Archive for the ‘Carbon price’ Category

FASTER carbon pricing mechanisms

Last week New York hosted amongst other events, the Papal visit, the UN General Assembly where some 150 world leaders gathered and Climate Week. Arguably this had the makings of a bigger coming together than COP21 itself, although many other issues were also on the agenda, such as the UN Sustainable Development Goals. Nevertheless, the climate issue progressed and the subject of carbon pricing was widely discussed, both how it might be implemented by governments and how companies could use carbon valuation internally in relation to project implementation and risk management.

A highpoint of the Climate Week events was the release by the World Bank of its FASTER principles on implementation of carbon pricing mechanisms . This is work to support the overall push by that organisation for greater uptake of explicit carbon pricing mechanisms at national level as governments consider how they might implement their INDCs.

FASTER is an acronym, with each of the terms further elaborated in a fairly readable 50 page accompanying document. The short version is as follows;

  • F – Fairness
  • A – Alignment of Policies
  • S – Stability and Predictability
  • T – Transparency
  • E – Efficiency and Cost-Effectiveness
  • R – Reliability and Environmental Integrity

I have a slight feeling that the acronym was thought up before the words, but each of the subject areas covered is relevant to the design of a carbon pricing mechanism by governments, such as a cap-and-trade system.

Importantly, the principles recognise many of the key issues that early cap-and-trade and taxation systems have confronted, such as dealing with competitiveness concerns, managing competing policies and complementing the mechanism with sufficient technology push in key areas such as carbon capture and storage and renewables. The latter requires something of a Goldilocks approach in that too little can result in wasted resource allocation, but too much while also being wasteful can end up becoming a competing deployment policy.

In the various workshops held during Climate Week, one aspect of the FASTER principles that did draw comment was the call for a “predictable and rising carbon price”. Predictability should be more about the willingness of government to maintain the mechanism over the long term, rather than a clear sign as to what exactly that price might be. For the most part, commodity markets exist, trade and attract investment on the basis that they are there and that the commodity itself will continue to attract demand for decades to come. We are still some way from a reasonable level of certainty that carbon pricing policies will be in place over many decades, given that they do not enjoy cross-party support in all jurisdictions.

Particularly for the case of a cap-and-trade system, a rising carbon price cannot be guaranteed. Rather, the system requires long term certainty in the level of the cap, after which the market will determine the appropriate price at any given point in time. This might rise as the EU ETS saw in its early days, but equally the widespread deployment of alternative energy sources or carbon capture and storage could see such a system plateau at some price for a very long time. Even within this, capital cycles could lead to the same price volatility as is seen in most commodity markets.

The guarantee of a rising price may not be the case for a tax based system either. Should emissions fall faster than the government anticipates, there could be popular pressure for an easing of the tax. As carbon tax becomes mainstream, we shouldn’t imagine it would be treated any differently to regular income based or sales tax levels, both of which can fluctuate.

The release of the FASTER Principles coincides with my own book on carbon pricing mechanisms, which was launched just prior to Climate Week. I cover many of the same topics, but drawing more on the events that have transpired over the last decade. Both these publications will hopefully be of interest to individuals and businesses in China, the government of which formally announced the implementation of a cap-and-trade system from 2017. This will be an interesting implementation to watch, in that it may well be the first such system that operates on a rising cap, at least for the first few years. Irrespective, the announcement ensured that Climate Week ended on a high note.

Why carbon pricing matters

An underpinning theme of my blog postings over the years has been discussion around government policy frameworks that seek to attach a cost to CO2 emissions – or so called carbon pricing. I have argued for them, commented on their inner workings and highlighted successes and failures along the way. At the start of each year I have published an overview of global progress, which of course has always featured the EU ETS, but now incorporates systems and approaches from countries such Kazakhstan and South Africa.

The importance of placing a cost on anthropogenic emissions of carbon dioxide cannot be understated, yet it took a fairly heroic effort from the World Bank this time last year to even get the subject of carbon pricing onto the agenda of the UN Climate Summit in New York. Despite the efforts in many countries, this important policy instrument still doesn’t get the recognition or attention it deserves. Yet, as I have argued on many occasions, including my e-book published to coincide with the Summit last year, the climate issue probably doesn’t get resolved without it.

So on the anniversary of that Summit, with Climate Week in New York coming around again, I have a second book being launched, devoted entirely to the all-important subject of carbon pricing as a national and global policy instrument.

Why Carbon Pricing MattersWhy Carbon Pricing Matters” looks at how various national pricing mechanisms work, why some of them may not work at all, what is wrong with others and of course seeks to answer the very question it poses in its title; why this policy instrument matters so much. With COP21 in Paris approaching, I have also argued the case for recognition of this instrument at the global level as well; this isn’t just about national policy implementation.

Not surprisingly the EU ETS gets a chapter to itself; there is a great deal of history here and many lessons learned, but some still to be recognized. As an Australian I have also ventured into the murky waters of carbon pricing policy in that country, which changes constantly and always throws up surprises. With a new Prime Minister, another round of debate may well be on the cards; we shall see.

Finally, I have again challenged the business community to think long and hard about this policy instrument – there are so many reasons why it is the best course to follow. Policy to manage carbon dioxide emissions is inevitable, so the choices we make now may impact the economy and environment for generations to come.

The book is available exclusively on Amazon, either for Kindle or iPads, iPhones and other devices with the Kindle App. This year, the book is also available in hard copy, given the number of requests I had for such treatment over the last twelve months. For those that haven’t caught up with my first attempt, it is now also available in hardcopy.

Where are the carbon market provisions?

With just 100 days to run until COP21 in Paris and a tenth of that available for formal negotiations, the various national delegations met in Bonn last week to try and push forward the 80+ pages of text, replete with hundreds of bracketed options, into something that looks like a climate treaty. By all media outlet accounts progress was slow. Although the process hasn’t reached the point where alarm bells are ringing, the political pressure is mounting with UN Secretary General Ban Ki-Moon set to confront world leaders at the end of September in New York.

A key issue that remains under discussion yet with little to show for months of effort is that of the role of carbon pricing in the Paris agreement. While the decision to implement a carbon price within a national economy will always remain a sovereign one, encouragement from the top is nevertheless important. After all, if a carbon price doesn’t make its way into the global energy system, it’s difficult to see significant curtailment of fossil carbon extraction taking place or equally, widespread deployment of carbon capture and storage to directly manage emissions when fossil fuels are used. This message has been sent loudly from all quarters, including business organisations, multilateral agencies such as the World Bank, NGOs and legions of observers in the academic community. The start of the session in Bonn coincided with an article from the Harvard Kennedy School in Cambridge, Massachusetts which argued that encouraging linkage of heterogeneous national systems should be a key element of the Paris agreement. Professor Rob Stavins and his colleagues aren’t seeking a complex structure, but a simple provision. The article concludes that;

“. . . . the most valuable outcome of Paris regarding linkage might simply be the inclusion in the core agreement of an explicit statement that parties may transfer portions of their INDCs to other parties and that these transferred units may be used by the transferees to implement their INDCs. Such a statement would help provide certainty both to governments and private market participants. This minimalist approach will allow diverse forms of linkage to arise, among what will inevitably be highly heterogeneous INDCs, thereby advancing the dual objectives of cost effectiveness and environmental integrity in the international climate policy regime.”

Such a provision would encourage (carbon) price discovery through market transactions at both inter-governmental and inter-company levels, which in turn could be passed through the energy supply chain, thereby shifting investment decisions. This isn’t a big ask, yet it seems to be a step too far for the national negotiators, even from countries with a long history of market development and support.

This is exactly what the International Emissions Trading Association (IETA) has been advocating for since this time last year and while many of the Parties to the UNFCCC have nodded their heads in agreement, very little has happened. IETA reports from Bonn that the mitigation group under the ADP produced a table that outlines the various issues that fall under the ‘mitigation umbrella’ which Parties want to include in the core Paris Agreement. That table is organised into three columns:

  • A column of issues that are largely agreed by Parties to be in the core Agreement,
  • A column of issues which require ‘further clarity’ on placement in the core Agreement,
  • A column of issues that will be in Decisions at the COP in Paris.

Carbon markets- including their function, governance, accounting, usage eligibility and future work programme all currently fall into the “further clarity” column, where Parties are still debating how to proceed. On the positive side (there is a real need to be upbeat about something) IETA notes that at the start of the mitigation session, some fifteen Parties mentioned the importance of an explicit recognition of market mechanisms in the core of the Agreement. They included the EU, the US, Marshall Islands (on behalf of AOSIS), Columbia, New Zealand, Norway, Tuvalu, Brazil, Australia, Switzerland, South Korea, Japan and Panama. After hearing Parties’ views the co-facilitators proposed to set up a spin off group led by Brazil to look further at joint implementation (i.e. transfers, trading etc.) and market mechanisms (e.g. the CDM is a market mechanism). This probably should have happened a year ago, but like the rest of the agreement it is coming down to the wire.

So the Paris agreement inches forwards and with it the fate of a global carbon market, at least for the near to medium term. The next and presumably last (no others are currently scheduled) negotiating session before Paris is in mid-October.

Do we have a wicked problem to deal with?

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Two recent and separate articles in Foreign Affairs highlight different routes forward for tacking the climate issue. One, by Michael Bloomberg, argues that the mitigation solution increasingly lies with cities (this isn’t just about city resilience) and the other puts the challenge squarely in front of the business community.

These are just two in a salvo of pre-Paris articles that seek to direct the negotiations towards a solution space, including some by me and other colleagues arguing the case for carbon pricing systems. The articles reminded me of a similar article in 2009, the Hartwell Paper, in which a group of UK economists cast the climate issue as a ‘wicked problem’, but still went on to propose a very specific solution (a big technology push funded by carbon taxes). That paper also built its argument on the back of the Kaya Identity, which I have argued simplifies the emissions problem such that it can lead to tangential solutions that may not deliver the necessary stabilization in atmospheric carbon dioxide. Nevertheless, there is still merit in focusing on a specific way forward – at least something useful might then get done.

But the description of the climate problem as ‘wicked’, is one that deserves further thought. The use of the word wicked in this context is different to its generally accepted meaning, but instead pertains to the immense difficulty of the problem itself. Wikipedia gives a good description;

A problem that is difficult or impossible to solve because of incomplete, contradictory, and changing requirements that are often difficult to recognize. The use of the term “wicked” here has come to denote resistance to resolution, rather than evil. Moreover, because of complex inter-dependencies, the effort to solve one aspect of a wicked problem may reveal or create other problems.

It is also important to think about which problem we are actually trying to solve. For example, it may turn out that the issue of climate change is immensely more difficult to solve than the issue of carbon dioxide emissions. There is now good evidence that emissions can be brought down to near zero levels, but this doesn’t necessarily resolve the problem of a changing climate. Although warming of the climate system is being driven by increasing levels of carbon dioxide in the atmosphere, the scale on which anthropogenic activities are now conducted can also impact the climate through different routes. Moving away from fossil fuels to very large scale production of energy through other means is a good illustration of this. In a 2010 report, MIT illustrated how very large scale wind farms could result in some surface warming because the turbulent transfer of heat from the surface to the higher layers is reduced as a result of reduced surface kinetic energy (the wind). This is because that energy is converted to electricity. This is not to argue that we shouldn’t build wind turbines, but rather to highlight that with a population of 7-10 billion people all needing energy for a prosperous lifestyle, society may inadvertently engage in some degree of geoengineering (large-scale manipulation of an environmental process that affects the earth’s climate) simply to supply it.

Even narrowing the broader climate issue to emissions, the problem remains pretty wicked. Inter-dependencies abound, such as when significant volumes of liquid fuels may be supplied by very large scale use of biomass or when efficiency drives an increase in energy use (as it has done for over 100 years), rather than the desired reduction in emissions.

An approach to managing wicked problems (Tim Curtis, University of Northampton) first and foremost involves defining the problem very succinctly. This involves locking down the problem definition or developing a description of a related problem that you can solve, and declaring that to be the problem. Objective metrics by which to measure the solution’s success are also very important. In the field of climate change and the attempts by the Parties to the UNFCCC to resolve it, this is far from the course currently being taken. There is immense pressure to engage in sustainable development, end poverty, improve access to energy, promote renewable technologies, save forests, solve global equity issues and use energy more efficiently. Although these are all important goals, they are not sufficiently succinct and defined to enable a clear pathway to resolution, nor does solving them necessarily lead to restoration of a stable climate. The INDC based approach allows for almost any problem to be solved, so long as it can be loosely linked to the broad categories of mitigation and adaptation. The current global approach may well be adding to the wickedness rather than simplifying or even avoiding it.

The short article referenced above concludes with a very sobering observation;

While it may seem appealing in the short run, attempting to tame a wicked problem will always fail in the long run. The problem will simply reassert itself, perhaps in a different guise, as if nothing had been done; or worse, the tame solution will exacerbate the problem.

In climate change terms, this translates to emissions not falling as a result of current efforts, or even if they do fall a bit this has no measurable impact on the continuing rise in atmospheric carbon dioxide levels.

But that is not to say we should give up, as the counter to this observation is that having defined a clear and related objective to the wicked problem that is being confronted, declare that there are just a few possible solutions and focus on selecting from among them. For me, that comes down to implementing a cost for emitting carbon dioxide through systems such as cap-and-trade or carbon taxation. As such, I am about to release a second book in my Putting the Genie Back series, this one titled Why Carbon Pricing Matters. It will be available from mid-September but can be pre-ordered now.

Why Carbon Pricing Matters

Who knew what and when?

A recent article in the Guardian, which was also carried through a number of other media outlets, implied some prior knowledge within the oil and gas industry of climate change and the impact of carbon dioxide emissions from fossil fuel use long before others had recognised its impact. The assertion was based on unearthed correspondence within Exxon where carbon dioxide emissions were discussed as early as 1981. The article goes on to say that “Climate change was largely confined to the realm of science until 1988, when the climate scientist James Hansen told Congress that global warming was caused by the buildup of greenhouse gases in the atmosphere, due to the burning of fossil fuels.”

In fact, information about the role of carbon dioxide as a greenhouse gas in the atmosphere has been widely available for over a century and has its foundation as far back as the early 19th Century, nearly 200 years ago. At that time, physicists were coming to terms with radiation physics and were attempting to understand why the Earth had a stable temperature. Knowing the energy falling on the planet from the Sun and after building an understanding of the radiation outwards from the Earth itself, the expected temperature of the planet could be derived. Unfortunately the calculation resulted in a number of somewhere around -15°C, which was clearly some 30°C lower than the observed temperature (about +15°C). Something else was in play, but at the time this was unclear. By 1862, an understanding of the role of certain gases in the atmosphere had been established, now more widely known as the “greenhouse effect”.

In 1896, Swedish chemist Svante Arrhenius used this information for a paper on the role of carbon dioxide that remains the foundation of 120 years of analysis of the Earth’s temperature and resulting climate (On the Influence of Carbonic Acid in the Air upon the Temperature of the Ground).


In this paper Arrhenius established a methodology for linking the change in surface temperature with the change in the level of carbon dioxide (carbonic acid as he referred to it as) in the atmosphere. Table VII of the paper showed the results of his calculation for different levels of carbon dioxide in the atmosphere ranging from K=0.67 (where K=1 for the level at the time) to K=3.0. For the latitude of the equator he derived the following results;

Carbonic acid = 0.67 Carbonic acid = 1.5 Carbonic acid = 2.0 Carbonic acid = 2.5 Carbonic acid = 3.0
Temperature change at Latitude 0° -3.02°C 3.15°C 4.95°C 6.42°C 7.3°C

The Arrhenius paper discusses the work of a Professor Högblom, another Swedish scientist of the day, who had even calculated how much the burning of coal at that time (500 million tonnes per annum) might change the surface temperature of the planet. The number was very small, but today annual fossil carbon extraction is some twenty to thirty times greater than this and more importantly the cumulative extraction (which we now know is what actually matters) since the late 19th century is hundreds of time this level.

By the late 1950s, thanks to the work of Charles Keeling of Scipps Institution of Oceanography in California, accurate measurements of atmospheric carbon dioxide were being made. In 1961, Keeling produced data showing that carbon dioxide levels were rising steadily in what became known as the “Keeling Curve”. In 1965, the first truly public warning as to the impact of rising levels of carbon dioxide in the atmosphere came from the President’s Science Advisory Committee (President Lyndon B. Johnson), with the words “Through his worldwide industrial civilization, Man is unwittingly conducting a vast geophysical experiment. . . . . This may be sufficient to produce measurable and perhaps marked changes in climate, and will almost certainly cause significant changes in the temperature and other properties of the stratosphere.

There have been many other such references and warnings, ranging from the 1988 testimony to Congress by NASA scientist James Hansen to Al Gore’s film Inconvenient Truth in 2006. Through all of these the story hasn’t really changed from the original calculations of Arrhenius in 1894, rather the understanding and methodology has been increasingly refined and improved.

The above timeline isn’t new and can be found in much more detail in many books, blogs and periodicals. Nor is it even close to comprehensive, with dozens of other scientists and institutions making important contributions to the early analysis, particularly in the 1950s. Nevertheless, it seems to need repeating. Although atmospheric warming may not have been a dinner table conversation in the 1980s, it wasn’t a secret either. A look at the use of the phrases “greenhouse effect”, “global warming” and “climate change” shows that they appeared in books in the 1970s.


Nor was it largely confined to the realm of science. Hollywood had even picked up on the issue in the 1973 film Soylent Green, where the greenhouse effect is specifically mentioned and is to some extent a core issue in the dystopian future that is postulated.

Soylent Green

Rather, what is unusual about the climate issue is the present day questioning of the background science that has come some 100-200 years after the scientific basis was first formulated and largely established, rather than at the time. In my forthcoming book, “Carbon Pricing Matters”, I touch on this issue as follows;

The need to manage global emissions and put a halt to the relentless build-up of carbon dioxide in the atmosphere requires the intervention of governments and cooperation between them to ensure their success; particularly when implemented through a cost on carbon dioxide emissions. There is an ongoing debate around the role of government and the degree to which it should be allowed to address the issue of global warming. There are many who believe that government should have only a modest role in society; others accept a much wider role, including one to solve broad-based issues that affect society at large, for example, the build-up of carbon dioxide in the atmosphere. For the latter group, a carbon price may not go far enough; it is a tool designed to tease out the solution over a generation or more. In the case of those who seek to limit the role of government, the imposition of a pricing mechanism across the entire economy can be seen as a step too far and may even raise questions about the foundation upon which the mechanism is based; the science of climate change.

Four demands for Paris

The call was very clear, here were “four demands” for Paris COP21 being presented to a group in London. But the surprise was the presenter; not a climate focussed NGO or an activist campaigning for change, but Fatih Birol, Chief Economist for the International Energy Agency. He was in an optimistic mood, despite the previous two weeks of ADP negotiations in Bonn that saw almost nothing happen. He opened the presentation by saying “This time it will work” (i.e. Paris, vs. Copenhagen and all the other false starts).

On June 15th Mr Birol launched the World Energy Outlook Special Report: Energy and Climate Change. The IEA usually launch a special supplement to their annual World Energy Outlook (WEO) and this one was the second to focus on the climate challenge and the policy changes required for the world to be on a 2°C emissions pathway. It was also something of a shot over the bow for the Paris COP21 process which had just completed another two weeks of negotiations in Bonn, but with little to show for the effort. Mr Birol is a master of such presentations and this one was memorable. He focussed almost entirely on the short term, although the publication itself looks forward to 2030 for the most part. With regards to the energy system, short term usually means 5 years or so, but in this case short term really meant December but with the resulting actions being very relevant for the period 2016-2020.

Mr Birol outlined four key pillars (as they are referred to in the publication) for COP21, but restated them as “demands”. They are;

  1. Emissions must peak by 2020. The IEA believes that this can be achieved with a near term focus on five measures;
    1. Energy Efficiency.
    2. High efficiency coal, both in new building and removing some existing facilities. IEA proposed a ban on building sub-critical coal.
    3. An even bigger push on renewable energy, with an increase in investment from $270 billion in 2014 to $400 billion in 2030.
    4. Oil and gas industry to reduce upstream methane emissions.
    5. Phasing out fossil-fuel subsidies to end-users by 2030.
  2. Implement a five year review process for NDCs (Nationally Determined Contributions) so that they can be rapidly adjusted to changing circumstances. I discussed the risk of a slow review process when MIT released a report on the possible COP21 outcome.
  3. Turn the global 2°C goal into clear emission reduction targets, both longer term and consistent shorter term goals.
  4. Track the transition – i.e. track the delivery of NDCs and transparently show how the global emissions pathway is developing as a result.

Interestingly Mr. Birol didn’t mention carbon pricing once, at least not until a question came up asking why he hadn’t mentioned carbon pricing – “Is carbon pricing no longer an important goal, you didn’t mention it?” asked a curious member of those assembled at the Foreign Office. He said yes it was, but given his focus was on Paris and that he saw little chance of a global approach on carbon pricing being agreed in that time-span, he didn’t mention it! I think this represents a major oversight on the part of the IEA although there is at least some discussion on carbon pricing in the publication. While it is true that a globally harmonised approach to carbon pricing won’t be in place in the near term, I would argue that an essential 5th pillar (or 5th demand) for Paris is recognition of the importance of carbon pricing and creation of the necessary space for linking of heterogeneous systems to take place. This looks like the fastest route towards a globally relevant price.

Mr. Birol didn’t mention CCS either, which is perhaps more understandable given the 5 year focus of much of the publication. However, Chapter 4 within the publication deals extensively with CCS and the IEA highlights the importance of CCS in their 450 ppm scenario through the chart below.


Finally, there was some discussion around the climate statement made by the G7 the week before and their commitment out to 2100. Looking at the statement released by the G7, they said;

“. . . . .we emphasize that deep cuts in global greenhouse gas emissions are required with a decarbonisation of the global economy over the course of this century. Accordingly, as a common vision for a global goal of greenhouse gas emissions reductions we support sharing with all parties to the UNFCCC the upper end of the latest IPCC recommendation of 40 to 70 % reductions by 2050 compared to 2010 recognizing that this challenge can only be met by a global response.”

My reading of this is that the G7 are recognizing the need to be at or nearing global net zero emissions by 2100. However, this isn’t how the statement has been reported, with several commentators, media outlets and even one of the presenters alongside Fatih Birol interpreting this as an agreement to be fossil fuel free by 2100. These are two very different outcomes for the energy system; the first one potentially feasible and the second being rather unlikely. Both the Shell Oceans and Mountains New Lens Scenarios illustrate how a net zero emissions world can potentially evolve, with extensive use of CCS making room for continued use of fossil fuels in various applications. The core driver here will be the economics of the energy system and the competitiveness of fossil fuels and alternatives across the full spectrum of needs. It is already clear that alternative energy sources such as solar PV will be very competitive and could well account for a significant proportion of global electricity provision. Equally, there are areas where fossil fuels will be very difficult to displace; I gave one such example in a case study I posted recently on aviation. Energy demand in certain sectors may well be met by fossil fuels for all of this century, either with direct use of CCS to deal with the emissions or, as illustrated in the IPCC 5th Assessment Report, offset by bio-energy and CCS (BECCS) elsewhere. Unfortunately the nuances of this issue didn’t make it into the IEA presentation.

That’s it from me for a couple of weeks or so. I am heading north on the National Geographic Explorer to see the Arctic wilderness of Svalbard and Greenland.

The recent letter on carbon pricing from six oil and gas industry CEOs to Christiana Figueres, Executive Secretary of the UNFCCC and Laurent Fabius, Foreign Minister of France and President of COP 21 sent something of a tremor through the media world, to the extent that the New York Times picked up on it with an editorial on carbon taxation. The editorial transposed the CEO call for a carbon price into a call for a carbon tax (as is currently applied in British Columbia) and then set about building the case for a tax based approach and dismantling the case for mechanisms other than taxation; but their focus was on cap-and-trade (such as in California, Quebec and the EU ETS). The New York Times suggested that cap-and-trade doesn’t work, but apparently didn’t look at the evidence.

In January 2015 the EU ETS was ten years old. There were those who said it wouldn’t last and any number of people over the years who have claimed that it doesn’t work, is broken and hasn’t delivered; including the New York Times. Yet it continues to operate as the bedrock of the EU policy framework to manage carbon dioxide emissions. The simple concept of a finite and declining pool of allowances being allocated, traded and then surrendered as carbon dioxide is emitted has remained. Despite various other issues in its ten year history the ETS has done this consistently and almost faultlessly year in and year out; the mechanics of the system have never been a problem.

Effective carbon price
Comparing approaches and policies is difficult, but in general the various mechanisms can be rated as shown above. The most effective approach to mitigation is a widely applied carbon price across as much of the (global) economy as possible. Lost opportunities and inefficiencies creep in as the scope of approach is limited, such as in a project mechanism or with a baseline and credit approach; neither of which tackle fossil fuel use in its entirety.

The chart clearly shows carbon taxation and cap-and-trade competing for the top spot as the most effective mechanism for delivering a carbon price into the economy and driving lasting emission reductions. Both approaches work, so differentiating them almost comes down to personal preference, which can even be seen in the extensive academic literature on the subject where different camps lean one way or the other. My preference, perhaps influenced by my oil trading background, is to back the cap-and-trade approach. My reasons are as follows;

  • The cap-and-trade approach delivers a specific environmental outcome through the application of the cap across the economy.
  • Both instruments are subject to uncertainty, however the cap-and-trade is less subject to political change; conversely, taxation policy is regularly changed by governments. The New York Times made note of this with its reference to Australia, which has removed a fixed price carbon price that was effectively operating as a tax.
  • The carbon price delivered through a cap-and-trade system can adjust quickly to national circumstances. In the EU it fell in response to the recession and perversely has stayed down in response to other policies (renewable energy goals) currently doing the heavy lifting on mitigation. Why is this perverse; because the other policies shouldn’t be doing this job when a cap-and-trade is in place to do it more efficiently.
  • Acceptance is hard to win for any new cost to business, but particularly when not every competitor will be subject to that cost. The cap-and-trade system has a very simple mechanism, in the form of free allowance allocation, for addressing this problem for energy intensive (and therefore carbon intensive) trade exposed industries. Importantly, this mechanism doesn’t change the environmental outcome or reduce the incentive to manage emissions as the allowances held by a facility still have opportunity value associated with them.
  • Most carbon policies are being formulated at country or regional levels, rather than being driven by global approaches. Cap-and-trade systems are well-suited to international linking, leading to a more harmonized global price, while tax coordination is complex and politically difficult. Linking leads to a level playing field for industry around the world which fosters acceptance.

The economic effectiveness of both a carbon tax and a cap-and-trade system for carbon pricing means that countries and regions of all shapes and sizes have an implementation choice. For large, multi-faceted economies, the cap-and-trade system is ideally suited for teasing out the necessary changes across the economy and delivering a lowest cost outcome. At the same time it offers the many emitters considerable flexibility in implementation. Equally, for some economies or sectors where options for change are limited, the offset provisions that often feature in the design of an emissions trading system can offer a useful lifeline for compliance. Still, in some economies, a direct tax may be the most appropriate approach. Perhaps this is for governance reasons related to trading, or a lack of sufficient market participants to create a liquid market or simply to encourage the uptake of a fuel such as natural gas rather than coal.

The choice between these instruments isn’t as important as the choice of an instrument in the first place, which is why the letter from the CEOs is so important at this time.

The past few weeks, highlighted by the Business & Climate Summit in Paris and Carbon Expo in Barcelona, has seen many CEOs, senior political figures and institutional leaders call for increased use of carbon pricing. This is certainly the right thing to be saying, but it begs the question, “What next?”. Many countries are already considering or in the process of implementing a carbon pricing system, but still the call rings out. While uptake of carbon pricing at national level certainly needs to accelerate, one critical piece that is missing is some form of global commonality of approach, at least to the extent that prices begin to converge along national lines.

On Monday June 1st six oil and gas companies come together and effectively called for such a step in a letter from their CEOs to Christiana Figueres, Executive Secretary of the UNFCCC and Laurent Fabius, Foreign Minister of France and President of COP 21. Rather than simply echo the call for carbon pricing, the CEOs went a step further and specifically asked;

Therefore, we call on governments, including at the UNFCCC negotiations in Paris and beyond – to:

  • introduce carbon pricing systems where they do not yet exist at the national or regional levels
  • create an international framework that could eventually connect national systems.

To support progress towards these outcomes, our companies would like to open direct dialogue with the UN and willing governments.

The request is very clear – this isn’t just a call for more, but a call to sit down and work on implementation. The CEOs noted that their companies were already members of, amongst other bodies, the International Emissions Trading Association (IETA). IETA has been working on connection of (linking) national systems for well over a year (although the history of this effort dates back to the days of the UNFCCC Long Term Cooperative Action – LCA – workstream under the Bali Roadmap) and I am co-chair, along with Jonathan Grant of PWC, of the team that is leading this effort.

Late last year IETA published a strawman proposal for the Paris COP, suggesting some text to set in place a longer term initiative to develop an international linking arrangement. I spoke about this at length to RTCC at Carbon Expo in Barcelona.

DCH Interview

The strawman is what it implies, an idea. It could be built on to develop a placemarker in the Paris agreement to ensure that the framework mentioned by the six CEOs actually gets implemented in the follow-up from Paris – as the CDM was implemented in the follow-up from Kyoto.

From my perspective, this week wasn’t just about carbon pricing, but also about climate science. On the same day that the FT published its story on the letter from the oil and gas industry CEOs, The Guardian chose to run a front page story implying that I had tried to detrimentally influence (apparently being a former oil trader!!) the content of the London Science Museum’s Atmosphere Gallery, a display on climate science that Shell agreed to sponsor some years ago. The reporter had based his story on exchanges between Shell and the Science Museum staff when the gallery was looking to do a recent refresh.

I did engage in such a discussion and I did make some suggestions as to content which I thought was new and interesting since the Atmosphere Gallery was first established. Unfortunately The Guardian wasn’t able to publish my proposals as they were put forward during a meeting between me and two staff members from The Science Museum, so to complete the story I will publish them here. Although this particular piece of science dates back to a 2009 Nature article by Oxford University’s Professor Myles Allen and his team, it didn’t feature in the Gallery when it was first put together (the Advisory Panel met during 2009 as part of the design phase of the Gallery). But today, it is the foundation work behind the concept of a global carbon budget which has become a mainstream topic of discussion. My angle on this was to illustrate the importance of carbon capture and storage in the context of this science, but with an emphasis on the science itself. My discussion with The Science Museum staff members took place on 23rd June 2014 and I asked them to consider the following for the refresh of the gallery:

1. As background, three papers that have come from Oxford University:

  • Warming caused by cumulative carbon emissions towards the trillionth tonne

Myles R. Allen, David J. Frame, Chris Huntingford, Chris D. Jones, Jason A. Lowe, Malte Meinshausen & Nicolai Meinshausen

  • Greenhouse-gas emission targets for limiting global warming to 2°C

Malte Meinshausen, Nicolai Meinshausen, William Hare, Sarah C. B. Raper, Katja Frieler, Reto Knutti, David J. Frame & Myles R. Allen

  • The case for mandatory sequestration

Myles R. Allen, David J. Frame and Charles F. Mason

2. Consider using (or adapting) a trillion tonne video made by Shell where Myles Allen talks about CCS in the context of the cumulative emissions issue:

3. Consider putting the Oxford University fossil carbon emissions counter in the Atmosphere Gallery as this would help people understand the vast scale of the current energy system and the rate at which we are collectively approaching the 2°C threshold;

Trillionth Tonne

4. Reference the Trillion Tonne Communique from Cambridge:

5. Offer the use of the Shell “CCS Lift” (an audio-visual CCS experience) to help explain this technology to the gallery visitors.

My pitch to The Science Museum was that this approach offered a real opportunity to feature the Science Museum and the Atmosphere Gallery in the very public discussion on carbon budgets, get some good media attention in the run-up to Paris 2015 (e.g. through the very visible counter), tell the CCS story in context (the Myles Allen video and the CCS audio-visual display) and raise awareness of the cumulative nature of the problem (i.e. the science). In the end they decided not to use this material, but I stand by the proposal.

A new report from the IMF

Last week many representatives of the global business community gathered at UNESCO Headquarters in Paris for the Business and Climate Summit, a prequel of sorts to the main COP21 event in December, but with only the business community involved. The goal was to demonstrate the involvement of the business community in the climate change issue and to set the stage for the business response to whatever is agreed by the Parties to the UNFCCC in December.

The event had significant political backing, with President Hollande speaking at the opening session. His speech went straight to the heart of the issue, with very matter of fact references to the important role of carbon pricing and the need for carbon capture and storage. Even UNFCCC Executive Secretary, Christiana Figures, endorsed CCS, not something she is known to do very often. The remarks by the President were backed up by many speakers, but Angel Gurria, Secretary General, OECD was perhaps the most memorable with his call for “a price, a price, a big fat price on carbon.”

The opening on May 20th set the scene for a major session on carbon pricing the next morning, with the World Bank and various business leaders taking the podium. While these speakers were all in agreement on the importance of carbon pricing, the harmony of the day before wasn’t quite as strong, with something of an argument between Tony Hayward, Chairman of Glencore and Kerry Adler, CEO of Skypower (solar) over the respective role of solar and coal in the coming decades. Mr Hayward saw little possibility of solar filling the breadth of industrial needs currently fulfilled by coal (and other fossil fuels).

The economic purpose of a cost on carbon dioxide emissions (carbon price) is as a response to the externality presented by our collective use of fossil fuels. This externality (the impact related to rising levels of carbon dioxide in the atmosphere) was discussed on several occasions during the Summit with regular reference to a new IMF report which argues that fossil fuel subsidies now stand at $5.3 trillion per annum. The vast majority of this arises from unaccounted externalities, such as the emissions of carbon dioxide and the impact of black carbon. Given that global fossil fuel production is some 10+ billion tonnes of oil equivalent per annum, then $5 trillion of externality equates to a charge for each tonne of production of some $500. The IMF report says that about a quarter of this relates to carbon dioxide emissions.

The publication of this number caused some excitement at the Summit and of course it got picked up in the media very quickly, in many cases with very little explanation as to its meaning. The IMF paper dwells at length on the need to cost in the externality and argues that despite a huge rise in energy costs that would result from such a charge, there would be a net welfare benefit to society at large. The report discusses the work of 19th Century Economist Arthur Pigou, who introduced the concept of externalities and proposed that negative externalities could be corrected by the imposition of a tax, now known as Pigouvian taxation. In the case of the climate issue, a carbon tax or the need to purchase emission allowances from the government are examples of Pigouvian taxes. The IMF report notes;

When the consumption of a good by a firm or household generates an external cost to society, then efficient pricing requires that consumers face a price that reflects this cost. In the absence of a well-functioning market for internalizing this cost in the consumer price, efficiency requires the imposition of a Pigouvian tax equal to the external cost generated by additional consumption.

. . . . . . 

. . . . . .

Eliminating post-tax subsidies in 2015 could raise government revenue by $2.9 trillion (3.6 percent of global GDP), cut global CO2 emissions by more than 20 percent, and cut pre-mature air pollution deaths by more than half. After allowing for the higher energy costs faced by consumers, this action would raise global economic welfare by $1.8 trillion (2.2 percent of global GDP).

But it is also important to consider the current value that is delivered by the availability of energy, a point also made by Tony Hayward on the carbon pricing panel. From an economic standpoint, it is worth taking this a step further. After all, why would the world be producing and using a fuel that brings such apparent economic hardship to society (i.e $5 trillion per annum worth of hardship)? The answer to this question implies that a positive externality must be outweighing this factor.

Although the IMF report doesn’t mention it, Pigou didn’t just talk about externalities in the negative sense, but also in the positive sense. Someone creating a positive externality—say, by educating himself and making himself more interesting or useful to other people—might not invest enough in education because he would not perceive the value to himself as being as great as the value to society. Pigou even advocated for subsidies for activities that created such positive externalities.

Despite the issues associated with using them, fossil fuels have brought tremendous value to society and continue to do so. Almost everything we take for granted in modern society from the food we eat to the iPhone we constantly use are here because of fossil fuels. This wealth creation that is tied to their use but not reflected in the price is a positive externality. Such a positive externality should be apparent in the price of fossil fuels, but because of their relative abundance around the world and the dislocation that often exists between extraction and use, this may not be the case. The positive externality is potentially so large that it is likely the root cause of some governments offering real incentives and (Pigouvian) subsidies to promote additional fossil fuel production. The IMF report calls these Producer Subsidies, but notes that they are relatively small.

None of the above is meant as an argument for not dealing with the environmental externalities associated with fossil fuels use. As noted many times during the Summit and as I have discussed often in the past, a carbon price is essential. But as other forms of energy scale up to the level at which we use fossil fuels, new externalities will present themselves. There will of course be the ongoing positive externality associated with energy provision, but negative externalities will almost certainly make themselves known as new industries emerge and new materials are introduced into society for everyday use (e.g. very large scale use of lithium). Perhaps the lesson from the IMF report is to start dealing with externalities much earlier in the cycle of production, before they reach a level which challenges our economic system to correct.

More steps towards Paris

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At the end of last week (May 15th) Canada submitted its Intended Nationally Determined Contribution (INDC) to the UNFCCC, becoming the 37th state to do so (including 28 countries within the EU). The three key points of the Canadian INDC submission are:

  • An emissions reduction pledge of 30% below 2005 levels by 2030 (the US has pledged a target of 26-28% below 2005 levels by 2025);
  • The reduction will be economy-wide and will cover all GHGs recognized under the UNFCCC;
  • Canada “may also use international mechanisms to achieve its target, subject to robust systems that deliver real and verified emissions reductions.”

This means that substantial progress is being made towards a good coverage of INDC submissions by the time of the Paris COP, although many eyes will now be turning to the emerging economies (e.g. China, India, Brazil, South Africa, Chile, Saudi Arabia etc.) for the real signal with regards tackling global emissions. Mexico has made a good start in that regard.

In just two weeks the national negotiators will meet again, this time in Bonn, to continue their deliberations in the lead up to COP21. But is the process in good shape?

Compared to this time in 2009 with the Copenhagen COP looming, I think it is in better shape. Although there are many details to be agreed, the negotiators at least know what it is they are trying to agree on; a relatively lean framework within which can sit the collection of INDCs from all countries for scrutiny and review. It has taken many years to get to this point and the process is far from complete, but the task at hand is now clear even though many will argue that it won’t be sufficient to deliver the goal to limit warming of the climate system to less than 2°C. At least there is thematic consensus which I don’t think existed in May 2009; was it to be top down or bottom up, what would happen to the Kyoto Protocol, should there be a global goal on temperature rise? These and many other questions were still in play.

Looking back on some of my first year of blog posts which were written in 2009, it was all very different.

  • Many eyes were on the deliberations of the US House of Representatives and the Waxman-Markey cap-and-trade Bill, with every expectation that the USA would take the lead on establishing a carbon price. Today, those eyes are on the world’s largest emitter, China, as it proceeds with its carbon pricing provincial trials and expansion to a nationwide system.
  • It wasn’t until the June 2009 UNFCCC meeting that the team from the Oxford University Department of Physics first presented their new thinking on a global carbon emissions limit of 1 trillion tonnes over the industrial era; now negotiators are actually considering the concept of net-zero emissions and therefore an end date to the ongoing accumulation of carbon dioxide in the atmosphere.
  • The British government produced a first of its kind report on the idea of global carbon trading. In some respects not much has changed, but the discussion has matured and the likes of the World Bank are now taking this concept forward. A linked market even exists between California and Quebec.
  • In July 2009 I came across the first electric vehicle charging stations in London and met a person who was taking delivery of the seventh Tesla in the UK. In 2014 there were 15,000 EV and PHEV newly registered and right now on AutoTrader there are 10 used Tesla cars for sale!!
  • The UNFCCC negotiations were operating on two tracks, the Kyoto Protocol (KP) and Long term Cooperative Action (LCA), with no real sign of them coming together.
  • There was little consensus on climate finance; today the Green Climate Fund has been established and there is an active process underway to start disseminating the initial developed country funding.
  • There was little sign of targets and goal setting from the major developing countries; today China has indicated a plateau in emissions by around 2030 and other countries are following their lead.

In hindsight it isn’t surprising that all of these issues were not resolved by the following December. The goals for Paris may not be as lofty as those for Copenhagen, but at least from the perspective of a mid-year review they appear more achievable. It’s been a few months since I have added a piece to my “Paris Puzzle”, but it is perhaps timely to do this now.

Jigsaw May 2015