Government schemes that regulate greenhouse gas emissions through the trading of carbon credits can actually increase profits for high-polluting companies if carbon credits are initially given to these companies free of charge, says new Brock University research.
Economist Marcel Oestreich and University of Guelph economist Ilias Tsiakas analyzed the impact on German industries of the European Union’s Emissions Trading System, launched in 2005 to combat climate change.
Under the system, regulators place a specific limit – or “cap” – on the amount of greenhouse gasses that factories, power plants and other companies are allowed to emit into the environment.
Some companies emit less than their limit, while others emit more. The ones that emit less can sell the difference to companies that emit more than their limit through certificates commonly known as “carbon credits.”
Responding to industry concerns that complying with the Emissions Trading System would make EU companies less competitive than their North American or Asian counterparts, EU regulators kick started the program by giving carbon credits to companies for free rather than charging for those credits.
Oestreich and Tsiakas compared the stock portfolios of those in “dirty industry” to their cleaner counterparts before and after the system’s 2005 launch.
“Dirty industry” companies are defined as those with the highest pollution rates. These are commonly found in the electricity, iron and steel, industrial and chemical sectors.
In contrast, “clean” industries emit low levels of pollution. Sectors include telecommunications, healthcare and electronics.
The study – forthcoming in the journal Banking and Finance – asked, “with all else equal, did the stocks of the dirty industry do better than the stocks of the clean industry during the initial phases of the trading scheme? Nobody else has looked into this yet,” says Oestreich.
“We show that, in the first years while the Europeans had given the free certificates, the dirty industry heavily outperformed the clean industry in terms of their stock returns.
Oestreich explains that despite industry receiving the carbon credits for free, industry tended to increase the consumer prices just as if they would have paid for the carbon credits. This resulted in windfall profits for the industry because while the industry didn’t have the cost of purchasing the carbon credits, it included the market value of those credits in determing the consumer prices.
“The “clean” industries did not require carbon credits as their emissions were typically not captured by the cap-and-trade system,” says Oestreich. “Thus, there were no windfall profits among the “clean” companies.”
Oestreich says that cap and trade systems can work effectively, but that their success depends on their particular design. He notes that, overall, the EU has been “successful” at reducing its greenhouse gas emissions, but that there were several issues with the design that other regulators could learn from.
“One of these issues is the question of allocation of certificates: Should the regulators sell the certificates, wherein revenues from the sale would go to the regulator, or should regulators give the certificates to industry free of charge, wherein revenues accumulate on the side of the industry?” says Oestreich.
He says that regulators can focus on finding a workable “middle ground” somewhere between the two extremes of regulators allocating 100 per cent of carbon credits free of charge and industry paying 100 per cent of the carbon credits’ costs.
“A cap-and-trade system is not necessarily a burden on the industry,” says Oestreich. “In the wider scheme of things one can argue that given the free allocation of carbon credits to the industry in Europe, there appears to have been a form of subsidy paid towards the dirty industry in the initial phases of this system.”
The European Union’s Emissions Trading System (EU ETS) was the first international measure of its kind to address climate change by reducing industrial greenhouse gas emissions.
It argues that putting a price tag on carbon gives “a financial value to each tonne of emissions saved, the EU ETS has placed climate change on the agenda of company boards and their financial departments across Europe,” says its website.
The EU predicts that emissions from sectors covered by the system will be 21 per cent lower in 2020 than in 2005; by 2030, emissions should be 43 per cent lower, says the EU.
The system covers more than 11,000 power stations and industrial plants in 31 countries, as well as airlines, across Europe.
Ontario premier Kathleen Wynne announced April 13 that Ontario would soon be implementing a similar “cap-and-trade” carbon pricing system.