Tuesday, January 13, 2015

Korea's Carbon Trading Market: Empty "Feel-Good" Politics

On January 12th 2015, in an effort to curb carbon dioxide emissions, Korea established the world's second largest carbon trading market. The government has decreed that this year's total carbon dioxide emission quota would amount to 1.59 billion tons. The government has also announced that the carbon emission quota would be imposed on 502 Korea-based companies.

According to the same article from The Korea Times, analysts estimated that the affected companies will have to spend nearly 12.7 trillion (US$11.71 billion) over the next three years to buy extra emission rights or to install carbon emission-reducing facilities.

Now the question is whether or not this will work. I, for one, have serious doubts.

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The world's largest carbon trading market was stared in 2005 and it is located in the European Union. The first phase of the carbon market, which lasted from 2005 to 2007, did not reduce carbon dioxide emissions. Instead, overall emissions increased 1.9 percent over that period.

But why would that be the case? It was because was “a surplus of allowances and international credits compared to emissions.” If this were a “natural” market, it would be easy to say that this oversupply of emission allowances was a result of market failure, which could be easily remedied by lowered prices. However, this is not a natural market. It was a market that was artificially created by the EU Emission Trading System (EU ETS), an intra-governmental agency.

So what happened? Politics happened. European politicians knew that cap-and-trade can be economically harmful. Especially due to the worldwide economic slowdown that began in 2008, no European politician wanted to go down in history as the one who deliberately exacerbated his or her country's unemployment woes. Case in point, even “good” European leaders like German Chancellor Angela Merkel thought that climate change politics must not trump jobs. Considering the economic gloom that has besieged Europe for the past few years, it should not come as a surprise that Chancellor Merkel was not alone in her opposition to stringent rules that dictated her country's economic productivity.

If a market that is imposed on the private sector is run by the government, there is always the possibility, nay assurance, that it will not be dictated by market forces, but rather by government diktats. Political convenience will always trump principles.

It was politics that failed the world's largest carbon trading market. There seems to be no reason whatsoever to suggest that Korean politicians will be any better than their European counterparts.

The irony! It BURNS!
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Subsidizing the Bad

Politics, of course, is not the exclusive domain of politicians. It goes without saying that corporate leaders also take part in it quite regularly through the form of lobbying.

The theory behind cap-and-trade has always been that that eventually, the government will reduce the availability of carbon permits, which will ensure scarcity. That way, the market will retain its value while at the same time forcing a reduction in the overall level of pollution. Then those businesses will further trade those permits with each other, thus forcing each actor to innovate and find new ways to produce less carbon dioxide emissions.

At least that's the theory.

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As mentioned earlier, a combination of industrial lobbying efforts and political impracticality have ensured that the the EU ETS granted more pollution rights to private firms than the polluters needed to cover their existing level of emissions. However, what makes it worse is that even before the rights were granted, the amount of pollution rights that the government considered to be allowable was calculated based on existing levels of pollution.

What that means is that those who have polluted the most in the past have been rewarded with the greatest subsidy. If that is not a backward way of doing things, not to mention unjust, then I do not know what is.

Will Korea avoid the mistakes that were made in Europe? I will always hope for the best, but I shall not bet the jeonse on it.

The Regulation of Everything

One of the most successful government acts that actually helped to reduce air pollution occurred in the United States. The Environmental Protection Agency began to regulate sulfur dioxide emissions, the gas that was most responsible for increased acid rain, in 1971. The world's first large scale cap-and-trade system was born in 1990 when the Clean Air Act was amended to create an allowance-trading program for sulfur dioxide.

By all measures, the creation of the sulfur dioxide cap-and-trade market has been viewed as a great success. As a result, many people who champion carbon cap-and-trade markets often point to the former as a way for the latter to go forward.

However, what people often don't realize is that that is like comparing apples and oranges.

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The most important difference is that when the American government tried to regulate sulfur dioxide emissions via its cap-and-trade system, only 110 coal-fired power plants were included in the system, which later expanded to 445 plants.

Then there is also the fact that long before the Environmental Protection Agency came around to creating the world's first cap-and-trade market, coal-fired power plants already had many low-cost options to reduce sulfur dioxide emissions without reducing electricity production. In other words, the technology that was needed to reduce sulfur dioxide already existed and was already underway in the private sector even before the Johnny-come-lately government entered the market. On the other hand, unlike sulfur dioxide emissions, an economically viable technology that helps to reduce carbon dioxide emissions does not yet exist.

Furthermore, unlike sulfur dioxide, which is industry-specific, carbon dioxide is emitted by everything and everyone. The biggest producers of carbon dioxide may be easy to point to – automobiles, electricity production, oil processing plants, and farms just to name a few. Unfortunately, however, that list includes millions of businesses, non-profit organizations, and even just ordinary individuals.

The Korean government may have picked out the largest 500 companies to impose its cap-and-trade system. However, there is no way that it can succeed in achieving its goals if it does not regulate everyone. Of course, the real problem with it is that it cannot regulate everyone. The government is neither omnipotent nor omniscient. Regulating everyone is simply impossible.

That's why I can sleep at night - the knowledge that as much as the government can try, it can't regulate everything
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Minimal Impact

For the sake of argument, however, let us presume that Korea's carbon trading market does work the way it is advertized and it does become successful. Then the question that has to be asked is how that success would be measured.

It is estimated that Korea produces approximately 630,000 kilo-tonnes of carbon dioxide per year, or about 1.69% of the world's total carbon dioxide emissions. On the other hand, China produces 10,330,000 kilo-tonnes and Russia produces 1,800,000 kilo-tonnes. Japan produces 1,360,000 kilo-tonnes and the United States produces 5,300,000 kilo-tonnes.

Korea is truly a shrimp that is surrounded by whales. The following link provides a “carbon atlas” of the world.

Even if Korea somehow manages to successfully stop using fossil fuels completely, it will not change the fact that other countries around the world will pick up Korea's slack in no time. After all, the world's largest consumers of fossil fuels are developing economies.

In other words, Korea's domestic cap-and-trade system will most likely have a virtually unnoticeable effect on global warming while imposing substantial costs on all Korean businesses and households.

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The Tragedy of Unintended Consequences

Again, for the sake of argument, we have to assume that the carbon trading market will be successful.

It is no secret that coal is one of the dirtiest ways to produce energy. However, as coal is relatively cheaper than other fuel sources, much of Korea's businesses rely on coal for their electrical needs. In fact, Korea is the fourth largest net-importer of coal in the world. Though this might not occur immediately, as natural gas is a cleaner alternative to coal, and especially considering the recent tumble in oil prices, it will only be a matter of time before Korean businesses will begin to rely on natural gas as a substitute for coal.

Oil prices have fallen in recent months and Saudi Prince Alwaleed bin Talal recently said that the world will never again see the price of oil rise to US$100-a-barrel. That might offer some comfort for Korean manufacturers. However, even if the prince is right, the law of supply-and-demand states that when demand goes up, ceteris paribus, the price will also go up.

As the price of natural gas goes up and coal remains undesirable due to its high carbon dioxide emission rates, Korean businesses will become less competitive. Seeing how Korea is already facing an uphill battle in maintaining its edge in the manufacturing industry vis-à-vis China, Japan, India, and other emerging Southeast Asian economies; not to mention Korea's aging population and low birth rate, this new cap-and-trade system will hurt Korean manufacturers' profit margins even further.

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And when a business' profit margins start to shrink, one of the first things that a business usually tends to do is lay off workers.

The rise in the price of natural gas, which is coupled by a decrease in demand for coal, will do more than hurt manufacturers, unfortunately. It will also affect average citizens as it will become increasingly expensive to cool and heat people's homes or to fuel their cars. It goes without saying that this will hurt the most vulnerable members of society, the elderly and the poor, more than it will affect anyone else.

Furthermore, as regulations will force businesses to be more mindful of carbon emissions, businesses will have no choice but to spend more money on carbon trapping technologies, which will lead to higher prices. And when prices go up, consumers buy less. It is a vicious cycle. It is also common sense, which many policymakers seem to lack.


The cap-and-trade system for carbon dioxide emissions has been a miserable failure in Europe and has been a political non-starter in the United States. There were good reasons for this.

Cap-and-trade may have been started with the best of intentions. In practice, however, it has turned out to be little more than empty feel-good politics. It is a noble failure that succeeds in doing only one thing – showing the rest of the world that people care, and are willing to do something about protecting Mother Earth. Never mind that the something that they are doing is, to use an understatement, counterproductive.

If only feeling good about oneself could solve all of the world's problems...
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