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The Economics of Climate
Change Policy
EC 133
May 1, 2007
Market Mechanisms to Reduce
Greenhouse Gases
• Carbon Tax
– Taxes levied on businesses or individuals on
a per-unit basis
– Pros/conlater
• Offsets
• Cap-and-trade
What is
an Offset?
FIRST
Project
reduces
one ton of
CO2
FINALLY…
Money goes back
to project to
reduce more CO2
THEN….
A Certified
Emissions
Reduction is
Created
THEN….
Polluting
Industry buys
the ton of
carbon, to
“neutralize”
one ton of its
emissions
What is Capand-Trade?
First, a cap is set on emissions
-This cap may be set by the government, as is the
case in Europe
-Or, it may be set by another carbon trading
platform, such as the Chicago Climate Exchange or
the Brazilian Futures Exchange
Cap= 1000 Tons CO2 (for entire country)
Two Companies: Cars and Electricity
Each are allowed to emit 500 tons of CO2
$$$
The Car company currently
emits 700 Tons of CO2
Reduces emissions to 600
The Electricity Company
100 Allowances Currently Emits 600 tons of CO2
Reduces emissions to 400
Options to Address Climate
Change
• Policy Options:
– The Kyoto Protocol
• Voluntary Initiatives (Independent of
National Policy)
– Regional, State, or City-wide agreements
– Offsets
– Privately run Trading Schemes
The Kyoto Protocol- Background
• Drafted in 1997 by the 3rd COP to the UNFCCC
• Calls for global reductions in GHGs by 5% below
1990 levels
– Countries have different targets, based on abilities to
reduce emissions
• Entered into force in February 2005
– Required that 55 countries, accounting for at least
55% of 1990 emissions, had to ratify the protocol
– Once the U.S. dropped out of negotiations, Russia
was the key for entry into force
Characteristics of Kyoto
• Countries divided into two groups: Annex 1
and non-Annex 1
– Only Annex 1 have targets
– Non-Annex 1 parties must demonstrate
“meaningful participation”
• “Hot Air”
• Flexible Mechanisms
– CDM, JI and ETS
Flexible Mechanims- Joint
Implementation
• Occurs between two Annex 1 parties
• Helps both countries attain targets costeffectively
Flexible Mechanism- Clean
Development Mechanism (CDM)
• Occurs between an Annex 1 country and a
non-Annex 1 country
• Helps the Annex 1 country attain target
cost-effectively, and contributes to
sustainable development of non-Annex 1
country
Flexible Mechanisms- Emissions
Trading Scheme
• Cap-and-Trade system between European
Countries
• Set a cap on certain industries, issue
allowances, and allow for trading
Why did Kyoto fail?
Kyoto Protocol: Prospects and
Problems
• Enforcement for non-compliance was not
specified in language of Kyoto
• Monitoring is expensive, also not specified
– Though CDM projects must include monitoring plan
• Flexible Mechanism have been successful in
encouraging participation of developing
countries
– Still, it is unlikely that any developing countries will
take on targets in the next round
• Without the U.S., it will be difficult to make real
progress to curb climate change
Alternatives to Kyoto:
What to do When the Government
doesn’t Believe in Global Warming
Addressing Climate Change in the
Absence of National Policy
• Regional or State Agreements
• City-wide or Firm Initiatives
• Carbon Tax
– Levy tax on industries on a per-emissions
basis
• Carbon Offsets
• Carbon Trading
Voluntary Market for Offsets
• Businesses and Individuals can buy
offsets from private providers, which are
often internet-based
• There is no cohesive set of standards for
quality of offsets, but verification and
labeling schemes exist
Voluntary Trading Schemes
• The Chicago Climate Exchange is the only
trading scheme in the U.S
• Privately Run
• Companies, Organizations, States, or
Cities enter into a binding legal agreement
to reduce greenhouse gas emissions by a
certain percent during various phases
– Not very stringent
Confused? It gets worse…
• Companies can purchase offsets to reduce their
emissions below the cap. Then they sell those
allowances for more than the price of the offsets,
and make a profit
• Companies can sell offsets to private providers,
who then sell those offsets to other companies
or individuals who are trying to reduce emissions
Choices in the Voluntary Market
• Reduce emissions through conventional
means  business case for cost effective
reductions
• Buy Offsets
• Participate in a cap-and-trade system such
as the Chicago Climate Exchange
Reducing Emissions through
Conventional Means
• Anyone can do this!!
• Measures:
• Positives:
• Drawbacks:
Offsets
• Anyone who can pay for them can buy
them– Price ranges from $5 per ton to $30
per ton
• Positives:
• Problems:
Carbon Trading
• Typically bigger companies, cities, states,
and organizations
• Positives
• Drawbacks:
Buyer Beware
•
•
•
Demand additionality
– Buyers of offsets should demand the reductions they are buying would
not have otherwise happened. They should demand that the
reductions are actually having a net benefit for the environment. In
fact, they should demand that the offsets institutionalize sustainable
development.
Demand verification
– The United Nations administers programs for verifying and certifying
emissions reductions. It is as robust as it gets, and you can't go wrong
buying reductions from these projects.
– A handful of experienced non-governmental organizations have
developed standards for carbon reductions. Offsets meeting these
standards are sometimes worthy of your investment.
Demand accountability by sellers
– buyers should make sure the reduction projects underlying their
offsets are receiving a fair share of the purported amount used to pay
for the carbon and their investment is not being siphoned off to
administration or other fees. When contributing to a charity most
donors insist on this criteria. The same applies to offsets.
Gilles Corre, director of Evolution Markets Ltd,
FT editorial May 1, 2007
Moomaw Returns
What is Needed to reduce by 75%?
• Sustained reductions of 3%/year by industrial
nations for the rest of the century
• This will reduce emissions by half in 23 years and
to one-quarter in 46 years
• This will assure that CO2 concentrations are
below 1990 levels and dropping at the end of the
century rather than continuing to rise
• Otherwise, there is a high probability that global
average temperature will rise by more than 4o F
during this century and might go as high as 12o F
What are the pros/cons of an
energy tax?
Case for taxes
• clear and less vulnerable to market
problems
• industry needs certainty regarding price
• timingfaster
• less opportunity for manipulation
• can hit more sectors
• can introduce compensating mechanisms
for low income families
Policy Questions
• Can the voluntary market meet the need to
reduce greenhouse emissions?
• Should the United States return to the
Kyoto table?
• Should the United States assess national
green taxes?
What is the optimal environmental strategy for the US?
?+?
Mandated
Voluntary
Business
case for
cost
efficiency
Supranational Targets
Build markets
Kyoto (II?)
Strategic
Philanthropy
National
Targets
Offsets
Carbon
trading
Supranational
mechanisms
CDM
Regulate Markets
JI
(ETS)
?
National
Mechanisms
Markets
Taxes
What are costs of non-action?