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Low Carbon Prices: Just a Phase or an Indictment of Cap and Trade?
In the wake of the weak climate agreements reached in Copenhagen a little over a week ago, the price of carbon has dropped substantially. The main exchange for the carbon emissions allowances that are traded as part of the European Union’s Emissions Trading System saw carbon dioxide emissions drop to €12.4 ($17.90) a metric ton Monday.
Prices have been volatile throughout the ETS’s first five years. Permits had reached a high of €30 ($43) in summer 2008 before dropping to €8 ($12) earlier this year.
On the other side of the Atlantic, the U.S. House of Representatives passed a climate change bill in June based on creating a similar cap-and-trade system. Like the ETS, the proposed U.S. system would limit industries’ emissions and eventually force companies to pay for allowances to offset their emissions — or allow them to sell excess allowances if their emissions are lower than expected.
The fact that prices for those allowances are so low in the cap-and-trade systems that already exist might be troubling for proponents of such a system’s ability to mitigate climate change.
"Price volatility is a problem in and of itself because it's not sending a clear market signal" to investors, says Daphne Wysham, a fellow at the Institute for Policy Studies and co-director of their Sustainable Energy and Economy Network.
She also points to offsets, such as the Certified Emissions Reduction credits created by the Kyoto Protocol's Clean Development Mechanism to pay for such projects as keeping forests unlogged, as "a drag on price because they're the cheapest option 
out there" for meeting the emissions targets on paper.
"You're essentially keeping the price low by allowing for carbon offsets," she says.
Other factors are at play as well. The price of carbon, as with that of any commodity, is seen as a function of demand. The current dip in prices, then, is a reflection of the low expectations for carbon dioxide regulation following the disappointing summit in Denmark and the stalling of climate legislation in the U.S. Senate. It is also a product of the slow economy, as less economic activity has meant lower emissions, and thus a lower volume for buying emissions permits.
The EU system and any future U.S. system are supposed to encourage a movement away from dependence on high-emitting, fossil-fuel based production by making those activities more expensive relative to cleaner alternatives. It is all about motivation. But for businesses to be sufficiently motivated to reduce their emissions they need a price incentive.
Carbon around 13 euros per ton is not expected to provide that push, and many analysts believe that, ultimately, prices will need to be much higher than they have been for cap and trade in carbon to achieve its ends. The International Energy Agency’s World Energy Outlook for 2009 said carbon prices should be at $50 (€35) a ton in 2020 and $110 (€67) in 2030 in order to provide the incentives that will push companies to invest in cleaner technologies.
The non-binding international accord announced by the U.S., China, India, Brazil and South Africa and “taken note of” by the other countries is not likely to raise demand enough to push up that price.
Meanwhile, the Regional Greenhouse Gas Initiative, which caps emissions in 10 northeastern U.S. states, is creating a fragmented market for firms, and one that is very dependent on political decree — a major factor in the price volatility seen so far.
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The false premise of cap-and-trade
Cap-and-trade is designed fundamentally to achieve the cap at the lowest possible cost, so aren't low prices good? As stated by EDF's Tony Kreidler, "If we're reducing emissions on schedule, if we're achieving the environmental goal with the cap, why would we not want to do it at the lowest-possible cost?"
Of course, the fallacy of that argument is that if the "goal" is climate stabilization, then we are not "achieving the environmental goal with the cap". According to recent global warming simulations, the end-of-century global temperature is expected to rise to a level "nearly double what ... the world can afford in order to avert catastrophic climate change". This is not a "worst-case" projection; it is rather premised on the assumption that "industrialized and developed countries enact every climate policy they have proposed at this point".
Cap-and-trade reduces costs, not just by seeking out low-cost emission reductions (which a carbon tax does equally well), but by deterring emission reductions beyond a predetermined, politically compromised target. Carbon trading operates to ensure that the reduction target is not exceeded, under the false premise that the cap is sufficient to guarantee "environmental certainty". For example, the pending federal cap-and-trade legislation is structured to nullify and deter state, local, and individual GHG-reduction actions by ensuring that any such GHG reductions within capped sectors would merely allow more emissions somewhere else.
The notion that a carbon tax would be "more easily repealed than an established carbon emissions market" is untenable. Cap-and-trade and taxes would both create a carbon emissions market based on the established carbon price, and Congress could relax or repeal either a cap or a tax with equal ease. A tax would have the political advantage that the price would be constrained by willingness-to-pay; and it would have the environmental advantage of being immune to price erosion and collapse.
What really gives cap-and-trade its political advantage over carbon taxes is free allocation, which makes it possible to impose a high emission price at relatively low cost to industry. However, tax revenue could also be used to substantially reduce costs without compromising energy decarbonization incentives. For example, if revenue from carbon fees is used to subsidize new renewable energy sources, it could give new renewables an immediate price incentive equivalent to $100 per ton even though the regulatory cost to industry would initially be zero (because there would initially be no "new" sources).
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