Gaming Carbon Must End to Solve Global Warming

 

Can economic incentives evolve to combat climate change?

Oct 6, 2014 By David Biello

Good Chinese communists now trade a commodity that can neither be seen nor felt, yet is responsible for changing the climate. The country has set up seven markets for trading carbon dioxide to test whether such a market can help restrain China's growing pollution problem. Taken together, the markets are the second largest in the world—after the European Union Emissions Trading Scheme. Early results from one of the markets, in the burgeoning city of Shenzhen, are promising, including reductions of 2.5 million metric tons of pollution, according to Vice Mayor Tang Jie. That's in contrast to China as a country's failure thus far to cut carbon intensity—the amount of pollution emitted as industry works—as promised in its 12th Five Year Plan, which ends next year.
"We desperately need speed and scale and action on climate change," says Rachel Kyte, the World Bank's special envoy for climate change. "Carbon pricing is a necessary if insufficient first step in [a country's] transformation toward an economy that is competitive and creating jobs, but is decarbonizing and on track for zero net emissions by the second half of the century."
In other words, the World Bank wants a price on carbon, like that occurring in these seven regions of China, because its team of economists and financiers thinks that climate change is an outcome of getting the prices of different sources of energy wrong. Fossil fuels are too cheap, and various alternatives—whether nuclear or solar—are too expensive. As Kyte notes, it's all about "getting prices right."
That phrase really means raising the price of fossil fuels. If coal, gas and oil are more expensive, then geothermal, hydropower, nuclear, solar and wind power become relatively cheap. "You clearly have to put a price on carbon so there is a level playing field and the cost of renewable energy is actually less than fossil-fuel generated electricity," says Ted Roosevelt, a managing director at global bank Barclays. That is the only way to encourage the massive investment in deploying the clean energy technology that is necessary to combat climate change. The "price" can be a direct tax, an allowance in a cap-and-trade scheme, or some other financial mechanism.
The World Bank used its financial weight to convince 74 countries, 23 states, provinces or cities and more than 1,000 businesses, including oil giant Shell, plus investors to join in a call for such a global price on carbon at the United Nation's Climate Summit on September 23.
The problem is: a price on carbon has not always worked to restrain carbon pollution. Even though more than 60 countries, cities, states and provinces have some form of a price on carbon—and many companies have an internal one, including ExxonMobil—the amount of CO2 being dumped into the sky continues to grow.
Old idea
The idea of charging rent for using the sky as a dump first popped up in 1920. Arthur Pigou, a top economist at the University of Cambridge, proposed taxing companies for the amount of pollution they emitted into the atmosphere. Pigou speculated that forcing companies to pay for the use of the air would discourage pollution, just as sin taxes on alcohol or tobacco discourage drinking and smoking. The idea never really caught on outside of academic circles, perhaps because even high sin taxes have failed to completely cure bad habits.
Other economists floated similar ideas over time, but it was the late Ronald Coase, a British-born economist who ended up teaching the dismal science at University of Chicago Law School, who first proposed the idea of assigning legal rights to pollute.
Polluters would be given (or sold) the right to pollute. Victims of the pollution, whether individuals or corporations or governments, could then purchase these rights to keep the polluters from polluting. A market would spring up and eventually reveal a level of pollution and cost acceptable to both the polluting company and society—an economically optimal level of pollution. Ownership would promote stewardship.
In 1991 Coase was awarded the Nobel Prize for this insight and throughout the 1990s environmental markets took hold in the U.S. to address everything from acid rain to water pollution. But the most ambitious effort to implement Coase's theory came in the effort to reduce the cost of cutting greenhouse gas pollution: international treaties to combat climate change, such as the Kyoto Protocol, built in trading as a key component.
To help the Kyoto process along, the World Bank set up investment funds in the early years of the 21st century dedicated solely to developing projects that could produce carbon credits. Each credit represented a specified reduction in CO2 that could then be sold to companies or countries with emission reduction problems. The new credits would help cancel out the pollution spewed by industry. Projects included new tree plantations, switching from coal burning to less-polluting fuels, and the destruction of ultrapowerful greenhouse gases like hydrofluorocarbons.
What happened instead was that Chinese companies cornered the market on both making and destroying such HFCs, reaping millions of dollars in profit. Companies were set up specifically to create HFC, only so that they could be paid to destroy the chemicals. An analysis by researchers at Stanford University found that as much as two thirds of all the emission reductions sold in this global carbon market were fake. The problem with Coase's pollution markets is that they can be gamed.
Financial schemes
Gaming was less of an issue when the European Union set up its Emissions Trading Scheme, in part because it followed the U.S. experience in trading the pollution that caused acid rain and had direct government oversight. But a different flaw emerged. In the U.S. power-plant owners traded allowances to emit sulfur dioxide under an overall cap, and acid rain–forming pollution was reduced at a low overall cost. In the ETS national governments gave allowances to emit carbon dioxide to various companies that pollute a lot. Swayed by lobbying, the bureaucrats in charge handed out too many. European utilities and other industries reaped millions of Euros from the free allowances while enjoying an overall cap that allowed pollution to continue to rise. This scheme to reduce greenhouse gases failed to cut pollution, among other problems. European leaders are now calling for a cull of excess allowances to partially fix the problem.
Another solution to the challenge of carbon markets has been to charge polluters for allowances in the first place, to ensure that the public reaps some gain from granting the right to pollute a common good like the air. In the cap-and-trade market that encompasses nine northeastern and mid-Atlantic states in the U.S.—the Regional Greenhouse Gas Initiative—auctions of such allowances have raised nearly $1 billion, more than two thirds of which has been invested in energy-efficiency programs or rebates or subsidies for clean energy. In California, which has its own separate program, a portion of allowance auction proceeds was used to deliver a $35 credit on every state resident's electricity bill this past April.
The magic of markets cannot accomplish everything, however. A pollution market cannot eliminate pollution, for what then would be left to trade? Markets also cannot offer justice: The burden of bad air falls disproportionately on the poor, who cannot afford to move away from major pollution sources such as oil refineries or coal-fired power plants or pay not to be polluted. Such markets also require continual oversight by government, both to ensure that polluters are only emitting what they say they are emitting but also that they actually have the allowances for that level of emissions—an oversight that is often lacking. And, like most markets, pollution markets are not truly free, distorted by the whims of government.
As any trader, even a Communist one, can tell you, a market set up by fiat can be closed by fiat. The U.S. Acid Rain Program begun in 1995—the best example yet of how the cap-and-trade idea can work—saw allowance prices drop from more than $1,500 to less than $1 based on changes first proposed by the Bush administration. And acid rain may be less but it has not gone away.
A simple plan
Given the pitfalls, perhaps Pigou's tax is better than Coases's market. Such taxes have fared well from British Columbia to Sweden, reducing pollution without diminishing economic growth. Although a tax does not set an overall limit for pollution, it can help reduce it, while also being used to offset other taxes or even to be returned to taxpayers in the form of a rebate or dividend, much as every resident of Alaska receives a check for a portion of the state's oil revenue. As such, the idea of a carbon tax has proved more politically popular, as evidenced by multiple posters at the People's Climate March in New York City on September 21 calling for such a tax. There was no poster calling for cap-and-trade.
Norway has had a carbon tax since 1991, roughly $72 per metric ton for the offshore oil and gas industry (rates vary by industry). At the same time, the country banned the practice of burning natural gas that comes up with the oil—all the CO2 for the atmosphere with none of the energy benefits—known as flaring. And, thanks to the tax, Norway hosts the world's largest CO2 storage project at its offshore Sleipner natural gas field, where millions of metric tons of CO2 have been pumped under the seafloor rather than dumped in the atmosphere. "We are by far the most carbon-efficient producer of oil and gas," says Hege Marie Norheim, senior vice president for corporate sustainability at Norway's state oil producer Statoil.
But a carbon-efficient oil and gas producer is still an oil and gas producer, which shows that a tax on carbon—even a relatively high one—is not a panacea. Since 1991 Norway has exported more than 16 billion barrels of oil. Each barrel meant 430 kilograms of CO2 entering the atmosphere when used. So Norway's oil production has added nearly eight billion metric tons of CO2 to the atmosphere when used after export to other European countries.
This is the problem of leakage: Norway's carbon tax stops at Norway's borders, unlike its oil exports. Although Norway's carbon debt pales in comparison with that of other major fossil-fuel producers, such as coal from Australia or the U.S.—and has been ameliorated by investments in efforts to prevent forests from being cut down in countries like Brazil—it is not insignificant.
Without a global tax on carbon then, there is little cost to doing fossil-fuel business, whether within countries or between them. And there is no sign of such a global tax regime emerging from either U.N. negotiations, the World Trade Organization or widespread adoption of individual carbon taxes among various countries. Further, how high would such a price on carbon have to be in order to slow the burning of coal, oil and natural gas?
But getting the prices right for energy does not have to involve adding a tax or creating a market for pollution. The least free market in the world today is the market for energy, rife with hidden subsidies, price controls and government mandates. In the U.S. alone simply ending tax breaks for coal, gas and oil producers would also change prices, perhaps also including ending subsidies for infrastructure like oil and gas pipelines and below-market price sales of coal to be mined from land owned by the federal government. Such benefits help make the buying and selling of fossil fuels the single most profitable market in the world, which explains the simple appeal of a carbon tax applied at the mine or well mouth to pay for some of the hidden costs of production—human health and global warming, to name two.
The ultimate goal is to control climate change. Making fossil-fuel burning expensive is just a means to that end. The problem can also be approached from the other direction at the same time: making alternative energy sources cheap by encouraging investment in research and development as well as deployment. In the end, all of the above—some form of a price on carbon plus subsidies for alternatives—is likely needed to combat climate change.
Or as Barclay's Roosevelt adds: "Unless we do this, have the [research and development] investments and a price on carbon, we will not successfully be able to decarbonize our economy and get global emissions down to a level where we've essentially saved the planet."
That seems a trade worth making.