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    Sources of Financing for Global Climate Action

    International auctioning of

    emission allowances (AAUs)

    Q&A and recommendations for the LCA/INF.2 negotiating text

What is international auctioning of emission allowances?

    Norway has proposed a mechanism for generating financing for climate change actions in

    developing countries through auctioning a portion of national emission permits, called

    AAUs1. Currently those countries with caps under the Kyoto Protocol are issued their entire

    allocation of AAUs free of charge. Under Norway’s proposal, instead of receiving all the

    AAUs free of charge, these countries would have a certain percentage of their allocation held

    back by the UNFCCC, and sold in a public auction. The auction would occur at the

    international level before the AAUs are allocated to national registries, and would be handled

    by an international institution. The resulting revenue would then be placed in a fund under the

    authority of the CoP to be accessed by developing countries for climate change actions.

Why is it crucial to get international auctioning included in the Copenhagen agreement?

    Can’t countries just contribute out of their national budgets?

    Because international auctioning of emission allowances, unlike some of the other suggested

    financial sources, has a high potential to generate a substantial amount of financial resources.

    Past experiences with funding for climate change as well as official development assistance

    have shown that developed countries often do not deliver the international financial resources

    they pledge to developing countries, and that international support often gets cut out of

    developed countries’ national budgets in the face of new domestic political and financial

    challenges. The funds mobilized through auctioning will not be in the shape of “donations” or

    “contributions” from developed countries, but in the form of payments for permits to emit

    greenhouse gasses, and would therefore be less politically vulnerable. Building on the AAU

    system also ensures that the financial commitments are directly linked to the same

    compliance mechanism that applies to the mitigation commitments.

1 Parties with commitments under the Kyoto Protocol (Annex B Parties) have accepted targets for limiting or reducing GHG emissions. These targets amount to a 5.2 per cent reduction in GHG

    emissions from 1990 levels over the five-year period 2008-2012.Under the Kyoto Protocol

    participating Annex B Parties are allocated Assignment Amount Units (AAUs), each equivalent to one tonne of CO2 equivalent emission, in an amount equal to the assigned emissions obligation. For

    compliance, at the end of the commitment period, AAUs must be surrendered in an amount equal to

    the actual covered emissions over the period. Annex B Parties that have ratified the Kyoto Protocol can exchange AAUs through emissions trading between nations.

    1

How much finance can international auctioning generate?

    The amount of revenue generated depends on assumptions on emission reduction obligations,

    the percentage of permit allocations auctioned and the carbon market price. Norway has

    estimated, by way of illustration, that auctioning of 2% of AAUs would generate an annual

    income of between 15 and 25 BN USD. Thus by extrapolation, auctioning 10% of permits,

    with a robust carbon price, could generate well in excess of 50-100 BN USD. Such amounts

    depend on ambitious reduction targets by industrialized countries, to ensure a strong carbon

    price. Stamp Out Poverty, a UK development finance campaigning group, estimated that the

    auction of 8% of AAUs would raise $56 billion per year (Spratt 2009). The Catalyst Project

    has calculated that either selling 13% of AAUs at 30 Euros per tonne or levying a 4% per 2tonne charge on 100 percent of AAUs would yield 70 billion Euros (Catalyst Project 2009).

AAU auctioning can be supplemented by other international sources such as aviation and

    maritime mechanisms, a share of proceeds for the flexibility mechanisms or other appropriate

    international levies. Also these international sources can be backed up by binding

    commitments on developed countries to ensure an adequate level of financing for developing

    country climate actions, with the responsibility to provide financial resources from other

    sources, including national budgets, if adequate financing is not available from the above-

    mentioned sources.

Will the amount of resources generated be predictable?

    This is an issue. The amount of revenue raised relative to the level of levy proposed (say 10%) will vary significantly depending on the price achieved at auction. One possible method of

    ensuring predictable funding through the auctioning mechanism is to determine a certain

    revenue requirement rather than a number of AAUs to be auctioned. Many NGOs estimate

    that the total financing needs for developing country adaptation and mitigation actions to be

    at least $160 billion, and potentially much higher. Some portion of this amount (conceivably

    100%, given ambitious reduction targets that result in a high carbon price) could be sourced

    from the auctioning mechanism. The auction would then proceed until the predefined revenue

    requirement is met. The downside of this approach is that the number of AAUs to be

    auctioned would be uncertain. Another option to ensure predictability of funding is to set a

    price floor for AAUs.

    Clearly the predictability and scale of financing generated will be increased by robust targets

    and a strong carbon market with tight limits on offsets. In any case, when assessing the

    predictability of auctioning mechanism, it is important to keep in mind that predictability of

    funding is an issue for other suggested funding mechanisms too. For example, it is very

    uncertain how much of the resources pledged as part of an assessed contribution scheme that

    will actually be delivered by developed countries, and how pledges might change in future

    years.

What will the cost be to industrialized countries?

     2 Pendleton & Retallack (2009) Fairness in Global Climate Change Finance, IPPR

    http://www.boell.de/downloads/ecology/fairness_global_finance.pdf

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    Holding back a share of allowances from distribution in order to auction them implies an additional cost of reducing emissions for participating countries. Each country will incur an economic cost as it implements measures to reduce emissions to the levels committed to under an international agreement. The auctioning will result in an additional cost, because the amount of AAUs issued free of charge is lower than the agreed emissions target, and governments will be required to purchase additional AAUs through the international auction process to receive their full allocation. Governments will be free to allocate revenues from domestic carbon taxes or emissions trading system to finance the purchase of these AAUs. Auctioning a certain percentage creates an additional incentive for emissions reductions. Some countries may consider it less costly to reduce domestic emissions below their agreed target level rather than buying additional AAUs or conversely to increase their emissions by buying additional AAUs.

    What are the political and legal challenges related to implementation of auctioning? This mechanism faces a political hurdle in the initial implementation, but once implemented it is a reliable mechanism to generate financing that is not hostage to individual national budgeting processes. The auctioning mechanism is based on a commercial transaction through which countries acquire a valuable commodity emissions allowances, that are

    legitimately issued by the international community, given that the atmosphere and prevention of dangerous climate change is a global public good.

Is auctioning of allowances an equitable funding mechanism?

    A mechanism for auctioning AAUs would by definition raise funds from those countries with targets, and which are thus issued AAUs. This group of countries currently includes those in Annex B of the Kyoto Protocol, with the exception of the US, but could expand in the future if other countries are included in Annex B, such as newly industrialized countries that meet certain criteria. Within this group there are different national circumstances, income levels and capacity to pay, which could be reflected in a differentiation of the percentage of AAUs that are held back and auctioned. Negotiation of a formula for such a differentiation could be based on an approach like Greenhouse Development Rights.

Does auctioning of allowances generate “public” finance?

    Funds raised from auctioning of AAUs (or from bunker fuel levies or emissions trading, for that matter) and turned over to an international public body such as a fund under the UNFCCC are different from financial flows through the carbon market, where the funds are not raised and allocated by a central public body. Funds raised from auctioning should therefore be considered public funding. Under current rules the purchasers will be national governments, but this may change in the future. But whether the buyers are public or private entities, the funds raised and turned over to a public body become public funds. The source of the public finance will, however, have implications for reliability, predictability and scale of the funds raised, as discussed elsewhere here.

How can auctioning of allowances be implemented?

    The following document discusses how the Norwegian Proposal might be implemented as a part of the Copenhagen Agreement.

    Norway’s Submission on AAU auctioning:

    http://unfccc.int/files/kyoto_protocol/application/pdf/norway270509.pdf

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CCAP Report: Norway’s Proposal to Auction Assigned Amount Units: Implementation

    Options. http://www.ccap.org/index.php?component=news&id=278

How does international auctioning relate to domestic auctioning of emission allowances?

    An important distinction that needs to be recognized between auctioning AAUs at an

    international level, as has been proposed by Norway, and auctioning emission permits at the

    national level. Emission trading at an international level is between nations and governed by

    an international body, while national based systems are governed by individual nations or

    regional groups, with trading of emission permits, in general, at the industry or firm level.

Current proposals advocating the use of emission allowances at the national level to generate

    revenue for international climate action include:

    ? The EU proposal to use revenues from the EU Emissions Trading Scheme (ETS):

    Auction for climate related measures, including adaptation (Germany has already

    implemented such a scheme through its International Climate Initiative); and

    ? The US International Climate Change Adaptation and National Security Fund (under

    the proposed Lieberman-Warner Bill).

Sources related to AAU auctioning:

    UNFCCC Finance-AWGLCA Norway’s Submission on auctioning allowances http://unfccc.int/files/kyoto_protocol/application/pdf/norway_auctioning_allowances.pdf

Murphy, Drexhage & Wooders (2009) International Carbon Market in Post 2012 Climate

    Change Agreement, iisd

    http://www.iisd.org/pdf/2009/international_carbon_market_mechanisms.pdf

    ODI Innovative Carbon-Based Funding for Adaptation http://www.odi.org.uk/resources/download/2527.pdf

Center for Clean Air Policy, 2009 Norway’s Proposal to Auction Assigned Amount Units:

    Implementation Options. http://www.ccap.org/index.php?component=news&id=278

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Textual Recommendation for Non-paper No. 13, Revised Annex IV

    of LCA/INF.2

Para 15, option 2 should be maintained along with the text in appendix 8, which

    should be amended to add the text in bold and underlined below. This text should

    not be linked to any text related to domestic auctioning of allowances, since they are

    separate and distinct approaches.

    Annex 8

1. A mechanism for financing climate change actions by monetizing emission allowances through

    auctioning is hereby established.

    2. This financial mechanism implies that a certain proportion of the total number of emission

    allowances under the Copenhagen Agreement is held back and auctioned at the international level.

    3. The auctioning will generate revenue that shall be used to assist developing countries in

    implementing climate change actions.

    4. Revenue generated by this mechanism will contribute to the fulfillment of financial obligations

    under the Convention of those countries taking on quantified emission reduction commitments.

    The scope of this mechanism is to provide financial resources for

    (a) Adaptation;

    (b) REDD;

    (c) Capacity-building;

    (d) Technology;

    (e) A multilateral insurance mechanism.

5. The Conference of the Parties shall determine the quantity of allowances to be auctioned at its

    [16th] session for the period [2013-2017] to support each financial need referred to in paragraph.

    6. In order to provide predictable funding, the method for determining the quantity to be auctioned

    may factor in price fluctuations in emission allowances. The quantity could be determined on the

    basis of a number of allowances, a fixed percentage of the total amount or a predefined revenue

    requirement or a combination of these methods.

    7. The Conference of the Parties shall adopt further principles, modalities, rules and guidelines for

    the functioning of this financial mechanism at its [16th] session, including adopting procedures

    for the determination of the quantity to be auctioned for subsequent periods.

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