THE VINE SEPTEMBER 28, 2009
In The New York Times today, James Kanter checks in on Europe's foray into carbon trading. In particular, he hears Jürgen Thumann, the president of BusinessEurope complain that it's been rather costly for Europe to be the only entity that's put a hard cap on greenhouse gases so far. If the United States, Australia, Japan, and other nations would only join in on the fun, then cutting carbon emissions would be much, much cheaper for everybody.
Thumann's actually onto something here. Last week, the U.K.-based Climate Group issued a report that looked at what would happen if industrialized nations started coordinating their climate-change efforts. More specifically, the Climate Group estimated that, by 2020, carbon prices in Europe would hover around $65/ton if the E.U. was still going it alone. But, if both the E.U. and the United States had interlinked cap-and-trade programs, the price would go down to $28/ton. And if all developed countries and China somehow hooked up under one big cap-and-trade system, the price of carbon could be as low as $4/ton. In other words, the cost of reducing carbon would be nearly negligible.
How would this be? Consider how a cap-and-trade program works: You have an overall cap on carbon emissions, but emitters are allowed to trade pollution permits among themselves. A company can either cut its own emissions or else pay another company that can reduce emissions more cheaply to do so. So the market, in essence, seeks out the cheapest, easiest reductions first. Here's an illustration:
Suppose you have two plants, and the first one is able to eliminate one ton of pollutants at a cost of $10,000. The second plant, perhaps because it uses a different fuel or newer boiler technology, can do the same for only $4,000. Under command and control, if you required them to remove one ton each, the cost would total $14,000.
But what if all you mandated was that two tons of pollutants be removed overall (the cap part) and allowed the plants to work out how to do it? Naturally, the first plant would just pay the second plant $4,000 to remove an extra ton of pollutants from its emissions (the trade part). At first this seems suspect: The first plant is being allowed to merrily pollute away. But you've still removed two tons of pollutants, and since it was done more cheaply—for $8,000 instead of $14,000—you can afford to ratchet down the cap. You can require that three tons of pollutants be eliminated overall, and since this still costs only $12,000, everyone comes out ahead. The public gets cleaner air, and the plants save money.
And the more countries included in a cap, there more "low-cost" opportunities there are to reduce carbon available, which means that the overall price of eliminating a ton of CO2 goes down. That'd be especially true if China were integrated into a global cap-and-trade program—a lot of China's coal plants are unbelievably creaky and inefficient, and it'd be much cheaper to clean them up first than it would be to clean up a more efficient coal plant in, say, Europe. (Eventually, you'd have to address the European plant too, as the overall cap kept racing downward, but there'd be moer time to develop the technology to do so.) An international cap-and-trade regime is much cheaper and more effective than having each country trying to in isolation.