Signed into law by President George H.W. Bush, the 1990 Clean Air Act Amendment was a dramatic change from previous environmental regulations, as it used market-based regulation to combat acid rain in the United States. Previously, the cost of pollution was borne by the decreased health of the general public and the environment and was only discouraged by inflexible regulatory oversight. However, after the law came into being, the costs were partially transferred to those power plants that created the majority of the pollution and the price of compliance had the elasticity needed for businesses to adapt. A wild success, the amended law has brought major reductions in emissions and acid rain, increased power generation, and $50 billion in improved health outcomes at a total cost 15-90% less than alternatives.
The United Nations Framework Convention on Climate Change (adopted in 1992) and the Kyoto Protocol (adopted in 1997) gave many nations around the world the incentive to reduce the carbon-based emissions that are causing global climate change. Seeing the market-based success of the Clean Air Act Amendments, most governments chose to employ a similar “cap-and-trade” regulatory model to achieve their carbon reduction goals. This was the origin of the various carbon markets. However, in order to make the transition as painless as possible, many of the earliest markets were created with a gross oversupply, which kept the price very low. Much of the optimism associated with the new markets met with this political reality and the additional burden of the 2008 economic collapse, causing prices to crash and driving many suppliers from the market. The perception that carbon markets do not work stems from this initial period of lost dreams.
However, something new is afoot. Those early markets have increased demand and reduced supply at the same time that new markets have come into existence. As it currently stands, there now exist carbon markets in places as diverse as Europe and New Zealand, provinces of China and prefectures of Japan, California, Quebec, and Kazakhstan. The demand for carbon offsets has grown significantly as a result, and the market has reason for even greater optimism as new, even larger markets emerge. China, the world’s largest polluter and second largest economy, is bringing a national market online by 2020. The United States, the world’s second largest polluter and largest economy, has strongly incentivized mass-based trading in the EPA’s Clean Power Plan, creating a national framework for state markets by 2022.
All of this combines to provide, for the first time, the price stability and upward trends that the market has craved. Prices for carbon have shown calm and steady improvement over the last two years, with conservative estimates predicting a growth of carbon credits from present values around $13 / metric tonne to $65 / metric tonne in 2040 in inflation adjusted dollars. Even Exxon-Mobil – the world’s largest publicly traded oil company – has placed the predicted value of carbon at $80 / metric tonne in 2040. Less conservative estimates see even greater gains.
The history of carbon markets is somewhat checkered, but we are on the verge of significant and investable improvement. It is an exciting time to be involved.