Linking the EU ETS with California’s Cap-and-Trade Program: A law and economics assessment

To date, no linking has taken place between emissions trading systems from different continents. This paper aims to evaluate the legal barriers and policy obstacles to linking the European Union Emissions Trading System (EU ETS) with California’s Cap-and-Trade Program in the United States, and to identify potential legal solutions to overcome them. A qualitative law and economics analysis is performed by combining the legal-dogmatic method with insights from economic theory. Primary sources are the respective legal frameworks, ETS regulations, past linking agreements and relevant case law, while secondary sources include the relevant legal and economic literature, as well as policy documents, reports and press releases. Due to constitutional constraints for California, an EU - California linkage of emissions trading systems is legally feasible on the basis of an informal agreement, through reciprocal amendments to the respective ETS regulations. This would require a majority approval via the ordinary legislative procedure in the EU and the approval of the state’s Governor upon California Air Resources Board’s notification in California. In addition, consent of the current linking partners, Switzerland and Québec respectively, is also needed. Potential barriers to linking the EU ETS and California’s Cap-and-Trade Program could emerge, in particular from misaligned provisions regarding offsets and, especially, price containment measures. Strengthening California’s Monitoring, Reporting and Verification (MRV) framework for offsets, potentially accompanied by the cooperative application of advanced monitoring technologies, can help alleviate this obstacle. The misalignment of price containment measures may present a greater challenge. California’s hard price ceiling may be considered to contradict with the EU’s political desire and legal requirement for an absolute emissions cap, as it can potentially lead to excess emissions. The absence of a minimum auction price in the EU ETS, on the other hand, could undermine the functioning of California’s allowance price floor. Reforms in each ETS can be considered, which come at a cost but will also generate benefits, including the prospect of a linked and thus larger ETS market with more abatement opportunities. Such reforms may include the introduction of a price collar in the EU ETS and the application of a maximum limit to California’s hard price ceiling. Their gradual implementation, possibly in conjunction with the initial establishment of a restricted linkage, could provide the required impetus for transcending the identified barriers. This largely depends on the political determination of both jurisdictions to accrue the expected advantages by aligning their ETS design differences. If successful, such a transatlantic linkage could enhance the cost-effectiveness of climate policy and inspire a bottom-up expansion of carbon markets worldwide. Co-author: Edwin Woerdman, e.woerdman@rug.nl.