Cap-and-trade, when studied under one simplified scenario, beats carbon tax, one study finds

© 2011 Joshua Stark

My title should have been the title to this article out today at California Watch.  Unfortunately, they picked a title with a tad less specificity, and in doing so have picked a side in the debate between the two ideas.  Their title:  Free cap-and-trade system beats carbon tax, study finds.

That study, Inducing Clean Technology in the Electricity Sector:  Tradable Permits or Carbon Tax Policies?, by UC Merced & the University of New South Wales, compares the possible impacts of a carbon tax vs. a cap-&-trade system using a model of a single, small firm that owns a coal-fired power plant.  In the abstract, the authors claim to find that, due to the inherent uncertainty of a tradable permit system, a small firm will more likely hedge its bets by investing in some hybrid form of clean tech. + coal than it would under a system with a more stable carbon price.

Now, I don't have $20 to put down on a copy of this study (chalk it up to microeconomics, both literally and figuratively), but I do have some questions - especially to California Watch:

-The study's abstract says nothing of a "free cap-and-trade system", and in fact, I don't have a clue as to what a "free" cap-&-trade system would look like.  People pay when carbon is priced, period.  So, California Watch, where did "free" come in?

-The study's abstract also explains that other ideas associated with C&T (e.g., offsets) are also more expensive than just a tradable permits system without them.  California Watch, why did you not include this little gem of news?

-And for the researchers: Why study a particular scenario that is unlikely to have much of an impact on carbon?  If energy companies were as the authors envision - small firms owning one coal plant - then uncertainty may lead to hedging.  However, we are talking about creating a contrived, government-mandated market with a number of very, very large firms.  These firms move markets, they tend to suppress volatility (which is why companies want to be big), and they unduly influence political economy in their favor (hence, offsets & free permits to them).  This last point cannot be understated, especially because any carbon price is going to be the result of a government regulation and it will be much easier to "game" the system if it has elements of contrived uncertainty in it. 

Also, consider this:  A clear government regulation pointing to a relatively quick increase in carbon prices will also lead a small firm to switch to clean tech.  In fact, if the price looks high enough, that firm will leave coal completely, thus saving lives.  This regulation will also lead big firms to switch.

Never forget that, no matter how we price carbon, it will be through a government regulation.

Uncertainty in carbon prices may, indeed, lead many companies to hedge their bets, although current history (carbon prices are surely uncertain right now) does not completely bear this out.  And if carbon prices were a commodity, rather than a priced-in externality, I'd be more inclined to allow some uncertainty.  But the fact is that any carbon price will be contrived, because it doesn't have to have a market price.  Since the price for carbon will come out of regulations (even a C&T price) and an artificial scarcity, since large companies can thrive on creating their own certainty and influence shifting and uncertain regulations to a greater extent, and since a clear sign that carbon prices will go up will also induce a strong shift toward clean tech., it is imperative that we have a clear and certain regulatory framework.