Making Sense of Emission Trading

At last there is real effort being made by media to understand Climate Change and one of the mechanisms proposed to deal with it: Emissions Trading. There seems to me a sea change happening. The public want to know more. They want to understand more.

It's good that PM Key is off to Copenhagen.
And it's good that China and the USA seem to have made significant decisions about their response to Climate Change just days before Copenhagen. All good.

I guess I've always been something of a skeptic. An Emissions Trading Sceptic. From time to time I'll run something here that throws a bit of light on the subject. In this blog I'll try to explain what emissions trading is (using stuff from the experts), and introduce some of the difficulties:

Explanation of Emissions Trading

This comes from an Australian economist writer for several Aussie newspapers. Peter Martin. It's a helpful explanation of how it might work for power stations in Australia....

"...To simplify, let’s suppose that the only emitters of carbon in Australia are power stations. Lets say that this year they have been emitting 100 units each.

If an emissions licensing and trading scheme were introduced next year the government might only hand out enough licences to allow the emission of 90 units.

Obviously each power station could comply if it cut its emissions by 10 per cent. It would be the same as if the government had legislated for a station-by-station 10 per cent cut.

But it would be a bad way of cutting total emissions by 10 per cent. Some power stations would find it difficult if not impossible to meet the10 per cent cut. They would be crippled. Others might find it easy. At little cost they might even be able to cut by 20 per cent.

Without trading in permits the stations that found it hard to cut would suffer, while the stations that could easily cut by more than required would be given no reason to do so.

Trading removes those problems. In the language of the economists, whatever the target for cutting emissions is, trading allows industry to meet it in the least damaging way possible.

Here’s how. A firm that can easily cut its emissions (perhaps because its coal-fired generator is nearing the end of its life and it can easily be replaced with a wind one) will find it has permits to spare. It might have been issued nine but only need seven, having two to sell.

Another firm, that can’t cut emissions without incurring a tremendous cost will find it cheaper to buy spare permits from the firm that no longer needs them. Its cost of producing power will go up but by nowhere near as much as it would have had it had no choice but to meet a target. Over time that firm will find that business case for switching to cleaner technology increasingly persuasive. But not all at once.

The firm that can easily cut emissions will have discovered a new way of making money, and the cleaner it makes its business the more money it will make. As a former Liberal Party leader used to say, it will become “incentivated”.

That’s the theory. It was put to the test in 1990 in the United States when President George Bush senior signed into law a new act designed to combat acid rain, caused by the emission of sulphur.

In a sharp break with the approach of the past the Bush administration issued annual permits to allow the continued emission of sulphur, but not quite as much as before. Then it encouraged the Chicago Board of Trade to set up an exchange on which those permits could be traded.

Each year the administration handed out fewer annual permits. Over ten years the price of a permit on the exchange climbed from $US100 to $US800 a ton. The polluters who could cut back easily found themselves rich. Those that couldn’t found business increasingly expensive — but not so expensive as to force them out of business straight away.

Over that decade sulphur emissions halved throughout the US. In some parts of the country acid rain declined 25 per cent. The annual saving in healthcare costs was said to top $US20 billion.

That’s the promise held out the promoters of emissions trading schemes for carbon.

Any the wiser? I hope so. Now here's a few comments from the other side. I quite like this one from John Blakeley that appeared in NZ Herald 19th November this year. He writes:

Carbon Trading: an indulgence we can't afford. He asks why parts of NZ's economy should be given credits for their sins of emission. "....Michael Kinsley, writing in Time Magazine in an article entitled: 'Credit for bad behaviour' in July 2007, suggested that the purchase of carbon credits to offset greenhouse gas emissions could be compared with the Middle Ages practice of buying indulgences for the forgiveness of sins. Martin Luther King (1487-1546) was a leader of the Protestant Reformation in Germany. His idea of revolt occurred when he saw indulgences being sold, a practice he openly condemned - leading to his eventually being excommunicated. In a similar manner to indulgences, purchasing carbon credits to offset greenhouse gas emssions can be seen as an alternative to making the hard decisions to reduce emissions. It is much easier for politicians to tell people they must pay a little extra for their electricity and petrol than to try and persuade them that they must cut back on their energy use...."

"...So from July 1, 2010, we will be asked to pay more for our electricity and petrol for a scheme which is likely to have no effect on reducing our gross greenhouse gas emissions. And it is unlikely that the average consumer is going to be happy to pay this extra cost as "indulgence money", especially at a time of considerable constraint on wage increases...."

"...I believe that it is now time to "go back to square one" and start again, to define the best, most cost-effective way for New Zealand to control future increases in greenhouse gas emissions. Purchasing indulgences by way of carbon credits is not the best way to go." (John Blakeley is a programme director in the Department of Civil Engineering at Unitec in Auckland.)

That's an interesting argument. It's one I feel empathy with because - for me - the important thing has to be actual reductions in carbon emissions. Not just some scheme which has got the banks, financiers, money lenders and economists all in a lather. Some of the other arguments are more sophisticated and go to the heart of actually implementing emissions trading. There is some very interesting information in Wikipedia for example (whose entries seem to be changing minute by minute as Copenhagen approaches) :

Emissions Trading Scheme Critics

Critics argue that emissions trading does little to solve pollution problems overall, since groups that do not pollute sell their conservation to the highest bidder. Overall reductions would need to come from a sufficient reduction of allowances available in the system....

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. 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 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" and "...leave much room for unverifiable manipulation"...

And it is the mechanics of manipulation and actual implementation that make interesting reading as well. From wikipedia again:

Measuring, reporting and verification (MRV)

Meaningful emission reductions within a trading system can only occur if they can be measured at the level of operator or installation and reported to a regulator.... For greenhouse gases all trading countries maintain an inventory of emissions at national and installation level; in addition, the trading groups within North America maintain inventories at the state level through The Climate Registry. For trading between regions these inventories must be consistent, with equivalent units and measurement techniques.

In some industrial processes emissions can be physically measured by inserting sensors and flowmeters in chimneys and stacks, but many types of activity rely on theoretical calculations for measurement. Depending on local legislation, these measurements may require additional checks and verification by government or third party auditors, prior or post submission to the local regulator.....

Enforcement

Another significant, yet troublesome aspect is enforcement. Without effective MRV and enforcement the value of allowances are diminished. Enforcement can be done using several means, including fines or sanctioning those that have exceeded their allowances. Concerns include the cost of MRV and enforcement and the risk that facilities may be tempted to mislead rather than make real reductions or make up their shortfall by purchasing allowances or offsets from another entity. The net effect of a corrupt reporting system or poorly managed or financed regulator may be a discount on emission costs, and a (hidden) increase in actual emissions.

So, going back to the Aussie economist's simple example, someone would have to actually measure what comes out of the exhaust chimneys of each of these power stations. All the time. And keep detailed records. And these measurements would need to be credible and independent. It's the whole thing about verification. The devil in emissions trading is in the implementation detail. Sounds good to economists, but becomes more and more of a practical nightmare the closer you get to nuts and bolts implementation.

Imagine doing it with cows!

That's enough for now. Just to get your interest, and perhaps suggestions for further explanation or "making simple"....