EU to cap airline greenhouse gas emissions

Contrails of a McDonnell Douglas aircraft (Contrails are just vapour, CO2 is invisible)

As of next year airlines that fly in and out of the European Union must come under the European Union’s Emissions Trading Scheme (ETS). Those based outside the EU can opt out if they prove to abide to similar regulation in their home countries. The entire industry in both Europe and abroad is trying to have the new regulations annulled or at least postponed.

All large polluting sectors in the EU are already subject to the ETS, but the airline industry works in a global way, so subjecting foreign airlines to it will cause all kinds of conflicts and may invite retaliation in several forms. On the other hand, subjecting only EU based airlines to the ETS would make them noncompetitive in routes shared with non-EU competitors.

Charging for carbon emissions is a practical method to reduced them. The debate on price versus quantity instruments in tackling climate change has been on for decades. Abatement costs might change in the future due to: fuel prices, domestic energy demand, energy saving technologies, etc. A carbon tax fixes the marginal cost of abatement, but allows the quantity of abatement to vary with economic conditions. A cap fixes the amount of abatement instead. Trading emissions in a market allows for cuts where they are most efficient, i.e. cheaper. Once a decision is taken by policy makers to tackle emissions both a cap and trade scheme or a carbon taxes are options. Economics theory shows these are equivalent only under certainty. However, certainty is a scarce commodity and cap and trade can lead to high volatility in the markets.

The Economist explains this well (Duffing the Cap, 15/06/2007): "taxes deal more efficiently than do permits with the uncertainty surrounding carbon control. In the neat world of economic theory, carbon reduction makes sense until the marginal cost of cutting carbon emissions is equal to the marginal benefit of cutting carbon emissions. If policymakers knew the exact shape of these cost and benefit curves, it would matter little whether they reached this optimal level by targeting the quantity of emissions (through a cap) or setting the price (through a tax). But in the real world, politicians are fumbling in the dark. And that fumbling favours a tax. If policymakers set a carbon tax too low, too much carbon will be emitted. But since the environmental effect of greenhouse gases builds up over time, a temporary excess will make little difference to the overall path of global warming. Before much damage is done to the environment, the carbon tax can be raised. Misjudging the number of permits, in contrast, could send permit prices either skywards or through the floor, with immediate, and costly, economic consequences. Worse, a fixed allotment of permits makes no adjustment for the business cycle (firms produce and pollute less during a recession). Cap-and-trade schemes cause unnecessary economic damage because the price of permits can be volatile. Both big cap-and-trade schemes in existence today—Europe's Emissions-Trading Scheme for carbon and America's market for trading sulphur-dioxide permits (to reduce acid rain)— suggest this volatility can be acute. America has had tradable permits for SO2 since the mid-1990s. Their price has varied, on average, by more than 40% a year. Given carbon's importance in the economy, similar fluctuations could significantly affect everything from inflation to consumer spending. Extreme price volatility might also deter people from investing in green technology. Even without the volatility, some economists reckon that a cap-and-trade system produces fewer incentives than a carbon tax for climate-friendly innovation. A tax provides a clear price floor for carbon and hence a minimum return for any innovation. Under a cap-and-trade system, in contrast, an invention that reduced the cost of cutting carbon emissions could itself push down the price of permits, reducing investors' returns."

Though some Economics disagree, Pindyck in his 2006 paper 'Uncertainty in Environmental Economics', states: "Weitzman (1974) [...] showed that in the presence of cost uncertainty, whether a price-based instrument or a quantity-based instrument is best depends on the relative slopes of the marginal benefit function and marginal cost function. If the marginal benefit function is steeply sloped but the marginal cost function is relatively flat, a quantity-based instrument (e.g., an emissions quota) is preferable: an error in the amount of emissions can be quite costly, but not so for an error in the cost of the emissions reduction. The opposite would be the case if the marginal cost function is steeply sloped and the marginal benefit function is flat. Of course in a world of certainty, either instrument will be equally effective. [emphasis added] If there is substantial uncertainty and the slopes of the marginal benefit and cost functions differ considerably, the choice of instrument can be crucial."

Anyway, in the big picture airlines only account for about 2% of greenhouse gases emissions, so maybe we could focus on more serious culprits, remember the Pareto principle?