Archive for July, 2010

A Lost Opportunity?

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The final decision by the United States Senate not to proceed with climate change legislation for now raises the very difficult question as to where the world is going with a market driven / carbon price solution to emissions management. Added to the US decision is the near terminal condition of emissions trading in Australia, with the CPRS on hold at best and the current Federal Opposition, now contesting what looks like a close election, saying that a carbon price will not appear in Australia while they are in office. On top of all this is the legal possibility that the CDM may not function post 2012 if new Annex 1 targets are not agreed.

A market driven approach has been around for a long time now – at least in the context of greenhouse gas emissions it dates back to about 1995 and the early discussions at the UNFCCC. In terms of managing pollutants it of course has its roots in the US SOx and NOx programmes and its origins in economic thinking go back even further. The fundamental reason for wanting to do this is that it offers the most flexible, lowest cost pathway to reducing emissions and in combination with the global financial markets can leverage the huge investments in energy infrastructure and drive them slowly but surely in a new direction. Over time, the underlying carbon price will make its way into the cost of all goods and services globally, which in turn will change demand patterns by favouring lower carbon footprint offerings.

The starting point for current efforts is the Kyoto Protocol. Despite the many rocks that have been thrown at it over the years and the reality that it is no longer fully suitable for a world with rapidly developing economies, it is nevertheless an inspired piece of work. The underlying AAU structure, augmented by the CDM and JI, lays the foundations for a global carbon market built progressively as nations implement domestic legislation, but importantly with a fungible carbon currency. It was principally the United States that advocated such an approach and in the end won the day. The structure itself effectively drives the signatory countries with absolute targets to implement a cap and trade structure at home and encourages those without targets to opportunistically invest in clean energy projects. So in 1997 everybody signed on to this and went off intending to implement such a structure, or so it seemed.

Thirteen years later only the EU has done so, although very recently New Zealand passed cap-and-trade legislation. A number of developing countries have also established the necessary national bureaucracy to implement and manage CDM projects and they have benefited from doing so. Some AAU trades have also been completed between governments in an effort to ensure compliance under the Kyoto Protocol. Global trade in carbon instruments has grown year on year as a result of all this, but the EU and NZ alone cannot effectively support and drive a global market. In any case, even if they did it would not be a market of sufficient size to actually address the underlying issue.

If we don’t implement cap-and-trade, the alternative is potentially a long way shy of a true market based approach. It could include all manner of arbitrary policies, patched together in an effort to cover all the main bases but at the same time possibly missing many of the much easier abatement opportunities that a market may uncover. It will also be more expensive as governments dip into the abatement curve in an ad-hoc way rather than working methodically from left to right on a lowest cost basis. One thing is clear though – governments the world over will continue to tinker with the energy system in a bid to address all manner of issues, with carbon high on the agenda.

But a shift away from a market based solution is not yet set in stone. Although the rhetoric is “clean energy”, significant political support remains for a “price on carbon”, even though as a policy tool it appears undeliverable in the short to medium term. For example, last week I was at the public day of the Clean Energy Ministerial in Washington  (convened under the auspices of MEF) and every single US speaker from Secretary of Energy Chu to Presidential Science Advisor Holdren and many international speakers gave the good talk on clean energy but made the point of adding “But what we really need is a price on carbon”.

 We are at a crossroads and have a choice. Society can accept the developing clean energy agenda with its higher cost of implementation and potentially disruptive affect on investment or it can again make the case for a carbon price solution to the issues at hand, ideally delivered through a market responsive approach such as an emissions trading system. In the interim we may all have to settle on hybrid models in order to build towards the final goal. But to do nothing but watch will be to accept a pathway forward that is both higher in cost and less flexible to implement, neither of which are attractive for business and consumers.

Climate change continues to appear on the electoral agenda globally, but this November in California it will be front and centre for the state’s voters. AB 32, the landmark emissions reduction legislation of the Schwarzenegger administration is under threat. Specifically, a proposition is now on the November ballot to suspend AB 32 until the economy improves.

Proposition 23: Suspends State laws requiring reduced greenhouse gas emissions that cause global warming, until California’s unemployment rate drops to 5.5 percent or less for four consecutive quarters. Requires State to abandon implementation of comprehensive greenhouse-gas-reduction program that includes increased renewable energy and cleaner fuel requirements, and mandatory emission reporting and fee requirements for major polluters such as power plants and oil refineries, until suspension is lifted.

AB 32 has led the California Air Resources Board (ARB) to develop a consistent statewide master plan to reach the goal of reducing emissions to 1990 levels by 2020 and has given it the authority to implement the necessary regulations to achieve the goal. The proponents of the Proposition seem to believe that the suspension of AB 32 will bring to an end the need for business to respond to such regulation. In fact, suspension may do more harm to business than the perceived benefit of the Proposition. Nature abhors a vacuum and so it seems do California air regulators. In place of AB 32 we may well see numerous state and local agencies, cities and counties turning their individualized attention to greenhouse gas emissions under existing authority.  Rather than  working in coordination with ARB to reach the AB 32 statewide reduction goal as many of these agencies have been, individual agency actions may result in a fragmented array of inconsistent regulations with no defined goal. Business could well find itself in a much more costly command and control environment rather than the more flexible market driven approach being developed by ARB. Local air districts could behave very differently with, say, a facility in Los Angeles facing very different regulations to one in the San Francisco area.

Many businesses are either in the process or on the cusp of new investment to meet the provisions of AB32, particularly the Low Carbon Fuel Standard (LCFS) which has its first compliance period starting only weeks after the November election. Compliance with the LCFS will likely mean changes to the Californian crude oil diet, new bio-fuel production plants and purchase contracts and investment in blending facilities, distribution terminals and gas stations. It also provides direct stimulus for growth in the nascent electric car industry which is now just attempting to gain a foothold in the market. Suspension of AB 32 could financially strand these investments and damage the prospects of new Californian industries based on electric mobility.

The Proposition also introduces a great deal of regulatory uncertainty. It does not provide for a smooth transition between the current situation and suspension or when the suspension is lifted.  The reintroduction of AB 32 then becomes a complete unknown, but with immediate impact, particularly if the 2020 goal remains intact.

Now is not the time to prevent the rollout of AB 32. Now is the time to work together to develop key AB 32 regulations, such as a cap and trade system.  We need regulations that help us transition to a low carbon future in a cost effective manner but balanced against economic needs.  Much can be accomplished by including adequate transition periods to prevent unnecessary economic disruption or short term costs and to address potential interactions with US Federal requirements.  Compliance related preparation and investment is already underway or in the pipeline and the design of AB 32 regulation may well serve as a useful template for the nation as a whole. The passage of Proposition 23 could result in a new and expensive regulatory pathway for business, with the loss of opportunity that the market based approach taken by ARB offers.

Good News or Bad News

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Recently Reuters reported that the Japanese government is looking at developing its own version of the Clean Development Mechanism (the offset / project mechanism instrument within the Kyoto Protocol). Japan has been a significant buyer of CERs (Certified Emission Reduction Units) in recent years, both directly and through voluntary agreements with Japanese industry but like many participants in this market has reportedly been frustrated by the bureaucracy of the CDM and the specific requirements placed on a project such that it is eligible. Nevertheless, with Japan and the EU as the principal buyers of CERS, the CDM system will have issued some 1.8 billion CERs by the end of 2012, which in turn equates to about $25 billion in carbon value and certainly more in overall project investment. Whilst the same investment may well have gone to developing countries anyway, it would not have been so focused on low carbon projects such as land-fill methane capture, wind and hydro.

To its credit much has been achieved under the CDM, but it remains an instrument of the Kyoto Protocol and subject to the jurisdiction of the CDM Executive Board (EB) which in turn operates through the Meeting of the Parties to the Kyoto Protocol. Above all else, the CDM has shown that a project mechanism can work and importantly can enable a targeted low carbon investment stream into developing countries. As a result, the idea of an offset / project mechanism of some sort exists in many government’s plans for legislation. But therein lies what is becoming a problem – each government wants a “made at home” solution. The latest incarnation of this is Japan.

Apart from government-to-government AAU transactions (under the Kyoto Protocol), the CER is the pretty much the only single fungible carbon price instrument globally. It can be utilized by all the Kyoto Annex 1 countries for compliance and in some cases that compliance has been cascaded down through the economy such that business trades CERs. This in turn links the carbon price those economies and allows at least some measure of optimization between them, albeit limited today. Optimization in turn means a lower cost of compliance for the economies in question. Multiple, jurisdiction specific offset mechanisms would prevent this from happening. The accreditation of a given project would typically be against one set of rules and therefore the resulting credits could only be used for compliance where those rules originate. Project developers would find the cost of multiple jurisdiction accreditation prohibitive. This means that there would be no linking mechanism between the systems and no opportunity to optimize. The result – a lost opportunity and a higher cost outcome. There will also be additional costs for the governments involved. Establishing the necessary monitoring and accreditation bodies is a complex and expensive task, just look at the CDM EB. Finally, it may be wrong to assume that it will all somehow be easier if done at home – even local solutions will have teething problems and will likely face all of the issues all over again that have been dealt with by the CDM EB.

So whilst it is good news that governments continue to favour market mechanism approaches to emission reductions, it may be bad news if they each try a home grown solution. At a very minimum, a global deal on project mechanism design and implementation, ideally building on but learning from the CDM, would be a solid achievement from the UNFCCC process in Cancun.

The recent G8/G20 in Canada and the relatively small amount of time spent discussing climate change has again brought some to question the intent of the Canadian Government with regards the issue. The reality is that successive Canadian Governments have struggled to formulate a policy mix which will suit the country, but at the same time Canada has been a great champion of overtly climate change technologies such as carbon capture and storage (CCS). As such, it is worth spending some time giving thought to the dilemma that is the Canadian economy and greenhouse gas emissions, particularly as the government continues to seek a policy mix that will deliver a meaningful reduction in emissions over the coming decade – at least as a first step.

This posting looks at the history (which we don’t always like, but it is what it is) and its potential implications – in the weeks to come I will focus on the “what now” as Canadian Federal policy makers look again at domestic legislation.

Canada is a Kyoto country, meaning that it has signed and ratified the Kyoto Protocol and agreed to cut emissions by 6% for the period 2008-2012 relative to 1990 under the governance of the Kyoto rulebook (i.e. with the benefit of international trade in allowances and the use of offsets). By contrast, actual emissions have risen by some 30+% over the period. It might be argued that in the grand scheme of things Canadian emissions are relatively small (CO2 emissions from energy use are about 2% of the global total), so what does it really matter? But in the Kyoto world it does matter, which in turn makes Canada a key player in any new global agreement that might emerge from the UN process.

The Kyoto Protocol is a compliance based system, which means that participants with caps (signatory developed countries) must ensure one allowance (AAU or Assigned Amount Unit) or equivalent unit (e.g. CER offset from the Clean Development Mechanism – CDM) is held in the national register for every tonne of CO2 or equivalent (e.g. methane with a multiplier of ~21) emitted to the atmosphere. Canada has been granted some 2.82 billion allowances for the five year compliance period and must purchase more on the international market if it wants to emit more than this amount. This is the basis of the international carbon market that the Kyoto Protocol seeks to foster. But it is now impossible for Canada to comply without a massive inflow of external allowances. According to estimates on the Environment Canada website this could be as many as 1 billion units for the period 2008-2012.

The future of the international climate change talks may well depend on the fate of the Kyoto Protocol, even though the USA is not a signatory party and many of those that are would rather see the world move on to new approaches. Any new approach could still have the legacy of Kyoto within it, particularly given the strong backing for the Protocol from developing countries. For them, it embodies the critically important principle of “common but differentiated responsibility”. Even the Copenhagen Accord endorsed by many nations in December recognizes the Kyoto Protocol and proposes that new 2020 targets for developed countries “will thereby further strengthen the emissions reductions initiated by the Kyoto Protocol”.

The prospects for a developing global carbon market may also rest with the fate of Kyoto and the way in which it can eventually morph into a new agreement. Non-compliance can always be dealt with, but even that has a process attached to it which requires the participants to follow yet another set of rules. The recent global financial crisis was an abject lesson in non-compliance, but it has still been resolved within a tough rule framework in order to maintain structure and credibility and to preserve the integrity of the system which then forms the basis for a redesigned future framework. Without such a solution, true financial collapse may have been the result.

Unresolved non-compliance could result in a truly failed first attempt at collective action on climate change. That would make the already difficult steps to a final global framework, particularly one underpinned by a carbon market, all the more challenging. Therein lies the dilemma for Canada, the difficult domestic decisions it will have to make and also its critical role in the international process.