Responsible Investment

Why a low carbon price can be good news for the climate

December 6, 2012
Image ‘Pollution’ by Eric Schmuttenmaer (CC BY-SA 2.0)

The cap-and-trade program is the centerpiece of California’s Global Warming Solutions Act of 2006, also known as AB 32 — a suite of clean energy solutions that has proved to be the engine of an astounding economic transformation that drove statewide growth at twice the rate of the U.S. economy during the peak of the Great Recession (2008-2010). Thanks to AB 32, California is leading the nation in clean energy investment, capturing the lion’s share of billions of dollars in cleantech venture capital, and boasting more jobs and businesses in the clean economy than any other state. Californians understand this: according to a recent Los Angeles Times poll, 63% of state voters support the law, saying the state needs to break from “outdated energy policies,” reward companies that produce energy from wind, solar and other renewable sources, and decrease U.S. dependence on foreign oil.

Energy innovation

Policy signals from California, the world's 9th largest economy, are clearing a path for energy innovation. The law requires California to return to 1990 levels of greenhouse gas emissions by 2020, an overall 15% reduction from today's levels. Cap and trade is projected to achieve nearly 20% of that goal by limiting emissions from the industrial, utility, and transportation fuels sectors — which account for roughly 85% of the state’s greenhouse gas pollution. It's all part of a decades-long legacy of environmental action that has driven technological progress in everything from improved tailpipe emission standards and higher performing gas mileage in automobiles to greater efficiency in household appliances, to greener building practices that have transformed markets and created hundreds of billions of dollars in economic value. While leaders in Washington D.C are just beginning to debate the potential of pricing carbon on a national scale, California is once again ahead of the curve.

When the auction results were released, a New York Times reporter pronounced them “a relief and a bit of a disappointment.” The relief was that nearly all the credits for 2013 were sold, with three times as many bidders as there were credits available, and amounting to almost $300 million in proceeds, which in this first round will mostly be allocated to back to the investor owned utilities and paid back to ratepayers as a twice-yearly “climate dividend.” The “disappointment,” she wrote, was that the clearing price for one ton of carbon closed just above the floor price of $10.

Cheaper is better

The reporter shouldn’t be disappointed. When it comes to a carbon cap, cheaper is better.

Why? Because a lower carbon price is a sign that power companies and other regulated entities don’t think it will be very costly for them to reduce their own emissions, so they didn't need to stock up on allowances or permits to emit. The low price California companies are willing to pay for allowances signals that they think we can cut greenhouse gas emissions even more cost-effectively than anticipated. That can only be a good thing.

Readers might think it odd for an environmentalist like me to cheer a low carbon price. But in California, it is the mandatory, declining cap on carbon that guarantees the environmental outcome; the price is simply what gets us there in the most cost-effective manner. And while we don't know that the $10 price will be sufficient to achieve the required reductions, the great thing about the cap is that we don’t have to know what the price should be. The market will decide that. And the best possible estimate of the “right” price now is $10.09 — because that’s what the auction revealed that the people who actually have skin in the game think the price should be. The beauty of the market is that it reveals the market participants’ collective estimate of the price. (That is why they call it “price discovery,” after all.)

If the price were to stay low, that would be a sign that California can further tighten its cap. Here the national program to reduce sulfur dioxide pollution that causes acid rain is a great example. The United States basically solved the problem of acid rain with a cap-and-trade system not unlike California’s. In the first phase, in the 1990s, the price turned out to be a far less than what had been predicted — because utilities found new and more cost-effective ways to cut pollution. That paved the way for the George W. Bush Administration to put in a much deeper reduction in emissions. That’s the dynamic we want.

A business-friendly approach

One note of caution. Monday's closing price is a temporary one that will continue to fluctuate as more players in enter the market and businesses decide how to best participate. We shouldn’t read too much into it. Further, while it’s nice to think about ways to spend the hundreds of millions of dollars being raised at auction, we should remember that the goal of the program is to place a hard cap on emissions, not necessarily to raise revenue — the program should reflect the most cost-effective way for businesses to reduce emissions.

I’ve outlined here a strategy for a business-friendly approach to curbing dangerous carbon pollution; like any policy, AB 32 needs to work for businesses in order to be successful. AB 32 includes a sufficient lead time and financial support for businesses to comply with the legislation and ample checks and balances to ensure the integrity of the carbon market. Further, AB 32 has had the advantage of six years of refinement by the Air Resources Board and learning from the E.U.’s carbon market.

Benefits of early adopters

Businesses and other entities in California who took action early on emissions reduction are already seeing the economic benefits of complying with AB 32. A recent report by the Environment California Research & Policy Center reveals eight organizations that span the range from brewing giant Anheuser Busch, which installed wind, solar, and biogas in its facilities, to family-owned farms, government agencies, schools, and nonprofits that have made other investments in clean energy solutions. Together, these early adopters reduced their emissions of global warming pollution by the equivalent of nearly 270 million pounds of carbon dioxide per year while saving approximately $3.60 million annually.

Further evidence can be found in a 2012 report prepared for the Environmental Defense Fund, where I work, which identifies seven sectors in the California clean economy that have consistently outperformed the rest of the state. Since the law passed in 2006, California has seen more than $9 billion in clean tech investments, and with every $100 million of capital invested creates 2700 direct jobs at venture-backed companies and many more indirect jobs. Since 2006, jobs in the clean economy have grown 10 times faster than total jobs.

Now we can look forward to new investments in California’s new clean economy driven by revenues raised in the carbon market, and to a new generation of businesses that will spring up in the state. A significant portion of the proceeds from the carbon market’s first auction are will be leveraged to further advance investments in the clean economy like energy efficiency, clean transportation, advanced storage and manufacturing, and renewable energy projects. Businesses that innovate and invest in these technologies will gain a competitive edge and enhance their bottom line.

The bottom line is this: a declining cap on emissions has been put in place in California, with a carbon market to stimulate investment. Voters like it, companies are participating, investors are responding, and the program is off to a smooth start. Three (quiet) cheers for California.

References

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as:“Why a low carbon price can be good news for the climate”, Eric Pooley, December 6, 2012.

Author(s)

Eric Pooley
Environmental Defense Fund

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