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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.

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 Paris – included 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.

Misleading Talk about Decoupling CO2 Emissions and Economic Growth

You can call it my pet peeve or even my obsession, but whenever I read about the claimed “decoupling” of CO₂ emissions and economic growth, I get annoyed. Webster’s Dictionary defines decoupling as “eliminating the interrelationship” between two processes. But the interrelationship between CO₂ emissions and economic growth has certainly not been eliminated.

Decoupling is the wrong word and metaphor to describe what has been happening. When a caboose is decoupled from a train, it stops moving altogether. A better metaphor, although less linguistically appealing, would be a “slipping clutch.” The engine continues to transmit power, and as a result the driveshaft continues to rotate, but with less velocity than when the clutch was new.

What Has Been Happening

True enough, the carbon intensities of many economies in the world, particularly those of the industrialized nations, have – for many years – been falling, as those economies have become less energy intensive (less energy use per unit of economic activity – Gross Domestic Product or GDP), and therefore less carbon intensive. For each dollar of economic activity, CO₂ emissions are less than they used to be. For each unit of economic growth, there is less growth in CO₂ emissions than previously.

Furthermore, in some cases, as economies grow, CO₂ emissions can actually fall. First, picture an economy which is growing exclusively in its services sector. In this case, economic growth might be accompanied by no change in CO₂ emissions. Now picture an economy which is growing in its services sector, while shrinking in its manufacturing sector (sound familiar?). In this case, economic growth might be accompanied by reduced CO₂ emissions. Now add to this picture the presence of some public policies, such as those that cause the closure of coal-fired electric generation plants, as well as greater dispatch of electricity from natural gas-fired plants. The result: economic growth continues, with falling CO₂ emissions. But there has been no decoupling.

Confusion Due to Failure to Employ Appropriate Counterfactual

The problem and the confusion arises from a very common mistake in the popular press and, for that matter, in many casual conversations: failure to use the right counterfactual for analysis. The fact that GDP is rising while emissions are falling does not mean that GDP is not affecting emissions. The appropriate counterfactual for comparison is how much would emissions have fallen had there been no growth in GDP. Presumably, emissions would have fallen even more. The excess of emissions in the factual case, compared with the counterfactual case, is the magnitude of emissions growth due to (actually, “associated with”) economic growth. There has been no elimination of the relationship between the two, although the nature and the magnitude of that relationship has changed.

What Factors Affect CO₂ Emissions?

So, why have CO₂ emissions been declining in some countries? Or, more broadly and more to the point, what factors have affected CO₂ emissions? Four stand out (although there are others).

First, energy comes at a cost in all economies, and so economic incentives exist to economize on energy use through technological change. The energy-intensity of the U.S. economy has gradually fallen – almost monotonically – since early in the twentieth century.

Second, putting aside energy-intensity and focusing on carbon intensity, some technological change has worked against the use of carbon-intensive sources of energy. The most dramatic example, specific to the United States, has been the combination of horizontal drilling and hydraulic fracturing (fracking), which has caused a significant increase in supply and dramatic fall in the market price of natural gas, which has thereby led to a massive shift of investment and electricity dispatch from coal to natural gas.

Third, in the richer countries of the world, including this one, the process of economic growth has led to changing sectoral composition: heavy industry to light manufacturing to services. The deindustrialization of California is a graphic example. Does the fact that California’s economy has grown while emissions have fallen mean that decoupling has occurred? Of course not. And, in the California case, there has also been a fourth factor …

Fourth, public policies have in some jurisdictions of the world (Europe, the United States, and most of the other OECD countries) discouraged carbon intensity. In the USA, this has happened both through climate policies and other, non-climate policies. Some non-climate policies, such as EPA’s Mercury Rule, discourage investment, encourage retirement, and discourage dispatch of coal-fired electricity, while other non-climate policies, such as CAFE standards for motor vehicles, bring about greater fuel efficiency of the fleet of cars and trucks over time. Climate-specific policies have also mattered, such as in California, where the Global Warming Solutions Act of 2006 (AB-32) has brought down emissions through a portfolio of policies, including an economy-wide CO₂ cap-and-trade system.

The Bottom Line

So, yes, the carbon intensity of many economies continues to fall – for a variety of reasons, including but by no means limited to public policies. And, in some cases, the combination of energy price changes, technological change, changes in sectoral composition, and climate and other public policies has meant that emissions have fallen in years when economic growth has continued. But don’t be fooled. Economic growth does affect CO₂ emissions. There has been no decoupling; just some (desirable) slipping of the clutch.

Of course, this is not an anti-environment message. On the contrary, a belief in decoupling per se could lead to a misguided laissez-faire attitude about the path of CO₂ emissions. Being honest and accurate about the links between (desirable) economic growth and (desirable) CO₂ emissions reductions puts our focus and emphasis where it ought to be: finding better ways to have both.