Introduction
Carbon Emissions and their relation to climate change are significant and have large societal and economic impacts globally. This has led to ambitious plans worldwide to promote decarbonisation and move away from fossil fuels as a primary energy source, including the GCC countries, with the example of Bahrain and Saudi Arabia pledging to go “carbon neutral” by 2060. This article intends to explore how a carbon trading scheme can help the GCC achieve its “carbon neutrality” status. We explore the following: First, what is a carbon-trading scheme, and what evidence exists of its effectiveness around the world, secondly, we explore the current state of GCC emissions and what these emissions could mean towards the region. Last, we look at the implications of continuous unchecked GCC emissions for the region, and what policy recommendations we can implement to counteract them.
Background about Carbon-trading scheme and evidence of effectiveness
Emissions trading schemes have gone through several phases of evolution. They can trace its roots to R.H. Coase's 1960 paper 'The problem of social cost,' which focused on the cost of harmful practices business force unto others, for example, pollution. This has been the theoretical basis of the 1977 Clean Air Act, with the first 'scheme' becoming part of the US Acid Rain Program of 1990. The 1992 UN Framework Convention on Climate Change (UNFCCC) came about as a response to the risks of global warming, which influenced the 1997 Kyoto Protocol, which included provisions for the development of market mechanisms that aid in limiting global emissions.
In addition to carbon taxation, emissions trading has emerged as an effective tool in the climate change mitigation kit. Using a market-based approach, emissions trading internalises the environmental and social cost of pollution, thus providing an economic incentive that promotes the efficient use of energy and the utilisation of cleaner sources of energy.
In practice, there are two main types of trading schemes: the cap-and-trade system and the baseline-credit system. In the cap-and-trade system, an upper limit on the total amount of emissions is set, after which emissions permits are sold or auctioned off. On the other hand, in the baseline-and-credit system, regulations are set in place without an upper limit, and emitters that comply earn credits they can sell to others.
The cap-and-trade system has become the most popular, being implemented successfully in a range of economies with currently over 20 systems in operation. The first and largest emissions trading scheme is in the EU that began in 2005 and remains a major part of the EU energy policy. Several countries have followed suit to keep in line with their emissions reductions obligation. The largest and most ambitious project outside the EU is the Chinese national carbon trading scheme launched in 2021, which followed several regional pilot ETS such as in Beijing and Hubei.
To date, assessments of the results of the EU ETS against the intended outcomes, namely emissions reductions and growth in low-carbon technologies, demonstrate significant positive results in terms of the former, yet mixed results in terms of the latter.
A 2020 study revealed that between 2008-2016, the EU saved more than a billion tons of CO2, corresponding to a 3.8% reduction in EU-wide emissions. Furthermore, case studies have found the EU ETS supported investment in carbon-efficient technologies; however, it provided little to no drive of fundamental innovation.
In China, various regional ETS programs were being implemented prior to the launch of the national ETS. Several studies, such as the 2020 study by Shaozhou and colleagues on the effect of ETS in those regions, indicate a significant decrease in carbon emissions and carbon intensity without negatively affecting economic development.
Overall, carbon pricing is an essential mechanism for emissions abatement, and it appears ETS is an effective policy instrument not only in providing a flexible and cost-effective reduction in emissions but also the development and deployment of low-carbon technologies, revenue generation stemming from permit-auctioning in addition to co-benefits such as the improvement in public health as a consequence of pollution reduction.
However, it is not without challenges. ETS are complex, requiring significant investments and robust readiness in areas such as stakeholders support, institutional infrastructure, and monitoring and verification systems. Moreover, ETS might need to be combined with other policy instruments to achieve significant emissions reductions, which naturally reveals the need to link different ETS around the globe, which faces several challenges such as geographic proximity, political and economic landscape, and the development priorities of participant countries.
Comparatively, basic carbon taxes are simpler, use existing infrastructure and offer price certainty for firms; however, the main drawback of quantity uncertainty, i.e., it does not guarantee a specific reduction in emissions.
With the proliferation of carbon pricing schemes worldwide, the GCC region may be positioned to benefit from similar policies. However, before we explore how a carbon pricing policy, specifically ETS, manifests in the region, we should first look at the current state of emissions.
Current State of GCC emissions
The Gulf countries are reliant on abundant oil and gas reserves, both for the majority of their revenues and primary energy consumption. However, this continuous use of fossil fuels led to a steady increase in CO2 emissions. While the contribution to the global CO2 emissions is relatively small, the Gulf countries are the highest emitters of CO2 per capita globally, which has been steadily growing.
The Gulf countries are set to suffer from the consequences of the unceasing increase in global temperatures and emissions. Some projections show the region will be inhabitable by the end of the century should temperatures continue to rise. Therefore, carbon emissions mitigation strategies are necessary to counter this existential threat and meet global and regional emissions reduction obligations. A regional carbon trading scheme may be a viable part of those strategies and could be built into the environmental and energy policy of the Gulf countries.
The Social cost of Carbon and the impact on the economy
The notion of social cost of carbon (SSC), i.e., the economic damage arising from emitting a tonne of greenhouse gases into the atmosphere, is well documented and employed in policy design. By calculating the net present value of future economic damage from emissions and through a cost-benefit analysis process, policymakers evaluate the monetary value of policy effect on emissions.
Estimates for the social cost of carbon differ; in a 2016 paper, William Nordhaus estimated the SCC to be US$ 31 per tonne CO2 and grows by 3% per year till 2050, furthermore regional SCC estimates vary with China at the highest end Russia at the lowest. Noticeably the middle east has the same share of 2010 global estimates of SCC as the US. Another 2019 meta-analysis review of 578 estimates for SCC covering 58 studies found a range of -50 to US$8752 USD per tonne CO2 and a mean of US$200.6 per tonne CO2. The wide variation in SCC is due to uncertainties such as the future magnitude of climate damage, discount rates employed, and regional socioeconomic differences.
The social cost of carbon estimates for the GCC countries varies as well. A 2018 study of country-level social cost of carbon found Saudi Arabia and the UAE have one of the highest SCC globally at US$47 US$ 24 tonne per CO2, respectively. These numbers may reflect the potentially severe effects of climate change on these countries. Estimates of the economic impact of climate change vary depending on the possible scenario outcome; in the least severe case of a below 2 degrees warming, by 2050, the world might expect a loss of 4% of its total GDP, and the Middle East region losing about 5% of its total GDP and the most extreme case of a 3.2 degrees warming, the Middle East might witness approximately 28% loss in total GDP.
Analysis of Sectoral emissions
A deeper look into the sectoral contribution of emissions in the GCC countries reveals the majority come from electricity generation, manufacturing, and transport across the GCC. However, in the case of the UAE, a large contribution is coming from bunker fuels due to the thriving shipping industry. Although those emissions are projected to increase further, forecasts show that the emissions in the region are in a rapid upward trend higher than the global growth. However, this increase goes hand in hand with the region's rapid economic growth.
The implementation of several emission abatement policies such as ETS and expected results depends on understanding the characteristics of the sectors and local considerations of the GCC countries.
The power sector is one of the biggest emitters of CO2, accounting for over 40% of global emissions, and the GCC is no different, where the sector is responsible for over 60% of emissions on average. While the GCC electricity sector has been going through some liberalisation in the form of subsidy reforms, it remains highly regulated, where the supply of electricity and tariffs settings are completely under state control. This subsidisation of electricity in the region might greatly dampen the impact of a carbon trading scheme, as the impact of an ETS depends on the extent energy prices reflect carbon cost in addition to a cap on the total amount of emissions. However, there could be some opportunities to price emissions into tariffs, for example, by targeting specific end-users such as industry and commercial use with tariffs that incorporate the allowance cost of their emissions.
While the benefits of an ETS might not be fully realised under such a tightly regulated system, the sector can and has been targeted by other companion policies, such as policies that promote the addition of renewables into the mix, i.e., subsidies, and drives to reduce electricity consumption and improve energy efficiency.
The transport sector is another major emitter of CO2 emissions in the GCC and globally and has been the fastest-growing source of said emissions. While the COVID pandemic drastically affected the sector, the sector is set to rebound. Transport can be divided into road transport and aviation. Implementing an ETS in the sector is a complex topic and whether it is an appropriate policy mechanism to tackle emissions from the sector.
One analysis on targeting transport in the EU ETS found it requires an unfeasible average carbon price of 217 Euros per tonne CO2 to achieve target emissions reductions. At current carbon pricing, no substantial reduction can be achieved. Another study found that ETS is a powerful tool in tackling emissions in the sector if it is supplemented with other existing standard-based policies. As previously mentioned, ETS in the transport sector is complex and faces several challenges. For instance, wherein the point of emission should ETS target downstream or upstream emitters; targeting downstream emitters may be viable for aviation but not for road transport where the upstream fuel suppliers are more valid targets. Additionally, the allocation of allowances in a way that balances the willingness to participate and consequent emission reductions.
Besides the above-mentioned complexities, implementing ETS in the transport sector in the GCC faces other hurdles. The transport sector-road and aviation- enjoy significant fuel subsidies combined with the absence of robust public transportation alternatives and lacking general public adoption of it, effectively making an ETS cost-ineffective. And while the GCC countries have alternatively focused on developing standards-based policies targeting vehicle emissions and fuel efficiency rating and building up of public transport infrastructure, a combination with an ETS and other tax-regimes, preceded by subsidy reform might have the greatest impact of emissions from the sector.
The third-largest contributor to emissions in the GCC is the manufacturing and construction sector. The industry is an ideal candidate for implementing an ETS as it achieves the dual objective of reducing emissions on the promotion of less-carbon intensive processes. For example, a study on the Chinese pilot ETS showed around a 10% reduction in industrial emissions and close to 0.8 % reduction in carbon intensity. However, another study found such significant reductions in carbon emissions resulted from a reduction of output. This highlights the need to balance the potential of carbon emissions abatement with economic output, the competitiveness of the industrial sector, and other socio-economic aspects like employment levels.
Another consideration is the risk of carbon leakage, which is particularly relevant to energy-intensive sub-sectors such as aluminium, refineries, and chemicals. These industries form the backbone of the industrial output of the GCC. An ETS targeting the industrial sector in the GCC may follow the EU ETS model by setting a cap on the total emissions while simultaneously offering a set amount of a decreasing free allowance against a benchmark based on the “cleanest” companies that balance of emissions targets, competitiveness, and carbon leakage risk.
Policy Recommendation
In the GCC, governance has a substantial role in environmental protection, as highlighted by Sarwar and Alsaggaf for Saudi Arabia; however, while the GCC has taken commendable and important steps in tackling carbon emissions through the introduction of reduction targets and the design of policies that cover energy efficiency and substantial investments into renewable energy, they need to be complemented by the introduction of a regional carbon pricing hybrid policy that may include a carbon tax and a cap-and-trade scheme based on the auctioning of free allowances that covers the various polluting sectors in addition to promoting through subsidisation and investments of green technologies such as electric vehicles. Furthermore, revenues raised from these schemes can be redirected into other environmental protection and emissions reductions initiatives. However, significant market liberalisation may have to occur prior in order to see significant results. Furthermore, as a regional block, the GCC may ease the burden of such schemes and increase the potential of success by exploring the potential of international harmonisation of climate policy and linking its own schemes to other schemes around the globe as part of a global carbon pricing system.
ABOUT THE AUTHOR
Mohamed spent over 8 years in the oil and gas industry in various roles. He holds a bachelor degree in mechanical engineering and a master's degree in energy and economics. His interests include energy economics, energy and environmental policy and sustainable development.
email: m.alamin@bahrainresearchgroup.com