COP-25 Disappointment Should Not Be Due to Lack of Aspirations for Future Ambition, But to Lack of Support for Global Carbon Markets

On December 18th, The Conversation (“academic rigor, journalistic flair”) – published my brief essay (“The Madrid climate conference’s real failure was not getting a broad deal on global carbon markets”), and today – in this blog post – I wish to share a slightly edited version with you (without the excellent graphics included in the original article).

The Reality Behind the Press Coverage

Press accounts of the Madrid climate conference that adjourned on Dec. 15 are calling it a failure in the face of inspirational calls from youth activists and others for greater ambition. But based on my 25 years following and analyzing this process together with scholars and government officials from around the world, I believe the reality is more complicated.

True, this round of climate talks did not produce an aspirational statement calling for greater ambition in the next round of national pledges. In my view, that’s not actually very significant in terms of its real effects, even though organizations such as Greenpeace and Extinction Rebellion framed this as the key task for this meeting.

On the other hand, the talks failed to reach one of their key stated goals: writing meaningful rules to help facilitate global carbon markets. As an economist, I see this as a real disappointment – although not the fatal failure some portray it to be.

Tackling the free-rider problem

Here’s some context to explain why international cooperation is essential to tackle climate change. Regardless of where they’re emitted, greenhouse gases mix in the atmosphere. That’s different from other air pollutants, which can affect localities or large areas, but not the entire world.

This means that any jurisdiction that reduces its emissions incurs all of the costs of doing so, but receives only a share of the global benefits. Everyone has an incentive to free-ride, relying on others to cut emissions while taking minimal steps themselves.

Recognizing this problem, nations adopted the United Nations Framework Convention on Climate Change at the Rio Earth Summit in 1992. As with many other international treaties, member countries agreed to hold regular meetings to devise rules for achieving the goals set out in the agreement. That’s how the Conference of Parties, or COP, process was launched.

Why climate change is a wicked problem

If the pace of progress at these meetings seems slow, keep in mind three factors that make their task enormously challenging.

First, every nation has an incentive to exploit the atmosphere and rely on other countries to cut emissions.

Second, making reductions costs money up front – but since carbon dioxide emissions remain in the atmosphere and warm the Earth for up to a century, many of the benefits of cutting emissions accrue much later.

Third, the costs of cutting emissions fall on particular sectors – notably, fossil fuel interests – that have a strong monetary incentive to fight back. But the benefits are broadly distributed across the general public. Some people care passionately about this issue, while others give it little thought.

At the COP-1 meeting in 1995 in Berlin, members decided that some of the wealthiest countries would commit to targets and timetables for emission reductions, but there would be no commitments for other countries. Two years later, nations adopted the Kyoto Protocol, which set quantitative targets only for Annex I (largely wealthy) countries.

That wasn’t a broad enough foundation to solve the climate challenge. Annex I countries alone could not reduce global emissions, since the most significant growth was coming from large emerging economies – China, India, Brazil, Korea, South Africa, Mexico and Indonesia – that were not part of the Annex I group.

Everybody in

At negotiations in 2009 in Copenhagen and 2010 in Cancun, distinctions between wealthy and developing countries began to blur. This culminated in an agreement at Durban, South Africa, in 2011 that all countries would come under the same legal framework in a post-Kyoto agreement, to be completed in 2015 in Paris.

The Paris Agreement provided a promising, fresh approach. It proposed a bottom-up strategy in which all 195 participating countries would specify their own targets, consistent with their national circumstances and domestic political realities.

This convinced many more nations to sign up. Countries that joined the Paris Agreement represented 97% of global greenhouse gas emissions, compared to 14% currently under the Kyoto Protocol. But it also gave every country an incentive to minimize its own actions while benefiting from other nations’ reductions.

Growing carbon markets

Are there ways to persuade nations to increase their commitments over time? One key strategy is linking national policies, so that emitters can buy and sell carbon emissions allowances or credits across borders.

For example, California and Quebec have linked their emissions trading systems. On Jan. 1, 2020, the European Union and Switzerland will do likewise.

Note, however, that such linking need not be restricted to pairs of cap-and-trade systems. Rather, heterogeneous linkage among cap-and-trade, carbon taxes and performance standards is perfectly feasible.

Expanding carbon markets in this way lowers costs, enabling countries to be more ambitious. One recent study estimates that linkage could, in theory, reduce compliance costs by 75%.

But for such systems to be meaningful, each country’s steps must be correctly counted toward its national target under the Paris Agreement. This is where Article 6 of the Paris Agreement comes in. Writing the rules for this article was the primary task for negotiators in Madrid (28 other articles were completed at the 2018 COP in Katowice, Poland).

Unfortunately, Brazil, Australia and a few other countries insisted on adopting accounting loopholes that made it impossible to reach agreement in Madrid on Article 6. Negotiators had an opportunity to define clear and consistent guidance for accounting for emissions transfers but failed to close a deal.

But if they had adopted guidance that extended much beyond basic accounting rules, as some countries wanted, the result could have been restrictive requirements that would actually impede effective linkage. This would have made it more expensive, not less, for nations to achieve their Paris targets. As Teresa Ribera, Minister for the Ecological Transition of Spain, observed at COP-25, “No deal is better than a bad deal” on carbon markets and Article 6.

The baton for completing Article 6 has been passed to COP-26 in Glasgow in November 2020. In the meantime, without agreement on an overall set of rules, countries may develop their own rules for international linkages that can foster high-integrity carbon markets, as California, Quebec, the European Union and Switzerland already have. If negotiators can keep their eyes on the prize and resist being diverted by demands from activists and interest groups, I believe real success is still possible.

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What to Expect at COP-25 in Madrid

The “Rulebook” for the Paris Agreement puts flesh on the bones of the skeletal 13-page Agreement, and was completed last year at COP-24 in Katowice, Poland, with the exception of one very important part of the Agreement, namely Article 6, which potentially  provides for international carbon markets and other forms of cross-border cooperation.  Watch for key developments in Madrid!

Key Challenge for Long-Term Success of Paris Agreement

There are two necessary conditions for ultimate success of the Paris Agreement.  First, adequate scope of participation.  This has been achieved, with meaningful participation from countries representing some 98% of global emissions – or some 85% if the U.S. withdraws in November, 2020 (compared with the 14% of global emissions from countries committed to emissions reductions under the current, second commitment period of the Kyoto Protocol).  The other necessary condition is adequate ambition of the individual national contributions.  This is where the greatest challenges lie.

The very element of the Paris Agreement that has fostered such broad scope of participation – namely, that the individual national “pledges” (Nationally Determined Contributions or NDCs) are anchored in national circumstances and domestic political realities – implies that individual contributions may not be sufficient, due to the global commons nature of the climate change problem, and the attendant free-rider issues.

So, are there ways to enable and facilitate increased ambition over time?  Linkage of regional, national, and sub-national policies can be part of the answer – connections among policy systems that allow emission reduction efforts to be redistributed across systems.  Linkage is typically framed as between cap-and-trade systems, but regional, national, and sub-national policies will be highly heterogeneous.  More about this below.

Merits and Concerns regarding Linkage

Linkage facilitates significant compliance cost savings by allowing firms to take advantage of lower cost abatement opportunities in other jurisdictions.  According to one recent study, costs could – in theory – be reduced to 25% of what they otherwise would be!  Also, linkage means improved functioning of markets by reducing market power and price volatility, and there are political benefits to linking parties as a sign of momentum when political jurisdictions band together.  Another advantage is administrative economies of scale.  Finally and very importantly, linkage allows for the UNFCCC’s key equity principle of “common but differentiated responsibilities and respective capabilities” (CBDR) to be achieved without sacrificing cost-effectiveness.

There are also some legitimate concerns about policy linkage.  First, there are distributional impacts, both in the form of redistribution within jurisdictions, and redistribution across jurisdictions.  Such impacts are politically problematic.  There is also the automatic propagation of some design elements, in particular, the cost-containment elements of banking and price collars which propagate from one linked system to another.  For that matter, weak design in one jurisdiction affects prices and quality in all linked jurisdictions.  And price shocks can propagate through linked jurisdictions.  Finally, there is decreased autonomy, as rules are set jointly by all linked parties.

Linkage and the Paris Agreement

There are three distinct but closely related levels of relevant policy action.  First, national (or regional) governments can establish emission-reduction policies, including carbon taxes, cap-and-trade systems, and performance standards.  Second, these jurisdictions can link their policy instruments through mutual recognition of permits, allowances, or credits via bilateral agreements.  This allows trade of these units across international borders, which facilitates lower-cost achievement of the aggregate target.  But such transfers of emission reduction responsibilities and actions need to be correctly counted toward compliance with respective NDCs under the Paris Agreement.  This is where Article 6 comes in!

In particular, Article 6.2 provides for Internationally Transferred Mitigation Outcomes (ITMOs) and Corresponding Adjustments, which together can function as the international accounting mechanism to correctly reflect a multiplicity of international private-sector exchanges (under various international linkages).

In other words, I view ITMOs as units of accounting for Corresponding Adjustments, not as a medium of exchange for government-government purchase and sale.  Otherwise, Article 6.2 would become equivalent to the Kyoto Protocol’s Article 17 (international emissions trading), and will fail as that did, because governments are not cost-minimizing agents, and lack requisite information even if they were (Hahn & Stavins, “What Has the Kyoto Protocol Wrought? The Real Architecture of International Tradeable Permit Markets,” 1999).

Is Heterogeneity a Challenge for Linkage?

Yes, it can be.  There are three major categories of heterogeneity that can pose challenges to effective international policy linkage under the Paris Agreement.  First, there are heterogeneous policy instruments:  cap-and-trade; tradable performance standards; emission reduction credits (offsets); taxes; and performance standards.  Second, there are heterogeneous jurisdictions and geographic scope:  regional, national, and sub-national; and status under the Paris Agreement (Party and non-Party).  Third, the NDC targets themselves area highly heterogeneous:  hard (mass-based) emissions caps; relative mass-based emissions caps (relative to BAU); rate-based emissions caps (per unit of economic activity or per unit of output); and non-emissions caps, such as some degree of penetration of renewable energy sources.  Also, there are differences in base year, target year, sectors, GHGs, estimated global warming potential, and conditionality.

Is Linkage Among Such Heterogeneous Policies Feasible or Wise?

With Michael Mehling (MIT) and Gilbert Metcalf (Tufts University), I have carried out research on heterogeneous linkage and the Paris Agreement (“Linking Climate Policies to Advance Global Mitigation.” Science 359, 2018).  Among our major findings is the following.  Most features of heterogeneity do not present insurmountable obstacles to linkage, but some present real challenges, and indicate the need for specific accounting guidance to avoid double-counting.    Article 6.2 provides an obvious home for this accounting guidance (Schneider, Duan, Stavins, Kizzier, Broekhoff, Jotzo, Winkler, Lazarus, Howard, and Hood.  “Double counting and the Paris Agreement rulebook.”  Science 366, 2019).

The Outlook for Heterogeneous Linkage under Article 6.2 of the Paris Agreement

The negotiators in Madrid have an opportunity to define clear and consistent guidance for accounting for emissions transfers under Article 6.2.  A robust accounting framework can foster successful linkages of climate policies across jurisdictions.  But if guidance extends much beyond basic accounting rules – such as implicit taxes on cooperation via what have been termed “share of proceeds” and “net global emission reduction” – then restrictive requirements will impede effective linkage, and thereby drive up compliance costs.  True to the spirit of the Paris Agreement, less may be more!

So, a combination of sensible common accounting rules and absence of restrictive criteria and conditions can accelerate linkage, allow for broader and deeper climate policy cooperation, and – most important – thereby increase the latitude of Parties to scale up the ambition of their NDCs.

Only time – and the work of the delegates in Madrid – will tell.

 The Harvard Project on Climate Agreements at COP-25

Along with my Harvard colleagues, Joseph Aldy, Robert Stowe, and Jason Chapman, I will be at the Twenty-Fifth Conference of the Parties (COP-25) of the United Nations Framework Convention on Climate Change (UNFCCC) in Madrid, Spain, leading our delegation from the Harvard Project on Climate Agreements (HPCA), December 8-11, 2019.

In addition to holding a series of bilateral meetings with various national delegations, I will participate in at least four events.  Two of these are panel sessions organized by HPCA, while the two others are panel sessions organized by national delegations.  Our team will be at COP-25 during the week of December 8-12, 2019.  COP-25 attendees who wish to meet with the Harvard Project during the conference should send an email Jason Chapman, Project Manager (jason_chapman@hks.harvard.edu).

Four Events in Brief

 Reducing Greenhouse Gas Emissions through Carbon Pricing:  Recent Research, Analysis, and Experience
Robert Stavins, Moderator and Panelist; Joseph Aldy, Panelist; Hosted by Harvard Project on Climate Agreements, Enel Foundation, and Tsinghua University Global Climate Change Institute; Monday, December 9, 2019; 11:30 am – 1:00 pm; Location:  Side Event Room 3

The Seventh Global Climate Change Think Tank Forum:  The Latest Developments in Climate Change Economics
Robert Stavins, Presenter; Hosted by China National Center for Climate Change Strategy and International Cooperation; Tuesday, December 10, 2019;  6:00 pm – 7:30 pm; Location:  China Pavilion

 Realizing the Potential of Article 6 of the Paris Agreement
Robert Stavins, Moderator and Panelist; Joseph Aldy, Panelist; Hosted by the Harvard Project on Climate Agreements; Wednesday, December 11, 2019;  12:30 pm – 2:00 pm; Location:  Pavilion of the International Emissions Trading Association (IETA)

 Enhancing Capacity of Developing Countries to Address Climate Change: Issues and Opportunities
Robert Stavins, Keynote Speaker; Hosted by Korea University, Green Asia, Center for Climate and Sustainable Development Law and Policy, Global Green Growth Institute, UNDP Seoul Policy Centre, UN Office for Sustainable Development; Wednesday, December 11, 2019;  3:00 pm – 4:30 pm; Location:  Korea Pavilion

 Two Harvard Project Events in Detail

 Reducing Greenhouse Gas Emissions through Carbon Pricing:  Recent Research, Analysis, and Experience

Monday, 9 December, 2019; 11:30am – 1:00pm, Location: Side Event Room 3

Speakers will present recent research and analysis of carbon-pricing policy to reduce greenhouse-gas emissions. The panel will give some attention to experience and prospects in South America and to China’s emerging national system. A new research paper by Robert Stavins on the relative merits of cap and trade and carbon taxes will provide a basis for much of the discussion.

Speakers: Joseph Aldy, Harvard University; Simone Mori, Enel; Raffaele Mauro Petriccione, Director General of DG Climate Action in the European Commission; Robert Stavins, Harvard University; Zhang Xiliang, Tsinghua University; government representatives to be invited.

Realizing the Potential of Article 6

Wednesday, 11 December 2019; 12:30pm – 2:00pm; Location:  Pavilion of the International Emissions Trading Association (IETA)

Panelists will discuss the potential of Article 6 to decrease mitigation costs and incentivize increased ambition. They will review the status of the negotiations on the Article 6 rulebook, including issues remaining to be resolved at that point in the COP – including potentially, ongoing discussion about double counting (environmental integrity) and the Article 6 – Article 13 interface (applications of the enhanced transparency framework to Article 6 transfers).

Panelists: Joseph Aldy, Harvard Kennedy School; Kay Harrison, Ministry of Foreign Affairs and Trade, New Zealand; Kelley Kizzier, Environmental Defense Fund; Andrei Marcu, European Roundtable on Climate and Sustainable Transition; Robert Stavins, Harvard Kennedy School

The Path Ahead

After COP-25, I will post an essay at this blog assessing the progress (or lack thereof) made in Madrid – on Article 6, as well as other elements and issues.

In the meantime, if you will be at COP-25, and would like to meet with the Harvard Project on Climate Agreements, please contact Jason Chapman (jason_chapman@hks.harvard.edu).

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A Key Moment for California Climate Policy

The past year has been a crucial time in international climate negotiations.  In December, 2015, in Paris, negotiators established an agreement on the next round of targets and actions to succeed the Kyoto Protocol, which was signed in 1997 and will effectively close down in 2020.  In Paris, negotiators set up a new and meaningful agreement for multinational action through individual country “Intended Nationally Determined Contributions” (INDCs).  The Paris round was crucial, because it expanded the coalition of contributions from countries responsible for 14% of global emissions under Kyoto (Europe and New Zealand) to 187 countries responsible for 96% of emissions under the Paris Agreement.

California’s Role in Global Climate Change Policy

California sent a delegation to the Paris talks. While not officially a party to the negotiations, California government officials attended to show support for broad and meaningful action.  For many years, spurring action beyond California’s borders has been the key rationale for developing a California-based climate policy.  This began with Assembly Bill 32 (AB 32), the Global Warming Solutions Act of 2006.  Initially, the focus was on encouraging action within the United States, including federal legislation, state-level actions, and multi-state compacts, but subsequent domestic action turned out to be much less than originally anticipated. As a result, California’s focus shifted to the international domain.

This is a good time to consider how the State can best demonstrate leadership on this global stage.  Action by all key countries, including the large emerging economies – China, India, Brazil, Korea, and South Africa – will be necessary to meaningfully address the climate problem.  Significant multinational contributions will be necessary to avoid having California’s aggressive in-state actions be for naught.  Absent such multilateral action, ambitious California policies do little or nothing to address the real problem.

But California can play a very important role by showing leadership – in two key ways.  One is to demonstrate a commitment to meaningful reductions in (greenhouse gas) GHG emissions.  In this regard, California has more than met the bar, with policies that are as aggressive as – if not more aggressive than – those of most countries.

The other way is to show leadership regarding how reductions of GHG emissions can best be accomplished – that is, in regard to progressive policy design.  California has a sophisticated GHG cap-and-trade system in place, which while not perfect, has many excellent design elements.  Countries around the world are now planning or implementing cap-and-trade systems, including in Europe, China, and Korea.  These countries are carefully watching decisions made in California, with particular attention to the design and implementation of its cap-and-trade system.  California’s system, possibly with a few improvements, could eventually be a model for even larger systems in other countries.

Can California Provide a Good Model of Progressive Policy?

Unfortunately, California’s climate policy has not relied heavily on its cap-and-trade system to achieve state targets.  Furthermore, rather than increasing reliance on this innovative market-based climate policy over time, recent proposals have doubled-down on the use of less efficient conventional policies to achieve GHG reductions. While some of these so-called “complementary policies” can be valuable under particular circumstances, they can also create severe problems.

One example of this is the attempt to employ aggressive sector-based targets through technology-driven policies, such as the Low Carbon Fuels Standard (LCFS).  In the presence of a binding cap-and-trade regime, the LCFS has the perverse effect of relocating carbon dioxide (CO2) emissions to other sectors but not reducing net emissions, while driving up statewide abatement costs, and suppressing allowance prices in the cap-and-trade market, thereby reducing incentives for technological change.  That is bad news all around.  These perverse outcomes render such policies of little interest or value to other regions of the world.

The magnitude of the economic distortion is illustrated by the fact that allowances in the California cap-and-trade market have recently been trading in the range of $12 to $13 per ton of CO2, while LCFS credits have traded this summer for about $80 per ton of CO2.

While reduction in transportation sector GHG emissions is clearly an important long-run objective of an effective climate policy, if the approach taken to achieving such reductions is unnecessarily costly, it will be of little use to most of the world, which has much less financial wealth than California and the United States, and will therefore be much less inclined to follow the lead on such costly policies.

The Path Ahead

With China now the largest emitter in the world, and India and other large developing countries not very far behind, California policies that achieve emission reductions through excessively costly means will fail to encourage other countries to follow, or even recognize, California’s leadership.  On the other hand, by increasing reliance on its progressive market-based system, California can succeed at home and be influential around the world.

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