Written by: Miles Fichtner
Big corporations like Tesla, GM, and other auto manufacturers are allowed to trade the amount of pollution they can omit. The amount of carbon dioxide that a car produces and the amount of energy a manufacturing plant takes to run is quantified down into a credit per tonne of carbon, in order to give a price and economic value to the amount of pollutant. This regulatory practice is based on an economic principle known as cap and trade, and is a major cornerstone to the race to carbon neutrality and goals to lower fossil fuel emissions. I will attempt to explain how this system works, and bring to light some of the benefits and complications with the regulation and clean energy solutions of this cap and trade model.
To understand how carbon markets work, it is important to understand that there are Compliance Markets which are regulated by different governmental agencies. In the United States, the EPA (Environmental Protection Agency) and the NHTSA (National Highway Traffic Safety Administration) regulate the carbon footprint of auto manufacturers emissions. The regulation of these auto manufacturers have fabricated private markets between large corporations, where the buying and selling of carbon credits is undergone to level out a downward sloping cap on total emissions. There are also Voluntary Compliance Markets (VCM), which are publicly traded markets, which allow everyday joe’s to invest in carbon negative sustainability projects, these may be more popular, as it has been a host to notoriety from financial news surrounding greenwashing scandals, and the emergence of blockchain as a financial and regulatory instrument. I however will not be talking about VCM’s as both Compliance Markets and VCM’s deserve their own papers.
Compliance Markets are based on specific allotments of carbon output that auto manufacturers are given, “A manufacturer’s total credits earned in a given period, therefore, are calculated as the product of 10 times the difference between the average fuel economy across each of its fleets (car and truck) and the fuel economy standard for those fleets.” (Leard and McConnell 4). This credit allotment is determined based on a mixture of EPA guidelines, as to what constitutes carbon output, and the manufacturers responsibility to quantify their production costs. The standardized value, as determined by these guidelines however, helps bring stability and credibility to the Compliance Markets, and the store of value helps the auto manufacturers gain crucial pricing information for trading.
The trading process is in place to allow for leeway to companies but also punishment to companies that go over their allotment of credit, as they are allowed to buy credits from a carbon negative company that has extra credits leftover, this creates a level of artificial supply and demand, that gives Tesla, for example, its ability to generate enormous revenues, as their cars are much more fuel efficient than what else is on the market, “The automaker reported a revenue of $554 million from the Q3 2023 sale of carbon credits, significantly contributing to its profits … which representent 29% of net income” (Jennifer L).
The total credits in the automotive industry in 2023 and the amount of credits over and under the regulated cap is reported below, where (GHG) is greenhouse gasses.
Environment Protection Agency (EPA) Automotive Trends Report.
What this graph helps illustrate is how the market is affected when companies in the industry go over the cap. The supply decreases from the regulation from the industry, and in effect, the price increases per unit and the demand for units increases rapidly. This generates momentum to trade credits, and gives a company like Tesla the opportunity to capitalize on its environmental efficiency.
The ability for government regulation to incentivize positive social and environmental utility through policy like this, shows the power and effectiveness of the cap and trade model. It illustrates how technological advancement through production efficiencies remain to be a crucial selling point for companies profitability as well, given that companies that can lower their production costs now earn an artificially created equity to trade to other companies.
One problem with the Compliance Markets is that production incentives from increased revenues, would occasionally increase their carbon footprint. Increased manufacturing and the costs of creating efficient batteries and throwing away batteries expends a heavy carbon footprint as well and these are not accounted for in the allotted credits. The energy consumption from rechargeable batteries is also unaccounted for, meaning when the everyday commuter in Southern California plugs in their Tesla for the night, the increased electric bill is not accounted for in the pollution cap Tesla receives from the EPA Corporate Average Fuel Economy (CAFE) requirements. “EPA allows manufacturers to count vehicles that run on electricity as having zero emissions of CO2. However, actual CO2 emissions from these vehicles depend on how the electricity that powers them is generated. Most studies of this issue have found that levels of CO2 emissions vary significantly depending on where the power is generated.” (Leard and McConnel 6).
The EPA CAFE law is based specifically in the United States by the EPA, and leaves holes in energy consumption when allocating carbon credits.This creates a heavier carbon footprint in the short run which begs the question, is it worth it?
Tesla receives more credit than they are due relative to other corporations whose production costs are more heavily accounted for in their allotment. This system gives Tesla greater market power in the carbon market despite higher production / energy costs unaccounted for the battery production and leakage into household carbon consumption.
Trading volume between auto manufacturers has also increased exponentially since the creation of the compliance markets back in 2005, thus creating a morally gray area where companies that are heavy pollutants can buy their way out with carbon credits traded from more efficient companies, “EPA argues, however, that the overall long-run efficiency of the rules will be enhanced by the alternative vehicles policy. This is because the more rapid introduction of alternative fuel vehicles will result in knowledge spillovers and industry-wide cost reductions. This long-run effect remains to be seen, but in the short-run, the policy will grant too many credits for electrics, drive up the cost of meeting the regulations, and reduce the stringency of the standards.” (Leard and McConnel 7).
Despite the EPA’s estimated long-term productivity of the markets, it is important to be wary and speculative of the underlying issues within the carbon compliance markets.
References
L, J. (2023, October 19). Tesla’s Record Carbon Credit Sales Up 94% Year-Over-Year. Carbon
https://carboncredits.com/teslas-record-carbon-credit-sales-up-94-year-over-year/
Leard, B., & McConnell, V. (2015). New Markets for Pollution and Energy Efficiency: Credit Trading Under Automobile Greenhouse Gas and Fuel Economy Standards. SSRN Electronic Journal.
RFF-Rpt-AutoCreditTradingREV.pdf
The 2023 EPA Automotive Trends Report. (2023).
https://www.epa.gov/system/files/documents/2023-12/420s23002.pdf