With the support of the California-based EPRI, UCCEE assisted Erik Haites, from Margaree Consultants in a project, which tested those liability provisions that have been put forward to foster the compliance of the Kyoto Protocol.

Background and Purpose

Annex I Parties will have emissions limitation commitments for 2008-2012 under the Kyoto Protocol. Annex I Parties whose actual emissions are lower than their commitments can sell the rights to the additional emissions (assigned amount units or AAUs) to other countries through international emissions trading (IET) or joint implementation (JI). Some governments are concerned that these mechanisms will encourage countries to sell AAUs they will subsequently need for compliance purposes (overselling).

A number of countries and non-governmental organisations have proposed rules for international emissions trading and joint implementation that are intended to deter non-compliance by Annex I Parties in the form of overselling. These rules are commonly called "liability" provisions. The purpose of the study is to develop a simple model to compare the liability proposals in terms of their impact on how well they can bring the Kyoto Protocol into compliance, and at what cost.

Compliance under the Kyoto Protocol

The compliance regime for the Kyoto Protocol is still being developed. It will deal with a number of compliance issues including inadequate emissions inventories and failure to achieve the national emissions limitation commitment. The rules governing the international emissions trading and joint implementation may also include compliance-related provisions, such as eligibility to use the mechanisms and the procedures to deal with disputed transactions.

Under the Kyoto Protocol each Party accepts responsibility for meeting its commitments. Thus, each Annex I Party is responsible for meeting its national emissions limitation commitment even if it sells AAUs to other countries. Penalties for non-compliance with the emissions limitation commitment could include financial penalties, reduction of Assigned Amount in next commitment period, trade sanctions, or limits on ability to acquire or transfer AAUs.

Historically, however, penalties for non-compliance with international agreements have been weak or difficult to enforce. Concerns that the rewards from the sale of AAUs may exceed the effective penalties for non-compliance have prompted a number of proposals that would provide an incentive to sell only AAUs likely to be surplus to the country's compliance needs.

If liability provisions are adopted as part of the rules for international emissions trading and joint implementation it is important that they be related to the broader compliance provisions. The main areas where consistency appears to be necessary are eligibility of Parties to use the mechanisms and validity of AAUs for compliance purposes. The eligibility criteria for buyers and sellers are likely to differ.

Liability Proposals

A number of governments and non-governmental organisations have proposed liability rules that include over a dozen liability proposals have been suggested in the literature and the international negotiations. The proposals reflect several different strategies for limiting sales of IET quota to amounts surplus to the seller's compliance needs:

• Attributing responsibility
• Seller subject to penalties for non-compliance
• Seller subject to eligibility requirements
• Buyer
• Shared liability
• Double liability

• Trading limited to surplus quota
• Sales prohibited until compliance established
• Sales limited to IET quota surplus to the seller's compliance plan
• Sales limited to quota surplus to defined compliance plan

• Limits on sales
• Annual retirement of IET quota equal to actual emissions
• Limits on sales
• Permanent reserve

• Restoration of default
• Compliance reserve
• Compulsory insurance
• Escrow account

• Progressive response to probability of default
• Traffic light

Other proposals include combinations of two or more of the above proposals. Those more complex proposals have not been evaluated.

Model to Compare the Liability Proposals

A simple model has been developed to compare the liability proposals in terms of the quantity of AAUs, or ERUs or CERs available over time and the cost of compliance to legal entities. The model is based on cost curves developed by MIT. The seller is assumed to be the government of a country that expects to have surplus AAUs. The government tries to maximise its revenue less the penalties due to non-compliance. The buyer will be assumed to be a legal entity that wishes to buy AAUs, or ERUs or CERs to meet its obligations under a domestic emissions trading program at minimum cost. The model stretches over the five-year period between 2008-2012.