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Sectoral Climate Clubs: The Next Phase of Carbon Pricing?

Emma Krause
Jun 03, 2022

Guidehouse Insights

Co-authored by Thobias Sach

For the first time, the world’s largest economic and political players share a common climate ambition. The European Union (EU) and the United States have articulated their commitment to climate neutrality and are taking political and legal action to reduce emissions with the goal of achieving net-zero climate targets by mid-century. China has also made substantive efforts to diminish their emissions, pledging to cut emissions under the Paris Agreement, reducing coal use, investing in renewable energy and electric vehicles, and launching a national emissions trading system (ETS). Aligned interest across these three key players presents an opportunity to actualize a long-discussed approach to addressing the international challenges of climate change: a climate club. 

William Nordhaus first proposed a climate club in 2015, positioning it as “an idealized solution to the free-riding problem that prevents the efficient provision of global public good” as the club operates as “an agreement on an internal minimum price on carbon and an external tariff.” Nordhaus goes on to emphasize that a key part of the club mechanism is that nonparticipants are penalized by participating countries levying a price, whether as a tariff or a carbon duty, on all imports from nonparticipants. There have already been attempts to establish climate clubs through international climate policy frameworks including the Kyoto Protocol and the Paris Agreement as well as specific policy mechanisms including linking ETSs, international carbon price floors, and alternatives to carbon tariffs such as a tariff reduction for environmentally sustainable products.

Gaining Momentum

As countries implement their Paris Agreement commitments, climate clubs are once again on the international climate policy agenda. In 2021, several German ministries published a white paper outlining building blocks of a cooperative and open climate club. Though the actual implementation of a climate club would require considerable World Trade Organization vetting and approval, newfound momentum for climate clubs offers an opportunity to examine climate clubs anew through learnings from carbon pricing systems.

There are 65 carbon pricing initiatives implemented around the world, covering a diverse array of sectors and representing 25% of global greenhouse gas (GHG) emissions. Through observing their operation and evolution, we have learned that having a single carbon price across all sectors is not always the most efficient or effective approach. Several jurisdictions, including the EU, Germany, and Canada have designed and implemented different carbon pricing mechanisms for different sectors. Growing use of carbon pricing combined with the growing momentum on carbon clubs offers an opportunity to leverage these learnings and explore the potential of sectoral climate clubs.

A New Approach to Climate Clubs

Approaching climate clubs in this new way would focus on tailoring climate clubs to specific sectors’ differing needs while enabling sectors to choose their abatement pathway based on the characteristics of their emissions profile. Sectoral climate clubs, through agreement on a sectoral internal minimum price and external tariff, can create an impetus to implement key measures, such as carbon pricing, CBAs, standards, and output-based performance systems, while aligning with the clubs’ requirements and addressing competitiveness challenges. Sectoral climate clubs can also help to diminish excess capacity generation of certain products, which generates unnecessary GHG emissions, deflates prices of high emissions products, and hinders the development and scaling up of competitive solutions for lower emissions production. Sectoral climate clubs offer an opportunity to view decarbonization strategies and goals through a new lens, providing an explicit breakdown of global decarbonization ambitions in individual sectors and reinforcing long-term signals to decarbonize while considering and leveraging the nuanced characteristics of each sector of the economy to better enable decarbonization.