Emissions Trading: Greener pastures

Siàƒ¢n Green

The last round of climate talks did not end on a positive note: two weeks of intensive negotiations between government heads in The Hague over the implementation of the Kyoto Protocol ended in deadlock with little agreement on some fundamental issues.

Figure 1. BP Reduction target to 2010 incorporating growth
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And while the UN Framework Convention on Climate Change (UNFCCC) Secretariat remains positive that progress can be made on Kyoto this year, the efforts to implement a meaningful international policy suffered another blow when US President George W. Bush declined to implement legislation that would curb greenhouse gas emissions from power plants.

This move appeared to contradict a campaign promise made by Bush, and was widely criticized by environmental groups. World Resources Institute (WRI) president Jonathan Lash described it as “a slap in the face to our allies who take climate protection seriously”.

Nevertheless, the USA’s stance on the Kyoto Protocol is well documented: Bush has unequivocally stated that he is against Kyoto because it exempts 80 per cent of the world from compliance, and this would cause serious harm to the US economy. At the last Conference of the Parties (COP-6) in The Hague, the US made clear that it wants carbon sinks to be included in emission reduction targets, and that flexibility mechanisms such as emissions trading are an important tool for fighting global warming.

The US is essentially concerned about the impact of Kyoto on its economy, particularly when the economic might of countries like China and India are excluded from compliance. A lack of flexible mechanisms for reducing emissions will result in high abatement costs, and Bush clearly wants the support of investors and businesses throughout the US before he commits to Kyoto.

But there is already a small faction of the commercial and industrial sector that is looking forwards and facing up to what they feel is inevitable: that carbon is going to be regulated sooner or later. These companies – and there are only a small number of them – are looking at ways to measure and reduce carbon dioxide and other greenhouse gases, and some have gone as far as implementing emission reduction and trading schemes.

Positive links

In October 1998, the WRI announced a collaboration with General Motors, Monsanto and BP to implement a scheme known as ‘Safe Climate, Sound Business’, aimed at promoting within the business community the belief that there is a positive link between climate protection and a sound economy.

“The big companies are implementing these programmes because they believe that carbon is going to be controlled or regulated – they’ll have to do it at some point in the future anyway,” says Nancy Kete, director of WRI’s climate, energy and pollution programme.

“They also believe that the financial future of the company is in better shape if they have managed carbon, as carbon is often associated with inefficient energy use. So the motivation is a mix of concern about climate change, concern that it’s coming anyway, and concern about the bottom line.”

These companies want to find policy options that are flexible and market based, allow least-cost mitigation strategies, and are sensitive to competitiveness issues. One of the companies that has taken this goal the furthest is BP.

Taking the lead

“Our goal is to reduce our emissions of greenhouse gases by ten per cent from a 1990 baseline over the period to 2010,” said BP CEO Sir John Browne in 1998. “In our terms that will now sit alongside our financial targets. That means it is a promise and, as with our financial targets, a promise is a personal commitment.”

Figure 2. BP has implemented an internal cap and trade emissions trading scheme
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By the end of 1999, BP had implemented a system of group-wide emissions trading as a central tool to deliver this target in a cost-effective manner. It is, according to BP, the first global greenhouse emissions trading system of its kind anywhere in the world, and has been operating since January 1, 2000.

Browne’s promise in 1998 entails cutting forecast emissions by some 30 million tonnes across the whole group – including the recent acquisitions of Amoco, Burmah Castrol and Arco. The company launched a pilot trading scheme in September 1998 involving 12 BP business units, but after little more than one year, decided to extend the pilot across the whole company.

By 2005, BP believes that the emissions trading scheme will have achieved a three per cent reduction in emissions from 1995 levels.

Although there is only limited experience of emissions trading in practice, BP believes that it is a highly effective tool for meeting emission targets, particularly for greenhouse gases which have a global impact.

Trading is a market-based mechanism that allows flexibility in compliance as opposed to regulatory or command and control techniques that apply the same standards on everyone. Trading forces companies to look at the options available to reduce emissions in a very quantitative way. The presence of a market also forces companies to ask why competitors are finding lower cost options than they have found themselves.

BP’s emissions trading scheme is based on a cap and trade system in which each business unit – of which there are approximately 150 – is set an emissions target and a basic allocation of allowances which permit the unit to emit greenhouse gases. Each unit must stay within its annual allowance of emissions; if its actual emissions are higher than its total number of allowances for the year then it must buy allowances from the market. Units whose emissions are lower than their allocation can sell allowances.

BP sets an overall annual group cap that moves it towards its 2010 target for emissions and ensures that a real annual reduction is achieved. A grandfathered approach has been taken to set the group cap, with 1998 emissions set as the base year. In addition, the cap is also set to take into account changes within BP: allowances associated with divestments are cancelled, new acquisitions are set allowances and are also faced with reduction targets, but no allowances are allocated for growth in operations.

Each business unit is given allowances based on their actual 1998 emissions, that is, direct emissions from BP assets apportioned according to BP’s equity share in the facility. The annual group cap, less the quantity of allowances banked from the previous year is calculated into an ‘allocation factor’. This allocation factor, applied to each business unit’s 1998 emission, sets the units’ allocations.

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When the allocation process is complete, the business units register their allowances with a central broker, based in BP’s oil trading group, which also registers each trade. Trading takes place throughout the year.

Under its scheme, BP trades both carbon dioxide (CO2) and methane (CH4). CH4 is reported in units of CH4 but is converted to CO2 equivalent units for trading. As CH4 is 21 times stronger than CO2 as a greenhouse gas, a reduction of 1 tonne of CH4 is equivalent to a reduction of 21 tonnes of CO2.

Each unit traded is known as an allowance, and equates to 1 tonne of CO2 equivalent. Each allowance is given a tag, or serial number, that identifies its year and place of origin – factors that would be important if regulation at a national level were implemented.

Compliance to the emissions reduction scheme in BP is ensured through the performance contracts of the individual business unit leaders, who are responsible for meeting their targets on an annual basis. The greenhouse gas performance thus runs alongside their financial performance – and that of the company’s – and progress is reported in the financial performance indicators of the company.

Real reductions

BP has reported that in the first year of the scheme’s operation, 2.7 million tonnes of CO2 equivalent were traded at an average market price of $7.60/tonne. Key learnings from the first year brought the following conclusions and actions for the second year:

  • Business unit allocations should continue to be based upon the grandfathering method with 1998 as the reference year
  • There will be no allocations for business growth but acquisitions and divestitures will modify allocations
  • There will be a mid-year adjustment to allocations to account for final banking and actual emissions figures during the previous year
  • The outsourcing of plant or utilities will be assessed on a case-by-case basis to determine allocation adjustments
  • Options for a futures market will be explored in 2001
  • A taskforce will be established to design a credit-based system and pilots will be conducted, building on a study completed in 2000.

BP has stated that it remains convinced that trading has the potential to help reduce greenhouse gases at least economic cost, and create the right incentives to innovation and investment which cannot be matched by command and control-style regulation or taxation.

The company recognises that its system may have deficiencies, but is planning to continually re-evaluate the system for improvement through dialogue with the business units.

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