What do France, Estonia, the Netherlands, the Czech Republic and the Walloon region of Belgium all have in common?
They are members of the European Union who announced last Thursday that their heavy industries had polluted less than they were expected to in 2005. Great consternation and dismay greeted this news.
Yes, I know, that sounds strange. But such is the world of carbon trading. At the beginning of 2005 the European Union launched its version of the Kyoto Protocol, an Emissions Trading Scheme that aimed to force E.U. members to cut back on their production of greenhouse gases. The way it was supposed to work was like this: Each nation was given a pollution "allocation." If its big greenhouse gas producers -- energy utilities, etc. -- polluted more than their allocation, then they would have to purchase carbon credits to offset the difference. But if they polluted less, they would generate credits that could then be sold.
Up until mid-April the system seemed to be working well. The going price for a ton of carbon dioxide emissions hit an all-time high of 31 euros just last week. Then, boom: Five nations prematurely announced unexpectedly low pollution numbers, sending a signal to traders that there might be far more carbon credits available on the market than demand. The natural result -- the price of carbon fell by half.
In the short term, the news is pretty bad for the fledgling market. Some traders think the ETS might be crippled until 2008, when the E.U. is scheduled to tighten targets for emissions reductions. As a result, all those venture funds pouring money into renewable energy and other potential carbon credit generating mechanisms may have to wait some time before their investments pay off. You can bet that the global warming skeptics and anti-Kyoto "free market" hard-liners are chortling.
They shouldn't be. If ever there was a case that demonstrated the meaning of the term "growing pains," this is it. The most obvious problem is that allocations were set too high. That can and will be fixed. National allocations were originally set partially in response to individual lobbying by various nations, a fact that generated a lot of criticism from environmental groups that are now having a hard time restraining themselves from saying, "I told you so." But the good news is that now there are some real baseline numbers to show how much pollution is occurring. That's a feature, not a bug. As one analyst noted, "price discovery" -- the process by which a market arrives at a value for a commodity -- is especially volatile when a market is in the early stages of its creation.
Trying to combat climate change with a cap-and-trade market-oriented plan like the ETS was never going to be easy. It's an immensely complicated effort to deal with a huge, intractable problem. But the earlier you get started, the quicker you figure out what works and what doesn't and how the system needs to be tweaked. It would be nice if U.S. politicians were paying attention.