A Model of International Transfers of Carbon Mitigation Outcomes: Analyzing the Impact of Article 6 of the Paris Agreement

Abstract

Problem Definition: Under the Paris Agreement, countries independently determine their contributions to help achieve the goals of the treaty. These ``nationally determined contributions’’ (NDCs) establish targets for greenhouse gas (GHG) emissions reductions. However, Article 6 (of the Paris Agreement) recognizes that it may sometimes be beneficial for countries to collaborate in reducing their joint emissions and proposes a mechanism called Internationally Transferred Mitigation Outcomes (ITMOs). ITMOs allow countries to transfer ``mitigation outcomes'', i.e., a reduction of emissions in one country can be credited to another. However, we lack a coherent theoretical framework for conceptualizing ITMO creation and implementation. In addition, the impact of ITMOs on domestic energy demands, prices, and other economic outcomes like total welfare within the participating countries are unclear.

Methodology and Results: In this paper, we present a theoretical and stylized model for the implementation of ITMOs between two countries, one producing a low carbon fuel and the other reliant on a high carbon fuel. We show that, under certain restrictions, low carbon fuel trade can benefit both countries. Furthermore, if a transfer of ITMOs is allowed, a higher amount of trade can be sustained to the benefit of all parties while still complying with emission caps. We also outline the impacts of ITMOs on domestic energy prices and the energy consumption mix in the two countries and show that appropriately designed ITMOs can lead to better economic and environmental outcomes for consumers and firms in both countries.

Managerial Implications: Our work also yields several operational implications with respect to the implementation of ITMOs. Specifically, we argue that ITMOs need not be priced and traded as commodities. Additionally, we show that ITMOs can lead to greater ambition in setting NDCs and incentivize low carbon innovation within countries.

Keywords: Carbon policy, sustainable operations, climate action

JEL Classification: C70,M20,Q30