Europe needs to account for the emissions of imported goods. That cannot happen without the international agreement on standards and certification systems for the carbon intensity of all steps in the value chain for all relevant products. Dolf Gielen and Francisco Boshell at IRENA and Massamba Thioye at the UNFCCC explain that several such systems exist around the world, but they need to be harmonised and widely adopted to truly reflect what is happening. It is a matter of urgency, as growing international trade must go hand in hand with the deep decarbonisation of energy intensive industries (think iron, steel, aluminium, chemicals and petrochemicals, building materials including cement, lime, glass, bricks, tiles). Following the European Commission’s proposal for a Carbon Border Adjustment Mechanism (CBAM), the authors summarise the issues and make their recommendations. They cover existing mechanisms like Renewable Energy Certificates, Power Purchase Agreements, GHG Protocol Corporate Accounting and Reporting Standard, Clean Development Mechanism as well as new accounting systems for green gases, and the role digitalisation can play.
The CBAM rationale according to the European Commission
The effort required going forward is much more important than the previous target of a 20% reduction in 2020, compared to 1990 levels (an objective that was already reached in 2018). It implies a much-accelerated emissions reduction in the coming decades.
Such emissions reduction can only be achieved if all sectors are considered.
Energy intensive industries
This includes energy intensive industries. These industries are a source of direct emissions, but they also consume significant amounts of electricity and heat, and they are a source of process emissions (Figure 1). Part of those industries are iron and steel making, aluminium making, the chemical and petrochemical industry, and ceramic materials production including cement, lime, glass, bricks and tiles.
The EU Emissions Trading Scheme (ETS) CO2 price is currently around 50 Euros per tonne of CO2. Having to buy such emission permits can significantly increase the production cost for some sectors. If importers in these sectors do not face the same carbon cost, this can distort competition, reduce competitiveness and increase imports. As a result, greenhouse gas (GHG) emissions could increase elsewhere, so-called carbon leakage, wiping out the GHG mitigation effort in Europe.
To manage that risk of carbon leakage, exposed industries have been so far granted free allowances and compensations for the increase in electricity costs under state aid rules as part of the EU ETS. However, free allocation under the EU scheme weakens the price signal that the system provides for the installations receiving it compared to full auctioning.
Phasing out free allocations
The European Commission has presented a proposal for a Carbon Border Adjustment Mechanism (CBAM) as a means to progressively remove the free allocation while addressing the risk of carbon leakage. Indeed, the impact assessment of the proposal concluded that a 10-year phasing in period starting in 2026, during which the free allocations of allowances under the EU ETS would be gradually phased out by 10 percentage points each year and the CBAM would be phased in, provides clear benefits relative to all other options considered in the proposal.
This policy option ensures a high level of effectiveness for the CBAM and it is expected to add compatibility with World Trade Organisation (WTO) rules. Indeed, free allocation to industry has been identified by some experts as a possible issue for the compatibility of the scheme with WTO. The use of the revenues from the levy has also been identified by some experts as another issue of compatibility with WTO. An UNCTAD report published on 14 July concluded: The CBAM could help avoid “carbon leakage”, but its impact on climate change would be limited – only a 0.1% drop in global CO2 emissions – with higher trade costs for developing countries.
The need for coherent carbon accounting systems
The need to track embodied carbon requires the establishment of methods to calculate it. A standard is required, and a certification system is needed. This is not a unique problem; such standards exist in other areas. Relevant international standards, such as the ISO standard 14040, relate for example to environmental life cycle assessment. Issues related to the allocation of impacts to different products resulting from a single production process, the allocation of emissions related to the production of process inputs such as electricity, and how to credit recycling benefits for materials have been discussed for decades and many methods exist. There is no single “true” approach, it is a matter of convention.
Many accounting systems have been developed in recent years in response to the need to measure climate impacts and mitigation efforts. The issue is that these methods often differ in terms of approach. This means that findings cannot be compared across studies. Also, double counting of benefits occurs where different parties claim the same benefits.
This paper outlines several leading initiatives and their approaches to the allocation issue in the context of the ongoing CBAM discussion.
The CBAM carbon accounting concept
The European Commission has published a proposal for a regulation of the European Parliament and of the council establishing a carbon border adjustment mechanism. According to that proposal, CBAM will initially be applied for cement, electricity, fertilisers, iron and steel, and aluminium and will require importers to buy CBAM certificates that are priced at the same level as ETS certificates. The number of certificates that need to be bought will depend on the volume and the carbon intensity of the imports. Hence, the need for a calculation method for carbon intensity of products.
For a company operating in a specific value-chain, its GHG emissions can be split into scope 1 (direct emissions from the production processes it owns or controls), scope 2 (indirect emissions related to electricity and heat provision) and scope 3 emissions (all indirect emissions not included in scope 2 that occur in the value chain of the company, including both upstream and downstream emissions).
CBAM specifies that for electricity imported in the EU, default values shall be determined based on either specific default values for a third country, group of third countries or region within a third country, or if those values are not available, on EU default values for similar electricity production in the EU. Where no specific default value has been determined for a third country, a group of third countries, or a region within a third country, the default value to be used for the determination of embodied CO2 in imported electricity is the EU CO2 emission factor, which is the EU average CO2 intensity of electricity produced with fossil fuels.
The alternative is to opt for actual emissions for the electricity exported to the EU. If a declarant has a power purchase agreement (PPA) with an electricity producer in a third country, the emission intensity of the delivered electricity can be applied. That CO2 intensity can be applied for the amount generated through the PPA, but for any additional electricity exported to the EU by the declarant, the default applies.
Recycling is not specifically mentioned. The energy and CO2 intensity of recycled aluminium and steel is much lower than for primary material produced from natural resources. Producers in Europe and abroad may opt to use more scrap feedstock to meet the requirements. This represents a potential loophole if only Europe applies such carbon accounting practices for energy-intensive materials and scrap can be imported for recycling, which would reduce the CO2 emissions embedded in Europe’s consumption but increase the carbon footprint of products consumed elsewhere.
Renewable Energy Certificates (REC)
Various standards have been developed to establish the renewable electricity content in supply. As renewable electricity has generally no direct CO2 emissions, the use of renewable electricity is a proxy for the use of CO2-free electricity.
In Europe, Guarantees of Origin (GO) are deployed for renewable electricity tracking and the standard CENELEC 16325 has been developed for GO tracking. Revision of CENELEC 16325 is currently ongoing with the intent to broaden the scope from electricity to gas including hydrogen as well as heating and cooling supply. Also, an international REC standard exists.
Market volumes are significant:
- In Europe, GO totalled 700 TWh in 2019
- In the US, Renewable Energy Certificates (REC) totalled 430 TWh in 2019, including renewable portfolio standards (RPS) and voluntary certificates
- Also, a global REC system has been developed that is deployed elsewhere (18 TWh in 2019)
These numbers can be compared with a total global electricity production on the order of 25,000 TWh per year, so around 5% of all electricity is counted as renewables through these systems.
Power Purchase Agreements
Apart from these accounting systems there are power purchase agreements (PPAs). 23.7 GW of corporate renewable PPAs were concluded in 2020, equal to nearly 9% of total renewable power capacity additions the same year. PPAs have grown significantly in the last three years. Amazon was the most active company, signing 35 PPAs totalling 5.5 GW of capacity. Semiconductor manufacturer TSMC, Total Energies, US telecoms company Verizon, and Facebook rounded out the top five in PPA volume terms.
PPA contracts can be used to prove the renewable nature of supply. However, discussions regarding the diversion of supply remain, even for new installations. For example, server centres in the Netherlands signed PPAs for new wind energy sources that would have otherwise fed into the grid. Similar scarcity issues exist related to hydropower in many places. Also, in situations where grids constitute a bottleneck, this may be a problem. CBAM specifically accounts for this issue.
GHG Protocol Corporate Accounting and Reporting Standard
The GHG Protocol Corporate Accounting and Reporting Standard provides requirements and guidance for companies and other organisations preparing a corporate-level GHG emissions inventory. In 2015, the GHG Protocol released the Scope 2 Guidance: an amendment to the Corporate Standard. This revision included new requirements for accounting for emissions from energy contracts and instruments (such as renewable energy credits) in GHG inventories, as well as eight Scope 2 Quality Criteria that all contractual instruments must meet in order to be considered a reliable data source for the scope 2 market-based method.
Clean Development Mechanism
While there are a few local, regional or bilateral schemes for trading emissions reductions, the Clean Development Mechanism (CDM), under the United Nations Framework Convention on Climate Change (UNFCCC), seems to be a unique, globally recognised and used scheme to issue and trade GHG emission reduction certificates.
The CDM has been developed as a market mechanism to offset emissions through a project-based approach. Since 2001, when the first CDM projects were registered, more than 2 billion Certified Emission Reductions (CERs) have been issued. In the context of the CBAM, and other carbon adjustments schemes with global implications, it might be worth looking into lessons learnt from the CDM concerning, for example, its governance and regulatory approach to ensure the endorsement from countries around the world.
In the CBAM, the GHG emissions embodied are emissions taking place within facilities as their scope 1 and 2 emissions. The CDM is well equipped for the determination of these types of emissions. Notably, the CDM has developed more than 200 standards (methodologies), approved by consensus by an international supervisory Board with a balanced geographical representation, and which have been used to determine GHG emission reductions related to more than 10,000 mitigation activities. Those standards are used to account for carbon emissions related to all type of activities under and in the absence of their implementation, including energy and industries such as cement, steel and iron, aluminium, fertilisers, etc.
Some of the CDM standards address the issue of allocation of GHG emissions where several products are generated by the same process. In the case of mitigation activities related to fuel switch (e.g. replacing diesel or coal with gas), the CDM standards use a Life Cycle Analysis and consider upstream emissions. The CDM has also developed useful tools to address diversion (e.g. diversion of renewable biomass) or to estimate emission intensity from electricity grids.
The CDM governance and regulatory framework can inform the development of a scheme for the determination of embodied CO2 emissions and a consumption-based approach to GHG accounting.
New accounting systems for green gases
With an increased interest in green hydrogen as an important enabler for the decarbonisation of energy demand that cannot be electrified, the discussion around methods to account for and trace the carbon emissions from hydrogen and its derivatives along the whole value chain is becoming more prominent.
For hydrogen, CertifHy is an example of an initiative aiming at an internationally harmonised GO mechanism for green hydrogen. Some industry sectors are also discussing the establishment of carbon certificates for hydrogen derivates. That is the case of Ammonia, with a working group created on the topic under the Ammonia Energy Association. In the context of the International Maritime Organization (IMO) there are discussions on different approaches to account for carbon emissions (tank-to-wake vs well-to-wake) and their implications for the use of e.g. renewable methanol as a low-carbon fuel for the shipping sector.
In addition to green hydrogen, biomethane is another alternative to greening the gas grids. In Europe, REGATRACE is committed to establishing a GO for biomethane and renewable gases.
Role of digitalisation
Carbon accounting and certification schemes require significant safeguards and resources to ensure the integrity of the whole system. That increases the complexity of applying those schemes at a global scale. For complex goods, which require other complex goods as inputs, it could be very challenging to track back the embodied CO2.
There might be a role for digital technologies to play in facilitating the implementation of such schemes. Technologies like Distributed Ledger Technologies (DLTs), e.g. blockchain, are emerging as a solution to automate transactions with carbon certificates, while securing the record of the data and integrity of the whole system. They can facilitate the demonstration of a claim as well as the verification of specific actual embedded CO2 emissions in complex goods produced in given installations of a given supply chain, lower than default values.
There are several initiatives pilot testing the use of DLTs to track embedded CO2 emissions in a supply chain. The International Renewable Energy Agency (IRENA) has also identified at least 10 initiatives using DLTs to issue carbon or renewable energy certificates in real time via smart contracts.
Standards and certification systems for the carbon intensity of products and services represent a critical component of the enabling framework for effective mitigation, particularly where a consumption-based approach to GHG accounting is clearly more relevant: GHG accounting for cities or for individual end-consumers. This brief overview has illustrated that several such systems exist around the world with different but related fields of application. Also highlighted was the fact that these systems are not consistent and there would be a merit to further harmonisation. Also, the development of new standards and systems can benefit from established practices.
Global buy-in is critical for the harmonisation of standards to determine the CO2 embedded in products and this is an urgent matter to unleash transformative climate actions at national, sub-national and end-consumer level. These standards will facilitate the deep decarbonisation of energy-intensive products.
There is a role for international organisations to facilitate the harmonisation of these standards to determine the CO2 embedded in products, critical to any consumption-based approach to GHG accounting. IRENA, with its Collaborative Framework on Green Hydrogen, and the UNFCCC secretariat, with its broad experience as standard setter for mitigation action, can support the harmonisation effort.
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