The Fine Art of Carbon Markets: Efficiency, Trust, and a Touch of Chaos
Estelle Cantillon (Université libre de Bruxelles) will present her co-authored paper with Aurélie Slechten on 'Market Design for the Environment' at the 2024 ECGI Responsible Capitalism Summit on 10 September.
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Imagine you're at an art auction. The paintings up for grabs aren't just any paintings; they're eco-friendly masterpieces that promise to save the planet. But here's the catch: some of these masterpieces might be fakes, and their prices can swing wildly. Welcome to the world of carbon markets, where the currency is carbon credits, and the stakes are as high as our planet's future.
Estelle Cantillon and Aurélie Slechten’s paper, "Market Design for the Environment," dives into the deep end of carbon markets, focusing on the EU emissions trading scheme (EU ETS) and the voluntary carbon credit market. Think of it as a masterclass in how to structure markets to not just buy and sell but to save the world.
The EU ETS: Carbon, Cash, and Controlled Chaos
The EU ETS is the granddaddy of carbon markets. It’s a cap-and-trade system designed to cap emissions and let companies trade allowances. The goal? To cut emissions where it's cheapest to do so. Simple, right? Not so fast.
- Market Scope and Coverage: The broader the market, the better the efficiency. But expanding coverage means more monitoring and enforcement headaches. And then there's carbon leakage – not the kind from your AC unit, but when companies shift emissions to countries with looser rules. Fun!
- Allowance Allocation: Initially, the EU handed out allowances for free based on past emissions. This led to some interesting gaming. Companies could emit more to get more allowances. Over time, they switched to auctions, but sectors at high risk of carbon leakage still get free allowances. Auctions are great for price discovery, but let’s face it, nobody likes paying for something they used to get for free.
- Price Stability: Volatility is a problem. Enter the Market Stability Reserve (MSR), a fancy way of saying “we’ll adjust supply to keep prices in check.” Did it work? Kind of. Prices still swing like a yo-yo, but at least we’re trying.
Voluntary Carbon Markets: The Wild West
If the EU ETS is a controlled chaos, the voluntary carbon market is pure wild west. Companies buy carbon credits to offset their emissions. These credits come from projects like planting trees or renewable energy. Sounds noble? Sure. Problematic? Definitely.
- Project Qualification and Governance: Ensuring carbon credits are real, additional, and permanent is like herding cats. Standards setters like Verra and Gold Standard try to keep things legit, but issues like additionality (would this project happen without the carbon credit money?) and permanence (what if the trees burn down?) make it tricky.
- Market Maturity and Liquidity: The market is still a baby. Liquidity is low, transparency is murky, and prices are all over the place. Trust is a huge issue, especially when studies show that many credits don’t deliver the promised climate benefits.
- Standardization vs. Flexibility: Balancing standardization to build trust with flexibility to accommodate diverse projects is like walking a tightrope. Attempts to bundle credits have faced resistance because nobody wants to buy a mixed bag of good and bad credits.
The Way Forward: Ideas and Ideals
Cantillon and Slechten suggest several ways to make these markets better:
- Better Monitoring and Reporting: Enhanced tech and stricter standards can ensure credits represent real reductions. Think satellite imagery and AI – high tech meets high stakes.
- Smart Market Design: Consider the unique characteristics of different pollutants and projects. For instance, carbon dioxide is a global pollutant, so leakage and boundary issues are critical.
The voluntary carbon market, in particular, needs some serious TLC. Researchers propose contract menus to prevent exaggerated claims and stricter conditions on credit use to prevent greenwashing. Dynamic accounting for nature-based credits, where credits are issued or cancelled based on real-time data, could help.
The Big Picture: Efficiency vs. Integrity
Markets are great at finding efficiencies but terrible at moral dilemmas. Carbon markets aim to save the planet by putting a price on pollution, but they also need to ensure that price reflects real environmental benefits. Integration between voluntary and compliance markets is on the horizon, but it needs to be handled with care. Too much integration, and we might see reduced emissions efforts.
Cantillon and Slechten remind us that while markets are powerful tools, they need careful design, constant monitoring, and a healthy dose of skepticism. As we navigate the carbon credit conundrum, we must balance efficiency with integrity, ensuring that our eco-friendly masterpieces aren’t just pretty pictures but real solutions for our planet.
So, next time you think about buying a carbon credit, remember: it’s not just an investment in your portfolio but a bid for the future. And like any auction, it pays to know what you’re buying.
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Estelle Cantillon is a professor of economics at the Université libre de Bruxelles (Solvay Brussels School of Economics and Management) and an affiliated researcher at the Toulouse School of Economics. Professor Cantillon's research sits at the intersection of market design and industrial organization, integrating theory with empirical data. Her publications encompass studies on auctions, procurement, competition between exchanges, and assignment problems. Currently, her research focuses on carbon emissions markets, the design of electricity wholesale markets, and policies related to climate transition. At the Solvay Brussels School, she holds the role of academic director of the Sustainable Development Initiative, which aims to foster changes across the School to support sustainability through education, research, and outreach efforts.
Read more:
- Access the paper here.
- Submit questions for the authors here.
- Register to join us in Berlin on 10th September.
