Archive for November, 2011

With delegates, energy / environment  Ministers, business representatives and NGO leaders arriving in Durban for COP 17, attention again turns to the pressing issue of actually reducing global emissions. The latest UNFCCC conference comes against the backdrop of two grim statistics of recent weeks – the record year on year (2009 to 2010) jump in global emissions just announced by the US Carbon Dioxide Information Analysis Center (CDIAC) and the prospect of an early “lock-in” of a minimum 2°C temperature rise this century, as indicated by the International Energy Agency in mid November.

As society grapples with these issues, the merit of various technologies and emission reduction approaches arises. Some advocate for a rapid switch to renewable energy, others favour nuclear and most argue that unless the efficiency of energy use is robustly tackled then there cannot be a solution. But a closer look at the current state of the global energy system reveals a very different reality.

As developing economy growth has accelerated in recent years energy prices have risen, albeit with rapid increases in both renewable energy deployment and fossil fuel production. Since 2000 the world has added 0.3 billion tonnes oil equivalent (btoe) per annum of non-fossil (zero carbon) energy, but nearly eight times this amount of fossil energy production (BP Statistical Review of World Energy). Even the global financial crisis has caused but a ripple in this trend. Demand is huge and growing. 

Arguably, we are in a time  where underlying global energy demand exceeds supply. This isn’t to say they are out of balance as that is not possible, but it says that if there were more energy then global economic growth would be even faster. This condition could well persist for a long time given population growth and the rapid expansion of several major economies – with more to follow.

A direct implication of this thinking is that the production of all fossil fuel energy is infra-marginal, i.e. there is nothing at the margin and that even the most expensive to produce barrel or tonne on the planet is profitable at current price levels. Rather, energy prices are increasingly being set by marginal and currently expensive local alternatives such as bio, wind and solar.  The further implication of this is that as developed countries install non-fossil energy supply or reduce their energy use through efficiency measures, the fossil energy that is backed out is simply moved elsewhere and there is no drop in global demand and no drop in global emissions – at all. This condition may also persist for a long time. In addition, in the case of rapidly developing economies such as China, renewable energy deployment is not backing out other fuels, rather it is supplementing a constrained fuel pool and allowing faster economic growth.

This then poses an enormous challenge for global efforts to reduce emissions. The current approach, which increasingly focuses on a “clean / renewable energy” solution, will not deliver a global reduction – at least not for a long time. Nationally there may be significant wins (e.g. the last 20 years has seen the UK reduce emissions through rapid uptake of natural gas), but on a global basis we are simply shuffling the fossil energy supply from one place to another (“Rearranging the deckchairs on the Titanic” comes to mind here). 

This then points to one solution in particular, the application of carbon capture and storage (CCS). With no reduction in fossil fuel use, carbon dioxide levels in the atmosphere will continue to rise  unless emissions are returned to their source. This argues for policy development to be tilted towards CCS technology with the goal of full  demonstration and commercialization in the short to medium term.

CCS is efficiently incentivized through a carbon price, although this is only emerging on a fragmented basis. But even national implementation which results in local rather than global CCS deployment can still be considered of global benefit as at least some emissions are captured and stored. As a carbon price becomes more global it does eventually force fossil fuels to the margin. This will then drive a  reduction in consumption as alternative energy sources come into the mix at lower and lower prices, but CCS remains a critical technology for this century at least.

For the UNFCCC process, this means an eventual complete about-face on CCS. Today it represents a glaring gap in the Clean Development Mechanism with CCS projects not even sanctioned for consideration. This at least is up for change in Durban. But longer term, following the thoughts outlined above, CCS should become the only viable offset mechanism for trade between nations given that it represents a tonne of CO2 sequestered. Permanent sequestration through forestry might also be considered. Anything else, no matter how laudable the project, may not actually represent a real reduction in global emissions.

On to Durban!!

Success slipping away?

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Earlier this year I looked at the prospects for the USA meeting its 2020 declaration to reduce greenhouse gas emissions by 17% by 2020, relative to a 2005 baseline. Success at least looked feasible, driven by three significant factors:

  1. The reduction in emissions as a result of the financial crisis;
  2. The surge in natural gas production which at least has the potential to back out coal in the power sector, thereby delivering a reduction in power generation emissions;
  3. The new and much more stringent CAFE standards which are now in place.

As illustrated in the chart below, a key element of the appraisal is the degree to which emissions bounce back after the recession, i.e. as production ramps up in response to new factory orders and so on. This is because of the scale of the fall in emissions as a result of the recession itself – some 500+ million tpa. 

Very recently the US Carbon Dioxide Information Analysis Center (CDIAC) released new estimates for global and national emissions for the years 2008, 2009 and 2010 – i.e. the key years in terms of the drop in emissions and first signs of recovery. The global trend is a concern given the significant jump of over 2 billion tonnes in CO2 emissions from 2009 to 2010 which more than offsets the 2008 to 2009 fall and puts global emissions at a record level.

The US figure is a real good news / bad news story. The rise from 2009 to 2010 was over 200 million tpa, which on the one hand indicates some recovery in the economy, but on the other puts significant pressure on a successful outcome  in 2020. The same projection but with the Industrial Recovery bar revised to 218 mtpa shows the target being missed by some margin.

 

A second critical element of this pathway is the rate at which natural gas backs out coal in the power generation sector – or coal generation is reduced as environmetal standards become tougher to meet, with natural gas filling the gap. The data for 2008-2010 isn’t conclusive, but it is showing some signs of a smaller recovery for coal than the national energy total and a loss of share in power generation to natural gas. 

Assuming about constant output from fossil generation through to 2020 (i.e. incremental power is picked up by new renewable capacity), then the necessary reduction scenario is only achieved if coal output drops by some 500,000 GWHrs and natural gas rises by a similar amount. More data is needed, but there is at least some indication that this trend may be underway, particularly now that petroleum based power generation has been driven to very low levels.

A carbon price for Australia – finally!

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Depending on your take on events the toll has been as high as two Prime Ministers and one Leader of the Opposition, but Australia now has a carbon pricing mechanism operating in the economy (I say “now” in that even though it doesn’t formally start until July, the price exposure for companies was there the instant the law was officially passed). There does remain some uncertainty given the “blood oath” made by the current Opposition Leader to repeal the law, but at least for now the business playing field in Australia has changed.

The mechanism starts next July and is structured such that it transitions to an emissions trading system a few years later. This means that from the outset the approach is allowance based, with the government selling allowances at AU$23 per tonne of CO2 and then the same allowances being returned to government for emissions compliance. Somewhere around 2015 this will change in that the number of allowances available for distribution will be capped and banking of allowances, together with an opportunity to use offsets, will be allowed.

Australia has followed a near text-book approach to implementation as it has decided to recycle the funds collected directly back to consumers affected by the carbon price in the form of tax changes, with a bias towards those on lower incomes. Trade exposed industries will also see a direct recycle back, thus minimising the change in their international competitive positioning. The approach adopted by the government follows the cycle discussed in the WBCSD publication Carbon Pricing released earlier this year.

 The goal of a carbon price is to create a change in the economy such that the market begins to differentiate between goods and services on the basis of their carbon footprint.

In its generic realization, the carbon price, initially experienced by the emitter or fuel provider (e.g. by paying a tax, purchasing allowances from the government or implementing a required project), is passed through to the consumers of the product. The result is a change in the relative cost of most goods and services based on their carbon footprint, and the emergence of a new cost ranking within the economy. This will influence the purchasing decisions of consumers.

Products with a high carbon footprint will be less competitive, either forcing their removal from the market, or driving manufacturers to invest in projects to lower the footprint. Any revenue raised by the government from carbon pricing, will be typically directed to the treasury as part of the overall national budget process. It should be used efficiently; for example, to offset any net change in costs to the consumer by reducing taxes.

A transparent pass-through of operating costs to the consumer is an important feature of any market. It allows the manufacturer to adjust the sales price to maintain profitability, as new costs enter a process, or existing costs change. An increase in the sales price could only occur to the extent that the market allows the change to take place, due to competition from manufacturers with a different cost structure that may limit the potential for cost pass-through. This gives rise to one of the principal challenges of introducing carbon pricing into an economy.

Carbon pricing is being introduced piecemeal throughout the world. Some manufacturers incur the cost of carbon, while others do not, although they may be competing in the same market. A manufacturer incurring the cost of carbon is penalized, as the market price is set by a lower cost provider without the carbon price. This can result in “carbon leakage”, where a higher cost manufacturer struggles to compete, and market share is gained by a producer not subject to the carbon price. Consequently, the environmental integrity of the approach can be undermined and economic distortions introduced. A global carbon price is therefore important in order to gain a level playing field. Another challenge arises in heavily regulated markets where the producer may not be able to raise prices, and therefore cannot recover the carbon cost.

The design of a carbon pricing policy must recognize these issues.

Back in February when all this started, an observer might have thought that the economic roof had caved in.

But despite the difficult politics that have surrounded the proposal (now law), the government should be applauded for persisting. Regearing the economy and creating a different set of winners (and losers) somewhere down the road is not an easy task, but it has to be done.A command and control policy set which might appear as an alternative is both more expensive for consumers and far less flexible for business.

I happen to be in South Africa this week and a similar set of proposals is under discussion, although more likely implemented as a straight carbon tax. Australia and South Africa are similar in many respects – both are heavily dependent on coal and both are major resource based economies. South Africa will need to be even more thoughtful than Australia regarding recycle back into the economy, given the different income distribution in this country and the pressing need of access to electricity for all the population, but the principles which guide them should be the same. There is also the additional complication of having a state run monopoly providing electricity to the country, but even that is starting to change as the government looks at the introduction of independent renewable energy suppliers. As was the case in Australia, the battle lines are being drawn, at least according to the Cape Times today.

That part of the global economy exposed to a direct carbon price remains small, but it is rising and Australia is an important step, as will be South Africa. So far this isn’t enough to change the terms of the global energy mix, but it is having regional impacts. A similar move in China and / or the USA would change all that though.