(First published on June 30, 2021)
By Michael Leach
(Photo Credit: Jonathan Verschuuren)
Introduction
Scholars and policymakers have been considering emissions trading systems ever since at least the 1960s when Ronald Coase imagined pollution and emissions as factors of production that could be converted into transferable legal rights.[1] Although it took a number of decades yet before the first markets for emissions trading took off, there are now a relatively limited pool of functional examples of emissions trading systems (ETS) around the world that provide some grounds for comparison and lesson learning as these systems continue to evolve and future ones are imagined. There is tendency among scholars to treat the puzzle of emissions trading as a kind of multi-case engineering design process that searches for optimally efficient mechanisms, system architectures, forms of regulatory market oversight. From such a perspective, the few examples of ETSs around the world can be mined for evidence about what models and practices work best, and then plugging them into existing systems in processes of technical refinement. What is less discussed, however, are the boundaries of what can be learned from such inter-system comparisons, something that becomes evident once ETSs are appreciated more as regulatory systems in and of themselves rather than as a specific kind of markets that are subject to regulatory oversight. This blogpost will draw attention to these limits through a very focused and cursory comparison of the EU ETS and the Canadian emissions reduction scheme under the Pan-Canadian Framework on Clean Growth and Climate Change along the narrow comparator of how the two are structured to produce prices on emissions.
ETS Comparisons
Comparative studies of ETSs are relatively few and far between, largely because the number of actual functioning ETS in the world is quite limited.[2] Of those that exist, ETS comparisons have largely been done to evaluate the effectiveness of different ETSs in creating a functioning market and achieving actual emissions reductions goals.[3]Other types of comparative studies have compared the experiences of different industrial sectors within single ETS systems to evaluate how well or poorly a given ETS incentivizes them to reduce their emissions and innovate cleaner technologies.[4] Still others have compared different specific features of ETS systems,[5] or have compared the relative effectiveness of ETS systems versus across-the-board carbon taxation to induce emissions reduction behavioural changes.[6] In almost all cases, the metric of comparison is the same, namely how effectively a given ETS achieves its respective goals.
By framing ETSs as forms of regulatory technology, however, much is missed about how contingent the designs of such systems are on the socio-political and legal environments in which they are created. By focusing on the technical pursuit of optimal models for ETS system designs, scholars sometimes forget to ask why it is that those few ETS systems that exist currently in the world differ from one another in the ways that they do. In 2013 Sanja Bogojevic argued that the EU ETS system was sui generis and unique because of the EU’s unique supranational legal environment. In so doing, Bogojevic challenged the notion that transferring ETS design and technologies from one jurisdiction to another is technical and straightforward.[7]
In the brief EU-Canada comparison offered below, the argument follows Bogojevic’s line of thought, not only to point out that the two achieve emissions prices differently, but also to argue that the reason for this difference is that both ETS frameworks are products of their respective idiosyncratic political contexts and constitutional legal regimes.
Comparing Europe and Canada
Both the EU ETS and the Pan Canadian Framework are based on a logic that markets can achieve prices for emissions in ways that will produce incentives for affected industries to reduce their emissions. Despite the similarity of their goals, the two systems achieve those prices in quite different ways, however. The reasons for these differences are not simply a matter of better or worse technical choice-making, but rather are intimately connected to the natures of the political and legal orders within which they are created. Indeed, any accounting for the differences between the Canadian and European ETS systems will always circle back to the constitutional natures of Canada and the EU as political unions, one being a national federation, the other a supranational federation.[8]
The EU ETS is structured to achieve prices by centrally determining and limiting permissible levels of emissions throughout the EU though establishing a cap on a restricted number of emissions allowances. Regulated industries are permitted to emit provided within the limits of the allowances that they own. By creating increasing scarcity of allowances as the cap is lowered annually, the ETS achieve prices on emissions as increasingly scarce allowances are traded among affected industries. Emission caps are determined centrally by the EU Commission and allocated by a combination of an open auction as well as some given freely to Member States to allocate as they feel is important. How many emissions allowances should be produced and auctioned or distributed is calculated according to both environmental considerations as well as the relative economic development of the different Member States, where some poorer countries are receive relatively more allocations to emit than richer ones). Over the course of its existence, the ETS has produced considerable fluctuations in emissions prices, but generally has been criticized for prices ending up too low, creating insufficient incentives on industries to reduce emissions accordingly.[9]
The Canadian system achieves emissions prices quite differently. The method for achieving emissions pricing proposed in the Pan Canadian Framework and promulgated with the 2016 Greenhouse Gas Pollution Pricing Act (GGPPA)[10]sets a basement benchmark price for all of its subnational provinces and territories to either match or surpass, using whatever means they choose, whether through a straight carbon taxes or by using market-based trading systems. In contrast to the EU ETS, the structural logic employed here is to rely on market forces (in those provinces that choose to establish a price through a trading system) to achieve an efficient sub-national emissions reductions within a framework that is centrally constrained by a basement emissions price setting. The Canadian federal system does not centrally determine emissions caps like the EU does because the point is not to intervene by controlling scarcity, but rather to set an outer framework for achieving at least a minimal price and then relying on the cost of emissions as the mechanism to structure how emissions are efficiently allocated throughout the economy. While sub-national provinces and territories that choose to set up their own ETSs are entitled to set their own cap and allowance allocation mechanisms to provide sufficient scarcity in order to achieve that price (or higher), unlike the EU Commission, it is not the Federal Government in Ottawa that does this.
Now, one can spend time wondering whether the European or Canadian ETS as they are structured will better achieve behavioural and emissions reduction goals. There is considerable debate in Europe, for instance, about whether or not to include a basement price equivalent (often referred to as an ‘auction reserve price’), while discussions in Canada have debated the value of a single national trading market instead of a sub-nationally variable one. To date, such a study has not been done, but its utility would be limited because the differences between the two systems are quite significant. The question of interest here, however, is not which system works better, but rather why it is that they are different to begin with. The choice of how a given political order will design its ETS to achieve prices is as much a political and structural question as it is a technical and economic one.
The fact that emissions prices in Canada and the EU are achieved through different forms of state intervention to manipulate prices, as well as the different roles and purposes that each system gives to the market to allocate resources and costs reminds us that both are fundamentally market-based regulatory systems, rather than merely emissions markets that are subjected to regulation. This framing nuance is important because whereas the latter suggests that achieving optimal prices should be possible through tinkering with forms of regulatory oversight to get the right fit, the former appreciates how the systems that produce prices are contextually sensitive and structurally determined by the political and legal frameworks in which they are created.[11]
Although Canada and the EU are both forms of federations, the manner by and purposes for which power and legal authority is distributed within each is critically important for understanding why the ETS systems that each designed look the ways they do. The most obvious difference between the two is that the EU ETS is a single system for the whole union, while the Pan Canadian Framework holds together a patchwork of different provincial approaches to pricing emissions, united by a common benchmark price floor. While the EU ETS was originally designed specifically to avoid the prospect of a balkanization of different national emissions trading markets within the union,[12] under the principle of subsidiarity that trading was more effectively done on a union-wide basis,[13] the legal and political logic of Canadian federalism precludes the possibility for the central federal government to construct a single carbon market for the entire country in the same way.
The Canadian form of federalism is based on a series of historical agreements that united British colonial provinces under a single federal government on the condition that provincial autonomy was protected from interference by the centre within certain designated areas of governance, including economic activity.[14] Section 92 of the Constitution Act of 1867 confers jurisdiction to provinces over much of the trade, industry, and resource extraction that are responsible for GHG emissions.[15] It is because of this that it would constitutionally difficult, if not impossible, for the Federal Government in Ottawa to play the same regulatory role that the EU Commission does when it determines emissions quota for Member States. Similarly, because the EU is historically a federal project to create a supranational, liberal, internal market among sovereign Member States, it would face a different constitutional legal challenge if the Commission were to impose a single price floor or benchmark (in EU ETS literature this is often referred to as an ‘auction reserve price’)[16] on the internal market in the way that the GGPPA does in Canada. While some scholars have argued that EU law would be permissive of such an action, they have also reported hesitancy on the part of economists in the Commission to consider it, concerned that if it were interpreted as a fiscal measure then passing it would be politically difficult, requiring a unanimous vote within the European Council.[17] In the absence of a centrally mandated basement price for emissions, however, the early phases of trading in the ETS is generally considered a failure for not producing high enough prices to sufficiently incentivize affected industries to reduce their emissions, helped in large part by giving too much discretion to Member States to freely allocate allowances through their National Allocation Plans (NAP) in ways that created competitive distortions and undesirably large windfall gains for some industries.[18]
Conclusion
The point here is not to argue that comparing ETS systems is not possible, nor that regulatory tinkering with ETS systems cannot be inspired by other examples around the world. Rather, the aim is only to emphasize the challenges that are involved in making comparisons between ETS systems. Indeed, in order for comparisons to be meaningful requires going well beyond technical considerations of economic and regulatory cause and effect. Just because a particular mechanism successfully structures a market in ways that do induce emissions reductions in one place does not necessarily mean that it will be feasible elsewhere.
Understanding the socio-legal embededness of ETS systems is important because if we assume that all of them (both those that currently exist and any future ones) differ in how they are politically, legally, and economically embedded, or, alternatively how the legal, political and economic contexts of each delimit the range of technical options available to their designers to a bounded set of technical options, then this poses certain difficulties when imagining the transplantation of ETS technologies from one place to another.
Furthermore, by viewing ETS systems as sui generis and embedded regulatory systems, rather than as differently regulated markets, one can also appreciate how difficult it will be to achieve any future integration of ETS markets globally, as some have called for.[19] Again, this is not to say that cross jurisdictional integration is impossible, and the case of the Western Climate Initiative that links the ETS markets of the state of California and Quebec proves its feasibility. At the same time, however, any such cross-border integration will require creating new sui generis ETS frameworks, as the EU did in 2003, but which will likely not be possible within Canada on a national scale.
This research is made possible through funding from the Netherlands Research Council NWO under grant number 406.18.RB.004.
[1] Ronald Coase, ‘The Problem of Social Cost’ (1960) 3 Journal of Law and Economics 1
[2] At the time of writing, emissions trading systems exist in a variety of formats and at various states of functionality in: Australia, Canada, China, the European Union, India, Japan (Tokyo), South Korea, the United Kingdom, and the United States.
[3] For example: Rita Sousa and Luís Aguiar-Conraria, ‘Energy and Carbon Prices: A Copmarison of Interactions in the European Union Emissions Trading Scheme and the Western Climate Initiative’ (2015) 6 Carbon Management 129; Erik Haites and others, ‘Experience with Carbon Taxes and Greenhouse Gas Emissions Trading Systems’ (2018) 29 Duke Enviornmental Law & Policy Forum 109
[4] For example: Sean Healy, Katja Schumacher and Wolfgang Eichhammer, ‘Analysis of Carbon Leakage under Phase III of the EU Emissions Trading System: Trading Patterns in the Cement and Aluminium Sectors’ (2018) 11 Energies 1231; Mohamed Amine Boutabba and Sandrine Lardic, ‘EU Emissions Trading Scheme, Competitiveness and Carbon Leakage: New Evidence from Cement and Steel Industries’ (2017) 255 Annals of Operations Research ; Georgia Makridou, Michalis Doumpos and Emilios Galariotis, ‘The Financial Performance of Firms Participating in the EU Emissions Trading Scheme’ (2019) 129 Energy Policy 250
[5] For example: Svante Mandell, ‘The Choice of Multiple or Single Auctions in Emissions Trading’ (2005) 5 Climate Policy 97
[6] For example: Fan-Ping Chiu and others, ‘The Energy Price Equivalence of Carbon Taxes and Emissions Trading – Theory and Evidence’ (2015) 160 Applied Energy 164
[7] Sanja Bogojevic, Emissions Trading Schemes: Markets, States and Law (Hart Publishing 2013)
[8] Armin von Bogdandy, ‘Neither an International Organization Nor a Nation State: The EU as a Supranational Federation’ in Erik Jones, Anand Menon and Stephen Weatherill (eds), The Oxford Handbook of the European Union(Oxford University Press 2012)
[9] For example: Christian Flachsland and others, ‘How to Avoid History Repeating Itself: The Case for an EU Emissions Trading System (EU ETS) Price Floor Revisited’ (2019) 20 Climate Policy 133
[10] Greenhouse Gas Pollution Pricing Act (S.C. 2018, c. 12, s. 186)
[11] Bronwen Morgan and Karen Yeung, An Introduction to Law and Regulation (Cambridge University Press 2012) 4-5
[12] Jonas Meckling, Carbon Coalitions: Business, Climate Politics, and the Rise of Emissions Trading (The MIT Press 2011) 115
[13] Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003
establishing a scheme for greenhouse gas emission allowance trading within the Community and amending Council Directive 96/61/EC, Preamble para 30.
[14] Canadian Western Bank v. Alberta, 2007 SCC 22, [2007] 2 S.C.R. 3
[15] Most notably: ’property and civil rights’ under s. 92(13); non-renewable natural resources under s. 92(A); and for all residual matters of ‘a merely local or private Nature in the Province’ under s. 92(16).
[16] Fischer et al argue that an auction reserve price is not the same as a minimum price in the market. The difference is quite nuanced, however, and for the purposes of this comparison I treat them as functionally equivalent.Carolyn Fischer and others, ‘The Legal and Economic Case for an Auction Reserve Price in the EU Emissions Trading System’ (2020) 26 Columbia Journal of European Law 1, 10 Hintermayer argues, though, that an auction reserve price is not the only design option for a carbon price floor in the EU ETS, noting that other possibilities could include schemes for government buy-backs to prop prices up, or as a top-up tax to bridge differences between market price and a price floor. Martin Hintermayer, ‘A Carbon Price Floor in the Reformed EU ETS: Design Matters!’ (2020) 147 Energy Policy 111905
[17] According to Fischer et al. economies from the Directorate-General for Climate Action (DG CLIMA) are concerned that the price-based nature of an auction reserve price as a basement price would qualify under the terms of Art. 192(2) TFEU as a quasi-tax mechanism “primarily of a fiscal nature” which would require the difficult threshold of a unanimous vote in the European Council to pass. Fischer et al. have argued against this, however, saying that the main purpose of an auction reserve price mechanism would not be to raise revenues but to make the ETS more effective. Fischer and others, 4, 16-20 citing in particular Air Transport Association of America and Others v. Secretary of State for Energy and Climate Change, Case C-366/10. EU:C:2011:637.
[18] Oliver Sartor, Clement Palliere and Stephen Lecourt, ‘Benchmark-Based Allocations in EU ETS Phase 3: an Early Assessment’ (2014) 14 Climate Policy 507
[19] Adam Rose and others, ‘Policy Brief – Achieving Paris Climate Agreement Pledges: Alternative Designs for Linking Emissions Trading Systems’ (2018) 12 Review of Environmental Economics and Policy 170class=WordSection2>
