LINKING HETEROGENEOUS CLIMATE POLICIES (CONSISTENT WITH THE PARIS AGREEMENT).

• Author: Mehling, Michael A.

1. Introduction 649 II. Why Is Linking Important? 651 III. Forms of Heterogeneity that Can Affect Linkage of Climate Policies 654 A. Heterogeneity of Policy Instruments 655 1. Links Between Cap-and-Trade Systems 656 2. Links Between Heterogeneous Policy Instruments 657 3. Experience with Linkage of Climate Policy Instruments... 660 4. Lessons Learned from Experience with Linkage of Climate Policy Instruments 664 B. Heterogeneity of Jurisdictions. 665 1. Level of Jurisdiction 665 2. Status Under the Paris Agreement. 668 C. Heterogeneity of Targets 676 1. Policy Instrument Targets. 671 2. NDC Targets Under the Paris Agreement 672 a. Target Type. 673 b. Reference and Target Years 674 c. Sectoral and Geographic Coverage 675 d. GHG Coverage. 675 e. Global Warming Potential Values 676 f. Heterogeneity of NDCs of Key Countries 676 IV. Illustrative Cases of Potential Climate Policy Linkages 677 A. Case 1: Two National Mass-Based Cap-and-Trade Systems, Paris Agreement Parties, Absolute NDC Targets 678 B. Case 2: Two Sub-National Systems (Carbon Tax and Cap-and-Trade), Both in Paris Agreement Parties with Absolute 680 NDC Targets. C. Case 3: Two Cap-and-Trade Systems, One a Regional Party of the Paris Agreement (with an Absolute NDC Target) and 681 One a Sub-National System in a Non-Party. D. Case 4: National Performance Standard with Absolute GHG NDC Target and Mass-Based National Cap-and-Trade with 683 Relative GHG Target, Both Parties to the Paris Agreement E. Case 5: Two National Mass-Based Carbon Tax Instruments 683 in Non-Parties of the Paris Agreement 684 V. Common Threads, Policy Implications, and Pending Questions 685 A. Accounting Treatment of ITMO Transfers and Use 687 B. Potential Further Issues for Attention C. The Outlook for Heterogeneous Linkage Consistent with the 689 Paris Agreement 696 VI. Appendices 696 A. Appendix 1: Paris Agreement Article 6. 698 B. Appendix 2: Achieving Global Cost Effectiveness I. INTRODUCTION

   The Paris Agreement, adopted by the Twenty-First Conference of the Parties of the United Nations Framework Convention on Climate Change (UNFCCC), (1) features a hybrid policy architecture, which combines top-down elements for monitoring, reporting, and verification, (2) with bottom-up elements, including Nationally Determined Contributions (NDCs) that specify what each country intends to do to reduce its emissions, taking into account domestic political feasibility and other relevant factors. (3) With this architecture, the Agreement represented a dramatic departure from almost two decades of negotiations prior to the Fifteenth Session of the Conference of the Parties in Copenhagen in 2009, (4) and thereby appeared to achieve a key necessary condition for ultimate success, namely adequate scope of participation, with participating nations accounting for approximately 97% of global greenhouse gas (GHG) emissions, (5) in contrast with the Kyoto Protocol (current, second commitment period), which accounts for 14% of global emissions from participating nations with quantified targets. (6)

   The other key necessary condition for ultimate success of this new approach is adequate, collective ambition of the individual NDCs, including net emissions reductions that would put the world on a path toward achieving the global goal of limiting temperature increases to well below 2 degrees Centigrade. (7) A central question is how to provide a structure, incentives, or both that will facilitate increases in ambition over time. International linkage of regional, national, and sub-national policies can be an important part of the answer.

   By linkage, we mean a formal recognition by a GHG mitigation program in one jurisdiction (a regional, national, or sub-national government) of emission reductions undertaken in another jurisdiction for purposes of complying with the first jurisdiction's mitigation policy. (8) Linkage can be very straightforward, as with the bilateral recognition of allowances under two cap-and-trade regimes, (9) but linkage can also take place among a heterogeneous set of policy instruments, such as between systems of performance standards, carbon taxes, and cap-and-trade. (10)

   Leading up to the Paris Agreement, linkage was a core focus of one key track of international climate negotiations, namely the Framework for Various Approaches (FVA), which originated at Thirteenth Session of the Conference of the Parties in Bali, Indonesia in 2007. (11) One challenge for negotiators in Paris was to ensure that the Agreement they reached would facilitate the growth and operation of international linkages, and, at a minimum, not put in place inappropriate or excessive rules that would obstruct effective, bottom-up linkage. (12) This was achieved with Article 6 of the Paris Agreement, (13) which recognizes that some Parties (14) to the Agreement "choose to pursue voluntary cooperation in the implementation of their nationally determined contributions" through "the use of internationally transferred mitigation outcomes." (15)

   A challenge now for jurisdictions around the world considering international linkages, as well as for those preparing guidance for the implementation of the Paris Agreement, is the substantial degree of heterogeneity that characterizes climate policies along three dimensions: different types of policy instruments, different levels of political jurisdictions implementing those policies, and different types of targets. Our purpose is to consider such heterogeneity among policies, and identify which linkages of various combinations of characteristics are feasible; of these, which are most promising and what accounting mechanisms (under Article 6) would make the operation of respective linkages consistent with the Paris Agreement. After a failed attempt in December 2018 in Katowice, Poland, to reach consensus on operational details for Article 6, Parties to the Agreement are scheduled to adopt such guidance at the Second Session of the Conference of the Parties serving as the Meeting of the Parties to the Paris Agreement (CMA) in Santiago, Chile, in November 2019. (16)

   To be clear, there are thus three conceptually--and operationally--distinct aspects of international policy linkage: 1) provisions in Article 6 of the Paris Agreement and related guidance that can facilitate international linkage, by providing--for example--for Internationally Transferred Mitigation Outcome (ITMOs) to be used as an accounting mechanism when "compliance" with NDCs is measured; 2) agreements between two jurisdictions (Parties to the Paris Agreement or possibly sub-national jurisdictions) to recognize emission reductions generated in the other jurisdiction; and 3) two or more compliance entities, with at least one in each of the linked jurisdictions, engage in an exchange, such as with allowances moving between two cap-and-trade systems.

   The Article is organized as follows. In Part II, we briefly review the arguments for linkage. In Part III, we examine the various options that exist under the major types of policy heterogeneity, relating these to the current status of climate policies around the world and to the actual NDCs submitted under the Paris Agreement. In Part IV, we identify five key cases of potential climate policy linkages, and examine each of these from a physical, economic, and legal perspective. Then, in Part V, we conclude by drawing on our analysis to identify common threads, lessons, policy implications, and pending questions still to be answered.

2. WHY IS LINKING IMPORTANT?

   The major economic argument for linkage is cost effectiveness, meaning the ability to achieve a given level of emission reductions at the lowest cost to society. Since a major impediment to ambitious climate policy is concern about the economic cost of mitigation, any policy that can lower the cost of mitigation should lower political resistance to ambitious policy. (17) We explain and demonstrate in Appendix 2 how equalizing the marginal cost of abatement across firms is a necessary condition for a globally cost effective policy.

   Linkage provides a mechanism to facilitate a shift of abatement activities from one country to another by allowing firms in the first country to count emission reduction efforts they facilitate in the second country towards meeting their own obligations (in the first country). (18) How this mechanism operates depends on the type of climate policy in effect in each of the linking countries, as we discuss below. (19)

   Thus, a major argument for linkage is the aggregate cost savings that linkage can bring about through convergence toward a common price of carbon--whether explicit with carbon-pricing instruments or implicit with other policy instruments--in the two linked jurisdictions. It has been estimated that international linkage could reduce the cost of achieving the emissions reductions specified in the initial set of NDCs under the Paris Agreement by 32% by 2030 and by 54% by 2050. (20) Another potential merit of linkage is improvement in the functioning of the individual markets through reduced market power and reduced total price volatility, although the link also potentially transmits price volatility from one jurisdiction to another. (21) Importantly, under the Paris Agreement's structure of voluntary statements of targets by each Party through its NDC, linkage holds promise of providing a means to achieve cost-effectiveness without sacrificing the UNFCCC's principle of common but differentiated responsibilities and respective capabilities. (22)

   Linkage also raises legitimate concerns, however, including the distributional impacts that will be felt in each jurisdiction, due to the presence of both winners and losers among individual firms and ultimately among different consumer groups to the extent changes in allowance prices are passed through to final consumers. For example, when allowance prices change (converge) in two linked cap-and-trade systems, firms that are...