Carbon Cap and Trade

Every year, sometime around July 15th, the good people of Staunton, Illinois gather by the Staunton Senior High School for what has become an annual point of pride for the community, as flocks of bicyclists from around the country gather at the starting line to begin a 30-mile road race.

The course scenery is pleasant but unremarkable, winding through cornfields and gallery forests in the hilly farm country of southern Illinois. What brings hundreds of competitors here every year is the competition’s unusual mechanism for tabulating individual scores. At this race, competitors must stop twice during the 30-mile course at break stations where they are offered glazed donuts. For every donut that competitors consume, five minutes are deducted from their scores. Thus, for even mediocre riders who also really good donut eaters, the ride offers an offset structure that makes them champions.

Today, most winners gain their competitive edge from their stomachs and not their legs. With top competitors in recent years stuffing down over 20 donuts each, winners now post negative times. That is to say, on the books of the people who run this competition, the laureates of the Tour de Donut have finished their races before they began.

To the best of our knowledge the Tour de Donut has still not drawn any theoretical physicists to Staunton to test whether competitors stopping at break stations are passing through wormholes in the space-time continuum. This is probably because scholars of relativity and quantum gravity are doubtful that eating donuts will make atomic clocks run backward, even in rural Illinois at daytime temperatures exceeding 28° C.  Physicists’ stubborn absence from the event suggests that they understand offsets to be a meso-level construct for a rule-bound game rather than a measurable dimensional phenomenon.

Figure 1:  They look like donuts, but they probably are not.  Cosmic superstring loops wiggle and oscillate, producing gravitational waves, then slowly shrink as they lose energy until they disappear. Scientists currently find little evidence that they are spontaneously elicited in deep-fried dough. (image by Matt DePies, University of Washington)

Offsets, when measured not in donuts but in carbon equivalents, have a similar correspondence to real-time facts. The problem, however, is that current climate change legislation being drafted in Washington, DC today is anchored in a scheme little more sophisticated than that offered by the glazed treat-loving architects of the Tour de Donut. And that is where the rubber meets the road.

Meet Lieberman-Warner , the sequel (1)

This year, Democrats in the United States Senate and House of Representatives have promised drafts of legislation that they claim will address catastrophic threats to global ecosystems, water supplies, and built environments. What nearly all have rushed to agree on publicly is that systems designed to reduce emissions of greenhouse gases must be market-based and pro-industry, and focused primarily on creating so-called “green jobs.” This crowd-pleasing language, however, masks the accounting mechanisms by which such legislation will achieve reductions. Much like the donut-eating scheme in the Staunton bicycle race, greenhouse gas reductions in market-based regulation or so-called “cap and trade” schemes are likely to be reductions that look a whole lot better on paper than they do on tree ring data indicating total atmospheric greenhouse gas accumulation.

On March 31st, House Energy and Commerce Committee Chariman Henry Waxman (D-CA) and Rep Ed Markey of Massachusetts released a draft bill that was immediately attacked by conservatives and dismissed quietly by neoliberals in the Obama camp as going too far too fast on emissions reductions. The bill called for a 20 percent decrease in emissions by 2020, compared with 15 percent in the White House outlines. The bill is touted as taking bold steps to address rising carbon dioxide levels in the atmosphere, but the fine print is what will cement the future course of U.S. industrial development to coal and nuclear power, and probably to the final evisceration of the Clean Water Act and the National Environmental Policy Act among others.

The bill will do this in two ways: first, by subsidizing research and development on carbon sequestration technologies that are unlikely to durably store large amounts of greenhouse gases in the best of circumstances, and will never in a million years be cost-efficient. Second, the Waxman-Markey system and its equivalents will put in motion a climate derivatives market so big and so risky that the world may end up being forced to choose between propping up investment banks that have crawled back to life trading financial instruments based in fictional emissions reductions, or in actually regulating industry and mining and physically restricting the flow of greenhouse gases to the atmosphere.

If the Lieberman-Warner Climate Security Act of 2008, a bill circulating in the Senate last year, or the currrent Waxman-Markey bill are any guide to this year’s coming attractions, climate change legislation from leading Democrats is likely to be based large giveaways of money-generating polluting rights to large industries, and on offsets, or low-priced carbon credits that polluters use to have other firms supposedly sequester carbon for them. As detailed in recent works by Larry Lohmann, Michael Wara and David Victor, Pat McCully (2) and others, experience in the European Union has shown such schemes create perverse incentives for the worst polluters and the shrewdest offset dealers to increase emissions in the short run and to game the trading schemes in the long run.

A simpler alternative that is subject to far less political manipulation is a carbon tax. In a political landscape where new taxes are verboten, a simple carbon levy is off the table among Congressional leaders and the Obama Administration. This is a shame. A cap-and-trade program would function like a heavy sales tax to ordinary citizens but would not function to readily redirect capital in a green direction. Instead, if big industry has it way, tens of billions of dollars in trading revenues would quickly disappear into the pockets of large industries, while coal plants, corn ethanol, and mega-dams are built at record rates.

A tax policy based on readily verifiable carbon emissions at the point of production or distribution, on the other hand, would send clear and rapid price signals to consumers. Prices at market would then reflect the total upstream carbon emissions attached to goods and services. This far more tangible market-based system would work rapidly and would remain fairly impervious to political manipulation. It would also be far easier to assess the effect of the tax on its intended target. Much as GDP growth has long been considered the economy’s master variable, the climate’s press-ready variable from a carbon tax would be total greenhouse gas emissions measured in carbon equivalents.

A little background

Those familiar with leading climate models readily enumerate the reasons why costly and far-reaching regulatory schemes are now a necessity:

Ninety percent of global energy production involves the burning of fossil fuels and the emission of CO2 to the atmosphere.  Carbon dioxide is the most important anthropogenic greenhouse gas and it is the major cause of two critical environmental problems: global climate change and ocean acidification. Some of the near-certain impacts of global climate change include global warming, regional-scale decreases in water availability, and sea-level rise. In turn, these changes will impact the health of agricultural and natural ecosystems. Likewise ocean acidification will deleteriously impact marine (and perhaps freshwater) ecosystems.

Although some observed climate changes and their related impacts are still subtle, simple and verifiable physical theory as well as more complex global climate models project far greater environmental change in our near future.  Although we anticipate some beneficial aspects of these changes in some locations (e.g. warmer climates and longer growing seasons at high latitudes, possible increased rates of plant growth at high latitudes due to CO2 fertilization), most experts anticipate that the overwhelming fraction of outcomes will be negative. Droughts are likely to decrease crop yields and endanger forests, rivers and aquifers may run dry, while ports and coastlines will likely flood from sea level rise.

With scientific consensus strengthening around the necessity of drastic cuts in carbon emissions, most visibly indicated by the widely publicized 2005 report of the Inter-government Panel on Climate Change, political elites in the U.S. have finally acknowledged that the most obvious solution to these critical environmental problems is to curtail fossil fuel burning as soon as possible, thus to largely curtail anthropogenic emission of CO2 to the atmosphere.

Current realities: bad and worse choices

Nearly three decades of Reaganesque rhetoric extolling the necessity of reaching goals through “markets,” no matter how convoluted or artificial, has clouded the judgment of policymakers and corporate eco-optimists who advise them. We are told that the choice we face is between a cap-and-trade system or no regulation whatsoever. This is not a real choice. What few Beltway insiders publicly acknowledge is that greenhouse gas reduction schemes currently operating in the European Union possess neither the characteristics of real markets nor the capacity to reduce global emissions of greenhouse gases by even close to the 80 percent thought necessary by 2050.

We hold that a cap-and-trade system is not, as apologists have maintained, a flawed but good start to a green economy. Instead, the rise of a cap-and-trade system for the U.S. economy, disastrously, intersects with an implosion of global financial markets. Currently, refugee capital suddenly unable to find profit margins in sub-prime mortgage securities or credit default swaps is eager to securitize the trading of six billion tons of U.S. greenhouse gases in globalized climate markets. In fact, a group of leading analysts advising Congress on cap and trade at the Duke University Nicholas Institute have recently put out an enthusiastic paper making recommendations about how policymakers should set up the derivatives market for climate-backed financial instruments. The same analysts are very clear about just how large a role derivatives will play in a cap-and-trade system, as they state in convoluted but determined Wall Street terms: “A low volume of allowances in the marketplace and/or significant concerns about allowance price volatility in future years may cause the majority of allowance-based instruments to trade as derivatives (including forward contracts) rather than allowances.” (emphasis ours). (3)

Since the late 1980s, successive speculative bubbles that have run through Wall Street and the Chicago Board of Exchange have destroyed trillions of dollars in wages and wealth of ordinary people. Now, brokerage houses interests turning climate securities into bundles of climate-based derivatives will sever the emissions reductions contracts on the market from the material act of reducing carbon in the atmosphere. The results of this final round of financial speculation, however, are unlikely to end in another bailout. Citizens fleeing cities disappearing under rising floodwaters won’t have any cash to cough up this time to keep the traders in corporate jets and fine penthouses on Park Avenue.

It is our contention that if anthropogenic climate change is indeed a threat and rapid carbon emission reductions are non-negotiable, then regulatory regimes must be transparent and independent of special interest pressures.  A cap-and-trade system would be neither. Furthermore the construction and oversight of gargantuan trading markets would be left to the Environmental Protection Agency, a secretariat with no history in overseeing markets of this magnitude and complexity. This would likely leave the task to be outsourced to eager executives fresh from Wall Street layoffs. If the abominable regulatory record of the U.S. Federal Reserve and the Securities and Exchange Commission is any indication of the willingness or the ability of government trade authorities to see to public interests above firm interests, the world is imperiled indeed by the implementation of a cap-and-trade system in the U.S. for carbon emissions.

We hold that a cap-and-trade system of the sort seen in most recent climate change legislation in Congress is a mistake for the following reasons:

1) The legislation delays real reductions far too long and facilitates the expansion of coal-fired energy plants.

If the Waxman-Markey draft bill in the House represents the high-standard mark for carbon reductions that will presumably be whittled down in committee sessions by lobbyists and floor amendments by science-unfriendly Republicans, we are likely to end up with a bill that does less than nothing as far as climate goes, but puts huge rents into the hands of moguls in industry and finance. Whereas the science indicates that the world must lower atmospheric release of carbon dioxide and equivalents 80 percent by 2050, the U.S. may not do anything for a generation. If last year’s  Lieberman-Warner is a guide to what sort of bill will be voted on, reductions in the next decade and a half are likely to be based on offsets of about 30 percent . (3) In May 2008, physicist and climate expert Joseph Romm argued in his blog, Climate Progress,  that this would making it quite possible that greenhouse gas emissions in the US would not begin to decline from 2005 levels until after 2025. (4)

This is probably most significant in opening the door for the expansion of coal-fired energy plants with no carbon capture and storage in place because it would enable them to meet their emissions caps through cheap offsets for as little as 15 to 20 dollars per metric ton. (5) Carbon capture and storage, meanwhile, even if limited abatement were feasible in engineering terms, would cost well over $150 per ton of carbon dioxide generated, (6) which would raise the cost per kilowatt hour over 60 to 100 percent to consumers. (7) Obviously, if an 85 percent savings on carbon reductions could be achieved through what offset enthusiasts claim may be as much as 4 million tons of “available” CO2 in the developing world, (8) then the coal industry will buy its way out of direct abatement and use the savings to finance its own expansion. Meanwhile, given the projected size of the coal infrastructure in the coming decades, if the carbon capture and storage facilities are either flawed in design (leaking millions of tons of CO2 back into the atmosphere) or in efficiency (costing far too much to make coal-fired energy competitive), then taxpayers are likely to be asked to pick up the cost of repair, retrofitting, or bailout.

2) The legislation relies on mechanisms that are failing elsewhere.

The argument for cap-and-trade generally relies on two empirical premises: first, the successful cap-and-trade legislation that reduced acid-rain causing sulfur dioxide emissions in the 1990s in North America; and second, the current use of cap-and-trade mechanisms in the European Union through the European Trading System (ETS). Skeptics, however, argue that the sulfur dioxide market was about one percent the size of what today’s carbon emissions markets would be, and that the only actors trading in the scheme were power plants with similar technologies and easily verified emissions. As for the second example, observers have pointed to the dubious results of cap-and-trade system that European countries put in place to come into compliance with the Kyoto Protocol. Of the total value of climate securities traded, the greatest bulk come not from reductions by European power plants, but from offsets in developing countries. Combining numbers cited by McCully and the Council on Foreign Relations. $18 billion of $25 billion in Certified Emissions Reductions (9) (CERs) traded on the ETS in 2007 were in offsets from projects in the developing world certified by CDM authorities as clean energy projects.

Accumulating evidence indicates that offsets are undoubtedly the most serious flaw in the Kyoto framework. Designed with the best of intentions, the offset system was meant to direct development capital from North to South in order to enable developing countries to expand their economies in a less carbon-intensive fashion. However, the relatively low cost of offsets appears to have made it easier for polluting firms in the Europe and Japan to postpone costly retrofits. Meanwhile, the CERs created through offsets are a slippery sort of derivative. Insofar as one CER represents one metric ton of CO2 not emitted to the atmosphere, it is, in fact, a financial tradable based not in a good or a service, but instead, in a positively post-modern twist, in a counterfactual event. Thus, whereas a bundle of CERs may in one instance be based on emissions levels from an existing power plant that fall below an established legal cap, in another instance—when based on offsets—a bundle of CERs is created by fiat when the CDM registration board declares that a new facility being built in the developing world would have been a more profligate polluter than if the CDM had not existed. Under these a coal plant in China or a mega-dam in Brazil can be declared to actually be reducing global carbon emissions because the same power plants would not have been built or would have been built (referred to in CDM terms as the principle of additionality) or would have been built with dirtier technology (determined by common practice analysis). (10) David Victor, who with Michael Wara examined the record of the first thousand or so projects registered by the CDM has claimed that up to two-thirds of the projects are non-additional. Pat McCully has pointed out that almost all the projects in the pipeline of the CDM registration board in Europe are located in powerhouse industrializing economies such as Brazil, India, China, and not one project so far has been registered in Africa. He also points out that the logic of the market (the need of polluters and brokers for large bundles of tradeable CERs) favors the registration of big dams in the tropical belt. Rather than being sources of greenhouse gas reductions, such dams are inevitably sources of large releases of atmospheric methane and net destroyers of tropic forest cover. According to McCully (2008):

Hydropower is the most common technology in the CDM pipeline, with 828 projects as of April 2008 – more than a quarter of all projects. Biomass is the second most common project type, followed by wind power. Non-hydro renewables together make up 36% of CDM projects. Only 16 solar power projects – less than 0.5% of the project pipeline – have applied for CDM approval. Demand-side energy efficiency measures, although a top priority in the fight against climate change, make up just one in every 20 projects.

Thus, while we hardily support North-South transfers of capital for the development of clean and accessible technology in lower-income countries, it is clear that offsets generated through market-based climate legislation is no means of doing this in a way that addresses poverty and promotes human welfare.

3) Once a flawed cap and trade system creates powerful constituencies invested primarily in its own continuation, the system creates incentives to torpedo correctives.

Experience shows legislative rigidity is an unfortunate by-product of a system where money plays so outsized a role in elections. An omnibus statute like the Farm Bill is a perfect example of this flaw. Begun in 1949, when nearly a quarter of the country’s population still lived on farms, but continuing through the present, it has set in concrete a set of arrangements that virtually no member of Congress will champion in public.  Everyone—even those who vote for it—denounce its effects, and yet its basic structure persists. Why? Its public subsidies create private fortunes, which create revolving-door lobbies and government appointments, which create convenient renewals of the pork every five years on the dot. A climate bill, similarly using language of markets and competitiveness, is up a labyrinthine regulatory apparatus that is charged both with establishing a scientific basis for tradeable, carbon-based securities and with regulating the way such securities are traded in global financial markets. This system, which will remain opaque to all but the best-versed of Washington insiders, is likely to create the same sort of nightmare. In such a system, citizens may be lulled into thinking that by applying so many experts of different stripes to the task of regulating science and markets in harmony, that we have done good by letting the private sector do so well in the climate business. Instead, we are likely to find the reverse, with messy and unscientific compromises made by regulators who must answer to Congressional overseers and their powerful private sector patrons. In this final round of minding the planet, however, we have no room for error and messy policymaking—the wager on the table is the last thing any of us possesses.

For these reasons, we earnest urge fellow citizens to take the science on climate change seriously and urge Congress to either write a bill that honestly addresses the need for greenhouse gas reductions through a straightforward carbon tax, or admit that it has no interest in taking tough measures to deal with the forces that may collapse our civilization.

Heather Williams is Associate Professor of Politics at Pomona College and can be reached at hwilliams@pomona.edu.

Paul Baker is Professor of Earth and Ocean Sciences at Duke University and can be reached at pbaker@duke.edu.


1. S. 3036

2. See Larry Lohman (2006) Carbon Trading, The Dag Hammerskjold Foundation; Wara, M. and D. Victor (2008) A Realistic Policy on International Carbon Offsets. Palo Alto, Stanford University, Program on Sustainable Energy and Development.; Pat McCully (2008) Bad Deal for the Planet: Why Carbon Offsets Aren’t Working and How to Create a Fair Global Climate Accord.

3. Monast et al (2009), “U.S. Carbon Market Design: Regulating Emission Allowances as Financial Instruments,” Durham, NC: Duke University Nicholas Institute.

4. This would be 15 percent domestic and 15 percent international. See sections 2404 and 2501, S. 3036, Lieberman-Warner Climate Security Act of 2008

5. Joseph Romm, “Boxer Bill Update: Probably No US CO2 Emissions Cut Until after 2025,” May 27, 2008, http://climateprogress.org/2008/05/27

6. S. 3036 specified no base price for offsets. Presumably supply and demand on climate exchanges would determine spot prices. This is an estimate based on current prices of Clean Development Mechanism carbon offsets in the European Trade System.

7. This is a figure that is generous to the coal industry and assumes that new technologies would reduce abatement costs by up to 50 percent with development of new efficiencies. Currently, U.S. Department of Energy figures for carbon capture only estimate cost per ton at $150, which raises the price of coal energy per kilowatt by 2.5-4 cents.  In today’s technology CO2 is recovered from combustion exhaust by using amine absorbers and cryogenic coolers. The cost of this is on the order of $150 per ton of carbon – deemed much too high for current commercial practice. USDOE (2009), “Carbon Capture Research,”.

Based on a price of 4 cents per kilowatt hour. Prices vary by state and power utility.

8. In a recent report on offsets, two cap-and-trade theorists argue the following: “Models suggest that with the inclusion of international offsets, as much as 4 billion metric tons could be available internationally….Since offsets from developing countries are among the least expensive mitigation options, significant financing would flow to these countries if international offsets were allowed.” Lydia Olander and Brian Murray (2008) ”Offsets: An Important Part of the Climate Policy Puzzle,” Nicholas Institute for Policy Solutions.

9. A CER is a strange number because it is a financial tradeable backed not in a good or a service, but instead by a contract signifying a counterfactual event.

10. McCully (2008) cites one egregious example of this strange bookkeeping in the Tata Ultra Mega Project in Gujarat, which will put 26 million tons of CO2 in per year for at least 25 years. Even though this plant will be India’s third largest source of CO2 emissions, and 16th largest in the world, the Tata Power Company claiming that its plant should be eligible for CER income because “no super-critical power plant is yet operational in India.” (8)

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