Climate Change 2001:
Working Group III: Mitigation
Other reports in this collection Impacts of Caps on the Use of Trading

From the above results, it is seen that all OECD countries have an interest in making the market as large as possible. Some Parties to the UNFCCC, however, have suggested that the supplementarity conditions of Articles 6.1.d, 12 and 17 of the Kyoto Protocol be translated into quantitative limits placed on the extent that Annex I countries can satisfy their obligations through the purchase of emission quotas. The rationale for the supplementarity condition is that, if the price of permits were too low, this would discourage domestic action on structural variables (infrastructure, transportation) or on innovation apt to modify the emissions trends over the long run. These measures are very often liable to high transaction costs and governments may prefer to import additional emissions permits instead of adopting such measures. In other words, minimization of the costs of achieving Kyoto targets may not guarantee minimization of the costs of climate policies over the long run; this is the case when the inertia of technical systems is considered (Ha-Duong et al., 1999) and when one accounts for the long term benefits of inducing technical change through abatements in the first period (Glueck and Schleicher, 1995).

Some works have studied the consequences of enforcing the supplementarity condition through quantitative limits: one of the EMF scenarios imposed a constraint on the extent to which a region could satisfy its obligations through the purchase of emission quota (the limit was one-third).

Figure 8.11: The double bubble.

However, the models cannot deliver any response without an assumption about ex ante limits on carbon trading, resulting into a stable duopoly between Russia and Ukraine or into a monopsony (Ellerman and Sue Wing, 2000). In the first case, the price of carbon will be higher than in a non-restricted market, and most of the additional burden will fall on countries in which the marginal cost curve is high because they have a lesser potential for cheap abatement. This is typically the case for Japan and most of the European countries (Hourcade et al., 2000b). The other possibility is for the market power to be controlled by the carbon-importing countries; in this case, the risk is that all or most of the trading will be of “hot air” at a very low price. Which of these alternatives will be realized cannot be predicted but, in both cases, quantitative limits to trade lead to outcomes that contradict the very objective of the supplementarity condition. Criqui et al. (1999) assessed the order of magnitude at stake with the POLES model, and examined a scenario in which the carbon tax is US$60/tC with unrestricted trade. They found that the carbon prices under the concrete ceiling conditions proposed by the EU fall to zero (with no market left for the developing countries) if the market power is held by the buyers. Alternatively, the carbon prices increase up to US$150/tC if the market power is held by the sellers, this risk being increased in the case of caps on hot air trading which increases the monopolistic power of Russia and Ukraine. Böhringer (2000) assesses the economic implications of the EU cap proposal within competitive permit markets. He concludes that part of the efficiency gains from unrestricted permit trade could be used to pay for higher abatement targets of Annex-B countries which assure the same environmental effectiveness as compared to restricted permit trade but still leaves countries better off in welfare terms. The Double Bubble

Here the case of the “double bubble” is examined, in which countries belonging to the EU have a collective target, making use of the flexibilty to shift emission quota within the group and the remaining Annex I countries trade among themselves to reach their individual targets.

Figure 8.11 shows the incremental value of carbon emission for the two groups and compares them with that of full Annex I trading. Notice that for the USA, the tax is lower in the case of the “double bubble” than with Annex I trading. The reason is that without the EU bidding for the Russian “hot air”, the demand for emission quotas falls as does its price. The EU on the other hand is disadvantaged under such a scenario. With their access to low cost emission quotas limited, the incremental value rises.

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