Category: Economics

In many quarters, there is considerable resistance to the idea of international carbon trading. Some people characterize it as shipping money abroad for no reason, or the buying of ‘Hot Air.’ While there have certainly been problems with the implementation of carbon trading so far, the principle is intellectually sound. It could serve as a strong mechanism for reducing the total costs of climate change mitigation.

To understand why, consider that the major purpose of international carbon trading is to make tonnes of greenhouse gas emission reductions into a commodity. As such, their economic characteristics would be akin to those of other internationally traded commodities. Consider, for instance, an island state that requires copper for various purposes. It is technically possible to acquire copper on their territory, but the costs of doing so are enormous. Their copper reserves are dispersed and of poor quality, making the cost per tonne of finished copper excessive. Provided that the cost of buying copper internationally is lower than that of producing it domestically, the sensible thing to do is to buy the stuff on the world market. If the situation changes somehow (international prices rise, or foreign prices fall), the economically optimal choice may change as well. In the case of copper, this is immediately clear to virtually everyone. States that can produce copper more cheaply relative to other things sell copper internationally while those in the converse situation buy it. Both states with low-cost and those with high-cost copper benefit from this arrangement.

When it comes to carbon emissions, there are still comparative advantages that differ between states. This creates the possibility of positive sum trade: an exchange where both sides end up happier than they would be without trading. A relatively wealthy state that has already eliminated all the greenhouse gas emissions that can be easily forgone can pay a developing state to cut their own emissions. The buying state spends less than they would for producing the reduction domestically, and the receiving state gets the economic incentive to mitigate.

To reach this point, a few critical things are needed. First, for emission reductions to be tradable as a commodity, they must be measurable and verifiable. They differ from other commodities in that it is much more challenging to measure the tonne of CO2 a factory does not produce than the tonne of carbon that it does. That said, the difficulty is surmountable. We know how much greenhouse gas is produced by using different fuels in different ways. We also know how much is produced through different kinds of industrial production, such as cement manufacture. All that is required is the infrastructure and personnel to quantify and ensure reductions.

A trickier problem is that of additionality. If Country X pays Country Y $Z to build a natural gas power plant that will produce ten million fewer tonnes of CO2 than a coal power plant, it can only legitimately bank those tonnes if it was only the payment that motivated the choice. If Country Y actually chose the gas plant because coal plants pollute terribly and coal prices have been rising, Country X did not produce as many ‘additional’ reductions as intended. As with simple measurement, additionality is a practical problem that can be addressed through scientific and economic tools.

Developing and deploying those kinds of tools, so as to further the emergence of a robust and effective international carbon market, should be an excellent way to cut total human greenhouse gas emissions in a relatively rapid and low-cost way.

A new article in Science provides observational evidence of the link between rising temperatures and extreme weather events:

These observations reveal a distinct link between rainfall extremes and temperature, with heavy rain events increasing during warm periods and decreasing during cold periods. Furthermore, the observed amplification of rainfall extremes is found to be larger than predicted by models, implying that projections of future changes in rainfall extremes due to anthropogenic global warming may be underestimated.

Of all the impacts of climate change, extreme weather seems especially likely to help spur mitigation action, especially when that weather occurs in rich states. Reasons for that include the visibility and newsworthiness of floods, droughts, hurricanes, and so forth. Another major factor is the importance of the insurance industry, especially insofar as their professional estimations of risk affect the cost and feasibility of different projects. That is, so long as policy-makers do not establish incentives for risky behaviour.

In the past, I have mentioned both marginal abatement cost curves for greenhouse gasses (curves that describe the cost of eliminating each successive tonne of greenhouse gas) and the economic analyses done by McKinsey. Recently, a friend reminded me of an informative graphic from one of their reports:

The whole report is available online. All the options listed on the left hand side, below the horizontal line, are actually projected to save money as well as reduce greenhouse emissions. Those to the right are progressively more expensive, up to about 50 Euros a tonne.

The graphic is quite interesting because it shows a ranking of the cost at which different technologies can achieve emission reductions. It’s also interesting that they projected how many technologies need to be implemented – and to what degree – to achieve stabilization of greenhouse gas levels at 550, 450, and 400 parts per million of CO2 equivalent.

Put on a graphic like this, it all looks very achievable.

One of the more interesting environmental blogs I read is Shifting Baselines: a fisheries focused site that concentrates on how our changing expectations about life in the sea conceal from us the gradual emergence of long-term changes. A couple of other shifting baselines have caught my attention recently. They have to do with the long term trends of Arctic sea ice depletion and increasing oil scarcity. In both cases, exceptional shifts in the recent past have given way to what look like temporary reprieves.

Last summer’s Arctic sea ice minimum was a major record-breaker. It sparked serious thinking about whether the Arctic summer could be ice-free within a decade. This summer’s melt now seems likely to be less severe. Does this mean our level of worry should diminish, or is this simply oscillation around a worrying downward trend? It certainly gives ammunition to those who would like to deny that there is a trend at all. In the long run, it probably doesn’t matter enormously whether the Arctic melts in ten years or thirty. Where it may matter considerably is insofar as awareness of Arctic melting either prompts the emergence of strong climatic policies or provides fodder for those who want to continue to delay.

The same might be said about the recent slip in the price of gasoline. That being said, the nature of the causal factors at work there seems more straightforward. Prices do not seem to be falling because supply constraints have been lifted. Rather, they are falling because people are cutting back on usage: both as a result of general economic weakness and as a result of high energy prices themselves. High gasoline prices are something of a double-edged sword for environmentalists. On the one hand, they do help to encourage investments in efficiency. On the other, they encourage the development of truly filthy alternative sources of fuel (like the oil sands), encourage the development of false solutions (like corn ethanol), as well as making it more challenging politically to support sound environmental policies.

Whether it is ice or energy under consideration, the general lesson of shifting baselines is pertinent. We need to see past short term trends and our focus on how the recent past and the present compare, looking onwards to fundamental forces and long-term developments. Of course, when it comes to systems as massive and complex as the global climatic and economic systems, doing so is enormously difficult.