A suggestion for a cap and trade scheme that maximises clean development
Cap and trade systems that allow participants to submit offsets are designed to allocate resources to the cheapest projects that reduce emissions, across the whole world. Take a look at McKinsey’s marginal costs of reducing greenhouse gas emissions by different methods. If a coal power station’s only option to achieve its cap is retrofitting the plant with clean technology, at a cost per ton of CO2-eqivalent abated of around $30, the plant can instead pay for wind farms to be built at around $15 per ton and pocket the difference.
This sounds like an economically sensible outcome, but it does have some flaws. The following is an idea for a cap-and-trade system that maximises the environmental benefit rather than minimising the cost, and also forces more competitiveness into the offset generation industry (without getting into the debate of whether offsets work or not).
(If you are familiar with the EU ETS, for credit read EUA and for offset read CER.)
- A cap is set and credits are distributed to participants accordingly.
- The fine per ton of emissions that a participant is responsible for but cannot cover with credits is set higher than you would reasonably expect the price of carbon to go in the trading round. The fine is the ceiling for the price of emissions. So far, so good – just like the European scheme. But:
- Participants may only present credits at the end of the round – they are not allowed to present any offsets.
- Certified offsets may be converted into credits at any time in the trading round according to the ratio (credit price / offset price) * a multiplier, where the multiplier is close to 100%. For example, if credits cost EUR20, offsets cost EUR10 and the multiplier is 80%, participants can convert 1.6 offsets into 1 credit.
- Converted credits are tradable but are marked. Participants may only present a certain proportion of marked credits among their overall portfolio at the end of the round.
This system still pushes capital to most efficient place, but has two further benefits. Firstly, it means that where the collective participants do not view it as economical to reduce emissions directly, they must purchase a larger volume of offsets than they do under a scheme where offsets and credits have equal weighting, and therefore finance more clean development. Secondly, it decouples the cost of credits and offsets in the system, allowing the cost of offsets to fall to a more competitive level. In Balance suspects that CER generation can be unreasonably profitable because the CER price is largely driven by the higher EUA price.