Emissions trading: Another financial bubble set to burst?

Media release issued Monday, 10 August 2009

While the Australian Government has settled on a greenhouse gas (GHG) emissions cap-and-trade scheme (the CPRS) as its primary policy response to climate change, a new CEDA report asks whether this is really the best and most durable approach.

The Australian community doesn't seem to be aware that it is not GHG emissions that will be traded, but a form of carbon derivatives.

A Taxing Debate - Climate policy beyond Copenhagen examines whether cap-and-trade should really be the policy of choice in the debate over how to reduce greenhouse gas emissions.

Contributors to the report argue it should not supplant the simpler idea of a carbon emissions tax.

CEDA's Chief Executive David Byers said authors in the report argue cap-and-trade may be a more politically acceptable approach than a carbon tax but only because it hides the true costs to consumers and creates a false sense of financial and economic security.

By contrast, a carbon tax would deliver more certainty of price signal, stability and transparency. It would provide clearer signals to investors; better enable firms to plan for investments in capital equipment and new low-emissions technologies; and introduce much needed simplicity and directness to climate policy.

"Having suffered a global financial crisis - in large part because of poorly managed, excessive credits and swaps originating from excess housing finance - contributors to the report question the integrity of carbon credits long-term", Mr Byers said.

"Will there be a carbon bubble of the wrong kind?" he asked.

The rhetoric on emissions trading includes references to the need to 'price carbon' but lacks the substance, simplicity, transparency and sense of an explicit price incentive.

CEDA's Director of Research and Policy, Dr Michael Porter, said there was a very threatening prospect that emissions trading would create a vast and uncertain set of derivatives trades based on carbon debits and credits.

"A carbon finance bubble could eventually dwarf the recent GFC problems," Dr Porter said.

"The trades will be vast because the big polluters won't be trading GHG emissions but carbon emission derivatives under a poorly understood and infant policy - the CPRS."

"If Wall Street's manipulation of debt and derivatives gave us the global financial crisis, the emissions trading is certain to give us far worse."

"Alternatively, a transparent tax system is not the deal-driven, offset and carve-out model that is really just a new front door to the return of protectionism, as an ETS is," Dr Porter explained.

A consumption-based carbon tax would also fit within the GST and WTO systems, as authors Geoff Carmody and former WTO Director Gary Sampson demonstrate in their papers.

Geoff Carmody, in his paper on a consumption-based carbon tax, argues that the CPRS is the "GST from hell" as it penalises the very export industries and import competing firms at the core of our export driven economy.

Dr Porter supports this view. "At a time when the country is reeling from the imported GFC, it is unwise in the extreme for the CPRS to invite backroom carve-outs and deals that exempt firms from the ravages of the CPRS," he said.

"At its core, the scheme involves trades not in carbon emissions but debits and credits and other derivatives that invite corruption, fraud and auditing nightmares across much of the third world of finance."

Dr Porter points to Professor Ross Garnaut's final report which states: "A well-designed emissions trading scheme has important advantages over other forms of policy intervention. However, a carbon tax would be better than a heavily compromised emissions trading scheme." (Emphasis added; Garnaut Climate Change Review Final Report 2008, p. xxiv.)

Prominent Yale economist William Nordhaus and Dr Porter argue in their papers that taxes are less vulnerable to manipulation, evasion and corruption - a significant risk in any international emissions trading scheme.

"My concern is phony carbon derivative trades will emerge, as already experienced in Papua New Guinea where of the head of its carbon trading office is suspected of being involved with trading 'mythical' carbon credits," said Dr Porter.

A tax in sync with consumers

Dr Porter, in his paper argues that a carbon tax creates the incentive and ability for people to reduce their carbon footprint; unlike an ETS which has no incentives for the community directly.

Dr Porter said many people who want to reduce their carbon footprint find they are excluded from the CPRS as it only focuses on wholesale emitters, and some of these - such as agriculture - have been currently exempted.

"People can monitor their energy consumption - and lower their costs - with new smart devices (eg mobile phones) that report on charges and consumption of utilities," he said.

The Copenhagen factor

The report also highlights perspectives from major countries - the United States, China, India, Germany and Australia - on the Copenhagen process and what, if anything, is likely to emerge from it.

Will there be a successor treaty to the Kyoto Protocol, due to expire in 2012? Or will it be impossible to overcome the doubts that persist about the ability of the Kyoto style 'targets and timetables' approach to deliver substantial quantitative greenhouse gas emissions reductions? Would the introduction of a global strategy with the flexibility necessary to adjust to national circumstances  (as suggested in Alan Oxley's paper), be more effective than the current emphasis on negotiating binding international or national emissions limits?

Graduated responses: A ramping-up of carbon tax

CEDA's Chief Executive, David Byers, said the papers point to a "policy ramp" as a more effective approach to efficient emissions reductions.

"A policy ramp involves modest rates of emissions reductions in the near-term followed by sharper reductions in the medium and long term as competitive low-emissions technologies are deployed," he said.

This is because the time scales involved with climate change are immense - actions taken today may not have noticeable effect for 50 years or more. Judgements about the level of discount rate used are critical to the calculation of costs and benefits. For example, Stern and Garnaut use a very low discount rate to derive their conclusions on the costs of delay and the benefits of acting early.

However, for Nordhaus and Porter an artificially low discount rate distorts the nature of the tradeoff between future and present generations.

A steady ramping up of policies provides a better response to intertemporal and intergenerational equity considerations.

A viable "Plan B"

Mr Byers said he hoped the report would advance the development of sensible and measured policy responses to the risk of climate change.

"A carbon tax may not be the policy of choice now, but the ETS bubble may burst and the world may - in the not too distant future - be looking for a viable "Plan B" to replace the problematic cap-and-trade system," he said.