Carbon Emissions Trading
EU Environmental Policy
This presentation covers
• Can carbon markets be
part of the answer in
controlling climate
change?
• What is the basic
economics of carbon
trading?
• Is the EU system working?
• What are the alternatives /
complements?
• Should carbon trading be
replaced with a carbon
tax?
Climate change – the biggest market
failure the world has ever seen?
The EU-Emissions Trading Scheme
• EU ETS is a market-based mechanism to incentivise
reduction of greenhouse gas emissions in a cost-effective
and economically-efficient manner.
• Similar system trialed in the USA - US acid rain program
employed a sulfur emissions cap and trade system and
successfully produced a 50 percent cut in emissions
• The scheme operates through the allocation and trade of
CO2 emissions allowances
• One allowance represents one tonne of carbon dioxide
equivalent.
• Long term goal - de-carbonization of EU economy
• Carbon trading scheme began in January 2005
• Now into 2nd phase – which lasts until end 2012
Pressure to reduce C02 emissions
The USA has the highest per capita
emissions of carbon but China and
India and other Asian countries have
huge populations – putting increased
pressure on carbon emissions
20-20-20
• EU Targets:
• 20% cut in greenhouse gas emissions by
2020, compared with 1990 levels
• 20% increase in use of renewable energy by
2020
• 20% cut in energy consumption through
improved energy efficiency by 2020
Trading the right to pollute
• Market failure can occur with missing markets.
• In the past there has been no market to trade and
enforce environmental property rights.
• Carbon trading seeks to create incentives to reduce
pollution.
• A cap is set on the emissions allowed
• The cap creates the scarcity required for the market
• At the end of each year installations are required to
ensure they have enough allowances to account for
their installation’s actual emissions.
• In Phase II increased penalties imposed on any
excess emissions rise to €100 per ton of CO2
Carbon Trading – assets and liabilities
• Businesses in the EU-ETS must implement carbon
management strategies in the medium term
• Assets: If a carbon emitting business can under-use its
initial allowance by better energy efficiency, it can sell
its surplus on the market.
• Liabilities: If a business is faced by high costs to
reduce its emissions, it must buy extra allowances
• The new carbon market should develop a price that
reflects the cheapest ways of implementing
emission cutbacks.
• As the market price of carbon emissions rises, so there
is an incentive for businesses to invest in technologies
that are more pollution efficient including carbon
sequestration.
Rewards and incentives?
• Reward efficiency – e.g. those businesses
that are pollution efficient
• Reward action – e.g. capital investment in
lower-carbon cleaner factories and
production processes
• Reduce pollution without damaging the
competitiveness of European businesses.
The Clean Development Mechanism
• CDM: allows
industrialized
countries to invest in
projects that reduce
emissions in
developing countries
- as an alternative to
what would
undoubtedly be
more expensive
emission reduction
programmes in their
own country.
• The CDM scheme
has been criticised –
fraudulent use of it
Weaknesses - Fools Gold?
•
Government failure?
•
Over-allocation of carbon quotas
and national freedom to allocate
•
Gave cash windfalls to some
businesses
•
Carbon price collapsed
•
This has driven up the demand
for coal fired energy! – a dirtier
fuel! (law of unintended
consequences)
•
Uncertainty of future of the
scheme makes it less likely that
businesses will invest in greener
technologies – all a question of
incentives!
•
Politicians unlikely to set
emissions cap low enough to
drive carbon prices to the right
level
The fool’s gold of carbon
trading
Recession and carbon prices
• EU recession has caused
reductions in output in steel,
paper, cement and glass
• Has led to a sell off of carbon
credits
• That has led to a big drop in
the market value of carbon
permits from Euro 35 to 9
• There is less incentive for
companies to stop polluting
• Fears for the future of many
clean energy projects
• Is there a case for a minimum
price on carbon emissions?
More videos
Is a carbon tax a viable alternative?
Carbon taxation
• A Carbon tax is a specific tax on the consumption of goods
which cause carbon dioxide emissions
• Case for a carbon tax:
– Cap and trade is like a tax so why not tax instead?
– Mandates a specific price on carbon – less uncertainty than
the emissions-trading price
– A way of internalizing externalities – the tax would raise the
marginal cost of the CO2E-emitting activities, up to the point
that the marginal social cost of abatement activities is
equated to the marginal social benefit from these activities
– Incentive for firms to lower their emissions and for consumer
behaviour to change
– Consumers will respond … perhaps in surprising ways
(behavioural economics has something to say here!)
– Revenue generated can be “ring-fenced” and then recycled –
i.e. spent on environmental initiatives
Negative Externalities and Market Failure
Price
Marginal social
cost (supply)
Marginal private
cost (supply)
Efficiency Loss
Marginal private
benefit (demand)
Social
Optimal
Output
Private
Optimal
Output
Quantity
Supporters of a carbon tax
Problems with a carbon tax
• What are the chances of agreeing a carbon tax across
different parts of the world?
• How much to tax when emissions of carbon are difficult to
measure accurately
• What is the true economic cost of CO2 emissions and
impact on climate change? Involves discounting the future
• Costs of compliance / risk of tax evasion
• Possible regressive effects on lower income households
• Less certainty about the effect on quantity of emissions
• Countries may free ride on others carbon taxes i.e. enjoy a
reduction in CO2 emissions without imposing their own tax
• Unless introduced across many countries – would
potentially damage competitiveness and jobs of countries
that bring a carbon tax in
• Would countries be prepared to raise the carbon tax to
reduce emissions? Low price elasticity of demand?
Evaluating the alternatives
•
When evaluating consider some of these points:
1.
Which interventions are likely to be most effective?
2.
•
In changing behaviour
•
In encouraging innovation and investment
•
In reducing emissions at lowest cost
What are the consequences for equity?
•
Between rich and poorer nations
•
Between rich and poorer within any one country
•
Between current and future generations
•
Between producers and consumers
3.
What approach offers the best chance of a global
programme?
4.
Putting a price on carbon is a necessary but insufficient
condition for achieving the required reductions in CO2