Market Mechanisms in the Paris Climate Agreement: International Linkage under Article 6.2

The Harvard Project on Climate Agreements hosted a research workshop in Cambridge, Massachusetts, on July 14–15, 2016, the purpose of which was to identify options for elaborating and implementing the Paris Climate Agreement, and to identify policies and institutions that might complement or supplement the United Nations Framework Convention on Climate Change (UNFCCC) process.  We were motivated by our recognition that while the Paris Agreement sets forth an innovative and potentially effective policy architecture for dealing with global climate change, a great deal remains to be done to elaborate the accord, formulate required rules and guidelines, and specify means of implementation.

Participants in the workshop – International Climate Change Policy after Parisincluded twenty-one of the world’s leading researchers focusing on climate-change policy, representing the disciplines of economics, political science, international relations, and legal scholarship. They came from Argentina, Belgium, China, Germany, India, Italy, Norway, the United Kingdom, and the United States.  (A list of workshop participants is here, biographies here, and the agenda here.)

The Harvard Project will next focus on communicating the ideas, insights, and recommendations of workshop participants to climate negotiators and policy makers, in the expectation that they might prove useful in elaborating and implementing the Paris Agreement. Each participant is preparing a brief—based largely on her or his presentation during the workshop. These briefs, together with a workshop summary, will be conveyed to participants in the Twenty-Second Conference of the Parties (COP-22) of the UNFCCC in Marrakech, Morocco in November 2016.  This will be done in meetings with negotiators representing UNFCCC member governments and in a side-event panel at COP-22.

Today I wish to share with readers just one of these draft briefs – namely, my own – on the topic of “International Linkage under Article 6.2 of the Paris Agreement.”

A Key Challenge for Sustained Success of the Paris Agreement

For sustained success of the international climate regime, a key question is whether the Paris Agreement with its Intended Nationally Determined Contributions (INDCs), anchored as they are in domestic political realities, can progressively lead to submissions with sufficient ambition?  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. By “linkage,” I mean connections among policy systems that allow for emission reduction efforts to be redistributed across systems. Such linkage is typically framed as being between two (or more) cap-and-trade systems, but national policies will surely be highly heterogeneous under the Paris climate regime.  Fortunately, research – by Gilbert Metcalf of Tufts University and David Weisbach of the University of Chicago – indicates that linkage between pairings of various types of domestic policy instruments may be feasible.

Linkage and the Paris Agreement

Experience indicates that linkage will bring both merits and concerns in most applications.  To begin with the good news, linkage offers a number of important advantages. First, it offers the possibility of achieving cost savings if marginal abatement costs are heterogeneous across jurisdictions, which they surely are. In addition, linkage can improve the functioning of individual markets by reducing market power, and by reducing price volatility, although we should recognize that price volatility will also be transmitted from one jurisdiction to another by linkage. Finally linkage can allow for the UNFCCC’s important principle of Common but Differentiated Responsibilities (CBDR), but do so without sacrificing cost-effectiveness.

The possibility of linkage also raises concerns, including that there will be distributional impacts within jurisdictions, that is, the creation of both winners and losers. Also, linkage can bring about the automatic propagation from one jurisdiction to another of some design elements, in particular, cost-containment mechanisms, such as banking, borrowing, and price collars. In this and other ways, linkage raises concerns about decreased autonomy.

Linkage under Article 6.2 of the Paris Agreement

It was by no means preordained that the Paris Agreement would allow, let alone encourage, international linkage.  Fortunately, the negotiations which took place in Paris in December, 2015, produced an Agreement that includes in its Article 6.2 the necessary building blocks for linkages to occur.

Under Article 6.2, emissions reductions occurring outside of the geographic jurisdiction of a Party to the Agreement can be counted toward achieving that Party’s Nationally Determined Contribution (NDC) via Internationally Transferred Mitigation Outcomes (ITMOs).  This enables both the formation of “clubs” or other types of coalitions, as well as bottom-up heterogeneous linkage.  Such linkage among Parties to the Agreement would provide for exchanges between compliance entities within the jurisdictions of two different Parties, not simply the government-to-government trading (of Assigned Amounts or AAUs), as was the case with the Kyoto Protocol’s Article 17.

Linkage among Heterogeneous Nationally Determined Contributions

There are three types of heterogeneity which are important in regard to linkage under Article 6.2 of the Paris Agreement. First is heterogeneity among policy instruments. As demonstrated by Metcalf and Weisbach (see above), not only can one cap-and-trade system be linked with another cap-and-trade system, but it is also possible to link a cap-and-trade system with a carbon tax system. In addition, either a cap-and-trade system or a tax system can be linked (via appropriate offsets) with a performance standard in another jurisdiction.  (Linkage with systems employing technology standards are not feasible, however, because such systems are not output-based.)

A second form of heterogeneity that affects linkage and is potentially very important under the Paris Agreement is heterogeneity regarding the level of government action of the relevant jurisdictions. Although the Paris Agreement has as Parties both regional jurisdictions (in the case of the European Union) and national jurisdictions, sub-national jurisdictions are also taking action in some parts of the world. In fact, linkage has already been established between the state of California in the United States and the provinces of Québec and Ontario in Canada.

A third form of relevant heterogeneity is with regards to the NDC targets themselves.  Some are in the form of hard (mass–based) emissions caps, while others are in the form of rate-based emissions caps, either emissions per unit of economic activity, or emissions per unit of output (such as per unit of electricity production). There are also relative mass-based emissions caps in the set of existing NDCs, such as those that are relative to business-as-usual emissions in a specific future year.  Beyond these, there are other parties that have put forward NDCs that do not involve emission caps at all, but rather targets in terms of some other metric, such as the degree of penetration of renewable energy sources.

Combinations of various options under these three forms of heterogeneity yield a considerable variety of types of potential linkages, which may be thought of as the cells of a three-dimensional matrix.  Not all of these cells, however, represent linkages which are feasible, let alone desirable.

The Path Ahead – Key Issues and Questions

There are a substantial number of issues that negotiators will eventually need to address, and likewise, there are a set of questions that researchers (including within the Harvard Project on Climate Agreements) can begin to address now. Among the key issues for negotiators will be the necessity to develop accounting procedures and mechanisms. Also, it will be important to identify means for the ITMOs to be tracked in order to avoid double-counting of emissions reductions. And a broader question is whether and how the UNFCCC Secretariat or some other designated institution will provide any oversight that may be required.

For research, three questions stand out.  First, among pairings from the (3-D matrix) set of instrument–jurisdiction–target combinations that emerge from the three types of heterogeneity identified above, which linkages will actually be feasible?  Second, within this feasible set, are some types of linkages feasible, but not desirable? And third, what accounting treatments and tracking mechanisms will be necessary for these various types of linkages?  Future research will need to focus on these and related questions in order to achieve the potential benefits of Article 6.2 of the Paris Agreement.  Please stay tuned as this work develops.