Introduction to Economics Lesson 10 / 08
Last week the federal government
released a so-called Green Paper on what is commonly referred to as
Carbon Trading or, more precisely as Carbon Emissions Trading.
The paper followed the release on July 4 of the Garnaut Climate
Change Review, and contains the Rudd government’s proposals as to how
it intends to deal with the perceived problems of climate change, in
particular with meeting Australia’s recently ratified obligations
under the Kyoto Protocol to reduce carbon emissions into the atmosphere.
Many, perhaps most Australians are still largely unaware what Carbon Trading actually means or what are the likely consequences of its proposed introduction into Australia.
What is Carbon Trading?
Carbon Trading is a process set
up and administered by a central authority
[usually a government], intended to reduce atmospheric pollution by
limiting the amount of such pollution that is allowed to occur, and the
introducing of economic incentives to ensure that such pollution that is
thereafter permitted to occur will be most efficiently and productively
distributed to achieve the maximum benefit therefrom
Although the process is typically referred to as carbon trading and is intended to address the emission of carbon into the atmosphere, it can be adapted to relate to and be used for a variety of polluting greenhouse gases by calculating the carbon equivalent of each such greenhouse gas. Emissions are measured in tonnes of carbon dioxide equivalent
How does it Work?
The initial step in the
process is for the central authority to set a cap or limit on the total
amount of atmospheric pollution that will be allowed and then to divide
the total amount allowed between individual polluters.
Thereafter each such polluter will be required to possess a
permit or credits equal to the total amount of pollution that they
The total amount of
pollution to be permitted in a given period and its division and
allocation amongst the various polluters is obviously a command decision
for the central authority. Allocation
of the permits or credits to individual polluters can then occur.
They could be auctioned off to the highest bidder with the
proceeds going to the central authority.
More likely however is that each polluter’s total quota will
be, at the outset of the scheme, assigned and transferred to them
without charge, based on their prior history. This is referred to as
bought, or been given, their permit or credits, individual polluters
will then be free to use them themselves, to sell those they do not need
to those who do, or to buy more, in effect thereby creating a market. For obvious reasons the system is sometimes referred to as
‘cap and trade’. The
fact that markets exist and that trading occurs has lead to the
suggestion that carbon trading is a form of free market
The basic model can be varied in a number of ways. Total volume of greenhouse emissions can be reduced by a lowering of the cap following each licence period, or a proportion of each permit traded can thereupon be retired or cancelled. Activities which have a beneficial effect in reducing atmospheric carbon such as forestation can be encouraged by granting carbon credits for such activities and permitting the recipients of such credits trade them on the market to those with a need to offset increased carbon emissions.
The 1997 Kyoto Protocol, which
commenced operation in 2005, aims to reduce the overall emissions of
participating countries by 5.2% of 1990 levels by 2012.
Now that Australia has ratified, the USA is the only
industrialized nation that has not rarified the Protocol.
Under the Protocol, nations that produce less than their national
quota can sell their credit to nations who exceed their quota.
In accord with the Protocol, the EU, has created the largest international carbon trading scheme called the European Union Emission Trading Scheme [“EUETS”]. It caps the emissions of all major carbon emission producers covering almost half of all EU carbon emissions
Apart from the EU, various
nations, states, [including NSW in Australia], provinces and territories
have introduced their own trading schemes for carbon, or similar schemes
for such things as renewable energy.
There are also a number of voluntary trading schemes, which have
been organized and are participated in by major corporations. Total
value of traded credits has grown significantly in recent years.
US$ 11 billion in 2005, US$ 30 billion in 2006, and US$ 64
billion in 2007.
London, which is regarded as the world’s carbon trading centre, handled the bulk of the market. It is projected that the carbon trading market will grow immensely in the next few years. Major American financial centres are unable to compete with London whilst the USA rejects Kyoto.
An alternative to carbon trading
as a way of reducing the emission of greenhouse gases, is to impose
carbon taxes. There is much
debate as to which method is preferable.
The administrative costs of taxes are much cheaper.
Politically carbon trading is more attractive, since it avoids
the concept of a tax and its resulting cost to people generally is less
Cap and trade is sometimes said
to be a price instrument whilst taxation is said to be a quantity
instrument. Under carbon
trading the amount of reduction is determined but polluters are
uncertain about the price of reduction since the value of the permits
traded on the market can vary.
Conversely, under a taxation system the price to the polluter is known and set by the tax. However what is uncertain is just how much reduction in emissions a given tax will cause to occur. In an endevour to resolve these uncertainties, various hybrid schemes have been devised to try and incorporate the best of both systems, including setting price limits on the price that can be charged for a permit on the market.
Why Carbon Trading?
Carbon trading is seen as an
effective tool in reducing greenhouse gas emissions and hence of
preventing Global Warming. The
costs of administering such a scheme and of its consequences are likely
to be great but far less than the likely costs of doing nothing. Big
Business generally supports the concept as well as does many Green
If so minded, the potential exists for the purchasers of permits or credits to purchase them with the intention of retiring them rather than to use. Al Gore, the leading Greenhouse activist, for instance, is a prominent supporter relying on the purchase of offsets to maintain his relatively opulent lifestyle.
Arguments against Carbon Trading
Criticism of the concept of carbon trading comes largely from two groups; firstly, from those who believe strongly in global warming and who regard carbon trading as not going far enough or as being too favourable to Business. Secondly, from those who do not accept the validity of global warming and who see carbon trading as a monumental example of waste and oppression. Some criticisms include;
David Sharp22 July 2008