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An inconvenient economic truth

Published 26 March 2009

Observations on carbon trading

Britain’s faith in carbon trading as a way of reducing greenhouse gases could be dangerously misplaced, according to an independent academic working with the Department of Energy and Climate Change.

Dr Chris Hope of the University of Cambridge’s Judge Business School has been commissioned by the government to calculate how much environmental polluters would have to be

charged for emitting CO2 to make it worthwhile for them to cut back. However, his research, due to be delivered to the government later this year, has led him to a far wider conclusion: that the current European Emissions Trading Scheme (ETS) is deeply flawed and should be replaced – or at least augmented – with a green tax.

Under the ETS, companies or countries are given quotas for their annual carbon emissions. If they exceed the quota, they have to buy extra from others who have undershot their limit. However, if they become more efficient, and so generate less CO2 than their quota, they can sell the surplus and make a profit. This raises a vital question: how much should energy users be charged for each tonne of CO2 they emit? For the ETS to work, the price has to be set at a level that makes it worthwhile for consumers to cut their energy use.

According to Hope’s research, the minimum price needed is about £85 per tonne, rising at roughly 2 to 3 per cent a year. What’s more, this price needs to show long-term stability. After all, the whole point of putting a price on carbon emissions is to place

a financial burden on heavy environmental polluters. If carbon prices fell, then that burden would shrink and there would be little incentive to improve efficiency.

So far, so simple – but Hope has reached a second, personal

and, for the government, far more embarrassing conclusion. He believes a market-based trading system such as the ETS is very unlikely to generate consistent high prices, and this instability could undermine the whole point of the scheme. The heart of the issue is a problem we are all sadly familiar with: financial markets are highly variable, with prices liable to surge and collapse. Hope says that the first two phases of the ETS have illustrated the problem: the prices of CO2 emissions quotas fell so low as to be almost worthless. Prices now stand at roughly £9.50 per tonne of CO2 – less than 12 per cent of what Hope’s calculations show is needed.

The alternative, he says, is to put a price directly on carbon. Hope means that Britain and Europe must consider a system of carbon taxes, by which a surcharge would be placed on gas, oil and coal according to how much CO2 they generate. Such a carbon tax on fossil fuels would lead to sharp rises in prices for electricity and heating – perhaps by up to 50 per cent. This sounds politically unacceptable but not, Hope believes, if the money were used to cut other taxes such as VAT or income tax. He calculates that the UK government could gain about £50bn in annual revenues – equivalent to roughly 10 per cent

of the current total tax take. “With this new source of revenue, they could then reduce other taxes such as VAT and income tax,” he says.

Ed Miliband, Britain’s Energy and Climate Change Secretary, defends the carbon cap-and-trade system. “The current low carbon price is a market response to the global economic crisis and is not a good guide to the future carbon price,” he said recently. “Cap-and-trade is still the right way to go.”

Hope, who worked with Lord Stern on the 2006 Stern Review on the economics of climate change, is in good company, however. At this month’s climate science summit in Copenhagen, William Nordhaus, Sterling Professor of Economics at Yale University, attacked cap-and-trade as unworkable, arguing that today’s low carbon price is an “inconvenient economic truth” that politicians are unwilling to face. “The world is making a huge wager that the cap-and-trade system will eventually do the job of slowing global warming,” he said. “To bet the climate on a model with such clear structural flaws is a reckless gamble.”

Jonathan Leake is the science and environment editor of the Sunday Times

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4 comments from readers

CTF
27 March 2009 at 11:13

Bravo--Dr. Robert Shapiro at the Climate Task Force reached the same conclusion: that a cap and trade scheme is fundamentally flawed whereas a revenue-neutral carbon tax avoids the pitfalls inherent to C&T, significantly reduces emissions, incentivizes the creation of green technology AND returns the revenue to the people. Hopefully, as more and more economists, scientists and opinion leaders line up in support of a carbon-tax, policy-makers will take note and follow suit.

ChrisJCook
28 March 2009 at 20:57

The sheer unworkability of emissions trading has been obvious for years. I had this article published by "Energy Risk" four years ago

http://www.opencapital.net/papers/Opinionemissions.pdf

Rather than attempting to monetise something with no intrinsic value - like emissions and carbon credits - we might instead consider monetising the energy value of carbon.

It's not difficult - energy producers may simply issue Units redeemable in energy value by reference to an Energy Standard.

http://www.slideshare.net/ChrisJCook/petro-clearing-january-...

Ken
27 June 2009 at 18:18

The whole argument is based on a fatally flawed postulate: that there is such a thing as anthropogenic global climate change. Whether it is a carbon trading scheme or a green tax or anything else designed to "solve" this non-problem is not the point. These taxes are designed to steal political power from the people and give it to politicians. You are volunteering to be slaves to government. Time is money, and money is power. Politicians end up with power that you once had.

Gideon Polya
29 June 2009 at 09:09

Excellent article. Top US climate scientist Professor James Hansen (Head, NASA s Goddard Institute for Space Studies) has completely dismissed Cap-and-Trade Emissions Trading Schemes (of which the pro-coal Rudd Labor Australian Government ETS is a spectacularly flawed, dodgy, irresponsible, anti-social, anti-humanity and anti-environment example): "The worst thing about cap-and-trade, from a climate standpoint, is that it will surely be inadequate to achieve the sharp reduction of emissions that is needed. Thus cap-and-trade would practically guarantee disastrous climate change for our children and grandchildren (see Dr James Hansen, Carbon Tax and 100% Dividend vs. Tax and Trade , Committee on Ways & Means, US House of Representatives, February 2009: http://www.columbia.edu/~jeh1/mailings/2009/20090226_WaysAnd... ).

Dr Hansen advocates a Carbon Tax and 100% Dividend Scheme in which a realistic Carbon Tax is applied and the receipts handed back to ordinary citizens (including children) - the greener the energy purchased the greater the profit for the citizenry.

In contrast, the shonky, pro-coal Australian ETS involves selling pollution permits to major polluters by rigged auctions and then (extraordinarily) handing most of the receipts back to the major polluters - it is designed to permit climate criminal Australia to continue burning and exporting coal for as long as possible. Australia is the world s biggest coal exporter and a world leading greenhouse gas (GHG) polluter. Thus Australia's domestic and exported annual per capita GHG pollution is 54 tonnes CO2-equivalent per person per year - 2 times that of the US, 10 times that of China, 25 times that of India and 60 times that of Bangladesh.

Unlike cap-and-trade ETSs, Hansen's precedented Carbon Tax and 100% Dividend scheme is not subject to dishonest manipulation by market money men.