Politics


The multi-party climate change committee has announced more details about carbon pricing in Australia. The approach is to have an initial fixed-price, and then to later transition to an emissions trading scheme. This is more-or-less the approach that I described in January 2010 here. A big advantage of the fixed-price approach is that there will be information about the effect of a carbon price on the economy and Australia’s emissions before Australia’s target is set.

Recent government projections suggest that Australia would need to reduce greenhouse gas emissions by  160 million tonnes of greenhouse gases per year by 2020 to reduce emissions to 5 percent less than 1990 levels, and by 270 million tonnes of greenhouse gases per year to reduce emissions to 25 percent less than 1990 levels. There is no politically feasible way to do this without a price on greenhouse gas emissions.

A carbon price works because if emission reductions are cheaper, there is an opportunity to make money from reducing emissions. It becomes like picking up a $100 bill from the ground. Now markets don’t work perfectly, and I might not pick up some of those bills (for example, due to an informational failure, I might not see some of them) but I’ll try hard to pick up as many as I can. Without a carbon price, this incentive is not there.

One argument used against carbon pricing is that it will increase the price of petrol or electricity, which is unpopular. But money raised from a carbon price can go back to households, and this is exactly what is planned. Petrol and electricity from fossil fuels will cost more, which will provide an incentive to use less, but we will get more than that back through paying less taxes, or through cheques in the mail. And we will get these cheques in the mail regardless of how much petrol or electricity we use, so the incentive to reduce emissions will remain.

Polluting industries will argue for assistance, and will have an incentive to exaggerate costs from a carbon price in order to bolster their case for assistance. But every dollar spent on assistance to industries will be one less dollar available for assistance to households. This is something that voters need to consider when greenhouse gas emitters make the case for assistance.

There is a string case for not all carbon price revenue to go to industry and households. Greenhouse gas emissions are an international problem, and carbon price revenue could be used to fund cost-effective emission reductions overseas and adaptation to the impacts of climate change. Technology advances could lower the cost of emission reductions, so there is a case for some carbon price revenue to be used for funding research and development. And the carbon price does not address emissions from agriculture, and probably not from land use, so there is a case for some of the money raised to provide incentives to sequester carbon in ecosystems.

Some key details:

  • The scheme would commence with a fixed-price in July 2012, this fixed price would increase by a fixed percentage each year.
  • After three to five years, the scheme would transition to a flexible price emissions trading scheme. The agreement does not specify any details about whether the emissions trading scheme would have measures such as price floors, price ceilings, or allowance reserves.
  • At least 12 months before the end of the fixed price phase, there would either be a decision on a 2020 target, or a decision to extend the fixed price phase. Issues that could be considered when deciding whether to extend the fixed price phase include: the state of the international carbon market; international developments in carbon pricing; Australia’s internationally agreed targets and progress towards meeting them, including whether they have been incorporated into a binding legal agreement; the fiscal implications of any on-budget purchases of internationally allowances that may be required to comply with any international emissions target; potential impacts on the Australian economy; and implications for investment certainty.
  • The scheme would cover emissions from energy, transport, industrial processes, fugitive emissions (methane leaking from things such as coal mines), and emissions from non-legacy waste (methane leaking from landfills). Agriculture would not be covered and sources covered under the proposed Carbon Farming Initiative would also not be covered.
  • The communiqué notes that “Options to provide economic value to activities which store or reduce carbon in the land sector could potentially include the use of Kyoto-compliant credits in the carbon price mechanism or alternative funding arrangements for the land sector.”
  • During the fixed price phase, international offsets will not be able to be used for compliance (although international allowances could potentially be purchased by the Australian government). During the flexible-price phase offsets could be used, with criteria concern quality and any other restrictions yet to be determined.
  • Many other matters, such as what to do with carbon price revenue, are still to be determined.
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The details are below. The proposal is for an initial fixed price transitioning to an emissions trading scheme. I’ll write some analysis on this later.

Carbon price agmt release 240211

MPCCC Carbon Price Mechanism Final

Update: More analysis here.

The journal Energy Policy has recently published a paper by my colleague Frank Jotzo and myself:

Wood, P.J., Jotzo, F., Price floors for emissions trading. Energy Policy (2011), doi:10.1016/j.enpol.2011.01.004

The paper (as well as this blog) proposes that one way that a price floor could be implemented is for emitters to pay an additional fee or tax per tonne of emissions. The carbon price is then equal to the sum of the ETS permit price and the extra fee. The UK government has proposed to introduce a carbon price floor via this approach, and has been engaging in consultations. The proposal is the reform the Climate Change Levy so that it functions like a carbon tax. Because the UK is part of the EU ETS, firms would also pay for EU permits, and so the effective UK carbon price will be equal to the sum of the Climate Change Levy and the EU ETS permit price.

The discussion paper includes three different “illustrative carbon price scenarios” of £20/tCO2, £30/tCO2 and £40/tCO2 which is somewhat more ambitious than likely to be proposed for the carbon price in Australia, or the price floor that was proposed in the Waxman-Markey Bill.

Because most EU emissions are determined by the EU ETS, the direct effect on global emissions is likely to be minimal. Emissions in the EU are determined by the cap. If the whole EU ETS had a price floor, and the floor price was met, then that would reduce total EU emissions; but when a single country has a price floor, overall emissions are unchanged. For this reason Climate Strategies has made the important point that the UK should embed its policy in a strategy to strengthen EU emission reduction targets.

What the UK proposal does do is provide ‘learning-by-doing’ on carbon pricing, which provides valuable information to other jurisdictions that may consider a carbon price. A UK price floor proposal is consistent with a polycentric approach to climate change. It also provides much more certainty about the carbon price for investors in emission reductions. By eliminating the risk that the carbon price will go below a particular level, the cost of investing in emission reductions is significantly less.

The UK proposal has attracted a storm of controversy. It will mean that polluters will have to pay more, and steel-makers have already started to complain. This is to be expected – if firms can shape government policy to reduce their costs, then their investment in shaping policy could have a huge payoff. This is why rent-seeking is such a big issue in climate policy.

What was less expected was the opposition from two environment groups: the WWF and Greenpeace (presumably the UK branches of these organisations). They have claimed in a media release that because a price floor will raise electricity prices, and nuclear generators do not have significant emissions, their profits will increase, which will make a “mockery of the Coalition government’s stated opposition to any form of public subsidy for nuclear” and “this is yet another taxpayer handout to a failing nuclear industry.”

Any carbon price will increase the profitability of nuclear energy, just like it will increase the profitability of renewable energy or energy-efficiency. A carbon price is technology neutral and the claim that it is a subsidy or taxpayer handout for the nuclear industry in completely ridiculous. This proposal is good policy and the WWF and Greenpeace should be supporting it rather than attacking it.

For more on price floors, see http://climatedilemma.com/2008/07/19/making-the-polluter-pay-prices-quantities-or-both/

This post first appeared on East Asia Forum.

The negotiators at Cancún are currently trying to negotiate a ‘balanced package’ – also known as a ‘six-pack’ – that combines progress on mitigation, transparency (measurement, reporting and verification – or MRV), adaptation, finance, technology, and REDD+ (reducing emissions from deforestation and forest degradation). The Mexicans are extremely determined to get some sort of outcome from the conference – both for the climate and for multilateral negotiations. They so far seem to have been quite confident in the way that they have facilitated the negotiations, and there seems to be much more trust in the Mexicans from Parties than there was for the Danes last year.

What is uncertain is how ‘good’ the decisions will be – in terms of criteria such as ambition (including capacity to ramp up ambition later), efficiency and equity; how detailed the decisions would be; and whether there is sufficient consensus to get a package of decisions at all. Different Parties are interested in progress on different elements of the six-pack, so the total level of progress will be determined by whatever element has the least progress. For example, the United States requires progress on mitigation and transparency in order to support progress on adaptation, finance, technology and REDD+.

There are two tracks to the negotiations: one track is focused on further commitments under the Kyoto Protocol for ‘Annex I parties’ (which consists of developing countries, but does not include many countries that could be considered ‘developed’ such as Qatar, Saudi Arabia, and Singapore); the other track is focused on implementing the Bali Action Plan – that covers the six-pack described above. Developing countries (including China) have stated that for an agreement, they require progress on a second commitment period of the Kyoto Protocol. There could be progress on ‘technical’ aspects of the Kyoto Protocol – such as new gases, surplus emission allocations, and accounting for forest management. But Japan has now stated clearly what many have already known – that they do not intend to inscribe their target into the second commitment period. If this issue is not resolved, it could cause a potential deal to unravel.

Below is a summary of where things are at in the six-pack:

  • On mitigation, key questions are how to anchor pledges that were part of the Copenhagen accord, and what could be done later to increase ambition. Points of contention include how developed country commitments relate to the Kyoto Protocol and the nature of developing country commitments. China has said that it would submit its emission reductions as a binding UN resolution – but this is conditional on progress on a second commitment period to the Kyoto Protocol. Todd Stern has described China’s announcement as nothing new.
  • There is some information on transparency in the negotiating text, but the United States want more detail. The Indian Environment Minister Jayram Ramesh has put forward a proposal, but it is uncertain how much support there is for it from major developing countries.
  • On adaptation, there is relatively clean text. But some countries (including Saudi Arabia) want adaptation to be linked to ‘response measures’, which essentially means that as well as assisting countries with adapting to the effects of climate change, oil exporting countries would somehow be compensated for lost fossil fuel revenue.
  • On finance, a major point of debate has been the establishment of a fund, that was called for as part of the Copenhagen Accord. Some countries wanted it established at Cancún, but others argue that time will be needed to set it up and that it should instead be set up in the period between Cancún and the negotiations next year in Durban, South Africa. Areas of discussion include the transitional committee to set it up, the operating entity of the fund, and its relationship to the World Bank. Australia’s Minister Combet has been involved with consultations on finance.
  • On technology, there is clean text, but the United States is likely to block progress if they do not see progress on other issues.
  • The text on REDD+ is largely complete, with most of the remaining areas of disagreement (mainly on the role of market mechanisms) expressed as clear options.

The Mexican Foreign minister, Patricia Espinosa, stated on Wednesday December 8 that an ambitious and broad package of decisions is within reach but we no not have it in our grasp. We are now in the final stage of negotiations, where the final political issues need to be resolved, and negotiators may not get much sleep. If nearly 200 countries can come up with an ambitious and broad package of decisions, it will be a major success in diplomacy that could rejuvenate the UN process.

The next UN climate conference, the 16th Conference of Parties to the UNFCCC, will commence on November 29 in Cancun, Mexico. ClimateDilemma will be attending these talks, will blog about what is going on, and also provide more up-to-minute updates via Twitter.

The stage was set at some negotiations earlier this year in Tianjin, China. It is unlikely that there will be anything like a comprehensive legally binding climate protocol emerge from Cancun, so the focus instead is on a “balanced set of decisions” on issues such as finance, adaptation, reducing emissions from deforestation and forest degradation in developing countries, technology, and possibly measurement, reporting and verification (transparency). The key stumbling block is agreement between the US and China on these issues. These difficulties were illustrated when in response to a speech by US Special Envoy on Climate Change Todd Stern, Chinese negotiator Su Wei referred to the US as what has been translated as a “pig preening itself in a mirror“.

As has been pointed out by Angel Hsu from Yale, this reference is to the character Zhu Ba Jie, from the Chinese novel Journey to the West. A well known television adaptation in some western countries is the show Monkey, a dubbed version of a Japanese television series. This will be particularly well known to Australians who grew up in the 1980’s (such as myself), when the show was very popular. In Monkey, Zhu Ba Jie is known as “Pigsy”.

Pigsy

Pigsy, portayed by Toshiyuki Nishida, from the opening credits for "Monkey"

Todd Stern’s speech made a number of salient points about the negotiations, but downplayed the problem of lack of US domestic progress. Lack of domestic progress is a major issue – the World Resources Institute has done a study investigating how much state-based approaches and regulation could reduce emissions without national legislation, and their most ambitious scenario has emissions lowered by 12 percent, which falls short of the 17 percent commitment. Stern also summarised the US negotiating position which is to not support action on “financing, technology, adaptation and forests” unless there is progress on mitigation and transparency.

Todd Stern made several comments that relate to China:

  • He stated that “you cannot build a system premised on the notion that China should be treated the same as Chad” and made some comments on China’s emission statistics;
  • He pointed out the “political reality” that it would be impossible to get support from US congress for an agreement that required action from the US but not from China and emerging markets;
  • He stated that in Tianjin, “Chinese negotiators have acted almost as though the Accord never happened, insisting on legally binding commitments for developed countries and purely voluntary actions for even the emerging markets”. He also stated that Chinese negotiators have merely listed their targets as a “fyi”, with “no political commitment to implement them”.

Stern’s statement that China should not be treated the same as Chad does bring up an important point about the way developed and developing countries are divided up in the Kyoto Protocol. The developed countries are specified as “Annex I Parties” which includes relatively poor countries such as Turkey, but does not include very rich countries including Qatar and the United Arab Emirates. It also does a mediocre job of distinguishing between different levels of per-capita emissions – Australia and the US have far higher per-capita emissions than France, and the highest per-capita emitter, Qatar, is not an Annex I country. The Kyoto Protocol has no mechanism non-Annex I countries to automatically become Annex I countries.

But the key issue is not so much whether emission reduction commitments are legally binding, it is whether countries will meet those commitments. Stern points this out in his speech, and so it is curious that Stern attaches so much attention to the legal status of China’s commitments. China is quick to point out that their targets are not legally binding, and stated in their Copenhagen Accord submission that “please note that the above-mentioned autonomous domestic mitigation actions are voluntary in nature”. China is perhaps more likely to meet its target than the US, and China has been implementing measures such as blackouts and slashing steel production in order to meet its domestic energy intensity target. So Stern’s statement that “Chinese negotiators have acted as though the Accord never happened” is not very fair. The other key issue is the ambition of the commitments themselves – an international agreement must be designed in such a way that the ambition of commitments can be readily ramped up – Kyoto has failed to do this, with countries preferring to take on weak targets and sell “hot air” (when countries – such as Russia – get allocated emission targets that are greater than business as usual emissions).

The largest barrier is Congress, in particular the US Senate. Ratifying a treaty requires 67 out of 100 votes, and even getting the Senate to vote on legislation requires 60. The US failed to pass climate legislation last year because it couldn’t get 60 votes in the Senate. If any institution was to resemble Pigsy, it would be the US Senate. But there have been failure at the White House as well: it made major strategic blunders when climate legislation was before the Senate; and failed spectacularly when it comes to framing and messaging, including on climate change. Congress is difficult because the Republicans are taking an extremist denialist position, but this could be politically damaging to the Republicans and untenable if the White House and/or the Democrats put pressure on the Republicans over climate change and framed the issue to be one of Republican obstruction, instead of one of “Democrats seeking bipartisanship”.

Issues with Congress and the strategic US-China relationship mean that there is little prospect for a fair legally binding and ambitious ‘top-down’ agreement in the near future, and that probably means the next decade. Since Copenhagen, the challenge is to ramp up emission reductions in a ‘bottom-up’ world, and turn political commitments into political action. We know from implementation theory and literature on private provision of public goods that if countries can commit to increase their reductions if others do the same, then a situation that is previously a “prisoner’s dilemma” becomes transformed into a situation where there is likely to be a cooperative outcome. Furthermore, if there is an expectation that there will be a legally binding agreement in the future that is fair, high per-capita emitters will have a strong incentive now to start reducing their emissions.

Progress in Cancún on transparency, financing, technology, adaptation and forests could ultimately facilitate cooperation on mitigation. One reason for optimism is that developing countries including India have made concrete proposals on measurement, reporting and verification (i.e. transparency), so the key reason for obstruction from the US may be resolved. But anything can happen in these negotiations, so only time will tell.

Much of the debate on carbon pricing mechanisms is on whether to go with a carbon tax (a price based approach), or with cap-and-trade (a quantity based approach). It should not be forgotten than any carbon pricing instrument is far better than having no carbon price at all. Often debates on carbon pricing instruments ignore various hybrid approaches that incorporate mechanisms such as price ceilings (a maximum carbon price), price floors (a minimum carbon price), and allowance reserves – which we will discuss here in more detail. It is disappointing that hybrid approaches sometimes get ignored, because the economics of uncertainty suggests that these approaches are superior in the sense of having the lowest expected costs. But governments may have other policy objectives than minimising costs in the presence of uncertainty, and hybrid approaches can be useful for these as well. Because of this, hybrid approaches to carbon pricing could lead to the consensus required to introduce a carbon price into Australia.

An allowance reserve is a little bit like a price ceiling. When an emissions trading scheme has a price ceiling, the government makes a commitment to sell an unlimited amount of extra permits at the ceiling price. With an allowance reserve, there are two differences: the amount of extra permits is limited; instead of selling them at a fixed ‘ceiling’ price, they are auctioned at a reserve price. An allowance reserve provides some price stability, but unlike a price ceiling, the total amount of emissions is also capped.

In Australia, a proposed emissions trading scheme (the Carbon Pollution Reduction Scheme or CPRS) failed to pass through parliament because the Liberal Party got taken over by deniers of climate change; but also failed to get the support of the Greens because the targets were too weak, and there were concerns that it risks ‘locking in’ weak targets. An issue with the CPRS is that it would have risked locking in a weak target range for too long – maybe 5-10 years but possibly longer. But there was some sort of administrative review mechanism in around 2013 or 2014, and including some sort of review mechanism is a useful part of any solution. But the main way to get a carbon price to work effectively is through having it send a strong long term price signal to investors in long-lived assets such as buildings and power plants. This is why there is resistance to setting targets for a shorter period of time.Since the August 2010 election, the support of the Greens will be required to introduce a carbon price. The two most difficult issues are the targets themselves, and what to do about the process for setting targets.

In January 2010, the Greens proposed an interim carbon tax for Australia. The idea being to introduce a carbon tax (or fixed-price ETS) and transition to an ETS with targets decided at a later date. But when the interim target is in place, how do you provide a long-term carbon price signal? This is important because assets such as power stations and buildings are very long-lived, so the future carbon price is what drives investment decisions. A solution is that after transitioning to an ETS with a cap on emissions, it should maintain a price floor. If the price floor is the same as the level of the carbon tax, and it steadily increases by some percentage above the rate of inflation, there will still be a strong long term price signal.

Introducing a fixed price beforehand will help, but there is no doubt that the issue of targets will be difficult even if a interim fixed price is introduced. One approach that could make this less difficult is to use an allowance reserve.  Consider the following approach: the amount of ‘normal’ permits (which are auctioned with a reserve price that is the same as the floor price, e.g. $20) adds up to enough emissions for a 25 percent reduction by 2020. But there is an allowance reserve auctioned at a reserve price of $40, and if all of them are auctioned that adds up to a 5 percent reduction by 2020. The Greens are happy, because if the carbon price is $40 or less, emissions will be less that the weak 5 percent target; and if the carbon price is less than $20, emissions will be less than 25 percent below 2020. The Government is happy, because they get to keep their targets, but gain some environmental credibility. Investors are happy, because they have long-term information about the carbon price.

If you wanted, you could have more than one allowance reserve. For example, you could have normal permits that add up to a 40 percent reduction; Allowance Reserve 1, that is priced higher than the normal permits and goes up to a 25 percent reduction; and Allowance Reserve 2, that has an even higher reserve price, and takes you up to a 5 percent reduction.

By going beyond the “carbon tax vs ETS” paradigm and thinking creatively, it may be possible to forge enough of a consensus to introduce a carbon price to Australia. Hybrid approaches to carbon pricing not only are advantageous in terms of the economics of uncertainty; they also provide us with new approaches for dealing with political realities.

An earlier version of this post appeared as a comment responding to Tim Hollo’s blog post ‘Is an ETS automatically more ambitious than a tax?’ at Crikey’s Rooted blog.

The absence of a comprehensive legally binding global deal has sometimes been used as an excuse for lack of policy action. Australia’s conservative opposition leader Tony Abbott claimed that the outcome at Copenhagen “vindicated his party’s decision not to support the Federal Government’s emissions trading scheme legislation”; the absence of an international deal was also an excuse when Australia’s former Prime Minister Kevin Rudd abandoned a proposed emissions trading scheme. But how much does slow international progress really matter?

In a report for the World Bank and a journal article, political scientist and Nobel Economics Prize winner Elinor Ostrom has argued that we should not wait for a ‘global solution’ to emerge from international negotiations before acting on climate change. Instead, action on climate change should occur at all scales. These include individual, community, municipal, regional, and national scales as well as the international scale.

Ostrom argues for a polycentric approach for several reasons:

  1. There is evidence that people are more likely to be cooperative than predicted by conventional game theory. People are in particular more likely to be cooperative when they trust each other to be reciprocators. For this reason, it is possible to have cooperative action without negotiating a ‘global solution’.
  2. Action on climate change can also lead to positive externalities such as clean air. Clean air is particularly relevant to China, where air pollution is a major problem.
  3. At any scale, policies may encounter errors, but without trial and error, learning cannot occur. A polycentric approach facilitates learning at multiple scales.

What implications does this have for critical areas of climate policy, such as technology and carbon pricing? Policies such as research and development, as well as investment in renewable energy, all help to drive down mitigation costs. Like clean air, this is a positive externality that we need more of.

Two major issues when trying to negotiate an international climate agreement are participation and compliance. This is one reason why legally binding agreements are desirable, but designing a treaty to maximize participation and compliance is difficult. When a country makes a commitment to reduce its emissions, how do we know it will meet this commitment? Action at multiple scales means that meeting such a commitment is much more likely. If a country introduces an emissions trading scheme, it will then be highly likely that it meets the target specified by the scheme. But in the United States, the national government did not successfully pass legislation. Fortunately there are regional measures in the United States that are reducing emissions: the Regional Greenhouse Gas Initiative is an emissions trading scheme that operates in ten states; eleven states and provinces in the US and Canada are developing the Western Climate Initiative; and seven states and provinces in the US and Canada are developing the Midwestern Greenhouse Gas Accord. These approaches make it easier for the United States to argue that it will reduce emissions by 17 percent by 2020.

Because domestic policies and measures add credibility to countries’ targets, a climate agreement with a mechanism for countries to list their policies and measures as well as targets is more likely to be successful. The Copenhagen Accord had annexes for developed countries to specify their targets and developing countries to specify policies and measures. It would make sense for climate agreements to have developed countries specify policies and measures as well.

The good news is that action on climate change is occurring at multiple scales. If Ostrom is right, there are reasons to be optimistic about the prospects for long-term cooperation. But there still are advantages to more agreement at an international level, including less excuses for inaction from politicians.

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