Much-Heralded Plan to Stop Global Warming Fails

Europe's carbon trading scheme flops, now what?

The most “inconvenient truth” about global warming is not – as Al Gore tells us in his new movie – that global warming will devastate our planet unless there is a major counter-offensive. It is that with the collapse of the European carbon-trading scheme last spring, there is no workable counter-offensive left.

Gore and other green activists have declared victory on the science of global warming, pointing out that recent developments have settled any doubt that global warming is real and that humans are the cause of it. While the case is far from closed, it is certainly true that one of the major gaps in the evidence for global warming has been filled – with revised data showing that the earth’s surface temperature is not flat as previously thought. Rather, it is rising at a rate that is consistent with the warming observed in the troposphere.

But if the scientific consensus about global warming has grown, the proper response to it remains more elusive today than ever before.

Amidst much fanfare last year, European and other signatories to the Kyoto treaty adopted emission trading as their method of choice to tackle global warming – instead of economy-busting carbon taxes or draconian command-and-control regulations. Under this scheme, each participating country is given a carbon allowance, which it then divvies among its domestic industry in the form of pollution rights or credits.

Companies are allowed to trade these credits with each other on the theory that those able to cut emissions cheaply would have an incentive to do so – and sell their spare credits to others for whom cuts are more expensive, keeping overall program costs as low as possible.

But this so-called market-based scheme collapsed in May when prematurely released data revealed that there was a glut of credits. The per ton prices for these credits dropped from 31 Euros to 12 Euros in just three weeks, finally settling near 9 Euros.

If the credit glut – and subsequent market crash – had stemmed from dramatic emission reductions as some initially thought, it would be cause for celebration. In fact, it was the result of an overly generous allocation of credits.

Nor can the problem be fixed simply by tightening each country’s allowances in the program’s second — 2008-2012 – phase.

For starters, countries – and companies – are awarded carbon allowances not on the basis of their previous emission levels – as was the case with U.S.’s sulphur dioxide trading program, the template for the European program. Rather, these allowances are based on each entity’s own future expectations of economic growth. The result is that everyone involved has every incentive to offer inflated growth expectations to obtain the maximum possible allowance they can get. Anyone that does otherwise becomes vulnerable to free-riders who quickly grab the credits that it has foregone.

This is exactly what happened to England. It was the first among European countries to put its cards on the table and present a good-faith guess of the carbon credits it needed. But France, Germany and other countries simply upped their opening requests to gobble as many of the available credits as they could.

The result is that UK is among the few countries that exceeded its total carbon allowance, forcing its companies to buy credits from their continental counterparts. In effect, UK’s energy consumers – who ultimately bear the cost of these credits — are subsidizing cheap energy for consumers elsewhere in Europe. England has sworn not to go first in the horse trading that will begin June 30 for the second phase of the program.

Nor is there any easy way to equitably allocate the carbon quota. Theoretically, the European Union Commission that currently oversees the program could audit polluting companies – all 12,000 of them – to establish their true emission needs. Setting aside the logistical difficulties of such a task, this would require a transfer of sovereignty from individual countries to a supranational authority that would likely break the fragile political consensus upon which the program is based.

But the bigger threat to the carbon program is its own internal contradictions. Even if every European Kyoto signatory meets its emission reduction target with total honesty – a big “if” given the inherent difficulty of verifying compliance – average global temperatures would drop an estimated 0.1 degree centigrade by 2050.

Such minuscule reductions will inevitably raise questions about the futility of the program – unless big Third World emitters are induced to join as well. But convincing these countries to sign up is going to be even more difficult now – than before the program was launched – given that they are likely to become attractive destinations for companies trying to escape the expense of purchasing carbon credits.

Emission-trading has flopped. But if the best idea that environmentalists have put on the table won’t avert Armageddon, it might be best for countries to eschew collective action altogether. They might be well advised to concentrate, instead, on maximizing economic growth and generating the resources necessary to deal with the threat – when and if it materializes.

Shikha Dalmia is a senior analyst with Reason Foundation. An archive of her work is here and Reason’s environment research and commentary is here.