Carbon price volatility is a real issue
Both The New York Times and The Wall Street Journal were at it this week, flogging stories about how falling carbon prices are threatening clean technology. I’ve written before about how easy it is to get distracted by carbon prices, which, under cap-and-trade, are more of a symptom of a broader issue, not a cause.
Another blow to the sector is the tumbling price of permits for emitting carbon dioxide, the main greenhouse gas. In countries where emitters must buy these permits, like those in the European Union, low prices mean emitters have fewer incentives to make their production process more efficient or move to less greenhouse gas intensive fuels.
No. Decreased consumption due to a massive recession, coupled with price declines for natural gas and other factors, is removing incentives to invest in efficiency or renewable energy. The sagging carbon price reflects that fact. It doesn’t cause it.
A substantive point lurks beneath the Times article: Carbon price volatility is one of the bad features of a poorly designed cap-and-trade system. Even if the specific price of carbon isn’t really the point, lots of bouncing around doesn’t do the environment or the economy a ton of good.
Fortunately, provisions for “banking” permits — meaning that they can be carried over from one year to the next — can do a lot to smooth out price volatility while maintaining the integrity of a cap. RGGI allows banking, the California AB 32 scoping plan includes banking, and even the USCAP plan calls for banking. Long story short, any national system in the U.S. will likely include provisions for banking allowances, which hopefully will dampen some of the price volatility Europe is currently experiencing.
Update [2009-1-26 10:44:57 by Adam Stein]: One thing I should have been more clear about: the European carbon market (known as ETS, for European Trading Scheme) didn’t allow banking between Phase I and Phase II of its implementation, but does allow banking between the current Phase II and Phase III. So if the ETS does allow for banking, why is the market crashing? Because the recession is really deep. Observers are forecasting a 20 – 30% drop in industrial output. Firms aren’t worried overly much about banking allowances if they’re not sure they’re even going to survive. Banking can help dampen volatility, but it can’t make it go away entirely.
As others have noted, auctioned allowances with a price floor are another mechanism for damping volatility. Although certainly a desirable feature in a cap-and-trade system, I’m not sure price floors would matter too much more than banking — by their nature, price floors tend to be pretty low.
Finally, none of this changes the original point: carbon prices are symptomatic of the same trends depressing clean tech investment. They aren’t the cause of the problem.