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Restricted linking of emissions trading systems: options, benefits, and challenges

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Abstract

With over 17 emissions trading systems (ETSs) now in place across four continents, interest in linking ETSs is growing. Linking ETSs offers economic, political, and administrative benefits. It also faces major challenges. Linking can affect overall ambition, financial flows, and the location and nature of investments, reduces regulatory autonomy, and requires harmonization of ETS design elements. This article examines three options that could help overcome challenges by restricting the flow of units among jurisdictions through quotas, exchange rates, or discount rates. We use a simple model and three criteria—abatement outcome, economic implications, and feasibility—to assess these ‘restricted linking’ options. Quotas can enhance cost-effectiveness relative to no linking and allow policy-makers to retain control on the extent of unit flows. Exchange rates can create abatement and economic benefits or unintended adverse implications for cost-effectiveness and total abatement, depending on how rates are set. Due to information asymmetries between the regulated entities and policy-makers setting the exchange rate, as well as uncertainties about future developments, setting exchange rates in a manner that avoids such unintended consequences could prove difficult. Discount rates, in contrast, can ensure that both cost-effectiveness and total abatement are enhanced. Overall, restricted linking options do not achieve the benefits of full linking, but also avoid some major pitfalls, as well as offering levers that can be adjusted, should linking concerns prove to be more significant than anticipated.

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Notes

  1. One-way linking, which refers to the situation in which units from one jurisdiction are recognized in another jurisdiction but not vice versa, could be seen as a special case of quotas where one jurisdiction introduces a quota of zero, whereas the other jurisdiction does not apply a quota.

  2. See http://www.worldbank.org/en/topic/climatechange/brief/globally-networked-carbon-markets.

  3. Burtraw et al. (2013) evaluated an exchange rate of 3 between California-Québec and RGGI. The findings are similar to our simplified model, though our model does not account for the presence of floor prices.

  4. Where linking is formalized in a linking agreement, this may require a termination procedure (Mehling and Haites 2009). The way the termination of a linking agreement is organized may affect abatement costs as well as subsequent price divergence (Pizer and Yates 2015).

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Acknowledgements

This article was produced based on an input to the ICAP Technical Dialogue on linking emissions trading systems. The authors would like to thank Michel Frerk, Constanze Haug, Aki Kachi and Marissa Santikarn from the ICAP Secretariat as well as several ICAP members for their constructive comments on a draft version of this paper. Bianca Sylvester and Luca Taschini also provided valuable feedback. An earlier version of the paper was presented at the workshop ‘Comparison and Linkage of Mitigation Efforts in a New Paris Regime’, organized by the International Emissions Trading Association, the Harvard Project on Climate Agreements, and the World Bank Group’s Networked Carbon Markets Initiative. Findings and opinions expressed in this study are those of its authors and do not necessarily reflect the views of ICAP or its members.

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Authors and Affiliations

  1. US Center, Stockholm Environment Institute, 11 Curtis Avenue, Somerville, MA, 02144-1224, USA

    Lambert Schneider, Michael Lazarus & Carrie Lee

  2. Wageningen Institute for Environment and Climate Research, Wageningen University, 6708 PB, Wageningen, The Netherlands

    Lambert Schneider

  3. Oxford Center, Stockholm Environment Institute, Florence House, 29 Grove Street, Summertown, Oxford, OX2 7JT, UK

    Harro van Asselt

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  1. Lambert Schneider
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Correspondence to Lambert Schneider.

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Schneider, L., Lazarus, M., Lee, C. et al. Restricted linking of emissions trading systems: options, benefits, and challenges. Int Environ Agreements 17, 883–898 (2017). https://doi.org/10.1007/s10784-017-9370-0

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