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 produce.

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 ‘grandfathering’

Having 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 environmentalism.

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.


International Trading

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.


Carbon Taxes

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 noticeable. 

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 organizations. 

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;

  • Effective carbon trading will require an army of administrators, inspectors and enforcers at great cost and with power to intrude and control peoples’ lives in ways typically not known before.
  • Two influential reports relied upon to support the concept of carbon trading compiled by two economists, that of Professor Stern in the UK and that of Professor Garnaut have been subjected to severe criticism by their peers.
  • Costs of introduction and of operation have been significantly underestimated and of not doing anything greatly exaggerated
  • Introduction of the scheme into Australia will wreck the economy since industry will be destroyed or leave the country for those countries with less or no controls.
  • China and other developing countries, whose growing output of emissions dwarfs that of Australia, do not intend to curtail their output of emissions, rendering such efforts effectively futile.
  • Carbon trading is tailored for Business and will be corrupted and controlled by it.
  • A growing number of scientists and an increasing volume of scientific evidence refute global warming.


                     David Sharp

                     22 July 2008 



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