Benchmarks for emissions trading – general principles for emissions scope
As more countries implement carbon pricing mechanisms for industrial emissions, greenhouse gas emission benchmarks have been widely implemented as a policy tool. In particular within emissions trading schemes, benchmarks are used to determine the level of free allocation of permits to sectors at the risk of carbon leakage.
This paper analyses how benchmark designs impact firms’ production decisions and create efficient incentives for production and technology choices. It develops an analytical model and uses the example of a steel mill to analyse and quantify how scope of indirect emissions coverage affect incentives.
This analysis shows that systematically adjusting the scope of emissions in benchmarks, supplemented with a consumption based policy, can establish comprehensive incentives to improve carbon efficiency throughout the value chain. Adjusting the scope of emissions in benchmarks removes adverse effects of outsourcing upstream production and provides an option to cover incremental costs of producing by-products, which can be used as low-carbon substitutes in other production processes.
Harmonizing the scope of emissions coverage in benchmarks across trading schemes will facilitate fair comparisons and cooperation to broaden the basis for setting benchmarks. Moreover, widening the scope of emissions covered in benchmarks expands options for cost effective mitigation whether on-site or off-site.
Key points for decision makers
- Carbon pricing through emissions trading scheme can support the decarbonisation of industry sectors.
- The importance of designing more precise and efficient benchmarks is magnified under output based allocation.
- The research clarifies two main principles for efficient benchmark design, distinguishing where carbon costs are not included in the price of an input or output to a production process; and where carbon costs are internalised.
- The generalized principles for efficient benchmark design that the research propose provide a predictable policy framework for innovation and investment to decarbonize energy intensive industry.
ISSN 2515-5717 (Online) – Grantham Research Institute Working Paper series
ISSN 2515-5709 (Online) – CCCEP Working Paper series