When factories belch smoke, everybody pays. Getting companies to suffer instead is the big idea behind carbon markets. Imposing costs on polluters compels them to find efficient ways to cut the emissions that cause climate change. That’s the theory. In practice, the young carbon markets in Europe, parts of the U.S. and China haven’t yet proven they can drive a switch to cleaner fuels. The question is whether this will change as the markets evolve and the global economy recovers.
Pollution has decreased in many of the areas covered by carbon markets, also known as cap-and-trade systems, though it’s probably too early to tell if they’re really helping to slow global warming. The recession and a drop in U.S. prices for natural gas, which pollutes less than coal or oil, probably had more to do with the decline. The effectiveness of carbon markets remains a matter of dispute at the United Nations-sponsored talks to forge a new global emissions pact by 2015. Europe’s experience has been inconclusive. It was the first to require pollution permits in 2005, only to see them plunge in value when industrial output and demand tumbled. That created a glut of pollution permits. With no political mechanism in place to manage the oversupply, the benchmark price for a permit to emit a metric ton of carbon plummeted from a high of 26.29 euros ($40.41) in 2008 to 2.46 euros ($3.30) in April 2013. Carbon markets of various forms have followed in the northeastern U.S., Australia and New Zealand. California and seven Chinese regions and cities began their own systems in 2013 and South Korea is planning to join in, all of them learning from Europe’s mistakes.
For emissions markets to work, they must provide incentives to upgrade plants, switch to cleaner fuels or pay for green investments in one place that theoretically offset pollution someplace else. Governments figure out how much pollution-cutting their economies can tolerate, then distribute or sell individual rights to release carbon dioxide. As the pool of permits shrinks over time, companies that clean up their acts have more allowances than they need and can sell them to offset costs. The types of carbon markets and their prices vary around the world, partly because emissions can be reduced at a lower cost in developing countries. The pilot systems in China, the world’s biggest emitter, don’t try to make cuts in the overall level of pollution, but instead aim to trim the amount per unit of industrial production. It’s therefore possible that China’s total emissions will continue to rise.
In the markets now up and running, the current price probably isn’t high enough to change the behavior of the polluters they’re targeting. That’s brought criticism from opponents such as New Jersey Governor Chris Christie, who pulled his state out of the carbon market used by nine U.S. states, saying it cost too much and did little. U.S. President Barack Obama tried and failed to bring a national cap-and-trade system to the U.S. during his first term, and has since focused instead on regulating emissions from power plants directly. Advocates argue that a market-based mechanism helps identify the cheapest way to cut pollution, even though it’s more complex and costly to maintain than a carbon tax. It may also provide important price signals to drive investment in green technologies ranging from energy-saving lightbulbs to solar power to carbon capture and storage. For advocates of carbon markets, it’s the best of a series of politically difficult options. Keeping the planet from overheating will probably require all of them.
The Reference Shelf
- Website of Bloomberg New Energy Finance, which provides data and analysis on the future of energy.
- International Emissions Trading Association’s annual report on carbon markets.
- McKinsey publishes research on carbon prices and the economics of different types of energy-saving investments.
- October 2013 report on California’s plans for reducing emissions.