Origins of Market-Based GHG Regulation in the U.S.

Because this week’s focus on greenhouse gases (GHG) is related to my personal project (http://v515brian.blogspot.com/2011/09/personal-project.html), I thought that I would use this opportunity to blog about my findings regarding the evolution of market-based GHG regulations in the U.S. 

Prior to 1970, the federal government conducted research on air pollution but had no formal authority to issue regulations prohibiting GHG emissions.  The Clean Air Act of 1970 changed this by authorizing the development of National Ambient Air Quality Standards (NAAQS) for air pollutants.  The act provided a crucial incentive for compliance by allowing citizens the right to take legal action against any organization that violated the new standards.  The Environmental Protection Agency (EPA) was established in 1971 in order to implement the requirements included in the Clean Air Act (http://epa.gov/oar/caa/caa_history.html).

After a long period of limited amendment, the Clean Air Act was significantly revamped in 1990 due to growing environmental concerns. Two of the driving forces behind the 1990 amendments were the desires to eliminate both acid rain and ground-level ozone which were being generated by high emission levels of Sulphur Dioxide (SO₂) and Nitrogen Oxide (NO_x).  Amendments within the 1990 act were the first attempt by Congress to control pollution through market forces.  Under the program, emissions of SO_{2 l}and NO_x were capped far below 1990 emission levels.   Regional organizations were established under the act in order to achieve mutual emission reduction goals (http://www.nrel.gov/docs/fy01osti/29448.pdf).

Several trading platforms have since gained traction in order to reach these emissions targets.  The Northeast States for Coordinated Air Use Management, an association of northeast and mid-Atlantic states, has initiated a trading program for NO_x (http://www.otcair.org/).  From 2003 to 2010, the Chicago Climate Exchange (CCX) operated a Carbon Exchange.  This exchange has since been dissolved and is operated as an over-the-counter (OTC) market.   Most recently, the California government, in conjunction with the government of British Columbia, is working to establish a carbon market that would go into effect on January 1, 2012.  In the beginning, British Columbia is expected to be a net seller of carbon credits, while California will be a net buyer. (http://www.nytimes.com/2011/05/02/business/energy-environment/02iht-green02.html).

Personal Project Blog 1 - Carbon Options Exchange Concept

Originally, for my personal project, I planned to create a business plan for a web-based venture that would aim to encourage environmentally-conscious, or “green” consumption.  However, as a result of being forced to think through this concept more thoroughly within my blog posts, I have decided to slightly alter my personal project.  I have come to the conclusion that the only way consumers will purchase green products en masse is if these products are less expensive (economically) than their non-green equivalents.  The term “equivalents” is important in this sentence.  If a product is not a commodity, it will not neccessarily have a non-green equivalent, and thus it does not have to be less expensive in order for consumers to prefer it.  But, in general, I am assuming this rule holds true most of the time.

In order to make green products less expensive than their non-green equivalents, producers of non-green products must be forced to incorporate environmental costs into the prices of their products.  In the past, many countries have achieved this outcome through governmental regulation.  In the U.S., similar efforts have failed due to a lack of political will to enact such legislation.  However, I believe I can succeed where the government has failed by created a web-based derivatives exchange in which options on U.S. carbon credits can be bought and sold in a liquid market.  This market does not rely on the underlying U.S. carbon credit currently existing.  Instead, it relies on the belief by corporations and individuals that U.S. carbon credits will exist at some time in the future. 

After talking with a derivatives trader who trades NOX and S02 credits on the behalf of utilities, I have become aware that similar options on U.S. carbon credits do currently exist.  However, these options are created by banks and are traded over-the-counter.  An exchange for carbon options would provide less expensive and more transparent pricing.  As a result, utilities and other corporations would be attracted to the new exchange, and ultimately, the current “market price” of environmental destruction would begin to be incorporated into the products of producers who buy these options.   

The next step that I plan to take on this project will involve talking with the founder of The Plastics Exchange in Chicago.  This is a relatively new exchange that I imagine encountered many of the same difficulties that would be inherent to creating a carbon options market.  I’m hoping that this meeting will help me to generate the revenue and cost assumptions that will be needed to create a financial model within my business plan.

The World Without Us

I enjoyed the readings this week in Wheeler on the topic of ecological design.  I was struck by the assertion, expressed by a couple of different authors, that humanity is at war against itself.  At one point in his sermon, William McDonough explained that we have designed a “vast industrial machine, not for living in, but for dying in.”  These words echoed in my mind as I read the article, “Principles of Green Architecture,” in which the authors described the insanity of a crude system in which climate was opposed by energy, aka air conditioning.   Both articles refer to the relationship between nature and humanity as a war.

These articles and their references to our impending end as a species reminded me of a book that I read titled, “The World Without Us,” in which Alan Weisman describes what would happen to our cities in the event that humans suddenly disappeared.  You can watch a video on the author’s website which illustrates this process for the typical single family home (http://www.worldwithoutus.com/index2.html).  The book provides the reader with a fuller sense of the fragility of our civilization and the level of participation that is required by humans in order to continuously prevent our cities from reverting back to their pre-industrial states.  Weisman explains how swiftly natural processes like the freeze-thaw cycle would destroy our infrastructure and how a lack of electricity would immediately flood important systems, such as the New York City subway.  It’s as if we are all living in a leaky boat, constantly patching holes and bucketing out water as fast as we can.

The Myth of Self-Sufficiency Part II: I was wrong, a little bit…

In my first blog, “The Myth of Self Sufficiency,” I used the law of comparative advantage in order to advocate against the concept of economic self-sufficiency promoted by Roseland.  I explained that the end result of self-sufficiency is a reversal of the process of specialization, which increases efficiency and is the driver of progress.  I will use this current blog post to admit that I was partially incorrect.  A form of self-sufficiency is possible.  However, it cannot be implemented via the method of “import-substitution” that Roseland describes.   Below is a brief walk through my newly revised thinking: 

The only way a community will be self-sufficient is if local goods and services are less expensive than their non-local equivalents.  Because this is not currently a reality, in order to accomplish this task, the government would need to artificially inflate the economic costs of non-local goods and services through taxes.  This has been done before in numerous economies and is called import-substitution.  The problem with import-substitution is that it decreases the competitive environment of industry.  As inefficiencies increase, disparities grow between the real prices of local and non-local goods and services.  Once this occurs, the unofficial economy will find a way to bring cheaper , non-local goods into the local economy in order to correct the imbalance.  This usually ends in a loss of tax revenue for the government, a monetization of government debt, and finally an implosion of the import-substitution system.

What I have realized (perhaps later than the rest of you) since writing my first blog is that the actual barrier to self-sufficiency is the recognition of only economic costs.  Instead of artificially increasing price through regulation, an alternative method for implementing self-sufficiency would be to recognize “true costs.”  But when I say “true costs,” I do not exactly mean economic costs + environmental costs.  I believe that environmental cost is just another term for “unspecified economic cost.” 

At this point, I imagine that most business managers, even if they don’t believe in climate change, would be willing to hedge their bets against its potential economic costs.  In other words, they would be willing to pay a premium, however small, as “insurance” against the negative effects of climate change.  I would argue that this premium is in fact,  "unspecified economic cost" or “environmental cost." 

This “insurance” and “premium” relationship is just another way to describe a call option.  And I would argue that the premium on a Carbon call option is the environmental cost component of “true cost.”  If U.S. businesses were provided access to such options, the cost of insuring against the potential costs of carbon usage would begin to be incorporated into prices, resulting in “true prices.”  Does the U.S. government need to implement regulation to “create” a cost of carbon, or "carbon tax?"  Not necessarily.  Creating a private U.S. market for carbon options would make less carbon-dependent local businesses more competitive than non-local businesses, and would ultimately move local economies toward self-sufficiency.

Personal Project

For my personal project I am aiming to launch a web-based business that will promote sustainabile consumption on the part of individuals.  While the business plan is still being formulated, the objective is to create positive financial incentives in exchange for altered patterns of consumption.  If the concept is ultimately successful, that will great.  If not, I'm hoping to learn a lot in the process.

The Myth of Self-Sufficiency

Nobody knows how to make a pencil.  Nobel Prize winner Milton Friedman would often cite this truism in order to explain how free markets worked.  Friedman explained that the wood, graphite and rubber components of each pencil are sourced from disparate locations across the globe, with the cooperation of thousands of workers who will never meet, ultimately coming together through a complex structure of prices that make up the free market system.

The contributions of each party within the pencil supply chain can be thought of as representative of human progress.  In the beginning, everybody had to do everything.  Each party was responsible for its own food, clothes, energy, etc.  It was only through specialization that humanity discovered a win-win situation.  It turned out that each party within a trade network had its own comparative advantage and that increased trade between parties resulted in increased productivity and a higher quality of life for all parties.

Interestingly, in our readings by Roseland and others, it seems that promoters of sustainable communities would like to reverse this process through what they call "import-substitution," and "self-sufficiency."  These sustainability advocates argue that total energy consumption will decrease once humanity has tightened its distribution systems by promoting local production and realizing the ultimate goal of "self-sufficiency."  I disagree with this unproven concept and believe that self-sufficiency should not be required within a sustainable community. 

It seems obvious that an unknown proportion of the energy costs saved by reducing the size of distribution networks will most certainly be added back to humanity's aggregate energy consumption by rolling back the aforementioned productivity gains won by specialization.  The net energy savings in this new system might even be negative.  The real problem is not trade itself, but transportation costs.  Instead of attempting to create impractical, "self-sufficient" communities, advocates of sustainable living should focus on engineering practical solutions to lowering the costs of trade.