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PRICE FIXING OF CARBON MARKETS. THERE IS A BETTER WAY.

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By Sheldon Fulton,

Forte Business Solutions Ltd.

If a baker priced his bread at $50/loaf, we would all opt for a new baker. If he priced it at $.05/loaf, we would buy all that we could possibly eat. Whether either baker stayed in business is a question for another day.

At what price do we consume more or less of a product? Bread is a fairly easy example. We check weekly flyers for specials. We compare fresh Focaccia from the specialty bakery to the ‘wonders’ of sliced bread from the local supermarket. Based on our knowledge and preferences, we make efficient and economic purchases.

Can the same dynamics be applied to carbon emissions? Canadian governments think so. They have decided that putting a price on carbon will discourage us from using carbon emitting products. In their “wisdom”, the right price today is $20/tonne. But in three years time, the ‘right price’ needs to be $50/tonne. 

Consumers, industries and businesses don’t know if $50/tonne is way too expensive or exceedingly cheap for reducing Canada’s emissions targets by 2030. Unlike bread, we have no ‘value benchmark’ to tell us it’s a good deal, as is obviously the case if you can snag a loaf of fresh Winnipeg Rye for $2.50.

Rather than government fixing an arbitrary price on emissions, let the dynamics of a market work out the most effective outcomes at the least cost. Markets quickly establish prices. They also connect the buyers that want a product and the sellers willing to produce such a product. 

Let’s assume one of our bakers lowers his carbon emissions by investing in a more energy-efficient oven. He reduces the emissions intensity of each loaf of bread he bakes. The dynamics of the emissions intensity market will allow him to sell his reductions to his competitors, thereby off-setting his investment. Ultimately the market will entice other bakers to follow his example.

What is the ‘right price’ for a tonne of carbon emissions reduction? The answer should be determined by market dynamics, not by a group of engineers, economists and environmentalists deliberating theoretical outcomes.

Is there a carbon reduction mechanism that would work?

A trading mechanism to reduce emissions intensity will result in optimum carbon reductions.

Emissions intensity trading first determines the carbon emissions intensity to produce any target product. It then relies on trading between market participants to ‘reduce’ this intensity in products over time. Emissions intensity trading would penalize high emitters and reward innovators across whichever industry sectors adopted it. 

The electricity market in Alberta provides a useful example of how an emissions intensity scheme could be implemented. 

Currently, every generating facility in the province has both the electrical output (MWhs) and the carbon intensity monitored by two separate entities (the Alberta Electric System Operator and Alberta Environment). If Alberta set overall intensity targets for each target period, then the above average emitters (coal) would need to either reduce generation or acquire offsets from low emitting generators (wind, solar, hydro). In essence, emissions intensity trading would affect a transfer of capital from high emitting facilities to low emitting facilities with no need for onerous regulations or central government intervention. The government policy makers would focus on targets and timeframes rather than setting arbitrary prices or complex regulations. 

Essentially, emissions intensity trading turns every industry participant into either a buyer or a seller, depending upon whether their product is above or below the emissions intensity target for their industry.

Electricity generation lends itself to this approach. Other high emissions sectors such as oil and gas, pulp and lumber, or transportation appear to be more complex. In fact, the carbon output levels for each of these sectors are already tracked. It would not be onerous to determine the emissions intensity for each participant’s products.

Setting a sector wide target and establishing a monitoring program are the pre-conditions to a market. Low emitters would sell to high emitters. Investments would flow to low emitting technologies to acquire ‘credits’ for sale. Imports and exports would be handled in a manner similar to that used for collection and credits such as a GST or import levies.

Emissions intensity schemes (EIS) could be developed for any sector. With the sophisticated tracking and identification technologies available today, programs could be implemented to overcome most of the historic issues and barriers. 

Take for example the delivery of parcels. An emission intensity could be determined for delivering a package by kilograms of weight per kilometre travelled. An electric delivery van below the target would have a credit for sale to a diesel truck that might be above it. More significantly, over time the most likely replacements for the diesel fleet would be electric vans. 

Development and implementation of EIS markets would employ the three cornerstones of any market:

  • Define the product or ‘contract’ to be transacted (tonnes of emissions reduction per unit of production);
  • Define the pricing mechanism (Bid/Offer match, auctions);
  • Define the Rules for trade and transaction confirmation.

Recognized markets would register participants, monitor trade and ‘clear’ completed transactions. Ideally these markets would evolve from the commercial sector rather than government. They would be assisted by, and subject to, oversight by the appropriate regulatory agencies, just as the Ontario Securities Commission oversees the operation of the Toronto Stock Exchange.

Achieving Canada’s carbon emissions goals would become a case of setting the intensity targets each year at the levels needed to bring the current 720 Megatonnes in line with the objectives for 2030 and beyond. If Canada wants a 20% reduction in emissions, then every sector would need to reduce its intensity level by 20%. The intensity ratchet for each sector would be 2.0% per year for the next ten years. 

The intensity targets would be set for review in three year increments. This would allow time for changes in behaviour as well as changes in investment programs and innovation to deployment. Industry participants in each sector should be involved in setting the targets and ratchet rates.

A market participant would be penalized for failing to meet their emissions intensity requirements, either through reductions or through the acquisition of offsets. The penalty would be a multiple of two-times the average price paid within each respective industry sector. Simply put, the cost of non-performance would be twice as expensive as performance.

Energy intensity markets would provide a definitive answer to the question “What is the right price for a tonne of carbon emissions reduction?” Governments should restrict themselves to setting national emission reduction targets. Let each sector set their intensity targets to achieve the national goal and allow natural market forces to cause the change to occur. 


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