State of play in international carbon markets 2024
This is the first installment of the Topic on the Month on 'Net zero carbon markets: new frontiers'
On 21 May 2024, the LIFE-COASE project brought together carbon market experts and regulators from around the world, including from the EU, California, Québec, China, New Zealand, Brazil and the UK, at the EUI Climate Week. The panel addressed the current state of international carbon markets and looked at recent developments related to their integration.
ETS landscape: new schemes and raised ambition
The event’s contributions showed that the global landscape of emissions trading systems (ETSs) is evolving rapidly, with new systems under development in advanced and developing economies. Currently, there are 36 ETSs in operation, which put a price on greenhouse gas emissions of around 10 Gt CO2e, equivalent to 18% of global emissions.1 The ETSs in force also generated record revenues of USD 74 billion in 2023.
Many ETSs are currently undergoing fundamental reforms to achieve more ambitious targets, such as the reforms to align the EU ETS with the Fit-for-55 climate package. New Zealand and the UK are also reforming their ETSs to achieve net-zero strategies, while California and Québec have recently launched a comprehensive system review. In addition to the operating systems, there are 22 ETSs in various stages of development. Major new ETSs were for example announced in Japan, Canada, Brazil, India and Türkiye. Among other things, the event focused on developments in Brazil, where the final adoption of the law introducing a new ETS is expected in the coming weeks. The so-called Sistema Brasileiro de Comércio de Emissões de Gases de Efeito Estufa (SBCE) is meant to cover about 15% of Brazil’s total emissions and to become operational in four to five years.
Design challenges for net –zero emissions
Both new and existing ETSs face structural challenges as accelerated emission reductions are essential to meet the Paris Agreement targets. As emissions within ETSs decrease, allowance prices rise due to scarcity, putting high pressure on consumers and hard-to-abate sectors. Regulators must balance maintaining an effective and acceptable price signal with maintaining market liquidity.
Scope expansion
Some jurisdictions are considering expanding the sectoral scope of their ETS, thereby increasing the liquidity of the market and the impact of the scheme on emissions reductions across the economy. An example of this is the extension of the EU ETS to the maritime sector from 2024. In addition, the Chinese national ETS is expected to be extended to new industrial sectors, and New Zealand and the EU are considering introducing a carbon price for emissions from the agricultural sector. More recently, some countries have introduced a separate emissions trading scheme alongside an existing one to cover new sectors, as in the case of the new EU emissions trading scheme for the transport and buildings sectors (EU ETS 2), which will come into force in 2027.
Linking ETSs
Another way to increase liquidity and reduce transaction costs is to link existing compliance markets. Some existing links, such as the one between California and Québec, have proven to be stable and new links are currently being explored. For example, a future link between the EU and UK ETSs remains possible, despite recent divergences in prices and design features. With the launch of the EU ETS 2, a possible link with the EU ETS “1” is also being discussed. In North America, 2024 marks the 15th anniversary of the Regional Greenhouse Gas Initiative (RGGI) and the 10th anniversary of the linking between the markets of California and Québec. Both markets are expected to grow but also face public opposition in potential partner states such as Pennsylvania, North Carolina and Washington.
The results presented at the event showed that many linked systems are successful, as they have proven stable and have achieved record-high prices for emission allowances in recent years. Participants agreed that linking offers major economic and environmental benefits and could even lead to a cost reduction of 40-50% of the current emission reduction pathways, allowing for a doubling of climate ambition. However, it was also emphasised that the overall progress of linking ETSs has been slower than expected, due to the heterogeneity of the systems and a lack of political trust. Participants therefore expressed concern about the increasing political fragmentation and the slow progress of international negotiations under the United Nations Framework Convention on Climate Change (UNFCCC).
More positive reactions were attached to the recently adopted EU environmental tariff on selected imported goods, the Carbon Border Adjustment Mechanism (CBAM). It was mentioned that the CBAM already accelerated ETS development in China and prompted many countries to consider further harmonisation with the EU ETS to avoid tariffs. It was concluded that the aim of designing border mechanisms should be to actively encourage other countries to introduce carbon pricing and to further harmonise existing systems. This could pave the way for concrete linkages between markets in the future.
Offsets and carbon removals
Yet another option for ETSs to ensure that net zero targets are met at an acceptable cost is the integration of credits that are generated in other compliance or voluntary markets. The use of credits for emissions reduction or removal varies significantly across jurisdictions, with some markets allowing a higher share (e.g., Canada, Indonesia) while others severely restricting or excluding their use for compliance (e.g., the EU, Germany, UK). Multilateral efforts are currently ongoing to operationalize cooperative approaches to facilitate the transfer of credits, but the discussion clearly demonstrated that key details remain unresolved after last year’s COP28. The negotiations on the definition of the cooperative approaches, methodologies and processes for carbon removal project development will continue at this year’s COP29. Participants particularly underlined the need for quality assurance of generated credits to maintain the integrity of compliance markets.
Finally, domestic carbon removals, including nature-based and engineered removals, seem to gain attention among ETS regulators. For example, the UK government is considering the option to include engineered removals in its ETS in the future and the EU Parliament and Council reached a provisional agreement on a certification framework for removals this February that could lead to an integration of removals in the EU ETS. However, as with emissions reduction credits, the need for removal credits to be subject to strict certification and monitoring requirements to ensure the additionality and permanence of carbon removals was emphasised.
