Is the idea of carbon trading just a lot of hot air?

Carbon trading sounds like a great idea: by putting a price on emissions, it punishes polluters and fosters green technologies. Find out if the reality matches the rhetoric
Felicia Jackson, David Robertson

THE THEORY By Felicia Jackson
We know we have to cut greenhouse gas emissions, but why is carbon trading the way to do it?
We have to start placing an economic value on the environment, but we can’t wait for the perfect solution. We need to act now, and that means using the market tools at our disposal to create the most flexible approach.
Changing the behaviour of governments and industry is likely to have a more immediate impact on emissions than encouraging individuals to buy low-carbon products and services. And to make countries and companies cut emissions quickly, we need to put a price on them. Doing so is not just about motivating polluters to reduce emissions; it is also about enabling politicians and bosses to keep track of the costs and benefits of emissions-cutting measures and make long-term investment decisions.
What are the chief advantages of carbon trading?
It imposes a limit on emissions, which shrinks over time. Trading in emissions — technically called “carbon offsets” — also makes sense as greenhouse gases are a global problem: it doesn’t matter where emissions are cut, as long as they come down. The cost of funding projects that result in lower emissions is immense, and we have to find a cost-effective way to manage this transition. Carbon trading fits the bill as it is economically efficient. As quotas get ever tighter, it becomes harder to generate credits and the cost of emissions becomes more onerous.
In that case, why is there so much international disagreement on tackling climate change?
The Kyoto Protocol was the first legally binding international framework to restrict greenhouse gas emissions, enshrining the concept of “common but differentiated responsibilities” for developed and developing nations. It is how these responsibilities should be enshrined in law that is causing disagreement.
The industrialised world has grown rich on the exploitation of the world’s natural resources. Developing countries are aggrieved to be told that they cannot follow the same path because of the threat of climate change. It does not help that, despite not having ratified Kyoto, the US is among countries insisting that the largest developing economies must accept binding emissions targets.
Offsets have been strongly criticised as a means for developed nations to outsource their responsibility for cutting emissions to the developed world. There is clearly a need to help the developing world to deal with the environmental impact of climate change, but there is little agreement on how this should be funded internationally.
So will carbon trading benefit the developing world?
The Clean Development Mechanism and Joint Implementation provisions of the Kyoto Protocol should act to encourage investment in new, clean technologies and, in the case of the CDM, generate flows of global finance and knowhow from rich to poor.

What does the future hold for carbon trading?
It seems almost certain that carbon trading and carbon market mechanisms will remain central. Outside the Kyoto framework, a number of regional schemes have been or are being introduced: the European Union has its ETS, the US has several schemes of its own (with Congress debating legislation that could see the creation of a federally regulated scheme), and Australia and the UK are launching their own national schemes.
THE PRACTICEBy David Robertson
Does carbon trading work?
There are some promising signs. In the EU, for example, emissions from businesses taking part in the ETS fell by just over 3 per cent in 2008 compared with the year before, and this while economic growth was 0.8 per cent over the same period. But despite some positive statistics, carbon trading on the whole does not work.
What has gone wrong?
The defining weakness of emissions trading schemes is that they are set up, run and regulated by governments. When the EU established the ETS in 2005, member governments were desperate to ensure that their national flagships did not suffer. The resulting machinations led to industries being allocated far too many credits — 3.4 per cent more than actual emissions. When this overgenerosity became fully apparent in 2006, the embryonic carbon trading market collapsed. The price of emissions fell from €30 to €10 per tonne of CO2 almost overnight and continued to fall to just a few cents a tonne when the scheme’s first phase ended in 2007.
What is continuing to go wrong in Europe?In an attempt to correct the failings of this first phase, the EU tightened emissions caps for phase II (2008-2012). Unfortunately, it appears that once again too many credits have been allocated, a miscalculation which the global downturn has only made worse. Some industries are now awash with credits and, in a further fudge, are being allowed to bank them for phase III (2013-2020). This will make hitting carbon targets much easier during the next decade. The likely result is a trading scheme that will be largely ineffectual during its first 15 years of operation.
Who pays?
To protect their industries from foreign competitors not subject to the pressures of carbon trading, governments have overallocated credits to some and underallocated to others. Power companies, for example, have received comparatively few credits because consumers cannot easily go elsewhere to buy their energy. This allows power utilities to pass on the cost of buying carbon credits to their customers.
Meanwhile, to cut their emissions quickly, power companies are switching from coal to natural gas, which emits less CO2 than coal for a given power output. This is making Europe heavily reliant on fuel supplies from Russia and the Middle East — with all the geo-political implications that entails.
What needs to change?
The European Union needs to be more aggressive in setting targets and allocating emissions quotas if they are serious about using the ETS as the primary means of changing corporate behaviour.
The power of governments to influence the permit allocation system should be removed (Italy and various Eastern European nations are currently said to be lobbying to weaken phase III emissions targets, for example). A central regulator should determine how permits are distributed to industry to prevent favouritism.
To be truly effective the same system needs to apply in all countries, otherwise emissions trading will always be open to “permit tourism” — companies moving their activities to territories with no trading scheme or an overly generous one.
Companies should not be given all their permits for free. This is a subsidy that creates windfall trading profits if a company emits less than its quota of carbon. 
Conquering Carbon: Carbon Emissions, Carbon Markets and the Consumer, by Felicia Jackson, is published by New Holland Publishers at £9.99