Emissions trading as a mechaism to do something about climate change.

I attended the Sydney Public Forum being held in conjunction with the Labor party initiated Garnaut Climate Change Review today and took away some very interesting points which I am not sure were the actual intention of the day. Having said that, however, the Garnaut Review has been set up to identify the real issues of climate change for Australia, so any and all points should be considered relevant to the outcome which is Professor Ross Garnaut's final report due in mid-2008.

Basically, the key message I took away from the session was the difference between carbon abatement and carbon trading. Although putting a price on carbon and setting up a market to trade carbon as a commodity should theoretically lead to carbon abatement in the economy, there is no guarantee that this will happen. Further to this, I learned that it is possible that the cost of carbon abatement (most probably defined as improving energy efficiency and investing in alternative technologies) may actually be 7 to 8 times cheaper than the cost of carbon trading!

That's huge... and it does beg the question as to why trading schemes have been identified as a key component in overcoming the climate change challenge... especially by environmentalists who would probably quake if they understood the full breadth of what markets actually create. (And please don't take that as a swing at environmentalists... I am just trying to highlight how climate change is never going to be an environmental issue again!).

To try and answer the question as to why trading has been proposed it is probably best to think about this in terms of economics 101: what is carbon? It's a negative externality of production. A trading scheme aims to place a price on carbon to internalise this cost. Why are we using a market mechanism? Because this lets the forces of demand and supply set the appropriate price of carbon. If a trading scheme wasn't used, it would (most probably) be left to government to set the price in the form of a tax.

So while a tax would be cheaper for the economy in theory (ie no need to auction permits, have bodies set up to ensure compliance, use trading houses or brokers to sell and buy carbon permits, or hire lawyers to create complicated rules regarding what constitutes a carbon off-set), if the price was set too high, there would be unnecessary burden on the economy, and conversely, if the price was set to low, there would be no real incentive to take action.

Because of this and because ultimately no one like taxes, a carbon trading scheme is now the quasi bi-partisan policy in Australia. What is interesting about this is that there is no bi-partisan support for the fundamental tool of controlling a carbon market... emission targets.

At the end of the day, regardless of what the target is, for the market to operate successfully (and many of the speakers outlined what would make the market successful today... see below*) targets are needed because they set the supply. Without the supply there can be no real demand and without demand or supply, according to economics 101, there can be no market. Furthermore without targets, business (regardless of their sector or structure) does not have the certainty to invest in carbon abatement which, when all is said and done, is the main goal of any climate change action.


*According to one speaker the requirements for a successful carbon market are

• certainty
• breadth and depth
• mature and large enough to encourage speculators
• long-term
• not dependent on a specific exchanges (ie the transaction will occur where is makes most rational sense).