…environmental economics and the implications of environmental policy

Archive for the ‘climate policy’ tag

An Over Allocation of Holiday Cheer…

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Now that I am back from enjoying an over allocation of wealth that is the Holiday Season, my mind turns back to all things climate policy. I have long thought that a majour gap in the current climate policy debate in Canada is allocations — how the large final emitters will be granted emission rights. One can’t help but wonder how it will all shake out given the maturations in Europe over allocations during the first trading period. As many economists predicted, if firms can pass on the costs of the permits to consumers then firms could be better off. This is indeed happening in Europe as the electrical utilities simply pass all costs on to consumers. The result is windfall gains:

Electric utilities are passing on the costs of emission rights directly to the price of electricity, even though they get most of the emission rights for free, and even if the electricity is generated in ways that do not produce greenhouse gas emissions, such as nuclear energy and hydroelectric power.
The extra dividend has boosted both the price of electricity and the profits enjoyed by electric utilities.

The “cost pass through” is a tricky concept to get one’s head around, but essentially it is about opportunity cost. Although the permits are freely allocated, they have a value in the trading market and thus using them to emit a tonne involves a loss in potential earnings. This loss is like a cost of production, and hence firms, especially regulated utilities, add this to production costs and voila, a price increase for consumers. Now, in competitive markets, this value may not be passed on if market share is to be retained, but in markets that are less than competitive, it is likely that the consumer will see some portion of this cost. But, since there is not really a cost here given permits are freely allocated, firms are better off and profits rise to the extent the cost can be passed on.

This is what is happening in Europe and this could happen in Canada. Carolyn Fischer and I did some allocations work on the Ontario electrical market a few years ago and found that under free allocations and a regulated market, electricity producers could be better off under trading—even with abatement costs accounted. On average with free allocations in a monopolistic market, utility profits increased more than a little with the high emission intensity generating sources showing the highest increase. Perverse I know, but a reality nevertheless. The solution of course is to auction the rights, like we do with telecommunications, and capture some of that allocation rent. This is what is now proposed in Europe.

So, in the wake of all our collective holiday over allocation, we should be asking if Santa will be giving our wealth to some of the large emitters and leaving us to pay for that hypothetical cost embodied in that lump of coal.

Written by Dave Sawyer

January 4th, 2008 at 3:46 pm

The Bali footnote that roared

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While most of us usually ignore the footnotes, for the “Bali Roadmap”, one footnote is worth closer examination. This footnote emerged when consensus on “binding targets” was not reached and there was a need to compromise. What then emerged was an implication that industrializated nations would consider making reductions of -20% to -40% below 1990. And so this seemingly innocuous footnote will be a focus of international climate policy for some time.

With some time on my hands during this Christmas slowdown, I thought I would take a first stab at what this footnote could mean for Canadian GHG reductions, GDP and climate policy. So here goes…

To hit the least stringent Bali -25% target (implied in the footnote):

Canadian GHG emission will need to drop 48% below the BAU in 2020 from a forecast level of about 865 MT in 2020 to ~455 MT;

Carbon prices need to climb in excess of $245 in 2020 (using the CIMS energy and emissions model coupled with the macroeconomic Canadian General Equilibrium and Emissions Model (C-GEEM developed by Nic Rivers and myself)). This carbon price assumes the most economically efficient policy scenario, an economy-wide price on GHG emissions. This would most likely include cap and trade for the large emitters (50% of emissions) and a carbon tax on the remaining emission (transport, buildings and manufacturing, etc.). And yes, other regulatory standards would also be needed on transportation and buildings, and incentives to CCS and renewables;

Technology deployment will need to be massive. CCS in upstream oil would have to hit 65MT and in the electrical sector would need to be another 42MT. Grid-power renewable electricity would have to grow to account for about 20% of all electricity supplied nationally;

Fuel switching would be unprecedented: domestic coal consumption would need to virtually disappear (down 90%), low-emitting electricity would need to expand by 40%, gas consumption would drop by 40% and petroleum would drop 25%;

GDP impacts for all this could be in the order of 1.9% annually, assuming no tax shifting or recycling by the federal government and emission trading with no auctioning (i.e. permit wealth is transferred between trading entities). This drop is about equivalent to the forecast GDP growth in 2020 without climate policy (See thumb);


And to get all this done, climate policy would have to get real serious real fast. The “optimal” emissions price path that minimizes GDP losses would look very different from the current policy path. This implies that starting today, policy stringency would have to be much higher and then ramp up post-2010 (see Thumb);


While Canada needs to take action, its hard to envision the political and perhaps economic system delivering reductions of this magnitude. All this leads me to observe, yet again that the whole Bali thing may have been more surreal than real.

Written by Dave Sawyer

December 21st, 2007 at 7:24 pm

Freaking out about GHG targets and not Bali

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This Globe piece got me thinking about what the Canadian private sector should be freaking out over with respect to climate policy. Is it the emission targets to 2015? No, the price cap for the Technology Fund effectively caps the financial obligation for a given target out to 2017. One simply multiplies forecast emissions by the Technology Fund’s allowable contribution limit to approximate one’s obligation. Is it Bali? Clearly not, since Bali is more surreal than real at this point.

Then what? I think it is uncertainty and that 2020 “aspirational” target of -20% below current levels. Why? If I am sitting down now to plan a project I need an expectation of the price of carbon in the future. I need to know what this variable cost called “carbon liability” will do to my project economics and how I can minimize the liability through design.

But, what is that price? Recent modeling (thanks Chris and Nic) suggests that the carbon price will need to climb from $25 in 2015, the approximate price cap under the Technology Fund, to about $80 to $100 in 2020 to hit a -20% below current target (see thumb). This means that if policy is implemented to hit the target, the liability grows fast and in the order of three to four times between 2015 and 2020. And thus the uncertainty — will climate policy add a carbon liability of this magnitude to my project in 2020?

So I think industry is faced with a very open question and therefore stuck in some sort of mental loop that goes something like this:

The carbon liability could be significant. But, there is so much uncertainty right now I need to discount this liability somewhat. But, the risk is still there. But what is the size of the risk, and by how much do I discount it…repeat loop…

I think “no one is uttering a word about Bali” because they are to busy muttering incoherently to themselves.
Carbon Price to Hit -20% in 2020

Written by Dave Sawyer

December 19th, 2007 at 10:27 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

“We need emission reduction actions, not targets”…or a little of both in Canada

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Chris Green, that quirky economist, has a good article in the Globe today on why the focus on targets is bad, and a focus on action is needed. His basic premise is that targets, especially long-term ones, are set in a political arena, which operates in the absence of clear information on the doable. Targets are then set beyond what is technically or economically achievable, and thus set to fail. The setting of targets also detracts considerably from the focus on action, and the inevitable failure influences implementation. Both of these observations are borne out in Canada’s Kyoto experience.

Chris makes some good sense, but I also think the long-term targets provide a focus for action. A well balanced climate policy would have one track that looks forward to vision where we need to go and how we need to organize and transform ourselves to transition to a lower carbon future. Another parallel tract would focus on short-term action and on setting the stage for longer term strategies to move towards the targets.

So Chris is bang on when he states:

Someone has to lead. Another round of climate target-setting would be a prescription for another decade wasted. While it may be politically difficult to chart a new course, there is no alternative if we wish to cope with climate change. Canada could at least get out in front with projects and policies — putting a price on carbon, strengthening energy efficiency standards, and increasing carbon capture and storage — that have a strong probability of encouraging development of the green technologies that will be essential to reducing greenhouse-gas emissions, even if the timing and magnitude of these reductions is inherently uncertain

I just think part of that leadership also involves rallying around a vision of the future. And that vision has to be anchored in where we need to be. So, we are stuck with targets. But as Chris points out, if we channel some of that energy used to argue over targets into action, we would be one our way.

Written by Dave Sawyer

December 13th, 2007 at 3:03 pm

“A Focus on the Promise of Trade to Combat Climate Change Rather than the Potential for Conflict”

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When the Trade Ministers meet to talk climate change and trade, there is promise. These are the folks that generally get things done in government. Toby Heaps has a great account of a first, and very important meeting of international finance ministers on climate change and trade in Bali. One nugget from this account is a World Bank assertion that trade barriers could be removed that could improve the flow of “climate friendly goods” between countries by something like 7 to 13%. These are big numbers and underscore an area that needs more attention: the removal of non-price barriers to lower carbon emissions.

Despite the focus on emission pricing, there is also a need to systematically crawl through the way we regulate and control behavior and see what is distorting movement to a low emissions profile. In many cases, removing these barriers opens up a suite of low cost options.

One notable example that recently stuck me as significant are barriers in the cement sector to burning waste fuels and adding supplemental cementing materials (SCM’s are a cement “filler” that is waste fly-ash from burnt coal). In Canada, we regulate the industry’s ability to burn waste materials and add SCM’s, but in Europe things are different. With proper air pollutant controls, the European cement sector has become a waste burning powerhouse, while reducing emissions a tonne (ok many tonnes). Similarly, the industry is allowed to add waste materials to their cement products up to something like 30% while maintaining quality, which lessens total emissions (1/3 from energy and 2/3 process) on a ratio in the order of 1:1.

In Canada, our SCM standard is 1% and we burn about 5% waste fuels nationally. Changing these standards would mean we could reduce energy and process emissions from this GHG-intensive sector by a much larger number at a much lower cost than options such as fuel switching (more Nox) or upgrading the kilns (more cost). And banning the burning of tires in Ontario, but allowing them to be shipped to Michigan and burnt in Cement kilns owned by the same folks in the same airshed is absurd (yes we do this).

It is always puzzling to an economist to see something that makes economic sense but is undersupplied. But when we do, we generally know there is some sort of distortion at play. In Canada, finding and removing these distortions should be a priority for climate policy. So, while Canada’s climate change delegation drags our good name through the volcanic sand in Bali, take comfort. Some smart people are at least thinking about this stuff on our behalf, and when they are trade ministers, we may just be better off.

Written by Dave Sawyer

December 11th, 2007 at 2:23 pm