EnviroEconomics.ca

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.

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.

On instrument choice, there has been a long-standing view of alternatives as substitutes. You either tax, trade or regulate a standard, or stage instruments in time say by taxing first to get movement in advance of a technology standard. This view is not surprising given much of the early environmental economics literature focused on the benefits of say trading over regulations and technology standards. But this has changed as the theorists have prodded and probed their analytical models and concluded that indeed there is a blurring of the lines, and that often, design elements can be merged to produce some sort of uber instrument. While theory says one thing, we can expect a lag in policy adoption as the policy wonks catch up. But in Quebec, somebody is paying attention:

Quebec Environment Minister Line Beauchamp announced Wednesday that her government has approved regulations to make the province the first in Canada to enforce the tougher emissions standards in cars, starting in 2010. The regulations require manufacturers to improve by 30 per cent the average emissions from their entire fleet of new cars by 2017…..Under Quebec’s plan, automakers would be forced to pay fines into the government’s green fund if they don’t meet their targets, while those that exceed the standard would be able to sell carbon credits to other companies.

What is astonishing about this is that we have elements of trading and taxes concurrently supporting a stringent regulatory standard in Canada. The monetary fines are a safety value that acts like a tax to recycle revenue and improve environmental performance, the trading provides cost-effective compliance through equalizing the marginal costs of producers and an on-going incentive through continuous improvement and the standard, well it is a North American first. And recall, Quebec has a carbon tax that is visible at the pump. Quebec through this “mixing and matching” of instruments seems to have technology change and consumer behaviour in transportation sector cornered. It’s all enough to make an environmental economist swoon.