This week’s question comes from Richard. He asks how the price of Carbon Dioxide is determined. Unfortunately for me this is not an easy question to answer since there are many different prices for carbon. I will give it my best and hopefully you will be satisfied…
The valuation of carbon is an attempt to place a price tag on the permission for emissions. But how much is clean air and the stability of our climate worth? And what is that worth to future generations? You might answer “immeasurable,” “infinite,” and “hugemongous.” If you answered any of these your are probably right. Unfortunately the world of business and politics does not work in those terms.
The price of carbon can be defined either as the market price of carbon credits, or the real or future damages caused by emissions. In 2003 the UN estimated that total global climate change damages were around $60B, that’s $60,000,000,000, or $8B than Bill Gates’ net worth. When even the richest man in the world can’t bail us out in a pinch we know we are in trouble… If you divide this immense sum by the annual GHG emissions in that year you get about $45/ton. So this could be seen as the cost of carbon emissions but it doesn’t take into account the future damages or past emissions so it is likely to be much more. So why is the current price on the Chicago Climate Exchange (CCX) at $2.35 per ton?
A market based GHG emissions trading system is a great way to harness the mechanisms of the markets to fix the problems that their mismanagement has created. By not putting a price on GHG emissions all along governments have given businesses the impression that their emissions are essentially free and that the atmosphere is a limitless dump for their gaseous waste. This is what economists call an externality, a cost that is passed on to society with no consequence to the debtor. That would be like giving me a credit card with no limit and passing my monthly bill on to society. If anyone has such a card my address is: 45 Main St….
So the price on the CCX reflects the fact that there are a lot of inefficiencies, since the market price of GHG emissions is generally equal to the lowest-cost mitigation measure. If a new $10 widget will prevent 1 ton of emissions, the cost of that mitigation measure is $10/ton. Since the price on the CCX is currently lower than that it would be cheaper to just purchase an emissions credit from someone else than to invest that $10, leaving you with $7.65 to invest in other ways. But, if the source of those cheap credits runs low the price will climb (simple supply and demand). When that price exceeds $10/ton it makes sense for you to install that widget and sell the carbon credit at a profit.
Since the European Climate Exchange (ECX) trades GHG credits that are mandated under the Kyoto Protocol the participation in that market is much greater (the CCX is voluntary). This, along with the greater average industrial energy efficiency in the EU, means that the price on the ECX is much higher, at $28.87. But this is still not close to the $45/ton that we calculated earlier…
According to one source, the Social Cost of Carbon is much higher, around $142.68. Until the carbon markets reach this level polluters will not be paying their debt to society but in the meantime they will be reducing their emissions using the most cost-effective means possible.
This weeks column was written to get you thinking. What do you think the cost of carbon emissions should be? How much would you be willing to pay for your vehicle’s 5 tons per year?
Pablo P√§ster, MBA
10/16/2007: I am attaching a diagram that shows the cost and potential of various GHG mitigation measures. The bars below the x axis represent actions with an immediate payback. Click on the picture to enlarge.