Can New Market Mechanisms Mobilize Emissions Reductions from the Private Sector?

Note

This Discussion Paper is the first in an annual series supported by the Enel Foundation addressing important topics in international climate policy, especially those pertaining to market-based approaches to climate change.

ABSTRACT

Negotiators, business leaders, and others concerned with climate change are attempting to develop market mechanisms that expand and improve upon those provided by the Kyoto Protocol. These "new market mechanisms" might be incorporated into a new international arrangement called for in December 2011 at COP-17 in Durban, South Africa. Dr. Michaelowa explores the paths forward in the first Harvard-Project discussion paper in an annual series supported by the Enel Foundation. The paper will serve as one basis for discussion at a side event at COP-18 in Doha, Qatar, co-hosted by the Harvard Project, the Enel Foundation, and the International Emissions Trading Association. See details on the side event here.

EXECUTIVE SUMMARY

In the international climate negotiations, new market mechanisms (NMM) have been proposed that would generate greenhouse-gas credits for entire sectors or for specific mitigation policies. The proponents of NMM have widely differing aims. Some want to upscale market mechanisms beyond distinct projects, [among other things] through a reduction of transaction costs and simplification of additionality determination. Others want to achieve a contribution of market mechanisms to global emissions reduction. However, NMM face a number of challenges. Under a sectoral mechanism with a no-lose target, emitters reducing emissions cannot be sure that their efforts will not be invalidated by other emitters who increase their emissions above the baseline level. Setting baselines for sectoral emissions and policy implementation is notoriously difficult, especially if having to be negotiated politically. Competition with existing mechanisms is likely to be fierce.

Incentives for emitters can be retained if governments are willing to "bail out" the entities that can be shown to have generated emissions reductions. This, however, leads to an unpredictable burden for government. A sectoral-trading scheme with binding commitments for emitters would solve the problem but could be seen as first step towards national-level emissions commitments. Alternatively, a tax could be levied on emissions increases of entities beyond their baseline whose proceeds are used to acquire emissions credits. Another option would be collection of financial deposits for each ton of greenhouse-gas emissions that are refunded if the emissions of the entity remain below the baseline.

Given the problems in achieving an incentive-compatible design of NMM, the current project-based mechanisms should be retained for sectors with large emitters or replaced by sectoral trading. Sectoral crediting would be appropriate for sectors with widely-dispersed emitters, such as transportation, where government policies provide better incentives than project-based mechanisms. Policy-based crediting could be used for households, waste, and parts of the power sector.

Axel Michaelowa, University of Zurich