Sustainable Industry

Why regulating the carbon market is better for Brazil

The Industry News Agency answers frequent questions about the discussions around the carbon market, which is at the foreground of the COP-26 negotiations

Establishment of a global carbon market is one of the strategies to help countries reduce emissions and achieve the Paris Agreement target of keeping the planet’s temperature rise below 1.5 °C. However, this is one of the points on which consensus has not yet been reached before the rulebook for implementing the agreement can be finalized, and expectations are high that the issue will be resolved at the next Climate Change Conference of the Parties (COP-26), which will be held from October 31 to November 12 in Glasgow, Scotland.

While negotiations are taking place abroad, several countries are now creating their own carbon pricing systems, in the form of taxation of emissions or trading of quotas via the carbon market. For the Brazilian industry – led by the National Confederation of Industry (CNI) – the most appropriate path given the pricing options for Brazil to contribute to achieving the Nationally Determined Contribution (NDC) targets is the regulated carbon market. The country has undertaken to reduce its greenhouse gas (GHG) emissions by 37% by 2025 and 43% by 2030 in relation to 2005 emissions.

How can carbon emissions be reduced?
There are two central strategies to take steps to mitigate greenhouse gas emissions. First, through “command and control” policies, where the State undertakes direct regulation. The second strategy is via economic instruments, through adoption of incentives and subsidies and through carbon pricing. This consists of attaching a price to greenhouse gas emissions.

Pricing can be conducted in two ways. The first is through carbon taxation and the second is through carbon markets, which can operate on a voluntary or regulated basis.

In the case of regulated markets, the most commonly found type worldwide is the Emissions Trading System, from the perspective of Cap and Trade approach. The regulated sectors engage in this market, where they can buy and sell GHG emission allowances (according to allocations determined by the government). This is the approach advocated by the National Confederation of Industry.

Why not adopt carbon emission taxation?
Carbon taxing in Brazil would lead to an increase in production costs, since some economic sectors will pay more taxes given that it is not possible to achieve zero emissions. Carbon taxing would result in a build-up in the supply chain, thereby generating losses in economic competitiveness. On top of this, there is no guarantee that the revenues from this tax will be allocated to emission reduction actions or low-carbon technology development actions.

The following potential losses have been mapped: 800,000 jobs lost; a drop of BRL 130 billion in GDP; increased costs and reduced economic activity by up to 3%, a decline in exports of up to 5% and an increase in industrial input costs, especially electricity (6%), transport (16%) and fuels (22%).

The Partnership for Market Readiness (PMR Brasil) project is led by the Brazilian Government in collaboration with the World Bank, and it assessed the economic and social impacts from the implementation of carbon pricing systems in Brazil. As a result, a suggestion for the most appropriate mechanism for the country was the regulated carbon market, i.e. – an emissions trading system under the Cap and Trade model – to support achievement of the goals undertaken by Brazil under the Paris Agreement.

How does carbon market regulation work?
Under the emissions trading system (ETS) and the Cap and Trade rationale, a maximum amount of greenhouse gas emissions is allocated to regulated entities (cap) and GHG emission permits are issued. Permits are provided free of charge or via auctions, and can be traded between companies. Regulation of a carbon market has been under discussion in Brazil in recent years, and it should move forward in the coming months.

Why is the National Confederation of Industry (CNI) in favor of a regulated carbon market?
Establishment of a regulated market would provide for an environment of legal security and industry confidence. With clear rules and guarantees for monitoring and governance, companies will be able to decide on the best strategy and what actions need to be taken to achieve it, such as changing equipment or investing in new technologies to reduce CO2 emissions, for example.

According to the president of CNI, Robson Braga de Andrade, this instrument will boost the business environment without increasing the tax burden. “The regulated carbon market will be more effective and will support the strategy for complying with the Nationally Determined Contribution (NDC) under the Paris Agreement,” he says.
What is CNI’s proposal for the creation of a regulated carbon market at the national level?

The industrial sector advocates for an initial learning phase and the use of the proceeds from the commercialization of greenhouse gas emission permits for reinvestment in low-carbon technologies. In addition, the industrial sector wants market regulation to also include the use of offsets (generating credits for offsetting) in several fronts, such as forest credits, renewables, waste management, etc.

The sector also makes the case that a robust system for measuring, reporting and verifying (MRV) greenhouse gas emissions and removals should be developed and put in place.

The industrial sector also suggests the creation of a committee with members from the government and the private sector, in addition to the creation of dedicated technical committees, also with members from the private sector, in support of the committee. According to the CNI, this is the basis for the system to work. For this mechanism to be effective, it is essential that there is a high level of governance on the part of the government to design and implement a system that is adapted to the national context.

CNI’s survey Carbon Market: analysis of international experiences covering initiatives from the European Union, Mexico, the Western Climate Initiative (WCI) in Canada and California, Japan and South Korea reveals the importance of well-structured governance with the participation of the private sector for the successful implementation of long-lasting programs.

Three crucial elements were identified in the most successful markets: governments with a strong collaboration capacity that goes beyond the public sector and is conducive of an open dialogue with the private sector; political will to move forward on the climate agenda as a matter of State, and not of a government, with a consistent approach over the years and experience; and a mandatory emissions reporting system.

In addition to leadership in the Executive branch, other pillars identified by the survey and supported by the CNI are decentralization; creation of new arrangements; organization of compensation systems; liaison with the private sector; and forms of engagement with unregulated sectors.

What is the status of discussions on the creation of a carbon market in Brazil?
Establishment of a regulated carbon market has been discussed by the Brazilian Congress. The main bill is PL No. 528/2021, by Representative Marcelo Ramos (PL/AM). It is currently under review at the Commission for the Environment and Sustainable Development (CMADS).

The matter has also been discussed within the Executive Branch. In 2016-2020, CNI, industry federations, trade associations, and businesses participated in the Partnership for Market Readiness (PMR Brasil) project, led by the Brazilian Government in partnership with the World Bank. The PMR is a global program that has supported 23 countries in evaluating carbon pricing instruments.

The PMR Brasil project ended in December 2020, with a recommendation for the adoption of a regulated carbon market. Floresta+ is also an initiative by the Brazilian Government. It was launched in 2020. This is a Ministry of the Environment program that includes a voluntary carbon market in native vegetation areas through the creation, promotion and maintenance of a market for environmental services.

Which pricing mechanisms have been adopted in other countries?
Dozens of regulated market systems are now in place for trading carbon quotas or for taxing emissions. According to a survey conducted by the World Bank – State and Trends of Carbon Pricing 2021 – in developed countries, carbon pricing has boosted productivity and innovation. According to WB data, US$ 53 billion in revenues were generated in 2020 from carbon pricing strategies that covered about 21.5% of global greenhouse gas emissions, as part of 64 initiatives.

For instance, the first emissions trading system in Europe (EU-ETS) was established 15 years ago and is now in its fourth phase. The ETS (Emissions Trading System) is the primary reference in the carbon market. Relevant initiatives have emerged in countries in the Americas, such as the United States, Mexico and Chile. In Asia, various countries have made substantive progress on the pricing agenda.

As the largest carbon emitter in the world, China this year launched its domestic market, the largest in the world by volume of emissions covered, with 2,225 companies from the electricity sector. These companies account for one-seventh of global carbon emissions from burning fossil fuels, according to the International Energy Agency (IEA).

What is the industrial sector already doing to reduce carbon emissions?
Sustainability is part of the strategy of Brazil’s industrial sector, which not only uses its energy mix to its advantage, but is constantly upgrading in order to boost its efficiency. Initiatives that currently contribute to achieving the emission reduction targets include efforts in the following fronts: renewables, waste recovery, energy efficiency, and increased efficiency in industrial processes. RenovaBio is also worth mentioning – this is a program that sets out annual decarbonization targets for the fuel sector.

While the share of renewables in electricity generation in OECD countries is around 18-27%, in Brazil renewable sources represent 83% of the electricity mix.

In order to demonstrate the sector’s achievements toward transitioning to a low-carbon economy, the CNI carried out a survey of initiatives and indicators in six segments – cement, aluminum, glass, paper and cellulose, chemicals, and steel –, which together account for 85% of the sector’s emissions.

For example, the cement segment in Brazil emits 11% less GHG when compared to the world average for the sector. In the paper and cellulose sector, while 9 million hectares are covered with tree crops for industrial purposes, another 5.9 million hectares are preserved with native forests, including Permanent Preservation Areas (APPs), Private Natural Heritage Reserves ( RPPN) and Legal Reserves (RL).

Recycling in Brazil reports highly representative rates. For example, the rate for paper is 66.9% – one of the highest in the world. In the aluminum sector, recycling accounts for about 56% of the total consumption of aluminum products, while the global average is 26%. In the case of aluminum cans for beverages, this percentage is 97%. The glass packaging industry recycles around 400,000 tons of glass per year, which is equivalent to a reduction of 100,000 tons of greenhouse gases not emitted into the atmosphere annually.

The chemical sector also stands out in this low carbon agenda. In 2006-2016, chemical industries reduced by 44% the emissions of greenhouse gases associated with their industrial processes. Steel also provides a relevant contribution. The steel sector led a pioneering initiative of using charcoal to replace mineral coal for the production of steel with a low carbon footprint. Charcoal is produced from wood sourced from planted forests. Thus, CO2 capture that occurs during the growth of trees matches – or even exceeds – the CO2 released during the steel production process.

How are CO2 emissions measured by the industrial sector?
Several public and private institutions participate in the process of preparing National Inventories by cooperating with the government to provide activity data, or to develop national parameters and emission factors. This is called a “top-down approach”.

Currently, a consolidated bottom-up emission inventories base (based on a self-reporting approach) is available to all economic sectors.

Although many companies report their emissions on a voluntary basis, states such as São Paulo and Rio de Janeiro already require the mandatory reporting of emissions.

Regarding voluntary reporting, the demands are associated with market requirements, external reporting, use of voluntary platforms, such as the Carbon Disclosure Project (CDP) and the Brazil GHG Protocol Program, as well as systems in the states of Minas Gerais and Paraná, which are still in the voluntary reporting stage.

How does the carbon market relate to compliance with Brazil’s NDC?
The carbon market is one of the instruments that can support Brazil in meeting the targets in the NDC. Other agendas exist for Brazil to implement the NDC, such as: progressing in the deployment of more competitive renewable energies; developing actions to fight illegal deforestation; strengthening the national biofuel policy; increasing recycling rates; implementing waste-to-energy schemes; implementing energy efficiency actions; progressing in the circular economy and bioeconomy agendas; among others.

How will the industrial sector be impacted by the NDC?
Brazil’s NDC is economy-wide and does not have sector-specific targets. This makes it more difficult to conclude any matters related to impacts on the industrial sector.

What are the expectations for COP26 and Brazil’s participation in the negotiations?
One of the main points that have been discussed and for which consensus is yet to be reached is the financial instrument established under the Paris Agreement. Under the Sustainable Development Mechanism (SDM), private sector organizations can invest in voluntary projects to reduce emissions of greenhouse gases (GHGs).
The global carbon market will be established through the SDM and, if properly operated, it will provide new business, investments and technology transfer opportunities to Brazil. Thus, it may be a sustainable development-driven solution for generating jobs and income in the Country, especially in the post-Covid-19 era.

Some topics are also on the industrial sector’s radar and have been part of the discussions prior to COP26 with the presence of ministers and senior representatives: climate finance, adaptation, technology transfer, and payment for environmental services.

What should be the country’s priorities in order to attract more investments for climate projects?
Priorities to attract more investments to Brazil include: renewables; hydrogen; actions to fight illegal deforestation; forest conservation; recycling; waste-to-energy; energy efficiency; circular economy and bioeconomy projects.

Brazil has a great potential to play a leading role in the transition to a low-carbon economy. Brazil’s energy mix has a large share of renewable sources, which is the case of just a few countries. According to data from the latest National Energy Balance (BEN 2020), the share of renewables is significant in electricity generation, where they account for 83% of the Country’s domestic supply.

According to the International Energy Agency (IEA), in the USA and in OECD member countries this share is around 18% and 27%, respectively. In addition, the Country is endowed with the greatest biodiversity (20% of the total number of species on Earth) and water supply in the world (12% of world reserves), with 58% of the national territory covered by forest.

What are the priorities for Brazil’s climate agenda?
The climate agenda as a whole includes the need to design a broader and more integrated national strategy for reducing emissions through policies that create an enabling environment for investments; the establishment of institutional governance and concerted efforts between the Government and the business sector to ensure more transparency in the fulfillment of the Paris Agreement targets; development of a decarbonization plan for the Country with inputs from the business sector; and R&D investments targeting new low-carbon technologies (such as offshore wind, hydrogen, and carbon capture and storage).

CNI advocates that the implementation of the commitments undertaken by the Country be integrated and transparent, with broad participation of the business sector. In order to contribute to this process, it has outlined 4 strategic pillars to develop a low carbon economy: energy transition, carbon pricing, circular economy, and forest conservation.

With regard to market in particular, CNI considers the creation of a regulated emissions trading market to be a priority. To achieve this, however, it is essential to establish a robust system for measuring, reporting and verifying (MRV) greenhouse gas emissions and removals.

What is the Carbon Border Adjustment Mechanism (CBAM)?
It is a measure of the European Union that establishes a carbon border adjustment mechanism (CBAM) to levy an additional tariff on imported products based on the amount of carbon emitted in their production. The legislative bill includes a three-year transition phase starting in 2023. United Kingdom, United States and Canada are also considering adopting similar measures.

By pricing carbon, Brazil is also protecting itself from new external taxes, such as the European Union’s CBAM.

How does this European Union tax affect Brazil?
The CBAM is an instrument to pressure Brazil to establish standards for internal carbon pricing. If Brazil can have a regulated market by the time the CBAM is put in place – a transitory phase is expected for 2023 – it can request a reduction in the number of CBAM certificates if it proves that it has already paid for carbon in the domestic territory.