Negotiators at the recently concluded (and utterly uninspired) international climate change talks in Warsaw, Poland were able to agree on very little. One bright spot may have been consensus on the need to retool international carbon market mechanisms as part of a future global climate agreement and also to use global carbon securities to help close the pre-2020 emissions ambition gap. Perhaps this consensus is unsurprising given that carbon markets are growing in popularity around the world (albeit not in Washington). In fact, carbon markets will cover roughly 3 billion people and a major share of the world’s economy by 2015, despite some high-profile backsliding in Australia. This growth is a good thing.
Carbon markets are catalyzing climate action across the world in both developed and developing economies and have already directed billions toward clean energy investments in developing countries. In fact, as our recent study shows, developing countries that were the first to participate in carbon markets a decade ago are racing ahead on climate action now.
Despite the Warsaw consensus, the international community is missing a huge opportunity to strengthen carbon markets now. Like the national economies they mirror, global carbon markets today are struggling, mainly as a result of the financial crisis but also on account of successful climate regulations that have reduced pollution enough to limit demand for carbon offsets. Carbon market prices in Europe, for example, are down an astonishing 85 percent from their 32-euro high. Some experts predict the glut of carbon market securities continuing for some time.
This oversupply of low-cost but valuable carbon credits is an anomaly in a world of rising carbon prices. Nations should join together to buy up these inexpensive credits and use them to establish an international carbon market reserve with the authority and mandate to manage the supply of global carbon market securities when prices rise or fall to extremes. Somewhat like a central bank, the reserve could sell today’s global carbon credits when prices rise in the future to reduce price spikes and then use the proceeds to buy credits and resupply when prices fall again. Reducing extreme price volatility would provide more stable financial flows to least developed countries for investments in renewable energy, energy efficiency and climate-friendly land-use. If governments do a better job of maintaining strong carbon markets in the future, the reserve could sell excess credits for cash (rather than maintaining a price floor function) to generate new financing—perhaps billions of dollars—to build resilience to the adverse effects of climate change in developing countries.
As we noted in December in our Brookings Global Economy and Development working paper with Cecilia Springer, an international carbon market reserve of 600 million tons of carbon securities could fundamentally change the volatility dynamics of the global carbon market. At that size, the reserve could eliminate global carbon price spikes in the early years of the emerging post-2020 climate policy period (when the world has agreed to have a new climate agreement in place). Such a reserve could reduce price spikes by as much as 40 percent.
Even in this age of growing fiscal austerity, nations could act on this recommendation at little cost. In today’s depressed carbon market, stockpiling 600 million tons of clean development mechanism (or “CDM”) credits would cost the international community at most $600 million and would represent a substantial head start toward the larger reserve that might eventually be necessary. Our estimates suggest that by 2030, a reserve of this size would be worth about $14 billion in today’s dollars if managed correctly (buying low and selling high), counting both cash and the value of remaining global carbon securities.
More can and should be done now to build on the world’s growing reliance on carbon markets and ensure that the benefits of climate action accrue to low-income countries as well. Establishing an international carbon reserve could help do just that and in the process help safeguard future global carbon markets from the lackluster performance of the global carbon market in recent years.
Note: A version of this article appeared on Brookings Up Front.
Trading Up: The Case for an International Carbon Market Reserve to Reduce Volatility at the Limits in 2020 and Beyond
Climate policymakers face major challenges when designing future global carbon markets. On one hand, domestic carbon markets are currently spreading and linking rapidly around the world; carbon markets, and carbon pricing instruments in general, present the most flexible mechanism to create low-carbon economies. Yet today’s global carbon market is somewhat dysfunctional and highly volatile—characterized by dramatic changes in supply, demand, price, and public confidence. In this paper we make the case for one useful, albeit partial, solution: a new international carbon market reserve with the authority and mandate to adjust the supply of global carbon market securities when prices rise or fall to extremes. An international carbon market reserve could help nations temper likely swings in global carbon markets by increasing the supply of carbon credits when demand exceeds supply, and potentially reduce supply by purchasing credits when prices fall.