Short-term impacts of carbon offsets on emissions trading schemes: lessons from the EU for the Paris Agreement

A post by Claire Gavard (ZEW Mannheim) and Djamel Kirat (University of Orléans, CNRS)

In 2015, the Paris Agreement established the Article 6.4 Mechanism, which makes it possible for activities contributing to emissions reductions in a host country to be used by another one to fulfil its national climate objectives. The exact design of the mechanism is still being negotiated. A paper that we recently wrote [1] sheds light on the short-term impacts of offsets on emissions trading schemes by conducting an empirical analysis of the EU experience in accepting credits from the Clean Development Mechanism for compliance in the European carbon market.

The study shows that the price volatility of offsets is largely driven by the price volatility of European allowances and that price shocks are mostly transmitted from EU allowances to offsets. However, before November 2011, knowing the credit price variations helps to better predict the allowance price variations while, after November 2011, it is the opposite. The existence of these two different regimes is explained by changes in expectations and restrictions regarding credits and their possible use for compliance in the EU.

This evidence of the possible existence of different regimes of interaction between emissions trading schemes and carbon offsets helps to draw lessons for the design of the new mechanism. Limits on the use of international credits in national or regional carbon markets mitigates the influence of the former on the latter but it also tends to reduce the value of offsets and hence their relevance for supporting climate related investments in developing countries.

Stricter conditions for the issuance of international credits are needed to improve their acceptability for compliance in emissions trading schemes. This would make the price of these credits rise and maintain their relevance for investment support. Even if this also increases the influence of offsets on national or regional carbon markets, stricter conditions for issuance are likely to strengthen the two types of policy instruments.

[1] This blog post is based on the article:

The views and opinions expressed in this post are solely those of the author(s) and do not reflect those of the editors of the blog of the project LIFE DICET.