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Naomi Klein Undervalues the Potential of the EU's Cap-and-Trade Plan to Curb CO2

Naomi Klein’s book “This changes everything” is the only bestseller to have discussed EU’s cap and trade system at such length. Klein is critical of cap-and-trade and goes as far as to say that it is a waste of time. The problem is that she omits crucial historical evidence to make this extreme conclusion.

Other reviewers have already pointed out many of the omissions Klein makes in her writing on climate policy. Joe Romm at Climate Progress has aptly shown how Klein mischaracterizes cap-and-trade. Canadian environmental economist Mark Jaccard has also pointed that Klein does not fairly present and weigh the evidence on carbon trading. Here, I take a look at what Klein has to say specifically about EU’s cap-and-trade policy.

I do not mean to vindicate EU’s cap-and-trade. It’s a system full of flaws. And while lawmakers in Brussels are working on fixing these, it is not clear whether they will have the political will to do so. As I’ve written before, the current proposals to reform the carbon market do not go far enough to make it an effective climate policy. My intention here is to provide a more historically accurate account of EU’s cap-and-trade than the one offered by Klein. And so, on to the review.

Can EU’s cap-and-trade work? 

The book chronicles the history and failures of EU’s cap-and-trade system. Klein reminds us that EU policy makers initially gave away all CO2 permits to companies for free, resulting in huge windfall profits. She laments the fact that European companies were allowed to use international carbon offsets, many of which, it later turned out, did not reduce emissions. And then she concludes it “hasn’t even worked” based on a single citation from a subset of environmental organizations, which claim the system has not reduced emissions. Let’s look at each of those in turn.

Klein fails to mention that the EU has been making polluters pay for half of all the CO2 permits since 2013, generating billions of revenues for governments to use towards climate finance. The EU has also phased out bad offsets, which Klein admits, and currently only allows genuine international offsets. Therefore, these purported flaws are actually nothing more than growing pains.

And has it worked? EU’s cap-and-trade did, in fact, reduce emissions in the past. Estimates suggest the system prevented hundreds of millions of tons of emissions in its first years of operation. Klein probably understands she is on loose ground so far so she goes further, trying to find something that is intrinsically wrong with cap-and-trade.

“The central flaw” of cap-and-trade, she says, is that it produces a carbon price that is too volatile. She correctly asserts that the fall of Europe’s carbon price from €30/t in 2008 to its current single-digit levels is delaying low-carbon investments. For this reason, Klein seems to suggest that we should scrap cap-and-trade. At the same time, she implicitly supports the idea of a carbon tax. However, price volatility is not an inherent feature of cap-and-trade. A properly designed cap-and-trade can deliver a stable carbon price just as a carbon tax would.

Based on the European experience, California has designed a successful cap-and-trade with a price floor. The policy is raking revenues in the hundreds of millions every year through the sale of CO2 permits, which the state is using to finance clean technology.

The UK has implemented a price floor, which is successfully curbing coal use. And the EU as a whole is finalizing a legislative process to put a de-facto soft carbon price floor across the continent (also called “Market Stability Reserve“). The only problem with EU’s efforts is that they do not go far enough. To be effective, cap-and-trade needs strong grassroot support.

The Catch 22 of cap-and-trade

Klein hits the nail on the head when she exposes the real inherent shortcoming of cap-and-trade – the system is so intricate that it makes it hard for the public to mobilize behind it. This is the Catch 22 of cap-and-trade. To work well, the policy needs the sort of massive mobilization Klein calls for, but people will only fight for it if they believe it can work well.

The book does not contemplate on whether mobilizing a grassroot movement to reform EU’s cap-and-trade is a worthwhile effort. This may be because Klein fails to notice how similar cap-and-trade is to the type of climate action that she actually supports.

She extols the 1970’s “golden age” of environmentalism, which, she says, was about two things: limiting pollution and getting the polluter to pay. These two principles are exactly what cap-and-trade is at its core. Lawmakers set a certain cap on pollution and determine rules on how to distribute CO2 permits and whether to raise revenues. By participating in the decision making, the public can fight on these fronts to ensure the policy delivers the desired effects.

Should Europe’s climate activists fight for a strong cap-and-trade?

The problem with Klein’s broad-brush coverage of cap-and-trade is that it will likely keep some on the left from fighting to improve it. Wouldn’t it be more constructive for climate activists to make the most of their cap-and-trade law?

After all, national governments raise billions of euros per year from selling CO2 permits. Shouldn’t concerned citizens be trying to convince governments to invest as much of this money as possible on badly needed climate finance? Or fighting for ways to increase the European carbon price? The price affects thousands of companies across 31 European nations. A higher carbon price will be immediately felt across polluting sectors and cause real emission reductions.

At the heart of our failure to tackle climate change, writes Klein, is cognitive dissonance. But does Klein underrate the potential of cap-and-trade due to cognitive dissonance of her own, which leads her to brand anything related to markets as disaster capitalism?

The views expressed in this article belong to Emil Dimantchev and not his employer Thomson Reuters.

Image Credit: South Bend Voice (Flickr)

Content Discussion

Bob Meinetz's picture
Bob Meinetz on April 9, 2015

Emil, the bottom line is whether cap and trade has reduced carbon emissions, not how many “billions of revenues it’s generated for governments to use towards climate finance” (what’s a revenue worth these days?) or how many hundreds of $millions it’s “raking in” for the State of California.

You write that “EU’s cap-and-trade did, in fact, reduce emissions in the past.” In support you provide one reference to a 56-page, non-peer-reviewed paper, distributed by an advocacy organization and written by non-credentialed authors. Because a common advocacy ploy here on TEC involves references to voluminous sources sans page numbers, could you provide some specifics on where in “Buckle Up! Tighten the Cap and Avoid the Carbon Crash” we might find evidence of the program’s efficacy?

You write that “The UK has implemented a price floor, which is successfully curbing coal use.” But the link you offer in support attributes the reduction in coal use to weather (ironically, likely due to climate change):

EU ETS Emissions down 4.5% year-on-year as mild weather curbs power consumption despite the glimpses of economic recovery.

The UK carbon floor is founded on a dubious premise to begin with – that by guaranteeing investors a minimum return on carbon credits, the value of carbon will be strengthened so that eventually it can be weakened. Huh?

Due in part to failures in the implementation of the EU ETS and a discrepancy between EU and UK emissions reduction targets, the EU scheme is not consistent with the pace and scale of change required to meet UK decarbonisation targets…The introduction of the Carbon Price Floor is intended to achieve these aims.

http://en.m.wikipedia.org/wiki/Decarbonisation_measures_in_proposed_UK_e...

I haven’t read Klein’s book so I can’t comment on the value of her analysis. That notwithstanding, you criticize her for “trying to find something that is intrinsically wrong with cap-and-trade”, then provide what’s instrinsically wrong yourself: the system is so intricate that it makes it hard for the public to mobilize behind it. People don’t believe it will work because it has all the hallmarks of a Ponzi scheme: billions of revenues to be made and all the complexity necessary to obfuscate a lack of measurable results.

Aka, smoke and mirrors.

Emil Dimantchev's picture
Emil Dimantchev on April 9, 2015

Hi Bob,

Thanks for the feedback.

You will find the estimates for emission reductions I mentioned on page 15 of the report. I do realize I linked a huge pdf for brevity purposes and I appreciate you comment and that you are willing to get into the details. Essentially one of the pieces of research that has looked into this was led by Denny Ellerman at MIT for a book called “Pricing Carbon” (cited in the report). The report cites another study by Deutsche Bank which corroborates the preivous findings. 

To your other comment, the amount of revenues cap-and-trade can raise is actually hugely important. The advantage of carbon pricing as a climate policy is that it can (if properly designed) generate the so called double divident – reduces emissions and raise revenues (that could be reinvested to reduce even more emissions!) This is what’s happening now with the EU ETS. Much of the money raised so far, 3 billion euro in 2013 actually (you can see proof at the link in the article), was used for climate funding, including renewables, and energy efficiency (the UK’s green deal program is one example). So literally, the higher the carbon price is on any given day or month or year, the more money we will have for climate finance. As Naomi Klein herself explains very well in her book, huge amounts of climate funding are needed to transition our economic system.

When it comes to UK’s price floor, the press release I linked says “gas-fired power generation finally reversed its downward trend and became more competitive against coal in some countries, due to plunging crude oil prices and national policies such as UK Carbon Price Floor” So as you can see, it is making the UK switch from coal to gas.

And you have misinterpreted me. I clearly did not criticize Klein for trying to find an inherent flaw with cap-and-trade. On the contrary, the fact she dedicated so much attention to cap-and-trade is exactly what inspired me to review it, which was the very first thing I said in the piece. And as you pointed out I happily admit that Klein is 100% right about cap-and-trade being too complex. The ultimate question for me is whether we can overcome this challenge. I would love to hear suggestions about how to go about clearing out some of that smoke you are talking about. 

Finally, I heartily recommend you read the book!

Cheers,

Emil 

Bob Meinetz's picture
Bob Meinetz on April 9, 2015

Emil, thanks for your reply.

It seems the UK carbon price floor would encourage the use of coal:

The supply of coal, natural gas or LPG to a generator with a generating capacity above 2 megawatts (MW) will continue to be exempt from main rates of CCL when the fuel is to be used for generating electricity.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/fil... (p2)

If both coal and natural gas are exempt from the climate change levy, and coal is cheaper, what’s the incentive to switch?

Bruce McFarling's picture
Bruce McFarling on April 10, 2015

“The UK carbon floor is founded on a dubious premise to begin with – that by guaranteeing investors a minimum return on carbon credits, the value of carbon will be strengthened so that eventually it can be weakened. Huh?”

So you are asserting that UK carbon floor is founded on the premise that by guaranteeing investors a minimum return on carbon reduction, the value ofcarbon reduction can eventually be weakened?

In general the argument for a cap rather than a tax is that if there is a maximum amount you wish to permit, the tax only raises the cost of exceeding that amount … while the argument for a tax rather than a cap is that the cap does not guarantee a monetary value so does not guarantee a rate of return, so uncertainty can result in underinvestment in projects with a long project life.

So the general argument for a cap with a price floor is that you offer a guaranteed floor rate of return on projects with a long life, while still having the cap in place to ration among different potential systems.

“Emil, the bottom line is whether cap and trade has reduced carbon emissions, not how many “billions of revenues it’s generated for governments to use towards climate finance” (what’s a revenue worth these days?) or how many hundreds of $millions it’s “raking in” for the State of California.”

There’s a difference here for a State and for a national government with control over its own currency. At a national level, the level of carbon price we require to take a serious bite out of carbon emissions would be a drag on the economy if used as revenue, and most or all ought to be refunded in some way to avoid the fiscal drag effects.

But that is at the national level, where a national government with control over its own currency can, and should, run budget deficits over the course of the business cycle, so long as they grow the debts on average less than the average growth of the economy and are long term useful investments in economic productivity. Below that level, at the level of states (and in the Eurozone, Eurozone countries), budgets have to be balanced over the business cycle, and given a federal government (or, in the Eurozone, a lack of a federal government) not behaving as it should in funding long term investment for the public good, a source of revenue to invest in useful ways by the state government could well be quite useful.

Nichol Brummer's picture
Nichol Brummer on April 10, 2015

.. this was a duplicate post and as I find I can edit but not delete it, I’ve emptied it ..

Nichol Brummer's picture
Nichol Brummer on April 10, 2015

Bruce correctly says that a sovereign government with control over its own currency is not budget constrained. The constraint on the budget is a soft one, as a too high deficit may be too stimulative, causing inflation. But we’re currently nearer deflation than inflation, so a larger deficit may even be necessary.

For the EU there is no fiscal authority, so revenue has to come from things like a price on carbon.  But again, it would be dangerous to tie this revenue too much to green goals, because it would quickly become an argument to not use any other revenue for those same goals.  In general it is better for governing bodies to separate the discussions about taxes or revenues from those about expenditure and investments. Things get unnecessarily complicated if you mix these up and create ever more constraints.

In a certain sense, the ETS system is a licence to print EUAs, which are worth money. This creates something like a fiscal authority, if not too many EUAs are given out for free, which makes them lose their value.

But this fact subsequently turns such a measure into a political bargaining game, where strong lobbies can get free EUAs. Or make sure the cap is kept low enough to not be very meaningful. Or both.

Within the power dynamics of the EU any single country can totally sabotage the whole ETS system. This is because its operating depends on repeated consensus decisions. It may be a good start to get rid of those countries that are sabotaging the system.  Try to set up a properly working ETS without Poland, rather one that doesn’t work, but with Poland.  (I’m just mentioning Poland, but maybe there are more?)

The current plans to save the ETS seem reasonable, but the fact that the process of even starting to implement them will take many more years doesn’t give much ground for confidence that it will work. The system is still hostage to Poland and others that will never want it to work.

The actual price for a ton of carbon emissions is really the best indicator to see if the system has teeth. Only a high enough price will convince people to shift from one energy source to another, or to redesign their process for more efficiency.  So a strong floor price could also create confidence that there is commitment to make the system effective.

Naomi Klein will only be shown wrong when the price is high enough to actually exert pressure on the market. To actually motivate market parties to make a real effort towards carbonisation.  At the moment I’m reading carbon traders telling the story that the market works, because it adapted the price in times when the economy is lying low.  But especially in crisis times we should put more effort and investment into transitioning towards a new and clean future.  So I’d argue this market is not working: this low price is just slowing down the transition at a moment where it could contribute to new economic activity and growth.

Bob Meinetz's picture
Bob Meinetz on April 10, 2015

Bruce, I’m not following your logic. How does purchasing carbon credits reduce carbon emissions? And how isn’t guaranteeing a long life on fossil fuel projects – including coal, in the case of UK’s carbon floor – completely at odds with the goal of reducing CO2 emissions?

Avoiding a larger discussion on the subject of whether federal governments should run budget deficits, you believe cap-and-trade is a long term investment for the public good. I won’t until I see some evidence it’s actually working, and not a greenwashing charade which guarantees fossil fuel companies a license to conduct business as usual indefinitely.

A revenue-neutral carbon tax, with four basic premises, eliminates all of these machinations transparently and effectively. I’m increasingly convinced that’s the reason it’s not catching on.

Bruce McFarling's picture
Bruce McFarling on April 10, 2015

How does purchasing carbon credits reduce carbon emissions?”

Its not the “and trade” part that reduces carbon emissions, its the “cap” part. If any carbon cap and permit system has the cap set too high, then the problem is not that the cap and permit system exists, its that the cap has been set too high. In either cap and trade or cap and auction, the “and” part is about reducing the total cost of the emissions reductions achieved.

The intrinsic problem is that the permit price with either cap and trade or cap and auction is designed to fluctuate with demand, which leads to uncertainty about the carbon price, which reduces investment in long-lived projects to reduce carbon emissions. That problem is magnified when the ongoing reduction in the cap has been set too cautiously or when, as in Europe, perverse fiscal and monetary policy are sabotaging economic growth, so that economic performance ranging from depression to sluggish growth leads to actual demand for carbon permits falling well short of projections.

The long term solution to either is to pick up the pace of the cap reduction, but in the short term, that is also a problem where a price floor gives substantial assistance.

With a cap that is progressively reduced, the cap-driven price will eventually take over from the floor price, unless technological progress stays ahead of the cap.

 

 

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