International transfers of mitigation to achieve the goals of the Paris Agreement
By Suzi Kerr (Motu Economic and Public Policy Research) and Mike Toman (World Bank)
More than a year has passed since the signing of the Paris Agreement under the United Nations Framework Convention on Climate Change, in which developed, emerging and developing countries across the world have pledged to limit or reduce their greenhouse gas emissions (GHGs) as a start toward limiting dangerous climate change. Under the Agreement, countries can work together to reduce emissions. Mike Toman, a Lead Economist in the World Bank’s Development Research Group, and Motu’s Suzi Kerr have come up with three basic guidelines for financing of emissions reductions in less economically advanced countries: 1. Do not conflate “international carbon markets” with “internationally transferred mitigation outcomes.” 2. Be cautious about the apparent gains from linking emissions trading markets. 3. Create contracts between developed and developing country governments for internationally transferred mitigation obligations. The individually tailored pledges of each country called Nationally Determined Contributions (NDCs) can include (under Article 6) provisions for countries to work together to reduce emissions. The options include financial support for developing countries to meet and then exceed their own pledges. The latter would occur under the general heading of “internationally transferred mitigation outcomes,” where a developed country can lower the cost of meeting its own NDC by supporting less-costly emissions reductions in another country.
Some countries, and other jurisdictions such as states, have set caps on total greenhouse gas emissions and decided to implement achievement of their caps through “carbon markets,” or “emissions trading.” Under this regulatory approach, regulated companies must monitor emissions and acquire, through purchase or free allocation, ‘allowances’ for the emissions for which they are responsible. The total number of allowances is equal to the cap. This allows the cap to be achieved more cost-effectively. Some jurisdictions with caps and domestic emission trading markets have also linked their markets by allowing allowances to be traded across jurisdictional boundaries. “International carbon markets” are seen as a way to make global emissions reductions more cost-effective. International cooperation in both the specification of goals (NDCs) and implementation of policy measures (e.g. emissions trading) can contribute to the effort to limit dangerous climate change. However, confusion has arisen in international discussions about options for cooperation during implementation. To help clear up this confusion, we offer three basic guidelines:
1) Do not conflate international carbon markets with internationally transferred mitigation outcomes. It is necessary to separate the specification of national goals and the development of mechanisms to meet those goals. One reason for international transfers of mitigation outcomes is that they allow a ‘buyer’ country to finance lower-cost emissions reductions in another country to meet its own commitment without losing environmental integrity. This allows them to be more ambitious. It also allows ‘seller’ countries to finance domestic mitigation beyond what can be achieved with their own resources. International carbon markets are one way to transfer mitigation commitments across countries, but they are not the only way, or necessarily the best. Using carbon markets among private participants requires that all participating countries have their own cap-and-trade programs, or provisions for project-based emissions credits similar to what took place under the Clean Development Mechanism. While in principle linked emissions trading markets and project mechanisms could facilitate extensive involvement in international trades by individual emitters motivated to achieve compliance obligations cost-effectively, only a few countries are prepared to embrace full market linkage and project mechanisms have experienced serious problems. 2) Be cautious about the apparent gains from linking emissions trading markets. As noted, cross-jurisdictional emissions trading covering more sources can allow emissions reductions to be achieved more cost-effectively. This could inspire more ambitious emissions reduction goals. However, linking two cap-and-trade programs can have significant distributional implications within countries, e.g. a market in a less advanced country facing a large external demand for emissions allowances would have an even higher domestic allowance price which would hurt emissions intensive industries. If the countries have different price management regimes (e.g. floor and/or ceiling prices), or different rules about acceptance of offsets, the effects of these provisions will automatically flow into the other’s regime. Full linking requires close coordination of rules. Smaller countries that link tend to give up autonomy in the design of their regulations and the domestic price of allowances or credits. International linking of emissions trading also exposes each country to political uncertainty around other countries’ climate change policies. Emission prices may vary significantly in undesirable ways in response to political changes outside the country’s control.
Linking a cap-and-trade system in one country to a system for project-based emissions reductions in another country also would involve technical complications, given that the latter country could maintain environmental integrity only if it offers credits for emissions reduction beyond compliance with its NDC. This can be guaranteed only ex-post when national inventory data is available. 3) Create contracts between governments in (more ambitious, richer) buyer countries and (less ambitious, poorer) seller countries for internationally transferred mitigation outcomes. An example is the results-based agreement between Brazil and Norway to reduce deforestation in the Amazon basin. Such arrangements can provide a robust foundation for internationally transferred mitigation outcomes, and thus mitigation obligations, by offering secure demand, emission prices and financing and engendering stable incentives to implement serious policies and make transformational changes across the sector or the economy of the seller country. Crediting baselines could be established for total seller country emissions, based on achieving their NDCs, or for individual sectors in ways that still allow confidence that seller countries can achieve their NDCs. Only if national inventories in seller countries show levels of emissions below these baselines could mitigation outcomes be transferred. International ‘climate finance’ that does not lead to transfers of mitigation outcomes could be strategically used to reduce the risk (to both the seller and the buyer) that the crediting baseline is not met and hence no transferrable outcomes (government level credits) are created. For example, an agreement, by providing a stable emissions price, could facilitate private sector investment in mitigation activities such as more efficient technology or reforestation in the ‘seller’ country.