Rising to the challenge of climate change
Emissions trading is not a new concept – especially in the US, where it was invented. It was the powerful, breakthrough idea that brought together environmentalists and industry, and Republicans and Democrats, in a legislative triumph on acid rain. Building on that success, the US advocated its inclusion in the Kyoto Protocol negotiations, and it was adopted as one of the 1997 treaty’s flexible mechanisms.
When the politics of climate change shifted in the US, the EU picked up the idea and ran with it. Following Europe’s pioneering efforts, several other regions have followed suit – including California and the New England states in the US.
A World Bank report this year found that over 60 regions have a price on carbon or are preparing to introduce a carbon pricing mechanism. In total, the world’s emissions trading systems (ETSs) were valued at $30 billion at the end of 2013, in markets from Europe to China, California, Kazakhstan and New Zealand. More ETSs are in the pipeline across the world.
This year, there is a loud and clear call from business and governments in favour of carbon pricing. This should be a central topic for the Paris negotiations – how to build on the successful national and regional efforts to price carbon, and how to make the markets fit for future use.
Cap-and-trade systems are the best pricing tool available to governments to fight climate change. They get the targeted reductions at the right price – unlike a carbon tax, which gets uncertain levels of reductions at the government’s set price. Trading systems allow emitters – typically power generators and industry – flexibility in how they meet that cap. They are free to choose how to comply, either taking steps to reduce their emissions onsite, purchasing allowances from other emitters which are beating their cap, or even buying offset credits when allowed.
Naturally, economic cycles influence emissions. They decline when industrial output falls, but rise in the boom times. The price within a cap-and-trade market system adjusts to reflect these ups and downs, as seen in the EU ETS (and are continuing to see, as that system’s design had no mechanism to handle a surplus of units, although this is now being addressed). A tax system, needless to say, does not adjust like this, so will be seen to bite harder in the hard times and almost seem lax in the good times, with emissions able to grow unchecked.
This price signal is one of the key aspects of a carbon market that make it important in the climate fight. The market will send a signal to business, which it can use to plan investments – and as emissions allowance prices get higher, more expensive technologies that the world needs to decarbonise, such as carbon capture and storage, become more economic.
If designed smartly, a cap-and-trade system could dispense with the need for feed-in tariffs and subsidies – as noted by the Intergovernmental Panel on Climate Change (IPCC). The market, and the private sector, would do the work so that taxpayers wouldn’t have to – and governments would meet their environmental objectives without undue burden to the public. The IPCC also noted the importance of cross border linkages in driving down costs – and enabling greater collective action.
This is the real “holy grail” for Paris: setting the framework for a globally networked market, allowing linkages between national systems. This would be even more efficient and effective than stand-alone markets, because it would expand the investment horizon across a broad set of opportunities.
Emissions trading tools work in developed and developing contexts alike. As shown by the Clean Development Mechanism (CDM), a robust offsetting system can help developing countries chart a cleaner course forward. An estimated $315 billion of capital has been leveraged by the CDM, into projects that range from large-scale industry-based initiatives and destruction to community-based clean cooking and solar lighting distribution. Climate change is not a new problem, yet these much-needed investments did not happen until there was a market system driving them.
In the coming months, governments will start to nail down the final details of the Paris climate agreement. If the world is serious about rising to the challenge of climate change, markets – even better, linked markets – have to play a role in the fight.
 World Bank. 2014. State and Trends of Carbon Pricing 2014. Washington, DC: World Bank.
 IPCC, 2014: Summary for Policymakers, In: Climate Change 2014, Mitigation of Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Edenhofer, O., R. Pichs-Madruga, Y. Sokona, E. Farahani, S. Kadner, K. Seyboth, A. Adler, I. Baum, S. Brunner, P. Eickemeier, B. Kriemann, J. Savolainen, S. Schlömer, C. von Stechow, T. Zwickel and J.C. Minx (eds.)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA.