Cap-and-Trade Challenges Addressed

Challenge 1: Lack of reliable emission data for transport

Reliable emission data even in aggregated form is generally not available for a transport sector. Controversies exist not only for the future emissions but even for an emission value in a given past year, called an emission baseline. The estimates for emission baselines vary widely, for international maritime by as much as by a factor of two.
Yet reliable emission data is the major prerequisite for all thus far proposed market-based schemes to reduce emissions (apart from the fuel tax). The crash of the carbon market within the European Union Emission Trading Scheme (EU ETS) in 2006 made the requirement for accurate emission data for cap-and-trade undisputable. One year later the carbon price was about 1% of the level from before the crash.
Risk of starting cap-and-trade schemes without reliable data is very high. Such schemes are useless until accurate information on emissions becomes available. Obtaining accurate information for thousands of small mobile emitters is expensive and can take years to complete. It might even be unrealistic to achieve, due to the cost, commercial sensitivities, and complexity of enforcing such data collection internationally.

Challenge 2: Methodological obstacles

In nearly all attempts, a quantity-based scheme was preferred over a price-based one. The quantity scheme sets the limit on emissions and lets the market decide the price for emissions. The price scheme sets the price for emissions and leaves the market forces to drive down emissions. The quantity-based schemes are often called cap-and-trade, as a quantity emission cap is defined for each participant, emission allowances are allocated or auctioned to participants, and are subsequently traded on emission markets, such as the EU ETS.

huge methodological and political issues to attribute emissions happening over high-seas to countries, or otherwise;
significant difficulties to distribute the emission allowances to participating transport entities within the countries, or similar, in a way that does not change their competitive positions;
administration costs are likely to be high due to the relatively small size and mobility of transport emitters;
scheme coverage is likely to be significantly less than 100% as large number of the smallest emitters below the minimum emission threshold are excluded;
the scheme alone will not materially reduce net emissions in the sector.

For the first issue, it is nearly impossible to obtain international consensus to attribute or allocate emissions from fuels used for international maritime transport (bunker fuels) to countries, routes or flags. The problem is so controversial that international discussions on the methodological issues related to relatively straightforward reporting and calculating of emissions from bunker fuels have stopped for 3 years now. The last time emissions from bunker fuels were discussed was at the 22nd session of UNFCCC Subsidiary Body for Scientific and Technological Advice (SBSTA) in May 2005. Since then the topic has been blocked on five consecutive sessions of SBSTA and informal consultations and other initiatives trying to resolve the deadlock have failed to deliver any progress.
Even if total emissions were allocated to countries, routes or flags, it would be very difficult to distribute fairly the emission allowances, or caps, to participating entities. For instance, a grandfathering approach based on historical emissions will penalize entities that have already become very efficient through previous investments in emission reductions, while rewarding inefficient entities by allocating them relatively high emission quotas. Conversely, benchmarking will have the opposite effect rewarding already efficient participants and penalizing inefficient ones, but could only be implemented if and when a reliable benchmark is created and recognized. Creating a commercially suitable emission benchmark or benchmarks is a great challenge for global shipping due to its complexity, large number of ship types and sizes, and variety of business models. Creating an emission benchmark is further made difficult by the likely opposition from inefficient entities that will oppose providing any performance related data on the ground of commercial sensitivity, or otherwise.
Another major issue is the high transaction costs of cap-and-trade for small emitters, and high administration costs due to large number of them. The cost is increased for complex and dynamic business relationships in transport. For instance, in shipping the fuel costs can be paid by different parties and companies typically operate ships under several flags. Therefore, additional transactions and multiple reporting would be required. There is a risk that for some participants the operational costs could exceed the price of emission allowances themselves, as was the case for small stationery emitters in Europe in 2006 when the emission price was very low. Additional problem is that the greater the additional costs to participants the greater the risk of non-compliance.
Several so called up-stream variants have been discussed to reduce the number of participating entities but none have proved practical yet. They considered regulated entities being fuel suppliers or ship producers. The fuel suppliers could be required to hold emission permits to cover the life-cycle emissions of all the fuel they sell. They could reduce emissions directly by switching to lower-emission fuels or indirectly by buying emission permits from other sectors. The other option would be to regulate ship manufacturers. In such a scheme it would be necessary to estimate the lifetime emissions from ships they sell rather than base regulation on actual emissions. The manufacturers could reduce emission directly by producing more efficient vehicles or indirectly by buying the emission permits.
Scheme coverage and therefore theoretical effectiveness of cap-and-trade for transport will likely be significantly less than 100%. The requirement to participate in cap-and-trade scheme is most often defined by an emission threshold. Emitters with emissions below that threshold are not required to participate in the scheme. For instance, for industrial installations in the EU ETS this participation threshold is set at 10 MtCO2 per annum. If a similar threshold were applied to sea going ships a majority of them will need to be excluded. In practice, the ship participation threshold should actually be higher due to their mobility and increased administration costs when compared with stationery industry installations. This questions effectiveness of such a cap-and-trade scheme.

Challenge 3 - Long-term actions and benefits

The existing approaches focus on current or near-term emission mitigations only. Although the imperative of technology-enabled breakthroughs (transformations) is acknowledged they are politically and financially unattractive as they are decades away in transport. The level of investments that could bring forward the transformations, such as hydrogen transport, are inadequate.

will not materially reduce net emissions in international transport;
will not stimulate the required long-term innovation.

From the outcome point of view the biggest problem is that a cap-and-trade scheme is unlikely to materially reduce net emissions of transport on its own, making the scheme ineffective. The reason stems from the low price elasticity of demand for transport and lower emission reduction costs in other sectors, such as electricity generation.
International transport especially is characterized by low price elasticity of demand. Consequently, insignificant price increases will not materially reduce demand and therefore emissions. It is anticipated that the impact of cap-and-trade schemes on price of transport would be small at around 2%-3%. A weekly fuel price fluctuation is often greater than this margin so the impact of the additional emission costs on demand will be negligible. For instance, in 2007 the cost of bunker fuels has increased by about 60% without any material reduction of demand for international transport.
Even if the price impact is much higher than 3%, net emission reduction attributable to the market scheme will be low. This is caused by two factors. First, transport emission reductions, especially in aviation and in shipping, are much more expensive than in other sectors. It would therefore be more economical to purchase emission credits from the other sectors, such as power generation.

Global warming is a stock gas problem, for instance carbon dioxide stays in the atmosphere for about 100 years. The long-term innovation and technology-enabled breakthroughs, such as hydrogen transport, are therefore critically important if the growth of emissions cannot be significantly reduced for decades, as is the case for international transport. Although the importance of transport breakthroughs is widely acknowledged they seem unattractive to politicians and investors as they are decades away.
One reason for the lack of market-based policy options to stimulate long-term programs is that the significant benefits of bringing forward technological breakthroughs have not yet been quantified for international transport.
A quantitative justification for investing in long-term mitigation is needed, including an assessment of benefits from such investments beyond 2050. Neither such quantifications nor ways to incorporate long-term mitigation in proposed market-based schemes have been found (IMERS proposes its own approach for that).

Challenge 4 - Differentiated priorities

Differentiated country priorities are not reflected in the proposed approaches to address emissions from international transport. Even though that the principle of “Common but differentiated responsibilities” is the cornerstone of the United Nations Framework Convention on Climate Change (UNFCCC).

developed countries are focused on mitigation of climate change;
developing countries are focused on sustainable economic development and adaptation to climate change.

Current financial mechanisms for adaptation to climate change are inadequate in both design and scale

Just one adaptation instrument is directly linked to mitigation activities. It is the 2% levy on Clean Development Mechanism projects of the Kyoto Protocol. It is estimated that the levy will contribute around $80M to $300M annually to the UNFCCC Adaptation Fund in the period 2008-2012. The adaptation needs are estimated at tens of $billions per annum, in the order of 50 times higher than all anticipated contributions.
The impasse in establishing a policy to address the climate impact of international aviation and shipping is often attributed to the nature of the Kyoto Protocol. Under the Protocol only developed countries (called Annex 1 countries) have quantitative emission reduction targets but emissions from international aviation and maritime transport are excluded from the targets. The reality and the problem itself are however, much more complex.
All existing market-based approaches consider the mitigation agenda only. An acceptable market-based solution has not been found after more than a decade of intensive work at the International Civil Aviation Organization (ICAO) and nearly a decade at the International Maritime Organization (IMO).
One cause of this failure is the cross-cutting nature of the issues at hand. The challenges described above are approached typically one by one as separate organizations own them, or parts of them. For instance, methodological aspects of international emissions is the domain of the UNFCCC SBSTA, the adaptation to climate change is the domain of the UNFCCC Subsidiary Body on Implementation (SBI) while the specific measures to reduce emissions for international aviation and shipping rest with ICAO and IMO, respectively. Additionally there is the Ad Hoc Working Group on Further Commitments for Annex 1 Parties under the Kyoto Protocol.
To break the impasse a new radically different, holistic approach is needed that balances interests and concerns of developing and developed countries and also eliminates the methodological challenges of cap-and-trade schemes.

Challenge 5 - Non-GHG impacts of transport emissions

Yet another difficulty is to reflect the complex non-GHG impacts of transport emissions in the GHG cap-and-trade scheme. Transport affects climate in a more complex manner than emissions from industry. Much of the transport climate impact is uncertain and comes from emissions of indirect greenhouse gases not covered by the Kyoto Protocol such as NOx and CO, and direct and indirect effects of aerosols. The aerosols trigger changes in the distribution and properties of clouds, for instance.
The warming impact of aviation is approximately twice of the impact caused by emission of CO2 alone. Shipping on the other hand, is exerting a cooling effect through reduced methane lifetime and atmospheric aerosols, which more than compensate for the warming effect of emitted CO2.
For aviation, some so far unsuccessful proposals have been made to implement a price multiplier within a cap-and-trade to reflect the greater impact of aviation. This approach cannot be used for maritime due to its overall cooling impact. The maritime multiplier would be negative, leading to ships obtaining money for their emissions, negating the entire idea of using cap-and-trade to contribute to overall emission reductions in the economy.

Challenge 6 - Lack of novel integrated approaches

Complexity, scale and separate treatment of the above challenges have inhibited novel integrated approaches that could eliminate rather than solve some of the major issues. Several important individual elements have not been connected by anyone to form a cohesive emission reduction solution so far.

price-based schemes
“no allocation” option for emissions
markets for emission certificates

Price based schemes using emission charges have been overlooked for international transport. Such policy options have become to a certain degree conspicuous by absence in nearly all work performed in Europe in recent years. When mentioned, several authors have questioned political feasibility of emission charges due to their similarities to unpopular taxes. At the same time economists argue that price-based schemes are superior to quantity instruments for GHG mitigation. A recent report from the US Congressional Budget Office also concluded that the net benefits of a GHG tax could be 30% to 34% higher than those resulting from a cap. Specific quantitative conclusions for transport sector have not been found.
In contrast with the abundance of options for cap-and-trade, there are practically no innovative proposals to employ price based schemes. One idea, so called solidarity levies on international air-tickets was proposed by France in 2005 and subsequently implemented nationally by a small number of countries. These countries raise additional funding for development and combating pandemics through a small levy on a travel ticket price, but the levy has no relation to emission reductions.
No innovative proposals to augment price-based schemes with some quantity targets for transport were found. Such targets could make a price based-scheme more politically compelling.
The UNFCCC SBSTA 4 in 1996 considered eight options for allocating GHG emissions from international aviation and shipping. One of them is “no allocation”, which means that emissions are not allocated to countries. This option has not been practically used yet and somehow neglected as a viable route.
Markets for CO2 such as the EU ETS have been created in the last few years and are maturing rapidly. In 2006 1.6 GtCO2 was traded worth $29bn, more than double that of 2005. Volatility of the CO2 price (carbon price) was high but it is expected to be much smaller from 2008 onwards due to better emission data.
Maturing of emission markets creates an opportunity to create innovative emission reduction schemes by linking them to the established carbon price. Such schemes have not been designed and proposed yet. The closest known proposal was to implement an environment tax system in New Zealand linked by value to market carbon price, but that proposal has now been replaced with a trading scheme.