A useful rule of thumb: Lower emissions are better for the environment
In the unlikely circumstance that reporters ever grow weary of chasing twitches in the oil markets or interpreting the wanderings of the Dow, they have a new toy to play with: the price of carbon. Which is fine, so far as it goes, except that they keep getting the story so badly wrong:
The global financial crisis and looming recession might actually make it cheaper to comply with Europe’s increasingly stringent caps on greenhouse gas emissions by pushing down the price of carbon-emissions permits (along with everything else traded on a market). The environmental downside? The economic slowdown and cheaper permits could mean less progress actually cutting emissions.
This is exactly backwards. Permits are cheaper because companies are cutting emissions, and companies are cutting emissions because the economic slowdown is causing them to reduce output. In a cap-and-trade system, expensive permits don’t make companies reduce emissions; the "increasingly stringent" cap does that. Expensive permits are just a sign that companies are having difficulty meeting the cap.
Achieving a specific price for carbon is not a policy goal for a cap-and-trade system: the cap is the policy goal. Supply and demand determine the price of carbon permits. If polluters find that they’re having an easy time cutting emissions (creating low demand for permits), then the price of permits will drop. If the cap is working properly — an important caveat — the price of carbon is somewhat incidental. The cheaper, the better.
This is not what environmentalists had in mind when they backed cap-and-trade as a way to ratchet down greenhouse-gas emissions.
Yes it is! This is just what everyone had in mind for cap-and-trade. Many have offered thoughtful critiques of this mechanism, but this is exactly how the system is supposed to work.
For the system to really spur change, the carbon price has to be high enough to give an incentive for polluters to install cleaner technologies or move to cleaner fuels. Capturing carbon emissions from coal plants and sticking them underground, for example, will cut emissions but will be expensive. A carbon price below 40 euros a ton tends to make "clean coal" economically unattractive.
No, for the system to spur change, the cap has to be set at a level that spurs change. Then the price of carbon will adjust based on the available supply of emissions reductions. Clean coal is economically unattractive because of the availability of much cheaper forms of carbon reductions, and that situation won’t change until such alternative supplies are exhausted. At a certain carbon price, clean coal becomes more economically attractive than dirty coal, but that’s not the relevant benchmark. It’s easy to imagine a scenario in which clean coal never becomes economically attractive, because other forms of low-carbon energy such as wind and solar take off (helping to keep down the price of carbon, which, again, is a good thing).
To be fair, it’s easy to confuse means (the price of carbon) and ends (emissions reductions) in this manner. Environmentalists do commonly talk about the carbon price at which various clean technologies become cost competitive with conventional sources of energy. Insofar as we assume certain technologies will play an important role in a post-carbon world, it’s natural to track the price of carbon and watch for certain thresholds to be met.
But this is still the wrong way to think about carbon prices. The price itself is interesting, but the important question is always why the price is at a particular level, which is really a question about supply and demand. Consider the following explanations for a low carbon price:
- Unseasonably mild weather has led to a drop in fuel usage, and therefore a drop in emissions.
- The carbon cap has been set at a level that is too high, resulting in oversupply of permits.
- The McKinsey report claiming that 40 percent of emissions reductions can be had for free via efficiency improvements turns out to be true. Businesses and individuals are having a field day slashing their energy consumption and saving money.
All three of these explanations are entirely plausible, and they tell wildly different stories. Story No. 1 is essentially boring. Energy usage fluctuates all the time, and the dip in carbon price is temporary. Story No. 2 indicates a structural flaw in the policy that means it may never work. Environmentalists, to the barricades! Story No. 3 is a happy tale in which both the environment and the economy benefit in lockstep.
Incidentally, the situation that the Wall Street Journal is writing up is story No. 1: economic downturn causes temporary dip in emissions. It’s a boring story — which is no excuse for getting it wrong.