Tuesday, 29 April 2008

The Architecture of Carbon Trading - Who Owns the Sky?

The Public do not understand and distrust carbon trading

I think it true to say that when most lay people approach the issue of carbon trading they do with a degree of scepticism, bewilderment and not a small amount of distrust. The immediate gut reaction is to say " If you want to reduce emissions of carbon dioxide in the atmosphere how on earth is having the right to trade in permits to emit CO2 going to help? You want to stop this thing happening not make money out of allowing it to happen".

They smell a rat and suspect that business and government are trying to pull a fast one - letting money making in markets take priority over the real job of reducing carbon emissions which should occur through regulation and through carbon taxes driving technological innovations and behavioural changes.

The public are right to be suspicious of offsets

Unfortunately there is quite enough in the early experience of voluntary carbon markets - the sorts of schemes called "offsetting" to promote "carbon neutrality" - and also in the early experience of the European Emissions Trading scheme to justify suspicion. Just under a year ago the Financial Times did some research and ran an article which said this:

“Industry Caught in Carbon Smokescreen – Companies and Individuals rushing to go green have been spending “millions” on carbon credit projects that yield few if any environmental benefits. A Financial Times investigation has uncovered widespread failings in the new markets for greenhouse gases, suggesting that some organisations are paying for emissions reductions that do not take place. Others are meanwhile making big profits from carbon trading for very small expenditure and in some cases for clean ups that they would have made anyway” http://www.ft.com/cms/s/0/48e334ce-f355-11db-9845-000b5df10621.html

And the public are also right to be suspicious of the European Union Scheme

So there is actually good reason for being sceptical - and there is good reason to be sceptical too of the European Union's Emissions Trading scheme which, in its first phase did not really succeed in reducing carbon emissions in Europe, is so complicated that most people and politicians do not understand it and, for a time, was seen to be giving rise to windfall profits to big power companies.
(£1.2 billion electric utilities 2005. DTI in addendum to CCBill)

Pendulum swinging to carbon taxes and regulation

Given this bad start it is not surprising that many politicians and campaigning organisations are now tending to favour carbon taxes and regulations rather than carbon trading - for example the Lib Dems, perhaps the Conservatives, or the Green Fiscal Commission, a think tank set up by the great and the good in the environmental, business and government policy making world.

What has been discredited are poorly designed schemes

Despite this what I want to argue is that there are many different possible architectures for the control of carbon emissions in a way that involves markets and that what has been discredited have been poorly designed systems not the per se possibility of having a system that could bring greenhouse gases under control.

In order to make this point strongly in a complicated field I want to try to get over three very basic points about any scheme to control carbon emissions.

The necessity for an overall cap

Firstly the necessity of having an overall cap that is enforced - otherwise a reduction happening at one place in the economic system simply slips into being energy and carbon that becomes available and is then used and emitted somewhere else. Thus - you buy carbon credits to offset the carbon emissions of your flight to India and the money goes to buy low energy light bulbs which are given to people in Goa. Hurray. However the power station burning coal to supply the light bulbs of Goa now has some surplus capacity which is available for another use - and the people using the low energy light bulbs have more cash in their pockets because their electricity bills have gone down. When most people buy low energy light bulbs what happens is that they leave them on longer. Without an absolute cap on the amount of energy and carbon used there is what is called a rebound effect. The existence of this rebound effect has been known to economists for almost 150 years. The emissions from your flight are still in the atmosphere and there is no net gain to the climate. Voluntary offset schemes which have no caps are ineffectual.

Control of carbon emissions should take place "upstream" and not "downstream"

The second point I want to make is that it matters a great deal where you enforce your control of carbon emissions. Here the key point that I want to make is that, to be effective, one really ought to control emissions, in the jargon, "upstream". Unfortunately most current schemes, and also most proposed schemes to extend current arrangements, are what are called "downstream systems".

The Garden Hose and Sprinkler analogy - two choices to reduce flow - the tap is upstream and the sprinkler is downstream

Let me explain these terms. Imagine you are watering the garden with a hose attached to a tap in your house at one end and a sprinkler at the other. After watering your garden you decide that you want to stop the flow of water. You have two choices. You can try to plug up the holes in the sprinkler - for example by stuffing match sticks into each of the sprinkler holes - or you can turn down the tap. The former is the upstream control mechanism. The latter is the downstream control mechanism. Which would you do?

Now think of fossil fuels entering and moving through the economy until they reach the point where they are purchased by the organisations and the individuals that will burn them giving rise to greenhouse gas emissions. We are talking about coal, natural gas and oil which is refined into petroleum and diesel and then sold on. It is burning these fuels that causes 3/4 of the emissions.

The upstream fuel taps - 10 oil refineries, 4 natural gas terminals, 40 coal mines and 12 coal ports

These fuels enter the economy though 10 oil refineries, 4 natural gas import terminals on the North Sea coast, 10 deep mines and 30 open cast mines and 12 dedicated coal port facilities - in all under 70 locations. These are the upstream locations - and figures are collected at these locations about exactly how much oil, gas, coal enters the economy.

Downstream - Sprinkler "holes" of varying sizes - including 900 larger users

The fossil fuels are then sold and distributed to users across the whole country. About a half of the fuel - a large part of it coal and natural gas - goes to very large users like power stations and iron and steel furnaces and blast furnaces - there are about 900 such large users in the UK.

Tens of thousands of organisations and smaller companies and millions of individuals

The rest goes to smaller companies, local authorities - and to us, the general public - every time we buy gas for the house or for the cooker or every time that we buy petrol or diesel for the car.

So our garden hose analogy has to be stretched a bit but is basically still true. There are a number of energy hoses attached to about 70 taps and they go on to sprinklers with a range of different size holes. There are 900 largish holes on the sprinklers and tens of thousands for smaller ones and about 60 million small ones for each of us as individual energy users.

Two possible approaches - at 70 locations or

Now there are two ways of controlling emissions through a permits system.

One can either impose a permit system on the upstream suppliers and require them to have permits before they sell fuels into the economy. This would be a system imposed at most at 70 locations.

Or one can try have a permit system downstream - requiring organisations and individuals to have permits before they can buy and use fossil fuels.

At 900 larger downstream locations - the EU ETS

And this, is exactly what has happened. With the EU Emissions Trading Scheme ETS they have started with a system requring the ETS at the 900 larger users to have permits.

.....then at thousands of smaller companies and local authorities - the Carbon Reduction Commitment

They are now moving to an extension with carbon trading extended to smaller units - hotels, supermarkets, local authorities and the like. This is the so called Carbon Reduction Commitment.

.....then at individual level - personal carbon allowances or TEQs

The next steps being considered by Defra might require every individual in the country to have a personal carbon allowance - there is quite an army of officials and academics researching this idea.

If you ask me this is plain bonkers but it is exactly what is happening.

What they ought to be doing is turning down the taps, or spigotts, at 70 different upstream locations which would be very simple and cost virtually nothing to administer.

So that is my second point - imposing carbon caps upstream rather than downstream. The basic principle is simple - as 3/4 of the global climate crisis is caused by burning fossil fuels you say that it is not allowed to sell fossil fuels into the economy without a permit. Fossil fuels are toxic goods and we need to get off them asap. You denominate the permits in the greenhouse gas content of the fuels when burned and you screw down the cap. In this way you can control the entire greenhouse gas content emitted from burning fossil fuels throughout the entire economy.

Who Owns the Sky? A resource that was though to be unlimited has to be made scarce

My third point concerns ownership rights - the question - who owns the Sky? For what I have not talked about is to whom and how should the permits be issued? Permits are in effect tradeable permissions to use the sky as a greenhouse gas dump. Up to now the right to use the earth's atmosphere in this way has not required anyone's permission. It has been free - now we are restricting that right so that it becomes valuable in the sense that companies and people will be prepared to pay money for it.

Scarce resources acquire a price, a scarcity value. Who get this scarcity rent?

So we can think about the right to use the earth's atmosphere in this way as a resource - it is a limited resource. No individual or company created this resource. They didn't invent it so can claim no intellectual property right over it. They didn't work or invest capital to create it. The income that arises from selling the permits arises solely from the fact that there is a scarcity which, in this case, is created legally and administratively. This is what economists call a scarcity rent. And a key question is - who gets this rent? Who owns the sky? There are logically only 3 possible answers to this question - either we all own it collectively, or the state and governments of the world owns it, or polluting companies own it.

3 Possible ownership and payments arrangements - each affects the design of carbon trading

Each of these different possibilities has a different consequence for how a carbons emissions scheme would run.

Possibility 1 - States and governments own the sky

If states or governments own the sky then they would sell or auction the permits to whoever wants to buy them and keep the auction revenues for whatever purpose they think important.

Possibility 2 - the people own the sky as a common resource - per capita shares

If the sky is owned by the people then one would either initially distribute all the permits to the people and require those who need them to buy them from the people - intermediary market makers like banks or post offices might buy them and sell them on. Or, another way of organising a people owned sky would be through a Sky Trust, operating on behalf of the people which would auction the permits and make per capita cash payments to the people. So what I am envisaging here are two different ways of recycling the sky rent to the people on a per capita basis.

Possibility 3 The sky belongs to the polluting companies - grandfathering free permits distributions

The other possibility is that the sky belongs to polluting companies. For example, in a downstream system you could say that, if Eon's Ratcliffe on Soar power station is currently creating, say, 3% of UK emissions covered in the ETS (that’s a guess) then next year when the permits for the Emissions Trading Scheme are distributed it would be given, for free, 3% of them. The jargon word here is "grandfathering". "Grandfathering" means that, when you set a cap or a limit then the principle for distribution of the limited number of permits is to match the proportional use that existed prior to the scheme. And the permits would be given for free. In this case the assumption is that the right to use the earth's atmosphere belongs to the companies.

So there are these three approaches. The atmosphere is owned by the state, the people or the polluting companies. Would you cynics like to guess which principle has been adopted for the European Union's ETS?

The EU System

At present the EU ETS gives some 90% of permits to big polluters free. There is an argument about whether it should auction them in the future, the figure of 50% has been mentioned after 2012.

You may read in the papers how many big companies are very keen on carbon trading. For example in the USA they are pressing Bush to have it. The PR machines of these companies love to give the impression that they are keen to be green if only there is a level playing field for the policy.

The enclosure of the sky - comparison to the enclosure of the common lands

Maybe... but the cynical view is that the big companies smell money. One way of seeing the situation is as an enclosure of a commons. In the 16th to 18th century the idea that the common lands could and should be enclosed into exclusive private property and no longer available to all for grazing livestock or collecting firewood and other foraging was seen by the poor as a theft by their masters. What we are looking at here is another enclosure process - this time of the atmosphere in favour of the corporate giants who want to take the Sky rent for themselves.

What there are is not is any idea that since this is a commons it doesn't belong to the state either. To me there is a real danger that if the sky rent went to the state it would be spent on big industrial schemes of dubious benefit like subsidising nuclear power. The earth's atmosphere could and should be managed as a commons and that means that the rents should come to us equally - in which case the money will go into the base of the economy and help ordinary people with the resources to insulate their homes and get their own lifestyles in order for a time of more expensive energy.

Equity implications - who will lose as there is less carbon energy and the price rises?

This is actually quite important because who gets the Sky rent has considerable equity and social justice implications. The consequence of any effective permits scheme will be to put up the price of energy considerably. Without any adjustments this will fall heaviest on the poor and so when it comes to making the reductions in energy use it will be them that take the heaviest hit as they will not have the purchasing power to pay for the rising energy prices. So we could face a situation in which the energy companies are making money which are coming out the pockets of the poor. That is in fact what we have in the EU ETS - if you want to sum it up you could describe it as a "poor people pay the polluter" principle.

Cap and Share

The policy I think would work is called 'cap-and-share'. Here a cap is set yearly, permits are sold to primary fossil fuel companies and the money rebated direct to all adults on an equal basis. The control is fully upstream and everyone, including the poor are compensated for rising energy and food prices. The higher price of embedded carbon makes green products and services more competitive and so start to transition the economy to a low carbon future.

As many people and companies gain from the system, deep cuts can be made in emissions and the price of carbon pushed up-and-up over several decades. If we want to make 90% or deeper cuts by 2050, I’d argue that it is the only system that is going to work. And here, therefore, lies a major thread of our hope to stabilise the climate – a hope that should not be delayed any longer.

Sources of further information


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