Cap and trade in the context of shrinking production
Questions are being asked of the two working installation-level cap and trade schemes in light of economic recession. The EU ETS – the world’s largest carbon market – is trading at about 16 Euros per tonne and is volatile because no-one is quite sure of the impact of shrinking production. Analysts believe that all reductions could now be met through purchase of CERs. Essentially this means that industry within the EU ETS has lowered its output and can comply with the cap by offsetting rather than making additional internal reductions.
The other scheme, RGGI, a scheme covering power plants in north-east US, held its second pre-compliance auction on 18 December and sold 31.5m allowances at a price of $3.38 per short ton (up 31c from the first auction, which is surprising given the commentary that follows). An article on BusinessGreen says:
… the auction came amid fears that the economic downturn meant the US scheme could repeat the mistakes evident in the first phase of the EU’s emissions trading scheme by setting the cap too high – a scenario that led to a glut of available emission permits and a collapse in the price of carbon.
Non-profit policy thinktank Environment Northeast released RGGI Emissions Trends & the Second Allowance Auction, a report which said emissions were currently 16 per cent below the cap. It pointed to skyrocketing fossil fuel prices earlier in the year as the primary reason for a lower than expected emissions rate.
“RGGI was negotiated back in early 2003 through 2005, and at that time everybody thought the trend would be up,” said Derek K Murrow, director of policy analysis at Environment Northeast. “Since it was negotiated we’ve seen a signfiicant decline, which is really a good thing. Now the question is whether that trend will continue as the programme starts up in 2009, in which case the cap might need to be bought down more quickly after the first compliance period. Or will emissions return to their historic levels, in which case the cap would be constraining?”
Comments like this suggest that cap-and-trade must deliver a carbon price that is neither zero nor unbearably high, and also force emission reductions beyond anything that happens ‘naturally’ (as a result of lower consumption or developments in eco-efficiency, for example). These characteristics sound more like tax than cap and trade. Cap and trade provides an absolute limit for emissions and a price crash indicates that the limit can be met with no unusual investment. Equally, if emissions rise unexpectedly, a cap and trade market will force decisions about where additional reductions will be made.
That’s the strength of cap-and-trade: unforeseeable events that effect emission levels are reflected in the permit price. If the price crashes due to unforeseen cuts in emissions, the cap and trade scheme is not a failed policy.