Market Mechanisms for Emissions Trading Full of Holes

Although better than the Bush plan of doing nothing, the Kyoto Protocol has its share of problems. The European Union in particular has relied on market mechanisms to achieve the goal of holding carbon emissions to 1990 levels by 2012. The plan works like this: Governments and Treaties set the level of emissions allowed by a region. Government bureaucrats then divide up this level of emissions into "emissions allowances" for individual emitters. That emitter then has the ability to emit to its full allowance, or cut emissions below its allowance and sell its remaining allowances on the open market. A coal plant may, for example, be given allowance to cover only its current level of emissions. If it wants to increase production, it needs to either purchase more allowances from another emitter or find ways to increase production with fewer emissions. To accommodate this trading, exchanges have sprung up to broker emissions allowances. However, some bureaucrats have demonstrated in this space their woeful lack of understanding of how markets work.

The framework looks good on paper. Rational businesses will try to at least save money by not facing required purchases of additional allowances. At best, they will try to optimize their emissions efficiency so they can make money by selling their allowances. The overall level of emissions can be dictated and managed down to the end goal (1990-level emissions) by rewarding the good players and punishing the bad players with those allowances.

The problems come in when you add the demands of a regulated, global, and liquid market for exchanging those allowances. Emissions allowances become a de-facto currency, and as any African despot can attest, a currency is only as good as the trustworthiness of the issuer. That's why dollars, euros, and yen account for most economic activity in the world, and not Venezuelan Bolivars and Cuban Pesos.

This gives both the participating countries and the individual emitters enormous room to cheat. The first order for keeping the allowance currency sound is to ensure compliance with emissions volume. This is harder than it sounds, since there is no national infrastructure in place to monitor smokestack emissions. Most countries rely on the companies' word. Think about that. How many companies would fudge numbers if they knew that telling the truth results in a fine?

The second order of business for keeping the allowance currency sound is to keep a tight lid on the issuance of new allowances. Just as turning on the printing press debases a national currency, issuing new allowances willy-nilly decreases their value. For this, you can blame the bureaucrats, especially in a loose confederation such as the EU, where every country expects the others to make up for their own shortfall. Unfortunately, we have a real life example of this. According to an MIT Technology Review article, in the European Union Greenhouse Gas Emissions Trading Scheme, member countries issued 3.4 percent more allowances than was needed in its first year of existence. Central banks would scream bloody murder if a national currency was debased that much in a single year. The result was that the bottom fell out of the price of a CO2 allowance, falling two thirds in April. Now, an allowance for 1 ton of CO2 emissions can be purchased for 10 euros, reducing for everybody the punitive cost of over-emitting.

In order for a market mechanism to work, you need to have buyers AND sellers. In emissions trading, in order to ensure buyers, the compliance mechanisms must be strengthened and the punitive measures for not complying must be painful. Without these, you only have a one-sided market -- sellers. When you have a one-sided market, the price tanks. When the price tanks, there is no value to cutting emissions in the first place.

Heat Waves Highlight Need for Conservation

Record temperatures throughout the US this week are only the beginning of the pain. Next month, when utility bills are received, northerners will only begin to understand. Energy demand is taxing all utitlities, and even though the grid is being monitored closely, the chance of brownouts and rolling blackouts remains high. For some, this heat wave will be the opportunity to lobby for more power plants, but conservation will be the lowest hanging fruit.

Our world consumes 13 terawatts of electricity each year, 80 percent of which comes from fossil fuel sources. Most of that power comes from coal, the dirtiest source of all, accounting for 37 percent of all greenhouse emissions. It not only contributes prodigiously to our global warming problem, it is also a source of mercury in our streams and metals in our soils. Humanity suffers from a cosmic curse that coal is most abundant in the U.S., China, and India. Despite all the evidence of its destructiveness, coal is on the drawing board more than any other source to meet surging needs in those countries.

However, each community has within its power the ability to practice the cleanest form of energy production around, conservation. Keeping those fossil fuels in the ground, or at least, slowing the rate at which they are pulverized and exploded, is not only the cleanest, but it provides an immediate monetary incentive in the form of savings. If your community needs to build a coal-fired plant, it will cost tens of millions and be belching CO2 for 50-60 years. Or, you could create a light bulb tradeout program that will cost a fraction, keep money in the community, and keep some coal in the ground. Even if a community purchased, gave away, and paid for installation of 3 Compact fluorescent Light Bulbs for each family, 8-10 percent of demand would vanish. And, it would take a fraction of the cost of building a new plant.

Many city-owned utilities offer energy audits for their customers, but few take advantage. Widespread insulation and caulking could save another 5-8 percent. The same could be said for smart windows, and efficient refrigerators and HVAC units. The best estimates from government agencies show that 40 percent of all electricity use could be eliminated with minimal top-down conservation.

Of course, this is not done for several reasons. First, even though it is exceedingly difficult to get the permits to build a power plant, it is still easier than trying to get 250,000 people to change their ways. Second, our government's subsidy programs are mostly geared toward finding new supply. The Energy Dept's Energy Efficiency and Renewable Energy office functions on half a billion dollars per year, which has been cut by the Bush Administration. Oil exploration subsidies to already fat corporations alone consume 10 times that. Third, maybe we, as Americans, have not yet suffered enough. In 2003, fifteen thousand people lost their lives in Europe as a result of that year's catastrophic heat wave. This was not in some backwards third world country.

Stay cool.

The Morality of Using Food to Fuel Our Cars

Somehow forgotten amidst our (meaning environmentalists) love affair with the idea of using corn and soybeans to fuel our planes, trains, and automobiles is the debate about the morality of using these crops for fuel when major swaths of the world population are still hungry. I also have a gathering unease about the already piggish interests that are pushing for more ethanol production. Taken together, I am rethinking the wisdom of the whole undertaking.

On the face of it, using ethanol as a replacement for foreign oil seems a no-brainer. It is a renewable resource. We have scads of farms that need more demand and higher prices for corn. Plus, the emissions from the tailpipe are significantly less, though there is still much debate over how much emissions are saved in the whole bushel-to-gas-tank process. It will create American jobs, farmers love it, and we get to stick it in the eye of the Canadians, Russians, and oil sheikhs.

Sorry to ruin the fairy tale. First, this week, the Proceedings of the National Academy of Sciences, estimated that if all the corn in this year's crop were used for ethanol production, we could satisfy only 12 percent of our energy needs. Add the entire soybean crop, and we can squeeze out another 9 percent. Of course, we would have neither of those bountiful harvests to eat, but hey, we could all use less corn syrup in our diets, and only the long-haired communal hippies are eating soy. All jokes aside, whether or not we exported directly to countries with staving populations, creating such demand for these crops would raise the global price of this commodity. Raising the price means that the poor countries who need it most will be able to afford less of it. This is sort of like how the American addiction to oil feeds the Iranian mullahs, even though we do not buy directly from them. Our demand fuels rising prices, which means that the mullahs can command a higher price elsewhere on the world market.

Second, ethanol can not be competitive with fossil fuels in the near future without massive government subsidies. Herein lies another problem. Despite their carefully crafted image to the contrary, the corn-growing lobby is one of the fattest recipients of government subsidies we have. There is no compunction about it, either. Several leaders of corn-growing regions cite the availability of easy federal dollars as the reason for the explosion in permits for ethanol processing facilities.

Third, because of the rush to get the federal dollars, ethanol processors are short circuiting the environmental benefits by using dirty coal to power their plants. A recent Grist article quoted energy analyst Robert McIlvaine as predicting that 100 percent of new ethanol plants will use coal, thanks to its predictable price and supply instead of the relatively cleaner natural gas. This all defeats the purpose of transitioning to this clean source in the first place.

Given the incredible logistical complexities and economic cost of replacing the fueling infrastructure for our transportation needs, it might be a boondoggle to attempt it in the first place. The price of bottled water is still more expensive than a comparable amount of gas. Not that we should give up.

Stationary generators of power are most capable of achieving our goals with federal subsidies. Forget about cars, for now. We should put our talents toward generating clean energy in stationary applications, such as power plants. These technologies are much closer, and will not require the massive re-working of our infrastructure. Then, we should deal with automobile pollution by migrating towards electric generation. This technology exists today with plug-in hybrids. Plug-ins will allow a Prius, for example, to use more energy from electricity. The car is plugged in at night, and in the morning, it's ready to go. If you find yourself short, then gas can cover the shortfall. In Austin right now, one could purchase a plug-in, and charge it with clean energy from the Green Choice program. Then, the decrease in demand for fossil fuels from stationary applications will cause the price of oil to fall, and allow us to re-capture the money and power that is currently going overseas.