…environmental economics and the implications of environmental policy

Technology Trickery — there is no free lunch

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McKinsey curves pop-up all the time, as in here today. And I am often asked to produce similar ones (see picture).

But the McKinsey curves have some important flaws, and drive me nuts for a couple of reasons.

Iron and Steel Curve
First, they assume no baseline. In time technologies will be deployed in response to rising energy prices and straight technology innovation, where energy efficiency occurs absent policy. This then lowers the emission intensity of the economy. So, absent policy we get a certain level of this stuff, and with this technology deployment we then have less of the potential to go after later. The McKinsey curves then overstate reductions, because they ignore what we are doing anyway. This then understates costs cause we have already deployed the stuff and moved up the curve regardless of what policy is in place.

And then there are costs. The costs are not what it would take to get folks to move into these technologies. Instead, they are a mix of social costs, and include all kinds of benefits, such as avoided tipping fees for waste management. This is good, but folks think of the curves as marginal abatement curves, which is not really right.

Simpson falls into this trap,

One of the very best attempts at measuring effectiveness and cost comes from McKinsey & Co., an international consulting firm that has produced a cost-abatement curve comparing different technologies used today or likely to be ready in the next two decades.

Mixing cost and effectiveness, and choosing approaches that won’t materially affect consumers’ lifestyles, McKinsey offers a rough guide to how the world might hold the rise in global mean temperatures to below 2 degrees Celsius. Obviously, different measures will be more appropriate for some countries than for others.

Finally, the costs don’t reflect behavioural choice. That is they are mostly engineering costs assuming long-paybacks and low discount rates. But this is not how folks make decisions. Take public transit. While it is cheaper than operating your own car, there is a reason many if not most don’t ride the bus. Simply, there are other determinants of costs that affect technology choices. And if you want to move folks out of their warm car pods and get them to exchange germs on transit, you have to whack them hard with prices. This means abatement costs are significantly underrepresented in the McKinsey curves.

The curves have done much to highlight potentials, which is good. But they can’t really be used in policy development because they overstate potentials and understate costs. And if we could really get all those free reductions, would we still be locked in inaction?

Written by Dave Sawyer

December 4th, 2009 at 11:41 am

Posted in Uncategorized

BC’s Take on Tax Interaction – Hit em again

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Tax interaction is where taxes add distortions to the economy (economist raises hands to checks, gasps “inefficiency!” and moans “ooooohhhhh”), and either reinforce each other as bads, or can be used to offset existing bads. The double dividend theory instructs that the hit from abatement costs and payments on emissions (tax on remaining emissions or permits auctioned) can be offset by reducing existing distortionary taxes on capital and labour. (see paper here). A strong double dividend means the economy is better off since the inefficiencies introduced by the carbon costs are smaller than the existing tax distortions that have been removed. A weak dividend means the carbon cost inefficiencies are larger than the existing distorions that were offset with carbon revenue. Most of the literature on this falls into the weak double dividend camp.

So what to make of BC (here):

I have just carefully read my Terasen Gas bill and became aware that I am paying GST on the carbon tax that was implemented recently. I contacted the provincial government tax department and was told “that is just the way it has been set up … the only exemption from GST is PST.” So when the harmonized sales tax (HST) is implemented, will we pay both on the carbon tax if part of the HST is PST? Just one of those questions one asks when considering the next government.

BC has been under fiscal pressure given the economic downturn, no question, which has been exacerbated by offsetting existing taxes with carbon tax revenue. But, has the incentive function of the tax given way to a fiscal function? Not sure, but certainly a tax on a tax on a tax can’t be good.

Written by Dave Sawyer

December 3rd, 2009 at 9:26 am

Posted in Uncategorized

Canada, trampled by a band of Neanderthals

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This is a must read leading up to Copenhagen. Not a lot to disagree with. Essentially, economic obesity and Mr Harper have turned Canada into the North Korea of the climate world.

Canada’s image lies in tatters. It is now to climate what Japan is to whaling

The tar barons have held the nation to ransom. This thuggish petro-state is today the greatest obstacle to a deal in Copenhagen

When you think of Canada, which qualities come to mind? The world’s peacekeeper, the friendly nation, a liberal counterweight to the harsher pieties of its southern neighbour, decent, civilised, fair, well-governed? Think again. This country’s government is now behaving with all the sophistication of a chimpanzee’s tea party. So amazingly destructive has Canada become, and so insistent have my Canadian friends been that I weigh into this fight, that I’ve broken my self-imposed ban on flying and come to Toronto.

So here I am, watching the astonishing spectacle of a beautiful, cultured nation turning itself into a corrupt petro-state. Canada is slipping down the development ladder, retreating from a complex, diverse economy towards dependence on a single primary resource, which happens to be the dirtiest commodity known to man. The price of this transition is the brutalisation of the country, and a government campaign against multilateralism as savage as any waged by George Bush.

Until now I believed that the nation that has done most to sabotage a new climate change agreement was the United States. I was wrong. The real villain is Canada. Unless we can stop it, the harm done by Canada in December 2009 will outweigh a century of good works.

Shame on us.

Written by Dave Sawyer

December 1st, 2009 at 11:57 am

Posted in Uncategorized

NRTEE New Read: Impacts and Adaptation in Canada’s North

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NRTEE released yesterday a good read on climate change and northern impacts (here).

TRUE NORTH: Adapting Infrastructure to Climate Change in Northern Canada
…First, make existing institutions work better now by mainstreaming adaptation into government policies, processes, and mechanisms and ensuring northern views are “at the table”, and second, build northern climate change adaptation capacity in science and at the community level, so the region is more resilient, self reliant, and less vulnerable in meeting the challenges of climate change adaptation in the years ahead.

Repositioning the climate debate to be less about globe and mail economics (mitigation is too costly) and more about avoiding on-going damages can only help.

Written by Dave Sawyer

November 27th, 2009 at 11:16 am

Posted in Uncategorized

Taking his head out of the tar sands…

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Jack Layton has a priceless quote here from question period today

“We are glad that the Prime Minister is finally taking this issue seriously and has taken his head out of the tar sands,” Mr. Layton said. “The question is: Is he going with any plan? So far, we have seen no plan even though it was promised by the Minister of the Environment.”

Of course referring to this,

Harper heads for Copenhagen after all

Fun times, eh.

Written by Dave Sawyer

November 26th, 2009 at 6:21 pm

Posted in Uncategorized

New Federal Targets — Target Trash Talk Redux

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Word on the street is new Federal targets will be announced at Copenhagen. Most likely PM Harper is playing follow the leader, literally following Obama to Copenhagen, So, expect harmonized targets with the US, which is -17% below 2005.

But anything can happen, cause target trash talk is way easier than action.

Written by Dave Sawyer

November 26th, 2009 at 10:33 am

Posted in Emissions Pricing

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More Target Trash Talk — Quebec Steps Up to the Mic

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The need to poke your finger in your neighbors eye runs deep in politics. How else does one explain another jurisdiction making target trash talk? Yesterday, Quebec stood up, and was counted — as another jurisdiction that has made a promises that it can’t keep.

Quebec breaks from Ottawa in plan to cut greenhouse gases

Quebec is taking the final step in its break from Ottawa on climate change, unveiling an ambitious plan to reduce greenhouse gases and blasting the federal government for inaction only a few weeks before a major international environmental conference.

Premier Jean Charest announced yesterday that, by 2020, the province will reduce greenhouse-gas emissions by 20 per cent below 1990 levels, a goal similar to the target the European Union has adopted.

The ambitious target-setting is the latest in a series of policy moves on the environment from the provinces, with Quebec and B.C. leading a surge ahead of the cautious position of the Harper government.

Quebec premier says Ottawa needs to do more to cut greenhouse gas emissions

Quebec Premier Jean Charest says Ottawa needs to do more to reduce Canada’s greenhouse emissions, as he committed Quebec to take a leadership role by accelerating its own efforts.
Charest said Monday the province will cut its emissions by at least 20 per cent from 1990 levels by 2020 and urged the federal Conservative government to raise its target above the three per cent it has set.
“It is in the interests of Canada, whose prosperity rests in large part on exportation, to give as much effort as its partners in this global fight,” he said in a speech attended by the who’s who of Quebec business leaders.

Or won’t keep once it sees what it will cost.

The announced target at 20% below 1990 levels seems to be much bolder than what others are saying, and notably the feds. It sounds deep, but it is not really since Quebec’s emissions have been more or less flat since 1990, growing only 5% in fifteen years. (see here).

But still it is bold, and to achieve reductions of this magnitude will require credible policy. I did some simple modeling of what it will take to hit the target. Assuming an economy-wide cap and trade system ala WCI (full coverage that includes vehicles and buildings), the following emerges,

Compliance Target. The target is 68Mt (-20 %/1990). This means that 28 Mt will need to be found in 2002, or a reduction of about 30% below BAU.

Permit Price. The permit price assuming action is taken in 2012 will need to be in the order of $135 tonne, with some pretty supped-up vehicle regulations, vroom vroom.

Total Cost. About $2 billion in capital, energy and operating costs in 2020 or about 0.5% of forecast GDP in 2020.

Distribution. Vehicles costs will rise 25% and electricity costs 10% (above forecast norms).

This is transformative stuff that requires real policies and real pain for some. Modeling has shown that these costs are doable, and actually not all that bad relative to the total economy. Indeed, the targets are technically and economically feasible, and policy can do it. But all too often we trip or rather choke on the types of costs outlined above.

So, why these jurisdictions continue to climate trash talk I will never ever understand. Once they start to look closely at what it will take to achieve what they have promised, they balk. Setting bold targets has proven time and again to result in non-polices and bold inaction.

Written by Dave Sawyer

November 24th, 2009 at 9:51 am

Protectionism always sells, but is it good climate policy

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Carbon tariffs are trade distorting period. They help those that may need help due to relative product price differences attributable to carbon pricing. But all others are worse off, and the economic models show that welfare is always decreased.

So, when I see this I cringe.

We need another carbon tariff

…We don’t need another Kyoto-type protocol in Copenhagen. What we need is to put a price on our own carbon emissions and a carbon tariff on everyone else’s.

First I ask another tariff? We have one already? But that aside, the basic economics are wonky and so Rubin’s assertion is wrong at worst and incomplete at best.

Three points support this. First, who we trade with, second, what we trade in and finally the emission intensity of all this stuff.

Who we trade with. Canada mostly trades with “western” countries who are all contemplating carbon polices. Canadian trade data shows that Canada exported about 85% to 90% of our total exports to Annex 1 type countries (under Kyoto), all of which are working towards carbon pricing of some sort (except of course Canada which speaks to a different risk). On imports, about 80% come from Annex 1 countries. So the risk, and the need for a carbon tariff accounts for a very small share of our imports and exports. Indeed China, that dastardly emitter, accounted for 3% of our exports and 10% of imports in 2008.

What we trade in? Major exports include oil, gas and their derivatives, electricity, a whack of car stuff, smelting products and aerospace. On imports, it is mostly the same, reflecting an integrated Canada-US market. China, on the other hand sends us golf bags, shoes and computers by the container. Not so big a competing overlap here with Canadian firms.

Emissions intensity. The emission intensity of our exports is much larger than of our imports, reflecting energy trade south and imports of manufacturing stuff north. Of our top 25 commodities, energy intensive exports account for about half of total exports whereas it is less than a third for imports. But when you compare what we import from China, the comparison stops cold. Simply the embodied carbon in oil and gas is a tad larger than that of computers.

So, border adjustments can help some, but as a major policy thrust they fall short in Canada. Their widespread use would only distort trade and reduce welfare. They sound sexy, have populous appeal, but from an economic perspective are unwarranted. Which perhaps explains why we may get border adjustments before we get a real carbon policy.

Written by Dave Sawyer

November 23rd, 2009 at 10:23 am

The Masks are off….

with 25 comments

See here and here for an elaboration of this,

Ottawa will delay the release of climate regulations until there is a firm agreement on a global approach and clarity on how the United States intends to regulate emissions – which could take until late 2010,

and the Minister’s comments

“In the absence of an international understanding, and in the absence of an international framework, it is difficult for any country to finalize domestic policies and to put in place its domestic approach — whether that’s a regulatory approach or a cap and trade, or something else,”

I guess if Canada developed a Regulatory Framework on Industrial Emissions when the US said it would do nothing and we had clear international commitments under Kyoto, then it would only make sense to abandon the Regulatory Framework in light of US action and a uncertain international agreement.

And they called Prime Minister Martin Mr. Dithers.

Written by Dave Sawyer

November 18th, 2009 at 8:59 am

Why Follow the Leader? CANUSA Permit Trade has a price

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Ah, it must be Spring in Copenhagen with all that talk of linking in the air. See Minister Prentice press release here for a good review of what he, or perhaps more precisely the PM is thinking.

I too have been all consumed lately with thinking on linking Canada-US permit trade. And I have come to a simple conclusion. Linked permit trade is not the answer.

Instead, we should go it alone with aligned carbon prices. Huh you say? Swimming against conventional wisdom am I? Well lets see….

My most recent modeling tumbles of the American Clean Energy Act (ACES09) and Canada’s Regulatory Framework for Industrial Emitters reveals that with linked permit trade carbon prices in 2020 will drop in Canada from $60 to $31 or so. This is basically noise for the US as our puny demand for US permits raises their permit price $1 from $30. The US carbon price under the ACES09 is so low because of all those low international offsets, which means we are also indirectly buying a whack of cheap offshore imports. Essentially, with linked permit trade Canadian oil and gas ceases to buy permits from Canadian electricity and domestic offsets and instead imports permits from US electricity. Regardless, a big $900 million sucking sound is heard south of the border as Alberta subsidizes US electricity through permit imports, which for some may be better than feeding those latte sippers in Ontario.

Now linking does reduce the GDP and sector hits, by more than half relative to a case if we do not link. When the numbers are tumbled, linking is really good as we avoid some high cost demonic I mean domestic abatement in oil and gas.
But with expectations to go deeper with climate policy, and reduce more in the long-term, the low price under linking reduces the incentive for transformative technologies such as CCS. No incentive for learning by doing, no innovation and hence no declining costs in time. And when we do want to go deeper in the future, CCS will be more expensive.
transformative technologies

So, instead of permit trade with the US, we peg a technology tech fund that floats with the US permit price. This makes us comparable on stringency, and so perhaps we avoid some of the countervailing border nastiness lurking in ACES09. But importantly it allows us to invest in CSS and other transformative technologies. Because they are important (see graph above).

The more I muck about with models, the more I am convinced oil and gas drive all things climate policy. They account for about 25% of national emissions in 2020, and have nothing but high abatement costs. They will access any safety valve we can throw at them to avoid those high costs, from offsets, to domestic permit purchases to cross border permit imports. But eventually they will have to reduce. And this means CCS.

So, bottom link, linked permit trade with the US drops the incentive to innovate and so might raise our long-term abatement costs. We can smooth relative prices to avoid high domestic abatement costs with cross-border permit trade, but pegging a technology fund to US permit prices is better.

Written by Dave Sawyer

November 16th, 2009 at 11:18 pm

Posted in emission trading