Download as a PDF here: A 'price on carbon' - what does carbon trading actually mean?
What does carbon trading actually mean?
Carbon trading is the short name for greenhouse gas emissions trading schemes. Carbon trading is a ‘market-based approach’ to reducing emissions. These schemes are described by advocates as being the most “efficient” way to reduce emissions, compared to more direct regulatory measures such as setting common standards for firms in an industry to meet.
Carbon trading schemes are purportedly designed to minimise costs to industry and create new opportunities for profit, whilst achieving emissions reductions. This is why carbon trading is the preferred policy framework of governments, big business, and international institutions such as the World Bank. However the experiments in emissions trading to date have not been cheap or environmentally effective. There have also been a series of additional social and environmental impacts associated with carbon trading.
Under a cap-and-trade scheme, the government sets a limit on the level of CO2e pollution. Most cap-and-trade schemes are located in rich nations who have obligations under the United Nation’s Kyoto Protocol. Each scheme’s cap is normally expressed as a percentage reduction on a particular year’s emissions (the “baseline”), for example, Australia’s 2020 target is a 5% reduction on the CO2e emitted in the year 2000.
Permits are then issued to the polluters obliged to participate in the scheme. Permits can be sold, but are usually handed out for free. These permits grant the holder a legal right to emit a certain quantity of CO2e. Participating firms must ‘retire’ carbon permits at various stages during the operation of the carbon trading market according to how much they have polluted. Adding all of these permits together is supposed to align with the total amount of pollution allowed under the nationwide cap.
Who trades what?
Under carbon trading schemes, it is not literally carbon which is traded, but rather these permits to pollute. Each permit equates to a common metric, most often equivalent tonnes of carbon dioxide (tCO2e). If companies pollute less than the level allowed by the permits that they own, they can sell their spare permits for a profit – or they can buy extra permits to allow them to pollute more.
The trading doesn’t end there however. All major carbon trading schemes proposed to date have also allowed for “carbon offsetting”. Offsetting is where a party outside of the carbon trading scheme creates a carbon “credit” by undertaking some activity or project which supposedly reduces an amount of CO2e pollution below a projected ‘baseline’ – what would have happened if the project didn’t attract carbon finance. Offset projects activities are undertaken in different nations and industries to those covered in a cap-and-trade scheme. For example, one of the most common types of carbon offset comes from textile factories in China.
The credits are sold to a polluter that is covered by a carbon trading scheme, who can then emit the equivalent amount of pollution without needing a permit. In other words, pollution “saved” by the party outside the cap-and-trade scheme “offsets” the pollution of the company covered by the scheme. Where offsetting is allowed, companies can in fact increase the pollution of their factory or power plant if they have purchased a sufficient amount of permits and offset credits.
In short, the “price of carbon" is what some companies must pay to buy pollution permits from the scheme itself, from other polluters or offset credits in order to continue polluting. The increased costs of emissions intensive products and services are then inevitably passed on to consumers.
What’s wrong with carbon trading?
Carbon trading is most commonly criticised by neo-conservatives, polluters, and big industry as an unfair tax on business or free enterprise. We think these criticisms are in fact part of a lobbying strategy intended to delay decisions to install climate policy, to influence the design of carbon trading schemes, and to increase the number of loopholes available to polluters.
Environmental groups are often very supportive of carbon trading. Some groups see carbon trading as good policy in its own right. For instance, there is also a common perception that carbon trading is an effective way to “make polluters pay”. Other groups recognise problems with carbon trading, but see it as a “first step” on the road to something better.
While we do not want to see ongoing pollution, carbon trading is an inherently flawed policy that will not move us away from a fossil fuel economy. Carbon trading will not solve climate change. What’s more, the claim that “polluters pay” under carbon trading is, quite simply, wrong. We have seen repeatedly that cap and trade programs mean that people end up paying and companies continue to profit and pump pollution into the air.
Locking in Emissions
It is claimed carbon trading encourages companies to reduce pollution. There are a number of reasons why this doesn’t work in practice and why carbon trading could never mitigate dangerous climate change.
As we mentioned in our explanation of offsets, companies can increase pollution if they simply purchase an equivalent amount of offsets. In this situation there is no overall reduction in pollution, it simply remains at the same level. However, if more offsets appear, fossil fuel industries can continue to expand their activities, infrastructure and market dominance, making future reductions in pollution even more difficult.
Most of the big polluters sell products that have fairly constant demand, like electricity. This means that people need to keep buying the products whether or not the price is higher. What this means in practice is that polluters can buy a lot of permits or offsets to keep polluting, and then increase the price of their products to consumers. They can increase the price beyond what is needed to cover the costs of the new carbon price, allowing them to make even more profit. In the first six years of the EU carbon market, for example, power companies generated windfall profits estimated at €19 billion in phase one (2005-8), and up to €71 billion in phase two (2008-12). Subsidies to energy-intensive industry through the two phases was estimated to amount to a further €20 billion.[i]
Addressing climate change means major changes in the way we run our economy and society – among them, an end to the use of fossil fuels. The fossil fuel industry will never embrace this change. If they can simply pass on the extra cost of having to purchase pollution permits or carbon offset credits to their customers, a “price on carbon” by itself won’t lead them to invest in large-scale renewable energy. They are more likely to respond to carbon trading by exerting their power and influence to keep the price of carbon low – and by using their market power to control the development of renewable energy (ensuring that it do not progress quickly enough to become a cheap energy source).
Polluters profit, people pay
Those with power in a particular market profit, and those without lose. For instance, if energy retailers put their prices up, consumers may find ways to use less energy – however, polluters will still make the same profit because they receive a higher price for the energy they supply. The public are the ones making the energy savings, but they’re not rewarded, polluters are.
An across-the-board increase in prices (e.g. electricity prices) is equivalent to a flat rate tax (that is, a tax where everyone pays the same amount, like a Goods and Services Tax). Under this kind of tax those people with less income are more affected. This is because the additional cost takes up a greater percentage of their income than it would for someone with a higher income. Firstly, if people are going to pay for a climate change mitigation policy, the policy should actually be effective at stopping dangerous climate change. And secondly, it should happen in a way where those who have more money, pay more.
Cookin’ the books
The enforcement of a carbon trading scheme requires a significant amount of carbon accounting. Polluters must declare their baseline emissions at the start of the scheme; they must record their emissions once the scheme is in operation; and they must balance these emissions against an adequate number of permits and/or offset credits. Further still, those who wish to sell offset credits must record the emission savings that they wish to sell. Given the opportunity, polluters (and offsetters) will lie about all of these figures. Polluters will always overstate their “baseline” level of emissions, especially if the government hands out the permits for free. This means that polluters are usually granted more permits than they need, enabling even more pollution.
Business sectors such as the accounting, audit, finance and legal professions are set to make millions of dollars under carbon trading. Accounting, auditing and legal advice and service fees are incurred by the government as part of their enforcement of the scheme. Financial speculators will buy and sell financial instruments that let polluters hedge their risk of a fluctuating carbon price. The lucrative business that can be wrought under a carbon trading scheme is a further incentive for the system to be more complex, less transparent, and have greater loopholes.
Sadly, we cannot trust government to monitor and control a whole new carbon accounting sector. Corporate lobbying and government reluctance, will undoubtedly lead to this sector “self-regulating” – which in the wake of wide-ranging corporate fraud and dishonest accounting practices, is a sobering thought. As Uruguayan activist Silvia Ribeiro noted, “In the wake of the largest financial crisis in history, the same bankers who can’t even keep their own house in order now claim they can manage the planet. Excuse us for not believing them.”[ii]
Carbon trading is a form of government regulation over industrial polluters. However, as a form of regulation, carbon trading is heavily skewed towards corporate interests. To start with, industry has enormous power over government. This power is exerted to corrupt carbon trading schemes, when they are being designed and after they are implemented.
The ‘perfectly designed’ carbon trading scheme exists only in the pages of economics textbooks and will never be implemented in reality. The major carbon trading schemes implemented to date, including the European Union Emissions Trading Scheme, have all been riddled with loopholes that have allowed industry to profit and prevented real shifts away from fossil fuels. We need only look to the free handout of $13 billion of ‘industry assistance’ in the Australian Clean Energy Future package, mostly made up of free permits, as an example. Of course the major loophole tacked on to carbon trading is carbon offsetting. (See “Carbon Offsets” under the Issues section of this site.)
Under carbon trading, governments are handing away and selling rights to pollute the atmosphere. While this may seem like an ideological point, it actually has important implications for the future of how we regulate pollution. Once this right to pollute the atmosphere has been privatised, it will have to be purchased back if is to become public again. In other words, if future governments decide that “cap and trade” does not work, they will be forced to pay huge amounts in compensation to polluters in order to buy back the right to regulate industry pollution directly.