Category: Carbon tax

Formulating an Article 6.2 transaction

dchone June 1, 2020

While Article 6 of the Paris Agreement remains in negotiating limbo, the text that emerged from Madrid for Article 6.2 gives a very strong indication of how countries view this mechanism and what will be required between Parties to see transactions begin to emerge. This includes the need for a carbon budget based Nationally Determined Contribution (NDC) or an NDC for which a budget can be formulated and a corresponding adjustment of NDCs to ensure environmental integrity and the avoidance of double counting. This is clearly spelled out in the Madrid text – III. Corresponding adjustments / B. Application of corresponding adjustments, paragraphs 8 to 13.

However, the actual buyer and seller will likely be private entities operating in the two countries making use of Article 6 and while the Paris rulebook is an important consideration in their transaction, the requirements of the rulebook will not be met by the transaction itself. Rather, the transaction of units between the buyer and seller must trigger a set of actions by the respective governments such that the Paris Agreement rules can be adhered to. This means that a link must exist between the inflow and outflow of carbon units within each economy and the implementation of the respective NDCs. Without such a link, the transaction effectively sits in the global voluntary market, which in turn means that the transaction cannot be used to meet compliance obligations that are crafted to guide the economy towards the goals described in the NDC.

The simplest such link that currently exists is where two emissions trading systems are joined, such as between Switzerland and the EU. Private entities operating within these systems can trade EU ETS allowances and Swiss ETS allowances, use the allowances for compliance in their respective country and know that there is some cascade upwards to the EU and Swiss NDC accounting. The approach is very simple, transparent and effectively a non-issue for the participants in the transactions. But what happens when there isn’t an existing trading system in place?

In the case of the Clean Development Mechanism (CDM) under the Kyoto Protocol, a project could be implemented in a developing country and upon agreement of the host country, the CDM Executive Board and a verifier, certified emission reduction units (CER) were issued. Apart from the checks already mentioned, these units were issued without context in that they didn’t relate specifically to a national plan to reduce emissions or have any economic bearing on the project host country other than bringing in valuable foreign investment. In the case of the buyer, the transaction was managed through the accounting rules of the Kyoto Protocol because the CERs would be added to the national inventory of assigned amount units (AAU) and then could be used for compliance against the national target. There was still a need for a system to cause the buyer to make the purchase, which in the case of the EU was the compliance requirements of the EU ETS.

But in the case of an Article 6.2 transaction, there is an impact on the national economy where the seller resides. Firstly, the requirement for a corresponding adjustment to the NDC means that an NDC carbon budget must be established. Secondly, the adjustment means that further reductions in country must be made to compensate for the sale, so a mechanism should ideally exist to ensure that those reductions are made and that they don’t cost more to implement than the proceeds from the sale. In the case of linked emission trading systems, the inherent design of the trading system provides this mechanism. A similar problem could exist at the buyers end, but the issue is often simpler. For example, the buyer may be using the units as an allowable alternative against payment of a carbon tax, in which case the decision to buy is based on the cost of available units from the recognized sources versus the payment of the domestic carbon tax.

Without an emissions trading system in place, the host country looking to generate income through the sale of units under Article 6.2 (ITMO or Internationally transferred mitigation outcome) has the perplexing problem of both tying the sale to the NDC and establishing whether the sale is of economic interest for the country. Depending on the eventual structure and agreement on Article 6.4, the same problems could also emerge. This means that the implementation of Article 6 will have a profound impact on the shape of mitigation policy in participating countries. It may be the case that the only way of solving this problem is through the implementation of a domestic emissions trading system, which makes Article 6 a catalyst for further uptake of cap-and-trade architecture (i.e. emissions trading systems). That would be a good outcome for all concerned.

The future of carbon pricing

dchone January 13, 2020

At this time of the year I usually review the progress in implementing carbon pricing around the world, but it seems timely to look more closely at where carbon pricing policy might be headed. That timeliness is driven by the bushfires in my home country of Australia, where the media have resurfaced the 2008 Garnaut Report. The Garnaut Climate Change Review looked in depth at the climate issue and also recommended ways in which the Australian Government might take on the task of emissions mitigation. The recent resurfacing of the report has come about due its very specific comments on bushfires, which have always been an important issue in Australia. Notably, the report says;

So here we are in 2020 and the effect is indeed very observable. But of equal importance are the recommendations on mitigation that Garnaut put forward. He proposed that Australia implement an emissions trading system, similar to that operating in the EU, with a view to inserting a carbon price into the Australian economy and allowing it to efficiently drive down emissions. After more than a decade of political wrangling, there is no carbon price in Australia and energy system emissions remain today at about the level they were when Garnaut penned his report.

Unfortunately the Australian story is not unique. As the reality of a changing climate has become increasingly apparent and despite widespread agreement among economists that a carbon pricing system of some form is the most economically efficient way of driving down emissions, the global uptake of this policy instrument remains limited.

The World Bank compiles a detailed list of carbon pricing systems and it shows that over 50 systems exist around the world, notionally covering over 20% of global emissions. But a deeper look reveals that most of these are very light taxes, typically under US$10 per ton of carbon dioxide. Many of the other systems are still in various stages of implementation, but there are a handful of systems that stand out;

The EU Emissions Trading System has been operating for 15 years and trades close to €25, but spent more than six years below €10 following the 2008 financial crisis. It covers half of EU energy system emissions.
The British Columbia carbon tax has been in operation since 2008 and operates at CAN$40 per ton.
The California cap-and-trade system (also linked with Quebec) has operated since 2012 and trades at nearly US$20 per ton.
Korean ETS has been operating since 2015 and trades at nearly US$30 per ton.
New Zealand have been a stalwart of emissions trading and have an economy wide system that has operated for many years and currently trades around NZ$30.

Source: World Bank

Nearly a quarter of a century into carbon trading and pricing, taking the 1997 Kyoto Protocol as a starting point, progress is muted at best and certainly not commensurate with the task at hand. In the Shell Sky Scenario, carbon pricing is a critical component for success, with implementation becoming global over the 2020s and a price range of $25-$60 developing by 2030.

But the harsh reality is that there is little sign of this happening, despite the need and despite the economic efficiency of the approach. Implementation can be challenging for policy makers; in some countries even small forced price changes in goods and services, sometimes linked to carbon price implementation, have led to street protests and worse. While some governments have tried to impose carbon pricing, the outcome often ranges from tepid implementation at a very modest price level to eventual retraction (e.g. Ontario). Others just seem to be philosophically allergic to the idea. So where does that leave us?

Explicit carbon pricing through taxation and trading systems may well have seen its best days, which perhaps means a turn towards more implicit mechanisms through standards and mandates. These may well be more expensive for society to implement but are often price opaque or even price invisible. Renewable energy mandates have had considerable success, so we may well see this type of policy imposed more broadly in areas such as transport (favoring Electric Vehicles) and home heating (requiring certain technologies in new builds and renovations). Within the industrial sector, a standard that prevents emissions would force the use of carbon capture and storage, with an implied carbon price of perhaps $50-$100 per ton.

The financial markets are beginning to impose a carbon price of sorts, with finance and investment for coal technologies becoming harder to find and some equity market commentators attempting to dissuade investment in certain companies with links to fossil fuels. In the week of the UN Climate Summit last September, an alliance of several large pension funds and insurers responsible for directing more than US$ 2.4 trillion in investments and under the name Net-Zero Asset Owner Alliance, committed to carbon-neutral investment portfolios by 2050.

Some governments are looking at border tariffs based on the carbon content of imported goods, which offers another more opaque means of imposing a carbon price.

Despite the above, carbon pricing won’t go away and as emissions eventually fall (which they will) a price could well emerge as a direct cost for carbon dioxide removal. The aspiration or even requirement to be a net-zero emitter will mean the funding of atmospheric carbon dioxide removal to balance remaining emissions. This could occur through natural solutions such as reforestation, or through technical means such as direct air capture and geological storage, but probably both. Sequestered carbon could become a commodity of sorts, trading widely and imposing a form of carbon price throughout society.

At the start of this new decade, carbon pricing may well be at a crossroads. Direct implementation through taxation and emissions trading systems is looking harder, even though it remains the preferred solution from an economic efficiency perspective. While the pressure to develop carbon pricing systems should not be eased, we may nevertheless see direct carbon pricing approaches take a back seat to more opaque mechanisms. But the eventual goal of net-zero emissions implies a price to deliver on the ‘net’. That is emerging today through trade in nature-based offsets, but largely in the voluntary markets. Eventually, a regulatory approach should emerge and then carbon sink pricing will be here to stay.

Looking again at carbon pricing

dchone September 23, 2019

It is Climate Week in New York and among the police barricades at the UN, the protests and traffic there is still the opportunity for new thinking and revisiting important subjects. Perhaps none is more important than the role that carbon pricing must play, yet its impact on the energy transition has been limited to date. One of the reasons for the modest uptake in carbon pricing (largely limited to the EU and a some parts of North America, but others now emerging, e.g. Singapore, South Africa and hopefully China) has been ongoing concerns relating to competition, be it for a single industry or more widely at national level compared to trading partners. By contrast, in the Shell Sky Scenario, government implemented carbon pricing emerges rapidly and robustly in the 2020s as part of a suite of critical policy measures to bend the global emissions curve and begin the long journey to net-zero emissions.

Following on from the Paris Agreement in 2015 the World Bank initiated a coalition to help usher in carbon pricing as a policy instrument. The Carbon Pricing Leadership Coalition (CPLC) brings together governments, civil society and industry and offers a forum to learn and share ideas. To that end, the CPLC created the High Level Commission on Carbon Pricing and Competitiveness and at the opening of Climate Week the Commission launched its report on the issue.

As the report discusses, those involved in the use of carbon pricing recognize the concerns that exist due to differential carbon prices between jurisdictions, currently ranging from zero (many places) to around $100 per ton of carbon dioxide (a few cases in some sectors in a handful of countries). There is the potential risk that high-carbon economic activity may move to regions without a carbon price or with a lower price. This could result in decreased profits and job losses. It could also exacerbate political push-back and undermine the intended environmental outcome of reduced GHG emissions. If this “carbon leakage” occurs, it would be a lose-lose: a loss of competitiveness or economic activity without an environmental gain.

But the report finds there is little evidence to date that carbon pricing has resulted in the relocation of the production of goods and services or investment in these products to other countries. This outcome is consistent with the economic literature assessing the competitive impact of environmental regulation more broadly. There may be several reasons for this, including the observation that carbon price levels have generally been moderate and existing programs include protection for at-risk sectors. In addition, tax rates, labour availability, and infrastructure may be more significant to investment decisions regarding location of production than environmental regulations.

While competitiveness remains a key concern for policymakers considering a price on carbon, the report argues that these concerns should not be overstated. Competitive risks exist primarily for highly emissions intensive and trade-exposed (EITE) sectors and jurisdictions that depend on such sectors. These risks can and should be addressed through a suite of locally tailored policy design choices intended to protect industry from unfair international competition even as they ensure that the incentive and support for low-carbon innovation remains.

The report points out that there are a variety of options to address competitiveness risks, including free allocation of emission rights and border measures. However, these should be based on a location-specific, data-driven evaluation of impacts. Once implemented, these measures should be periodically re-evaluated to ensure their effectiveness and usefulness. To that end, data transparency from industry, at least with government officials, is particularly important for assessing how and when intervention is necessary.

The report also revisited the broader carbon pricing subject for the sake of context and not surprisingly found that carbon pricing is an effective, flexible, and low-cost approach to reducing greenhouse gases (GHGs). Combined with other policies, carbon pricing can help accelerate and ensure a smooth transition to a low-carbon economy. Perhaps the more important context is that carbon pricing is intended to drive a shift away from high-emissions products to low-emissions products and processes. That intent may mean that some firms that compete against these low-emissions substitutes may experience a loss of market share and reduced profits even as others adapt, increase their profitability and develop new business models. That is the point of the instrument and more broadly, it is the point of the transition required to address the climate issue.

The CPLC isn’t the only organisation revisiting the basics of carbon pricing for Climate Week. The World Business Council for Sustainable Development (WBCSD) released its own report on the views of the business community on carbon pricing. The new WBCSD paper presents reasons why business supports carbon pricing as a critical enabler to raise climate ambition and calls for governments to put on a price on carbon and develop clear and consistent long-term carbon pricing policies as part of their national commitments and long-term strategies.

My own reflection on all this takes me to the movie Groundhog Day, but perhaps better phrased as Groundhog Decade when it comes to the climate issue. Ten years ago and in some cases more, I contributed to and was involved in the release of similar reports that came to the same conclusions and in some cases from the same organisations. Yet a decade later, the advance of carbon pricing as a preferred policy instrument has been modest at best and in the interim the largest implementation of carbon pricing (the EU ETS) spent much of the time languishing at very low levels and therefore having very little impact on the energy transition; fortunately in the case of the EU that has now changed. Not surprisingly, global greenhouse gas emissions have risen over the last decade.

But this time around something else has to change as there isn’t another decade to just discuss and think about the implementation of carbon pricing – in fact the decade just passed wasn’t thinking time either, it was the time during which all that had been discussed should have been implemented. Now there is no time for prevarication if the goals of the Paris Agreement are to be realised. The Sky Scenario and many other similar pieces of work make that abundantly clear.

The potential for rapid energy transition in North America

dchone March 5, 2019

Over recent weeks and months there has been considerable discussion in the USA and Canada on clean energy transition pathways, carbon pricing and the Paris Agreement. This has been catalysed by the IPCC 1.5° report, the arrival of new political figures on the scene and the prospect of elections in 2019 and beyond. As I discussed in my recent post on a new report that outlines a pathway for global transition consistent with 1.5°C, very steep emission reductions are called for in North America over the coming decade, as shown in the chart below. For the 1.5° case, a reduction of about 80% is proposed from 2015 to 2030.

Source: Achieving the Paris Climate Agreement Goals – Sven Teske (Editor)

But is such a rapid transition possible for an energy system as large as that found in the USA? This is similar to a pathway that has been proposed by those calling for a Green New Deal in the USA. But it is very different to that proposed by the Sky Scenario, released by Shell in 2018.

In Sky, to reach the goals of the Paris Agreement, global emissions need to peak in the 2020s and be falling by 2030, which happens in large part through an initial mobilization of effort throughout the 2020s. But emissions in the USA don’t get even close to an 80+% reduction in that time. North American emissions peaked around 2005 and are slowly falling, but in Sky the pace of change triples in the 2020s with a significant boost in effort, led by government policies such as carbon pricing and electric vehicle mandates and incentives. But by 2030, emissions have fallen by only 23% compared with 2015.

This would constitute a major shift in direction for the US economy. Five significant changes in the energy system in the decade to 2030 in Sky for North America are;

Doubling of wind generation. This should be a relatively easy goal, but on the basis of current build rates it would not be met. Current US capacity is around 90 GW with a recent quarter seeing 0.6 GW added.
A six-fold increase in solar generation. Current build rates would deliver about a third of the required capacity by 2030.
Coal use down by a third.
Natural gas demand plateaus and is the same in 2030 as it is in 2020.
Electric vehicle (EV) sales boom and by 2030, 20% of all vehicle miles traveled are in electric vehicles.

To imagine even more than this is quite challenging. In the EV sector, sales in the USA in 2018 grew rapidly, but still only amounted to 2.1% of the total (Source: EVVolumes.com). A looming issue is the lack of EV models in the SUV / light truck category, although this should start to correct in 2020 with several expected. Nevertheless, this category size makes up a large portion of the US market and it may take some time for consumers to adopt electric versions of their favourite model. While an all EV sales line up might be possible by 2030, an all EV fleet isn’t. For a 100% EV fleet to occur in 2030, all new passenger vehicle sales need to be electric in the next year or two.

In the power generation sector, the multipliers given for wind and solar above, together with an unchanged role for nuclear, results in over half the power generation coming from non-fossil sources by 2030. In Sky, it isn’t until after 2040 before coal is phased out, but natural gas persists in the power mix until the 2060s. A faster transition would require not only a further acceleration in solar and wind deployment, but also the development of major grid storage capacity to replace natural gas. Although there is some grid battery storage today, it amounts to some 2 GWh (Source: PV Magazine), a tiny fraction of the amount that might be needed for a 100% renewable energy system. Further technical developments will be required, or perhaps storage will be combined with ultra-high voltage long distance transmission.

But the most static sector over a ten year period may well be heavy industry; sub-sectors such as cement, iron ore smelting and petrochemicals. While Sky sees some shift towards electricity, the change from 2020 to 2030 is modest. Carbon dioxide emissions remain unchanged at 400 million tonnes per annum over this period. Change is measured in decades rather than years. This is because of the time it takes to develop new industrial processes that don’t use fossil fuels for energy (e.g. hydrogen based iron ore smelting), retrofit exiting capacity and build the necessary infrastructure to support such change (e.g. hydrogen generation).

The next ten years is critical for a transition that meets the goals of the Paris Agreement and this was a feature of the House Resolution for a Green New Deal. Significant changes must be achieved to set the scene for net-zero emissions in the decades following. But to imagine wholesale energy system change in s decade is not realistic. There may well be narrow pockets of very deep change found in parts of the system, but complete change remains a fifty year project.

Note: Scenarios are not intended to be predictions of likely future events or outcomes and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities. Please read the full cautionary note in http://www.shell.com/skyscenario.

Carbon pricing policy in 2018. Was it a year of progress??

dchone January 10, 2019

Carbon pricing remains at the centre of most government policy discussions on climate change, but in a year which saw the Intergovernmental Panel on Climate Change (IPCC) give an unambiguous warning on the need for mitigation action, carbon pricing policy development rather stumbled along.

Undoubtedly the highlight of the year was the restoration of the EU Emissions Trading System (ETS) to again become a meaningful mechanism, with prices rising to over €20 as EU growth gained momentum and allowance supply tightening. The recognition that the Market Stability Reserve would be a feature of Phase IV in the 2020s certainly contributed to this. Also in the EU, discussions opened around the need for an EU ETS floor price, following the successful example set by the UK which has seen coal almost vanish from the generation mix since their implementation of such a system.

Singapore also moved forward with the implementation of its carbon tax.

But outside the EU and Singapore it was hard to find any stellar examples of progress, although intent remains high in many jurisdictions. Rather, 2018 was a year troubled by a number of developments in the carbon pricing space;

In Canada, a new government was elected in the province of Ontario and true to their election manifesto the new Premier took rapid action to remove Ontario from the cap-and-trade system it had only recently joined with California and Quebec.
Also in Canada, the Federal government moved ahead with its backstop pricing mechanism which will kick in for individual provinces if they do not implement a price through some mechanism of their choice. While this was a positive development, the prospect of litigation from some provinces (either by the current provincial government or by an opposition in waiting) means that this program may have a bumpy ride in the years to come.
In Brazil there has been discussion for some time now on implementation of a carbon pricing policy, but this is unlikely to continue under the new administration.
In Australia, even the possibility of a carbon based policy being implemented seemed to create political turmoil. Nevertheless, Australia is not devoid of a mechanism in that the Safeguard Mechanism put in place with the Emissions Reduction Fund has created a secondary market for Australian reduction units on the back of some industrial facilities exceeding their safeguard cap.
In France, protests erupted late in the year on the back of a carbon tax implemented in the fuels market, although many other factors also lay behind the demonstrations. The government was forced to delay implementation.
Finally, the year ended with failure at COP24 to agree on the rule-book for Article 6 of the Paris Agreement. While the Article 6 mechanisms are not there to directly implement carbon pricing, their use would certainly help catalyze such developments in many economies.

In between the highs and lows of 2018, there was still progress. China announced further details of its upcoming cap-and-trade system and continues to make progress in implementing their plans and Kazakhstan is now looking to reboot their early system. The very long running discussion on a carbon tax continued in South Africa with the prospect of a system emerging in 2019, although the parliamentary process has yet to conclude.

But this is not the required profile of action for a world that is intent on reaching the goals of the Paris Agreement. That profile was illustrated by the May release of the Shell Sky Scenario which highlighted the extraordinary rate of progress required in this policy area in the 2020s. Whereas in 2020 Sky shows only modest uptake of carbon pricing, reflective of the situation today, by 2030 some form of carbon pricing is covering the bulk of the global economy at a level between $25 and $60 per tonne of carbon dioxide.

Sky Scenario carbon pricing profile (Source: Shell analysis)

Developments in this space need to pick up pace dramatically in 2019, but perhaps the transparency and reporting framework agreed at COP24 will help in that regard. While the Paris rulebook makes no specific demands on governments to implement policy, it will put a spotlight on the actions they choose to take and the mitigation they seek to achieve. Carbon pricing policy ought to see some uptick under such circumstances.

Overview of carbon pricing developments (Source: own analysis)

Note: Scenarios are not intended to be predictions of likely future events or outcomes and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities. Please read the full cautionary note in http://www.shell.com/skyscenario.

After San Francisco . . . .

dchone September 27, 2018

In mid-September the climate change focused world turned its attention to San Francisco to attend, watch, listen and participate in the myriad of events surrounding the Global Climate Action Summit. The Summit was designed to show the extent of action taking place around the world to respond to climate change, but it was also a political statement of intent that the United States remained committed to the goals of the Paris Agreement through the actions of States, cities and the business sector.

There is no doubt that a wide range of actions are underway and that a major energy transition is in its early days of ushering in significant change. But does all this add up to a pathway that meets the goals of the Paris Agreement? Earlier this year Shell published its Sky scenario, which illustrates the depth and breadth of change required in the coming decades. One of the key drivers of the required change in Sky is the widespread use of policy mechanisms, both market based and mandated requirements. Within the mix, carbon pricing looms large, as shown in the chart below.

The exact nature of the carbon pricing mechanism is not specified in Sky, but it would include all the various forms seen around the world today, ranging from taxes, cap-and-trade, baseline-and-credit and so on. What is clear though in Sky, is that even by 2020 some form of carbon pricing is at least getting going in most jurisdictions and that by 2030 it is very well established, both in terms of coverage and impact.

Yet in the days after the San Francisco summit, the OECD released a report which showed just how large the gap is between where the world ought to be with this policy approach and where it actually is. The report looks at the use of carbon taxes, carbon allowance-based systems and specific fossil fuel taxes. The report notes that the latter have distorted the overall picture owing to the prevalence of gasoline taxes in various parts of the world. These taxes have led to greater efficiency in markets where they are imposed, but have not ushered in a transport transition.

Overall the report finds that the aggregate carbon pricing gap is declining at a snail’s pace. Using EUR 30 per tonne of CO2 as a benchmark, the gap for the 42 countries (OECD+G20 cover 80% of global emissions) as a whole dropped from 83% in 2012 to 79.5% in 2015, and is estimated to reach 76.5% in 2018. The authors note that new carbon pricing initiatives have the potential to significantly reduce the carbon pricing gap, with emphasis on the China ETS starting up soon. However, the report doesn’t include recent back-tracking such as in Ontario where the cap-and-trade system was halted. Even more recently, political disagreement has led to another setback in Australian climate policy.

Even as carbon pricing slowly grows in coverage, more companies adopt science-based targets and more cities pledge to use renewable energy and force certain vehicle types out of use, global emissions continue to rise. The sum of the parts is not yet close to adding up to a change of direction for the whole. This may be related to one salient aspect of the OECD report; the lack of carbon pricing coverage of industrial emissions. In the chart below extracted from the OECD report, industrial emissions are hardly touched by carbon pricing, yet as global development proceeds rapidly and GDP rises, it is industrial emissions that rise as cities are constructed, cars built and domestic appliances manufactured in the hundreds of millions of units.

For the most part industrial emissions are not covered by city pledges and looking at the list of companies with science-based targets, large industrial entities are a small subset of the ~500 companies that have adopted this approach. Even at national level, industrial emissions have been difficult to account for. Many OECD countries have moved industrial operations offshore, therefore seeing an apparent fall in domestic emissions even as they import embedded emissions in various goods and services.

San Francisco was a landmark event and a timely celebration of progress to date, but so much more remains to be done. At the heart of the effort must be a more comprehensive and joined up approach across national borders to carbon pricing. Voluntary and locally mandated distributed action is a worthy stopgap measure, but it is unlikely to put the world on a ‘well below 2°C’ pathway.

Carbon market developments in 2017

dchone January 15, 2018

Looking back at my 2017 post on developments in 2016, it becomes clear that the past twelve months have been more consolidation than progress in terms of carbon market development. It also means that the coloured map (below) hasn’t really changed, apart from a slight set-back and the very positive addition of Singapore.

A big story that emerged in 2016 was the prospect of a nationwide emissions trading system in China. Observers waited throughout 2017 for the formal commencement or at least an announcement, but news didn’t come until mid-December of an imminent launch. Rather than an economy wide cap-and-trade system, the government announced that an emissions rate based system would commence in the electricity sector. Harvard’s Rob Stavins has written extensively about it in a recent blog post.

The Chinese carbon market will double the share of global CO2 emissions covered by worldwide carbon-pricing systems to almost 25 percent.

China wasn’t the only country in the news. Also within the Asian economy, Singapore announced the start of a carbon tax based system from 2019, with a draft Bill appearing for consultation during 2017. The tax will be applied on power stations and other large direct emitters which produce more than 25,000 tonnes of carbon dioxide equivalent of greenhouse gases a year. There are currently 30 to 40 of such large emitters, mainly from the petroleum refining, chemicals and semiconductor sectors. The proposed tax will be around S$10-$20 per tonne CO2.

In North America, progress was mixed. The focus continued to be on Canada with the September announcement that Ontario had entered into an agreement to formally link its carbon market with markets in Quebec and California effective January 1, 2018. The Agreement will allow the governments of Ontario, Quebec and California (the Parties) to hold joint auction of greenhouse gas emission allowances and to harmonize regulations and reporting requirements. An important addition to this was the passage of a Bill in California to extend that State’s cap-and-trade system through to 2030. But with the announcement that the US would be leaving the Paris Agreement and that the Administration would be rolling back the Obama Clean Power Plan, progress in the rest of the country was muted.

In Central Asia, the Kazakhstan emissions trading system remained suspended (hence the change from green to orange), but following an announcement by the government, this should revert to operational status in 2018.

South Africa also moved forward slightly, with a further consultation announced on its draft carbon tax legislation.

Here in the EU, the ETS continued, but 2018 saw much needed reforms agreed. The main elements of the agreement are:

The linear reduction factor will be 2.2 % from 2021;
Each year from 2019 to 2023, 24 % of the cumulative surplus of allowances will go to the Market Stability Reserve; from 2023 the allowances held in the reserve above the total number of allowances auctioned during the previous year should be cancelled;
Conditional lowering of the auction share by 3 % of the total quantity if needed, to avoid application of the cross-sectoral correction factor;
Member States may voluntarily cancel allowances to offset national climate and energy policies that reduce the demand.

The EU ETS expanded slightly with the agreement of a link with the Swiss ETS, although it may be some time before this comes into practice. The ratification of the agreement will require the approval of the Council and Parliament, which is expected in early 2018. When parties are technically ready to connect the two systems, they will formally deposit their instruments of ratification. The agreement will enter into force at the start of the following year.

As the year concluded and nations met in Bonn for COP23, it was also clear that carbon pricing, both through taxation or a trading system was being widely considered. This offers considerable hope for the years to come.

Applying Pigouvian charges

dchone August 17, 2017

A recent article in the Guardian argues that fossil fuels receive about $5 trillion per year globally of unseen benefits, representing some 6.5% of global GDP. The journalist concludes that this must point to a dim future for this energy source. The discussion stems from a paper that has been recently published in the journal, World Development, but is originally a piece of work by two analysts who work for the IMF that surfaced prior to COP21 in 2015. The same authors are involved with the current article.

The new version of the paper classifies these benefits into two types,

‘‘pre-tax subsidies”— these arise when consumer prices paid by fuel users are below the opportunity costs of fuel supply (e.g., many oil producers in the Middle East and North Africa traditionally set domestic prices below international prices). This is the definition that leaders had in mind at the 2009 G20 Pittsburg meeting when they called for a phase out of energy subsidies (IEA, OPEC, OECD, & World Bank, 2010).
‘‘post-tax subsidies”— these arise when consumer prices are below the cost of supply when a ‘‘Pigouvian” charge ⁽¹⁾ is included to reflect environmental damages. Economic efficiency requires that the prices of goods and services reflect not only supply costs but also (i) (most importantly) environmental costs like global warming and deaths from air pollution and (ii) taxes applied to consumer goods in general.

A visit to the IEA website on energy subsidies shows that the value of pre-tax consumer price subsidy worldwide totaled $493 billion in 2013, falling to $322 billion by 2015 as oil prices fell globally. This is equivalent to ~$25 per tonne of oil equivalent, or $3.50 per barrel. By comparison, these amounted to $390 billion in 2009 (in 2014 dollars), the year the G20 and APEC commitments were made. The value of these estimates has fluctuated from year-to-year in line with reform efforts, the consumption level of the fuels in question, international prices for fossil fuels, exchange rates and general price inflation. IEA decomposition analysis reveals that, while movements in world prices typically have the greatest impact from year-to-year, policy interventions have played an important role as well. These subsidized prices are primarily focused on oil and electricity and in many cases, are a mechanism for distribution of benefits to very low income segments of the national population. For example, India subsidized oil, electricity and natural gas in 2015 for its consumers for an amount of nearly $20 billion, but is not a recognized oil producer.

However, the focus of the Guardian article is the lack of charges for externalities in relation to fossil fuel use. By applying a series of Pigouvian charges to fossil fuels, covering issues such as carbon dioxide emissions and air pollution, they argue that fuels are under-priced by some $5 trillion per annum. The additions made also cover issues related to fossil fuel use, but not directly caused by them. An example is road traffic congestion and safety which the article specifically mentions. These would also be externalities in a transport system powered by electricity. In total, these missing post-tax charges for coal amount to $2.5 trillion, oil is $1.5 trillion and natural gas about $400 billion. Pre-tax price subsidies for coal hardly exist, amounting to just over $1 billion per annum globally per the IEA.

Applying this methodology to fossil fuels also opens the debate for other goods and services. For example, many governments offer direct help to farmers and subsidise food prices. The production of rice and beef contributes some 6 billion tonnes of carbon dioxide equivalent to the atmosphere in the form of methane, which alone amounts to an externailty of $250 billion per annum or roughly $1.30 per kilo in the case of beef (vs. a US average ground beef price of $7 per kilo).

A robust and comprehensive application of Pigouvian pricing across the economy incorporating all externalities would likely touch every single product or service in use today, excluding any energy penalty related to fossil fuels. Environmental damage and health issues remain widespread in the world, despite great efforts to address them at every level of society. Many are simply a function of the vast scale on which manufacturing operates, which in turn results in some environmental degradation. In March 2014, the Guardian reported on the social and environmental costs associated with the production of rare earth metals, which have become critical in the manufacture of a multitude of electronic products today, including renewable energy systems. The article raised questions on cancer rates, which in turn links human mortality costs with these products.

In the case of fossil fuels, the simplest and most effective way of confronting this issue is to introduce a carbon price, ideally at a level that reflects the social costs of use. The World Development article uses a figure of around $40 per tonne of carbon dioxide. While this wouldn’t address every aspect of fossil fuel use, it would nevertheless go a long way towards addressing the concerns of the authors.

(1) This refers to the work of Arthur Cecil Pigou, a University of Cambridge economist who published The Economics of Welfare in 1920. In this book, Pigou introduced the concept of externality and the idea that external problems could be corrected by the imposition of a charge. By ‘externality,’ Pigou meant an indirect economic impact of an activity that happened outside the immediate system where the activity was underway. The externality concept remains central to modern welfare economics and is at the heart of environmental economics. In the case of climate change, the externality is the release of carbon dioxide into the atmosphere and the future social and economic impact caused by the consequent increase in the surface temperature of the planet. Externalities can be both positive and negative, but in the case of carbon dioxide emissions, it is considered negative. Pigou argued that the activities associated with a negative externality should be penalized to the extent of the impact, such that their real economic value can be assessed. This penalty is widely known as a Pigouvian Tax. Alcohol taxes are Pigouvian; so are taxes on cigarettes.

Carbon pricing in 2016

dchone January 16, 2017

Given that 2016 marked the first full year of climate policy development after COP21 in Paris and was the year in which leaders lined up to sign and then ratify the Agreement, one might have expected a deluge of new carbon pricing policy initiatives. Rather, the picture was mixed, although there were some notable advancements. Three stood out in particular;

The Chinese government confirmed that 2017 would see the start of its nationwide emissions trading system. This will supersede the various regional pilot systems and should emerge as the largest ETS in the world once it is up and running. The system is likely to commence in the second half of this year, probably at the start of Q4.
The Canadian Government announced that carbon pricing would apply on an economy wide basis from 2018 onward. This could be implemented at provincial level, but if not the Federal Government would intervene and apply it through a taxation based mechanism. For provinces with an explicit price-based system, the carbon price should start at a minimum of $10 per tonne in 2018, and rise by $10 per year to $50 per tonne in 2022. Provinces with cap-and-trade need: (i) a 2030 emissions reduction target equal to or greater than Canada’s 30 percent reduction target; (ii) declining (more stringent) annual caps to at least 2022 that correspond, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems.
The international aviation industry announced an offset mechanism to limit growth in commercial aviation emissions, effectively bringing a carbon price into that sector.

There were other developments and in the map below Australia has moved from blank to a light shade of green. This is because its Safeguard Mechanism started. It will require Australia’s largest emitters to keep emissions within baseline levels such that the country’s other efforts to reduce emissions (e.g. the Emissions Reduction Fund) aren’t eclipsed by emissions growth from existing facilities. The safeguard will apply to around 140 large businesses that have facilities with direct emissions of more than 100,000 tonnes of carbon dioxide equivalence (t CO2-e) a year. This will cover around half of Australia’s emissions. The entity with operational control of a facility will be responsible for meeting safeguard requirements, including that the facility must keep net emissions at or below baseline emissions levels. The mechanism will apply broadly to a variety of business entities, including corporations, partnerships, trusts, and local councils. Baselines will reflect the highest level of reported emissions for a facility (hence the light green) over the historical period 2009 to 2014 Entities with a baseline can comply by ensuring emissions are below that level or by buying Australian Carbon Credit Units.

But the year was not entirely marked by positive progress. In particular, there was the resounding defeat of Washington State’s Initiative 732, which sought to implement a tax on carbon emissions in exchange for cuts to existing taxes. Washington State rejected the idea of a carbon tax by 59 percent to 41.

So we end 2016 with some 23% of greenhouse gas emissions (including China) covered by some form of carbon pricing (Source: World Bank: State and Trends of Carbon Pricing 2016), operating at an average level of something like US$10 per tonne of carbon dioxide. It has taken 20 years to reach this point, with the Kyoto Protocol marking the starting point. To even match the market based Oceans outlook offered by the Shell New Lens Scenarios, carbon pricing needs to cover some 80% of the global economy at a level of $30 or more by 2036, i.e. in under 20 years. That scenario reaches net zero emissions within this century, but has been assessed by MIT as having the impact of limiting warming of the climate system to around 2.7°C, somewhat above the ambition of the Paris Agreement despite the net-zero outcome.

One can only conclude that much remains to be done in 2017 and beyond.

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“The New Lens Scenarios” and “A Better Life with a Healthy Planet” are part of an ongoing process – scenario-building – used in Shell for more than 40 years to challenge executives’ perspectives on the future business environment. We base them on plausible assumptions and quantification, and they are designed to stretch management thinking and even to consider events that may only be remotely possible. Scenarios, therefore, are not intended to be predictions of likely future events or outcomes, and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities.

It is important to note that Shell’s existing portfolio has been decades in development. While we believe our portfolio is resilient under a wide range of outlooks, including the IEA’s 450 scenario, it includes assets across a spectrum of energy intensities including some with above –average intensity. While we seek to enhance our operations’ average energy intensity through both the development of new projects and divestments, we have no immediate plans to move to a net-zero emissions portfolio over our investment horizon of 10-20 years.

Carbon pricing in 2015

dchone January 7, 2016

Perhaps more than any other aspect of the climate agenda, carbon pricing took a major step forward in 2015. This was supported by many initiatives, but most notably by the creation of the Carbon Pricing Leadership Coalition under the auspices of the World Bank. This in turn encouraged a variety of private sector interventions, such as the mid-year letter on carbon pricing from six oil and gas industry CEOs to the UNFCCC. All these actions urged governments to implement carbon pricing policies within their economies as the principle mechanism for advancing climate change action.

In terms of real policy developments, the January 2016 map (below) doesn’t look radically different to the January 2015 map, but a number of important changes took place;

China confirmed the implementation of a nationwide ETS, with a proposal that would see such a system up and running over the coming 2-3 years.
The fledging California-Quebec linked market is likely to see both Ontario and Manitoba join on the Canadian side.
Alberta announced its intention to implement a comprehensive carbon tax from 2017.
The US Clean Power Plan has elements within it that could (but not a given) lead to widespread adoption of a trading model, which in turn implies a carbon price developing in the US power sector.
India again doubled its coal tax in the middle of the year, now at 200 Rupees per tonne of coal. While not a strict carbon price, it will have a similar impact. However, the level is very modest (<$2 per tonne CO2), even compared to the current low price of coal (~$40 per tonne).
The aviation industry is moving closer to a voluntary carbon pricing system.
South Africa moved forward with its carbon pricing legislation.
The EU introduced the Market Stability Reserve as a mechanism to begin to manage the allowance surplus in the EU ETS.

The year ended with what may become the most important element of all, Article 6 of the Paris Agreement. While this doesn’t mention carbon pricing at all, it nevertheless provides fertile ground for its development through international trade of allowances and various other carbon related instruments. It also seeks to create a new global mechanism to underpin emissions reductions and promote sustainable development.

2016 will need to build rapidly on these developments if a government implemented carbon price based approach is to become the global model for reducing emissions. The ambitious goal of the Paris Agreement will need much wider and faster uptake of carbon pricing policy than is apparent from the charts below.