The much maligned EU-ETS

February 19, 2009

The EU Emissions Trading System (EU-ETS) started up successfully in 2005 and its critics haven’t stopped finding fault since. Unfortunately, these critics rarely tell the whole story and those who read the criticisms are probably not in a positon to know what is actually going on in the EU.

In a recent editorial, the Washington Post supports the arguement for a carbon tax by using the EU-ETS as “Exhibit A” in the case against emissions trading. Whilst the facts it presents are not incorrect, the context within which they are presented is questionnable.

  • “Emissions targets were set too high. . . . . The value of a carbon credit plummeted.” At the start of the ETS the data on which the EU Commission based its initial allocation was of poor quality and the Commission also took a very conservative approach to the cap. After all, this was a learning phase during which they were looking for participants to learn to measure, manage, trade and account for emissions – all of which happened. By design, the phase was stand-alone, in that there was no facility to bank surplus allowances into future periods. This meant that when the market realised the three year phase was in surplus, the price plunged quickly to zero as surplus allowances would have no future value. But the phase was a success in that a large liquid market with well prepared participants resulted.
  • “Companies made windfall profits by charging customers more for energy while selling allowances they didn’t need.” The Commission recognised that over time the CO2 price would be passed through to consumers and they indicated clearly that such pass through would trigger a shift to auctioning. That is exactly what has happened and in Phase III much higher levels of auctioning will be implemented – 100% auctioning for most of the EU power sector where price pass through is a reality. The lesson learned here, and picked up by the Regional Greenhouse Gas Trading System in the USA, is that a deregulated electricity sector can pass through the CO2 price very quickly and so should be subject to much earlier auctioning.
  • “And the Europeans have not had much success reducing greenhouse gas emissions.” Emissions within the traded sector are within the cap that has been set and continue to be. Emissions will only fall by the amount the cap dictates, no more. It is not a question of “success” as such, but a question of where the cap is set. And we know that this was set conservatively in the first phase for the reasons given above.
  • “Disputes on the next round of reductions led to the creation of a two-tiered system to appease Eastern European countries fearful of the cost to their industries.” A deal has been done between 27 sovereign states to move ahead with Phase III of the system. The cap is clear and is linked to the EU target of a 20% reduction by 2020. Most of the allowances in Phase III will be auctioned to participants, but some industries will still qualify for free allocation, but subject to a tough benchmarking process. Only only one in ten of these industries will actually get their full allocation for free and they will be the lowest emitters in any sector.

Put simply, the EU-ETS works. Yes, the first phase had its issues, but much has been learned from this. Others can put the learnings to immediate use. Phase III will be very different to Phases I and II. The EU now has a robust system in place that can and will deliver the needed reductions.

The editorial goes on to argue that “A carbon tax, by contrast, is simple and sure in its effects. Last summer, when gas prices shot up past $4 a gallon, average miles driven dropped significantly, as did energy consumption.” It is certainly true that a $2+ rise in the price of gasoline will change driving habbits, but that is equivalent to a tax of over $200 per tonne of CO2. Such a tax would roughly triple the price of cement for example. By contrast, the EU-ETS has traded in the range of $10-$40 per tonne of CO2 and that alone has resulted in a complete change in the way the power generation sector is operating. It has even been sufficient to get companies thinking hard about when they should start to implement carbon capture and storage.

David Presenting to UK Media

Presenting to UK Media

The policy solution is neither a blanket tax or a total reliance on cap-and-trade. The latter is ideally suited to the big emitters such as power generators and large industry. With a cap in place the power sector can begin its journey to zero emissions and get there in 30+ years. Much of the manufacturing sector can do the same, but probably not completely, so they may rely on some form of offset for many years to come. It is hard to imagine any lawmaker implementing an immediate $2 gasoline tax (which is quite possibly why some are advocating they do) and even that may only drive the US auto sector to look like more like its EU counterpart – where an even higher gasoline tax has been in operation for decades. A different approach is needed here, one that agressively targets vehicle efficiency, incentivises lower carbon fuels and implements road use policies such as the Congestion Charge in London. Finally, the built environment needs urgent attention as well, but revised building codes and efficiency retrofits (e.g. insulation) are probably the answer.

Yesterday I gave a short presentation to various London media folk on emissions trading:

 

Emissions Trading Media Briefing February 2009http://static.slideshare.net/swf/ssplayer2.swf?doc=emissions-trading-media-briefing-february-2009-1235007396523984-2&stripped_title=emissions-trading-media-briefing-february-2009

View more presentations from David Hone. (tags: climate change)

But I found a better presentation on the basics here:

Cap-and-trade through musical chairs: Short introhttp://static.slideshare.net/swf/ssplayer2.swf?doc=cap-trade-thru-musical-chairs-short-1196929999848068-4&stripped_title=cap-trade-thru-musical-chairs-short

View more presentations from grist. (tags: cap-and-trade change)

A bit of focus please

February 15, 2009
Amongst the continuing gloomly financial news this week, we were reminded that the impact of climate change is unaffected by the short term prospects of the global economy. Professor Chris Field, speaking at the American Association for the Advancement of Science conference in Chicago, claimed future temperatures “will be beyond anything” previously predicted. “We are basically looking now at a future climate that is beyond anything that we’ve considered seriously in climate policy,” he said. Professor Field said his 2007 report, which predicted temperature rises between 1 deg.C and 6 deg.C over the next century, seriously underestimated the scale of the problem.
But the recession is having quite an affect on the response.
In Australia, after the Garnaut report, the government Green Paper and very recently the White Paper on the final design of the emissions trading system, the government has asked the parliamentary Economics Committee to “inquire into the choice of emissions trading as the central policy to reduce Australia’s carbon pollution”. This in the same month Melbourne saw record high temperatures, that I as a native of that city, never even imagined were possible. Whilst enquiry is the natural course of government, coming so late in the process will be unsettling for the markets that are already starting to form around the prospect of allowance trade in Australia. Unease, delay and caution in the face of recession are not what we need.
On the other side of the Pacific, again triggered by the recession, a massive stimulus plan has been approved by the House and Senate in Washington and now awaits the President’s signature. Within it are billions for renewable energy, carbon capture and storage and energy efficiency measures such as home insulation. This is all good, but where is the broader plan within which this sits and the emissions trading system to drive future deployment after the initial boost from the stimulus. In reality, it could still be three or four years away – and that will just be for the start-up phase. I alluded to the framework back in January and whilst I welcome the energy components of the stimulus package, the encompassing framework is really a necessity.
So, a mixed week for government staring down the twin barrels of climate change and recession. Whilst stabilising our economies remains an essential priority, a laser like focus on energy and climate change is an absolute necessity.

The big picture

February 9, 2009

This week in the “Green Room” on the BBC News website the opinion article discusses the role of population and the environment. Not surprisingly a furious debate on the issue follows. I am not going to enter into that affray, but it is useful looking at this issue in the context of CO2 emissions.

The discussion on population and growth is best described by the Kaya Identity which can be written as follows:

CO2 emissions = Population * Wealth/person * Energy/GDP * CO2/Energy

The four parts of this simple equation show the key elements that contribute to overall energy related CO2 emissions. Apart from population, there is a factor for development (i.e. wealth per person), a factor for the energy we use to generate a unit of wealth (or Gross Domestic Product – GDP) which can also be called “efficiency” and finally a factor that represents the type of energy we use to generate that wealth, but expressed in terms of CO2 emissions.  This final factor will be effectively zero for wind, but quite high for coal, for example.

Arguably, all four of these factors should be in play when it comes to managing CO2 emissions. In reality, we are limiting our efforts to just two of them. We don’t really want to talk about population and we seem to have even less desire to talk about wealth limitation. The latter is also problematic given the large wealth disparity that exists in the world today.

That leaves us with efficiency and the type of energy we use. This is where the big focus of policy development sits – encouraging energy efficiency and using tools such as emissions trading to shift the type of energy we use to lower CO2 options or to eliminate the CO2 emissions using technologies such as carbon capture and storage.

The question that the Kaya Identity poses for us is a simple one. Can we reduce CO2 emissions by nearly two thirds in just 40 years (i.e. a 50% reduction from 1990 levels by 2050) whilst population and GDP inexorably rise (by ~50% and ~300% respectively), relying only on energy efficiency and a shift in the type of energy we use (or the massive application of carbon capture and storage) ?

What about the recession?

January 30, 2009

Another area of active debate at the moment is the extent to which we should be respondong to climate change whilst in the depths of a recession. The views seem to range from “Not at all, we can’t afford it” to “We must, it will create millions of jobs, take us out of recession and save the world in the process.”

Putting the hyperbole to one side, it is better to do some solid analysis of the issue and move forward on that basis. With thanks to my colleague Martin Haigh in the Shell scenario team, let me share some thoughts from the environmental perspective.

For starters, we have assumed that the economic downturn results in emissions that are constant from 2010 to 2020, but with little or no action undertaken in terms of mitigation. Then the Shell Blueprints scenario (the low CO2 scenario) pathway carries on,  but one decade later than in the scenario itself. The result is an increase in emissions of 214 Gt CO2e over the century.

This then means that if we don’t act during this recession and delay action on climate change for a business cycle of a decade, then we might expect an extra 30 ppm CO2e by 2100, and an extra 0.25°C on the long run temperature rise. Given that we are nearly at 450 CO2e already and aspire to no more than 500 ppm CO2e (i.e. ~ 450 ppm CO2), 30 ppm is very significant.

At least from an environmental point of view, delay is simply not an option.

I am not going to wade into the economic arguements of jobs and public spending etc. because there are certainly plenty of people that know far more about this than me. I will instead refer you to an excellent publication by some people that can comment on this aspect, namely McKinsey and Co. They have just released a short report entitled Climate change and the economy – Myths versus Realities.

I hope that you come to the same conclusion that I do – continuing to act to reduce emissions is both environmentally necessary and economically the right thing to do.

More focus on Antarctica

January 28, 2009

Whilst we hear much about the rapidly vanishing sea ice in the Artic, Antarctica seems to go relatively unnoticed. Until recently that is. The following BBC articles point to the growing problems there as well. Don’t forget the rule of thumb that warming at the poles is about twice that of the global average (i.e. 1 deg.C globally translates to 2 deg.C polar).

http://news.bbc.co.uk/2/hi/science/nature/7843446.stm

http://news.bbc.co.uk/2/hi/science/nature/7843170.stm

http://news.bbc.co.uk/2/hi/science/nature/7851276.stm

Can Emissions Trading Deliver?

January 23, 2009

From Whitehall to the Whitehouse (http://www.whitehouse.gov/agenda/energy_and_environment) energy is on the agenda. With the recent high cost of energy still on policy makers minds, difficulties with Russian gas, the constant flow of environmental signals reminding us of a changing climate and economies desperately looking for ways to stimulate activity and create jobs, the idea of an “energy revolution” seems appealing.

The Whitehouse web site calls for the implementation of an economy wide “cap-and-trade” programme to reduce greenhouse gases by 80% by 2050. But is this really sufficient to do the job? An 80% reduction in emissions requires nothing less than an energy revolution, but can such a revolution really be delivered by an emissions trading system?

There is no question that emissions trading will be an important part of the necessary policy approach, but on its own it is far from the comprehensive framework that is needed. Such a framework comes from a look at not just what is wanted, but also a consideration of how it might be done.

The World Business Council for Sustainable Development publication Pathways to 2050 (www.wbcsd.org/web/publications/pathways.pdf) showed that “mega-trend” scale changes will be required in four key sectors of the energy economy – power generation, industry & manufacturing, transport and buildings & commerce. Each of these will need specific and different policy approaches to enable the necessary changes.

Technology will also be key to the changes required. Certain existing technologies must be rapidly deployed and a range of new technologies will need to be brought to market. A typical technology pathway model consists of three phases, Discover & Develop, Demonstrate and Deploy and each are needed to allow the technology to progress down the cost curve. Policy development often fails to consider the “demonstrate” phase, which sees the first commercial scale implementation of a particular technology and may require the construction of supporting infrastructure. Early infrastructure construction facilitates the shift to full deployment.

To fully enable the necessary changes to take place, policy must focus across all the sectors and along the full technology path. Within this framework, “cap-and-trade” is the instrument of choice for the deployment of technology (leading to emissions reduction) in the power generation and industry & manufacturing sectors. But that is just a small portion of the full framework. Deployment mechanisms must still be implemented in the transport and buildings sectors, demonstration support for a variety of technologies will be needed in all sectors and a comprehensive research and development programme is required across the whole economy.

In the European Union, progress has been made in completing the framework. The recent passage through the EU Parliament of the Energy and Climate policy package included a significant support measure for the EU carbon capture and storage demonstration programme. At a CO2 price of EUR 30, nearly EUR 10 billion will be available for commercial scale demonstration of this important technology.

In the US, the journey towards a new energy policy package is only just beginning. Whilst “cap-and-trade” will rightly feature as a cornerstone of the overall approach and will likely be the most visible and talked about aspect of what is to come, policy makers will also need to look beyond this single instrument to deliver the desired revolution.

A Blueprint for the Future

January 16, 2009

The US Climate Action Partnership (USCAP) has now released its Blueprint for Legislative Action,  a weighty weighty 24 page document which gives a complete overview of the steps needed in the USA to deliver an 80% reduction in emissions against 2005 levels. This represents a unique consensus between thirty very different organisations, mostly business, but importantly including a number of environmental organisations such as the World Resources Institute and the Pew Center for Climate Change.

The consensus is unique in that the organisations represented cover the whole value chain within the economy. For example, at one end are power generators, who may well have to raise electricity prices as a result of the CO2 costs they face, and at the other end is an aluminium company, operating facilities that are very sensitive to electricity price as they compete in world markets. Similarly, there are oil companies and vehicle manufacturers, mining companies and consumer facing companies, service companies and technology companies.

The backbone of the Blueprint is an economy-wide “cap-and-trade” system, supported where necessary with additional measures to accelerate change. In addition, there is solid recognition of the need for fiscal support for early commercial demonstration of key technologies for the future, such as carbon capture and storage.

Somewhat surprisingly, or maybe not, criticisms are already being made. Too much support for business, too many allowances allocated for free and from one commentator – “U.S. Climate Action Partnership Proposal Deeply Flawed”. But the Blueprint is a solid piece of work, the result of many hundreds of hours of work and analysis. I have kept only a tiny fraction of the USCAP e-mails that arrived in my InBox since Shell joined and I have over 300 of them – many of those with long and detailed attachments expressing positions and challenging others. This was not a hasty piece of work, so criticizing it in even less time than it takes to read and digest the full document seems trite.

As I have mentioned before, the challenge in front of us over the coming decades is huge. We don’t even really know if we can run an industrial society with near zero emissions, yet that is what we are seeking. Like it or not, we are going to have to take this step-by-step and the Blueprint represents a pretty big first one.

The Case for Business

January 14, 2009

Tomorrow (January 15th) will see the United States Climate Action Partnership (USCAP – a group of businesses and leading environmental organizations  that have come together to call on the federal government to quickly enact strong national legislation to require significant reductions of greenhouse gas emissions – www.us-cap.org) unveil details of the regulatory approach that should be taken in the USA to address climate change. But more about that tomorrow, after the formal announcement.

In advance of their annoucement it is worth thinking about why business even wants such regulation thrust upon it. After all, isn’t the traditional role of business to oppose government regulation? Whilst that has certainly been true in the past and may well continue to be true for certain types of regulation in the future, increasingly it is not the case when it comes to constraining CO2 emissions. This is game changing stuff and business has realised that in completely redesigning the rules of the game, it is better to be part of the design team than just the player at the end.

This is not to say that this makes it easy for the players, far from it. Rather, with business at the table, government can at least design a game (or in this case a regulatory environment) that can be played. Business has realised that the risk behind such pervasive legislation as will be required to reduce CO2 and other greenhouse gas emissions is that the business environment itself may become unworkable. It has also realised that if far reaching effective legislation is enacted now that puts us on a 40 year journey towards near zero emissions (an 80% reduction is effectively near zero and in any case by 2060+ it really will have to be zero), that is much better than the chaos that will ensue when government tries to grapple with really rapid reductions in say 2020 or 2030, having done little about it now.

Nobody really wants all this and there is no doubt that this is, to steal a phrase, a really incovenient issue. But it is the reality of the world we live in and what we are doing to it. There is a strong case for business to be involved in redesigning the environment in which it operates, principally so it can continue to deliver benefit to its shareholders and provide the goods and services that society depends on. Today, there is still the opportunity to do this in a thought through and constructive manner with government, business and civil society all at the table.

Tax or Trade

January 12, 2009

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.

Business and Opportunity

January 7, 2009

You may have read Guardian (UK) writer George Monbiot’s blog yesterday, It will take more than goodwill and greenwash to save the biosphere, which is based on an interview with Shell CEO Jeroen van der Veer. In fact some of the interview is included as a video clip.

What is presented is an interesting discussion on the role of companies, the environmental integrity of investments and the direction that companies should invest in for the good of the planet. But the stark reality of the world in which we live and the system that we have collectively chosen to support our lives is that it is opportunity based. Where an opportunity exists, it will be seized and value extracted – that is the nature of our society. But we have also learned over many centuries that rules and laws are good things. They modify behaviour and ensure that commercialization of opportunity doesn’t in itself destroy value elsewhere. The same rules should apply everybody, for reasons of fairness. Good rules and laws may even open up new opportunities within which others can prosper. But it seems that we are still learning – clearly the rules within our financial system are still not quite robust enough.

The application of rules and laws applies to the environment as well. Lord Nicholas Stern clearly showed in The Stern Team Review that the development and use of abundant energy today is destroying future value, because todays CO2 emissions will have an impact down the line through climate change. So, the rules of the game need to change.

Over the past year in particular, and there will be even more in 2009, I have been busy with a number of colleagues in Shell seeking the necessary rule changes in the energy system, such that business will seize the opportunity presented by the demand for energy in a different way. We strongly believe that a market based rule system, with an emissions trading system at its core, is the way forward to address the issue of CO2 emissions. We also believe that standards should be set for vehicle efficiency, that vehicle fuels should be targeted with a declining CO2 footprint and that a high level target for the use of renewable energy is needed. The people in Shell believe that our company can prosper under a new set of rules. Most of this rule set is now in place in the EU. That is good – but global will be better.

In the Monbiot article, the Shell investment in Canadian oil sands is challenged. But this is an opportunity that many Canadians want to develop. So how do we square this off with environmental concerns – the answer is simple, change the rules. We think that Canada should introduce an EU style emissions trading system, ideally as part of a broader North American approach. With a declining cap (to deliver, for example, the Obama pledge of an 80% reduction by 2050), oil sands will have to find a new way forward. Carbon dioxide capture and storage may be one solution, allowing continued growth. Or maybe the solution doesn’t present itself, in which case oil sands development will plateau and decline.

Either way, changing the rules is the way forward. George Monbiot said as much in the last line of his blog as well.