Climate Architecture after 2012:

Prospects for a Transatlantic Carbon Market?

bridges vol. 30, July 2011 / Feature Articles

By Andreas Tuerk

{enclose Vol.30_Tuerk.mp3}

What comes after Kyoto_small.jpg
What comes after Kyoto and Copenhagen?

In many ways, the Copenhagen climate summit of December 2009 marked a departure from the practice of multilateral climate cooperation compared to the previous two decades. The Copenhagen summit aimed to agree on a new international treaty to reduce greenhouse gas emissions after the expiration of the current reduction targets in the Kyoto Protocol, which ends in 2012. The Copenhagen Accord, a set of decisions only taken notice of in Copenhagen, was driven by the US and strongly influenced by China and a few other emerging economies. It is characterized by a voluntary "pledge and review" system for emission reductions, by which countries propose voluntary reduction targets that are reviewed within an international process. However, there are no sanctions for failure to meet the targets. Such an approach is therefore fundamentally different from the current UN-based multilateral approach, and reflects the vision for international climate architecture as espoused by the US - which never ratified the Kyoto protocol - while the EU is still advocating that Kyoto-style top-down climate architecture be continued after 2012. A top-down approach is based on science - with internationally agreed-upon targets - as part of an internationally binding treaty such as the Kyoto Protocol.  Proponents of bottom-up approaches highlight the importance of flexibility, which they believe will allow each state to define activities that are technically, economically, and politically acceptable in light of local or regional conditions. However, bottom-up approaches may not provide the same degree of certainty of emissions reductions.

While the US never ratified the Kyoto protocol, in the EU the Kyoto protocol motivated the implementation of the European Emissions trading scheme (EU-ETS). The EU-ETS, operational since 2005, is the largest multi-country, multi-sector greenhouse gas emissions trading scheme worldwide, regulating about 10,000 facilities that currently emit around 2 Gt (gigatonnes - a billion metric tons) of CO2 per year. Within this cap-and-trade scheme, large industrial greenhouse gas emitters and electricity producers are required to hold a certain amount of emissions permits, each representing the right to emit a tonne of CO2. The total permits they are allocated by the regulator represent their emissions cap. Companies unable to meet their emissions target through internal actions, or only at high costs, must buy permits from those who pollute less or can reduce emissions more cheaply. These trading activities result in the pricing of CO2 permits. Under such systems, in theory, emissions reductions ought to be carried out where they are least expensive.  

In the United States in recent years, dynamic initiatives have been launched at the state level to implement greenhouse gas emissions trading schemes, especially on the east coast (Regional Greenhouse Gas Initiative) and the west coast (Western Climate Initiative). In addition, several legislative proposals for a federal system have been under discussion the past few years in the US Congress. On the other side of the globe, New Zealand has implemented an ETS that became operational in July 2010, Australia has proposed a national ETS, and Japan and South Korea are discussing the implementation of such a scheme.

{access view=guest}Access to the full article is free, but requires you to register. Registration is simple and quick - all we need is your name and a valid e-mail address. We appreciate your interest in bridges.{/access} {access view=!guest}The European Commission strongly advocates the establishment of a global emissions trading market through bilateral links between trading schemes. Bilateral links mean that credits from one scheme can be used in the other and vice versa. The EU has the vision that OECD countries should establish cap-and-trade systems and form an OECD-wide CO2 market by 2015. According to the EU plans, major emerging economies such as China would also implement cap-and-trade systems and integrate into the OECD market by 2020.  In theory, linking CO2 markets promises higher liquidity and a larger number of abatement options, thereby increasing economic efficiency. The Commission has the vision of a broad, globally linked carbon market as a key instrument in achieving the deep cuts in greenhouse gases needed to reach the EU objective - limiting global warming to a 2 degree temperature increase - and as the basis for any post-2012 climate regime.  

co2 smoke stack_small.jpg
Hopes for an EU-US carbon market going up in smoke?

Since the US decision to withdraw from the Kyoto Protocol, bilateral engagement with the United States has been an important strategic focus of the European Union. One pathway to strengthened climate cooperation across the Atlantic could involve the integration of domestic emissions trading systems in both regions through unilateral or bilateral market linkages. Given that Europe and the US account for roughly 80 percent of CO2 emissions, it is clear why a transatlantic market link would form the logical nucleus of any larger CO2-trading regime. The EU's idea was that linking emerging domestic industry trading systems would support the top-down approach of a possible future "Kyoto-type" international climate regime with a bottom-up nationally driven process. For the EU, this was also a fallback option in the event that no global agreement could be achieved - a scenario far more likely in the current setting.

Linking of emissions trading systems does not require all design features of the affected trading systems to be harmonized. Some differences can be tolerated without detriment to the link, and others require only minor technical changes. However, some features constitute significant barriers to effectively linking trading schemes, including the relative stringency of reduction targets of an individual scheme or price-management and cost-containment mechanisms. In any case, the relative stringency of targets is one of the most politically critical issues when two or more systems consider linkage. Thus, it may be a political precondition for linking that all systems involved have comparable stringent emissions caps. The EU-ETS has almost no cost-containment provisions because the European Commission advocates the free play of market forces; but most of the proposals for a federal US emissions trading scheme introduced in the US Congress included cost-containment measures such as price caps or safety valves. This would mean that if a certain CO2 price level is reached, the regulator would issue additional permits limiting the cost for the companies to meet the reduction target but increasing the amount of CO2 that can be emitted, thus undermining the reduction target.

Recent bills introduced in Congress in 2009/10 to establish a US federal climate law, such as the Waxman-Markey bill , gave hope for the establishment of an EU-US carbon market, as they included fewer barriers to linking than did earlier proposals. In July 2010, however, the Democratic leadership of the United States Senate conceded failure to pass comprehensive climate legislation during the 111th Congress. As widely expected, the US midterm elections on November 2, 2010, resulted in a victory for the Republican Party, which successfully captured a majority in the House of Representatives and eroded the majority of the Democratic Party in the Senate. Likewise, gubernatorial elections in six states saw Democratic incumbents replaced by Republican contenders, and a majority of states now have Republican governors. These election results are likely to dampen any prospects for decisive action on climate change, both RGGI logo_small.jpg at the federal level and in a majority of states, and therefore for a large-scale transatlantic carbon market.  While all this clearly lessens the probability of a federal emissions trading system being established in coming years, the election outcomes in a number of progressive states, especially on the East and West Coasts, have potentially strengthened front-runner efforts to promote climate action, including CO2 markets.  On the East coast, one regional emissions trading scheme in place since 2008 as part of the Regional Greenhouse Gas Initiative is a cooperative effort by ten US Northeastern and Mid-Atlantic states.

Western Climate Initiative.jpg On the West Coast, the Western Climate Initiative comprising seven Western states and four Canadian provinces, has developed a comprehensive strategy for reducing global warming pollution 15 percent below 2005 levels by 2020; this includes a regional CO2 market set to begin in 2012. Cap-¬and-¬trade will be the central policy instrument for mitigation, complemented by additional policies for specific sectors and activities. Five WCI partner jurisdictions are currently working toward starting their programs in 2012: California, New Mexico, British Columbia, Ontario, and Quebec. These partners represent approximately two thirds of the total emissions in the WCI jurisdictions. In 2015, the WCI market could cover as much as 750 million tons of CO2 emissions.  The WCI has set an overall design for the cap-and-trade systems in the participating countries while details are being decided in the individual jurisdictions. California, the largest jurisdiction under the WCI, has made the strongest progress towards implementing a cap-and-trade scheme, as a detailed design of its planned scheme was approved by the California Air Resources Board (CARB) in December 2010. While not all participating jurisdictions will be implementing emissions trading systems when the WCI begins in January 2012, those expected to move ahead comprise approximately two ¬thirds of the total emissions in the WCI area, and may constitute a market one third the size of the

Hedegaard and Brown_small.jpg
EU Commissioner for Climate Action Connie Hedegaard visiting California Governor Jerry Brown in April 2011.

EU-ETS by 2015. Although specification of several design details in the WCI trading system has been left to the individual partner jurisdictions, the overall WCI program design rules out insurmountable obstacles for a transatlantic market link; the design of the WCI is far more aligned with the EU-ETS than are any of the proposals for a federal US scheme. At present, however, it stands to reason that a link with the EU-ETS will not be a priority for WCI participants, despite the strong interest expressed on the European side. When individual emissions trading systems in the WCI partner jurisdictions become operational in 2012, these systems will first seek bilateral links with each other in order to create a liquid carbon market.

In theory, the RGGI system, already up and running, is another candidate for linking with the EU-ETS. However, while the functional design features of both systems are generally compatible, RGGI CO2 prices are very low due to an over-allocation of emission permits to covered entities. Linking to the RGGI system would therefore mean trading of permits that don't correspond to emission reductions. Thus, linking would only be an option for the EU if the RGGI cap were substantially tightened.

However, if the EU succeeded in establishing trading with regional US initiatives, in particular to the WCI given its size, this would likely send a strong political signal and revitalize the discussions about a global carbon market. Even if linkages between the EU-ETS and regional US trading systems lie several years in the future, markets on both sides of the Atlantic may be indirectly linked, in the meantime, via acceptance of common emissions reduction certificates in developing countries. An accordance of views between the US and EU regarding such certificates would therefore be of crucial importance in enabling both indirect and, over time, perhaps direct links.

Although it is unlikely that the Kyoto protocol will be extended after 2012, this does not mean that the international community will remain inactive: The Copenhagen accord called countries, industrialized and developing countries, to submit voluntary targets and measures. One country after another has elaborated domestic targets and actions, and has presented these to an international audience. More importantly, countries are already enacting policies and measures to achieve their Copenhagen pledges, even in the absence of a legally binding international treaty. One may hope that this dynamic will gather further steam in the years ahead, and ultimately culminate in a corresponding strengthening of the international framework.

In most countries, the new policies and measures are not likely to include domestic emissions trading for the foreseeable future, but that does not apply to all countries. Several nations will probably seek to strengthen existing and create new bilateral and multilateral initiatives including CO2-trading schemes. As there will be no federal climate legislation in the US and Canada for a number of years, an OECD-¬wide carbon market is unlikely in the short ¬term and mid-¬term, and a bottom-¬up climate architecture - the more likely scenario going forward - will probably not be based on a global carbon market. Rather than one unified regime, the next decade is likely to yield a patchwork of regimes. Emissions trading and linked carbon markets, including a possible link between the EU-ETS and a regional US scheme, may be one of the more important strands in this regulatory landscape, but it will probably not be the backbone of international efforts.

Climate Strategies_small.jpg The above article is based on the following paper:
Mehling, M., A. Tuerk, and W. Sterk. “Prospects for a Transatlantic Carbon Market: What Next after the US Midterm Elections? ” Climate Strategies Working Paper, April 14, 2011. The paper builds on research on transatlantic climate policy carried out in recent years in cooperation between the Ecologic Institute, Washington, DC; Joanneum Research, Graz; and the Wuppertal Institute, Germany.


About the author: Andreas Tuerk is a senior researcher at Joanneum Research Graz, and at the Wegener Center for Climate and Global Change at the University of Graz, Austria.