Systematic problems with Emissions Permits Trading and other forms of carbon trading

At present the cost of energy from renewable sources is higher than the cost of energy from burning fossil fuels. Emissions Permits Trading puts a price on emissions so that the cost of energy from burning fossil fuel will rise to be the same or greater than the cost of energy from renewables. This is then meant to spur investment in renewable energy sources which will replace fossil burning energy sources.

Scenario 1

Let us assume trading in permits works in encouraging investment in renewables. If it works then we will construct many renewable energy systems and due to technological advances the cost of renewables will go down. This means the price of emissions permits will go down. What business person will buy emissions permits today knowing that the price is likely to be lower tomorrow? If everyone thinks the same then we will see wide fluctuations in the price of emission permits with a corresponding instability in energy prices which leads to economic inefficiencies.

Scenario 2

Let us assume that the system gets going and existing energy producers purchase just enough permits to meet their current production. As the number of permits is reduced so the price of permits will rise well above the price needed to encourage renewables. This means that the price of all energy will rise to be just below the price of energy produced with high costing permits. This means that existing permit holders will get super profits and will not sell their permits but rather reduce their production which will in turn increase their profits because of the higher prices of all energy. This means it is in the interests of existing permit holders to make the cost of permits high and the best way of doing that is not to invest in renewables but to put the excess profits elsewhere.

Scenario 3

If the market in emissions permits works as in theory it is likely to be very volatile. Other financial markets such as exchange rates show a great range in prices for currencies even though we would expect that the relative values of currencies should be slow moving. As soon as the cost of energy rises well above the cost of renewables there will be political pressure to either increase the number of permits, ignore the permits or fiddle with the market in permits so that the price remains low. This will then defeat the idea of having a market in permits because the market will no longer be free.

Scenario 4

For emissions trading to work the cost of fossil fuel burning energy should rise to be greater than the cost of renewables. Assuming all the extra money collected from emission permits goes towards building renewable energy sources the cost of building enough renewable energy sources for a given reduction in emissions must be greater using this approach than a more gradual slower investment approach. This is because more money is spent earlier than later with permits because we know that the technology of renewables will become cheaper due to economies of scale and from learning how to better build plants. That is, emissions permits trading MUST be more expensive for a given reduction in emissions than a slower more gradual investment approach.


The above may or may not happen as suggested – or they all may happen to some level. Whatever the future of trading holds we can be assured it will not work the way predicted by computer models because trading involves decisions by many people many of whom can influence and change the rules. What we do know is that the system will be modified to try to keep it to its objectives of reducing emissions and not distorting the economy. The real problem with emissions permits trading is that we are not sure it will work at all. The evidence of other attempts at imposing global economic changes are not good. The ozone hole started to reduce but now appears to be increasing in size. The early attempts at European carbon trading failed. In Australia the attempts at carbon trading have failed. We can all postulate in retrospect why the systems failed but the most likely reason is that the underlying assumptions are flawed. The probability is high that any carbon trading system will fail. We cannot afford the time to experiment with systems that may or may not stop global warming.

A guaranteed solution to the problem

There is a guaranteed solution to the problem available to us. It is very simple and is built on existing systems that we know will work. The system operates as follows.

1. Put a flat tax on all carbon emissions.
2. Use the money from the tax to build renewable energy sources or to invest in energy saving methods or in ways to absorb carbon.

The argument against this approach is that governments are not good at spending taxes and we need markets to decide the best way to invest. This argument is a good one. The solution to the problem is to create a market to spend the taxes.

One way to do this is to give the tax money back to the people from whom it was collected but require them to spend the money on infrastructure that will reduce greenhouse gas emissions. We can make this even more effective if we give the money collected to those whose lifestyles produce few greenhouse gases . This means the distribution of money will have a secondary benefit of encouraging behaviour changes and of rewarding people whose lifestyles produce few greenhouse gases. As these people are often the poor the system is socially equitable.

This approach does not require ANY new economic systems. It only requires a system to keep track of the redistributed money and ensure it is spent in reducing emissions as agreed when it was given.

As the system involves a redistribution of money it makes no difference to the GDP of the country. What it does do is to force investment in renewable energy systems and in other ways of reducing greenhouse gas emissions and diverts money from other consumption.

It does this through a market in sustainable technologies so solving the issue of governments directing expenditure. Instead it allows the market to direct expenditure.

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