To What Extent Can International Emissions Trading Curb Climate Change?

The establishment of international markets for trading CO2 emission certificates is currently progressing at an extremely sluggish pace. This is the result, firstly, of countries that might participate in such markets having strong incentives to issue as many CO2 certificates as possible. Another reason is that governments can appoint individuals to ministerial positions – where they will be responsible for climate policy – who prioritise corporate profits over environmental protection as a means of signalling to other countries that they will have to shoulder more of the burden in terms of climate protection. The interplay of these two mechanisms results in countries pursuing less ambitious climate policies where the primary concern is palming off the majority of the responsibility for lowering CO2 emissions onto other countries. These are the findings of a study conducted by the Centre for European Economic Research (ZEW) in Mannheim.

Emissions certificates can only be traded internationally if two or more countries agree to be involved. The most attractive emissions trading markets are those that bring together countries with high abatement costs per additional tonne of CO2 and greater willingness to pay for avoided emissions with countries with low abatement costs per additional tonne and less willingness to pay. The EU and China would therefore be the perfect match – however, there is currently no emissions trading being conducted between these two markets. Apart from the European Emissions Trading Scheme, which Iceland, Liechtenstein and Norway are also part of, the only other international market for CO2 emission certificates is the one that exists between the US state of California and the Canadian province of Quebec.

Emissions trading promises efficiency gains

Overall, markets for trading emission certificates lead to efficiency gains for the companies involved since markets of this kind reduce the abatement costs per tonne of CO2. “However, the appeal of emissions trading for both sides depends not only on the potential efficiency gains, but also on the total number of certificates being distributed,” says Dr. Wolfgang Habla, a researcher in the ZEW Research Department “Environmental and Resource Economics, Environmental Management” and co-author of the study.

According to the results of the study, there are two mechanisms which cause countries involved in international emissions trading to issue more certificates than would be the case in two completely separate emissions trading markets, for instance. The first is that countries can make a profit from emissions trading by intentionally issuing more certificates than their domestic companies actually need and then selling the surplus certificates to companies in the other countries participating in the trading scheme at the current market price. To make this tactic less appealing, other countries can lower the market price of CO2 per tonne by also making more certificates available on the market. If a large number of the countries involved in an emissions trading market behave in this way, this can lead to countries issuing far too many certificates, a policy which encourages rather than restricts an increase in overall emissions.

Strategic ministerial appointments undermine effective climate policy

The second mechanism is a climate policy instrument used by many countries that is just as important as the number of emission certificates issued, namely the choice of who gets to shape climate policy - often the environment minister - and thus the person who decides how many certificates the country will issue. Countries involved in emissions trading markets have an incentive to appoint ministers who will prioritise company profits over environmental concerns. “This is because countries can use the strategic appointment of certain individuals as environmental policy-makers to signal to other countries that they are not willing to go to great lengths to reduce their emissions, but rather that these other countries should be more ambitious in their climate policy and issue fewer certificates,” explains Habla. Countries thus use their choice of environmental policy-makers to ensure that more of the financial burden associated with ambitious climate policies falls on other countries rather than on themselves.

“Since all countries are faced with this same incentive to appoint environment officials who do not see environmental protection as their top priority, overall CO2 emissions end up being higher when international emissions trading is introduced than if the countries involved all had their own internal emissions trading schemes that were not connected via an international market,” Wolfgang Habla explains. This is why joining an international emissions trading market is not an attractive option for certain countries or blocks of countries like the EU. “This also explains why establishing international emissions trading markets is so difficult,” says Habla.

A superior authority is needed to monitor volumes of certificates issued

Rather than ultimately bringing about a reduction in CO2 emissions, global emissions trading – via the two mechanisms outlined above – can actually lead to higher CO2 emissions than if there had been no international trade in CO2 certificates. This interplay may make the concept of international emissions trading unattractive as an instrument for slowing the rate of climate change.

“Remedial action might work if an authority is established, not at the national level but at a superior level, to set the volume of certificates participating countries can issue, as is the case in the EU,” says Habla. This approach would effectively override the two mechanisms outlined above and could result in countries pursuing more ambitious climate policies that will fully exploit the potential efficiency gains of emissions trading.

For further information please contact

Dr. Wolfgang Habla, Phone +49 (0)621/1235-155, E-mail wolfgang.habla@zew.de