If you walked past a newstand on Saturday in London it was hard not to notice that climate change was back on the front page of the Independent — Oil giant comes in from the cold. The article, with its very bold headline, covered a recent speech by Rex Tillerson, CEO of ExxonMobil, in which he called for a carbon tax in preference to an emissions trading system. In his speech, strengthening global energy security at the Woodrow Wilson International Center for Scholars, Mr Tillerson also said that an emissions trading system was complex and added uncertaintly due to price swings.
I am not going to use this blog to argue with ExxonMobil, but I do think it is important to revisit the reasons why cap-and-trade (or emissions trading as we call it in the EU) is the policy instrument of choice in the EU and now Australia and is already operating in parts of the United States.
- An emissions trading system is designed to deliver an environmental outcome, in that the cap must be met. This is certainty that is critcal for the environment. Whilst a carbon tax delivers some level of fiscal certainty, it does not necessarily deliver any particular environmental outcome. Emissions could fall, but equally they may continue to rise. It may take some years for policy makers to establish the level of tax necessary to deliver a given emissions reduction pathway.
- Importantly and particularly in the current financial situation, an emissions trading system will deliver its environmental objective at lowest cost to the economy. By combining trading with a price for emitting CO2, the approach seeks out the most attractive reduction projects within the market which then drives the overall system to a lowest cost outcome. Emissions trading was applied to the problem of sulphur emissions from power stations in the United States. The overall cost of the meeting the environmental goal has been much lower than expected.
- Despite claims of complexity by some, an emissions trading system is in fact remarkably simple. It does require monitoring and verification of emissions, but so too would a tax based system. Once the environmental objective is established and the equivalent number of allowances distributed – ideally by auction, the market then does the rest. In a tax based system, much of the infrastructure of a trading system would have to be replicated. For example, if for the sake of simplicity the point of tax collection was at the top of the value chain with the fuel supply (e.g. at the coal mine or oil well or point of import), a crediting system would have to be devised for downstream projects which dealt specifically with emission reduction (e.g. a carbon capture and storage project). Crediting would then require specific project oversight, measurement and verification. Alternatively, the point of tax collection could be set at the point of emissions, but that would entail a much broader bureaucracy due to the very large number of emitters.
- A national trading system can be linked with other such systems, delivering over time a global market based approach. The bigger and broader the market, the wider the range of projects it can encompass, which leads to even lower costs overall.
- A trading system offers policy flexibility which is important for business. For example, in Phase III of the EU Emissions Trading System some allowances will be distributed for free to deal with competitiveness concerns. Despite this, the incentive to reduce emissions remains in that the allowances have a value. This construction would be difficult to replicate in a tax based system, in that competitiveness issues would best be dealt with by not taxing – so the incentive to reduce emissions would vanish. Other tax constructions which attempted to mimic the “free allowance” position are feasible, but would add to the complexity of the approach.
So there is a choice – an approach designed specifically to tackle the environmental challenge in front of us, but which offers flexibility and lowest cost for business whist still ensuring the environmental objective is delivered, or more taxation.
I will opt for cap-and-trade any day.
Interesting argument at the gobal level but how about focusing also on protecting the environment at a local level?
I really appreciate the Shell involvement in the global warming issue. Your scenarios for the future are really interesting ; there is a call for government leadership and more regulations, that is quite unusual and quite new for a ww company like yours..
Your CEO motto for the future is right: More Energy, less CO2.
There must be a price on the pollution, because clean energy like CSS has a cost.
But how to properly put this price on carbon?
There, I seriously disagree with you. The cap and trade may be interesting in some particular areas with few actors involved. For the CO2 and other greenhouse gases, this is just not the case. A large part of the emissions are directly made by individual choices (using a car instead of biking, flying overseas instead of visiting his family in the country, overheating one’s home instead of investing for isolation, …).
I agree that industrial companies like yours have a lot to invent and build for the low carbon society we are all looking for, but in our society customer is king and we need a way to drive the customer decision towards a low carbon way of living.
That is the purpose of a carbon tax, with reimbursement to help poor people to deal with it.
Order of magnitude of the tax level: 1€ per gas litter (roughly equivalent to a carbon kilo), this level could be reached after a 10 years ramp up.
With friends in Bordeaux, we have launched an organisation to involve people in the global warming issue. Our organisation is named TACA (as TAx CArbon) and we would be pleased to get your feed back about our web site:
http://taca.asso-web.com/
Regards
As President Obama stated in his inaugural address we will “roll back the specter of a warming planet.” This should be encouraging news to Shell and to people everywhere who recognize the seriousness of the risks posed by climate change and the need to make confident strides towards changing how we generate and use energy. The quality of the future we bequeath to our children and grandchildren depends on how well society as a whole rises to the challenge.
As you state, Shell’s unequivocal position supports cap and trade as the means to bring about the transformation of the global energy mix. Shell policy advocates, however, should be aware of a rising tide of voices favoring a carbon tax regime as a more efficient mechanism to manage climate change and need to be prepared with convincing arguments for its position.
While there are many forms a tax could take, for the purpose of this discussion, the model I hold up is one in which a predictable, well-conceived and rising tax is applied at the point of oil, gas and coal production or at the landing point of imported supplies. Further, 100% of tax revenues are distributed equally per capita on a regular basis. Additionally, any goods imported from countries without sufficiently equivalent GHG controls – by this I mean countries not judged to be upholding their common but differentiated responsibility – are subject to an import duty. Given that the combustion emissions of these fuels are known at the point of production, applying the tax “upstream” ensures that the cost of carbon is embedded in all goods as they move through the supply chain. Individuals who use less energy than the average person – either directly or indirectly through the products and services they buy – would receive a net positive dividend. Those using more energy than the average would get less back than they paid in. Individuals and companies would have an incentive to reduce their energy consumption. Developers of “green” technologies and renewable energy supplies would have an additional incentive to invest.
Some arguments in support of a carbon tax regime are as follows:
1. The most consistent argument put forth to advocate for cap and trade is that a falling emissions cap ensures declining emissions. In theory this is true though in practice there are shortcomings. For the purposes of this discussion, let us suppose that all claimed reductions are real and assume that the carbon dioxide equivalent impacts of all greenhouse gases are known with certainty. Under these conditions, a well-conceived cap and trade program would result in atmospheric concentrations of CO2 remaining below the target level exactly on schedule. This is good if the sole objective is to hit the target on schedule. This is good if the consequences of deviation from the descent path or the end target are known to be catastrophic. This is good if the emissions reduction target must be achieved no matter what the cost.
However, if the objective is to achieve emission reductions at a cost that is less than the cost of climate change, then a carbon tax should be preferred. Put differently, a carbon tax is more apt to ensure the cure isn’t worse than the disease. Studies have demonstrated that a carbon tax regime would deliver a substantially greater net benefit than a cap and trade regime. (See William A. Pizer, “Combining price and quality controls to mitigate global climate change” and the February 2008 Congressional Budget Office paper: “Policy Options for Reducing CO2 Emissions.”) This is not a radical perspective among economists. For one, Lawrence Summers, President Obama’s nominee for Director of the National Economic Council, supports a carbon tax.
The reason a carbon tax is more economically efficient is because price volatility in tradeable emission allowances can cause compliance costs to rise above the value of environmental benefits achieved. Recent history in financial markets provides ample evidence that market prices do not always reflect intrinsic value. Speculation in oil markets is one specific example. J.P. Morgan’s global investment officer is on record as saying “an enormous amount of speculation ran up the price” and “140 dollars in July was ridiculous.” (http://www.cbsnews.com/stories/2009/01/08/60minutes/main4707770.shtml) In addition to market forces running amok, unusual weather, unforeseen economic growth, supply chain disruptions or other exogenous factors could lead the cost of compliance to levels that are suboptimal for societal benefit.
2. A tax regime is transparent and simple to administer. Countries know the amount of coal, oil and gas produced within their borders. They also know the amount of energy they import. It is administratively simple for the small number of impacted energy producers to pay a tax against these quantities. A country generally knows if its carbon footprint is growing or shrinking by the amount of coal, oil and gas it consumes. [Land use changes, fugitive emissions, methane venting, and PFCs and HFCs are special cases to be considered] It is also relatively simple for the government to distribute dividend checks or make electronic funds transfers to its citizens. Conversely, there is little that is simple or transparent about cap and trade. An entire cottage industry of carbon offset middlemen, traders, trainers, advisors, lobbyists, measurers, verifiers and policy writers has exploded to support cap and trade. This does not make for an efficient or a low cost solution.
I agree that carbon capture and storage projects will require monitoring and verification to earn credits under a tax regime but the number of qualifying projects at this point is quite small.
3. The price certainty offered by a tax regime enables businesses and consumers to make sound investment decisions. One of the reasons companies have been unwilling to invest in emission abatement activities is that they are uncertain whether the future price of carbon will support the investment. Under a tax regime, the CO2 price schedule would be transparent. Financial organizations would have no incentive to trade for profit. There would be no debate over the future price of carbon. Capital could be efficiently deployed for abatement activities.
Critics of a carbon tax point out the potential for energy users to simply accept the higher cost without modifying their behavior. Consequently, global emissions might not decline. This may be true in the short run; there are certainly individuals who are relatively insensitive to cost increases. However, it violates economic logic to assert that quantity and price are somehow decoupled when it comes to the supply curve for emission reductions. Price and quantity define the two axes of supply and demand curves. A quantity limit represents a vertical demand curve that maps to a corresponding price based on the supply curve just as an emissions cap translates to a cost of allowances. In the same way, a given price limit on carbon represented by a horizontal demand curve translates through the supply curve to a quantity of emissions reductions.
Granted we do not know with certainty the shape of a nation’s or the world’s abatement supply curve and therefore do not know the price corresponding to a given quantity target nor the quantity associated with a given price target. But to assert that we have no idea of the shape of the supply curve implies that caps are currently being set without regard to the potential cost that will be imposed on the economy and therefore without any assurance the net benefits will be positive. Do the designers of the European Union GHG Trading Scheme have an idea of the price at which allowances will be traded during the 2nd and 3rd Trading Periods? If so, those might be good levels on which to base the escalating carbon tax.
As to the need to fine-tune the tax to achieve the desired results, in the grand scheme of climate change, it probably matters very little if specific reduction targets are hit each and every year. Small deviations from the emissions reduction plan in any given year would likely be compensated in subsequent years.
In short, the arguments in favor of a carbon tax cast reasonable doubt on the relative merits of cap and trade. While there is indeed great momentum behind cap and trade, over the coming months as US legislators craft a climate change bill and global negotiations continue over the successor agreement to Kyoto, Shell should be prepared to reinforce its arguments or else rethink its position in support of cap and trade. Though cap and trade worked in the relatively small confines of the US power sulfur market, the antidote to climate change may require an entirely different and more economically efficient formulation.
To Tim Ebben: I agree with you. A carbon tax is much more powerfull than cap and trade to cut our CO2 emissions.
Tim and Jean,
Many thanks for your comments. I suspect we are going to have to agree to disagree on this issue. Whilst we are both coming from the same place in terms of the urgent need to put a price on CO2, the best mechanism for doing so remains contentious.
Whilst I can see merit in the arguements put forward by Tim, for me the bottom line is that cap-and-trade not only delivers a clear environmental outcome, but does so at lowest cost to the economy by driving the participants along the abatement curve in an organised way. I don’t think a tax system will be as effective.
I am also a trader from way back and am pretty passionate about the important role of markets in our society. Another aspect that concerns me is that a new tax is a very difficult sell in the world of politics. That is not the case with “cap-and-trade” – or at least it hasn’t been so far.
David, we agree that the aim is to put a price on the carbon. This price is unknown in cap vand trade, subject to the speculations of the traders, while it is a clear message with a carbon tax (crystal clear as + 10 cents per oil litter every year, starting today).
That is why a cap and trade is politically easier to sell: the politicians don’t understand that the prices of carbon based products will rise, (while it is the very purpose of the system) and think that cap and trade is unpainful, that is why they politically support it.
David, you are passionate about the merits of the market, but the financial crisis is proving that the market is not our perfect guide, not at all!.
That is why a carbon tax is hard to sell, but is the right and bold decision to be taken if we really want to be serious about the future of our climate.
Not that I’m totally impressed, but this is more than I expected for when I found a link on SU telling that the info here is awesome. Thanks.