A recent article in Scientific American makes a lot of good points about carbon markets and emission trading. Perhaps most important among them is the recognition that the simple existence of a market cannot ensure good environmental outcomes: there must be strong and appropriately designed institutions backing it up. Otherwise, well-connected firms will be able to wriggle through loopholes, fraud will occur at an unacceptable level, and cheating will be endemic.
The article points out some of the big failures in carbon markets so far. Within the European Union Emission Trading Scheme, far too many permits to emit were distributed for free. As a result, their price collapsed in April 2006. Even worse, coal companies in Germany and elsewhere were given free permits to pollute, able to sell some of those permits for cash, and willing to charge their customers for carbon costs that never existed. Also problematic has been the prominence of HFC-23 (trifluoromethane) projects within the Clean Development Mechanism of the Kyoto Protocol. Getting rid of HFC-23 entirely should have only cost about $136 million. It has an absurdly high global warming potential (12,000 times worse than CO2), and is easy to destroy and replace with less problematic chemicals. So far, firms have been able to earn $12.7 billion for partial elimination. The authors of the article suggest that simply paying for the $136 million worth of equipment would be far more sensible than allowing firms to exploit the price difference between the value of emission reduction credits and the cost of eliminating HFC-23.
Other problems with markets include the difficulty of working out what emissions would have been in the absence of some change (the approach used for many carbon offsetting systems) and the way markets can encourage incremental approaches to emission reduction rather than the fundamental overhaul of industrial sectors and energy infrastructures.
None of this is to say that markets are not important. Indeed, carbon pricing is an essential component in the fight against climate change. What it shows is that participants in markets cannot be implicitly trusted, and neither can the governments operating them. There must be mechanisms for oversight and enforcing compliance and a constant awareness about possibilities for cheating or gaming the system. Insofar as it has helped people to develop a better sense of these things, the Emission Trading System of the EU has been a valuable front-runner.
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Shouldn’t the cheapness of getting rid of HFC-23 reduce the price of CDM credits to the marginal abatement cost of HFC-23? You would then expect all HFC-23 production to be eliminated, at that price, before the price of CDM credits shifted up to the marginal abatement cost for the next cheapest option.
Green protectionism
Nov 15th 2007
From The Economist print edition
A dangerous flaw in a bill to control carbon emissions
FOR those (such as this newspaper) who argue that the only way to avert dangerous climate change is to set a price on CO2 emissions, what’s going on in America’s Congress is excellent news. A bill to set such a price has achieved a remarkable degree of cross-party support (see article). Federal emissions controls in America are essential to tackling climate change globally. So it is especially unfortunate that the bill includes a provision that would turn the fight against climate change into a tool for protectionists.
Global warming
Getting the message, at last
Nov 15th 2007
From The Economist print edition
Congress is now taking climate change fairly seriously
Cap-and-trade in the north-east
Embracing Reggie
Nov 15th 2007
From The Economist print edition
A scheme that tries to avoid Europe’s mistakes
“COULD America’s first experiment with a cap-and-trade scheme for greenhouse gases go awry? That is the fear of some observers of the Regional Greenhouse Gas Initiative (RGGI), an agreement among ten north-eastern states to cut emissions from power plants by 10% between 2009 and 2018.
The states in question formed RGGI (pronounced “Reggie”) out of despair at the federal government’s failure to tackle emissions growth. Some states in the West and the Midwest are working on similar schemes. But RGGI will be the first to start up: emissions will be capped from January 1st 2009.”
“RGGI’s designers hope to avoid some of the flaws that have dogged the Emissions Trading Scheme (ETS), the European Union’s ongoing experiment with cap-and-trade. European governments handed out emissions permits to existing power plants and factories free of charge; that turned out to be a windfall for big polluters, who were able to sell on unneeded permits for huge profits. Moreover, it gradually became clear that governments had handed out too many permits, causing their price to fall to almost nothing in the first phase of the scheme, which ends this year. If permits are so cheap, why cut emissions?”
HFC-23 is a by-product of the production of HCFC-22: a refrigerant.
The concern is that creating a market for HFC-23 destruction encourages HCFC-22 production.
HFC-23 is destroyed by incineration.
Eliminating HFC-23 projects from the Clean Development Mechanism could significantly increase the cost of Certified Emission Reductions.
At present, HFC-23 projects produce about 41 Mt of certified CO2 reductions. By 2012, they are expected to be 502 Mt.
A carbon tax will never be high enough to do the job.
A low carbon tax would create the illusion of action without changing business as usual.
Indian chemical company SRF is also receiving substantial numbers of CDM carbon credits for eliminating an obscure industrial waste product known as HFC23, a highly potent greenhouse gas.
HFC23 is a by-product of manufacturing refrigerant gases used to cool fridges and air conditioners.
It is nearly 12,000 times as toxic as carbon dioxide in its climate impact if it enters the atmosphere.
But getting rid of HFC23 is quite easy and relatively cheap.
The solution is to burn it off in an incinerator.
SRF has installed an incinerator for burning off HFC23 at its plant in Rajasthan.
The project has been registered with the CDM and is receiving up to 3.8 million carbon credits a year.
These are currently worth $50m to $60m a year.
SRF is likely to receive the credits for a period of about 10 years, so it is in line for a total windfall in the region of more than $500m, a gigantic sum for a smallish chemical plant located in rural India.
Is Obama Administration Failing an Early Climate Test?
By Emily Gertz
At an interagency meeting, this still-unnamed economist argued that HFCs would be needed to trade against other greenhouse gases in a US carbon market — and thus that the US should support controlling them under the Kyoto climate change agreement and its successor treaty.
“In other words,” writes SolveClimate’s David Sassoon,
“a utility company or cement manufacturer on the hook to reduce CO2 emissions under a federal climate law could opt to find sources of HFCs and have them destroyed instead. Since HFCs are as much as 11,990 times more potent than CO2, small amounts could substitute for large amounts of CO2 emissions and offer a cheaper alternative to emissions reductions, lubricating the economy to a more gradual embrace of a price on carbon. It also means CO2 emissions would ratchet down more slowly.
The difference of opinion within the administration on one of its signature issues was an unexpected development.”
G.J.M. Velders, D.W. Fahey, J.S. Daniel, M. McFarland, and S.O. Andersen. 2009. The large contribution of projected HFC emissions to future climate forcing. PNAS, doi: 10.1073
The projections are based on new baseline scenarios out to 2050. The new global HFC emission projections are significantly higher than previous estimates especially after 2025 in developing countries. By 2050, the emissions are equivalent to 9-19% (CO2 eq. basis) of the projected global CO2 emissions in a business-as-usual (BAU scenario and contribute a radiative forcing in the range of 0.25-0.40W/M2, which is about a factor of 3 larger than previous estimates. By 2050, the HFC radiative forcing fraction is projected to be 7-12% of that for CO2.
“There are also concerns about market-based schemes. Even though markets could provide much-needed finance for REDD schemes, many people are uncomfortable that they could also yield big profits for investors and landowners. In China, a market-based scheme to encourage companies to phase out a powerful greenhouse gas, HFC-23, produced such enormous windfall profits for some companies that the government felt it necessary to impose a 65% tax, with the proceeds invested in green development projects.“
More on the problems with HFC-23
How carbon markets work in the Regional Greenhouse Gas Initiative
I draw three major lessons from the report.
1. Keep trading transparent. Ownership of RGGI permits are registered in a public tracking system. Futures and options are exchange-traded on the Chicago Climate Futures Exchange and the Green Exchange. Smart, because:
Public exchanges are attractive to firms that need a simple way to trade standard products. Moreover, public exchanges effectively eliminate the risk of default by counter-parties, since the exchange constantly monitors the account holdings of each participant to ensure that they have posted sufficient financial security to meet their obligations.
RGGI does allow over-the-counter (OTC) trades (trades between two private parties) for futures, options, and other derivative products. While OTC markets do provide some benefits for certain firms, they are murkier than public exchanges. And even the public exchanges may not require all the details that are important to understanding a transaction. (Potomac identified one instance in which a small quantity of allowances was traded at a price that seems too high—and though there are a number of perfectly reasonable explanations for the trade, the exchanges did not require sufficient information from the trading parties to allow the market monitor to draw conclusions.)
2. Keep a level playing field. RGGI publicly announces the “clearing price” of its auction at a pre-specified time so that all participants have access to the same information and the same time. Similarly, the U.S. Commodity Futures Trading Commission publishes a weekly report documenting the positions, both long and short, of firms trading futures and options on the commodity exchanges. Once again, market participants operate with shared information, which curbs manipulation.
3. Keep an eye on the ball. Frequent analytical reports, like this one from Potomac, are key to ensuring that the carbon markets are well-functioning and fair. Good market monitoring can enable government regulators and administrators to act in a timely fashion if something goes awry. And they can fine-tune their policies and procedures based on good information.