Trading in a carbon limited world

Reducing carbon emissions requires all of us to change our behaviour. But how? Matt Prescott explores the potential for a market mechanism that will transform our personal economies and could help save the planet.

The idea of trading carbon as commodity began with Kyoto. Now the carbon market appears to be here to stay. There is a strong interest at all levels – individual, business and government, in engaging with this newcomer  in the financial world.  

Carbon is an unusual commodity. It evokes a great deal of emotion and is tied to areas of social and environmental thinking that have never previously been aligned with conventional capitalist thinking. But through the carbon market we are  beginning to see the ecological future of our planet priced and traded as a commodity.

Whilst this may sound like an unfeeling solution to the climate change crisis, environmental groups in the west are warming to the carbon market’s potential.  Why? Because we need to reduce emissions dramatically in the next ten years, according to the world’s leading climate scientists. With time so short, we have to go with the biggest tool we’ve got – the market. 

Carbon trading is one of the mechanisms approved by the Kyoto Protocol for nations to reduce their emissions of greenhouse gases. The Kyoto Protocol created the Clean Development Mechanism (CDM) to enable emissions being saved in one part of the world to be sold in another. The result is a vast number of projects, mostly in developing nations, being certified for emissions reductions. Renewable energy projects such as wind power are common. These are checked to avoid ‘double counting’ and sold into one of a number of carbon markets from where the credits can be purchased.

The outcomes, in terms of environmental and social impact have been mixed so far, and the Kyoto Protocol is under fire for failing to deliver anything near the emission reductions the world needs. Indeed global emissions are continuing to rise and few countries can claim to have bucked the trend. But much has been learned since Kyoto and the learning curve is getting steeper. 

Learning from the EU

The European Union has been operating an Emissions Trading Scheme (EU ETS) since January 2005, with the first phase due to end in December 2007. beyond which the second phase will coincide with the first Kyoto commitment period which operates from 2008 to 2012 and requires signed-up developed nations to have reduced their greenhouse gas emissions by around 5% below their 1990 levels. At its peak, the price for a tonne of carbon (CO2 equivalent) was above €30. Currently it is hovering around €12. 

This is a "cap and trade" scheme. In such a scheme, those that emit carbon are each given credits — an allowance that entitles them to emit a specific amount of carbon. The total amount of credits cannot exceed the cap – which is the overall limit of total agreed emissions. The EU ETS covers around 40% of total greenhouse gas emissions from EU nations in several industry sectors such as paper, mineral and energy. The basic logic of any cap and trade scheme is that the market will find the cheapest savings. Any organisation covered by the scheme has two options if it exceeds its permitted allowance. It can purchase the more emissions rights in the market or it can reduce its own emissions through greater energy efficiency. According to the theory of the market, each installation will tend to make the most economically rational decision within its capped "carbon budget".

Global impacts 

Many project-based carbon reductions take place in China and India – two fast growing economies which offer many opportunities to deliver verifiable reductions because the pace of development of their energy infrastructure is so fast. Investment in clean renewable energy technologies aided by the finance made available through the carbon market makes low carbon developments more attractive to them. As the market for carbon expands, there is an ever greater opportunity to further reduce emissions.  

On many fronts, carbon trading has so far proved to be a successful mechanism, though some criticise it for its traditional capitalist approach. However, criticism is muted, given the current lack of  alternatives. Given the urgent need to reduce emissions,  a strong carbon market offers a way to unlock the creative potential of many of the world’s great financial and cultural centres to try to solve the greenhouse gas emissions problem. 

You, the new actor

At the present time, 44% of emissions in the UK are attributable directly to individuals, but the  individual is not currently a player in the carbon market. In a globalised carbon market, the initiative to reduce emissions may not stay with governments. Companies and communities who recognise the scale of the threat of climate change to their own futures and the future of their families  could themselves become the drivers.

As a concerned citizen, one could buy verified carbon reductions and not sell them – hence removing carbon from the market and therefore forcing the price up, but the RSA does not believe this is enough. We are  looking at an entirely new approach to individual carbon trading which we hope could hold the key to balancing the development of the economy with the need to control carbon emissions in a fast, effective and equitable manner. It is the new show in town. 

At present, there are few actors in the EU ETS – 12,000 installations, representing approximately 45% of EU CO2 emissions. The RSA conceives of every individual in the UK becoming an actor and, if the scheme succeeds, every individual in the EU – nearly 500 million people.

It would work like this: The government of the UK would allocate to each adult in the UK an equal per capita share of the 44% of the country’s emissions that are attributable directly to individuals (through fuel and electricity purchases). The remaining 56% of the UK’s carbon emissions would be auctioned to government and business.

That 56% operates in much the same way as the EU ETS. However individuals are now actors in the same market. If they emit less than their personal allocation, they can sell their emissions rights to those emitting more than their share. 

Decoupling emissions from growth

So what would happen if each person was financially responsible for his or her own emissions? Firstly we would find out where our allowance was going: do we drive a big car? Do we leave the lights on? Do we have the heating turned up too high? Do we take many flights? If there was a strong financial incentive and individual access to the market, we think we would see a rapid move away from wasteful to low-carbon lifestyles. People would look for low-carbon products and services to save on their emissions allocations. If there was demand for low-carbon products, entrepreneurs, in turn,  would develop and produce them for the market.  

Each year, to fight climate change, the carbon budget will have to shrink.  As the budget is shrunk,  the goods and services required to meet the  lowered targets will become available and affordable and a new low-carbon culture will continue  to propel this change. 

It would be good in other ways, too. It would enhance public health and energy security  and, indeed, the Contraction and Convergence model could also be delivered through this mechanism. So what starts out looking like an idea with a strong core of market economics, on closer inspection turns into something which speaks to the heart of a strong and just society.

Matt Prescott is the director of CarbonLimited. The Royal Society for the encouragement of Arts, Manufactures and Commerce (RSA) is at the heart of work to further the debate on personal carbon trading through the CarbonLimited project. CarbonLimited runs until December 2008 and is delivering a programme of research, public debate and piloting.

Homepage photo by Marek Futrega