Only ten beers on the table

The response by James Shaw to today’s breach of the ETS price cap has reminded me of the most helpful analogy I have heard to describe how a binding ETS cap really does neutralise every policy under the cap under nearly all foreseeable circumstances. The analogy comes from Eric Crampton. It involves beer.

To recap today’s events:

• Earlier today, the government issued an extra 1.6 million ETS emissions units to defend the price cap
• Those extra units will raise New Zealand’s emissions by 1.6 million tonnes
• Shaw is looking at ways to neutralise the extra units so that they do not raise overall emissions. One of those ways is to issue 1.6 million fewer units in the future. Shaw is correct that this will indeed neutralise the emissions from the extra units issued today.

Shaw’s implied view is that in order to neutralise the extra units under a binding ETS cap, you have to reduce the cap. Right on. Shaw did not say he is also looking at more EV subsidies to neutralise the extra units. That is good because it would not work.

So here is my adapted version of Eric’s beer analogy, the takeaway being the cap is the cap is the cap:

Each Friday, Alex, Bob and Cath drink beer together. Alex always drinks 3 pints, Bob 4 pints, and Cath 5 pints. They have all 12 pints delivered to their table at the start of the night and go home when the last glass is empty.

Tonight, the pub has run dry. Only 10 pints arrive at their table. The friends discuss how to divide up the smaller number of beers. They come up with all kinds of elaborate schemes.

Further complicating things, the pub owner is friends with Alex and decides to charge her only half price for whatever she has to drink. It is such a good deal that Alex ends up drinking four pints, more than her usual three.

So what effect does the owner’s subsidy and all the elaborate schemes have on the total number of beers consumed? Zero. Exactly 10 pints are consumed, because that is all the beer there is. The subsidy and the schemes change how the beers are divided – but do not and cannot change the total number of beers consumed.

And so it is with a binding ETS cap. Subsidise EVs all you like. Raise taxes on petrol. Ban new gas connections. Do all the elaborate, tricky policies you want. They will have zero effect on total emissions. Because total emissions under a binding cap is solely determined by the cap – the number of emissions units issued by the government.

Next month, the government will commit tens of billions of dollars-worth of new emissions policies under its Emissions Reduction Plan. Nearly all of them will work under a binding ETS cap. As a result, they will not change total emissions by a single tonne. We will be no closer to our emissions targets, not by one gram. We will just be poorer.

Hundreds of officials, perhaps thousands, working away on their elaborate plans to lower emissions cannot see the obvious truth. Whatever their plans, there will be ten beers on the table.