Carbon Emissions TradingEU 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?

The Emissions Trading Scheme

• 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 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 The USA has the highest per capita emissions of carbon but China and emissions of carbon but China and India and other Asian countries have India and other Asian countries have huge populations – putting increased huge populations – putting increased pressure on carbon emissionspressure 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 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.

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 The fool’s gold of carbon tradingtrading

Negative Externalities and Market Failure

Price

QuantityPrivate Optimal Output

Marginal private cost (supply)

Marginal private benefit (demand)

Marginal social cost (supply)

Social Optimal Output

Efficiency Loss

Evaluating the alternatives

• When evaluating consider some of these points:

1. Which interventions are likely to be most effective?• In changing behaviour

• In encouraging innovation and investment

• In reducing emissions at lowest cost

2. 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

Thank youThank you