A joint working paper that I have written with Dr Frank Jotzo on Price Floors for Emissions Trading is on the Environmental Economics Research Hub website.
See also:
October 27, 2009
Price Floors Paper
Posted by Peter Wood under Carbon Price Signals | Tags: emissions trading, price ceiling, price floors, Waxman-Markey |Leave a Comment
October 26, 2009
Liberals want to lock in insufficient targets for 20 years
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas, Politics | Tags: Carbon Pollution Reduction Scheme, gateways, legal architecture, schedules, scheme caps |Leave a Comment
The Australian government is presently negotiating with the Liberal Party amendments to its proposed Carbon Pollution Reduction Scheme. The Age is reporting that one of the proposed amendments is to extend the period of specific caps on emissions from 5 years to 10 years, followed by a further 10 years of upper and lower bounds for Australia’s target (gateways). At present the governments policy is for 5 years of caps, followed by 5 years of gateways, but the legislation allows the government to set the gateways for as long as they want.
At present, for political reasons most countries are proposing emission reduction targets for the next ten years that are significantly weaker that what the science is suggesting. This will result in countries having to make very steep emission reductions after 2020, or the more likely outcome of dangerous greenhouse gas concentrations. For this reason the next round of commitments for industrialised countries should be for the 5 year period 2013-2017 rather than the 8 year period 2013-2020. There should also be a mechanism where countries can increase the ambition of their targets without having to renegotiate and re-ratify an international agreement.
It is Climate Dilemma’s understanding that Australia would prefer a shorter commitment period for industrialised countries after 2012. Australia is also proposing a mechanism for increasing emission reduction commitments as part of its “schedules” approach to the legal architecture for a post-2012 agreement. The coalition’s proposal to lock in targets for 10-20 years would not be compatible with a shorter commitment period. It would be a serious barrier to Australia increasing its own mitigation ambition. This proposal will undermine Australia’s international negotiating position.
Update: Peter Wood has an opinion piece on this in The Canberra Times, October 28, 2009, Page 11.
October 12, 2009
Kerry-Boxer bill more likely to be passed
Posted by Peter Wood under Politics | Tags: John Kerry, Kerry-Boxer, Lindsey Graham |Leave a Comment
For the Kerry-Boxer bill (the US Senate emissions trading legislation) to be passed, it will require 60 out of 100 votes in order to avoid a filibuster. This will be difficult. Passage of the bill has become significantly more likely due to the support of Republican Senator Lindsey Graham. Graham and Kerry have written an op-ed in the New York Times supporting climate legislation and discussing what is likely to be in it. This is good news, and Senator Graham deserves to be congratulated.
August 26, 2009
Summary of UNFCCC Submissions
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas | Tags: COP15, Kyoto Protocol, UNFCCC, World Resources Institute |Leave a Comment
The United Nations Framework Convention on Climate Change (UNFCCC) negotiations in the lead-up to the December 2009 Copenhagen Summit have been quite complex. There are two streams to these negotiations: the Ad Hoc Working Group on Further Commitments for Annex I Parties under the Kyoto Protocol (AWG-KP) and the Ad Hoc Working Group on Long-term Cooperative Action under the Convention (AWG-LCA).
For those of us who do not have the time to navigate through the different submissions on the UNFCCC website, the World Resources Institute have produced a nice summary (mainly focussed on submissions for the Long-term Cooperative Action negotiating text).
August 10, 2009
Frontier Economics proposed modifications to the CPRS
Posted by Peter Wood under Carbon Price Signals, Politics | Tags: Carbon, Carbon Pollution Reduction Scheme, Frontier Economics, Malcolm Turnbull, Penny Wong |[4] Comments
The Australian opposition and Senator Nick Xenophon have commissioned a report from consultants Frontier Economics on the proposed Carbon Pollution Reduction Scheme (CPRS), and possible modifications. Opposition Leader Malcolm Turnbull has described it as a greener, cheaper, smarter ETS; Minister for Climate Change Penny Wong has stated “It is not a hybrid, it is a mongrel. It is not a credible alternative, it is a smokescreen.”
The main feature of this “intensity based” proposal is that the electricity generation sector is treated in a similar way to “Emissions Intensive Trade Exposed” industries are treated under the CPRS, firms are allocated a large amount of free permits based on their production, so if the amount of the good being produced is reduced, they receive less free permits. Under Frontier Economics’ proposal, electricity generators will receive a large amount of free permits provided that they continue to produce the same amount of electricity.
So if I was to own a brown coal fired power station, I would have less incentive to close it down or generate less electricity, but I would still have an incentive to find ways to make it burn brown coal with less emissions. This will reduce the amount of opportunities to reduce emissions, and increase the cost of reducing emissions. This would increase the carbon price, but Frontier Economics’ modelling assumes that Australia would be part of a well linked global carbon market, and so assumes that the carbon price is completely exogenous. This is why Australia imports more permits from overseas. In practice this would likely mean that we buy more CDM credits, whose additionality properties are questionable.
There is no problem with credible international permits. As far as the earth is concerned, it does not matter where emissions reductions occur. The problem with the Frontier Economics proposal is with why there will be more purchases of international permits. More international permits will be purchased because it will be harder and more expensive to reduce emissions in Australia.
Another problem with shielding the electricity generation sector is that if all countries did this, there will be far less opportunities for emissions reductions, the global carbon price will be much higher, and emissions reductions will be more expensive. Also, by shielding the electricity generation sector, the impact on electricity prices is reduced, dramatically reducing the incentive to reduce electricity usage. The approach in the CPRS to provide payments to households that would offset the effect on prices of the CPRS is much more sensible.
The modelling not only assumes that the carbon price is exogenous, it also assumes that it has no volatility (it increases in real terms by about 4% per year), and there is no uncertainty about what it is. The report therefore has nothing to say about whether an ETS, carbon tax, or hybrid approach (with price ceilings, price floors, or both) is preferable. However, a complex CGE model of the Australian economy is not neccessary to answer this question. The results of Roberts and Spence (1976) and subsequent studies strongly suggests that a hybrid approach with ceilings and floors is the best way of managing this uncertainty.
One more problem with the Frontier Economics report is that it describes its approach to the electricity generation sector as being similar to that proposed in the Waxman-Markey bill that is presently before the US Senate. This is nonsense. Waxman-Markey allocates a large amount of free permits to electricity retailers, who must pass on these benefits to customers, but not in the form of cheaper electricity — payment to customers would not depend on how much electricity they use. The approach of Waxman-Markey is closer to the CPRS, both do not reduce the incentive to decrease electricity usage. The Frontier Economics approach completely distorts this incentive.
Elsewhere: Comments by Ben Eltham at New Matilda, Bernard Keane at Crikey, Robert Merkel at Larvatus Prodeo, Joshua Gans at Core Economics, Andrew Bartlett.
Update: Harry Clarke states “Turnbull’s attempt to give them more to ease electricity prices is not good economics. Make consumers bear the higher prices and give them generalised tax relief. Capture the sought after substitution effects you want but offset the impoverishing income effects.”
Update: Stephen Howes and Frank Jotzo in the Sydney Morning Herald state “Frontier’s modelling fails to establish its claim that it would deliver cheaper mitigation. In fact, it suggests the opposite.”
Frontier’s modelling fails to establish its claim that it would deliver cheaper mitigation. In fact, it suggests the opposite.
August 5, 2009
Treaty Ratification and the US Senate
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas, Politics | Tags: agriculture, game theory, international climate negotiations, subgame perfect equilibrium, US Senate, Waxman-Markey |Leave a Comment
After an international treaty is negotiated, it then has to be ratifed by its participants. This can be modelled as a two stage extensive form game. In Stage 1, the players negotiate the treaty; in Stage 2, each country decides whether to ratify the treaty. For some countries, for example the United States, ratification can be difficult. The United States requires 67 out of 100 Senate votes in order to ratify a treaty.
The most important solution concept for an extensive form game is known as a subgame perfect equilibrium. Each stage of the game is treated as a subgame. The subgame perfect equilibirum is an equilibirum which is also a Nash equilibirum for each subgame.
The main technique for calculating subgame perfect equilibria is known as backwards induction. In this technique the subgame perfect equilibria for the “last” subgames are calculated first. Then taking these actions as given, we calculate the equilibria for preceeding subgames and so on.
By backwards induction, for negotiators in Stage 1 to play the subgame perfect equilibrium, they will take into account that a treaty will have to be sufficiently aligned with the domestic interests of the United States, in order for it to be ratified by the United States. The US Senate has two representatives from each state, so states with low populations (such as those in the midwest) are disproportionately represented. Coal is widely used in the midwest, and agriculture is an important industry. The US Senate is likely to want to see commitments from major developing countries. All of these issues are therefore likely to be important in international negotiations.
The US Senate will most probably consider the Waxman-Markey bill before the negotiations in Copenhagen commence. The Waxman-Markey bill will most likely require 60 out of 100 votes to avoid a filibuster. Issues that will affect the passage of the Waxman-Markey bill through the Senate will also be important for treaty ratification.
June 11, 2009
Pathetically weak target from Japan puts Australian coal exports on the agenda
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas | Tags: Bonn, coal exports, fossil of the day, George W. Aso, Japan, Taro Aso, threat, Yvo de Boer |[4] Comments
The Japanese Prime Minister Taro Aso has announced it’s 2020 greenhouse gas emissions target — “I have decided to aim at a 15 percent reduction from 2005,” Aso told a news conference. This is a reduction of 8 percent compared to the international baseline year of 1990. Japan’s Kyoto target is a reduction of 6 percent compared to 1990 levels over the commitment period 2008-12. Japan’s 2020 target therefore translates to a 2 percent reduction compared to it’s Kyoto target.
When asked about Aso’s target, Yvo do Boer, executive secretary of the UNFCCC said “I think for the first time in two and a half years on this job, I don’t know what to say”. Activists unveiled a giant photo of “George W. Aso” and honoured Japan as “special fossil of the day”.
How should other countries respond to this proposed target? They certainly should not accept it. This suggests that any proposed agreement needs a higher target for Japan, whether it signs on or not. In order for an international environmental agreement to stop climate change from being a prisoner’s dilemma, there needs to be credible punishments for non-compliance or non-participation with an agreement. Japan imports large amounts of coal, both for steel making and electricity generation. Japan is Australia’s largest coal customer; Australia is Japan’s largest coal supplier. In 2007-08, 46 percent of Australian coal exports went to Japan. In 2005, 57 percent of Japanese coal imports were from Australia. The emissions from a years worth of Australian coal exports to Japan would be equal to roughly 290 million tons of carbon dioxide.
If Australia wants to do something constructive about Japan’s weak target, Australia should either levy a carbon tax on coal exports to Japan, or stop exporting coal to Japan. The other main exporters of coal to Japan are Indonesia and China. If Australia could get these countries to do the same thing, that would be a powerful incentive for Japan to get its act together. Australia may not have to actually do this, the threat to do so, if it is credible, could be enough.
Coal and Safety, no. 28, March 2006
June 6, 2009
Waxman-Markey has a price floor
Posted by Peter Wood under Carbon Price Signals | Tags: price floor, Waxman-Markey |Leave a Comment
The American Clean Energy and Security Act, also known as the Waxman-Markey bill, has a reserve price for permits that are auctioned. This functions as a type of price floor. It is not a strict price floor, because there is nothing preventing the market price for permits from getting lower than than the auction reserve price. Also, only something like 15% of permits will initially be auctioned [Actually significantly more than 15% of permits are likely to be auctioned, because entities that are allocated permits for free have the option of having them auctioned by the Administrator. However, firms may buy international permits from other qualifying cap and trade schemes, which could drive the US market price to less than the reserve price.]
This is what the bill has to say:
Section 791 (d) RESERVE AUCTION PRICE.—The minimum reserve auction price shall be $10 for auctions occurring in 2012. The minimum reserve price for auctions occurring in years after 2012 shall be the minimum reserve auction price for the previous year increased by 5 percent plus the rate of inflation (as measured by the Consumer Price Index for all urban consumers).
The fact that the reserve price increases by 5% above the CPI is very important. This sends a strong long term signal to investors. People will think twice about investing in new coal plants when they know that the carbon price will be at least $39 in 2040, $63 in 2050, and $100 in 2060. If the initial price was higher (say $20 or $50), there would be an even stronger signal. A higher floor price would also send a stronger signal to developing countries that the US is prepared to play its fair share in reducing global emissions.
May 19, 2009
Paul Krugman discusses the Waxman-Markey legislation
Posted by Peter Wood under Carbon Price Signals, International Cooperation and Prisoner's Dilemmas, Politics, Uncertainty, Probability and Risk | Tags: carbon tax, emissions trading, Paul Krugman, price floor, stock externalities, Waxman-Markey |[3] Comments
In a New York Times column, Nobel prize winning economist Paul Krugman has written some commentary on the Waxman-Markey legislation that proposes to introduce an emissions trading scheme in the United States. It is well worth reading. In his column, when Krugman discusses some of the objections to the scheme, he states:
One objection — the claim that carbon taxes are better than cap and trade — is, in my view, just wrong. In principle, emission taxes and tradable emission permits are equally effective at limiting pollution. In practice, cap and trade has some major advantages, especially for achieving effective international cooperation.
Not to put too fine a point on it, think about how hard it would be to verify whether China was really implementing a promise to tax carbon emissions, as opposed to letting factory owners with the right connections off the hook. By contrast, it would be fairly easy to determine whether China was holding its total emissions below agreed-upon levels.
I agree with Krugman that cap and trade has major advantages in terms of achieving international cooperation. This is the main reason why I support cap and trade. However, because carbon dioxide is more or less a stock pollutant, it has been argued that setting a price by introducing a carbon tax will be more likely to reduce emissions by an appropriate amount. I therefore disagree with Krugman that setting a tax is equivalent in principle to having tradable permits, because of uncertainty.
A cap and trade system with a price floor has the same advantages to emissions trading when it comes to international cooperation; it also has the same advantages of carbon taxation (and is probably superior to carbon taxation) when it comes to managing uncertainty. Unfortunately,it is very to find a serious discussion about price floors in the peer-reviewed economic literature since 1976 (but Roberts, M. J., Spence, M., 1976, ‘Effluent Charges and Licenses under Uncertainty’ is well worth reading). Most of the discussion on hybrids between cap-and-trade and carbon taxes has been about schemes with price ceilings.
See also:
Update: The Waxman-Markey bill does in fact have a price floor.
May 17, 2009
The next iteration of the CPRS legislation
Posted by Peter Wood under Carbon Price Signals, Politics | Tags: Carbon Pollution Reduction Scheme |Leave a Comment
The Carbon Pollution Reduction Scheme legislation was introduced into Parliament on Thursday May 14, 2009. This legislation includes new measures that were announced on May 4, which includes a delay of a year before firms must purchase permits. Below are some of the changes to the bill compared to the Exposure Draft Legislation.
The object of the act has been changed, with the addition of 4(a) to Section 3 of the legislation:
(4) The third object of this Act is: (a) if Australia is a party to a comprehensive international agreement that is capable of stabilising atmospheric concentrations of greenhouse gases at around 450 parts per million of carbon dioxide equivalence or lower—to take action directed towards meeting Australia’s target of reducing net greenhouse gas emissions to 25% below 2000 levels by 2020;
The government’s has announced policies (not in the bill) for what it would expect of developing and developed countries before agreeing to a 25% reduction:
The Government will adopt a 25 per cent target only as part of an ambitious international agreement involving comprehensive global action capable of stabilising greenhouse gases in the atmosphere at 450 ppm CO2-e or lower. Such a comprehensive and ambitious agreement must meet following conditions:
1. comprehensive coverage of gases, sources and sectors, with inclusion of forests (e.g. Reducing Emissions from Deforestation and forest Degradation – REDD) and the land sector (including soil carbon initiatives (e.g. bio char) if scientifically demonstrated) in the agreement;
2. a clear global trajectory, where the sum of all economies’ commitments is consistent with 450 ppm CO2-e or lower, and with a nominated early deadline year for peak global emissions no later than 2020;
3. advanced economy reductions, in aggregate, of at least 25 per cent below 1990 levels by 2020;
4. major developing economy commitments to slow growth and then reduce their absolute level of emissions over time, with a collective reduction of at least 20 per cent below business-as-usual by 2020 and a nominated peak year for individual major developing economies;
5. global action which mobilises greater financial resources, including from major developing economies, and results in fully functional global carbon markets.
There has also been a very minor modification to the sections of the legislation that deal with scheme caps and gateways (which describe how Australia will set its trajectory), with the addition of sub-sections 14 (7) (relating to the caps) and 15 (6) (relating to the gateways):
14 (7) If: (a) regulations are made for the purposes of this section; and (b) on a particular day (the tabling day), a copy of the regulations is tabled before a House of the Parliament under section 38 of the Legislative Instruments Act 2003; then, on or as soon as practicable after the tabling day, the Minister must cause to be tabled before that House a written statement setting out the Minister’s reasons for making the recommendation to the Governor-General about those regulations.
Subs-section 15 (6) is identical to 14 (7) except that it applies to a different section of the legislation. This changes are extremely minor and do not address the serious problems with this aspect of the legislation that I have raised before.
The most significant changes to the legislation relate to how the price cap (fixed price permits) will work, which is in Section 89 of the legislation. In the first year of operation, 2011-2012, the price of carbon will be set at $10 per tonne CO2-e — in this year the CPRS will function like a carbon tax; between 2012-2013 and 2015-2016, the government will issue fixed price permits that will initially be at $40, and increase by 5% above the CPI in subsequent years. As well as everything being shifted back by a year, the method in which the fixed price permits is set is slightly different. Previously, the price was set precisely in the legislation, and increased by 7.5% each year.
May 7, 2009
Fairness and the Ultimatum Game
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas | Tags: fairness, reciprocity, subgame perfect equilibrium, ultimatum game |[2] Comments
In the ultimatum game, there are two players and a sum of money. The first player proposes how to divide up the sum of money, and the second player chooses whether to accept or reject the proposal. If the second player rejects the proposal, neither player receives anything. This game has a unique subgame perfect equilibrium where the first player receives all of the money, or almost all of the money when payoffs are discrete.
Experiments where people have played the ultimatum game have consistently found that the first player will usually offer significantly more money to the other player than the subgame perfect equilibrium, and the second player will be unlikely to accept the offer if they are offered less than 30% of the total amount.[1]
It has been argued by Fehr and Gächter that the ultimatum game provides evidence that economic agents don’t just base their decisions on pure self interest, and reciprocal considerations play an important role in people’s actions. It has been argued by Barrett that the ultimatum game also provides evidence that an international environmental agreement is more likely to be self-reinforcing if it is perceived by its parties to be fair. [2]
[1] Güth et al. (1982), An Experimental Analysis of Ultimatum Bargaining, Journal of Economic Behavior and Organization, 3, pp. 367-388
[2] Fehr and Gächter (2000), Fairness and Retaliation: The Economics of Reciprocity, The Journal of Economic Perspectives, 14 (3), pp. 159-181; Barrett (2003), Environment and Statecraft – The Strategy of Environmental Treaty-Making, pp. 299-301.
May 4, 2009
Changes to CPRS legislation
Posted by Peter Wood under Carbon Price Signals, International Cooperation and Prisoner's Dilemmas, Politics | Tags: 2020 target, Carbon Pollution Reduction Scheme, inter, international climate negotiations, international emission allcoations, price floor, scheme caps, scheme gateways |1 Comment
Australia’s Prime Minister, Kevin Rudd, has announced some changes to the proposed carbon pollution reduction scheme legislation. In short, this is what is being proposed:
- The scheme will be delayed until July 2011;
- In 2011-2012 the carbon price will be set at $10/tonne and there will be an unlimited amount of permits;
- Emissions trading will be begin proper in July 2012 — I don’t know if there will be any price caps or floors after July 2012.
- There will be “recession buffer” where industries eligible for assistance at the 60% rate “would receive a 10% buffer for a finite period”, while those eligible at the 90% rate “will receive a 5% buffer for finite period”.
- The 5%-15% target reduction range will be kept unless an agreement consistent with 450ppm CO2-e is agreed to, in which case Australia will agree with a 25% reduction on 2000 levels.
- Some token measures that enable households to buy and cancel permits — something that they probably would be able to do anyway.
Some of the fine print on how the targets will work is here.
I’ll reserve my final opinion until I see whet the new legislation looks like next week, but it does seem like overall it is a slight improvement. There is stuff in the scheme that is unfortunate, such as the delay, the $10 carbon price in 2011-12, and the extra 5-10% free permits to emissions intensive industries. But the targets for 2010-11 and 2011-12 in the White Paper were so weak that I wouldn’t have been surprised if the carbon price was less that $10 in those years anyway. The 5-10% extra free permits to emissions intensive industries won’t affect the overall target, but is an equity issue and a waste of taxpayers money.
In my opinion the conditional target is more important than the unconditional target, because that is what makes the most of a difference for international cooperation. The willingness to go beyond 15% emission reductions is very good news, the government has partially fixed what was the worst problem with the CPRS. Unfortunately a 25% reduction for Australia would only consistent with 450 ppm CO2-e that was very generous to Australia, and unlikely to be acceptable to developing countries, low per-capita emitters, and countries responsible for low amounts of historical emissions — in other words Australia would be getting a “special deal”, which is similar to free-riding. What Australia should be doing is be willing to accept a reduction of at least 25% by 2020 as part of an agreement consistent with a stabilisation target of 450 ppm CO2-e or less.
One way to respond to this development would be to put on the table proposals that have not been on the agenda so far. A steadily increasing price floor should be at the top of the list, as should be overhauling the scheme caps and gateways approach for setting the target (too inflexible), and the ability of firms to buy an unlimited amount of CDM credits (which have additionality problems). Only a steadily increasing price floor will drive the investment in renewable technologies that we need.
On whether the legislation should be passed, I would be very reluctant to pass it unless something was done about the scheme caps and gateways approach to setting the trajectory. The problem with the gateway approach is that the minister can set lower (and upper) bounds on Australia’s emissions forever. It is not appropriate for the minister to set any lower bound for emissions, let alone forever.
April 30, 2009
The Coming Climate Crunch
Posted by Peter Wood under Climate Science | Tags: Nature journal, The Coming Climate Crunch |Leave a Comment
The scientific journal Nature has released a special issue on climate change – The Coming Climate Crunch. It has a good editorial, and some important papers. According to the editorial:
Nations urgently need to cut their output of carbon dioxide. The difficulty of that task is manifest: emissions have continued to rise despite almost two decades of rhetoric, diplomacy and action on the matter. But that unhappy fact should not be taken as a licence for fatalism. Governments have a wide range of pollution-cutting tools at their command, most notably tradable permit regimes, taxes on fuels, regulations on power generation and energy efficiency, and subsidies for renewable energy and improved technologies. These tools can work if applied seriously — so citizens around the world must demand that seriousness from their leaders, both within their individual nations and in the international framework that will be discussed at the United Nations Climate Change Conference in Copenhagen this December.
There is also a good blog post at RealClimate about the issue, which states:
At the heart of it are the two papers which calculate the odds of exceeding a predefined threshold of 2°C as a function of CO2 emissions. Both find that the most directly relevant quantity is the total amount of CO2 ultimately released, rather than a target atmospheric CO2 concentration or emission rate.
April 23, 2009
Submission to the Senate Select Committee on Climate Policy
Posted by Peter Wood under Carbon Price Signals, International Cooperation and Prisoner's Dilemmas, Politics, Uncertainty, Probability and Risk | Tags: Australian Senate, Carbon Pollution Reduction Scheme, carbon tax, emissions trading, Scheme Cap, scheme caps, scheme gateways |Leave a Comment
My submission to the Senate Select Committee on Climate Policy is here. Here is the abstract:
This submission is on the Australian Government’s Exposure Draft Legislation for the implementation the Carbon Pollution Reduction Scheme (CPRS), and Australia’s climate policy in general.
This submission is primarily concerned with two issues. Firstly we shall look at the issue of achieving international cooperation to reduce greenhouse gas emissions. We shall examine how this relates to the targets in the CPRS, and the approach for choosing targets, based on “scheme caps and gateways”. This relates to items (1) (c) and (1) (d) of the terms of reference.
Secondly we examine the issue of what is the best instrument for a carbon price signal. We conclude that an emission trading scheme with a “price floor” is the most appropriate policy for Australia. This relates to items (1) (a) and (1) (d) of the terms of reference.
Summary of Recommendations
We have two key recommendations.
- To not set a lower bound for Australia’s emissions after 2015. We therefore recommend the removal of paragraphs 2(b) and 3(b) from Section 15 of the Exposure Draft Legislation.
- To introduce a floor in the carbon price. The price floor could be implemented by either altering Section 129 of the Exposure Draft Legislation, or by altering Section 103 of the Exposure Draft Legislation.
April 14, 2009
How the CPRS could be modified to have a price floor
Posted by Peter Wood under Carbon Price Signals, Politics, Uncertainty, Probability and Risk | Tags: Carbon Pollution Reduction Scheme, carbon tax, emissions trading |[3] Comments
The proposed Australian Carbon Pollution Reduction Scheme is a policy that seeks to reduce greenhouse gas emissions by introducing a price on carbon. Possible policies for carbon pricing include cap and trade schemes, carbon taxes, and hybrid approaches. Cap and trade schemes involve setting the quantity of emissions, with this quantity and the market determining the carbon price; carbon taxes involve setting the carbon price directly, with the market determining the amount of emissions. Hybrid approaches can usually be thought of as cap and trade schemes but where there is either a minimum price – a price floor, a maximum price – a price ceiling, or both.
The CPRS is a cap and trade scheme, but there is a transitional ceiling on the carbon price (Section 89 of the Exposure Draft Legislation). This ceiling will be phased out by 2015. While this ceiling exists, the emissions cap can always be exceeded by firms buying permits that are at the value of the price ceiling. To this extent the CPRS has similarities to a carbon tax.
One of the main arguments in favour of cap-and-trade is that international negotiations are based on a “target-and-timetables” approach. Emissions trading (on a national scale) has the advantage that there is much more certainty that a given target will be reached. This increases the credibility of targets under international negotiations, more so than a carbon tax.
There are other advantages to a carbon tax. If the cost of mitigation is lower than expected, then there will be more mitigation with a carbon tax. There will be no limit to the amount of low cost mitigation that occurs. Under a carbon tax, voluntary measures that reduce emissions will add to Australia’s total emissions reductions.
A emissions trading scheme with a price floor has many of the advantages of a carbon tax and many of the advantages of a cap and trade scheme.
There are two ways that the CPRS legislation could be modified so that a price floor is introduced:
- The price floor can be maintained by having firms pay an extra fee when they surrender their permits, based on the amount of their emissions. The carbon price then becomes equal to the sum of the permit price and the extra fee. This could be achieved by altering Section 129 of the Exposure Draft Legislation.
- The price floor could be maintained by having a reserve price when permits are auctioned. This could be achieved by altering Section 103 of the Exposure Draft Legislation.
The approaches to introducing a price floor above are different to what was discussed in the Garnaut Review. The Garnaut Review considered and rejected a mechanism for introducing a price floor by having the government buy back permits. The Garnaut Review did not consider the approaches examined above.
If a price floor was introduced, changes may also be needed to be made to the legislation with regard to international trading of permits. If a price floor was introduced, what price should it be set at? There are two possible approaches to this:
- One approach would be to set it so that it is relatively low, but is high enough to mean that the amount of low cost emissions reductions is not limited, and high enough to provide some certainty to investors in low emission technologies. Under this approach, the emissions cap would be expected to be the main policy that drives emissions reductions.
- Another approach would be to have a significantly higher price floor, that is close to the social cost of carbon. Under this approach, the price floor is likely to be what drives emissions reductions. Under this approach the main role of the emissions cap is to provide certainty that a given target will be achieved, and add credibility to international negotiations.
If the role of the floor price was merely to provide insurance against the carbon price being exceptionally low (as was the case in the EU ETS during 2006 and 2007), it would not be necessary – there are better mechanisms from preventing this, such as banking, and making sure that there is scarcity when setting the cap. The idea of setting the floor price to be equal to the social cost of carbon is that the floor price has just as important a role as the permit price in driving emission reductions. There is a good chance that the slope of the marginal cost function of mitigation is higher than the slope of the marginal benefit function over short time scales, which suggests that the floor price will be a better driver of emission reductions.
Another issue with carbon pricing is how much should the price floor increase each year? An appropriate choice may be to have the price indexed by a discount rate of 4%, which is the discount rate used in Treasury modeling.
For more on why we need a price floor, see also:
March 25, 2009
Scheme Caps and Gateways under the CPRS
Posted by Peter Wood under Climate Science, International Cooperation and Prisoner's Dilemmas, Uncertainty, Probability and Risk | Tags: Carb, Carbon Pollution Reduction Scheme, CPRS, gateways, James Hansen, Martin Weitzman, McKinsey Global Institute, scheme caps |[3] Comments
We turn our attention to the issue of scheme caps (Part 2, Section 14 of the Carbon Pollution Reduction Scheme Exposure Draft Legislation) and gateways (Part 2, Section 15 of the Exposure Draft Legislation). The legislation states that the regulations must set a scheme cap for five years or more into the future; and may set a scheme gateway, with upper bounds and lower bounds for the scheme cap for the financial year beginning on July 2015, and any later financial year. This is slightly different to what is stated in the White Paper, which is that “the Government intends to provide up to 10 years of gateways beyond the minimum five years of certain Scheme caps, taking into account progress in international negotiations” (Policy decision 10.3).
There are two issues here. Firstly, are the caps and gateways that are in the government policy (the White Paper) appropriate? Secondly, is the framework for caps and gateways (the Exposure Draft Legislation) appropriate? Let us focus on the second issue.
Suppose for a moment that there was a comprehensive international agreement that not only reduced greenhouse gas emissions, but also reduced emissions in an optimal way. Reducing emissions in an optimal way would take into account the climate science, as well as the costs of mitigation and damages from climate change. The economics of climate change suggests that we should do our best to avoid even a low probability of potentially catastrophic outcomes1. The science, according to the NASA climate change scientist Dr James Hansen, suggests that if we maintain carbon dioxide concentrations of 450 ppm or more, for sufficiently long, the Earth would be pushed toward an “ice-free state”, and “the passing of climate tipping points and dynamic responses that could be out of humanity’s control”. Hansen therefore recommends that “an initial CO2 target of 350 ppm, to be reassessed as effects on ice sheet mass balance are observed, is suggested”2.
What sort of emission reductions are required to stabilise CO2 levels at 350 ppm or less? For any particular target, there is more than one trajectory to that target, and more than one way of allocating emissions between countries for any particular global trajectory. Most studies that have been done so far have focused on higher stabilisation targets, but there have been some that have included trajectories that stabilise at 350 ppm CO2. One of the more recent studies has OECD countries reducing their emissions by 5.17% per year3. No one has modelled in any detail (as far as the author is aware) what the mitigation costs of stabilisation at 350 ppm or less of CO2 are. However, there have been studies that suggest that the cost of stabilising at 450-500 ppm CO2-e of greenhouse gases are low.4
If optimal international cooperation on reducing greenhouse gas emissions was achieved, Australia could have reductions in emissions allocations of over 5% per year. This may be expensive, but an approach that is optimal globally is likely to have net benefit for Australia, more so than for most other countries. It would not in in Australia’s interest to rule out such a possibility.5
- what the science is saying about the climate situation,
- Australia’s high per-capita emissions,
- Australia’s high historical emissions,
- and Australia’s high capacity to reduce emissions or pay for emissions reductions because of its high per-capita GDP,
it is not appropriate to rule out any level of emissions reductions beyond 2015, and certainly not for an unlimited amount of years into the future. It is appropriate to have an upper bounds on Australia’s emissions for years beyond 2015, but not lower bounds. Part 2, Section 15 of the Exposure Draft Legislation should therefore be changed to reflect this issue. This could be easily achieved by removing paragraphs 2(b) and 3(b) from Section 15 of the legislation.
There are also problems with setting weak targets five years in advance: The targets for 2010-2013 are extremely weak, with the 2010-2011 target probably being greater than the amount of emissions. When combined with the 5-15% target range, there will probably be a very low carbon price. The only thing that is likely to prevent the price from collapsing is the banking of permits. It could also be argued that flexibility in emissions reductions could facilitate unforeseen international circumstances, either in the science, or in negotiations. Being able to tighten targets within shorter time-spans could also facilitate voluntary measures to reduce emissions. It is therefore recommended that Section 14 of the legislation is changed so that instead of an exact cap being set for five years, a gateway of upper and lower bounds is set for five years.
It could be argued that measures that reduce the certainty of the scheme cap provide uncertainty for investors. This is true in a limited sense, but there is also severe risk and downside uncertainty on impacts from climate change, there are uncertainties in the damage function. There is uncertainty in international negotiations. There are uncertainties in what carbon price will be required to achieve a certain level of emission reductions. There are uncertainties in the costs of emission reductions. There is uncertainty in whether the targets specified by the Australian government will be sufficient to drive sufficient to drive investment in low emission technologies. Some of these uncertainties could be managed by price based approaches, such as by having a floor on the permit price.
Measures that shift risk and uncertainty from investors to the climate are not appropriate any more, and may not be credible. This is particularly the case when it comes to measures that are not consistent with international cooperation on reducing emissions. This is because a world with poor cooperation on climate change policy is a far more uncertain world than a world where good cooperation is achieved.
1Weitzman (2009), On Modeling and Interpreting the Economics of Catastrophic Climate Change, The Review of Economics and Statistics, 91(1): pp. 1—19.
2Hansen et. al. (2008), Target CO2: Where Should Humanity Aim? The Open Atmospheric Science Journal, 2, pp. 217—231.
3Meinshausen (2006), Multi-gas Emissions Pathways to Meet Climate Targets, Climatic Change, 75, pp. 151—194 — p. 166.
4McKinsey Global Institute (June 2008), The carbon productivity challenge: curbing climate change and sustaining economic growth
5There are huge barriers to this level of international cooperation, but it is not unheard of. The Montreal Protocol on Substances That Deplete the Ozone Layer achieved a level of cooperation that was not far from optimal, this is discussed in Barrett (2003), Chapter 8.
March 24, 2009
Why Australia’s 15% conditional target undermines cooperation
Posted by Peter Wood under International Cooperation and Prisoner's Dilemmas, Uncertainty, Probability and Risk | Tags: 15% conditional target, Carbon Pollution Reduction Scheme, contraction and convergence, CPRS, CPRS White Paper, Garnaut, international environmental agreements, international negotiations, targets and trajectories, Treasury modeling |1 Comment
The Carbon Pollution Reduction Scheme is likely to rule out net emissions reductions of more than 15% of 2000 levels by 2020 (Part 1, Section 3 (4) of the Exposure Draft Legislation). This reduces the likelihood of any international agreement that stabilises greenhouse gas levels at 550 parts per million or less, because it rules out Australia playing its proportionate part in emissions reductions.
It has been suggested in the Treasury modeling that the 15% target is consistent with global stabilisation of greenhouse gases at 510 ppm, but this is unlikely to be true. This modeling claims that the CPRS -5 and CPRS -15 “multi-stage” scenarios are more realistic than the Garnaut “contraction and convergence” scenarios because the multi-stage scenarios assume that different countries start taking on emissions reductions at different times1. But there is another difference, the CPRS scenarios assume that when a group of countries start making emission reductions, they all do so at the same rate relative to the reference scenario. Because emission reductions do not relate to per-capita emissions, this is unlikely to be perceived as equitable by developing countries and low per-capita emitters, and therefore unlikely to be an approach that would be accepted by developing countries.
The Garnaut scenarios are based on all countries eventually converging to the same per-capita emissions allocations in 2050. After 2050 different countries may have different gross amounts of per-capita emissions, but they are allocated the same number of permits per person. Is a convergence date of 2050 likely to be acceptable as part of an international agreement? In his Targets and Trajectories Supplementary Draft Report, Garnaut stated
A relatively gradual convergence to equal per capita allocations, with the year 2050 proposed by the Review, could be seen in developing countries as developed-country-biased, as it perpetuates for some time the current unequal patterns of use of the atmosphere. What is outlined is probably at the limits of acceptability to developing countries—it demands a modest departure from developing countries’ current emissions growth path in the short term, and strong deviations in the medium term.
It is important for Australia to be flexible on issues that relate to equity, including whether an agreement is based on per-capita emissions, and the convergence date for an agreement based on per-capita emissions. This is because it is more likely that a large number of countries will agree to an international environmental agreement if it is perceived to be equitable.3 For Australia, a developing country and a high per-capita emitter, to not be flexible on equity issues that favour high per-capita emitters, would undermine the likelihood of a comprehensive international agreement that reduces greenhouse gas emissions.
There is also the possibility that an international agreement is reached that is not consistent with Australia’s targets. Australia would then have two choices: It could accept the agreement and change its targets; it could not accept the agreement and face the consequences of being perceived to be a free-rider. The CPRS White Paper argues for scheme caps and gateways because they provide certainty to investors4, but they do not provide certainty if there is a risk that Australia will have to change its targets in order for it to participate in an international climate agreement.
Because Australia should be flexible on the issue of contraction and convergence, and the convergence date, international scenarios with an earlier convergence date should be considered. This should include a 2040 convergence date and a 2030 convergence date. Ball-park estimates5 suggest that a convergence date 10 years earlier (i.e. 2040 instead of 2050 or 2030 instead of 2040) would require Australia to have its 2020 emission allocation reduced by 8-16%.
1Treasury (2008), Australia’s Low Pollution Future – The Economics of Climate Change Mitigation, Page xi.
2Garnaut (September 2008), Targets and Trajectories – Supplementary Draft Report, Page 14.
3See Barrett (2003), Environment and Statecraft – The Strategy of Environmental Treaty-Making, pp. 299-301, for a game theoretic discussion on why fairness is perceived to be important by participants in a cooperative outcome.
4Department of Climate Change (December 2008), Carbon Pollution Reduction Scheme – Australia’s Low Pollution Future (White Paper), Chapter 10.
5Wood (September 2008), Submission to the Carbon Pollution Reduction Scheme Green Paper, Page 8.
March 5, 2009
Ten Problems with the Carbon Pollution Reduction Scheme
Posted by Peter Wood under Carbon Price Signals, Politics | Tags: Carbon Pollution Reduction Scheme, CPRS |Leave a Comment
The Carbon Pollution Reduction Scheme (CPRS) is the centre-piece of the Rudd governments climate policy. It aims to reduce Australia’s emissions to between 5 and 15% of 2000 levels by 2020. It involves setting a cap (but not a strict cap) on emissions, and distributing permits that can be traded. Some of these permits will be auctioned, some will be handed out for free. Firms will also be able to purchase an unlimited amount of international permits to meet their obligations. Permits will be treated as property rights, so if Australia wishes to reduce its emissions by more than the specified targets, then firms will have to be compensated.
Unfortunately, because the CPRS wants to provide “certainty for investors”, it locks many of the bad decisions in, making it extremely difficult to improve later. In effect, this shifts risks from investors and firms to the taxpayer, future generations, and the environment. Below are some problems with the CPRS, as described in the White Paper:
- The CPRS pretty much rules out Australia accepting emissions allocations that correspond to reductions in emissions of 15% or more by 2020. This is effectively using “precommitment” to attempt to rule out Australia’s participation in an international agreement that is equitable and comes anywhere near what the science says we need to do (Policy Position 4.2).
- The fact that there is a “gateway”, that rules out net emissions reductions that are greater than a particular level in 10 years after the gateway is set is not appropriate. Given what the science is saying about the emergency that we are in, it is not appropriate to rule out any level of emissions reductions. There are also strong equity arguments for this. Australia’s high historical and per capita emissions, and capacity to invest in reducing emissions are all arguments for allocating low amounts of emission allocations to us. Australia should be flexible when it comes to equity in international negotiations and any form of “gateway” undermines this (Policy Positions 10.1-10.14).
- Land clearing and logging native forests have significant emissions that are not dealt with, but carbon sink forests attract an offset. At relatively low carbon prices, it will be more profitable to manage plantations as carbon sinks than use them for wood. This will increase the demand for native forest timber, increase native forest logging, and increase total emissions (Policy Position 6.22). Because deforestation and native forest logging is not addressed, the CPRS could also promote the burning of native forest biomass (Policy Position 6.14), because emissions from such activities are “zero rated”.
- Emissions permits are treated as a property right, rather than a compliance instrument. This makes it much more difficult to improve the CPRS, because firms will have to be compensated. It is also totally inappropriate for the present government to create property rights that infringe on the rights of future generations (Policy Position 8.1).
- The absence of a price floor means that public goods from activities such as home insulation, developing new technologies, voluntary measures and so on are not realised. Instead more permits are freed up for big emitters. The CPRS should have a price floor, otherwise it would be better to replace it with a tax. The price floor (or tax) should increase each year by a certain amount (e.g. 4%).
- The 5% unconditional target is far too weak (Policy Position 4.2).
- Exact yearly targets are set 5 years in advance and cannot be tightened (Policy Position 4.4). The targets for 2010-2013 are extremely weak, with the 2010-2011 target probably being greater than the amount of emissions (Policy Position 4.5).
- There will be a price cap on permits, so the emissions cap can be exceeded by firms buying more permits at a price of the level of the cap (Policy Positions 8.9—8.12). According to the White Paper:
- The scheme will have a transitional price cap for the period 2010–11 to 2014–15.
- The level of the price cap will rise in real terms by 5% per year.
- The level of the price cap will be set at $40 commencing in 2010-11.
From an environmental perspective, the Carbon Pollution Reduction Scheme has the same disadvantage that a carbon tax has, there is no real cap on emissions. It has none of the advantages that a carbon tax has. The Carbon Pollution Reduction Scheme is not a cap-and-trade scheme, because there is not a strict emissions cap. It is a hybrid between an emissions trading scheme and a carbon tax – but it is not a very good hybrid.
- Much money is being squandered on assistance to emissions intensive industries (EITEs – Chapter 12, coal fired generators – Chapter 13, gassy coal mines). The coverage of assistance to “emissions intensive trade exposed” industries has been expanded to include industries that made the most noise, such as liquefied natural gas. Rentseekers have been rewarded. There will also be $3.9 billion dollars (assuming a $25 carbon price) in free permits handed out to coal-fired electricity generators. This is money that could have been invested in low emission technologies, reducing emissions from deforestation or forest degradation, or assistance to low income households. Instead it does nothing more than line the pockets of shareholders.
- The large amounts of assistance to polluting industries have meant that there much less funding available for compensating households. The distribution of assistance to households is strange, households with incomes of less than $20,000 are given less assistance than households with incomes between $20,000 and $120,000. Newstart recipients will recieve $14.20 more per fortnight; people on the minimum wage will recieve $14.95 more per fortnight.
There are some good things about the design of the CPRS. The coverage is greater than the EU ETS. Less permits are handed out for free than with the EU ETS. If the issues above are addressed, then we will have a well designed emissions trading scheme that could be used to efficiently make deep emissions reductions. If Australia put together some good carbon pricing policies, then these policies could be adopted elsewhere.
Update: The exposure draft legislation Carbon Pollution Reduction Scheme Bill 2009 is now available from the Department of Climate Change website here.
February 25, 2009
Turnbull’s estimate that we can reduce emissions by 150 Mt CO2 through land use is conservative
Posted by Peter Wood under Carbon Price Signals, Politics | Tags: agriculture, deforestation, environmental plantings, land use, logging, Malcolm Turnbull, rangelands |Leave a Comment
When the leader of the Liberal Party, Malcolm Turnbull, announced that the Liberals will go for stronger targets than Labor, he mentioned that 150 Mt of carbon dioxide could be sequestered through land use, including a technology known as biochar. How likely is it that we can do this? Does Malcolm Turnbull have the right policy for achieving this?
It is hard to tell whether Turnbull has the right policies because not much has been revealed about how this will be achieved. One issue with land use emissions and sequestration is that it is hard to measure. For example, to accurately measure carbon in soil, you need to dig a lot of holes. This makes it highly unlikely that soil carbon could credibly be included in an emissions trading scheme. Treating biosequestration as an offset is also problematic. For offsets to be credible, they need to be permanent, measurable, verifiable, and additional. Many emissions associated with land use are not accounted for under the Kyoto Protocol, but are nonetheless very real.
Another problem with the above approaches is that if large amounts of carbon are sequestered, and they contribute to a given total target, then unless the target can be strengthened, the credits could flood the market. This could lead to the emission reductions from fossil fuels that are necessary for decarbonisation not taking place.
We shall now examine how many emissions reductions are possible from different land use areas. These numbers are just estimates, but they allow us tio arrive at a ballpark figure.
Related posts:
* Greenhouse Gas Emissions from Agriculture and Land Use Change
* Green Carbon
|
Estimated potential for sequestering carbon in terrestrial ecosystems |
||
|
Sequestration or emissions reduction activity |
Estimated annual sequestration potential (CO2-e yr-1) |
Notes |
|
End to land clearing |
63 Mt |
Emissions in 2006 from land clearing were 63 Mt CO2-e (using Kyoto accounting). |
|
Protection and regrowth of native forests |
136 Mt plus |
Mackey et al. (2008)1 consider a study area consisting of 14.5 million hectares of native forests in south-eastern Australia. They estimate that it is possible to sequester 7.5 Gt CO2-e in these forests if logging is halted. This is converted into 136 Mt CO2-e per year for 100 years using an equivalence factor derived by Costa and Wilson (2000)2. Scope for considerable more storage with all native forests protected. |
|
Rangelands sequestration |
250 Mt |
Garnaut (2008)3 has an estimate of 250 Mt CO2-e per year for several decades, for “comprehensive restoration of degraded, low-value grazing country in arid Australia”. Garnaut also includes an estimate of a sequestration potential of 286 Mt CO2-e per year in soil for 20-50 years for changed practices to rehabilitate previously degraded rangelands. |
|
Soil carbon – cropped land |
68 Mt |
Garnaut (2008). |
|
Environmental mixed species plantings |
44 – 143 Mt |
Polglase et al. (2008)4 presents three scenarios, each of which has a net annual equivalent return of over $150 per hectare per year for a carbon price of $20 per tonne CO2-e:
|
|
Total |
561—660 Mt |
This estimate is 97—114% of Australia’s 2006 greenhouse gas emissions (576 Mt CO2-e). |
1Mackey et al. (2008), 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, Australian National University, E Press, Canberra.
2Costa and Wilson (2000), An equivalence factor between CO2 avoided emissions and sequestration—description and applications in forestry, Mitigation and Adaptation Strategies for Global Change, 5, pp. 51—60.
3Garnaut (2008), Garnaut Climate Change Review, Table 22.2, pp. 542-543.
4Polglase et al. (2008), Regional Opportunities for Agroforestry Systems in Australia, Rural Industries Research and Development Corporation, Publication No. 08/176, pp. 77—80.
