progressing towards post - 2012 carbon markets

6

Disclaimer
The findings, opinions, interpretations and conclusions expressed in this report are entirely those of the authors and
should not be attributed in any manner to the UNEP Risø Center, the United Nations Environment Program, the Technical
University of Denmark, nor to the respective organizations of each individual author.
UNEP Risø Centre
Systems Analysis Division
Risø National Laboratory for Sustainable Energy
Technical University of Denmark
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DK-4000 Roskilde
Denmark
Tel: +45 4677 5129
Fax: +45 4632 1999
www.uneprisoe.org
ISBN 978-87-550-3944-5
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FOREWORD
The transition towards low carbon development
and more broad based green growth are vital to
addressing some of the most pressing challenges
facing the global community, such as global warm-
ing and unsustainable use of natural resources.
Confronting the end of the first Kyoto Commit-
ment period in 2012 with no agreed outcome for
global cooperation on future emission reductions,
there is an urgent need to look for new opportu-
nities for public and private cooperation to drive
broad-based progress in living standards and keep
projected future warming below the politically
agreed 2 degrees Celsius.
Responding jointly to these global challenges the
United Nations Environmental Program (UNEP)
and its UNEP Risø Centre (URC) have in coopera-
tion with the Global Green Growth Institute (GGGI)
prepared the Perspectives 2011. The publication
focuses on the role of carbon markets in contribut-
ing to low carbon development and new mecha-
nisms for green growth, as one core area of action
to address the challenges noted above. Under the
title of ‘Progressing towards post-2012 carbon
markets’ the publication explores, how carbon
markets at national, regional and global levels can
be developed and up-scaled to sustain the involve-
ment of the private sector in leveraging finance
and innovative solutions to reduce greenhouse gas
emissions.
GGGI opened the first regional office in May 2011
at the Technical University of Denmark, where the
UNEP Risø Centre is located and this report repre-
sents a first collaborative effort.
Richard Samans John Christensen
Executive Director Head
GGGI UNEP Risø Centre
8

EDITORIAL
The absence of agreement on a second commit-
ment period for the Kyoto Protocol or another le-
gally binding agreement is creating uncertainty for
investors looking to invest in emissions reduction
activities all over the world. This year’s Perspec-
tives from UNEP and its UNEP Risoe Centre focuses
on the mushrooming of initiatives that are filling
the global vacuum while waiting for a post-2012
climate agreement. These may provide the building
blocks and lead the way for carbon markets in the
future. Local and regional initiatives have emerged
in countries like India, South Korea, China, Japan,
Australia, Brazil and others. Compared to the situ-
ation prior to negotiating the Kyoto Protocol, the
international community may find that it no long-
er shapes the global carbon market, but will need
to find ways of integrating the market fragments
that have already established themselves.
The current situation gives rise to a number of
questions. Is a global carbon market possible that
incorporates these diverse initiatives? If so, what
would it look like? How can carbon markets reach
their full potential and contribute to a significant
scaling-up of climate finance by 2020? Can bot-
tom-up approaches and voluntary markets help
us reduce greenhouse gas emissions sufficiently
to keep global warming below 2 degrees Celsius?
How will existing mechanisms evolve, and how
will new instruments operate: independently, or as
part of an integrated global carbon market? Do the
new instruments constitute a threat or an oppor-
tunity for carbon markets?
Ten articles in Perspectives 2011 address these
questions. Durando Ndongsok shares experiences
from the CDM in Africa and takes a critical look
at the perspectives for CDM and future mecha-
nisms in Africa, despite a preferential status in
the EU ETS post-2012. Christian Egenhofer con-
tends that the future European carbon market is
unlikely to induce noticeable demand while it still
remains the backbone of global carbon markets.
The carbon credit overhang may seek towards the
voluntary markets that are experiencing a new dy-
namism, as described by Dinesh Babu, or it may
wait for a scaled-up cost-efficiency mechanism
like the sectoral crediting approach, as suggested
by Wolfgang Sterk. Meanwhile the USA and Canada
are lagging behind on carbon trading, as both Rob-
ert Stavins and David Sawyer describe, while at the
same time experiencing a significant fragmenta-
tion of the emissions-related markets within their
borders. Axel Michaelowa argues that fragmen-
tation comes at a cost and maintains that a top-
down regime remains the preferential outcome
of the negotiations. But fragmentation is already
becoming a reality in China, a rapidly rising new-
comer in the exclusive group of countries that, as
described by Wei Lin, Hongbo Chen and

Jia Liang
Editors: Søren Lütken (snlu@risoe.dtu.dk)
and Karen Holm Olsen (kaol@risoe.dtu.dk)
9

is seeking to establish its own national carbon-
trading markets. Therefore, as Kishan Kumarsingh
describes, the role of the UN is fast becoming that
of the ‘coordinating entity’ of a global programme
of activities, the diversity of which is threatening
the liquidity of the global carbon market unless a
regulator assumes the task of ensuring compat-
ibility. Finally, there is still the chance that Durban
will provide the breakthrough and deliver a suite
of new GHG market instruments, as Andrei Marcu
suggests, that will ultimately go beyond off-setting
and mean the beginning of up-scaled carbon mar-
kets, with additional benefits for the atmosphere.
Perspectives 2011 is organized into three inter-
related sections covering policy, existing instru-
ments and new instruments. The first section is a
collection of articles presenting the range of policy
responses from a number of essential players – the
EU, China, the USA and Canada, and not least the
UN in a potentially coordinating role. The second
section discusses perspectives for existing mar-
kets and mechanisms, in which the CDM and its
recent adjustments and additions may inspire the
structuring of future instruments, while the volun-
tary market, free from top-down regulation, may
also explore other less compliance-related cor-
ners of emissions-reduction markets and indeed
inspire the development of new approaches. Such
new approaches are the focus of the third section,
in which sectoral crediting and new market mecha-
nisms are the main concepts being promoted in
the negotiations.
Paradoxically, while many seem to be on the look-
out for something new to follow the Kyoto flexible
mechanisms, the CDM is thriving. Never has the
number of new projects entering into validation
on a monthly count been higher than now, reach-
ing over 200. Of course, part of this is an End of
Business syndrome, but a more positive interpre-
tation is that it provides evidence for an invest-
ment momentum that is unlikely to come to a halt
overnight. Thus, what the current market has done
above anything else is to ensure that there is a
common understanding of the issue and a global
drive to find ways to keep rewarding the pursuit of
emission reductions.
Acknowledgements
Perspectives 2011 has been made possible thanks
to support from the Global Green Growth Institute
(GGGI) (www.gggi.org), which opened an office on
the DTU Risø Campus in Denmark in 2011. The
Perspectives series started in 2007 thanks to the
multi-country, multi-year UNEP project on Ca-
pacity Development for the Clean Development
Mechanism (CD4CDM), funded by the Ministry of
Foreign Affairs of the Netherlands. Since 2009,
Perspectives has been supported by the EU project
on capacity development for the CDM in African,
Caribbean and Pacific countries (ACPMEA). A wide
range of publications have been developed to sup-
port the educational and informational objectives
of capacity development for the CDM with the aim
of strengthening developing countries’ participa-
tion in the global carbon market. The publications
and analyses are freely available at www.cd4cdm.
org, www.acp-cd4cdm.org and www.cdmpipeline.
org
Finally, we would like to sincerely thank our col-
leagues in UNEP and the UNEP Risø Centre, par-
ticularly Maija Bertule, Jørgen Fenhann, Mauricio
Zaballa, Kaveh Zahedi, John Christensen and Mette
Annelie Rasmussen, for their support in the edi-
torial process, including administration, outreach
and communication.
The UNEP Risø Centre
Energy and Carbon Finance Group
10

Supporting low-carbon development in developing
countries, UNEP and its UNEP Risø Centre (www.
uneprisoe.org) have a leading role in analytical
development and capacity building for the CDM
and NAMAs and are well positioned to support the
development and implementation of mitigation
actions in developing countries. A core thematic
focus is to help developing countries pursue de-
velopment objectives using carbon finance to pro-
mote renewable energy and energy efficiency. The
group consists of about fifteen staff coordinated
by Miriam Hinostroza: milh@risoe.dtu.dk.
11

Section 1
Policy
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13

Fragmentation of international
climate policy – doom or boon
for carbon markets?
Abstract
After Copenhagen and Cancun, fragmentation of
carbon markets is in full swing, with the EU and
Japan actively dismantling the role of the CDM
as “gold standard” currency of the global carbon
market. While some political scientists argue that
fragmentation could be advantageous for the
climate negotiations, economists see it nega-
tively, as it drives mitigation costs upwards and
leads to a hodgepodge of rules with high transac-
tion costs. The voluntary market as a laboratory
for fragmentation has shown that high-quality
credits are restricted to a tiny share, prices vary
by several orders of magnitude and registries as
well as verification standards have proliferated.
Thus fragmentation should be resisted as far as
possible.

The rise and fall of centralized
international climate policy
Anthropogenic global climate change is one of the
biggest challenges for mankind entering the 21
st

century due to its particularly “nasty” policy char-
acteristics. Mitigation of greenhouse gases has the
character of a global public good whose benefits ac-
crue to everybody while costs have to be borne by
the entity financing the mitigation activity. In con-
trast to other public goods such as public security,
benefits from climate change mitigation do not ac-
crue immediately, but only in the future, and the
level of benefits is contested. For some actors, e.g.
people living in high latitudes where climate change
increases agricultural productivity (see Yang et al.
2007), mitigation of climate change might actually
not be desirable. Moreover, given the uncertainty
surrounding climate change impacts, people might
prefer to “wait and see”, and eventually call for gov-
ernment help if impacts actually occur.
Axel Michaelowa
University of Zurich
Perspectives
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After two decades of increasing visibility and sali-
ence, international climate policy is at a crossroads.
Hitherto, climate policy had followed a path of in-
creasing centralization and coordination, climbing
up a ladder of increasingly detailed international
agreements. Climate negotiators had the general
impression to follow in the footsteps of ozone di-
plomacy, where a generic framework treaty was
strengthened over time by specific treaties, ratchet-
ing up emissions commitments as well as resource
transfers from industrialized to developing coun-
tries to fund emissions mitigation. With the UN
Framework Convention of Climate Change agreed
in 1992, the Kyoto Protocol negotiated in 1997 and
the Bali Plan of Action agreed in 2007 on the prin-
ciples of a post-2012 climate regime, the Montreal
Protocol precedent seemed to be a perfect fit.
Of course, game theorists (Barrett 1998) and po-
litical science realists (Victor 2001) had long stated
that the free riding induced by the global public
good characteristics of climate policy would lead
to a failure of a centralized international approach.
They had seemed to triumph already in 2001 when
US president Bush repudiated the Kyoto Protocol.
But then the rest of the world rallied to defend
the Kyoto approach, and the Protocol entered into
force in 2005. 2007 brought the consecration of
climate policy as an issue of highest global impor-
tance with the award of the Nobel Peace Prize to the
Intergovernmental Panel on Climate Change and Al
Gore. Everything seemed on track to culminate in a
glorious event that would lead international climate
policy in its third decade and set up a really global
climate regime – the Copenhagen climate summit
of late 2009.
But fate intervened by unravelling the real estate
bubble in the US. By mid-2009 policymakers in
countries previously proud of their role as climate
policy pioneers were struggling to keep their econo-
mies afloat. Hopes of the US playing the role of a
climate policy frontrunner evaporated after Con-
gress failed to pass a comprehensive emissions
trading bill. Those advanced developing countries
that had weathered the storm well were not really
eager to take up the role of greenhouse gas miti-
gation pioneers. Instead, they discovered climate
policy as a field where they could assert their newly
won economic power and defy industrialized coun-
tries through a new negotiation group called BASIC.
This explosive cocktail derailed the Copenhagen
negotiations, with things made worse by the host
country’s inept handling of the summit. What was
hoped to be the herald of a new era of global co-
operation on climate change mitigation dissolved
into a glimpse into the abyss of a fragmented cli-
mate policy with each country just doing what it
felt to be appropriate, without any comparabil-
ity or transparency of mitigation efforts. While
through last minute attempts the abyss was pa-
pered over by the “Copenhagen Accord”, it became
quickly visible that Copenhagen heralded a sea
change in climate policy. Ever since then, interna-
tional climate policy faces the inconvenient truth
of fragmentation, even if hidden behind many
smokescreens of UNFCCC language and “success-
es” in negotiations such as Cancun in 2010.
Why fragmentation of climate policy
is a bad idea
Biermann et al. (2007, p. 8ff) discuss pros and
cons of fragmentation from a political science
view. In their view, fragmentation could lead to
faster agreements among frontrunners and avoid
watering down of commitments. Moreover, it
would allow side payments and allow to involve
non-state actors as well as solutions tailored to
specific circumstances. Competition between dif-
ferent approaches could lead to innovation. Os-
trom (2010) argues that bottom-up “polycentric
efforts” could lead to a situation that is better than
an ineffective centralized regime. However, many
15

of the arguments do not fully fit to the current
regime, as it allows for differentiation of commit-
ments, side payments through climate finance and
voluntary non-state action. According to Biermann
et al. (2007) the disadvantages of a fragmented ap-
proach include less potential for package deals,
lack of fairness, incentives to engage in a race to
the bottom and lack of transparency.
From an economist’s viewpoint, the disadvantag-
es dominate. Due to the characteristics of green-
house gas mitigation as a global public good, it is
economically ideal to agree on emissions targets
globally and to harness the cheapest mitigation op-
tions through market mechanisms. While simple
marginal abatement cost curves as reported by Mc
Kinsey need to be treated with caution (see Ekins
et al. (2011), and the dynamic effects of mitigation
policies need to be considered when comparing
measures, experience from the Clean Development
Mechanism has shown that it was able to mobilize a
significant volume of low-cost reductions, but also
higher cost ones (Castro 2011). The effect of frag-
mentation will be that overall emissions mitigation
effort will be lower than required by the 2°C target
acknowledged both in the Copenhagen and Cancun
agreements (Kartha and Erickson 2011 summarize
all relevant studies and conclude that the tempera-
ture rise would be in the interval 2.5°C to 5°C) . This
is even acknowledged by realists, Carraro and Mas-
setti (2010) propose wryly to use 50 billion $ to buy
mitigation in developing countries in order to close
the effort gap. They do not realize that under a
fragmented approach, there is no incentive for any
country to spend huge sums on mitigation abroad.
A comparison of modelling studies show that any
fragmentation of mitigation action will unequivo-
cally lead to mitigation cost increases (Hof et al.,
2009). This is the case in any configuration of mar-
ginal costs. In a fragmented world, carbon prices
will differ and even if there is “linking” of different
jurisdictions (Flachsland et al. 2009), transaction
costs will occur. Further negative effects are car-
bon leakage, i.e. the increase of emissions outside
a group of countries that mitigates emissions due
to the reduction of fossil fuel prices caused by the
mitigation action (Sinn 2008). Fragmentation of
market mechanisms will deter financial institu-
tions which need a minimum turnover and stabil-
ity to enter a market. In a fragmented market, sell-
ers of credits will be at the mercy of each single,
unique buyer for specific types of credit while cur-
rently, international competition protects sellers
against overly greedy buyers. While some buyers
would look for high-quality credits, as done by the
EU today, there would probably be a “race to the
bottom” in order to minimize costs of complying
with the pledge.
How does a fragmented climate policy
world look like?
The key characteristics of the centralized world
of the Kyoto Protocol regime and their counter-
parts under a fragmented regime are shown in
Box 1.
Often, a fragmented system is seen as equal to a
“pledge and review” system, which was first pro-
posed by Japan in the early 1990s and has resurfaced
from time to time. However, the review element still
needs to be based on some common ground, which
would lack in a fully fragmented system.
A full fragmentation would mean that all countries
define their climate policy unilaterally. While even
in the bleakest scenario, the UNFCCC would persist,
it would uniquely provide rules for reporting of na-
tional greenhouse gas inventories. So some degree
Fragmentation of mitigation action will
unequivocally lead to mitigation cost
increases.

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