Prospects for Markets for Internationally Transferred Mitigation Outcomes under the Paris Agreement

Abstract

The Paris Agreement (PA) opens for parties to use Internationally Transferred Mitigation Outcomes (ITMOs) for implementing their Nationally Determined Contributions (NDCs). This paper analyzes spot, forward and options market trading of ITMOs up to the end of the first PA trading period (2030), given uncertainty about (1) the fulfillment of parties’ NDC targets, and (2) the existence and functioning of the ITMO markets, as ITMO banking beyond 2030 is not allowed. Closed-form solutions are derived for options trading and its welfare impacts given uniform distributions of parties’ uncertainties about fulfilling their individual commitments. Access to call options for late ITMO purchases leads to larger forward ITMO sales or less current mitigation, help parties stay in NDC compliance in 2030, brings early revenue to low-income parties, and is welfare enhancing for all parties. Access to put options for late ITMO sales is less important, and will not be used when put options are not subsidized and parties are risk neutral. The ITMO markets can be enabled by donor-provided climate finance. Effectively functioning ITMO markets can dramatically reduce parties’ costs of achieving their NDCs, and could increase parties’ ambitions, then also reducing global greenhouse gas emissions under the agreement.