No Time for Cap and Trade

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November 2017 Sarah Miller

It's possible, given enough time and political will, that a carbon cap-and-trade market could be developed that delivers specified emission reductions on time and under budget. Possible in theory, that is. In practice, more than a decade of trying hasn't produced much success in cap-and-trade for the EU or any other large political entity, and the earth is running out of time. Carbon pricing is needed now, not at some uncertain point in the future. It's probably needed to speed the transition to carbon-free power generation and, eventually, to a full zero-net-carbon economy. And it's certainly needed now if gas is to win out over coal as the favored fossil fuel of the transition years, while renewable generation and storage are built up. The quickest, simplest and, in some places, most politically palatable way to get that carbon price is through a tax, not a convoluted emissions trading system (ETS). Oil industry leaders are increasingly advocating carbon taxes. More should do so -- as should those environmentalists who remain wedded to the outdated notion that only cap-and-trade can guarantee falling emissions. Real-world evidence suggests the opposite.

For a cap-and-trade system to work efficiently as a market and, more importantly, to deliver a sizeable cut in emissions, the designers have to get several difficult things right. They have to set the baseline for emissions accurately or the price won't be at the required level. And they can't over-estimate either broader economic performance or the speed of transition to low- or no-carbon alternatives. If they do, the system won't have any impact.

The EU Emissions Trading System, launched back in 2005, has had trouble on all these fronts, leaving carbon emission prices at around €7 ($8) per ton, so low they have little if any effect on fuel choices and thus on carbon dioxide (CO2) emissions. A South Korean ETS introduced in 2015 has suffered from higher-than-expected prices and low trading volume over the past year, generally attributed to problems on the baseline emissions front, and it's as yet unclear whether the system has had any certifiable impact on emissions

Despite years of practice with regional schemes, the Chinese have found developing a national ETS so technically difficult and politically fraught that they have had to delay its introduction by several months to the end of this year, slash the number of industries covered from eight to no more than three and basically limit the initial market to little more than a training exercise in managing all the variables.

California has been relatively effective at controlling emissions across the transport as well as power generation sectors, partly because its ETS sets a floor on prices and partly because the state has numerous other regulations that are more effective than the emissions market itself, including outright restrictions on the purchase of coal-fired power and requirements for increasing sales of zero-emission vehicles -- generally battery electric vehicles (EVs). The price of emissions allowances at California's latest auction, held jointly with the Canadian province of Quebec, was $14.75/ton, well above the $13.57/ton floor price and nearly twice the EU ETS level, but still too low to make much difference in fuel choices.

Some advocates of cap-and-trade argue that, as long as emissions reduction goals are met for whatever reason -- be it a weak economy, or wind farms and solar panels being installed faster than expected -- it's only appropriate that the carbon price should be low. A higher charge on the economy isn't needed, and the ETS quite appropriately reacts to that by generating a low carbon price. That's fine if a carbon price is viewed only as a backup in case everything else fails. But if the goal is to slash carbon emissions as far and as fast as practicable, a backstop isn't what you're looking for from carbon pricing. You want it to actually do something.

The rapid drop in the cost of renewables -- from solar panels to onshore and, more recently, offshore wind -- has raised the possibility that a transition to renewable electricity and widespread use of EVs will come in fairly short order without a hefty carbon price. But none of the mainstream energy demand forecasting models indicate the transition will be rapid enough to meet the internationally agreed target of holding global temperature rise at, or preferably "well under," 2°C. It could be argued, however, that these models should be ignored, given how consistently and dramatically they have underestimated the speed at which these technologies have spread in recent years.

Betting Against Catastrophe

The question remains, however, whether it's prudent public policy to bet on a continuing acceleration in the fall of renewable energy prices when climate experts are virtually united in maintaining that the consequences of getting it wrong would be "catastrophic." If that much is at stake, it would seem imperative for governments to go on the offensive against emissions, rather than to rely on the vagaries of the marketplace for solar panels and EVs.

One way or another, coal use has to be slashed quickly and then phased out entirely if emissions reduction goals are to be met. Unless the transition to renewables with battery or other storage backup isn't almost unbelievably rapid, that means lower-emitting natural gas will need to replace much of that coal, at least for a time. Whether that period of time is a few years or a few decades, no one knows, but what is clear is that cutting every ounce of emissions possible is not just desirable but necessary, so policymakers should get on with encouraging such savings.

In recent years, the US has managed to produce all the gas it could use at prices often under $3 per million Btu, thereby undercutting coal and putting the country on a path of falling emissions -- without a carbon price. In the rest of the world, however, even in the years since the 2014 oil price collapse, gas has been uncompetitive with coal virtually everywhere, almost always without a stiff carbon price. Oil and gas industry executives have been rightly admonishing themselves recently to do more to drive down the cost of producing and transporting gas, allowing for a lower gas price. But they're unlikely to get the delivered cost to most users down far enough and fast enough to compete with coal.

One rarely mentioned, embarrassing little secret about cap-and-trade systems is that those that have worked effectively so far tend to rely heavily on a mandated floor price to keep them operating -- a floor price that is essentially a carbon tax by another name. Just how effective such thinly disguised carbon taxes can be is evident not only in California but also in the UK, where a gradually rising national floor price under the EU ETS, now at £18 ($24), has spurred a plunge in coal-fired power from over 40% of generated power when it was introduced in early 2013, to 9% in 2016.

Germany, in contrast, has no floor price under the EU ETS and still generates about 40% of its electricity from coal, with its enormous strides in renewables mainly canceling out drops in nuclear -- and gas-fired -- generation. Hence the likelihood that Germany will fail to meet carbon reduction goals.

A carbon price may only be needed to give gas an advantage over coal for a decade or less before a new energy system takes shape. However, the transition may well be much longer, and either way, a carbon price is vital to emission reduction efforts in those years. Carbon trading can't dependably provide that price. Carbon taxes can.

Sarah Miller is Editor-at-Large at Energy Intelligence, and a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

Carbon Capture (CCS), Low-Carbon Policy, Energy Storage
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