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Emissions Trading: A Brief Resume

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
November 26th, 2008

My latest approach to the interior mechanics of emissions trading began with going into the library of the Asian Institute of Technology (Bangkok) when I was teaching there last year, and later the universities of Stockholm and Uppsala, and examining everything I could find on this subject, particularly in economics textbooks. That was when I rediscovered something that I had become painfully aware of many years ago.

THE DIFFERENCE BETWEEN ECONOMIC SCIENCE AND REAL SCIENCE IS THAT THE LATTER DEALS WITH THE BEHAVIOUR OF NATURE, WHILE TOO MANY PRACTITIONERS OF THE FORMER ARE OBSESSED WITH COMPREHENDING THE BEHAVIOUR OF MODELS, ALTHOUGH MANY OF THOSE MODELS HAVE NO RELATION TO ANY STATE OF NATURE THAT EXISTS ON THIS PLANET, OR IS LIKELY BETWEEN NOW AND DOOMSDAY.

In these circumstances it might be suggested that emissions trading is an excellent way to get rid of excessive carbon dioxide (CO2) employing what the game theorist Ken Binmore calls a “toy market”, by which he means a market that is devoid of annoyances like risk (or uncertainty), monopoly, irrationality, dishonesty and anything else that prevents a few simple equations from being put on a blackboard for the delight of drowsy teachers and students. Despite a statement in Newsweek that in order to suppress excessive CO2, the United States needs a cap-and-trade system of the kind providing ‘wonderful’ results in Europe, the ugly truth is that the European arrangement is completely without any economic or environmental value except for the brokers and ‘intermediaries’ who expect to get rich by playing games with ‘emissions credits’. When given the opportunity I describe cap-and-trade as a cynical deception.

One of the best short accounts of the flaws of emissions trading originates with Emma Johansson (2003), who points out that “…a utility that runs fossil fuel-fired plants will be exposed to an additional price risk that affects risk and return. As a result the classic spark spread (price difference between the price of electricity and the price of the fuel used to generate the electricity) will have an additional component.” What Ms Johansson forgot to add was that according to mainstream economic theory, this increase in risk will almost certainly reduce the investment in physical capital, and therefore many of the new electric generating plants that are essential for maintaining our standard of living later in this century might not be constructed. After reading the Johansson paper interested parties can scrutinize a short article by Uwe Maassen in the same publication, which examines some further inconveniences that can come about if an unreasonable confidence is placed in ‘carbon trading’.

In a recent issue of the Newsletter of the International Association for Energy Economics (IAEE)), Mr Erling Mork accused me of failing to understand the magnificent service that he feels is being rendered electricity consumers and producers by the presence on this earth of the Nordic Electricity Exchange (Nordpool). The truth is that I am one of the few persons in the academic world who is fully cognizant of the makeup and functioning of that establishment, in that among other things I am aware that without Nordpool and the electric deregulation ‘scam’ of which it is a part, my electricity bill and that of my colleagues would be considerably lower.

Fortunately, Mr Mork opened his critique by admitting that Nordpool has suffered liquidity problems, which was a signal for me to relax and forget about searching his unhappy communication for any imperfections in logic, because it is a well known fact in theoretical economics – dating back at least to the work of Leon Walras in the l9th century – that if an auction market has inadequate liquidity, then it is best for both its present and potential customers if it closes its doors (or cancels a particular contract). As it happens though, Nordpool can continue with its elegant ‘hustle’ because with a little luck and some help from paid and unpaid publicists, marketable emissions contracts might be capable of turning the unfolding financial winter into summer for a few neophyte Gordon Gekkos and ‘masters of the universe’. By way of contrast, like the various components of the electric deregulation swindles, there is no guarantee that ‘carbon trading’ is capable of providing appreciable benefits for producers or consumers or anybody else not actively engaged in eulogizing emission based assets to gullible individuals who do not understand that in reality they should not exist.

As to be expected, the head of the New York Mercantile Exchange (NYMEX) claims that emissions trading will “evolve to be big business”, but at the same time he has made it clear that NYMEX will not swing into really serious action until, in his words, he sees which of the existing contracts “developed gravity”. By gravity he could conceivably mean liquidity, although I am not sure, but when I find myself dining again at my college in Sydney, I intend to inquire if there is anyone present who could explain whether that bizarre expression has a background in standard English.

According to Andrei Marcu of the International Emissions Trading Association, “Europe is now clearly committed to action on climate change, whatever happens to the Kyoto treaty.” I’m sure that he is sincere in this belief, because his salary (and bonuses) will depend on the trading successes of carbon permits, and not the fate of the Kyoto Protocol nor a reduction in the stock of physical carbon in the atmosphere. For him and his collaborators, cash comes first, and carbon in its various forms somewhere to the rear. Another heavyweight player in this burlesque, Professor Michael Grubb of London’s Imperial College, as well as the ludicrously named ‘Carbon Trust’, informed The Economist (UK) that “Kyoto was designed for the rich countries to miss their domestic targets. That’s why we included international emissions trading.” (April 3rd, 2004). The identity of the “we” to whom he was referring was not clarified, however for the purpose of the present contribution it could apply to everyone with expectations of a first-class ticket on what they hope will become a carbon-trading gravy train, which means at least a battalion of ‘wannabes’.

NEW SOUNDS FROM STOCKHOLM

Several years ago the Swedish minister of industry announced that Swedish firms that are heavy users of energy will have their energy taxes reduced if they take steps to become more energy efficient. Ceteris paribus this makes sense, because the minister and his advisors might have been thinking in terms of a technology based approach to CO2 suppression that could serve as an alternative to emissions trading, or for that matter a substitute for some half-baked political initiative that would force energy intensive firms to move out of the country. But as I argue in the first chapter of my new energy economics textbook (2007), the Swedish government could best assist in carbon suppression by reopening the nuclear facilities in the south of Sweden that were prematurely closed, while at the same time constructing another large facility that made full use of the latest technology. If this were done, then any commitments Sweden has accepted for reducing CO2 could be efficiently satisfied without having to utilize the services of retrograde organizations of the Nordpool variety, because nuclear installations permit an enormous reduction in the output of CO2.

Discussing this sort of tradeoff in Sweden is a waste of time however, because what we have in this country is a variant of the situation in Berlin when the Soviet Army entered the suburbs of that exciting city just before the end of the Second World War, and Josef Goebbels stood on a balcony and gave a thrilling speech to several thousand over-age combatants before he sent them out to be massacred. Here, in the land of the Midnight Sun, politicians and certain higher civil servants diligently practice a servile conformity to international pressures and crank concepts, in order to be rewarded with a quantum of recognition when they prance through the corridors of the European Union’s headquarters in Brussels. If this means that Swedish taxpayers must bleed, then the discomfort of these citizens is one of the penalties that must be accepted for choosing to live in Scandinavia instead of Pago-Pago or on the rim of the Kalihari.

Some persons may be dissatisfied with my terminology in this contribution, as well as the manner in which I have approached certain issues – for example comparing emissions trading to the widely acknowledged fiasco of electricity deregulation. Occasionally I receive mail from critics, whom I immediately inform that I would be genuinely overjoyed if they appeared in Uppsala some fine day for the purpose of ventilating their objections in an open forum. But if they did, I would have no choice but to make it clear that the directors of many energy intensive companies in Sweden – despite their traditional preferences for market-based solutions – have for the last few years informed friends and neighbours in this country and elsewhere that emissions trading is one of the worst ideas ever hatched, and may cause irreparable harm to consumers as well as the Swedish economy.

Unfortunately I can remember failing to convince one of my former mathematical economics students that he should accept the above assertions at face value. He wanted some ‘algebra’, and this is what I gave him. A few years ago the Swedish government planned to issue one group of companies emission permits for 250,000 tonnes of CO2 per year. The emissions from these companies were 450,000 tonnes the previous year, which implied that if those enterprises wanted to maintain the output of the previous year, then they would have to go into a ‘market’ (or perhaps better what the prominent New Zealand economist Owen McShane called a “pseudo market”) and purchase – at an unknown price – emission permits that gave them the right to emit about 200,000 tonnes of CO2.

Purchase at an unknown price! Isn’t this the kind of dilemma that Emma Johansson was talking about, and which may be one of the reasons why even Jerry Taylor – senior fellow and environmental researcher at the conservative Cato Institute (in Washington D.C.) – has expressed a preference for carbon taxes over cap-and-trade foolishness. I too have a preference for carbon taxes, because among other things it may be possible to design a system in which the tax revenues can be returned (in some simple or complicated way) to the aggregate of enterprises paying these taxes. Let me also express my sincere hope that the important algebraic excursus above was not too difficult for present readers, because it might be true that even I would have been able to arrive at the correct solution (=200,000 tonnes of CO2) shortly before being expelled from engineering school (in Chicago) for poor scholarship, and informed on the same day by the splendid Dean of Engineering that I was completely hopeless.

Although not called a tax, the emissions trading referred to in this note is equivalent to a tax, and as we know from elementary and intermediate microeconomics textbooks, the tax will be divided between producers and the persons who purchase energy from them – depending upon the elasticities of supply and demand curves. Of course, consumers who use the services of energy firms could avoid to some extent increased electricity prices by the simple expedient of spending at least a part of their winters in Darfur or exotic Guadacanal, or if those options are too expensive they could try wearing thick fur underware and fur-lined baseball caps indoors, but despite the proven ability of the Swedish electorate to accept all sorts of nonsense from their political masters, I suspect that they would soon find themselves wondering if they really and truly wanted emissions trading complicating their lives.

A FINAL COMMENT

Before receiving feedback and questions I would like to express once more a genuine belief that emissions trading (or carbon trading) or cap-and-trading is one of the most absurd departures in modern economics, and is exceeded only by the scandalous resort to electric deregulation. Both of these ‘work’, if that is the correct expression, only in the early chapters of elementary economics textbooks that view supply and demand through the rosy prism of full competition. In case readers have forgotten what that means I cite the criteria given by O’Sullivan and Sheffrin in their excellent introductory textbook: informed buyers and sellers, perfect competition, and no spillover benefits and costs. What about uncertainty? Well, sharp and alert consumers and producers could be beautifully informed about present economic phenomena, but they might have a problem estimating the course of events in the coming years. If this is true, then it might be a good idea to remember something that Fredrik Nietzsche said: ”The future is as important for the present as the past”, and the misty future that characterizes emissions trading is even more important, although nothing can be done about it!

Readers who might want a more extensive acquaintance with this topic should turn to the publications of the CARBON TAX CENTER, which can be located via Google, as well as the article by David Victor and Danny Cullenward in Scientific American (2007), which has the title ‘Making Carbon Markets Work’. Also of interest is a paper by Ruth Greenspan Bell (2006). And finally I want to mention – without naming – a ‘newsletter’ in the great city of New York whose personnel seem to have a strong professional belief in the emissions trading scam, and whose manager has given me a negative recommendation similar to the one I received from the Dean of Engineering at Illinois Institute of Technology, although on this occasion I was not quite sure if it was fully deserved.

REFERENCES

Baltscheffsky, S. (1997). ’Världen samlas för att kyla klotet’. Svenska-Dagbladet

Banks, Ferdinand E.. (2009). Economic theory and the price of oil. Forthcoming.

_____(2007). The Political Economy of World Energy: An Introductory Textbook. London, New York and Singapore: World Scientific.

_____. (2004). ‘A faith-based approach to global warming’. Energy and Environment, Volume 15, Number 5: 837-852.

_____.(2001) ‘Global Finance and Financial Markets’ London, New York and Singapore: World Scientific

_____. (2000). ‘The Kyoto negotiations on climate change: an economic perspective. Energy Sources (Volume 22, July).

Bell, Ruth Greenspan (2006). ‘The Kyoto Placebo’. Issues in Science and Technology: Resources for the Future.

Beyer, Jim (2007) ‘Comment on Banks’. Energy Pulse (www.energypulse.net).

Frank, Robert H. (2007). Microeconomics and Behavior. New York: McGraw- Hill.

Goodstein, David (2004). Out of Gas: The End of the Age of Oil. New York and London: Norton.

Harlinger, Hildegard (1975). ‘Neue modelle für die zukunft der menshheit’ IFO Institut für Wirtschaftsforschung (Munich).

Johansson, Emma (2003). ‘The current status of the greenhouse markets’. Oxford Energy Forum (May).

Maassen, Uwe (2003). ‘The EU’s proposal concerning emissions trading’. Oxford Energy Forum(May)

Nadeau, Robert (2008). ‘The economist has no clothes’. Scientific American (April).

O’Sullivan, Arthur and Steven H. Sheffrin (2008). Economics: Principles and Tools.New Jersey: Prentice Hall.

Stipp, David (2004). ‘Climate collapse’. Fortune (Feb. 9, 2004).

Yohe, Gary W. (1997). ‘First principles and the economic comparison of regulatory alternatives in global change’. OPEC Review. 21(2): 75-83.

Victor, David G. and Danny Cullenward (2007). ‘Making carbon markets work’. Scientific American (2007).

Professor Ferdinand E. Banks
November 26th, 2008
ferdinand.banks@telia.com