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Here we go again . . .or not. Carbon trading vs taxes in economic dislocation

Posted Feb 18 2009 12:11pm

By Marc Stuart

One of my favorite quotes of all time I heard attributed to Barry Diller, the guy who worked for Rupert Murdoch long enough to get the Fox Network up and running, thereby kick starting The Simpson’s and many family moments of mirth in the Stuart household. At some point, Barry purportedly said “Anything worth doing is worth doing badly”. Which Fox undoubtedly proved at its outset. But what Barry meant is that you can spend all your time passing around memos and white papers and studies on what to do and bureaucratize something to death. Or you can just do it and figure things out on the fly.

I think a lot about that when I think about emissions trading and the way these first couple years have fared. We’re now in the 5th year of trading emissions in Europe and there is plenty of evidence that while “badly” may be a bit strong, there are at some serious ambiguities regarding its success. The first three year phase (2005-2007) saw the emissions commodity take a 99% price dive, from over €30 to less than 30 eurocents, in a period of a year or so. Clearly, if it only costs 30 cents to toss a ton of CO2 into the atmosphere – hey, my kids could do it with the spare change they find in the couch while watching The Simpsons.

As the second Phase of the European market begins its second year, it’s starting to have the same familiar smell of Phase 1. Ok, today we’re not that far along – the European carbon allowance is down only some 65% from its peak, and what was €30 is now meandering under €10. What does it mean? Coal to gas switches will go the other way – buy cheap coal and cheap allowances and you’ve got an economic winner that doesn’t put money in Putin’s pocket. Wind development in Europe will finally slow. Carbon capture and storage plans are being shelved. Emission credits from developing countries – the kinds that EcoSecurities specialize in, have followed the same price trajectory. With the prices so low, people are reconsidering the financial viability of investments to lower emissions and in some cases, stopping projects altogether and tearing up contracts. Banks who bought forward emission rights at €15 are deeply underwater in yet another new and inexplicable market. The net result is that certain hydro projects in China are unlikely to get financed, smelter efficiency upgrades in South Africa will go back to the drawing board and landfills in Brazil will keep bleeding uncontrolled methane into the atmosphere.

Bottom line is if you want any kind of emissions mitigation in the developing world, you better hope for some kind of price recovery in the carbon market. And soon.“Cratering the Carbon Market - The Sequel “- will of course give critics of emission trading another opportunity to trot out their arguments that trading doesn’t work and the only way to control emissions properly is via a tax. I might give some credence to that argument - if the price crash in the two periods was created by remotely the same thing. Well, on a macro level, of course it was – imbalance of supply and demand – but here’s where it gets tricky. Phase 1 was caused by too much supply, when EU governments failed to set individual emission caps at the right level, having been convinced by their industries that “just a little more” wouldn’t hurt anybody. Conversely, the Phase 2 retreat has been caused by an unprecedented free fall in demand, when European industry followed Wall Street and the rest of the world into economic strangulation and basically went on vacation, just waiting for somebody, somewhere to order something. In latter 2008, steel production in Germany dropped 30%, thermal electricity in Spain more than 20%, auto production in the UK virtually ground to a halt. Hey, if China’s industrial production dropped double digits in response to the crisis, what the heck do you think Europe – not exactly known as the most cost effective place to do business in the first place - is going to do?

Same thing, some will say – it shows that the market that emissions trading can’t work, that it’s just a shell game foisted upon public policy by a financial sector always looking to create new markets and products. Carbon tax , they say, that’s far more transparent, fairer, effective, can’t be gamed. Just one problem – it simply doesn’t reduce emissions. Unless you get so draconian as to be politically suicidal – not a common condition among our elected leaders. Sweden has had $100 plus carbon taxes for nearly two decades and emissions are down just a tiny fraction in that time. Other carbon taxes in Europe at best have managed to halt emissions rise. And here in the US, you can consider the de facto carbon tax of $200 a ton we managed to layer into the gasoline supply system in 2007 and 2008 while oil climbed to nearly $150 bucks a barrel. Yep, a hundred gallons of gas emit a ton of CO2 – so when you move a gallon of gas a buck, it’s costing you another hundred dollars to emit a ton of CO2. And we barely moved the needle on consumption when all of a sudden we were paying $4-5 a gallon. If ExxonMobil is out there advocating a carbon tax – as they reportedly are - my bet is that their research shows that this is the best way to not impact their sales. Plus they know that in American politics, asking for a tax is about the best way to make sure that nothing happens If you want to reduce emissions, you simply have to cap emissions on as big a part of the economy as you can swallow, stick to the cap and keep ratcheting the cap down. Over decades, not years.

What the small EU experiment has shown - and yes, covering some 6% of global emissions means it’s small - is that there probably is a role for a central emissions bank to tweak emissions rights supply during extreme economic dislocation. Probably not quite as needed on the top end of the market (where emission credits and domestic abatement can mitigate price spikes), but there could be a role there as well, particularly if the Clean Development Mechanism (CDM) continues to underdeliver because of bureaucratic morass, even in bullish economic periods when emission reductions are highly valued.

Despite the initial snickering of being on Fox, The Simpson’s are now among both the longest running and most profitable shows in the history of global television. The network that Barry Diller started with entertainment equivalent of baling wire and scotch tape has gone from being a running joke to televising Super Bowls and having the highest rated shows on the air. Perseverance with emissions trading will similarly pay off in the end far better than any carbon tax.Doing it comparatively “badly” in a first half decade of experimentation has taught us well how to improve the system to achieve the necessary sustainable downward ratchet of carbon emissions over the next 100 years.

Marc Stuart is the Co-Founder and Director of New Business Development for EcoSecurities, a global carbon trading firm. The views expressed are his own and do not necessarily represent the view of EcoSecurities

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