Emissions Trading Scheme design and implementation: Recommendations for Ukraine

REUTERS/JO YONG-HAK

Emissions Trading Scheme Design and Implementation: Recommendations for Ukraine Prepared for The United Nations Development Programme

By THOMSON REUTERS POINT CARBON

ACKNOWLEDGEMENTS This report has been prepared by Thomson Reuters Point Carbon as part of the work under the project “Capacity Building for Low Carbon Growth in Ukraine.�

Thomson Reuters Point Carbon is very grateful to the Ukrainian State Environmental Investment Agency (SEIA), the United Nations Development Programme (UNDP), and the European Bank for Reconstruction and Development (EBRD) for the strong support provided throughout the Project.

This project is kindly supported by the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety of Germany.

Thank you to all the participants who provided feedback and content for this report, including Dymytro Paderno, Oleksii Khabatiuk among others.

LEAD AUTHOR Justin E. Felt

PROJECT TEAM Dr. Nataliia Ivanenko (Independent) Vladimir Laskarevsky (Independent) Sumeet Manchanda Olga Gassan-Zade Nataliya Vasylieva Fernando Gusmao Ganna Korniyenko Rakesh Radhakrishnan

TABLE OF CONTENTS Executive Summary .............................................................................................................. 4 1

Introduction .................................................................................................................... 7 1.1 Ukraine Activity in Kyoto Markets ............................................................................... 7

2

3

4

5

6

Emission Reduction Potential, Costs and Readiness by Sector...................................... 9 2.1

Electricity .............................................................................................................. 11

2.2

District Heating ..................................................................................................... 13

2.3

Manufacturing ....................................................................................................... 14

2.4

Transport Emissions ............................................................................................. 16

2.5

Residential and Commercial Fossil Fuel Consumption (Excl District Heating)‌‌17

2.6

Mining and Gas..................................................................................................... 18

2.7

Waste (Landfill, Water) ......................................................................................... 19

2.8

Agriculture, Forestry, and Land-Based Emissions ................................................. 20

Lessons from Existing Emissions Trading Schemes..................................................... 22 3.1

Sectoral Coverage and Point of Obligation ........................................................... 22

3.2

Targets ................................................................................................................. 24

3.3

Allocations and Auctions ....................................................................................... 26

3.4

MRV Rules and guidelines .................................................................................... 28

3.5

Offsets and Flexible Mechanisms ......................................................................... 30

3.6

Market Rules and Oversight .................................................................................. 33

Recommendations for ETS Design .............................................................................. 35 4.1

Sectoral Coverage and Point of Obligation ........................................................... 36

4.2

Targets ................................................................................................................. 39

4.3

Allocations and Auctions ....................................................................................... 43

4.4

MRV Rules and guidelines .................................................................................... 45

4.5

Offsets and Flexible Mechanisms ......................................................................... 46

4.6

Market Oversight and Rules .................................................................................. 49

Implementation Plan..................................................................................................... 51 5.1

Case studies of Phase I EU ETS, RGGI, California ETS implementations ............ 51

5.2

Implementation Recommendations ....................................................................... 53

References ................................................................................................................... 58

Executive Summary This paper, commissioned by the United Nations Development Program (UNDP) and in service to Ukraine, will lay out our recommendations for the design and implementation of an emissions trading scheme (ETS). The conclusions will draw from the learned experiences from other ETSs, as well as research into the Ukrainian economic, environmental and political context. This paper will provide specific recommendations in most situations, in order to make this document as useful and instructive as possible, though this also leaves it at risk of being at odds with the final decisions that are made.

Growth in energy-efficient industries and technological modernization, along with the economic downturn in manufacturing, contributed to a 40% reduction in the carbon intensity of Ukraine's GDP for the period 2000-2008. The energy intensity of Ukraine is still relatively high compared to its peers.

Across the electricity and industrial sectors, there is a huge opportunity for improvement with the replacement of outdated boilers, district heating network upgrades, kiln modifications, energy management, and development of clean sources of energy (among other actions). Across the district heating, electrical, and manufacturing sectors alone, there are nearly 100 million tons of CO2 equivalents of reductions (by 2030) that are profitable and pay for themselves (EBRD, 2012).

Based on lessons learned in other emissions trading schemes and an understanding of emissions projections and potential reductions in the Ukrainian economy, Table 1 spells out the recommended design of a Ukrainian ETS. Table 1: ETS design recommendations Component Coverage

Sub-component Sectors covered

Targets

Threshold Gases covered Target type

Depth of target

Allocation and auctions

MRV

Offsets

Allocation methodology Auctioning versus allocation

Auction design Number of years Timing of “true-up� of allowances Amount of offsets allowed Project types

Recommendation Pilot phase (2 years) includes the electricity sector. Phase 2 also includes manufacturing (metallurgy, cement, coke, cement, ammonia/fertilizer, lime, nitric acid, adipic acid, ferroalloys) and district heating.

25,000 tCO2e/year CO2, N2O Two options, with a preference for the intensity approach: 1) Intensity target. The target is a per cent improvement in GHG intensity per unit of output for capped sectors/facilities starting in the first year of the program, based on a baseline. Intensity targets will not be set per facility but sector wide (unlike in the Alberta ETS). See Section 4.2 to learn more.

2.) Absolute target. The target would be a per cent reduction in absolute emissions from a baseline such as 2005 or 1990.

This is ultimately the decision of Ukraine. TRPC views the carbon price calculations attractive for a target that mandates emissions be equal to 2010 levels by 2030, assuming a 2018 commencement of the program.

The pilot phase should be less stringent than phase 2. See Section 4.2 to learn more.

Benchmarking using production.

In the pilot phase, the electricity sector would receive partial allocations.

In phase 2, manufacturing would receive 100% allocation initially, district heating would receive a partial allocation, and electricity sector would receive no allocation. The balance of allowances would be sold at auctions, or potentially set aside. See Section 4.3 to learn more.

Sealed bid, uniform price English auctions Facilities should track emissions and production of capped industries three years prior to the start of the program April of the following year, with 100% annual compliance.

Offsets are allowed to be used for compliance up to 8% of each entities annual obligation.

Methane capture projects for coal mines, landfill gas, livestock methane, and wastewater.

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Standards allowed

Market oversight and rules

Floor Ceiling

Banking/borrowing

Joint Implementation projects in Ukraine for approved project types. This should be transitioned over time to new standardized methodologies for approved domestic project types.

A price floor enforced at auctions.

A soft price ceiling, with a set aside from existing allowances that release to the market, based on certain price triggers. The release could occur in the auctions.

Banking will be allowed in all instances, except between the pilot phase and phase 2. There will be no borrowing.

In order for an ETS to successfully launch, proper implementation and execution of the needed steps beforehand are crucial. Drawing upon the timelines and actions from other successful schemes, this paper recommends the following implementation process outlined in Table 2. These sets of actions assume a start date of January 1, 2018 for the ETS. Table 2: ETS implementation recommendations Year 2013

2014

2015

2016

Milestones / Tasks (in chronological order) a) Completion of high level consultations. Based on roundtables and inter-ministerial discussions, research funded by UNDP, EBRD, World Bank and other organizations should clarify the best policy approaches for reducing emissions. This would be the time frame to decide that ETS is the preferred approach, and to decide broadly on designs and frameworks. b) MRV initial preparation. At this stage, the design of the processes (including documentation, GHG protocols, emissions factors, identification of key players and government agencies) should begin. As with the high level consultations, it should be done in conjunction with EBRD, UNDP, World Bank, USAID and other organizations projects. a) Passage of cap-and-trade legislation. This bill authorizes budget and authority for initial specific consultations, stakeholder workshops, creation of multiple workgroups, a timeline for implementation, and MRV guidance. The bill makes clear the lead regulator, as well as secondary state agencies that would need to contribute. It should contain high level GHG emissions targets, and guidance on sectoral coverage. The legislation should be based on the high level consultation work performed in conjunction with multilateral agencies. b) Work groups are formed. A mix of stakeholders, academics, and officials convene into three different work groups: a. ETS design group (lead group); b. Economic modeling group (focused on leakage, allocation, and costs); c. GHG emission modeling group. c) Final MRV Regulation released/legislated. This ruling will set out the timeline for MRV tracking, including the commencement of GHG and production monitoring in January 2015. It also provides standard documentation, guidance on the creation of infrastructure to capture the data, GHG calculation guidelines, and verifier accreditation. It should also authorize training and promotion of new verification entities, and explain the roles of the state agencies in this process. a) GHG Tracking begins, accreditation of verifiers starts. Tracking of production and GHG emissions by facility is initiated, in addition to the GHG tracking of the wider economy. The procedures and infrastructure to approve verifiers is in place, with training and workshops to assist in the process, and programs to attract established verifiers from other ETS schemes.

Given it will take time to train and accredit verifiers, the initial year of reporting (2015) may be done without independent verification. b) Publication of findings from each of the three work groups. Each group will hold a separate stakeholder workshop and comments will be noted. The findings of the different groups will be integrated into one document prepared by the ETS design group, which determines the specific recommended design of the ETS. c) Draft Cap-and-trade regulation/law released. The preliminary document will set out targets, sectoral coverage, phased approach, linking, offset limits, offset eligibility, enforcement, allocation methodology, methodology for new entrants reserve, auction process, registry implementation, and compliance timelines. The government will present the regulation and listen to stakeholder comments. d) Additional work groups are convened: a. Auctions. An auction work group is convened with stakeholders, researchers, and state officials, to explore auction design, monitoring, and timeline. b. Linking and offsets The linking and offsets workgroup convenes to refine and explore designs and approaches. The linking group will weigh opportunities to partner with other ETS schemes. a) GHG Tracking with mandatory independent verification begins. GHG emission reporting (which began in 2015) will now also need to be verified by an independent auditor that is

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b)

c)

d)

e) f)

g)

2017

a)

b) c) d)

accredited by the relevant state agency. The accreditation agency should now tightly monitor verification, and revoke accreditation if impropriety is found.

Workgroups publish and present auction, offsets and linking findings.

Recommendations and comments sought for auction rules and updates/refinements to new offset eligibility rules, as well as linking with other systems.

Final Cap-and-trade regulation/law passed. The final law/regulation will reflect new information, stakeholder comments, and political developments, covering the same ground as the draft document.

Auction and registry proposals sought. Proposals are sought for an auction platform builder and operator. They also may look to hire an auction monitor, that will report results and ensure there is orderly and non-collusion between the different participants.

Auction rules finalized. The rules are finalized, and auction design, monitoring plan, budget, and timeline are determined.

Linking and offsets determination made. The decision to link will be made, in concert with the other country’s government. The offset eligibility and rules updates will be determined at this point as well.

Registry and auction operators chosen. The contracts are finalized and the operators begin to set up the infrastructure. The registry would likely be an enhancement of the existing registry used for Joint Implementation projects.

Updated final cap-and-trade regulations are published. Updates to the regulations based on new developments, stakeholder consultations, and developments on the auction, offsets, and linking components. This regulation should also specifically create a regulatory and legal framework for the market, assigning roles for the state agencies that monitor and regulate commodity markets, natural gas, electricity, and other affected sectors.

Trial Auction. A trial auction occurs, to test the infrastructure and security of the auction, as well as give auction participants an opportunity to practice.

Registry goes live: Registrants are able to access registry. A series of publications and trainings will help capped entities in joining the registry.

First auction occurs. The first live auction occurs, and a public report published shortly after the auction should disclose number of bids, size of bids, number and classification of participants, settlement price, subscription levels.

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1 Introduction This paper, commissioned by the United Nations Development Program (UNDP) and in service to Ukraine, will lay out our recommendations for the design and implementation of an emissions trading scheme (ETS). The conclusions will draw from the learned experiences from other ETSs, as well as research into the Ukrainian economic, environmental and political context.

This paper has four sections following the introduction. The first section will look at the Ukraine economy and GHG emissions overall, and then go through each economic sector assessing its readiness for inclusion to the ETS and ability to cost-efficiently reduce GHG emissions. For the sake of completeness, this report will investigate all economic sectors with significant greenhouse gas emissions. The next section will provide a review of significant cap-and-trade programs globally, highlighting the designs on the ground, key decision criteria and takeaways. The recommendations section follows with specifics on key components of the proposed ETS program for Ukraine, drawing heavily from the conclusions and data of the two previous sections. Finally, the paper will describe the process of implementing the program, with timelines and actions explained, all in reference to what has been successful in other ETSs as well.

Consequently, this paper is organized into the following sections after the introduction: 2. Emissions reduction potential, costs and readiness by sector; 3. Lessons learned from existing emissions trading schemes; 4. Recommendations for design; 5. Implementation plan.

Where it is appropriate, Thomson Reuters Point Carbon will provide specific recommendations for design and implementation, in order to make this document as useful and instructive as possible, though this also leaves it at risk of being at odds with the final decisions that are made. Aligned with the objectives of this project, the recommendations optimize reductions within Ukraine, meaning that preference will be given to domestic reduction activities and offsets. Along similar lines, this paper’s design recommendations assume that this would be a standalone program, though design features that ease linking will be given preference.

1.1 Ukraine Activity in Kyoto Markets Ukraine’s initial involvement in carbon markets began with its ratification of the Kyoto Protocol in 2004, which opened its participation in the Joint Implementation 1 (JI) markets and the creation of what is now called the State Environmental Investment Agency (SEIA) in 2007. Ukraine leads all other nations in JI registered projects, with a total of 204 registered JI projects and 495 million issued emission reduction units (ERUs) from 2008 through 2013. Ukraine created the Green Investment Scheme (GIS) in 2010 to funnel the profits to investments that would help the country grow sustainably. Through the Kyoto markets, Ukraine has also sold 47 million carbon units called assigned amount units (AAUs). See Table 3 for data on JI.

1

Joint Implementation is a flexible mechanism defined in Article 6 of the Kyoto Protocol, which allows developed country (Annex B) signatories to register emission reduction projects and carbon credits and sell them to other developed countries. In practice, it functions very similarly to the Clean Development Mechanism.

7

Table 3: Joint Implementation in Ukraine Project Type

Number of JI projects Total issued ERUs (million with issued ERUs tCO2e) Energy Efficiency Total 81 151.2 Heat/power consumption 8 14.2 District heating 13 9.2 Generation 16 29.2 Power transmission 15 28.1 Industrial/other 29 70.6 Fuel switching 3 5.9 Fugitive emissions 43 114.4 Coal 16 28.9 Oil & gas pipelines 27 85.5 Cement blending 3 1.4 Forestry/land use (LULUCF) 5 14.9 Renewable power 5 1.5 Waste 6 9.4 Other 58 196.0 Total 204 494.7 Source: Thomson Reuters Point Carbon CDM/JI database as of 15 September 2013, UNFCCC

8

2 Emission Reduction Potential, Costs and Readiness by Sector In this section we will focus on GHG emissions and ETS readiness for the overall economy as well as for each sector. Each sector will be evaluated based (a) its proportion of GHG emissions, (b) the presence of large emitters, (c) the reliance on export markets, and (d) relative cost of abatement. The conclusions drawn in this chapter will inform the paper’s design recommendations, in terms of which sectors should be capped, the amount of financial support sectors may need in the face of international export competition, and the level of abatement possible.

According to the United Nations Framework Convention on Climate Change (UNFCCC) and Thomson Reuters Point Carbon analysis, the greenhouse gas (GHG) emissions in 2010 totaled 383 million tons of carbon dioxide equivalent (Mt CO2e), excluding land management. 88% of the emissions are in the sectors outlined in this report. A variety of manufacturing sectors totaled 94 Mt, with metallurgy representing the largest sector. Electricity and district heating combine for roughly 24% of emissions (see Table 4).

Across all sectors, emissions from fossil fuel consumption made up over 75% of emissions, with industrial processes making up 12%. For electricity, district heating, transport, and manufacturing (with the exception of cement and a few other subsectors) most emissions come from fossil fuel combustion, of which CO2 is the predominant GHG. Methane emissions primarily arise from agriculture and leakage from natural gas piping infrastructure and coal mines, while the majority of N2O emissions come from agriculture and fertilizer. Overall, CO2 is the leading GHG, followed by methane and nitrous oxide. There are negligible emissions from the other greenhouse gases (see Table 5).

Table 4: 2010 GHG emissions by sector Sector Industry and electricity Electricity District heating Mining and Gas (extraction & pipelines) Manufacturing Metallurgy Fertilizers Petrochemicals Food processing Coke production Cement Residential and commercial fossil fuel consumption Agriculture Waste Handling Transport Other Total

Mt CO2e 221 65 29 33 94 70 9 2 3 5 6 40 39 10 29 45 383

Source: UNFCCC, Thomson Reuters Point Carbon Table 5: 2010 GHG emissions by gas GHG CO2 CH4 N2O HFCs PFCs SF6 Total

Mt CO2e 290 64 29 1 0 0 383

% of total 76% 17% 7% 0% 0% 0% 100%

Source: UNFCCC GHG emissions in industry, electricity, residential, agriculture, waste, and transport combined to decrease 3.2% between 2000-2010. Growth in energy-efficient industries along with technological

9

modernization contributed to a 40% reduction in the carbon intensity of Ukraine's GDP for the period 2000-2008, though the energy intensity of the Ukraine is still relatively high compared to its peers.

Emissions from the major sectors decreased drastically from 2008 to 2010 with the onset of the financial crisis, with most of the reductions taking place in the industrial and power sectors. Industrial output decreased 22% in 2009 (see Figure 1).

Figure 1: 2000-2010 dynamics of GHG emissions (excluding land use) and GDP

Source: UNFCCC, Thomson Reuters Point Carbon, World Bank For clarity into facility-level data, the reported numbers from the recent 2012 state statistical air observations provide some answers. 5,500 stationary facilities in Ukraine reported their point source CO2 emissions, totaling 198 million tons of CO2. A small number of facilities made up most of the pollution, with 333 facilities emitting 189 million tons CO2e, or close to 96% of the reported emissions in easily capped sectors (see Table 6). The 47 entities that emit more than 500,000 tons per year totaled 80% of reported emissions. These facilities were almost exclusively in the electricity, industrial/manufacturing, and heating sectors. The 47 largest facilities include 15 thermal power plants, 8 metallurgical plants, 7 combined heat and power plants, 5 chemical plants (production of ammonia and soda), 4 factories producing cement, 2 Mining facilities, 2 coke plants, one plant producing ferroalloys, one alumina plant and one refinery plant.2

2

State Statistics Service of Ukraine, “Form No.2 TP (air)�

10

Table 6: 2012 Facility-level emissions by size of project Facility-level emissions t CO2e 25,000 to 50,000 50,000 to 500,000 Greater than 500,000 Total

Number of facilities

Total emissions (Mt CO2e)

106 180 47 333

3.8 26.5 159.1 189.4

Along similar lines, the ownership structures of the emitters are concentrated in a few organizations.

Among facilities with greater than 25,000 tons CO2/year, System Capital Management (including Metinvest and DTEK) alone is responsible for 45% of CO2 emissions (see Table 7).

Table 7: Share of 2012 emissions by ownership Owner (management company)

Share of emissions from facilities greater than 25,000 t/year 45%

System Capital Management (JSC SCM, DTEK, MetInvest) State-owned enterprises PJSC “ArcelorMittal Krivoy Rog” ISD Corporation PJSC “Donbasenergio” Total

11% 7% 6% 5% 74%

2.1 Electricity Included in this sector: Electricity generation; cogeneration/combined heat and power (CHP) excluding heat component if used for separate processing or district heating purposes Ukrainian power generation assets are heavily nuclear and coal-fired, with hydro-electricity making up the balance. There is relatively little gas generation (see Table 8). Wind and solar generation are negligible, though there are a number of installations in place, supported by high feed-in tariff rates to achieve 11 per cent share of renewable energy production by 2030.

Forecasts for electricity consumption by the Ukrainian government show a close to 50% increase from 2010 through 2030, due to GDP growth and industrial. Most of the growth would be in coal and nuclear generation, though renewable power is due to grow significantly as well. At the same time, electricity conservation measures will be put in place to help mitigate some of that increase.

Ukraine is typically a net exporter of power to Eastern European countries such as Hungary, Slovakia, Romania, Poland, Moldova and Belarus among others.3

3

Interfax Ukraine, “Ukraine boosts electricity exports 39.3 percent in 2013,” 2013. http://www.kyivpost.com/content/business/ukraine-boosts-electricity-exports-393-percent-in-2013-321628.html

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Table 8: Electricity production projections in Ukraine Indicator

Units

Total Elecitrity plus imports Total Electricity Production Nuclear Hydropower Thermal (Coal) Thermal (Natural gas) Other non-renewable Non-hydro renewable Imports

TWhs TWhs TWhs TWhs TWhs TWhs TWhs TWhs TWhs

2010 (Actual) 190 188 89 12 68 0 19 0 2

Baseline Forecast 2015 2020 215 236 215 236 96 116 12 13 82 75 2 2 22 27 1 4 0 0

2025 259 259 126 14 83 2 28 7 0

2030 282 282 133 14 92 2 28 13 0

Source: Ministry of Fuel and Energy, Energy Strategy of Ukraine for the period until 2013, Draft 06.2013 Table 9: ETS-relevant sectoral factors 2010 emissions Mt CO2e Absolute % of total 65

17%

2010 emissions Mt CO2e (Large facilities*) Per cent of total Number of large (range) facilities* 90%-100% 35

Total exports 2011 (Million USD) 340

* Large facilities are those with capacities greater than 20 MWs for fossil fuel plants Sources: TRPC calculations, Enipedia, World Bank, UNFCCC, CIA World Factbook Abatement possibilities The technical condition of most power plants and power are poor. These facilities could be upgraded or closed in favor of new, more efficient units with the use of modern technologies (for example, with supercritical parameters, circulating fluidized bed boiler, and other technologies).

The energy sector in Ukraine has significant investment potential for carbon neutral sources. The potential of solar energy and wind power is confined to specific regions, but still has opportunities for growth, though biomass is the renewable energy source with the greatest potential across all regions of the country. A number of nuclear plants are set for mothballing, though new nuclear sites are still a possibility (see Table 10). Hydroelectricity has been historically strong, but opportunities for large scale growth are somewhat limited.

Table 10: Abatement options for the electricity sector under 40 EUROs t/CO2e Action

Cost/tCO2e (EUROs) -300 -300 -175 -149 -94 -48 -28 -28 1 31

Solar photovoltaic development Coal plants rehabilitate existing Coal plants upgrade existing Demand side efficiency in industry Coal plants new build Hydroelectric plants (small scale) Wind project development Nuclear power (partially complete units) Power transmissions and distribution upgrades Coal power generation biomass co-firing

Abatement in 2030 (tCO2e) 3 3 5 3 1 1 16 15 3 1

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario.

ETS Readiness The power sector is a strong candidate for inclusion into the ETS, as it is a significant contributor to GHG emissions, with many large point sources and low cost of abatement. Though there is some export of electricity, most of that originates from nuclear and hydroelectric sources, so a cap on fossil fuel generation should not hinder its competitiveness (see Table 11). 4 4

Central Intelligence Agency, World Fact Book 2011

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Table 11: ETS relevant factors for electricity Sector emits a significant amount of GHGs High

Rank (high/med/low)

Sector dominated by large point sources High

Sector exposed to international competition Low

Cost of abatement

Low

2.2 District Heating Included in this sector: District heating boilers, the heating component of CHP and industrial thermal sources.

Large-scale district heating plays a key role in heat supply, accounting for approximately 60 per cent of total end use. The majority of district heating facilities are owned by municipal authorities.

Residential and communal services consume roughly 70% of the heat from thermal energy, with many numerous facilities providing heat: combined heat & power (CHP), heating boilers, waste heat from industrial sources. The number of heating plants in the system in 2010 was 33,312.5 Table 12: District heating facilities in Ukraine Number of facilities 28,563 3,839 708 202 33,312

Capacity (Gigacalories per hour) <3 3 to 20 20 to 100 >100 Total of 35,000 GCal/hour

Source: Ministry of Fuel and Energy, ”Energy Strategy of Ukraine for the period until 2030”, Draft 06.2013 Table 13: ETS-relevant sectoral factors 2010 emissions Mt CO2e Absolute % of total 29

7%

2010 emissions Mt CO2e (Large facilities*) Per cent of total Number of large (range) facilities* 30-50% 910

Total exports 2011 (Million USD) N/A

* Large facilities defined as those with capacity greater than 20 gigacalories/hour Sources: TRPC calculations, Ministry of Fuel and Energy Abatement possibilities Recent calculations show that by 2030, annual reductions from district heating facility upgrades could yield large reductions (see Table 14). Smaller scale but still significant changes on the demand side (improving insulation for instance) in residential and commercial buildings could also yield roughly 4 Mt CO2e by 2030.

5

Ministry of Fuel and Energy, ”Energy Strategy of Ukraine for the period until 2030”, Draft 06.2013

13

Table 14: Abatement options for the district heating sector under 40 EUROs t/CO2e Action New coal combined heat and power serving district networks Coal combined heat and power, existing capacity serving district heating New coal heat only boiler serving district heating networks Non-residential buildings served by district heating networks Residential buildings served by district heating networks Gas Heat-only boiler, serving district heating networks (upgrade existing) District heating network upgrades

Cost/tCO2e (EUROs) -257 -125

Abatement in 2030 (tCO2e) 3 1

-51 0 0 3

0.4 1 3 9

20

19

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario. Residential and building improvements that are served by district heating are included in this, as demand side reductions.

ETS Readiness District heating should be strongly considered for regulating as part of the cap, as it is has a sizable contribution to overall GHG emissions, and a very low cost of abatement. There are many large point sources which will be easier to regulate, though there are also a proportion of smaller facilities that won’t be capped. It is by nature serving local customers, so it has no issues with international competitiveness (see Table 15). The fact that many facilities are owned by municipalities may pose some unique challenges however.

Table 15: ETS relevant factors for district heating

Rank (high/med/low)

Sector emits a significant amount of GHGs Medium

Sector dominated by large point sources Medium/high

Sector exposed to international competition Low

Cost of abatement

Low

2.3 Manufacturing Included in this sector: manufacturing of metallurgy, fertilizers/ammonia, petrochemicals, food processing, coke production, cement and other manufacturing enterprises.

With plentiful natural resources and a legacy of industrial support to the former Soviet Union, Ukraine has a strong manufacturing and processing base. The manufacturing sector was deeply affected by the recession, with a 24% drop in GHG emissions from 2008 to 2009, with the cement, ammonia/fertilizer, and ferrous metal industries dropping by 58%, 39%, and 19% respectively. Some growth occurred in 2010, and GDP has been rising steadily since, so these industries will see their GHG emissions growing as well (see Table 16).

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Table 16: GHG emissions for the manufacturing sector 2000-2010 Manufacturing sub-sector

Mt CO2e 2000 2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Metallurgy Fertilizers Petrochemicals Food processing Coke production Cement Total

77 10 1 5

78 10 2 5

75 10 2 5

79 11 2 5

80 11 2 5

79 12 2 5

85 12 2 6

93 11 2 5

81 11 2 4

66 7 2 3

70 9 2 3

% of total for 2010 74% 9% 2% 4%

5

5

5

5

6

5

5

6

5

5

5

6%

4 103

4 105

5 102

6 109

7 111

8 111

9 119

11 127

11 114

5 87

6 94

6% 100%

Source: UNFCCC, Thomson Reuters Point Carbon Ferrous metallurgy is the dominant industry, contributing approximately 20-25 per cent into GDP and generating approximately 30-35 per cent of Ukrainian export. Taking advantage of its immense iron ore reserves, Ukraine produced more than 33 million metric tons of crude steel, ranking it 10th in the world in 2012.6 The share of non-ferrous industry (aluminum, copper, etc) in Ukrainian economy is small, with less than 5 per cent of GDP in 2010. Currently ferrous metallurgy combines more than 200 entities, including 19 integrated steel mills and plants, 12 tube plants, 12 coke plants, 10 refractory plants, 12 mining and metals enterprises, a number of ferroalloy plants and more than 100 companies specializing in scrap and waste metals reprocessing.

Other industries such as the ammonia market support the fertilizer and nitrogen-based products, with natural gas as the input and fuel. Cement production is a large source of carbon dioxide emissions, both from energy consumption as well as the chemical process to make clinker. The refining of petroleum products occurs in six refineries and seven gas processing plants, where refinery gas and natural gas are combusted to make petroleum and other hydrocarbon products, though refinery utilization and production have been trending down and been erratic. 7 Table 17: ETS-relevant sectoral factors Sector

Metallurgy Ammonia/Fertilizers Refineries Food processing Coke production Cement Total

2010 emissions Mt CO2e Absolute

% of total

70 9 2 3 5 6 94

18% 2% 0.4% 1% 1% 1% 25%

2010 emissions Mt CO2e (Large facilities*) Absolute Number of large facilities* 80-100% 19 80-100% -80-100% 6 80-100% -80-100% -80-100% 14 --

Total exports 2011 (Million USD) 18,890 1,791 3,030 380 143 135 --

* Large facilities defined as annual GHG emissions greater than 25,000 tCO2e per year Sources: TRPC calculations, UNFCCC, State Committee of Statistics of Ukraine Abatement possibilities Apart from the cement sector, there is extremely high depreciation in equipment throughout all subsectors of the manufacturing industry. The most significant opportunities lie within the steel sector where inefficient processes can be modified. Some of the major opportunities are the replacement of open hearth furnaces, as well as implementation of continuous steel rolling, and coal dust capture and use as fuel. Recent research calculates reductions in the steel sector could reach 39 Mt CO2e annually by 2030 (see Table 18).

World Steel Assocation, ”World Steel in Figures 2013,” 2013. http://www.worldsteel.org/dms/internetDocumentList/bookshop/WSIF_2013_spreads/document/WSIF_2013_spreads.pdf 7 International Energy Agency, “Ukraine 2012,” 2012.

6

15

Table 18: Abatement options for the processing sector under 40 EUROs t/CO2e Action Oil refineries (energy management, improved process controls, etc) Lime (shell heat loss reduction, improved kiln combustion,etc) Ammonia (energy management, process improvements) Ceramics (improved drying and firing) Steel (replacement of OHF, process improvements) Cement (high clinker substitution, process improvements)

Cost/tCO2e (EUROs) -102 -65 -57 -37 -35 12

Abatement in 2030 (Mt CO2e) 2 7 4 1 39 7

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario.

ETS Readiness Manufacturing sectors (including among others iron/steel, ammonia, cement, nitric acid, adipic acid, refineries, and lime) have large point sources with easily-realizable paths to abatement as well as a large proportionate carbon footprint. Therefore, manufacturing is a strong candidate for inclusion into the ETS. Manufacturing is exposed to international markets, however, so the sector could benefit from free allocation of allowances (see Table 19).

Table 19: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs High

Sector dominated by large point sources High

Sector exposed to international competition High

Cost of abatement

Low

2.4 Transport Emissions Included in this sector: fossil fuel combustion for mobile sources in transportation (road, rail, sea) After Russia and Poland, Ukraine is the third largest passenger car market in Central and Eastern Europe. IEA estimates that demand for domestic transport fuels will grow by 2 to 2.5% per year assuming GDP grows by 4% per year during 2010 to 2020. Ukraine’s oil pipeline system is run by an affiliate of Naftogaz, called Ukrtransnafta. Gasoline and diesel fuel are the predominant fuels used in road transport.8 Railways have traditionally dominated freight transport although here as well, road transport is expanding with more trucks on the road.9 Table 20: ETS-relevant sectoral factors 2010 emissions Mt CO2e Absolute

% of total

29

8%

2010 emissions Mt CO2e (Large facilities*) Absolute Number of large facilities* N/A Small mobile sources

Total exports 2011 (Million USD) N/A

* Large facilities defined as annual GHG emissions greater than 25,000 tCO2e per year Sources: TRPC calculations Abatement possibilities The largest abatement possibilities deal with increasing fuel efficiency of the fleet, which has a large proportion of soviet-era obsolete vehicles on the road. Analysis shows that the process of upgrading the fleet of retail transportation fuels could reduce 16 Mt CO2e annually by 2030. However, International Energy Agency, “Ukraine 2012,” 2012.

UNECE, ”Policy Reforms for Energy Efficiency Investments,” 2011. http://www.unece.org/fileadmin/DAM/energy/se/pdfs/eneff/eneff_pub/EE21_FEEI_RegAnl_Final_Report.pdf 8 9

16

investments in freight and public transport would also help to clean the transportation sector (see Table 21).

Table 21: Abatement options for the transport sector under 40 EUROs t/CO2e Action Passenger Road transport (increased fuel efficiency, hybrid and electric vehicles, LPG) Freight Road transport (increased fuel efficiency, preventative maintenance) Public transport (modernised buses)

Cost/tCO2e (EUROs) -129

Abatement in 2030 (Mt CO2e) 16

21

1

31

1

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario.

ETS Readiness Transport is not traditionally well-suited for down-stream capped regulation, as the point sources of emission are small and mobile. Upstream regulation could be done through Ukrtransnafta, though that could present administrative difficulties, and the upstream entities are not able to reduce emissions (aside from biofuel blending) since the drivers are the end consumers. Transport does contribute significantly to GHG emisssions and at the consumption level is not subject to international competition since all domestic demand would be included (see Table 22).

Table 22: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs Medium

Sector dominated by large point sources Low

Sector exposed to international competition Low

Cost of abatement

Medium/low

2.5 Residential and Commercial Fossil Fuel Consumption (Excluding District Heating) Included in this sector: residential and commercial burning of fossil fuels that are not connected to district heating In 2009, over 92 per cent of the housing stock was owned privately, 6.3 per cent in communal ownership and 1.5 per cent in state ownership.10 Nearly 40 per cent of residential and commercial heating is produced through decentralised heating (separate from district heating), ranging from boilers serving individual apartment blocks or commercial buildings, to household boilers. 11 78% of households are connected to upstream distribution systems run by Naftogaz.12 Abatement possibilities Over 80 per cent of housing stock in the country was built prior to 1980; due to under-investment in maintenance and refurbishment, the stock is largely inefficient. At least 80 percent of needed refurbishments are related either to energy saving or energy distribution, and investments with simple payback terms can result in the reduction of gas consumption by 25 to 30 percent. 13 ETS Readiness Residential and commercial consumption is not a sector easily included into an ETS. Though it is a large source of emissions, there are disparate sources of emissions at each household and building.

10

Worley Parsons and Energy Community presentation, 2011. http://www.energy-community.org/pls/portal/docs/328185.PDF BNEF/NERA, “The Demand for Greenhouse Gas Emissions Reduction Investments: An Investors’ Marginal Abatement Cost Curve for Ukraine.” EBRD, 2012. http://www.ebrd.com/downloads/research/economics/publications/specials/Ukraine_MACC_report_ENG.pdf 12 International Energy Agency, “Ukraine 2012,” 2012.

13 IFC, ”Promoting Energy Efficiency in Ukraine’s Residential Housing,” 2013. http://www.ifc.org/wps/wcm/connect/region__ext_content/regions/europe+middle+east+and+north+africa/ifc+in+europe+and+c entral+asia/countries/promoting+energy+efficiency+in+ukraine+residential+housing 11

17

Like the transport sector, upstream regulation could be centralized through Naftogaz, but again Naftogaz is not well placed to institute reductions and it would be difficult logistically to administer Naftogaz’s participation (see Table 21).

Table 23: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs Medium

Sector dominated by large point sources Low

Sector exposed to international competition Low

Cost of abatement

Medium

2.6 Mining and Gas Included in this sector: coal mine fugitive gases, oil and gas extraction fugitive emissions, pipeline distribution fugitive emissions The main emissions in this sector are from leakage-related methane and CO2 from fuel combustion in extraction of fossil fuels. Coal mining emissions result from methane leakage from mine ventilation, and natural gas extraction leads to methane leakage from gas wells and volatile leakages from gas plants. There are also significant methane leakages in natural gas transportation pipelines, primarily from fitting seals. There are also gas losses due to technological gas discharging and gas combustion for gas transportation.

Table 24: ETS-relevant sectoral factors 2010 emissions Mt CO2e Absolute

% of total

33

9%

2010 emissions Mt CO2e (Large facilities*) Absolute** Number of large facilities* 20-50%** ~200**

Total exports 2011 (Million USD) 609***

* Large facilities defined as annual GHG emissions greater than 25,000 tCO2e per year ** Only concerns coal mines *** This number reflects coal exports Sources: TRPC calculations, UNFCCC, US Environmental Protection Agency Coalbed Methane Outreach Program, Ministry of Statistics Abatement possibilities Methane leakage from natural gas extraction processes will need to be minimized through reconstruction and major overhauls of the underground gas storage facilities, gas transportation infrastructure, and upgrading of gas measuring and distribution facilities. Ukraine is an important party to Europe’s natural gas pipeline infrastrusture. Roughly 80% of the 120 billion cubic meters that Russia exports to the EU-27 goes through Ukraine’s pipelines. Much of this infrastructure exhibits wear and tear, and needs upgrading.14 Fixing the numerous leaks by tightening valves and other measures along the pipeline infrastructure would reduce similarly 19 Mt CO2e. There are already 27 JI projects in this space that have actively reduced and generated 86 Mt CO2e cumulatively since 2008.15 Capture of methane from coal mines would yield 27 Mts CO2e in 2030, though it would come at the cost of 33 Euros per tCO2e (see Table 25).

14 15

Ministry of Fuel and Energy, ”Energy Strategy of Ukraine for the period until 2030”, Draft 06.2013 Point Carbon, Database of CDM and JI projects, 2013

18

Table 25: Abatement options for the mining sector under 40 EUROs t/CO2e Action Natural Gas Distribution lines (tightening valves in pipeline, etc) Coal mine methane (enhanced degasification, flaring, power production)

Cost/tCO2e (EUROs) 1 33

Abatement in 2030 (Mt CO2e) 19 27

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario.

ETS Readiness Mining and gas pose challenges for inclusion under a cap, since methane emissions are difficult to measure, and fugitive emissions sites are numerous and often in many separate areas. Though the level of GHG emissions are significant, this sector is not conducive to carbon caps given the monitoring and implementation issues (see Table 26). However, it is important to note that in terms of offset markets, there are potential opportunities, especially in coal mine methane; this is due to the fact that the calculations of reductions simply extrapolate from the amount of methane captured, which is relatively simple to measure.

Table 26: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs Medium

Sector dominated by large point sources Medium/low

Sector exposed to international competition Medium

Cost of abatement

Medium

2.7 Waste (Landfill, Water) Included in this sector: landfill gas, waste water gas The main GHG in the waste sector is methane, arising from landfilled organic waste and from wastewater. Ukraine produces between 10 and 12 million tons of municipal solid waste per year, and this is expected to grow in line with expected GDP growth until it reaches per capita levels comparable with rich countries. Most solid waste in Ukraine is put into landfills, of which only approximately 30 per cent can be said to be managed landfills. Over 6,000 official landfills exist, plus many more illegal ones. There is an urgent need to consolidate and potentially open 50-100 larger, properly managed landfill sites. Land plot allocation for landfills is a significant challenge.16 Abatement possibilities The two leading measures for GHG reductions arise from the capture of methane in landfills and waste water plants, which combined would reduce emissions by 6 Mt OO2e in 2030.

Table 27: Abatement options for the transport sector under 40 EUROs t/CO2e Action Waste water (flaring, waste treatment and anaerobic digestion) Landfill gas (composting, waste treatment, energy generation)

Cost/tCO2e (EUROs) 26 37

Abatement in 2030 (tCO2e) 2 4

Source: NERA and BNEF, “An Investors’ Marginal Abatement Cost Curve for Ukraine,” EBRD, 2012.

Notes: Negative cost denotes a positive net value for the investment. Also, costs per ton are weighted if multiple tiers of the same action. Costs and reductions are for “planned policy” scenario.

ETS Readiness Waste is not a significant source of emissions, and the landfill gas and other emissions sources are difficult to measure (see Table 28). Consequently, the sector is not well-suited to inclusion in cap-and16

IFC (2012), Municipal Solid Waste Management: Opportunities for Ukraine. http://www.ifc.org/wps/wcm/connect/31b3d8004bc75c31b99dff1be6561834/PublicationUkraineMSW2012en.pdf?MOD=AJPER ES

19

trade programs. There is a possibility for landfill gas to play a role in the offset markets, which will be discussed more in section 4.5.

Table 28: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs Low

Sector dominated by large point sources Low

Sector exposed to international competition Low

Cost of abatement

High

2.8 Agriculture, Forestry, and Land-Based Emissions Included in this sector: land use, fertilizer from crops, forestry, livestock emissions, and other agricultural and land-based emissions In 2012, nearly 71 per cent of Ukraine’s land was used for agriculture, with a further 17.6 per cent of land covered by forest. Ukraine produced 5.2 per cent of world’s barley and 2.3 per cent of the global output of wheat in 2012. The country is the world’s leading exporter of barley, with an average market share between 2000 and 2010 of 14.1 per cent. 17 In 2010, poultry, pork, and beef/veal made up 46%, 31%, and 21% of the meat production in Ukraine. 18 In terms of forestry, the majority of forest lands are concentrated in the western (Carpathians) and northern parts of the country. The state owns more than 99 percent of forests, the remainder being owned by municipalities and private companies or small private owners.

Table 29: ETS-relevant sectoral factors 2010 emissions Mt CO2e Absolute

% of total

39

10%

2010 emissions Mt CO2e (Large facilities*) Absolute Number of large facilities* N/A Many small sources

Total exports 2011 (Million USD) 14,386

* Large facilities defined as annual GHG emissions greater than 25,000 tCO2e per year Sources: TRPC calculations, UNFCCC, State Statistics Committee of Ukraine Abatement possibilities The largest source of agricultural emissions are from the fertilizer and related N2O emissions, which occur upstream at the production level (covered in the Processing section) and also from their application and later emissions at the crop level.

Abatement in the areas of livestock can also be realized, through the capture of methane from the pooling and capping of their waste, with the methane either flared or combusted for heat or electricity.

Consolidation of cattle into larger farms should help make these kinds of projects profitable. There is currently only one issued JI project in this space, but there is the possibility to increase these kinds of projects.

Forestry also provides an opportunity for abatement, though the role of the private sector may be limited in this space, as most forestland is owned by the government.

ETS Readiness Agriculture encompasses many broad sources of emissions that are rarely concentrated in one player or area, making it very difficult to regulate under an ETS, though it is a significant source of overall FAO, ”Agriculture and Trade Packground Policy Note: Ukraine,” 2013. http://www.fao.org/fileadmin/templates/est/meetings/wto_comm/Trade_Policy_Brief_Ukraine_final.pdf 18 US Dept of Agriculture Foreign Agriculture Service, “Ukraine Livestock and Products Voluntary Annual Report,” 2011. http://gain.fas.usda.gov/Recent%20GAIN%20Publications/Livestock%20and%20Products%20Voluntary%20Annual%20Report _Kiev_Ukraine_9-8-2011.pdf 17

20

emissions (see Table 30). In terms of offsets, the landfill gas methane capture projects could be brought into carbon offset markets. Forestry and fertilizer management are also well represented in offset markets, but do present some complexity as far as measurement and additionality determination are concerned.

Table 30: Conclusions on ETS relevant factors

Rank (high/med/low)

Sector emits a significant amount of GHGs Medium

Sector dominated by large point sources Low

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Sector exposed to international competition High

Cost of abatement

Medium

3 Lessons from Existing Emissions Trading Schemes This section will describe and compare (in table form) the following emissions trading scheme: EU ETS, California, RGGI, Australia19, Kazakhstan, and Alberta. Descriptions will also provide context where necessary and conclude the lessons learned from the different systems. The components of the ETSs are broken down into six sections: 1. Sectoral coverage and points of obligation; 2. Targets; 3. Allocations and auctions; 4. Monitoring reporting and verifying (MRV) rules and guidelines; 5. Offsets and flexible mechanisms; 6. Market rules and oversight.

3.1 Sectoral Coverage and Point of Obligation The central features of an ETS are its boundaries: sectoral coverage, threshold of regulation, GHGs included, and the gases involved. This determines the size of the program, and how much of the economy will face carbon constraints and regulation. See Table 31 for the breakdown.

Table 31: Sectoral coverage and point of obligation across ETS systems System

Sectors

Point of regulation and emission threshold

Gases covered

EU ETS Phase2

Electricity generation and five major industries: oil refineries, coke ovens, iron and steel, cement, glass and ceramics, and pulp and paper. The aviation sector was included in 2012 (Aviation sector postponed).

Coverage expanded to include CO2 emissions from bulk organic chemicals, ammonia and aluminium sectors, and N2O from certain processes and PFC from aluminum production.

In 2013 electric utilities (including electricity imported from other states) and large industrial facilities are covered, and in 2015 distributors of transportation, natural gas and other fuels are added to the scheme.

Installation level. Facilities with annual emissions >25 000 tCO2e/year or 35 MW for combustion installations.

CO2

Same as Phase 2

EU ETS Phase3

California

RGGI

Electric power generators

Australia

Electricity generation, mining, industrial processes, manufacturing, waste, transport and construction

# of installations ~11,000

Volume of emissions covered 40% of total EU GHG emissions

CO2, N2O and PFC

~11,500

43% of total EU GHG emissions

Installation level. Industrial sector and electricity generated in California. For residential natural gas, transport emissions, and imported electricity, the distributor is regulated.

Facilities with annual emissions >25 000 tCO2e/year.

Installation level. Facilities with capacity of 25 MW or greater

CO2, CH4, N2O, SF6, HFCs and PFCs, NF3 and other fluorinated gases

~600

Program will cover 85% Californiaâ&#x20AC;&#x2122;s GHG emissions

CO2

~168

Installation level. Facilities that emit >25,000 t CO2e/year or >10,000 t CO2e/year for certain waste facilities.

CO2, CH4, N2O and PFCs

~500

~28% of emissions in participatin g states Approximat ely 60% of Australiaâ&#x20AC;&#x2122;s GHG emissions

19

It should be noted that during the writing of this paper, Australia has reversed course and is dismantling the plans for capand-trade mechanisms. Therefore, the descriptions in this paper should be taken as illustrative of their initial plans for carbon pricing.

22

Kazakhstan

Alberta

Definitions

Six sectors covered in second trade period: agriculture, transport, oil & gas, mining & metallurgy, chemical industry, power sector.

Large industry, power plants, gas plants, oil sands mining and upgrading facilities, oil sands extraction facilities, chemical manufacturing and forest products.

Economic sectors which should deliver compliance units to compensate for their emissions

Enterprise level. Facilities with annual CO2 emissions exceeding 20,000 tCO2e

Only CO2 covered during the pilot phase.

~178 compan -ies

55% of the country’s GHG emissions

Installation level. Facilities that emit more than 100,000 tons CO2e/year

CO2, CH4, N2O, HFC, PFC, SF6.

~100

Approximat ely 45% of Alberta’s GHG emissions

Point of regulation: determines which entity is responsible for the delivery of compliance units: if the fossil fuel producer (energy producers and fuel suppliers), or at the point of combustion (fuel distributors and final consumers).

Emissions threshold: minimum volume of emissions per year to be included in market

Gases covered by the market.

Number of emitting units/ installati ons.

Percentage of emissions covered by the market

Source: Thomson Reuters Point Carbon Deciding factors.

The decision for coverage and point of regulation depends on a number of factors including:  Commitment to GHG reductions. A larger program will create a wider incentive for reductions across multiple sectors.  Relative GHG reduction cost. The sectors with lowest per ton abatement costs are the most attractive to cap, especially in the earlier stages of a market.  Implementation costs. Emissions trading schemes should endeavor to not overly burden smaller entities, whose emissions are a small percentage of the overall picture. Larger entities have the economies of scale and regulatory apparatus to handle this additional administrative burden. This factor is naturally balanced against the imperative to cap as much emissions as possible.  Leakage. Defined as the movement of emitters from a capped regime to a non-capped regime, this is an issue for sectors that have exposure to international markets, such as export-oriented industries. If a sector would incur incremental carbon costs versus its international competitors, this could weigh into its inclusion into the system.

Takeaways.

There are a few patterns from which to draw conclusions:  Sectors. Sectoral coverage typically involves the power and industrial sectors, as they have relatively few installations compared to their share of emissions. Power has the added benefit of having very little risk of leakage. Transport and non-industrial natural gas combustion present more difficulties, though California, Kazakhstan, and Australia do cover the transport sector. Since the emissions for these sectors are disparate, they are typically regulated upstream at the distribution level, though this separates the point of regulation from the point of combustion. Agriculture, waste, and other sectors tend pollute from smaller, non-distinct sources, and are therefore more difficult to regulate.  Point of regulation. Installation-level is optimal, given the difficulty with tracking the specific emissions of a firm as a whole.  Threshold of regulation. There are multiple approaches, though they center roughly around 25,000 tCO2e per year.  GHGs included. The most common are CO2, N2O, and CH4. The gases covered ultimately should be a function of their relative presence as part of the potential capped inventory, as well as the ability to monitor them.

23

3.2 Targets When designing an ETS, the target is likely to be the most controversial—as well as perhaps the most crucial—element for the ultimate success of the program. The target sets the emissions reduction goal versus a baseline, and it determines the scarcity that drives reductions and provides the supply side of the equation when it comes to carbon price formation. Table 32 and Table 33 respectively highlight the different targets across the schemes, as well as the current market conditions and fundamentals.

Table 32: Targeting across ETS systems System

Cap

EU ETS Phase2* EU ETS Phase3**

Average cap 2,086 MtCO2e

California

Average cap is 2,039 MtCO2e in 2013.

Cap declines by 1.74% per year. 2020 target is 21% cut on 2005 emissions.

2013 cap is about 2% below forecast emissions for 2012. Cap declines by 2% in 2014 and about 3% annually from 2015 to 2020.

RGGI***

Initial cap: 10% below 2009 cap level by 2018 New cap (after 2012 review): 91 Mt in 2014 declining 2.5% per year to 78 Mt in 2020.

Australia

No cap for the fixed priced period (July 2012 – June 2015)2015 onwards: cap set by the Government or default cap from the legislation.

Absolute cap for 2013 (pilot phase), which should not exceed the total volume of emissions in 2010. No reduction target has yet been set or approved for the second trade period of the ETS.

Kazakhstan

Alberta

Intensity target per unit of output 12% lower than the 2003-2005 baseline. Sum of caps is about 116 million tCO2/year.

Definitions

Maximum volume of emissions in a certain period

Start Year and trading periods 2008-2012

Absolute/ Intensity

2013-2020

Absolute

Started in 1st Jan 2013.

1s compliance period: 2013-2014 2nd compliance period: 2015-2018 3rd compliance period: 2018-2020 Started in 1st Jan 2009.

1s compliance period: 2009-2011 2nd compliance period: 2012-2014 3rd compliance period: 2015-2020 Fixed price period: July 2012 – June 2015 Cap and trade period: July 2015-June 2020 Pilot phase in 2013, second phase tbd (either 2014-2020, or 2014-2015) with a Phase III that spans 2016-2020.

Started in July 2007.The program is not divided in trading periods.

Program start date and compliance period duration

Absolute

Absolute

Absolute

Absolute (for the fixed price period)

Absolute

Intensity cap

Absolute cap: a total quantity of GHG emissions over a set period of time.

Intensity cap: a maximum quantity of GHG emissions per unit X (GDP, per product, etc)

*EU ETS Phase2: Covers 27 member states + Norway, Iceland and Liechtenstein ** EU ETS Phase3: Covers the 30 countries of Phase II plus Croatia ***Nine states are part of RGGI: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont.

Source: Thomson Reuters Point Carbon Deciding factors.

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In deciding the proper target, the policy-maker should understand the priorities within the administration, and also the GHG trajectory and costs of the economy.  Commitment to GHG reductions. A deeper cut will drive more GHG reductions, and communicate to the domestic and international markets a commitment to climate action.

Reduction decisions should be based on sound projections of GHG emissions in multiple scenarios.  Costs. A deeper target and a higher price will exact more costs on business. This and environmental aspects need to be weighed in tandem. Cost calculations should be based on sound research on reduction costs, ideally on a recently published Marginal Abatement Cost Curve (MACC), such as that which will be delivered to Ukraine as part of the modeling stream of this UNDP project.  Target flexibility. The targeting mechanism can be absolute or flexible. The former provides certainty on reductions and creates stability in the program. However, the latter can help insulate the targets from external factors such as economic collapse or growth, though it does not provide the certainty that participants may crave.

Takeaways.

Every major, mature ETS system is in a current state of oversupply, including California (see Table 33 for current market conditions,) so the predominant takeaway is that targets should be more stringent, as well as more flexible to deal with external shocks.  Target stringency and related oversupply. The oversupply owes to a number of factors, most significantly the economic difficulties in the past five years, in addition to fluctuations in weather and fuel prices. Reduction targets may not have been set as aggressively given that the costs of reduction are often overstated since they underweight the influence of unforeseen innovation.20  Targets types. The targets are all set against a baseline, which have varied between multiyear baselines or single year baselines. Multi-year baselines typically are the average of 2-3 years, which helps smooth away any outliers in any one year. All programs use absolute targets, with the exception of Alberta. Interestingly, the only system not in oversupply at the moment is Alberta, which may have benefited from the insulating effects of intensity-based targets.  Progressiveness of phases. Most systems employ “phases” that allow changes in scope, target, and rules at regimented intervals. It is best practices to include multiple phases, especially earlier in the program, to allow for adjustments to the program and changes in scope.

Table 33: Current market conditions across ETS systems System EU ETS Phase2 EU ETS Phase3 California

RGGI

Australia

Kazakhstan

Price of allowances and comment Highly volatile: starting in Eur 20/ton in 2008 prices went down to Eur 7/ton in 2012 due to the economic downturn in Europe.

Prices started at Eur 5/ton in 2013 and are expected to reach Eur 7/ ton by 2020.

Auction clearing price ranges from US$ 10-14/ton, near the price floor. Recent TRPC forecast pegs the market as oversupplied until phase 3.

Auction clearing prices are close to reserve prices, or US$ 1,80 – 2,00/ton. The reserve price is the same as the price floor. The market is oversupplied.

The carbon price started at $23.00/t in 2012-13 and will increase 2.5% per year to $24.15 in 2013-14 and $25.40 in 2014-15.

Price formation is still developing.

20

Volumes 7.5 Gt CO2e negotiated in 2012

Will be reported at end of 2013.

23 million CCAs sold in 4 auctions until Set/2013 Almost 500 million allowances were traded in 2012 No trading activity

No trading activity

Taylor, Margaret. “Innovation under cap-and-trade programs,” University of California Berkeley. 2012. http://www.pnas.org/content/early/2012/03/08/1113462109.full.pdf

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Alberta

The market price has hit the ceiling price of C$15 for every ton, which is the price for alternative payment, based on tight fundamentals.

For 2007-2011, Alberta’s carbon pricing system had achieved 32.3 million tons of reductions in CO2e.

Definitions

Price of the compliance units

Volumes negotiated

Source: Thomson Reuters Point Carbon

3.3 Allocations and Auctions Allocation is the process where regulated companies receive allowances free of charge from the regulator, generally following a methodology based on their historical emissions or their historical production—known as grandfathering or benchmarking respectively. Auctions present an alternative way to distribute allowances, by selling the allowances in organized auctions. The balance between auctioning and allocating is a central question, since auctioning drives price discovery, liquidity, incentives for carbon reduction, and government revenue, though at a potentially higher cost to industry and the end consumer. See Table 34 and Table 35 for different approaches in different systems for allocation and auctioning.

Table 34: Allocation methodology across ETS systems Syste m EU ETS Phase 2

Auction/allocation balance

Methodology for allocation

Grandfathering for industrial sectors and benchmarks for the power sector.

EU ETS Phase 3

Benchmarks set at product level for industrial sectors, with trade-exposed sectors receiving extra allowances. No allocation for the power sector (with few exceptions in Eastern Europe*) Grandfathering for the industrial facilities at a sectoral level, but based on benchmark at the facility level. For the power sector, each utility’s free allocation will be a percentage of the total electricity sector allocation

Grandfathering: allocation based on historical emissions Benchmarking: based on performance benchmarks by fuel for the best available technology, assuming standardized load factors.

Product benchmark that reflects the GHG performance of the top 10% performing companies. Facilities’ allocation is calculated based on the median historic production of 2005-2008, or 2009-2010 (whichever is higher) multiplied by the applicable benchmark Free allowances for each industrial sector equal to about 90% of average emissions, based on a benchmark that rewards efficient facilities. Distribution updated annually based on production and efficiency.

Value of free allowances to electric utilities to benefit customers. Free allocation will be phased out over time.

Individual states decide the volume of allowances to be auctioned and freely distributed. Overall, most of the allowances are sold.

The level of free allocation will be dependent upon the level of emissions-intensive trade-exposed industries (EITE) that apply for assistance through free allocation. The exact amount that will be auctioned is not a fixed percentage, but determined by the Regulator once free units are allocated Allocation volume based on historical data, at 100% of 2010 level of emissions Emissions cap for the year is a free allocation (12% cut on 2003-2005 emissions per unit of output, multiplied by actual output for the year)**.

Allowance allocation formula

California

RGGI

About 90% of allowances auctioned

Australia

Free allocation to trade exposed energy intensive industries. The rest is auctioned.

Kazak h-stan Alberta

Free allowances during the pilot phase.

Auctioning is being discussed for phase 2.

Free allocation

Definitions

Grandfathering: allowances are granted based on historical emissions.

Benchmark: allowances are granted based on companies’ performance compared to specific benchmark *Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Lithuania, Poland and Romania have made use of a derogation which allows them to give a decreasing number of free allowances to existing power plants for a transitional period until 2019. **Companies can chose between 4 compliance options: 1) Reduce emissions internally; 2) Pay a fee of C$15 for each ton above the target to the Climate Change and Emissions Management Fund (CCEMC); 3) Buy

26

emissions offsets generated from non-covered facilities in Alberta; 4) Buy Emissions Performance Credits (EPCs) from covered facilities that have reduced their emissions intensity below their target.

Source: Thomson Reuters Point Carbon Table 35: Auction methodologies across ETS systems Syste m EU ETS Phase 2 EU ETS Phase 3 California

Auction type

Frequency

Auction rules

Single round, sealed bid format, uniform price*

Monthly, with exception of Germany, which conducted weekly auctions Weekly auctions at EEX and fortnightly auctions at ICE

All successful bids are allocated at the auction clearing price

Single round, sealed bid format, uniform price*

Quarterly auctions

RGGI

Single round, sealed bid format, uniform price* TBD

Quarterly auctions

Winning bidders will all purchase allowances at either the lowest price at which the entire supply of allowances is exhausted (the settlement price), or the reserve price, whichever is reached first. Auction purchase limits prevent any covered entity from purchasing more than 15% of the allowances sold at any auction, while non-covered entities are not allowed to purchase more than 4% of an auction’s allowances.

Purchase limit of no more than 25% of the allowances offered at a single auction

No auction at this stage No auctions

N/A

The auction schedule will allow purchase of 1/8 of the total vintage allocation in the two years prior to that vintage, 4/8 are made available during the vintage year, and 1/8 are available in the year following the vintage.

N/A

N/A

N/A

Australia

Kazak h-stan Alberta

Same as Phase 2

The proposal is that the first auction will take place in 20132014 financial year

All successful bids are allocated at the auction clearing price

DefinRules for placing Frequency of the Auction rules and regulations itions bids at the auction auctions * Singe round, sealed bid, uniform price: Single round means that bids are submitted during one given bidding window. Sealed bids are submitted without seeing other participant’s bids. Uniform price means that all successful bidders will pay the same auction clearing price. Prices increase as in an English auction.

Source: Thomson Reuters Point Carbon

Deciding factors.

The methods for distributing and selling allowances are an important component of the program.  Costs of reduction. Marginal abatement cost curve analysis should yield an understanding of the costs associated with the target. If some sectors face high relative upfront investment costs for compliance, there is an argument for greater share of allocation. Similarly, the companies able to profitably reduce should require a smaller share of free allowances.  Exposure to international competition. Companies in energy-intensive industries competing in the international market could face a handicap given they have to pay a domestic carbon price. Free allocation can reduce the costs, and mitigate the impact on their international competitiveness, as well as reduce the chance that the company leaves the market. Therefore, companies subject to leakage can arguably push for more free allocation.  Economic efficiency. A number of studies have pointed to the efficiency of the “polluter pays” principle, whereby requiring emitters to pay for allowances ensures there is a proper economic incentive for reduction.21 Free allocation does not cost anything, and therefore does

Ramseur, Jonathan. “Emission Allowance Allocation in a Cap-and-Trade Program: Options and Considerations,” Congressional Research Service, 2008 21

27



not provide as much incentive. However, this needs to be balanced by the political and social costs associated with saddling emitters with more expenses.

Allocation methodology. Grandfathering benefits from simplicity, since emitters are simply given 100% or a fraction of their previous emissions. Benchmarking, which has gained momentum due to recent changes to the EU ETS Phase 3, however allocates based on a production benchmark, which does not penalize firms for already being efficient.

Benchmarking also provides additional motive for energy inefficient plants to upgrade, since they would receive the same number of allowances as a comparably productive but more efficient plant.

Takeaways.

The path followed by most programs now begins with an early emphasis on allocation, gradually shifting to mostly auctioning as a program matures.  Allocation versus auctioning. In early phases, allocation should be considered for sectors that either have a difficult task in reducing emissions, and also trade-exposed industries. In practice, this means that industry (metallurgy, cement, refineries) would receive the most from allocation. The sectors that are not trade exposed, such as power and heating, would receive comparatively less.  Allocation methodology. Based on the experience in EU ETS Phase 1 and the success of benchmarking in subsequent programs, it is best practices to use benchmarking as the allocation methodology. The carbon intensity per unit of product can be decided either by using a “best in class” efficiency, such as in EU ETS Phase 3, or an intensity reflective of the average of the sector. California puts a slight spin on the benchmarking process, by grandfathering allowances for a whole sector, but then allocating by benchmark at the facility level.  Auction type and process. In all systems, the single round, sealed bid, uniform price methodology has been predominant and effective.

3.4 MRV Rules and guidelines Monitoring, reporting and verification (MRV) incorporates all aspects associated with tracking and submitting GHG emissions data and other indicators. Companies “true-up” by reporting their emissions to the regulator at the end of a compliance period, in parallel with the submission of the required allowances or other credits. Even before the ETS system commences, programs typically require GHG tracking, to ensure data about reductions is known beforehand.

The regulator also indicates the methodologies for calculating GHG emissions, the accreditation process for the verifiers who put their stamp of approval on the data reported, and the timeline for submitting the data. As part of this process, registries are set up to hold the allowance accounts.

Table 36: MRV rules across ETS systems Syste m EU ETS Phase 2

True up timeline

GHG reporting deadline

Definition of trading units

Compliance year is the calendar year. True up deadline is following 30 April.

Reporting deadline is 31 March of following year.

EU ETS Phase 3

Same as Phase 2

Same as Phase 2

EU allowance (EUA) which is Kyoto consistent. The EU Allowance (EUA) is to be defined as a financial instrument and covered by financial market regulation EU allowance (EUA) which is Kyoto consistent.

http://nepinstitute.org/get/CRS_Reports/CRS_Climate_and_Environment/Other_Greenhouse_Gas_Emissions/Emission_Allocat ion_Allowance.pdf

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California

Participants must provide allowances and offsets for 30% of previous year’s emissions annually and provide the balance at the end of the compliance period. Annual true up is in November of the following year.

March 31 following the end of a compliance period

Participants must continue to report emissions annually and have them verified by an independent third party. Trading program emitters must register with the California Air Resources Board.

California Carbon Allowances (CCAs) 1 CCA = 1 metric ton of carbon dioxide equivalent (tCO2e).

Emitters are required to report quarterly CO2 emissions to RGGI states through the US Environmental Protection Agency's (EPA’s) Clean Air Markets Division Business System

RGGI allowance (RGA) 1 RGA = 1 short ton CO2

During the fixed price period, 75% of emissions obligations must be surrendered by June 15 of the relevant compliance year. For the fixed price period, compliance deadline is following 1 February.

TBD

Companies must report emissions annually

Australian Carbon Credit Unit (ACCU) which is Kyoto consistent.

From 2014, the reporting deadline will be 1th April.

Alberta

Facilities must comply by 31 March for previous year's emissions.

The reporting deadline and compliance deadline are the same: 31 March of the following year

Currently called “allowance units”, which is equal to 1 tCO2e Emission Performance Credit (EPC)

Definitions

Deadline for entities to submit compliance units to compensate for their emissions

Deadline for entities to submit GHG inventories

RGGI

Australia

Kazak h-stan

Tradable unit within the market

Source: Thomson Reuters Point Carbon Deciding factors.

MRV process is more about implementation than design, though there are still several factors to consider.  MRV readiness. The timing of the commencement of the program and the earliest reporting timeframe will be determined by MRV readiness. For many systems, the reporting infrastructure may already be available (including registries), and it is a matter of improving or updating. For other systems, a whole new process would need to be implemented, which can take 1-2 years.  True-up timeframe. In the EU ETS, true-up and reporting occurs near the beginning of 2Q while California allows for true up later in the year. A later deadline gives companies more time to report and eases the burden, but also extends the program to later in the year, and delays data transparency of the program. Along similar lines, the California system pushes most of the allowance submission to the end of the phases rather than annually, allowing companies to delay their submission until later. The EU ETS in contract requires full annual true-up.

Takeaways.

The MRV systems have in most cases performed well, though there are still lessons to be learned.  Timing of facility-level emissions and performance data. The oversupply of EU ETS Phase 1 has taught policymakers that understanding facility emissions is paramount to setting appropriate targets. Therefore, early tracking is now best practices, and the reporting for multiple years allows for outliers in any specific year to be smoothed out. Tracking performance data also allows for benchmarked allocation methodologies.

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

MRV procedures have been followed. The EU ETS and RGGI have enjoyed near universal compliance by the capped entities. Policy-makers can therefore look to the EU ETS as the positive examples.

For more information on MRV implementation and timeline, please see Section 5 on the implementation plan.

3.5 Offsets and Flexible Mechanisms In ETSs, regulated entities can submit carbon offsets in place of allowances, up to certain limits.

Offsets are certified reductions arising from projects or sectors that decrease GHG emissions beyond business as usual, denominated in metric tons of CO2e. The reductions that would not have happened absent the project are described by the term, “additional.” The reductions occur in sectors and geographies not covered by the cap, and create a low cost additional supply of complianceequivalent securities to reduce the overall cost of complying with the program without (theoretically) threatening the environmental integrity of the target. To set up a standalone program, eligibility requirements around vintage, standards, verification, project types, and geographies need to be determined.22 23 Table 37: Offset limits and linking across ETS systems Syste m EU ETS Phase 2 EU ETS Phase 3

Limit

California

Offsets can be used for up to 8% of a facility's compliance obligation.

However, the use of international sector-based offsets is limited to 2% of a firm’s total compliance obligation in the first compliance period and 4% of a firm’s total compliance obligation in the second and third compliance periods Offsets are allowed to be used for 3.3% of a company's obligation.

This rises to 5% when price reaches $7/ton CO2 and to 10% when price reaches USD10/ton CO2.

Domestic credits limitation: 5% of companies’ compliance obligation during the fixed price period. Unlimited use during the flexible price period International credits limitation: No use for compliance liability during the fixed price period. Flexible price period: international credits can be used up to 50% of an entity's compliance obligation, being 12.5% CERs/ERUs.

RGGI

Australia

Linking prospects

CERs and ERUs up to 50% of reduction effort for 2008-2020; total probably 1,700-1,900 CERs/ERUs

On 10th July 2013, the EC proposed the use international credits during the 2008-2020 period up to the higher of two limits: 1) The international credit entitlement specified in the national allocation plan for the phase 2; or 2) 11% of the free allocation of EU allowances granted to them in that period. The proposal is under scrutiny of the European Parliament and Council. If no objection is raised in 3 months, the Commission will adopt and publish the Regulation.

22

Link with Australia pending commencement of ETS. Link with Switzerland being negotiated. EU has expressed a willingness to discuss links with other existing and proposed schemes.

California is part of the Western Climate Initiative (WCI) and it is linking with Quebec.

Discussing link with WCI

Hope to link with EU ETS from 2015. Discussions to link with New Zealand.

Vintage represents the year that the reduction happened. A credit with a 2012 vintage was certified for reductions that took place in 2012. A standard is a set of GHG reduction calculation methodologies, requirements for verification and accreditation, and infrastructure to create carbon offset securities. Project type is a generic term for the category of reduction. Examples of project types include forestry, landfill gas capture, and livestock methane capture.

23 To learn more about compliance-oriented offset standards such as Clean Development Mechanism (CDM) and California Air Resources Board (CARB), as well as voluntary programs like Verified Carbon Standard (VCS), Climate Action Reserve (CAR), American Carbon Registry (ACR), Climate Community & Biodiversity Alliance (CCBA), and Plan Vivo (among others), please consult the following reports from Point Carbon, Ecosystem Marketplace, and SEI: http://www.pointcarbon.com/research/promo/research/1.2236309?&ref=searchlist, http://www.forest-trends.org/vcm2013.php, http://sei-us.org/Publications_PDF/SEI-WWF-ComparisonCarbonOffset-08.pdf

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Kazak h-stan

Alberta

Definitions

Government decree allows for domestic offset projects within Kazakhstan, and specifies a priority list of offset projects types that can be implemented. Offset projects outside priority list possible on a case by case basis. Currently no limits on the amount of carbon units from domestic offset which can be used by an operator.

Unlimited use of Alberta offsets.

Maximum volume of offsets which can be used for compliance

Hoping to link with EU ETS, and potentially other schemes

Exploring linking with the province of Saskatchewan Prospects of linking with other markets through of the use of offsets.

Source: Thomson Reuters Point Carbon Table 38: Offset eligibility across ETS systems Syste m EU ETS Phase 2

Eligible standards

Eligible project types

Geographic eligibility

CDM and JI only

No geographic restriction

EU ETS Phase 3

CDM and JI only

California

Early action credits and ARB approved Compliance Offset Protocols. Possibly, international REDD credits could enter the market.

RGGI

RGGI has put in place its own offset protocols and registry for projects based within RGGI jurisdictions, unless an MOU is signed with another state.

Australia

Domestic offsets: Carbon Farming Initiative (CFI) International credits: CERs/ERUs (and in future potential other international credit types)

No CERs/ERUs from hydro projects >20 MW that have not met World Commission on Dams guidelines, HFC-23 reduction projects, projects that reduce N20 from adipic acid production, nuclear energy projects, or tCERs or lCERs from afforestation and reforestation projects.

Same project type restrictions as phase 2 and only credits from projects registered after 2012 are eligible, with exception of projects in least developing countries (LDCs).

Destruction of ozone depleting substances (ODS), Urban forestry, U.S. forestry, Destruction of methane from livestock manure systems.

Landfill methane capture and destruction, reductions in sulfur hexafluoride (SF6), afforestation, boiler efficiency in building sectors, and avoided methane in manure management.

CFI: credits from projects in agriculture and land-use management.International credits: No credits from hydroelectricity projects above 20 MW that have not satisfied World Commission on Dams guidelines, HFC-23 reduction projects, projects reducing N20 from adipic acid production, nuclear energy projects, or temporary as well as long-term CERs from afforestation and reforestation projects (tCERs or lCERs).

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If the project was registered after 2012, only credits from LDCs are accepted.

US generated credits.

Possibly, international credits could enter the market later*

Access to offsets from outside the region allowed only when prices $7 ton CO2 and international offsets allowed if price reaches $10/ ton CO2.

No restrictions on country of origin

Kazak h-stan

Legal framework for future inclusion of international offset programmes exists, but dependent on outcome of climate negotiations

Priority list of offsets: Mining and metallurgy (utilization of mine methane); agriculture; housing and communal services; forestry; prevention of land degradation; renewables; processing of municipal and industrial waste; transport; and energy-efficient construction.

Focus initially is on domestic market.

Alberta

Alberta approved protocols only.

Alberta has over 12 offset protocols including for reduced tilling (most common), wind, enhanced oil recovery, energy efficiency, and hydroelectricity.

Types of projects accepted

Alberta offsets only

DefinOffsets protocols/ standards Geographic restrictions on itions accepted the origin of the offsets *California signed a Memorandum of Understanding (MoU) with Acre (Brazil) and Chiapas (Mexico) to study the possibility of accepting REDD credits from these jurisdictions. Agreement on the eligible standards is yet to be reached.

Source: Thomson Reuters Point Carbon Deciding factors.

Carbon offsets can be viewed either as an innovative way to reduce costs while expand reductions beyond the capped sectors, or alternatively an administratively complex mechanism with questionable environmental attributes. The decision if and how to include them, is therefore far from straightforward.  Openness to flexible mechanisms. The decision to include offsets depends firstly on the qualitative viewpoints of environmental groups, economists and policy-makers. Looking at past history and opportunities domestically, the decision should be made if they should be included, and what limits should be placed on them.  Partnerships with other programs. Any partnerships or linking with other programs could include offsets, either indirectly through the other ETS program (where excess allowances can be sold into the Ukrainian ETS) or partnering directly with other geographies that produce offsets specifically for that ETS.  Eligibility of project types and standards. The environmental attributes, locations, project types, and prices of existing offsets should be weighed in terms of ease of monitoring the reductions, emission reduction capability, and economic/environmental strategy of the policy makers.

Takeaways.

There have been numerous lessons learned from CDM and other offset compliance markets. Here are a few of the most pertinent for Ukraine.  CDM Offsets are a source of controversy. A number of reports have looked critically at the environmental integrity of CDM markets.24 Others have criticized it for its inability to scale and administratively succeed.25 However, CDM has been praised in other publications for its ability to incentivize significant reductions and help create a global carbon price.26  Offsets need to evolve. The next generation of offsets will likely be larger scale, and begin to move farther away from the specific project paradigms, which suffer from a lack of scalability and reliable additionality assessments. In California, offsets have also created across the board eligibility standards that meet the additionality requirements, without going through the specific additionality of that individual project.

US GAO, ”International Climate Change Programs: Lesssons Learned from the EU ETS and CDM,” 2008. http://www.gao.gov/products/GAO-09-151 25 SEI, CEPS, and CO2logic, ” ”Study on the Integrity of the Clean Development Mechanism,” 2011. http://ec.europa.eu/clima/policies/ets/linking/docs/final_report_en.pdf 26 Gillenwater, Michael and Seres, Stephen, ”The Clean Development Mechanism: A Review of the First International Offset Program,” C2ES, 2011. http://www.c2es.org/docUploads/clean-development-mechanism-review-of-first-international-offsetprogram.pdf 24

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3.6 Market Rules and Oversight The rules and regulators of emissions trading schemes safeguard the program from negligence and market manipulation, while promoting price stability and liquidity.

Floors and ceilings help to keep prices from rising or falling above or below agreed upon levels. A price ceiling can be “hard,” meaning that the regulator creates new allowances and releases them into the market, or a “soft” ceiling, where a set aside of allowances can be sold at certain price triggers.

A price floor is usually incorporated into auctions, which has the effect of creating a price floor for the whole market. Penalties (also known as alternative compliance payments) can also act as a price ceiling when set low enough, since regulated entities would rather pay the penalty than buy a more expensive allowance.

Another set of allowance mechanisms includes banking and borrowing, which help to even out the supply and demand curve, so that year to year variations of emissions versus the cap do not lead to large price swings. Banking allows the transfer of unused allowances or credits from the past or current compliance period to a future period. Borrowing makes available allowances designated for future compliance periods for the current year’s obligations, usually with an interest rate applied, and requirement to replace it in the following periods.

The regulators that oversee the program ensure implementation and enforcement of the rules. The regulators also coordinate the operation of the auctions and registries, and manage (often with other state agencies) the financial and legal implications of environmental commodity trading.

Table 39: Market rules across ETS systems Syste m EU ETS Phase 2 EU ETS Phase 3

California

RGGI

Australia

Price floor/ ceilings

Set asides

Banking/ borrowing

Penalty

No price management mechanisms

No set aside

Penalty of €100/ton plus 1 EUA.

No price management mechanisms at this stage.

However, the EU is considering the introduction of a price management reserve as part of a structural reform of the EU ETS. Price floor starting at USD$10 for 2012 auctions.

The price floor will rise annually by 5% plus the rate of inflation.

No hard price ceiling, but the Allowance Price Containment Reserve (APCR) will work as a soft ceiling

EC proposes to postpone (backloading) the auction of 900 M allowances from years 2013-2015 to 2019-2020.

Price Containment Reserve (PCR) collects a portion of allowances from auction and releases them if trigger prices are reached

Unlimited banking. No borrowing between phases, but unlimited borrowing within-phase.

Same as Phase 2

Unlimited banking. No borrowing, but 3 year compliance period.

Four allowances must be provided for every ton of emissions that was not covered in time

Reserve price started at $1.86 in 2009, increasing to $1.98 in 2013 A price ceiling and price floor will apply for the first 3 years.

No set aside

No set aside

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Unlimited banking.

Borrowing not allowed.

Unlimited banking from July 2015. Borrowing from the next compliance year for up to 5% of emissions

Penalty of €100/ton (adjusted by Eurozone inflation rate) plus 1 EUA.

Varies by state.

Penalty will be 2 times the benchmark average price of carbon units during the compliance year.

Kazak h-stan

Not currently planned

Not currently planned

2013 allowances cannot be transferred to following periods. Borrowing allowed between pilot and second phase. Banking to be allowed during second trade period Unlimited banking. No borrowing.

Alberta

No price management mechanisms, but the fee of C$15/t CO acts as price ceiling.

No set aside

Definitions

Maximum and minimum allowance price

“Reserve” of a certain number of allowances to be released in the market under certain conditions

Banking: transfer of allowances or credits from one compliance period to the next. Borrowing: the use allowances designated for a future compliance period to meet current compliance obligations

10 MCI/ tCO2 (Monthly Calculation Index, currently equivalent to approx. USD 110)..

Fine $200 per tonne of CO2e over the emissions intensity limit.

Penalty for noncompliance

Source: Thomson Reuters Point Carbon Table 40: Market oversight across ETS systems Syste m EU ETS Phase 2 EU ETS Phase 3

Primary regulator European Commission (EC)

Market Oversight

Registry operator

Auction operator

No independent institution, but the EC has a monitoring role

Member countries governments

European Commission (EC)

European Commission (EC)

California

California Air Resources Board (CARB)

RGGI

RGGI states

EC is studying the introduction of energy markets legislation to ensure better market regulation CARB works with California Independent System Operator (CAISO), the Commodity Futures Trading Commission (CFTC), and the Federal Energy Regulatory Commission (FERC).

Potomac Economics, independent market monitor

European Energy Exchange (EEX) for Germany, Netherlands and Lithuania EEX for 24 member states and Germany, ICE for UK

Australia

Clean Energy Regulator

Kazak h-stan

Ministry of Environmental Protection (MEP) Alberta Environment is the regulator

Alberta

Gov’t and Parliament retain oversight of regulation TBD

Alberta Environment

CARB operates its online registry: Compliance Instrument Tracking System Service (CITSS)

Markit North America (Auction Administrator) and Deutsche Bank National Trust Company (Financial Services Administrator)

RGGI CO2 Allowance Tracking System (COATS) is operated by RGGI Inc., a non-profit providing technical and administrative services TBD

RGGI Inc. coordinates central auctions of behalf of RGGI states

TBD

No auction

Alberta’s Environment and Sustainable Resource Development receives the compliance data e reports the program results

No auction

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TBD

Definitions

Entity responsible for market regulation

Independent entity to ensure there is no market manipulation

Collects and tracks emissions and compliance units

Conducts allowances auctions

Source: Thomson Reuters Point Carbon Deciding factors.

In the process of setting market rules, regulators should set a range for carbon prices that stakeholders are comfortable with, to inform if and where to set price floors and ceilings. In the case of high prices, they should also assess the importance of maintaining the environmental integrity of the program.  Commitment to environmental integrity. Price ceiling mechanisms that generate and release extra incremental allowances, or set an alternative compliance payment, have the effect of allowing more emissions than the target mandates. Soft price ceilings that release allowances from set aside pools (taken out of the allowance pool) keep emissions within the cap while providing relief, though soft price ceilings cannot guarantee the price ceiling.

Takeaways.  Banking is best practices. Banking allows the market to take a longer approach to the fundamentals of the market, and therefore reduces volatility.  To ensure compliance to the target, penalties should be indexed to the carbon price. A penalty that is indexed to a multiple of the carbon price ensures compliance regardless of where the market moves.



Price floors are best implemented through auctions. A price floor at the auctions de facto enforces a price floor for the market, since the auction will be undersubscribed as a result, and the unsold allowances will be taken out of the supply. This rebalances the supply and demand until it meets the floor price. In the RGGI market for instance, exchange traded market price did not drop below the auction floor despite a massive oversupply of allowances.

4 Recommendations for ETS Design This report will lay out its design options and recommendations for a Ukrainian ETS. This report has described the Ukrainian economic and environmental perspective by sector, as well as the lessons learned from the other ETS programs. This report will now bring those together into a comprehensive set of recommendations. For many decision points, there will be a table listing five criteria for that decision, with a rating between “positive”, “neutral”, or “negative”, with a positive rating meaning that this option favors well on this criteria, when evaluating whether it should be recommended. If the criteria is not applicable to that option, it will receive a “N/A”. The six criteria are:  Economic cost. A positive rating denotes that this design element does not require participants to incur potentially harmful costs.  Environmental benefits. Design elements which maximize reductions of GHG emissions receive a positive rating.  Usage in global ETSs. Positive ratings for this option indicate that other ETSs featured similar design components.  Effectiveness in global ETSs. This criterion assesses whether those designs options were effective in the ETSs.  Market stability and liquidity. An option that promotes market stability and liquidity receives a positive rating.  Ease of implementation. Components receive a positive indicator if they are easy to implement.

Table 41 below summarizes all the recommendations into one cohesive summary table, and the options recommendations will be explained and justified in the following subsections. As mentioned earlier in the document, these recommendations endeavor to be very specific in order to provide the most value and substance to this analysis.

Table 41: Recommendations overall summary Component

Sub-component

Recommendation

35

Coverage

Sectors covered

Targets

Threshold Gases covered Target type

Depth of target

Allocation and auctions

MRV

Offsets

Allocation methodology Auctioning versus allocation

Auction design Number of years Timing of â&#x20AC;&#x153;true-upâ&#x20AC;? of allowances Amount of offsets allowed Project types Standards allowed

Market oversight and rules

Floor Ceiling

Banking/borrowing

Pilot phase (2 years) includes the electricity sector. Phase 2 also includes manufacturing (metallurgy, cement, coke, cement, ammonia/fertilizer, lime, nitric acid, adipic acid, and ferroalloys) and district heating.

25,000 tCO2e/year CO2, N2O Two options, with a preference for the intensity approach: 1) Intensity target. The target is a per cent improvement in GHG intensity per unit of output for capped sectors/facilities starting in the first year of the program, based on a baseline. Intensity targets will not be set per facility but sector wide (unlike in the Alberta ETS). See Section 4.2 to learn more.

2.) Absolute target. The target would be a per cent reduction in absolute emissions from a baseline such as 2005 or 1990.

This is ultimately the decision of Ukraine. TRPC views the carbon price calculations attractive for a target that mandates emissions be equal to 2010 levels by 2030, assuming a 2018 commencement of the program.

The pilot phase should be less stringent than phase 2. See Section 4.2 to learn more.

Benchmarking using production.

In the pilot phase, the electricity sector would receive partial allocations.

In phase 2, manufacturing would receive 100% allocation initially, district heating would receive a partial allocation, and electricity sector would receive no allocation. The balance of allowances would be sold at auctions, or potentially set aside. See Section 4.3 to learn more.

Sealed bid, uniform price English auctions Facilities should track emissions and production of capped industries three years prior to the start of the program April of the following year, with 100% annual compliance.

Offsets are allowed to be used for compliance up to 8% of each entities annual obligation.

Methane capture projects for coal mines, landfill gas, livestock methane, and wastewater.

Joint Implementation projects in Ukraine for approved project types. This should be transitioned over time to new standardized methodologies for approved domestic project types.

A price floor enforced at auctions.

A soft price ceiling, with a set aside from existing allowances that release to the market, based on certain price triggers. The release could occur in the auctions.

Banking will be allowed in all instances, except between the pilot phase and phase 2. There will be no borrowing.

4.1 Sectoral Coverage and Point of Obligation In this section, we will look at the decisions involving sectoral coverage, threshold for point sources, and greenhouse gases.

Decision Point 1: Which sector(s) to include. The following are the significant GHG sources in the Ukrainian economy: (a) Electricity. This includes traditional fossil fuel power generation, as well as the power component of combined heat and power plants (CHP); (b) District heating. Included here are the communal boilers and heating units for communities; (c) Mining. This includes fugitive emissions from natural gas and oil extraction, as well as coal mine methane emissions and natural gas distribution; (d) Manufacturing. This encompasses facilities in metallurgy (steel), fertilizer/ammonia, petrochemicals, food processing, coke production, cement, and other manufacturing subsectors; (e) Residential & commercial direct consumption. This includes direct consumption and combustion of natural gas in non-industrial facilities and houses;

36

(f) Transport. This involves the mobile combustion of petroleum and other fossil based fuels, for transport such as automobiles, boats, planes, and trains; (g) Agriculture. This includes emissions from fertilizer application, livestock waste, land use and forestry; (h) Waste. Landfills and wastewater are included in this sector.

Table 42: ETS indicators for decision point 1 Economic Cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation Economic Cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) Electricity Neutral/positive

(b) District heating Positive

(c) Mining Negative

(d) Manufacturing Neutral/positive

Positive

Positive

Neutral

Positive

Positive

Neutral

Neutral/negative

Positive

Positive

Neutral

Neutral

Positive

N/A

N/A

N/A

N/A

Positive

Neutral/positive

Neutral/negative

Positive

(e) Residential Neutral

(f) Transport Neutral

(g) Agriculture Neutral

(h) Waste Negative

Neutral

Neutral

Neutral

Negative

Neutral/negative

Neutral

Negative

Negative

Neutral/negative

Neutral

N/A

N/A

N/A

N/A

N/A

N/A

Negative

Neutral/negative

Negative

Negative

Recommendation.

This paper recommends that the electricity, manufacturing and district heating sectors be included in the final program. Manufacturing includes metallurgy, cement, coke, cement, ammonia/fertilizer, lime & limestone, ferroalloys production, adipic and nitric acid.

Electricity and manufacturing are included, because: i.

They have easily identifiable, large point sources which make up most of the emissions in the sector; ii.

They release a significant portion of GHG emissions (17%, 25% respectively); iii.

The reduction opportunities in these sectors are numerous and largely profitable; iv.

The power and manufacturing sectors are subject to many regulations and reporting requirements, so this will not create significant incremental burden.

District heating is also capped because: i.

It has some of the greatest potential for cost-effective reductions of any sector; ii.

It has large point sources similar to the power and manufacturing industry, though there are more medium to small facilities in this sector than in power and manufacturing; iii.

The MRV process is not complicated since it is principally fossil fuel combustion based.

For the breakdown of phases, we would recommend that the pilot phase include the electricitysector only, because: i.

Reductions potential in the power sector is the greatest, with 44 Mts CO2e of reductions are possible annually by 2030 for a sector that emitted 65 Mts in 2010;27 ii.

The thermal power sector has a large portion of private companies such as DTEK that are used to traded markets (through power trading), more than the manufacturing and heating sectors; 27

BNEF/NERA, 2012.

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iii.

The market is more uniform than the manufacturing and district heating sectors, easing administrative and regulatory burdens in the early going.

Given that the electricity sector is dominated by DTEK-owned facilities, there need to be provisions to ensure they do not use their market position to impose anti-market behavior. This could be enforced through strict monitoring of the auctions to ensure that the different DTEK entities bid independently, as well as setting restrictions on the total number of allowances DTEK-owned entitites could buy at the auctions.

For phase 2, the paper recommends incorporating manufacturing and district heating.

This paper does not recommend that agriculture, waste, transport, residential heating, and natural gas distribution (part of mining) be included. They have too many point sources to easily regulate, as part of the capped sector. Coal mine methane (part of mining) and waste are also relatively expensive in relation to other reduction measures. These sectors however could play a role in the offset markets (see Section 4.5 on Offsets).

In later phases of the program, transport could possibly be included where it is capped at the upstream partner, as it is in California. This does present agency issues, where the capped entity (petroleum distributor) does not have the abilityâ&#x20AC;&#x201D;aside from the introduction of biofuelsâ&#x20AC;&#x201D;to reduce emissions, since the drivers will be the ultimate emitters.

Decision Point 2: What is the threshold for point sources: These typically come in the form of capacity or emissions thresholds. (a) Capacity (20 MW, etc): EU ETS caps incorporate capacity thresholds in conjunction with emissions thresholds. (b) 25,000 tCO2e/year. This is the threshold that has been effectively utilized by many ETSs. (c) 100,000 tCO2e/year. Alberta utilizes this approach.

Table 43: ETS indicators for decision point 2 (a) Capacity Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(c) 100,000 tCO2e

Neutral

(b) 25,000 tCO2e/year Neutral

Neutral

Neutral

Negative

Neutral/positive

Positive

Neutral/negative

Positive

Positive

Positive

N/A

N/A

N/A

Neutral

Neutral

Neutral/positive

Neutral/positive

Recommendation.

This paper recommends a 25,000 tCO2e annual threshold for compliance. The reasons are: i.

This threshold is simple, unlike a capacity-based threshold which will differ greatly by sector and subsector. ii.

California has successfully employed this threshold, and Kazakhstan has a similar 20,000 threshold. The EU ETS uses this threshold in conjunction with a capacity threshold. iii.

The 25,000 threshold optimizes coverage under the cap, ensuring that very small facilities do not have to undertake the burdens of compliance, while still maximizing coverage.28 Based on a recent analysis of Ukraineâ&#x20AC;&#x2122;s emissions tax reporting, 96% of 2012 CO2 facility stationary emissions that were reported to the government came from facilities emitting greater than 25,000 tons of CO2. The 25,000 threshold would also limit the regulation to only 333 facilities in Ukraine, keeping

28

Calfiornia EPA, Q&A, 2011. http://www.ccdsupport.com/confluence/pages/viewpage.action?pageId=112034968

38

the administrative burden relatively low.29 For comparison, in the EU ETS 95% of facility emissions occurred above the 25,000 t/CO2e threshold.30 Extrapolating these findings to the 2010 overall emissions of Ukraine cited in this report, roughly 41% of total emissions would be covered (see Table 44).

Decision Point 3: What greenhouse gases should be capped: (a) CO2. 76% of Ukraine’s GHG emissions; (b) CH4. 17% of Ukraine’s GHG emissions; (c) N2O. 8% of Ukraine’s GHG emissions; (d) HFCs, PFCs, SF6. Collectively <1% of Ukraine’s GHG emissions. 31 Recommendation.

This paper recommends including CO2 and N2O in the cap, as they together comprise over 84% of GHG emissions overall. Those two gases would encompass 98% of total GHGs in the combined electricity, manufacturing, and district heating sectors.

CH4 is not a significant GHG in electricity, district heating, and manufacturing processes, so we do not recommend its inclusion. Furthermore, it is difficult to monitor given its presence in agriculture and disparate sources such as waste, oil wells, and natural gas pipelines. We also do not recommend SF6, HFCs, or PFCs, as they are very small sources of emissions.

Altogether, based on our recommendations for sectoral coverage, threshold, and greenhouse gases, the program would cover roughly 41% of GHG emissions (see Table 44).

Table 44: Summary of coverage of ETS Sector

Mt CO2e in 2010

% of total emissions

Mt CO2e covered over 25,000 threshold (approximately)

Electricity Manufacturing District Heating Total

65 94 29 188

17% 25% 7% 49%

59 85 14 158

Mt CO2e covered with threshold with CO2 and N2O only 59 82 14 155

% of total emissions that are covered 15% 21% 4% 41%

Sources: Thomson Reuters Point Carbon, UNFCCC

4.2 Targets The target dictates the level of GHG reductions for the covered sectors of the economy. Most targets are set against a baseline year(s) of emissions. Fundamentally, there are two specific decision points with regards to targeting for an ETS: (1) The type of target, and (2) the level of reduction.

Decision Point 4: Type of target. The two approaches used in ETSs are: (a) Absolute target versus a baseline. In this approach, absolute targets are set against the GHG emissions of one year or the average of a number of years. (b) Intensity target based on production. This approach sets an emissions goal based on production efficiency. Though Alberta applies the intensity target by facility, this particular option sets sector-wide targets based on that measure. GHG intensity means the emissions of CO2e per generation of each respective output unit (power generation in MWhs, heat output, tonnes of steel, etc). A baseline GHG emissions intensity level for power for instance could be 0.35 tCO2e/MWh, with the mandate to improve it 2% each year.

Table 45: ETS indicators for decision point 4 (a) Absolute

(b) Intensity

29

State Statistics Service of Ukraine, “Form No.2 TP (air)” Ecofys, “Small installations within the EU Emissions Trading Scheme,” European Commission, 2007. http://ec.europa.eu/clima/events/0065/docs/finalrep_small_installations_en.pdf 31 UNFCCC, “National Inventory Submissions, 2013. http://unfccc.int/national_reports/annex_i_ghg_inventories/national_inventories_submissions/items/7383.php 30

39

Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

N/A

N/A

N/A

N/A

Positive

Neutral/negative

Neutral/negative

Positive

Neutral

Positive

Neutral

Neutral

Recommendation.

We conditionally recommend an intensity target. Though this approach is only used by one ETS, the oversupply exhibited in most systems advises that existing approaches to targeting are not meeting effectiveness goals. Here are the reasons for an intensity target: i.

Absolute targets are by nature affected by external factors not related to abatement, such as recessions, weather, price fluctuations, and plant shutdowns. For instance, the EU ETS and California markets are long primarily because of the financial crisis. By creating intensity targets that are tied to production, abatement can only be met by improving efficiency and not by outcomes where output is simply reduced. ii.

The intensity-based target in Alberta has succeeded in providing a strong carbon price, and is the only ETS that is currently short of compliance instruments. iii.

Efficiency performance versus target is more stable than absolute emissions versus absolute target, so year to year the fundamentals of the market should not change dramatically, creating a clearer carbon price to incentivize further reductions.

It is important to note that environmental stringency is a separate discussion from approach; the ability to drive reductions is a function of how deep the intensity/absolute targets are versus the business as usual projections. They do function differently however in different circumstances. All else being equal, the intensity target is stronger than an absolute target in periods of low production, and weaker during periods of production growth.

To see how this works in practice, the following is a description of an intensity target setting process.

The target is a per cent improvement in GHG intensity per unit of output for capped sectors/facilities starting in the first year of the program, based on a baseline. As an example, the 2018 GHG emissions cap could be set in April of 2018, based on 2017 reported production and 2018 projected production by capped sector/subsector. This could then be multiplied by the 2018 GHG target intensity by sector/subsector to find the number of allowances for that year. Sector-specific allowances pools could be allocated to their respective sectors, or set for sale in the auction or set aside. Intensity targets will not be set per facility but sector wide (unlike in the Alberta ETS).

Table 46 goes through some sample calculations for setting a cap for the electricity sector system in 2018 and 2019, where caps are set for that corresponding year in April based on a production forecast for that year. For simplicity we assume a baseline of 0.35 Mt CO2e/TWh, with 2% improvement each year in 2018 and 2019.

40

Table 46: Example of process of setting intensity caps in 2018 and 2019 annually for electricity Annual cap setting components

2017

2018 cap-setting (set in early 2Q in 2018) Actual production in capped sector (TWhs) Forecasted capped production (TWhs) Target intensity 2% improvement (Mt CO2e/TWhs) 2018 emissions cap for electricity (MT CO2e) 2019 cap-setting (set in early 2Q in 2019) Actual production in capped sector (TWhs) Forecasted capped production Target intensity 2% improvement (Mt CO2e/TWhs) 2019 emissions cap for electricity (MT CO2e)

2018

2019

200 210 0.343 72.1 209 215 0.336 72.3

However, in the case that an intensity target severely limits the ability of the program to link with other desired ETSs, then the options should be widened to also include absolute targeting approach, which would share more characteristics with other programs.

Decision Point 5: Level of reductions.

For the purposes of understanding the costs and benefits, this paper will extrapolate a 2030 business as usual (BAU) emissions forecast, looking at three different tiers of reductions versus an absolute target.32 For the sake of simplicity for this analysis, it is assumed that the program starts in 2018, features absolute emissions reduction targets, and covers 100% of electricity, district heating, and manufacturing.

Below are three target levels for GHG emissions for 2030 from a 2010 baseline: a) 10% growth. This translates to reductions of 114 MtCO2e versus BAU in 2030, and a carbon price of €13/tCO2e in 2030. Adding in 10 Mts of offsets, that price reduces to €1/tCO2e. b) 0% growth (flat): This translates to GHG reductions of 132 Mt CO2e versus BAU in 2030, and a carbon price of €35/tCO2e in 2030. Adding in 10 Mts of offsets, that price reduces to €24/tCO2e. c) 10% decline: This translates to GHG reductions of 151 Mt CO2e versus BAU in 2030, and a carbon price of €65/tCO2e in 2030. Adding in 10 Mts of offsets, that price reduces to €41/tCO2e (see Figure 2).

32

The BNEF/NERA 2012 MACC assessment projected a 2.7% compounded annual growth rate of GHG emissions from 2010 to 2030 in the ”planned policy” scenario. Using updated 2010 actuals and including only electricity, district heating, and manufacturing sectors, we calculate that the 2.7% growth rate leads to a 2030 emission number of 321 Mt CO2e under this scenario from 188 Mt CO2e in 2010. We use the marginal abatement cost curve (MACC) developed by BNEF/NERA to calculate the carbon price, including only actions relevant to those sectors. To learn more about these calculations, and what a MACC is, please consult the The BNEF/NERA report: http://www.ebrd.com/downloads/research/economics/publications/specials/Ukraine_MACC_report_ENG.pdf

41

Figure 2: Three target scenarios applied to business as usual emissions

Source: Thomson Reuters Point Carbon, using data from BNEF/NERA Recommendation.

The target is ultimately the decision of the government, balancing environmental leadership with the risks posed by carbon costs to the economy. Therefore, this recommendation should only serve as a suggestion.

For the absolute target, this paper recommends a target that reflects 0% growth from 2010 to 2030, as that results in a favorable €35/tCO2e in 2030, representing 132 Mt of reductions in 2030.33 Other ways to state this target for electricity, district heating and manufacturing are: ~3% below 2000 emissions, ~6% below 2005, or ~60% below 1990.

This paper views the €35 price point as the ideal, as most initial projections overestimate costs, and underestimate the innovation that creating a carbon price allows.34 In addition, offsets would further reduce the carbon price.

It should be known that the carbon price is calculated at the incremental cost of reductions, not the average cost of reductions. Roughly 100 Mt CO2e of reductions calculated in the BNEF/NERA report were break even or profitable investments, meaning that close to 75% of the GHG emissions reductions should impart no net cost on compliance entities.

For an intensity target, we would advise putting in place GHG intensity targets that mirror 132 Mt of reductions versus BAU in 2030, based on careful analysis of BAU production forecasts by sector.

In terms of phases, this paper recommends employing a pilot phase for two years, where emissions reductions are not as stringent or flatten out. In the Phase 2, the target can become more stringent, to make up the difference, as players better understand the market and how to reduce at that point. Table 47 shows an example of the absolute targets by year and by phase, as a percentage of 2010 emissions.

33

Carbon price is calculated by taking the required reductions versus BAU, and matching it to the reductions on the Marginal Abatement Cost Curve determined by EBRD through BNEF and NERA. The incremental cost per Mt CO2e required to get to that level of reductions in 2030 is the carbon price.

34 Taylor, Margaret. “Innovation under cap-and-trade programs,” University of California Berkeley. 2012. http://www.pnas.org/content/early/2012/03/08/1113462109.full.pdf

42

Table 47: Example of an absolute cap that achieves 0% growth in emissions from 2010 by 2030, in terms of per cent of 2010 emissions Pilot phase Electricity District Heating Manufacturing

2018 122 % --

2019 122 % --

--

--

Phase 2 2020 120 % 120 % 120 %

2021 118 % 118 % 118 %

2022 116 % 116 % 116 %

2023 114 % 114 % 114 %

2024 112 % 112 % 112 %

2025 110 % 110 % 110 %

2026 108 % 108 % 108 %

2027 106 % 106 % 106 %

2028 104 % 104 % 104 %

2029 102 % 102 % 102 %

2030 100 % 100 % 100 %

4.3 Allocations and Auctions Another key set of design decisions revolve around the methodology for allocation, and how much to allocate versus auction. The two competing processes of allocation are grandfathering and benchmarking. Grandfathering allocates allowances based on some proportion of previous yearsâ&#x20AC;&#x2122; emissions for the facility.

Benchmarking distributes allowances based on past performance. So for instance, the benchmark could be 0.5 allowances for each MWh produced in the previous year, so a facility that produced 1 million MWhs previously would receive 500,000 allowances. Typically, these benchmarks are differentiated based on technology, and are defined by the average emissions intensity of the market, or best-in-class performance.

Decision Point 6: Best allocation methodology: Two of the most common approaches are: (a) Grandfathering based on historical emissions (b) Benchmarking based on historical production Table 48: ETS indicators for decision point 6 Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) Grandfathering N/A

(b) Benchmarking N/A

Neutral

Neutral/positive

Neutral

Positive

Negative

Positive

Neutral

Neutral

Neutral

Positive

Recommendation.

This paper recommends a benchmarking approach to allocation. Benchmarking allocates permits to those entities based on historical production, not historical emissions. The reasons for this are: i.

Benchmarking does not penalize plants for already being efficient; plants with equivalent historical production but divergent GHG intensity will receive the same number of allowances, with the more efficient entity in a much better compliance position. If allocation is based on historical emissions, then the less efficient plant will receive more allowances. ii.

Benchmarking on historical production is fairly simple, as the only calculation required is production data, while allocation on historical emissions requires more calculations and perhaps leads to a higher probability of overstatement.

Decision Point 7: How much to allocate versus auction: The balance between giving away allowances and selling them via auctions is a crucial element: (a) Auctions. Allowances are distributed via open auctions where players bid on purchasing the allowances. (b) Allocation. Allowances are freely given to entities, based on various methodologies.

43

Table 49: ETS indicators for decision point 7 Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) Auctions Neutral/negative

(b) Allocation Neutral/positive

Neutral/positive

Neutral/negative

Neutral

Neutral

Positive

Neutral

Positive

Negative

Neutral

Neutral

Recommendation.

This paper recommends a preferential weighting to auctioning. The reasons are: i.

Auctioning provides a clear price point for the market place, and promotes stability and liquidity in the allowances. ii.

Auctioning follows the polluter pays rule, meaning that capped entities would have to purchase allowances, providing more incentive to perform internal abatement then if they were to be freely allocated allowances. iii.

Auctions have been successfully implemented in many ETSs. iv.

Auction revenues, if properly administered, can be directed towards activities that further reduce emissions and reduce the burden on capped companies.

However, allocation is recommended in the cases of (a) the pilot phase where entities are in need of funding to make investments for reduction, and (b) entities facing international competition where carbon pricing would create a disadvantage. The amount of allocations for those industries subject to international competition should be based on their exposure to export and international markets.

It should be noted however that auctions (if not recycled back to industry) do raise costs for regulated companies and potentially the end consumer, and avenues should be explored to mitigate those costs.

For district heating, we recommend that the yearly allocations should be weather-based, given that facility emissions are highly dependent on winter weather. In order to better manage their compliance position, additional allowances should be provided if above average heating is required.

Table 50 displays an example of our recommended allocation percentages by sector by year, with the balance of allowances being set aside or auctioned.

Table 50: Example of percent allocation by sector by year Pilot phase Electricity District Heating Manufacturing

Phases 2 and beyond

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

50% --

50% --

--

--

0% Variable 100 %

0% Variable 90%

0% Variable 80%

0% Variable 70%

0% Variable 60%

0% Variable 50%

0% Variable 40%

0% Variable 30%

0% Variable 20%

0% Variable 20%

0% Variable 0%

Decision Point 8: Design of auctions: The auctions that take place in the carbon market are similar to auctions for other commodities and financial products. The market price is set where the demand from the various bidders matches the supply offered, though the methodology of how that price is determined differs between the various formats. In terms of carbon auctions, the sealed bid, uniform price auction has been the one predominant format. A number of academic papers have also researched the potential efficacy of the sequential English clock auction. In this decision point, we look at: (a) Sealed bid, uniform price English auction. All bidders only have one round to bid, and typically will bid a number of different lot sizes at different prices in that one round. There is no interaction

44

between the participants, which is why it is called “sealed bid”. For instance, in California a participant would perhaps bid 10,000 tons at $15, and also 20,000 tons at $12, etc. The auction operator adds all the bid lot volumes from all the bidders, starting with those that proposed the highest prices on down. The incremental price at which the accumulated volume of bid lots equals the total allowances for sale, is the clearing or market price. All bidders with bid lots that were priced higher of the market will purchase at that clearing price of their submitted volumes. (b) Sequential English clock auction. In this format, there are multiple bidding rounds rather than one bidding round. The auction operator starts at a low price point where it is assumed there will be excess demand, and then receives bids for volumes from the participants for each round. Each round features a slightly higher price; the round where the total volumes bid equal the total lot being sold will be the market price. Each participant with volumes bid in that round will receive their bid volumes at that market price.

Recommendation.

This paper recommends a sealed bid, uniform price English auction, because: i.

It has been successfully implemented in EU ETS, RGGI, and California. ii.

It provides a clear, price point for buyers. iii.

It promotes a orderly auction.35 36 To learn more about these types of auctions, please consult the footnoted resources in this document.

4.4 MRV Rules and guidelines Monitoring, reporting and verification (MRV) implementation ultimately depends on the structure of the ETS, the sectoral scope, and the point of regulation. Therefore, many of these elements are imbedded in other sections, and the timeline for MRV as well as implementation will be further discussed in Section 5.

However, there are a few decisions with regards to MRV. Decision Point 8: When to start tracking facility-level emissions and production prior to ETS launch: (a) Two or three years (b) One year (c) None Table 51: ETS indicators for decision point 8

Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) Two or three years Neutral/negative

(b) One year

(c) None

Neutral

Neutral/positive

N/A

N/A

N/A

Neutral/positive

Neutral

Negative

Positive

Neutral

Negative

Positive

Neutral

Negative

Neutral

Neutral

Neutral

Recommendation.

This paper recommends tracking production data and facility-level emissions three years prior to the start of the ETS. The reasons for this are:

Holt, Charles and Shobe, William. ”Testing Emission Allowance Auctions with Common Values,” University of Virginia, 2012. http://people.virginia.edu/~wms5f/files/holt_shobe_6-12.pdf 36 Burtraw, Dallas and Palmer, Karen. ”Allowances Under the Regional Greenhouse Gas Initiative,” Resources for the Future, 2007. http://www.rggi.org/docs/rggi_auction_final.pdf 35

45

i.

ii. iii. iv.

It provides clear production and emissions historical data for the purposes of allocations, with the average of three years allowing years with uncharacteristic emissions to be smoothed over.

It would provide three years of â&#x20AC;&#x153;learning by doing,â&#x20AC;? wherein any issues or challenges with regards to MRV would be brought forward.

It would open the door to charging a more expansive intermediate carbon tax during those three years, if that is the policy that the government wants to pursue.

The three years of collection would provide additional data that could inform adjustments to the program, including targets, sectoral coverage, and other areas.

Decision Point 9: Timing of the true-up: True-up is the process of regulated entities turning in their allowances for compliance. Most programs require annual true-ups, though California only requires a fraction of the allowances to be turned in annually, with the remainder being turned in at the end of the phases. The options are: (a) True-up annually (b) True-up at end of the respective phase Table 52: ETS indicators for decision point 9

Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) True-up annually Neutral

(b) True-up at end of phase Neutral

N/A

N/A

Positive

Neutral/negative

Positive

Neutral

Positive

Neutral

Neutral

Neutral

Recommendation.

This paper recommends 100% annual true-up requirements, with allowances due by April of the following year. The reasons are: i.

Annual true-up requirements by April of the next year have been effective in the EU ETS, and RGGI markets, with very few instances of non-compliance. ii.

Compliance at the end of phases (rather than annually) compresses allowance activity into tight windows, where companies may have to purchase a significant portion of three years of allowance needs into the period of time before the true-up deadline. Annual true-up does not compress multi-year demand into a single year window. Annual true-up therefore spreads out volatility, and promotes even and continuous liquidity.

4.5 Offsets and Flexible Mechanisms The design of offset mechanisms differs widely between ETSs, and so there is wide latitude to approach this market. Carbon offsets are projects that reduce emissions beyond a baseline, and are verified and monetized into carbon credits.

Decision Point 10: Amount of offsets allowed into the system. (a) Unlimited. The Alberta and Kazakhstan systems do not limit offsets. (b) 8% of total obligation. This is the limit in California. The EU ETS Phase 3 employs a similar rate, though it differs by country/NAP. (c) 3% of total obligation. This is the limit for RGGI. (d) None.

46

Table 53: ETS indicators for decision point 10 (a) Unlimited Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(c) 3% of obligation Neutral/Negative

(d) None

Positive

(b) 8% of obligation Neutral

Neutral/negative

Neutral

Neutral/positive

Positive

Neutral/negative

Positive

Positive

Negative

Neutral

Positive

Neutral

N/A

N/A

N/A

N/A

N/A

Neutral

Neutral

Neutral

Positive

Negative

Recommendation.

This paper recommends that offsets should be limited to 8%. i.

This mirrors the approach that the leading EU ETS and California markets have implemented. ii.

The limit of 8% is large enough to bring enough volumes to bring costs down, and also ensure there is enough demand to lead to a critical mass of offset credit development. 8% of a 200 Mt CO2e market would create theoretically 16 Mt of demand per year. iii.

8% is still small enough that it ensures that offsets will not swamp the allowance market and dilute the market with too much supply.

Decision Point 11: Eligible project types/sectors: The following are leading candidates for offset project types in the Ukraine and the international markets. (a) Forestry: Carbon is sequestered either by conserving forestlands, or replanting trees on fallow land. (b) Fugitive emissions from gas pipelines: Natural gas/methane fugitive emissions from pipelines are reduced. (c) Coal mine methane (CMM). Fugitive methane from coal mines is captured, and either flared or used for power generation/heat. (d) Landfill gas: Fugitive methane from landfills is captured, and either flared or used for power generation/heat. (e) Livestock methane: Fugitive methane from livestock waste is captured, and either flared or used for power generation/heat. (f) Incineration of industrial gases. High global warming potential gases, such as PFCs, ozone depleting substances, SF6 are incinerated. (g) Energy efficiency: Energy intensive processes are made more efficient. (h) Wastewater: Fugitive methane from wastewater is captured, and either flared or used for power generation/heat. (i) Renewable power/energy/fuel switching: Clean energy is employed instead of fossil fuels. (j) Non forestry land use change: Project owners change their land use practices to reduce emissions.

47

Table 54: ETS indicators for decision point 11 (a) Forestry Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(c) CMM

Neutral

(b) Gas pipelines Positive

Neutral/negative

(d) Landfill gas Neutral

(e) Livestock methane Neutral

Positive

Negative

Positive

Positive

Positive

Neutral/negative

Neutral

Neutral/positive

Positive

Positive

Negative

Neutral

Positive

Positive

Positive

N/A

N/A

N/A

N/A

N/A

Negative

Neutral

Positive

Positive

Positive

(f) Industrial gases Positive

(g) Energy efficiency Positive

(h) Wastewater Neutral

(i) Renewable energy Positive

(j) Land use (non-forestry) Neutral/negative

Neutral

Positive

Neutral/positive

Neutral

Neutral

Neutral

Neutral

Positive

Neutral

Neutral

Neutral

Neutral

Positive

Neutral

Neutral

N/A

N/A

N/A

N/A

N/A

Positive

Neutral/negative

Positive

Negative

Negative

Recommendation.

This paper recommends that methane capture projects (wastewater, landfill gas, livestock methane, and coal mine methane) should be included because: i.

They are straight forward to monitor and calculate, as the emission reduction activity is simply a function of the methane that is captured. Though it is very difficult to track methane emissions, it is not difficult to track how much methane is captured by a single activity. ii.

They have a strong track record of performance and environmental integrity in global offset markets. iii.

The total reduction potential for these project types is 33 Mts annually by 2030.37 It is important to note that Energy efficiency and renewable energy projects are more complicated, in that they have potential double-counting issues with the capped sectors. Forestry and land use projects are further complicated by the need for permanence as well as the potential for reversals.

With pipeline fugitive emissions, there may be questions as to the additionality of the offset credits.

Decision Point 12: Eligible systems/standards/geography: (a) International clean development mechanism (CDM). This project-based standard works through the UNFCCC and Executive Board administration for approval and issuance. CDM credits are used primarily for Kyoto Protocol compliance and compliance in the EU ETS (with some exceptions). (b) International voluntary standards (VCS, CAR, etc). Credits issued to these standards are typically purchased by those looking to voluntarily offset their emissions. (c) Domestic project-based offsets/JI. This includes domestic JI projects, or projects similar to their methodologies. (d) Domestic standardized offsets. This subset would create offsets similar to the standardized approaches that Climate Action Reserve/California market employs, where top down performance milestones determine reduction calculations.

BNEF/NERA, “The Demand for Greenhouse Gas Emissions Reduction Investments: An Investors’ Marginal Abatement Cost Curve for Ukraine.” EBRD, 2012. http://www.ebrd.com/downloads/research/economics/publications/specials/Ukraine_MACC_report_ENG.pdf 37

48

Table 55: ETS indicators for decision point 12

Economic cost Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

(a) CDM

(b) Voluntary

(c) Domestic JI

Neutral/positive

Neutral

Positive

(d) Domestic standardized Neutral/positive

Neutral

Neutral

Neutral/positive

Positive

Positive

Negative

Neutral/positive

Neutral/positive

Neutral/negative

Neutral

Neutral/negative

Positive

Positive

Neutral

Neutral

Neutral

Neutral/positive

Neutral

Positive

Negative

Recommendation.

This paper recommends that domestic Joint Implementation projects should initially be eligible. The projects should follow the “track 2” approach that requires independent verification. Eventually, this system will transition to new domestic standardized offsets standards for eligibility. i.

Domestic offsets will ensure money invested stays within the country and reductions happen in Ukraine. ii.

For ease of implementation, the JI uses existing infrastructure and methodologies to get the program off the ground in the beginning years of the program. iii.

The “Track 2” approach ensures reliable monitoring and better assurance of additionality, since independent verifiers attest to the projects’ quality. iv.

The transition to top down, standardized methodologies will allow for projects to be set up less expensively, with more scalability for the longer term, though the environmental integrity will still need to be closely analyzed.38 This will necessitate the authorization and creation of new methodologies and infrastructure.

For JI and new standardized methodologies, the projects would need to be one of the approved project types, as listed in Decision Point 11.

To further ensure that projects are additional, project eligibility should be restricted to only those activities that started after cap-and-trade legislation had been approved and passed.

4.6 Market Oversight and Rules The rules that govern market mechanisms primarily serve to make the market function in a stable, liquid, and fundamentally sound manner.

Decision Point 13: Incorporating price stabilization measures: (a) Price floor: Typically this is enforced via a floor at auctions. (b) Hard price ceiling: In this instance, the regulator either creates new allowances if the price reaches the ceiling, or sets an alternative compliance penalty at a low enough point where it acts as de facto price ceiling. (c) Soft price ceiling: A set aside from the cap releases allowances at set prices to help contain a high price.

Table 56: ETS indicators for decision point 13 Economic cost

(a) Price floor Neutral/negative

(b) Hard price ceiling Neutral/positive

(c) Soft price ceiling Neutral

Michaelowa, Axel. ”Strengths and weaknesses of the CDM in comparison with new and emerging market mechanisms,” Paper No. 2 of CDM Policy Dialogue, 2012. http://www.cdmpolicydialogue.org/research/1030_strengths.pdf 38

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Environmental benefits Usage in global ETS systems Effectiveness in global ETSs Market stability and liquidity Ease of implementation

Positive

Negative

Neutral

Neutral

Negative

Neutral

Positive

N/A

Neutral

Positive

Neutral

Positive

Positive

Neutral

Neutral

Recommendation.

This paper recommends both an auction price floor, and a soft price ceiling, for the following reasons: i.

Price floors provide certainty for investors of a minimum price point, and it stabilizes the price in an oversupplied market. ii.

Price floors enforced at auctions have proven effective in RGGI and California markets in keeping prices above the floor. In the RGGI market for instance, the exchange traded market price did not drop below the auction floor despite a massive oversupply of allowances. iii.

Auctions are also ideal for price floors, as they naturally rebalance supply and demand.

Oversupplied markets will end up with auctions that are undersubscribed, with the unsold allowances then taken out of the supply. iv.

Price ceilings protect compliance entities from supply shortage shocks. v.

A soft price ceiling (as opposed to a hard price ceiling) does not violate the integrity of the cap, since the allowances released are still taken out of the existing set aside of the allowance pool. It does provide buffering in the case where markets become too tight.

Decision Point 14: Banking and borrowing: (a) Banking between phases. The entities are allowed to use past or current year vintage allowances for future yearâ&#x20AC;&#x2122;s compliance. (b) Borrowing between phases. Entities can â&#x20AC;&#x153;borrowâ&#x20AC;? allowances from future compliance periods to use in the current year true-up. Allowances would need to replaced, with the appropriate interest rate applied. (c) No Banking or borrowing.

Recommendation.

This paper recommends banking, but not borrowing. Banking however should not be allowed between the pilot phase and phase 2, to allow for the initial two years to not affect future phases.

Here are the reasons for this: i.

Banking has been effectively used in all major ETS programs. ii.

Banking provides price stability, by assuring that the market looks at long term fundamentals which tend to be more stable. iii.

Borrowing is not allowed in the RGGI and California programs, and is limited in EU ETS Phase 3, for the reason that it creates administrative complexity and exists simply to allow entities to delay compliance.

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5 Implementation Plan The implementation of an ETS is a multi-year process, involving varying workstreams, stakeholder engagements, hiring of independent operators, and legislative and regulatory filings. All these different components of implementation need to work together in a coordinated fashion. Though each scheme is different and presents distinct design and operational features, the implementation steps will generally fall into five basic streams.

Initial Legislation To formally start the process, there is typically a law or an agreement that sets broad goals, budget, oversight, and lays out the implementation schedule and responsible agencies.

Workgroups/consultations To best understand how to design the ETS, a process of research and stakeholder engagement should be performed. This allows the regulator to gather input, create models, and further refine the ETS designs. Topics covered included GHG emissions forecasts, economic modeling, MRV frameworks, leakage, allocation, auctions, and offsets. Often separate committees are set up to handle these topics, and workshops are arranged to present and discuss them in depth, and present them to external stakeholders.

Subsequent legislative/regulatory rulings The most important step of the process will be the regulations that determine the rules of the program.

In the other ETS programs, there tend to be initial rulings or drafts, that are then followed in a year or two by final ruling or law. This allows for proper time for comments and revision. The directives can be in one document, or spread a number of specific directives. The final document provides specifics on targets, scope, allocation, auctions, linking, MRV rules, offsets, enforcement, legal definitions, and market rules.

Given that GHG and production monitoring should precede the ETS, often there is a separate MRV regulation, spelling out the requirements for reporting, GHG calculation methodologies, and accreditation procedures for verifiers.

MRV-specific tasks Tracking production and GHG emissions of the capped entities is crucial to proper installation of an ETS, so best practices dictate that this data be gathered, reported, and verified with the proper regulator. The production data (which may already be tracked separately) will assist in benchmarking for allocation and emissions intensity analysis. It is best practices to have at least 2-3 years of GHG and production data at the level of regulation prior to the commencement of the ETS. Platform execution The infrastructure for the ETS must also be prepared. The registry allows entities to report their emissions, track and transfer ownership of allowances and offsets, and turn in instruments for compliance. The registry is not necessary for the reporting of the GHG emissions prior to the start of the program, but it is necessary once the program has begun, as it allows the regulated entities to hold and trade allowances. Assuming auctions are part of the program, the auction platform will need be built, with proper monitors in place and an operator able to maintain it.

5.1

Case studies of Phase I EU ETS, RGGI, California ETS implementations

Viewing how different systems approached the creation of an ETS can be instructive for Ukraine. For this section, we focus on the EU ETS Phase I, California and RGGI ETS implementations.

EU ETS Phase I The EU ETS started the pilot Phase I in 2005 through 2007. It was preceded by small pilot ETS programs in the UK and Denmark. Following a series of consultations and debates, the European Council passed and published the EU ETS Directive in October of 2003, requiring the member nations to submit National Allocation Plans (NAPs) by March of 2004, though a handful of countries submitted them late. NAPs stated the targets and scope, as well as MRV requirements and registry guidelines

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at the state level. After approval from the EC, these set the program forward. In terms of offsets, a July 2003 EC directive posted officially authorized the use of CDM and JI as eligible offsets.39 Registries were created at the national level by the end of 2004, and linked with what was eventually called the Community Independent Transaction Log (CITL) to allow for trading between nations. The system also connected with the CDM registry and the UNFCCC’s International Transaction Log (ITL).

Auctions were not included in the first phase.

In terms of monitoring, there was very little facility-level GHG data gathered before the start of the program, so allocations were based on high level assumptions. This inaccurate data later led to an overallocation of the pilot phase, when the program started in 2005. It is important to note that Denmark and the UK required independent verification of emissions, and consequently their phase 1 allocations were much more accurate than other countries’. The pilot phase of the EU ETS therefore demonstrated the importance of proper GHG monitoring before the start of the program.40 RGGI RGGI’s approach to the ETS implementation followed a methodical path. A consortium of northeast US states formed a number of working groups in 2003 and 2004 focusing on different aspects: energy modeling, cost/benefit modeling, model rule development, registries, and offsets. An initial model rule published in December 2003 gave way to the research and recommendations from the different working groups, presented in August 2005. A separate study later focused on auction design in October 2007.

A memorandum of understanding (MOU) signed in December 2005 followed, and the final model rule was published in January, 2007. The model rule determined targets, scope, allocation, offset limits and eligibility. Each state joining RGGI passed legislation by the end of 2008 in line with the model rule, officially joining the ETS in January 1, 2009. The state-level legislation also ruled on MRV issues such as verifier accreditation.

The states formed a non-profit entity, RGGI Inc, in July 2007 to coordinate the implementation and create the registries and auction platforms. The registry, RGGI COATS, went live in July, 2008 and the first auction successfully took place in September 2008.

Since the program only covers the power sector, its monitoring easily dovetailed on US federal requirements for production and pollution reporting, allowing the program to have strong and lengthy view of historical GHG emissions.

The program implementation in 2009 was been smooth. The market however is oversupplied, and consequently in February 2013, the model rule was updated and separately legislated months later at the state level to strengthen the targets.41 See Figure 3 and Table 58 for timelines for RGGI. California The process began with the passage of the AB32 bill in 2006, which set broad goals for California for GHG emission reductions, and authorized the California Air Resources Board (CARB) to regulate a cap-and-trade program as part of a broad suite of climate policies.

Before and after CARB published an initial draft regulation of the program in September 2009, CARB orchestrated a series of workshops through 2009-2010. The workshops featured reports and presentations on all the aspects of the cap-and-trade programs, reflecting the political realities of California that require numerous stakeholder consultations. An Economic and Allocation Advisory committee was also convened and held regular meetings to assess economic impacts and projections.

CARB separately published the mandatory reporting rule (MRR) in December 2007 (updated in 2012) that provided guidance on MRV, and required emitters to begin reporting GHG emissions at a facility39

Point Carbon, “2003 – The end of the beginning?,” 2003.

40

Point Carbon, “Lessons Learned in 2004,” 2005. http://www.pointcarbon.com/wimages/CMA_lessons_learned_2005gg8alfm.pdf 41 RGGI, inc. http://www.rggi.org/rggi

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level in 2008 and dictated emission calculation methodologies. It also determined that industrial production data and broad scope emissions (transportation, residential natural gas) would need to be reported by the start of 2011. It also provided rulings on verifier accreditation.

The platforms for the registry (called CITTSS) went live in July of 2012, and the first auction took place in November of 2012, though a practice auction was held a few months earlier in August.

The final regulation was published in December 2011, and was updated in April 2012 to include linkage with Quebec. The initial start date of the program pushed back to 2013 from 2012 to allow enough time for all the infrastructure to be put in place. The market began fairly smoothly on January 1, 2013, after the successful auction several months prior. 42 See Figure 3 and Table 58 for timelines for the California system.

5.2 Implementation Recommendations This paper will be providing a specific implementation scenario that we would provide a helpful prescription of a proper ETS implementation. There are many factors that go into an implementation plan, including the design and scope of the program, along with the political and organizational realities of governance. This paper seeks to maximize its usefulness by being as specific as possible.

Assumptions based on Section 4 recommendations  An ETS that commences on January 1, 2018;  The first phase will be 2018-2019;  Targets for companies will be based on facility-level emissions;  The ETS will feature auctioning of permits, and will build and operate its own platform.

Recommendations The implementation roadmap incorporates the strengths, lessons learned, and observed timelines of previous ETS implementations, while also taking into consideration the Ukrainian context. The key elements of this implementation plan are:  There is a four year timeframe from initial legislation to commencement, mirroring what has been witnessed in other successful programs.  Similar to the EU ETS and California programs, this report envisions a broad climate bill/directive that lays out the climate goals, timelines, and budgets, but then leaves specifics to be determined by later secondary legislation.  This report recommends the creation of separate working groups focused on distinct facets of the program. An overarching ETS design working group coordinates the different groups and pulls them together to create an integrated and cohesive set of design recommendation for the ETS.  The process is iterative, meaning that there multiple publications of the underlying regulation, and many opportunities for stakeholder workshops and engagement.  The MRV regulatory guidance occurs before the primary cap-and-trade regulation, given that there needs to be a long lead time in creating the infrastructure and procedures for GHG and production monitoring. It also allows for training and the creation of tools to help with MRV. Table 57 below details the timeline and implementation plan for a Ukrainian ETS commencing in 2018.

Table 57: Example of implementation plan for Ukraine Year 2013

42

Milestones / Tasks (in chronological order) a) Completion of high level consultations. Based on roundtables and inter-ministerial discussions, research funded by UNDP, EBRD, World Bank and other organizations should clarify the best policy approaches for reducing emissions. This would be the time frame to decide that ETS is the preferred approach, and to decide broadly on designs and frameworks. b) MRV initial preparation. At this stage, the design of the processes (including documentation, GHG protocols, emissions factors, identification of key players and government agencies) should begin. As with the high level consultations, it should be done in conjunction with EBRD, UNDP, World Bank, USAID and other organizations projects.

CARB, ”Cap and Trade Program,” 2013. http://www.arb.ca.gov/cc/capandtrade/capandtrade.htm

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2014

a)

b)

c)

2015

a)

b)

c)

d)

2016

a)

b)

c)

d)

e) f)

g)

Passage of cap-and-trade legislation. This bill authorizes budget and authority for initial specific consultations, stakeholder workshops, creation of multiple workgroups, a timeline for implementation, and MRV guidance. The bill makes clear the lead regulator, as well as secondary state agencies that would need to contribute. It should contain high level GHG emissions targets, and guidance on sectoral coverage. The legislation should be based on the high level consultation work performed in conjunction with multilateral agencies.

Work groups are formed. A mix of stakeholders, academics, and officials convene into three different work groups: a. ETS design group (lead group); b. Economic modeling group (focused on leakage, allocation, and costs); c. GHG emission modeling group.

Final MRV Regulation released/legislated. This ruling will set out the timeline for MRV tracking, including the commencement of GHG and production monitoring in January 2015. It also provides standard documentation, guidance on the creation of infrastructure to capture the data, GHG calculation guidelines, and verifier accreditation. It should also authorize training and promotion of new verification entities, and explain the roles of the state agencies in this process.

GHG Tracking begins, accreditation of verifiers starts. Tracking of production and GHG emissions by facility is initiated, in addition to the GHG tracking of the wider economy. The procedures and infrastructure to approve verifiers is in place, with training and workshops to assist in the process, and programs to attract established verifiers from other ETS schemes.

Given it will take time to train and accredit verifiers, the initial year of reporting (2015) may be done without independent verification.

Publication of findings from each of the three work groups. Each group will hold a separate stakeholder workshop and comments will be noted. The findings of the different groups will be integrated into one document prepared by the ETS design group, which determines the specific recommended design of the ETS. Draft Cap-and-trade regulation/law released. The preliminary document will set out targets, sectoral coverage, phased approach, linking, offset limits, offset eligibility, enforcement, allocation methodology, methodology for new entrants reserve, auction process, registry implementation, and compliance timelines. The government will present the regulation and listen to stakeholder comments.

Additional work groups are convened: a. Auctions. An auction work group is convened with stakeholders, researchers, and state officials, to explore auction design, monitoring, and timeline. b. Linking and offsets The linking and offsets workgroup convenes to refine and explore designs and approaches. The linking group will weigh opportunities to partner with other ETS schemes.

GHG Tracking with mandatory independent verification begins. GHG emission reporting (which began in 2015) will now also need to be verified by an independent auditor that is accredited by the relevant state agency. The accreditation agency should now tightly monitor verification, and revoke accreditation if impropriety is found.

Workgroups publish and present auction, offsets and linking findings.

Recommendations and comments sought for auction rules and updates/refinements to new offset eligibility rules, as well as linking with other systems.

Final Cap-and-trade regulation/law passed. The final law/regulation will reflect new information, stakeholder comments, and political developments, covering the same ground as the draft document.

Auction and registry proposals sought. Proposals are sought for an auction platform builder and operator. They also may look to hire an auction monitor, that will report results and ensure there is orderly and non-collusion between the different participants.

Auction rules finalized. The rules are finalized, and auction design, monitoring plan, budget, and timeline are determined.

Linking and offsets determination made. The decision to link will be made, in concert with the other countryâ&#x20AC;&#x2122;s government. The offset eligibility and rules updates will be determined at this point as well.

Registry and auction operators chosen. The contracts are finalized and the operators begin to set up the infrastructure. The registry would likely be an enhancement of the existing registry used for Joint Implementation projects.

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2017

a)

b) c) d)

Updated final cap-and-trade regulations are published. Updates to the regulations based on new developments, stakeholder consultations, and developments on the auction, offsets, and linking components. This regulation should also specifically create a regulatory and legal framework for the market, assigning roles for the state agencies that monitor and regulate commodity markets, natural gas, electricity, and other affected sectors.

Trial Auction. A trial auction occurs, to test the infrastructure and security of the auction, as well as give auction participants an opportunity to practice.

Registry goes live: Registrants are able to access registry. A series of publications and trainings will help capped entities in joining the registry.

First auction occurs. The first live auction occurs, and a public report published shortly after the auction should disclose number of bids, size of bids, number and classification of participants, settlement price, subscription levels.

Table 58 and Figure 3, it should be clear how the timeline and process described above compares directly with the California and RGGI systems.

Figure 3: Comparison timeline of recent ETS programs

Table 58: Detailed view of implementation milestones for California and RGGI Initial Consultation Design/ effectiveness Economics MRV

California

RGGI

4/2009 Presentation by CARB on cap-andtrade; 12/2009 follow up workshops; 11/2009 Economic analysis presented; 4/2010 Economic impacts of AB32 6/2009 Presentation on verification and reporting

8/2005 Staff working group provides recommendations 8/2005 Staff working group provides recommendations 8/2005 Staff working group provides recommendations

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Auctions GHG projections/ MACC Allocation/ benchmarking Leakage Offsets

Legislation & Rulings Climate legislation Preliminary directive Final directive on targets, scope, allocation MRV-specific Begin tracking facility-level emissions Begin tracking production MRV/ Reporting rules Verification accreditation rules Rules set for auctioning Platforms First auction scheduled Launch registry

4/2009 Different formats presented at stakeholder meeting 10/2010 Report on 2020 projections prepared for capped sector

10/2007 Auction design study

3/2010 Report on allocation posted on Economic and Allocation Advisory Committee 4/2009 Leakage concept paper presented

8/2005 Staff working group provides recommendations

Series of workshops in 2009 on limits, early action, project types; 6/2010 workshop on cost containment

8/2005 Staff working group provides recommendations

8/2005 Staff working group provides recommendations 8/2005 offset limit analysis published; 7/2006 offset supply curves forecasted

9/2006 Assembly Bill 32 (AB32) passed committing to statewide reductions 9/2009 CARB issues preliminary draft regulation 12/2011 Final regulation order published

Early in 2008 Legislation passed at state levels 12/2003 Preliminary model rule published; 12/2005 MOU signed by states 1/2007 final model rule released by RGGI; 1/2008 MA passes local legislation.

1/2008 CARB starts tracking facility-level emissions; 1/2011 CARB also starts tracking broad scope emissions and power import emissions 1/2011 start tracking per mandatory reporting 12/2007 rule for mandatory reporting; 9/2012 mandatory reporting updated 12/2011 Final regulation order published

1/2000 power GHG facilities are tracked at federal level

12/2011 Final regulation order published

1/2007 model rule released by RGGI; 1/2008 MA passes local legislation.

11/2012 First auction held (practice auction in 8/2012) 7/2012 User registration available

9/2008 first auction held

Sources: CARB, RGGI Inc.

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1/2000 power production tracked at federal level 1/2007 model rule released by RGGI; 1/2008 MA passes local legislation.

1/2007 model rule released by RGGI; 1/2008 MA passes local legislation.

7/2008 RGGI COATS goes live

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