Carbon Markets

Putting a Price on Pollution

Carbon lede

When factories belch smoke, everybody pays. Getting polluters to feel more of the sting is the big idea behind carbon markets. Putting a price on carbon dioxide fires up the search for the cheapest way to cut the emissions that cause climate change. That’s the theory. In practice, the young carbon markets in Europe, parts of the U.S. and China haven’t yet proven they can drive a switch to cleaner fuels. It’s also not clear if they’ll work better than a simple carbon tax. The question is whether global trading of pollution permits will take off as new markets link up and the world economy recovers.

The Situation

Emissions have decreased in many of the areas covered by carbon markets, usually known as cap-and-trade systems, though it’s probably too early to tell if they’re really helping to slow global warming. The recession and a drop in prices for natural gas, which pollutes less than coal or oil, probably had more to do with the decline. The effectiveness of carbon markets remains a matter of debate at the United Nations-sponsored talks to forge a new global emissions pact by the end of 2015. Cap-and-trade is getting more attention in the U.S. as one way to help power plants comply with proposals to cut emissions. President Barack Obama tried and failed to start a national cap-and-trade system during his first term. The European Union was the first to require pollution permits, in 2005, only to see them plunge in value when industrial output and demand tumbled. The glut sent the benchmark price for a permit to emit a metric ton of carbon dioxide plummeting 90 percent from its 2008 high to a low of 2.46 euros ($3.30) in April 2013. The price recovered to about 7 euros by the end of 2014. Carbon markets of various forms have followed in the northeastern U.S., California, New Zealand, seven Chinese regions and Korea, all of them learning from Europe’s mistakes. Two Canadian provinces are joining California’s market even as that country shuns a national approach.

Source: ICE Futures Europe
Source: ICE Futures Europe

The Background

For emissions markets to work, they must provide incentives to upgrade plants or switch to cleaner fuels. Governments figure out how much pollution-cutting their economies can tolerate, then distribute or sell individual rights to release carbon dioxide. As the pool of permits shrinks over time, companies that clean up their act have more allowances than they need and can sell them to offset costs. Thus market forces organize the best way to reach the goal. The types of carbon markets and their prices vary around the world, partly because emissions can be reduced at a lower cost in developing countries. The pilot systems in China, the world’s biggest emitter, don’t try to cut the total pollution level, but instead aim to trim the amount per unit of industrial production.

The Argument

In the markets now up and running, the current price probably isn’t high enough to change the behavior of the polluters they’re targeting. That’s brought criticism from opponents such as New Jersey Governor Chris Christie, who pulled his state out of the carbon market used by nine U.S. states, saying it cost too much and did little. Advocates argue that a market-based mechanism identifies the cheapest way to curb pollution and ensures a certain level of cuts. It can be more complex and costly to maintain than a carbon tax, though in some countries, including the U.S., a tax is politically unpopular. Many countries — including U.K. and most Scandinavian nations — use a hybrid approach. What’s more, carbon markets can provide important price signals to drive investment in green technologies ranging from energy-saving lightbulbs to solar power to carbon capture and storage.

The Reference Shelf

  • Website of Bloomberg New Energy Finance, which provides data and analysis on the future of energy.
  • New York Times graphic showing how carbon markets work.
  • International Emissions Trading Association’s annual report on carbon markets. 
  • McKinsey publishes research on carbon prices and the economics of different types of energy-saving investments. 
  • Bloomberg View published a series of editorials in 2014 advocating a carbon tax.

First Published Nov. 28, 2013

To contact the writer of this QuickTake:

Alessandro Vitelli in London at avitelli1@bloomberg.net

To contact the editor responsible for this QuickTake:

Leah Harrison Singer at lharrison@bloomberg.net