Problems with "cap and trade"

http://www.npr.org/templates/story/story.php?storyId=123037162

While the US Congress is still wrangling over the implementation of a "cap and trade" market in the US (and its passage through the Senate is doubtful), it is already up and running in Japan, New Zealand, and the EU. So for Obama to claim at this week's State of the Union that the US is "leading" the effort to curb climate emissions is just hysterical. Those other nations pollute far less than us per capita, and are at least a decade ahead of us in terms of emissions management. For the record, Obama's actual quote was, "[The US has] gone from a bystander to a leader in the fight against climate change." Maybe he meant to use the future perfect tense.

First implemented to curb acid rain and now used for CO2/methane after the UN Kyoto summit, the cap and trade system works basically by the government imposing pollution limits/credits on various emitters. If company X exceeds its quota, then it must buy unused credits from cleaner companies (on an emissions market), or "offsets" that neutralize their pollution overage with green initiatives (investment in a wind fam, tree plantings, etc.). The global climate market is now worth $150B, and emissions offset certificates are the fastest-growing commodity in history. A previous posting described how celebrated NASA climatologist R. Hansen is against this system, so I won't repeat his arguments (http://worldaffairs-manwnoname.blogspot.com/2009/12/top-climate-scientists-slams-copenhagen.html).

Markets do have the ability to maximize wealth/efficiency, reveal true value, and improve conditions for millions of people, and they have in the past. But we also know that markets can degenerate into giant scams that benefit the super rich and those privy to extra information. Ironically, the corporate sector is at odds about America's involvement in global cap and trade. The energy industry is of course fiercely opposed (and has spent millions on ads and lobbying Washington), but Wall Street was actually disappointed that Bush pulled us out of Kyoto. They have lobbyists on the opposite side of the climate debate pushing for America's participation in the emissions market. Each day Congress stalls, they miss out on a ton of easy money, even more than what is being made at the current London-based climate exchange. Already Goldman, JPMC, Citi, Bank of America, Barclays, and others have trading desks there. 2 major entities are being traded: climate offset resources/credits and speculative derivatives based on carbon futures, with the latter just being a gambling hall for the price of carbon, similar to currency markets. Brokers and polluters are scouring the globe to find potential "green" projects that could qualify as carbon offsets to be sold to the highest bidder.

You can see that there are two major problems associated with the system. The first is inaccurate measurement/pricing, and the second is turning a "promise" into a tangible commodity. For the first, how do you accurately measure carbon emissions, avoid fraud/tampering, and decide how much pollution is tolerable by various industries? I believe the EU erred on the conservative side and flooded the market with too many emissions credits, thereby depressing their value. And how do you calculate if a solar farm in the Mojave Desert is offsetting a coal plant in Napoli? The UN, which manages the market under the Kyoto protocols, relies on "validation" companies to audit emission valuations (like how S&P or Moody's rate stocks). These companies assess the various polluters and offset projects, and assign appropriate emission values. But the UN actually had to take the 2 largest companies offline after investigations showed that they lacked sufficient expertise and quality control to make accurate assessments in 50% of their studies (accounting for 1/4 of the total market). The UN determined that some carbon offset projects were inflated at 15-35% higher CO2 savings than what they could reasonably provide. And in fact, that percentage probably holds true for the overall EU carbon market as well. Call it the carbon bubble.

Second, commodities markets rely on certain delivery. When you buy oil or pork bellies futures, you know you will receive ownership of those products at the amount, price, and time you agreed on. But carbon futures are promises and assumptions. Speculators buy offsets that claim to save X tons of carbon over Y months. But wouldn't it make more sense to buy and sell carbon savings that has already happened for sure? I will buy the 2009 carbon savings from this geothermal plant for Z dollars to offset my 2010 pollution overage. Some of the proceeds will go to fund future green projects, which in turn will be sold on the market AFTER they have delivered their climate benefits. What if your wind farm is sabotaged by rebels, or a storm wipes out your newly planted forest, or your resource doesn't even get built (since most offsets are not finished at the time of sale)? Since many offset projects are in undeveloped areas, there is less security and oversight. You already paid for the offsets and the government expunged your pollution, so contract-wise everything is fine. But the planet doesn't get the emissions savings it was promised.

If we really want to efficiently limit emissions, we first need a carbon tax, and then some elements of cap and trade can work properly. Because cap and trade on its own creates a huge, expensive, confusing bureaucratic infrastructure to manage. Half of the effort is wasted on upkeep and middle men each taking their cut. But if we had perfect information about pollution and offsets, as well as perfect pricing and monitoring, then of course the market would work. But all the corruption problems plaguing Wall Street also exist for cap and trade, though with less oversight resources and less institutional knowledge for the latter.

http://www.rollingstone.com/politics/story/31633532/as_the_world_burns
http://www.pbs.org/frontlineworld/stories/carbonwatch/
http://www.harpers.org/archive/2010/02/0082826

Top climate scientist slams Copenhagen and cap/trade

http://www.guardian.co.uk/environment/2009/dec/02/copenhagen-climate-change-james-hansen
http://www.kqed.org/epArchive/R912070900
http://www.columbia.edu/~jeh1/

NASA and Columbia's Dr. James Hansen, the preeminent American global warming scientist since the 1980s (Al Gore is the figurehead but Hansen is the brains), has really come out against the Copenhagen summit (boycotting it in fact), the big nation's emissions reductions targets, and the whole concept of "cap and trade". While heads of state seek to reduce carbon emissions to 1990's levels by 2020 or so, Hansen thinks we need doubly aggressive reductions to even have a chance of averting climate disasters. Like we can live with the inevitable 1 meter sea level rise as a consequence of our past pollution and climate trends, but a 10 meter rise (if we do nothing) will be thoroughly disruptive to human kind. And despite the cheerleading and positive spin, it doesn't look like China and India will be of much help. They have agreed to reduce their "carbon intensity" by 20-40% by 2020, but not actual emissions. Intensity only refers to carbon emitted per unit of energy/commerce, so intensity goes down as GDP grows anyway (which India's and China's will obviously do). Therefore nations can reduce their intensities without ever doing anything about carbon. So while the US and China are the top carbon polluters (42% of total CO2), their carbon intensities are far below those of Congo or Kampuchea (<1% of global pollution), so obviously something is amiss.

Cap and trade (establishing total emissions limits and allowing low-polluting businesses to sell their carbon credits to high-polluting ones, or back to the government, which is in effect in Western Europe as we speak) is also inherently flawed according to him (though not for the reasons that Glen Beck believes). He even goes further to say that it is just a smoke screen to conceal, or at least prolong, business as usual (quite plausible considering the Washington-business relationship). We capitalists stubbornly believe that the "miracle of the market" will save us every time. A "carbon exchange" will incent less pollution while funding innovation. But is it the fairest and most efficient way of doing so? For a potential cap and trade industry, imagine the bureaucracy and costs associated with establishing such a complex, dynamic, lawsuit-fraught commodity exchange.

Just as investment houses nickel and dime us year after year for "managing" our 401(k) accounts, cap and trade will be run (or at least manipulated) by big Wall Street banks, who will also take their "service fee" cut of the pool. We've seen what happened with savings & loan, energy trading, telecoms, mortgage derivatives, and credit-default swaps, so can you just imagine the tricks that Goldman Sachs and others are scheming up for this nascent market that gov't is not equipped to properly regulate? The big banks have hundreds of people working on this already, and no bills have even reached the Senate floor yet (but they smell blood in the water with a carbon exchange expected to be worth a cool $1T). Already big polluters like energy companies and factories are threatening that they will have to pass costs onto the consumer due to the carbon fines from their business operations, and more than likely the banks' service fees for maintaining the carbon exchange will also get passed onto us. Yes some of the money will funnel into green research (mostly "clean coal" that will never be as clean as nuclear), but rest assured that Wall Street will extract its pound of flesh first.

In addition, "carbon offsets" will grant polluters more room to pollute, while not truly offsetting their actions, so it's really cheating the cap. Like Exxon could earn x more carbon credits for paying to protect y acres of forest from deforestation. That sounds very kind of them, but really what has it done? Since all forests are not protected, loggers and ranchers will just level another tract of land instead. And all the while Exxon gets to spew more carbon for pocket change (which will obviously benefit Exxon financially, or their bean-counters wouldn't have approved it). Another concern is "grandfathering". When sulfur limits were imposed by Congress to address acid rain pollution in the 1980s, coal power companies persuaded regulators to exempt older plants constructed before 1970. Maybe that explains why so few new power plants have been constructed, while demand has steadily grown. So despite the cap, it was business as usual, and the same might occur with carbon (you can imagine the companies whining about the huge costs of retrofitting old plants).

Hansen suggests that on the other hand, why not just impose a fee on carbon for a fixed amount, like we do for air travel and cigarettes? Like water, energy is artificially cheap in America, so that the social and environmental costs of wasting those resources are not directly felt by the waster. The reasons for this are varied, but clearly due to gov't policy. But just as the cost of used motor oil or car battery disposal is factored into the garage fees you pay, the costs of carbon pollution to the environment should be included in the carbon-emitting products we buy and the carbon-emitting business practices of most or all companies. But of course industry lobbies hate this idea because it will make their operating expenses rise while reducing revenues/productivity. A carbon fee would fund green projects and research, just as part of the cigarette tax funds gov't health programs like S-CHIP. If we were to tax $115 for every ton of carbon (or $1 for every gallon of gas, 8 cents per KWH electricity), we would net $670B each year for public use. Imagine what good that would do - we could even bail out Wall Street again during the next bust. Some of that money could even be paid back to the public to offset the higher costs of carbon-based goods or subsidize green retrofits/products (up to $250 per legal US resident per month). So instead of cap and trade (where the public gets nothing, and could even be shafted), we should implement "fee and dividend".