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How do carbon markets work? - YouTube
Channel: The Economist
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Companies are driven by money
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So putting a price on carbon emissions...
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...should encourage businesses to stop polluting, right?
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Thatâs exactly what carbon markets were designed to do...
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...reduce emissions by charging polluters...
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...but so far they havenât achieved that aim
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Hereâs why:
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Towards the end of the 1980s America had a problem
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For years, its power stations...
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...had been emitting large amounts of sulphur dioxide...
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...which was falling back to Earth as acid rain...
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...causing harm to plants, aquatic animals and infrastructure
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But there was no incentive for the power plants...
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...to stop emitting sulphur dioxide
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Weather warnings, an acid-rain alert is in effect
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So in 1990 the American government launched an experimentâŠ
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...passing a law to force polluters...
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...to pay for their emissions, by establishing a new kind of market...
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...governed by a system called âcap-and-tradeâ
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Eight years later, acid-rain levels over large regions...
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...in eastern America had fallen by 20%
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And a new way of cutting emissions was born
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In 1997 the international climate-change treaty...
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...known as the Kyoto protocol...
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...suggested applying the concept of cap-and-trade to carbon
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In the years that followed different countries and regions...
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...set up their own carbon markets
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Many of these used cap and trade
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And this is how it works
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A government sets a cap on the amount of CO2...
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...that can be emitted by an industry
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It splits the cap into permits...
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...and either gives or sells these permits to firms
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If a company doesnât use up all of its allowance...
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...it can sell what it doesnât need
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If it needs more permits, it can buy them from those with spares
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Each year the cap gets stricter...
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...and the shrinking pool of permits gets more expensive
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The genius of cap-and-trade systems when theyâre done properly...
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...is that they both use a stick and a carrot
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That gives them an incentive to innovate, to get cleaner and cleaner...
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...it provides that carrot for innovation...
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...and that trading mechanism...
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The magic of the market unleashes those animal spirits...
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...in favour of decarbonisation
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While regulation can introduce a new industry standard...
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...it doesnât give firms an incentive to cut emissions below a certain level
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But a carbon market creates a race in which companies...
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...are motivated to cut emissions as fast as they can
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The more they cut emissions, the fewer permits they have to buy...
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...and the more excess they have to sell
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So in theory in a cap-and-trade market...
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...carbon-dioxide emissions should fall...
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...but in reality, theyâve continued to rise
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Because incentives work only if theyâre big enough
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Carbon markets are great in theory, but in practice...
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...we run into a problem
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Carbon prices have been far too low to motivate change...
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...thatâs needed to decarbonise the world economy
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According to Joseph Stiglitz and Nicholas Stern, two economists...
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...in order to meet the Paris Agreement goal of limiting global warming...
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...to two degrees above pre-industrial levels...
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...the price of carbon worldwide...
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...needs to be between $50-100 per tonne by 2030
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However, the majority of carbon prices still remain far below that figure
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Whatâs more, even if carbon is priced appropriately...
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...the fines for exceeding permitted levels...
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...are sometimes ineffectively low
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In the EU, a fine can be as low as âŹ100 per excess tonne
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Considering thatâs not that much more than the price of a permit...
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...itâs hardly a deterrent
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And thatâs if firms even get caught
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Now in theory, regulators enforce carbon prices and permits...
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...but in practice, it can be very challenging
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Thereâs measurement problems...
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...direct emissions versus indirect emissions
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Thereâs questions of cheating, for example...
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...you find in most markets around the world...
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...enforcement is lax and punishment is not great
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And even if some markets adopt effective deterrents...
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...the ones next door may not
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If you look globally...
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...you have a mind-boggling variety of rules, systems...
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...enforcement mechanisms
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And so if youâre a company thatâs based in multiple countries...
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...divisions of your company making the same product in the same way...
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...will face a mind-boggling patchwork of rules, regulations that differ
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Worse than that, you have leakage, among these markets as well
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The direct result of this patchwork of systems...
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...is known as âcarbon leakageâ
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A business or an industry relocates from an area...
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...with high environmental regulations...
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...to somewhere where the rules are more relaxed
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Which means it can avoid having to pay for its carbon emissions
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But these problems have solutions
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The role of regulation is important because absent regulation...
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...nobody would pay for carbon emissions or pay a penalty for emitting carbon
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So almost by definition, government has to create the market...
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...set the rules, enforce penalties, set a carbon cap...
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...for example, the maximum amount a company or industry can emit
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If governments limited the number of permits, it would drive their price up
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Setting a minimum price that rises over time...
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...would mean the price would never fall too low...
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...and governments could enforce more stringent deterrents...
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...for potential rule-breakers
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Getting serious about regulating carbon markets...
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...really involves regulators making it clear to industry...
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...that they will not tolerate cheating
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They will not tolerate leakage or obfuscation...
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...and ultimately that they will hold corporate executives to account...
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...for their carbon emissions
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I think weâre getting there, particularly in the European Union...
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...weâre seeing much more seriousness...
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...that this is not a frivolous greenwashing exercise...
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...nudge, nudge, wink, wink, but rather that this is as serious as safety...
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...or other regulations. This is not yet the case in many other parts of the world
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It would help if the world had more integrated carbon markets...
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...but as thatâs unlikely to happen in the short term...
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...one solution to help prevent carbon leakage is a border tax
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The EU has recently proposed to tax the carbon emitted...
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...in goods produced outside its carbon market
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Importers would have to pay the same amount...
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...as if the goods had been made in the EU
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Meaning it wouldnât be any cheaper...
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...to source goods from a region with less regulation
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If weâre going to get serious about dealing with climate change...
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...within the next few years, we must...
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...achieve something like a global carbon price...
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...and some form of harmonisation amongst economies
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Now weâre getting to something like momentum in this direction
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The big kahuna is China because itâs such an industrial powerhouse...
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...itâs so carbon intensive
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If it doesnât get serious and work with other economies...
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...to harmonise carbon pricing and carbon-trading systems...
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...then most of the worldâs efforts will probably be undermined...
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...by the fact that countries like China...
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...are producing heavily carbon-intensive goods
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And weâll see multinationals shifting production...
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...to those places even more than they have in the past
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As climate change has moved up the political agenda...
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...governments are starting to improve how their carbon markets work
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Since 2019, the EU has been taking steps...
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...to reduce the number of permits it hands out
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Partly as a result, carbon prices in the EU...
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...are now hitting record highs of over âŹ60 per tonne
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Carbon prices in other markets are also rising...
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...as regulators look at ways to make them more effective
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If it seems that money can be made...
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...other countries might create their own markets
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We have seen just in the last 12 to 18 months...
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...a dramatic take-off in carbon markets
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This is a really exciting time for people...
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...who believe that there is a good marriage...
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...between public policy and regulators and markets and innovators
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If prices stay high enoughâŠ
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...helped by commitments from governments and regulatorsâŠ
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...then greener industrial processes would become more attractive
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And carbon markets could start to achieve their original goal
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...of helping to decarbonise the world
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Iâm Vijay Vaitheeswaran...
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The Economistâs global energy and climate innovation editor
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To keep up to date with all of our climate-change coverage...
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...please click on the link
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