Robust Carbon Markets: Rethinking Quantities and Prices

Environmental policy with uncertainty is often posed as a choice between a price (tax) versus a quantity (cap and trade) instrument. In practice, the dominant approach across the globe is cap and trade, but the quantity targets (emissions caps) are typically over-achieved and the prices in these markets are typically lower than anticipated. One reason for low prices is the contribution to emissions reductions from companion policies that promote technologies such as renewable energy and energy efficiency. Paradoxically, the success of companion policies in reducing emissions has the unintended effect of undermining confidence in carbon markets by driving down prices in those markets, and the “waterbed” effect in the carbon market may erode the emissions reductions. This presentation evaluates a new approach that has been implemented in the Regional Greenhouse Gas Initiative called the emissions containment reserve. This mechanism automatically increases stringency when prices are lower than expected, improves cost-effectiveness, and reinforces the contribution of companion policies to achieving emissions goals.