1. 1
Professor Hector R Rodriguez
School of Business
Mount Ida College

2. 2
Course Map – Topics Covered in Course
• Society
– The Corporation and Its Stakeholders
– People for the Ethical Treatment of Animals
– Corporate Citizenship
– The Social Responsibility of Business
– The Shareholder Primacy Norm
– CSR, Citizenship and Sustainability
Reporting
– Responsible Investing
– The Community and the Corporation
– Taxation and Corporate Citizenship
– Corporate Philanthropy Programs
– Employees and the Corporation
– Managing a Diverse Workforce
• Environment
– A Balanced Look at Climate Change
– Non-anthropogenic Causes of Climate
Change
– Sulfates, Urban Warming and Permafrost
– Conventional Energy
– The Kyoto Protocol
– Green Building
– Green Information Technology
– Transportation, Electric Vehicles and the
Environment
– Geo-Engineering
– Carbon Capture and Storage
– Renewable Energy
– Solid, Toxic and Hazardous Waste
– Forests, Paper and Carbon Sinks
– Life Cycle Analysis
– Water Use and Management
– Water Pollution

3. 3
• Today, consumers (and industries we support) dump an
unlimited amount of greenhouse gases into the atmosphere
for free; fossil fuel prices do not reflect their full cost.
• Policy makers have two main options for putting a cost on
greenhouse gas pollution:
1. A carbon tax or “pollution fee”
2. Creating a market for carbon emissions
• In order to stabilize global warming, fossil fuel prices
would rise under either policy.
• Americans appear to have little appetite for a carbon tax.
• But there is also little understanding of the market-based
alternative – a carbon cap-and-trade program.
Climate Economics

4. 4
• “Cap-and-trade” means a government authority establishes
a cap that limits the total amount of pollution allowed, and
then distributes permits for a “right to pollute” the global
atmosphere, which can be traded as private property.
• The amount of greenhouse gas emissions permitted
declines each year, creating demand for a new
commodity: carbon permits.
• When offered enough money (or faced with high enough
costs), polluters who own permits (or need permits) will
reduce their emissions.
*A familiar game can help illustrate the concepts…
Cap & Trade Climate Policy
Source: Holmes Hummel, November 21, 2007

5. 5
This game of managed scarcity can help illustrate the following
important concepts and issues:
• Banking
• Borrowing
• Equity
• Ethics
• Allocation
• Auction
• Trading
• Targets
• Leakage
• Offsets
• Safety Valve
Musical Chairs: A Helpful Analogy

6. 6
Each chair represents the “right to pollute”: one metric ton
of carbon dioxide (1 mtCO2) (or an equivalent amount of
any other greenhouse gas)
If you have a permit, you can have a chair.
Musical Chairs: A Helpful Analogy

7. 7
At the start of the game, everyone has a seat – because there
are no limits on carbon emissions.
2010
Musical Chairs

8. 8
After the first year, a cap is imposed by limiting the amount of
permits and making players compete for the permits
available. In our analogy, one player doesn’t have a chair…
2011
Musical Chairs
Would
anyone be
willing to
trade their
chair for
$30?Sure! For that
price, I can finance
an efficiency
upgrade,
eliminating my
need for a pollution
permit.
So, the market price for the “right to pollute” in the first
year is $30 for one ton of carbon dioxide…

9. 9
• At that price, some players may realize it would be more
profitable to reduce their emissions and sell their permits.
• Profit opportunities are a main driver for innovation and
investment in the global economy today, and the climate
challenge needs both.
2011
Using Market Incentives
If I could I build wind
farms to replace my
coal power plants, then
I could sell permits…
Hey, I made a profit by
reducing my fossil fuel
use and avoiding
carbon emission costs!
2012

10. 10
• The purpose of the game is to reduce greenhouse gas
emissions.
• The game authority reduces the number of permits available
each year until the ultimate target has been achieved.
• In a market, players leave when they find better options as
costs rise.
• Cap-and-trade lets players choose at what price they leave
the game – and how they want to make that change.
Achieving Reduction Targets
Wind Power
Green
Buildings
Hybrid
Vehicles
Solar Power

11. 11
• The last polluters remaining in the game are those who:
– can afford to pay the most, or
– have the least flexibility to change games.
• The underlying assumption is that uses of fossil fuels
for which people are willing to pay the most must be
the most valuable.
• To stabilize global warming, most uses of coal, oil, and
gas will have to move to a different game: the clean
energy economy.
2050
Achieving Reduction Targets

12. 12
• There are no “time out” options between rounds.
• As the cap tightens in each new round, fewer permits are
available.
• So, players with permits charge the buyers higher prices.
2020
Achieving Reduction Targets
How high can
the price go?
As high as it
takes to motivate
one of us to get
up…

13. 13
The Problem of Leakage
• The two available options are
1. Buy a permit from another player, OR
2. Reduce emissions
• Either choice may be difficult for some energy-intensive
businesses (e.g. aluminum, cement) competing in the
global economy.
At higher carbon prices, I’ll need to close
my cement plant – or move it to another
country...
• “Leakage” occurs when polluters move to avoid regulation – which is
why an international agreement is so important.

14. 14
$20 $20$20
• Opposite to leakage, a player may find a business sector that
isn’t covered by the policy … but has a lower cost
opportunity to reduce emissions.
$15
Reducing
methane
from
hog farmsSELL
PRICE:
The Problem of “Offsets”
As high as it takes
to motivate one of
us to get up…
How high can
the price go?
In that case…
I’ll move here…
• Because all tons of carbon emissions affect the
atmosphere the same, this offset could be accepted as
equivalent to a permit.

15. 15
The Problem of “Offsets”
• However, it can be difficult to verify that the player’s
investment was responsible for those reductions – and that
they actually happened.
• Therefore, standards for offsets must be high to ensure
the carbon reductions are real – and not “hot air.”
• China, India, and other countries have some very low cost
opportunities to reduce emissions.
• However, the U.S. Congress did not ratify the Kyoto Protocol
that makes use of the Clean Development Mechanism for
offsets.

16. 16
• Some companies want market-based policies, but not market
risk.
The Problem of a “Safety Valve”
My business cannot cope with the
possibility that carbon prices might
exceed $20/mtCO2!
• A “safety valve” would put a cap on the carbon price rather
than on the emissions, allowing firms to protect their
investments by buying unlimited pollution permits at a
guaranteed maximum price.
$20 $20$20 $20 $20$20

17. 17
• A “safety valve” would effectively violate the cap on
emissions, and convert the policy to a stable tax.
• Anyone can burn as much coal as they’d like if they can pay
the fee.
• With a “safety valve” on the price of carbon, the market
drivers are weaker, making command & control policies
even more important.
• Building codes, fuel economy standards, renewable portfolio
standards, tax laws, and other legal requirements would be
essential – as they are today.
The Problem of a “Safety Valve”

18. 18
• Players who receive more permits than they need would like
to “bank” them.
• By saving a spare permit, the player can pollute that amount
in a future year or to sell that permission to someone else in
the future.
• Similarly, some people who lack sufficient permits to cover
their pollution would like to “borrow” them from the permits
they expect to receive in the future.
2020
Banking

19. 19
Two critical aspects of cap-and-trade are determined by
how each round begins:
1. Which polluters should be required to play?
2. Should polluters have to buy permits in an auction –
or should they receive a free allocation of permits?
Coverage and Distribution

20. 20
For practical reasons, most proposals only require fossil fuel
suppliers and large polluters to play directly.
As they pass on their costs, the rest of the economy is
affected.
Oil
Refineries
Coal
companies
Natural Gas
companies
Power
Plants
Mining
plants
Chemical
companies
Aluminum
smelters
Examples of “covered” pollution sources:
Coverage

21. 21
Though sales of coal, oil, and gas should decline as carbon
prices rise, economists say less than 20% of the permits
should be given for free to compensate those firms for
additional profits they might have had otherwise.
Permits auctioned
to “covered” companies
Free permits
allocated to fossil fuel
companies
$20 $20 $20 $20 $20 $20$0BUY:
Auctioning Permits v. Allocating for Free
Source: Reference: Lawrence Goulder, Congressional Budget Office Conference on Climate Change, 2007.

22. 22
• By contrast, the Lieberman-Warner bill for U.S. climate policy
proposes giving away more than half the permits.*
• Those companies start out each round “sitting down” at no
cost.
$0 $0 $0 $0 $20 $20$0BUY:
* Though portion would change over time, 1/4 are still free in 2050.
Auctioned permits
bought by corporations
Free permits
allocated to corporations2012
Auctioning Permits v. Allocating for Free

23. 23
Why is this a cause for concern?
1.Unfair competition: New players entering the market with
innovative ideas have difficulty competing against pre-existing
polluters who get free permits as a subsidy to diminish their
political opposition.
2.Unearned windfall profits: In a carbon market, firms that
buy permits in an auction will try to pass costs to customers,
and others receiving a permit for free can sell their permits at
that same price.
3.A cap-and-trade policy with 100% auction avoids giving away
unearned windfall profits and returns all proceeds to a public
policy process for spending decisions.
Auctioning Permits v. Allocating for Free

24. 24
• A carbon tax and a cap-and-trade policy both would raise
fossil fuel prices.
• Prices of products and services that use fossil fuels would
also rise.
• This would impose hardship on low-income households
unless the climate policy specifically includes “carbon cost
rebate” measures funded with revenues raised from either a
tax or a permit auction.
Concerns About Equity

25. 25
• Is it ethical to privatize the sky and treat pollution as a
commodity traded like private property?
• Is it ethical to make a profit from carbon trading?
• Will the complexity of a cap-and-trade system rival our tax
system, opening similar opportunities for loopholes and
favored treatment?
• Would our political institutions be reliable to manage this
massive new market over decades under tremendous
pressure?
Additional Questions to Consider