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Linking Heterogeneous Climate Policies (and Activities at COP-23 in Bonn)

It’s well known that the Paris Agreement has achieved broad participation by countries accounting for some 97% of global GHG emissions (in contrast to the 14% of global emissions associated with countries taking on responsibilities under the current commitment period of the Kyoto Protocol). That is a very important accomplishment, but as negotiations begin to elaborate key details of the Agreement (as they will in Bonn in November), a critical question is how to create incentives for countries to increase ambition over time. The ability to link different climate policies, such that emission reductions undertaken in one jurisdiction can be counted toward the mitigation commitments of another jurisdiction, may help Parties increase ambition over time. A new paper from the Harvard Project on Climate Agreements by Michael Mehling of MIT, Gilbert Metcalf of Tufts University, and myself explores options and challenges for facilitating such linkages in light of the considerable heterogeneity that is likely to characterize regional, national, and sub-national efforts to address climate change. The full paper is available for downloading, as is a two-page summary.

We will be presenting our results on November 13^th and 14^th in Bonn at the Twenty-Third Conference of the Parties (COP-23) of the United Nations Framework Convention on Climate Change. At the end of this blog essay, I offer some details about these and other forthcoming activities of the Harvard Project on Climate Agreements at COP-23 in Bonn.

Background

Linkage is important, in part, because it can reduce the costs of achieving a given emissions-reduction objective. Lower costs, in turn, may make it politically feasible to embrace more ambitious objectives. In a world where the marginal cost of abatement – that is, the cost to reduce an additional ton of emissions – varies widely, linkage improves overall cost-effectiveness by allowing jurisdictions with relatively higher abatement costs to finance reductions from jurisdictions with relatively lower costs. In effect, linkage drives participating jurisdictions toward a common cost of carbon, equalizing the marginal cost of abatement and producing a more efficient distribution of abatement activities. These benefits are potentially significant: The World Bank has estimated that international linkage could reduce the cost of achieving the emissions reductions specified in the initial set of NDCs submitted under the Paris Agreement 32% by 2030 and 54% by 2050.

Article 6 of the Paris Agreement provides a foundation for linkage by recognizing that Parties to the Agreement may “choose to pursue voluntary cooperation in the implementation of their” NDCs through “the use of internationally transferred mitigation outcomes” (ITMOs). In contrast to the Kyoto Protocol (which likewise included provisions for international cooperation), the voluntary and flexible architecture of the Paris Agreement allows for wide variation, not only in the types of climate policies countries choose to implement, but in the form and stringency of the abatement targets they adopt.

Heterogeneous Linkage

Linkage is relatively straightforward when the policies involved are similar. However, linkage is possible even when this is not the case: for example, when one jurisdiction is using a cap-and-trade system to reduce emissions while another jurisdiction is relying on carbon taxes. There are several potential sources of heterogeneity: type of policy instrument used (for example, taxes vs. cap-and-trade vs. performance or technology standard); level of government jurisdiction involved (for example, regional, national, or sub-national); status under the Paris Agreement (that is, whether or not the jurisdiction is a Party to the Agreement – or within a Party); nature of the policy target (for examle, absolute mass-based emissions vs. emissions intensity vs. change relative to business-as-usual); and operational details of the country’s NDC, including type of mitigation target, choice of target and reference years, and sectors and greenhouse gases covered.

Analyzing Potential Linkages (Consistent with the Paris Agreement)

The full paper examines five specific cases of linkage, with various combinations of features, to identify which types of linkage are feasible, which are most promising, and what accounting mechanisms are needed to make their operation consistent with the Paris Agreement. Each of the cases maps to a real-world example.

Most forms of heterogeneity – including with respect to policy instruments, jurisdictions, and targets – do not present insurmountable obstacles to linkage. However, some of these characteristics present challenges and call for specific accounting guidance if linkage is to include the use of ITMOs under the Paris Agreement. In particular, robust accounting methods will be needed to prevent double-counting of GHG reductions, to ensure that the timing (vintage) of claimed reductions and of respective ITMO transfers is correctly accounted for, and to ensure that participating countries make appropriate adjustments for emissions or reductions covered by their NDCs when using ITMOs. Additional issues under Article 6 include how to quantify ITMOs and how to account for heterogeneous base years, as well as different vintages of targets and outcomes.

Issues for the Climate Negotiators

Broader questions that bear on the opportunities for linkage under Article 6.2 include the nature of NDC targets and whether these are to be treated as strict numerical targets that need to be precisely achieved; the nature and scope of ITMOs, which have yet to be defined, let alone fully described, under the Paris Agreement; and finally, whether transfers to or from non-Parties to the Agreement (or sub-national jurisdictions within non-Parties) are possible, and if so, how they should be accounted for. Parties have differing views, however, on whether the guidance on Article 6.2 should extend to such issues.

Clear and consistent guidance for accounting of emissions transfers under Article 6 can contribute to greater certainty and predictability for Parties engaged in voluntary cooperation, thereby facilitating expanded use of linkage. At the same time, too much guidance, particularly if it includes restrictive quality or ambition requirements, might impede linkage and dampen incentives for cooperation. Given their limited mandate, Parties should exercise caution when developing guidance under Article 6.2 that goes beyond key accounting issues. This does not mean that concerns about ambition and environmental integrity should be neglected. However, if the combination of a set of common accounting rules and an absence of restrictive criteria and conditions can accelerate linkage and allow for broader and deeper policy cooperation, it can also increase the potential for Parties to scale up the ambition of their NDCs. And that may ultimately foster stronger engagement between Parties (and non-Parties), as well as with regional and sub-national jurisdictions.

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The Harvard Project on Climate Agreements at COP-23 in Bonn

We will conduct three panel events at the Twenty-Third Conference of the Parties (COP-23) of the United Nations Framework Convention on Climate Change (UNFCCC) in Bonn, Germany, during the week of November 13, 2017. If you have credentials to access the secure area of the COP, you are most welcome to attend any or all of these. Also, COP-23 attendees who wish to meet with the Harvard Project during the conference should email: Jason Chapman (Jason_Chapman@hks.harvard.edu).

Events in Brief:

Heterogeneous Linkage and the Evolution of Article 6
Monday, November 13
12:00 – 1:30 pm
Pavilion of the International Emissions Trading Association (IETA)

Implementing and Linking Carbon Pricing Instruments: Theory and Practice
Tuesday, November 14, 2017
11:30 am – 1:00 pm
Side Event Meeting Room 12

Carbon Pricing Policy Design
Tuesday, November 14, 2017
2:00 – 3:30 pm
Pavilion of the International Emissions Trading Association (IETA)

Events in Detail:

Heterogeneous Linkage and the Evolution of Article 6, Monday, November 13, 12:00 – 1:30 pm, Pavilion of the International Emissions Trading Association (IETA)

Participants:

Jos Delbeke, Director General for Climate Action, European Commission

Kelley Kizzier, Co-Chair, Article 6, Subsidiary Body for Scientific and Technological Advice

Michael Mehling, Deputy Director, Center for Energy and Environmental Policy Research
Massachusetts Institute of Technology

Gilbert Metcalf, Professor of Economics, Tufts University

Robert Stavins, A. J. Meyer Professor of Energy and Economic Development, Harvard Kennedy School

Abstract:

Implementing and Linking Carbon Pricing Instruments: Theory and Practice, Tuesday, November 14, 2017, 11:30 am – 1:00 pm, Side Event Meeting Room 12, Co-Hosts: Harvard Project on Climate Agreements and Enel Foundation

Participants:

Andrei Marcu, Senior Fellow, International Centre for Trade and Sustainable Development

Michael Mehling, Deputy Director, Center for Energy and Environmental Policy Research, Massachusetts Institute of Technology

Gilbert Metcalf, Professor of Economics, Tufts University

Simone Mori, Head of European Affairs, Enel

Robert Stavins, A. J. Meyer Professor of Energy and Economic Development, Harvard Kennedy School

Other participant(s) to be determined

Abstract:

The Paris Agreement has achieved one of two key necessary conditions for ultimate success — a broad base of participation among the countries of the world. But another key necessary condition has yet to be achieved — adequate collective ambition of the individual nationally determined contributions. This panel will consider how this issue might be addressed by international linkage of regional, national, and sub-national policies — that is, formal recognition of emission reductions undertaken in another jurisdiction for the purpose of meeting a Party’s own mitigation objectives. A central challenge is how to facilitate such linkage in the context of the very great heterogeneity that characterizes Nationally Determined Contributions along several dimensions. We consider such heterogeneity among policies, and identify which linkages of various combinations of characteristics are feasible; of these, which are most promising; and what accounting mechanisms would make the operation of respective linkages consistent with the Paris Agreement. The panel will draw in part on a paper by Michael Mehling, Gilbert Metcalf, and Robert Stavins, “Linking Heterogeneous Climate Policies (Consistent with the Paris Agreement),” available here

Carbon Pricing Policy Design, Tuesday, November 14, 2017, 2:00 – 3:30 pm, Pavilion of the International Emissions Trading Association (IETA), Co-Hosts: Harvard Project on Climate Agreements and Enel Foundation

Participants:

Daniele Agostini, Head of Low Carbon Policies and Carbon Regulation, Enel

Joseph Aldy [via videoconference], Associate Professor of Public Policy, Harvard Kennedy School

Gilbert Metcalf, Professor of Economics, Tufts University

Robert Stavins, A. J. Meyer Professor of Energy and Economic Development, Harvard Kennedy School

Other participant(s) to be determined

Abstract:

This panel will review experiences with cap-and-trade and carbon-tax policies, and draw lessons from those experiences. Panelists will also examine the choice between — and design of — such policies, through a political-economy lens, in order to highlight important public policy principles and policy options in carbon-pricing-policy design. The panel will draw in part on a paper by Joseph Aldy, “The Political Economy of Carbon Pricing Policy Design,” available here.

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.

The Promise and Problems of Pricing Carbon

Friday, October 21^st was a significant day for climate change policy worldwide and for the use of market-based approaches to environmental protection, but it went largely unnoticed across the country and around the world, outside, that is, of the State of California. On that day, the California Air Resources Board voted unanimously to adopt formally the nation’s most comprehensive cap-and-trade system, intended to provide financial incentives to firms to reduce the state’s greenhouse gas (GHG) emissions, notably carbon dioxide (CO₂) emissions, to their 1990 level by the year 2020, as part of the implementation of California’s Assembly Bill 32, the Global Warming Solutions Act of 2006. Compliance will begin in 2013, eventually covering 85% of the state’s emissions.

This policy for the world’s eighth-largest economy is more ambitious than the much heralded (and much derided) Federal policy proposal – H.R. 2454, the Waxman-Markey bill – that was passed by the U.S. House of Representatives in June of 2009, and then died in the U.S. Senate the following year. With a likely multi-year hiatus on significant climate policy action in Washington now in place, California’s system – which will probably link with similar cap-and-trade systems being developed in Ontario, Quebec, and possibly British Columbia – will itself become the focal point of what may evolve to be the “North American Climate Initiative.”

The Time is Ripe for Reflection

California’s formal adoption of its CO₂ cap-and-trade system is an important milestone on the multinational path to carbon pricing policies, and signals that the time is ripe to reflect on the promise and problems of pricing carbon, which is the title of a new paper that Joe Aldy and I have written for a special issue of the Journal of Environment and Development edited by Thomas Sterner and Maria Damon on “Experience with Environmental Taxation” (“The Promise and Problems of Pricing Carbon: Theory and Experience,” October 27, 2011). [For anyone who is not familiar with my co-author, let me state for the record that Joseph Aldy is an Assistant Professor of Public Policy at the Harvard Kennedy School, having come to Cambridge, Massachusetts, from Washington, D.C., where he served, most recently, during 2009 and 2010, as Special Assistant to the President for Energy and Environment. Before that, he was a Fellow at Resources for the Future, the Washington think tank.]

Why Price Carbon?

In a modern economy, nearly all aspects of economic activity affect greenhouse gas – in particular, CO₂ – emissions. Hence, for a climate change policy to be effective, it must affect decisions regarding these diverse activities. This can be done in one of three ways: mandating that businesses and individuals change their behavior; subsidizing businesses and individuals; or pricing the greenhouse gas externality.

As economists and virtually all other policy analysts now recognize, by internalizing the externalities associated with CO₂ emissions, carbon pricing can promote cost-effective abatement, deliver powerful innovation incentives, and – for that matter – ameliorate rather than exacerbate government fiscal problems. [See the concise and compelling argument made by Yale Professor William Nordhaus in his essay, “Energy: Friend or Enemy?” in The New York Review of Books, October 27, 2011.]

By pricing CO₂ emissions (or, more likely, by pricing the carbon content of the three fossil fuels – coal, petroleum, and natural gas), governments wisely defer to private firms and individuals to find and exploit the lowest cost ways to reduce emissions and invest in the development of new technologies, processes, and ideas that could further mitigate emissions.

Can Market-Based Instruments Really Work?

Market-based instruments have been used with considerable success in other environmental domains, as well as for pricing CO₂ emissions. The U.S. sulfur dioxide (SO₂) cap-and-trade program cut U.S. power plant SO₂ emissions more than 50 percent after 1990, and resulted in compliance costs one half of what they would have been under conventional regulatory mandates.

The success of the SO₂ allowance trading program motivated the design and implementation of the European Union’s Emission Trading Scheme (EU ETS), the world’s largest cap-and-trade program, focused on cutting CO₂ emissions from power plants and large manufacturing facilities throughout Europe. The U.S. lead phase-down of gasoline in the 1980s, by reducing the lead content per gallon of fuel, served as an early, effective example of a tradable performance standard. These and other positive experiences provide motivation for considering market-based instruments as potential approaches to mitigating GHG emissions.

What Policy Instruments Can be Used for Carbon Pricing?

In our paper, Joe Aldy and I critically examine the five generic policy instruments that could conceivably be employed by regional, national, or even sub-national governments for carbon pricing: carbon taxes, cap-and-trade, emission reduction credits, clean energy standards, and fossil fuel subsidy reduction. Having written about these approaches many times in previous essays at this blog, today I will simply direct the reader to those previous posts or, better yet, to the paper we’ve written for the Journal of Environment and Development.

Although it is natural to think and talk about carbon pricing using the future tense, a few carbon pricing regimes are already in place.

Regional, National, and Sub-National Experiences with Carbon Pricing

Explicit carbon pricing policy regimes currently in place include the European Union’s Emissions Trading Scheme (EU ETS); the Regional Greenhouse Gas Initiative in the northeast United States; New Zealand’s cap-and-trade system; the Kyoto Protocol’s Clean Development Mechanism; a number of northern European carbon tax policies; British Columbia’s carbon tax; and Alberta’s tradable carbon performance standard (similar to a clean energy standard). We describe and assess all of these in our paper.

Also, the Japanese Voluntary Emissions Trading System has operated since 2006 (Japan is considering a compulsory emissions trading system), and Norway operated its own emissions trading system for several years before joining the EU ETS in 2008. Legislation to establish cap-and-trade systems is under debate in Australia (combined with a carbon tax for an initial three-year period) and in the Canadian provinces of Ontario and Quebec. And, of course, California is now committed to launching its own GHG cap-and-trade system.

International Coordination Will Be Needed

Of course, climate change is truly a global commons problem: the location of greenhouse gas emissions has no effect on the global distribution of damages. Hence, free-riding problems plague unilateral and multilateral approaches, because mitigation costs are likely to exceed direct benefits for virtually all countries. Cost-effective international policies – insuring that countries get the most environmental benefit out of their mitigation investments – will help promote participation in an international climate policy regime.

In principle, internationally-employed market-based instruments can achieve overall cost effectiveness. Three basic routes stand out. First, countries could agree to apply the same tax on carbon (harmonized domestic taxes) or adopt a uniform international tax. Second, the international policy community could establish a system of international tradable permits, – effectively a nation-state level cap-and-trade program. In its simplest form, this represents the Kyoto Protocol’s Annex B emission targets and the Article 17 trading mechanism. Third and most likely, a more decentralized system of internationally-linked domestic cap-and-trade programs could ensure internationally cost-effective emission mitigation. We examine the merits and the problems associated with each of these means of international coordination in the paper.

What Lies in the Future?

In reality, political responses in most countries to proposals for market-based approaches to climate policy have been and will continue to be largely a function of issues and factors that transcend the scope of environmental and climate policy. Because a truly meaningful climate policy – whether market-based or conventional in design – will have significant impacts on economic activity in a wide variety of sectors and in every region of a country, proposals for these policies inevitably bring forth significant opposition, particularly during difficult economic times.

In the United States, political polarization – which began some four decades ago, and accelerated during the economic downturn – has decimated what had long been the key political constituency in the Congress for environmental action, namely, the middle, including both moderate Republicans and moderate Democrats. Whereas Congressional debates about environmental and energy policy had long featured regional politics, they are now fully and simply partisan. In this political maelstrom, the failure of cap-and-trade climate policy in the U.S. Senate in 2010 was essentially collateral damage in a much larger political war.

It is possible that better economic times will reduce the pace – if not the direction – of political polarization. It is also possible that the ongoing challenge of large budgetary deficits in many countries will increase the political feasibility of new sources of revenue. When and if this happens, consumption taxes (as opposed to traditional taxes on income and investment) could receive heightened attention, and primary among these might be energy taxes, which can be significant climate policy instruments, depending upon their design.

That said, it is probably too soon to predict what the future will hold for the use of market-based policy instruments for climate change. Perhaps the two decades we have experienced of relatively high receptivity in the United States, Europe, and other parts of the world to cap-and-trade and offset mechanisms will turn out to be no more than a relatively brief departure from a long-term trend of reliance on conventional means of regulation. It is also possible, however, that the recent tarnishing of cap-and-trade in U.S. political dialogue will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments. It is much too soon to say.