Sustainability Strategies Addressing Supply-Chain Air Emissions (2014)

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82 A P P E N D I X A International Case Studies Introduction This case study cluster explores international experience in managing freight transportation emissions. A cap-and-trade initiative was previously proposed as a possible way to manage and reduce greenhouse gas (GHG) emissions in the United States. Although a proposed cap- and-trade initiative failed in Congress in 2010, Assembly Bill 32 mandates that the California Air Resources Board (CARB) develop regulations and market mechanisms to reduce Califor- nia’s GHG emissions (although this does not currently apply to transportation). In this appendix, the researchers consider the implementation and impacts of mandatory emissions trad- ing in New Zealand and the extension of the European Union Emissions Trading Scheme (EU ETS) to aviation emissions in Europe. Although neither of these programs is aimed specifi- cally at freight transportation, they both impact this sector and thus hold potential lessons for managing supply-chain GHG emissions. These mandatory regulatory regimes are compared and contrasted with the voluntary private Fair Winds Charter Initiative aimed at reducing shipping emissions. Mandatory Emissions Trading Case Study: New Zealand Emissions Trading Scheme Inception Context. New Zealand’s geographical isolation makes the country highly reliant on ocean and air freight. Freight trans- port has increased as the economy has grown. Between 1990 and 2006, total transport emissions increased by 5.6 million metric tons of carbon dioxide (CO2), or by 64 percent (Min- istry for the Environment, 2008a). New Zealand’s emissions trading scheme (ETS) was introduced by the government in response to climate change. Objective. As a signatory of the Kyoto Protocol, New Zealand was obliged to reduce its GHG emissions to 1990 lev- els in the first commitment period (2008 to 2012) or pay for the difference. The ETS was introduced in 2008 as a low-cost approach to creating market incentives that encourage con- sumers and businesses to change their behavior and reduce emissions. Legislation. Legislation and regulations that support the ETS (Ministry for the Environment, 2011a) include the following: • 2002 Climate Change Response Act: Ratified the Kyoto Protocol; • 2008 Climate Change Response (Emissions Trading) Amend- ment Act: Introduced the ETS concept; and • 2008 Climate Change (Liquid Fossil Fuels) Regulations: Define the liquid fossil fuels covered by the ETS, and the methods for participants to monitor and calculate the emissions that result from the use of those fuels. Program Components Participants. The ETS applies to specific sectors, includ- ing forestry; industrial processing; transport (which includes liquid fossil fuels used on land, sea, and in the air, as well as fuels used for non-transport purposes); synthetic gases; stationary energy (power generation); waste; and agriculture (Ministry for the Environment, 2007a). Mandatory report- ing was phased for each sector between 2008 and 2013. The liquid fossil fuels sector joined in July 2011 (Ministry for the Environment, 2008b). The ETS applies to liquid fossil fuel suppliers (e.g., fuel wholesalers) rather than emitters (e.g., road users). Consis- tent with the Kyoto Protocol, emissions from fuel used for international aviation and marine transport purposes are exempted from the ETS (Ministry for the Environment,

83 2011a). The ETS applies to CO2, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluo- ride, which are all of the GHGs specified in the Kyoto Proto- col (Barrat, 2008). Program Components. Credits in the form of New Zealand Units (NZUs), representing 1 ton of CO2 equivalent (CO2e), are issued by the Crown and can be traded in the mar- ket through the New Zealand Emissions Unit Register. Under the program, the aggregate quantity of net emissions is set (and is decreased over time), while the price of emission units is determined by the market (Ministry for the Environment, 2011b). The ETS operates within the cap on emissions estab- lished by the Kyoto Protocol during its first commitment period (2008–2012). There is no cap on emissions. However, domes- tic emissions that exceed New Zealand’s allocation under the Kyoto Protocol are required to be matched by emission units bought internationally from within the Kyoto cap on emissions (Ministry for the Environment, 2008b). Participants are required to monitor and report their own emissions. Each business is granted a GHG emissions allowance or permit, and is required to purchase a sufficient quantity of NZUs to cover any emissions in excess of their designated GHG allowance. Participants “pay” for each ton of CO2 equivalent they emit by surrendering emission units to the government at year end (Ministry for the Environment, 2007a). Businesses that require large amounts of energy to create their products or have significant emissions associated with industrial processes (e.g., steel producers) receive a free allo- cation of units (Ministry for the Environment, 2007a). These generous free allocations and the lack of a carbon price signal have led to criticism of the ETS and its effectiveness in reduc- ing emissions. In contrast, the transportation industry/fuel suppliers do not receive a free allocation, so they may pass on any costs incurred to their customers; thereby, limiting the impact of the scheme on their profits (Ministry for the Environment, 2008a). Transition Arrangements. The ETS was amended in 2009 to help moderate its impact during the worldwide economic downturn by including a transition phase from July 1, 2010, to December 31, 2012. During this phase, participants in the trans- port (liquid fossil fuels), energy, and industrial sectors were only required to surrender 1 unit for every 2 metric tons of emis- sions until 2013. Participants also have the option to buy NZUs from the government (instead of the market) for a fixed price of NZ$25 per NZU (Ministry for the Environment, 2011a). Engagement Process Engagement has been a key feature of the design and imple- mentation of the New Zealand ETS. From December 2006 through March 2007, the government consulted broadly on design options for price-based measures to reduce GHG emissions in different sectors (Ministry for the Environment, 2007a). This consultation process included approximately 50 public or multi-sector meetings, workshops, and meet- ings with Aboriginal groups, and approximately 100 focused stakeholder meetings. The consultation events took place throughout the country, with over 4,000 people attending. Over 3,000 written submissions were received (Ministry for the Environment, 2007a). A key reason for selecting an emissions trading scheme over other strategies (e.g., emissions tax) to manage GHGs was the wide stakeholder support received. Further, an emis- sions trading scheme was considered favorable for the follow- ing reasons (Ministry for the Environment, 2007a): • Provides businesses with greater flexibility for managing GHG obligations; • Provides the government with relative certainty about the volume of emissions, and hence the environmental objec- tives, whereas a tax simply adds a price on each unit of emissions and does not limit emissions per se; and • Allows for automatic adjustment to the international price of emissions. Following this initial consultation, the government under- took an extensive engagement process with stakeholders and Aboriginal groups to develop and refine the ETS. The public engagement process consisted of the following four key stages (Ministry for the Environment, 2007b): • Stage 1: In-principle decisions on ETS core design features (2007); • Stage 2: Engagement and final decisions on core design, as well as detailed design features and implementation for forestry and liquid fossil fuels (primarily transport) sectors (2007/2008); • Stage 3: Parliamentary select committee process and pas- sage of core legislation by Parliament (2008); and • Stage 4: Engagement and final decisions on detailed design of the ETS and implementation process (2008–2012), involving ongoing engagement with major stakeholders and Aboriginal groups on program decisions, regulation, and implementation. Engagement activities varied and included the following (Ministry for the Environment, 2007b): • Cross-sector emissions trading workshops; • Several regional Aboriginal hui (meetings); • Workshops with the private sector; • A nongovernmental organization forum;

84 • Numerous one-on-one meetings with key stakeholders; • Written submissions received by the government from various stakeholders; and • Establishment of a Climate Change Leadership Forum to facilitate communication with the broader community on the proposed design of the ETS, including senior represen- tatives of sectors and firms subject to the ETS, community and nongovernmental organization representatives, aca- demics, and the chief executives of the government depart- ments responsible for advising on the ETS. In 2011, an independent panel reviewed the ETS to con- sider how the scheme should evolve past the first Kyoto com- mitment period. The panel consulted widely and received more than 150 submissions from the public, which provided input into a set of recommendations to the government for amendment of the ETS (Ministry for the Environment, 2012). Key amendments potentially affecting the freight/liquid fossil fuels sector involve extending the one-for-two reporting and fixed price options in the transition phase to 2015. Following the 2011 panel review, the government engaged the public for feedback on the proposed set of amendments to the ETS through a call for submission of comments. Cross-Jurisdictional Consistency Although the principal unit of trade under the scheme is the NZU, international carbon emission units also can be traded and surrendered. Allowing international trading means scheme participants can quickly buy or sell emission units without causing a significant movement in their price (Ministry for the Environment, 2008b). It also means the price of units tracks the international price of emissions. This allows New Zealand businesses with limited low-cost ways of reducing their own emissions to fulfill the country’s emis- sions trading scheme obligation by buying emission reduc- tions from overseas (Ministry for the Environment, 2008b). At present, the only other existing mandatory regional ETS is the EU ETS. Certain differences in the design between the EU and New Zealand schemes are likely to make direct bilat- eral linking challenging in the short term (Ministry for the Environment, 2008b). Australia introduced its Carbon Pollution Reduction Scheme in July 2011—an ETS designed to commence with a 1-year period in which the carbon price was set at New Zealand $10/metric ton CO2e (Ministry for the Environment, 2011b). The New Zealand government is working with Australia on harmonizing New Zealand’s ETS with the Aus- tralian scheme. One impediment to linking the two schemes, however, is that Australia is not a party to the Kyoto Protocol. This means that trade would not be in Kyoto units, which would have increased New Zealand’s Kyoto liability if linking had occurred in the first commitment period (Ministry for the Environment, 2007a). Impacts on Freight The Ministry for the Environment estimated that during the transitional phase, the ETS would add $0.031 per liter to the cost of gasoline and $0.033 per liter to the cost of diesel (Ministry for the Environment, 2010). Analysis of liquid fossil fuel prices by Covec (2011) identified a statistically significant impact of the ETS, suggesting an impact of approximately $0.04 per liter to the price of diesel and petrol—$0.01 higher than the Ministry for the Environment’s initial estimate. Domestic freight operators do not participate directly in the ETS but will face these additional costs as a consumer of liq- uid fossil fuels (Ministry of Transport, 2011). Although this cost increase may seem small, the aggregate effects to the sup- ply chain can be significant (Ministry of Transport, 2012). Analysis by the Ministry of Transport found that the additional operation cost to heavy vehicles due to the ETS is approximately $0.98 per 100 km for road freight transport (Ministry of Transport, 2012). The average net tonnage per vehicle is 7.4 metric tons, thus the ETS adds around $1.32 per 1,000 net metric ton-kilometers to vehicle operating costs (Ministry of Transport, 2012). These estimates are based on fuel consumption information collected during 2006. If the heavy vehicle fleet has gradually been replaced by more fuel- efficient vehicles since then, the effects of the ETS would be lower than those illustrated above. In 2009, over 16,500 million metric ton-kilometers of road freight was moved in New Zealand. The ETS therefore adds $22 million per annum to road freight costs for a similar level of cargo movements as in 2009 (Ministry of Transport, 2012). The Ministry of Transport estimates that the ETS will add approximately $0.45 per 1000 ton-kilometers to the cost of rail freight (New Zealand Productivity Commission, 2012). Additionally, many transport operators working in the for- estry industry are already feeling a slowdown as a result of the forestry industry adopting the scheme since 2008. The scheme makes it more costly to fell trees and therefore creates a decreased demand for transport services on behalf of the forestry industry (Barrat, 2008). Outcomes Following the introduction of the ETS, New Zealand is on its way to meeting its Kyoto obligation, with net emissions dropping significantly from approximately 70 million met- ric tons CO2e to below 55 million metric tons CO2e between 2007 and 2009 (Ministry for the Environment, 2011a). Within the first reporting period of the ETS (1 July to 31 December 2010), approximately 8 million metric tons of CO2e

85 emissions were reported and 4 million NZUs (i.e., 4 million metric tons CO2e) were surrendered by the transport sector— 18 percent more than was initially projected (Ministry for the Environment, 2011a). This constitutes almost half of the emission unit surrenders from all participant sectors within the ETS for the 2010 calendar year (Ministry for the Environment, 2011a). A total of 16.3 million metric tons were reported and a total of 8.1 million metric tons were surrendered (Ministry for the Environment, 2011a). Summary 1. Following introduction of the New Zealand ETS, a 21 percent reduction in overall GHG emissions was achieved between 2007 and 2009. The transport sector surrendered more than 18 percent more NZUs than was originally proj- ected during the first reporting period in 2010, indicating the program’s success in reducing emissions. 2. The regulation affects all domestic freight transportation. However, the scheme applies to fossil fuel suppliers rather than emitters thus reducing potential complex compli- ance requirements for carriers, many of whom have lim- ited capacity. 3. The main impact on domestic carriers is increased fuel prices (which are estimated to increase by $1.32 per 1,000 metric ton-kilometers). The aggregate effect across the supply chain is considered to be significant. These price increases affect all carriers, and can be passed on to ship- pers and ultimately to consumers. Such price increases can encourage more efficient truck fleets and driver behavior. Further, because the relative fuel price increases to the rail freight sector are just 34 percent of that of road freight, this may have the effect of promoting a shift to rail. 4. Part of the success of the New Zealand ETS is due to the intense and ongoing consultation process prior to, during, and subsequent to the implementation of the ETS. The ETS was supported by stakeholders above other strate- gies because it provides businesses with greater flexibility in managing GHG emissions, offers government greater certainty about the quantity of emissions to be reduced, and allows for adjustments to the international price of emissions. 5. In addition to the consistency in the application of the ETS within New Zealand, the scheme also is consistent with international trading platforms, ensuring that NZUs can be internationally traded with other types of emissions units. This means that the price of NZUs tracks the international price, allowing emission units to be traded without causing a significant movement in their local price. This permits busi- nesses that may have limited low-cost ways of reducing their own emissions, to fulfill their obligations by buying emis- sion reductions from outside of the country. 6. The ETS regime has been implemented in a flexible man- ner that ensures a degree of responsiveness to economic conditions (although this has been criticized by the envi- ronmental lobby). For example, amendments introduced in 2009 as a result of the worldwide economic downturn allow for a transition phase between 2010 and 2012. This offers respite to participants in the transport (liquid fossil fuels) sector who are only required to surrender half the required emissions units. Participants also have the option to buy NZUs from the government (instead of the mar- ket) for a fixed price, thereby mitigating adverse business impacts during this period. Case Study: EU Aviation Emissions Trading Scheme Inception Introduction. The International Air Transport Associa- tion developed joint industry targets for the reduction of car- bon emissions, which have been endorsed by Air Transport Action Group. These voluntary targets include an average annual fuel efficiency improvement of 1.5 percent to 2020, with carbon-neutral growth beyond 2020. The International Air Transport Association also has set an ambitious goal for the industry to decrease 2005 net carbon dioxide emission levels by 50 percent before 2050. These targets are supported by the International Air Cargo Association. However, these voluntary targets and aspirations have been insufficient for the EU, which extended the EU ETS to cover carbon emissions from aviation in 2009. Objective. The stated goal of the EU ETS is to reduce total carbon emissions by 20 percent by 2020. The scheme works by capping emissions from the aviation sector. If avia- tion emissions increase beyond this cap, aircraft operators are required to purchase allowances from other sectors par- ticipating in the EU ETS scheme. In 2010, aircraft operators began 2 years of mandatory pre-compliance reporting, with emissions trading beginning in January 2012. Aircraft opera- tors are required to account for their CO2 emissions, surren- dering emissions allowances to the regulatory authority each year, equivalent to the amount of carbon-equivalent emitted. All flights arriving and departing from European airports are covered by the scheme with some exceptions (e.g., military aircraft and commercial aircraft operators with very limited operations). Allocation of Allowances. Affected operators were required to submit an Annual Emissions Monitoring Plan in 2010 providing details of activities and metric ton-kilometers. This provided the benchmark that determined each operator’s carbon allowances for future years. Most aviation allowances

86 (85 percent) are distributed to aircraft operators free of charge. The remaining allowances (15 percent) are auctioned. A pro- portion of the allowances are reserved for allocation to new and rapidly expanding aircraft operations, thereby protecting eco- nomic growth and the commercial viability of new businesses. Proceeds from auctioned allowances are required, by law, to be used to mitigate the effects of climate change. Involvement and Engagement Absence of agreement despite several years of proactive engagement by the International Civil Aviation Organization (ICAO) resulted in the EU taking a firm lead by incorporating aviation emissions into their own cap-and-trade system and extending the requirements to cover third-party countries. The EU imposed the aviation ETS on foreign flights with- out the prior agreement of the affected countries or airlines, resulting in significant opposition. In 2011, 26 ICAO member countries (including the United States, China, India, Russia, and several Latin American countries), signed the “Delhi Declaration.” The declaration opposes the EU Aviation ETS, instead declaring support for the ICAO efforts to develop air- craft carbon emissions standards with the intent of adopting such standards at the General Assembly in 2013. ICAO does not, in principle, oppose the use of “market forces” to reduce airline emissions. However, the organization is urging the EU to refrain from including non-EU flights in the EU ETS and to work collaboratively with the international community (Leggett, 2012). The International Air Cargo Association also has lobbied the EU to suspend the ETS until a global agree- ment can be reached with the ICAO. Since January 2012, some governments have instructed their airlines not to participate, threatened to sue the EU, or suggested they might impose trade sanctions (e.g., bills before the U.S. House and Senate also seek to exclude U.S. aircraft from participating in the EU ETS). Nevertheless, the Euro- pean Court of Justice recently ruled that the EU has the right to levy such taxes or fees. Any operator who fails to comply with the ETS will be fined €100 per day per ton of emissions. Early reports are that 99 percent of airlines are in compliance. There are indications that perhaps as a result of action by the EU, other governments (such as China) are developing their own plans to reduce emissions from their own airlines, and are negotiating to explore exemptions for Chinese air- lines based on “equivalent measures.” Cross-Jurisdictional Consistency Although enacted without the agreement of countries out- side the EU, the ETS consistently applies to all airlines flying into or out of EU airports. The legislation includes various options to avoid double counting on certain flights and ensure optimum interaction between EU ETS and measures adopted outside the EU. Such options include exemptions for flights arriving at EU airports from countries that have adopted equivalent measures and agreements with other countries to ensure optimum interaction of measures. Further, if an international agreement on global measures to reduce GHG emissions from aviation is reached, the EC has stated it will consider amending the EU Aviation ETS. EC officials have, in fact, stated their preference for agree- ing on global, binding measures via the ICAO, but require three conditions to be met first: it must deliver more emis- sions reductions than the EU ETS on its own; it must have clear targets and measures; and any action must be nondis- criminatory and apply to all airlines (Legget, 2012). Impacts on Airlines and Freight Studies estimate that the EU Aviation ETS will only have a small impact on U.S. airlines and emissions, and that growth of U.S. aviation business will not be constrained by this regu- lation. Where carriers are able to pass on all additional costs to consumers, profits for U.S. carriers are, in fact, expected to increase. In addition, some studies estimate that airlines may benefit from substantial windfall gains from free allowances from the EU ETS. Nevertheless, a future increase in the pro- portion of allowances auctioned would reduce windfall gains, and profits may decline (Malina et al., 2012). Research specific to the air cargo sector found that the EU ETS may create distortions, favoring express freight over standard cargo because of differences in demand elasticity and yields. Further, it seems that EU-based airlines are at a disadvantage under the scheme compared to non-EU carriers because of the high proportion of short-haul operations sub- ject to the EU ETS. Nevertheless, the study finds that the EU ETS creates some incentives for airlines to use pure freighter aircraft models (as opposed to belly-hold capacities of pas- senger aircraft); to shift their activities toward long-haul missions; to increase load factors; and to introduce emissions abatement measures. However, the magnitude of the finan- cial burden to airlines (in terms of demand and cost effects) remains modest, and potential incentives are therefore small (Schröder, 2008). Impacts on business will ultimately depend on the ability to pass costs on to customers. For example, the New Zealand Productivity Commission estimates that the ETS will impact around 10–15 percent of New Zealand air freight exports (by value) and that New Zealand exporters may face higher cost increases relative to their international competitors (who, in general, are located closer to European markets). Indications are that the EU ETS will increase air freight rates from New Zealand to the EU by around $60 to $70 per metric ton, an increase of approximately 1.6 percent on the price of air freight

87 to the United Kingdom, for example. New Zealand exporters will have limited ability to pass on these costs. Further, this may in some cases unfairly prejudice New Zealand products whose carbon footprint may be less than that of European products (New Zealand Productivity Commission, 2012). Outcomes It is too early to assess the impacts on GHG emissions. However, modeling indicated that CO2 emissions from U.S. airlines would continue to grow between 2011 and 2020, but by a reduced amount (3 percent) if the costs of the aviation ETS were passed on to customers (Malina et al., 2012). Summary 1. The EU’s perception that the aviation industry lacked a clear, coherent, and combined commitment to reducing their carbon emissions led to their extending the EU ETS to cover aviation emissions in 2009. 2. The aviation sector was not involved in the design or devel- opment of these regulations and has actively opposed their implementation, threatening nonparticipation, to sue the EU, and to impose sanctions. However, a European Court of Justice ruling declared the aviation ETS to be lawful and the EU warned that sanctions in the form of fines will be imposed on noncompliant airlines. Early studies reported 99 percent compliance. 3. Although applied to flights arriving to and departing from the EU only (rather than all global flights), the regu- lation is complied consistently across all airlines serving EU airports. Although reporting and compliance adds to administrative efforts and costs, large commercial airlines generally have the capacity to meet requirements of the EU ETS. 4. The regulation does allow exemptions for certain flights (e.g., military aircraft and commercial aircraft operators with very limited operations). The reservation of a pro- portion of the allowances for allocation to new and rap- idly expanding aircraft operations protects the economic growth and the commercial viability of new businesses, allowing economic growth at the same time as environ- mental protection. 5. A system that is implemented in one geographic region and implemented in the absence of broad-based engage- ment is not generally optimal. Nevertheless, the aviation ETS appears to have provided a catalyst for change beyond the EU: other governments (such as China) are developing plans to reduce emissions from their own airlines, and are negotiating to explore exemptions for their airlines based on “equivalent measures.” European Community officials have, in fact, stated their preference for agreeing on global, binding measures via the ICAO, and have stated that if an international agreement on global measures to reduce GHG emissions from aviation is reached, they will con- sider amending the EU Aviation ETS. 6. Studies estimate that the EU Aviation ETS will have only a small impact on U.S. airlines, and that growth of U.S. aviation business will not be constrained by this regula- tion, although emissions will grow at a slower rate. Likely impacts for air cargo are considered to be a preference for freighter aircraft (as opposed to belly-hold capacities of passenger aircraft), a shift toward long-haul missions, increases in load factors, and the introduction of GHG emission abatement measures. 7. Impacts on the private sector are ultimately dependent on the ability of shippers and carriers to pass costs on to customers. Studies indicate non-European exporters with longer journeys and greater emissions may face higher cost increases relative to competitors. Where exporters have limited ability to pass these costs on, this may in some cases unfairly prejudice their products whose whole life carbon footprint may be less than that of European prod- ucts. Thus, the EU ETS may not result in a net reduction in carbon emissions for certain products. Voluntary Private-Sector Emissions Reductions Initiatives: Hong Kong Fair Winds Charter Inception Introduction. The Fair Winds Charter is a voluntary, industry-led, unsubsidized fuel switch program for ocean- going vessels calling at Hong Kong. It is the first initiative of its kind in Asia, as well as the first unsubsidized voluntary fuel switch in the world. The charter was announced in October 2010 and went into effect January 1, 2011. This voluntary ini- tiative is intended to provide a “bridge” between the current situation and a future regulation in respect to low-sulfur fuel use for vessels calling at Hong Kong ports. Context. Globally, there has been recognition of, and actions to, mitigate the health impacts arising from sulfur emissions in fuel, specifically within the maritime sector. The International Maritime Organization (IMO) regulates inter- national shipping, and the current sulfur limit is 3.5 percent with the limit set to drop to 0.5 percent in 2020 following a review in 2018. Within emission control areas (ECAs), sulfur limits are stricter. At present, the sulfur cap within ECAs is 1 percent, and this is set to drop to 0.1 percent in 2015. Some regional governments have adopted policies and operating rules that are more demanding than the ECA limits. For example, the EU already requires use of 0.1 percent sulfur fuel (or use of equivalent technology to meet this standard), and

88 in 2006 at the San Pedro Bay area in California, the Ports of Los Angeles and Long Beach introduced the Clean Air Action Plan that included various measures to reduce supply-chain air emissions in the vicinity of the ports. Such efforts in Europe and the United States helped set international prec- edent and drove changes in shipping line operations. Hong Kong and the Pearl River Delta (PRD), consisting of Guangdong, Shenzhen, and Macau—in size, about equal to the San Francisco Bay area—are home to approximately 50 million people. The region is a major source of global pro- duction, handling approximately 10 percent of all container traffic as goods are shipped to consumers around the world. Air pollutants from waterborne traffic are significant. A series of studies sponsored by the Hong Kong Environmental Pro- tection Department found nearly 4 million people in Hong Kong alone were directly affected in by container port emis- sions, with container vessels accounting for approximately 80 percent of all vessel emissions. The research linked SO2 emissions to increased rates of hospital admissions and death. As more data became available and the public health issues were better understood by the communities, interest grew in addressing maritime emissions. Program Components Regulatory Context. Achieving a significant improve- ment in the region’s overall air quality would require the adoption of common rules across Hong Kong and the PRD. Such an achievement would necessitate coordination across multiple lines of government. Unlike ports in the United States and Europe, Hong Kong has no port authority. Rather, all five terminals are privately owned. Although there is a port association, it lacks any regulatory authority. In addition, jurisdictional boundaries between Hong Kong and the PRD undermine the potential for common environmental goals, policy setting, and regulation. Further, the creation of an ECA would require liaison with the IMO and the agreement of the Central People’s Government in Beijing, which would also need to apply for ECA recognition. The Charter. The charter signatories acknowledge the impacts that emissions from their vessels have on air quality in Hong Kong and the PRD Region. These international car- riers voluntarily commit to switching to a fuel with 0.5 per- cent sulfur content or less while at berth and to collaborating with the Hong Kong Special Administrative Region (SAR) and Guangdong governments to introduce regulation on shipping emissions that are consistent with international standards. The initiative began on 1 January 2011 and applies until 31 December 2012. Charter signatories also urge the Hong Kong SAR to take the lead and work with the Guangdong govern- ments to regulate the use of low-sulfur fuel in the PRD by December 2012, and to encourage broader industry partici- pation through the provision of incentives. Engagement Process Starting in 2007, Civic Exchange, a nonprofit policy advo- cacy group, convened regular stakeholder meetings and work- shops to develop a Green Harbors vision for Hong Kong. Participants included government officials, shippers, shipping lines, cruise lines, ferry operators, public health officials, and others. Broad agreement on the need for cleaner fuel and prac- tices by the maritime industry was relatively easily achieved. However, agreement on the mechanism by which this would be implemented was elusive. The shipping lines, already abiding with regulations in Europe, the United States, and elsewhere, preferred regulatory requirements for low-sulfur fuel. There is a financial conse- quence for using cleaner fuel. If all shipping lines incurred the same cost, it would be passed onto the shippers and end con- sumers. However, if only some shipping lines are using low- sulfur fuel, they are at a disadvantage. A regulatory requirement would create a level playing field across the industry. However, government officials in Hong Kong favored vol- untary action on the part of the shipping lines as a first step. The ports at Hong Kong and the Greater PRD compete with one another. There was concern that if Hong Kong went alone in mandating cleaner fuel, cargo would divert to the other ports with adverse economic consequences for the Hong Kong ports. There was also concern that achieving common regulatory requirements across the PRD region would take time for the required coordination and approvals. Gaining Consensus A middle ground was finally achieved in May 2010. Maersk Line was a key player and agreed to support a “virtual level playing field” if a critical mass of shipping lines would agree to voluntarily switch to 0.5 percent sulfur fuel at berth. Maersk was able to demonstrate the expected cost impacts from its experience at other ports. Civic Exchange drafted the Fair Winds Charter for review by the shipping lines, and in October 2010, 18 shipping lines (about 70 to 80 percent of the market calling at Hong Kong) signed the Fair Winds Charter committing to fuel-switching for a 2-year period. The charter allowed the region to realize benefits while giv- ing the governments of Hong Kong and the PRD time to work together to achieve common legislative requirements by the charter’s expiration at the end of 2012 (Fair Winds Charter, 2012). More recently, in response to the Hong Kong govern- ment’s recent pledge to mandate fuel-switching at berth, Fair Winds Charter members have agreed to extend their volun- tary agreement to use cleaner fuel for another year to January

89 2014, while the legislation to make fuel switch mandatory in Hong Kong is developed. This is intended to keep up the momentum within the industry and is an example of coop- eration between the public and private sectors—in this case, led by the private sector. Outcomes It has been noted by the authors of the charter that as a vol- untary agreement, the charter has limitations. Because not all shipping lines participated, the “virtual playing field” meant that those not participating maintained a competitive advan- tage. There is no mechanism to document the full benefit and impact of the charter because participating shipping lines are not required to disclose the type of low-sulfur fuel in use or the percentage of their fleet participating. Civic Exchange noted that some shipping lines claim that public disclosure of participation levels are an additional administrative require- ment which adds to costs (Civic Exchange, 2010). As of spring 2012, legislation still had not been enacted in either Hong Kong or across the PRD. Even though a demon- strable track record of progress has been established, the char- ter’s continued success was in question. The shipping industry also was reportedly under significant financial strain in 2011 due to rising fuel prices and container demand had not fully recovered from the financial crisis. Hong Kong announced financial subsidies of about 40 per- cent through reduced port fees to support the participating shipping lines, but the continued participation by all charter signatories is in doubt as shipping lines continued to hope for broader regulatory requirements. Summary 1. Data, analysis, and evidence in respect to the impacts of emissions on public health (gathered and disseminated by public-sector and nongovernment organizations) pro- vided a starting point for the education of the public and industry on the adverse impacts from shipping activity. This drove demand for change and prompted action on the part of the private sector. • The Hong Kong Environmental Protection Depart- ment commissioned a series of studies to document public health impacts from the maritime sector. • Civic Exchange prepared communication documents to explain the findings and promote awareness among the public. 2. Regulation in other parts of the world also provided a catalyst that drove voluntary activity in Hong Kong. Private-sector ocean carriers were ahead of the pub- lic sector, calling for tighter regulation around air emis- sions and acting sustainably. Tighter emissions regulation applied in one part of the globe also indicated that ship- ping lines were potentially more willing to take action in Hong Kong, particularly when all were acting together and able to pass the costs on to shippers, thus reducing any unfair advantage on the part of nonparticipants. 3. Trust and partnerships, established through ongoing engagement, dialog, and collaboration among the non- profit sector, government, and industry were essential to finding workable solutions. For example: • Interdisciplinary and collaborative research funded by the Hong Kong Environmental Protection Depart- ment and other foundations established a history of trust gained through collaboration between public and nonprofit sectors on scientific research, public health policy, technology pilots, and other efforts. • Civic Exchange was a key facilitator, providing a forum and informal channel for representatives from differ- ent government agencies (that would not otherwise have worked together) to exchange information with one another and the private sector, public health offi- cials, and other stakeholders. Thus, established silos and difficulties that sometimes preclude different jurisdictions and branches of government from work- ing together, were overcome. For example, although at the beginning of the Civic Exchange’s Green Harbors visioning effort, maritime emissions were not a pri- ority for the Hong Kong government, staff participa- tion increased awareness and escalated the issue. Civic Exchange also was afforded access to officials through- out the PRD region that would likely be harder for offi- cials from public agencies to gain on their own due to jurisdictional and political divisions (Galbraith et al., 2008; Civic Exchange, 2010). 4. The “Green Brand” and sustainability often is focused on carbon. Concerns about criteria air pollutant (CAP) emissions are typically more prevalent in those parts of the supply chain closest to consumers. Manufacturers and shippers frequently focus on carbon because end consum- ers tend to be concerned about the carbon footprint, and also because there is a direct relationship between carbon emissions reductions and fuel/costs savings. The ability to pass on to shippers the costs incurred through volun- tary activities to mitigate CAP emissions in Asia is per- ceived to be more difficult as compared to such activities in the United States and Europe, closer to the consumer. Consumers tend to be more aware of the impacts closer to home, while activities and practices at the source are not always in focus. 5. Common and consistent regulation is needed on a broader scale, building on voluntary initiatives already underway. The private sector is supportive of regulation where it is applied fairly and, together with the nongovernment

90 sector, can assist in bringing forward regulation that may take time (particularly in a multi-jurisdictional context). Civic Exchange and the shipping lines, through working collaboratively with government, have achieved notable successes, including the following: • The Framework Agreement on Hong Kong-Guangdong Cooperation (2010), which includes commitment to the progressive adoption of fuel emission standards (Booth and Loh, 2012; Hong Kong Environment Bureau, 2010). • The Bay Area was identified as the subject for a spe- cific consultation in 2011, in the Study on the Action Plan for the Bay Area of the Pearl River Estuary Public Consultation Digest. This study mentioned specifically the potential creation of a joint ECA to regulate emis- sions from marine vessels (Booth and Loh, 2012; Study Team of the Action Plan for the Bay Area of the Pearl River Estuary, 2010). • The Regional Cooperation Plan on Building a Qual- ity Living Area was launched in September 2011, out- lining specific measures for controlling air pollutant emissions (including the use of low-sulfur fuel at berth and the potential establishment of an ECA) (Hong Kong Environmental Bureau et al., 2010; Booth and Loh, 2012). • The Hong Kong Environmental Protection Depart- ment submitted proposals to the Panel of Environmen- tal Affairs in the Legislative Council and is on a path toward proposing emissions regulations. In the interim, the Financial Secretary announced a $260 million sub- sidy over a 3-year period to cover reduced port fees for ships that use 0.5 percent sulfur or better while at berth at the Hong Kong ports (Booth and Loh, 2012; Hong Kong Financial Secretary, 2010). 6. One of the downsides of this voluntary initiative is that as there was no requirement for monitoring and report- ing, it is not possible to ascertain the emissions-reduction outcome. Conclusions This case study cluster compares mandatory emissions trading schemes with voluntary emissions-reduction initia- tives in a non-U.S. context. Comparison of these schemes yields several lessons. Voluntary initiatives (such as the Fair Winds Charter) can only go part way in achieving emissions reductions. In the case of CAP emissions particularly, participants in voluntary ini- tiatives to reduce emissions generally incur higher costs (e.g., by using lower sulfur fuel) and carriers may find themselves at a commercial disadvantage, unable to pass these costs on to customers or to compete. Regulatory requirements can create a level playing field, requiring all carriers to meet the same requirements, and incur similar financial consequences. As an interim measure, voluntary initiatives can achieve emis- sions reductions, particularly where legislative and regula- tory processes take time, and where coordination is required between multiple agencies, which can be difficult to achieve. However, common and consistent regulation is required to build upon the voluntary initiatives already underway. Cooperation between private-sector interests and involve- ment of the nongovernment sector can be instrumental in reducing emissions and driving regulatory change, as evi- denced by the Fair Winds Charter case study in Hong Kong. Here, Civic Exchange and the shipping lines engaged the public sector in ongoing dialog, undertook collaborative research, and implemented technology pilots. Nongovern- ment agencies such as Civic Exchange have a role to play in facilitating information exchange and dialog and can assist in overcoming silos within the public sector that may preclude public agencies from working together. Emissions regulations applied in one region can prompt voluntary behavior on the part of multinational carriers to reduce emissions in other locations. For example, the expe- rience of requiring reduced sulfur content in marine fuels in Europe and the United States, together with their commitment to sustainable development, provided a catalyst that drove voluntary activity on the part of a group of ocean carriers in Hong Kong. Here, the private sector is ahead of the pub- lic sector in terms of responding to air quality issues. Their commitment to sustainability and their experience of using reduced sulfur fuels elsewhere, arguably equipped ocean car- riers with the knowledge and confidence to engage in fuel- switching along with a greater level of certainty as to impacts on their business. These ocean carriers are now pressing the public sector for regulatory change. In contrast to the Fair Winds Charter, the EU Aviation ETS is an example of the imposition of emissions regulations following the private sector’s perceived inability to reach an agreement on a global emissions reductions approach for the aviation sector. The implementation of the EU Aviation ETS was only possible because of high levels of domestic coopera- tion (on the part of EU countries), as well as the economic power wielded by EU countries acting together (i.e., airlines are unable to divert to other locations to avoid the tax). The EU ETS does include a level of flexibility that enables local jurisdictions to craft their own regulations to qualify for equivalency, keeping emissions fees at home, rather than paying these to the EU. This has prompted action of the part of other governments (for example, China is now exploring options to reduce emissions from its own airlines). Regulatory measures have a better chance of success where substantial consultation and stakeholder involvement occurs from the outset, as evidenced by the New Zealand Emissions Trading Scheme case study. Early consultation resulted in an

91 agreement to pursue the emissions trading scheme route as it was perceived to provide business with greater flexibility in managing GHG emissions. Ongoing engagement in the design and implementation of the scheme improved accept- ability among stakeholders. Inputs from an independent panel as to the evolution of the New Zealand ETS also assisted in ensuring flexibility in response to the worldwide economic downturn, for example reducing the number of emissions allowances to be surren- dered and providing the option for participants to buy NZUs at a fixed price. Thus, the government was able to ensure sen- sitivity to the needs of the economy during the downturn, while remaining committed to the cap-and-trade path. (Note, however, that New Zealand is a country of less than 4.5 mil- lion people, about a quarter of that in the greater Los Angeles area, for example. Thus, extensive consultation in this context is a relatively easy process which will likely be significantly more challenging in different contexts.) A further factor potentially underpinning the success of the NZ ETS is the fact that the onus for reporting lies with the fuel wholesalers rather than with the emitters (e.g., small carriers and owner-operators) themselves, thereby alleviating the administrative burden on small businesses. Thus, while the ETS results in additional costs to freight transport as a result of increased fuel prices, these are applied across all sec- tors (with higher costs for more polluting modes). Such price increases can encourage more efficient truck fleets and driver behavior. Further, because the relative fuel price increases to the rail freight sector are just 34 percent of that of road freight, this may have the effect of promoting a shift to rail. Jurisdictional consistency is a further feature of the New Zealand ETS, which has been designed to be consistent with other international emissions trading schemes. For a small country such as New Zealand, this was particularly important because it means that emission units may be traded with- out causing a significant movement in the domestic price, thereby permitting local businesses, which may have limited low-cost ways of reducing their own emissions, to fulfill their obligations by buying emission reductions from outside of the country. Similarly, although arguably enacted unilater- ally, the potential for jurisdictional consistency is built into the EU Aviation ETS through equivalency measures. In prac- tice, however, jurisdictional consistency is proving difficult to realize in the short term because of differences in the design of the EU ETS and that of New Zealand. Similarly, integrating the Australian ETS with that of New Zealand poses difficul- ties for New Zealand because Australia is not a party to the Kyoto Protocol.