ANALYSIS: Carbon tax or carbon market? The jury is out

LONDON (Reuters) - Maybe the best thing about a carbon market is that it is not a tax.

Meant to be a pivotal weapon in the fight against global warming, carbon markets still have much to prove ahead of a major United Nations report this Friday that will detail climate policy options.

Hitherto, the idea of a market has been widely acceptable while carbon taxes met opposition. But the market’s own failings -- including a system which hands windfall profits to Europe’s biggest polluters -- may yet swing the pendulum back.

The hub of the global carbon market is the European Union’s emissions trading scheme, which has so far failed to deliver a steady carbon price while handing huge profits to the utilities which produce energy and emissions.

This curious reverse of the widely held “polluter pays” principle has seen some European airlines begging to join and U.S. utilities flocking to lobby for a similar scheme.

Under the Kyoto Protocol, Europe’s flagship climate change policy will later this year link to carbon trading globally in a combined market that was worth $30 billion last year.

Some policy analysts and economists are wondering if it was all a mistake.

“My guess is the carbon market will be pretty volatile and economists will be sighing in a few years and saying ‘I wish we’d gone for a carbon tax’,” said Dennis Anderson, professor of energy and environmental studies at London’s Imperial College.

“I think in a few years we’ll revisit a tax.”

The principle of a carbon market or tax is the same: to put a price on emissions of heat-trapping carbon dioxide and so force businesses and individuals to think more carefully about their greenhouse gas emissions.

A draft version of the forthcoming U.N. report, seen by Reuters, sits on the fence, referring to the merits of each: carbon markets set a definite outcome through emissions quotas, while taxes set a definite price.

The U.N. administers a carbon trade which allows rich countries to buy carbon emissions permits from poor ones by funding clean energy projects. It is upbeat about its role.

“The carbon market has the potential to green the world’s economic growth,” the U.N. climate chief Yvo de Boer said on Wednesday.


Advocates point to public resistance to carbon taxes, and the political scars of past mooted carbon taxes in Britain, the European Union and elsewhere.

But at the global level, in sealing an international climate change deal to succeed the Kyoto Protocol taxes may be more workable, argues Nobel prize-winning economist Joseph Stiglitz.

Carbon markets work by giving each country a fixed quota of emissions permits -- if they exceed their quota they have to buy permits from countries which have undershot theirs.

If a Kyoto successor pact handed out permits on the basis that each person got the same amount -- perhaps the fairest way -- countries like the United States with per capita emissions well above average would have to import billions of permits from the likes of India.

“That would involve hundreds of billions (of U.S. dollars) of transfers, the distributive consequences are huge,” Stiglitz told Reuters.

“The very reason that I argue for a carbon tax is it’s very difficult to decide on the allocation of emissions rights. There’s no principle that anybody has put forward that’s agreeable.”

By contrast, each individual country would at least get to keep the proceeds of a carbon tax.


Paradoxically, the EU scheme also amounts to easy profits for the utilities, analysts say: some put the figure clearly in excess of 5 billion euros ($7 billion) annually, assuming a steady carbon price of 20 euros.

Under the scheme, governments hand utilities free quotas for emissions. If utilities exceed these they will have to buy extra permits on the market: if they emit less they can sell the surplus.

Utilities use the carbon emissions permits when they burn fossil fuels to produce power, but are passing on this cost to consumers in power prices, even though they received most permits for free.

“It’s completely ridiculous,” said UBS utilities analyst Per Lekander, who estimated German power generators alone would profit by 5 billion euros per year, before tax, by 2010.

The EU carbon market caused a quarter of the rise in British power prices in 2005, according to an official estimate.

“Free allowances gave large profits to the electricity industry,” said Terry Barker, Cambridge University economist and a lead author of the forthcoming U.N. report.

“The intention was to give them money to get involved.”

Additional reporting by Alister Doyle