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.

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.

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.

Ok, so cap and trade with the US just got really interesting:

Canada to seek climate deal with Obama

Here

There was talk of this post election, including morphing the current intensity based system (in the Regularly Framework) to something with a hard or binding cap before 2015. Linking a national cap and trade program to the US is likely a step in the right direction since with the US involvement, competitiveness issues largely fall away (if we all have the same carbon price there are not cost differentials in product markets). This issue has been a major stumbling block to moving forward and resolving it will help. But, new excuses will likely arise that will lead to more inaction, notably our current economic and financial poverty, and what about China and India? But still, this seems to be a good omen from Canadian Climate Policy.

And most US proposals bring under the cap and trade program emissions from buildings, transportation and other manufacturing, which is something Canadian policy has not done (i.e. the Regulatory Framework covers about 50% of Canada’s emissions).

But I think the more important question is can we assume linking cap and trade systems is always good? I can think of a number of reason why linking initially with the US could be problematic:

Policy sovereignty. For anyone who has reviewed the WCI design document knows, once you sign on, you have to adopt what others have developed. And in the case of say Manitoba with 3 MT of reductions and California with 300 MT, whose interests do you think matter? This has been the case with WCI and it could be the case with Canada and the US.

Governance. With the provinces forging ahead, this sudden resurgence from the feds can’t make the Canadian WCI partners too happy. And with multiple trading systems emerging, it could be a real nightmare for large emitters.

More distributive impacts. While economic theory says linking is good since it lowers overall compliance costs, the incidence of trading is not uniform between buyers and sellers. Simply, linking permit trade to a larger market will change domestic permit prices, and if you are a buyer or seller, this matters. So, some may be better off and some worse.

Volatility. A larger market with voracious (and ahem, unregulated) traders will drive price volatility, which results in uncertain permit prices and inefficient outcomes. Something industry hates.

So, linking can be good but it can be bad, so one needs to proceed with caution. In other words, when you hitch yourself to star, be prepared for a wild ride.

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.

If one looks back over the carbon policy discussions in Canada credit for early action figures prominently. Simply, under cap and trade, some argue that they should receive credit for action initiated in the lead-up to implementation. The core argument is that in expectation of a future carbon constraint, early action was undertaken to align with normal capital decisions. Thus, the argument goes, the early action should be recognized in setting the new carbon constraint to be less stringent. Now if you can follow all that, or it you know intuitively what I m talking about, you know why credit for early action is a mess – it is hard to sort out what is real or not. And so with a mechanism to enable credit for early action the regulator has to disentangle investment decisions and motives going back some years and then see how this influences the new allocation. Additionally and administrative burden both likely suffer with credit for early action.

Under the current Canadian plan, there is 5 MT allocated for early action. Not a lot, which is good, but still enough to trigger all kinds of positioning, and to require a few folks at Environment Canada to sort this all out.

And why am I ranting about this? Well there is a neat article here on how one BC municipality will see a carbon bill increase of $300,000 in 2012 under the BC carbon tax. And the link to credit for early action? The carbon tax will implicitly account for all early action undertaken through the lower emission intensity whereas trading may not.

In the case of Burnaby, a range of investments have lowered energy use, emissions intensity, and ultimately the carbon tax burden,

But the best example is Burnaby’s recent earth-friendly upgrades to 49 city-owned buildings. Completed by Honeywell Ltd., the $6-million project includes new light fixtures, water-saving measures and digital controls to keep heating, ventilation and air-conditioning costs down. “That cut down our energy consumption in total by 20 per cent for all of municipal operations”.

No need to sort out motives – the emission intensity does that. This is why a tax can be fairer than trading when one looks at early action. And certainly it is administratively simpler.

And what do rate payers in the municipality get? They get the great cost pass though,

Burnaby residents will be stuck with the bill. “We don’t have any other (funding) source but the property tax,”

But then again, the $300,000 cost in 2010 is less than 1% of Burnaby’s projected $333 million expenditures in 2010. Which makes me wonder why a 1% increase in operating costs four years from now is news.

While academic economists have long argued for a carbon tax, the political realities have driven policy to cap and trade. In response, those smart folks thinking of good policy design came up with the “safety valve” to allow for cost containment. The safety value concept has political appeal since it essentially caps the upside costs of a cap and trade system and so takes away the uncertainty of what cap and trade may end up costing emitters. It also has had appeal in the past since the climate fight was thought to be a marathon and not a sprint where cost containment seemed more important than short term action. But this has changed as new climate science points to the need for deeper action sooner. And so the rise of the safety valve is worth considering and needs a closer look.

The safely value is a significant component of Canada’s current climate policy in the form of the technology fund (payments to the feds for technology development and deployment) and the recently refined pre-certified projects mechanisms (i.e. payments for CCS). Both of these allow for some share of emissions to be paid into the two compliance mechanisms on a declining balance to 2018. They are in effect a tax that is accessed 100% up to 2018 if compliance costs or permit prices rise above the access price of these compliance mechanisms, capped at about $23 in 2017 (see thumb below). How the 65$ per tonne cost announced recently by the feds interacts with the pre-certified projects list is not yet clear to me, but still it is well below the costs of CCS for the reductions required under the government’s 2020 target of -20% below current emissions.

Given its prominence in Canadian climate policy and indeed worldwide, it is useful to better understand the safety value. An excellent article emerged recently on the history and development of the safety value (see here),

What started as an obscure, almost monastic dispute among economists three decades ago has now emerged as a potential make-or-break point for the proposed legislation. Tracking its tangled history may now be essential to outsiders who want to understand this issue — and the huge economic stakes involved — as champions on both sides of the political arena saddle up to do battle over it.

As well as a good post at Common Tragedies (see here),

The key issue with the safety value will be the tension between those that want it to be very high, and so ensure emission reductions and those who define cost containment as no cost at all and so want a low value. In the Canadian case, the safety value has been set very low, and so emission reductions during to 2012 to 2018 period will be correspondingly low. This is not pure conjecture but rather based on modelling, where Canadian compliance costs indicate that the technology fund will be fully subscribed at the current price caps.

And so, we are left with a tax layered on a cap and trade system. While the policy skeptics decry that a tax will not work, by extension neither will cap and trade, at least not how it is being implemented in Canada. And with the science arguing for more reductions, the current design of the safety value will leave Canada with a growing stock of high emitting technology that will be costly to alter in future years. That is, if politicians eventually decide to take action, future compliance costs will be higher due to short-term inaction. Canada’s use of the safety valve, it seems, is about shifting the cost and therefore political burden in time.

Ok, so in taking a look at the CBO document a couple of points are worth mentioning.

First the report’s main conclusion that a carbon tax is five times more efficient than cap and trade is based on a policy comparison that is unreal. Essentially the inflexible option compared is unlike any cap and trade system that would be seriously contemplated. The poorly performing “inflexible” cap and trade policy has no design features for price certainty, like a safety valve, banking or borrowing. Most designs allow for intertemporal shifting of abatement effort to allow for efficiency in time. When these are added, the efficiency approaches that of a tax in the CBO document (see Figure 1-2). This assumed policy inflexibility seems excessive and is not therefore a real option. Yet the report makes the inefficiency argument strongly based on this comparison. This is not quit right.

Next, the report does make some good points on why a cap and trade program is less desirable. The case about administrative complexity is a good one, where cap and trade requires a number of design features that need to be tweaked in time to enable price certainty. This seems like a heavy administrative burden and thus the tax seems to be more desirable.

I think the authors of the report could have done us all a better service if they had highlighted one single point – design matters. In designing these programs effort is required to get things right – balancing price certainty through containing costs is important, but so is getting emission reductions. The report argues that reductions later are ok, and thus price certainty is more important (based on Weitzman’s argument that marginal costs are rising but damages are flat and somewhat uncertain and thus price certainty is preferred). But this does not mean that a tax is preferred, but rather that price certainty is important and can be achieved in cap and trade and a carbon tax.

While this report is worth the read, a critical eye seems warranted.

The CBO report (see my last post) has a number of folks talking. But I like this reaction, (here)

Good Climate Policy, Bad Politics.

A new report from the Congressional Budget Office confirms one of the most depressing facts about climate change: The best policy is the one that’s going nowhere in Washington.

The CBO report concludes that a tax on carbon emissions “would be the most efficient incentive-based option for reducing emissions and could be relatively easy to implement. If it was coordinated among major emitting countries, it would help minimize the cost of achieving a global target for emissions by providing consistent incentives for reducing emissions around the world.” But the major presidential candidates aren’t supporting such a tax, and the few proposals on Capitol Hill to impose a tax are not expected to go anywhere anytime soon.

I still plan to take a closer look at the report, and don’t totally support the whole sale adoption of the report’s conclusion without a closer read. But still, even if cap and trade is as efficient given similar design, the post’s inference holds…carbon tax is a four letter word in politics.