The Future of the Global Carbon Market Beyond 2012

As one of its key features, the Kyoto Protocol introduced market mechanisms in order to achieve climate targets at the lowest cost. Instruments like emission trading, the Clean Development Mechanism and Joint Implementation have established markets for emission reductions worldwide. These instruments owe their existence to the Kyoto Protocol. However, the current commitment period of the Kyoto Protocol expires in 2012, and the prospects for an immediate successor agreement remain bleak. The 16th edition of Climate Talk discussed what this situation entails for the market mechanisms, and what measures the affected firms can take to deal with the uncertain outlook.

The so-called "flexible mechanisms" of the Kyoto Protocol - i.e. Joint Implementation, the Clean Development Mechanism and emissions trading - were established to involve private actors in the implementation of international climate targets. By setting a price for carbon emissions and allowing for trade among different actors, these mechanisms established economic incentives for emission reductions and created markets to trade such reductions. However, the first commitment period of the Kyoto Protocol runs out at the end of 2012. Although the international climate negotiations recently saw some signs of progress at the last negotiation round in Cancun, it looks less and less likely that a second commitment period will be agreed before the current one expires. A gap between the current and the next trading period would thus seem a realistic possibility. Given this situation, the Climate Talk discussed the possible consequences of such a gap in the flexible mechanisms, in particular, the Clean Development Mechanism.

The opening input statements were given by Sonja Butzengeiger (Perspectives), Rainer Durth (KfW) und Thomas Forth (Ministry of the environment).

Sonja Butzengeiger described the outlook for continued emissions trading from a business perspectives. To get companies to invest in CDM beyond 2012, above all else, they need to have clear signals that the CDM will continue to operate, and that the carbon price will be sufficiently high to warrant further investments. However, firms differ in their assessment of the current situation: whereas small businesses will primarily use the carbon market to fulfill their legal obligations (compliance), larger companies tend to consider the carbon market from a strategic perspective. Second, the regulatory regime for CDM needs to remain reliable and predictable. The current, cumbersome administrative procedures are in need of reform in order to speed up the process of registering CDM projects. Third, the existing uncertainty about the period after 2012 does impose an obstacle for the CDM, and the outcome of the Cancun negotiations did not do much to reduce this uncertainty. Currently, signals for the post-2012 period are set by the bilateral activities of major players like Japan, rather than through the multilateral negotiations. As for the new concepts discussed in the multilateral climate negotiations - sectoral mechanisms and NAMAs (nationally appropriate mitigation actions), it is still very unclear how they will work and how they could fit in with the current CDM regime.

Rainer Durth of the state-owned KfW Bank predicted a growing significance for climate funds that purchase emission reduction certificates from international projects. While the carbon market has seen a dynamic development in recent years, there is still much room for improvement. The KfW's climate protection funds has therefore been set up specifically to address and overcome market imperfections, such as lack of access to carbon markets or the spreading of risks. In addition, the supported projects are expected to contribute to broader development objectives beyond emission reductions. To the buyers of certificates, such funds can be valuable in that they reduce transaction costs and spread risks across different projects, while suppliers will benefit from longer-term purchasing agreements. In this way, funds can help to hedge risks for both sides. For the future, programmatic approaches and sectoral projects offer interesting opportunities, moving beyond the current focus on large point-source emitters. Since the uncertainties in this market will be high in the initial phase, state-supported funds such as the KfW's will continue to have a role also beyond 2012.

Thomas Forth of the Federal Environment Ministry described the challenges from a policy perspective. The slow progress of the international negotiations is problematic for the development of an international carbon market in different ways: for instance, the problem of surplus AAUs in Eastern European countries remains unresolved, and with it the challenge of creating scarcity of emission allowances and sufficient incentives for investing into climate protection. The future of the Joint Implementation mechanism is currently uncertain, as this instrument has failed to deliver a satisfactory number of projects and allowances. At least for the CDM, the Cancun negotiations have brought some momentum and resulted in a number of concrete tasks, such as greater transparency in the CDM executive board and a more even geographic distribution of the CDM projects.

The ensuing discussion touched upon a number of technical and political issues surrounding the reform of the CDM. It became clear that strong and credible political targets are needed from policy makers, to allow the carbon market to respond to these signals. The lack of clear signals for the period beyond 2012 is problematic, as it does not give investors a solid basis on which they could base their expectations. The discussion also touched on the fact that CDM is currently concentrated on a small number of countries, and explored options how a broader participation could be achieved, particularly from African countries. In particular, the issue emerged whether public funds are more effectively used to support the development of carbon markets in these countries or to directly support climate-related projects.

The Climate Talk was concluded in a nearby restaurant, where the discussions of the evening where continued in an informal setting. Climate Talk is a platform for experts to discuss the current political, legal and economic issues surrounding climate protection. It is convened by Dr. Camilla Bausch and Benjamin Görlach of the Ecologic Institute, and Dr. Susanne Dröge of the German Institute for International and Security Affairs (SWP). The event on 15 December was hosted by the SWP and chaired by Susanne Dröge.