Wednesday, October 1, 2008

The Norwegian lesson on cap-and-trade

From the WSJ:
In 1991, Norway became one of the first countries in the world to impose a stiff tax on harmful greenhouse gas emissions. Since then, the country's emissions should have dropped. Instead, they have risen by 15%.

Although the tax forced Norway's oil and gas sector to become among the greenest in the world, soaring energy prices led to a boom in offshore production, which in turn boosted overall emissions. So did drivers. Norwegians, who already pay nearly $10 a gallon, took the tax in stride, buying more cars and driving them more. And numerous industries won exemptions from the tax, carrying on unchanged.

Implications for cap-and-trade v. carbon tax:

The risk of implementing a carbon tax instead of carbon cap-and-trade with auctioned permits is that no environmental benefits are guaranteed.

Although the tax has increased efficiency by providing companies with a new cost to optimize, this cost is not directly linked to the supply and demand for the right to pollute. Without the ability to set a strict environmental goal, we may simply increase carbon efficiency without reducing net carbon emissions.

This is what has happened in Norway, a country that has written and implemented one of the strictest and best-designed pieces of carbon regulation in the world. Norway has instituted a very high carbon price, even though its heavy industry (oil and gas) is particularly vulnerable to the economic implications of a carbon price.

Despite all this, the medium-term increase in the profitability of the energy markets in the past ten years has increased net emissions. The carbon efficiency of Norwegian oil and gas extraction is unmatched in the world, but emissions are still going up. The dynamics of the price movement for carbon are key; even with a tax that has priced carbon for fifteen years at twice the current prevailing price in the ETS secondary markets, Norwegian emissions have increased.

By setting a legislated, decreasing cap on emissions, a well-executed cap-and-trade can ensure that carbon emissions drop, while still providing the efficiency increases of a fixed carbon tax.


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