2. Chapter 2: Market and Non-Market Mechanisms: An Overview
2.5 Critiques of Market-Based Mechanisms
2.5.1 Critiques of Kyoto Market-Based Mechanisms
Reviewing the function of mechanisms introduced by the Kyoto Protocol highlights concerns associated with the use of MBMs. One key issue in this field is the impact of flexibility mechanisms on environmental integrity of the Kyoto Protocols mandated levels of emissions reduction.122 In particular, there is a concern that the Kyoto MBMs may cater to industry and development, at the expense of environmental integrity. This is not simply an issue of industry receiving undue profits. If functioning improperly, the CDM and other flexibility measures may lessen overall emission reductions if sponsored projects do not result in additional reductions but are still claimed and used as offsets.123 To demonstrate, in the first operational period of the CDM, the EU ETS provided the largest demand for CERs.124 The quality of the CERs, therefore, has global impacts for climate change action as developed countries can used them to lessen domestic efforts.125
The CDM has generated considerable academic scholarship and criticism in relation to overall effectiveness, issues calculating accurate baselines and the environmental integrity of claimed reductions.126 Wara, for example, claims that the design of CDM has resulted in manipulation of baselines in order to inflate offsets created, resulting in “windfall profits”
for industry.127 Wara also argues that in 2008, the CDM was paying “perverse incentives”
to projects involving refrigerant chemicals, especially a category of hydrofluorocarbon known as HFC-23.128 Other studies have found that the overall benefits of the CDM with regards to lowering emissions are “uncertain” and that it has achieved only “limited” impact on sustainable development.129 By contrast, Mehling claims that the CDM resulted in “a documented ability to dramatically reduce the cost of achieving mitigation commitments”
122 See i.e., van Asselt and Gupta 2009.
123 van Asselt 2016, p. 347.
124 European Commission 2020, n.p.
125 van Asselt and Gupta 2009, p. 333; Nagy and Varga 2009, p. 64.
126 See e.g., van Asselt 2016; Schneider 2013; Wara 2008; Nagy and Varga 2009.
127 Wara 2008, p. 1763, 1781-1789.
128 Wara 2008, p. 1781-1785. Since this time, some countries such as New Zealand have taken steps to ban or regulate the use of HFC-23 CERs, see e.g., Beckford 2011. Parr 2013 also builds on Wara’s arguments relating to HFC-23 to criticise the free market approach of the CDM.
129 Nagy and Varga 2009, p. 70.
and appears disappointed with country decisions to restrict or refuse to trade in CERs.130 Mehling also notes that the Marrakech Accords imposed strict and detailed rules regarding additionality, project verification and certification with aimed to increase the environmental integrity of the scheme.131 Yet another perspective on the CDM comes from Nagy and Varga who claim that the cost of the CDM approval process may be hindering the overall cost-effectiveness of the scheme.132 This debate highlights the complexities in determining effectiveness of climate change policies, particularly in relation to the balancing of stringency of monitoring, review and verification with financial benefits.
Literature relating to the Joint Implementation mechanism has raised similar concerns related to project activity between countries which emission reduction commitments under the Kyoto Protocol.133 These projects generate ERUs which can be then be traded. In one study, researchers assessed that the additionality claims of 73% of ERUs were “not plausible”, highlighting a fundamental issue with the scheme.134 The researchers estimate that the reliance on ERUs from the Joint Implementation mechanisms may have increased global GHG emissions by approximately 600 million tCO2, with 400 million tCO2 being incorporated via the EU ETS.135 Steps can be taken to try and ensure credits are of high environmental quality. In the case of the EU ETS, for example, there were concerns raised about the environmental integrity and market effect of Clean Development Mechanism and Joint Implementation credits. As a consequence, Directive 2033/97/EC requires that these credits are supplementary to domestic reductions and prevents the use of credits from “land use change and forestry activities projects”.136 While safeguards can be put in place in individual ETSs to try to address these issues of environmental integrity, such studies indicate that the Kyoto MBMs have significant flaws in relation to additionality and environmental integrity.
130 Mehling 2018, p. 15.
131 Ibid, p. 12-13.
132 Nagy and Varga 2009, p. 64.
133 Kollmuss et al. 2015.
134 Ibid, p. 6.
135 Ibid, p. 5.
136 Directive 2003/87/EC, article 30.
The generation, purchase and trading of emissions units through the MBMs in the Kyoto Protocol gives rise to concerns about the alleged failure of developed countries to take leadership in reducing emissions. MBMs in the Kyoto Protocol should enable developed countries to assist developing countries and also to enable cost-effective emissions reduction.137 However, this arrangement also arguably enables developed countries, who are responsible for historical emissions and best placed to take actions to reduce domestic emissions, to simply pay others to undertake reductions.138 In addition, the unequal position of parties in the international negotiations139 has led to concerns of “carbon colonialism”.140 A related concern is that CDM and Joint Implementation projects have focused more on cost-effectiveness, to benefit Annex B countries, with little consideration of the genuine and long-term sustainable development of developing countries.141 Similarly, there have been concerns about a lack of geographical balance, with the vast majority of CDM project funding received by India and China while Africa, the Middle East and Europe and Central Asia account for only approximately 6.5% of all projects.142 While the use of MBMs is voluntary, developing countries who refuse to participate may face greater difficulty accessing finance for sustainable development and climate change adaptation and mitigation measures.143 The international climate change regime incorporates technological and financial transfer mechanisms, such as the GCF, which should counter this risk. However, the financial support made available by developed nations has been below pledged amounts and is seen as inadequate.144 The extent to which the use of MBMs may enable developed countries to unduly influence developing countries remains unclear, however, it is apparent that this is a concern for many countries. NMAs have significant potential to address these issues of fairness, equal access and participation if used complementary to MBMs. They can, for instance, assist in enabling participation of countries without well-developed markets in developing projects or avoiding high-carbon development pathways.
137 van Asselt and Gupta 2009, p. 332.
138 Ibid, p. 338.
139 Ibid, p. 341–342.
140 Ibid, p. 337.
141 Ibid, p. 344.
142 UNEP DTU Partnership 2020.
143 van Asselt and Gupta 2009, p. 338.
144 OECD 2019; OECD 2016.
There are also issues related to the cooperative measures for emissions trading established in Article 17 of the Kyoto Protocol. This section enabled the development of international carbon markets for Annex B country Parties under the UNFCCC. The agreed upon modalities, rules and guidelines for cooperative emissions trading state that CERs, ERUs, assigned amount units and removal units can be transferred and acquired by eligible Parties.145 The design of ETSs and associated mechanisms has significant impact on whether they can be linked under Article 17. The first major factor is the “heterogeneity of jurisdictions”, which refers to the characteristics of the jurisdictions seeking linkage.146 This includes factors such as whether a country is a Party to the Kyoto Protocol and whether they have a national GHG registry and estimated emissions data.147 Linking has potential to broaden the international carbon market, thus increasing cost-effective measures for climate change mitigation.148 However, similar to the issues associated with CERs, broadening linkage under Article 17 of the Kyoto Protocol can result in reduced environmental benefits on a global scale if credits are not properly verified.149
Another issue with the design of cooperative emissions trading under Article 17 of the Kyoto Protocol is that national governments often must rely on industry to obtain emissions data in order to set an baseline.150 This must be accurate enough to be used to set a cap which is realistic, but ambitious enough to incentivise decarbonisation.151 Once a cap has been set at an appropriate level, increasingly stringent measures should be put in place to ensure the cap is decreased overtime and encourages additional emission reductions.152 This may be done based on historical emissions, termed “grandfathering”, via sector-based benchmarks or via auctions which also generate revenue.153 Although auctioning has significant benefits for the pricing of carbon and revenue generation for governments, most allowances are issued
145 FCCC/KP/CMP/2005/8/Add.2, p. 18.
146 Mehling et al. 2018.
147 FCCC/KP/CMP/2005/8/Add.2, p. 18.
148 FCCC/TP/2008/2, p. 37–38.
149 Mehling 2018, p. 1, 5; Schneider and La Hoz Theuer 2018; Schneider 2013.
150 Nagy and Varga 2009, p. 79; Narassimhan et al. 2018, p. 971; Schneider 2013, p. 132.
151 Narassimhan et al. 2018, p. 971; Schneider 2013, p. 132.
152 Narassimhan et al. 2018, p. 971.
153 Narassimhan et al. 2018, p. 975; van Asselt and Gupta 2009, p. 332; van Asselt 2016, p. 342–343153
through grandfathering, especially during the first years of an ETS.154 This process affects the distribution and pricing of emission rights. In the EU ETS, for example, it was estimated that a combination of grandfathering and over-allocation of trading credits resulted in a profit of some €6-8 billion for the main four power production companies in Europe.155 While these concerns are predominately related to national ETSs, linking under Article 17 of the Kyoto Procotol means that financial downturn or over-allocation in one jurisdiction has the potential to affect carbon price in others.
As demonstrated, while the Kyoto Protocol MBMs are designed for the purpose of increasing cooperation, cost-effectiveness, flexibility and the ambition of climate action, mechanisms for international trading and offsets can have significant concerns related to environmental integrity, power-relations and equality of access and participation. Mehling states that the new market mechanisms under the Paris Agreement have, to some extent, responded to the concerns with Kyoto Protocol market mechanisms.156 However, only time will tell if this is successful. Moving beyond the specific Kyoto Protocol mechanisms, there are also more general criticisms of MBMs to explore.