Tuesday, September 22, 2009
Tuesday, September 8, 2009
Thursday, August 13, 2009
Saturday, August 8, 2009
Limits on CO2: Caps
Let us first consider limits (or "caps") on carbon emission. Intuition tells us that if the limit is higher than the amount currently emitted, then the CO2 price is zero, and there is no change in the amount of CO2. So, the first requirement is that the limit set should be less than the amount emitted. This might seem obvious, but could pose problems during early stages of implementation if the emitted amounts are not known with a high degree of confidence. In fact, this uncertainty wreaked havoc in the European Emissions Trading Scheme (EU ETS) , where prices collapsed after it was discovered that the caps were set too high.
Fig. 2. Price of energy vs. the quantity of CO2 emitted in the presence of a limit (Cap). In this case, the price of electricity = marginal cost + cost of CO2.
When the limits are set lower than the current levels of emission, then equilibrium requirements dictate that the price of electricity has to rise sufficiently such that the intersection of the demand curve with the limit is now the price of electricity. Since the cost of the electricity by itself (production cost) has not changed, the difference between the two horizontal lines is therefore the cost of CO2.
Now, cost estimation can be done given the limits and the demand curve. Since limits are not set yet, and the obtaining the demand curve is non-trivial, we have to resort to other means for estimation. We can use the range of prices observed in the European market as a guide to estimate. (Note that the CO2 price is completely determined by the limits being set and the demand curve, and therefore, the regulator can choose any value such that the price falls in a desired band.)
The calculations are given below, along with the assumptions and the sources of the data.
Therefore, under the simple assumptions that we listed above, the average house-hold is likely to spend $6.13 per month higher once the legislation is introduced. If the carbon price increases, the amount will also increase. The plot below shows the linear relationship (Additional amount spent = 0.613*Price per Ton of CO2) between the carbon price and the additional amount to be spent by the household.
Friday, August 7, 2009
Fig. 1. Price vs. Quantity, assuming a constant marginal price for energy. The intersection of the two lines is the equilibrium price (same as the marginal price) and the equilibrium quantity, which is the quantity that will be consumed.
The demand curve (which is the curve representing the quantity demanded Q at any price P) is downward sloping, as the demand is likely to be high if energy is cheap. For example, people drive more (resulting in more demand for energy) when gas is cheap and less when it is more expensive.
Note: One could argue that nobody demands CO2, and therefore this whole argument is flawed. However, even though CO2 is a pollutant, which is a "bad" rather than a "good" that we actually want, supply-demand arguments are still applicable. This is because the CO2 is actually a byproduct of the good that we seek, which is energy.
In the absence of any limits the quantity of CO2 emitted is the equilibrium quantity, which happens to be 5.6 GigaTons in the US (~44,000 lbs of CO2/per person). In the next post, we will focus on limits and the basis for determination, taxation vs. cap and trade etc.
Thursday, May 28, 2009
Wednesday, May 20, 2009
Monday, May 18, 2009
Friday, May 15, 2009
Thursday, May 14, 2009
(1). Utilities : 35%
(2). Energy Intensive Industries (Steel, Aluminum, and Cement): 15%
(3). Refineries: ??
(4). Auto: 3%
So, in all, more than 50% is of the credits are already spoken for. This is almost exactly along expected lines. The key is the sunset provisions for these credits, whether they expire automatically, or not, a point that Felix Salmon addressed earlier.
Tuesday, May 5, 2009
Alternatively, the government could auction 100% of the credits, and give the producers cash (from the proceeds) which would clearly be unpopular in the long run, and politically indefensible (or at least less defensible, considering farm subsidies are not that different, and they have been around for a while).
Either way, the cap and trade legislation is an excellent Economics 101 primer. A somewhat technical analysis of this legislation is provided here.
Monday, May 4, 2009
However, I think this is not universal. Let us consider a case where offsets are freely tradeable across international boundaries, and where each country has a specific target to meet. If a major carbon producer finds itself short, then the demand for carbon in that market rises, increasing the price of the offsets. This would lead to migration of the offsets from other countries into this country. Since offsets play a significant role in meeting emissions targets in most markets, this would lead to an increase in compliance costs for all the other producers as well.
So, while the overall cost of compliance may come down, all the different entities may not see a reduction in the price. In fact, if USA came online and started demanding CDM credits similar to Europe, the likely scenario is that the cost of compliance will go up for the Europeans. So, this might be a good time to buy the guaranteed CERs or the CER futures.
Wednesday, April 22, 2009
Wednesday, April 15, 2009
An additional factor that has not got much attention is the fact that, in the presence of offsets, (assuming they are allowed after Copenhagen), one could see the emergence of a global carbon price. If the offsets are cheaper than carbon permits in the domestic market, then the demand for carbon offsets would rise, increasing their price, and achieving an equilibrium with the different carbon markets around the world. This could lead to a lower cost of compliance, although this lower cost of compliance will likely benefit the producers rather than the consumers). I haven't seen an analysis of this effect, so I will be scouring the literature to see the effects.
"Granville Martin, vice-president for environmental affairs at JP Morgan, said access to OTC contracts was critical for bank financing. “You can’t scale up carbon finance without OTC markets,” he said.
For example, a utility wanting to build a power plant would only get a loan if it could hedge its long-term carbon and fuel risks. In many cases, he said, an appropriate contract is not available and, moreover, the utility would have to tie up a huge chunk of capital with the exchange as collateral.
For such contracts, investment banks would often be the only counterparty, and they could manage the risk by, for instance, taking a second lien in the power plant rather than upfront cash.
Forcing such trades through exchanges would add a significant hurdle to low-carbon development, and would be pointless if the reason was just to ensure transparency, Martin said.
“If the concern is ‘dark corners’ you can come up with solutions. You can have disclosure and preserve OTC,” he said."
Tuesday, April 7, 2009
However, if there is a very small probability of a catastrophic event (essentially tail risk) and if global warming has some positive feedback (in the non-judgemental engineering sense of the word), then there is no way to know this probability*the expected loss, and therefore, the expected value calculations could be off significantly. If the recent financial crisis has highlighted one thing, it is that people are terrible at tail risk assessment. Given that people are unable to appropriately assess tail risk, it seems to me that Pascal's wager arguments would suggest that we should be more actively pursuing climate change mitigation. Taleb makes a similar point here.