Cap-and-trade system keeps markets honest

  • August 27, 2007

{mosimage}If capitalism can save the planet, it’s running out of time in Canada where market-based approaches to greenhouse gas reduction have yet to be tried.

For the most part, Canada’s capitalists are anxious to enter the carbon trading business, but so far Ottawa has failed to institute regulations necessary to create a market for CO2 reductions. The Montreal, Toronto and Winnipeg stock exchanges have each proposed cap-and-trade systems which would allow big smokestack companies to sell credits for reductions they make in carbon emissions.

The Montreal derivatives exchange has gone so far as to sign a letter of intent in 2005 with the Chicago Climate Exchange to create the Montreal Climate Exchange. But the MX is still waiting on a plan from Ottawa for Canadian compliance with the Kyoto Protocol.

The absence of an exchange which prices in the cost of pollution distorts the markets, in the sense that the real cost of industry isn’t accounted for. Environmental degradation becomes what economists call a negative externality.

{sidebar id=1} “You’re a factory owner and you’re using fresh water and you pump out all this horrible guck,” said economist Bernie Wolf, director of the international business program at York University’s Schulich School of Business. “It goes downstream and makes life difficult for the farmers and makes life difficult for the people who drink water, and the factory owner is quite happy because it doesn’t cause him any problem. He is, in fact, causing negative externalities for these other groups. In the process, he’s actually using more resources than he should be because he’s only considering his actual costs — not the costs that society bears, which would have to include pollution. So, the market doesn’t work perfectly.”

The market might work better if there were a price for pumping extra carbon into the atmosphere. But is the market the best way to deal with environmental crisis?

The Social Investment Organization would like to see a cap-and-trade system for carbon reduction, because it would make the markets more honest, said SIO executive director Eugene Ellmen.

“Right now there’s no price of carbon. Companies can essentially put as much carbon into the atmosphere as they want, and there’s no economic penalty for doing that and no economic incentive to reduce their carbon emissions,” he said.

Putting a price on carbon, one that will be reflected in corporate balance sheets, would “help the stock market to understand that alternative energy companies are the way to go,” said Ellmen. Many ethics- and sustainability-based mutual funds that are members of the SIO invest in alternative energy companies.

Ellmen suspects the lack of a market-based approach to greenhouse gas reduction from Ottawa may reflect the influence of oil companies on the Conservative government.

“The other parties in the House of Commons support it. Why the Conservatives are dragging their heels, I really don’t know,” he said.

In June the opposition party-sponsored Kyoto Protocol Implementation Act was signed into law. It requires the government to explain to Parliament how it is complying with Kyoto, but the government has yet to announce any measures. Opposition parties have also rewritten the government’s own Clean Air Act to require greenhouse gas reductions. That bill has yet to make it to third reading.

In August provincial premiers were scheduled to talk about a cap-and-trade system at the Council of the Federation meetings in Moncton, N.B., but objections from Alberta Premier Ed Stelmach stalled the issue.

A Catholic approach to markets and market-based solutions is never unqualified support, said Kenneth Melchin, a Saint Paul University theology and economics professor.

{sidebar id=1}“The basic stance of Catholic social thought is a qualified approval of the market framework, with serious concerns that it be bounded and basically regulated in the interest of the common good,” Melchin said.

There has to be more to markets than a simple price and demand mechanism as outlined in classical economics, said the professor. An effective market has to account for collective long-term goals that may be at odds with individual, short-term desires — including the longer term goal of improving the environment, he said.

Catholic social teaching would lean toward markets if they could be “theatres in which human responsibility can be exercised to move the economy in the direction of the common good,” said Melchin.



Cap and trade — how it works

Catholic Register Staff

The basic precondition for making a market for carbon is a cap, or limit, on the total amount of carbon a defined pool of industry is allowed to put into the air.

In Europe the carbon market works with national limits set by the 27 nations in the European Union. Though the Montreal Stock Exchange, the Toronto Stock Exchange and the Winnipeg Stock Exchange have all made detailed proposals to set up and run a Canadian exchange for trading in carbon, Ottawa has not yet come up with a plan for complying with Canada’s Kyoto obligations which would include national limits on CO2.

In a cap-and-trade system, electricity generating plants and other large final emitters of carbon dioxide would be given a choice between reducing their emissions below their share of the national target or buying credits from companies who have already met the target.

Imagine a country with two large industrial plants. Together these plants emit 1,000 tons of CO2. Plant A emits 600 tons and Plant B emits 400. If the national CO2 limit is set at 700 tons this target could be met by reducing emissions at both plants by 30 per cent. However, it costs Plant A $50 per ton to reduce its emissions, while at Plant B it only costs $25.

If Plant B can cheaply reduce its emissions by 200 tons, or 50 per cent, it could sell credits for its extra 80 tons of carbon reduction to Plant A. By buying Plant B’s extra reductions, Plant A would reduce its compliance burden. It would only have to reduce emissions by 100 tons, instead of 180.

In theory the little nation with two big factories has reduced its carbon emissions by the same 30 per cent as if it had imposed a 30-per-cent reduction on both factories. The difference is that it only cost $25 per ton for the majority of the reductions and Plant A didn’t have to lay off workers to pay for its more expensive reductions.

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