Is a cap-and-trade system the only solution to the carbon emission problem?

pollution of a power plant

On Friday, July 31 I was fortunate (thanks, Dr. Sroufe) to attend a luncheon at Duquesne University at which Paula DiPerna was the guest speaker prior to her commencement address to Duquesne University’s most recent crop of sustainability MBA students. Paula has a distinguished background with significant experience in the carbon trading business and is currently a special advisor to CDP (formerly the Carbon Disclosure Project).  Here’s my report on what I heard:

Paula’s main thesis is that the only really workable solution to the carbon emission problem is a good cap-and-trade system. A carbon tax or other forms of carbon pricing just won’t work because it is impossible to find the correct price to apply. There will always be too much ambiguity regarding the price and businesses hate ambiguity.

She supported her thinking by starting with the idea that the Keeling Curve is a well-accepted demonstration of the rising impact of CO2 in the atmosphere. There is no ambiguity there. But, she continued, it has taken almost 44 years since the first United Nations Conference on the Human Environment in 1972 until the Paris 21 COP later this year to maybe reach a point where a combination of mainstream investors’ voices, plus carbon pricing in multiple countries, plus policy changes might actually lead to real decreases in CO2 in time to actually make a difference.

As backup, she stated that the rise in Socially Responsible Investing (SRI) has been dramatic, reflecting the investment management world’s acceptance of the need to consider the environment in its investment decisions. Between 2012 and 2014, the United States’ SRI has risen 76%; in the European Union, SRI is up 30%; and in Asia, SRI has grown 32.5%. This is all a reflection of both the need to decrease risk, as well as take advantage of new opportunities.

In addition, entirely new investment businesses are being built based on these same principles. S&P has an entire line of products that support carbon efficiencies: Paula called out the Green Bond Index, Clean Industry Indices, and Fossil Fuel Free indices. She stated that these products exist because people (meaning investors) WANT these products and that’s a good sign. (Author’s note: I did not know about these indices, but find their breadth and size fascinating. This is one way in which the market really is working, albeit in a laggardly fashion.)

Better, the S&P Carbon Efficient Index has tracked the S&P 500 perfectly between 2005 through 2015, so there has been no penalty for the SRI approach. Now that they have ten years of actual data, many more investors will consider SRI a legitimate approach to investing. No one can any longer use the argument that the same returns can’t be earned from an SRI portfolio as from a standard portfolio. Paula also mentioned Northern Trust’s active low-carbon approach to investing client portfolios as an example of how SRI has gone mainstream.

There is specific business risk that rising CO2 levels bring to the world and businesses—Paula mentioned Hurricane Sandy in the New York City area and its billions of dollars of impact. Investors increasingly factor these sorts of risks into investment decisions, which means that more companies will need to factor them into decision-making as well.

Paula expressed her opinion that a Global Cap and Trade mechanism was both necessary and inevitable. She remarked that it already worked remarkably well in the USA to combat SO2 as the cause of acid rain. She showed a map of CO2 Cap and Trade markets already in place and functioning, and observed that it is ironic that the USA invented the Cap and Trade system but now does not have a national market for CO2. In her opinion, that is like inventing the automobile in the USA and then not allowing anyone in the country to drive cars. (I don’t think this is the map Paula showed, but here is a good interactive map of the world’s existing carbon markets:

To support her projection that Cap and Trade is inevitable, Paula also discussed the fact that a number of companies have started using an internal shadow price for carbon. That is, for internal cost accounting purposes, companies are already assuming a price for carbon emissions and making decisions accordingly. They are preparing for the inevitable actuality. Companies such as Bayer and Canadian Tire want certainty and are already pricing CO2 to accommodate that. And besides the companies themselves, investors also care whether this potential carbon price is factored into a company’s future plans and make investment decisions accordingly.

Paula notes that California has already established a Cap and Trade market. China is about to and she thinks when that happens, they will MAKE the market and everyone else will jump on-board. Countries and investors will create linkages between countries, similar to today’s currency trading markets, and THAT will be revolutionary. By 2018, she thought, China, the EU, Canada, and Australia could all be linked.

Paula brought up the notion that under one estimate, it will take $44 trillion dollars to curb the rising CO2 emissions. One way of deploying that large sum is well-illustrated using McKinsey and Company’s GHG Abatement Cost Curve. They present some interesting research regarding which pieces of CO2 abatement the market may handle and which will need financial and policy support to achieve.

And when it comes to the policy aspects, Paula suggested that we all need to have a hand in supporting our elected officials and regulatory bodies, giving them the cover and motivation they need to create the proper Cap and Trade markets. So, start writing your letters….

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