Is Cap and Trade Dead on Arrival?

At some point in 2009, the government may get past managing the crisis du jour and turn to those nasty, seemingly intractable problems we nevertheless have to address. such as greenhouse gas emissions.

One idea that had been bandied about is the idea of cap and trade, which would allow big bad carbon emitters to buy the right to do so from those who had cleaned up their act. I’m not alone in being less than keen about this regime (the very fact that Wall Street firms are keen to act as brokers should give cause for pause, and even conservative economists like Greg Makniw prefer straight up carbon taxes to cap and trade).

But the cap and trade concept may already have been dealt a near-fatal blow. As John Dizard explains in more detail, a court ruling called the legal standing of these rights in question, and it may not be possible to dispel the cloud around them.

From the Financial Times:

The most serious struggle will be over climate change, or the regulation of carbon emissions. You can forget all the chitchat about finding a consensus on this one: the coal people and the enviros are in this match until one side is carried out….

Wall Street and Chicago always like the creation of trading markets for new assets, especially if they can be inefficiently priced by the professionals. So while the coal people hate climate legislation, a lot of traders see an opportunity.

One of the problems, though, is that there are already government-created markets for sulphur dioxide and nitrogen oxide emissions, and those markets are in trouble. As I have written earlier in this space, a Federal appeals court decision on July 11 of last year appeared to kill the long-term value of credits under what was called the Clean Air Interstate Rule, a set of markets for pollution credits created by the Environmental Protection Agency. At a stroke, some tens of billions worth of rights to emit noxious gases were slashed in value by the court’s ruling that the EPA had exceeded its authority.

The EPA, along with utilities and some enviros, asked the court to modify or reconsider its decision, and, unusually, the court had second thoughts. In late December, the court indefinitely stayed its cancellation of Cair, allowed the trading to remain in place, and told the EPA that it had to come up with a fix, sometime in the undefined future. That is the simple version.

So, the price of the right to emit one ton of sulphur over the next year, which had been up to $600-$800, fell back to as little as $100 after the initial decision, and has now, after the court’s reconsideration, risen to $150-$200. At $600, utilities found it economic to build new pollution control systems before they were required by law, since they could sell for a lot of money the emission credits they earned…..

Now, though, the court ruling, and the wider realisation that allowances under cap-and-trade are not really property rights, has chilled such markets. Risk management committees for corporate buyers and trading houses are likely to hesitate before buying pollution permits that could lose value.

So any new market-based emissions controls had better have more certainty than the flawed Cair. In leaving Cair in place, the court seemed to reason it would retain its effectiveness in reducing emissions over the next couple of years, but that is not the case. Instead, the EPA’s pollution allowance market people believe the low prices created by the uncertainty over the future of Cair will have the perverse incentive of inducing utilities to use up existing pollution allowances by emitting more than they would have, while postponing building new controls. Or so the agency’s economic models say…

The Cair mess shows that it is easy to get market design wrong. With mortgage and derivatives markets, that costs billions. With Cair, it costs shortened lives.

Now, of course, it is possible that a new, bullet-proof version of trading rights could be devised. But it would probably be subject to serious scrutiny before anyone invested in the hope of being able to sell the resulting carbon rights.

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  1. bg

    “even conservative economists like Greg Makniw prefer straight up carbon taxes to cap and trade”

    This seems obvious to me, as conservatives prefer consumption taxes and dislike complex schemes designed to engineer an outcome.

    Also Greg believes (Pigou club) that energy taxation in particular favors the optimizes the incentives to the actual high social cost of energy use (defense, polution, etc.)

  2. mmckinl

    Is Cap and Trade dead on Arrival?

    One can only hope so. We need a carbon tax. It would be more comprehensive; easier and cheaper to implement and enforce AND would send many more tax receipts right to our beleaguered treasury.

    Special rates for utility bills should be made more progressive to help low income households. Industrial rates could be justified with counetrvailing charges on imports from countries that do not have a tax and those charges could then be used as export subsidies to help competitiveness overseas.

  3. Paul Hodgson

    mmckinl: You’ve expressed my views exactly and more succinctly that I could have.

    Yes Yves, let’s keep the deal-makers well away from this side of the economy.

  4. Mitchell

    Cap-and-trade is the approach to emissions reductions used or promised by many countries, whereas I can’t think of a single one which proposes to use a carbon tax. An increasing part of the post-Kyoto-protocol diplomacy, I read, is about creating a global carbon-trading system. There is enormous political capital invested in this approach, and I doubt that one suspended ruling is going to stop it.

  5. Anonymous

    An increasing part of the post-Kyoto-protocol diplomacy, I read, is about creating a global carbon-trading system.

    The purpose of which is, IMO, to provide state-independent funding for a “real”* world government; possibly transforming the UN into one!

    All the professional politicians around the globe are gagging over the career possibilities in such a setup.

    *One that can bring enough violence to actually solve an argument.

  6. coldwhiteguy

    The EPA should determine the number and price of emission permits annually and auction them off. The proceeds of that auction should be distributed to every U.S. resident. That’s a resource distribution plan that directly transfers the benefit to the individual owners. That’s how they do it in Alaska, and it’s worked great- every year i get a check for the sale of a resource I own a part of. And isn’t that a nice change from just the rich guys getting the money?

  7. Anonymous

    I think we’ll be getting enough carbon reduction through reduced economic activity. The whole GW agenda needs to be put on the back burner or, preferably, tossed into the garbage can of fads prior.

    My idea would be to tie the issuance of new licenses for nuclear power plants to the retirement of older coal plants.

    Say Entergy, Dominion or Exelon want to build a 1500 MW nuke. Make
    them retire 750MW of coal generation for the privilege.

  8. Namazu

    Why should we expect a global cap-and-trade system to work when the world can’t even agree not to allow farmers in developing countries to compete on a level playing field with our Big Ag? Common sense left the building a long time ago on carbon. A Pigou tax could put us on the road back.

  9. Anonymous

    I’m a futurist with decades of experience. The politics of global warming really stinks. I am convinced the entire global warming subject is dirty politics at its worst.

    Aside from the temperature issue, the increased CO2 levels in the air have several benefits.

    Even the worst imaginable global warming scenario is easily resolved by slightly increasing the albedo of the earth (i.e. slightly increasing the amount of sunlight reflected into space).

    Ocean acidification is also easily solved if that should turn out to be an issue.

    The whole idea of controlling carbon emissions is nuts.

  10. joebhed

    Thanks for addressing this.
    As usual mmckinl has hit spot on the problematic issues attached to C&T.
    This will be the biggest international financial marketing debacle to come down the pike since fractional reserve based banking.
    Mitchell opines on the 'enormous political capital' invested in C&T.
    While true, any open investigation of the support for C&T will find there is no basis to believe it will do anything except unnecessarily increase the cost of achieving our carbon-balancing goals.
    In other words, we have the conclusion without having the debate.
    There are some incredibly unique perspectives coming forward right now on the positive benefits of the carbon tax.
    There is also an invalid notion out there that the global C&T experience, primarily with SOX and NOX reductions under acid rain regulation, supports the gigantic leap to C&T to manage carbon.
    The SOX-NOX solutions were available off the shelf, it was an easy choice for polluters.
    Most admit that the solutions to our carbon balancing goals are still undefined, and the uninformed move to C&T will result in a policy of cap-and-pay more than is necessary.
    What is needed is some congressional leadership on the dialogue that is taking shape.

  11. Mike

    Technical comment.

    CAIR was overturned because NOX and SOX emissions affect pollution on spatial scales of hundreds of miles. Reducing emissions in Minnesota has negligible impact on Georgia and vice versa. The specific problem was a Tennessee power plant that was producing a huge amount of pollution that was affecting North Carolina.

    While I think Cap and Trade is flawed for other reasons, it would not be affected by the same spatial issues as CAIR because CO2, N2O, CH4, and the other trace greenhouse gases have spatial scales that are global. Where the pollutants are emitted is therefore irrelevant.

  12. Anonymous

    “The whole idea of controlling carbon emissions is nuts.”……so it is.

    Won’t stop the EPA from trying to tax cows at $25 a head for emitting methane.

  13. Mitchell

    Anonymous futurist @ 9.12am,

    What albedo-changing method do you have in mind? Turn to page 8 here and you find an estimate that even if you do all that you can to increase the albedo of the roofs and pavements of the world, it only offsets a few years’ CO2 emissions.

    I’d also like to know what your remedy for ocean acidification is.

  14. Anonymous

    According to British Air Minister, their Scientific Study for 2008 on Co2 Green-House Gases, named 18,000 Jet-Liners as #1 emissions of Co2 Gas at 12%, But (12% x 5yrs =60%)a 'Solid' majority was transported by Aircraft to Cruising Altitudes, in thin, cold upper-atmosphere areas! The hot Co2 gases heated by Jets go up & gets 'Stuck' above the cold air-layers! Autos are not present above 25,000 ft! There are no factories, nor Coal Power Plants above this altitude!Co2 gas is a heavy gas that doesn't 'Float Upwards'normally!Cars in CA or FL, don't affect N.Y., Iowa, Kansas, or their upper-atmospheres! Same for factories & Power-Plants in PA, Ohio & Michigan–no effects! Obama's Cap & Trade standards "Gets Rid of Nothing" & 'gives him Taxes, which trickle-down to ave.consumer–paid by"Tax-Payers'–who make less
    than $50,000 per year! Understand Suckers–He got you,coming & going!
    Gore, Pelosi & Obama are "Frequent Flyers" that contribute to this "Green-House" Effect!(They're not interested in stopping Co2 emissions that they're causing!)Southwest Airlines state their jets
    made over 1.5 million Ascents to cruising altitudes-during one year!
    (This is like having a continuous "Freight-Train" dumping Box-car loads of Co2 Green-house Gases into the upper-atmosphere-!! Is there anyone–that doubts Facts?

  15. mheck

    In any case, a carbon tax makes only sense, if the money is flowing out of the country. How are you checking if e.g. Switzerland is following the rules? There is no chance. It is fairly easy to find out the total emissions from fossil fuels for Switzerland, but how do you know, if the overall framework isn’t set up to counter the effect of a carbon tax system? Only if the money flows out of the country, the gov’t has a real incentive to make the regulation in a way, that CO2 emissions are really reduced.

    The argument about the more easy to implement carbon tax was always focused on the domestic politics place of advanced nations.

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