OECD-CEFIM-IEA Focus Group Discussion: Approaches to Emission Trading System (ETS) schemes in the power sector, 23 November 2021, Paris

1. IEA 2020. All rights reserved.
International approaches to ETS scheme design
in the power sector
Kieran McNamara, Environment and Climate Change Unit, International Energy Agency
IEA/OECD CEFIM International approaches to ETS design, 23 November 2021

2. IEA 2021. All rights reserved.
Role of ETS? What is it designed for and expected to do?
• Role of an emissions trading system? To drive emissions reductions or to provide a
backstop for other policies?
• Ideally, a carbon price would play the central – if not singular – role in driving cost-
effective emissions reductions but in reality the role of the carbon price is limited by three
main factors:
- Governments and regulators face constraints in implementing carbon prices at a level
that would send a strong signal throughout the economy
- Multiple objectives overlap and co-exist with emissions reductions within the energy
transitions agenda
- Market failures make it difficult for a carbon price signal to get through and play the
role it is meant to
• In response, governments develop packages of policies, of which carbon pricing may be
only one (though important) element.

3. IEA 2021. All rights reserved.
The power sector is one of the most covered by ETS around the world
Source: ICAP, 2021

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The ETS and coal-to-gas switching in the EU power sector
Allowance prices are a potential tool to trigger the switch from more carbon-intensive fuels used to
generate electricity - lignite and hard coal - to less carbon-intensive ones, such as natural gas
• The EU ETS has achieved its stated goal of
meeting targeted emissions levels, with a
reduction in emissions from the power sector
playing the biggest role.
• Available evidence suggests that the ETS has
not been the primary driver of emissions
reductions in the sectors that it covers, owing
to the over-allocation of allowances and
resulting weak price signal.
• Nonetheless, the allowance costs have been
high enough to favour coal-to-gas switching in
the power sector before 2011 and since 2016.

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United Kingdom: in combination with complementary policies, a
moderate carbon price can lead to significant shifts in power generation
In the UK, a carbon price of about £23/tCO2 in combination with complementary policies triggered
dramatic changes. However, a necessary condition for this was a liberalised power market.
Source: UK BEIS, 2019
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Historical share of gas and
coal in UK electricity generation
Coal Gas
April 2013
Carbon price support of
£5/tCO2 on top of EU ETS price
introduced
April 2015
Price support doubled and frozen at
£18/tCO2

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California’s cap-and-trade: backstop system alongside other policies
California’s cap-and-trade system is intended as a backstop to other policies that are
expected to deliver the bulk of emissions reductions towards the state’s targets
• These other mitigation policies, however, could underperform relative to expectations. If this case, the
cap-and-trade system acts to ensure that the goal is achieved, by filling the gap in the emissions
reductions over and above what is achieved by the prescriptive measures.
• Since 2009, coal generation for California has declined by over 60%...but the effect of cap-and-trade
(ETS) is generally thought to have been relatively modest compared to other policies, such as
renewable portfolio standards, rooftop solar, emission performance standards
16
25 64
64
217
0
200
400
600
Cumulative GHG reduction
Cumulative GHG Emissions Reduction by Measures (MtCO2)
Short-lived climate
pollutants
Trasnport measures
Energy Efficiency
Cap-and-Trade
Total Reduction goal
622 MtCO2

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RGGI - delivering on policy goals other than reducing CO2 emissions?
• Established a regional cap on CO2 emissions, which sets a limit on the emissions from regulated
power plants within the RGGI states.
• Over time, the regional cap declines, so that CO2 emissions decrease in a planned and predictable
way.
• Fossil-fuel-fired electric power generators with a capacity of 25 MW or greater are required to hold
allowances equal to their CO2 emissions over a three-year control period
• Regulated power plants must acquire one CO2 permit for every tonne of CO2 they emit. Allowances
are distributed at quarterly auctions.
• Certain projects that reduce CO2 and GHG emissions outside of RGGI regulations may be eligible for
awards of offset allowances, may be used by regulated power plants to meet up to 3.3% of
compliance obligations.
• States invest the proceeds from allowance auctions in programmes to improve energy efficiency
and accelerate the deployment of renewable energy technologies.
• Since inception, RGGI emissions have reduced by more than 50%, twice as fast as the United States as
a whole, and raised over USD4 billion to invest into local communities…but the system has had
minimal impact as a direct driver of CO2 emissions reductions.

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ETS and electricity market structures
Ideal world (from a carbon price point of view):
• Free markets: change of the merit order of
electricity dispatch: The ETS increases the
short-term variable cost of fossil fuels (e.g.
coal-fired power plants), which lose positions
in the merit order and their annual operating
hours are reduced in an economic dispatch
model. This results in lower emissions and
reduced profitability of high-emission power
plants.

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ETS and electricity market structures
• Reality; partially or fully regulated markets
- Producers may be constrained in
making investment or generation
decisions, and may face regulated
wholesale and retail electricity prices.
- If electricity prices are highly regulated:
the carbon price signal may not be
visible to consumers.
- The carbon price may have limited
impact on the merit order shift towards
low carbon energy sources.

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Regulated dispatch and retail prices in Korea ETS
• The Korean ETS operates in a free wholesale electricity market
with regulated retail prices:
- The ETS carbon price does not influence the dispatch of
individual power plants - it is not incorporated into the
assessment of direct fuel costs for the power generation
plan
- At the retail level, regulated prices limit the level at which
the ETS carbon price is reflected in electricity prices for the
end user
- KEPCO: to address the inability to pass on wholesale
carbon price fluctuations to end-users, extension of ETS
to cover also indirect emissions associated with
electricity and heat consumption by large industrial users
by increasing the allocation of their emission allowances.

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Conclusions: what can Indonesia learn?
• The power sector is a major source of emissions: policy makers need to assess how carbon price
signals affect potential emissions reductions, including in investment, dispatch, and wholesale and
retail markets.
• An ETS operates most efficiently in markets where the carbon signal can be distributed across all
market players, affecting decisions for power plants and consumers by means of market forces.
• The design of an ETS will be shaped by the structure of the power market. Options available to reflect
and strengthen the carbon price effect, depending on institutional arrangements.
• ETS auctions generate revenues. The challenge for policy makers is how to make best use of these
revenues. These can be used to invest in further climate mitigation action or to address distributional
impacts, such as providing compensation for low-income households.
• Policy makers need to carefully assess interactions between ETS design and other energy-related
policies such air pollution control, renewable energy, energy efficiency, economic restructuring and
power sector reform.
• Ultimately, the practical policy implementation of an ETS in the power sector needs to be designed in a
way that fits with local contexts and integrates with other policy priorities.

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Thanks for your attention!