Blind Faith in Markets

Pope Francis' new Encyclical Letter on climate change (Laudito Si') is making waves. Though I couldn't be happier to see the Vatican take a firm and proactive stance on climate, it's not for me to say what this should mean for the Catholic community. And it's too soon to say what impact the Encyclical will have on the international climate negotiations leading up to COP-21 in Paris later this year. But I feel like I need to weigh in on the policy community's response to the Pope's views on emissions trading. 

Many have noticed the Pope's critical views on unfettered capitalism, a theme that underlies his environmental message in the new Encyclical. He also has some harsh words about the experience with carbon markets to date. Here's a key passage:

The strategy of buying and selling “carbon credits” can lead to a new form of speculation which would not help reduce the emission of polluting gases worldwide. This system seems to provide a quick and easy solution under the guise of a certain commitment to the environment, but in no way does it allow for the radical change which present circumstances require. Rather, it may simply become a ploy which permits maintaining the excessive consumption of some countries and sectors. (Laudito Si' ¶ 171)

I think this particular passage is best read in light of the longstanding concern among developing countries that rich countries will use market-based mechanisms to avoid reducing their consumption of natural resources to a more equitable level, but there's no question the Encyclical raises doubts about markets. For example, the noted Harvard economist and carbon market proponent, Robert Stavins, views it as a direct assault on emissions trading

California exceptionalism

Over at Legal Planet, UCLA's Ethan Elkind picks up on this passage and suggests that the Pope has been unfair to California, where he says the experience with carbon markets has been positive:

I’ve been impressed with California’s efforts to implement [cap-and-trade] so far … the California Air Resources Board developed strong and thoughtful rules that have apparently worked to forestall market manipulation and garner real results in terms of emissions reductions. 

Where's the evidence of that?

I've been an outspoken critic of California's carbon market, which has devolved significantly from its intended design and is no longer effectively reducing net greenhouse gas emissions. But you don't have to take my word for it. From the final report (PDF link) of the California Air Resources Board's Market Simulation Group (MSG), here's the expected supply of emissions reductions in California's carbon market: 

 Abatement supply in California's carbon market — Source: MSG report, Figure 1

Abatement supply in California's carbon market — Source: MSG report, Figure 1

Looking just at the market's impact after taking account of complementary measures (like the Low Carbon Fuel Standard and the Renewable Portfolio Standard), here's how the MSG projected compliance in the carbon market: 

Abatement supply in California's carbon market — Source: MSG report, Table 6
Note: MSG report assesses multiple carbon market price scenarios. Today's market price is effectively at the allowance reserve price, and therefore I have shown only the MSG data for this price scenario.

Thus, according to the State's own market advisers, more than 85% of emissions reductions in the market are expected to come from changes involving out-of-state emissions. This includes (1) carbon offsets that allow in-state emissions to persist by claiming reductions in out-of-state emissions, and (2) resource shuffling, which occurs when the state's utilities claim credit for swapping their dirty electricity contracts with unregulated, out-of-state parties—a practice best described as an accounting trick that offshores greenhouse gas emissions liability. 

In other words, less than 15% of abatement is expected to come from reducing in-state greenhouse gas emissions. From my perspective, that's a lot closer to what the Pope called "a ploy which permits maintaining the excessive consumption of some countries and sectors" than a program that "get[s] the job done."

A safety net that pays for itself?

Elkind cites two other reasons to justify California's cap-and-trade program, both of which are much more important to the political economy of state climate policymaking and better describe its current reality. I'm glad he includes these points, but think much of the critical background was left out. Let me take a stab at filling that in. 

First, Elkind calls the carbon market a "critical safety net" that helps make sure the state reaches its 2020 target of returning to 1990 emissions levels. This is certainly how many stakeholders speak of state climate policy. During the development of ARB's original Scoping Plan, for example, one often heard the phrase "no ton left behind" used to describe the cap-and-trade program. As my colleague Michael Wara has consistently noted, this is because the bulk of California's climate mitigation efforts can be found in so-called complementary policies at the sector level, where effective carbon prices are perhaps an order of magnitude higher (yet less visible) than in the carbon market. Should any of California's complementary policies policies fall short—whether due to technical complications or litigation—then the comprehensive carbon market should step in.

In theory, then, the carbon market helps guarantee that the state's sectoral policies will reach its overall emissions target. Unfortunately, this view assumes that pressure to weaken the carbon market rules won't accompany an unfortunate outcome in sectoral policy—yet we've already seen that pressure overwhelm market regulators in the case of resource shuffling. So far California's complementary policies have survived intense litigation; time will tell how much mitigation they generate through 2020. Let's hope that these policies get the job done, and if not, that political leaders are willing to tolerate higher carbon market prices.

Second, Elkind points to the market's ability to raise significant new revenues for the state. This is by far the most important feature of the market in practice, not an incidental benefit that follows from an purportedly effective policy. It's time we start talking about this more explicitly, because if revenue generation is the political engine that drives state climate policy, there's no point in hiding that from public discussion. (To his credit, Elkind is out in front on this point—but others in the policy discussion are much more reserved in their public remarks.)

Instead of prematurely celebrating the market's success, experts should acknowledge the fiscal role it plays in state policymaking and seek ways to strengthen the overall system without overselling the market's benefits. I simply don't buy the idea that we're secretly going to raise a bunch of money for a climate revolution, even if this were an ethical approach to governing—and I don't think it is. Perhaps at $13/tCO2e (today's price) no one will notice. But to get to $50 or $100, which we will absolutely need to drive long term change, there's no way to hide the impacts. So let's get the discussions out in the open and build strong support for the road ahead. 

A welcome message

There's plenty of good news when it comes to California's climate policy—including many world class sectoral policies—but no evidence that the carbon market itself is driving emissions reductions. That doesn't mean the carbon market is worthless: perhaps it can serve as an insurance policy, or perhaps it will raise revenue to enable ambitious new policies going forward. Nevertheless, those functions are different (and in many ways inconsistent) with than the headlines arguments supporting carbon markets. 

For my part, I think the Pope's message applies to California's carbon market as it exists today—"in no way does it allow for the radical change which present circumstances require." Let's hope state policymakers rise to the challenge as California begins charting its path to 2030 and 2050 emissions targets. Even though California is a leader, we'll need much more effort to reach our goals.