kyoto

The Kyoto Protocol was signed yesterday. Most of the blogs that I have read have been negative, because I tend to read people that are free market orientated and penalising fossil fuels is obviously an attempt to distort the market.

Climate change is real, and it is going to cause problems in the long term. The cuts to carbon emissions required by Kyoto are not enough to stop it, especially since they do not cover the developing nations like India and China. But the cuts to fossil fuel emissions are not Kyoto's most important part, the most important part are the carbon credits. Let me explain.

Imagine a company, it wants to sell one product but in order to create this product it also creates a waste by-product. It cannot not produce this by-product as it is inextricably linked with the product itself. To try and produce one without the other would be like trying to produce sodium (Na) from salt (NaCl) without producing and chlorine (Cl), the universe just won't let you do it. Since you have to spend money on creating this by-product this is going to eat into your profits so you are going to try and reduce the cost of its creation as far as possible. The company that reduces this cost furthest will be able to generate the most profits and so will be rewarded by the market.

In the case of a green energy company carbon credits are the product, electricity the by-product. No green energy company can currently sell their electricity on the open market at a profit, so green energy is not a viable business. By creating a new product that green energy companies can sell, Carbon Credits, at a profit the situation changes so that green energy becomes a viable business. The invisible hand of the market will then spur innovation to make green energy cheaper until it can be sold on the open market at a profit. At this point the market will phase out fossil fuels as they can no longer compete with green energy as they will both be selling electricity at the same price, but the fossil fuels will have the extra expense of the carbon credits reducing their profits while increasing the profits of the green suppliers. As this phase out happens the market for carbon credits will diminish as there are less buyers naturally eliminating itself.

The market is being manipulated, but it is being manipulated in order to get green energy out of the Catch 22 situation that it is currently in. It cannot get to the point where it is profitable without major investment. But no one is going to invest in a business that cannot make a profit and therefore generate returns on that investment. Especially if there are other companies in that market where their money would make a handsome return.

So who pays for it? Well the customers for the green energy companies are the fossil fuel energy companies, who will pass the costs onto the customers. However in a competitive market these costs will reduce over time as the costs of the carbon credits reduce as the green energy companies produce more and cheaper electricity of their own.

We shouldn't worry about the Americans not signing up. Should it work and the green energy companies be profitable they will invest, especially as they near market prices for their electricity, the entrepreneurial spirit that drives American culture is always looking for new markets where they can make a profit. Should it not work, well it would not have worked had the US been signed up either. Kyoto not working is a very real possibility it is after all very much a big government project and was created by must be the biggest committee that has ever been convened which is not an encouraging sign. If it doesn't then it was at least a valuable experiment on what not to do when it's successor is created.

Simply doing nothing and hoping climate change will go away is not an option, but neither is trying to pursued people to go back to energy consumption levels of some mythical pre-agrarian time, yes I'm looking at you George Monboit, when we apparently live in tune with nature.