1
Professor Hector R Rodriguez
School of Business
Mount Ida College
2
Course Map – Topics Covered in Course
• Society
– The Corporation and Its Stakeholders
– People for the Ethical Treatmen...
3
• Today, consumers (and industries we support) dump an
unlimited amount of greenhouse gases into the atmosphere
for free...
4
• “Cap-and-trade” means a government authority establishes
a cap that limits the total amount of pollution allowed, and
...
5
This game of managed scarcity can help illustrate the following
important concepts and issues:
• Banking
• Borrowing
• E...
6
Each chair represents the “right to pollute”: one metric ton
of carbon dioxide (1 mtCO2) (or an equivalent amount of
any...
7
At the start of the game, everyone has a seat – because there
are no limits on carbon emissions.
2010
Musical Chairs
8
After the first year, a cap is imposed by limiting the amount of
permits and making players compete for the permits
avai...
9
• At that price, some players may realize it would be more
profitable to reduce their emissions and sell their permits.
...
10
• The purpose of the game is to reduce greenhouse gas
emissions.
• The game authority reduces the number of permits ava...
11
• The last polluters remaining in the game are those who:
– can afford to pay the most, or
– have the least flexibility...
12
• There are no “time out” options between rounds.
• As the cap tightens in each new round, fewer permits are
available....
13
The Problem of Leakage
• The two available options are
1. Buy a permit from another player, OR
2. Reduce emissions
• Ei...
14
$20 $20$20
• Opposite to leakage, a player may find a business sector that
isn’t covered by the policy … but has a lowe...
15
The Problem of “Offsets”
• However, it can be difficult to verify that the player’s
investment was responsible for thos...
16
• Some companies want market-based policies, but not market
risk.
The Problem of a “Safety Valve”
My business cannot co...
17
• A “safety valve” would effectively violate the cap on
emissions, and convert the policy to a stable tax.
• Anyone can...
18
• Players who receive more permits than they need would like
to “bank” them.
• By saving a spare permit, the player can...
19
Two critical aspects of cap-and-trade are determined by
how each round begins:
1. Which polluters should be required to...
20
For practical reasons, most proposals only require fossil fuel
suppliers and large polluters to play directly.
As they ...
21
Though sales of coal, oil, and gas should decline as carbon
prices rise, economists say less than 20% of the permits
sh...
22
• By contrast, the Lieberman-Warner bill for U.S. climate policy
proposes giving away more than half the permits.*
• Th...
23
Why is this a cause for concern?
1.Unfair competition: New players entering the market with
innovative ideas have diffi...
24
• A carbon tax and a cap-and-trade policy both would raise
fossil fuel prices.
• Prices of products and services that u...
25
• Is it ethical to privatize the sky and treat pollution as a
commodity traded like private property?
• Is it ethical t...
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Emissions Trading Markets (Cap & Trade)

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Emissions Trading Markets (Cap & Trade)

  1. 1. 1 Professor Hector R Rodriguez School of Business Mount Ida College
  2. 2. 2 Course Map – Topics Covered in Course • Society – The Corporation and Its Stakeholders – People for the Ethical Treatment of Animals – Corporate Citizenship – The Social Responsibility of Business – The Shareholder Primacy Norm – CSR, Citizenship and Sustainability Reporting – Responsible Investing – The Community and the Corporation – Taxation and Corporate Citizenship – Corporate Philanthropy Programs – Employees and the Corporation – Managing a Diverse Workforce • Environment – A Balanced Look at Climate Change – Non-anthropogenic Causes of Climate Change – Sulfates, Urban Warming and Permafrost – Conventional Energy – The Kyoto Protocol – Green Building – Green Information Technology – Transportation, Electric Vehicles and the Environment – Geo-Engineering – Carbon Capture and Storage – Renewable Energy – Solid, Toxic and Hazardous Waste – Forests, Paper and Carbon Sinks – Life Cycle Analysis – Water Use and Management – Water Pollution
  3. 3. 3 • Today, consumers (and industries we support) dump an unlimited amount of greenhouse gases into the atmosphere for free; fossil fuel prices do not reflect their full cost. • Policy makers have two main options for putting a cost on greenhouse gas pollution: 1. A carbon tax or “pollution fee” 2. Creating a market for carbon emissions • In order to stabilize global warming, fossil fuel prices would rise under either policy. • Americans appear to have little appetite for a carbon tax. • But there is also little understanding of the market-based alternative – a carbon cap-and-trade program. Climate Economics
  4. 4. 4 • “Cap-and-trade” means a government authority establishes a cap that limits the total amount of pollution allowed, and then distributes permits for a “right to pollute” the global atmosphere, which can be traded as private property. • The amount of greenhouse gas emissions permitted declines each year, creating demand for a new commodity: carbon permits. • When offered enough money (or faced with high enough costs), polluters who own permits (or need permits) will reduce their emissions. *A familiar game can help illustrate the concepts… Cap & Trade Climate Policy Source: Holmes Hummel, November 21, 2007
  5. 5. 5 This game of managed scarcity can help illustrate the following important concepts and issues: • Banking • Borrowing • Equity • Ethics • Allocation • Auction • Trading • Targets • Leakage • Offsets • Safety Valve Musical Chairs: A Helpful Analogy
  6. 6. 6 Each chair represents the “right to pollute”: one metric ton of carbon dioxide (1 mtCO2) (or an equivalent amount of any other greenhouse gas) If you have a permit, you can have a chair. Musical Chairs: A Helpful Analogy
  7. 7. 7 At the start of the game, everyone has a seat – because there are no limits on carbon emissions. 2010 Musical Chairs
  8. 8. 8 After the first year, a cap is imposed by limiting the amount of permits and making players compete for the permits available. In our analogy, one player doesn’t have a chair… 2011 Musical Chairs Would anyone be willing to trade their chair for $30?Sure! For that price, I can finance an efficiency upgrade, eliminating my need for a pollution permit. So, the market price for the “right to pollute” in the first year is $30 for one ton of carbon dioxide…
  9. 9. 9 • At that price, some players may realize it would be more profitable to reduce their emissions and sell their permits. • Profit opportunities are a main driver for innovation and investment in the global economy today, and the climate challenge needs both. 2011 Using Market Incentives If I could I build wind farms to replace my coal power plants, then I could sell permits… Hey, I made a profit by reducing my fossil fuel use and avoiding carbon emission costs! 2012
  10. 10. 10 • The purpose of the game is to reduce greenhouse gas emissions. • The game authority reduces the number of permits available each year until the ultimate target has been achieved. • In a market, players leave when they find better options as costs rise. • Cap-and-trade lets players choose at what price they leave the game – and how they want to make that change. Achieving Reduction Targets Wind Power Green Buildings Hybrid Vehicles Solar Power
  11. 11. 11 • The last polluters remaining in the game are those who: – can afford to pay the most, or – have the least flexibility to change games. • The underlying assumption is that uses of fossil fuels for which people are willing to pay the most must be the most valuable. • To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy. 2050 Achieving Reduction Targets
  12. 12. 12 • There are no “time out” options between rounds. • As the cap tightens in each new round, fewer permits are available. • So, players with permits charge the buyers higher prices. 2020 Achieving Reduction Targets How high can the price go? As high as it takes to motivate one of us to get up…
  13. 13. 13 The Problem of Leakage • The two available options are 1. Buy a permit from another player, OR 2. Reduce emissions • Either choice may be difficult for some energy-intensive businesses (e.g. aluminum, cement) competing in the global economy. At higher carbon prices, I’ll need to close my cement plant – or move it to another country... • “Leakage” occurs when polluters move to avoid regulation – which is why an international agreement is so important.
  14. 14. 14 $20 $20$20 • Opposite to leakage, a player may find a business sector that isn’t covered by the policy … but has a lower cost opportunity to reduce emissions. $15 Reducing methane from hog farmsSELL PRICE: The Problem of “Offsets” As high as it takes to motivate one of us to get up… How high can the price go? In that case… I’ll move here… • Because all tons of carbon emissions affect the atmosphere the same, this offset could be accepted as equivalent to a permit.
  15. 15. 15 The Problem of “Offsets” • However, it can be difficult to verify that the player’s investment was responsible for those reductions – and that they actually happened. • Therefore, standards for offsets must be high to ensure the carbon reductions are real – and not “hot air.” • China, India, and other countries have some very low cost opportunities to reduce emissions. • However, the U.S. Congress did not ratify the Kyoto Protocol that makes use of the Clean Development Mechanism for offsets.
  16. 16. 16 • Some companies want market-based policies, but not market risk. The Problem of a “Safety Valve” My business cannot cope with the possibility that carbon prices might exceed $20/mtCO2! • A “safety valve” would put a cap on the carbon price rather than on the emissions, allowing firms to protect their investments by buying unlimited pollution permits at a guaranteed maximum price. $20 $20$20 $20 $20$20
  17. 17. 17 • A “safety valve” would effectively violate the cap on emissions, and convert the policy to a stable tax. • Anyone can burn as much coal as they’d like if they can pay the fee. • With a “safety valve” on the price of carbon, the market drivers are weaker, making command & control policies even more important. • Building codes, fuel economy standards, renewable portfolio standards, tax laws, and other legal requirements would be essential – as they are today. The Problem of a “Safety Valve”
  18. 18. 18 • Players who receive more permits than they need would like to “bank” them. • By saving a spare permit, the player can pollute that amount in a future year or to sell that permission to someone else in the future. • Similarly, some people who lack sufficient permits to cover their pollution would like to “borrow” them from the permits they expect to receive in the future. 2020 Banking
  19. 19. 19 Two critical aspects of cap-and-trade are determined by how each round begins: 1. Which polluters should be required to play? 2. Should polluters have to buy permits in an auction – or should they receive a free allocation of permits? Coverage and Distribution
  20. 20. 20 For practical reasons, most proposals only require fossil fuel suppliers and large polluters to play directly. As they pass on their costs, the rest of the economy is affected. Oil Refineries Coal companies Natural Gas companies Power Plants Mining plants Chemical companies Aluminum smelters Examples of “covered” pollution sources: Coverage
  21. 21. 21 Though sales of coal, oil, and gas should decline as carbon prices rise, economists say less than 20% of the permits should be given for free to compensate those firms for additional profits they might have had otherwise. Permits auctioned to “covered” companies Free permits allocated to fossil fuel companies $20 $20 $20 $20 $20 $20$0BUY: Auctioning Permits v. Allocating for Free Source: Reference: Lawrence Goulder, Congressional Budget Office Conference on Climate Change, 2007.
  22. 22. 22 • By contrast, the Lieberman-Warner bill for U.S. climate policy proposes giving away more than half the permits.* • Those companies start out each round “sitting down” at no cost. $0 $0 $0 $0 $20 $20$0BUY: * Though portion would change over time, 1/4 are still free in 2050. Auctioned permits bought by corporations Free permits allocated to corporations2012 Auctioning Permits v. Allocating for Free
  23. 23. 23 Why is this a cause for concern? 1.Unfair competition: New players entering the market with innovative ideas have difficulty competing against pre-existing polluters who get free permits as a subsidy to diminish their political opposition. 2.Unearned windfall profits: In a carbon market, firms that buy permits in an auction will try to pass costs to customers, and others receiving a permit for free can sell their permits at that same price. 3.A cap-and-trade policy with 100% auction avoids giving away unearned windfall profits and returns all proceeds to a public policy process for spending decisions. Auctioning Permits v. Allocating for Free
  24. 24. 24 • A carbon tax and a cap-and-trade policy both would raise fossil fuel prices. • Prices of products and services that use fossil fuels would also rise. • This would impose hardship on low-income households unless the climate policy specifically includes “carbon cost rebate” measures funded with revenues raised from either a tax or a permit auction. Concerns About Equity
  25. 25. 25 • Is it ethical to privatize the sky and treat pollution as a commodity traded like private property? • Is it ethical to make a profit from carbon trading? • Will the complexity of a cap-and-trade system rival our tax system, opening similar opportunities for loopholes and favored treatment? • Would our political institutions be reliable to manage this massive new market over decades under tremendous pressure? Additional Questions to Consider

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