A plain English look at the post-Kyoto carbon market

October 31, 2011, by Tim Stumhofer

“Will failure to strike a post-Kyoto deal in Durban kill the carbon market?”

With the latest big annual United Nations climate conference just a month away in Durban, South Africa, this question is seeing attention from the press the world around. The question seems innocuous enough, but as with so much in climate policy —and particularly the UN process— answers come in pieces, with caveats, and almost exclusively in acronym-thick jargon difficult for anyone who doesn’t happen to be a full-time climate policy wonk to penetrate.

We are doubtless guilty of falling into the climate domain language trap ourselves in this blog, dissecting the often inaccessible nuance of carbon accounting program design. Complexity in past posts notwithstanding, we thought it might be timely and instructive to break down the post-Kyoto question for a broader audience.

Defining our terms: “The Carbon Market”

First, let’s talk definitions. If we’re to consider the impact on “the carbon market” what all exactly is wrapped up in the carbon market?

This is exactly where the challenge of addressing this question starts: whether written in the singular “carbon market,” plural “carbon markets,” or any of its synonymous forms (e.g., emissions trading, cap-and-trade, etc.) popular reference is almost always some form of catch-all term. What’s implied for inclusion under “the carbon market” (the form I’ll stick to in this post for continuity’s sake) may be everything from one discrete scheme to a few specific programs or an even wider net employing more generous interpretations of what should be considered.

The reality here isn’t necessarily as wide ranging as I may suggest, but the language is nevertheless imprecise, and it stands to reason that any question of analysis need at a bare minimum define its scope of coverage.

In the interest of not getting too bogged down with the details of different programs or going to the trouble of developing a taxonomy to academically address this definition, let’s consider at a high level a few different types of carbon market programs that are generally discussed. To keep things simple we’ll keep it to three labels: compliance, pre-compliance, and voluntary.

The compliance programs are perhaps the most obvious. These are programs structured around legal obligation. Compliance schemes may hinge on obligations at various levels, from international treaties, to national regulations, down to municipal ordinances. The key point is that meeting these commitments is compelled by law.

Examples include international (country to country) emissions trading under the Kyoto Protocol, national and supernational (firm to firm) emissions trading programs like the European Union Emission Trading Scheme (EU ETS) or New Zealand’s ETS, as well as other market-based national climate policies like Britain’s Carbon Reduction Commitment and subnational programs like the Regional Greenhouse Gas Initiative in the United States or the New South Wales abatement program in Australia. Programs that are in the design phase, but when operational will be obligatory, such as Australia’s freshly approved program or California’s cap-and-trade scheme, would also make this list when they formally start up. The compliance net should include both the programs themselves and also related offset programs that mint instruments accepted for program compliance.

Pre-compliance programs are slightly less cut and dry. Pre-compliance may mean different things to different people. For the sake of creating a definition so we have something to work with let’s consider the programs developed with the intent to support regulatory objectives. As any lawyer will tell you, intent can be quite difficult to prove, but we’re painting with broad brushstrokes for the sake of illustration. These programs might include initiatives established to eventually integrate with regulatory programs, or programs that might become compliance regimes themselves. Such programs may even have elements of law and regulation in them, but they don’t completely fit the bill of a compliance scheme.

In the context of the carbon market, “pre-compliance” is often used to describe offset project development that braves the regulatory uncertainty of early day program design (see Ecosystem Marketplace’s annual state of the voluntary carbon market report for one definition of pre-compliance). Indeed projects developed for use in future compliance programs, such as has been seen across the United States —most recently for California’s program— would seem to suit the pre-compliance label.

But looking more broadly, a strong case could also be made that larger-scale international initiatives like national and subnational (“nested”) avoided deforestation schemes (referred to in UN acronyese as “REDD” or Reducing Emissions from Deforestation and forest Degradation in developing countries) and “nationally appropriate mitigation actions” (NAMAs) —think: very large activities often on a municipal, sector, or even economy-wide scale— are also a part of the pre-compliance carbon market. These initiatives and programs look to tightly dovetail with future international agreements and associated markets, but are undertaken without a proper market to speak of today. Part and parcel to these larger scale programs is the development of emissions measurement, reporting, and verification (MRV) infrastructure at all scales. Finally, pre-compliance also includes a whole class of “voluntary” programs founded with an explicit or implied intent to transition to a compliance program. Examples include Japan’s voluntary “JVETS” program, the ever-growing number of voluntary schemes emerging in China, and even the now defunct US-based Chicago Climate Exchange.

Rounding out our categorization of the carbon market, voluntary programs would be those that don’t meet the “intent” requirement of pre-compliance programs. In other words, programs that are truly optional and don’t have serious designs on becoming part of the climate regulation edifice. Maybe they were designed to stave off regulation, give organizations an opportunity to prove their climate bona fides to stakeholders, or provide a mechanism for climate-concerned citizens to take some action on their own part. Whatever the reason, for this classification we’re talking about programs that are not going to tie into compliance programs anytime soon.

As with pre-compliance offsets, voluntary or “true voluntary” (to lean on another Ecosystem Marketplace definition) offsets —that is, those used for “carbon offsetting”— provide a good starting point for breaking out the voluntary carbon market. In reality these distinctions are quite porous, meaning what is pre-compliance one day may be compliance the next or even voluntary the next. (The Voluntary Carbon Standard’s recent name change to the “Verified Carbon Standard” concisely illustrates the fluidity of these classifications.) Without devoting too much energy to trying to create a perfect definition of “voluntary” here I think this and the other rough working classifications provide sufficient latitude to broadly break up “the carbon market.”

Now that we’ve gone through the trouble of breaking out the carbon market into its component flavors, let’s revisit that scenario we started with: There is no “successor to Kyoto,” — no second Kyoto commitment period or other binding collective target-based treaty agreement. Where does that leave the carbon market?

Compliance markets

First, let’s take a look at what happens without that Kyoto successor? For one, Kyoto’s first (and only) commitment period expires. And, with that expiration, out the window go international treaty commitments for Australia, Canada, Europe, Japan, New Zealand, Russia, and a few other former Soviet countries like Ukraine. Legally, that’s about it.

The expiry of Kyoto will close the door on one part of today’s compliance market, international emission trading between Kyoto countries (versus firms). But the Kyoto national allowance trading market, while large in scope, was just one compliance mechanism, and not a particularly active one. Other compliance schemes governed by national and subnational legislation have been clear in communicating that the conclusion of Kyoto commitments will not slow their programs. Indeed, the European Union Emission Trading Scheme, the world’s largest trading program by transaction volume, is actively continuing to expand its scope at the very time the region’s Kyoto commitments wrap up. In a similar vein, in Australia a slated carbon tax program is pegged to start up just as Kyoto winds down. (The Australian program ramps up ambition in later years, converting to a trading scheme in 2015.) Likewise, compliance programs have been ushered forward in countries without Kyoto targets in spite of the looming end of the Kyoto era and what many market participants would characterize as serious pessimism about the renewal of international commitments. (How much more aggressive the growth of today’s compliance market would have been with a global climate deal in reach we’ll never know.)

However, the Kyoto Protocol as a legal instrument survives and continues to be legally binding, as it does not terminate with the end of any given compliance period. The most notable surviving element of the Protocol in the absence of a second commitment period is the Clean Development Mechanism (CDM)1 —an “offset” scheme that credits emission reductions financed in developing countries. The CDM plays maybe the most confused role in the post-Kyoto scenario. The offset program, designed as a “flexibility” mechanism for Kyoto compliance, was linked to other compliance programs, namely the EU ETS and the much smaller New Zealand Emission Trading Scheme. There is nothing to legally or administratively prevent the CDM from continuing to operate under the UNFCCC. The CDM is self-funding, and as long as the Parties to the UNFCCC agree not to shut it down and there remains demand for the offset credits it issues, it can continue. Notably, without international emissions trading, the CDM is left to serve as one of the few obvious options for linking various national and subnational programs.

Pre-compliance markets

Perhaps one of the most important considerations regarding the failure to re-up Kyoto is the degree to which policymakers and market participants have anticipated this outcome. Indeed, large pre-compliance initiatives (e.g., REDD, NAMAs) and supporting program capacity building efforts have emerged in a policy environment that arguably assumes no immediate Kyoto successor (or has at least seriously discounted the possibility). Time will bear out the assumption that these initiatives can survive in a post-Kyoto scenario, but the fact that these investments are being made as Kyoto elapses returns us to attempting to derive meaning for the carbon market.

Employing the strictest definition of what the Kyoto expiration impairs, the commitment period’s conclusion has no immediate bearing on these emerging mechanisms. In other words, they are not legally constrained without Kyoto’s targets. If anything a lapsed Kyoto commitment period, in removing the dominant regulatory structure under the umbrella of an international treaty, may open up more room for pre-compliance markets.

Voluntary markets

Finally, the voluntary market, much heralded as a proving ground for innovation, is not immediately impacted by Kyoto’s expiration. Hinging on corporate and individual sentiment and ambition, rather than government policy like the compliance and pre-compliance markets, the voluntary market is notoriously challenging to predict. Arguments could be made that a post-Kyoto conclusion of international commitments could either depress or invigorate true voluntary market-based efforts.

Checking the pulse

So in the end where does this leave us? I’ve tried to be reasonably even-handed, but, of course, in choosing to confront the supposition that the expiration of the Kyoto Protocol’s commitment period will be an end to all carbon markets I’ve addressed something of a straw man argument. In other words, no one who closely follows climate policy seriously believes that the end of Kyoto will, in one fell swoop, bring down with it the entire universe of market-based approaches designed to mitigate climate changing emissions. In contrast, what I meant to illustrate in this quick stocktaking is that in the absence of a Kyoto successor much survives. Critically, however, the markets do lose some other key institutional pieces, including a centralized structure (as observers and participants have been saying for some time the integration of markets is challenging without the coordination to link them).

Yet taking a step back from this exercise, all the stocktaking and legal analysis in the world still leaves us with a very poor proxy measure of the related looming question: When will the world show the collective ambition to seriously address climate change? …a question to which Durban is liable to provide another ambiguous, caveated, and buzzword-rich response.

What we can say is, from an infrastructure and market readiness perspective, a post-Kyoto world may not be in substantially worse shape to address that challenge.

1 If anyone reading this can provide a clear explanation of what happens to the Clean Development Mechanism’s much smaller sister Kyoto offset program, Joint Implementation, in the absence of a second Kyoto commitment period please post in the comments.

One response to “A plain English look at the post-Kyoto carbon market”

  1. John Mouth says:

    Thanks for this informative and accessible post. It seems to me that, in the grey area overlapping voluntary and pre-compliance, firms make movements towards emissions accounting and reduction to prep for possible future regulation that may affect them. While the move may also open access to green markets and reduce costs associated with energy usage, it also gives the firm a leg up in the event that future regulations are implemented. Like, say a gun registry, the maintenance of a program is less costly than scrapping it and starting over in the future if and when necessary.

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