By Catherine Leining, Policy Fellow at Motu Economic and Public Policy Research

In late August 2015, the Stockholm Environment Institute (SEI) released a study, accompanied by a letter in Nature Climate Change, reporting that 80% of the Kyoto Emission Reduction Units (ERUs) used by developed countries to help meet their climate change targets for 2008-2012 came from Joint Implementation (JI) projects with “questionable or low environmental integrity.” The authors concluded that JI may have contributed to increasing global emissions by 600 million tonnes of carbon dioxide equivalent compared to what would have happened otherwise. According to the Guardian, UN officials have confirmed the findings.

Some commentators have used these findings to call into question the use of international emission trading to help meet future emission reduction commitments, an issue that will be negotiated in Paris later this year. In this context, it’s important to recognise the fundamental role that weak national mitigation targets played in producing this outcome.

For example, in a post in Carbon Pulse, Mark Belton, Managing Director of Permanent Forests NZ, described what happened in the NZ ETS when the influx of ERUs led to a crash in emission prices and enabled post-1989 foresters and recipients of free allocation to benefit from arbitrage at the government’s expense. He wrote,

“Given the NZ ETS case study, what hope is there that ETS mechanisms, which are now the favoured mechanism around the world, will deliver emission reductions required to achieve the 450 ppm stabilisation target? It is a question that must be faced head on in Paris.”

It’s worth clarifying a few points in Belton’s post.
• First, ERUs were not the only culprit in the NZ ETS; firms also surrendered Certified Emission Reductions (CERs) issued under the Clean Development Mechanism (CDM) with low prices and variable integrity.
• Second, not all Kyoto units were tarnished, and some NZ ETS participants made the effort to source Kyoto units with higher integrity.
• Third, the arbitrage opportunities for both post-1989 foresters and free allocation recipients have now been closed, the first by abrupt legislation (see this post for more information) and the second by delinking the NZ ETS from the Kyoto market at the end of May 2015.
• Fourth, the NZ ETS was not the only destination for ERUs from 2012 to mid-2015, since over that period ERUs could still be used in the EU ETS and governments could continue to buy them for Kyoto compliance.

There are valuable lessons to be learned from what has happened with JI. Abandoning emissions trading is not one of them. The most important lesson for future negotiations is the value of ambitious mitigation targets with transparent reporting and international accountability that facilitate legitimate collaborative mitigation effort.

UNDERSTANDING THE PROBLEMS WITH JI

The JI mechanism was the developed-country equivalent of the CDM for developing countries: an opportunity for one country to undertake a new and additional emission reduction project and sell the reductions to another country to help it meet its national emission reduction target. The challenge in designing project-based mechanisms is how to ensure that their value to the atmosphere is comparable to that of reducing emissions under a national commitment backed by a sound greenhouse gas inventory.

Unlike CDM projects, JI projects were nested within the national GHG inventories of developed countries with binding targets. Each time the host government issued an ERU, it needed to cancel one of its Assigned Amount Units (AAUs) issued in line with its target. This meant that if any JI projects were credited inappropriately, the host government would bear a compliance cost to “make good” the units under its target but there would be no risk to the atmosphere. In this way, the “additionality” of ERUs was assured in relation to the overarching target.

Parties correctly identified a potential problem with this: what if the project’s host country didn’t comply with its target and/or didn’t provide an adequate inventory report? They solved this problem in the detailed rulemaking by creating two tracks for JI:
• under Track 1, the host government could self-certify its JI projects on the basis it expected to meet its national target with a credible inventory, and
• under Track 2, the JI projects would pass through an independent review process under UN oversight similar to that applied to CDM projects so it wouldn’t matter to ERU buyers if the host government did not deliver on its national target or inventory.

ERU sellers and buyers could choose their preferred track; 97% of ERUs came through Track 1, and these are the focus of the SEI study.

Parties failed to address a second problem: what happens if the overarching target by the project’s host country is not additional to business as usual in the first place? The negotiated 2008-2012 Kyoto targets for several Eastern European countries – most notably Russia and Ukraine – failed to account appropriately for “hot air” emission reductions reflecting economic collapse rather than mitigation. SEI found that some of these countries issued self-certified ERUs on the basis of weak national targets combined with flawed project accounting methodologies and, in some cases, perverse incentives for project developers to increase emissions in order to earn units for reducing them. Other countries have then bought those units as offsets and emitted against them.

The study’s authors conclude this has enabled global emissions to increase above what might have happened otherwise if those ERUs had not been sold. This conclusion is somewhat contestable; under the Kyoto rules, the equivalent number of units could have been sold or banked in the form of surplus AAUs, producing the same increase in global emissions. The emissions increase identified by the authors should not breach the limit that was negotiated for 2008-2012, assuming that all Kyoto developed-country Parties deliver on their targets as expected (this assessment is underway).

Under a better environmental outcome, countries with “hot air” targets would have voluntarily increased their target ambition and cancelled the surplus, ensuring any traded ERUs or AAUs were additional to business as usual, or buyers would have rejected surplus Kyoto units from those countries in any form.

A key point to remember here is that all Kyoto Parties agreed to the “hot air” targets allocated to some Eastern European countries in the first commitment period. Those targets were not a secret or a surprise; they were the price of the negotiations at the time. The EU as a whole benefited from “hot air” within some of its own Member States. The collective ambition over 2008-2012 declined further when the US failed to ratify the Kyoto Protocol.

IMPLICATIONS FOR UPCOMING CLIMATE NEGOTIATIONS

Fundamentally, JI fell victim to low mitigation ambition and short-term self-interest by both sellers and buyers. The problem wasn’t the mechanism of trading, but what was being traded.

The bottom line for the climate is that achieving the two-degree global goal requires committing to ambitious mitigation pathways that will shift the world toward a zero-net emission economy. Mobilising financing at unprecedented speed and scale to support mitigation where it is most cost-effective will require leveraging the full power of markets operating at the scale of sectors.

Emissions trading can be an effective part – although certainly not all – of the mitigation solution, but only if it is implemented within an enabling framework of ambitious targets, transparent reporting, and international accountability. Creating that framework is the key step that needs to be taken in Paris this year.

This post was originally published in the blog New Zealand’s Low-Emission Future.