Why secondary carbon markets should be minimized in climate legislation
It is fine and necessary to put a price on carbon, via either a carbon tax or 100 percent auctioned cap-and-trade permits. But in the latter case, when those permits are not sold directly to polluters but are released into a secondary market (either via auctioning or, worse, via giveaways), those markets tend to prioritize maintaining their own existence over reducing emissions.
In short, a price is fine; an actual market is not.
Part of this is that creating such markets creates a whole new set of lobbyists, the carbon traders, who do not exist to reduce emissions, but to trade carbon. As the examples below show, imperfections in such secondary markets will lead to short-term conflicts between the interests of carbon traders and the interests of climate reductions. (And since such secondary markets will be created by human beings, they will have imperfections.) In the long run, total or near-total phaseout of fossil fuels will also lead to total or near-total phaseout of emissions trading. So you have a long-term conflict of interest between carbon traders and emissions phaseout as well.
In short, in addition to straight economic arguments, which I will deal with in another post, there are strong political economy arguments against carbon trading: We have a big enough carbon lobby to fight without creating a whole additional political sector with a self-interest in maintaining emissions. Specific examples follow.
It is pretty universally agreed that one flaw in implementing the initial stage of the Kyoto treaty was creating too many permits. But bad as that was, the permits were initially scheduled to expire.
Unfortunately, the players involved saw the priority as preserving the market rather than as reducing emissions. So it was agreed that the permits would not expire after all when the current phase of Kyoto ends. That restored the value of the permits and saved the secondary carbon markets. The price, of course, was that the permits — which, it is universally agreed, should never have been issued — will hang around until they can be used.
Similarly, the CDM market is pretty widely acknowledged to be a failure. The primary claimed goal behind CDM was to develop clean infrastructure for poor nations. (That is why it was called “Clean Development Mechanism,” not “Cheap Carbon Credit Provider.”) However, given the additionality questions about CDM and the fact that renewables and major efficiency improvements combined account for a minority of CDM expenditures, I don’t believe a serious argument can be made that it has contributed significantly to such infrastructure. I would add that that there are serious questions [PDF] about whether CDM carbon credits even represent net reductions, given the iffiness of measuring additionality in project-based credit generation. The evidence is overwhelming that CDM increases emissions. But you don’t have to agree with this to see that it has failed as a means of producing clean infrastructure.
Yet, you can see one small example here that the CDM industry is overwhelmingly pushing to loosen, rather than tighten, regulations on CDM. It looks like the current push is to increase the percent of requirements CDM and JI can meet in spite of complaints in the linked article.
The world’s main carbon markets are all created by and maintained under the Kyoto treaty. (Various voluntary markets are tiny in comparison.) And in every one of these Kyoto markets, we can see both those with ideological stakes in trading and those with financial stakes in carbon markets lobbying for the interests of these markets over creating actual emissions cuts. That should come as no surprise. Those are the incentives secondary markets create.