How do you price the tonne of carbon that, once burned, tips the balance and triggers catastrophic, irreversible global warming?
For the last ten thousand years, we have basked in an exceptionally stable climate. Agriculture has flourished, and great cities and civilisations have grown.
Then, two hundred years ago, fossil fuels exploded into our economy, powering a massive consumption boom but also threatening to destroy the climate stability that underpins our survival. We now face a huge challenge – how to apply the brakes to the thundering fossil-fuel powered engine that now drives the global economy. We have just a few years left to replace our entire energy infrastructure with low-carbon alternatives.
How can we achieve this enormous task? Nothing changes human behaviour faster than a hefty punch in the wallet, so the obvious answer is to put a price on carbon emissions, perhaps by raising fuel taxes. But this does not guarantee that we will keep our emissions below the 'tipping point' beyond which lie the horrors of unstoppable climate change - melting ice sheets, gushing methane and collapsing ecosystems.
Instead we have pinned our hopes on a solution that combines the awesome power and creativity of the market with regulation to keep emissions to a safe level: Cap and Trade.
Cap in hand
The theory is brilliant - we decide how many tonnes of carbon dioxide we can safely emit, and issue a corresponding number of carbon permits to companies. Companies that reduce emissions below their allocated level can sell surplus permits to more polluting companies. Carbon reductions will be made efficiently – cheapest first – and there will be strong incentives to switch to low carbon technologies.
And so the European Emissions Trading Scheme was launched in 2005, covering power generators and heavy industry that accounted for almost half of EU carbon dioxide emissions. Unfortunately, industry lobbying led to key departures from the idealised theory. Permits were issued free of charge based on the past emissions of each company – a process known as grandfathering - whereby heavy polluters are rewarded with more permits, while companies that have already reduced emissions lose out.
More bizarrely, the cap was set above the actual starting emissions of the participants. When this became apparent, the price per tonne of carbon crashed from a high of €30 to less than €1, while the emissions of the participants increased by almost 2 per cent. Meanwhile, the participants were enjoying huge windfall profits from selling their surplus permits.
What price market?
The scheme is being tightened, with emissions capped at 6 per cent below 2005 levels by 2012, and 21 per cent by 2020. Permits will increasingly be auctioned rather than given away. But bigger problems remain. Around half of all emission cuts are bought in from developing countries, under the Clean Development Mechanism (CDM). The idea is that by investing in an energy efficient factory in Africa or a wind farm in India, companies can achieve emission reductions much more cheaply than at home, while developing countries get a boost towards sustainability.
The notion is great in theory, but it is very difficult to verify that the projects would not have happened anyway. One study shows that 76 per cent of CDM projects were already completed before the CDM funding was approved. More worryingly, this 'leakage' of emission savings does nothing to stimulate the rapid shift to clean technology that we need. Almost half of the EU’s Kyoto commitment of a cut of 8 per cent below 1990 levels will be met by projects outside the EU.
The market price of carbon bears no relation to its environmental and social costs. The Stern Report estimates that the real damage caused by a tonne of carbon dioxide is at least $85 – and that covers only the more easily quantified costs such as loss of agricultural crops, and barely begins to take into account the impacts of catastrophic events such as coastal flooding, massive loss of biodiversity and large scale social upheavals.
Other studies have reported figures of over $350/tonne. Prices of €30 to €45 are needed to drive investment in renewable energy projects, but market prices have rarely exceeded €30 and are highly volatile, crashing to around €10 during the recession, with 60 per cent of companies cancelling carbon reduction projects as a result.
When the market is just too slow...
Instead of driving the transition to sustainable technologies, the carbon market is undermining and delaying the changes we need. Companies mistakenly believe that the carbon emissions are 'paid for', absolving them of any need to take further action. Governments are not allowed to impose further carbon cutting regulation on companies taking part in the trading scheme, and even face opposition to subsidising renewable energy. The market will sort it all out, we are told, and we must not interfere.
But the market is not reacting fast enough to deal with the scale of the problem we face. A recent study showed that the prices of scarce resources tend to rise only slowly until the resource is almost exhausted. Economists agree that the costs of a tonne of carbon rise as more is emitted, because the damage caused increases. By this reasoning, the price of the last tonne that will tip us into unstoppable climate change might well be infinity. But by then it will be too late. Action must be swift and early if we are to change course for a low carbon economy.
Cap and trade can be a useful tool, but only if the cap is low enough and if we close the loopholes that allow our emission cuts to leak overseas. We also need a floor price for carbon, to keep investments flowing, and a strong framework of government support for renewable energy and energy efficiency, to escape our structural lock-in to fossil fuel technologies. Most importantly, we need to reform our economies to escape the addiction to consumption-led growth that underlies all our environmental problems.
For too long, our politicians have failed to realise that the economy is a sub-system of the environment. It cannot stand alone. Will we one day look back from the wreckage of our world and wonder why we let the market set its price so low?
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