Monday, February 23, 2009

Wong not wrong on case for an ETS

Generally I found Penny Wong's support for an Emissions Trading Scheme (ETS) based on 'cap and trade' to achieve a specific level of emissions reduction over an equivalent tax persuasive.  If we knew exactly how the world operated then it wouldn't matter at all.  One could set a quota to hit a certain desired emissions cutback or set the tax on emissions (the tax) to hit exactly this same level of cutback.  But with uncertainty in the world about costs of mitigation in firms and in the damages that emissions cause things are not so neat. Setting a quota will then yield a variable price in the ETS (and hence a variable cost of compliance) whereas setting a fixed tax will mean that the level of emission reductions will be variable. 

As Wong points out the ability to trade emissions quotas internationally is an attractive consequence of an ETS.

Some have ridiculed the European emissions trading market on the grounds that carbon prices have drifted close to low levels recently because of the recession. As John Quiggin points out, if you like taxes that act counter-cyclically to stabilise the economy - so called automatic stabilisers - this is not at all a bad outcome. The economy gets a carbon price reduction when it faces hard times and a boosted price when it can best afford it. 

Other arguments for ETSs include the possible critical sensitivity of the environment to GGE variation and hence to catastrophic threshold effects. Maybe we wish to ensure that certain cuts in emmissions will be made.  Transferable quotas based on an ETS also allow the use of markets to hedge risk. To quote Chichilnisky/Heal:

"Hedging could occur via the trading of derivatives such as futures or options on TEQs (transferable emissions quotas), a possibility mentioned in previous sections. To elaborate, if a utility anticipates a sharp increase in the costs of CO2 emission, it will choose the energy source that is least intensive in CO2 emissions. This exposes it to the risk that scientific research will reveal CO2 accumulation in the atmosphere to be less threatening than previously believed, with a consequent increase in the number of TEQs issued by regulators and a drop in their price. To offset the risk of being "wrong footed" in this way, the utility would either sell TEQs forward, or buy put options on them. In either event it would profit from a drop in quota prices, and this profit would in some degree offset the costs incurred unnecessarily by the selection of the least CO2—intensive technology".

My non-economic preference for supporting an ETS scheme over a carbon tax is that it has been agreed on by various enquiries under both the Howard government and the Rudd government's Garnaut review. Time to get on with it.

Update: There is literature supporting a tax rather than 'cap-and-trade'.  This paper emphasises the revenue yielded by a tax and the ease (in the US) of introducing such a policy.  I'll collect some material and post a response when I get time.


Anonymous said...

I pretty much agree with everything you say here, Harry.

But I think you underestimate the force of the argument that we have to stay in line with others. If we did it by a carbon tax while everyone else was doing an ETS it would make international negotiations and practicalities of cross-border operations quite difficult. Not to mention,as you point out, the advantages of international trade in permits.

Steve said...

Harry, I thought one of the best counter-arguments over at JQ's post on this was put by TerjeP, who said that the problem is that too much volatility in the price of carbon under an ETS makes investment in new, more expensive, clean power much more dubious.

Sounds pretty convincing to me, and I don't think JQ responded to it.

Prominent greenhouse scientists such as Hansen are extremely sceptical of an ETS being a successful way to go, because it leaves open too many ways for the system to essentially be frauduently used to not reduce emissions globally.

It seems to me that economists are building a beautiful scheme in theory, but one which will be too complicated to achieve its goal with any certainty.

Even if you cannot predict with certainty what level of emissions a carbon tax at a certain level will achieve, it at least cuts out a large level of the avenues for fraud in international trading of carbon permits, and I wouldn't be surprised if it ends up working better simply for that reason.

hc said...


I wonder if the fraud issue depends on whether you set quantities or prices. Under an ETS you lie about emissions to satisfy your carbon quota while with a tax you lie about your emissions to avoid the tax.

Terje's point is right but variability in carbon prices can be partially offset in derivative markets.

I have long argued that new technologies for dealing with energy supply diversification need government guarantees given the amazing instability in oil prices for the past 100 years and the uncertainty regarding the 'peak oil point'.

Government intervention is necessary anywhere since regardless of issues of oil exhaustion we still face the climate change issue. Even if we had all the oil in the world we still need to move away from it.

Steve said...

Harry, isn't the point with fraud that the lying is harder with a carbon tax? With international trading of permits, you have credits dependent on the honesty of enterprises in countries such as China, India etc. You also have to rely on the companies doing the "validation" of offsets being competent, a problem that has already arisen:

By the way, because ETS has held such sway, I have never seen a detailed description of how a carbon tax could work. I am assuming that it would basically mean that each country just audits its own emissions, and you don't have international offsets involved. If you could claim credits under a carbon tax for offsets done internationally, then there would no fraud advantage.

Mikhail Silverwood said...


Where we are now.
We are currently living in a system of oil and coal. This is unsustainable as eventually we'll run out.
It does tremendous damage to our environment via damaging our gases in the air, the litter, oil spills, 'climate change', smoke making it harder to breath, smog which is killing our children and elderly, sewerage dumped into the ocean.
We are also heavily vulnerable to foreigner stock market speculators who manipulate the price of oil in order to make more money.

Where we want to be.
In a system where Australia and the whole world is run on clean renewable energy.
It will do wonders for our environment - it will create a world in which humans and nature can live in a peaceful coexistence, which is a world no one can disagree with.
And it will protect us from speculators by making us energy independent from others.

The biggest problem is that those renewable energy technologies haven't been properly developed and created yet.

So how do we get from A to B?
a) Government intervention. Nationalise the entire energy sector, push tonnes of capital into renewable energy investments. When those technologies come available, disband the oil and coal industries and make the whole country run on renewables. Outlaw other types of energy sources.

b) Neo-liberalism. Don't do anything. Allow the invisible hand of the 'free market' to eventually bring us to renewable energy.

c) Tax and spend. Put a tax on carbon, which will eventually make oil and coal so expensive to use that it will force capitalists to invest into renewable energies. (The extra revenue collected from the tax can assist further government programs.) But by giving millions of dollars in credits, you are reducing the impact of the very program you're pushing in place for that reason.
Of course, this is a tax on the poor and working class, while the rich don't get affected at all.

d) Make investment cheap as chips. Put a tax onto the rich, while will gain a certain level of extra government revenue.
Use this money to give credit and tax cuts to all capitalists who invest money into renewable energy.
Capitalists will go anywhere if it means they can make money - so make renewable energy such a delicious option that they can't resist it.

e) Don't do anything. Claim that the environment isn't being damaged at all by coal and oil, and that everything is just fine the way it is now.