Trading Flexibility for Predictability - Differential Emission Dynamics and the Formation of Common Carbon Markets

Obersteiner, M. ORCID: https://orcid.org/0000-0001-6981-2769, Jonas, M. ORCID: https://orcid.org/0000-0003-1269-4145, Nilsson, S., Shvidenko, A., & Gluck, M. (2000). Trading Flexibility for Predictability - Differential Emission Dynamics and the Formation of Common Carbon Markets. IIASA Interim Report. IIASA, Laxenburg, Austria: IR-00-063

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Abstract

The Kyoto Protocol was a success in the sense that it established legally binding commitments to reduce carbon emissions for a very specific set of actions and a specific set of actions and a specific set of countries - emission reduction of Annex B sources (mainly combustion of fossil fuels) in industrialized countries. However, the Protocol failed to establish a comprehensive set of markets of full geographic (all countries) and full structural coverage (all sources of GHGs). In this paper, we argue that it is mainly the economic and technological dissimilarity between carbon systems (e.g., country specific fossil fuel emissions, regional terrestrial methane fluxes to the atmosphere) that impede the formation of a single global GHG market covering all sources. It appears that the international realpolitik requires second best (worst) solutions in order to be agreeable to all potential parties. This paper discusses a methodology of developing such a solution by forming Common Carbon Market Systems (CCMS), which is an analogy to the existing international trading blocks. An optimal emission target for a specific carbon system functions as a measure to assign membership in such a trading block. It reflects the carbon systems specific dynamics and the related uncertainties. In this paper, we argue that clusters of similar GHG emission patterns expressed by similar targets will find themselves more willing to establish common rules among themselves than in one global market, since the winner-loser gap can drastically be reduced within a CCMS and the established market rules will better fit the dynamics of the respective carbon systems. Furthermore, products to be traded in a CCMS will be more readily identified, more comparable, and thus markets of CCMS will be more transparent and predictable. We conclude that in a post-Kyoto world CCMS might be instrumental in increasing the participation in, the comprehensiveness and finally the effectiveness of, international actions to combat global climate change. However, we will have to live with some efficiency losses.

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