I have posted a brief piece on Carbon Trading at Maxspeak. http://maxspeak.org/mt/archives/002593.html
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October 09, 2006 PROBLEMS WITH CARBON TRADING - By Gar W. Lipow The Dag Hammarskjöld Foundation has published an impressive and beautifully written analysis of Carbon Trading. The full text is available in PDF form at no charge http://www.dhf.uu.se/pdffiler/DD2006_48_carbon_trading/carbon_trading_web.pdf At 381 pages, I'm not going to attempt to summarize here. But the following does touch on some of the major problems with carbon trading: The Kyoto protocol includes project based emission reductions. Instead of reducing your own (or somebody else's) greenhouse gases, you can finance a project in a poor nation (one without any Kyoto obligations) which supposedly lowers emissions. The problem is that credits are based not on proven reductions, but on claims that without carbon credits the situation would be worse. A highly toxic landfill in Durban, South Africa gained credits for keeping the dump open, and burning methane from the landfill to generate electricity onsite. Consultants determined that only plausible alternative was to generate electricity from coal. Shutting down the site, and saving same amount of electricity through efficiency measures was ruled out as implausible. So was purifying site methane and selling it to the local gas company. This sort of thing is the rule, not the exception in carbon credits. As one example, most experts agree renewable energy could supply significant amounts of carbon neutral energy, but less than 2% of project carbon is generated by renewable sources. Attempts have been made to compensate by calculating fudge factors. The idea is that you figure out that ,say, 20% of carbon reductions are valid and credit that percent. The problem here is confusion between risk and uncertainty. Flip a coin, and you have a 50% chance of coming up heads. This applies to all sorts of things - with a very small percent error factors, insurance companies can calculate risks and life expectancies for all sorts of things. But project based carbon credits depend on guessing which of an a number of alternatives would have been chosen - narrowing the possibilities down to two. That is uncertainty. You don't know, and you will never know, not even in retrospect, which alternative would have been chosen. Not only don't you know which alternative path would have been taken, you don't know whether all possible alternatives were considered. Insurance companies, which deal mainly with risk, get very practical feedback. If their actuarial calculations are too far off (i.e. further off than their competition) they either pay unexpectedly high claims, or refuse classes of policies they could have profitably carried. In the absence of feedback, it would be tough to put a number on risk, and certainly makes no sense to put one uncertainty or ignorance. So carbon consultants have no means of telling whether fudge factors are correct. They have every incentive to provide the highest estimates they can get away with; essentially printing money - until carbon markets collapse (as they recently did). To make it worse, we have another type of project - sequestration. Instead of reducing sources we create new sinks - absorbing carbon. For example, local grasslands are converted into giant Eucalyptus plantations to absorb carbon. No one really know how much carbon is sequestered by growing plants. We do know that a great deal of it is absorbed by soil, which many release greenhouse gases as temperatures rise. We know that tilling such plantations releases old carbon that was imbedded in soil structure. We know machinery, and fertilizers, and pesticides for such plantations consume fossil fuel energy. We know that carbon fixation rates vary tremendously within the same species of plants, depending on micro-climate, soil, pests and other variables, so we don't know the difference between these plantations and whatever they displace. And in addition carbon plantations are often victim of forest fires, or other ways of ending plant lifespan - including harvesting once credit for the sequestration has been sufficiently laundered. So not only is forestry based carbon sequestration highly uncertain, there is good reason to believe in many cases it is a net emitter. (Carbon sequestration from fossil fuels provides more measurable short term reductions. But long term stability is questionable, and there are severe side affects, such as acidification.) A second type of carbon trading is emissions trading. Two companies both need to reduce carbon output by 5%. Company A can has cheap cuts it can make, where company B only has expensive reductions available. So Company A shrinks carbon pollution by 10%, and company B buys half those reductions. We will see in a bit that with carbon there are reasons this will not work well. But leaving those aside, given that there are project credits as part of the same system, this is a disaster. Because both A and B have incentives to buy cheaper (mostly or totally invalid) project credits rather than reduce their own emissions. But of course emissions trading as actually practiced has flaws of its own. The point of emissions trading is to grandfather in big polluters by granting them Carbon Credits at no charge. and letting them sell them; otherwise (as we will) see a carbon tax, or minor variation thereof, would do the same thing. Obviously this is a simple giveaway of a new form of property (carbon permits) to the rich and powerful. The logic, of course, is that you are giving into political reality, and bribing them to "buy into" the system. Of course this spawns massive abuses - even beyond the giveaway. For instance a great many energy companies that have both coal and natural gas generators were given credits as though they generated electricity only from coal. (Natural gas is a lower intensity carbon emitter than coal, even if burned with equal intensity.) That meant that those particular utilities had surplus carbon credits without needing to reduce carbon intensity by one gram, and had a windfall from selling carbon. In other cases, carbon credits were issued for whole industries based on inflated economic projections - resulting in huge surpluses that contributed to car bon market collapse. This is worse than an inefficient means of reducing carbon. In the long run there is every reason it will block or delay decarbonization. There is the obvious problem of false or inflated credits of course. But it goes beyond this. In poor nations, phony carbon credits absorb money that people are spending (often with sincere intentions) to help solve global warming. At least some of that money, probably a fairly high percent, might be invested in real renewable energy projects rather than paper credits if the counterfeit was not so widely available. It is old economic principle that bad money drives out good. There is a firm called the Gold Standard that tries to tries to do severe filtering - financing only valid projects. It remains a marginal firm, struggling to compete with other carbon credit firms. Customers complain that it does not provide enough low cost carbon credits, that it is far more expensive than other funds. And of course that is true. Actual reductions in carbon emissions are much more expensive than creative accounting. In rich nations you run into another problem. Firms concentrate on various ways of gaming the carbon market rather than reducing emissions. Huge amounts of money in Europe are spent lobbying for grants of free carbon credits. Lobbyists fight to loosen standards on credits, to extent the life to grant all sorts of rights. So emission trading actually reduces innovation that could help solve the climate crisis. It is the old problem with systems that are too easy to game - money flows to lawyers and lobbyists, not engineers. We have looked at some of the problems with the current system. The question arises - is the problem with emissions trading or just this particular implementation? Each year we burn fossil fuels produced from plant matter that took 400 years to grow. From a greenhouse viewpoint, we need to reduce emissions by about 80% to 90%. Almost every nation has to reduce fossil fuel use, as do most fossil fuel users - ultimately to zero or close to it. Carbon equivalent concentrations in the atmosphere are already higher than is safe. Except in an extremely temporary or marginal sense, it simply is not possible to produce significant "excess" reductions worth trading. The best way to reduce carbon emission is to produce less coal, oil and natural gas every year, until we reduce fossil fuel to zero, or close to it. If we are serious about greenhouse gas reduction, there simply will not be enough "emission credits" for sale to let us drive 9 MPG hummers. Similarly, true emissions trading is by nature complicated and lacks transparency. Grandfathering is not a bug in the system, but a feature. Let's look at what an "emissions trading" system would look like without grandfathering. Imagine a system where you had permits for each unit of carbon equivalent, auctioned world-wide to the highest bidders. Each permit would expire after a year or so, and the number of permits available would shrink each year. Would you attach a carbon measurement device to every smokestack, automobile and carbon emitter? It might be possible, but that is expensive and a lot of trouble. A better way would be to simply require reporting of fossil fuel consumed - coal, oil, gas. Since average carbon equivalents are known (approximately) for each, you could come up with a number that is close enough for the incentive system you are trying to set up. In industry fossil fuel consumption is something you have to keep track of as part of basic cost accounting anyway. Fossil fuels used to produce electricity would be included in the cost. Utilities could report fossil fuels sold directly to businesses and households. For automobiles and other non-utility home appliances (propane appliances, powered mowers and such) you could estimate usage by model and usage. Although possible, the transaction costs of this are not trivial. There is a simpler way. Rather than requiring permits at the individual user level, require resource extractors to buy permits for each barrel, or ton, or thousand cubic feet mined or drilled. Let them pass through the cost of this to their customers as fuels were sold. Emissions permits would mostly be traded along with the fossil fuels they permitted , in the same markets fossil fuels currently trade in. (You would have true permit trading in the margins between companies who extract less than expected, and companies who make discoveries that allow them to produce more.) Essentially this would be a carbon tax combined with rationing. It is not (with the extremely minor exception noted) an emissions trading system at all. As soon as you depart from this - allow grandfathering, move the permitting further along the supply chain to distributors or consumers of fossil fuel you end up with all or most of the problems the current system shows. Any real emissions trading systems (where emissions permits are significantly separated from extraction or initial sale of fossil fuels) increases transaction costs. And such a system, by reducing transparency, increases the space for gaming the system - increasing incentives to put money into lawyers and lobbyists rather than engineers, reducing innovation. A true tradable permits system reduces incentives for innovation in other way. The idea behind such a system is to make sure that low hanging fruit is picked first. But the problem is it not only makes sure that low hanging fruit is picked first, it encourages going to extreme lengths to find that low hanging fruit - to search your nation, continent, or the world. When you take the search for low hanging fruit to this extreme in a context where everyone eventually has to cut, you delay innovation which needs to eventually be made. Worse, you squeeze the profitability out of innovating firms long enough that they may be gone by the time the low hanging fruit has been used up. We are not going to get major greenhouse gas reductions if everybody is busy looking for low hanging fruit thousands of miles away, and no one is implementing well known processes to reduce their own emissions.
