Carbon Markets and Paris Expectations - Separating rhetoric and reality

Finnish Institute of International Affairs · 15.10.2015 09:00 - 10:30

For decades, economists have endorsed carbon pricing as a cornerstone of policy efforts to reduce greenhouse gas emissions. One approach to pricing carbon, the creation of a market for tradable emission rights, has proven more palatable to policymakers due to the flexibility it offers both in its design and during compliance. But while carbon markets have proliferated at the national and subnational level, experience with their operation has been mixed. More recently, and with a view to the ”domestic turn” in the climate negotiations, attention has shifted to the establishment of carbon market hubs, or clusters, as a way of leveraging the efficiency gains of carbon trading beyond jurisdictional boundaries. Ultimately, advocates envision a global carbon market that facilitates the optimal allocation of mitigation efforts around the world, and in doing so creates a channel for climate finance, promotes diffusion of innovative technologies, and allows greater climate ambition with available resources. The seminar discusses the on-the-ground developments in the carbon market and critically assesses the main promises and pitfalls. Furthermore, the seminar addresses the politics of the different expectations for the Paris climate meeting (COP-21) in December 2015.

Towards a Global Carbon Market?

Michael Mehling, Executive Director of the Center for Energy and Environmental Policy Research at the Massachusetts Institute of Technology (MIT), and a Visiting Professor at the University of Strathclyde Law School. Previously, he was President of the Ecologic Institute in Washington DC, an environmental think tank with partner offices in Berlin and Brussels, and held research and teaching appointments at Georgetown University and the Universities of Greifswald, Helsinki and Constance.

The Politics of Paris Expectations

Antto Vihma, Senior Research Fellow at the Finnish Institute of International Affairs, Helsinki, Finland, and a writer/editor for the Earth Negotiations Bulletin. He was recently named Adjunct Professor (docent) in Climate Policy and Law at the University of Eastern Finland. Vihma specializes in questions of legitimacy and effectiveness of international agreements, and energy issues in external relations. Vihma is also the author of several widely cited policy briefs on climate and energy issues.


Mika Aaltola, Programme Director, the Finnish Institute of International Affairs

Summary of the seminar:

Mika Aaltola, Programme Director at the Finnish Institute of International Affairs, opened the seminar by remarking that economists have for decades endorsed carbon pricing as a cornerstone of policy efforts to reduce greenhouse gas emissions.  While carbon markets have spread, the experiences derived from the introduction of these markets have been mixed. Recently attention has shifted to the establishment of carbon market clusters or hubs as a way of leveraging the efficiency gains of carbon trading beyond jurisdictional boundaries. The seminar dealt with these topics and with the expectations surrounding the forthcoming Paris climate meeting, to be held in December.

Michael Mehling, Executive Director of the Center for Energy and Environmental Policy Research at the Massachusetts Institute of Technology, begun his presentation by underlining that emissions trading has become an important, yet problematic instrument in policy-making. He compared the emissions trading to a ”headache” which now, with discussions about a global market, is being developed into a ”global headache”. Mehling started by recalling some of the political rhetoric around the issue. The Petersburg Dialogue, in which both Angela Merkel and Francoise Hollande participated, called for carbon markets and pricing on a national and regional level. International carbon markets are currently discussed not only in the context of policy-making but also in the context of the corporate world, including calls for an international framework to connect the national levels. The G7’s leader’s declaration from June 2015 also mentioned the use of carbon market based instruments. So there are appeals, both from the private and the public sectors, to expand the use of carbon markets as a tool to mitigate greenhouse gas emissions and to allow for some sort of cooperation between different carbon markets. 

The International Carbon Action Partnership (ICAP) has suggested that the models for organizing a global carbon market are not going to come about in a harmonious ”top-down” fashion, for example through an international treaty, but will instead emerge as a result of ”bottom-up” cooperation between domestic jurisdictions and potentially even subnational and local jurisdictions. Already six years ago The International Emissions Trading Association (IETA) anticipated this shift in viewing the emergence of a global carbon market from the top-down model to the bottom-up model. Mehling pointed out that even the European Commision had the ambitious vision of creating an OECD-wide carbon market by 2015. So the idea of a global carbon market is not a new one. Mehling underscored how in spite of all the talk about a global carbon market, one has not yet emerged or been formed. Mehling asked why has all this rhetoric on the global carbon market not yet become reality.

Mehling pointed out that the paradigmatic shift that has happened since the Copenhagen conference is the realization that traditional multilateralism resulting in an international treaty, which would then be ratified by a vast majority of states, is not at the moment possible to achieve. The focus, in both politics and research, has moved towards other heterogeneous forms of cooperation. One of the ramifications for this is that the top-down architecture for carbon trading set out by the Kyoto Protocol will not be an outcome of the Paris meeting. At the same time Mehling emphasized that emissions trading as a flexible economic instrument for greenhouse gas mitigation is a reality at the national and subnational level. In Asia many countries, including China, have moved forward aggressively with creating emissions-trading systems. This expansion of the emissions trading system has been taking place at national and subnational levels despite the mixed experiences of the European Union’s emissions-trading system. 

Essentially the idea of emissions trading is that you create a price for carbon and set an absolute limit, but allow for the market to determine where emissions will be reduced. In a perfect market nobody would be able to reduce emissions cheaper than others. The more participants in the market the more you can leverage this efficiency. Many developing countries with carbon intensive power generation have more potential for lover cost abatement than in more technologically advanced countries with more carbon efficient power generation. According to the economic rationale the market would in these cases allocate the effort to those regions that can reduce emissions the cheapest. Mehling pointed out that he believes this is why there is an international drive to integrate carbon markets, to leverage the efficient allocation potential of the market.  But Mehling pointed out that the political and legal realities pose challenges to the economic theory behind this reasoning.

Mehling then went on to describe what the linking of carbon markets means in practice. Linking leads to the allowance of internationally buying and selling carbon credits (for example EUA:s). One of the positive implications of this that you cannot point to another country, in this linked market, and accuse them of having lover abatement costs or lover climate and carbon constraints. This levels the playing field internationally.

There are, however, a few conditions for making linking successful. Economic theory provides us with strong arguments for the linking of markets, the argument that it leads to pure economic benefit and the politically strong argument about increasing competitiveness. But one major obstacle to linking these markets relates to compatibility, which concerns politics.  What are you ready to tolerate concerning differences between different markets?  Furthermore, the will to establish linked markets can also be constrained by so called ”contagious” features of the markets being linked.  These are features such as price caps, price ceilings and flexibility options. These features allow one market to dominate central issues, like price forming, of the other markets it is being linked with. Contagious features of markets may undermine the environmental integrity, and states may lose the sovereign control over your admissions trading system. 

Mehling continued by introducing multilateral thinking into this schema. From a theoretical point of view multilateral integration of markets shouldn’t be harder to implement than bilateral integration of markets, it just means bringing in more actors to the market. But the political reality is that it is not easy to coordinate simultaneous actions carried out by various different actors, especially if we go beyond regional organizations of regional integration. The multilateral linking of markets can generate indirect links – these are links between markets that are not linked to each directly but through some link to some other market they both share. Mehling stressed that the indirect links matter greatly. They work in a contagious fashion, transferring effects between unlinked markets although they formally are not linked. This can quickly lead to a very complex network of indirect links between different markets and actors, a network that officially is not visible but exists through the indirect links. According to Mehling, you quickly enter into a governance and administration complexity that is as hard to control as the plans for international top-down agreement on market integration. Mehling went on to ask how you can make the linking of multiple markets more efficient and feasible from a governance point of view, and presented three models for this. The first model tries to harmonize the design features of the different markets or trading systems from the outset. This has been attempted for example by the Western Climate Initiative. If all the markets being linked are similarly designed then linking these is not such a big issue, there would be no contagious features to anticipate or react to. If the markets are similar from the outset then it also would be easy to create a central governance organ to oversee the network of linked markets. 

The second model is based on the idea of carbon market clusters or ”clubs”, of which the EU is an example. Mehling said he understands the attraction these kinds of clusters exert over smaller markets, for example the EU template provides aspiring markets with a large market with liquidity, robustness and so on. The easiest way of linking with clubs has so far proven to be geographic proximity and existing economic ties. From the point of view of aiming for larger integration of the carbon market the existence of clubs can pose a problem: integration within clusters can lead to more difficulties in integrating markets across clusters. Mehling pointed out that this model presupposes that the systems being linked in the clubs or clusters are similar or compatible. 

Mehling called the third model a hub-based approach. It can be used for linking multiple markets, and does not necessarily presuppose compatibility between the markets being linked., An example of this is the ”Networked Carbon Markets” initiative. The hub-based approach involves central governing organs – ”hubs” – to which all the participating markets must link. The hubs will account for the governing of differences between the markets. In this model, Mehling explained,  the markets could be forced to link for example through standardizing rating agencies and offset systems. In this way heterogeneous markets could be linked together despite the differences existing between the markets.

Mehling concluded his presentation by investigating the role of the Paris climate meeting (COP21) in this context. Mehling noted that in a recently published informal negotiating text for the Paris meeting there are no mentions of markets, at least not in the central parts of the document. It opens the door to allow for accounting for transfers of responsibilities, which is the central thought behind these markets. In the document this is called a mechanism to support sustainable development. Despite of the documents hinting at some possibilities, Mehling underscored that we have no way of knowing whether the outcomes reached in Paris will open the door for trading across jurisdictions, which would be needed for linking markets. 

The rhetoric is there but the actual actions have so far witnessed failures and difficulties. The international negotiations are far from putting forward a blueprint and Mehling concluded by saying that we will have to wait for the Paris meeting to see if the outcome matches the rhetoric, or if global carbon markets will remain an economic fantasy.

Antto Vihma, Senior Research Fellow at the Finnish Institute of International Affairs, delivered a presentation dealing with the politics surrounding the Paris expectations. Vihma begun by pointing out that there appears to be a lot of anxiety surrounding the discussion on the Paris meeting which stems from the fact that the 2-degrees target is slipping out of reach or is achievable only by making bold assumptions about the future emission cuts. Contributing to this anxiety are also the ongoing impacts of climate change, which are beginning to show themselves. The second observation Vihma offered was that the expectations for the Pars meeting are political in a narrow sense, as different actors and stakeholders use these expectations to forward their interests. Vihma pointed out that it is very challenging to call s the Paris meeting a success or a failure, because its impacts are going to be felt for some time both at national and international levels. In addition to this the negotiations themselves are very complex, covering a vast amount of topics. For Vihma the important question was to try to identify the value added. How does the Paris meeting complement already existing international and national efforts? On the international side, Vihma underscored, that it’s important to note that how the Paris meeting is perceived will have implications for the UN negotiations themselves, for what alternatives might be available for UN-based climate governance.

Vihma compared the idea of a top-down climate agreement, which was under considerable discussion in the Copenhagen meeting, to Sleeping Beauty: a be-all end-all agreement just waiting to be actualized. But according to Vihma there is another way of perceiving a possible climate agreement, in this view it is composed bit by bit from pieces, at some point being more than the sum of the whole. In this view Paris is not the end but one piece in the ongoing climate efforts.

Moving to the analysis of the politics of the Paris expectations Vihma mentioned the importance of the interpretation of the Paris meeting for many actors such as the EU, it having a direct impact on EU policy. A similar logic is according to Vihma at work elsewhere- if the meeting is viewed as a success it will empower other actors to push for more ambitious plans. Most industrial lobbyists and most environmental NGOs are very knowledgeable about the potential outcomes of the meeting. But there are also actors voicing unrealistically or cynically high expectations for the meeting, for example expecting the meeting to establish a global carbon market or a global carbon tax. These actors know that these goals will not be met but they set the expectations so high that the outcome will show itself as a failure, which leads to loosing political momentum aimed at raising ambitions on climate issues. Noting that many progressive actors set similarly high expectations Vihma pointed out that these expectations can be seen as giving a positive impetus to the negotiations, introducing political pressure for reform. Thus similar expectations can be used by actors with different political agendas.


Vihma went on to explain how   hard it is to assess the outcome of the meeting analytically. Many attach importance to the 2-degrees target, which is an easy target to formulate and understand. However it is obvious that the current pledges on the table for the meeting will not lead to the 2-degrees target being met. Using this target as a metric for measuring the success or failure will inevitably lead to the meeting being viewed as a failure. On a general level it’s hard to estimate what kind of impacts an agreement in Paris has on the domestic politics of countries. The effects these kinds of agreements have cannot always be seen right away, the lag in perceiving the effects of these kinds of agreements makes analysis challenging. There might also be normative shifts in paradigms that these kinds of talks set in motion, seeing the effects of these shifts takes time. Vihma noted that another factor obscuring analysis of the outcomes of the meeting is the complexity of the negotiations themselves. The negotiations address mitigation, finance, adaptions, transparency of action and support, capacity building, technology issues and so forth. Each area is distinct and brings its own added value in relation to the other areas. The analysis also has to prepare for that, even though we have well analyzed and realistic expectations, the UNFCCC simply doesn’t deliver. One of the most critical questions is to provide transparency for strengthening cooperation between nations. This will require compromise on crucial issues, like the extent of differentiation among developing and developed countries. . Providing transparency is something the UNFCCC has not done very that well in the past. In addition to this the UNFCCC decision-making process could also lead to the UNFCCC not being able to deliver on the agreements. Vihma argued that reducing the number of players around the negotiation table will only enhance the efficiency of the outcome if the UNFCCC process stumbles. Otherwise smaller or more exclusive platforms cannot build enough political pressure to drive change either.



Presentation by Michael Mehling, part 1/3
Presentation by Michael Mehling, part 2/3
Presentation by Michael Mehling, part 3/3
Presentation by Antto Vihma