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The New Carbon Cash, Explained

BC's about to dive into a vast market that limits and trades emissions. How it will work (or not).

By Tom Barrett 14 Mar 2008 | TheTyee.ca

Tom Barrett is a Tyee contributing editor with a focus on global warming issues.

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Coming fast: 'Cap and trade' profits.

With B.C.'s carbon tax causing a ruckus inside and outside the province, the second big piece in the government's climate change puzzle has been getting less attention.

That would be cap and trade -- a system that bureaucrats are working flat out to bring to life by August.

Such systems have worked well in places, but they have also had serious problems. As people tend to observe in these situations, there's a close relationship between the devil and the details.

Recently, the Los Angeles Times ran an editorial that warned of the dangers of getting the details wrong.

It compared cap and trade to California's ill-fated energy deregulation scheme and called it "a staggeringly complex undertaking that will once again create opportunities for dishonest traders to manipulate the market. . . .

"If California, which leads the country in addressing the threat of global warming, gets this program wrong, it could discredit efforts to fight the problem nationwide, if not worldwide," the Times said.

How it works

Cap and trade works like this: Governments place a limit, or cap, on the amount of greenhouse gases that can be emitted. Big emitters must obtain permits to cover their emissions. A company that reduces its emissions below the level of its permits can sell its surplus permits to companies that are over their targets.

A price is set on emissions and a market is created for emissions permits. Companies that aggressively reduce their emissions can make money by selling permits on the market.

For companies that don't meet their limit, the cost of having to buy permits on the market acts as an incentive to make long-term decisions that will reduce emissions.

Meanwhile, overall emissions are kept to a regulated level. Over time, governments lower the overall cap so that the big emitters produce less and less greenhouse gas.

That's the theory. However, there are many questions being thrashed out right now that will determine how well the system will work.

What sectors of the economy will be covered?

How big a polluter do you have to be before you're covered by the program?

How do you make sure the permits accurately reflect emissions?

Do you give away the permits or auction them?

How much flexibility do you allow emitters?

What about offsets? Should emitters be allowed to meet their targets by paying for, say, tree planting?

How do you keep companies from moving to another province or state to avoid the system?

Western Climate Initiative: remember that name

These questions are being thrashed out by the Western Climate Initiative, a group that includes B.C. and Manitoba as well as Arizona, California, Montana, New Mexico, Oregon, Utah and Washington.

The member governments of the WCI have been holding meetings and churning out papers on possible ways to design the system. Members will be in Vancouver March 26 to talk about offsets.

The B.C. government says that by joining the WCI, rather than developing a system of its own, the province will become part of a large market that "provides more opportunities for low-cost emissions reduction solutions."

According to last month's budget, "WCI members now have a population of 63 million people, significantly more than the population of Canada, and [the WCI] is likely to grow. Participating in this larger market also helps ensure that B.C. businesses face the same policies as their competitors in other WCI jurisdictions."

One of the biggest questions being debated is the scope of the WCI system. A recent paper from the sub-committee looking at this question has upset some environmentalists by suggesting that transportation fuels may have to be left out of the system until more studies can be completed.

(This is less of an issue in B.C., which is bringing in a carbon tax on fossil fuels this summer.)

Similarly, the WCI must wrestle with the question of how big an emitter needs to be before it's covered in the scheme. Obviously, if only the very biggest emitters are covered, fewer emissions will be captured. However, including smaller emitters adds to the administrative difficulty and cost.

Exploiting the system

Overall, the WCI's goal is to reduce emissions by 15 per cent below 2005 levels by 2020.

A big question is how to issue the permits. Do you give them out or do you auction them? Or do you start by handing them out free and move to an auction?

Matt Horne, an analyst with the Pembina Institute, has been watching the WCI closely. He notes that social and environmental groups tend to favour an auction system. Industry, not surprisingly, prefers a free system.

There are concerns, Horne says, that free allocation could lead to windfall profits. And what if a company takes its free permits, sells them off, then shuts down?

An auction system, Horne says, could forestall a problem raised in a recent Globe and Mail story.

The story, by Justine Hunter, says that Howe Sound Pulp and Paper has switched to coal from cleaner-burning natural gas as a supplementary energy source.

B.C. government officials, the story said, "sound peeved by the company's actions.

"They don't directly accuse the mill's owners -- Canfor Corp. and Oji Paper Co. -- of attempting to drive up their emission base prior to the cap-and-trade regulations," the story said.

"But the suggestion is implied in the government's reaction. A senior official, asked about the introduction of coal at the Howe Sound mill, said his team is working to ensure that a company can't inflate its pollution levels before the baseline is set for an emissions cap.

"'We'll close the loopholes in the design,' the official said, 'and make sure we set the base levels so that there are not deliberate attempts to distort emissions.'"

Auctioning off emissions permits -- thereby making companies pay a price for their current emissions -- would be a way to plug this loophole, said Horne.

System 'safety valves': will they work?

Then there's the controversial question of "safety valves" or "circuit breakers" in the system.

Such mechanisms would protect companies if the market for emissions permits becomes too expensive. The WCI could guarantee that if the price for permits in the trading market goes above, say, $50 a tonne, companies wouldn't have to pay the higher price. Instead, they would be allowed to purchase permits from the government, rather than the market, at $50 a tonne.

For the companies' point of view, such a guarantee represents certainty. From some environmentalists' point of view, it's a free pass for more emissions.

There are similar concerns around offsets. Say the system allows a permit-holder to meet its limits by buying credits from a forest company, for example, that is planting trees that absorb carbon dioxide.

If the forest company was planning to plant those trees anyway, with or without the cash from the permit-holder, letting them sell offsets won't make any difference in the overall emissions levels.

In other words, while it's nice to reward actions that reduce emissions, paying someone to do something they would have done in any event doesn't get rid of any extra emissions.

And then there is 'leakage'

WCI officials are also concerned about what they call "leakage" -- companies that might move to other jurisdictions rather than pay for cap-and-trade permits.

While this could be a problem in the long term, the Pembina Institute's Horne believes that in the early years of the program, carbon prices won't be high enough to drive companies to jurisdictions that don't have cap and trade.

And, presumably, if cap and trade programs become more widespread, leakage will become less of a problem.

Carbon markets are becoming increasingly common, although the experience hasn't always been smooth. The European Commission created a system in 2005, but it's been dogged with problems. The EU's emissions data were badly flawed; too many permits were issued and their value fell through the floor.

But cap and trade has worked well in some places.

During the 1990s, the U.S. used a cap-and-trade system to limit the emissions that cause acid rain. Under the system, sulphur dioxide emissions dropped by 45 per cent compared to 1980 levels.

Related Tyee stories:

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