Delegates at COP21 last weekend unanimously adopted the Paris Agreement, an effort to limit the rise in global temperatures to ‘well below’ 2°C. Its significance as a step forward for global cooperation on climate change should not be understated. It is the first deal to commit all countries to reduce emissions. It sets up legally binding five-year reviews of emissions reductions and contains a commitment from rich countries to raise US$100 billion a year by 2020 to assist poor countries to transition their economies away from fossil fuels.
It has been heralded as historic, landmark, and ambitious, yet it falls short in some important areas. Member states submitted their own emission reduction commitments called ‘Intended Nationally Determined Contributions,’ which are not legally binding or enforceable. At current levels they are also manifestly inadequate. Projections suggest they will only limit temperature rises to 2.7°C. The Agreement’s biggest contribution, then, may be as a framework for action moving forward – a mechanism for coordinating and reinforcing political will. But this may also be its biggest failure. It has further entrenched incentives to focus only on demand-side policies that were first established in 1992 in the UN Framework Convention on Climate Change (UNFCCC).
The UNFCCC established a measure of emissions based on consumption of fossil fuels within territorial boundaries. This means that for the purpose of all international negotiations, as well as most domestic policies, contributions to emissions reductions are only valued if they reduce the amount of fossil fuels burned and green-house gases emitted within the relevant jurisdiction. Consequently, the focus of policy is on the demand-side. This is anything that consumes fossil fuels – from driving a car or running a factory, to power plants, which consume fossil fuels to supply electricity. As a result, supply-side policies (those that target exploration, extraction and transportation) are neglected.
Admittedly, there is a natural bias towards demand-side policies. Clean energy subsidies are popular, if inefficient, and the impact on carbon pricing is minor. Supply-side policies, in contrast, target powerful status quo players and are therefore politically challenging. The conventional wisdom also suggests that supply side policies result in ‘leakage,’ a situation where supply side policies will relocate production rather than reduce it. New research from the Stockholm Environment Institute questions the validity of this bias, however. The authors accept that some leakage does exist, but argue that similar leakage also exists with demand-side policy. Pollution intensive production may shift to economies with emission reduction goals which are soft or under-enforced. The best policy should then be determined on a case-by-case basis according to market analysis, rather than a broad theory.
Disappointingly, instead of working to correct this bias and place supranational pressure on domestic policy makers to resist the lobbying of big fossil fuel companies, the Paris Agreement has implicitly precluded supply-side efforts. This will weaken incentives to achieve cost effective emission reductions going forward. It is especially noticeable in a country like Norway, where the marginal benefit from each dollar spent on further suppressing domestic demand is much lower than the marginal benefit to global emissions of a reduction in supply, even accounting for the effects of leakage. The best mix of demand and supply-side policies for global emissions will not be the best mix for domestic emissions. The incentives created by the agreement are thus perverse.
Criticising the Paris Agreement in this way may still be making the perfect the enemy of the good; surely policies which reduce domestic emissions will still contribute to limiting warming. But the agreement does nothing to correct incentives for governments to support domestic industry. Even as demand reduction policies are being implemented, governments continue to subsidise fossil fuel exploration and production, putting upward pressure on supply. If the Paris Agreement has its desired effect (to signal an end to the fossil fuel era) then it will only intensify this dynamic. In the anticipation of sustained reductions in demand, the future value of resources for fossil fuel suppliers will fall dramatically. The incentives for fossil fuel suppliers are thus to extract fossil fuels in the short term for any price above their marginal cost, because any unit contribution to their investment will be better than what they can expect to receive in the future.
So without any complementary supply-side policies, the global supply of fossil fuels is likely to increase further above socially optimal levels. The resultant downward pressure on fossil fuel prices will be working against demand-side efforts, keeping fossil fuels relatively cheap against their green competitors. This of course assumes a genuine commitment to emissions reductions (which is not yet assured) but a global agreement could have had the potential to correct against the demand-side bias that exists in climate change policy. Instead, the Paris Agreement has further entrenched it, and to the extent that it is successful in becoming the framework for future action, it will continue to misdirect policy for years to come.
 Lazarus, M., P. Erickson and K. Tempest, “Supply-side climate policy: the road less taken.” SEI Working Paper, no.13 (2015). http://www.sei-international.org/publications?pid=2835