Thursday, June 28, 2007

Cheap ways to reduce greenhouse emissions

An interesting article in The Economist last month took a look at the cost of various options for reducing greenhouse emissions (summarised in the graph above).

Two things are particularly notable:

  • There are a number of options that have a negative cost. In other words, not only would they reduce emissions, they’d also save us money. The biggest one is insulation and low-energy lighting is also up there.
  • The solutions we hear a lot about – such as wind, solar and carbon capture – are among the most expensive options.

So why are we not voluntarily making decisions that would not only reduce emissions but also save us money?

The Economist identifies a couple of possible reasons, the most compelling to my mind is that the people who make the choices are not the people who pay the costs of those decisions. For example, property developers have to pay for insulation but they won’t get the benefits of lower electricity bills, so their incentive is to go cheap on insulation. If the property is to be rented out, it’s not even the buyer who pay those bills – it’s a tenant.

How to solve this? In theory, awareness of the issue should be enough: if tenants and buyers of new houses (or other buildings) are aware that good insulation can save them substantial amounts of money, they should demand it and be prepared to pay more for it – in the same way they’d be prepared to pay more for a good bathroom or kitchen.

So why isn't this happening? And seeing as it doesn’t seem to be happening, is there a role for government in mandating it in building standards or requiring developers and sellers to at lease provide understandable information (eg, energy efficiency ratings)?

[HT: RSMG Blog]

Monday, June 25, 2007

Monday, June 18, 2007

Should carbon taxes be linked to global temperatures?

I’ve mentioned before the possibility of creating markets in long-term weather – that is, betting on future climate change – as a method of predicting and insuring against climate change. Betting markets are good at predicting future outcomes – you can look at the odds on horses in a race if you want to get an idea of who’s likely to win. The idea is that allowing climate scientists, businesses, etc to bet on future climate change would be a way of aggregating all the knowledge that people have about likely future climate change in a way that’s more decentralised and independent than say the consensus method of international scientists at the Intergovernmental Panel on Climate Change (IPCC). There are advantages and disadvantages of either way of distilling the information from thousands of climate scientists into consensus estimates of likely climate change.

In an article last week in Canada’s Financial Post, Canadian economist Ross McKitrick proposes a different method of removing scientific uncertainty about climate change from the policy response to climate change. He proposes a carbon tax where the tax rate is linked to average global temperatures over the prior 3 years:

Climate models predict that, if greenhouse gases are driving climate change, there will be a unique fingerprint in the form of a strong warming trend in the tropical troposphere... The Intergovernmental Panel on Climate Change (IPCC) states that this will be an early and strong signal of anthropogenic warming. Climate changes due to solar variability or other natural factors will not yield this pattern: only sustained greenhouse warming will do it. Temperatures in the tropical troposphere are measured every day using weather satellites…

Suppose each country implements something called the T3 tax, whose U.S. dollar rate is set equal to 20 times the three-year moving average of… estimates of the mean tropical tropospheric temperature anomaly [warming], assessed per tonne of carbon dioxide, updated annually. Based on current data, the tax would be US$4.70 per ton...

This tax rate is low, and would yield very little emissions abatement. Global-warming skeptics and opponents of greenhouse-abatement policy will like that. But would global-warming activists? They should -- because according to them, the tax will climb rapidly in the years ahead.

The IPCC predicts a warming rate in the tropical troposphere of about double that at the surface, implying about 0.2C to 1.2C per decade in the tropical troposphere under greenhouse-forcing scenarios. That implies the tax will climb by $4 to $24 per tonne per decade, a much more aggressive schedule of emission fee increases than most current proposals. At the upper end of warming forecasts, the tax could reach $200 per tonne of CO2 by 2100, forcing major carbon-emission reductions and a global shift to non-carbon energy sources.

Global-warming activists would like this. But so would skeptics, because they believe the models are exaggerating the warming forecasts. After all, [the average tropical troposphere temperature] went up only about 0.08C over the past decade, and has been going down since 2002. Some solar scientists even expect pronounced cooling to begin in a decade. If they are right, the T3 tax will fall below zero within two decades, turning into a subsidy for carbon emissions…

Under the T3 tax, the regulator gets to call everyone's bluff at once, without gambling in advance on who is right. If the tax goes up, it ought to have. If it doesn't go up, it shouldn't have. Either way we get a sensible outcome.
It’s an intriguing idea. I suspect its biggest detractors would be energy-intensive industries, who would have no certainty about the level of carbon taxes in the future. McKitrick’s response is that those industries will just have to forecast that as best they can and actually sees this as an advantage:

best of all, the T3 tax will encourage private-sector climate forecasting. Firms will need good estimates of future tax rates, which will force them to look deeply, and objectively, into the question of whether existing climate forecasts have an alarmist bias. The financial incentives will lead to independent reassessments of global climate modelling, without regard to what politicians, the IPCC or climatology professors want to hear.

(This is the advantage too of a long-term weather market. Presumably McKitrick’s proposal would lead to the development of such a market so that energy-intensive industries could assess - and hedge - their exposure).

There are a few potential problems with the proposal that immediately spring to mind.

The first is that it relies on the fact that “climate models predict that, if greenhouse gases are driving climate change, there will be a unique fingerprint in the form of a strong warming trend in the tropical troposphere”. But what if that isn’t the case? McKitrick’s claim is that his proposal takes the scientific debate out of the policy response, but it relies on climate model predictions that troposphere warming reflects man-made emissions and leads other warming. If he’s prepared to accept this finding, why not go the step further and accept the estimates of warming presented by those models and then base the level of tax on those?

It also doesn’t really deal with the problem of lag periods: the tax paid now depends on the level of warming now. But the purpose of the tax is to prevent increased warming in the future: surely its level should be based on an assessment of what’s required to constrain future temperature increases.

McKitrick’s answer is that “investors planning major industrial projects will need to forecast the tax rate many years ahead, thereby taking into account the most likely path of global warming a decade or more in advance”. And that’s no doubt true for major industrial projects. But household consumers of electricity and petrol will make their decisions based on today’s prices.

A related problem is that it doesn’t deal with dangerous thresholds. The tax is linear: it increases by US $20 for every 1 degree rise in temperatures. But damage isn’t linear. What happens if our best science suggests that damage will be moderate up to, say, two or three degrees but that, above that, there will be feedback loops and greatly increased risks of catastrophic damage? If that was the case, we’d want an aggressive tax before those dangerous levels are reached. McKitrick’s tax would only start becoming aggressive once those levels were passed, by which time even much higher tax rates may have become much less effective.

It’s an interesting idea though that deserves some attention and debate. I think it’s interesting that market approaches may help not only with developing effective and low-cost policy responses, but may also help improve our understanding of the science on which policies must be based.

[HT: Lars Smith at Conservation Finance]

Thursday, June 14, 2007

Review of Environmental Economics and Policy

The first issue of the Review of Environmental Economics and Policy is out and articles can be downloaded for free.

The Review

...seeks to fill the gap between traditional academic journals and the general interest press by providing a widely accessible yet scholarly source for the latest thinking on environmental economics and related policy...

Looks like there's some interesting articles, with a focus on carbon taxes and emissions trading.

Monday, June 04, 2007

Who do you trust with the challenge of climate change?

That’s what Australia’s Prime Minister John Howard asked yesterday, when announcing his Government’s policy on climate change for the next election:

We must get this right. If we get this wrong, it will do enormous damage to our economy; to jobs and to the economic wellbeing of ordinary Australians, especially low-income households. The question I pose to the Australian people, quite directly, is this: who do you trust to take the vital decisions about our future?

Howard announced yesterday that his government would introduce emissions trading by 2012:

I announce specifically that Australia will move towards a domestic emissions trading system, that’s a cap and trade system beginning no later than 2012.

Secondly, we will as a nation set a long term aspirational goal for reducing carbon emissions but we need to assess very carefully with detailed economic modelling the impact any target will have on Australia’s economy and Australian families, this target will be set next year 2008.

Thirdly, the scheme will be national in scope and as comprehensive as practicable, designed to take account of global developments and to preserve the ompetitiveness of our trade exposed emissions intensive industries.

Fourthly, Australia should not pay higher energy costs than necessary to achieve emissions reductions, in other words, governments need to let the market sort out the most efficient means of lowering emissions with all low emissions technologies on the table and that of necessity must include nuclear power.

First, credit where credit is due. The PM has now committed his government to introducing a domestic emissions trading scheme by 2012. In effect that’s a commitment to reduce our emissions unilaterally even if it’s not required under the next round of Kyoto after 2012 (or some other international agreement). On the other hand, he has deferred setting a target for reducing emissions until next year, ie, after the election. That’s really half a policy. It’s like announcing that you’ll introduce a goods and services tax but you haven’t worked out what the rate will be. Or you intend to give a huge boost to health spending, but you haven’t worked out how much or where it will be spent. (Trust us).

Trust on climate change action is a double-edged sword. We need effective action but at a reasonable cost to the community. The Liberal Government enjoys the community’s trust that it will have broadly sensible economic policies, but I don’t think the community trusts it to deal with climate change effectively. It has spent the last 10 years taking only modest action on climate change and at the same time has damaged the cause of effective action by rejecting the Kyoto Protocol, supporting the world’s biggest polluter - the United States - in its stance to take no effective action on climate change, and publicly expressing its scepticism that climate change is even a problem.

We’re starting to get some reasonable modelling on the costs of emission reduction pathways. Strong targets will impose costs on businesses and households, but are entirely consistent with strong economic growth. Indeed, they make relatively little difference to overall projections for growth. Leaders that we can trust will be those that tell us the truth:

  • It’s true we’re a small player in all this. Adopting a strong domestic target won’t in itself save us from the risk of dangerous climate change.

  • However, it’s a likely prerequisite for getting our neighbours to play their part.

  • Strong targets will mean that we’re not as wealthy in 50 years as we would be with no targets. But we’ll be much wealthier than we are now. The economic chaos that Howard fears the ALP’s “reckless and irresponsible” target may inflict is being 169% wealthier on average than we are now compared to 184% wealthier if we don’t set a target.

  • Of course, that doesn’t take into account the dangers that climate change presents to our wealth. I reckon being only 169% wealthier in 50 years is worth it to avoid the (small) risk that climate change will make us much poorer, in nasty ways.

  • Nevertheless, the flipside is also true. On the best estimates, climate change will make people in 50 or 100 years poorer than they otherwise would be – but (unless things go really wrong) still substantially wealthier than we are right now. So don’t be too worried about the people of 2100 – they’ll probably be better off materially than you or me.

  • To a large extent, climate change is an economic issue. Some of the problems of climate change will be dealt with better by spending money on adapting than by spending money on reducing the severity of climate change. For example, we could invest billions on reducing the severity of climate change to reduce the spread of malaria that it will cause as warmer regions expand. But we might save millions more lives by investing that money in research into malaria treatments.

  • But, most importantly of all, climate change is not just an economic issue. It will destroy or radically alter species, ecosystems, landscapes, and communities. The extra wealth we’ll gain from inaction won’t compensate us for that. I hope our leaders can show that that’s something they understand.

I’m working my way through the PM’s task group’s report and in the next couple of weeks, I’m going to outline what it means, where we are in terms of climate change policy in Australia, and some of the things you need to understand to make some sense of it all, including:

  • What is emissions trading?

  • How does it differ from a carbon tax?

  • What are the main political parties proposing?

  • How does Australia fit into the global challenge?

  • What are the economic effects of imposing a cost on emissions?

  • How do you choose an emissions target?

Are there any other questions you’d like answered? Let me know: leave a comment or email me at ozelaw [at] yahoo [dot] com.

Friday, June 01, 2007

Emissions trading - the report is out

The Prime Minister's Task Group on Emissions Trading has handed down its final report and it is now available.

It recommends an emissions trading scheme based on the following principles:

  • a long-term aspirational emissions abatement goal and associated pathways to provide an explicit guide for business investment and community engagement an overall emissions reduction trajectory that commences moderately, progressively stabilises, and then results in deeper emissions reductions over time and:
    · is sufficiently flexible that it can be periodically recalibrated by government to changing international and domestic circumstances through regular and transparent reviews
    · provides markets with the ability to develop a forward carbon price path to guide business investment decisions and help drive longer-term technology development – markets would be expected to establish a low initial carbon price and a forward price curve that rises over time

  • maximum practical coverage of all sources and sinks, and of all greenhouse gases with permit liability placed on direct emissions from large facilities and on upstream fuel suppliers for other energy emissions with those sectors initially excluded from the emissions trading scheme subject to other policies designed to deliver abatement

  • initial exclusion of agriculture and land use from the scheme though agricultural emissions should be brought into the scheme as practical issues are resolved

  • a mixture of free allocation and auctioning of single-year dated emissions permits that:
    · provides an up-front, once-and-for-all, free allocation of permits as compensation to existing businesses identified as likely to suffer a disproportionate loss of value due to the introduction of a carbon price
    · ameliorates, through free allocation, the carbon-related exposures of existing and new investments in trade-exposed, emissions-intensive industries while key international competitors do not face similar carbon constraints, but which also provides ongoing incentives for abatement and adoption of industry best practice allows for the periodic auctioning of remaining permits

  • a ‘safety valve’ emissions fee designed to limit unanticipated costs to the economy and to business, particularly in the early years of the scheme, while ensuring an ongoing incentive to abate

  • recognition of a wide range of credible carbon offset regimes, domestically and internationally

  • capacity, over time, to link to other comparable national and regional schemes in order to provide the building blocks of a truly global emissions trading scheme

  • incentives for firms to undertake abatement in the lead-up to the commencement of the scheme, including through the purchase of offset credits from carbon plantations, and potentially from other accredited activities

  • revenue from permits and fees to be used, in the first instance, to support emergence of low-emissions technologies and energy efficiency initiatives (the focus might shift more toward households and business as the scheme matures).

That mostly sounds pretty good to me but I think the emphasis is clearly on being business-friendly more than being effective (where those two goals conflict).

Will be interesting to delve into some of the detail. Some initial thoughts:

The 'safety valve' fee is potentially worrying

The idea of a cap-and-trade scheme is that the government sets the maximum emissions, issues permits for that level of emissions and then emitters trade the permits. If one emitter can reduce its emissions for less than the market price of the permit, it will do so and sell the excess permits it has. If another emitter wants to expand and that will involve more emissions, it will need to purchase permits. It will then have an incentive to pursue options that involve relatively less emissions so that it doesn't have to buy as many new permits.

If the government stands by ready to charge a 'safety valve' fee to emitters that don't have enough permits, that sets a maximum price on the permits: if it's cheaper just to pay the fee than to buy the permits, you'll just pay the fee, so the permits won't rise above that price.

But that means that the cap on emissions isn't really a cap. If emitters pay the fee rather than buying permits, then the cap will be exceeded. From business's point of view it's a good thing: it means there's a known worst-case-scenario in terms of the costs it will impose. But if it's set too high, the reduction in emissions could be much lower than we anticipate.

The allocation of free permits is controversial

Ideally, you should auction all permits. As Peter Martin says in the Canberra Times:

The best way to distribute permits is to auction them. The firms that need them will pay what they are worth and pass on the costs to consumers in higher electricity prices. The government can use the money it raises from each year’s auction to cut income tax, to cut company tax, or to support the development of low-carbon technologies.


Polluter after polluter that has made a submission to the Prime Minister’s taskforce on emissions trading has said that while it supports the idea of a trading scheme, it wants the price of the permit set low and it wants to be given enough permits - gratis - to cover most of the pollution it already does.As Australia’s most venerable economic modeler and one of the signatories to the economist’s letter Professor Peter Dixon of Monash University told me: “It’s the same as putting a tax on carbon pollution and then instead of doing something useful with the proceeds - like cutting another tax - giving it to the shareholders of the polluting companies”.

It is even better than that for the polluting companies. If they get given for free permits that a would-be competitor would need to buy, they get given a built-in cost advantage. Their would-be competitors might not bother! No wonder they like the idea. (Economists call the idea “grandfathering” and call the result a “barrier to entry”.)

Expect a lot of political argy-bargy over this one.

PM's Emission Trading Task Group - report out midday today

I've just been informed that the report will be posted on the Task Group's website at midday today.

Today's Sydney Morning Herald has a brief summary and the recommendations are a little disappointing (if not surprising). The good point is that it recommends a domestic cap-and-trade system (with fees for exceeding permit requirements - which makes it more like a hybrid cap-and-trade / carbon tax).

Other features of the report according to the SMH:

  • The scheme "must not overtly harm the economy" (so it will be restricted to measures that covertly harm the economy??)
  • too early to set a target until more modelling has been done
  • would not be introduced until at least 2012
  • revenue from the scheme should be used to support low emission technologies
  • no mandatory renewable energy target.

The Canberra Times has a slightly better summary and Peter Martin has a good piece on the economics.

I'll try and put up a summary of the main recommendations shortly after midday...