Effectiveness of Carbon Trading

If a factory must release emissions beyond its allowance, it must buy permits from the owner of a cleaner plant.

Under a cap and trade carbon scheme, participating governments set a limit on the carbon emissions allowed on a given period and allocate carbon permits to the industry. Those that produce less emissions than expected can sell their spare permits to facilities that release emissions beyond their original allowance.

Some of those carbon permits are gradually withdrawn from the market. The value of the remaining permits increases, and more facility owners have to switch to cleaner production methods. How well does it work in practice?

The Baseline

The effectiveness of a program cannot be measured if its original target is not known. The Kyoto Protocol can be taken as a case study, as this international agreement did set in motion the most complete Emission Trading System to date. At the time when its terms were being negotiated, a yearly increase of one or two percent in carbon emissions was expected. The original proposal by the G77 called for a reduction in emissions to 15 percent below the 1990 level, but consensus could only be achieved after setting a more modest target of 5 percent below 1990 levels, to be reached by 2012.

The Ambiguous Case of the European Union ETS: Phase I

Because the U.S. did not ratify the protocol, the success of the strategy must be measured with basis on its implementation in the European Union. The early results of the program, however, were less than encouraging: In the first phase of the program (2005 to 2007), too many permits were issued, leading to a situation where companies had no motivation for switching to cleaner processes. There was a glut of spare permits available, leading to a drastic decrease in their market value, and there was a 1.9 percent increase in emissions: basically, this stage of the program made no difference on the "business as usual" level of emissions.

The Ambiguous Case of the European Union: Phase II

The second phase of the EU Emission Trading System, scheduled for 2008 to 2012, had a significantly increased scope and oversaw a reduction of 3 percent in carbon emissions, a decline steeper than anything experienced in the previous 40 years. This sets the participating countries well on track for reaching the 5 percent target by 2012. According to reports by the International Energy Agency, however, a significant fraction of this diminution can be attributed to the global economic downturn taking place at the time. Because of the economic climate, it is difficult to assess the actual effectiveness of the carbon trade program so far.

What Can Be Expected for Phase III?

Several changes are expected for the third phase of the protocol: Fewer permits will be issued and more of those will be assigned by auctions instead of by allowances. This is expected to lead to a 20 percent cut relative to 1990 levels. However, because "leftover" carbon permits can be banked for future use, analysts fear that the environmental gains achieved during the financial crisis of 2007 could be lost as economic conditions improve and unused permits are "cashed-in" during Phase III of the program, scheduled for 2013 to 2020.

Carbon Trading for the Developing World: The Big Business of Cheap Fixes

Under the Clean Development Mechanism of the Kyoto Protocol, industrialized countries can exceed their quotas if they invest in clean programs for developing countries. Emission cuts can be enacted more inexpensively there, transforming emission reduction into a lucrative business: According to a study by Nature, an investment of about $100 million in the reduction of HFC23 (a byproduct of refrigerant production) can generate $6 billion in credits. Detractors of the scheme argue that it provides perverse incentives, rewarding polluting plants. On the other hand, it did cut HFC23 emissions that had been going on for decades.Under that light, the program can be said to be effective: It encouraged a cut in emissions without placing a burden on industrial operations.

References

• Department of Energy and Climate Change: EU Emission Trading System
• International Energy Agency: From financial crisis to 450 ppm
• New Scientist: Kyoto Protocol 'loophole' has cost $6 billion
• Sandbag: Rescuing EU ETS from Redundancy
• Transnational Institute: Carbon Trading - How it works and why it fails