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Over the Hills and Far Away, Part 2 - Trading Carbon Across the Atlantic

As environmental protection and decarbonization efforts have ramped up in the past few decades, policymakers around the world have come up with a variety of schemes to lower industrial emissions. The Kyoto Protocol in 1997 committed developed nations to reduce their greenhouse gas (GHG) emissions by a defined amount from 1990 levels by 2012. The treaty was never brought up for ratification in the U.S. Senate, which unanimously opposed it because developing nations — such as China — weren’t included. Across the Atlantic, the Kyoto Protocol was received much more favorably, with all 15 members (at the time) of the European Union (EU) ratifying the treaty in 2002. In 2005, the EU launched the Emissions Trading System (ETS) as a mechanism to help reduce emissions from power plants, industrial facilities and commercial aviation, covering nearly half of total EU emissions. In today’s RBN blog, we explain the European cap-and-trade system, examine how the ETS is affecting the EU’s refining industry as a whole, and drill down to the refinery level to discuss disparities in carbon-cost exposure from one refinery to the next.

This is the second part in our series, which dives into the complex world of oil refining and carbon regulation, and how carbon emissions are likely to increasingly impact the competitive playing field for refiners in the Atlantic Basin. In Part 1, we covered the scope of emissions from refining operations (accounting for 3% of overall U.S. GHG emissions) and how refinery complexity and crude slates play a role in emissions intensity. We delved into where those emissions come from within the refinery and some ways to reduce them, and how, due to the nature of refining, the only way to make drastic reductions to emissions was through costly carbon capture and sequestration (CCS). We also touched on some mechanisms governments can take to “nudge” refiners and other emitters to invest in carbon capture and reduce their overall emissions. Today, we dig into one of the three approaches: cap-and-trade.

In a cap-and-trade model such as the EU’s ETS, the government sets a certain threshold on a regulated activity (the “cap”) and then steps the cap down over time. In this case, annual GHG emissions serve as the regulated activity, with the cap falling by a certain amount each year, usually a couple of percentage points, until the specific emissions target is reached. “Allowances” function as carbon credits in the ETS, with each one representing 1 metric ton of carbon dioxide equivalent (MTCO2e) emissions. They are distributed to emitters in various ways (more on that in a bit) and industries covered by the ETS must surrender an EU allowance every year on April 30 for each metric ton of emissions over the previous year. A secondary market is set up so emitters can freely trade allowances with each other to cover any imbalances between an emitter's emissions and allowances on hand — the “trade” component of the scheme.

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