Everyone is bad at pricing carbon — and society is paying

March 14, 2014

A new report by the Environmental Defense Fund, the Institute for Policy Integrity, and the National Resource Defense Council shows how far away we are from understanding carbon emissions’ full cost to society.

The US government estimates that the social cost of carbon emissions is about $37 a tonne. But the report finds that the “latest scientific and economic research shows that $37 should be viewed as a lower bound” for the cost of carbon. Current models, the report says, miss or poorly account for the damage carbon does to human health, agriculture, oceans, forests, and ecosystems.

There is currently no global, liquid market for carbon that would give us a good idea of carbon’s actual costs. Instead, there is a haphazard collection of exchanges and trading systems established overseen the European Union, the UN, countless NGOs, the State of California, and private exchanges.

The result is that carbon markets aren’t very good at doing what they were created to do, which is put a price on the social costs of burning fossil fuels. Economists call these costs externalities. Society, rather than the the person who buys a gallon of gas or a tonne of coal, pays the cost of carbon emissions — in the form of climate change and its attendant problems. In theory, carbon markets are supposed to more accurately reflect the true cost of fossil fuels to society, by increasing the the price paid by the users.

These markets, however, are highly uneven. For example, a tonne of carbon on the European Union’s Emission Trading Scheme is trading around €6 to €7, or between about $8.30 and $9.75, per Reuters. Prices per tonne on the Chicago Climate Exchange range from 2¢ to $5 — seriously, between two cents to five dollars, for what is ostensibly a commodity.

A big part of the reason why the price for carbon in the European Union is so low is because the government assembled a highly-engineered market in order to ensure low prices. The market was meant to be a phased-in program that has largely shielded consumers and industry from rapid price increases. Unfortunately, price increases are precisely what will push people to use less carbon, and help make clean energy competitive. Alternatively, prices are so much lower and wider-ranging on the Chicago Climate Exchange because of a lack of regulatory standardization.

The status quo fossil fuels market, the $37-a-tonne government estimate, and the carbon market’s pricing represent, respectively, a market failure, a policy failure, and a sort of public-private partnership in market failure. Given the science of global warming, coming up something like a penalty price for carbon emissions is the best hope of cutting emissions.

We’re left with market prices that are too low — prices that hardly anyone pays — and a higher but incomplete government estimate of a price that no one pays.  No one is putting an accurate price on carbon and getting emitters to pay that price. And we’re all the worse off for it.

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