Archive for May, 2012

While much of the focus in the recent UNFCCC meeting in Bonn was on the protracted discussion around agenda and chair for the ADP (Ad-Hoc Working Group on the Durban Platform for Enhanced Action), some progress was made in other meeting rooms. On the middle Saturday a workshop was held for initial discussions around the call for a “New market Mechanism” (NMM). A report out from the workshop can be found here.

So far, the discussion on a NMM has tended to focus on the crediting of mitigation activities in developing countries, such as the role performed by the CDM. The talk is often about up-scaling rather than having an initial discussion about the market conditions necessary for crediting to be effective or alternatively to ask what a market mechanism actually is. For some, the CDM can be represented as shown below. 

This is a very supply biased conversation, when in fact the full description of the mechanism must include both the creation of supply and the likely demand. The mechanism is much broader than the CDM and involves the core design of the Kyoto Protocol and the various elements within it. 

There are many definitions of “market mechanism”, but all talk about the process of the whole market rather than just a sub-part within it. Here are three;

  1. Means by which the forces of demand and supply determine prices and quantities of goods and services offered for sale in a free market.
  2. The use of money exchanged by buyers and sellers with an open and understood system of value and time tradeoffs to produce the best distribution of goods and services.
  3. The process by which a market solves a problem of allocating resources, especially that of deciding how much of a good or service should be produced, but other such problems as well. The market mechanism is an alternative, for example, to having such decisions made by government.

As the NMM discussion matures and eventually becomes part of the ADP, a much broader discussion on the need for a viable carbon market will be necessary. This cannot be limited to a discussion on crediting mechanisms because these, if standing alone, are not market mechanisms. A working mechanism requires some means of establishing price and particularly demand, a feature not inherent to the CDM.

The assumption that demand for credits will somehow be created is arguably a flawed one. The Kyoto Protocol addressed this by assigning AAUs to certain countries and making the CER (from the CDM) a fungible instrument, thereby allowing interchange for compliance. The AAU approach created demand in countries that had compliance obligations which in turn completed the market mechanism. Nations that held AAUs tended to cascade the instrument directly into their economies or if not, a proxy (e.g. the EUA under the EU ETS). Either way, the compliance obligation remained and allowed private investors to participate in the market.

There was a certain elegance in the market mechanism design of the Kyoto Protocol, one that shouldn’t be lost in the transition to a new international agreement. While it may not be smart politics in some quarters to highlight the benefits within the KP, the NMM discussion will do well to learn from what was developed in years gone by and not throw the baby out with the bathwater.

In a recent New York Times opinion piece, NASA climate scientist James Hansen again puts forward his very compelling argument for strong action on limiting global CO2 emissions. Some observers have challenged his thinking, but the warnings he has given over the last thirty years have proven to be pretty much on the mark as observations show that the world is warming.

In the most recent piece, Hansen links the production of synthetic crude from oil sands bitumen in Alberta as a game changer for the climate. He states;

That is why I was so troubled to read a recent interview with President Obama in Rolling Stone in which he said that Canada would exploit the oil in its vast tar sands reserves “regardless of what we do.” If Canada proceeds, and we do nothing, it will be game over for the climate. . . . . . . The concentration of carbon dioxide in the atmosphere has risen from 280 parts per million to 393 p.p.m. over the last 150 years. The tar sands contain enough carbon — 240 gigatons — to add 120 p.p.m.

There is no doubt that the oil sands bitumen reserves in Canada are very significant. In a recent report the Alberta Energy Resources Conservation Board (ERCB) estimates that provable reserves stand at some 170 billion bbls, with a potential total reserve of some 1.7 trillion bbls. The first figure represents the current estimate of recoverable oil on the basis of existing technology, whereas the latter is indicative of the total amount of oil in the region, recoverable or not. The second figure is the one that equates to 240 gigatons of carbon quoted by James Hansen.

But actual production of oil from the region gives rise to a completely different set of figures. Production of oil sands bitumen started in the late 1960s and by 2010 had reached some 1.6 million bbls per day (ERCB figures). ERCB estimates production at about 3.6 mbbl/day by 2020. Assuming an increasing trajectory which sees production doubling again by 2050 (to 7 million bbbls/day), total cumulative production over 80 years would be 74 billion bbls, which equates to some 35 billion tonnes of CO2 emitted through the production and use of the oil. This equates to an increase in atmospheric CO2 of about 2 ppm (by contrast, Saudi production over the same period could contribute about 6 ppm). If production continued through to 2100 and reached 10 million bbls/day, cumulative production would exceed current proven reserves (so assuming technology improvements) and would equate to an increase in atmospheric CO2 of about 7 ppm over 130 years of production. The resource may be vast, but production is limited by the rate at which new projects come on stream. Given a scenario of complete inaction on climate change over the very long term, it may well be that oil sands might eventually contribute some 100 ppm to atmospheric CO2 levels, but that could take 1000 years. Current trends would likely have us hitting a climate induced “brick wall” long before that.

The point here is not to argue that this is all OK or that James Hansen is wrong, but to illustrate that the issue of CO2 emissions and the resulting climate impact cannot be linked to any individual fossil fuel extraction. Each and every major reserve on the planet can clearly only contribute a few ppm at most over the coming 50 to 100 years, but so goes the tragedy of the commons. This of course highlights the critical need for collective action.

The point that Hansen is really making is that oil sands is illustrative of an ongoing global trend to extract or mine increasingly challenging reserves of oil, gas and coal and bring them to market. Global energy markets are driving this behaviour and will probably continue to do so as population increases and economies develop. Put simply, energy is in demand and the market will respond.

Given the recent change in estimates for global natural gas supply, there is now evidence that the availability of fossil fuels may not be self limiting, at least for a century or so (and possibly much longer as extraction technology improves). This argues strongly for the introduction of carbon pricing, which Hansen also calls for in his opinion piece.

Carbon pricing is the essential precursor to technologies such as carbon capture and storage (CCS), which may be the only available route forward to allow both energy demand to be met and CO2 emissions reduced. Alberta has at least started down this route, with a C$15 price driving behaviour in oil sands operations. That price, in combination with a technology incentive package, should see CCS activity emerge as part of future oil sands development.

This week in Australia the carbon pricing mechanism (no, it isn’t a tax, despite some similarities) is back in the news as the government releases it’s budget for the coming fiscal period. The fixed price period of $23 per tonne (and rising) represents a significant new source of income for the government, although when the mechanism was announced so too were a number of cost offset measures for the consumer and trade exposed industries. As such, the system is largely revenue neutral, but this has done little to quell the noisy opposition to the policy package. On Wednesday, the day after the Budget was released, many newspapers again raised the issue of increasing prices related to the carbon pricing scheme and therefore falling living standards, despite statements by the government over recent months that the system recycles its revenue back through the economy. Unfortunately, public perception appears to be on the side of those who argue that this is a new and unnecessary cost burden.

This isn’t the only negative view that the public have of climate change policy. The other is that energy austerity is the mechanism we must adopt to reduce emissions. The source of this is many and various, including the government itself, some NGOs and even a few business organisations. “Turn out the lights to save the planet” has become a common rallying cry and is amplified by campaigns such as Earth Hour which calls for cities to be blacked out for one hour a year to highlight the issue of energy use and climate change.

So the public are left with the view that energy austerity and extra cost are the two routes to follow if climate change is to be robustly addressed. Little wonder it is an uphill battle gaining political traction on this issue. Perhaps some new and more accurate messaging should be formulated to help sell the need for policy action.

The energy austerity issue is one that can and should be tackled. Reducing energy use and improving energy efficiency are both good things to do, but should be advocated for on the basis of managing energy costs, not attempting to address climate change. For reasons discussed in an earlier posting, local energy austerity may not even be an effective emissions reduction strategy at all. At issue with energy is the emissions from our current sources, not necessarily how much we use. After all, energy availability is almost unlimited, it’s just harnessing it economically that is the challenge.

The austerity message has its roots in various social agendas, but has kept into the environmental agenda as well. It is easy to see why this has happened, given the clear link between ecosystem welfare and overuse (e.g. logging in tropical rain forests), but for the climate change debate this particular approach may not be helping the issue at all.

The climate change issue needs to return to its roots, which is managing, reducing and ultimately eliminating anthropogenic CO2 emissions. This is done by changing the primary energy mix, implementing upstream CCS and shifting final energy use in homes and transport (where emissions are very to capture) to carriers such as electricity, hydrogen and bio.

Such a change won’t come at no cost, but elements of it can be conveyed to the public more easily. For example, running a home entirely on electricity is very doable today, both in hot and cold climates. The option of electric, hydrogen fuel cell or bio mobility is also becoming a reality – and potentially an attractive one as oil prices remain in the realms of $100 per barrel. These are very different value propositions to the austerity message.

The emphasis then shifts to the upstream and the use of renewable energy in the electricity sector together with technologies such as CCS in combination with natural gas. Here costs can be managed and change implemented over time as the grid is renewed and expanded. This can be achieved through carbon pricing, either directly in a cap and trade system or indirectly through emission performance standards. Although the scale of change is less, over the last thirty years many countries have managed to almost eliminate sulphur emissions from both the electricity and transport sectors and have done so without great public rancour. Costs have dropped and the job has just been done.

Getting the message right is essential if we want to make progress on this issue. Pedalling austerity and high cost is neither helpful or even correct.

The ongoing debate in Europe about the current state of the Emissions Trading System (ETS) and the low carbon price outlook is gaining momentum and importantly gaining advocates for action. In response, Commissioner Hedegaard announced a much earlier than planned review of EU auctioning, which could potentially pave the way for a removal of allowances from the system.

There is no doubt that pressure for action is building, with a number of senior EU business figures making representation at a recent meeting of EU Environment Ministers in Denmark. Short statements were delivered by video, including one by the Shell CEO, Peter Voser. These can be viewed on the Danish Presidency website, with the Shell piece at the end (starts at 13:40).

But it isn’t just business in the EU getting into the debate. The academic community on both sides of the Atlantic are also weighing in. Rob Stavins, Albert Pratt Professor of Business and Government and Director of the Harvard Environmental Economics Program has offered some useful insights into the issues facing the ETS. He cuts to the heart of the issue, that being the proliferation of “complimentary” policies at both EU and member state level. Quoting from his blog:

 But, in any event, the European Commission’s Energy division, Environment division, and Climate division should sort out the real effects of the “complimentary policies” that have contaminated the EU ETS, and which fail to bring about additional emissions reductions but drive up costs.  Whether any of this is feasible politically is a question that my European colleagues and friends can best address.

I have written quite a bit about complimentary measures in the past. For me, the clearest example of the issue is the impact of the UK Carbon Floor Price, shown in the illustration below.

  

I won’t repeat the explanation for this, but you can find it here.

 The complimentary policy issue is also addressed by Climate Strategies in their recent analysis of the ETS, which can be found here. They argue that;

 . . . . the combined impacts of recession, response to the carbon price in 2008-11, and complementary measures, have led to a surplus of emission allowances that will last out to 2020. As a result, EU ETS allowance prices have collapsed. This undermines the EU ETS’s value as a driver of either emission reductions or investment. At a time of economic uncertainty and fiscal crisis, EU energy-related industries have lost orientation for investment, and governments have lost an expected €100bn of auction revenue.

 Climate Strategies conclude the following:

 A triad of measures are required to meet three distinct needs:

  • Set-aside to restore the ETS price (and auction revenues) to meaningful levels, and restore confidence that EU policy will provide market signals that are consistent with science, international and strategic processes.
  • Rising Reserve Price Auctions or other measures to cap downside risks for investors and to stabilize minimum auction revenue expectations in the face of deep uncertainties; these would also reduce tensions between the ETS and complementary measures, and preclude the prospect of ongoing interventions through further set-aside.
  • Negotiations towards 2030 goals, initially based around sector specific needs and building up to a comprehensive agreement on 2030 commitments, set in the realities of both domestic possibilities and international developments.

The three measures address different needs and are mutually reinforcing.

For those interested in what Peter Voser, CEO of Shell said, here is the transcript:

Over ten years ago Europe set itself the challenge of reducing emissions while maintaining economic growth. The EU ETS was developed to do this by establishing a carbon market, guiding investment along a path of lowest cost CO2 mitigation. A robust carbon price was envisaged to encourage rapid turnover of legacy infrastructure and therefore deliver new investment. By 2008, this journey was well underway. But today the ETS is in danger. There is a risk it will fail to deliver on its promise to drive new energy investment and reduce emissions.

There is a surplus of allowances and the CO2 price is currently too weak.  The drop in energy use as a result of the financial crisis is one factor. If this was the only cause, there might be an argument to let the system correct itself over time.

But, there is also a policy design cause, arising from the superimposition of multiple layers of policy, such as renewable targets, nuclear build rates, efficiency mandates and more. As the ETS has weakened, this process has accelerated.

  • The impact is that the cost to society of decarbonisation is rising because the ETS is not working as a competitive mechanism. 
  • Secondly, a depressed carbon price signal within the EU is failing to stimulate investment or create certainty for investment decisions.
  • Consequently, the central role of the ETS is undermined and prospects for an EU ETS in a global carbon market are diminished.

The low carbon price, far from bringing relief to industry during a period of financial austerity, is a result of the high cost and uncompetitive energy pathway we are on. We should not forget that the ETS was designed to deliver the lowest cost route to CO2 targets in 2020 and beyond.

Against this backdrop, I would like to contribute to your deliberations with the following proposals:

  • Firstly, I would encourage the Commission to implement an immediate recalibration of the system by setting aside some 1 billion or more allowances – in effect recasting the baseline upon which the system rests. This will restore some of the economic relevance to the system and would make the ETS politically significant again. We should reset the level of ambition agreed in the 2009 Energy and Climate package, while maintaining the safeguards for industries exposed to carbon leakage.
  • Secondly, we must consider climate policy after 2020. The ETS must drive long term change. Overlapping policies should be avoided or tested for alignment to prevent conflicting objectives. Simply put, we need a single EU CO2 target for 2030 as the key policy driver guaranteeing technology neutrality. We would also recommend a reserve price in post 2020 auctions to guard against unexpected macroeconomic changes, provide a level of investment risk support and restore market confidence.

A signal from Ministers assembled here today would be a significant step towards restoring confidence on the EU’s flagship climate policy.