Bookmark and ShareAndrew Simms is nef‘s Policy Director and head of nef’s Climate Change programme.

Selling permits to emit carbon dioxide is fine in theory, but there's a fatal flaw that means it can never avert climate catastrophe.

One day renewable energy looks like a sunrise industry, the next, tumbleweeds are blowing around a setting solar panel. What has changed? The price of emitting carbon dioxide.

In 2005 the European Union created the world’s first proper carbon market, the EU Emissions Trading Scheme (ETS), which compels highly polluting industries to buy permits to emit CO2. The number of permits is limited, so the idea is that supply and demand set a price that encourages the development of a low-carbon economy. A rising price with no wild fluctuations sends an economic signal to invest in clean energy. But it’s not working.

The price of a tonne of CO2 on the ETS has had a roller-coaster ride – soaring one minute, plummeting the next. In the past year it has lurched from over €30 to €8, and now languishes at around €10. Disastrously, such low and unpredictable prices for CO2 remove the economic incentive to decarbonise economies.

This is the partly the result of the economic downturn. As heavy industries mothball factories, energy use drops and demand for permits goes down. At the same time businesses try to raise cash by selling their unused permits, flooding the market and further depressing prices. French energy company EDF recently complained that carbon markets were failing just like the market for subprime mortgages. As a result, all kinds of green energy schemes are grinding to a halt.

So how do you set a meaningful price for carbon? The reality is more complicated than the ETS might suggest, which is a problem for those who advocate using market forces to reduce emissions. As NASA climate scientist James Hansen points out, getting it right or wrong could determine whether or not we can avert irreversible climate change.

Apart from the ETS, there are many ways to put a value on carbon. You can, for example, work out what it costs per tonne to reduce emissions. But calculating this “marginal abatement cost” is complicated by doubts over the effectiveness of carbon offsetting and the true impact of some supposedly green technologies.

Another method is the “social cost of carbon”, which estimates the cost of the damage from emitting a tonne of carbon over its whole lifetime in the atmosphere. This has been used by the UK treasury, and the Dutch government and the World Bank have experimented with it. But with so many variables to account for, estimates range from £35 to £140 per tonne. The UK has now dropped it for a new “shadow price of carbon”, an approach supported by the French government and some members of the European Commission.

The shadow price is similar to the social cost but includes “other factors that may affect willingness to pay for reductions”, to use the UK government’s own words. It is “a more versatile concept”. In other words, it gives politicians some scope to rig the price. Although well intentioned, it is vulnerable to abuse.

Each of these methods has its advantages and disadvantages, but there is one problem that none can solve. I’ll call it the paradox of environmental economics, in which worthy attempts to value natural resources hit a wall.

The paradox is this. All these methods of pricing carbon permit the creation of a carbon market that will allow us to pollute beyond a catastrophic tipping point. In other words, they require us to put a price on the final “killing” tonne of CO2 which, once emitted, tips the balance and triggers runaway global warming. How can we set such a price? It’s like saying, how much is civilisation worth? Or, if you needed a camel to cross a desert alive, what is a fair value for the straw that breaks its back?

The paradox reveals the fatal shortcoming of market solutions to environmental problems. Unless the parameters for carbon markets are set tightly in line with what science tells us is necessary to preventing runaway warming, they cannot work. That palpably did not happen with the ETS, which initially issued more permits to pollute than there were emissions and now, in the recession, is trading emissions that don’t exist – so-called hot air.

Carbon markets cannot save us unless they operate within a global carbon cap sufficient to prevent a rise of more than 2 °C above pre-industrial temperatures.

rationing

In wartime, rationing proved to be both fairer and more effective than taxation.

Governments are there to compensate for market failure but seem to have a blind spot about carbon markets. They could counteract the impact of low carbon prices by spending on renewable energy as part of their economic stimulus packages, yet they have not done so. The UK, for example, has spent nearly 20 per cent of its GDP to prop up the financial sector, but just 0.0083 per cent in new money on green economic stimulus.

Price mechanisms alone are unable to do the vital job of reducing carbon emissions. They are too vague, imperfect, and frequently socially unjust. To prevent over-consumption of key resources such as fuel during the second world war, the UK government rejected taxation in favour of rationing because taxation unfairly hit the poor and was too slow to change behaviour. Rationing was the quicker, more equitable option. Carbon rations calculated in line with a safe cap on overall emissions provide a more certain way of hitting emissions targets.

Is there an answer to the paradox of environmental economics that could make the market approach workable? I can’t imagine one, but am open to suggestions. Even if you could price the killing tonne, it is a transaction that should never be allowed. Economics becomes redundant if it can rationalise an exchange that sells the future of humankind.

This article was first published in the New Scientist, April 2009.

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