Peter Barnes Explains Carbon Caps

Posted on Friday, December 11th, 2009 at 11:43 am by dpacheco

The following is an excerpt from Climate Solutions: A Citizen’s Guide by Peter Barnes. It has been adapted for the Web.

Carbon caps

Theory

In theory, a descending economy-wide carbon cap is the best way, if not the only way, to guarantee a predetermined decrease in carbon emissions by a predetermined date. That’s because it’s an absolute limit on emissions rather than just an incentive or regulation.

A carbon cap would function through the issuance of permits. Each year the number of permits would be reduced. To cut emissions 80 percent in 40 years, the number of permits would be reduced by a yearly average of 2 percent of current emissions.

Because a cap requires permits, it introduces the opportunity to trade those permits. Businesses like this feature because it gives them flexibility in reducing emissions. But it’s important to remember that the key to the system is the cap, not the trading.

Like a carbon tax, a decreasing carbon cap will drive up the price of fossil fuels. As fewer permits become available, their price in the market will rise, and the higher prices will be passed on to consumers. If private companies keep the higher prices, they’ll reap windfall profits. If government gets the higher prices, the money can be used for public benefit. If citizens get the higher prices back, they can maintain their current purchasing power.

The main arguments for carbon capping are:

  • It physically drives down pollution, which is the only way to ensure sufficient reductions within the time required;
  • If done right, it can cover all the carbon in the economy;
  • If done right, it can return money to citizens and generate revenue for public investments;
  • Businesses prefer a cap to regulations and taxes, and politicians will vote for a cap.

History

The idea of capping and trading pollution permits was developed by economists in the 1960s. It got its first major test with the Clean Air Act of 1990, which applied it to sulfur dioxide emissions from coal-burning power plants. (Such emissions cause acid rain.) The program successfully cut emissions on schedule and is widely considered a success.

In 2005, the European Union applied the sulfur cap-and-trade model to carbon. The resulting scheme is widely considered a failure. It has led to huge windfalls for companies that received free permits, higher prices for everyone else, and no reduction in emissions. The EU is now trying to fix the program.

In 2006, nine northeastern U.S. states formed a Regional Greenhouse Gas Initiative, which adopted a carbon cap for electric utilities. Unlike the EU, most of the U.S. states decided to auction carbon permits rather than give them away to polluters. This will avoid private windfalls and allow the states to invest the revenue in useful ways.

Among the lessons learned from these experiences are:

  • Carbon is a special commodity—it is ubiquitous and vital to our economy. It can be capped but not in the same way as minor pollutants.
  • Capping carbon has big price impacts and can generate correspondingly big windfalls or revenue.

Reality

Carbon capping can be complex, especially when it involves giving free permits to companies and allowing companies to offset rather than reduce their emissions (see Offsets Aren’t Permits, p. 60). If these features are removed, carbon capping becomes simpler, fairer, and more transparent.

Unfortunately, there’s intense lobbying by companies to receive free permits, and this could distort the whole system. Politicians in the northeast states stood up to this lobbying, but it’s not clear that politicians in other states, or in Congress, will do so.

Several bills in Congress blend free permits with auctions. Others include “safety valves” that allow extra permits to be issued when the price of permits reaches a pre-set level. Such hybrids have many layers of complexity and are far from transparent. In general, they favor historic polluters at the expense of consumers and other businesses.

Who’s in Favor

  • Carbon caps with free permits are favored by utilities and some environmental groups.
  • Carbon caps with price ceilings (also known as “safety valves”) are favored by oil companies.
  • Carbon caps with auctions are favored by public interest, labor, and some environmental groups.

Who’s Opposed

  • Some environmentalists oppose carbon trading (though not caps per se) on the grounds that it privatizes pollution and, in some cases, shifts pollution to poor communities.
  • Likely Consequences

    • Several state carbon caps plus, after 2009, a federal one
    • Many complexities and inequities that will take time to sort out
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