The Economics of Climate Change Policy

EC 133

May 1, 2007

Market Mechanisms to Reduce Greenhouse Gases

• Carbon Tax– Taxes levied on businesses or individuals on

a per-unit basis– Pros/conlater

• Offsets

• Cap-and-trade

What is

an Offset?

Project reduces one ton of CO2

A Certified Emissions Reduction is Created

Polluting Industry buys the ton of carbon, to “neutralize” one ton of its emissions

Money goes back to project to reduce more CO2

FIRST

THEN….

THEN….

FINALLY…

What is Cap- and-Trade?

-This cap may be set by the government, as is the case in Europe

-Or, it may be set by another carbon trading platform, such as the Chicago Climate Exchange or the Brazilian Futures Exchange

First, a cap is set on emissions

Cap= 1000 Tons CO2 (for entire country)

Two Companies: Cars and Electricity

Each are allowed to emit 500 tons of CO2

The Car company currently emits 700 Tons of CO2

Reduces emissions to 600

The Electricity Company Currently Emits 600 tons of CO2

Reduces emissions to 400

$$$

100 Allowances

Options to Address Climate Change

• Policy Options:– The Kyoto Protocol

• Voluntary Initiatives (Independent of National Policy)– Regional, State, or City-wide agreements– Offsets– Privately run Trading Schemes

The Kyoto Protocol- Background

• Drafted in 1997 by the 3rd COP to the UNFCCC• Calls for global reductions in GHGs by 5% below

1990 levels– Countries have different targets, based on abilities to

reduce emissions

• Entered into force in February 2005– Required that 55 countries, accounting for at least

55% of 1990 emissions, had to ratify the protocol– Once the U.S. dropped out of negotiations, Russia

was the key for entry into force

Characteristics of Kyoto• Countries divided into two groups: Annex

1 and non-Annex 1– Only Annex 1 have targets– Non-Annex 1 parties must demonstrate

“meaningful participation”

• “Hot Air”

• Flexible Mechanisms– CDM, JI and ETS

Flexible Mechanims- Joint Implementation

• Occurs between two Annex 1 parties

• Helps both countries attain targets cost-effectively

Flexible Mechanism- Clean Development Mechanism (CDM)

• Occurs between an Annex 1 country and a non-Annex 1 country

• Helps the Annex 1 country attain target cost-effectively, and contributes to sustainable development of non-Annex 1 country

Flexible Mechanisms- Emissions Trading Scheme

• Cap-and-Trade system between European Countries

• Set a cap on certain industries, issue allowances, and allow for trading

Why did Kyoto fail?

Kyoto Protocol: Prospects and Problems

• Enforcement for non-compliance was not specified in language of Kyoto

• Monitoring is expensive, also not specified– Though CDM projects must include monitoring plan

• Flexible Mechanism have been successful in encouraging participation of developing countries– Still, it is unlikely that any developing countries will

take on targets in the next round• Without the U.S., it will be difficult to make real

progress to curb climate change

Alternatives to Kyoto:

What to do When the Government doesn’t Believe in Global Warming

Addressing Climate Change in the Absence of National Policy

• Regional or State Agreements

• City-wide or Firm Initiatives

• Carbon Tax– Levy tax on industries on a per-emissions

basis

• Carbon Offsets

• Carbon Trading

Voluntary Market for Offsets

• Businesses and Individuals can buy offsets from private providers, which are often internet-based

• There is no cohesive set of standards for quality of offsets, but verification and labeling schemes exist

Voluntary Trading Schemes

• The Chicago Climate Exchange is the only trading scheme in the U.S

• Privately Run

• Companies, Organizations, States, or Cities enter into a binding legal agreement to reduce greenhouse gas emissions by a certain percent during various phases– Not very stringent

Confused? It gets worse…

• Companies can purchase offsets to reduce their emissions below the cap. Then they sell those allowances for more than the price of the offsets, and make a profit

• Companies can sell offsets to private providers, who then sell those offsets to other companies or individuals who are trying to reduce emissions

Choices in the Voluntary Market

• Reduce emissions through conventional means business case for cost effective reductions

• Buy Offsets

• Participate in a cap-and-trade system such as the Chicago Climate Exchange

Reducing Emissions through Conventional Means

• Anyone can do this!!

• Measures:

• Positives:

• Drawbacks:

Offsets

• Anyone who can pay for them can buy them– Price ranges from $5 per ton to $30 per ton

• Positives:

• Problems:

Carbon Trading

• Typically bigger companies, cities, states, and organizations

• Positives

• Drawbacks:

Buyer Beware• Demand additionality

– Buyers of offsets should demand the reductions they are buying would not have otherwise happened. They should demand that the reductions are actually having a net benefit for the environment. In fact, they should demand that the offsets institutionalize sustainable development.

• Demand verification– The United Nations administers programs for verifying and certifying

emissions reductions. It is as robust as it gets, and you can't go wrong buying reductions from these projects.

– A handful of experienced non-governmental organizations have developed standards for carbon reductions. Offsets meeting these standards are sometimes worthy of your investment.

• Demand accountability by sellers– buyers should make sure the reduction projects underlying their

offsets are receiving a fair share of the purported amount used to pay for the carbon and their investment is not being siphoned off to administration or other fees. When contributing to a charity most donors insist on this criteria. The same applies to offsets.

Gilles Corre, director of Evolution Markets Ltd,FT editorial May 1, 2007

Moomaw ReturnsWhat is Needed to reduce by 75%?

• Sustained reductions of 3%/year by industrial nations for the rest of the century

• This will reduce emissions by half in 23 years and to one-quarter in 46 years

• This will assure that CO2 concentrations are below 1990 levels and dropping at the end of the century rather than continuing to rise

• Otherwise, there is a high probability that global average temperature will rise by more than 4o F during this century and might go as high as 12o F

What are the pros/cons of an energy tax?

Case for taxes

• clear and less vulnerable to market problems

• industry needs certainty regarding price

• timingfaster

• less opportunity for manipulation

• can hit more sectors

• can introduce compensating mechanisms for low income families

Policy Questions

• Can the voluntary market meet the need to reduce greenhouse emissions?

• Should the United States return to the Kyoto table?

• Should the United States assess national green taxes?

What is the optimal environmental strategy for the US?

Voluntary Mandated

Offsets Carbon trading

Business case for cost efficiency

Build markets

Kyoto (II?)

National Targets

(ETS)

Supranational Targets

Strategic Philanthropy

Supranational mechanisms

CDM JI Taxes

National Mechanisms

Markets

?

?+?

Regulate Markets

What are costs of non-action?