Analysis of alternative schemes to finance different emission reduction strategies

REUTERS/ Toru Hanai

Analysis of alternative schemes to finance different emission reduction strategies with special reference to proceeds from post-Kyoto Mechanisms Prepared for The United Nations Development Programme

BY

THOMSON REUTERS POINT CARBON London, 25 November 2013

ACKNOWLEDGEMENTS This report has been prepared by Thomson Reuters Point Carbon as part of the work under the project “Capacity Building for Low Carbon Growth in Ukraine�.

Thomson Reuters Point Carbon is grateful to the Ukrainian State Environmental Investment Agency for the strong support provided throughout the Project.

This project is kindly supported by the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety of Germany.

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ABOUT POINT CARBON Based on research on environmental, energy and resource management politics at the independent Fridtjof Nansen Institute in Norway, Point Carbon was established in 2000 and has since pioneered in providing services in the carbon and energy markets. The company has grown and matured along with the rapidly developing global environmental markets. Starting with an office in Oslo, Point Carbon now has offices established in Beijing, Kyiv, Malmö, London, Washington D.C and Rio de Janeiro. In May 2010, Point Carbon was acquired outright by Thomson Reuters, the world's leading source of intelligent information for businesses and professionals. This acquisition provides access for Point Carbon to a wide range of data and corporate resources that will enhance our services as well as connect us to a wider client and distribution network for our services.

With over 30 000 clients worldwide, Point Carbon is uniquely positioned as the world’s leading provider of independent news, analysis and consulting services for European and global power, gas and carbon markets. Point Carbon’s in-depth knowledge of power, gas and CO2 emissions market dynamics, positions it as the number one supplier of market intelligence. With clients in over 150 countries, including the world’s major energy companies, financial institutions, international organizations and governments, Point Carbon provides its clients with marketmoving information through monitoring fundamental markets, key market players and business and policy developments. Reports are also translated from English into Japanese, Mandarin, Portuguese, Polish, French, Spanish and Russian. Point Carbon presently employs around 200 specialists, including experts on international and regional climate policy and regulations, mathematical and economic modelling, forecasting methodologies, risk management, technical project knowledge and price discovery. Point Carbon also runs a number of high-level networking events, conferences, workshops and training courses.

POINT CARBON ADVISORY Point Carbon Advisory currently numbers around 15 people based in Oslo, London, Washington D.C, Rio de Janeiro and Kyiv. The department delivers bespoke, fully independent consultancy and multi-client studies to governments and companies in all corners of the world. The department capitalizes on Point Carbon’s world class databases, models, networks and teams of highly skilled analysts covering carbon, energy, corporate strategy, finance and economics. These assets uniquely position Point Carbon Advisory to meet clients’ needs for customized and indepth analysis on a wide range of carbon and energy issues. Advisory Services took off as the major provider of bespoke strategic advice by delivering “multi-client studies” on European and global emissions trading back in 2003. The high quality of the work provided by Point Carbon Advisory has been widely recognized internationally.

At the Energy risk awards 2010 it received the Advisory firm of the year award.

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TABLE OF CONTENTS Acknowledgements ........................................................................................................................... 2 Table of Contents............................................................................................................................... 4 Executive Summary ........................................................................................................................... 6 1

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Introduction and backgound ...................................................................................................... 8 1.1

Overview of Post-kyoto market and non-market mechanisms ...................................................................8

1.2

Cross cutting initiatives ..............................................................................................................................11

1.3

Managing the overlaps in the mechanisms ...............................................................................................12

1.4

The Doha Amendment to the Kyoto Protocol and the Durban Platform for Enhanced Action .................13

1.5

Post-Kyoto Finance.....................................................................................................................................14

Strategies to finance different Emission Reduction schemes ................................................... 16 2.1

3

Creation of the Ukrianian low carbon emission fund ................................................................................17

2.1.1

Structure of the fund .............................................................................................................................17

2.1.2

Public Private Partnerships under the Ukrainian Low carbon Emission Fund .......................................18

2.2

Revenue Recycling through tax rebates and thresholds ............................................................................21

2.3

Pre-ETS taxation on GHG emissions ...........................................................................................................21

2.4

Design and implementation of Carbon Market and non-market Mechanisms .........................................22

2.4.1

Carbon market mechanisms ..................................................................................................................23

2.4.2

Non-carbon-market mechanisms ..........................................................................................................24

Financing strategies to reduce emissions from heat and electricity (carbon market mechanisms) 3.1

26

Emission Trading Scheme ...........................................................................................................................26

3.1.1

Implementing an ETS at facility level and utilizing the financing potential ...........................................26

3.1.2

Creating a forward price curve ..............................................................................................................28

3.2

Alternatives to an ETS ................................................................................................................................29

3.2.1

Tax on the consumption of fossil fuels by large point sources ..............................................................29

3.2.2

Feed in tariffs for renewable and low carbon energy ............................................................................29

3.2.3

Renewable portfolio standards with or without renewable obligation certificates (ROCs) or renewable

Energy certificates (RECs) ....................................................................................................................................30

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3.2.4

Energy efficiency standards for power and heat producers ..................................................................31

3.2.5

Legislation on fuel use ...........................................................................................................................31

Financing strategies to reduce GHG emissions from non-heat and non-energy sources (non-carbon market

mechanisms).................................................................................................................................... 32 4.1

National approaches which raise revenues ...............................................................................................33

4.1.1

Tax on CO2 emissions from small and diffuse point sources .................................................................33

4.1.2

Landfill tax ..............................................................................................................................................34

4.1.3

Tax on high GWP feedstock gases .........................................................................................................36

4.1.4

Tax on bunker fuels for national transportation ...................................................................................37 4

4.1.5 4.2 4.2.1

Agricultural and land use, land use change and forestry programmes .................................................39

4.2.2

Standards and labelling schemes ...........................................................................................................41

4.2.3 4.3 4.3.1 4.4

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Education ...............................................................................................................................................41 Localized approaches .................................................................................................................................42 Corporate initiatives and initiatives in Government departments and institutions ..............................42 Policies which can conflict with efficient and effective ETS .......................................................................43

4.4.1

Energy efficiency measures ...................................................................................................................43

4.4.2

Feed in tariffs for renewable energy .....................................................................................................44

4.4.3

Tax breaks for low carbon technology ...................................................................................................44

4.4.4

Monopolies and oligopolies in the energy sector ..................................................................................44

4.4.5

Taxes on fossil fuel consumption in parallel to an ETS ..........................................................................44

4.4.6

Fossil fuel subsidies ................................................................................................................................45

4.4.7

Subsidies for heat, power, transport .....................................................................................................45

Ukraine’s role in the international climate change negotiations .............................................. 46 5.1

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Road tax for vehicles based on engine size / emissions ........................................................................38 National approaches to reducing emissions which need financing ...........................................................39

Financing technology change via the post-Kyoto mechanisms..................................................................46

Conclusion ............................................................................................................................... 48

Appendix 1: Project finance principles ............................................................................................. 50 Appendix 2: Key issues in the design and implementation of an Emissions Trading Scheme............ 51 Key elements of an ETS .......................................................................................................................................51 Allocation procedures .........................................................................................................................................53 Registry, trading and transfer..............................................................................................................................54 Use of offsets.......................................................................................................................................................54 Penalties for non-compliance .............................................................................................................................55 Other issues .........................................................................................................................................................56 Appendix 3: design and implementation of non-carbon market mechanisms.................................. 57 CO2 emissions from small and diffuse point sources (small- and medium size district heating, transport and SMEs) ...................................................................................................................................................................57 Methane emissions from waste ..........................................................................................................................58 Fugitive emissions from oil gas and coal .............................................................................................................59 Emissions from flaring methane..........................................................................................................................60 GHG emissions as by-products of production processes ....................................................................................60 Use of high GWP gases ........................................................................................................................................61 Emissions from agriculture ..................................................................................................................................61 Emissions from land use, land use change and forestry .....................................................................................62 Emissions from bunker fuels ...............................................................................................................................63

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EXECUTIVE SUMMARY This report proposes that the Government of Ukraine firstly establish and then capitalize the “Ukrainian Low Carbon Emission Fund� (ULCEF or the Fund), to create a co-investment vehicle to finance a wide range of policies and measures ranging from public private partnerships to build key low carbon infrastructure and debt and equity services to ETS-captured entities, to grants for R&D, venture capital for innovation and micro-finance for smallscale Ukrainian farmers. The Government of Ukraine will commit funds to ULCEF raised via GHG emission taxes and auction revenues and the fund will be open to external investors offering a range of investment opportunities with commercial returns and / or GHG emission reduction outcomes. The Fund will design a project development function to ensure a strong pipeline of bankable projects is available for investors.

Revenues from taxes and the auction of Ukrainian Allowances will also be redistributed to exposed sectors of Ukrainian society through a newly designed re-distribution mechanism. This is to ensure that the rising cost of Ukrainian Allowances does not result in rising cost of living for low income earners, but instead is revenue neutral to both low income earners and rural communities. At the same time, these policies will encourage investment in recycling and re-usable technologies and discourage natural resource use.

The authors propose that Emission Trading Schemes have been grossly under-valued as a means of raising capital and financing the transition to a low carbon economy, largely as a result of the failure of the Kyoto Protocol and European Union Emission Trading Scheme to create strong price signals for the future. GHG emitting companies which face either falling future allowance prices or uncertain carbon policies cannot make investments in low carbon technology. As a result, both of these schemes have failed to generate sustainable emission reductions.

Ukraine has a real opportunity to be amongst the early successful innovators in the development and implementation of a low carbon strategy by learning from the mistakes of the early movers. In this report, the authors explain how Ukraine can create its own domestic emissions trading scheme capturing large stationary point sources of CO2 emissions, accompanied by a suite of non-market based policies and measures to gain control over all of the remaining sources of GHG emissions from the Ukrainian economy.

The emissions trading scheme, covering approx 74% of Ukraine’s emissions is the chief source of revenue for the financing strategy. Long term policy stability and a rising forward price curve are central to its success. Strong governance at a suitably senior Ministerial level is essential. Initially, compliance with policies and measures may be challenging in the Ukrainian environment, but long term education and awareness-raising activities coupled with engagement at Chief Financial Officer and Board of Director level in ETS captured entities will ensure that companies do not simply view the ETS as another environmental regulation and cost of production, but rather as a finance raising instrument. Linkage to other ETS may be considered, but should only be undertaken if the candidate scheme is similarly successful in using a rising forward price curve to finance the transition to low carbon technology.

The study recommends the introduction of a GHG emissions tax as soon as possible, by requiring emitting entities to purchase Ukrainian Allowances at a fixed rate and surrender allowances equal to a proportion of their annual emissions. After two or three years the tax will transition into an ETS via the auction of allowances and trading.

Emission intensive trade exposed industries will receive a decreasing proportion of their allowances for free, ideally against benchmarks reflecting best practice or best available technology. The Administrators of the scheme will auction allowances with a floor price and the number of available allowances will fall in line with future 6

targets. The Administrators will have the authority to manage the supply of allowances in order to ensure that any surplus is not detrimental to the rising forward price curve, which will enable captured entities to raise finance from the Fund.

The package of measures will trigger significant changes in the Ukrainian economy and drive it towards a less resource intensive and more energy efficient future. The timing for the launch of the fund is ideal – lessons have been learnt from early movers and there is strong international appetite for large scale, low carbon bankable investments. The opportunities exist – Ukraine has many inefficient industries, massively under-developed and out-dated infrastructure combined with a highly educated workforce and a strategic position between Russian and Europe. The Fund will both meet this demand and capitalize upon this opportunity by including a project development function.

Ratification of the Doha Amendment to the Kyoto Protocol would help to send a clear message of a commitment to emission reductions although the strategy will have only just started to bear fruit by 2020. Longer term legally binding commitments will strengthen the policy certainty and reduce risks for investors but even in the absence of a global agreement, Ukraine could design and operate its own ETS and co-investment fund, driving its own policies which ensure the future value of a Ukrainian Allowance.

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1 INTRODUCTION AND BACKGOUND The purpose of this report is to provide an analysis of alternative schemes to finance different emission reduction strategies with reference to the post-Kyoto mechanisms. It is part of a series of reports which will be used to prepare a comprehensive low carbon strategy for consideration by the Government of Ukraine. In order to achieve this objective, the report starts with a description of different emission reduction strategies that may be applied to the various sources of GHGs which are present in Ukraine – this is important because different sources of GHGs need to be managed appropriately if emission reductions are to be achieved with efficiency and effectiveness.

In section 2, the report lays out the five key elements which are critical to the design of the financing strategy.

These include revenue generation from the implementation of GHG emissions tax followed by an Emission Trading Scheme (ETS); the creation and capitalization of the Fund; the redistribution programme; an Emissions trading Scheme for large stationary point sources; and finally a range of additional policies and measures to capture all of the remaining sources which cannot be captured under the ETS. Section 3 explains the design and structure of the ETS and alternatives to an ETS. More details relating to the ETS are presented in Appendix 2.

Section 4 explains how non-carbon-market approaches will capture the remaining sources of GHG emissions under a range of policies and measures, some of which will raise modest amounts of capital and others which will require financing in the form of grants and subsidies.

Sections 5 and 6 provide a brief review of post-Kyoto financing opportunities and short conclusion respectively.

1.1

OVERVIEW OF MECHANISMS

POST-KYOTO

MARKET

AND

NON-MARKET

The primary objective of an emission reduction strategy is to design and implement policies which will result in significant long term reductions in GHG emissions to meet 2050 targets and in the second half of the 21st century, stop emitting fossil based CO2 altogether. With this major task in sight, it is clear that long term, far-reaching policy decisions are required, and the international community already has considerable experience with a wide range of emission reduction strategies designed to tackle different sources of GHG emissions.

In order to identify alternative strategies to reduce emissions GHGs, it may help to consider two broad approaches which reflect both the international post-Kyoto negotiations and a practical approach to reducing emissions.

Broadly speaking, emissions may be divided into two main categories –GHG emissions which can be addressed using carbon market mechanisms and GHG emissions which cannot easily be addressed by carbon markets. The objective of dividing sources into these two groups is that by 2050, Ukraine would be managing all of its sources of GHG emissions under one of the two broad approaches, as suggested in figure 1 below. This approach is consistent with research showing that coverage of global emissions by GHG management strategies and legislation has 1

increased from 45% in 2007 to 67% in 2012 .

1

http://www.tandfonline.com/doi/full/10.1080/14693062.2013.845409#.UmkY3HDksih

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Furthermore, it is estimated that over 40 national and 20 sub-national jurisdictions, in both developed and 2

developing countries, already have or are considering implementing explicit carbon pricing . Together, these countries and regions account for around 21% of the total of 50 GtCO2e that are emitted globally each year. Since these mechanisms usually do not cover all domestic emissions, the effective coverage is reduced to around 7% of global emissions. However, if domestic coverage was extended in developed countries and if emerging economies, including China (beyond its carbon market pilots), Brazil, Chile and others were to go ahead with their planned 2

initiatives, effective coverage could put a price on almost half of global CO 2 emissions .

Total emission of GHGs in 2050

Fossil Fuel emissions from stationary sources (approx 75%)

Market base mechanisms covering all stationary sources of Combustion and process CO2 emissions, via international Caps or New Market Based Mechanism

Non-market based mechanisms Covering CO2 emissions From mobile sources, Forestry and land use, small sources, households etc

Agriculture, Land use , transport and others (approx 25%)

Potential JI projects in disorganized sectors

Figure 1: Two broad categories of GHG emission management activities Source: based on a presentation to the parties on Non-market based approaches by Project Developer Forum available at http://unfccc.int/cooperation_support/market_and_non-market_mechanisms/items/7712.php

This broad classification has some parallels with the terms currently being defined in the international post Kyoto negotiations – New Market Mechanisms (NMM) and Non-Market based Approaches (NMA), both possibly sitting under the Framework of Various Approaches (FVA) and reflects the fact that if sources are not captured by Market Mechanisms than in the absence of any new concept, they must be captured by non-market based approaches.

Dividing Ukraine’s sources of GHG in this manner is helpful because it provides a basis from which to start to analyse different financing options.

2

World Bank (2013), Mapping Carbon Pricing Initiatives: Developments and Prospects 2013, Carbon Finance at the World Bank, Washington DC.

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Market Mechanisms, or perhaps more accurately Carbon Market Mechanisms, create a price for GHG emissions and include Emission Trading Schemes (ETS) covering groups of facilities or one or more sectors of the economy and project based activities in individual facilities or communities. ETS operate on the basis of cap and trade whilst project based activities operate on the basis of baseline and credit.

Emission Trading Schemes work on the basis of allocating an allowance to participants, requiring them to surrender allowances equal to their periodic emissions and enabling them to trade and transfer the allowances.

The allocation process is complex. Over-generous allocation means there will be no demand, insufficient allocation could cause prices to rise and impair economic growth – but much has been learnt from the experiences of the Kyoto Protocol, the UK ETS and the EU ETS. In the context of this discussion, the main points are: a)

Facilities which engage in an ETS must be able to monitor report and verify their GHG emissions with a high degree of accuracy, and in a transparent, comparable (across installations), complete (capturing all relevant sources) and consistent (over time) manner; and b) Governments which implement ETS create a new class of sovereign asset – for example a Ukrainian Allowance, which the market can use to raise capital to finance technology upgrades and other activities which result in lower GHG emissions, but the amount of capital which can be raised is a reflection of investors’ confidence in the long term policy and price signals.

Taken together, these two points can be used to identify a large proportion of the national emission inventory which could be managed and financed through a domestic emissions trading scheme under the carbon market mechanisms.

Sources which cannot monitor, report and verify (MRV) their greenhouse gas emissions in the appropriate manner cannot participate in ETS (because they cannot generate real, permanent emission reductions). Therefore noncarbon-market based approaches must be found to reduce their emissions. Some sectors / sources may be able to change from non-carbon-market approaches to a carbon market mechanism as and when they improve their MRV capacity. Typical sources which are suited to non-carbon-market based approaches include household emissions from fossil fuel consumption for cooking, back-up generators, private vehicles and agricultural sources. These sources are unable to utilize carbon markets as sources of finance and therefore need to be influenced in different ways, for example, through incentives such as subsidies or taxes, awareness raising, the introduction of standards etc. Non-carbon-market based approaches include taxes and subsidies which economists tend to think of as market mechanisms but they are distinct from carbon market mechanisms because they do not create a price for GHG emissions or mechanisms for their trade and transfer.

High GWP gases may be treated under either market or non-market based approaches. Experience has shown that under market based mechanisms, they can be prone to allegations of manipulation and where they impact upon health and safety issues, additional concerns may arise. Alternatively the Government of Ukraine could establish and co-invest in a fund to support investments in low emission projects and include a window for grant based finance to simply fund a small number of end-of-pipe abatement projects.

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This approach is echoed in the recent OECD report which highlights how important it is that Governments develop complimentary and coherent policies across the entire economy in recognition of the fact that not only must st

society reduce its emission massively before 2050, but also that during the second half of the 21 century, we must stop emitting CO2 altogether.

1.2 CROSS CUTTING INITIATIVES There are a number of cross cutting initiatives which can complicate the picture and impact upon the objectives and efficiency of some of the above schemes. Regulations and standard setting in various sectors can have significant impacts, for example: 





The EU ETS was designed to be the flagship policy for the EU’s GHG emission reduction targets however the introduction of renewable energy portfolio standards and the energy efficiency targets have 4 conflicted with the EU ETS such that it has not acted as the main driver of technology change . In fact, a large part of the EU ETS targets can be achieved by the energy efficiency directive, undermining the need 5 for the ETS, but not necessarily giving the right long term signals .

Residential, commercial and public electricity consumption is highly impacted by energy efficiency drives such as, for example, white goods labelling schemes, the introduction of LED and CFL lights to replace incandescent bulbs, transition from cathode ray tube televisions to flat screen LED and LCD technology etc.

The European Directives on Packaging and Packaging Waste, recycling initiatives and food standards have an impact upon waste collection and disposal which in turn impacts upon methane emissions from landfills and dumps.

Actions by different entities can also have cross cutting impacts, for example: 

  

6,7,8

There are a number of City and Mayoral initiatives under which municipal authorities and Mayors are acting to cut GHG emissions from cities, implementing a wide range of initiatives which may cut across broader national initiatives.

Many companies are engaged in their own voluntary GHG reductions programmes seeking either to highlight their performance in Corporate Social Responsibility initiatives and / or cut running costs.

Government departments and institutions are seeking to reduce running costs and avoid being “named and shamed” and as a result may be taking steps to voluntarily reduce emissions.

Individuals and families are also active in reducing their GHG emissions through a wide range of activities triggered by a number of different stimuli including improved education and awareness raising; replacement of domestic equipment with more efficient and newer designs; seeking to reduce running

3 http://www.oecdilibrary.org/docserver/download/5k3z11hjg6r7.pdf?expires=1382953607&id=id&accname=guest&checksum=107BACAA83C6E9EA611901DFF3 97EC2E 4 http://ec.europa.eu/clima/policies/package/ 5 http://www.oxfordenergy.org/wpcms/wp-content/uploads/2011/07/Applying-belt-and-braces-to-EU-energy-policy1.pdf 6 http://www.citymayors.com/environment/greenhouse_gas.html 7 https://www.london.gov.uk/priorities/environment/tackling-climate-change/london-energy-and-greenhouse-gas-inventory 8 http://c40.org/about

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costs (in response to increased energy costs and / or falling incomes in the current economic climate) and / or voluntary actions to reduce carbon footprint.

There is significant interest in boosting these kinds of localized initiatives under Work stream 2 of the Ad Hoc 9

Working Group on the Durban Platform for Enhanced Action with the aim of addressing the mitigation gap 10

between now and 2020, identified in the UNEP Gap Report .

These initiatives draw funding from different sources of finance, for example, through cost savings of the measures themselves; municipal taxes; corporate financing etc. and as a result, can be hard to track. In addition, the reduced emissions may or may not be claimed by the entities which create them but they will also show up in reduced consumption of electricity and reduced emissions from electricity generation or they may be hidden by increases in electricity consumption in other sectors of the economy. The impact of cross cutting measures on other policies and measures must be carefully assessed and managed and as will be discussed in the report, calls for strong crossministry coordination and cooperation.

1.3 MANAGING THE OVERLAPS IN THE MECHANISMS With cross cutting initiatives as well as national efforts implemented in a top down manner, a number of challenges and complexities arise which need to be taken into consideration in planning and designing emission reduction strategies, including;    

Measuring the impacts and particularly any co-benefits of the initiatives Double counting of results and finance – whereby two initiatives claim the same emission reductions or claim to have mobilized the same finance; Competing initiatives which impact upon the efficiency one or both measures; and Conflicting messages or policy signals in a space which calls for long term certainty.

Some of these items are being addressed under the Framework of Various Approaches (FVA) which is currently being defined by the Parties to the UNFCCC. Together with the NMM and NMA, FVA is the third “initiative” arising out of the international negotiations which may help to shape the international response to GHG emissions via the outcome of the 2015 climate agreement and in a post-Kyoto world.

The NMM, NMA and FVA are important because they may help to define parameters against which international finance may be available to countries to help them tackle different types of emissions and provide rules or guidance on how to account for actions and outcomes. So, for example, if the NMM defines how domestic emission trading schemes may be created and used to generate emission reductions for international transfer, then it will be important to ensure that corporate or municipal initiatives are not claiming the same emission reductions or trading and transferring them through voluntary programmes.

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http://unfccc.int/resource/docs/2012/adp1/eng/03.pdf and http://unfccc.int/resource/docs/2013/tp/04.pdf http://www.unep.org/publications/ebooks/emissionsgapreport/

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1.4 THE DOHA AMENDMENT TO THE KYOTO PROTOCOL AND THE DURBAN PLATFORM FOR ENHANCED ACTION The new agreement on post 2020 climate policy is due to be agreed in Paris in Dec 2015 and come into force in 2020. Under this new agreement, all Parties are expected to take some form of legally binding commitment.

Ukraine has already ratified the first commitment period of the Kyoto Protocol and via the Doha Amendment, submitted a target for the second commitment period. This submission demonstrates that politically, the Government is not unwilling or unable to take on an absolute cap in its GHG emissions. This is a very significant political commitment and it is important that this momentum is maintained because, if approached from the correct perspective, a cap can present very significant opportunities to the Government and the economy; thus it should not be considered as a threat. Setting an economy wide cap is an important driver for the implementation of a domestic emissions trading scheme, which itself is a very powerful means of raising finance to fund the upgrading of the energy and industrial sector and bring significant co-benefits to the Ukrainian economy, as we will discuss in this report.

Without an economy wide emissions cap, it is politically very difficult to create an emissions trading scheme. In the United States, for example, President Obama has consistently sought to implement some form of market based mechanism but has been unable to do so because Congress would not ratify the Kyoto Protocol and allow the adoption of a cap on emissions because they believe that it would be detrimental to the competitiveness of the US economy whilst other trading partners are not capped. The result is that California alone is moving forward with an ETS whilst the rest of the country will face regulations under the Clean Air Act administered by the Environmental Protection Agency. Under this approach, US industry will not be able to raise finance on the basis of emission allocations. China and South Korea have so far succeeded in creating ETS in the absence of a formal cap but both countries have significant pledges and significant domestic issues which the schemes can help to address (local air pollution in China and energy security and resources use efficiency in Korea). th

Looking forward, and with the IPCC 5 Assessment Report in mind, it is clear that both developed and developing economies will need to make substantial cuts in GHG emissions and, referring to the Durban Platform for Enhanced Action, these will be legally binding. An absolute cap on economy wide emissions, or on sectors of the economy, is the most likely outcome and countries that have existing caps under the Kyoto Protocol will find it much easier to accept a cap under the Durban Platform. The key point to understand is that a cap is not a threat to the growth of the national economy. Accepting an economy wide cap and translating it into a domestic emissions trading scheme with the potential to link internationally to other schemes is a means of financing low carbon technology on a national scale, with many additional co-benefits. A domestic emissions trading scheme anchored by an internationally binding cap provides the kind of long term policy certainty that creates a future price curve and which investors seek prior to supplying equity and debt to build new plant and production capacity.

In terms of a hierarchy of financial instruments, a legally binding cap on GHG emissions and the ability to create a sovereign asset in the form of a Ukrainian Allowance, is far more advantageous to the economy than, for example, the ability to implement individual project-based activities. For these reasons , this report concludes that it would be to Ukraine’s advantage to continue engagement in the national carbon markets, set long term goals for the continued reduction of GHG emissions and build an internationally linked ETS, covering as much of the domestic economy as possible.

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If Ukraine did ratify the Doha Amendment, how would it meet its target? Approximately 78.5% of Ukraine’s emissions come from the combustion of fossil fuels for the production of electricity and heat. These are stationary sources which are ideally suited to emissions trading. A well designed ETS, learning from the lessons of the EU ETS in particular, and starting with a tax on GHG emissions, could be fully operational by 2018 and with the right political signals, it could be starting to bring about technology change in a way in which the EU ETS has so far failed to do by 2020. Such a tax and ETS would also need to be part of a comprehensive and coherent set of policies implemented within a low carbon development strategy, tackling all sources of GHG emissions in Ukraine. The strategy would need to take into consideration existing commitments, such as those created under the EU’s Energy Community which Ukraine has joined. The tax and subsequent revenues from the sale of Ukrainian Allowances could be used to initially capitalize a fund to invest into both (non-revenue generating) abatement projects and commercially viable infrastructure projects. The tax would transition into an ETS in which an increasing proportion of allowances would be auctioned above a floor price with the revenues continuing to being used for further investments via the fund and to finance a range of revenue recycling measures which would offset increases in the cost of living for certain sectors of society.

1.5 POST-KYOTO FINANCE Ukraine will only be able to benefit from “proceeds from the post-Kyoto mechanisms” under certain circumstances. The current discussions around post-Kyoto mechanisms envisage the creation of new market mechanisms for the international transfer of emission reductions but this must be viewed against the past 10 years experience with international emissions trading, project based mechanisms and the growth of domestic emissions trading schemes. Project based mechanisms such as the CDM and JI award emission reductions against a business as usual baseline. For reasons of international competitiveness, buying Parties such as the EU no longer want to buy emission reductions from producers who do not take on caps and are therefore pushing for the creation of new market mechanisms aimed at sectors of the economy. To all intents and purposes, these are likely to be sectoral emission trading schemes where participants are awarded allowances against a cap and excess allowances can be transferred internationally.

This approach will lead to the creation of linked emission trading schemes. In their recent negotiations with the previous Labour Government in Australia, the EU has clearly indicated their desire to link ETS at the expense of using emission reductions as offsets. Nations with domestic ETS which link will clearly prefer to purchase unlimited amounts of compliance grade allowances from their trading partners (making the selling industries work harder to meet their caps) rather than subsidize their competitors by purchasing emission reductions. When the EU ETS and the Australian CPM announced their intention to link, national allowances were to be fungible, quantitative restrictions on the use of emission reductions from the Australian Carbon Farming initiative were unchanged, but the quantitative restrictions on the use of international offsets fell from 50% to 12.5% of target.

Furthermore, under the Durban Platform negotiations leading up to an agreement in 2015, all countries will have some kind of legal obligation to meet and will become increasingly wary of selling their low cost abatement opportunities to other nations.

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It is highly unlikely that the Parties will favour a return to JI style transactions against national allocations until such time as real scientific based targets, rather than political targets, have been accepted by nations. This also presupposes adoption of a global top down agreement creating fungible units; it is also possible that governments will prefer to set their own independent targets under a patchwork of national actions. Either way, there will be a decreasing number allowances available for transfer.

This report proposes that the future, and access to post-Kyoto financing, lies in creating a carbon price via domestic emission trading schemes, potential inking of domestic emission trading schemes and, as will be explained below, leveraging private sector investment into low carbon technology through the free allocation and auctioning of emission allowances in conjunction with clear, long term policies that create a robust and upward trending forward price curve. Ratification of the Doha Amendment may not be essential to the creation of a forward price curve and access to post-Kyoto financing but it would undoubtedly help because it would mean that any domestic targets were linked to legally binding international targets – which would give added confidence to investors.

It is against this background that this report seeks to identify alternative strategies for reducing GHG emissions in Ukraine and then analyzes different approaches to finance these strategies.

In the following sections we provide an overview of emission reduction strategies for different kinds of sources including emissions from the generation of electricity and heat and emissions from other CO 2 and non-CO2 sources (chapter 2). In chapter 3 the reports presents options for revenue recycling and the creation of the Ukrainian Low Carbon Emission Fund. The report then considers different schemes to finance emission reduction strategies in the heat and energy sectors and other sectors (chapters 4 and 5 respectively). Chapter 6 briefly looks at Ukraine’s role in the international post-Kyoto negotiations and access to post-Kyoto finance and chapter 7 provides a short conclusion.

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2 STRATEGIES TO FINANCE DIFFERENT EMISSION REDUCTION SCHEMES Based on Table 1 below and the description of market and non-market based approaches it is proposed that Ukraine implements both carbon market and non-carbon market approaches at a national level in conjunction with a Government backed co-investment Fund to finance a range of activities and a revenue redistribution mechanism to offset the negative effects of the taxes on exposed sectors of society.

The national priority is to achieve an internationally binding cap on economy wide GHG emissions by spreading emission reduction activities across different sources, raising revenues from taxes on fossil fuels and the auction of Ukrainian Allowances and using some of those revenues to capitalize a co-investment fund to support the costs of emission reduction technologies and practices in other sectors of the economy, and the balance to reduce the costs to disadvantaged sectors of society in a revenue neutral manner. This national priority should also position st

Ukraine to move towards zero carbon emissions in the second half of the 21 century.

Accordingly, it is proposed that the Ukrainian authorities: 1.

2.

3.

4.

Create the Ukrainian Low Carbon Emission Fund (UCLEF or the Fund) to raise and manage capital to finance investment in low carbon technologies. The Fund should be ready to receive the first revenues from GHG emissions taxes and the ETS. Design a redistribution mechanism to protect low income segments of society and exposed communities from the impacts on increased costs of goods and services.

As a precursor to the ETS, require captured entities to purchase allowances at a fixed price and surrender them prior to the transition to an emission trading scheme.

Develop and apply an ETS to:  Large point sources of CO2 from combustion of fossil fuel and process emissions;  Once adequate data is available, consider including large point sources of certain high GWP gases including PFCs and possibly N2O from nitric acid production; and  Once established, consider links with other national ETS, specifically the EU ETS. It is proposed that the ETS would cover approximately 74% of national emissions and the share of the national reduction target to be met via the ETS would be determined based on analysis of marginal abatement cost curves in a quantitative assessment of the Ukrainian economy and GHG emissions.

5.

Develop and apply a range of non-market based approaches to:  CO2 emissions from small and diffuse point sources (residential, commercial and public buildings, transport and SMEs)  Methane emissions from waste  Fugitive emissions from oil gas and coal  GHG emissions from the production and use of HFCs, SF6, NF3  Emissions from agriculture  Emissions from land use, land use change and forestry  Emissions from bunker fuels

.

16

It is also proposed that carbon market and non-carbon-market approaches are prioritized either on the basis of the proportion of national emissions which they cover or, if data is available, the proportion of required emission reductions which they can deliver.

Each of these five elements is described below:

2.1 CREATION OF THE UKRIANIAN LOW CARBON EMISSION FUND The Ukrainian ETS, and its preceding tax, will collect significant revenues from the sale and auction of Ukrainian Allowances and these should be used to finance a transition to a low carbon economy. It is proposed to achieve this goal through the creation of the Ukrainian Low Carbon Emission Fund (ULCEF or the Fund)

2.1.1 Structure of the fund Based on the foregoing discussion, it is clear that there are policies which can act as sources of finance and policies which require finance. In recognition of this fact, it is proposed that the Government of Ukraine establishes a fund to invest in GHG emission reduction activities, for example the Ukrainian Low Carbon Emission Fund (ULCEF or the Fund) and contributes a proportion of the revenues collected from taxes and the ETS into this as a co-investor.

The ULCEF would raise additional finance from regional and multilateral development banks, sovereign wealth funds, possibly the Green Climate Fund and other international climate related sources of finance. The ULCEF would provide a range of different types of financial support through at least seven windows including, but not necessarily limited to: 1.

2.

3.

4.

5.

6.

7.

Equity and concessional debt finance for investments in low carbon technology in the energy sector and manufacturing processes, specifically including low cost / long term finance will help to build renewable energy infrastructure and carbon capture and sequestration and the development of a biomass industry in Ukraine; Equity and debt for Public Private Partnerships (PPP) for the construction of large infrastructure projects in the energy, transport sector and waste management sectors. Due to the scale and long term nature of these activities and their associated emission reductions, PPPs will play an important role in Ukraine’s low carbon future. PPPs are described in more detail below; Venture capital for innovation; Grants for implementation of abatement projects; and non-revenue generating activities in sectors such as agriculture and land-use; Micro finance for the agricultural sector; Grants for research and development and educational and awareness-raising across society; and Adaptation to climate change.

Examples of how and where these funds could be deployed to help entities captured under an ETS and sources of GHG which are not suited to emission trading, are detailed in the following sections.

17

The ULCEF would be run by an independent Board of Trustees who would manage funds on behalf of investors, including the Government of Ukraine. Investment from the Government of Ukraine and the independence of the trustees from the Government are important for providing confidence to external investors.

The Trustees would apportion funds to the different windows above with targets for expected financial returns and also emission reductions. The selection criteria would be designed to ensure that a range of technologies and sectors benefit from the Fund and that it does not simply invest in the least cost abatement opportunities. This is important because, as total emissions decrease, any remaining sources of emissions become more significant and innovation and research and development are required across all sources.

The Fund would specifically seek to build upon Ukraine’s highly technically skilled workforce in order to ensure that Ukraine is well positioned to provide low carbon technology and expertise in the future in areas of, for example, nuclear power, transmission technologies, smart grids and carbon capture and sequestration.

The fund would also support the development and introduction of innovative financial instruments such as the creation and strengthening of Energy Supply Companies providing distributed heat and power generation, energy efficiency and insulation services; first loss and insurance products for energy efficiency projects; results based finance for abatement projects etc.

In order to ensure that there is a ready pipeline of bankable projects, the Fund would support a project development team with the objective of building a pipeline of bankable projects and helping other elements of the Ukrainian economy to do likewise.

The fund would work in close collaboration with the inter-ministerial committee responsible for the implementation of the Emissions Trading Scheme to ensure that there is a good supply of projects coming forward to the fund. For example, the majority of captured entities which are purchasing allowances at auction or receiving allowances via free allocations will at some stage need to invest in low carbon technologies. The Fund will provide debt and equity for such projects.

As a co-investor in the Fund, the Government will have an interest in ensuring that the price of carbon remains sufficiently high to support the Fund’s investments, so whilst the Government will not directly control the price of allowances, they will be encouraged to ensure that other policies do not impact negatively upon the carbon market.

2.1.2 Public Private Partnerships under the Ukrainian Low carbon Emission Fund There is no single, internationally accepted definition of “Public-Private Partnership”, but the World Bank11 takes a broad view of PPP, as: A long-term contract between a private party and a government agency, for providing a public asset or service, in which the private party bears significant risk and management responsibility This definition encompasses PPPs that provide new assets and services, and those for existing assets and services.

It can include PPPs in which the private party is paid entirely by service users, and those in which a government agency makes some or all of the payments. The definition encompasses contracts in many sectors and for many

11

http://www.ppiaf.org/sites/ppiaf.org/files/publication/Public-Private-Partnerships-Reference-Guide.pdf

18

services, provided that there is a public interest in the provision of the service, and that significant risk and management responsibility have been transferred to a private party.

As Governments are increasingly challenged by the demands of expanding urbanization, the rehabilitation of aging infrastructure, and providing services to those lacking or underserved12, so they look increasingly to PPPs to:   

Improve the delivery of services and the operation of infrastructure by tapping the expertise and efficiency of the private sector; Mobilize private capital to speed up the delivery of infrastructure and services and eliminate subsidies; and Enable more efficient use of resources by improving the identification of long-term risks and their allocation, while maintaining affordable tariffs.

PPPs combine the different skills and resources of various partners in innovative ways and allow for the sharing of risks and responsibilities. This ensures governments benefit from the experience and expertise of the private sector, and allows them to focus instead on policy, planning and regulation by delegating administrative and dayto-day operations.

This approach aligns very well with the objectives of an Emission Trading Scheme, which similarly allows the private sector to develop and apply their expertise to find the most efficient ways to reduce emissions.

Combining PPP with ETS creates a power mechanism to finance emission reduction technologies and long term low carbon infrastructure.

PPP is commonly used in developing new infrastructure in the following emission intensive sectors:

Sector Transport

Water and waste

Power

Project Types Roads, tunnels, and bridges.

Rail.

Mass transit systems.

Ports.

Airports Bulk water treatment.

Water distribution and sewerage systems.

Solid waste management services Generation assets.

Distribution systems

Globally, PPP was identified by Ernst and Young in 2011 as one of the top 10 opportunities for major 13

organisations .

12

http://www.ifc.org/wps/wcm/connect/AS_EXT_Content/What+We+Do/Advisory+Services/About+Us/PublicPrivate+Partnerships/Why+PPPs/ 13

http://www.ey.com/Publication/vwLUAssets/The_top_10_risks_and_opportunities_for_global_organizations/$FILE/Business%20Challenge%20 main%20report-%20SCORED.pdf

19

Source: Ernst and Young

The threat of climate change has added a new dimension to the design and implementation of PPP projects in various sectors, including power, transportation, water, sanitation, waste and health. Proactive policy approaches and innovative legal, contractual and commercial frameworks are spearheading a new generation of PPP projects based on clean technologies designed to meet this challenge. International funding institutions such as the IFC are increasingly investing in ‘green PPPs’ such as an innovative rooftop solar project in India where the benefits include: improved energy services at affordable prices with virtually no state subsidies; mobilization of private 14

sector investment; a new long-term (25 years) revenue stream for government . New waste infrastructure in the UK has been developed primarily using a form of PPP over the past 15 years when UK emissions from waste have fallen dramatically.

15

PPP projects are generally financed using project finance arrangements . In project finance, lenders and investors rely either exclusively (“non-recourse” financing) or mainly (“limited recourse” financing) on the cash flow generated by the project to repay their loans and earn a return on their investments. This is in contrast to corporate lending where lenders rely on the strength of the borrower’s balance sheet for their loans. ETS provides a new and additional source of finance through either the sale of un-used emission allowances or the avoided need to purchase. PPP can finance pure abatement projects and projects which install technologies which reduce energy and or raw material costs.

It is important to stress that the project finance structure should be designed to optimise the costs of finance for the project. It should also underpin the allocation of risks between the public and private sectors as agreed in the PPP contract. In particular, the project financing should ensure that financial and other risks are well managed within and between the PPP Company shareholders, sponsors and its financiers. This should give comfort to the Government that the PPP Company and ULCEF are both incentivised and empowered to deal in a timely manner with problems that may occur in the project. Indeed, to a very large extent, the project finance structure should ensure that the interests of the main lenders to the project are aligned with those of the Government – that is, that both need the project to succeed in order to meet their objectives. Where this is the case, the Government

14 15

http://www.ifc.org/wps/wcm/connect/d0a75c804b077348b4acfe888d4159f8/SuccessStories_IndiaGujaratSolar.pdf?MOD=AJPERES http://www.eib.org/epec/g2g/annex/1-project-finance/

20

can be confident that the lenders will take on much of the burden of assuring the ongoing performance of the project. This is a key element of the transfer of risk from the public to the private sector in PPPs. More details on the principles of project finance under the PPP are presented in Appendix 1.

2.2 REVENUE RECYCLING THROUGH TAX REBATES AND THRESHOLDS Raising taxes on energy consumption is a highly regressive action because it increases the cost of living or reduces the quality of life for significant sectors of society, particularly those on low incomes and those living in rural areas.

Other taxation and emission trading scheme, notably the Australian ETS, have taken steps to ensure that whilst taxes increase, rebate mechanisms are deployed to ensure that the consumer is no worse off.

It is proposed that a proportion of funds from emission taxes and the auction of Ukrainian Allowances would also be redistributed to the poorer segments of society. Possible means of achieving this include: a)

Ensuring that infrastructure projects reach rural locations – for example to upgrade district heating plants to burn biomass, creating biomass industries, improving housing infrastructure etc. b) Improving public transport to rural and deprived city areas. c) Introduction of an income tax threshold so that, for example, individuals are not taxed, until, for example, their income exceeds a multiple of the minimum wage. Whilst this also favours higher income earners, the proportional increase for low income earners is greater. This approach was applied in the Australian Carbon Pricing Mechanism, taking approx 1 million low income earners out of the tax bracket.

These measures put money back into the pocket of the consumer who will ultimately pay for any costs which producers choose to pass on to domestic markets, and or increase the quality of life for low income earners and rural communities. At the same time, tax cuts can have a stimulating effect on the local economy by increasing the amount of money that individuals have to spend.

2.3 PRE-ETS TAXATION ON GHG EMISSIONS Ukraine already levies an eco-tax or local air pollution tax on registered point sources. Currently the level of tax on GHG emissions is very small and not related to the global warming potential of the gases. In order to prepare industry for an emissions trading scheme, and in order to start to raise some revenues to capitalize the Fund, it is proposed that the Ukrainian ETS starts with a non-trading phase where participants are required to purchase Ukrainian Allowances equal to a proportion of their annual emissions and surrender those at the end of each annual reporting period. The price of allowances would be fixed and there would be no trading of allowances permitted. Under this design, the first phase would effectively be a tax on GHG emissions. This is similar to start-up phase of the Australian Carbon Pricing Mechanism.

The advantages of starting in this way are several; 1) It immediately raises awareness amongst participants that GHG emissions are being regulated.

Anticipating a degree of non-compliance, this means that companies have several years to comply

21

before the trading phase of the ETS starts, by which time all captured entities are expected to be aware of their responsibilities; 2) It introduces the concept of acquiring and surrendering Ukrainian Allowances ahead of the time when companies can trade them, giving them time to understand the implications and consequences of the forthcoming trading scheme; 3) The revenues from the sale of Ukrainian Allowances can be used to capitalize the Fund.

The existing local air pollution tax is relatively insignificant and could be left in place or the GHG elements under it could be zero rated.

2.4 DESIGN AND IMPLEMENTATION OF CARBON MARKET AND NONMARKET MECHANISMS Table 1 below shows how different sources might be treated under carbon and non-carbon market approaches.

These strategies and difference approaches to their finance form the basis of this report: Table 1: Matrix of sources and alternative approaches to management and finance Sources

GHG

Carbon market mechanisms

Non-carbon-market

based

approaches Energy Supply Electricity and heat

CO2

Ideally suited to ETS.

Renewable

portfolio

Renewable schemes;

standards;

obligation tax;

regulation;

trading energy

efficiency standards; feed in tariffs Fugitive

emissions

N2O

National emission standards

CH4

Regulation

from oil, gas and

and

performance

standards

coal Energy Consumption Residential, commercial

CO2

Tax on fossil fuels, performance

and

standards, regulation

public Industry

CO2

Large point sources are suited

Small point sources may be taxed

to ETS Transport Transport

energy

CO2

supply

Energy

consumption

in

production of bio-fuels to be

Smaller sources may be addressed through tax on fossil fuels

included in ETS if sources are large enough Transport

energy

CO2

Performance standards for vehicles;

demand

tax on fossil fuels; promotion of bio22

fuel; removal of fossil fuel subsidies Non Energy Sectors Industrial processes

CO2

Although there is limited scope

Recycling initiatives

to reduce from this source, may be easier to include in ETS Non-CO2

Include in ETS if allocation is by

Best addressed through regulation or

GHGs

auction

(HFC,

against

SF6,

baseline

N2O,

Technology

or or

grandfathering

tax on by-product / waste emissions

post-abatement

with financial support for abatement;

Best

and a tax on the purchase of specialist

Available

gases

PFCs) Waste

CH4

Feed in tariff for landfill gas to energy; Regulation on methane emissions from landfill funded through landfill tax

Agriculture

N2O and

Feed in tariff for biomass and biogas

CH4

to

energy;

Awareness

raising,

performance

standards,

product

certification LULUCF

CO2

Feed in tariff for biomass to energy; Awareness

raising,

performance

standards, product certification Bunker fuels Aviation and marine

CO2

bunker fuels

ETS may cover domestic fleets

Tax on fossil fuels for smaller sources

and domestic emissions if large enough

2.4.1 Carbon market mechanisms In the context of this report and the post Kyoto Mechanisms, Carbon Market Mechanisms are designed to generate emission reductions which can be transferred internationally. This includes Emission Trading Schemes which can either accumulate excess allowances which can be traded ex-post or linking of schemes which enables allowances to be traded ex-ante.

Smaller and less ambitions initiatives may include sectoral schemes which are currently being defined, but are likely to be smaller emission trading schemes where allocations could be based on CDM and JI baseline methodologies and standardized baselines or country specific allocation procedures.

23

There are a number of objectives behind the creation of an Emissions Trading Scheme which go beyond simply 16

complying with a cap . These include the following, in no particular order:  

  

To create a sovereign asset that may be used to raise finance for technology change and economic growth; To achieve or beat an absolute cap in emissions by triggering change in favour of low carbon technology and low carbon energy in a cost efficient manner by using market forces to identify least cost abatement opportunities; To protect emissions intensive trade exposed (EITE) industries from international competition which operates in the absence of emission caps; To create a long term price signal by providing sufficient political certainty in the future of the ETS and demand for allowances; To generate a wide range of co-benefits for Ukrainian society including job creation, innovation, research and development, attractive investment opportunities etc.

Long term certainty is the single most important element in the success of the ETS and if there is any suggestion that the Government is not fully behind the initiative, then long term certainty will be undermined and the value of the sovereign assets will fall. To create and maintain certainty, key institutional infrastructure is required. The sectors and sources of GHG emissions which are suited to a market based approach are listed in Table 1 above.

Aspects of the design and implementation of an Emission Trading Scheme are further described in Appendix 2.

2.4.2 Non-carbon-market mechanisms As explained in the introduction, non-carbon market mechanisms are the kind of instruments which need to be applied to sources of gases which cannot be covered under market mechanisms. Together carbon market and noncarbon market mechanisms ultimately need to cover 100% of the sources of GHG emissions.

Non-carbon-market mechanisms must eventually capture all sources of GHG emissions which cannot be addressed under a carbon market mechanism such as an ETS. Some sources may start under the non-carbon market mechanism and through the improvement of MRV procedures, ‘graduate’ to the carbon market mechanism.

Inclusion in the carbon market mechanism is preferable because it offers participants the chance to profit by exploiting individual circumstances to reduce emissions further and greater flexibility to raise finance on the back of allowances. Non-carbon market mechanisms cannot provide these benefits and finance must be raised through the use of grants and subsidies or reductions in tax. In many cases, taxed entities may simply choose to pass the costs on to consumers.

However, there is already a wide body of experience with policies and measures designed to change behaviour and many of these can be applied to all of the sources of GHGs which are not covered by market mechanisms. For example, grants and subsidies can be utilized to change behaviour in favour of low carbon or energy efficient technologies whilst taxes can be applied to make carbon emitting technologies increasingly expensive. Training, awareness raising and educational programmes throughout society can help to change behaviour in the long term,

16

See for example the “Purpose of the Commission proposal” for creation of the EU ETA available here http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2003:0463:FIN:EN:PDF

24

starting with children’s education if necessary. The development and introduction of performance and design standards can gradually effect change throughout the built environment. The sources and sector of the economy which are suited to non-carbon-market approaches are listed in table 1.

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3 FINANCING STRATEGIES TO REDUCE EMISSIONS FROM HEAT AND ELECTRICITY (CARBON MARKET MECHANISMS) Carbon market mechanisms have the potential to be self financing because they create value by monetizing a newly created sovereign asset. As such they do not need external financing, however if used correctly, they can also create significant additional flows of finance to pay for non-carbon market activities.

If allowances are distributed for free, then there will be no revenue collected but captured entities receive valuable assets for free and can leverage those assets to raise capital; if and when allowances are auctioned or sold, significant revenues will accrue, some of which will need to be redistributed to overcome of the regressive impact of the ETS, as described above.

Running costs are not insignificant for either the regulatory authority or the captured entities. The regulatory authority’s costs could be recovered via a tax on transactions of allowances or fees (UK government recovers the 17

costs by charging fees for various services provided under the EU ETS ) whilst captured facilities are likely to pass the administrative costs on to customers or include them their general costs of management.

The alternatives to a carbon market mechanism for the heat and electricity sector would include a combination of the following measures:     

Tax on the consumption of fossil fuels Feed-in tariffs for renewable and low carbon energy (note, Ukraine recently introduced feed in tariffs for 18 renewable energy) Renewable portfolio standards with or without renewable obligation certificates (ROCs) or renewable Energy certificates (RECs) Energy efficiency standards for power and heat producers Legislation on fuel use

Together these policies may cover the same sources as an ETS but the main disadvantage is that they do not provide captured entities with either flexibility as to how they comply or progressive opportunities to finance a transition to a low carbon technology. Each option will be discussed in more detail below.

3.1 EMISSION TRADING SCHEME 3.1.1 Implementing an ETS at facility level and utilizing the financing potential It is critically important that facility operators who participate in an ETS see it as a financing opportunity and not another round of environmental regulation designed to increase the cost of production and generate revenues for Government. Entities which see it as an opportunity will be more open to using a free allocation to raise capital to invest in new plant. Entities which view it as another piece of environmental regulation will be more likely to manage it on a short term basis as a cost of production. For this reason it is important that the outreach, 17 18

http://www.environment-agency.gov.uk/business/regulation/38817.aspx http://www.iea.org/policiesandmeasures/pams/ukraine/name,38470,en.php

26

awareness raising and training programmes provide the right kinds of information to the correct members of the management team.

For example, a notional facility emits on average 1 million tonnes of CO 2 from the combustion of fossil fuels each year. The facility could implement process efficiency changes such as installation of variable frequency drives, insulation, heat recovery units and recycling, all with a lead time of 1 year, at a cost of EUR 5 million which would deliver savings of 250,000 tonnes of CO2 emissions per year, reducing their fuel bills by 25% at the same time. Prior to the introduction of the ETS, this is not a financially attractive option because fuel is relatively cheap and debt is relatively expensive. On commencing the ETS, the installation receives notification that it will receive a free allocation of 900,000 allowances, decreasing by 2% per annum over the next 5 years, after which free allocations will fall at 20% per year and additional allowances will be available through auctions or trading.

If the facility implemented their process efficiency changes in year one, then over 5 years their allocation and emissions would be as follows:

Year

Allocation

Emissions

Balance

1

900,000

1,000,000

(100,000)

2

882,000

750,000

132,000

3

864,360

750,000

114,360

4

847,073

750,000

97,073

5

830,131

750,000

80,131

4,323,564

4,000,000

323,564

At the end of the five year period, they would have accumulated an excess of 323,564 allowances. If allowances are valued at EUR 10 per tonne, then this would represent an additional EUR 3.2 million on top of 25% saving in fuel costs.

The ULCEF would seek to finance projects of this nature with debt and equity being returned through the sale of excess allowances, reduced need to purchase allowances and savings in energy costs. This simple calculation radically changes the outlook for investment in low carbon technology.

As an indication of how powerful carbon markets can be, the CDM has mobilized USD 500 bn of investment in 19

7000 CDM projects . Clearly not all of these have been built however money has been sourced on the basis of underlying revenues or savings plus additional revenues from the sale of CERs, or in the case of pure abatement projects, solely from the sale of CERs. The key point is that the CERs are delivered ex post, so projects are financed on the expectation of successful delivery and forward price curves. In an ETS, allowances are issued ex ante and can be sold or used to raise finance up front in a number of alternative, low risk ways. The result is that under ETS,

19

Sum of declared investments in registered and under-going validation CDM projects in the July version of the CDM pipeline available http://www.cdmpipeline.org/

27

the main risk is related to the technical implementation of emission reduction activities, which is altogether much less risky than the CDM. Whilst this is a very simple example, it demonstrates how the free allocation of allowances can be used to trigger investment in low carbon technology. In order to capitalize on the opportunity, participants need to have good information on the marginal costs of GHG emissions in their facility – commonly demonstrated in a marginal abatement cost curve and a robust forward price curve. If they do not have this information to hand, they may be too slow to act and only ready to start investing after the free allocation period has passed. At that stage it becomes much harder to raise the finance because the savings are the result of reduced costs rather than the result of increased sales revenues.

Captured entities are only going to view the ETS as an opportunity if: a)

This approach is brought to the attention of the Board and not treated as a production cost issue or the concerns of the Health, Safety and Environment team; and b) The market is confident that allowances will be worth (at least) for example EUR 10 at the end of the phase.

Both of these goals can be achieved if the ETS is designed and implemented carefully from the outset.

3.1.2 Creating a forward price curve The future value of allowances is predicted in a forward price curve. At present, there is no established forward price curve for Certified Emission Reductions (CER) and the forward price curve for EUA in the EU ETS is very weak and highly volatile, because of the lack of certainty about future targets and policies.

The CER price curve is non-existent because there is no certainty of demand in the future. The EU ETS, the largest consumer of CERs has excess allowances and has excluded CERs from certain types of projects and certain geographies. There is no confidence in the market that demand will return. Sovereign buyers such as Norway and Sweden are picking individual projects and paying non-market prices on the basis of environmental, social and sustainable development impacts. Even if Parties to the UNFCCC set more ambitious targets, there is no guarantee that they will use CERs. The EUA forward price curve is very weak because of the oversupply of allowances; uncertainty about whether the European parliament will approve measures to reduce the over-supply in the medium term; and perhaps most significantly, because of the potential for other energy and industrial directives to intervene with the goals of the EU ETS. For example, the Energy Efficiency Directive for power generators has set targets for annual improvements in energy efficiency which, if they are met, will mean that power generators meet their EU ETS obligations, whereas meeting the EU ETS targets does not guarantee meeting the energy efficiency targets. Hence the Energy 20

Efficiency Directive becomes the driving force, undermining the objectives of the EU ETS . Finally, the annual reduction in EU allowances of 1.74% per annum, does not ensure that the EU meets its 2050 target. More stringent reductions are required but they have not yet been agreed- the lack of long term certainty reduces confidence in the mechanism.

20

http://www.oxfordenergy.org/wpcms/wp-content/uploads/2011/07/Applying-belt-and-braces-to-EU-energy-policy1.pdf

28

The conclusion is that if Ukraine wants to implement an ETS with the objective of financing a transition to a low carbon future, they must design a scheme which ensures that the price of allowances will increase in real terms in the future, irrespective of the economic climate. The scheme must have environmental integrity, avoid creating windfall profits and avoid damaging emission intensive trade exposed industries. It must be able to react to macro economic trends without giving the government excessive ability to intervene in the market and since it is distributing sovereign assets, it must ensure that the Ukrainian population sees real benefits.

3.2 ALTERNATIVES TO AN ETS 3.2.1 Tax on the consumption of fossil fuels by large point sources Taxes are simple to apply and will raise significant revenues but they do not guarantee that a cap will be met and they provide the taxed entities with only two choices – pay the tax or cut consumption. Taxes can be subject to political manipulation and for that reason may lack the long term certainty needed trigger investments. In the absence of long term certainty taxed entities will tend to pass the tax on to consumers rather than make capital investments to reduce their own emissions. In times of growing economic output, consumers will pay more for energy consumption. In times of falling economic output, consumers will complain about the tax and politicians will come under pressure to reduce it.

The final result is that total emissions may go down slightly and the Government will have collected significant revenues. What do they do with the revenues? If the Government uses the revenues to reduce emissions, more than 75% of the emissions come from the taxed entities so the Government will need to re-distribute the tax revenues to the power generators, industrialists and heating plants who paid it in the first place. The Government will have to decide how best to distribute the funds and how to monitor their use. This process can become highly bureaucratic and is a very inefficient way to trigger investment in low carbon technology when an Emission Trading Scheme will identify the least cost abatement options much more easily and efficiently. Alternatively the government could invest the tax revenues in a fund similar to the ULCEF described above who could operate in a similar manner as described above, but without the leveraging effect of the increasing value of allowances.

3.2.2 Feed in tariffs for renewable and low carbon energy 21

Ukraine recently implemented feed in tariffs . Feed in tariffs for renewable energy can have a mixed impact.

Under a feed in tariff, higher prices are paid for renewable energy fed onto the grid and the cost is met by small increments in cost for all consumers. On the positive side they trigger investment in renewable energy and result in innovation, research and development and reduction in unit costs. With these benefits come employment and economic activity and if the tariff works, growth in renewable energy potential. However experience has shown that as a means of reducing carbon emissions, they can be very expensive. In Germany, where a substantial renewable energy feed in tariff programme resulted in a growth in renewable energy capacity from 7% to 17% between 2000 to 2009, the feed-in tariffs have resulted in the implicit cost of abatement rising well above the CO 2 allowance price under the EU ETS, ranging from EUR 65 per tonne CO 2 for hydropower to EUR 655 per tonne CO2

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http://www.iea.org/policiesandmeasures/pams/ukraine/name,38470,en.php

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for solar . The solar renewable energy feed in tariffs in Germany and Spain were later modified and the programme was cut short in the UK because the costs were seen to be too high for the rest of the consumers and the uptake was greater than expected. This attracted severe much comment from the private sector who severely criticized the Government for changing policies, introducing policy risk and undermining long term business confidence.

A generous feed in tariff may act to undermine the carbon price if run in parallel with an ETS. If the feed in tariff achieves its goal of triggering investment in renewable energy, demand for emission reductions will fall and the price will fall. As a result, the ETS will have a lower impact on other sources of emissions for whom polluting will remain a cheaper option. In effect, the feed in tariff will be subsidizing polluting practices elsewhere in the economy.

That said, there may be instances where specific feed in tariffs are helpful, as in the case for landfill gas to energy and methane utilization covered in section 5 below.

Under an ETS, renewable energy benefits from being zero rated which means that it can benefit from a higher wholesale price without having to acquire allowances or surrender them. This only works if the fossil fuel generators are required to purchase their allowance and if the prices are high enough. A variation on this system has encouraged a massive increase in renewable energy in China and India via the CDM, where investors have benefitted from the sale of CERs with or without feed in tariffs.

During a free allocation period, renewable energy could be kick-started with a short term feed in tariff which stops once power generators start to purchase allowances at auction. This would complement the ETS in its early days by supporting the development of renewable energy experience and reducing unit prices, and remain coherent as the ETS starts to take effect.

3.2.3 Renewable portfolio standards with or without renewable obligation certificates (ROCs) or renewable Energy certificates (RECs) Under a renewable portfolio standard, power producers are required to meet either capacity or supply targets from renewable sources. This approach only covers the electricity generation component of the large point sources and does not cover heat providers or captive power generation (although they could be covered). In situations where electricity is produced in a monopoly or an oligopoly, a renewable portfolio standard (RPS) could be a more effective way of ensuring a transition to renewable power whilst an ETS could suffer from lack of liquidity or the dominance of one or several very large participants. Under an RPS, wholesale electricity prices may rise as producers are forced to invest in potentially more expensive renewable sources and grid upgrades to distribute the power, plus develop the base load or storage capacity for times when renewable sources are offline.

This increase in cost will be passed on to consumers some of whom may need support via a redistribution of revenues to overcome the regressive impact of higher electricity prices. Under a simple RPS, the Government is not raising any revenue to compensate affected users.

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OECD Environmental Performance Reviews: Germany 2012, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264169302-en.

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Including a trading element allows producers to meet their obligations via a market; creates advanced opportunities to finance investment in renewable sources and via the auction of allowances, could provide the Government with resources to redistribute.

3.2.4 Energy efficiency standards for power and heat producers Under this initiative the Government would mandate energy efficiency improvements across the board. Such measures could be implemented in the short term in Ukraine where energy efficiency is low however, on its own, it may result in increased energy prices. Coupled with a tax on fossil fuels however, emitters may find that it becomes cost effective to improve efficiency and reduce expenditure on higher fossil fuel and energy prices.

In order to strengthen the Energy and Climate Package, the European Union has adopted a 20% energy efficiency improvement target across the entire energy chain, from production to use. This is expressed as a 1.5% improvement goal per annum. It requires producers, transmitters and large users of energy improve their energy efficiency through investments in new plant and technology and improving the energy efficiency of equipment, particularly buildings. Unfortunately, the 1.5% improvement means that by complying with this target, energy producers will fulfil most if not all of their EU ETS target which has the result of reducing demand for allowances and lowering the price. Without measures to remove allowances to compensate, this directive has undermined the EU ETS.

3.2.5 Legislation on fuel use The Government could also choose to simply legislate against the use of certain fuels. Depending on the specific circumstances, fuels may be phased out over time or facilities shut down whilst still operational. Several examples exist: 





In Sweden, the government is moving towards the phase out of fossil fuels for heating by 2020 and by 2015 in Government buildings. Sweden has a very well developed biomass energy sector which has been progressively developed since the introduction of fossil fuel taxes in 1990 and before that since the oil crisis in 1973. Through innovation, research and development they have been able to improve their energy security and rely increasingly on substantial resources of home grown biomass as either a primary product of their forest estate or a waste product of the timber industry. Biomass has a lower energy density and to be more efficient should be used locally rather than transported. It is ideal for use for heating purposes.

In Australia, under the Carbon Price Mechanism, approx 2000 MW of brown coal power plants, emitting in excess of 1.2 tonnes of CO2 per MWh of electricity were planned to be closed with the owners receiving compensation to lay off staff and pay down the remaining investments from the revenues raised by the carbon tax and later sale of emission allowances.

In Germany, plans to phase out nuclear power combined with a renewable energy feed in tariff have triggered much greater investment in renewable energy sources.

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4 FINANCING STRATEGIES TO REDUCE GHG EMISSIONS FROM NON-HEAT AND NON-ENERGY SOURCES (NON-CARBON MARKET MECHANISMS) As described above, there are a number of non-carbon market based activities which can be used to bring additional sources of GHG emissions under control and encourage reductions in emissions. These can be divided into several categories as follows: National approaches which raise revenues     

Tax on CO2 emissions from small and diffuse point sources (transport, production of bio-fuels and SMEs) and re-distribution to transport and housing sector.

Waste tax to raise money to pay for installing recycling facilities, waste to energy technology, sanitary disposal of waste, leachate treatment and collection and destruction of methane from remaining waste.

Tax on high GWP gases (HFCs, SF6, NF3) so that they are phased out / strongly recycled Tax on bunker fuels for national transportation Road tax for vehicles based on engine size / emissions

National approaches which need financing    

Agricultural and land use programmes such as product labelling schemes, energy efficiency and production efficiency in farms All kinds of standards and labelling schemes such as building standards, white goods labelling, energy efficiency rating for properties, energy audits, fleet efficiency standards Feed-in tariff for renewable energy from waste, biomass and biogas, bio-fuels Abatement of high GWP gases as by-products or waste products of other processes.

Localized approaches  

Congestion charge for access to major cities with revenues used to support public transport City taxes on specific goods and services for example hotel accommodation, conferences, airport tax and taxies with revenues used to finance public transport, public bike rental schemes, electric transport etc., all of which improve the quality of the local environment of the city as well as addressing GHG emissions.

Corporate initiatives, including Government departments and institutions   

Corporate initiatives to reduce running costs and increase profits Corporate initiatives to improve and report upon Corporate Social Responsibility Corporate initiatives to capture market share

The scale and cost efficiency of potential emission reductions from these sources are quite variable. Within noncarbon-market based emissions there are some relatively easy sources to address (for example high GWP gases with end-of-pipe abatement solutions). Taxing other sources (e.g. emissions from transportation) and subsidizing other activities such as renewable energy via feed-in tariffs need careful planning. For example, studies have shown that market mechanisms are by far the most efficient means of reducing emissions; taxes can result in

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relatively high emission reduction costs to society; policies which offer subsidies to the production or use of fossil fuels conflict with emission reduction policies; feed in tariffs can be very expensive and conflict with the operation of emission reduction schemes. The general conclusion is that the ETS should be the primary policy, creating a price which triggers technology change. Non-carbon-market based approaches should be consistent and coherent 23

with the ETS .

Some of these activities raise financial revenues and some need finance. The ULCEF will collect revenues from taxes and the sale and account of UAs and use those funds to pay for a wide range of activities suited to the different kinds of policies and measures required to reduce emissions from various diverse sources.

The following section details how each of the above emission reduction schemes can work to either raise and redistribute finance or use finance raised elsewhere in an efficient and effective manner, and to operate coherently with other carbon market policies.

4.1 NATIONAL APPROACHES WHICH RAISE REVENUES 4.1.1 Tax on CO2 emissions from small and diffuse point sources This tax could cover residential, commercial and public buildings, transport, production of bio-fuels and SMEs. In its simplest form it can be levied at the point of sale of the fossil fuel so that retailers collect the tax and pay it to the Government. Renewable sources such as biomass are zero rated. It should cover sources which are not captured by the ETS. Ukraine may consider whether smaller district heating plants should be captured under the ETS or pay a tax on fuel. The advantages of the tax are that the costs are known but the disadvantages are that facilities cannot benefit from the financing opportunities of a free or partially free allocation and better performance through the sale of unused allowances, and if not carefully designed, MRV costs can also be significant. From a policy perspective, greater participation in the ETS is preferred.

Setting the level of the tax can be difficult. The tax rate should bear some relation to the expected price of carbon emissions under the ETS, yet it may be more important to simply make it clear that the tax will rise in real terms, so that consumers get a very clear indication that they should plan to use less fossil fuel in the future.

Tax on fossil fuel is highly regressive and impacts poorer families and rural communities. A redistribution programme is required and there have already been examples in Australia (under the Carbon Price Mechanism); in Ireland; and in British Columbia. For example, tax revenues may be collected in a fund and used to finance the upgrading of existing plants to make them more efficient, or conversion from gas to biomass or to reduce income tax or labour taxes.

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Alternatives to a tax Alternatives to reduce emissions from fossil fuel consumption are more complex to implement and do not necessarily cover such a wide scope. Some of these measures might be more suitable to contemplate in the medium to long term: 1) The UK, for example, levies tax on fossil fuel for transport but treats commercial and institutional emitters and SMEs differently through the Carbon Reduction Commitment and Climate Change Levy. Fuels for domestic heating are not specifically taxed but there are very few district heating schemes. Vehicles also pay road tax based on engine size. The result is a complex set of legislation which has been developed over the past 15 years or so.

2) Sweden is moving towards a total ban on the use of fossil fuels for heating from 2020 however they have a well developed biomass sector.

3) The EU ETS includes domestic air travel but does not cover international flights or other bunker fuels such as inland, intra-European or international shipping.

4) Road pricing would be an advanced alternative to a tax on fossil fuels for transport with a fee for using roads including an emissions tax. This would magnify the impact of a road pricing scheme by making it even more expensive to travel during periods of high congestion when fuel consumption per km is higher and could be used to tax luxury vehicles more heavily. In the longer term it would also help to differentiate the costs to users of hybrid and electric vehicles who would not pay the same charges as fossil fuelled vehicles.

5) Taxes could be levied on the purchase or construction of combustion equipment with higher taxes on less efficient equipment and for example coal burning equipment whilst electric engines might be subsidized.

However, the main disadvantage of this is that it can lead to a prolonged use of old and inefficient equipment which in the end could actually increase emissions.

4.1.2 Landfill tax Landfills are a source of methane but also have a number of other negative environmental and social impacts, including:    

Ground water contamination Local air pollution Resource inefficiency Land use and devaluation of land

Collection and sanitary treatment of waste is an expensive process and is a service which the population generally undervalues. Traditionally and globally, it has been free or provided at a low cost and the costs have been nontransparent, hidden within local government budgets and in some cases, undertaken on the black market driven by the value of recyclable materials.

Reforming the waste sector is already a priority for the Government of Ukraine and there are two complimentary policies which can help to achieve this goal: 1) Implementing or significantly raising a waste tax, which could be applied at two levels – i) for inert waste (i.e. rubble, bricks, cement, rocks, soil etc) and ii) a significantly higher rate for all other waste. Hazardous waste would be addressed via other policies.

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The intention of this policy is to make waste disposal more expensive and hence provide an incentive to reduce, reuse or recycle materials wherever possible. Monies collected from the tax are used to construct and operate the sanitary landfills including the installation and operation of landfill gas capture technology. Examples of complimentary policies include:   

The EU Directive on Packaging and Packaging Wastes whereby manufacturing industries are required to recover packaging materials; Requirements to increase the recycled and recyclable components of vehicles such that many vehicles now include the cost of recycling in the sale price; Requirements to consider the impacts of decommissioning or demolishing equipment and buildings;

Negative impacts of these policies include an increase in fly-tipping and localized burning of waste which have negative local environmental impacts and will need to be addressed via locally appropriate means. Implementing these policies in rural areas can be inefficient because of the low density of population and the relatively low proportion of waste which they generate. For these reasons, landfill taxes could be implemented at a municipal rather than national level.

Placing a price on unsorted landfill will create or help to formalize a recycling industry. This is important because recycling is often performed via a black market with very poor treatment of workers. Financial support from the landfill tax can help to build proper, safe recycling facilities. Good quality recycled materials contribute to greater resource use efficiency and help, for example, industries with process CO2 emissions which need to increase recycled material use.

2) Implementing a feed in tariff for renewable energy from waste This tariff would apply to electricity generated from the capture and combustion of methane from biological sources including landfill, municipal sewage, agricultural waste products (solid and liquid manure). The tariff would recognize the increased costs of generating electricity from smaller sources such as landfills and the costs of connecting to the grid. Depending on the exact scope of an Emissions Trading Scheme, such sources might or might not be captured but if they are, the renewable energy would be zero rated providing and would benefit from generally higher rates for sale of the power as the price of carbon is gradually factored into the wholesale electricity price.

A landfill tax and feed in tariff would support the national priorities of moving towards 2050 targets and ultimately zero carbon emissions. Future income from the landfill tax could be used to secure investment from either the public or private sector to build and operate sanitary landfills. A strong forward curve on the carbon price plus a feed in tariff for renewable energy from waste would attract private sector finance to build and operate small scale power plants at landfill sites. Regulations for grid connection, power purchase agreements and preferential dispatch would need to be addressed.

Alternatives to a landfill tax Three alternatives to finance these measures have been identified but each of these would still need to be implemented in conjunction with some form of landfill tax or other legislation otherwise unsorted waste with a lower biological waste content, a lower methane yield and therefore less efficient methane capture will continue 35

to be deposited in the landfill sites, filling them more quickly, slowing organic breakdown, and losing the benefit of material recycling: 1) An alternative for the destruction of methane would be work with a multilateral development bank or the GCF to establish an international fund to finance the abatement of methane. Such a fund could be set up with finance from donors to inject equity into commercial investments generating a return from the sale of power by benefitting from a feed in tariff and / or zero rating in an ETS. 2) A second alternative would be to develop a results-based finance model whereby financial support is given in return for construction and operation of sanitary landfills including verified emission reductions from the destruction of methane. However it is less likely that Ukraine would be considered a major recipient of such finding as the monies are more likely to be directed towards less developed and least developed countries.

3) A final alternative would be to create a national programme to destroy methane from landfill with legislation requiring collection and, say, 95% destruction by, for example, 2025. Landfill operators would have 10 years during which they need to transition to comply with the legislation. Early compliance could be met with the award of “emission reduction units” which could be fungible with allowances in the domestic ETS and also be bankable. This approach would reduce the need to rely on imported emission reductions for use as offsets, avoiding the transfer of finances to potentially competing countries. The Australian CPM proposed to use a domestic Carbon Farming Initiative as a source of emission reductions; Korea plans to use domestic projects before allowing international units into their scheme from 2021.

South Africa and China have similar ideas. Also, it is interesting to note that this model was used by EU accession states as a basis for JI projects from 2008 to 2012. Several accession states registered JI projects in the landfill sector which were complying with the EU Landfill Directive ahead of the accession deadline of 31 Dec 2012. As a result their actions were considered “additional” and Emission Reduction Units awarded accordingly. It might also be possible to attract some concessional loans from a development bank to support this activity at a national or even municipal scale on the basis that it is equivalent to Nationally Appropriate Mitigation Action and would set a good example of how other countries could move towards a low carbon future.

4.1.3 Tax on high GWP feedstock gases SF6 is used, for example, in the manufacture of semiconductors, as an insulating gas in magnesium die-casting, double glazing and transformers and as a tracer gas. Some refrigerant gases have moderate to high GWP or contain small impurities of high GWP gases. Nitrous oxide is used for medical purposes.

These gases, though generally small in quantity, are purchased and consumed for specific purposes. Where technically feasible alternatives exist, the use of these gases could be taxed at the point of sale at rates which make alternatives economically attractive. If there are no technically feasible alternatives, a tax is likely to result in innovation and the creation of technical alternatives. If the tax fails to reduce consumption then the tax would need to be raised or ultimately, use of the gas phased out.

The revenues from such taxes can be used to finance research and development of cheaper alternatives and to help pay for recycling or capture and destruction of existing inventories of gases such as HFCs in old refrigeration units.

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However, before implementing such a tax, an impact study would be required to check that this would not have a significant impact upon domestic industry which would be competing with imported supplies that do not necessarily pay the tax. Whilst this might be addressed via Border Carbon Adjustments, no Government wants to risk starting a trade war.

Alternatives to a tax on high GWP feedstock gases Instead of taxing the use of these gases the Government could simply prohibit their use, which should be easy to do through banning the production and import of the gases and tracking existing inventories. However, this immediately restricts economic activity, giving it no flexibility to users and retailers. If enforced, such tax would lead to a total phase out of the gases whilst a tax could simply result in continued use of the gases with payment of the tax.

Another alternative is to include these gases in an ETS, either at the point of production or point of use runs the risk of creating windfall profits and / or un-recoverable losses.

4.1.4 Tax on bunker fuels for national transportation Aviation and marine emissions are a growing source internationally. Whilst it is likely to small, it is a growing source of emissions and thus should not be ignored. As other emission sources come down, growing aviation emissions could become a significant source. Furthermore, aviation emissions are highly concentrated on business and the affluent end of society which could lead to a situation whereby a small proportion of the population become increasingly responsible for larger and larger share of any future allocation.

Aviation has received high profile coverage via the EU ETS and the European Commission’s intention to include international flights within the scope of phase 3 of the EU ETS. It is now understood that ICAO are moving towards the creation of a global carbon market for aviation post 2020. In the meantime, Ukraine could consider including domestic aviation in an ETS although its small size might make this relatively cumbersome. A tax may be more efficient. Domestic aviation is usually a captive market since planes cannot afford to transport fuel. As Ukraine embarks on the low carbon transition path, one of the first things it would need to do would be to gather high quality data on aviation emissions for use in any future allocation process.

Alternatives to a tax on bunker fuels for national transportation    

A requirement to blend a minimum proportion of bio-fuel in jet fuel, however the quality of the bio-fuel needs to be assured as the consequences of contamination in jet fuel are severe; Upgrading of the domestic air fleet to more efficient planes; Reducing the weight of aircraft through re-fitting, charging passengers for luggage etc (many domestic and budget airlines already do this); Banning auto-generation by planes on the ground and requiring them to run air-conditioners / heaters from grid supplies whilst parked; optimizing routes; avoiding holding and minimizing time in the air; improving transport links to airports to reduce vehicle use.

Marine emissions are harder to address because ships can have very long life-spans and are not easy to retrofit.

Emission standards for sulphur dioxides and oxides of nitrogen (SOx and NOx respectively) usually over-ride GHG 37

emission concerns and running engines to reduce GHG emissions increases emissions of SOx and NOx because of the poor quality of the fuels. Tax on marine fuel can induce leakage as ships either fill up in other locations, risk losing business to international competitors, or re-register the ships in other jurisdictions. Enforcing regulations on foreign flagged ships is difficult. Long-term commitments to reduce emissions through the introduction of emission standards for engines in new and re-furbished ships and design criteria to increase efficiency are probably the most realistic approach. This may have more success through the International Maritime Organisation (IMO).

Collecting data on GHG emissions from the marine industry and raising awareness of the significance of GHG emissions amongst the marine industry would be a good starting point to address emissions in this sector.

4.1.5 Road tax for vehicles based on engine size / emissions Road tax is a common source of income for Governments. In the UK, the road tax is now levied by engine size, with electric and some hybrid vehicles emitting up to 100g/Km attracting zero road tax and with high end vehicles 24

emitting over 255 g per Km paying up to GBP490 per year . Many luxury cars have emissions above this level..

This is an effective tool if the tax is sufficiently high; with high fuel prices, the difference in annual tax costs can make it financially attractive to purchase a more efficient car. Encouraging the purchase of newer vehicles has other benefits as well including faster adoption of higher safety standards; quieter and smaller vehicles with lower emissions improve the quality of the environment in cities. Road tax is less regressive than fuel tax because consumers have more choice on the size of engine they purchase and it does not directly impact upon people living in rural communities. Taxes may be designed to discourage the use of un-necessarily powerful vehicles in urban settings and luxury vehicles with high levels of emissions.

Alternative to road tax for vehicles based on engine size / emissions Commonly proposed alternatives to road (and fuel) tax are road tolls, congestion charges and road pricing. The first two of these have been widely implemented in the EU, though not usually to reduce emissions but to pay for road infrastructure, control congestion in cities or simply to raise revenue. Road pricing combines aspects of both road tolls and congestion charging.

Applying road tolls can be counterproductive because it may encourage drivers to take alternative routes which may increase mileage and thereby increase emissions and also cause congestion at toll gates which may increase emissions. The latter can be addressed through electronic tagging of vehicles and automatic charging via direct debits / pay-as-you go accounts.

Congestion charging may take the form of a road toll during certain times of the day or be used to charge for access to a city, for example. Short term solutions to congestion and air pollution include number plate restrictions with even and odd number plates being permitted on alternate days.

Such approaches have a beneficial impact upon a city environment by reducing the presence of cars and congestion, improving access and improving the quality of life of residents in the city. Congestion charging needs

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https://www.gov.uk/vehicle-tax-rate-tables

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to be implemented in conjunction with good public transport schemes such as park and ride facilities or mass rapid transport.

London operates a Low Emission Zone

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pricing scheme which directly targets particulate emissions from diesel

engines in lorries and vans. It uses number plate recognition cameras linked to the national vehicle database to identify vehicles and determine the engine size, EURO standard compliance and whether abatement equipment such as filters are fitted. It then levies the fee accordingly. Daily fees are between GBP100 and GBP200 per 24 hours, which acts as a strong deterrent, and reflects the fact that London does not want particulate emissions in the local air. The website is clear that they would rather that drivers comply than pay the fee.

Road pricing has been highlighted as a much more sophisticated solution to GHG emissions and today’s technology makes it much more practical. A fully integrated road pricing scheme which could operate via standard mobile phone technology could replace road tax, fuel tax, tolls and congestion charges with users having the ultimate freedom of choice over the kind of car they buy, the miles they drive by what route and when. Although there are many examples of congestion charges and variable fees, there appear to be no examples of fully integrated national road pricing systems operational at this time.

Other alternatives to vehicle emissions are improved public transport and mass rapid transport schemes. These range from improved pedestrian access, bicycles, dedicated bus lanes, restrictions on street parking, high occupancy lanes (for cars with one or more passengers); above and below ground metros etc. These kinds of infrastructure can be very expensive however the benefits to quality of life and property values are also very material such that the investment in infrastructure can be recovered through increases in property values.

Installing an efficient public transport system, for example, can have a massive impact on the value of real estate and some costs associated with the construction could be recovered via a sales tax on property or increased rental values. These kinds of initiatives are best implemented on a municipal scale with the costs being met from city budgets with financial support from Government and donors. Japan, for example, is financing the construction of a mass rapid transport system in Jakarta in return to emission reductions under the Japanese Joint crediting 26

Mechanism .

4.2 NATIONAL APPROACHES TO REDUCING EMISSIONS WHICH NEED FINANCING 4.2.1 Agricultural and land use, land use change and forestry programmes Agriculture, land use, land use change and forestry emissions are difficult to deal with for a number of reasons:   

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Land use activities are by definition carried out over very large areas making data collection difficult; The methods of quantifying or estimating emissions from these sources are highly uncertain and in some cases reversible; The agricultural and land use community may not be naturally inclined to comply with regulations and a high level of non-compliance may result;

http://www.tfl.gov.uk/roadusers/lez/default.aspx http://www.thejakartapost.com/news/2013/08/31/ri-establishes-carbon-deal-with-japan.html

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

Adding costs to food production has a very direct impact upon the cost of living for poorer communities; increases in food prices can have serious impacts, while for the public as a whole it could result in strong rejection of the low carbon policies.

On the other hand there are a range of measures which can be implemented to reduce GHG emissions and increase productivity in the process.

New Zealand has included agriculture in their ETS, however, it has been problematic. Australia has introduced the Carbon Farming Initiative as project-based opportunity to participate in managing GHG emissions from agriculture and land-use.

The Republic of Ireland has significant proportion of its emissions arising from its livestock and dairy industry and has invested heavily in working with farmers to improve agricultural practices. 62,000 farmers managing over 50% of Ireland’s farmed land are now part of the Rural Environmental Protection Scheme

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which promotes

environmentally beneficial farming practices whilst also helping to make farming more profitable. Ireland recently used its Presidency of the EU to further promote the importance of farm management to increase productivity 28

whilst reducing emissions . For example:  

Organic farming standards reduce demand for chemical fertilizers and reduce emissions of nitrous oxide from fertilizer applications.

Inoculations and feed additives and manure management can reduce emissions of methane from livestock and increase the conversion of food energy into live body weight, improving financial returns to farmers.

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Forest management standards such as the FSC and PEFC promote forest and land use management standards that help to reduce GHG emissions whilst also creating value for forest owners through reduced management costs and better marketing activities.

The land use sector also has the potential to produce biomass and bio-fuels, either as a direct crop (such as oil seed crops or fast growing woody biomass) or as a by-product of farming production (for example wheat straw, biogas from liquid and solid manure). Sweden has demonstrated its ability to provide significant amounts of woody biomass and with support and funding, Ukraine could also become a significant user of biomass for power generation and district heating.

However, none of these activities are likely to be revenue raising for the Government and are more likely to require financial assistance in order to run training and awareness raising programmes. These are the kinds of activities that can very usefully be financed using revenues from taxes on fossil fuels or the sale of GHG emission permits.

The TIMES Ukraine report proposed that emissions from the agricultural sector in Ukraine could be reduced by 720 million tonnes in 2050 at a cost of between EUR 12.8 bn to EUR 15 bn. Along with this would come increased

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http://www.teagasc.ie/environment/REPS/REPS.asp http://www.teagasc.ie/publications/view_publication.aspx?PublicationID=2776 29 http://www.fsc.org/ 30 http://www.pefc.org/ 28

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yields, higher quality products perhaps meeting certified status under various food and farming initiatives (e.g. organic food), employment and greater food security.

4.2.2 Standards and labelling schemes There are many examples of standards and labelling schemes which are designed to increase user awareness and encourage better energy efficiency. These range from voluntary carbon foot-printing on food products, mandatory white goods labelling schemes, to energy efficiency standards for buildings complete with auditing programmes.

These kinds of initiatives are very important in increasing public awareness and encouraging better practice. In many cases more efficient equipment is cheaper in the long run but, if consumers are not aware of the figures and values, they cannot make informed decisions.

However, developing standards requires financial support from central government and funds may be made available from other green taxes to help run these programmes. Industry may be willing to participate, especially those seeking to gain market share through the development and sale of more efficient products. Funding competitions help to raise the profile and promote innovation, while grants for research and development can create new ideas.

In the UK, properties for sale must now advertise their energy efficiency (i.e. insulation) levels because heating costs and acceptable level of comfort are a material factor in people’s choice of where to live.

4.2.3 Education The world which the young people of today will inhabit in 2050 must be very different from what we see today.

Today’s school children will be responsible for ensuring that we achieve the 2050 targets and that the economy is st

ready to move on to phasing out CO2 in the second half of the 21 century. They will work in an economy which is very different from today’s economy, perhaps one where a greater proportion of GDP is derived from service sector industries and agriculture, with lesser reliance on primary and extractive industries and more use of recycling and re-using resources. They must perform under a different set of parameters than the economy does today and they will need to have a very different set of values than the leaders and decision-makers of today.

In order to get them ready for this challenge, Ukraine could start to address the education of its youth so that they do not take heat, transport and energy at the flick of a switch for granted. To make the changes which the world needs to see, Ukraine’s population would benefit from a different set of values and those values could be introduced through education. Skills and training will need to change to meet the demand of a low carbon future and the Government needs to allocate resources to start making those changes happen.

For example, architects, designers, builders and contractors in the housing sector need to learn about new standards and technology in order to start specifying and installing low carbon heating systems, insulated buildings etc. Their contribution to the challenge could be kick-started by running awareness raising programmes and ensuring the new trainees learn about the newest technologies.

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4.3 LOCALIZED APPROACHES A number of approaches to reducing GHG emissions may work better at a local level than a national level. This is usually related to population density, localization of benefits and the commercial models which are used to provide services. Local initiatives include: Landfill tax: Local authority or municipal collections and treatment of solid waste which are run or paid for by municipal authorities from city taxes, council tax etc., may present a good framework for the application of landfill tax. The population are captive (i.e. they have few opportunities to do anything other than recycle, reduce and reuse their waste or dispose of it via formal refuse collections) but they can also benefit from clean and efficient waste collection services. The scheme can be used to establish and run a sanitary landfill operation which will benefit the local environment and, for example, present city residents with a recycling depot for items which they cannot dispose of via the regular refuse collections. Sanitary landfills must be constructed with leachate and landfill gas collection systems and the gas must at least be flared if it cannot be used for power or heat generation.

Waste must be sorted to recover recyclable materials and other, more advanced waste to energy systems may also be investigated. Rural populations may need slightly different treatment since the lower density of population would have an impact on waste collection.

Congestion charges are most likely to be designed and implemented at a municipal level. City residents are the ones who will benefit from improved air quality and reduced congestion and traffic noise but support will need to improve public transportation choices.

4.3.1

Corporate initiatives and initiatives in Government departments and institutions

Many corporations already implement emission reduction activities in order to:   

Save on costs; Report to shareholders via corporate sustainability reporting initiatives; and / or Improve the quality of products and services by making them more carbon efficient.

All three of these kinds of initiatives are very important because they can result in very significant reductions in GHG emissions which may or may not be recognized, but if they are double counted, or at least not accounted for correctly, they could suggest that more is being done than is the case, or they could under or over estimate the costs of emission reductions leading to the inefficient or ineffective distribution of capital. For example: 



Cost saving measures such as an energy efficiency campaign to turn off lights and computers overnight and manage heating and ventilation more efficiently might result in reduced electricity consumption. This reduces costs for the company and electricity demand from the grid. If the electricity producer is covered by an ETS, it reduces the number of allowances they will need to surrender, even though they did not participate in the emission reduction activities.

However, if the commercial entity calculates their reduced energy consumption and hence reduced energy emissions, they may report them in their Corporate Social Responsibility report and claim they have reduced the national emissions by X tonnes; meanwhile the electricity provider is making the same claim through the surrender of fewer allowances.

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

And finally, if a manufacturing company decides to change the design of a product to make it more energy efficient and consumers choose to buy this model over others, the carbon footprint goes down for years to come.

These kinds of initiatives can be very significant and can be driven very effectively by the private sector if they are incentivized. There is very significant scope for the Government to initiate programmes which encourage private sector involvement, support innovation, research and development, and encourage companies to reduce the carbon footprint of products and services which can then the quantified and tracked in a transparent manner.

Examples include reductions in VAT or import taxes on energy efficient devices; subsidies for insulation or upgrading of buildings; competitions for funding for innovation; enrolment in voluntary, trade or government programmes etc.

4.4 POLICIES WHICH CAN CONFLICT WITH EFFICIENT AND EFFECTIVE ETS Finally, a number of the alternatives listed above have the potential conflict with the long term goals of an Emissions Trading Scheme. An ETS is designed to create a price for releasing GHG emissions to the atmosphere and to give a long term signal about that price, so that emitters can make a financial case for investing in new technology. Uncertainty about the price undermines the ability to build a strong case which results in emitters either not making investments or investing in higher carbon technology. This leads to the “lock-in” fossil fuel burning technologies for another 20 to 30 years or longer.

Other policies, which may be designed to promote, for example, renewable energy would seemingly help with the overall objective of reducing GHG emissions but they can act to undermine the carbon price. For example, in the EU, under the Energy Efficiency Directive the entire energy chain is required to improve its energy efficiency by 1.5% per annum. Whilst improved energy efficiency is a good objective in general, in practice it will:  

result in reduced emissions, which will lower the demand for Allowances and hence lower the carbon price; and it will reduce energy consumption but not necessarily from the most carbon intensive plants. Depending on how and when the energy efficiency measures are implemented, they may knock out renewable 31 energy or nuclear, rather than coal fired and hence improve energy efficiency but not reduce emissions .

The solution of course of is to ensure that the policies are implemented in a coherent manner so that the impact of 32

the energy efficiency measures can be reflected in the number of allowances which are released to market .

Policies that can have such effects include:

4.4.1 Energy efficiency measures As described above

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4.4.2 Feed in tariffs for renewable energy Feed-in tariffs have been very effective in triggering a massive decline in the cost of solar panels, however they are traditionally financed by increasing the cost of energy for all consumers and studies have shown that, in the European context, they have proven to be a very expensive way of reducing GHG emissions. On the one hand, a long-term power purchase agreement with a feed-in tariff “adder� will give investors certainty that they can achieve their required rate of return. However, if implemented in conjunction with an ETS, they distort the market’s ability to find the least cost abatement options and hence they do not give consumers the best value for money. The preferred outcome is that a carbon price signal is generated, which encourages power producers to find the lowest cost solution including the cost of emitting GHGs. The same investment may be made, if it is the most cost-effective, and the final cost to the consumer and the economy will be lower. In Germany, for example, the feed in tariff achieved emission reductions at a cost of USD69 per tonne from landfill gas to USD342 per tonne 33

from geothermal power against an average carbon price of USD18.62 per tonne.

So whilst there are clear benefits of a feed-in tariff (lowering the cost of technology, employment creation, etc.) an ETS is widely considered to be a more cost efficient approach.

4.4.3 Tax breaks for low carbon technology Depending on how these are administered, they may distort the identification of least-cost abatement opportunities. Alternatively, money could be allocated to support research, development and innovation.

4.4.4 Monopolies and oligopolies in the energy sector An ETS thrives on depth and liquidity, which means greater number of participants undertaking higher volume of trade. Where emissions are dominated by a small number of very large emitters, these goals will not be achieved and the market price may be set by one or two large buyers or sellers. Policies which support monopolies and oligopolies are therefore to be avoided. The introduction of competition into the energy sector is already an objective of the Ukrainian authorities.

If the electricity generation sector is too large and a monopoly exists, a tax on fossil fuels for electricity production may be a better approach until more competition can be introduced, leaving the ETS to function with industrial emitters and district heat generation (which may require a threshold for entry).

4.4.5 Taxes on fossil fuel consumption in parallel to an ETS There would be no point in running two schemes in parallel on the same fuels but they may run in concert to ensure that all emissions from both large and small sources are captured in some way. The Australian CPM started with what is effectively a tax and then was expected to transition to an ETS. Taxing fuels that are captured in an ETS would be very inefficient from an administrative point of view, and the same result could be achieved by implementing a floor price on the sale of allowances.

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4.4.6 Fossil fuel subsidies Policies which encourage the production or use of fossil fuels operate in direct conflict with a tax or ETS covering the use of fossil fuels. In Ukraine’s case existing policies may include subsidies to the coal mining industry and district heating. These subsidies need to be addressed and re-designed so that they may continue to support the affected communities but not promote the production or inefficient use of fossil fuels.

4.4.7 Subsidies for heat, power, transport Similarly, subsidies for heat, power and transport which result in some users paying a lower price for the service have a distorting effect and discourage efforts to reduce fuel consumption, increase efficiency and reduce emissions. Efforts should be made to make such privileges available only to the vulnerable members of the society to discourage wasteful practices.

In conclusion, if implemented, an ETS should be the overarching policy which drives investment into low carbon technology. Other policies may work alongside but they should be designed in such a manner that they do not undermine certainty in the long-term price curve.

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5 UKRAINE’S ROLE IN THE INTERNATIONAL CLIMATE CHANGE NEGOTIATIONS Ukraine is an Annex В Party under the Kyoto Protocol; it had a target under the first commitment period and participated in Joint Implementation. Ukraine has lodged a target for the second commitment period of the Kyoto Protocol under the Doha Amendment, but it has yet to ratify. To date, only four countries have ratified the Doha Amendment.

Ukraine’s national strategies foresee that the country will increase its agricultural production and service sector whilst reducing its reliance on primary industries. Its population is expected to fall whilst standards of living will increase. Ukraine, like many other countries, needs to finance a transition to a low carbon economy and, in the process, ensure employment, investment opportunities, energy security and sustainable development.

As discussed above, creating a strong and reliable long-term price signal for carbon emissions is the most efficient way of reducing the GHG emissions. This is even more relevant to Ukraine than its neighbours and competitors because most of Ukraine’s emissions are derived from heat, energy and industrial sources which are very inefficient. Putting a price on carbon should rapidly reduce emissions and trigger wide-scale transition if the price is high enough and the future price curve is reliable enough.

To ensure that the price curve is reliable, Ukraine needs to work with other Parties to the UNFCCC to secure a strong global agreement which sees all nations taking on legally binding caps and moving away from baseline and credit approaches to cap and trade. Ukraine has already operated under a cap and can continue to do so. Long term caps are the only mechanism which will provide long term certainty of a carbon price.

5.1 FINANCING TECHNOLOGY MECHANISMS

CHANGE

VIA

THE

POST-KYOTO

At present, there are no post-Kyoto mechanisms which can be used to finance technology change. The post-2020 agreement is being negotiated now, new market mechanisms, non-market-based approaches and the framework of various approaches are all under discussion, as is the future of the CDM and JI. However, there are some very clear signals as to where financing for a country such as Ukraine can and cannot come from: 



Project based mechanisms such as JI (for Ukraine) and CDM (for non-Annex 1 countries) have very little future. ERUs from JI projects are highly unpopular because of concerns over a lack of environmental integrity. JI is effectively stalled until the second commitment period is ratified. When, and if, this happens, units available for transfer will be substantially reduced under the assumption that Ukraine like other countries, will have adopted a scientific based target which does not take account of the recent collapse in economic output. CDM is likely in future to be restricted to Least Developed Countries and under-developed sectors. No national governments are, at present, planning extensive or unrestricted purchases of CERs or ERUs. Linkage of ETS is a much more attractive future. Emissions trading schemes imply a cap on emissions.

Even if the allocation of allowances is generous at the outset, the scheme should start to move emitting 46





industries towards common levels of performance. The EU ETS, the largest sub-Kyoto emissions trading scheme to date, is very clear that it wants to buy units from capped entities moving towards global benchmarks. It no longer wants to subsidize competitors via baseline and credit methodologies.

As a form of new market mechanism, an ETS would enable Ukraine, and Ukrainian industry, to participate in the transfer of international units and, as a result, deploy mechanisms to raise international finance to pay for new technology. Via a linked ETS, Ukrainian industry and investors would be incentivized to find the lowest cost abatement opportunities and deliver a wide range of benefits in a cost-efficient manner.

The alternatives to an ETS would be to implement non-carbon market mechanisms such as taxes and regulations. These approaches would deliver emission reductions which would be identified at the level of the national inventory and which, if Ukraine had an economy-wide cap, would result in the creation of units for transfer via what today is called International Emissions Trading. Such activities might take place under the Framework of Various Approaches.

Although the final outcome in terms of transfer of international units could be the same under an ETS and nonmarket based approaches such as taxes, the way in which the outcome is achieved, and the costs, are significantly different. Under an ETS, individual facilities are directly incentivized to find and deliver the lowest cost abatement opportunities and can use the future price of the allowances to attract international finance to pay the costs.

Under a tax, individual facilities pay the tax which the government then uses to support the costs of deploying the low carbon technologies, before counting up the resulting emission reductions and selling them in the international market.

It is clear that whilst non-carbon market approaches such as taxes have a role to play, an emissions trading scheme is by far the more powerful approach. ETS have, unquestionably, had some teething problems however answers to these challenges are being demonstrated in the design of ETS around the world on daily basis. With careful design, Ukraine can move to implement a domestic emissions trading scheme and take its own steps to ensure that the scheme creates a robust forward price curve which will support future investment. A linked ETS will enable Ukraine to participate in post-Kyoto financing mechanisms and help it move to a low carbon future.

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6 CONCLUSION There are a large number of strategies which can be applied to different schemes to reduce GHG emissions in Ukraine. However, it is important to recall that approximately 75% of Ukraine’s emissions come from the consumption of fossil fuels in stationary units – for power generation, heat, industrial production and industrial processes. These sources are ideally suited to emissions trading schemes for the reasons described in the preceding chapters. Other sectors are also important but attention must be focused on the largest proportion of emissions as soon as possible.

Introducing an ETS is a long and complex process and requires considerable institutional capacity, good quality data, high levels of awareness and engagement amongst captured entities. It takes time to build these components, therefore starting with a GHG emissions tax, or the need to purchase allowances at a fixed price and surrender them, as proposed under the Australian Carbon Pricing Mechanism, can provide a solid basis from which to build an ETS. Creating an ETS involves the creation of a new sovereign asset – a Ukrainian Allowance. This sovereign asset has a financial value which is determined by a future price curve. The future price curve is determined by the policy signals which the Government gives. If the forward price curve is robust and upward trending, covered entities will be able to use allowances to raise international finance to pay for low carbon technology. If the forward price curve is weak, volatile and level or downward trending, then emitters will view the allowances as a cost of production and simply purchase allowances and pass the costs on to consumers. The EU ETS is currently closer to the second situation for a number of reasons, but with the benefit of the lessons learnt in the EU and elsewhere, Ukraine can design a robust ETS which would give it access to “post-Kyoto” financing in order to turn its economy from one of the most inefficient in terms of tonnes of CO 2 per unit GDP, into an economy which can meet and st

potentially beat its 2050 target and go on to phase out emissions of CO 2 in the second half of the 21 century.

Working in conjunction with this carbon market mechanism, Ukraine can develop a range of non-carbon market mechanisms designed to tackle different kinds of sources of GHG emissions so that, by 2050, virtually all of Ukraine’s sources of GHGs are under some form of management. These approaches include taxes, standards, regulation and all come with a wide range of co-benefits for society and the economy.

In order to ensure that projects are financed, the report proposes that the Government of Ukraine establishes the Ukrainian Low Carbon Emission Fund, into which the Government and people of Ukraine will co-invest, using revenues collected from taxes on GHG emissions and the auction of Ukrainian Allowances. The Fund will operate a number of investment windows offering other investors the chance to invest in project specific activities within captured entities, public private partnerships for the development of major infrastructure, micro finance for Ukrainian farmers, venture capital for innovation, and a range of grants targeting performance changing activities including education, awareness raising, outreach activities pilot projects and research and development.

Some of the revenues will also be redistributed to exposed sectors of society to ensure that the taxes and ETS do not result in a significant increase in their cost of living. Several proposals have been made to improve the quality of life of low income earners and rural communities including the introduction of an income tax threshold which would lift some of the poorest sectors of society out of the income tax bracket.

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Ukraine has been an active participant in the Kyoto Protocol to date. It has submitted a target for the second period but has not yet ratified the Doha Amendment. In view of the potential impact that a low carbon development strategy, including a domestic ETS, may have on Ukraine’s emissions, it is proposed that Ukraine recognizes its future role in the negotiations on the post-2020 agreement and the fact that a binding cap can add real political certainty to long term commitments.

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APPENDIX 1: PROJECT FINANCE PRINCIPLES In a project finance transaction a PPP Company would usually be set up by the sponsors solely for the purpose of implementing the PPP project. It will act as borrower under the underlying financing agreements and will be a party to a number of other project-related agreements.

The top-tier funding provided by lenders or capital market investors, usually referred to as “senior debt”, typically forms the largest but not the sole source of funding for the PPP Company. The rest of the required financing will be provided by the sponsors in the form of equity or junior debt. Grants, often in effect a form of public sector unremunerated equity, may also contribute to the financing package.

Since senior lenders do not have access to sponsors’ financial resources in project-financed transactions, they need to ensure that the project will produce sufficient cash flow to service the debt. They also need to ensure that the legal structuring of the project is such that senior lenders have priority over more junior creditors in access to this cash. In limited recourse financings, lenders will seek additional credit support from the sponsors and/or third parties to hedge against downside scenarios and the risk of the project’s failing to generate sufficient cash flow.

Finally, lenders will wish to ensure that where a project suffers shortfalls in cash as a result of poor performance by one or more of the PPP Company’s subcontractors, these shortfalls flow through to the subcontractor, leaving the ability of the PPP Company to service the debt unimpaired.

Even though responsibility for arranging the financing of a PPP rests with the private sector (the PPP Company is the borrower), it is important for the Authority’s officials and their advisers to understand the financing arrangements and their consequences, for the following reasons: 

When the Authority evaluates a bidder’s proposal, it must be able to assess whether the proposed PPP contract is bankable and whether the proposed financing is deliverable in light of the market conditions and practices prevalent at the time. Awarding the PPP contract to a company that ends up being unable to finance the project is a waste of time and resources.



The allocation of risks in the PPP contract can affect the feasibility of different financing packages and the overall cost of the financing.



The financing can have an impact on the long-term robustness of the PPP arrangement. For example, the higher the debt-to-equity ratio, the more likely it is that in bad times the PPP Company will run the risk of a loan default, possibly terminating the project. Conversely, the more debt in a project, the more lenders are incentivised to ensure that project problems are addressed in order to protect their investment.



If the PPP includes State guarantees or public grants, the Authority will play a direct role in some part of the financing package.



The amounts and details of the financing can directly affect contingent obligations of the Authority (e.g. the payments the public sector would have to make if the PPP contract were terminated for various reasons).

The Authority’s financial advisers should have a thorough understanding of what will be needed to make the PPP project bankable, given market conditions and practices prevalent at the time. Carrying out market sounding exercises at different points during the project preparation stages will greatly assist in developing a good understanding of investor and lender attitudes. It will save a great deal of time if any credit enhancement is to be provided by the public sector.

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APPENDIX 2: KEY ISSUES IN THE DESIGN AND IMPLEMENTATION OF AN EMISSIONS TRADING SCHEME Key elements of an ETS Legislative authority: The ETS must be created with a very clear political mandate. This is why ratifying the Doha Amendment to the Kyoto Protocol would be beneficial. If Ukraine takes a target in the second commitment period and engages in negotiations supporting the formation of the post-2020 agreement, stakeholders will see that the Government is committed to long term action on GHG emissions. This commitment can then be implemented through, inter alia, the creation of a Ukrainian Emissions Trading Scheme.

The European Union created the EU ETS with broad political support and a unanimous vote in the EU Council of Ministers. First proposed in a green paper in 2000, the scheme was rapidly developed and finally approved in 34

October 2003, 14 months before it was due to be implemented . Since then, the EU ETS has suffered from a number of events and issues which have undermined some of its political support. These include, but are not limited to: 



 



The oversupply of allowances in the first phase which resulted in the price falling to zero – even though the first phase was recognized as a pilot phase and there was no banking of allowances into the second phase, critics seized on this event as an indication of the failure of a market mechanism; The global financial crisis caused a significant drop in manufacturing and industrial output and energy demand with the result that the second phase of the EU ETS was also long. This exposed some weaknesses in the design of the EU ETS (notably that the Commission and National Governments had no easy way of reducing the number of allowances in response to external impacts); A number of frauds including a VAT fraud and theft of allowances from some accounts in the registries of some countries; Import of Certified Emission Reductions from a handful of industrial gas abatement projects which environmental groups considered were non-additional; critics complained that the EU ETS was resulting in the transfer of revenue out of the EU to competitors and that the EU was getting nothing in return; Domestic political issues such as, most recently, the German elections which caused the German chancellor and individual MEPs to avoid backing reforms in the EU ETS so as not to appear to be increasing the costs for the German economy and German industry, although after the elections, support was then forthcoming.

Such events have helped to undermine long term certainty in the EU ETS, resulting in weak forward prices for EU Allowances, which in turn has failed to trigger the kinds of technology change and fuel switch the global environment needs if it is to stay below the 2⁰C target.

Strong implementing agency: An ETS requires a very high level of compliance and strong and unambiguous enforcement of penalties for entities which fail to comply. Climate change and GHG emissions are often considered to be environmental issues and therefore are often placed under the authority of the Ministry of the Environment, however, the entities involved in the ETS are power generation companies and large industrial

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facilities and a case can be made for placing the responsibility for implementation with a cross-ministerial committee under the chairmanship of a very senior minister, for example the office of the Vice Prime Minister.

Wherever it is located, the implementing agency will be responsible for a number of very important decisions including:   

  

 

Defining the scope of the scheme and ensuring all eligible facilities are captured Awareness raising amongst captured entities and stakeholders Defining the allocation process and overseeing the final allocations to individual facilities – this amounts to the distribution of sovereign assets worth, potentially, tens or even hundreds of millions of USD and must therefore be carried out in a very transparent manner; Receipt and cancellation of allowances against verified emissions; Decisions on and enforcement of compliance; Publication of monitoring and reporting guidelines and guidance on a number of specific technical issues relating to topics such as definition of facilities; treatment of shared equipment; new entrants and treatment of closed facilities; Creation of an accreditation process for independent verification; Reporting to Parliament and stakeholders in a transparent manner.

On the basis of these different activities, it is clear that no single Ministry will contain all of the necessary competencies and that cross-ministerial cooperation will be required.

Third Party Verifiers: In order to ensure that emissions data is accurate and avoid mistaken or intentionally erroneous reporting of emissions, it is essential that all data is subjected to third party verification by independent verifiers. Such entities exist internationally and some are already active in Ukraine and have, for example, been performing similar services for Joint Implementation. Third Party verifiers are already accredited to perform verification under the EU ETS and validation and verification of JI and CDM projects. Ukraine could utilize existing accreditations subject to an extension of scope confirming that the entities in question have sufficiently qualified staff in Ukraine, with, for example, an appropriate level of knowledge of:    

relevant legislation; guidance documents; Ukrainian economic sectors; and Ukrainian language.

The accreditation must also confirm that they are independent of any economic interests in the facilities and companies they audit and that they have sufficient insurance cover in case of negligence.

Alternatively, the Ukrainian authorities could establish a new accreditation scheme which would require existing verifiers to apply once again but would also level the playing field by extending the opportunity to national 35

Ukrainian entities .

35

In practice, the verification work tends to be performed by large agencies that specialize in third party inspection. When new entities enter the space, there is a danger that they are unable to carry sufficient insurance to cover any significant errors, which could ultimately undermine the environmental integrity of the scheme.

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An extensive outreach and communications programme is required to ensure that all entities which are eligible for the ETS are notified and informed of their obligations and that sufficient training and awareness raising is undertaken so that captured entities know and understand their obligations and are able to comply from the outset. This will require the ability to engage with trade associations and bodies representing the captured sectors.

It may also be useful to design and deliver training courses for various levels of professional and technical staff. For example, some companies entering the EU ETS found that their Articles of Association did not permit them to engage in trading of commodities; other companies struggled with the technicalities of monitoring and calculating their emissions. Consultants may play a very important role in helping companies comply and therefore a well trained cadre of consultants may be critical to a successful scheme; and if one objective of the ETS is to facilitate the financing of new technology, then the CFO and Directors will need to understand how the scheme works. For all of these reasons and more, an extensive outreach and communications programme will be essential to the success of the scheme.

The authorities in charge of the roll out of a carbon tax in the Canadian Province of British Columbia managed the introduction of their carbon tax particularly well though extensive consultation and through the formation of 36

several commissions to ensure public awareness and participation .

Participating entities should be identified early on so that they can engage with the outreach programme.

Companies will need time to prepare to engage, and for example, ensure that their articles of association or other legal constitutional documents allow them to engage in trading of emission allowances. Databases of existing facilities available through operating permits, or existing environmental or financial reporting requirements are likely to hold the vast majority of participants.

Allocation procedures Allocation is the most complex and contentious element of setting up the ETS. There are two established approaches – grandfathering and auctioning.

Under grandfathering, allowances are issued to participants for free based on historic emissions data usually reduced by one or more factors. Historic data may be collected for a number of years and then for example the average value taken or the allocation can proceed on the basis of one year’s data – though obviously this is at risk of being unrepresentative for some entities. In either case, it is essential that the historic data is independently validated. Participants may either make mistakes (there are several examples of entities reporting grammes as tonnes and consequently claiming to have emitted 1 million times more emissions than in practice); and more significantly, many participants will by now understand that the allocation is based on historic emissions and therefore higher historic emissions will result in a more generous allocation.

Grandfathering results in the free distribution of sovereign assets and assuming the ETS results in trade, these assets have a financial value. If entities have received them for free then they will be able to use them to raise capital to finance the purchase and installation of new technology. On the other hand, if the state hands out these assets for free, then they miss the opportunity to raise significant amount of revenue.

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Auctioning of allowances is the economically optimum approach because it results in price discovery and, in theory, participants should buy what they need or buy more and bank the remainder. However, in the early stages of an ETS, participants are unlikely to be sufficiently aware of the costs of abatement, or of how many allowances they will need to buy and there is a risk that, for example, early movers will purchase excess allowances at low prices and later sell them for substantial profits. This kind of behaviour would undermine the credibility of the scheme.

In practice, it may be best to combine grandfathering and auctioning with an early pilot phase during which allowances are not bankable, whilst at the same time ensuring that the value of allowances is sufficiently high to enable capital to be available for investment in new technology.

Registry, trading and transfer Registries are extremely important in the overall process because they ensure that allowances are held in one place at one time, i.e. that they are not double counted. They provide the accounts into which to issue allowances, accounts for transferring allowances as a result of trades, and cancellation and surrender accounts. Experience with the EU ETS has shown that these accounts must be secure against theft and, if the ETS is to engage in international transfers, they have to be capable of dealing with different types of units. Several commercial companies have built registries for various EU Governments and the International Transaction Log for the UNFCCC so there is now a good wealth of experience in designing such platforms.

Use of offsets Emission reductions derive from two mechanisms, the Clean development mechanism (CDM) and Joint Implementation (JI), which were introduced into the Kyoto Protocol along with International Emissions Trading, as flexibility mechanisms to give Annex В Parties flexibility in how they achieved their targets. Under each of these mechanisms, emission reduction units are awarded for reductions in emissions which would not have arisen in the absence of the Kyoto Protocol. To date they have been derived from project based activities usually in individual installations but increasingly, under Programme of Activities, from many individual sources such as households.

The projects must pass an additionality test to prove that they are not business as usual and calculate baseline emissions using an approved methodology.

The international community quickly realized that they could source the lowest cost abatement opportunities and keep prices in ETS at an acceptable level. After a while, however, it transpired that the CDM was all too successful at sourcing low cost abatement activities and the markets were being flooded with “industrial gas” credits produced at the cost of a few cents per tonne. At the same time, there were allegations that i) the baselines for some projects were being manipulated; and ii) many projects were not additional. JI suffered firstly from institutional delays and then from rapidly growing issuances again, accompanied by allegations that the units were not backed by real reductions (though in the case of JI, the emission reductions are backed by the cancellation of 37

Assigned Amount Units). Consequently, offsets have gained quite some reputation through the EU ETS.

37

To give them their proper title, offsets are actually Certified Emission Reductions (issued under the CDM) or Emissions Reduction Units (issued under JI). They do not become “offsets” until the owning entity retires them against a compliance obligations

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The upshot is that whilst flexibility is vitally important to a capped economy or sector, there is currently a general bias against the use of offsets. This perception is misplaced. There is no evidence that baselines were manipulated and whilst some projects which were registered in the past might not be registered against today’s interpretations of the rules, these projects were judged, individually, to be additional at the time of registration.

Today, emission reductions are cited as one of the primary causes of the failure of the EU ETS to deliver on its objectives, but if the recession had not taken place and allowances were trading at EUR30 per tonne, emission reductions would be playing a very important cost containment role.

The challenge, therefore, is to find a way in which offsets can still remain as an option to control price without them being seen as a means of transferring wealth to other countries, subsidizing competitors and damaging the environmental integrity of the cap.

There are a number of proposals to achieve these goals: 1) Create a domestic offset programme. This can be quite complex and expensive to set up if there is little demand however it is also a good way of extending the reach of the ETS to other sectors of the economy not covered by the ETS and keeping money in the country. The example of early compliance with regulation in the landfill sector given below could be a means of generating domestic emission reductions.

Australia designed the Carbon Farming Initiative to provide offsets to the Carbon Pricing Mechanism. The main danger of this a domestic scheme is that standards are not sufficiently high and it creates a barrier to future linkage, because if schemes link, then units from a domestic scheme can be laundered into allowances and sold into the linked scheme. The EU ETS has not allowed its own domestic offset projects, relying instead in the international mechanisms under the Kyoto Protocol.

2) Set qualitative limits. These limits typically restrict units from particular technologies or countries. The EU ETS has pioneered these and others have follow suit, most notably with the ban on industrial gas credits and then a ban on post 2012 projects implemented outside Least Developed Countries and finally a ban on pre 2012 CERs after March 2015.

The problem with qualitative limits is that they do great damage to the international markets, which like ETS, need robust forward price curves. The impact of an impending ban is to cause any holders of the units subject to the ban to sell them at lower and lower prices, simply because after the ban they will be worth nothing and even 1 cent is better than nothing. This contributes to massive volatility in the market, so if they are to be used, such bans should be announced at the outset and not changed or introduced retrospectively.

3) Set quantitative limits. Most schemes have set quantitative limits on the use of offsets in order to ensure that achieving targets is supplemental to domestic action.

Penalties for non-compliance Compliance must be strictly enforced and hence there must be high penalties for non-compliance. In the EU ETS, non-compliance during the first was would result in a penalty of EUR30 per tonne plus a requirement to surrender allowances; in the second and subsequent phases the penalty rose of EUR 100 per tonne, still with the requirement to surrender the necessary number of allowances. This means two things: 1) The penalty is not a price ceiling; and 55

2) The cap cannot be breached via the penalty system.

As an alternative, the Korean ETS is proposing to penalize non-compliance by requiring offenders to purchase new allowances at a cost of 3 times the average price during the compliance period up to a maximum of approx USD 90 per tonne (it is not clear whether the ceiling is USD90 or USD270) . This means that the penalty can act as a price ceiling and as a source of new allowances which could result in breaching the cap.

Other issues There are many more complex issues around establishing an ETS including monitoring guidelines, new entrants, technical issues around combined heat and power production, definition of boundaries etc. These are well described on a UK Government website available here: https://www.gov.uk/participating-in-the-eu-ets

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APPENDIX 3: DESIGN AND IMPLEMENTATION OF NON-CARBON MARKET MECHANISMS CO2 emissions from small and diffuse point sources (small- and medium size district heating, transport and SMEs) a)

Proposed non-carbon market approach: Tax on fossil fuels for all entities which are not covered by the ETS. b) Objectives: The objective of this measure is to discourage the use of fossil fuels and encourage a switch to lower carbon technologies and sources of renewable energy, and greater energy efficiency. c) Scope of coverage: All sources of CO2 from fossil fuel consumption which are not covered under the ETS. d) Use of revenues: The revenues from the tax may be directed towards the Ukrainian Low Carbon Emission Fund and/or to the redistribution mechanism to protect exposed sectors of society from the impacts of rising costs. Specifically, the fund could support investments in improved public transport; grants and subsidies to improve housing stock (e.g. insulation and upgrading of less efficient district heating plants), construction of biomass district heating plants particularly in rural locations close to biomass resources, implementation of metering and household level controls for heating, and pilot projects to demonstrate the benefits of new technologies. The redistribution mechanism could direct revenues to partial rebating tax paid by district heating systems, particularly in rural zones and raising income tax thresholds. e) The ULCEF could also be expended on reduced import duties or subsidies on the purchase of fuel efficient vehicles and electric cars; a scrappage scheme to take some of the oldest and least efficient vehicles off the road; research and development into bio-fuels and biomass and support for low carbon innovation. f) Design and implementation considerations: The tax would be levied on carbon content of fuel multiplied by the typical oxidation factor in the median technology at a rate which reflects the expected or average price of emissions in the ETS. The tax could be banded so that larger users pay a higher tax rate or the tax rate increases as CO2 emissions increase however this is more complicated than a simple flat rate. The tax could also be banded by geographic region with urban dwellers paying higher rates than rural communities under the assumption that urban communities are less likely to be living in energy poverty.

The tax would be levied at the point of sale with retailers responsible for collection and surrendering of the tax. Bio-fuels and biomass would be zero rated. g) Potential impact: Consumers of fossil fuels would immediately see an increase in the cost of fuel consumption. For households this may trigger more conservative use of private cars; gasoline and diesel users would see an increase in the cost of fuel consumption for transport and this would have knock on effects on costs of retail products as transport costs would increase. For this reason the tax may be introduced at a low rate and increased annually, giving a clear signal of the future but also going people time to adapt. As the costs of motoring rise, it would encourage use of public transport and the purchase of more fuel efficient vehicles and help early movers switch to hybrid and electric vehicles. For households this may trigger more conservative use of gas for cooking, although this is not a major source and probably not represent a significant cost to most households. District heating plants burning gas and any that are still burning coal will be required to pay the tax but in recognition of the lack of flexibility around the management of district heating requirements, the majority of the tax would be rebated against agreements to upgrade existing plant. Grants would be available for pilot projects to convert to biomass followed by soft loans from the Fund for production and use of biomass. Pilot projects would be

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established around the installation of heating controls, building standards would be upgraded to improve insulation and grants would be available for R&D and innovation in the Ukrainian environment. h) Co-benefits: There are a wide range of co-benefits which include better use of public transport; reduced road traffic and less congestion; increased speed at which new vehicles with higher emission standards and safety standards are deployed; improvements in local air quality. i) Disadvantage: There are also quite significant disadvantages due to the historic infrastructure in Ukraine; for example residence in apartment blocks with a long tradition of district heating and old heating systems in many rural locations. The main problem is that the tax will increase the costs of heat and transport which are increasingly essential to modern life and again, can impact heavily in rural locations.

Some sectors of society are highly susceptible to being pushed into energy poverty by such increases, and the practical collection of the tax may also be a challenge. Recycling of the revenues is therefore very important in order to ensure that whilst the tax rate goes up, other taxes such as income tax and labour taxes comes down or the costs of taxes in some areas are significantly rebated. j) Alternative approaches: The UK has addressed this category of sources using three different approaches: a tax on transport fuel (which was not based on GHG emissions); the CRC (formerly the carbon reduction commitment) for non-carbon intensive enterprises such as hotels, shopping complexes and institutions who are required to purchase allowances to emit and surrender them; and the Climate Change Levy (CCL) which applies different rates of tax to SMEs which are not captured under the EU ETS, with significant reliefs if the entities achieve negotiated reductions in GHG emissions. This differentiation reflects a significantly more complex regulatory environment. Starting with a flat rate tax on all fossil fuels does not preclude developing more complex approaches in the future.

Methane emissions from waste a) Proposed non-carbon market approach: Landfill tax b) Objectives: To make disposal of waste to either landfill or incinerator more expensive than recycling waste. c) Scope of coverage: Municipal waste collection and disposal services and disposal of commercial waste, possibly on a city / municipal basis. The tax could be extended to cover municipal sewage. d) Use of revenues: Revenues collected may be used by local municipalities, who with the help of the Fund, may enter into public private partnerships with landfill operators to build and operate sanitary landfills.

The private operators are granted a licence to receive waste and charge a tipping fee for, for example, a period of 30 years. The tipping fee would set within a range of parameters to ensure that citizens get good value for money and the private sector operator can work out what kinds of services they can offer.

Alternatively the tax can be directed to the Fund from where soft loans and/or equity may be provided to help the private sector build the landfills with an expected commercial return. e) Design and implementation considerations: Implementing a landfill tax may take time in Ukraine because of the apparent lack of any form of payment mechanism for the disposal of waste and the likelihood that if faced with paying for disposal, citizens may resort to fly tipping. A number of different models may be applied such as charging a tipping fee at gate to the landfill. Collection services would pay the tax and would recover the additional costs from the clients who produce the waste. The clients (e.g. residential apartments) could pay a flat rate or a volume based rate on the number of waste receptacles which are emptied. Alternatively the city council could charge a fee to properties and use that run the landfill. A third option is that individuals need to purchase coloured bags into which different kinds of waste can be 58

deposited, and refuse collectors then to collect and recycle. The dangers are that waste is tipped illegally by either residents, to avoid paying the tax in the first place, or waste handlers who would have collected the tax but avoid paying it to the landfill operator. Apartment blocks with rubbish shoots also complicate the sorting of waste at the household level. It is possible that a range of different approaches may need to be adopted with consolidation towards one approach over a period of decades. f) The landfill tax should be designed to compliment other policies such as waste to energy in industrial facilities and use of waste for power generation, recycling in industries with process emissions captured in the ETS incineration of waste, waste in the food and beverage sector, and collection and treatment of leachate. g) Potential impact: A landfill tax will encourage councils to implement waste segregation in collections; recycling of wastes and improvement of markets for recycled materials. Good quality sorted waste may enable composting of organic waste to be undertaken (although sometimes there are problems with heavy metal contamination from batteries included in waste streams). The programme reduce waste to landfill and increase methane yield making capture and potential abatement or use more efficient.

Depending how effective capture is, will reduce emissions of methane from waste by 50% or more. This initiative may lead the way to feasibility studies for more advanced technologies such as gasification or composting. h) Co-benefits and disadvantages: Creation of sanitary landfills will have major environmental co-benefits including air quality and ground water contamination. It may address social issues around waste pickers and black market exploitation of labour, providing a clean and safe working environment where workers are paid a fair wage. i) Alternative approaches: Raising revenues to pay for the additional costs through a general council or city tax is less efficient because residents will not associate the tax with the amount of waste they produce.

Fugitive emissions from oil gas and coal a) Proposed non-carbon market approach: Regulation b) Objectives: The phase-out of fugitive emission from the production and transport of coal, oil and gas. c) Scope of coverage: Mines and oil and gas fields and oil and gas pipelines; bunker fuel storage and associated infrastructure. d) Use of revenues / source of finance: No revenues collected. These measures will instead cost the respective industries and these costs may be partially addressed through grants, subsides and soft loans from the government’s co-investment fund in return for demonstrated improvements in performance. e) Design and implementation considerations: Well proven technologies exist to abate methane from these sources at a relatively low cost. These regulations should regulate the release of methane during routine operations and set thresholds in terms of total environmental load and maximum emissions at any one point in time, defining how the measurements are to be taken. Care is required to ensure that, for example, methane concentration in ventilation or drainage systems in mines cannot simply be diluted to avoid deploying more expensive abatement technology. Ventilation air methane would need to be abated; unless there is a use for the low quality heat, this does not generate any revenue but the amount of VAM can be reduced by improving methane drainage and or under-taking pre-drainage of mine seams.

Localized low pressure gas distribution networks may be a source of significant methane emissions and these need to be subjected to systematic maintenance and repair.

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f)

Potential impact: The regulations should ensure that efficient abatement equipment is installed and that all leaks are stopped. These measures will lead to improved safety performance, especially in the deep coal mining sector and would encourage resources recovery and, in conjunction with a feed in tariff, heat and power generation (see below). g) Co-benefits and disadvantages: Better safety and energy recovery. h) Alternative approaches: These sources could be either taxed or included in an ETS. Under both mechanisms there is a danger that safety could be compromised as producers seek to reduce costs by delaying or avoiding taking safety measures. An ETS also runs the risk of either triggering windfall profits or threatening the commercial success of the enterprise in the event of large escape of methane. The Government of UK operates a flaring trading scheme in the North Sea encouraging oil platforms to recover “off-gas� and either pipe it to shore or use it for power generation. A similar scheme could be applied to any industries which flare methane.

Emissions from flaring methane a) Proposed non-carbon market approach: Feed in tariff for heat and power b) Objectives: To encourage investment in heat and power generation from methane that would otherwise be flared under the regulations described above. c) Scope of coverage: Heat and power generated from methane from landfill and other biological sources, possibly from fossil sources including coal mine methane and oil and gas production. d) Use of revenues / sources of finance: No revenues collected. The feed in tariff would be collected via a small increase in retail energy prices but the total amount of power generated from these sources would be small. e) Design and implementation considerations: Abatement of methane is the primary objective but there may be situations where heat or electric power can be generated for the grid from biogenic sources of methane. Such emissions are considered to be CO 2 neutral if the methane is from biomass and biogenic sources of carbon, therefore it would be classed as renewable energy. Coal mine methane could be included but it is not carbon neutral or renewable. f) Potential impact: Where economically viable, this scheme would encourage better use of resources and promote energy security. This scheme could be used for heat generation and, for example, encourage farmers to use biogas for heating animal sheds in winter or the food and beverage sector to use waste products for energy. g) Co-benefits and disadvantages. None h) Alternative approaches: Heat and power generation from methane could be treated as project based activities in a domestic project mechanism but proving additionality is always difficult when there is a revenue stream from power generation.

GHG emissions as by-products of production processes a) Proposed non-carbon market approach: Regulation b) Objectives: To phase out emissions of high GWP GHGs which are by-products of manufacturing processes via the application of abatement technologies or investment in new technology. c) Scope of coverage: HFC from refrigerant gas production and N2O from nitric and adipic acid, PFCs from aluminium production.

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d) Use of revenues / sources of finance: No revenues collected. These measures can be financed by the industry through increased costs of production. Where abatement costs are high due to the need to rent catalysts, financial support in the form of soft loans or underwriting price variations in precious metals may be required which can be provided via the Fund e) Design and implementation considerations: The abatement technology exists for these gases and it should be applied. It will result in increase in the cost of production and the final product, but the Ukrainian Government should work with other Governments to implement similar regulation to minimize the impacts on competiveness. Total phase out PFCs from aluminium production may be technically challenging; limits may need to be set. f) Potential impact: Total abatement of these gases within 12 months of implementation. g) Co-benefits and disadvantages. None h) Alternative approaches: These gases could be included in an ETS but if there is any free allocation it must be based on post abatement emissions; including these sources in an ETS runs the risk that operators will compromise health and safety to avoid excessive costs.

Use of high GWP gases a) Proposed non-carbon market approach: Tax on the purchase of gases b) Objectives: To make alternative technologies financially attractive c) Scope of coverage: All high GWP gases used in production processes and products including HFCs, SF6, N2O and NF3 d) Use of revenues / sources of finance: These gases should be taxed at source and the revenues used to support the adoption of new technology via the Fund. e) Design and implementation considerations: Gases may be recycled in closed loop systems, in which case only losses will be needed to be purchased and taxed; some gases may exist only for a period of time during manufacturing processes and therefore do not need to be taxed unless there are any losses.

Recovery of gases from old equipment, for example HFCs and HCFC from refrigerant plant should be carried out under controlled conditions. Increased use of refrigerant gases in air conditioners must be addressed; the tax must become prohibitively expensive and not just another cost for consumers. f) Potential impact: The tax should lead to the total phase out the use of these gases. g) Co-benefits and disadvantages. This tax will stimulate research and development and innovation. h) Alternative approaches: Where these gases are not manufactured in Ukraine the importation could be banned or increasingly restricted. They could be included in an ETS but this would be complicated because the retailer would have to surrender allowances equal to the GHG potential of the gas but the gas may never be released. Controlling the use of the gas amongst individual users would not be practical and if prices are not sufficiently high in the ETS, the cost of allowances may not be high enough to trigger change.

Emissions from agriculture a) Proposed non-carbon market approach: Production standards, education and awareness raising. b) Objectives: Raise the standard of agricultural production such that emissions per unit of production continue to fall. c) Scope of coverage: Livestock, dairy, poultry and cultivated crops

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d) Use of revenues / sources of finance: This activity does not raise revenues. It would be funded by grants from the Fund or from central government with benefits returning to the economy through increased and better quality productivity, employment, food security etc. e) Design and implementation considerations: The design of this programme must take into consideration the diversity in agricultural land holdings contrasting large scale agri-business with traditional farming.

Agric-businesses may be required to meet improving standards whilst minimizing impacts upon the environment including issues such as nutrient loading, water abstraction etc. Traditional framers on the other hand will benefit from training and awareness-raising around continuing advances in agricultural practices and access to micro finance from the Fund. The Ministry of Agriculture, through an extensive network of agents, will establish long term relationships with farmers and agricultural workers, whilst recognizing that many agricultural workers are poorly educated. If Ukraine intends to increase its agricultural output and take advantage of its location between and adjacent to key markets, improved quality of produce will be important. Both New Zealand and Ireland, for example, have high proportion of their GHG inventory arising from agriculture and have implemented policies and measures to address this.

If Ukraine increases productivity from agriculture and reduces reliance on extractive and primary industries, these countries could provide useful examples of how to progress. f) Potential impact: These measures should lead to a long term decline in emissions per unit output and an increase in the efficiency of production. In Ireland it also increased profitability of farming by making the farming practices more efficient. This activity would involve extensive outreach to all farmers in Ukraine with the aim of raising their awareness and improving their standards of production so as to maximize yields per unit of input and minimize GHG emissions per unit of output. At the same time, the quality of output can be raised with greater differentiation between products and standards helping to strengthen Ukraine’s agricultural industries. For example farms may operate to a variety of standards reflecting best practice such as organic production, low or no carbon production, good agricultural practice etc. combined with strengthening of local brands and traditional products. g) Co-benefits and disadvantages. The scheme will reduce excessive use of fertilizer and chemicals, reduce erosion, encourage conservation, increase soil carbon, safeguard employment and food security. h) Alternative approaches: Taxing or placing farmers under an ETS are not considered to be suitable alternatives because of the challenges of enforcing compliance. At the same time, such measures are likely to increase the cost of food which has very important political implications.

Emissions from land use, land use change and forestry a) b) c) d) e)

Proposed non-carbon market approach: Standards, awareness-raising and grants Objectives: Increase net sequestration in forestry and land use sector Scope of coverage: All non-agricultural landuse Use of revenues / sources of revenues: No revenues are generated. The initiative is funded via the grants window in the Fund.

Design and implementation considerations: Ukraine already has extensive plans for the creation of national parks which, if implemented, will provide good opportunities to achieve the objectives of this policy. All of the forest estate should be managed under an internationally recognized standard such as FSC or PEFC, as these standards generally improve forest management and the ability to manage carbon storage effectively.

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f)

Potential impact: Funding may be offered from the co-investment fund to improve forest management and the ability to alter forest management to increase carbon storage through for example, managing the age structure of the forests, stocking rates, improving soil carbon; reducing erosion and banning on-site burning of harvest debris. Promoting biomass industries can make unproductive and undervalued forest usable and lead to better management and an overall increase in carbon storage. g) Co-benefits and disadvantages. Improved habitats, protection of biodiversity, tourism and recreation.

Reduction in illegal harvesting, increased receipts of timber royalties. h) Alternative approaches: Regulation, but difficult and costly to enforce.

Emissions from bunker fuels a) b) c) d)

Proposed non-carbon market approach: Tax Objectives: Reduce usage and slow the growth in the use of aviation fuel in particular.

Scope of coverage: Domestic air and water transport.

Use of revenues: The taxes collected will be remitted to the Fund which in turn will be available to support Public projects designed to encourage the production of bio-fuels for jet engines; upgrading of the national fleet or airlines; improving rail and bus transport options. e) Design and implementation considerations: This is not a major source of emissions in Ukraine but it is a generally a growing source and as other sources come down, it will increase in significance. The emissions are caused by business and affluent members of society. f) Potential impact: Increase the cost of air travel, encourage airlines to reduce the weight they transport; fill seats on planes. g) Co-benefits and disadvantages. Raise awareness amongst the travelling public and encourage them to use alternative lower carbon methods; discourage excessive travelling for leisure. h) Alternative approaches: Include aviation in ETS. This approach is being implemented in the EU ETS and if only domestic flights are included, this may be a practical alternative.

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