In the absence of a coordinated global emissions market, a number of self-contained regional carbon-trading programs have formed that independently establish, track, and cancel their own compliance permits. In order to increase the cost-effectiveness, liquidity, and stability of these markets, the entities that control them may choose to link programs together in a framework that allows permits to be unilaterally or bilaterally accepted across joined systems.
Conversely, these programs can also be severed from one another and dismantled. New Jersey delinked from RGGI and ended its state carbon compliance in 2011, and Australia’s new government recently abolished its carbon pricing program even before it could be linked with the EU’s Emissions Trading System. The termination of links between regional carbon markets—as well as the possibility that a program will be delinked in the future—can have significant impacts on their performance, especially when permits from these programs are banked for use toward future compliance obligations.
Because even speculation about the future fate of a linked program can affect current market outcomes, it’s important to consider the possibility of delinking during the design stages for regional carbon markets. In a new RFF discussion paper, “Terminating Links between Emissions Trading Programs,” we explore whether key choices about delinking and the handling of banked permits can improve market outcomes when links between carbon programs are—or are at risk of being—severed. Our analysis features a two-region model where markets are first linked together, such that permits from either region can be used to comply with emissions regulations, then delinked under an asymmetric (banked permits return to the region that issued them) or symmetric (banked permits are split between participants) policy.
In general, we found that costs will rise when markets are delinked and prices can diverge even before delinking occurs. However, using a symmetrical policy to deal with the market’s banked permits dampens cost increases and prevents price divergence before they separate. In comparison, an asymmetric policy brings higher abatement costs along with the possibility of price divergences before separation occurs. Most importantly, these trends remain the same whether the delinking of the two carbon markets is real or speculative. This final conclusion should be a strong indicator for policymakers that provisions for delinking markets should be considered when links are initially established, as future uncertainty about possible delinking could otherwise be detrimental to each of the systems involved. This points to a general need to consider the necessary evolution of market-based policies when designing and evaluating such policies.
