Inefficiencies of Cap and Trade

This article is the second of a three-part series on America’s Cap and trade system. In the last piece, we introduced the mechanisms driving America’s Cap and trade system and how large-scale firms like Tesla have managed to profit off of legislation designed to incentivize environmentally-friendly activity within the automotive industry.

The following article expands on some of the inefficiencies hampering cap and trade as an effective framework for building towards a carbon neutral world.

Introduction

We can look at the cap and trade approach to controlling emissions as a two-pronged initiative.

The simpler strategy is to encourage future investors to engage in deals that in and of themselves will reduce the production CO2 and other pollutants. That is, convince the producers of tomorrow to invest in low-carbon plants, electric vehicles, and so on.

The trickier method is to convince current business practices to abide by greener guidelines by incentivizing support and punishing opposition.

As viable as cap and trade is on paper, the success of any green initiative depends on how well it is designed and executed. In its current state, cap and trade has failed to hold the biggest emitters accountable and reduce emissions at a progressive rate.

Inefficient Emission Reduction and Accountability

From an economic perspective, cap and trade suffers due to low-allowance prices. Most cap and trade propositions fail to provide a price yield high enough to stimulate long term emission control.

For example, researchers at Carnegie Mellon University note that even a CO2 emissions permit of $50/ton will have an insignificant impact on demand reduction in the transportation industry: “for each increase of a dollar per metric ton of CO2, the price of a gallon of gasoline can be expected to increase by only about one cent.” As the team from CMU notes, current cap and trade proposals being discussed will not yield prices that high for several decades.

Low allowance prices have stunted even the most progressive of cap and trade programs. Viewed as the global benchmark for green initiatives worldwide, California’s cap and trade legislation has failed to reduce emissions in its oil and gas and automobile industries.

Most applications of cap and trade treat corporations as part of a geographically-defined group. In doing so, the onus of reducing emissions has fallen to a small subset of companies that have reaped the benefits of their green practices at the expense of their non-abiding competition.

The market-based approach to cap and trade has incentivized companies to buy and stash regulatory credits at an alarming rate. Peer reviewed studies have shown that, “by the end of 2018, companies had banked more than 200 million regulatory credits — enough for almost as many tons of CO₂ as the total reductions expected from cap and trade from 2021 to 2030.”

To make matters worse, recent cap and trade operations been shown to give away regulatory credits for free to some of its largest emitters. Fear of the competitive disadvantage that cap and trade has placed on businesses has convinced states like California to distribute regulatory credits to some of its biggest polluters (companies in gas and oil drilling) for free.

Inefficient Outcomes for Consumers

From a producer perspective, support for cap and trade should be positive regardless of what kind of firm you are. If you are GM or Ford and have failed to keep up with the evolution of the electric vehicle, then you will love cap and trade for its lenient punishments, cheap and easily available regulatory credits and lack of finger-pointing.

On the other hand, if you are Tesla, then cap and trade may well be the only thing keeping you alive. Tesla has been exceedingly rewarded under cap and trade for its forward-looking technology, eating the lunches of its competitors while simultaneously becoming the most valuable automaker in the world.

But what about the consumer?

Cap and trade was implemented to derail the negative externalities of polluting firms. Naturally, the trickle down effect of greener firms would benefit the consumer right? More stable climates, brand new job sectors, futuristic technology…

While these promises may one day ring true, the short-term realities of cap and trade for the typical consumer will mean things like hiked gas prices and job losses.

As difficult as some of the aforementioned issues will be to solve, it may be society’s overreliance on fossil fuels and other harmful emissions that proves to be the greatest barrier. As Stanford researcher Danny Cullenward warns, any attempts to rectify cap and trade in its current form risks a “politically toxic” consumer reaction.

Conclusion

The inefficiencies plaguing cap and trade are complex and interconnected in nature. Whether it be the political might of oil and gas conglomerates, consumer interest, or the price gap between fossil fuels and green alternatives, one thing remains.

If cap and trade is to remain the answer to climate change conundrum, then things need to change, and soon.

In the final article of this three part series, we discuss a framework for remedying the market inefficiencies of cap and trade.

This article is intended as a three-part series where we intend to update our stance and provide insight into alternatives to the current market mechanisms driving carbon neutrality. We are eager to learn so any feedback would be excellent. Thanks you for your time.