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Archive for the ‘cap and trade’ tag

I am confused….a carbon tax is five times more efficient than cap and trade?

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The US Congressional Budget Office has just released a report that argues that a cap and trade system is much less efficient than a tax. Download the report here (02-12-carbon.pdf) and see coverage by the Wall Street journal (Here).

At first glance it seems we have an apples and oranges issues where the reductions are not similar for the two scenarios. Or the design elements diverge significantly. So, one would expect lower costs if one is comparing lower targets or a less flexible policy. But these folks at the CBO are not dumb, and they consulted some big brains on this (Billy Pizer of RFF and Weitzman from Harvard) so the report needs a closer look. More to come…

Written by Dave Sawyer

February 14th, 2008 at 11:06 pm

Carbon tax or cap and trade? Bad economics is muddling the debate

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There are two articles in the Globe today that perpetuate bad thoughts on carbon policy and carbon costs. The first article (see here) pegs costs way too high by assuming that every single molecule of carbon results in a uniform costs at the highest carbon price, say $50,

At $15 a tonne, if Keephills were to fail to cut 12 per cent of its emissions, or 360,000 tonnes, the price tag on the facility’s emissions would be a mere $5-million…But at $50 a tonne, the price for Keephills would rise to $18-million. For all of TransAlta’s Canadian operations, the total penalty at $50 a tonne would rise to about $170-million.

But, there will be lower cost opportunities at the facility. So they will take abatement action and make carbon reducing investments up to the point where they can either get cheaper reductions elsewhere through trading or pay some sort of fee like that enabled under the Technology Fund or a carbon tax. And if there is recycling even this cost would be reduced on remaining emissions.

As a very general rule of thumb, since the marginal cost curve is rising (that is more reductions are more expensive), the total cost of reductions is total emissions times the carbon price divided by 2 or

Total costs = ~(Qemissions * Pcarbon)/2

This is essentially the area under the marginal abatement cost curve fixed by the price (tax) or quantity (cap/allocation) constraint. So, in the example cited, the costs are more like $8 million for the facility and $85 million for all TransAlta’s operations. And most likely there is a facility target and therefore no cost for remaining emissions of if the target emissions are achieved the fee on remaining emissions is returned (as in the case of Sweden). Suppose there is a 25% reduction required from 360,000 tonnes. This then lowers actual costs of about $2.25 million. Not trivial but not nearly as high as reported.

And where to start on the second article (see here). Here are a few samples from the article,

A much better, more effective route is a cap-and-trade system with auctioned allowances, under which government sets the future target for emissions – the cap – and turns to free market mechanisms to achieve those targets… government then has to make a guess as to where to allocate all of the carbon-tax revenues, hopefully avoiding the appearance of pork barrel politics and special interests.

With auctioning of permits, the firm must buy their allocations, which transfers cash to the regulator, and thus the cap and trade behaves a lot like a taxes. Government still has to deal with the revenue.

And then this,

A tax is simply not the best way to create effective incentives to cut emissions, and it’s not the right mechanism for promoting innovation that will abate human-caused climate change.

This argues that taxes will not result in continuous improvement, that is an ongoing incentive to reduce emissions. Not likely, since the firm will continue to see the tax and thus seek ways to avoid paying it though making investments that lower emission while minimizing the tax burden.

And perhaps most challenging,

…That’s because a carbon tax puts the government into a nearly impossible Goldilocks scenario: It must set the price of carbon just right. Not too high, meaning everyone overpays and the economy is damaged. And not too low, in which case emissions reductions are not maximized. Additionally, as we move forward, we cannot afford a system where carbon prices remained static in such a dynamic environment.

But if we set a cap too high and there is no cost constraint (i.e. price cap), costs emerge that are unanticipated. Government then has to release more permits to reduce compliance costs, which dilutes the cap (more emissions) and reduces the real value of permits (like printing money and causing inflation). In practice, the regulator will have to adjust either the cap or the tax rate as new information on climate science, cost and abatement responses emerge.

Both cap and trade and a carbon tax have challenges that need to be sorted out. But we need better reporting on this stuff. Otherwise we will continue to muddled and mired in debate…but then again that suits some folks just fine.

Written by Dave Sawyer

February 11th, 2008 at 3:22 pm

The Great and Honourable Target Bun Fight: The Standing Committee “Debates” Deep Carbon Reductions for Canada

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The Standing Committee on Environment and Development is currently debating a private members Bill on deeper targets for Canada (Bill C-377). The Bill is all about more aggressive targets relative to the government’s plan. But, in actuality, these targets are in line with the Bali Footnote for 2020 (-25% below 1990) and not too far off from the Government’s Current Plan (Turning the Corner). The current plan calls for -20% below 2005, which is about minus 35% in 2020 below the business as usual, and the Bill is -50%.

Since Parliament is in a minority position, this Bill has not died and is given some due process. But, make no mistake, this Bill will not live to see the day given election fever.

I had the pleasure of seeing the target bun fight up close. My testimony to the Members is here: Standing Committee Testimony – Sawyer, including a cost estimate for the targets contained in both Turning the Corner Target and Bill C-377 (using C-GEEM, a CGE model and CIMS, the UBER Canadian emissions and energy model).

In a nut shell, carbon prices will need to be in the order of $100 for Turning the Corner and about $200 for Bill C-377. GDP impacts would then range between 0.6% and 1.2% annually, which is less than the forecast rate of growth (2% to 2.5%). While these impacts may not seem large, there are also impacts on groups, such as low income households and energy intensive exporters, that are much much larger. These impacts need to be better understood and policies devised to address the income hit while maintaining the emission signal. Energy prices would then rise, with electricity by something like 25%, petroleum products on average 15% and natural gas 10%. Or something like that.

All this assumes domestic action, a cap and trade system for large emitters, a carbon tax for you and me, performance regulations for vehicles and buildings, some subsidies to renewables and carbon capture and storage, and importantly a reduction in income tax to offset the carbon revenue. Whew.

And since costs rise rapidly after abatement of about -20% below the BAU, access to lower cost and real international reductions is critical if costs are to be contained and distributive impacts minimized.

My one observation from the Standing Committee was that most, but not all, of the Honorable Members were more interested in getting on record their own thoughts and not interested in probing the witnesses for information or insight. Which made me wonder what I was doing there?

And debate is a funny term for some of these folks. It was mostly a bun fight reminiscent of grade six…” your climate policy is stupid…of yah yours is even stupider and your shoes are lame”…..and that’s when I piped up and pointed out that, well, actually both of your targets are very similar and if you think his will wreck the economy, then so will yours. But that is not quit correct either, and if we do it right, and get going today, we can likely muddle through without killing the Canadian Golden Goose.

Written by Dave Sawyer

February 8th, 2008 at 3:10 pm

If “Cap and trade isn’t the solution” decreasing abatement flexibility is certainly worse.

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I am not sure what this writer was thinking when this article was published in the Globe and Mail. Essentially the author argues that cap and trade will necessarily result in freeriders and hot air and therefore should be scrapped. While the case on freeriders and offsets may be a good one, railing against cap and trade seems dubious,

“with the shutdown of numerous uncompetitive industrial facilities following the demise of the Soviet Union, Russia has enormous carbon credits for sale. With little that can be done to reduce emissions from their already state-of-the-art facilities, economically struggling European manufacturers end up sending billions of dollars to Russia.”

Russian hot air was created because Russia was over allocated. Simply, there was no adaptive capacity in the cap setting to allow for the collapse of the soviet economy and the subsequent creation of fake emission reduction credits that could theoretically be used for Kyoto compliance by other Annex I countries. Most well designed cap and trade systems have closure provisions, where there are “use of loss” rules that require credits from closure to essentially be clawed back. So, design could have dealt with the hot air, and it was not an inherent flaw in cap and trade that led to this particular outcome but rather poor policy design.

The article then goes on to say that instead of cap and trade, a series of performance based regulations should be set for individual plants. A provision for a technology type fund is then mentioned, which is good for cost containment (i.e. a price cap that mimics a carbon tax),

The first step is to implement predictable, long-term, progressive targets for emissions reduction tied to each unit of a plant’s output. … Canadian businesses who fail to meet their targets could pay a set price per excess tonne to a federally administered emissions fund. This pool of cash would be designated to specific national environmental objectives; for example global warming adaptation and mitigation studies, energy-efficient city design including densification and public transit, or programs to encourage personal emissions reduction such as home energy efficiency improvements.

But, this is essentially a transfer to government and not between industry, which has obvious political and frankly economic efficiency questions. Adopting the freerider argument one can see a technology fund leading to all kinds of weird and whacky calls on revenue (see post here on carbon tax for Toronto) and high cost and low effectiveness investments. A technology type fund is good, but we are talking billions and billions of dollars in revenue.

Perhaps of bigger concern in this article is the rallying against abatement flexibility. The central premise of cap and trade is to allow emitters to smooth marginal costs. One emitter over complies, one under complies, the latter compensates the former and both are better off. This flexibility leads to innovation and continuous improvement and other good stuff. Stifle this flexibility and higher costs are inevitable.

So, if Canada is to achieve the reductions laid down by the federal governments or the provinces, flexibility is required. Flexibility in policy, flexibility in access to cheap reductions either domestically or internationally and flexibility to adapt to changing circumstances. And domestic reductions at increasingly stringent targets are really really expensive. So before we collectively dis those foreigners, perhaps we should shake their hand and see if there are credible and cheap reductions to trade.

Written by Dave Sawyer

February 5th, 2008 at 4:15 am

Trading is better than Carbon Taxes…for those with a vested interest that is

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Andrew’s comments from the last post dovetail nicely with my thoughts on this report in the Financial Post (here). Essentially, the article argues that emission trading is more effective than carbon taxes. Trouble is, this preference comes from constituents who are lining up to defend their stakes in the great carbon trading game:

“This is an industry that did not exist four or five years ago — an industry that has very rapidly emerged (with) products that you take for granted in other businesses are just being developed now.”

One of the NRTEE’s recommendations included the observation that an upstream trading regime would be more effective than a downstream trading regime (see the NRTEE report and Chris and Nic’s technical report available by request from NRTEE). Essentially, if you move the regime up closer to production and importation you get a wider transmission of the carbon price across the economy, a desirable outcome since costs tend to be more evenly distributed. With a broad based upstream system there is no need for a complementary tax as in the case of the current downstream large emitter system, where only 50% of Canada’s emissions see a price signal. Problem is, Canada would need to ultimately transition the current “proposed” downstream system to an upstream system sometime near 2020. But this would alter existing rights, and notably all those free allocations, trading fees and allied services making money off the downstream system (same^2 for offsets).

And thus the transition challenge — constituents. Like it or not trading is creating vested interests that will protect the status quo and lobby accordingly. This will make change hard, especially in time.

And now the fun…you have to love an article and a quote in the National Post, that bastion of conservative thinking, that basically says that individual decision makers need to be told what to do:

“You can tax me on gas, but I still consume gas and there’s nobody to tell me how much I should consume,”

I love it. Only in Canada, Eh.

Written by Dave Sawyer

January 10th, 2008 at 4:11 am

Singing and spitting around the Climate Policy camp fire…

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Huh? Seems somehow the NRTEE got the warriors holding hands (see here):

The report drew widespread accolades – including expressions of appreciation from both the Canadian Association of Petroleum Producers and the David Suzuki Foundation.

And then…

Pierre Alvarez, president and CEO of the Canadian Association of Petroleum Producers, lauded several of the policy principles stated in the report. “It’s very clear that this is not a shot at the oil and gas industry, or the coal industry; that it applies across the economy and across the country,”

Usually in environmental policy when you piss off industry and the ENGOs you have done something right. So, I am not quit sure what to make of all this singing around the NRTEE campfire. But before we all hold hands for another sing song, there are sobering reminders from politicians and the public that some are not prepared to pay a cent to reduce carbon emissions. This one is particularly good (here). There is a mindset here that needs more attention, and thus we may need slick advertising campaigns such as the one tonne challenge after all. Who would have thought?

But my personal favorite quote from all this is from the Minister himself:

“Every time a report comes out, you can’t change your mind.”

So its seems that all us economists and policy wonks who have been pushing this stuff for a while should step aside and make way for the spin doctors. Perhaps, it is their time.

Written by Dave Sawyer

January 8th, 2008 at 3:12 pm

Finally, some clarity in an otherwise muddled national climate debate….

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After about a year of beavering away, the NRTEE released its final advice note today to the Minister of Environment, and more importantly all Canadians (see “>Here). This piece of work sets down some fundamental principles that Canada should follow if longer-term and deeper GHG reductions are to be pursued. While there is some great stuff in the report (and the background paper prepared by Chris Bataille and Nic Rivers and others at MKJA – contact NRTEE for a copy, it is worth it), importantly, I think the report’s greatest contribution is to bring some “street cred” to two concepts:

First, the interim report released in June introduced the concept of an emission price to the media and hence Canadians. Before the June report, the use of this term was not so widespread, but now it is more widely used by the media;

Second, with this report, the carbon tax debate is effectively launched. There is now no hiding from an economy wide carbon tax as a realistic policy choice. I suspect we will now see more discussion at the political level on this. See here for some early evidence.

I think the next important step, as I have said in the past, is to make carbon tax synonymous with “carbon tax shift”, where revenue recycling and tax shifting further other goals. But for now I am just happy the report was (finally) released and is getting such favorable press. The report has legs, and NRTEE deserves credit for having the forsight to call a spade a carbon tax.

Written by Dave Sawyer

January 7th, 2008 at 9:53 pm

A One Oared Climate Policy: “So, what about the rest of the emitters?”

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Andrew Leach , an environmental economist out of U of A, has good article in the Edmonton Journal today on an issue that one can’t help but see in the media: a contradiction in Canada’s domestic and international climate policies. His point is simply that while Canada is calling for binding targets for all emitters internationally, only the large emitters domestically face a real incentive to take action. The rest of us are offered subsidies, that we may or may not respond to, and some sporadic technology standards, that may or may not touch our emissions.

Instead, we need a more comprehensive climate policy. Ideally, this would include a domestic carbon tax for the sectors not covered by the cap and trade for large emitters – that includes you, me, our buildings and cars. Practically, this implies a cap and trade and an emission tax implemented concurrently so that a price signal is seen and hopefully felt by all. These two price signals should form the basis of our climate policy, but would not get the job totally done, and thus other regulatory standards, say for vehicles and buildings will be required, as well a projects on CCS and subsides for innovation.

If we are really serious about carbon and want to minimize cost, we need a broad-based carbon tax to complement the proposed trading regime. Without it, we will continue to have one oar in the water. Rowing in circles is a bit of a rush and can be fun, but mostly it gets tiresome.

Written by Dave Sawyer

December 18th, 2007 at 2:39 pm