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Carbon trading won't work

Experiments with the market scheme favored by 
Schwarzenegger shows trading favors big polluters 
without curbing global warming gases.

By Michael K. Dorsey

MICHAEL K. DORSEY, assistant professor on 
Dartmouth College's faculty of science, teaches 
in the environmental studies program.

April 1, 2007

Economists, some environmentalists and a growing 
gaggle of politicians are pushing a grand 
strategy that a market mechanism - known as 
"carbon cap and trade" - can rescue us fastest 
from a climate catastrophe. But early evidence 
suggests that such a scheme may be a Faustian 
bargain.

Gov. Arnold Schwarzenegger is one of the chief 
proponents of the market view. He has joined the 
governors of Washington, Oregon, New Mexico and 
Arizona to create the Western Regional Climate 
Action Initiative, which "sets the stage for a 
regional cap-and-trade program" that he hopes 
will serve as a model for a national program. The 
Kyoto Protocol, which went into effect in early 
2005 (but which the United States has not 
signed), also endorses this approach.

Carbon cap and trade works this way: A group of 
nations (signatories to the Kyoto Protocol) or a 
group of states (the five Western states in 
Schwarzenegger's plan) cap their carbon emissions 
at a certain level. Then a government agency, 
such as the European Union or the California 
Environmental Protection Agency, issues permits 
to polluting industries that tell them how much 
carbon dioxide they are allowed to emit over a 
certain time.

Companies unable to stay under their cap can 
either buy permits, or "emission credits," on a 
trading exchange, which allows them to pollute 
more, or they will face heavy fines for exceeding 
their carbon dioxide targets. Firms that are able 
to come in under their caps can sell their excess 
credits on the exchange. Thus the right to 
pollute is a commodity bought and sold in a 
market.

The idea of trading pollution rights was part of 
the reauthorized 1990 Clean Air Act. The program 
successfully reduced the amount of sulfur dioxide 
emissions, which cause acid rain, largely because 
the sources were few enough (about 2,000 
smokestacks in the Midwest) that they could be 
monitored effectively and because there was a 
national system, administered by the federal 
Environmental Protection Agency, to enforce the 
legally required limits, or caps.

Carbon trading on a global scale, however, 
amounts to an untested economic experiment. The 
most ambitious carbon-trading experiment to date 
began in the European Union in 2003. About 9,400 
large factories and power stations in 21 member 
states were targeted, and the EU Greenhouse Gas 
Emissions Trading Scheme was established to trade 
pollution rights.

In January 2005, the EU governments distributed 
carbon credits - permits to pollute - to the 
companies and power plants. The credits were 
based in large part on what the firms estimated 
their annual carbon dioxide emissions would be. 
Because these credits were given out, not 
auctioned off, the firms did not pay for their 
pollution. Yet they stood to make money by 
selling them.

The EU's official accounting of the companies' 
emissions, released in April 2006, revealed that 
the companies' and power plants' actual emissions 
came in below estimates. Some said the firms had 
inflated their earlier emissions estimates, and 
thus all had credits to sell. This situation 
produced a surplus.

Once it was known that the number of available 
permits exceeded demand, prices slumped. Indeed, 
fear that there are too many permits for sale 
(combined with concerns about the EU's regulatory 
shortcomings) have effectively collapsed the 
market. A March 2007 report from Deutsche Bank 
Research noted that "many EU nations are still a 
long way from delivering on their Kyoto Protocol 
commitments to reduce carbon dioxide emissions."

Researchers at Open Europe, an economics think 
tank in Britain, recently issued a report on the 
experiment. They concluded that the EU Greenhouse 
Gas Emissions Trading Scheme represents "botched 
central planning rather than a real market." As a 
result, the report said, carbon trading has not 
resulted in an overall decline of the EU's carbon 
dioxide emissions.

Worse, the early evidence suggested that the 
trading scheme financially rewarded companies - 
mainly petroleum, natural gas and electricity 
generators - that disproportionately emit carbon 
dioxide. The pollution credits given to the 
companies by their respective governments were 
booked as assets to be valued at market prices. 
After the EU carbon market collapsed, accusations 
of profiteering were widespread. In fall 2006, a 
Citigroup report concluded that the continent's 
biggest polluters had been the winners, with 
consumers the losers.

Larry Lohmann, who works with the Corner House, a 
research organization in Britain, argues that 
carbon trading is little more than a license for 
big polluters to carry on business as usual. For 
instance, the Greenhouse Gas Emissions Trading 
Scheme was further weakened by provisions that 
allowed big polluters to buy cheap "offset" 
credits from abroad. A British cement firm or oil 
company that lacked enough EU permits to keep on 
polluting could make up the shortfall by buying 
credits from, say, a wind farm in India or a 
project to burn landfill gas to generate 
electricity in Brazil. "Such projects," Lohmann 
said, "are merely supplementing fossil fuel  not 
replacing it."

These problems may soon infect the cap-and-trade 
system of the five Western U.S. states. In July 
2006, Schwarzenegger and British Prime Minister 
Tony Blair announced their intention to join 
together to address global warming, possibly by 
linking emerging markets for pollution credits in 
the U.S. with established ones in Europe.

U.S. industry and environmental leaders recently 
joined together under the catchy name USCAP, for 
U.S. Climate Action Partnership. Among the 
participants are Alcoa, Caterpillar, Duke Energy, 
DuPont, General Electric, Pacific Gas & Electric, 
the Natural Resources Defense Council and the Pew 
Center on Global Climate Change. The group called 
for some form of carbon cap and trade, but its 
reduction targets, in effect, would keep 
atmospheric carbon dioxide at roughly current 
levels over the next five years.

The EU experience doesn't augur well for the 
effectiveness of a global carbon-cap-and-trade 
scheme in a world characterized by growing 
economic inequality and enormous differences in 
governmental capacity to provide oversight, let 
alone regulation. The risk is that by the time 
it's apparent such a scheme is not working, 
extreme climate change will already be wreaking 
havoc.