Potential and Limits of Carbon Market Integration

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INTRODUCTION

The purpose of this term paper is to determine the potential and limits of the carbon market integration . In this paper we will discuss shortly about the political economy of the carbon trading systems and top-down and bottom-up integration scenarios towards a global carbon market.

Cap-and-trade systems establish property rights to emissions, allocate them to actors that are included in the system, create a market in which those actors can trade these property rights and, finally, institute penalties for non-compliance. The purpose of these regimes is to either reduce energy demand or to change the way energy is produced (switching into non-carbon alternatives). Proponents of emissions trading suggest that such a market-based approach to emissions reduction constitutes the most effective and efficient mechanism to achieve ambitious mitigation goals. It should be noted in this

context ,however, that the achievement of both objectives on a large scale must work

through a process of technological change and innovation.

One of the key targets of emissions trading schemes is the power sector. This makes

sense. The power sector, in most countries firmly wedded to a fossil fuel-based energy

paradigm, is responsible for close to 60 percent of worldwide emissions of CO2. The

goal of putting a price on emissions is to incentivize power producers to switch into low-

carbon (or carbon-neutral) generation capacity. The challenge here is enormous. The

International Energy Agency (IEA) estimates that between 2007 and 2030, more

than US$26 trillion in new energy sector investment is necessary in order to keep up

with world demand. (1) These investments, a significant portion of which will have to be realized in major emerging economies such as China and India, will determine

emissions trajectories for decades to come. Under a business-as-usual scenario (i.e.

without putting a price on carbon, either through emissions trading or some other

suitable policy tool) much of that investment will go into the cheapest technology

available. In many cases that would mean coal – the most damaging of all energy

sources from a climate change point of view.

There are two avenues through which a global carbon market could eventually emerge,

both of which will be considered in this analysis: a top-down approach and a bottom-up

approach. (

Negotiating a Global Deal: The Top-down Approach

A global deal implies that every country in the world will adopt a binding carbon

reduction target that covers the greenhouse gas emissions of its entire economy. Such

an international agreement would facilitate trading between governments, and could

also include additional flexible offset mechanisms, such as the current Kyoto Protocol

does. In addition, a global carbon market based on government-to government trading

of allowances would also require some basic rules of the game in terms of market

governance as well as a mechanism for compliance management. A top-down

approach to building a global carbon market does not necessarily imply that individual

countries that are signing on to such an agreement would have to setup company-

level trading schemes in order to comply with their commitments. However, it would be

likely that a global deal would result in a mushrooming of such company-to-company

trading schemes.

This section argues that by far the most significant problem of a global deal, without

doubt, remains the political difficulties involved in cutting it in the first place. Negotiating

global burden-sharing in a multilateral process remains especially difficult due

to the number of players (and thus veto points) that are involved. As carbon caps can

have large distributional consequences, the political-economic conflicts that

characterize these global negotiations are colossal. Moreover, there...
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