Linking Emissions Trading Schemes

Luke F. Gale

Sept 2015

The UK Parliament has considered the linking of disparate emission trading schemes and the idea will be considered at the upcoming climate summit in Paris.

Part of the problem with CO2 pricing is that oranges need to be compared with oranges. It’s difficult to compare CO2 pricing when it is denominated in local fiat currency. Fiat money is a form of sovereign risk, an IOU of a country’s central bank. Countries can reduce their debts to foreigners by devaluing their currencies. Denominating in US dollars or the Euro creates a distortion and introduces political risk if one considers that China has aspirations for its currency to be a global player. China is the greatest emitter of CO2.

For any linked global ETS all it takes is one province or state to set the lowest price first to get the thing rolling. This may be very low, say a few US cents or yuan per tonne of CO2. This will be a ‘critical mass’ moment. Where it goes from there – who knows?

Market forces should set the price from there.

Governments have to initially set this price because CO2 is a negative externality. It’s a lot easier, and less risky, for a government to do this, alone, if the price is very low. Everyone else will follow, in theory. But they have to do this with confidence.

The trick is for some global instrument to be invented that all countries feel is fair and just. It has to be beyond sovereign risk in a world where sovereignty matters. Each tribe has their own table of values. No one wants a “global E.U.”.

It has to operate separately from free trade agreements and tariffs.

It has to include all nations, however small, not just the biggest emitters.

It has to be efficient where trades are irreversible where no resort to any supra-national body or international court is possible. I fear that the mindset at the Paris summit is going in this direction.

It has to be beyond litigation, disputes, and even sanctions. The obvious reason for this is that the atmosphere is beyond sovereignty.

The number of instrumental units should have a cap.

There has to be some simple rule that instantly creates consensus, where every country instantly gets it. It might be that, like all of the best innovations, this instrument comes from the private sector, perhaps from left of field. The reason being that innovators have the motivation that they will be compensated for their intellectual property. The mechanism for this compensation can be built into the instrument. The task for the inventor is to maximise his compensation but only to the point that the market will bear – not more or less.

The instrument has to last for centuries rather than decades.

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