Emissions Trading

On June 10th, 2006 The Economist published an article entitled 'Gaming gases' that discusses the exploitation of the carbon market by power companies. Thus far, it appears that these corporations have the comparative advantage in this newly formed market, instead of the environment.

Why a scheme designed to punish polluters is rewarding them.

All new policy instruments have teething troubles but the European Emissions Trading Scheme (ETS) has more than its fair share. Designed to discourage the production of greenhouse gases and encourage investment in cleaner forms of energy, it has rewarded polluters rather than penalising them, and failed to boost alternatives.

The article continues by saying:

Three problems have emerged. The first is the consequence of handing allowances free to existing polluters (a process known as 'grandfathering') . The polluters pocketed them, passing on the extra cost of production to their consumers. Moreover, once trading took off, the price of allowances rocketed to €30 ($40) a tonne. Developing countries, meanwhile, were selling permits for about half that (because they cannot yet be traded, and are regarded as riskier). So polluters have been cashing in their allowances, buying cheap Clean Development Mechanism (CDM) permits--and keeping the difference. According to a report by IPA Energy Consulting, Britain's power companies alone have profited to the tune of around £800m ($1.5 billion) a year.

The second problem was that when the scheme started there was little information about how much pollution the 13,000 factories were emitting. The original levels claimed by member governments were not much more than guesswork, and not surprisingly were generous. Now that levels are being monitored, it turns out that Europe is not emitting as much as it thought it was. When this emerged last month, the price of carbon allowances crashed.

Third, the current phase of the ETS lasts for only three years. Nobody knows what level of allowances will then be set. Since the payback period for cleaner power-generating technology is at least five years, there is no incentive for producers to invest in cleaner technologies.

None of this suggests that using the market to curb emissions is a bad idea. But if the EU is to create a system for airlines, it should learn from the ETS's teething troubles. The scheme should be based on reliable information, permits should be auctioned not grandfathered and it should run for long enough to get polluters to change their ways.

To view a previous article on carbon trading, click here