More Carbon Offsets

The recent assertion that Al Gore is a carbon glutton has led to quite a number of articles and commentaries about "carbon offsets," which is like "cap and trade" policy being discussed as part of our policy toward global warming.

The basic idea of "cap and trade" (or carbon offsets) is an idea that comes from environmental economics. Different sources for controlling carbon emissions will have different marginal costs of control, and this means that it is possible to design, in principle, a public policy that achieves a reduction in carbon emissions at least cost.

Say that the cost to me of reducing one ton of carbon emissions from my economic activities would be $50. Suppose also that someone else is able to reduce a ton of carbon emissions from their own economic activities at a cost of $40. It would then be possible for me to pay this other person, say for illustration $44, to would reduce 1 ton of carbon emissions from his economic activities. The result would be a decrease in carbon emissions by one ton. At the same time, the other person would make an extra $4 on his supply of carbon emissions reduction to me, and I would keep an extra $6 in my pocket. As always, both parties to the voluntary exchange would be better off. At the same time, from the "social point of view" the cost of this additional 1 ton of carbon emissions reduced cost $6 less than if I had been the person to reduce the carbon emissions.

The WSJ summarizes well the reason for liking a cap and trade or carbon offsets approach to climate change policy:

This kind of trading works, and we've argued in these columns that cap-and-trade beats the pants off just plain capping by lowering the overall economic burden of a cap.

Unfortunately, even when the wisdom in the economic ideas gets the attention of our elected leaders in Washington, the way politics works means that if "cap and trade" is the basis for the public policy chosen to deal with climate change, it is most likely that "cap and trade" will not be implemented in a fashion that actually is the "cap and trade" from economics.

The same commentary in the WSJ points this out as well:

The difficulties don't lie with the trading, but with the cap, which is where the companies lobbying for restrictions come in. James Rogers, CEO of Duke Energy, put it plainly earlier this year: "If you're not at the table when these negotiations are going on, you're going to be on the menu." Translation: If a cap is coming, better to design it in a way that you profit from it, instead of being killed by it.

Which is why the emphasis really should be cap-and-trade. It's all about the cap, because without it there's no trading. We don't buy our daily ration of oxygen because it's in abundant supply. Same with carbon dioxide--there's no constraint on your ability to produce CO2 until the government creates one. When it does, it creates an artificial scarcity. What Duke, Entergy, TXU, BP, Dupont and all the rest want is to make sure that when the right to produce CO2 becomes limited, they're the ones that end up owning the allowances. Because that would mean they could sell them, and make money off something that previously wasn't worth a dime.

Thus, Entergy, a utility that relies heavily on natural gas and nuclear power and thus produces relatively less CO2, would love a cap that distributes the allowances based on how much electricity you churn out, rather than on how much CO2 you produce. Entergy's "carbon footprint" is small compared to some other utilities, so an electrical-output-based cap would be windfall city. Dupont, meanwhile, wants credit for reductions already made because it sees instant profit in costs already paid. It also wants a cap to cover as many industries as possible so it can make money selling emissions-reduction products.

We don't begrudge anyone the opportunity to make a buck. But there's a difference between making money by producing things people want and making money by gaming the regulatory process. There's no market here unless the government creates one, and who has the profit opportunity depends entirely on who the government picks as the winners and the losers in designing this market in the first place. So it's no wonder that almost any business that has ever put an ounce of CO2 into the atmosphere is rushing to show its cap-and-trade bona fides.

Note carefully what the businesses in support of cap and trade want the design of the cap and trade policy to look like. Basing the policy on electricity production isn't the economic idea, which of course focuses on the carbon emissions. Allowing previously achieved reductions to be sold later, is also not really the economic idea because so far there has been no cap imposed. Political incentives, rent seeking, and compromise are ideas that characterize the way our system of politics works, and they all point to the expectation that even a good economic idea is pretty unlikely to actually ever be implemented as conceptually explained and conceived.

The concluding paragraph in the WSJ commentary points to Bruce Yandle's theory of bootleggers and baptists that has been spawned by public choice theory:

The emerging alliance of business and environmental special interests may well prove powerful enough to give us cap-and-trade in CO2. It would make Hollywood elites feel virtuous, and it would make money for some very large corporations. But don't believe for a minute that this charade would do much about global warming.

The baptists of global warming are of course the environmental special interests and the virtuous Hollywood elites, and the bootleggers are the existing businesses that will provide the money to grease the wheels of climate change politics in return for the ability to design the rules in their favor. Unfortunately, this is just the way our system of political economy works.