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Why Design of Carbon Markets Is So Important

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Various interested parties have written about the efficacy (or lack thereof) with regard to carbon-related market schemes of all sizes and types.  Probably one of the more visible programs is the global emissions offset scheme enacted in the wake of the Kyoto Protocol.  This is the case for good reason: Kyoto represented the largest effort to date to deal with carbon emissions and related activities at the international level.  The short story can be summarized by two competing viewpoints.  On the one hand are people who think the Kyoto-scheme was real progress because it did something for the first time.  On the other hand, critics claim that the scheme is a failure for any number of reasons, most not actually dealing with real-world facts.

Who’s right?  Well, as usual, there are valid points made on both sides.  It is true that a global market was created where none before it existed.  In and of itself, that is probably a good thing.  It allows us to monitor how such a program works and make modifications with time if something needs to be tweaked or overhauled.  To that point, the critics make a good argument.  The scheme very likely isn’t working.  But critics will leave it at that without examining it in further detail.

I’m going to look at one part of the scheme in a little more detail and explain why the scheme isn’t working as efficiently as it should.

Quickly: there are too many credits in the market.  In economic terms, there is a drastic oversupply of offset credits.  By definition, the market will operate inefficiently.  How inefficient is the market?  After all, if we are talking about just a little oversupply, we are also talking about small inefficiency.  How does 1,000X oversupply grab you?  Yes, that number is correct and it is wildly inefficient.  This scheme is laughable (or would be if part of a comedy routine).  Unfortunately, it is what passes for real-world policy today.

Thomson Reuters Point Carbon estimated the anticipated demand at 11.5 Million metric tons.  They further estimated the supply at 13 Billion metric tons.  Countries were issued a number of tradable emissions allowances if they agreed to CO2 emissions targets.  Therein lies the problem.  A first-order approximation to the problem is this: would you buy ice cream cones if you had 1,000X the number of vouchers to get free ice cream cones?  No, nobody would buy cones in such a market.

Another important factor in this problem is the following: participating countries have established emissions targets that are higher than business-as-usual emissions projections.  In so doing, they completely dismiss the concept of a target.  They might as well not identify their targets because they are so high.

The terribly written 2009 U.S. climate and energy bill would have done something similar: the government was going to give away free allowances to industries who would then trade them.  The cap (in cap-and-trade) would slowly be ratcheted down in time.  But the ratchet was going to happen so slowly that there would always be a massive surplus of credits with which to trade.  Businesses could take their sweet time deploying new technologies to pollute less without fear that the government would impose penalties for violating emissions caps.

What should be done?  In either case, the credits should not have been doled out for free.  Was it a carrot to get industry to sign on to these agreements (or at least not fight them tooth-and-nail publicly)?  Yes – albeit an extremely large carrot.  The credits should have cost something up front (who gets free stuff at the beginning of any market anyway?) so that they had some real-world value assigned to them.  The emissions targets should have been more reality based instead of higher than business-as-usual.  Perhaps the programs would not have been successfully implemented (the US version failed for a number of political reasons, not technical reasons), but at least the policy would have been designed to actually accomplish more than a great deal of green-washing.

Instead, the carbon emissions offset market is likely to fail.  And ideological critics of such programs will cry far and wide that no such market can ever be successfully implemented.  Lay-people that don’t understand the nuances and minutiae will readily agree with such an assessment, even though the end result was nearly  pre-ordained in the first place.

Alternatively, smaller groups (cities and states in the US, for example) have created smaller markets.  They are testing the design of markets in a reasonably non-public setting.  I think this is a good thing so that unnecessary politicization of the market does not drown out well-intentioned efforts to figure out the best formulation of markets moving forward.  These small-scale efforts are being pursued, for the most part, by parties who are voluntarily interested in them in the first place.  There is little coercion or dead weight involved, which should work well in the formulation discovery process.  I hope to see additional interested parties join the most successful ventures at a slow rate so that close watch can be kept on market performance and corrective actions taken by a more limited number of parties.  With increasing size comes increasing competing interests, which will seriously challenge the successful operation of the market (one primary reason why Kyoto and other massive international efforts have failed to date, in my opinion).

The task of carbon market design and execution is no small feat.  It is enormously complex.  However, the markets should not be set up at the beginning to fail.  They should be designed to succeed.  The fact that this statement constitutes a “Duh!” moment tells you a lot about today’s policy orientation.

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3 thoughts on “Why Design of Carbon Markets Is So Important

  1. James Hansen’s analysis of this issue is incisive, brutal, and – as yet – unfalsified. It has also been ignored by politicians because there is no benefit to them (or business) in pursuing it.

    Hansen observes that the UNFCCC/Kyoto process has failed:
    – Emissions have not been curtailed (they have continued to accelerate).
    – Humanity is definitely interfering with the climate system (a clear breach of Article 2 of the UNFCCC).

    Emissions Trading does not provide any incentive to reduce emissions (it only provides an excuses to continue polluting). Behaviour modification will only be achieved by providing incentives. The market alone cannot do this; but neither can taxation (because people are suspicious of governments and taxation is too opaque).

    Hansen’s Fee and Dividend solution is elegantly simple: Suppliers of fossil fuels pay a fee per unit volume sold and the government distributes all the income received equally to all citizens in the form of a dividend (through the tax system). The government therefore gains nothing; and citizens who reduce their consumption the most will see the greatest benefit.

    Sadly, this solution will never be implemented unless voters demand that it is. Government of the people, by the people, for the people is therefore the solution. Sadly, I know of no country where such a system exists: What most people in most Western countries currently have is government of the people, by the politicians, for big business.

  2. Pingback: State of the Poles – Mid-September 2012: Record Low Arctic Ice Extent; Antarctic Ice Above Climatological Normal « Weatherdem’s Weblog

  3. Pingback: Recent Carbon Market News – April 2013 | Weatherdem's Weblog

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