Potential impact of the emerging CO 2 market : Building on the Costa Rican experience

Under the United Nations Framework Convention on Climate Change, the countries of the world have been debating climate change mitigation strategies for the past decade. In 1997, the strategy discussion was still ongoing. However, that year, at the Third Conference of Parties (cop-3) in Kyoto, a Protocol was agreed to (still in the ratification process at the time of this writing) that included provisions to allow countries to meet their reduction commitments by buying credits from other countries. Costa Rica has been a pioneer in developing and selling emission reduction credits. Deforestation is the second largest source of CO2 emissions to the atmosphere and forest growth absorbs carbon dioxide gases (CO2), which contribute to global warming. Costa Rica’s carbon credits come primarily from the conversion of cultivated fields and pastures into forests, as well as from the reduction of deforestation. In 1996 the country sold its first 200,000 tons of carbon emission reduction credits to Norway for us$10 per ton. However, in late 1997 when it tried to auction an additional 1,000,000 tons of carbon credits with a floor price of us$20 per ton, it received no bids. The country is currently evaluating its strategy. Preliminary results show that, depending on the final rules, regulations, and carbon prices, carbon trading is likely to promote the expansion of national park areas and to induce some farmers to switch from traditional agricultural to forest plantations and private forest conservation. These conclusions are very important for two reasons. First, more than 75% of the projects with CO2 mitigation potential from Latin American and African countries are forest-related. Second, forest projects constitute the least cost option of the emerging us$9 billion per annum carbon market between industrialized and developing countries. However, if the Intergovernmental Panel on Climate Change (ipcc) does not clearly recommend including forest projects in the overall climate change mitigation strategy, these projects are likely to be rejected by the Convention or remain 354     in limbo. Moreover, if forest projects are excluded, then fuel-switching projects in large developing countries like China and India will become the least cost options and will capture the bulk of the market, effectively limiting the participation of Latin American and African countries in climate change mitigation activities. Some background on global warming During the last decade, many scientists and policymakers became convinced that increased emissions of carbon dioxide or other “greenhouse gases” (methane, nitrous oxide, and related synthetic compounds) were contributing to the warming of the planet. These emissions had grown with industrialization, particularly from the burning of fossil fuels, such as coal and petroleum, to power industry; to heat, cool, and light homes and offices; and to transport goods and passengers. Deforestation is the second largest source of carbon dioxide emissions to the atmosphere after fossil fuel combustion. Several factors have made it difficult to reach an agreement on a global warming mitigation strategy. First, there is still substantial scientific uncertainty about the link between global warming and the so-called greenhouse gases. To many it seems obvious that the planet is warming. Proof comes in the form of receding polar ice caps and the 14 warmest years in recorded history all happening within the last two decades (temperatures have been recorded since 1866). However, it is still unclear whether warming is a long-term trend and to what extent the build up of greenhouse gases is contributing to it. The scientific models of climate change are so complex and sensitive that small and plausible differences in assumptions could significantly alter predictions about future temperatures. Second, the benefits of preventing global warming are in dispute. Concerned scientists forecast that rising temperatures will lead to massive coastal flooding, dramatic changes in crop yields, more violent storms, the extinction of species due to habitat loss, and other terrible results.Yet others argue that the world may adapt to rising temperatures without enormous suffering or cost, particularly if the temperature increase is not too extreme. Some models also indicate that global warming might help many parts of the world by increasing rainfall and extending growing seasons. Third, there is disagreement about how the burden of reducing greenhouse gas emissions should be shared among the countries of the world. Historically, industrialized countries have emitted the lion’s share of greenhouse gases; the United States alone has accounted for nearly 25%. However, the “business-as-usual” forecasts show that the proportion of emissions from developing countries will rise rapidly as they industrialize (see Table 1). Developing countries argue that they should not have to reduce their emissions below their current modest levels, and should be allowed some margin for growth. Industrialized nations are reluctant to bear the burden alone, however, or to make sacrifices that might encourage profligate emissions by others. The strategy debate has been further complicated by uncertainty as to how much it will cost to reduce emissions. Pessimists point out that sources of energy with low or no greenhouse gas emissions tend to be either fairly expensive (such as solar or wind power) or to present other environmental risks (such as nuclear power). Optimists argue that the costs of alternative energy sources and cleaner 1 Estimates of annual global emissions from deforestation range from 0.6 to 2.8 billion tons, compared to around 6.0 billion tons from fossil fuel combustion (Houghton 1991; Smith et al. 1993). 355 -,    - technologies would decline rapidly once businesses and households were given incentives. The potentially high costs of reducing emissions make tradable emissions credits more attractive. The basic idea is that every country will agree to reduce emissions by a certain amount and if countries that can reduce emissions at a relatively low cost are able to exceed their reduction commitments, they would be allowed to sell “credits” for the excess to countries where emissions reduction is more expensive. The United States successfully established a domestic market for emissions credits to help reduce sulfur dioxide emissions from power plants in the 1990s. The hope is that a similar market for greenhouse gas emission credits could reduce the cost of slowing global warming. International conventions on climate change The countries of the world took a key step toward a global agreement on climate change in 1988 when they established the Intergovernmental Panel on Climate Change () to assess the scientific, technical, and socioeconomic research on climate change. The ’ work helped convince many in the world community that the risk of global warming was serious enough to warrant action. This led to the United Nations’ Earth Summit in Rio de Janeiro in 1992. The Parties to the Rio summit approved the United Nations Convention on Climate Change, which called for the rollback of greenhouse gas emissions to 1990 levels and was later ratified by 165 countries. The Convention set no specific targets for individual countries, however, so its effect was more symbolic than practical. A subsequent summit in Berlin in 1994 also saw only limited progress. By 1997, however, concern about global warming had increased to the point that at the third Conference of Parties in Kyoto more specific measures were actual projected annual % change 1995 202