Carbon credits: Is the US about to repeat EU's mistake?

In a perfect world, "cap and trade" and tax amount to the same thing. The question is, which system addresses the real world better? Industry prefers a cap and trade system to tax for two reasons. First, for SO2 reduction you can buy SO2 certificates. It works well. (Though implementation so far it has been confined and small). The system that was first implemented in Europe proved to have been too liberal in allocating certificates. Some "stupid Euro system" talk resulted in the US media. Second, the only problem with tax is that it is hard to do politically.

- Jorma Ollila, Chairman of Royal Dutch Shell, speaking in Helsinki, statement from the IPI panel discussion live-blogged by Jotman


How did Europe make a mess of cap and trade? Is the US about to make the same mistake? Peter Fairely discusses the European cap and trade debacle in the Jul/Aug issue of MIT's Technology Review:

In theory, limiting the supply of the pollution allowances helps to establish a price for the emission of carbon dioxide. That, in turn, is meant to provide industrial manufacturers and power producers with financial incentives to develop cleaner technologies. The reality has played out very differently, however. A glut of pollution credits, distributed without cost during both the first, transitional phase of the program and the current working phase, drove down the value of the EUAs. As a result, Europe's carbon dioxide emissions remain priced well below 20 euros per ton. With the price of pollution so low, economists say, industries that generate and consume energy have no incentives to change their habits; it is still cheaper to use fossil fuels than to switch to technologies that pollute less.

The article examines the failure of the EU's approach:

in May 2006, EUAs plummeted in value, to less than 15 euros. After recovering briefly in the summer of 2006, EUA futures settled at close to zero for the remainder of the trial phase. Emissions data released in May 2008 revealed that European states, relying on unreliable emissions estimates and under pressure from various industries, had handed out EUAs for 6,321 million tons of carbon dioxide during the first phase, exceeding total actual emissions during the period by 107 million tons.

Global recession is now undermining the second phase of the trading system, which started last year. The European Union set the cap for the 2008-2012 period at 6.5 percent lower than the cap for the trial period. Trading volumes initially exploded, according to Point Carbon. But the rally proved short-lived. The EUA price slid to an average of just 11 euros in the first quarter of 2009, as manufacturing slowed in the face of the recession.

The faltering trading scheme may be doing real harm. Free permits and weak carbon pricing have rewarded the heaviest carbon polluters while hurting Europe's consumers. Most EU states gave extra allowances to heavy industries such as cement and steel, because they didn't want to threaten the manufacturers' international competitiveness; by the same logic, states gaverelatively few allowances to producers of electricity, a commodity that must be generated close to consumers and thus is not forced into global competition.

The next part makes a lot of sense. If you give polluting industries something of long-term value for free, then you should offer the same give-away to non-polluting companies. Otherwise, the state discriminates against those who have invested in alternative energy:

But consumers aren't the only ones penalized by the trading scheme and its process of handing out EUAs. Power producers using relatively clean technology are also suffering. Perversely, coal-heavy utilities with the highest emissions benefit the most from carbon trading, since most states allot them more EUAs. This gives them an unfair advantage over producers generating power with natural gas or renewable sources, which release less carbon.

It seems to me that ideally, carbon credits would be distributed to every citizen. Citizens could then sell these credits to companies An equally fair but more efficient way to achieve the same ends would be for the government to auction off the credits, and then send rebate checks to taxpayers. This approach would help compensate citizens for any price increases resulting from the carbon tax (carbon trading, essentially being a tax on industry).

If any carbon trading scheme is to have an effect on climate change, carbon emissions have to be expensive:

How much higher? Surveys of business leaders suggest that they will not seriously reconsider the way they use energy until the price of carbon exceeds 30 euros per ton. The late Dennis Anderson, a professor of energy and environmental studies at London's Imperial College, concluded in 2007 that significant change will come only when carbon prices "move to the upper end" of a range that he put at 40 to 80 euros per ton. Anderson estimated that the 40-euro threshold would have to be met to make onshore wind farms and nuclear power a better investment than natural-gas or coal-fired power plants, while prices would have to approach 80 euros to make carbon capture and storage worthwhile. Even higher prices would be needed to make solar and offshore wind economical.

Economists at the International Energy Agency have recently calculated that holding global warming to a reasonable level would require an annual investment of $1.1 trillion per year. And it would require a $200 per ton price on carbon, said the IEA, to drive the necessary innovation.

The US does not appear to be headed in the right direction. It does not seem to be learning from Europe's mistake:

The U.S. bill, as it stood at press time, proposes to cut emissions to 17 percent below 2005 levels by 2020--essentially taking the U.S. back to (rather than much below) 1990 levels. And, as with Europe's trading system, a mix of offsets and renewable-energy mandates threatens to further undermine the carbon price. Analysts project U.S. carbon prices at a meager $15 to $20 per ton in 2020--barely a 10th of the price called for by the IEA. Most allowances, meanwhile, will be distributed without charge, despite the risk of windfall-profit taking and perverse market incentives. That move will also deprive President Barack Obama of revenues needed to fund the $150 billion, 10-year program of clean-energy R&D outlined in his 2010 budget proposal.

The prevailing wisdom among supporters of the Waxman-Markey bill is that Congress, wary of putting energy-intensive industries at risk, won't pass anything stronger. Best to get a carbon price established in the U.S. economic system now, supporters say, and tighten the system later. But this cap-and-trade scheme could be weak enough to send a dangerously wrong signal to financial markets looking to invest in new energy technologies. If you have any doubts about that, just take a look at the EU.

Can the dysfunctional US political system be expected to accomplish anything worthwhile?