Friday, April 2, 2010

Is the cap-and-trade moment over?

The recent reports that carbon emitting companies in Europe are awash with a huge excess of permits to emit carbon dioxide has again raised questions on the ability of European Union's Emissions Trading System (EUETS) in particular and cap-and-trade mechanisms in general to achieve carbon emission abatement.

In view of its market-driven approach, cap-and-trade had emerged as the preferred option (over carbon taxes) to reduce greenhouse gas emissions, and this was manifested in the Waxman-Markey Energy and Climate Change Act proposals which have been passed by the House of Reps in the US. However, as John Broder wrote in a recent op-ed, it appears to have fallen out of favor as an instrument to combat climate change, especially in the US, due to the weak economy, the Wall Street meltdown (and the general suspicion about markets in general and in particular about trading in intangible assets such as emission allowances), determined industry opposition and its own complexity.

The main idea behind carbon trading was to give companies the incentive to reduce emissions by requiring the heaviest polluters to buy additional pollution permits. As a cap on the number of permits steadily tightened, companies that invested in greener production would be best placed to continue competing in a low-carbon economy of the future. However, as cap-and-trade schemes got implemented across the world, the extent of dilution in its implementation brought considerable disrepute to the approach itself.

It has been argued that the initial free allocations of permits under the EUETS in 2005 was so generous that it left polluting industries with enough cushion to survive and even make some money trading their excess allowances. The Waxman Markey Bill too had proposed giving away pollution allowances to industry rather than allocated based on past emissions, giving the impression that it was another example of corporate welfare than contributing to any meaningful reduction plan.

Adding to these, the Great Recession with its resultant idling factories, declines in production, and postponed investments have driven down the prices of carbon permits, making them too cheap to achieve any meaningful emission reductions. It is estimated that because of recession, emissions from industries covered by the EUETS have dipped by as much as 11%. They have been languishing at around €13/tonne of CO2 ($17.60) for some months now, a price "that experts have said is far too low to result in a significant change in the way companies generate and use energy".

Robert Stavins argues that the opposition to cap-and-trade approach is understandable since "any climate policy approach — if it was meaningful in its objectives and had any chance of being enacted — would have become the prime target of political skepticism and scorn". He also points to how cap-and-trade continues to remain the dominant instrument to address the carbon emission challenge in many countries like Australia, New Zealand, South Korea, and Japan.

I am fully with Robert Stavins in arguing that it is incorrect to proclaim the death of cap-and-trade. This blog has consistently maintained that carbon taxes are easier to administer than cap-and-trade. However, any politically acceptable carbon mitigation plan will have to include cap-and-trade to complement the carbon taxes.

Update 1 (11/4/2010)
James Kanter does not think that the cap-and-trade moment is not over.

Update 2 (30/8/2010)

The CDM also approves carbon offsets for destroying the gas, HFC-23, that is a byproduct from the manufacture of refrigerant gases. HFC-23 has several thousand times the potential of carbon dioxide — the most common greenhouse gas — to trap heat in Earth’s atmosphere. HFC-23 credits also make up about half the supply of international offsets approved by the United Nations to date.

A nonprofit organization, CDM Watch, has recently raised allegations with the United Nations’ climate office that some plants were producing more refrigerant than they needed to meet market demand to cash in on credits for HFC-23.

Update 3 (31/10/2011)

Excellent summary of the carbon pricing debate. See this paper by Robert Stavins and Joseph Aldy. See also this essay by William Nordhaus.

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