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 installations 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 fools 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