California’s carbon trading plan is problematic at best

Under California’s landmark 2006 Global Warming Solutions Act, AB 32, the state must reduce greehouse gas emissions to 1990 levels by 2020. Carbon trading, also known as cap and trade, is an essential part of this. The deadline for formalizing the plan is next month. But, as always, the devil is in the details.

California’s cap and trade proposes to reduce emissions by making power plants and large manufacuring firms get an allowance permit for every ton of carbon dioxide they produce. Permits can be bought and sold freely. The number of permits available each year will drop, thus forcing the price of permits up. The theory is that this increased cost of doing business will force corporations to reduce emissions.

But the program starts wrong by giving away permits to large businesses, especially those with out of state competition (which would be almost all business, wouldn’t it?) The state is calling this giveaway a “soft start.” It could also be called “free money” as the permits can then be sold by companies who paid nothing for them.

There are numerous other problems with this cap and trade plan. It will unquestionably raise the price of energy and gasoline in California as companies pass on their costs to consumers. This might not be the best of all possible plans during a recession and when businesses are already leaving California because of high prices and what they see as too much regulation.

The logic can also be circular. Gasoline refineries will cut their carbon emissions and the price of gas to consumers will rise. This will theoretically make car owners more likely to buy hybrids or electric vehicles. But the price of electricity will also be going up as utilities lower their emissions, so the cost of running that EV could spike too. Electicity bills for home and business will almost certainly rise too. I’m guessing consumers will not be overjoyed by this.

The plan also allows companies to offset 8 percent of their emissions by investing in or buying permits from companies elsewhere that promise to reduce their emissions too. This would include lumber companies doing clearcutting who promise to do it in a kinder, gentler way. It’s also difficult to see how all the required monitoring of emissions can be done in a transparent, open, and reliable way.

Europe’s carbon trading market has been unsuccessful so far. Also, carbon markets are small and thus can be gamed and manipulated. California regulators say they will be watchful but they will be up against investment banks, hedge funds, and the like. Some hedge funds have hundreds of billions. Could they simply buy all available credits, force the price up, then dump them for a big profit? Some of them no doubt are thinking about it. There’s there’s the question of derivatives. In this case it would bundling carbon credits together, selling them off in tranches to speculators, then buying and selling faux insurance on them. If that sounds crazy, well, that’s precisely what happened with mortgages. And that did not end well.

Cap and trade has a laudable goal: to reduce carbon emissions. But the plan is complicated, perhaps easy to game, will raise the cost of fuel and electricity, and does not appear to have strict oversight. So it’s difficult to see how it can work.

(crossposted from CAIVN)

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