Cap-and-trade trumps taxes for clean tech adoption

Jul 08, 2011 By James Leonard

A cap-and-trade system is more likely than a carbon tax system to trigger the adoption of clean energy technologies, according to a study by professor Yihsu Chen at the University of California, Merced.

The study — coauthored by Chung-Li Tseng of the University of New South Wales in Australia and published this month in the Energy Journal, a quarterly journal of the International Association for Energy Economics — also found that the volatile pricing of a cap-and-trade system could lead to earlier adoption of clean technology by firms looking to hedge against carbon cost risks.

The study used economic models based on a framework of real options to determine the optimal timing for a coal-burning firm to introduce clean technologies using the two most commonly considered policies — cap-and-trade, in which carbon emissions are capped and low-emission firms can sell excess permits to high-emission firms; and carbon taxes, which employ a fixed monetary penalty for per-unit carbon emissions.

"To our knowledge, there has been no formal study based on real options that compares the investment timing of these two instruments," Chen said. "In our view, cap-and-trade offers ‘carrots' while taxes offer ‘sticks.' Cap-and-trade induces firms to explore profit opportunities, while taxes simply impose penalties to turn clean technology into a less costly option."

For the study, the researchers considered a scenario of a relatively small firm that owns a coal-fired power plant and is obliged to supply power to its customers. They compared cap-and-trade and models in determining when the firm would choose to add a natural gas power plant, a relatively resource, in order to meet its energy demands while maximizing its long-term profits.

The study found that when considering the relationship of the related costs and risks, the cap-and-trade model triggered the adoption of clean energy technology at a lower overall price than a tax policy did. Further, the study found that the volatility of unfixed permit prices — often a criticism of cap-and-trade policies — was the key difference that led the firm to add a natural gas plant earlier than it would have under a more predictable tax system.

Chen's study is yet another example of UC Merced faculty conducting research into some of society's most challenging problems.

"In this time of global climate change, policy choices are critical in steering polluting industries toward more timely of clean technologies," Chen said. "Based on our study, mechanisms designed to reduce cap-and-trade permit prices or suppress price volatility — which have been implemented in existing cap-and-trade programs like the Regional Greenhouse Gas Initiative — are likely to delay investments."

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GSwift7
3 / 5 (6) Jul 08, 2011
also found that the volatile pricing of a cap-and-trade system could lead to earlier adoption of clean technology by firms looking to hedge against carbon cost risks


The problem, of course, is that it has been tried and it has failed in every attempt so far. The inverse relationship between the carbon credit price and attainment of the goals makes the program less and less effective over time, and when the funds get mis-directed to the general fund to cover government budget problems, members begin to jump ship. Perhaps the idea can work, but not in the formats attempted so far. I have said from the very beginning that it will not work as long as it is set up as a cash grab for greedy third party speculators and cash-strapped governments.
GSwift7
3 / 5 (4) Jul 08, 2011
continued:

I hate to say this, but the way Obama is trying to do it now, through EPA regulations, is probably a much better method. I would suggest a lot of changes to the way it is being done though.

My largest concerne is that the final cost of any of these types of measures is eventually passed on to consumers of energy. That would be me. If I am going to pay the price for this, then I want a guarantee that the money will benefit me in some tangible way. They need to make sure the funds go towards research, infrastructure projects, and incentives for energy efficiency for consumers. I haven't been able to figure out where the EPA fees are being directed under Obama's current plan, but I fear that they will just go into the EPA operating budget. The biggest problem with using EPA regulation is of course the cost of EPA oversight. Maybe they could privatize the audit system with contractors or something to reduce the cost. I don't know how, but EPA is not very cost effective.
GSwift7
1.8 / 5 (4) Jul 08, 2011
continued again:

They need to make sure the funds go towards research, infrastructure projects, and incentives for energy efficiency for consumers.


By the way, the Department of Energy already has those programs, so it would be relatively easy to direct the EPA carbon fines into the existing DoE programs without incurring hardly any additional administrative costs in the process. Just PLEASE don't set up a new government agency to duplicate the work of existing agencies.

I don't support eliminating our government, but there are lots of innovative ways that we could make it function a lot more efficiently. My current occupation is in the field of Lean Manufacturing. They could apply the Lean principles of eliminating waste, just like so many major companies are doing.
emsquared
4.3 / 5 (4) Jul 08, 2011
I hate to say this, but the way Obama is trying to do it now, through EPA regulations, is probably a much better method.

Don't fool yourself. Costs of compliance with regulation by the EPA are also passed on to the consumer. Which don't get me wrong, most of the EPA's regulations are good, necessary things which better air quality by removing pollutants that are direct threats to health and environmental quality.

My problem with the EPA though is they have no effective check or balance, yet enact policy that is as good as law and directly effect society and the economy. Did you know, according to the EPA you breath out a toxic substance?
GSwift7
2.7 / 5 (3) Jul 08, 2011
Don't fool yourself. Costs of compliance with regulation by the EPA are also passed on to the consumer


Yeah, I know. I'm just saying that the regulations versus the trading scheme is a tough choice and that the regulations might be the lesser of those two evils.

I agree about the EPA being too omnipotent, but it really isn't that much different from other agencies which do basically the same thing. The SEC, FAA, IRS or TSA, for example. If everything our government does needed to go through Congress, then we would be in big trouble.

As a general rule of thumb, when a regulation is questionable I would say that it isn't a good regulation. In that case it should either be changed or eliminated.
emsquared
3 / 5 (2) Jul 08, 2011
I'm just saying that the regulations versus the trading scheme is a tough choice and that the regulations might be the lesser of those two evils.

True, at least regulations would accomplish a definite decrease in CO2 (and give me greater job security :D). I fear any cap and trade system would just shuffle it around, resulting in no net reduction in CO2 emissions, which is of course presumably the point, yet still cost the consumer.
I agree about the EPA being too omnipotent, but it really isn't that much different from other agencies which do basically the same thing.

Also true, however I would argue the EPA has a much greater purview then any other that I can think of, with minimal effort put into the thought ;P Every good or service can be tracked back to CO2 at some point, everything. Also, having dealt with various levels of the EPA and subordinate authorities, it bothers me how few science trained professionals work for them in decision making roles based on science.
lengould100
3 / 5 (6) Jul 08, 2011
Cap-and-Trade is a fabulous thing ... for brokers and traders. Who like to publish "studies" confirming thier opinions. And own congress.
GSwift7
1 / 5 (1) Jul 08, 2011
Also true, however I would argue the EPA has a much greater purview then any other that I can think of, with minimal effort put into the thought


I think the biggest difference for the EPA is that they get so much more outside pressure from special interest groups through law suits. You don't see environmental groups bringing legal charges against the FAA all the time. I think that tends to cloud the mission of the EPA with things they don't want to mess with in many cases.
omatumr
2 / 5 (8) Jul 08, 2011
A cap-and-trade system is more likely than a carbon tax system to trigger the adoption of clean energy technologies


The problem is the lack of scientific evidence that CO2 causes global warming.

1. "Super-fluidity in the solar interior: Implications for solar eruptions and climate",
Journal of Fusion Energy 21, 193-198 (2002):

http://arxiv.org/.../0501441

2. "Earth's Heat Source - The Sun", Energy and Environment 20, 131-144 (2009):

http://arxiv.org/pdf/0905.0704

With kind regards,
Oliver K. Manuel
Former NASA Principal
Investigator for Apollo

Shakescene21
5 / 5 (1) Jul 09, 2011
Professor Chen's analysis is only valid for industries that do not produce internationally-traded products. The fatal flaw to cap-and-trade is that consumers can simply buy imported products, and the amount of CO2 generated is even greater than before. (Chinese manufacturing is very carbon-intensive, and then the product must be shipped across the Pacific.) It would violate WTO treaty agreements to place a special duty on imported CO2-intensive products. In contrast, with the carbon-tax approach a special carbon tax on imported products for imputed-CO2 emmissions will probably pass WTO review, although this is still to be determined.
Uri
5 / 5 (2) Jul 11, 2011
continued:
My largest concerne is that the final cost of any of these types of measures is eventually passed on to consumers of energy. That would be me. If I am going to pay the price for this, then I want a guarantee that the money will benefit me in some tangible way.


Agreed, I'd be much more inclined to support a carbon tax if the revenue generated was used for Energy R&D or even just went to the National Park Service, or making funds be available to make roads more bike friendly etc. If it just goes back into the general fund its just as likely to get used for something I wouldn't support.

As for cap & trade it just reminds me too much of the Catholic church granting indulgences, there is too much room for abuse, and no way to guarantee that goods won't be purchased/manufactured outside the country.
GSwift7
3 / 5 (2) Jul 12, 2011
As for cap & trade it just reminds me too much of the Catholic church granting indulgences, there is too much room for abuse, and no way to guarantee that goods won't be purchased/manufactured outside the country.


As a case in point, Germany is claiming emissions reductions. According to articles I have read, they are reaching those goals within their borders but only because they are buying coal-fired power from neighbors who are not part of the European Carbon Trading Scheme. They closed down a few relatively clean plants in Germany, which ran using reasonable but not perfect scrubbing tech. Now they get power from former Soviet Eastern Europe which still uses the oldest and dirtiest coal tech available. The secondary effects of sending billions of Euros out of the country to buy power from other countries is insane too. The off-shore wind farms in Germany are not sustainable either. The North Sea is too rough. Maintenance is a nightmare, and they seldom operate for long.
omatumr
1 / 5 (2) Jul 12, 2011
This has absolutely nothing to do with the threat of CO2-induced global warming [Or the 1974 global climate scare of "Another Ice Age"]: www.time.com/time...,00.html

It is part of a 40-year plan to pretend global climate
change is "our common enemy" in order to:

a.) Unite nations,
b.) End nationalism and the threat of mutual
c.) Destruction in a full scale nuclear exchange.

I endorse those noble goals, but not abuse of science

To establish a one-world, tyrannical government like George Orwell described in the book, "1984."

www.online-litera...ll/1984/