EnviroEconomics.ca

In reading this one would think that we are on the verge of the next great ponzi scheming structured financing debacle,

The next big scam: carbon dioxide

In referring to the $7.4-billion in fraud that have occurred in the last 18 months in the EU’s carbon market: “It is clear that [carbon trading] fraudsters are fully aware of the potential that trading in intangible commodities has to further their ends. Such goods or services can be traded without the need to be physically moved or transported, which represents an obvious opportunity to frustrate Law Enforcement efforts to track and trace transactions.” So much fraud has been occurring that, Europol estimates, up to 90% of all carbon market volume in some EU nations was related to fraudulent activities.

Permits for CO2, a tasteless, colourless and odourless gas, epitomize an “intangible commodity.” The underlying commodity for these permits, CO2, until recently had few producers, few customers and few commercial uses. With the rise of fears over global warming, governments decided to turn this niche gas into what could soon be the world’s most traded commodity

Can we minimize gaming in the trading market? Probably, given stock market regulators routinely set the conditions to minimize fraud and then enforce these. And does the “intangibility” of carbon necessarily lead to fraud? If carbon can be counted and then reconciled, is it truly intangible? Company valuations are typically based on intangibles, like goodwill, and product pipelines are always intangible as in pharmaceuticals. And don’t get me going on how the magic of technology drives tech valuations. So the fact that carbon is “intangible” does not necessarily lend itself to fraud. Stock markets work on intangibles on a minute-by-minute basis.

In the end, the prevalence of fraud is about instrument choice: with the choice of carbon markets over carbon tax, one is necessarily trading off market gaming for inept government spending. Trading is what most people want given aversion to tax, and so one has to live with immature markets, speculation, volatility and gaming. With each layer of the carbon trading onion revealed, it is no wonder folks are drifting back to carbon taxes.

A senior federal cabinet minister has added some long awaited clarity on where Canada is going with climate policy in advance of Copenhagen,

“I don’t think we’ve been ambiguous on this issue…”

(here)

Be patient cause we have no policy....

This picture, and indeed the whole federal policy, is eerily paralleling the Bush administrations bold forays into climate policy … see post here

Our climate policy is this big...

As always, while the feds fiddle, energy intensive industries are rolling out high emitting capital with low expectations that they will see real carbon prices,

I think there is certainly hope in the industry that they can see some clarity in the near future,” Dunbar said.

“They don’t want to see this situation with all this uncertainty drag on for years. I think the sooner they can have clarity, the better off they are and the easier it will be for people to make decisions.”

He said there are many points of view on the subject –some players wouldn’t even mind a carbon tax, for instance –but most agree they want a fair regime that applies equally to all emitters, without picking winners and losers.

Some $100 billion worth of oilsands projects for northern Alberta were deferred or canceled last year as credit markets froze and commodity prices tanked.

The only certainty in Canadian climate policy is inaction.

My attention turned to perverse subsides recently for a number of reasons (see here).
Subsidies are obviously a bad thing, especially if they promote more of something we are spending cash to reduce. In Canada when one thinks of fossil fuel subsidies, one thinks oil and gas. Pembina has done a lot of work on oil and gas subsidies, resulting in a Green Budget Coalition recommendation (see a short summary here).

Pembina estimates direct tax expenditures on the oil and gas sector by the feds to be about $1.4 billion annually (here). But this is likely decreasing due to the federal government’s repeal of the oil sands development expenditures valued at about $300 million annually (see here).

So, say $1.1 to $1.4 billion annually rolling forward in time.

Is this a big number? Initially, I thought not given that oil and gas GDP was about $76 billion in 2005, so the tax subsidy was about 1.8% of annual GDP. But then I looked at emissions. Oil and gas emissions were about 130 MT in 2005. This means that the effective subsidy is equivalent to a carbon price of $11/tonne. This caught my eye. Enough so that I thought it worth modeling what it could mean for emissions.

The best way to model the subsidy is to reduce production costs by the rate of the effective subsidy to production, and not as a carbon price. But, just for fun, and because it is easier, I simply put a carbon price of $11/tonne into the sector and modeled the results (in CIMS). Essentially the policy case would be: what happens if we drop subsidies to the sector and price emissions the equivalent value?

In this policy case, national GHG emissions from oil and gas drop significantly in time, from a BAU of about 214 MT in 2020 to 179MT. Over the long-term, emissions drop by 2050 from 230MT to 169 MT. See chart below. These are significant reductions.

So, it is great to be proven wrong and it seems there is scope to look at this subsidy issue a lot closer. Indeed, $11/tonne is a crazy number, and put in context with the federal government’s Technology Fund safety valve price of $15 to $22, it seems the Feds are pricing emissions even less than we thought.

There is an article today indicating more delays with rules for California’s cap-and-trade program (here)

California’s blueprint to address global warming won’t include details of an emissions-trading program as regulators try to build consensus on how best to organize the market-based system….”They were a long way off at approaching consensus on the major design elements.”

This outcome is hardly surprising given the administrative complexity of cap-and-trade systems. Indeed, this is a major reason why carbon taxes tend to be preferred — complexity. But, do cap-and-trade systems necessarily take more time to implement than carbon taxes?

To answer this, one can look to the differences in the decisions required to implement the two emission pricing options. Regardless of the emission pricing policy, cap-and-trade or tax, there are a series of common questions that must be addressed by decision-makers. These include questions of who is covered and what is the desired goal, be it certainty in emission reductions or containing costs. Questions of revenue need are also common to both, with a need indicating a preference for auctioning in cap and trade. Similarly, linking with other jurisdictions must be considered under both cases, wherever it is a question of the two-way linking to allow trading or simply to ensure that carbon prices align to minimize competitiveness impacts.

While carbon taxes tend to align more closely with existing institutional functions, cap-and-trade systems are not that different. Auctioning telecommunications rights is standard practice, as is emission monitoring and verification and allocating transferable rights in the fishery. But as in the fishery, it is this last function that requires time. Allocation is really the source of why cap- and-trade systems are relatively slower to implement. The source of this is uncertainty is over both economic gain and possible economic loss. Since cap and trade systems have unknown prices in advance of implementation, there is price uncertainty, and therefore more policy caution as well as constituent engagement. This engagement slows implementation through opening the door to gaming by both participants and policy makers alike. Contrasting allocation decision making to setting a common tax rate and one can readily see why cap-and-trade is less speedy to implement.

But is this necessarily a given outcome? Likely not under at least two conditions:

• First, if policy makers decide that allocations will be set on rules over discretion then these rules simply need to be established and the allocations made. But still, the rules must be contemplated and set; and,

• Second, if cost uncertainty is taken off the table through an over allocation of permits, prices will be low, and the threat of adverse cost outcomes minimized. Of course the trade-off is lower emission reductions, but really this is analogous to a low tax rate that can be ratcheted up (or the cap down) in time.

And is slow implementation necessarily bad? Likely not given that CO2 is a stock pollutant and cumulative emissions matter. We would likely be indifferent between a fast to start carbon tax system versus a slower to start cap and trade system as long as cumulative emission reductions are the same. What matters here is the cumulative emission reductions, and with a stringent future cap, perhaps speediness is not necessarily better relative to a low tax given the cumulative reductions.

So while cap and trade is is more likely a slower option to implement, it is not necessarily inferior to cap and trade when considering a stock pollutant such as CO2. And design and policy choice can blur the lines on the speediness criterion, thus making us indifferent between the two.

I have been wrestling on a daily basis about not killing the carbon tax by taking the low road and supporting an upstream cap and trade system for emissions from buildings, transport and manufacturing. UCT essentially assigns caps to fuel wholesalers who then simply pass on the value of purchased permits downstream to fuel users, who see a signal a lot like a carbon tax.

But then I came across this quote from what looks to be Obama’s Treasury Secretary, a known fixer in the financial world:

“Most consequential choices involve shades of gray, and some fog is often useful in getting things done.”

(here)

Many have been saying this of upstream cap and trade, but the fog analogy hit home for some reason. So, perhaps it is time to blow some smoke. As my Scottish grandma would say, Lang may yer lum reek!

Ok, I have been traveling and talking climate policy for over a week now, and in talking (ok too much for some) and reading and thinking about this post-election phase, I have just one thing to say….

Tax, tax tax tax tax tax tax tax tax taaaaaaaaaaaaaaaaaaaaaaax

There I said it. And boy it feels good. So, folks, and you know who you are, lets stop backsliding on carbon tax and hiding its intent with new labels (the benevolent grandma’s benefits fund) or fuzzy instruments (upstream cap and trade anyone?). Lets call a tax a tax and get back to advocating the need for cost-effective climate policy over the long term.

Governments, political will and stakeholder perceptions all change but policy fundamentals don’t. So, while taxing carbon has experienced a set back (or a resurgence depending on if you can remember the carbon tax wilderness of only a few short years ago), us folks talking and influencing climate policy should not overly weigh the political and stakeholder acceptability criterion. That is not our job – sound climate policy guidance is. So, while some see the death of carbon taxes post-election, I am still toasting to its health and planning for the long-term. Although I am drinking just a tad more. Cheers.

Retail politics is about selling multi-colored sweaters (or targeted policies) to all kinds of folks, given wide-ranging preferences. Some had said that this election was the death of retail politics in Canada, especially when the Prime Minister started to slip in the polls due to his non-response to the financial meltdown. The logic was that he was not able to move away from his scripted day-to-day retail policy agenda in the face of the mounting uncertainty.

Well, I think retail politics are alive and well thank you very much, and in fact this election shows that heavily weighted single issue platforms can bite, and bite hard. Take the Liberal Leader’s exclusive focus on the carbon tax with recycling. While this balanced economic and environmental policy was supported by climate policy intelligentsia, it failed to resonate with a broad enough electoral base. And without other planks in the platform, the Liberals died a slow death.

So many commentaries in today’s press (see here and here) miss the point somewhat. Canadians still support environmental action, but importantly they also care about a whole host of other issues:

“it’s the economy stupid, and oh yes health care, and what about…..” says Joe Canadian.

And if one is unable to convey a range of policy ideas, then one is perceived as myopic, out of touch and subsequently penalized at the polls. So while retail politics did seem to cost the Prime Minister his majority through his inability to react to the financial crisis (Ontario anyone?), platform myopia hurt Mr. Dion more.

So, while Mr. Dion’s single vision was a good one, and would have worked best for Canada on the climate issue, the vision was incomplete, and so did not reach a wide-enough retail audience. Blaming the election loss on the carbon tax is therefore as myopic as the Liberal Party’s platform. The key to electoral success seems to be selling the sweater-vest after all.

The Economist has an article on why Prime Minister Harper deserves a second mandate, but not a majority (here). Two ideas support this:

One a majority is not warranted for his stand on climate policy:

Simply to rubbish this [Dion’s carbon tax] as a “crazy” idea that would “screw everybody”, as Mr. Harper has done, shows a disappointing lack of leadership, and is grounds enough to deny the Conservatives a majority.

Two, the Prime Minister should not lose the election over his measured response to a possible recession that is most likely a non-event:

But it is his seeming non-reaction to what is so far a non-crisis that looks likely to deny him the majority he was seeking, and could even let in the opposition. In what is the first credit-crunch election in a big Western country, Mr. Harper’s ejection would set a dispiriting precedent that panic plays better politically than prudence.

Well, spreading economic panic cuts both ways, and selling the carbon tax as a recession waiting to happen makes the probability of a financial crisis induced recession all the more believable. After all, our energy costs pale in comparison to our savings, loans and investments. Indeed, my carbon exposure looks a lot more contained than my financial exposure. So, the Economist may argue that the Prime Minister is being penalized for a non-crisis, but when you tell folks a recession is possible, you better be prepared when they believe you.

Ok, so the Conservative Plan is good for oil sands and the Liberal plan is not. This must be the case because the National Post says so:

..his (Dion) “Green Shift” carbon-tax scheme is, by itself, enough to persuade us that he is the wrong man to be running this country. As our banking and financial-services sectors become strained by the worldwide credit crunch, this country is increasingly dependant on our oil and gas sector to sustain us through rough waters. Yet these are exactly the industries Mr. Dion wants to soak.

Huh?

Have not the smart folks on the Editorial Board read the Conservative Plan? Here are a few tidbits that show why the Conservative Plan, which is heavily based on regulations, could impose higher costs on the sector:

– The current biofuel standard requires 5% of all gasoline to come from ethanol, which will reduce refining output correspondingly (lost profits anyone?). With the price differential between ethanol and fossil fuel supplied gasoline running at about 15% to 50% higher, the biofuel standard could raise gasoline prices 3 to 5 cents per litre thereby further suppressing demand somewhat (and recall the Liberals are exempting gasoline from the Carbon Tax);

– CCS requirement on all new facilities will impose costs upwards of $100/tonne on new facilities, compared to the $40 liberal tax, before recycling to income tax;

– It is not clear what the permit costs will be for the intensity trading system but the Technology Fund is capped at about $23 in 2017. So, these costs are not far off the Liberal $40 tax rate and when compared with CCS for new projects, and the recycling under the Liberal Plan, it is not clear the Conservative Plan is a clear cost winner;

– And while the China and India ban on oil sands related exports would not cost producing facilities since there are no exports, it will distort investment decisions, and therefore lead to higher costs. That is, folks were planning pipelines to Vancouver to ship oil.

And this is a straight up comparison on economic impacts and not emission reductions – that is, what do we get for all this spending? Well, I am not in a position to say, but lots of smart folks think the Conservative Plan will be less effective. I am not so sure since the coverage of the Liberal Plan is limited, and so may deliver a limited set of reductions.

But perhaps I will let the National Post have the last word on the inherent contradiction that permeates the election coverage on carbon policy (here):

What regulators never tell anybody is that regulatory regimes, in practice, are always going to be wrong in the long run — mainly because they undermine and destroy markets.

Now for those of you who have spent anytime at a University know, the best definition for the institution is a group of anarchists who share a common parking lot. Generally, these are the folks who eviscerate first and argue points of fact later. This is why an open letter supporting a carbon tax and revenue recycling from 230 of these intellectual knife wielders matters – they all agree on the basic points. They buried their respective hatchets as it were and sent a message to the electorate (see coverage here). Indeed, as they themselves recognize:

That’s an astonishing number for academics not typically inclined to act collectively and quickly on policy issues.

The open letter can be found here:

But here are the main points:

1. Canada needs to act on climate change now.
2. Any substantive action will involve economic costs.
3. These economic impacts cannot be an excuse for inaction.
4. Pricing carbon is the best approach from an economic perspective.
1. Pricing allows each business and family to choose the response that is best and most efficient for them.
2. Pricing induces innovation.
3. Carbon is almost certainly under-priced right now.
5. Regulation is the most expensive way to meet a given climate change goal.
6. A carbon tax has the advantage of providing certainty in the price of carbon.
7. A cap and trade system provides certainty on the quantity of carbon emitted, but not on the price of carbon and can be a highly complex policy to implement.
8. Although carbon taxes have the most obvious effects on consumers, all carbon reduction policies increase the prices individuals face.
9. Price mechanisms can be regressive and our policy should address this.
10. A pricing mechanism can allow other taxes to be reduced and provide an opportunity to improve the tax system.

I particularly like point seven that follows point six – it basically reads: yes cap and trade can send a carbon price, but it is administratively ugly to implement, so why go there when a simple tax is available. And point five is directed at the Conservative Plan.

While the economists don’t fully support the Liberal plan:

“You can say that the Liberals have a carbon tax. Is it a good carbon tax? That’s a whole other question…This is not about influencing the election, it’s about clarifying debate.”

Make so mistake, by “clarifying the debate”, these 230 academics stealthily eviscerate the Conservative Plan.