The Story of Cap n Trade...

Traders haven't got much of a good press recently as they have been blamed for excessive risk taking and nearly bringing down capitalism. It's a great story, but it ain't true. Retail banks - thats RBS to you and me - took excessive risks and brought down capitalism not the traders.

And so to another great story - the story of cap and trade.


The Story of Cap & Trade from Story of Stuff Project on Vimeo.




You have to hand it to Anne Leonard and her team - they know how to get press and get a great story out there. But let’s look closely at some of the accusations:


1. The cap and give away.
The free permits. I have discussed this earlier this year. Phase 1 (2005-2008) of the European Union Emissions Trading Scheme (EU-ETS) which this story is based on was a cap and giveaway. Billions were made by the utility companies in windfall profits. Which is why in phase 2 (2008-2012) and especially in phase 3 (2012-2020) the allowances will have to be bought at auction. The proposed US cap and trade scheme is also proposing auctions and the CRC Energy Efficiency Scheme - the UK's trading scheme for smaller businesses - has 100% auctions. In fact virtually every economist argues for it. It ain't a cap and giveaway anymore.


2. Caps too loose
In phase 1 for the EU-ETS, the caps were too loose which meant the carbon price fell sharply. But it’s been suggested that this was deliberate to secure buy-in from industry. Get them in, and then tighten the cap. In Phase 2 the EU rejected most national allowance plans - not the UK's - but virtually everyone else's. For phase 3, member states won't be allowed to set them - only the European Commission which means a tighter cap AND a wider cap that will include aviation and more industries. There is also a strong argument for a price floor which basically makes it a tax and cap and trade. The US proposal also suggests a price floor.

3. Offsetting
People really don't like offsetting, but lets get a few things right. There are two types - certified emission reductions (CERs) that are generated by Clean Development Mechanism (CDM) projects and voluntary emissions reductions (VERs) which are not.

CDM projects have to get verified by 12 UN bureaucrats and need to show that they are providing additionality (that a renewable project, for example, would only go ahead if there was income generated from CERs) AND that they are not just replacing home country emissions. If a utility company funded a project in China to reduce emissions of a coal plant, they would have to prove that they have reduced emissions at home first.

So, a utility company within the EU-ETS, may decide that it is more cost-effective to reduce emissions in another country (where coal fired stations are less efficient) than to reduce emissions further at home (where coal fired stations are more efficient). First, they have to get the project approved and that takes 18 months; remember, there are only 12 of these UN bureaucrats to approve 1000s of projects. Second, the EU-ETS only allows a small percentage of offsetting - around 10% - and once this has been reached there is no more allowed. Finally, they have to hope that their project in another country is built to spec and works to spec and reduces emissions. Oh, by the way, they can't use voluntary emissions to offset their own emissions as they are not regulated by the UN.

When CDM works well it can benefit countries through increased income and technology transfer. If China, India and Brazil want to grow, CDM projects can facilitate this without increasing carbon emissions.

So where does this leave us? Well, it's great story, but it's spoilt by the facts. Leonard is short on alternatives, but let’s visit them, briefly. First, we could have a carbon tax and there is a strong argument for this over cap and trade. The problem is that businesses and the public don't like them, accountants are great at reducing tax burdens and how do we harmonise a global carbon tax? There's no precedent.

What about simply telling business to meet a standard? Well, how do we define a global standard? Should it be the same for all countries? Also, command and control systems tend to reward complacency and companies that do the minimum. Companies that go beyond the minimum are simply not rewarded.

Ultimately, in my view, it's down to two things: first, the trading of carbon blows people's minds away. Think about it, it doesn't physically exist like coffee or oil or other commodities. Second, a vocal section of environmentalists don't like the profit motive or capitalism and see cap and trade as part of this problem. I don't see it as that way: it's government regulation using the profit motive. Without government, the carbon market wouldn't exist. The other benefit is that cap and trade is on the brink of securing a better climate change deal - that's some achievement.