carbon markets - pros and cons of market driven mechanisms

8/9/2019 Carbon Markets - Pros and Cons of Market Driven Mechanisms

http://slidepdf.com/reader/full/carbon-markets-pros-and-cons-of-market-driven-mechanisms 1/18

1

Carbon Markets: Pros and Cons of Market Driven Mechanisms in

Mitigating Carbon Emissions

Submitted by

Group2



2

Table of Contents

EXECUTIVE SUMMARY ......................................................................................................................... 3

INTRODUCTION: HOW CARBON TRADING WORKS ................................................................... 3

LITERATURE REVIEW .......................................................................................................................... 5

CRITICISM OF CAP AND TRADE SYSTEM ....................................................................................... 6

MERITS OF CARBON TRADING SYSTEM ......................................................................................... 8

DEMERITS OF CARBON TRADING SYSTEM ................................................................................... 9

TRADING V/S CARBON TAXES ........................................................................................................ 15

GOVERNANCE CHALLENGES OF CARBON MARKETS ............................................................... 16

REFERENCES .......................................................................................................................................... 18



3

Carbon Trading is "hard to implement, it's hard to monitor, it's non-transparent, it's highly political,

highly manipulative, which is why the banks love it, the banks all want to trade, this is an investment

banking dream”.

Jeffrey Sachs

Executive SummaryThe above quote rightly captures the essence of functioning of Carbon Trading; it is a highly complex

system of business. This report is prepared as part of the course curriculum of the subject “Business

Sustainability & Carbon Market” to analyse the role of market driven mechanism of carbon trading & the

merits and demerits of this mechanism. It starts with the introduction of the carbon trading concept &

mechanism. The focus of the report is on evaluating the strengths and weaknesses of the prevailing cap

and trade system. We have reviewed certain literary works in order to throw light on existing situation

of the trading system. The challenges faced in the implementation process and governance challengeshave been discussed thoroughly in the report. Finally, we compare the trading mechanism and the

carbon tax mechanism with each other.

Introduction: How Carbon Trading Works

Emissions trading or Cap and Trade mechanism refers to a system where carbon emission is controlled

by international bodies or governments. An upper limit of emissions is set initially which reduced

gradually towards a national reduction target. Companies are issued permits that set the emission limit

and these permits can be traded in market. Essentially, this rolls in a system where companies can buy

and sell carbon emission allowances as per their needs. The buyer of the permit here pays for the right

to polluting and the seller is rewarded for effectively reducing emissions.

The costs and effectiveness of carbon trading system depends on the structure and methods of permit

distribution which are as follows

Cap and Trade System: A cap is set at national level and the cap is divided into permits. These

permits are then distributed to regulated firms at set a fee or for free or by auctioning or by any

combination of these methods

Baseline & Credit System: In this case also a national level cap is set. However the cap here is sum

of baseline emission levels of all the regulated firms. The main difference from Cap and Trade

system is that as a firm grows, the baseline increases in this case. Kyoto Protocol is the best example



4

of this system. In Kyoto, the participating countries are expected to reduce their emissions to 5.2%

below their 1990 level by the year 2012.

The Mechanism

To understand the mechanism of Cap and Trade system we consider the example of a single firm.

Suppose it faces an increasing marginal emission abatement cost curve as shown in the figure below

Figure 1

If the firm is under no regulation that constraints its emission level, it will avoid abatement cost entirely

and will spend zero abatement cost. In such a case, marginal abatement cost that is represented by the

area (B+C+D) will be completely avoided. Suppose an assessment is made and it is found that optimal

abatement happens at the point where marginal benefit curve and marginal cost curve intersect. At this

point, a cap is set, which is represented by a vertical line. The polluting firm has to reduce its emission to

the level e*. The abatement cost of the firm is B. Under market mechanism, the firm is given permit to

emit till the vertical cap level. But if the firm can save some emission, it will be allowed to sell it to a firm

that needs to operate beyond the cap level for that firm; thus a trade system unfolds. Similarly, tax

system can also be applied to achieve reduction in emission as shown in the figure.



5

Literature Review

Tale of Two Crises: What the Global Financial Crisis Means for the Global Environmental Crisis

( Kyla Tienhaara, Environmental Policy and Governance, pg 197-208, 2010)

In 2008-2009 world was hit by worst financial crisis in a generation (US sub-prime crisis) and at the same

time it was also suffering with the environmental crisis of all times. Over the course of 2008 and 2009,

research findings from a number of studies were released which indicated that climate change is

occurring far more rapidly than previously anticipated. At the same time, many financial institutions like

Lehman Brothers collapsed. The article talks about how the financial and environmental crisis are linked

together positively i.e. if one goes down, other will reduce too as opposed to the economic hardship

given by some as an excuse for delaying action on critical environmental issues. This article first

examines the relationship between the causes of the two crises and explores the opportunity that the

financial crisis presents for responding to the environmental crisis. Then it critically examines the plans

to devise a ‘green recovery’ from the financial crisis.

The deregulation of financial crisis led to creation of credit boom which fuelled consumption which in

turn led to debt creation. Foster and Magdoff (2009, p. 28) point out, household incomes have been

stagnant or declining for decades, and yet consumption has continued to climb. What happened in the

subprime crisis is a result of above point. Consumption was increasing on the back of unsustainable

debt. Mortgage debt is not just an American Phenomenon. People have started buying bigger houses

even though the no. of people residing has decreased. This has lead not only to increased debt but also

increased consumption of resources, effecting environment in a negative way.

A set of economic programmes called The New Deal was introduced after The Great Depression focused

heavily on fiscal stimulus in order to help the economy escape. Now, NGOs are talking about a Green

New Deal. They give various arguments in favour of this new deal. Renewable energy sector are labour

intensive and thus will remove the problem of unemployment. Green projects have higher return on

capital; reducing reliance on scarce resources will help in preventing future economic downturns. Most

importantly, the cost of taking action to deal with issues such as climate change are much lower nowthan they will be in the future.

Despite above arguments, many still believe that economic development and environmental protection

are fundamentally at odds with one another.



6

The aim of any efforts at recovery, whether green or brown, is to restore economic growth. Many

believe that technology can solve any environmental problem or resource limitation. This has given rise

to concept of smart technology that allows growth to continue with declining material throughput. But

there are views that say that technologies developed to resolve one problem often end up creating

myriad new, often unanticipated, problems. One example is nuclear energy. An overemphasis on

technology also tends to displace solutions to problems that are simple. Although much is made of

technological solutions that range from switching to energy-efficient light bulbs to installing solar panels

on roofs, it is rarely suggested that individuals and families should consider buying/building smaller

homes.

Thus a fundamental change in the way we think about the economy is required to ensure a truly green

recovery.

Criticism of Cap and Trade System

Emission trading has been criticized for a variety of reasons. Several organizations are joining the ranks

of growing criticism of cap-and-trade programs around the globe, saying carbon offset programs do

more harm than good and could result in significantly higher costs for some industries.

In the popular science magazine New Scientist, Lohmann argued that trading pollution allowances

should be avoided as a climate change policy. Lohmann supported conventional regulation, green taxes,

and energy policies that are "justice-based" and "community-driven." According to Carbon Trade Watch

(2009), carbon trading has had a "disastrous track record." The effectiveness of the EU ETS was

criticized, and it was argued that the CDM had routinely favoured "environmentally ineffective and

socially unjust projects."

The Story of Cap and Trade

Annie Leonard provided a critical view on carbon emissions trading in her 2009 documentary The Story

of Cap and Trade. This documentary emphasized three factors:

1. Unjust financial advantages to major polluters resulting from free permit

2.

An ineffectiveness of the system caused by cheating in connection with carbon offsets

3. Distraction from the search for other solutions

Offsets

Forest campaigner Jutta Kill (2006) of European environmental group FERN argued that offsets for

emission reductions were no substitute for actual cuts in emissions. Kill stated that "(carbon) in trees is



7

temporary: Trees can easily release carbon into the atmosphere through fire, disease, climatic changes,

natural decay and timber harvesting."

Supply of permits

Regulatory agencies run the risk of issuing too many emission credits, which can result in a very low

price on emission permits. This reduces the incentive that permit-liable firms have to cut back their

emissions. On the other hand, issuing too few permits can result in an excessively high permit price. This

is one of the arguments in favour of a hybrid instrument that has a price-floor, i.e., a minimum permit

price, and a price-ceiling, i.e., a limit on the permit price. A price-ceiling (safety value) does, however,

remove the certainty of a particular quantity limit of emissions.

Incentives

Emissions trading can result in perverse incentives. If, for example, polluting firms are given emission

permits for free, this may create a reason for them not to cut their emissions. This is because a firm

making large cuts in emissions would then potentially be granted fewer emission permits in the future.

This perverse incentive can be alleviated if permits are auctioned, i.e., sold to polluters, rather than

giving them the permits for free.

On the other hand, allocating permits can be used as a measure to protect domestic firms who are

internationally exposed to competition. This happens when domestic firms compete against other firms

that are not subject to the same regulation. This argument in favour of allocation of permits has been

used in the EU ETS, where industries that have been judged to be internationally exposed, e.g., cement

and steel production, have been given permits for free.

Auctioning

The revenues from auctioning go to the government. These revenues could, for example, be used for

research and development of sustainable technology. Alternatively, revenues could be used to cut

distortionary taxes, thus improving the efficiency of the overall cap policy.

Distributional effects

The Congressional Budget Office (CBO, 2009) examined the potential effects of the American Clean

Energy and Security Act on US households. This Act relies heavily on the free allocation of permits. The

Bill was found to protect low-income consumers, but it was recommended that the Bill be changed to be

more efficient. It was suggested that the Bill be changed to reduce welfare provisions for corporations,

and more resources be made available for consumer relief.



8

Merits of Carbon Trading System

Flexibility

The carbon-credit trading system gives companies flexibility in how they attain their individual emissions

targets. A company can, of course, simply work to improve its efficiency and reduce its emissions. If,

however, the company is unable to, or chooses not to, it can purchase carbon credits, or it can offset its

emissions with sequestration efforts or project-based credits. No matter what course an individual

company chooses, it should not, have a negative effect on the aggregate emission levels of an industry,

country, region, etc.; the level of permissible emissions is established in advance and the interaction of

carbon credits, project-based credits, and sequestration credits should result in a zero-sum effect.

Good for Greenhouse Gases

According to the Center for Clean Air Policy, ―Carbon dioxide emissions have no local effects, and the

release of CO2 from one place in the world has the same effect as a release from any other place. With

respect to the global climate, each ton of carbon dioxide has the same radiative forcing effect regardless

of where on the globe it is emitted initially. Thus, reductions of carbon dioxide or methane offer the

same climate benefits regardless of where they occur. Trading ensures that reductions are made as

efficiently as possible. A carbon tax system provides no guarantee that a target emissions level will be

reached. A cap-and-trade system, in theory, does

Cost Effective and Provides Rewards

Because of the flexibility noted above, companies can seek out the most inexpensive pollution reduction

strategies. And if a company can sell its unused credits for more than it costs to make further

reductions, it will continue to reduce emissions

Ensuring environmental protection

Cap-and-trade systems for pollution control can guarantee that pollution will be limited to the quantity

specified by the ‘cap’, if it is suitably enforced. The pollution cap is reduced from one period (often

several years) to the next, thereby reducing total emissions over time. In the EU, for instance, the cap in

the 2008 –2012 period was set so that emissions would be reduced by 5% compared with 1990 levels,

and the cap for the next period (2012 –2020) has been set to reduce emissions by at least 20% compared

with 1990 levels, although the EU commission is currently contemplating tightening the cap to a 30%

reduction by 2020, a position which has the support of the United Kingdom, France and Germany,

among others. In this way, cap-and-trade systems provide policymakers and environmentalists with the

certainty that a given emissions target will be met.



9

Minimising waste

Cap-and-trade schemes therefore ensure that the cheapest short-run sources of abatement are

undertaken first, because firms have an incentive to reduce their emissions whenever they can do this

for less than the market price. There will be many different ways firms can economise on their

emissions. The market price ensures that firms are rewarded if they do make reductions and penalised if

they don’t. Just as the ‘cap’ supports environmental integrity, the ‘trade’ supports minimum cost.

Maintaining liberty

A final moral virtue of economic instruments, including both carbon trading and taxes, is that these

policies allow regulated entities (whether countries, firms or individuals) the liberty to reduce their

emissions using the methods they see fit. In the (relatively unlikely) event that government actually

knew more cost-effective ways to reduce emissions than individuals, there would still be value in

allowing individuals to make their own choices, and indeed to make (and learn from) their own

mistakes.

Demerits of Carbon Trading System

Long-term structural changes not addressed

Simply setting emission targets without careful consideration of necessary long-term structural change

will not work for greenhouse emission reduction. According to Lohmann, the 1987 Montreal Protocol on

Substances that Deplete the Ozone Layer had success in reducing ozone-depleting compounds because

very few factories needed to be involved and substitute compounds were easily found. He feels that

reducing greenhouse emissions will require long-term restructuring of entire energy sectors within

industrialized economies.

Allocation, regulation, and enforcement difficulties

If credits are allocated to individual companies or industries at the outset of carbon trading

implementation, allocating the correct amount will be very challenging. In Great Britain, hospitals have

incurred huge costs because of carbon trading while many oil companies have enjoyed huge profits.34

The hospitals have had to spend a great deal of money on administrative costs associated with the

system and have suffered large shortfalls because of an insufficient allocation of credits. The oil

companies, on the other hand, were allocated an excessive amount of carbon credits which they sold for

large sums of money.



10

Huge Political Problem

The allocation of credits also opens the door to huge political problems. It is reasonable to assume that

an enormous amount of campaigning will be done on behalf of interested parties to increase their

allotment. At very least, some parties will feel short changed. At worst, every party will feel short

changed and allege wrongdoing. Another obvious difficulty of any system is the regulation and

enforcement of polluters. Creating a regulatory framework with appropriate penalties will require

extremely careful consideration. Depending on the regulations, companies may be able to manipulate

the system and avoid penalties by reorganizing and reconfiguring their companies to fall below emission

footprint thresholds.

Measurement challenges

Accurately and efficiently monitoring greenhouse gas emissions is a complicated task. Even more

difficult than monitoring the output from a particular company is measuring the effects of sequestration

on project-based efforts. Deciding exactly how much carbon credit a company deserves for preserving a

forest or planting trees is nearly impossible to objectively calculate.

Countries have to weigh their priorities

Australia, for instance, is hesitant to commit to carbon trading because its richness in fossil fuels is one

of its most important competitive advantages.36 Committing to a carbon trading system could hurt the

nation’s economy. It is difficult for any country to balance short-term and long-term considerations. And

if some countries do not have to abide by the same system, it can put those within the system at a

tremendous disadvantage.

Market manipulation

Any openly traded market is at risk for manipulation. And the greater the numbers of participants with

access to the market, the greater the numbers of participants with the opportunity to manipulate it.

Low Price of Carbon Allowance

It is being argued by some critics that the price signals needed to stimulate investment in low-carbon

technologies are not being provided by carbon trading schemes and nor are they likely to in the future.

The fact that carbon trading emphasizes low-cost options, is likely to put off the major economic

adjustments that are needed to be required urgently. The highest price that EUAs have reached so far

was around €30 in July 2008. In contrast, while onshore renewable energy becomes competitive w ith

dirty coal at around US$50 per tone. Some estimates put the level of carbon price necessary to make

low-carbon technology competitive as high as €500 per tonne. In practice it is increasingly argued that



11

the price signals needed to stimulate investment in low-carbon technologies are not being provided by

carbon trading schemes and nor are they likely to in the future.

Dis-incentivising Innovation

Even if alternative technologies were more cheaply available, there are additional problems with the

incentive structure provided by carbon trading. The supporters of carbon trading say that the Polluters

have an incentive to make extra emission reductions under emissions trading so that they can sell

credits. Therefore, emissions trading stimulates innovation. This model accurately explains the situation

of sellers of credits. But it is also obviously incomplete. It leaves the buyers of credits out of the picture.

For them, the situation is directly opposite for the buyers of credits – the highly polluting firms whose

emissions exceed their allowances and for whom the adjustments to less carbon-intensive modes of

production are expensive. Carbon trading makes lower-cost credits available to these firms as an

alternative to the higher-cost investments that they would otherwise have to make. Hence trading

removes any incentive that they have for technological innovation. So, economy gets stuck in high

carbon infrastructure.

In conclusion, carbon trading can actually prevent the types of innovation that are urgently needed in

order to support decarbonisation in developed countries. Although trading provides limited incentives

for firms for whom emissions reductions are low cost to invest to make those reductions, it removes

incentives for firms who have to make heavy adjustments to do so by allowing them to purchase

additional permits on the carbon market. It is an opt-out.

The overall impact is to put off the very difficult, expensive adjustments to our economic and industrialinfrastructure to the very last moment. This significantly increases the risk of failure to keep global

temperature increases below the critical threshold. In order to maximise our chance of keeping within

this threshold, developed countries must embark immediately on the structural transformation of their

economies, investing in fundamental adjustments to energy production and use. Relying on carbon

trading has the opposite effect – focusing action on the cheapest adjustments first and leaving the

hardest transitions for capital-intensive industries until last.

Offsetting won’t deliver fair and adequate global emission cuts There is offsetting mechanism which allows developed countries to count emissions reductions in

developing countries toward their own targets for emissions reductions under the Kyoto Protocol. Not

only does offsetting fail to cut emissions, it delays essential structural change in developed country

economies. It also institutionalises the idea that cuts can be made in the developing world in place of

cuts in the developed world when the science demands reductions in both.



12

There is today a massive gap between the per capita carbon footprint of people in developed countries

and those who live in the developing world. Emissions produced per person in the UK are roughly twice

those of a person in China and more than 10 times those of someone in India. Per capita emissions in

the United States are even higher: the average person in the United States is responsible for nearly four

times as many emissions as the average person in China, and 20 times as much as someone in India. The

idea of the differential between the share of emissions which Annex 1 nation could have made to the

amount of emissions which they made can be taken from the pie charts shown below.

Source: Statistics from Third World Network, Climate Debt: A Primer, June 2009.

Taking into account current and projected emissions on a per capita basis, an 80 per cent reduction in

developed country emissions by 2050 with no offsetting would still not ensure the levelling-off of per

capita emissions by 2050. If offsetting is added into the equation, then global inequalities in the

production of carbon emissions increase further.Offsetting is an instrument whose essential role is to transfer responsibility for emissions reductions

from developed to developing countries. As such, it will mean we fail to ensure adequate cuts in

emissions reductions globally. It also further entrenches a deeply inequitable development framework

where inhabitants of developing countries are locked in to a low and decreasing share of global carbon

emissions. Under global emissions scenarios which allow offsetting from the developed to the

developing world, even with greater availability of cleaner technology, people in developing countries

will not be able to make the necessary increases in their emissions associated with improvements in

standards of living and essential services such as housing, food, fuel, health, education and transport.

Offsetting denies poor people in developing countries the right to development.

Offsetting frequently can be worse than doing nothing and doesn’t deliver emissions cuts at

all

One of the key criteria for offset projects under the Clean Development Mechanism is that they are

additional. This means they should contribute to reducing, avoiding or sequestering emissions in

27%

73%

Actual Historical Emissions

Non-Annex 1 A nnex 1

76%

24%

Fair Share of Emissions

Non-A nne x 1 A nne x 1



13

developing countries beyond those activities that would have happened anyway. Otherwise, the net

effect would be an actual increase in carbon emissions globally. Although developing countries

submitting projects for crediting under the CDM are required to prove that their projects are additional,

in practice there are major difficulties in actually testing and proving additionality.

First and foremost, the CDM Executive Board – which is responsible for approving offset projects for

CDM crediting – is massively under-staffed and relies on third party verifiers to check the claims made

by project proponents. In practice the verifiers are paid by the project developers themselves, leading to

significant conflicts of interest and strong pressure on the verifiers to approve projects which may not

necessarily be additional.

Beyond these practical difficulties associated with proving additionality, there are much more

fundamental problems with the CDM, including the perverse incentives that it creates, and how to

determine what is and is not additional. There are big incentives for developing countries to claim that

projects are additional when they are not. There are even reports that the CDM is actually encouraging

the building of refrigeration plants in the developing world so that the companies can then benefit from

the sale of the credits. According to a Joint Committee of the UK Parliament “the economic incentives

offered by the CDM appear actually to be encouraging the building of refrigerant plants in the

developing world, simply in order that the HFC by-products from the plant can be incinerated, and the

credits generated from this sold at a large profit.”

Another example is that of hydro-electric power plants in China. In total, more than 200 large-scale

Chinese hydro plants are progressing through CDM validation. The Government claims that the projects

would not have gone ahead without CDM revenues – for example, because a coal-fired station would

have been cheaper to build. However, this ignores the fact that the Chinese Government is a strong

supporter of hydro-electric development, that hydro-electric power is a major component in its five-year

plans, and that the Chinese hydro-electric industry is expected to grow from 132-154 gigawatts (GW) of

capacity in 2010 to 191-240 GW in 2020 – growth equivalent to around 20 large coal-fired power

stations.88 This growth is continuing at the same rate as it has previously, and there is no evidence that

removing the CDM would stop China continuing its strategy of building more dams.

Given the significant finances available through the CDM for the development of such projects, it wouldbe unreasonable to expect countries not to factor it into their economic planning. Hence it becomes

impossible to know when a project is additional, and to prove it.



14

Involvement of financial speculators

At any one time the vast majority of permits and credits available in the carbon markets are owned by

other actors – traders and speculators whose participation in the markets is for the purpose of making

money from the buying and selling of credits and permits, ie speculation.

Carbon trading has been publicized as a new ‘asset class’, for hedge funds, energy traders, private equity

funds and large global investment banks such as Barclays, Citigroup, Goldman Sachs, Credit Suisse, BNP

Paribas and Merrill Lynch as well as index providers and European exchange-traded commodity

sponsors.

The involvement of these actors whose sole purpose is to profit from the trading of carbon credits is

cause of concern because it increases the potential for a speculative bubble. A speculative bubble is

where trading in a commodity takes place in increasingly high volumes at prices which are increasingly

unrelated to the underlying value of the commodity, eventually leading to a stock market crash where

the tradable value of the commodity suddenly aligns itself with the underlying value.

In the carbon markets, the risk is twofold. The first is that the involvement of speculators will drive the

development of what has been described as subprime carbon, i.e. contracts to deliver carbon that carry

a relatively high risk of not being fulfilled. The second is that we become increasing reliant on carbon

trading as a mechanism for reducing emissions as proposed by key global actors like the European

Union, and then the increasing prevalence of these subprime carbon contracts leads to a market crash

which fundamentally undermines an already weak and ineffective mechanism for avoiding catastrophic

climate change.

Moreover, some market participants have expressed concern about the impact the fixed supply of

emission allowances might have on the derivatives market if the number of outstanding derivative

contracts grows at such a rapid pace that the number of financial contracts exceeds the pool of

underlying assets that can be delivered at expiry.

Many of the problems with offsetting examined earlier – the prevalence of perverse offset projects

where companies create powerful greenhouse gases just to destroy them so as to claim offset credits,

the problems with proving additionality, and the problems with verifying greenhouse gas savings from

more legitimate offset projects – are likely to lead to the creation of more and more subprime offset

credits, eventually undermining the confidence of the markets in the value of the assets being traded.



15

Trading v/s Carbon Taxes

A carbon tax is a tax on the carbon content of fuels — effectively a tax on the carbon dioxide emissions

from burning fossil fuels. A carbon tax sets the price of a unit of CO2 and allows the quantity of CO2

emissions to fluctuate instead of the price. The advantage of this is that a clear fixed price signal is

created, which adds certainty to investment decisions. The disadvantage is that total emissions are not

capped, so creating environmental uncertainty. A carbon tax aims to reduce the marginal benefit that a

firm receives from polluting so that firms will freely choose to emit the socially optimal amount of

carbon dioxide.

A carbon tax regime may be less exposed than an ETS to the influence of market power, since in a

trading scheme with few participants there could be more potential for one firm to withhold allowances

and attempt to manipulate the market. In practice, however, this should not be such a problem if

emitters of all types trade with each other, as opposed to having separate types of allowances for

different industry sectors, some of which (e.g. electricity generation) may be highly concentrated.

Carbon trading is more of a market-based solution than carbon taxes.

1. Uncertainty about environmental benefits of abatement

Taxes have potential disadvantages in not directly constraining emissions and so risking serious

social welfare losses where this leads to threshold effects being triggered in some scenarios.

2.

Price Stability

The biggest argument in favor of a carbon tax is the potentially much greater price stability that

this brings relative to an ETS. A tax therefore produces greater certainty about returns to

abatement investment. However, this argument is pitched against an ETS without banking and

borrowing (or price floors and ceilings). The options of banking and borrowing allow firms to

smooth emissions over time, which in turn smoothes the price of allowances and increases

certainty and thus investment.

3. Revenue-raising capabilities

A carbon tax has obvious revenue-raising benefits as well as direct environmental impacts, and

this is often used as an argument for taxes as the revenue can be reinvested in zero/low carbon

technology. However, this argument assumes that allowances are grandfathered in an ETS. The

preferable solution is for allowances to be auctioned, potentially generating the same revenue

as a tax.

4.

Simplicity and administration and compliance costs



16

A carbon tax will generally be simpler and cheaper to administer than a trading scheme because

of the complex nature of an ETS. The tax instrument does not require the architecture to mimic

a market and the administrative costs that are attached to this, nor does it require the set up

and monitoring of banking and borrowing in order to achieve a stable price signal. Furthermore,

a tax could be collected through the current tax infrastructure. Compliance costs for companies

will also generally be lower for a tax than an ETS scheme, since the former could be

incorporated within the activities of a company’s existing tax department, whereas dealing with

a trading scheme may involve a whole new department.

5. Political acceptability

Finally, and most importantly in practical terms, an ETS currently appears more politically

feasible than a carbon tax, particularly when considered at international level. This reflects the

fact that a carbon tax is often seen by the public as a revenue raising instrument with potential

environmental benefits. However, due to the cap that is imposed by an ETS, the emphasis of this

instrument is very much on its environmental benefits and it only acts implicitly rather than

explicitly as a tax.

Governance Challenges of Carbon Markets

There has been a strong growth in carbon trading at both domestic and international markets. The

worth of carbon markets is expected to reach €2 trillion or more by 2020. Apart from the framework

established by Kyoto Protocol, the carbon markets are largely fragmented and organised along

domestic/regional boundaries.

A significant challenge to implement an efficient carbon market system involves developing governance

systems to manage investors’ risks across ecological scales. As the number of projects in the voluntary

market is increasing, it is necessary to have in place a range of types and combinations of governance

mechanisms, structures and actors functioning efficiently to result in emission reductions.

Governance Priorities in the Global Carbon Market

Significant transformation in global energy, industries and transportation will be required in the next

few years to achieve a considerable greenhouse gas reduction. Substantial investments in R&D and

deployment of advanced energy technologies will be necessary to achieve this goal. To ensure efficient

mitigation, carbon markets are being used to incentivise and channel the investments in green

technologies. However, adequate regulation is required in order to reduce speculation, manipulation or

market abuse.



17

To ensure the success of emission trading mechanism, following measures are of vital importance:

1. A simple and transparent system

2. A good decision process with a central coordinating mechanism

3.

A robust, binding cap

4. Predictability / certainty

5. Low transaction costs

6. Good data availability

7. Varying marginal abatement costs for different actors

8. Flexibility and linkages to international offsets effective monitoring, reporting and verification to

ensure integrity of the system

9. Compatibility across various carbon markets

A number of governance functions have been identified that may be assigned to a new or developing

institutional framework for carbon markets. These functions can be placed in the context of important

variables in order to relate them to the level of centralisation and the formal nature with which they

may be implemented.

1.

Market Integration and Convergence

a. Ensuring comparability of reduction pathways

b. Sustaining compatibility of central design features

c. Avoiding fragmentation of national/regional markets over time

2.

Environmental Performance and Integrity

a.

Implementing robust monitoring and enforcement structures

b. Ensuring adequate administrative and regulatory capacities

c. Securing additionality of offset credits

3.

Market Efficiency and Integrity

a. Managing volatility and price extremes in the market

b. Avoiding manipulation by dominant market actors

c.

Ensuring market transparency in spot and derivative tradingd. Regulating exchanges and OTC trading

e. Regulating speculation and risk management with derivatives

Both improved governance and a robust regulatory framework with stringent targets can help in

establishing a global market for the greenhouse gas mitigation priorities. Good governance will increase

the prospects for efficient greenhouse gas abatement through reliable operational markets.



18

References

1. http://www.brookings.edu/~/media/research/files/papers/2009/12/climate%20selin%20vande

veer/12_climate_selin_vandeveer

2.

http://ecologic.eu/files/attachments/presentation/2009/mml_11122009_copenhagen.pdf

3. http://iacconference.org/documents/WSGettingCarbonMarketGovernanceRightFromDayOne_G

ernotWagner_14thIACCLongWorkshop.pdf

4.

www.foe.co.uk/resource/reports/dangerous_obsession.pdf

5. http://www.ukmediacentre.pwc.com/imagelibrary/downloadMedia.ashx?MediaDetailsID=1431

6. http://specials.kenanflagler.unc.edu/kicse/ORIG%20Shared%20Documents/Analysis%20of%20C

arbon%20Trading%20as%20a%20Means%20to%20Emissions%20Reduction.pdf

7.

http://www.carbonshare.org/docs/capvscarbontax.pdf8. http://www.thegreensupplychain.com/NEWS/09-11-11-1.php

9. http://www.springerlink.com/content/p538443681k30r32/fulltext.pdf

10. http://economistsview.typepad.com/economistsview/2008/06/carbon-taxes-vs.html

http://www.brookings.edu/~/media/research/files/papers/2009/12/climate%20selin%20vandeveer/12_climate_selin_vandeveer







http://iacconference.org/documents/WSGettingCarbonMarketGovernanceRightFromDayOne_GernotWagner_14thIACCLongWorkshop.pdf





http://www.foe.co.uk/resource/reports/dangerous_obsession.pdf

http://www.ukmediacentre.pwc.com/imagelibrary/downloadMedia.ashx?MediaDetailsID=1431

http://specials.kenanflagler.unc.edu/kicse/ORIG%20Shared%20Documents/Analysis%20of%20Carbon%20Trading%20as%20a%20Means%20to%20Emissions%20Reduction.pdf




http://www.carbonshare.org/docs/capvscarbontax.pdf

http://www.thegreensupplychain.com/NEWS/09-11-11-1.php

http://www.springerlink.com/content/p538443681k30r32/fulltext.pdf

http://economistsview.typepad.com/economistsview/2008/06/carbon-taxes-vs.html



http://www.springerlink.com/content/p538443681k30r32/fulltext.pdf

http://www.thegreensupplychain.com/NEWS/09-11-11-1.php

http://www.carbonshare.org/docs/capvscarbontax.pdf



http://www.ukmediacentre.pwc.com/imagelibrary/downloadMedia.ashx?MediaDetailsID=1431

http://www.foe.co.uk/resource/reports/dangerous_obsession.pdf




