August 2008


Courtesy of wordle.

Suppose that a carbon price reduced the production of a trade exposed emissions intensive good. Loss of production could increase the goods price, which could increase production elsewhere (where there is not a carbon price). Similarly, if we were to reduce exports of a fossil fuel (e.g. coal), there could also be a similar price effect.

Assuming market clearance and no non-linear (bubble like) price effects, some manipulation of partial derivatives leads to the following equation:

where:

  • R is the ratio of the change in quantity supplied from overseas (from countries that do not apply a carbon price) to the change in quantity exported (from countries that do apply a carbon price) – this value will be negative;
  • Qo is the quantity supplied from countries that do not apply a carbon price;
  • Qe is the quantity exported from countries that do apply a carbon price;
  • Qt is the total quantity supplied (Qt = Qe + Qo);
  • εs is the price-elasticity of supply, for expanding supply;
  • εd is the price-elasticity of demand, which will be negative.

Inelastic demand is associated with necessities, such as staple foods and so on. If there are substitutes, such as gas, then demand becomes more price-elastic. The price-elasticity of supply depends on factors such as spare-production capacity and bottlenecks.

The above equation has the following implications:

  • The magnitude of R will be less than 1, unless the elasticity of supply is infinite or the elasticity of demand is zero, in which case the magnitude of R will be equal to 1. This suggests that the common assertion from industry that “any loss in production will be offset by an increase in production elsewhere” is technically incorrect.
  • As Qo approaches zero, R will approach zero. So the greater the coverage of the carbon price, the less that leakage is a problem, even if coverage is not complete. Because the above equation would affect the payoff matrix, when the coverage is greater, the prisoner’s dilemma will be marginally easier to resolve.

The above equation suggests that sectoral agreements to apply a carbon price in trade exposed sectors would be a useful approach. Even if the coverage of the sectoral agreement is not complete, the agreement would still be advantageous to resolving the prisoner’s dilemma. Because the mathematics of whether to apply a carbon price to fossil fuel exports is also governed by this equation, sectoral agreements among fossil fuel exporters, especially coal exporters, would be a useful mechanism for increasing the coverage of the carbon price.

Levies on exports may be a better alternative to border adjustments on imports or protectionism for emissions intensive industries. There is a precedent for this – in order for China to reduce the incentive for other countries to re-introduce levies on textile imports, it imposed a small levy on its textile exports. It has been suggested that this tactic could help unlock climate change negotiations. At present, a levy on Australia’s coal exports could significantly increase the coverage of a carbon price.

While reducing carbon leakage would affect global greenhouse gas emissions, the ultimate way that the carbon leakage problem will be solved will be for the successful resolution of international climate negotiations, and full coverage of a carbon price. Protection of emissions intensive industries will encourage, through reciprocity, the protection of these industries elsewhere, and more costs overall. It may be that the best approach to carbon leakage would be to ignore it. This would suggest that assistance to trade exposed emissions intensive industries could be reduced.

Addressing climate change requires the resolution of a prisoner’s dilemma, and preferably resolving it quickly. The prisoner’s dilemma can be thought of as a multiplayer repeated game, with communication between players, this makes it easier to resolve. In some ways present mitigation actions are more important in how they contribute to resolving the prisoners dilemma than their direct affect on emissions.

The most successful algorithms in experiments involving simulated multiplayer prisoner’s dilemmas have been ‘tit-for-tat’ strategies, this suggests that the issue of reciprocity is important. Weitzman’s recent work affects the cost of not cooperating, but does not effect the marginal benefit from free-riding. This affects the pay-off matrix in a way that increases the chance of resolving the prisoner’s dilemma (but also increases the cost of not resolving the prisoner’s dilemma). How much this affects the prisoner’s dilemma depends on how much different agents value Weitzman’s “VSL-like parameter”, and how much risk aversion they have. Other factors include the disaggregated climate change impacts, how much an agent values environmental goods, and what discount rate they use.

One approach that would encourage developing countries to participate in an international agreement is a pure per-capita approach (paywalled). All participating countries are allocated permits based on their population and average per-capita emissions. High per-capita emitters would buy permits from low per-capita emitters. According to the paper by Baer et al. on a per-capita approach:

The Kyoto Protocol assigned emissions caps to the industrialized countries based on their 1990 emissions levels (a “grandfather clause”). By basing future emissions caps on past levels, the protocol rewards historically high emitters and penalizes low emitters. A fair long-term agreement will require a transition to limits based on equal per capita emissions.
A per capita allocation can work because it is simple. Most of the alternatives under consideration blend past emissions with analysis of outcomes. They assume that the consequences of climate change for different nations, as well as their abilities to ameliorate or adapt, can be understood in advance.

A per-capita allocation is the same as the end point of a contraction and convergence approach. The question then becomes what is the amount of time taken to reach the end point. Equity arguments would suggest that this should take place quickly. It may be difficult to achieve this because high per-capita emitters could make it difficult. If Australia, a very high per-capita emitter, advocated a short convergence period, this outcome would be more achievable.

The Australian Industry Group and other industry organisations are arguing that Australia shouldn’t have a renewable energy target because emissions trading will bring about reductions at “least cost”. They argue that because the amount of emissions is set by the emissions trading cap, policies that encourage the deployment of renewables will not reduce emissions further, and will increase the cost of emissions reductions. It is true that in a traditional emissions trading scheme there will not be a reduction in total emissions, because the cap has already been set. However, if there was a price floor (which could be maintained by having an additional carbon tax), this is no longer a problem, provided the floor (tax) is sufficiently high.

There is a flaw in their argument which relates to how much we value the future (discount rates). The costs of renewable energy depend on the initial investment cost (high compared to other energy sources) and the ongoing costs (extremely low). Firms will discount the future more than an ethical approach to climate change will discount the future. This means that firms are likely to invest more in emissions reductions that are cheaper now but not necessarily cheaper over the long term. This is a market failure, which can be addressed by policies that encourage the deployment of renewable technologies, such as mandatory renewable energy targets and feed in tariffs.

A very important report on greenhouse gas emissions and Australia’s native forests has been released:

Brendan G. Mackey, Heather Keith, Sandra L. Berry and David B. Lindenmeyer, Green Carbon: the role of natural forests in carbon storage. Part 1, A green carbon account of Australia’s south-eastern Eucalypt forests, and policy implications. The Fenner School of Environment and Society, The Australian National University.

The report demonstrates that Australian forests have far larger carbon stocks than previously recognised. According to the report:

Our analysis shows that in the 14.5 million ha of eucalypt forests in south-eastern Australia, the effect of retaining the current carbon stock (equivalent to 25.5 Gt CO2 (carbon dioxide)) is equivalent to avoided emissions of 460 Mt(2) CO2 yr-1 for the next 100 years. Allowing logged forests to realize their sequestration potential to store 7.5 Gt CO2 is equivalent to avoiding emissions of 136 Mt CO2 yr-1 for the next 100 years. This is equal to 24 per cent of the 2005 Australian net greenhouse gas emissions across all sectors; which were 559 Mt CO2 in that year.

So the carbon in Australia’s south eastern forests is equivalent to approximately 25.5 billion tonnes of carbon dioxide. But the report also suggests that native forest logging has degraded forests to the extent that 7.5 billion extra tonnes of carbon dioxide are in the atmosphere. Unfortunately greenhouse gas emissions from logging native forests do not count as a “change of land use”, so emissions from forest degradation do not have to be accounted for under the Kyoto protocol.

Native forests are also more reliable than plantation forests as carbon stores, especially over long time periods.

The green carbon in natural forests is stored in a more reliable stock than that in industrialized forests, especially over ecological time scales. Carbon stored in industrialized forests has a greater susceptibility to loss than that stored in natural forests. Industrialized forests, particularly plantations, have reduced genetic diversity and structural complexity, and therefore reduced resilience to pests, diseases and changing climatic conditions.

The report also states:

It is possible to achieve protection of the carbon stocks in natural forests by switching to timber sourced from existing plantations and, if necessary, from new plantations on previously cleared land. In this way, the commercial demand for wood fibre can be met and the contribution of natural forests to greenhouse gas mitigation can be maximized.

Sounds like another good reason for not logging native forests.

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