Carbon emission trading

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See also: Personal carbon trading, Emissions trading, carbon offset, and carbon project

Carbon emissions trading is a form of emissions trading that specifically targets carbon
dioxide (calculated in tonnes of carbon dioxide equivalent or tCO2e) and it currently
constitutes the bulk of emissions trading.

This form of permit trading is a common method countries utilize in order to meet their
obligations specified by the Kyoto Protocol; namely the reduction of carbon emissions in
an attempt to reduce (mitigate) future climate change.

Contents

[hide]

 1 Economics
o 1.1 Costs and valuation
o 1.2 Ethics and fairness
o 1.3 Coase
o 1.4 Equity
o 1.5 Taxes versus caps
o 1.6 Trading
o 1.7 Incentives and allocation
 2 Units
 3 Market trend
 4 Business reaction
 5 Voluntary surrender of units
 6 Criticisms
o 6.1 Structuring issues
 7 See also
 8 References
 9 External links

[edit] Economics
Emissions trading works by setting a quantitative limit on the emissions produced by
emitters. The economic basis for emissions trading is linked to the concept of property
rights (Goldemberg et al.., 1996, p. 29).[1]

[edit] Costs and valuation

The problem of climate change is one where emitters of greenhouse gases (GHGs) do not
face the full cost implications of their actions (IMF, 2008, p. 6).[2] There are costs that
emitters do face, e.g., the costs of the fuel being used, but there are other costs that are
not necessarily included in the price of a good or service. These other costs are called
external costs (Halsnæs et al.., 2007).[3] They are "external" because they are costs that
the emitter does not face. External costs may affect the welfare of others. In the case of
climate change, GHG emissions affect the welfare of people living in the future, as well
as affecting the natural environment (Toth et al., 2001).[4] These external costs can be
estimated and converted in a common (monetary) unit. The argument for doing this is
that these external costs can then be added to the private costs that the emitter faces. In
doing this, the emitter faces the full (social) costs of their actions (IMF, 2008, p. 9).

[edit] Ethics and fairness

The way of dealing with climate change has particular ethical issues and other issues
related to the fairness of the problem. To actually calculate social costs requires value
judgements about the value of future climate impacts (Smith et al.., 2001).[5] There is no
consensus among economists over how to value the fairness (economists use the term
equity to mean fairness) of a particular climate policy, e.g., how to share the burden of
costs for mitigating future climate change (Toth et al., 2001).[6] Nor do economists have
any professional expertise in making ethical decisions, e.g., over the value assigned to the
welfare of future generations (Arrow et al.., 1996, p. 130).[7] Typically all the impacts of
policy, both the costs and benefits, are added together (aggregation), with different
impacts on different individuals assigned particular "weightings," i.e., relative levels of
importance. These valuations are decided by the economist doing the study. Valuations
can be difficult since not all goods have a market price.

There are methods to infer prices for "non-market" goods and services, however, these
valuations can be controversial and disenfranchise the indigenous people, e.g., valuations
of human health impacts, or ecosystems (Smith et al.., 2001).[8] There is also controversy
over how potentially positive climate impacts, e.g., tourism in particular regions
benefiting from climate change, offset negative impacts in other regions, e.g., reduced
food production (Smith et al.., 2001).[9] The main advantage of economic analysis in this
area is that it allows a comprehensive and consistent treatment of climate change impacts.
It also allows the benefits of climate change policy decisions to be compared against
other possible environmental policies.
[edit] Coase

Coase (1960) (referred to by Toth et al.., 2001;[10] and Helm, 2005, p. 4)[11] argued that
social costs could be accounted for by negotiating property rights according to a
particular objective. Coase's model assumes perfectly operating markets and equal
bargaining power among those arguing for property rights. For climate change, the
property rights are for emissions (permits or quotas). However, it should be noted that
other factors affect the climate other than just emissions, e.g., the ocean, forests, etc.
(Goldemberg et al.., 1996, pp. 28–29).[1] In Coase's model, efficiency, i.e., achieving a
given reduction in emissions at lowest cost, is promoted by the market system. This can
also be looked at from the perspective of having the greatest flexibility to reduce
emissions. Flexibility is desirable because the marginal costs, that is to say, the
incremental costs of reducing emissions, varies among countries. Emissions trading
allows emission reductions to be first made in locations where the marginal costs of
abatement are lowest (Bashmakov et al.., 2001).[12] Over time, efficiency can also be
promoted by allowing "banking" of permits (Goldemberg et al.., 1996, p. 30). This
allows polluters to reduce emissions at a time when it is most efficient to do so.

[edit] Equity

One of the advantages of Coase's model is that it suggests that fairness (equity) can be
addressed in the distribution of property rights, and that regardless of how these property
rights are assigned, the market will produce the most efficient outcome (Goldemberg et
al.., 1996, p. 29).[1] In reality, markets are not perfect, and it is therefore possible that a
trade off will occur between equity and efficiency (Halsnæs et al.., 2007).[13]

[edit] Taxes versus caps

A large number of papers in the economics literature suggest that carbon taxes should be
preferred to carbon trading (Carbon Trust, 2009).[14] Counter-arguments to this are usually
based on the possible preference that politicians may have for emissions trading
compared with taxes (Bashmakov et al.., 2001).[15] One of these is that emission permits
can be freely distributed to polluting industries, rather than the revenues going to the
government. In comparison, industries may successfully lobby to exempt themselves
from a carbon tax. It is therefore argued that with emissions trading, polluters have an
incentive to cut emissions, but if they are exempted from a carbon tax, they have no
incentive to cut emissions (Smith, 2008, pp. 56–57).[16] On the other hand, freely
distributing emission permits could potentially lead to corrupt behaviour (World Bank,
2010, p. 268).[17]

A pure carbon tax fixes the price of carbon, but allows the amount of carbon emissions to
vary; and a pure carbon cap places a limit on carbon emissions, letting the market price of
tradable carbon allowances vary. Proponents argue that a carbon tax is more easy and
simple to enforce on a broad-base scale than cap-and-trade programs. The simplicity and
immediacy of a carbon tax has been proven effective in British Columbia, Canada -
enacted and implemented in five months. Taxing can provide the right incentives for
polluters, inventors, and engineers to develop cleaner technologies, in addition to creating
revenue for the government. [18]

Supporters of carbon cap-and-trade systems believes it sets legal limits for emissions
reductions, unlike with carbon taxes . With a tax, there can be estimates of reduction in
carbon emissions, which may not be sufficient to change the course of climate change. A
declining cap gives allowance for firm reduction targets and a system for measuring
when targets are met. It also allows for flexibility, unlike rigid taxes.[19]

[edit] Trading

In an emissions trading system, permits may be traded by emitters who are liable to hold
a sufficient number of permits in system. Some analysts argue that allowing others to
participate in trading, e.g., private brokerage firms, can allow for better management of
risk in the system, e.g., to variations in permit prices (Bashmakov et al.., 2001).[20] It may
also improve the efficiency of system. According to Bashmakov et al.. (2001), regulation
of these other entities may be necessary, as is done in other financial markets, e.g., to
prevent abuses of the system, such as insider trading.

[edit] Incentives and allocation

Emissions trading gives polluters an incentive to reduce their emissions. However, there
are possible perverse incentives that can exist in emissions trading. Allocating permits on
the basis of past emissions ("grandfathering") can result in firms having an incentive to
maintain emissions. For example, a firm that reduced its emissions would receive fewer
permits in the future (IMF, 2008, pp. 25–26).[2] This problem can also be criticized on
ethical grounds, since the polluter is being paid to reduce emissions (Goldemberg et al..,
1996, p. 38).[1] On the other hand, a permit system where permits are auctioned rather
than given away, provides the government with revenues. These revenues might be used
to improve the efficiency of overall climate policy, e.g., by funding reductions in
distortionary taxes (Fisher et al.., 1996, p. 417).[21]

In Coase's model of social costs, either choice (grandfathering or auctioning) leads to

efficiency. In reality, grandfathering subsidizes polluters, meaning that polluting
industries may be kept in business longer than would otherwise occur. Grandfathering
may also reduce the rate of technological improvement towards less polluting
technologies (Fisher et al.., 1996, p. 417).

The economist William Nordhaus argues that allocations cost the economy as they cause
the under utilisation an efficient form of taxation.[22] Nordhaus points out that normal
income, goods or service taxes distort efficient investment and consumption, so by using
pollution taxes to generate revenue an emissions scheme can increase the efficiency of
the economy.[22]

Form of allocation

The economist Ross Garnaut states that permits allocated to existing emitters by
'grandfathering' are not 'free'. As the permits are scarce they have value and the benefit of
that value is acquired in full by the emitter. The cost is imposed elsewhere in the
economy, typically on consumers who cannot pass on the costs.[23]

{{cquote|It is important that we stop thinking in terms of payments to Australian firms in

order to compensate them for the effects of the domestic emissions trading scheme. There
is no basis for compensation arising from the loss of profits or asset values as a result of
this new policy. The rationale for payments to trade-exposed, emissions-intensive
industries is different and sound. It is to avoid the economic and environmental costs of
having firms in these industries contracting more than, and failing to expand as much as,
they would in a world in which all countries were applying carbon constraints involving
similar costs to ours.|||Ross Garnaut [24]

[edit] Units

The units which may be transferred under Article 17[clarification needed] emissions trading, each
equal to one metric tonne of emissions (in CO2-equivalent terms), may be in the form of:
[25]

 An assigned amount unit (AAU) issued by an Annex I Party on the basis of its
assigned amount pursuant to Articles 3.7 and 3.8 of the Protocol.
 A removal unit (RMU) issued by an Annex I Party on the basis of land use, land-
use change and forestry (LULUCF) activities under Articles 3.3 and 3.4 of the
Kyoto Protocol.
 An emission reduction unit (ERU) generated by a joint implementation project
under Article 6 of the Kyoto Protocol.
 A certified emission reduction (CER) generated from a clean development
mechanism project activity under Article 12 of the Kyoto Protocol.

Transfers and acquisitions of these units are to be tracked and recorded[clarification needed]
through the registry systems under the Kyoto Protocol.[citation needed]

[edit] Market trend

Carbon emissions trading has been steadily increasing in recent years. According to the
World Bank's Carbon Finance Unit, 374 million metric tonnes of carbon dioxide
equivalent (tCO2e) were exchanged through projects in 2005, a 240% increase relative to
2004 (110 mtCO2e)[26] which was itself a 41% increase relative to 2003 (78 mtCO2e).[27]

The increasing costs of permits have had the effect of increasing costs of carbon emitting
fuels and activities. Based on a survey of 12 European countries, it was concluded that an
increase in carbon and fuel prices of approximately ten percent would result in a short-
run increase in electrical power prices of roughly eight percent.[28] This would suggest
that a lowering cap on carbon emissions will likely lead to an increase in the costs of
alternative power sources. Whereas a sudden lowering of a carbon emission cap may
prove detrimental to economies, a gradual lowering of the cap may risk future
environmental damage via global warming.

[edit] Business reaction

Economist Craig Mellow wrote in May 2008: “The combination of global warming and
growing environmental consciousness is creating a potentially huge market in the trading
of pollution-emission credits." [29]

With the creation of a market for mandatory trading of carbon dioxide emissions within
the Kyoto Protocol, the London financial marketplace has established itself as the center
of the carbon finance market, and is expected to have grown into a market valued at $60
billion in 2007.[30][not in citation given] The voluntary offset market, by comparison, is projected
to grow to about $4bn by 2010.[31]

Twenty three multinational corporations came together in the G8 Climate Change

Roundtable, a business group formed at the January 2005 World Economic Forum. The
group included Ford, Toyota, British Airways, BP and Unilever. On 9 June 2005 the
Group published a statement stating that there was a need to act on climate change and
stressing the importance of market-based solutions. It called on governments to establish
"clear, transparent, and consistent price signals" through "creation of a long-term policy
framework" that would include all major producers of greenhouse gases.[32] By December
2007 this had grown to encompass 150 global businesses.[33]

Business in the UK have come out strongly in support of emissions trading as a key tool
to mitigate climate change, supported by Green NGOs.[34]

[edit] Voluntary surrender of units

There are examples of individuals and organisations purchasing tradable emission

permits and 'retiring' (cancelling) them so they cannot be used by emitters to authorise
their emissions. This makes the emissions 'cap' lower and therefore further reduces
emissions. In 1992, the National Healthy Air License Exchange was established to pool
donations for buying and retiring sulfur allowances under the USA sulfur allowance
trading program.[35]

The British organization "Climakind" accepts donations and uses them to buy and cancel
European Allowances, the carbon credits traded in the European Union Emission Trading
System. It is argued that this removes the credits from the carbon market so they cannot
be used to allow the emission of carbon and that this reduces the 'cap' on emissions by
reducing the number of credits available to emitters.[36]

The British organisation Sandbag promotes cancelling carbon credits in order to lower
emissions trading caps.[37] As of August 2010, Sandbag states that it has cancelled carbon
credits equivalent to 2145 tonnes of CO2.[38]

British activist Merrick Godhaven has criticised Sandbag's approach of voluntarily

cancelling carbon credits because it would require millions of pounds to be effective and
because it signals acceptance of carbon trading, a system designed by polluters.
Godhaven considers carbon trading is a flawed response to reducing emissions for several
reasons. The caps on emissions are set by industry lobbying, not by science. It is unjust as
it seeks out the lowest cost emissions reductions, usually of poorly verified offsets in less
developed countries. And the free allocation of permits to EU power and steel companies
resulted in windfall profits.[39]

[edit] Criticisms

It has been argued that trading is a form of colonialism, where rich countries maintain
their levels of consumption while getting credit for carbon savings in inefficient industrial
projects (Liverman, 2008, p. 16).[40] Nations that have fewer financial resources may find
that they cannot afford the permits necessary for developing an industrial infrastructure,
thus inhibiting these countries economic development. Other criticisms include the
questionable level of sustainable development promoted by the Kyoto Protocol's Clean
Development Mechanism.

Another criticism is of non-existent emission reductions produced in the Kyoto Protocol

due to the surplus ("hot air") of allowances that some countries have. For example,
Russia has a surplus of allowances due to its economic collapse following the end of the
Soviet Union (Liverman, 2008, p. 13). Other countries could buy these allowances from
Russia, but this would not reduce emissions. Rather, it would simply be a redistribution
of emissions allowances. In practice, Kyoto Parties have as yet chosen not to buy these
surplus allowances (PBL, 2009).[41]

Critics of carbon trading, such as Carbon Trade Watch, argue that it places
disproportionate emphasis on individual lifestyles and carbon footprints, distracting
attention from the wider, systemic changes and collective political action that needs to be
taken to tackle climate change.[42][Full citation needed] Groups such as the Corner House have
argued that the market will choose the easiest means to save a given quantity of carbon in
the short term, which may be different to the pathway required to obtain sustained and
sizable reductions over a longer period, and so a market-led approach is likely to
reinforce technological lock-in. For instance, small cuts may often be achieved cheaply
through investment in making a technology more efficient, where larger cuts would
require scrapping the technology and using a different one. They also argue that
emissions trading is undermining alternative approaches to pollution control[clarification needed]
with which it does not combine well, and so the overall effect it is having is to actually
stall significant change to less polluting technologies.

The Financial Times published an article about cap-and-trade systems which argued that
"Carbon markets create a muddle"[clarification needed] and "...leave much room for unverifiable
manipulation".[43][clarification needed] Lohmann (2009) pointed out that emissions trading
schemes create new uncertainties and risks,[vague] which can be commodified by means of
derivatives, thereby creating a new speculative market.[44][clarification needed]

Recent proposals for alternative schemes to avoid the problems of cap-and-trade schemes
include Cap and Share,[clarification needed] which was being actively considered by the Irish
Parliament in May 2008, and the Sky Trust schemes.[45] These schemes state that cap-and-
trade or cap-and-tax[clarification needed] schemes inherently impact the poor and those in rural
areas, who have less choice in energy consumption options.

[edit] Structuring issues

Corporate and governmental Carbon emission trading schemes (a trading system devised
by economists to reduce CO2 emissions, the goal being to reduce global warming) have
been modified in ways that have been attributed to permitting money laundering to take
place [1]. The principal point here is that financial system innovations (outside banking)
open up the possibility for unregulated (non-banking) transactions to take place in
relativity unsupervised markets. The principle being that poorly supervised markets open
up the possibility of structuring to take place