionately higher administrative costs than larger entities. Examples from practice show that jurisdictions have engaged with the issue of small emitters and have implemented two main approaches. The first is to set thresholds for their exclusion, with supporting policies in place to maintain a level playing field and to manage distortionary effects. The second approach is to reduce the MRV obligations proportionately for smaller emitters and those with simpler processes through the use of tiered systems, with the application of default emissions factors where appropriate. In using a proportionate approach, a basic principle has been applied - simple and conservative s are applied first, with the option to move to more accurate and less conservative s. The collection, management, and quality assurance of emissions data are fundamental aspects of ETS operation, with a clear operational trade-off between data quality and administrative burden. Several approaches to simplifying reporting and verification have been successfully implemented. Firstly, finding synergies with existing data gathering and reporting obligations has the potential to minimize reporting tasks. Secondly, the standardization of reporting ats can streamline and simplify data management, with some jurisdictions applying more advanced integrated software plats for this purpose. Third-party verification is still the most robust approach to quality control, with limited options for simplifying procedures. Free allocation also entails potentially high levels of complexity in operation. One basic approach to simplification of free allocation is to reduce the differentiation of rules and procedures in the legislation, STRIVING TO KEEP ETS SIMPLE 4 yet this reduces the potential for targeted treatment of sectors and industries. Integrated electronic plats have been used to automatically calculate free allocation based on reporting data. Of the various approaches to free allocation via benchmarking, dedicated product benchmarks are found to be the most straightforward to apply, particularly for small- and medium-sized entities. However, establishing such benchmarks requires complex data collection and significant upfront administrative effort from the regulator. A secure registry is essential for an ETS, with only limited potential to reduce the administrative burden. Measures such as automatic compliance options or dedicated compliance accounts may be considered to reduce the security requirements proportionately for some users. More broadly, the ‘soft’ approaches to simplification, such as knowledge sharing, capacity building, guidance documents and help desks, inter-agency communication and coordination, and stakeholder consultation, can increase the efficiency of operations over time. Providing participants with structured feedback has been found to increase the quality of ination provided and to reduce the need for checking and correcting. Over time, operational experience gained via learning-by-doing can help both covered entities and regulators to reduce costs and optimize resources. Furthermore, ongoing stakeholder engagement can uncover opportunities for streamlining and simplifying, which become more apparent after systems are operationalized. STRIVING TO KEEP ETS SIMPLE 5 Table of Contents 1 Introduction . 8 2 Simplification objectives and trade-offs 9 2.1. Objectives of simplification . 9 2.2. Administrative burden and transaction costs . 9 2.2.1. Administrative burden of the regulator 9 2.2.2. Administrative transaction costs of covered entities . 10 2.3. A degree of complexity is inevitable 12 2.4. Striking the right balance. 12 3 Major ETS design elements that determine complexity 13 3.1. Point of regulation . 13 3.2. ETS scope . 13 3.3. of allocation 13 3.4. Additional design elements . 14 4 Simplification approaches – lessons from current practice . 16 4.1. Thresholds for participation - when size matters . 16 4.1.1. Exclusion thresholds in practice . 16 4.1.2. Competitiveness concerns and opt-in 20 4.2. Simple by default – emissions factors and tiered approaches to monitoring . 21 4.2.1. Default emissions factors 21 4.2.2. Tiered approaches . 22 4.2.3. Simple emitters . 24 4.3. Dealing with emissions data – reporting made simpler . 25 4.3.1. Synergies with existing accounting or reporting systems . 25 4.3.2. Standardization . 26 4.3.3. Quality, transparency and accountability through verification 27 4.4. Rules and exceptions– dealing with complexity in allocation 29 4.4.1. Integrating electronic systems for allocation . 29 4.4.2. Establishing product benchmarks 29 4.5. Simple and secure registry operation . 31 4.5.1. Proportionate security requirements . 31 4.5.2. Automatic compliance options . 31 4.5.3. Harmonization of common registries . 32 4.6. Mitigating complexity - when simplification is not possible 33 4.6.1. Stakeholder consultation regarding simplification . 33 5 Conclusion 34 6 Bibliography . 36 STRIVING TO KEEP ETS SIMPLE 6 List of Tables Table 1 Overview of major design elements in the systems surveyed 15 Table 2 Participation thresholds across different jurisdictions 17 Table 3 Tiered uncertainty requirements – example from the EU ETS 23 Table 4 Tier requirements in the EU ETS categorized by installation size and source stream . 23 List of Figures Figure 1 Average transaction cost € per tCO2 emitted by EU ETS participants in Germany 11 Figure 2 Share of EU ETS installations and emissions related to annual CO2e emitted . 18 List of Boxes Box 1 Administrative transaction costs in the EU ETS – small and simple emitters 152 Box 2 Thresholds and small emitter opt-out provisions in the EU ETS 230 Box 3 Qubec- ensuring a level playing field for fuel distributors 232 Box 4 Small emitters and the EU ETS tier system . 236 Box 5 Electronic reporting plats in practice 239 STRIVING TO KEEP ETS SIMPLE 7 Acronyms ACRONYM Use tabs to separate acronym from text Cal-eGGRT California Air Resource Board’s electronic Greenhouse Gas Emissions Tool CEMS Continuous Emissions Measurement Systems CITSS Compliance Instrument Tracking System Service DEHst Deutsche Emissionshandelsstelle EPA US Environmental Protection Agency ETS Emissions Trading System ETSWAP Emissions Trading Scheme Workflow Automation Project FMS ula Management System GHG Greenhouse Gas HFC Hydrofluorocarbons ICAP International Carbon Action Partnership IQEA Inventaire qubcois des missions atmosphriques ISO International Organization for Standardization MRR Monthly Recurring Revenue MRV Monitoring, Reporting costs drop sharply at first and then more gradually. This indicates that there are both fixed costs associated with MRV the main driver of the pattern, as well as marginal costs that larger emitters are better able to manage through economies of scale see Figure 1. Figure 1 Average transaction cost € per tCO2 emitted by EU ETS participants in Germany Source Heindl 2012 Secondly, entities in different sectors were found to face different levels of transaction costs. In particular, power utilities generally face lower costs than other sectors, as MRV procedures are highly standardized for utilities with relatively simple processes e.g., monitoring based on the carbon content of fuel s. Companies with more complex and diverse industrial processes face more complex MRV procedures to ensure environmental integrity and accuracy of data. As companies factor their administrative transaction costs into their investment decisions, this affects their relative cost of abatement, meaning that small companies and those with complex processes effectively face a higher carbon price per ton of CO2e. Although overall costs related to MRV are not found to hamper the environmental effectiveness of the instrument, the studies from Heindl 2012, 2017 emphasize that it is still important to avoid excessive administrative burdens and strive for a level playing field for all regulated entities. It should be noted that the EU ETS monitoring guidelines applicable in Phases I tailored provisions for aviation that ensure equal treatment of operators on flight routes California 25,000 tCO2e; Opt-in option below threshold; and all imported electricity is covered Qubec Mandatory 25,000 tCO2e; Opt-in 10,000 tCO2e RGGI 25MW generation capacity Tokyo Large emitting facilities 1,500 kl crude oil equivalent New Zealand De Minimis low thresholds Korea Company 125,000 tCO2e/year Facility 25,000 tCO2e/year Switzerland 20 MWth installed capacity China national ETS* Energy consumption 10,000 tce/year ca. 26,000 tCO2 Mexico pilot ETS* 100,000 tCO2/year STRIVING TO KEEP ETS SIMPLE 18 Box 2 Thresholds and small emitter opt-out provisions in the EU ETS The EU ETS is designed to have a relatively comprehensive coverage across its covered sectors, so as to maximize the benefits of a large carbon market and ensure a level playing field for businesses. Participation for most of the covered activities is determined by sector specific capacity-based thresholds, like for example the total rated thermal exceeding 20 MW or the production capacity e.g., exceeding 75 tons per day for the manufacture of ceramic products. Small emitters installations with low emissions are in general obliged to participate if they exceed the capacity-based thresholds. Figure 5 Share of EU ETS installations and emissions related to annual CO2e emitted Source Fallmann et al. 2015 from Umweltbundesamt, EUTL verified emissions s 2013 Recognizing that small emitters faced disproportionately higher administrative transaction costs, Article 27 of the EU ETS Directive Directive 2003/87/EC allows Member States to implement at national level an opt-out scheme for small emitters, defined with a threshold of less than 25,000 tons of CO2e per year. This opt-out provision was applied from Phase III starting in 2013 Fallmann et al., 2015. However, installations still have to be subject to measures that will achieve an equivalent contribution to emissions reductions. Furthermore, to ensure that they do not exceed the opt-out threshold, installations must also still monitor and report their emissions albeit usually under simplified conditions. From 2021, an additional opt-out possibility will be in places for installations that exceed capacity-based thresholds but emit less than 2,500 tons of CO2e per year. These, as well as reserve or backup units which do not operate more than 300 hours per year, can be excluded without equivalent measures. Box 2. continued below STRIVING TO KEEP ETS SIMPLE 19 Box 2 continued Thresholds and small emitter opt-out provisions in the EU ETS In Phase III, the opt-out provision has only been used to a limited extent. According to national reports ted in 2017, only eight countr