Point Carbon: Prospects for a transatlantic carbon market

 Guest commentary

By Michael Mehling, Andreas Tuerk and Wolfgang Sterk, Climate Strategies

History repeats itself: years of standstill on climate policy at the US federal level had largely relegated transatlantic climate cooperation to EU engagement with progressive US states and regions when, in 2008, the election of a Democratic president and Congress raised hopes for a substantial breakthrough.

Following the demise of federal climate legislation in the US Senate, however, prospects for a transatlantic carbon market are once again dependent on the possibility to link the EU ETS with regional carbon markets, such as the trading system envisioned under the Western Climate Initiative (WCI).

While not all participating jurisdictions will be implementing an emissions trading systems when the WCI begins in January 2012, those expected to move ahead comprise approximately two-thirds of the total emissions in the WCI area, and may constitute a market with a third of the size of the EU ETS by 2015.

Specification of several design details in the WCI trading system is left to the individual partner jurisdictions; still, the overall WCI program design rules out insurmountable obstacles for a transatlantic market link, such as hard price ceilings.

Some degree of harmonisation with the EU ETS might be needed in the area of cost containment as well as offset provisions. But arguably one of the most important criteria for successful linking of carbon markets, comparability of carbon prices, should not pose a significant obstacle: according to current price forecasts, allowance prices on the US West Coast are predicted to be higher than allowance prices expected in the EU ETS, and roughly commensurate if the EU tightens its reduction target (from an overall goal of 20 per cent under 1990 levels).

At present, however, it stands to reason that a link with the EU ETS will not be a priority for WCI participants, despite the strong interest expressed from the European side.

After the individual emissions trading systems in WCI partner jurisdictions become operational in 2012, these systems will first seek bilateral links among each other in order to create a liquid carbon market.

Also, WCI partners are already in advanced discussions with the other regional trading initiatives in North America to explore bilateral linking over the mid-term.

In theory, the Regional Greenhouse Gas Initiative (RGGI) system, which is already up and running, is another candidate for linking.

However, while the functional design features of both systems are generally compatible, RGGI prices are so low that linking is hardly attractive for either side.

Linking would therefore only be an option if the RGGI cap were substantially tightened. Still, if the EU succeeded in establishing a trading link to RGGI, the WCI, or other regional initiatives, its actions would likely send a strong political signal and revitalise the discussions about a global carbon market.

A transatlantic link between the EU ETS and a federal US trading scheme has become unrealistic for the foreseeable future.

Any hopes that the US will ratify a legally binding international climate agreement anytime soon have been quashed by the US midterm election

Admittedly, the US administration may still pursue a number of policies to regulate greenhouse gas emissions, but any such measures will likely steer clear of emissions trading in order to avoid being repealed by Congress.

While linkages between the EU ETS and regional US trading systems may thus lie several years in the future, markets on both side of the Atlantic, in the meantime, may be indirectly linked via acceptance of a common offset credit, such as CDM units or other new international credits.

Such indirect linkages would already yield a share of the economic benefits offered by direct linking. An approximation of views between regional US systems and the EU regarding international offsets would therefore be of crucial importance to enable both indirect and, over time, also perhaps direct links.

In particular, the development of criteria to provide credits on a sectoral basis should be an area of collaboration between the US and the EU in the future exploration of new market mechanisms.

This is an extract of a working paper produced by the authors for Climate Strategies. The full report can be viewed here: http://climatestrategies.org/research/ our-reports/category/65/318.html