Developing a Sectoral New Market Mechanism

By Wolfgang Obergassel, Hans Bolscher, Jeroen van der Laan, Jelmer Hoogzaad and Jos Sijm

At the 2011 COP in Durban, Parties decided to establish a ‘new market-based mechanism’ (NMM) to promote mitigation across ‘broad segments’ of developing countries’ economies. So far, they have only defined some broad outlines of how it is to function. The Doha COP in 2012 identified ‘possible elements’ of the NMM to be addressed in the development of the NMM’s modalities and procedures but Parties have so far been unable to make progress on details. At last year’s COP in Lima and the recent session in Bonn, proceedings effectively stalled due to controversies about whether agreeing on details of the NMM at this point would prejudge elements of the Paris Agreement. Nonetheless, submissions by various Parties and groups of Parties such as the Environmental Integrity Group and the EU continue to advocate for the establishment of an NMM. For example, in its INDC, Switzerland explicitly indicated its intention to use the NMM for achievement of its post-2020 targets.

Our article in Climate Policy identifies available options for the NMM elements defined in the Doha decision and reviews these options against a number of criteria, including environmental effectiveness, economic efficiency, political and administrative efficiency, and others. On this basis, the article identifies options that are best suited to fulfil the main objectives of the NMM as decided at the Durban conference, namely, ‘to enhance the cost-effectiveness of, and to promote, mitigation actions’. In addition, the article analyses potential applications of the NMM for five country-sector combinations: the power sector in Chile and South Africa, the steel sector in Brazil, the refineries sector in Indonesia, and the cement sector in Vietnam. The analysis assesses the emission reduction potential that could be mobilized through the NMM as well as the institutional market readiness of the sectors.

Our analysis finds that, although there are often trade-offs, several design options recommend themselves for maximizing mitigation outcomes and economic efficiency. These include broad coverage, starting with indexed targets instead of absolute targets to enhance political acceptability and minimize the risk of over-crediting, keeping crediting/trading periods short to avoid long-term lock-in of low ambition, and establishing independent governance bodies nationally and internationally.

The examination of five country-sector combinations finds that lack of data and of institutions that could manage the NMM are key bottlenecks. In addition, the analysis reveals the existence of substantial no-regret reduction potential, suggesting that either the incentives to improve the efficiency of operations or the means to do so may be lacking, for example due to the existence of monopolies/oligopolies. Governmental capacity building and Nationally Appropriate Mitigation Actions (NAMAs) might be more appropriate in the short-term, preparing the ground for the adoption of market-based approaches at a later stage. For example, if a government has a preferential feed-in tariff for power generated with renewables, the NMM could help provide the financial means to increase the price differential with power from fossil sources or to increase the scope of the policy, either in terms of more expensive technologies or in terms of volume. Such a system would require less preparation than an entirely new programme because the institutional capacity is already largely in place.

Looking forward, the Paris Agreement will pose new issues for the NMM and market mechanisms in general. One key motivation of the NMM’s proponents was the desire to draw developing countries more strongly into global mitigation efforts. This objective may be deemed to have been overtaken by time, given that the Paris Agreement is envisaged to contain mitigation contributions from all Parties. The purpose of the NMM will therefore need to be recalibrated. The most recent submissions by the EU and the Centre for European Policy Studies (CEPS) suggest that the primary route for international emissions trading should be linking of domestic market-based systems. The NMM would in this view have a complementary role, covering countries that do not have domestic systems or do not meet eligibility criteria for linking their systems internationally.

Another aspect is that while the Kyoto Protocol’s Clean Development Mechanism (CDM) so far operates in an uncapped environment, in the post-2020 period, market mechanisms will to a large extent operate within the boundaries of countries’ contributions. In terms of accounting needs, market mechanisms operating in developing countries post-2020 will therefore be more similar to Joint Implementation (JI) than to the current CDM. If not properly accounted for, emission reductions could be claimed double, by both the host countries and by the credit buyers. Therefore, the Paris Agreement will need to contain clear provisions to prevent double-counting of emission reductions.

However, this may be easier said than done. If the pledges under the Cancún Agreements are an indication of what to expect, there may be a broad range of types of contributions under the Paris Agreement, including emission reductions relative to business as usual, intensity targets, low-emission development plans and strategies, sectoral mitigation plans and strategies, or individual policies and actions. How to reconcile transfers of emission units with some of these types of contributions is far from straightforward.

The work on how to operate market mechanisms under the UNFCCC is hence far from over.

Reflections on “Developing a sectoral new market mechanism: insights from theoretical analysis and country showcases”, by Wolfgang Obergassel (né Sterk), Hans Bolscher, Jeroen van der Laan, Jelmer Hoogzaad, Jos Sijm, published in Climate Policy, Vol. 15, issue 4.

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