Roadmap for Implementing a Greenhouse Gas Emissions Trading System in Chile: Core Design Options and Policy Decision-Making Considerations

Motu and partners were contracted by the World Bank through its Partnership for Market Readiness (PMR) initiative to “Draft a proposal for the implementation in Chile of a Greenhouse Gas Emissions Trading System (ETS)”. The specific objective in the terms of reference is to “Propose a detailed roadmap, including its design elements, to inform decision-making for an advanced model of an ETS in Chile”. This is one of a set of four related reports commissioned to assist the Chilean government in preparing its “market readiness proposal” (MRP) for submission to the World Bank. This report is the first step in a process that aims to clarify how an ETS could work in Chile and what the environmental, economic and social impacts would be. This process will allow the Chilean government and key stakeholders to assess, in a more informed way, whether an ETS would be desirable in Chile, as well as the optimal design of an ETS to achieve policy objectives and priorities. Given that Chile intends to move forward with a climate policy, an ETS presents several environmental, economic, and political advantages relative to other instruments, but also some challenges. This report addresses each of the core components of an ETS: sector coverage; point of obligation for regulated sectors; the level of ambition; linking to other markets and use of (domestic and international) offsets; emissions trading phases; and allocation of units. Cost containment, price stabilisation and potential use of border carbon adjustments are not covered in detail in this report. Design options are analysed from a largely conceptual basis, but drawing on lessons learned in operating schemes and taking account of Chile’s national circumstances to the extent of available information, as well as highlighting critical points of divergence in scheme design depending on the underlying policy goals. The design options are brought together in a decision-making framework out of which we identify a smaller number of central options that appear to make the most sense for Chile. Each of the sections on core components identifies issues where Chile-specific research is needed to better inform key design decisions and technical implementation of the scheme ultimately chosen. Research needs for the next phase of policy development are discussed. We conclude with a high-level discussion of process going forward, both in terms of education and learning to enable an informed national debate, and in terms of developing broad (political, industry, and public) support for more serious consideration of an ETS as an option for Chile. Chile could have several overlapping objectives for an ETS: cost-effectively contributing to global emission reductions; lowering the carbon-footprint of Chile’s exports in anticipation of potential trade restrictions against high-emitting countries and products; driving sustainable development including stimulation of new technology; profiting from sales of units to international buyers; generating co-benefits and avoiding perverse outcomes. The balance among objectives will affect design decisions so clarity about their relative weight and their implications for design is useful. There was a clear signal at the Durban climate change conference (2012) that at some point developing countries will be asked to have commitments. Chile will want to be prepared to respond to this. Greenhouse gas (GHG) emissions trading systems evolved out of domestic cap-and-trade systems that control local pollutants. If there were a global GHG agreement with a cap, Chile would simply be one entity within the global cap-and-trade market. Absent a global GHG agreement with a cap, every ETS is a compromise between a system that contributes cost-effectively to global emissions, and a system that protects local interests in an unstable and uncertain world. The greatest strength of emissions trading is that it encourages private actors to use their own knowledge and skill to find the best mitigation actions, including long-term investments. In a perfect world mitigation is done by the myriad of actors who can influence emissions, at the times and in the places where it is lowest cost. Even in an imperfect global market, if it is possible to link emissions markets across countries, linking facilitates cost-effective location of mitigation effort across countries by equalising prices across markets, and is likely to allow Chile to create a more ambitious system without imposing unacceptable costs on its economy as a whole. In the current imperfect world, with an uncertain long-term price and short-term prices that could be quite different from the long-term price, simply linking to the “international price” without further price stabilisation measures would impose risk and volatility on Chile and would not necessarily move it effectively toward a low-carbon economy. Linking to other ETS (as a seller) may also not be feasible in the near term, since the international market rules post-2012 are still under negotiation in the United Nations Framework Convention on Climate Change (UNFCCC) and bilateral agreements outside this framework are still evolving; linking in order to sell units can be a complex process. However, an ETS can benefit Chile even before international ETS linking is possible. It could facilitate financing for a highly credible Nationally Appropriate Mitigation Action (NAMA) or through Reducing Emissions from Deforestation and Degradation (REDD+); send a regulatory and price signal that influences long-lived investment decisions and stimulates new technology development, thus placing Chile on a lower-emission sustainable development pathway; establish Chile as a leader; avoid any negative emissions-related trade repercussions from other countries; generate in-country revenue that can support government policy objectives; and produce additional environmental, economic, and social co-benefits. As international pressure builds for more ambitious global mitigation, Chile will be better prepared to contribute to international climate change agreements and compete effectively in a carbon-constrained global economy. In a world with an agreed global cap-and-trade system, there would be much work involved in designing and negotiating that system, but the domestic implementation would then follow. In our present situation, design involves a series of compromises – essentially domestic negotiations – in terms of the domestic cap, international linking and price control and stabilisation and protection against leakage. The aims when making these compromises are to achieve credibility of emissions reduction effort, a level of carbon price that Chile is comfortable with, and an acceptable overall impact on the Chilean economy. This tension from these compromises arises in each section below. Each offers one or more proposals for specific design decisions. Our final prototype draws on the design considerations specific to each section, and creates a package of coordinated compromises across issues. These are not recommendations but sensible options to consider as starting places for further analysis and discussion among government, researchers, and stakeholders.