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Eating into ETS: Could food and farming be part of an emissions trading scheme in the UK in the future?

AUTHORS: Julia Bognar, Krystyna Springer (IEEP) and Ben Reynolds (IEEP UK)

With greenhouse gas emissions reduction, agriculture has proved to be one of the sectors with the most limited progress and one where the debate around action has become the most polarised. With calls for policies such as meat taxes considered too blunt by many on all sides, the search continues for more sophisticated and targeted solutions which reward farmers for taking appropriate action and shifting consumer demand. With emissions trading schemes becoming more established for other sectors, could this approach translate to agriculture and do so in a way that supports a just transition?

This interview was prepared by IEEP UK Executive Director, Ben Reynolds. Ben spoke to our colleagues from the Land use and Climate team, Julia Bognar and Krystyna Springer, about their work on this new potential policy avenue for the European Commission and how this might apply in the UK.

So, in a nutshell, how could agricultural emissions be woven into the Emissions Trading Scheme (ETS)?

JB: The important thing to note is that agriculture is not going to be in the current ETS. There are concerns about how complicated it could be to expand it and how to deal with removals in agriculture. Not least, it would involve a similar number of obligated parties to the current ETS. So the Commission were exploring the potential for this as a separate, third ETS. Compare this to New Zealand, which is actively thinking about weaving agriculture into its existing ETS, amongst other options, including an on-farm carbon levy or a processor-level carbon levy.

KS: There are good arguments for agricultural emissions to be dealt with via a dedicated ETS, given some of the unique problem drivers in the agricultural sector, including the degree of carbon price uncertainty that farmers can bear.

JB: It should be emphasised this study is exploratory at the moment – it’s not something that’s officially proposed.

You looked into this in an EU context and explored five options – the mechanics of which we don’t have space to go into fully here and also partly, as you outline them in an earlier blog. This included three on-farm options: one which looked at all on-farm emissions, another focusing on livestock and one solely on peat; and also an upstream option looking at inputs including fertilisers, and a downstream option, looking at meat and dairy processors. Which of these came out top?

KS: All the options have their potentials and trade-offs, which may be mitigated through specific design choices.  The ones with the most potential are likely those targeting the largest sources of agricultural emissions, such as livestock and fertiliser use, while those incorporating Land Use, Land Use Change and Forestry (LULUCF) emissions come with comparatively greater challenges and risks. In the study, we explore five specific models, but variations or combinations of those could also be considered, e.g. an on-farm ETS covering all agricultural nitrous oxide and methane emissions or combinations of the upstream and downstream models.

From your report, the downstream option seemed to have some advantages, particularly its popularity – how would that work and could a combination of different options work?

JB: From our expert roundtable, there was a general consensus to deal with on-farm emissions directly. However, at the subsequent larger stakeholder meeting, there was more appetite for the downstream option.

KS: This may be because it appears to many to be the most feasible option from a practical perspective. There are more powerful actors further down the value chain that many felt should carry the weight of the transition more. This option also appears to be supported by some of the food processing industry players, including some that have spoken in favour of introducing a carbon levy so the first movers are not disadvantaged. There is still a big question mark over how these supply chain actors would work effectively with farmers to reduce emissions.

JB: An example used was Arla Foods rewarding farmers for taking biodiversity and climate-friendly actions on farms, and their being compensated with higher prices. But there are questions about whether you could make this kind of relationship translate into a broader AgETS scheme at different scales. The EU is trying to ensure fairer trading practices, but power imbalances remain between large food corporations and (often) small farmers. So any AgETS scheme would need to address the risk that larger businesses further up the supply chain would simply push the problem onto farmers or consumers (although the potential resulting changes in consumer behaviour would be a desired outcome). With the economies of scale of adopting new practices, there is a risk that larger farms would benefit and that it would perpetuate the decline of small, medium and family farms if not created with these farmers’ considerations in mind.

KS: This is likely to be a problem for all AgETS options, not just the downstream one. There is a justified concern that carbon markets could drive the intensification of agriculture. Our research did not explore this in a lot of detail, so further research would be needed to avoid this scenario.

Your report highlights that some revenue from the ETS could go to farmers to support good practices. How would this work, and where would the money come from – is it businesses offsetting or is it only linked to the sale of credits?

JB: The money would come from the sale of the allowances. On an annual basis, businesses surrender a number of permits that correspond to their quota. These allowances can be bought from other participants or in an auction from the government. And this generates revenue for the government. The prevailing criticism is that when the free allocation of allowances was high in the EU ETS, necessary changes in technologies and practices were altered based on investment decisions. However, some studies found that free allocation did not have such a large negative impact on investments, and it is generally accepted that this is how an ETS instrument is introduced for new obligated parties. Evidence demonstrates that expectations of future stringency in allocations facilitate innovation – as you reduce the free allocation you can achieve the serious reductions.

And how might this sit alongside the shift in farm payments – could farmers be paid twice for the same actions, and is this materially a problem?

KS: How you’d align these different instruments is really important. Farm payments should be aligned with the incentive mechanisms created through the ETS, with ETS revenue being additional to the existing public financing. There is a clear need for better-targeted transitional aid for farmers in the short and medium term – i.e. before governments are able to use revenues from an ETS to fund it. There are question marks over whether you would generate really significant revenue early on after the introduction of an agricultural ETS – this depends on the system design with respect to free allocation and the carbon price levels. This poses questions about when the financing would reach a meaningful volume to support farmers and reduce emissions.

What do you see as the benefits of this policy compared to others that have been floated, such as meat taxes?

JB: We really wanted to explore this in the study and, more generally, to look beyond ETS to wider polluter pays options e.g. A carbon tax vs ETS vs regulatory options. A Canadian think tank assessed all carbon pricing instruments across the globe and showed ETS (albeit not an AgETS) to be more effective than carbon taxes, but it does depend on the sector. It is possible that the presence of a cap on emissions/quota in ETS helps. Denmark is considering a carbon tax, but wants to know if the EU are going to implement something similar before they do their own scheme.

KS: In some ways, it’s quite simple as taxes aren’t really viable at an EU level – we discarded the carbon tax option in our study because of the requirement for Council unanimity on fiscal matters.  But in the UK context this remains relevant. With an ETS, you get more certainty on the mitigation outcomes. With taxes, you have more certainty over the price outcomes but not mitigation.

Is there also a consideration of political tenability about the public perception that whilst both may lead to price rises and generate revenue, an AgETS is a market mechanism; it can be framed as being at arms-length from the Government, where a tax cannot?

JB: Yes, that may be a factor. With both options the impact on prices and how costs will be passed through which really will affect the outcomes. This raises the spectre of carbon leakage, and whether this might lead to an increase in lower standard/high emission imports that are not subject to the ETS.

This would be mitigated by weaving it into a Carbon Border Adjustment Mechanism (CBAM), right? Similar to the link the EU is currently making between its ETS and CBAM.

KS: It would be incredibly difficult to weave a wider range of agri-food products into a CBAM because of the complexities resulting from limited supply chain traceability. Just take meat as an example, and products containing meat, and look at all the steps from the impact and source of animal feed through to the end product. Alternatively, it is possible that existing trade barriers might prevent carbon leakage to some degree. However, it’s important to remember that CBAM only covers imports and does not address export substitution. The EU remains the largest exporter of agri-food products globally – a decrease in the competitiveness of EU exports may therefore mean that a significant portion of the demand in international food markets is likely to be met by cheaper agri-food products from other regions, associated with higher GHG intensities and meeting lower sustainability standards.

JB: Regardless of CBAM, the trade implications of an AgETS are very interesting. Would the agriculture industry just increase its exports outside the EU? And what would happen if the EU and UK implemented this at different points? The OECD has done some good analysis looking into carbon leakage. It shows that when you get key jurisdictions to do agriculture policies to reduce emissions collectively, then the risk of carbon leakage goes down. Other studies have shown that carbon leakage can be reduced with multilateral agreements with key trade partners.

For more on this read our report Applying the polluter pays principle to agricultural emissions.

Image by Carolien van Oijen on Unsplash

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