Don't let the carbon market die

The Copenhagen climate change conference achieved too little, but a modest global carbon tax would make amends

Oliver Tickell
guardian.co.uk, Monday 25 January 2010 17.00 GMT
Some people have good reason to be shocked that banks have pulled out of the carbon market, not least recent economics graduates whose dissertations on carbon finance now qualify them only for unemployment. And JP Morgan, which paid a jaw-splitting $204m for carbon trader Ecosecurities last September, must be feeling a little sore. Perhaps it relied on the GHG Emissions Credit Trading report (yours for a mere $397), which predicts a $4.5 trillion carbon market by 2020.
No less chagrined must be Gordon Brown, who sees the carbon market as key to the global response to climate change, and to the economic fortunes of the City of London. As Brown told WWF in 2007, the government wanted binding limits on developed country emissions in a post-2012 climate agreement, because London was the world's carbon trading capital, and "only hard caps can create the framework necessary for a global carbon market to flourish". Thus he made it clear that the health of the carbon market took a rather higher priority than the health of the climate system.
The same outlook was evident among the designers of the Kyoto protocol, which created the global carbon market through its various carbon trading mechanisms, such as the clean development mechanism (CDM). The great achievement of the protocol was not to reduce carbon emissions – they actually rose at an increasing rate under its watch, three times faster in the early 2000s than during the 1990s – but to create a market in emissions rights and notional emissions reductions worth tens of billions of dollars a year.
With the failure of the Copenhagen climate conference to agree a successor to the Kyoto protocol for beyond 2012, it is right that confidence in the future of carbon markets has fallen. Hopes have all but evaporated that the industrialised "Annex 1" countries will reach agreement in time, thanks to the rifts that emerged at Copenhagen between the US and China. Other Annex 1 countries will not sign up to an agreement that does not include the US. The US will not sign up to an agreement that does not constrain the emissions of China and other big developing country emitters. And China is in no mood to sign up to anything much at all, at least until the Annex 1 countries take a serious lead.
So is the carbon market dead? Well, reports of its demise may have been exaggerated. The world's major carbon market is not that created directly by the Kyoto protocol, but the European Union's emissions trading system (EUETS), which allows emissions "allowances" to be traded among the EU's carbon polluters. Set up as part of the EU's means to achieve its Kyoto target, it turns over around 3 billion tonnes of carbon each year, three times the Kyoto compliance market.
The EUETS also allows for a proportion of emissions reductions to be met using Kyoto protocol carbon credits. And even if there is no global 2012 agreement, the EUETS is set to continue, as the means to deliver the EU's promised 20% cut in EU-wide carbon emissions by 2020. There is thus the bizarre prospect that a "zombie" Kyoto protocol may continue to create CDM-based carbon credits for the EUETS market, even after the protocol itself has effectively expired, with no new emissions reduction targets beyond 2012.
But that still leaves the carbon market seriously short of growth prospects. And here the problem is not so much Copenhagen, as the US. Specifically, Massachusetts. The Waxman-Markey bill that would have created a US carbon market to rival the EUETS was already in deep trouble before Barack Obama lost his controlling majority in the US senate. Now, the election of pickup truck-driving and proud of it Republican senator Scott Brown means the bill is looking dead in the water – and the putative US carbon market with it.
So what next? Bjorn Lomborg and I disagree on many things, but we do have one important point of accord: that a uniform global carbon tax would represent a considerable improvement on the flawed and ineffective carbon markets that we have created to date. To work properly, the tax must be global; and it must be levied "upstream", at the small number of locations where fossil fuels are produced and their flows are concentrated, rather than the billions of locations at which they are burnt.
It should begin at a modest level of a few dollars per tonne of CO2, so as not to frighten participating countries off – and even a $3 carbon tax, almost invisible in terms of cost impact, would raise $100bn per year. To encourage developing countries to sign up, the rich countries should double-match fund the carbon tax revenue, and put the whole into a climate fund. This could be spent in participating developing countries to finance their adaptation to climate change, fund forest conservation, advance the development and deployment of renewable energy, and research geo-engineering techniques – just in case we need them to stabilise the world's climate. All this would be, incidentally, in perfect harmony with the Copenhagen accord.
Over time the carbon tax should rise – or, better still, be replaced with a more sophisticated economic mechanism based on the auction of carbon permits, subject to a reserve price, as set out in my "Kyoto2" framework. But a simple, modest carbon tax is surely the best first step we can take towards getting there. As well as raising much-needed funds to finance climate solutions, it would also send an important signal to companies and investors – that long-term investments in clean energy, energy efficiency and a low carbon future will be rewarded: something that today's boom-and-bust carbon markets have failed to achieve.