EnviroEconomics.ca

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.

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…

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.

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.

The Canada West Foundation just released a nice comprehensive inventory of Canadian provincial and Federal policies on climate mitigation. The document can be found here: Building on Our Strengths: An Inventory of Current Federal, Provincial, and Territorial Climate Change Policies. It is a nice tight survey that provides both the announced targets as well as thematic approaches to implementing the targets.

I like the second paragraph,

The rapidly changing policy environment surrounding climate change initiatives poses a challenge to an up-to-date inventory of climate change efforts. The authors have done their best to include policy developments to the end of 2007. It should also be noted that many government initiatives overlap, both across programs and across jurisdictions. For example, some initiatives that may have an impact upon GHG emissions may be presented in other sections of the report, as they are lodged in other policy areas.

Overlap, uncertainty and a rapidly changing policy environment…all threats to sound policy that will need to be sorted out. This is why the governance issue may be one of the most important elements to address if Canada is to implement cost-effective mitigation.

My Coles Notes summary of the document goes something like this: a single carbon tax in Quebec, lots of talk about trading, a whack of subsidies to renewables and tables and tables of targets. The authors did a great job with what little they had to work with.

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.

Now, this is getting interesting. As many had predicted, and as some teach to first year economics students (see here), consumers and not the regulated community are experiencing the “cost pass though”:

Gaz Métro passes it on $15 per year for residential customers… When the provincial government imposed the country’s first carbon tax last fall, it wanted producers to pay….[But Gaz Métro has] began charging 0.67 cents per cubic metre of natural gas that it sells to its 170,000 customers. It will then remit $38 million to Quebec this year for its new $200-million annual green fund, aimed at reducing greenhouse gases. The hike means about $15 more per year for the typical Gaz Métro residential customer.

(article here)

Is the firm worse off with this climate policy? Perhaps not, and in fact, if the total’s are not reconciled, they could be better off. And is the household worse-off? $15 is eight double-double’s at Tim’s, a weeks worth of coffee for the average Joe. Hmmmm, not so bad maybe. Can we afford this? So far it seems like a yes. Are we getting reductions? Probably not many, but let’s wait and see.

Perhaps it is better, after all, that consumers see the cost increase since carbon taxes are about reductions and not just revenue. In other energy markets, say gasoline, folks are insensitive to price increases, and carbon related increases may not stimulate reductions, but can raise revenue, as gas taxes demonstrate. In this case, the revenue can then be recycled back for any host of objectives, my favorite being reducing other taxes in a neutral shift or for investing in areas where markets fail, like R&D and some technology deployment.

But the big message from the article is that blanket assumptions that carbon costs will adversely hurt industry are clearly wrong. It all depends on the ability of the firm to pass on costs. Affordability is then the next question — can the firm or the consumer afford the cost increase? The only way to answer this question is to compare the cost with income (profits) or sales and determine if the Hit is large.

But in the case of the Quebec carbon tax, it is only Tim’s that will suffer since the value of carbon in Canada continues to be measured in “coffees lost” and not tonnes reduced.

The argument that carbon taxes are nothing but a tax grab is disingenuous (see here). No government seriously considering carbon pricing can afford, politically, to say anything but a carbon pricing package will be revenue neutral, at least mostly anyway. Reductions in other taxes, notably income, and subsidies to the “little” guy, like building retrofits are the political reality with carbon taxes. And free allocations of permits will be the order of the day, at least that is until the utilities start making windfall profits as they pass on the theoretical cost of the permits and their regulated 9% ROI to you and me. So, it is disheartening to see such irresponsible reporting at a time when markets are in chaos:

With all the talk about the need to stimulate growth and keep the economy humming, how many policy leaders are going to be keen on new green and carbon taxes? Despite all the talk…no politicians I’ve heard are raising the idea. And what will Prime Minister Stephen Harper do with his various carbon initiatives now that the economy is teetering on the brink of diffucult (sic) times and growth forecasts are falling by the minute? We’re in a new economic ball game, and the short-term rules are changing around economic and political policy. The first to go, I predict, will be talk of carbon taxes.

And this focus on the short-term will end up costing more in the future. Inaction results in higher costs later on, assuming one will eventually take action on carbon mitigation. Get going now and you avoid technology lock-in, that is, more stock of higher emitting technology that is long lived, and you stimulate, somewhat, technology development through both R&D but also learning by doing (cause we have more stock installed and learn as we go). Plus lower operating costs will eventually make some, but not all, more productive and thus competitive.

For those with real impacts, carbon policy can address the income hit though, for example, output-based recycling recycling which basically subsidizes output while maintaining the carbon price signal. This lessens the economic hit by returning revenue to industry assuming they have taken action to reduce emissions (i.e. they “see” the mitigation cost and reduce emissions and then are returned the tax on the remaining emissions since abatement occurred). Simply, policy design matters and preordained outcomes are therefore not certain.

So, myopia may sell ink, but it is no way to make rationale, economic decisions. And oh yes, markets tend to go up after they go down.

Of course lots of folks are lining up to capitalize on the great carbon economy shift that is coming. None more so than the nuclear industry. While this Globe article infers that nuclear may be cost-effective at higher carbon prices, it also highlights the cost obfuscation coming from the industry:

The (UK) White Paper glosses over this problem with a number of glib assumptions. In its economic analysis, which reckons that the all-in cost of nuclear power will be some £39 a megawatt-hour, compared with £38 for gas and £30 for coal, the government admits that nuclear is only marginally competitive. However, it has also used an important assumption, that the carbon price is €36 a tonne.

According to this, the cost of nuclear is just 2 dollars Canadian more per MWh relative to natural gas assuming an carbon price of about $72 CDN per tonne. This is crazy stuff. If the price gap was this small (CDN $76 for gas and CDN$78 for Nuclear), we would have widespread proliferation of nucs for electricity and all kinds of industrial applications. Indeed, with the price swings in natural gas, and the steady price appreciation since 1999 (140 percent or so in the delivered price), would we not have more nucs if costs were that competitive? (setting aside those little deployment barriers of 20-year build horizons and regulatory hurdles for a moment).

A more realistic figure is perhaps twice the purported cost, say $125 to 150 MWh, which means that at emission prices of about $200 dollars is required before nuclear is competitive with combined cycle gas. And there are lots of other reductions and deployment opportunities that should occur at carbon prices below $200.

So, cost-effectiveness is a good criterion for guiding carbon policy and is the reason why the nuclear folks are running all those Monte Carlo models seeking, desperately, to find a sweet spot. Unfortunately, it is the rate payer who will ultimately get skewed.