Sinks, emissions intensity caps and barriers to emissions trading

The European Union (EU) has raised concerns about the use of sinks and an Emissions Intensity system in Canada and has decided not to allow sinks to be included in its trading system. Despite this restriction, the EU has shown interest in expanding its trading system to include other countries such as Japan and Canada, while Canada hopes to use sinks and a domestic trading system with an Emissions Intensity regulatory mechanism to meet its Kyoto GHG commitments. In this paper, we briefly discuss some of the implications of the Emissions Intensity regulations scheme, and then develop a simple credit model with trade to illustrate the effect of a trade ban put in place by the EU, first, when it is fully binding and second, when there are countries that can act to arbitrage both markets (e.g., Japan). We also look at the possibilities of using harmonization frameworks to control trade, as well as using a form of discounting with respect to Canadian credits. We show that it is highly unlikely that a trade barrier will increase the use of emission reduction (and decreased use of sinks), and that, particularly in the likely case that Canada will import credits, trade barriers will actually increase the use of sinks. We do find, however, that the use of discounting could serve as a possible policy alternative to increase the use of EU reductions, while decreasing the quantity oj Canadian sink credits.