Carbon markets, climate change and reductions in polluting gases are hot topics on the sustainability agenda. To discuss these issues, three researchers at the Center for Sustainability Studies (FGVces) at Fundação Getulio Vargas’ Sao Paulo School of Business Administration (FGV EAESP), Guilherme Lefevre, Gustavo Breviglieri and Guarany Osório, recently published a study setting out recommendations on elements necessary to create and implement an emissions trading system – an instrument that Congress is currently discussing.

Greenhouse gas pricing instruments have been increasingly adopted around the world. As of 2021, they were in place in 64 jurisdictions. In this context, FGVces’ study aims to contribute to debate on carbon pricing policy as a means of reducing greenhouse gas emissions in Brazil.

Climate change poses a threat to humanity over the next few decades. However, the actions taken and commitments adopted to date are insufficient to avoid the worst impacts of this threat. It is therefore necessary to make climate change initiatives more ambitious.

To this end, 10 recommendations were presented to create and implement a cap-and-trade regulated carbon market in Brazil, also known as an emissions trading system. These recommendations are based on studies and initiatives led by FGVces on the topic of carbon pricing between 2012 and 2021.

The use of economic instruments such as regulated carbon markets represents a more cost-effective way to address environmental problems and reduce greenhouse gas emissions. In practice, regulations must be developed to provide a framework for this purpose, but such regulations have not yet been implemented in Brazil. FGVces’ study will help the country move forward in adopting a mandatory carbon pricing mechanism.

“Despite the positive effects of carbon pricing instruments, especially their potential cost-effectiveness, carbon pricing does not represent a panacea or silver bullet,” the researchers write. Other complementary instruments will always be necessary, such as command and control measures to reduce illegal deforestation.

Mandatory pricing of greenhouse gas emissions can be achieved through either a tax or the creation of an emissions trading system. In theory, these two instruments are equivalent and they allow stakeholders to choose between reducing their greenhouse gas emissions, paying the tax or acquiring a permit to emit.

Brazil: efforts and embargoes
 

Regarding Brazilian efforts to reduce the effects of climate change, the country has undertaken to cut its greenhouse gas emissions by 50% by 2030, compared to the 2005 figure, and to become carbon neutral by 2050.

In 2009, the National Climate Change Policy came into force. Among other goals, it is designed to encourage the development of the Brazilian Emissions Reduction Market (MBRE). Regulations governing this market have not yet been issued. In the three researchers’ view, the MBRE may be an important instrument, especially in terms of promoting voluntary carbon markets. Unlike mandatory carbon pricing, in voluntary carbon markets, carbon credits are bought by organizations and people to offset or neutralize their greenhouse gas emissions, without being legally obliged to do so. It was recently determined that the MBRE will be used to implement measures provided for in Decree 11,075 of May 19, 2022.

In terms of mandatory pricing, there is a legislative process under way to create an emissions trading system in Brazil, based on Federal Bill 2,148 of 2015 (amalgamating bills 10,073 of 2018, 5,710 of 2019, 290 of 2020 and 528 of 2021). The replacement text was proposed in May 2022. The progress of this bill caused several business organizations, including the National Confederation of Industry, to release statements on the topic.

Recommendations
 

In their report, the researchers presented 10 recommendations on elements needed to create and implement a cap-and-trade emissions trading system in Brazil (also known as a regulated carbon market).

1 – Structure a monitoring, reporting and verification (MRV) program for greenhouse gas emissions before the start of the emissions trading system.

An MRV program stipulates standardized procedures for measuring, accounting for and communicating greenhouse gas emissions to the relevant authorities at the lowest possible organizational level, such as plant or industrial facility. The greater the availability and quality of information on greenhouse gas emissions in the country, the better the design and implementation of an emissions trading system.

2 – Define comprehensive and representative coverage of emission sources that are not yet regulated.

An emissions trading system is just one element of a national climate policy and it is therefore not necessary to include all Brazil’s greenhouse gas emissions. Thus, a regulated carbon market can, at least initially, focus on the sectors and activities that account for the bulk of the country’s emissions and for which it is possible to stipulate and monitor compliance with the guidelines of an MRV program.

3 – Define an absolute emissions ceiling based on historical averages.

Given the urgency of the problem, as well as the nature of Brazilian commitments and targets, the researchers recommend stipulating a maximum volume of greenhouse gas emissions in absolute terms (an absolute target), unrelated to other parameters and variables such as economic growth (a relative target).

4 – Issue permits through free allocation and auctions.

In general, permits can be allocated free of charge, through auctions or through a mix of the two methods. The costs of reducing emissions for each regulated entity are uncertain for the regulator and the allocation of permits via auctions would ensure that permits are directed to those that value them the most, i.e., those that find it the hardest to reduce their emissions. On the other hand, the acquisition of permits in auctions represents an additional cost for companies and it could have negative consequences for the competitiveness of regulated entities. To minimize these impacts, a portion of the permits within the emissions ceiling could be distributed free of charge, especially to those sectors that are most emissions intensive and exposed to international trade.

5 – Adopt price stabilization mechanisms and compliance flexibility.

Great volatility in the prices of permits to be issued could generate uncertainty among regulated entities, affect their decisions and harm the instrument’s effectiveness. Thus, the adoption of mechanisms such as a Market Stability Reserve is recommended. Another practice that would help control permit prices is acceptance of the use of carbon offset credits generated from mitigation projects carried out voluntarily by actors not covered by the emissions trading system, to reconcile a portion of the emissions of regulated actors, as long as they are duly validated by strict procedures.

6 – Promote stakeholder engagement.

To ensure greater representation and participation of different segments of Brazilian society and potential regulated entities in the construction of an emissions trading system, it is important to have a strong component of engagement and training in its design. This contributes to its success and increases its acceptance among different players.

7 – Consider linking.

Although not necessary, linking between the domestic instrument and similar instruments abroad could create opportunities for the participants of a national emissions trading system. In principle, linking increases and diversifies the number of buyers and sellers in an emissions trading system. This can increase liquidity while reducing price volatility.

8 – Establish compliance rules, balancing stimuli, to achieve emission reduction and competitiveness.

Procedures and mechanisms to promote, facilitate and enforce the objectives of the emissions trading system must be designed so as not to unduly harm the competitiveness of agents that may not be able to meet all their obligations.

9 – Enable the recycling of revenue from sales of permits by the regulatory body.

Any revenue from the sale of permits by the regulatory body, such as in auctions, could be “recycled” in order to reduce the impact of the emissions trading system on the Brazilian economy. This could be done by proportionately reducing other taxes.

10 – Allow broad participation of agents in the secondary market to increase liquidity.

The researchers recommend opening up the secondary market for permits to any individuals and organizations that are interested in buying or selling them, even if they are not covered by the emissions trading system. The participation of other actors will increase liquidity in the market and thus contribute to the smooth functioning of the instrument.

Prospects
 

The recommendations presented above are aimed above all at contributing to decision making based on information, in order to guarantee the environmental integrity and climate ambitions of Brazil’s future emissions trading system.

“Careful consideration of the design of the main elements of an emissions trading system, taking Brazil’s specific characteristics into account, is necessary so that the country can reduce its greenhouse gas emissions at the lowest possible cost to society,” write Guilherme Lefevre, Gustavo Breviglieri and Guarany Osório.

To see the full report, click here.