Streetwise Professor

April 25, 2013

The Euros Wanted to Make A CO2 Market in the Worst Way, and They Succeeded!

Filed under: Climate Change,Economics,Exchanges,Politics,Regulation — The Professor @ 4:34 pm

There’s lots of angst in Euroland over the plunging price of European Union CO2 Allowances.  Trading activity has crashed along with prices. And the Eurocrats are casting about ways to “fix” the “problem.”  And Eurocrats being Eurocrats, their mooted fixes are interventionist monstrosities that make a mockery of the idea of a “market” for CO2.

The reason for the price decline is blindingly obvious.  The European economy is sputtering, and lower industrial activity translates into lower output of CO2, and hence lower demand for emissions allowances.

In other words, the Europeans wanted to reduce CO2 emissions, and they got their wish.  Just not the way they intended: a bad economy accomplished their mission for them.   If they’re so intent on reducing CO2, you’d think they’d be happy.

But no, of course, they’re not.  They were hoping that economic activity would be robust, and that the resulting demand for allowances would keep the price high, thereby making powering this activity by fossil fuels more expensive.  This, in turn, would lead to greater reliance on no-carbon renewables like wind and solar.  In this version of Euro Disneyland, where wishes come true, windmills and solar panels would be powering a thriving economy: they would have their low carbon cake, and their economic growth ice cream too.

But no such luck. The sluggish economies, and the resulting low price of CO2, have delivered a body blow to the economics of renewables.

And that’s where much of the angst is coming from.  If it was all about reduced CO2 output, it shouldn’t really matter how you get there.  But of course investors in wind, solar, etc., want to support those investments, and the cratering of the CO2 price is very bad news for them.

So the angst is about protecting investments in renewables.

How are they going to go about this?  There have been proposals to delay the issuance of some new allowances for a couple of years to support the price, but these were shot down in the European parliament.  That delay-“backloading”-was considered by many to be prelude to canceling them altogether.

Such interventions make a mockery of the idea of a carbon market.  The man-made “supply” of allowances is subject to change at political whim, and becomes contingent on price, and how that price affects political constituencies.  This adds a huge element of risk to trading in this market.  It also adds a huge element of risk to any investment that depends on the price of CO2.  This can include not just wind and solar, but conventional power plants, and any other investment (e.g., refining or chemical manufacturing) that emits CO2.  And once the EU allows the economic interests of industries to drive supply decisions so as to affect price, all these affected parties have an incentive to influence the process.  That consumes real resources, and given the unpredictable and shifting nature of political equilibria, adds to the uncertainty over future supply.

In other words, these man-made carbon markets are not time consistent.  Unless the EU can commit not to change supply in the future, the “market” will largely involve speculation on future policy, with a huge degree of feedback.  Speculations about policy will affect prices, and prices will affect policy, which will affect prices, and on and on.  (Example: the price of CO2 allowances fell by 50 percent when the Euro Parliament rejected backloading.)

Which is wickedly ironic, given Euro attitudes about speculation.

That’s no way to make a market.  And come to think about it, any “market” that is a completely political construction is almost a contradiction in terms.  It can be at best a simulacrum of a market, at most a form of “market socialism”, but not the idealized market socialism of years past, but a market socialism buffeted by special interest politics and political economy considerations.

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  1. It’s more than protecting investments in renewables. Haven’t all of these geniuses promised a Green Revolution where jobs will be coming out of our ears because of this new economic renaissance? They’re in denial that it isn’t happening (actually, just the opposite) And you’re right, this “market” stinks to high heaven. It’s as if they’re reading from a Russian playbook with their commodities “market.” Whatever happened to “fairness”? Doesn’t this just put the carbon market in a few elite hands? It’s almost Stalinist (without the collective farms) that they can do anything if they just have the political will to do it. What’s happening in the California carbon market nowadays? I never know how to tell.

    Comment by Howard Roark — April 25, 2013 @ 5:39 pm

  2. In other words, the Europeans wanted to reduce CO2 emissions, and they got their wish. Just not the way they intended: a bad economy accomplished their mission for them.

    As PJ O’Rourke said:

    “We were going to stop global warming by signing the Kyoto protocol on greenhouse gas emissions. Then we realized the Kyoto protocol was ridiculous and unenforceable and that no one who signed it was even trying to meet the emissions requirements except for some countries from the former Soviet Union. They accidentally quit emitting greenhouse gases because their economies collapsed.”

    Comment by Tim Newman — April 26, 2013 @ 1:20 am

  3. Carbon credits are laughable. A carbon credit is produced when someone certifies to some bureau that he has avoided creating an amount of greenhouse gas. So, people are being paid for what they are not doing, after promising that they would have done it, but for the credit scheme.

    Accordingly, I expect relentless competition in bringing efficiency to bear on NOT DOING things. This has to bring the cost of carbon credits to near zero, regardless of greater or lesser emission of CO2 because of industrial activity.

    A carbon tax would be expensive, increase prices, and be politically dangerous. I think it would be a mistake as being wildly costly compared to the costs of global warming, whether man made or not.

    In comparison, carbon credits are a boon to politicians and their cronies, generating politically distributed profits extracted from energy industries. This also raises prices, but in such a diffuse way as to avoid most political danger.

    Why do politicians want credits to remain expensive? Their early schemes were not as efficient at doing nothing, and they want a return on their early investment and real costs in producing credits. It is protection of an early industry from later, more efficient competitors.

    Comment by Andrew_M_Garland — April 26, 2013 @ 1:37 am

  4. ( Add this to my previous comment )

    === ===
    [edited] The CDM scheme allows firms manufacturing HCFC-22 to earn huge carbon credits by destroying its byproduct, HFC-23. Since the cost of producing HCFC-22 is lower than the revenue generated by the sale of carbon credits issued for destroying HFC-23, it is possible that HCFC-22 is being manufactured solely for the purpose of destroying its byproduct and earning carbon credits instead.

    Over 50% of the total carbon credits issued until July 2012 were for the destruction of HFC-23 (Hydro Fluoro Carbons-23).

    Renewable energy projects like wind, solar and biomass, together, account for less than 30% of the total carbon credits issued in India. The figure is 20 per cent for the world.
    === ===

    Who could have predicted this? I daresay not the politicians.

    Comment by Andrew_M_Garland — April 26, 2013 @ 1:39 am

  5. Accordingly, I expect relentless competition in bringing efficiency to bear on NOT DOING things.

    Major Major’s father, from Catch-22:

    “His specialty was alfalfa, and he made a good thing out of not growing any. The government paid him well for every bushel of alfalfa he did not grow. The more alfalfa he did not grow, the more money the government gave him, and he spent every penny he didn’t earn on new land to increase the amount of alfalfa he did not produce. Major Major’s father worked without rest at not growing alfalfa. On long winter evenings he remained indoors and did not mend harness, and he sprang out of bed at the crack of noon every day just to make certain that the chores would not be done. He invested in land wisely and soon was not growing more alfalfa than any other man in the county.”

    Comment by Tim Newman — April 26, 2013 @ 4:51 am

  6. See… the eurotards can succeed. The politicians doled out favors to constituents, increased taxes on citizens (ratepayers) and lowered C02 all at the same time. It is rather amazing.

    Comment by scott — April 29, 2013 @ 2:40 pm

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