November 12, 2019

Simulation Gives Students First Experience with Carbon Market

Nicholas Institute for Environmental Policy Solutions
Simulation Gives Students First Experience with Carbon Market

For a couple of hours on a September evening, the Berntsen Classroom at Duke University's Fuqua School of Business sounded more like a trading floor.

Teams of student investors strategized over whether to buy or sell on the market. In a few cases, they negotiated directly with each other, going back and forth over the right price.

The 50 Duke students in the room weren’t trading stocks, though. They were getting their first exposure to a carbon market.

“You’re going to be faced with a challenge, you’re going to see the opportunity, and I think you’re going to act in a way that a rational person would,” Josh Margolis, managing director of environmental markets at the Environmental Defense Fund, told the students at the beginning of the evening.

Margolis, a Duke alum, led the students through an interactive simulation of a carbon market — or emissions trading system — using EDF’s CarbonSim tool. Over the last seven years, he has brought CarbonSim to thousands of stakeholders in countries as far ranging as China, Mexico, South Korea, and Chile. The simulation gives participants an opportunity to see how a carbon market works in practice, develop strategies for staying under its caps, and adjust the system to best meet specific emissions reduction goals.

Margolis noted a relatively high level of knowledge about financial markets in the Berntsen Classroom. More than a third of the students that night were from the Executive MBA course “Energy Markets and Innovation” taught by Daniel Vermeer, executive director of the Center for Energy, Development, and the Global Environment (EDGE) at Fuqua. Several others said they had traded equities, stocks, or bonds before.

No one raised a hand, though, when Margolis asked if anyone had experience with a carbon market. That’s common for many of the groups he works with.

“They have, perhaps, a Rorschach image of what a carbon market is, but your image is different than her image is different than his image,” Margolis said. “It’s important for us to understand that whatever baggage we brought in terms of what we think markets are, we need to set that aside to understand some basics. Once we have those basic tools, we then can create a market that works for us.”

For the simulation, the students split into teams of two or three and selected a company. Acting as the government in the exercise, Margolis set an initial cap of 356 million tons of carbon that could collectively be emitted. The simulation then assigned portions of the cap to 242 companies, some run by students, but the vast majority controlled by artificial intelligence.

The government met a large part of the companies’ individual targets at the beginning of the exercise by issuing free allowances, each equivalent to a ton of carbon emissions. The challenge for the students was to figure out how to make up the shortfall at the lowest possible cost each year over a three-year period. As in real-world cap-and-trade programs, the cap declined each year in the simulation.

“I would dare to bet that you are going to participate in a carbon market over the course of your career, so you get a head start on other people who don’t what a carbon market is,” Vermeer told the students before the exercise.

The student teams had four ways to meet their targets:

  • Invest in abatements, such as energy efficiency measures or reforestation projects
  • Purchase allowances at government-run auctions
  • Trade allowances on the market
  • Buy allowances directly from other companies

After an “open hand” round in the first year, the students developed their own strategies over the rest of the simulation, with some coaching from Margolis, Vermeer, and Jackson Ewing, a senior fellow at Duke’s Nicholas Institute for Environmental Policy Solutions who has helped Margolis run CarbonSim in Europe, Asia, and the United States. The winning team of John Ruskell and Hassan Nadeem tailored its approach specifically to meet the compressed timeframe for the simulation. 

“We were looking for investments and abatements that would be able to get up to speed quickly enough so that we would be able to see the benefit and not cost us too much in the short term,” said Ruskell, a student in Vermeer’s course.

Nadeem, a master of environmental management student in the Nicholas School of the Environment, previously worked as a business analyst in his native Pakistan and has long had an interest in carbon markets. For him, one of the most interesting parts of the evening was watching the numbers add up.

“When we actually went through the simulation, we saw the reduction in emissions,” Nadeem said. “That was actually one thing that makes you believe in the concept of carbon trading and seeing it as an effective market tool for curbing greenhouse gas emissions.”

In addition to the emissions reductions, the cap-and-trade program in the simulation generated more than $10 billion in revenue through the government-run allowance auctions. As Margolis pointed out, political leaders can use money from these auctions to deliver near-term benefits to their constituents and build support for the program. In California, for example, proceeds from the state’s carbon market are funding electric vehicle rebates, home solar panel installations, mass transit projects, affordable housing, and more.

Margolis said that he wants to continue bringing CarbonSim to college students to help the next generation of leaders better understand that markets can help reach climate goals and stave off a “hell and high water” scenario.

“We ended up in this particular problem through incremental decisions that were made by the generations that have come before,” Margolis said. “Incremental solutions won’t get us out of it. We need to have clear vision to understand that a cap is absolutely necessary to achieve the carbon reductions that we’re looking for.”

The Carbon Simulation Game Night was co-sponsored by the Duke University Energy Initiative, Nicholas Institute for Environmental Policy Solutions, and Fuqua’s Center for Energy, Development, and the Global Environment (EDGE).


Story by Jeremy Ashton