EU Energy Policy Blog

Part 1 and Part 2 of this series explained why caps have been rejected by developing countries, why offsets can’t do the job, and why we need to expand from caps to carbon pricing. This part 3 outlines Flexible Global Carbon Pricing, a plan for re-orienting the Kyoto Protocol toward international cooperation.

COOPERATION. Flexible Global Carbon Pricing (FGCP) follows the basic economic principle of the Kyoto Protocol which was designed to establish a global carbon price. But the FGCP design philosophy is almost the opposite. Instead of focusing mechanically on emission targets, FGCP is designed to encourage international cooperation.
For example, flexible pricing allows a choice of capping or taxing carbon instead of rigidly insisting on caps. Allowing this choice helps accommodate national political realities. The Environmental Defense Fund (EDF) has always argued that caps were essential, because the U.S. electorate would reject a tax. This ignores the fact that the Indian electorate would reject a cap that is ten times lower than the American cap.
EDF insists that science tells us the limit on emissions, so we must use caps not taxes. But science only talks about global limits, not national limits, and its answers are imprecise. Also limits do not provide certainty, but are easily changed or disregarded. Insisting on caps makes the price of carbon highly uncertain and the cost to society uncertain. This makes agreement and cooperation more difficult.

FLEXIBLE GLOBAL CARBON PRICING consists of (1) a definition of national carbon price, (2) the Pricing Incentive, (3) its adjustment rule, and (4) a Clean Development Incentive. There is also the global price target, P*, which is decided politically.

THE FGCP DEFINITION of “national carbon price” provides flexibility. A nation’s carbon price is total carbon revenues collected divided by total greenhouse gas emitted. The revenues can be collected with a carbon tax, a gasoline tax, by auctioning allowances, or in several other ways.
In order to cover the European cap-and-trade market, freely distributed allowances are also defined to collect carbon revenues, based on the average market price of allowances.

THE PRICING INCENTIVE encourages nations to set a high-enough price so that the world average carbon price is P*. If a country collects more carbon revenue than required by P*, it is rewarded, and it is penalized if it collects less.
This incentive can also be thought of as a market. If a country chooses to under collect, it can pay someone else to collect extra carbon revenue for it. For example, if a country was obligated to collect €10 billion, but only wanted to collect $9 billion, it could pay Z times $1 billion to a central exchange which would use that money to purchase $1 billion extra carbon revenue from other countries.
The Pricing Incentive market is like allowing capped countries to buy offsets if they don’t want to meet their cap, but it extends this flexibility to allow any country to choose to go over or under the global target and be paid or charged accordingly.

THE ADJUSTMENT RULE. The parameter Z is the incentive rate, or it can be thought of as the price of under-collection. It might be 10%. If it is very low, many will choose to pay others to collect carbon revenue and the average carbon price will fall below P*. Consequently, Z must be adjusted from year to year to keep the average global carbon price equal to P*. There is a simple automatic adjustment rule that raises Z when the global price is too low and lowers Z when it’s too high.

CLEAN DEVELOPMENT INCENTIVE (CDI). Equal carbon taxes treat nations equitably in the sense that a poor country automatically pays less tax, roughly in proportion to its income. Consequently a tax automatically provides “common but differentiated responsibilities,” as required by the Kyoto Protocol.
Nonetheless, a very poor country may find the same $20 carbon tax more burdensome than a rich country finds it. Also poor countries have caused much less of the climate problem. Consequently we should lighten their burden.
The CDI can also be thought of as a simple version of Mexico’s Green Fund. The CDI specifies how much money will be collected by the fund, who will pay how much and who will receive how much. Besides assisting poor countries, it serves two other important purposes. First the CDI encourages non-carbon-pricing programs to reduce emissions, and second it encourages poor countries to comply with P*. This means that the enforcement of carbon pricing will likely be entirely positive for poor countries, and the trade sanctions mentioned in Part 2, will be needed almost exclusively for countries with very high emissions.

Part 4 will look more closely at the Pricing Incentive and it’s adjustment rule. A paper on Flexible Carbon Pricing Is available on stoft.com. A simpler, version is presented in Carbonomics Part 4, which can be read for free on Google here.

Steven Stoft

This entry was posted on Wednesday, August 12th, 2009 at 9:50 pm and is filed under Climate Change. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.