The Pope, The Atmosphere and the Importance of Carbon Markets

The Earth's atmosphere is perhaps the most scarce resource of which we can conceive. Its width from the edge that meets the earth to the edge that meets outer space is only about 100 kilometers and the whole ring is only about 480 kilometers. This remarkable thin wafer of gases in constant motion provides all the air we breathe, dictates our weather, and protects the earth from the sun's radiation and heat. So precious and rare is our atmosphere that it has no counterpart on any other planet in space -- known or conjectured. Yet, in this glorious cosmic penthouse, we store garbage, notably greenhouse gases that cause climate change. We abuse the penthouse because we pay nothing for it. Yet all life is made possible by that rare space. No money can buy it and no money can create it. The value of our atmosphere lies outside any chance of pricing it. Yet, price it we must for if we do not price the use of the atmosphere, we shall continue over-using it, as we at times over-eat at an unlimited buffet.

Lately His Holiness Pope Francis has strongly weighed in against this environmental gluttony, bringing a much welcome voice to call for urgent action to cut greenhouse gases. But though the Pope has perfectly conveyed the moral arguments that compel us to protect the environment, he unfortunately dismissed one of the few tools available to actually address the problem in practical terms: carbon markets.

But the words "carbon market" are imprecise, and only half the story. A carbon market makes environmental improvement only when it is paired with a "cap," or a mandatory limit on pollution, and is designed to help enforce that limit. With a cap, a carbon market implements what is known as a "cap-and-trade." At the national level, the national government sets its limit or "cap." This is the maximum number of tonnes all emitters in the country can emit over a given period. A national cap requires that the nation as a whole reduce its greenhouse gas emissions below a certain level, compared to a chosen baseline year, by a certain target year--like a national "carbon diet." Progress toward the reduction target is verified by governments and 3rd party auditors. But though each tonne of gases reduced has the same physical measurement, achieving that tonne of reduction may vary in cost, depending on the technology or method chosen. Reduction costs vary from polluter to polluter, e.g., some factories can install solar lighting more cheaply or quickly than others, or an aging electricity plant is expensive to retrofit, so achieving one tonne of reduction is cheaper for the factory than the antiquated utility, which may have to make a more significant investment in cleaner technologies. Emitters have different starting points--some emit many tonnes and need many allowances, while others do not. There is no "one size fits all" approach to climate change, and to organize and hasten emissions reductions, a nation needs incentives that make it costly to pollute and less costly to avoid pollution. Carbon markets can provide those incentives at a national scale.

In a fully-fledged cap-and-trade, the market does not convey the right to pollute, nor does it convey a "guise of commitment," as the Pope wrote in his environmental encyclical. In a cap-and-trade, all polluters must act, but the system also adds flexibility. In a cap-and-trade, such as those now operating in the European Union, including Italy, or California in the US, and even in China, supply of those permits, known usually as allowances, is kept tight and corresponds to the number of tonnes of emissions that are permissible to stay within the limit. Allowances are serialized and tracked. Rather than issue more allowances, to allow more pollution, if anything, governments keep ratcheting down the supply by tightening the emission reduction requirements. Prices may rise, bids may go up and down, but there are never more allowances--never more room in the penthouse. Just like there are only 52 cards in a deck and never more. Extra cards at the poker table are dealt only by a cheat.

Governments issue allowances once a year or so, like dealing out the card deck. Emitters--mainly utilities and industrial companies--play their hand. They bid for that scarce supply, which are not rights to pollute but rights to use up some of the atmosphere's scarce space with tonnes of greenhouse gases which are, after all, inherent in all fossil fuel energy use still so common worldwide, especially in poor countries.

But, emitting those gases may should gradually become avoidable, by use of more energy efficiency or new technology, especially as room in the penthouse--the allowance--becomes more and more costly. It could gradually become cheaper to stop emitting than buy expensive allowances, thus triggering investments in cleaner technologies and energy efficiencies. . Emitters who are more efficient, or more inventive, can then sell their surplus allowances to the emitters who, for whatever reason, lag behind.

But, if the cap is tight enough and the rigor serious, no emitter can escape the system. No one can buy a way out.

Monitored and well designed, cap-and-trade system are a vital tool. And, a cap-and-trade system was embedded in the US Clean Air Act and largely credited with helping eliminate noxious emissions of sulphur dioxide, the culprits causing acid rain and smog. Cap-and-trade, indeed, was essentially a U.S. invention. A cap-and-trade system addressing climate change was the centerpiece of the landmark Waxman-Markey legislation that passed the US House of Representatives in 2009 but did not reach the U.S. Senate. Had that bill succeeded, addressing climate change now in the U.S., and the world would be much easier and manageable and carbon pricing and markets much further along.

Now, as the world approaches the impending international climate change discussions in Paris in December 2015 cap-and-trade systems are likely to be much discussed. There is nothing exotic or new about them; they are familiar tools and their principle is sound. Let us see how they fare.