Cost Effective

Carbon Trading Is So Wrong

So, the theory of Cap-and-Trade goes like this.

You set an upper Cap on Carbon Dioxide Emissions.

You dole out Carbon Dioxide Emissions Permits or Allowances. Or you sell them. Or you auction them.

Each year the amount of Carbon Dioxide Emissions Permits gets less and less.

Then a Market in Carbon will operate.

Those organisations and businesses who find it easy to cut Carbon Dioxide Emissions do that.

Then they trade their unused Carbon Permits or Allowances with those who find it harder to cut their emissions.

This Carbon Market, according to Economic Theory, should be the most efficient, that’s cost-efficient, in implementing the Carbon Cap.

So, if it’s cost-efficient, you would not expect the price of Carbon Permits to be very high.

The Carbon Traders would get rich, but nobody else should be badly impacted.

Yes, organisations and businesses will be expected to invest in making Carbon Dioxide Emissions reductions.

Which they won’t, of course. Which organisations and businesses will want to spend capital on cutting emissions ? For the corporates, that’s shareholders’ returns you’re spending ! For the organisations, including the governments, that’s peoples charges and taxes you’re increasing !

But anyway, that small problem aside, if Carbon Trading is so efficient, you should expect to see the price of Carbon coast along the sea floor, rock bottom, as people cut their emissions in order not to have to buy Carbon Permits.

And yet, and yet, even Nicholas Stern admits that this might not be enough to engender, motivate, incentivise investment into emissions cuts.

Nicholas Stern, and many others, now see that a floor needs to be set for Carbon Dioxide Emissions Permits, the lowest price at which Carbon can be traded.

If that idea gains momentum, the obvious question is : why not make it a Carbon Tax ? It would be effectively the same.

4 replies on “Carbon Trading Is So Wrong”


I came across this from a link on climate change news. I’m having trouble following your argument. I prefer a carbon tax to cap and trade, but only because I think the latter is easier to manipulate.

But that’s a problem with how it works in practice. You’re addressing the theory, and I don’t think you’ve done it correctly.

An efficient trading market does NOT mean that the price of carbon trading permits will be really low. The price will depend on HOW MANY trading permits you allow. That’s the “cap”. You cap how much CO2 can be emitted each year, and then trade those permits.

So if you set the “cap” at half of the emissions from a usual year, then the cost would be very, very high as people scrambled bid up the cost. Some businesses that found carbon was not essential to their business model would cut emissions instead, while those that couldn’t get rid of emissions so easily would have to buy credits, and pay the price.

The reason that they would spend capital on reducing emissions is that it would be against the law to emit without a permit. That’s often a pretty strong motivator for shareholders.

Of course, in the real world, most of this won’t happen, because governments are giving out lots of emissions permits, and getting loopholes put into the law. Which is why I don’t think it’s all that good of a way to deal with the problem. But the way you explain cap and trade makes me think you’re not clear on even the basic theory.


Thanks for your thoughtful comments and analysis.

You say that the price of Carbon “will depend on HOW MANY trading permits you allow.”

My reply is twofold :-

(a) The reason why a Carbon Trading regime is so strongly supported for the core of the proposed Copenhagen Treaty is that the Economists say that a free market in Carbon will allow the price of Carbon to be “optimal”. That means optimal for buyers and sellers alike. Because the market would be universal and cover all sectors of the Economy, it is likely that all parties would soon settle on the lowest cost they can. It is not inevitable that the price would become high and rising. It would be in everyone’s interests to keep the price low, since they would all need to spend money on de-Carbonisation, and so be unwilling to spend much on Carbon Emissions Permits. Those who are obliged to purchase Carbon Allowances will make arrangements with those who sell them to keep the prices low. This kind of deal is inevitable.

(b) There is a group of Carbon Emitters that will find de-Carbonisation easy, and so be in a position to sell a lot of their Carbon Permits. There is another group of Carbon Emitters that will not find de-Carbonisation easy, and they will find it expensive. Plus they will have to purchase Carbon Allowances. These two groups are not fluid, they cannot change camp easily. In other words those who will need to buy Carbon and those who will sell Carbon will be pretty much the same groups all the time. This condition is anti-competitive, in other words, it will not be possible to compete to de-Carbonise for the large Carbon Emitters. This will bust the “free” nature of the market and will lead to low Carbon prices.

My conclusion is that the price of Carbon will have nothing to do with the notional “scarcity value” of Carbon Allowances/Permits. In other words, the price of Carbon will not rise as the cap is ratcheted down (as less Carbon Allowances are made available each year).

And if I am correct, that the Carbon price will remain low, then it will stop being an incentive to de-Carbonise.

De-Carbonisation will happen, but the Cap will be more important than any Carbon Trading in making de-Carbonisation happen.

My position is that one cannot confuse the monetary price of Carbon Permits with the negative impact of Carbon Emissions.

In other words, de-Carbonisation has a higher value than a Carbon Trading market can provide.

For me, Cap-and-Trade is therefore an artificial and futile regime. We just need the regulatory Cap. Forget the Trading. It is a mere diversion and distraction.

I’ve been interested in taxations for lengthier then I care to admit, both on the private side (all my working life history!!) and from a legal stand since passing the bar and following tax law. I’ve offered a lot of advice and righted a lot of wrongs, and I must say that what you’ve posted makes impeccable sense. Please continue the good work – the more individuals know the better they’ll be equipped to deal with the tax man, and that’s what it’s all about.

I’ve been active in taxations for lengthier then I care to admit, both on the individualized side (all my working life story!!) and from a legal viewpoint since passing the bar and following up on tax law. I’ve rendered a lot of advice and rectified a lot of wrongs, and I must say that what you’ve posted makes utter sense. Please continue the good work – the more people know the better they’ll be equipped to comprehend with the tax man, and that’s what it’s all about.

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