Online Debate: Green and Pizer on emissions trading
Here are the latest postings from CFR.org’s Online Debate on greenhouse gas policy:
June 28, 2007
William A. Pizer
Mr. Green asks two questions. First, does SO2 and lead trading demonstrate emission trading is a viable option for greenhouse gas emissions? Many of the concerns he raises have nothing to do with whether a trading system will work. Proxy indicators, in particular, are recommended by the IPCC and would presumably also be used in a tax approach. Among the other issues, the idea of too many diverse sources is interesting. Usually, more trading and greater diversity of traders would be good. But even by the numbers, there is not much difference between the SO2 program (3,456 electric generating units in 2005) and an upstream CO2 system (around 2,000 units). Regarding technological solutions, he ignores fuel switching and conservation—exactly the same results that would arise under a tax.
The second question is whether a safety valve can fix the volatility issue. Mr. Green discusses the recent run-up in SO2 prices and the failure of an apparent safety valve mechanism. But the recent run-up is not volatility—it reflects the tightening of the program under the new Clean Air Interstate Rule, with firms reducing emissions now to bank for the future. Recent SO2 prices of around $1500 are extremely close to future compliance costs predicted by economic analyses. While Mr. Green suggests there is currently a safety valve, that is not true. The mechanism he refers to is a special reserve, offering up to fifty thousand allowances at $1500 (adjusted for inflation). The relevant proposals for a CO2 safety valve would not be limited to 0.5 percent of total allowances and would cap volatility. Discussions of the European Union program are irrelevant: They do not have a safety valve. Interestingly, there was no discussion of the effectiveness of true safety valve mechanisms in the trade and renewable energy applications where they have been used with considerable success.
In the end, much of our debate is really about whether a trading program or tax is more likely to well-designed. We agree on the basic features that are important—coverage, price stability, raising revenue to cut other taxes, minimizing rent seeking. There are plenty of practical examples of how those features can be addressed in either approach. The question is whether they will be. Mr. Green claims that emission-trading schemes have been plagued by corruption and subversion. While I am not sure his claim is true, it is certainly true that taxes have been subject to such manipulations on a grand scale. And, while such forces in a tradable permit system lead to redistribution, in a tax system they lead to distortions—a much worse outcome.
June 27, 2007
Kenneth P. Green
Mr. Pizer makes many claims for the superiority of emission-trading regimes over a revenue-neutral carbon tax. I’ll examine two here: First, the claim that the successes of lead and sulfur trading demonstrate the utility of carbon emission trading regimes. Second, that price volatility can be averted with the proper use of “safety valves.”
Do SO2 and lead trading demonstrate emission trading is a viable option for greenhouse gases? A bit of drilling down suggests not. Sulfur and lead trading were local issues, and were pollutants of relatively short duration in the environment (before being rained out). There were far less entities that had to trade (as compared with greenhouse gas trading), and the chemicals in question were easily measured at the point of emission. Initially, SO2 trading was only applied to a single sector: Only 110 coal-fired power plants were included in the system, subsequently expanded to 445 plants. In addition, there were readily available technological options to reduce emissions. Carbon trading features none of these: There are no off-the-shelf technologies that can reduce the carbon content of fuel; there would be many thousands of diverse trading entities across multiple sectors of the economy (not simply coal power generation); emissions can only be monitored by proxy indicators; and the pollutants themselves are of long to extremely-long duration in the environment.
Can safety valves fix the volatility issue? Mr. Pizer points to the success of the SO2 trading program to suggest carbon trading would work well to control carbon and avoid price volatility. But as my colleagues and I point out in a recent AEI Environmental Policy Outlook, “There has been significant volatility in emission permit prices, ranging from a low of $66 per ton in 1997 to $860 per ton in 2006, as the overall emissions cap has been tightened, with the price moving up and down as much as 43 percent in a year. Over the last three years, SO2 permit prices have risen 80 percent a year, despite the EPA’s authority to auction additional permits as a “safety valve” to smooth out this severe price volatility.” Carbon trading has fared no better in initial runs, as economist William Nordhaus points out: “We have preliminary indications that European trading prices for CO2 are highly volatile, fluctuating in a band and [changing] +/- 50 percent over the last year.”
It is true, in theory, that a perfectly designed carbon trading system can match the efficiency of a carbon tax. However, in practice, emission trading systems have been plagued by corruption and subversion that make such a perfect scheme highly unlikely.
