Reducing Carbon Emissions in the MENA Region: The Potential of Market-Based Policy Tools
Carbon markets, carbon taxes, and the role of market-based policy instruments in curbing emissions
The past decade has witnessed worldwide pledges to reduce carbon and greenhouse gas (GHG) emissions and achieve net zero by 2050 to align with the Paris Agreement. As such, governments, the public sector, and the private sector all play an important part in fulfilling these commitments.
Carbon markets are carbon emissions trading platforms, where public or private buying and selling of carbon credits is carried out by firms, corporations, or any other entity within different industries that partake in polluting activities. One carbon credit is a certified, tradeable permit that reflects the right to emit one tonne of carbon dioxide or the equivalent quantity in another GHG. There are two types of carbon markets: compliance carbon markets (CCMs); and voluntary carbon markets (VCMs).
CCMs are created by governments and driven by regulatory obligations [1]. The[BB(1] cap-and-trade system, the widely implemented compliance scheme, grants “permits” to listed businesses and industries that give them the right to pollute up to a predetermined limit. To ensure that emissions into the atmosphere are decreasing over time, this limit is periodically lowered. A company will either purchase more permits if it must exceed the cap, or sell its excess permits to other businesses that need them if they do not need to exceed the cap. To permit trade, governments set legislation and industry standards to authorize the buying and selling of carbon credits.
VCMs or voluntary programs, on the other hand, operate outside of the compliance market but allow the same players and private individuals to voluntarily buy carbon offset credits issued by carbon standard organizations, and stored in their registries [2]. A company that purchases a carbon offset has taken steps towards lowering the amount of carbon emissions it had previously or will unavoidably put into the atmosphere through nature-based or technological-based efforts. Once the offset is withdrawn or “retired” from the registry, it can no longer be used or transferred.
Alongside carbon markets, government-imposed carbon taxation requires businesses to pay for each ton of GHG emissions produced from using carbon-based fuels [3], without regard to a set cap. This instrument in particular serves as the main policy for eventually eliminating fossil fuel-based activities as corporations look to switch to cleaner technologies and methods to avoid taxation.
With a price placed on carbon emissions through trading (in carbon markets) or taxation (in carbon taxes), market-based environmental policy instruments serve as a catalyst for financing different types of solutions that complement national-level and corporate-level climate measures, in turn attracting businesses and entrepreneurs to innovate and enabling countries to experience a smooth transition to a net-zero economy.
Global trends, challenges, and opportunities
As reported recently by the World Bank, revenue from carbon pricing in global carbon markets increased by 50% in 2021 compared to levels in 2020, which can be a substantial source of funding for other R&D activities, emerging technologies, and net-zero initiatives [4]. The EU’s CCM, known as the emissions trading system (ETS), has served as the foundation of the EU’s climate strategy and policy since its introduction in 2005. Today, it remains the first largest carbon market, operating in all member states and including thousands of power and industrial plants.
The Clean Energy Business Council (CEBC) spoke briefly with experts from Ernst & Young, our corporate member, about the present carbon pricing policies in the EU/UK and what the MENA region can learn from them. Kasia Klaczynska Lewis, Partner at EY Poland, Head of EY’s Energy & Sustainability Legal Practice, and Leader of EY’s EU Green Deal Center of Excellence, is an international expert on the EU Green Deal and oversees cross-border projects related to decarbonization and sustainability. Jean-Pascal D.H. Boutin, Partner at EY’s Law Energy team, is an experienced law professional and specializes in energy-related regulations, advising on different renewable energy procurement solutions and structures to help ensure businesses’ operations are environmentally friendly.
“It [EU ETS] has been a system that has evolved by design in stages, and it has definitely contributed to significant emission reductions,” said Kasia Lewis on the contribution of the ETS to the EU’s net-zero targets over the past almost two decades. “Because it is a compliance mechanism, it requires companies to achieve decarbonization targets. The number of allowances that are available in circulation both purchased or granted for free, is reduced every year.”
Figure 1. H2 2021 Carbon Pricing in Global Carbon Markets.
Source: S&P Global Platts, Shanghai Environment and Energy Exchange, Korea Exchange.
As for VCMs, both individual and industry-wide schemes have been developed. For instance, the International Air Transport Association (IATA) has established the Carbon Offset Program, an industry-wide scheme for member airline operators who are committed to offset CO2 emissions to fly net-zero by 2050. Jean-Pascal Boutin said that investor pressure and COP26 appear to be two of the main drivers for corporates in the UK to trade in VCMs.
Although the market value of VCMs is now much lower than that of CCMs, it is anticipated that the market will witness a dramatic expansion, reaching a market value of up to 30 billion U.S. dollars in 2030 [5]. However, current obstacles must be overcome to fully realize the promise of VCMs, “We need to see VCMs scaling up in terms of governance, integrity, and legal certainty. Right now, it is a very unregulated space, but the direction of travel is towards greater transparency and integrity,” said Kasia Lewis.
When compared to carbon markets, the price that companies will have to pay for emissions in carbon taxation is considerably clearer and more definite. Nevertheless, Kasia Lewis added that the two strategies are not mutually exclusive, and each have their advantages to emission reduction targets. Policy changes in OECD and G20 countries as a result of COVID-19's impact during the previous two years included price increases [6] for carbon tax systems that were already in place as well as administrative delays [7] for both tax and compliance market schemes. Countries with less ambitious net-zero targets have witnessed policy changes that are unfavorable to climate goals. In general, neither the planned adoption of carbon taxes nor carbon markets in those nations was greatly impacted by the pandemic [8].
Figure 2. Map of Carbon Taxes and Markets
Source: The World Bank 2022 “State and Trends of Carbon Pricing 2022”
A noteworthy development is the ascending application of digital carbon markets, which use distributed ledger technologies, particularly blockchain, to trade carbon offsets. “We are already seeing a number of projects starting to use blockchain, because data is key,” said Jean-Pascal Boutin. Existing carbon-backed cryptocurrencies mainly serve the voluntary carbon market scheme. They contribute to the acceleration of global climate finance by developing a digital infrastructure for tokenizing carbon offsets. Due to their public and immutable nature, digital carbon markets are said to be able to address some of the key issues that the VCM scheme should address, namely high integrity and supply chain transparency [7]. Using digital technologies will help address the monitoring, reporting, and traceability with considerations to the integrity of the traded credits.
Gaining momentum, MENA carbon pricing is becoming a reality
The region’s booming oil and gas industry increases the need for the development of robust carbon emissions reduction projects, with MENA’s GHG emissions per capita reaching 13 tons of CO2 emitted per capita annually [8]. Although carbon taxation is not active or planned in the region, several countries have already executed or are scheduled to implement voluntary carbon market schemes, and more will inevitably investigate the construction of far-reaching carbon markets by leveraging their fully fledged financial infrastructure.
Qatar
MENA’s first and sole voluntary carbon program, Qatar-based Global Carbon Council (GCC), was launched as part of an initiative by the Gulf Organization for Research and Development (GORD) to promote and support carbon reduction efforts. The council works with organizations as a project supporter on emissions reduction measures and establishes a market system between the owners of the projects who can sell their carbon offsets.
Saudi Arabia
Since Saudi Arabia proclaimed its pledge to attain net-zero by 2060 earlier this year, Saudi Arabia’s Public Investment Fund (PIF) and Saudi’s Stock Exchange Tadawul announced signing an agreement with notable partners [9], including the largest oil producer, Aramco, to construct MENA’s VCM and create and trade carbon credits. More partners are expected to be invited to join the agreement, and the establishment of the market is projected to take place in 2023.
United Arab Emirates
The world’s first fully regulated carbon trading exchange under the VCM scheme in the region is also a goal of Abu Dhabi, the capital of the United Arab Emirates. Set to be established by the Abu Dhabi Global Market (ADGM) in partnership with AirCarbon Exchange (ACX), it will enable companies to trade carbon credits similar to other financial assets.
Egypt
Recently, the Egyptian Exchange (EGX) disclosed that it is collaborating with the Ministry of Environment to propose a carbon credit exchange that would allow carbon credits to be sold both domestically and internationally [10].
Direct investments in climate technologies and other adaptation methods are considered an offset measure through which businesses can earn carbon credits. Businesses in the region accordingly stand to gain significantly from carbon markets as MENA has been highly involved in the energy transition. Drawing on existing carbon pricing and emissions reduction measures around the world, the region can benefit from challenges that have been previously encountered. Identifying the stakeholders involved, their roles, and their interactions with each other are essential. More key players besides governments and policy makers include heavy emitters, exchanges, and project developers.
In compliance markets, governments and policymakers must primarily introduce a range of regulatory tools and enforcement mechanisms that urge transparency and compel organizations to commit to reducing emissions and adhering to the necessary standards. In voluntary markets, on the other hand, involved participants need incentives to be encouraged to participate.
Above all, collaboration between the public and private sectors will be key to the effective use of environmental policy tools and the construction of a reliable carbon pricing architecture.
About the Clean Energy Business Council (CEBC):
The Clean Energy Business Council (CEBC) is a non-profit, non-governmental association that brings together leading local and international organizations in the MENA clean energy sector from both the private and public spheres. It is the only clean energy industry group to cover the MENA region.
About EY:
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[BB(1]Should we add quotations on the "cap-and trade" system? [BB(1] [BB(1]