I just returned from Florence, Italy, where I participated in the Second Carbon Market Workshop, organized by the European Commission, and hosted by the European University Institute. This workshop, which brought together government representatives from around the world (with a sprinkling of academics and NGO representatives to add some spice to the discussion), was convened to examine how regional, national, and sub-national jurisdictions can cooperate in ways that could increase the effectiveness and/or reduce the costs of their respective climate change policies. One of my tasks at the workshop was to make a brief dinner speech. Jos Delbeke, the long-time, legendary Director-General of Climate Action for the Commission, asked me to talk about how the Paris Agreement might help or hinder practical climate policy cooperation around the world. I drew extensively upon my research with Michael Mehling and Gilbert Metcalf. Here is the gist of what I said in my dinner speech.
Some Paris Agreement Fundamentals
The hybrid design of the Paris Agreement was key to its successful enactment in 2015 and its coming into force in November, 2016. The hybrid design to which I refer is the combination of top-down (centralized) and bottom-up (decentralized) elements. The top-down elements include, for example, the requirement that countries state their national contributions every five years, a schedule which is binding under international law for those jurisdictions that have ratified the Agreement. The key bottom-up element is the set of individual Nationally Determined Contributions (or NDCs) themselves, which are not part of the Paris Agreement itself, but rather are listed in a separate Registry. These are not binding under international law, but rather are left to the domestic authority of the respective countries.
This dual structure led to the achievement of one of two necessary conditions for ultimate success of the Paris Agreement, namely adequate scope of participation, which now includes countries accounting for 97% of global emissions, compared with the 14% that are covered by the current, second commitment period of the Kyoto Protocol.
But adequate scope of participation is only one of two necessary conditions; the other is adequate collective ambition. Unfortunately, the fundamentally voluntary nature of the NDCs – which is precisely what facilitated the exceptionally broad scope of participation – works against adequate ambition to address this global commons phenomenon, which is plagued by free rider problems.
The Challenge for Climate Negotiators
This raises the key overall challenge that faced the negotiators in Bonn in May and will face them in Katowice, Poland, in December (at the Twenty-Fourth Conference of the Parties of the United Nations Framework Convention on Climate Change): What can they do, when writing rules to put flesh onto the skeletal Paris Agreement, to encourage countries to increase their ambition over time? That’s where carbon markets and cooperation among jurisdictions potentially come in.
International Cooperation under the Paris Agreement
Largely because cooperation among jurisdictions — including through carbon markets — can lower abatement costs, such cooperation may be essential for the ultimate success of the Agreement. This cooperation might take the form of international linkage, where by “linkage,” I mean connections among policy systems that allow emissions reduction efforts to be redistributed among those systems.
Such linkage is typically framed as between cap-and-trade systems, but regional, national, and sub-national policies are and will be highly heterogeneous, including not only cap-and-trade, but offset systems, carbon taxes, performance standards, and technology standards. Note that we already see this sort of heterogeneity within the European Union’s own set of climate change policies, as well as within California’s suite of climate initiatives.
The good news is that linkage among highly heterogeneous policies is eminently feasible, as I have written about previously in this blog, drawing on my research with Michael Mehling (MIT) and Gib Metcalf (Tufts University). The even better news is that one part of the Paris Agreement provides a potential home for such international cooperation, linkage, and carbon markets – Article 6. (If you are interested in the details, I recommend a recent report from the Asian Development Bank, “Decoding Article 6 of the Paris Agreement.”)
The Promise and Problems of Article 6
In the negotiations that led up to the 2015 Paris climate talks, it was by no means clear what role — if any — market mechanisms would play in the Paris Agreement. In the negotiations, the European Union, Brazil, and other countries played crucial roles in generating the compromise that became Article 6 of the Agreement.
That compromise resulted in text that — to put it kindly — is very much subject to interpretation. Now, as Benito Müller, Kelley Kizzier, and their colleagues have observed, intentional vagueness and ambiguity of text can be quite helpful in achieving a negotiated compromise, but such vagueness is decidedly not helpful when it comes to making an agreement operational.
This compromised home for markets emerged in Article 6 despite the entrenched opposition of a small set of vocal countries — including some Latin American socialist economies (the so-called ALBA coalition) — who wanted nothing of the kind to appear in the Paris Agreement. They succeeded in keeping the word “market” out the Paris Agreement, but the concept and the potential reality is very much there! (Ironically, at their insistence, the phrase “non-market” doesappear in the Agreement.)
In any event, provision for markets and international cooperation is implicit in Article 6.2, which allows for cooperative approaches involving Internationally Transferred Mitigation Outcomes (or ITMOs), which are vague and without definition, but can function as an international accounting mechanism for international trades, exchanges, and cooperation. And Article 6.4 establishes a more centralized mechanism to contribute to emissions mitigation and support sustainable development, essentially as a successor to the Clean Development Mechanism (and may soon come to be called the “Sustainable Development Mechanism” or SDM).
Advantages and Concerns about Cooperation and Linkage
Despite the opposition I mentioned, most parties to the Paris Agreement are supportive of cooperative approaches (and more than half explicitly mentioned carbon markets in their respective NDCs).
This may be because of six important advantages of such cooperation: first, cost savings by allowing firms to take advantage of lower cost abatement opportunities in other jurisdictions; second, reducing market power of individual firms by enlarging the market’s scope, and reducing total price volatility by thickening markets; third, political benefits to Parties, by providing a sign of “momentum” as jurisdictions band together, possibly influencing other parties to participate; fourth, administrative economies of scale through knowledge sharing in design and operations, as well as shared administrative and oversight costs; fifth reducing leakage and competitiveness impacts by harmonizing the shadow price of carbon across jurisdictions; and sixth, allowing for the achievement of the UNFCCC’s critical principle of “Common but Differentiated Responsibilities” without sacrificing cost-effectiveness.
There are also real concerns about linkage: first, distributional impacts within and across linked jurisdictions; second, automatic propagation of certain design elements, in particular, cost-containment elements (banking, borrowing, and price collars); and third, decreased national autonomy.
Back to the Article 6 Negotiations and International Policy Linkage
Article 6 can be a home both to linkage of the sort we usually talk about, as well as “soft linkage,” such as an agreement — explicit or implicit — to harmonize carbon prices either at some level or within overlapping bands.
Thinking about the UNFCCC negotiations taking place now, most types of heterogeneity – of policy instruments, level of political jurisdiction, and nature of NDC targets – do not present insurmountable obstacles to linkage, but some do present real challenges, and indicate the need for specific guidance as the rulebook of the Paris Agreement is written.
Unfortunately, some countries want the Article 6 guidance to go beyond fundamental issues of accounting and environmental integrity to broader matters of environmental ambition, which properly belong in other parts of the Paris Agreement. Whereas, accounting provisions to avoid double-counting of NDC actions through ITMOs surely belong in the Article 6 rulebook, some countries have proposed, for example, that all ITMO exchanges themselves must actually reduce net emissions.
This sounds very much like the U.S. Environmental Protection Agency’s 20% rule in its 1970’s Emissions Trading Program, which required that net emissions fall by 20% with each trade. This was a tax and an inhibition on trading, and the result was that virtually no trading occurred. This reminds me of a corrupted version of George Santayana’s admonition that those who do not learn from history are doomed to repeat it. Instead we have, “I’ve learned from my mistakes, and I can repeat them exactly the same again.”
The general problem is that if the guidance extends much beyond basic accounting rules, then restrictive requirements could actually impede effective cooperation. True to the nature and spirit of the Paris Agreement, less can be more!
UNFCCC Update from Bonn
I closed my dinner comments in Florence with a brief update on the negotiations that concluded the previous week in Bonn. The two weeks of meetings of the Article 6 group were reported to be much tougher than they had been previously, yet the progress on the Article 6 work is actually ahead of that of groups focused on other parts of the Paris Agreement. Although positions on Article 6 are hardening, there is no clear blocking party or coalition (unlike in the work on some of the other parts of the Agreement). There may be less resistance to agreement simply because participation in Article 6 instruments would ultimately be voluntary.
The Path Ahead
So, as the negotiations proceed, a combination of common accounting rules and an absence of restrictive conditions can accelerate linkage, allow for broader and deeper climate policy cooperation, facilitate the emergence of a robust global carbon market, and – most important – increase the latitude of the Parties to the Paris Agreement to scale up the ambition of their long-term contributions to global greenhouse gas emission reductions.
Whether that will come to pass, we simply do not know as of now. As usual, only time will tell.
This post originally appeared on Robert Stavins’s blog, An Economic View of the Environment