New York Business Roundtable: Key Takeaways

With the U.S. Congress currently debating whether and how to establish a domestic cap-and-trade system to address climate change, the outcome of those discussions is critical to global climate negotiations in Copenhagen and beyond, according to a roundtable discussion on post-Kyoto climate policy hosted by Barclays Capital, with insights from the Harvard Project on International Climate Agreements.

The business roundtable in New York, which included participants from a range of industries and key government officials, looked at the implications of U.S. domestic climate policy for the international process, the current state of the Waxman-Markey bill in the U.S. Congress, and the future of national and global carbon markets. Climate negotiators are gearing up for the 15^th Conference of the Parties in Copenhagen, at which a successor to the Kyoto Protocol will be negotiated.

Speakers at the April 30, 2009, roundtable included:

Theodore Roosevelt IV, Managing Director, Barclays Capital
Robert N. Stavins, Director, Harvard Project on International Climate Agreements
Manik Roy, Vice President of Federal Government Outreach, Pew Center on Global Climate Change
Nancy Kontou, Head of Cabinet, Cabinet of Mr. Stavros Dimas, European Commissioner for Environment
Paula Dobriansky, Senior Fellow at Harvard Kennedy School's Belfer Center; former Under Secretary of State for Democracy and Global Affairs (2001–2009)
Frank E. Loy, former Under Secretary of State for Global Affairs (1998–2001)
Meg McDonald, Director, Global Issues, Alcoa

Below is a summary of key insights from each of the sessions. In keeping with the ground rules of the roundtable, the comments are not attributed to specific individuals. The comments made during the sessions reflect the opinions of the commenter only; the opening speakers at each of the sessions, the Harvard Project on International Climate Agreements, and Barclays Capital do not necessarily agree with the comments made within a given session. The account below is intended to summarize the discussion and is not a formal set of recommendations from the Harvard Project.

Carbon Markets After 2012: Challenges and Opportunities

Summary of Key Discussion Points:

Carbon markets could be incorporated into an international climate agreement through: (1) International emissions trading or (2) Linking of domestic cap-and-trade systems through a decentralized, bottom-up system to succeed the Kyoto Protocol.
Under international emissions trading, countries would be allocated permits for net emissions. This allocation could reflect historic emissions, income, population, etc. A large allocation to developing countries could induce participation. But trading among states may be problematic—unlike firms, states are not simple cost-minimizers. So countries could devolve tradable permits to firms, with trading within and across borders. The market could link with the Clean Development Mechanism (CDM), an arrangement under the Kyoto Protocol that allows developed countries to invest in emissions-reduction projects in developing countries.
Alternatively, an international policy architecture could evolve from the bottom up through linkage of national/regional cap-and-trade programs.

One problem with linking cap-and-trade systems directly is that cost-containment mechanisms automatically propagate from one system to the next; e.g., if the United States has a "safety valve" (price ceiling) in its cap-and-trade system and links with Europe's cap-and-trade system, then Europe would automatically get the U.S. safety valve.

But this problem is largely avoided if both countries link indirectly though the CDM.

The future international climate agreement could facilitate such linkage.

Europe would like to see a wider carbon market—in particular, the European Union is hoping to see an OECD-wide carbon market by 2015.
To link, the systems would not need to be identical—but they would need to be compatible. Some consider the cap to be particularly important because it defines the level of ambition.
The idea of offsetting domestic emissions by purchasing offsets in other countries is sound: It is one of the most cost-effective ways to achieve emissions reductions. But in practice, the CDM has many problems. Nevertheless, due to its advantages in getting resources to developing countries, and the difficulty in building new institutions, some argued that it may make sense to reform it, rather than scrap it. Others advocated eliminating it.

The U.S. decision on this issue is considered particularly important. The standard that the United States sets for recognition and management of offsets will become the global standard.

Possible reforms of the CDM could expand coverage of carbon pricing. A policy-oriented CDM could generate credits based on the impacts of specific policies. A sectoral-based CDM could allow for an entire sector to generate credits.

One way a sectoral CDM could work: Developing countries could agree to set a benchmark for emissions reductions. If they reduce emissions beyond the benchmark, they could earn credits. This could be done by sector to reduce emissions leakage. It also may be a way of moving from the current CDM (based on projects), to a sectoral CDM, to a full cap-and-trade system in developing countries.

After implementing a cap-and-trade system, we may see a future tug-of-war about the price of the allowances. Industry may be concerned that that allowance price is too high, while environmental advocacy groups and policymakers will want the price to be high enough to have desired effects.
In establishing a cap-and-trade system, Europe has seen considerable fluctuation in the price of allowances. This has been interpreted by some as proof that the system is not working well. Actually, the decrease in allowance prices when demand declines—such as during the global recession—is proof that the system is working as intended.

Investment decisions are long term. What is most important is not where the carbon price is today, but where the carbon price is likely to be in the future—especially whether authorities signal that they will continue to put a price on carbon.

Implications of U.S. Domestic Climate Policy for the International Process

Briefing on the Obama Administration's Climate Policy

Summary of Key Discussion Points:

Cap-and-trade systems offer several advantages, which is why most attention in the United States has been focused on it. Advantages include: Proven cost-effectiveness in achieving meaningful emissions reductions, an easy means of compensating for the inevitably unequal burdens imposed by climate policy, the system's effectiveness is unlikely to be degraded by political forces, a history of successful adoption and implementation, and that it provides a straightforward means to link with other counties' climate policies.
President Barack Obama is making a cap on greenhouse gases a priority. He already has taken actions to support this, including proposing revenue from a cap-and-trade program in the budget. President Obama argues that investment in clean technology will help the United States grow out of the economic downturn, and that a cap-and-trade system is essential for driving that investment.
Though the U.S. Congress is discussing a domestic cap-and-trade bill this year, we are not likely to see the bill passed until 2010. A floor vote in the U.S. House of Representatives, however, could come in the summer of 2009.
In the U.S. House of Representatives, winning moderate Democratic votes, especially from districts that rely heavily on coal and oil, will be critical to passing a bill. This is in addition to holding liberal Democratic votes.
The Waxman-Markey draft reflects this effort to get a balanced bill.

It covers 85 percent of U.S. greenhouse gas emissions through a cap-and-trade system.

It includes international offsets.

The Federal Energy Regulatory Commission will regulate the cash market in allowances and offsets; the President delegates regulation of the derivatives market.

Greenhouse gases are not regulated as criteria pollutants or hazardous air pollutants under the Clean Air Act.

State cap-and-trade programs are put on hold for five years.

In the U.S. Senate, it is critical to get bipartisan support, as 60 votes will be needed to pass a U.S. domestic bill, and 67 votes will be needed to approve an international treaty.

On Competitiveness:

Although research has shown that international competitiveness is not a major economy-wide economic issue, it is a real issue for some energy-intensive manufacturing sectors, particularly those subject to international competition. More importantly, it is a very high-profile political issue.
Free allocation of allowances makes companies happy but does not affect leakage or competitiveness (apart from liquidity effects). However, if free allocation is tied to production (as in the Waxman-Markey "home rebate"), it can reduce leakage. However, this creates perverse incentives—it is a subsidy to production, so it works against cost-effectively reducing U.S. emissions.
Other policy options to address competitiveness:

Import allowance requirement—requiring that imports of a small number of highly energy-intensive goods (iron and steel, aluminum, cement, bulk glass, paper, fossil fuels) must hold allowances if not coming from a country that has a cap-and-trade system or other price on carbon. This is an implicit border tax. In principle, this can level the playing field. However, it may not be WTO-compliant, and it would have no effect on leveling the playing field for U.S. exports.

Border rebate for exports to level the playing field. Though this would subsidize exports, it would not address imports.

Border import adjustment (tax) plus border export subsidy. This raises questions about consistency with trade law, and about feasibility.

On competitiveness, the bottom line is that all options raise domestic output and thus raise domestic emissions; all options reduce foreign output and thus reduce foreign emissions. Net global emissions impacts are ambiguous, though the effects can be significant in some energy-intensive and trade-sensitive sectors. It would also be very challenging to calculate embodied emissions for foreign products and defining and enforcing reliable rules of origin.
Best way to address competitiveness is to expand the set of countries taking on meaningful commitments under an international climate agreement or other mechanism(s).

On Implications for the International Negotiations:

The international agreement hinges on the shape of U.S. legislation; until we know what the U.S. domestic climate policy looks like, we will not have an international agreement.
The best possible outcome in Copenhagen may be an intermediary agreement on the principles for an architecture of the post-2012 framework with agreements on:

Developed countries: target range

Developing countries: mitigation action types

Developed countries: support for developing country actions

The specific commitments would be agreed in 2010 or 2011.

It is very important for other countries to take U.S. domestic law—and the U.S. political system—into account: they need to understand that President Obama must work within both of these. The U.S. president is unlikely to be able to go further than whatever is in the U.S. domestic cap-and-trade law.
International negotiators may want to consider moving to a 2005 baseline, rather than 1990.
One way to bridge international divides would be to reflect the actions that countries have already undertaken in the agreement text—to give credit for the contributions that they are making.