After Paris-2-Path to emission reduction: global Industry carbon emissions benchmarking

Li Jianguang / Deputy Manager, Beijing Design Carbon Co. Ltd. / 2016-01-18

Administrative barriers in individual countries or regions in effect help certain heavy polluters to stay competitive, dampening the global effort for emission reduction. If all countries adopt the same carbon emissions benchmark for the same sector, and if all parties to the Paris Agreement allow their businesses to trade permits across borders, it will not only facilitate emission reduction efforts within a certain industrial sector but also across sectors, improving global emission reduction efficiency.

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On December 12, 2015, the biggest ever climate conference concluded after a 13-day negotiation marathon. A global agreement on the reduction of climate change that may be legally binding was reached. Yet when the hurray and extolment has appeased, the Paris Agreement seems also to be fading from view. Many concerned about climate change cannot help but wonder if the 12-page document with 29 articles is going to make a real difference in the global emission reduction and to hold the global average temperature rise to well below 2 °C, even 1.5 °C above pre-industrial levels. According to the agreement, the global emission reduction target will be achieved through nationally determined contributions submitted by individual countries and through their implementation. For such a scheme to work, countries must achieve their intended nationally determined contributions. Moreover, the sum of the individual countries’ nationally determined contributions must be greater than the global emission reduction target. Yet it remains unsettled how emission reduction targets are to be assigned to reflect the principle of common but differentiated responsibilities, and to be accepted and implemented by all parties without affecting global food production and security.

Necessity of Global Industry Carbon Emissions Benchmarking

Putting aside the question of how individual countries’ emission reduction targets are distributed, even if countries are willing to meet their respective targets, reducing emissions on a national or regional basis is not necessarily the most efficient approach. If different countries have different targets, there may be different benchmarks for the same sector in each country. A cap-and-trade system would not make a big difference if nations or regions set up administrative barriers that deterred global sector carbon emission benchmarks from being adopted. If heavy polluters in a given industry in a country are not effectively eliminated by a carbon trading scheme, then globally the whole sector would still have high levels of emissions. Example 1 is used to expound this.

Example 1: Table 1 below shows that, in Country X, the amount of pollution emitted by Company A is 4 tCO2, lower than the national benchmark of 5.5 tCO2. So in the carbon trade market of Country X, A is allowed to sell 1.5 tCO2 quota, receiving financial reward and incentives to improve productivity. The glitch is, if A is put among its international peers, its weight of pollution is actually above the global sectoral average. Consequently the business should instead buy carbon quota, not sell. Facing increased cost of production, A will have to either reduce production or take energy-saving measures. Therefore it is safe to say that setting up emission reduction targets on a national or regional level actually protects some heavy polluters and raises the global level of carbon emissions in certain sectors.

Let us suppose that Company C and D, both incompetent companies, are eliminated as they exceed their respective domestic benchmark. The carbon emission per unit of product is 4.5 tCO2 in Country X, 3 tCO2 in Country Y and 2 CO2 in Country Z, setting the global average emissions for producing one unit of a product at 3.2 tCO2. Alternatively if we assume that all administrative barriers are abolished and a global benchmark is adopted, then all businesses in X, as well as C and D in Y, will be sifted out. As such, the global average emission for producing one unit of product stands at 2.7 tCO2, 0.5 tCO2 lower than when national or regional targets are in place.

Table 1. Carbon Emissions (tCO2) of Producing One Unit of Undifferentiated Products in Four Countries

Table 1 proves that administrative barriers in individual countries or regions in effect help certain heavy polluters to stay competitive, dampening the global efforts in emission reduction. If all countries adopt the same carbon emission benchmark for the same sector, and if all parties to the Paris Agreement allow their businesses to trade permits across borders, it will not only facilitate emission reduction efforts within a certain industrial sector, but also the efforts will grow to be across sectors, improving global emission reduction efficiency.

Example 2: Table 2 below shows that both A and B emit 7 tCO2 respectively to produce one X and one Y, so the global total carbon emission from producing two Xs and two Ys is 14 tCO2. If we set a universal benchmark for global emission from producing X and Y, then A will stop producing X and B will stop producing Y. Given the demand for the products remains the same, A will have to produce two Ys whereas B will have to produce two Xs. Now global total carbon emission for the production of two Xs and two Ys stands only at 10 tCO2, 4 tCO2 lower than before the benchmark was adopted.

Table 2 Carbon Emissions of Producing One Unit of a Certain Product in Various Countries

Compared to nationally/regionally determined contributions, global sectoral emissions benchmarking can not only reduce the amount of carbon emissions within a sector for producing a certain product (as shown in Example 1), but also remove administrative barriers and spur countries or regions to improve their production modes, bringing down the emissions intensity within a sector. So how do we determine the benchmark in a certain industry sector?

As Graph 1 shows below, in goods production, as the number of goods and the size of production go up, carbon emission for the production of every extra unit of product, like the cost of production, drop first. Emission then goes up when the number of produced goods reaches a certain level, at which the emission for the next unit produced is higher than that for the previous one. A marginal value of N0 is defined at this point. But when a business produces N0 units of goods, the average emissions per unit is not the lowest. The lowest point is reached when it produces N0+Nx units. If, at a known point, emission for producing the (N0+Nx+1)th unit is higher than the average emission per unit for the production of a total of N0+Nx+1 units, then Nx can be determined. N0+Nx thus is the optimal production scale for a business in an economy that controls emission. If a large portion of a business’ cost is for energy, then N0+Nx is also its optimal cost production scale. Carbon emission for a certain sector can be benchmarked based on the sector’s overall emission reduction targets when every business has their optimal production scale established, that is to say, when the average emission per unit of product is at its lowest point.

Graph 1 Relationship Between Product Quantity and Carbon Emissions in Production

Global sectoral carbon emission benchmark enables the establishment of bilateral or multilateral carbon markets across the world with the nationally determined contributions as outlined in the Paris Agreement as their bases. This will prevent the kind of unintegrated, inefficient emission reduction efforts by individual countries and regions we saw after the Kyoto Protocol. Furthermore, setting clear benchmarks provides a form of technical and data support for the assessment of emission reduction cost for different sectors. Under the Clean Development Mechanism (CDM) of the Kyoto Protocol, industries with different emission reduction cost have bought permits at the same price or enjoyed similar quantified emission reduction commitments. Global emission trade will be fairer and more efficient if industry emission benchmarks are widely adopted.

Key to Developing Global Sectoral Emission Benchmarks: Finding A Nash Equilibrium

A truly valuable, stable carbon market that facilitates the global emission reduction efforts by nature cannot be a one-sided market that only favours some players. Even a renewable energy market with all the capital in the world cannot stay stable in the long run. To build a valuable, long-term, and stable global carbon market, the first step is to understand the interests and appeals to all parties, then find a Nash Equilibrium (In the decision-making process to tackle climate change, players are in Nash Equilibrium when the emission quotas are most efficiently distributed and no player can benefit from changing their own reduction targets). Only on such a basis can a global carbon market be established and perfected.

So how can the Nash Equilibrium under the Paris Agreement be found? We can take a look at what led to the failure of the CDM, if history is anything to go by. Parties to the Kyoto Protocol had clear goals. Developed countries wished to cut their own emissions and at the same time help developing countries to do the same by providing funds and transferring technologies. In exchange, developed countries would have fewer or no investment commitments in dealing with the loss brought about by climate change in the future. Developing countries also wished not to be affected by climate change. In this regard, the two sides converged, and the Kyoto Protocol consequently came into being. But the CDM did not help bring down emission from developing countries; the global emission reduction targets were missed. Moreover, developed countries were left in an extremely undesirable situation as they were expected to bankroll the global emission reduction efforts as well as future climate change adaptation. There was no Nash Equilibrium, and the Protocol became a failure.

The Paris Agreement also has a clear goal—— holding the global average temperature rise to well below 2 °C, if not 1.5 °C above pre-industrial levels. To achieve this end, each individual country is required to set an ambitious nationally determined contribution target. But when the realisation of the worldwide goal could mean that some countries cannot maintain normal production levels, every country will strive for low-hanging fruits to protect businesses and interests. Currently the nationally determined contributions submitted are short of meeting the global emission reduction goal, even though the Agreement has emphasised the principle of “common but differentiated responsibilities”, and an approach to adaptation that does not threaten food production. Still, players with their conflicting interests are not in Nash Equilibrium, and a valuable, stable, long-term, and effective global carbon market is not in the offing.

But the problem will be easier to solve if the competition is among businesses rather than countries. First of all, there is not as much at stake for businesses, so competition will be fairer and more rational. In addition, since energy cost is a share of the overall cost of production, all businesses hoped to reduce emission. It is in the interests of all players within one sector to reduce cost of production by increasing efficiency. A Nash Equilibrium is reached when the goal of minimum emissions is achieved by businesses’ pursuing the minimum cost of production.

In the future, it is advisable that a global carbon market or a bilateral/multilateral carbon market to be built depending on the sector emission benchmark. More questions need to be answered, for example, what type of working schemes should be developed to determine permit prices for different sectors; how permits can be traded across sectors; how sector differentiation can be utilised to promote emission reduction programmes that are additional, such as a ventilation air methane abatement programme; and how a sector-wide emission benchmark can be used to determine a sensible and appropriate baseline scenario for individual carbon emission reduction programmes, preventing cheating in emission reduction certification.

To conclude, the Paris Climate Conference has set the global emission reduction goal, the realisation of which depends critically on actual implementation. Currently and for a long time to come, reduction plans and implementation programmes will be developed based on nationally determined contributions. But we hope in the future, a global carbon market based on sector emission benchmarks can be established to phase out national or regional administrative barriers, and to provide a truly efficient platform for global emission reduction efforts. (Hao Guo also contributed to the article)