Emissions Trading Systems: Trajectories for Development

Across the continent Eurasia, major constituencies such as the EU, China and Russia are forging ahead with their plans to develop an emissions trading system (ETS). The system works by putting a limit on overall emissions which is reduced each year. Within this limit, companies can buy and sell emission allowances – this ‘cap-and-trade’ framework provides companies with the flexibility to cut their emissions in the most cost-effective way. At this stage such systems are segmented globally, but with time there is likely to be greater harmonization in the operation of national and regional ETS systems. The current crisis period may well expedite such harmonization efforts as the ETS in the EU is actively being emulated across the major regions of the world economy, including in China and potentially Russia.

The main progress in developing the ETS framework was achieved by the EU, which launched the EU Emissions Trading System (EU ETS) in 2005 as the key pillar of its strategy for cutting carbon emissions. Today EU ETS is the largest carbon market in the world. The main idea behind the operation of the ETS system is that it allows companies that need to produce additional units of carbon emissions to buy the certificates in the market from those that have surplus certificates. The trading scheme creates the conditions for an efficient distribution of carbon emission quotas, which in turn are continuously reduced, resulting in greater pressure on the economy to de-carbonize.

The Covid crisis appears to have expedited plans to forge ahead with advancing ETS systems as the global community is targeting a green recovery that will prioritize lower emissions and more sustainable growth in the longer term. Such priorities have been outlined both at the level of international organizations (IMF) and individual countries (EU economies).

The importance of ETS systems arises from the fact that this mechanism establishes linkages between the operation of financial markets and climate stability. In effect, it allows for the markets to determine the price of carbon emissions rather than the governments setting the price levels. Perhaps most importantly, the ETS is predicated on companies and governments taking active measures towards establishing transparent procedures to determine the carbon dioxide footprints across companies.

The start of 2021 was marked by significant headway undertaken by China and Russia in advancing their ETS agenda:

Starting from 2011 China has put forward pilot emissions trading platforms in eight cities and provinces, paving the way for a national trading scheme that was unveiled in 2017. The operational phase of China’s ETS began on 1 February 2021, starting with 2,225 entities in the power sector. Entities whose emissions exceed the free allocation will be required to purchase an allowance in the open market. Trading is targeted to begin in mid-2021.

In December 2020, the Russian Ministry of Economic Development together with the government of Sakhalin approved a roadmap aiming the island’s carbon neutrality by 2025. This pilot project envisages development of carbon trading system. In the event of success, Sakhalin ETS may be scaled out to the rest of the country via creating a national ETS framework.

For Russia the introduction of the national ETS system is particularly important given the need to devise its own system of verifiable carbon footprints for corporates that would be recognized abroad. This in turn would allow Russia’s companies to pay their carbon emissions taxes in Russia rather than in the EU. The development of a liquid carbon emissions trading mechanism would also establish additional connections between Russia’s financial markets with global peers.

On the global level, the lack of integration across national and regional ETS systems implies that different regions register varying levels of prices for carbon emissions. In the case of the EU ETS it is now above 50 dollar per tonne. An integrated ETS market across the global economy would allow for greater liquidity in the global ETS system and greater allocative efficiency in the distribution of emissions trading certificates. A major benefit to the global economy would arise from the entry of developing economies into the global ETS system, as this would redound materially to raising environmental standards and their incorporation into the market operations.

Overall, in the past several years we have witnessed a very important shift in the de-carbonization agenda of the world economy as all of the main players have advanced greater ambitions in this area. The US with the coming of the Biden administration re-entered the Paris agreement on climate change, China declared its commitment to achieving carbon neutrality by 2060, the EU has advanced its “Green deal” initiative and is further raising ambitions in advancing the climate agenda. China and Russia starting from this year have exhibited greater ambition in launching their emission trading systems. There appears to be a global consensus shaping up on the need to advance the de-carbonization agenda and the development of ETS systems.

Given these trends, there appears to be sufficient scope to create a platform for bringing the standards in national and regional ETS systems into greater conformity. Environmental concerns as well as greater operability of trading systems may be among the relatively few areas where there is unlikely to be significant divergence in the approaches and aspirations of the global economy’s major heavyweights.

From our partner RIAC

Yaroslav Lissovolik
Yaroslav Lissovolik
Founder, BRICS+ Analytics contact: yl[at]brics-plus-analytics.org