Topic: Cap and Trade
Today, listening to NPR was really enlightening. Terry Gross was talking to Mark Schapiro about Cap and Trade and the Carbon economy. The work done by Mark is incredible. Basically, Cap and Trade is a program that has two parts - set the emission caps and trade the over the cap emissions. The system is amazingly speculative and according to this documentary, $150 billion is involved per year. So, here is the run down.
First the demand side:
Lets imagine a utility company being regulated in Europe has a carbon emission limit of 100 million tonnes. However, with the technology investments in place, they can only come to 120 million tonnes. So, the company will need to buy 20 million tonnes to satisfy the 100 million tonnes cap. The deal is that if you create it, someone else offsets it. For an airline, a DC-10 may be highly inefficient but they want to use it as it is paid for. The emissions for this plane may be twice that of a Boeing and when, in total, they exceed for a certain year, then the company has to go to commodities market to buy it.
Then the Supply side:
There are three ways for the company to offset the extra pollution -
- Go green - Adopt more green technologies. This option is the simplest and companies can take either the efficiency route or the conservation route. Many companies are giving incentives for conservation to their customers. The interesting fact is that the customer's love for environment is exploited and used to cover up for Vendor's inefficiencies. The second way is to reduce the energy usage by adopting more environment friendly technologies like Solar, wind or in some cases, planting trees.
- Partner with an offset creating firm and trade the credits. When a large utility company parterns with a tree plantation firm, they buy carbon credits from that firm to offset emissions. Do you remember the optional line item on your bill to offset carbon emissions. This is likely the guy who gets it. But remember, the customer still paid indirectly for the utility company's inefficiency.
- Go to public commodities market and buy the carbon credits. The utility company or airline can buy carbon credits from a developing country company or other company which is planting trees in Amazon forest or simply has extra credits because it is operating under capacity or not emitting enough.
This is the most interesting part of the trade. US is a non-signatory to the Cap and Trade agreement. About 37 countries included in the Kyoto protocol signed it. So, guess where the business of carbon credits is centered - London. Most big investment banks (the remaining ones!) have set up a shop there. They deal in carbon credits. They buy the carbon credits from across the globe and create bundles and sell them to the companies which exceeded their cap. They take deep cuts in the money and it keeps their fat wallets growing.
The Moral Dilemma:
There are several very disturbing things in this system:
- Carbon credit certificates are speculative in nature. They are regulated but by different bodies. They are based on future expectations not as of today. How do you measure the green house impact of a tree that has not been planted yet.
- Why the middlemen? Investment bankers have no business being paid for auctioning environment.
- It pays some companies for sitting idle. An undercapacity plant may trade off its carbon credits to an inefficient plant, thereby, having a Zero sum effect on the environment.
It almost seems like a fictitious market in existence. A bubble waiting to burst! Mr. Bernake, will u be there?