From the EU ETS to a global carbon market?

Since the introduction of the Kyoto Protocol, some local, national and regional carbon trading mechanisms have been launched in Europe, North America, Asia and the Pacific. Other emissions trading systems, for example in Latin America, North America, Russia and Asia are planned or under consideration.

The EU emissions trading system (EU ETS) can be seen as the world’s biggest, regional carbon market, aiming to reduce greenhouse gas emissions through a cap and trade system. According to Horstink and Bode, in 2012 the EU ETS took “up between 84% and 98% of the value of all carbon markets (…) [and covered] about 50% the EU’s total CO2.” Even though the EU ETS has changed business as usual and led sectors to cut their emissions, the issue and the effects of greenhouse gas emissions are not limited to Europe or specific countries. Therefore, the European Commission and the International Carbon Action Partnership are striving for a mechanism that links the different cap and trade systems beyond the European border, in order to create an international level playing field, share knowledge and support a worldwide cooperation on climate change. This international collaboration should also lead to reduced costs, a more stable carbon price and an increase of the market liquidity.

How could the implementation of a global carbon market look like, taking into account that some national and regional mechanisms already exists? On the one hand, there is the top down approach, which is based on multilateral decision making processes and where allowances would be traded among governments, on a country level. This system, however, requires a strong political will and cooperation from all countries and is therefore unlikely to happen in the near future. On the other hand, the so called bottom up approach is discussed and planned to be established. This method links the already existing emission trading systems and emissions could freely be traded on a company level. Despite the technical challenges that the bottom up approach generates, it brings a high need for regulatory supervision and coordination along. Furthermore, this approach needs to take the different market rules into consideration, which makes the implementation rather challenging.

Both approaches involve inherent risks and a high political willingness to compromise. Despite a likely dispute about the overall cap, some other key points that would need to be negotiated are how allowances are allocated, what kind of offsets could be used or which sectors should be involved. Once a global carbon market is established, it is likely that the different local players are becoming less responsible regarding their own targets, which might result in less ambitious caps.

To give you an example of how difficult it is to converge two mechanism, we are taking a closer look at the planned link between the EU ETS and the Australian Carbon Pricing Mechanism (CPM): The European Commission states on their website, that a first step towards an international carbon market lays in a cooperation with Australia. From 2018 on, businesses from both systems shall be able to trade emissions among each other. However, it might be quite a challenge for the EU ETS to link with a non-existent system. Despite the fact that Australia had set up the CPM as an emission trading scheme, which became law in 2011, this mechanism has been annulled last year. When a new government was elected in 2013, they announced the repeal of the CPM in order to lower costs for businesses and households. Instead of the CPM, the Australian government now aims to establish a Direct Action Plan, including an Emissions Reduction Fund. In the Emissions Reduction Fund Green Paper, which was released in December 2013, the government stated that “the Emissions Reduction Fund will provide a pool of capital to purchase the lowest cost abatement through a reverse auction, and this will be a far more effective means of reducing Australia’s emissions than the carbon tax”. Yet it can be questioned if Australia will meet its 2020 goal in emissions reduction with a mechanism, which “is designed to allow businesses to continue ordinary operations without penalty”.

One can only imagine how challenging it is to not only to establish a national systems which satisfies all stakeholders, but to take it one step further and trying to consider all the different multilateral interests. A good example is the planned linkage between the EU ETS and the Swiss emission trading system. Even though both systems are quite similar and both parties already have a strong political connection, the negotiations are ongoing since 2010.

At first glance, an international carbon market seems to offer many benefits to all participants. A closer look, however, reveals many issues and raises the question whether an international carbon market is more efficient than national or regional markets and, considering the political reality, whether it is feasible and desirable after all. In my opinion, a global carbon market is unlikely to emerge in the near future, since there are too many disparities in the different mechanisms, as well as on a political level. Keeping in mind how the EU ETS has changed since it was first launched in 2005, one can imagine how difficult it must be to coordinate a global carbon market. In my opinion, it is more likely that different approaches will coexist. Despite my doubts about a global carbon market, I do believe that every country needs to take actions against greenhouse gas emissions and that countries should share knowledge and best practices about emission trading systems.

Main sources

Behr, T. and Witte, J. (2009). Towards a global carbon market?  Potential and limits of carbon market integration. Global Public Policy Institute.

Horstink, M. and Bode, J. (2012). The future of global carbon markets. IESE Business School. Publisher: Ernst & Young.

IEAT. The world’s carbon market.

International Carbon Action Partnership (ICAP).

Parliament of Australia.

Schweizerische Eidgenossenschaft.

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