Making climate change policies fit their own domain

A new framework acts as a sound guide for policy formation.

There is a widely held narrative for climate policy that runs something like this.  The costs of damage due to greenhouse gas emissions are not reflected in economic decisions.  This needs to be corrected by imposing a price on carbon, using the power of markets to incentivise efficient emissions reduction across diverse sources.  Carbon pricing needs to be complemented by measures to address other market failures, such as under-provision of R&D and lack of information.  Correcting such market failures can help carbon markets function more efficiently over time.  However further interventions, especially attempts by governments to pick winners or impose regulations mandating specific solutions, are likely to waste money.  This narrative, even if I have caricatured it a little, grants markets a central role with other policies in a supporting role.  Its application is evident, for example, amongst those in Europe who stress and exclusive or central role for the EUETS.

While this narrative rightly recognises the important role that markets can play in efficient abatement, it is incomplete to the point that it is likely to be misleading as a guide to policy.  A better approach has recently been characterised in a new book by Professor Michael Grubb and co-authors.  He divides policy into three pillars which conform to three different domains of economic behaviour.  Action to address all three domains is essential if efforts to reduce emissions to the extent necessary to avoid dangerous climate change are to succeed.  These domains and the corresponding policy pillars are illustrated in the chart below.

Three domains of economic behaviour correspond to three policy pillars …

Domains and pillars diagram

In the first domain people seek to satisfy their needs, but once this is done they don’t necessarily go further to achieve an optimum.  Although such behaviour is often characterised by economists as potentially optimal subject to implicit transaction costs this is not a very useful framework.  Much better is to design policy drawing on disciplines such as psychology, the study of social interactions, and behavioural economics.  This domain of behaviour relates particularly to individuals’ energy use, and the corresponding policy pillar includes instruments such as energy efficiency standards and information campaigns.

The second domain looks optimising behaviour, where companies and individuals will devote significant effort to seeking the best financial outcome.  This is the domain where market instruments such as emissions trading have the most power.  Policy making here can draw strongly on neoclassical economics.

The third domain is system transformation, and requires a more active role from governments and other agencies to drive non-incremental change.  The policy pillar addressing this domain of behaviour includes instruments for technology development, the provision of networks, energy market design, and design and enforcement of rules to monitor and govern land use changes such as deforestation.  Markets may have a part to play but the role of governments and other bodies is central here.  The diversity of policies addressing this domain means that it draws on a wide range of disciplines, including the study of governance, technology and industrial policy, institutional economics and evolutionary economics.

As one moves from the first to the third domain there is increasing typical scale of action, from individuals through companies to whole societies, and time horizons typically lengthen.

This framework has a number of strengths.  It is both simple in outline and immensely rich is its potential detail.  Each domain has sound theoretical underpinnings from relevant academic disciplines.  It acknowledges the power of markets without giving them an exclusive or predominant role – they become one of three policy pillars.  It implies that the vocabulary of market failures becomes unhelpful, as I’ve previously argued.  Instead policy is framed as a wide ranging endeavour where the use of markets fits together with a range of other approaches.  While this may seem obvious to many, the advocacy of markets as a solution to policy problems has become so pervasive, especially in Anglo-Saxon economies, that this broader approach stands as a very useful corrective to an excessively market-centric approach.

The framework is high level, and specific policy guidance needs to draw on more detailed analysis.  The authors have managed to write 500 pages of not the largest print without exhausting the subject.  However, the essential framework is admirable in its simplicity, compelling in its logic, and helpful even at a high level.  For example it suggest that EU policy is right to include energy efficiency, emissions trading and renewables – broadly first, second and third domain policies respectively – as well as to be active in third domain measures such as improving interconnection, rather than relying exclusively on emissions trading (although as the EUETS covers larger emitters, so first domain effects are less relevant for the covered sector).

The framework in itself does not tell you what needs to be done.  In particular the challenges of the third domain are formidable.  But it provides a perspective which deserves to become a standard structure for high level guidance on policy development.

Adam Whitmore – 31st October 2014

Costing damages from climate change offers only a partial guide to choice of policy

Estimates of the cost of damages from greenhouse gas emissions are more use for ruling in policy measures than ruling them out.

Estimates of the cost of the damages caused by greenhouse gas emissions (often referred to as the social cost of carbon) are widely used to assess the cost effectiveness of policies to reduce emissions.  Broadly speaking, emissions reductions that are cheaper than the cost of damages are judged cost-effective, while emissions reductions more expensive than the cost of damages risk being deemed not cost effective.  For example, the US EPA uses an estimate for the social cost of carbon of $39/tonne of CO2 (in 2015 at a 3% discount rate) as its benchmark, with policy measures leading to emissions reductions at a cost lower than this being considered cost effective.  Such estimates also act as a benchmark for carbon prices, on the grounds that an economically efficient carbon price should equal the expected cost of damages [1].

Detailed modelling is used to estimate the additional costs of damage per tonne of additional emissions (see notes at the end of this post for a short summary of this process).  The modelling is often thorough and elaborate, and attempts to be comprehensive.  However there are several factors which tend to lead to estimates of the cost of damages being below what it is really worth paying to avoid emissions.

Omitted costs

Many of the costs of climate change are omitted from models, essentially assuming that they are zero.  For example, knock-on effects, such as conflict from migration, are often not modelled, but may be among the largest costs of climate change.  Other costs are dealt with only partially, because they are difficult to estimate reliably [3], or difficult to measure as a financial loss.  For example, it is difficult, and in many ways impossible, to develop adequate costings for the loss of major ecosystems.

Difficulties in estimating the effects of large temperature changes

Models designed to estimate the cost of damages for a temperature change of one or two degrees may be become highly misleading if used to estimates the costs of larger temperature changes.  Damages may increase only quite slowly with small temperature changes, but are likely to increase quite rapidly thereafter, and perhaps catastrophically when certain thresholds are reached [4].  This is often not represented adequately in models.  For example, the widely used DICE model shows GDP only approximately halving with a temperature rise of 19 degrees centigrade.  This is unlikely to be realistic, and indeed the model’s author has cautioned against its use for temperature changes above around 3 degrees.  But temperature changes above 3 degrees would be very likely under a business as usual emissions scenario, and the effects of such large temperature changes are a major cause for concern.

Treating GDP growth as exogenous

Most models assume that the drivers of GDP growth are largely unaffected by even very severe climate change.  Over a century, even slow growth (anything above 0.7% p.a.) more than doubles GDP, and so more than offsets the costs of warming even if GDP is assumed to halve from the level it would otherwise reach.  Even with a temperature rise of 19 degrees over a century people appear, on average, better off than today, because the benefits of growth (more than doubling GDP) outweigh the costs of climate change (halving GDP).  Calling this result counterintuitive is something of an understatement.

Role of risks

Analysis often excludes some risks which are difficult to model, for example some types of climate feedbacks.  This effectively assumes that they won’t happen and so won’t cause any damage, ignoring the risks.  Indeed, even attempting to set a single average cost of damages fails to address the question of willingness to tolerate the chance of a cost much larger than the estimated average (due to low probability high impact events).  The EPA does estimate of the cost in the upper tail of the damage distribution, and some other modelling explicitly includes a range of sensitivities.  However these approaches, at best, go only part way towards addressing the problem of the risk of catastrophe outcomes, especially in view of the other limitations I’ve outlined.

Finally, the process of assessing policy measures needs to take account of all costs and benefits.  Measures to reduce emissions often have valuable co-benefits for health which need to be factored in to decision making.  And analysis needs to take account of future benefits for emissions reduction, for example in promoting early stage technologies.

Estimates of the cost of damage from greenhouse gas emissions remain useful inputs into decision making.  They can be useful in ruling policy measures in – if a policy measure has a cost per tonne below even a cautious estimate of the cost of damages then it is very likely cost-effective.  But they are much less useful for ruling measures out.  It is probably worth paying a good deal more to reduce the risks of large changes to the climate than the conventional estimates of damage costs suggest.  And in any case judging which risks are acceptable will always be a matter of political and ethical debate, rather than a simple matter of costings.

Adam Whitmore – 13th October 2014

Notes

[1] This principle that pricing of pollutants should reflect the cost of damages is commonly discussed in terms of Pigovian taxes or the Polluter Pays Principle.  

[2] The cost of damages, commonly referred to as the social cost of carbon (SCC), is usually estimated by modelling the cost of damages from additional emissions.  A base case emissions track is specified.  The changes to the climate and the resulting impacts associated with this base case emissions track are modelled.  The financial costs of the damages resulting from the impacts, for example due to rising sea levels, are estimated.  This process is repeated, adding an additional (say) billion tonnes of extra emissions, and calculating the costs of the additional damages that result.  The (discounted) additional cost of damages per tonne of additional emissions is derived from this.  These calculations are usually done using elaborate models known as Integrated Assessment Models (IAMs).  Estimates of the Social Cost of Carbon such as those used by the US EPA can refer to estimates from several different IAMs.  The uncertainties involved in the modelling lead to a wide range of estimates for the SCC. 

[3] A good survey of omissions from calculations of the SCC is given by a recent report co-sponsored by the US NGOs the Environmental Defense Fund and National Resources Defence Council:  http://costofcarbon.org/blog/entry/missing-pieces

[4] A good review of the limits of modelling can be found in Nicholas Stern, The Structure of Economic Modelling of the Potential Impacts of Climate Change, Journal of Economic Literature 2013.  This includes the reference to damages at very large temperature changes, quoting work by Ackerman, Stanton and Bueno: Fat tail, Exponents, Extreme Uncertainty: Simulating Catastrophe in DICE, Ecological Economics 69, 2010

 

Carbon regulation becomes the norm

Regulation of greenhouse gas emissions, including caps and prices, is spreading around the world.  Jurisdictions without something in place are becoming the exception.

Back in January I noted  that carbon pricing is in place or legislated in jurisdictions accounting for around a quarter of the world’s CO2 emissions from energy and industry (with typically around half of emissions in these jurisdictions being priced).    This is a huge increase from ten years ago, just before the introduction of the EUETS, when the corresponding figure was less than 1%.  But this trend is now set to go much further as limits on carbon emissions spread nationally in China and the USA.  A national emissions trading scheme in China is expected before the end of this decade, following on from the provincial trial schemes already established.  EPA regulation in the USA will introduce caps on emissions from the power sector to take effect from 2020.  These measures will mean that jurisdictions accounting for around two thirds of emissions will have some sort of cap or pricing in place.  (EPA regulation will be implemented at a state level.  It is likely to involve carbon pricing in some cases, although some states may pursue a more direct regulatory approach.  In either case emissions will be capped.)   This will have been achieved in only about a decade and a half.

With measures in place across the EU, the USA, and China, carbon caps and pricing will have become the norm rather than the exception.  This is likely to put pressure on other jurisdictions without such measures to act.  This trend is likely to be reinforced by agreement at the UNFCCC conference in Paris next year, even if, as expected, any agreement there stops short of legally binding emissions reduction targets.

Step chart

The blue line represents the proportion of global emissions of CO2 from energy and industry occurring in jurisdictions with carbon pricing (i.e. excluding other sources of CO2 such as deforestation, and other greenhouse gases).  The green line represents the proportion of emissions actually priced, which is typically about half the total, because some sectors are usually excluded from pricing.

Looking at broader climate legislation, including not just carbon pricing but also other measures aimed at emissions reduction or adaptation to climate change, a similar pattern of rapid growth is evident.  The number of pieces of climate legislation introduced in the last ten years was nearly four times that in the previous ten years.  And legislation has been introduced in both developed and developing countries.

Globe data on legislation

Source:  GLOBE study of climate change legislation (see notes)

There are, of course, many reasons to remain cautious about progress.  The outlook national scheme in China remains uncertain in the timing of its introduction (here assumed to be 2018), its stringency and its effectiveness.  US EPA regulation remains subject to legal challenge, although it seems likely to survive this.  Prices in the EUETS remain low.  And, even with all the present and prospective schemes in place, emissions reductions goals still fall short of what’s necessary to have a good chance of meeting the international commitment to limit the rise in average temperatures to 2 degrees (a goal which now looks extremely challenging in any case).

But there has been tremendous progress in a relatively short space of time.  Discussions on climate policy needs to recognise this context.  Any claims along the lines that either that “no-one’s doing anything” or “we’re the only ones doing something” are no longer valid.  There remains a pressing need to enhance this world-wide momentum, so that global emissions can peak and begin their ever more necessary downward track.  But acknowledging that should not obscure the remarkable progress that has been made.

Adam Whitmore –  30th September 2014

Notes

The spread of caps across the USA is shown as a single step on the above chart.  However the form of implementation of limits will in practice vary between states.  The caps under section 111(d) of the clean air act proposed by the EPA in the US are currently intensity based, with the conversion to mass based standards a matter of continuing discussion.  Implementation as the state level will vary, and it is likely that it will include pricing in some cases by not others.  Some states may join the Regional Greenhouse Gas Imitative (RGGI), others may include some kind of flexibility that in effect creates a carbon price in one state, or in a group, while others may pursue a more direct regulation of individual plants.

Japan and Mexico, which were deliberately excluded from the chart I posted in January as they have very low prices.  However they are included here.  The intention here is to give an indication of all the jurisdictions with action in some form.

The raw data for the chart showing the number of laws is here (see p.27):

http://www.academia.edu/6214974/The_GLOBE_Climate_Legislation_Study_A_Review_of_Climate_Change_Legislation_in_66_Countries._4th_Ed._Nachmany_Michal_Fankhauser_Sam_Townshend_Terry_Collins_Murray_Landesman_Tucker_Matthews_Adam_Pavese_Carolina_Rietig_Katharina_Schleifer_Philip_and_Setzer_Joana_  (see p.27)

Tranmission links to enable wind power

The availability of long distance transmission systems can help smooth out variations in availability of wind power, but helps solar less.  Policy needs to enable long-distance links to allow continuing increases in wind generation.

One of the challenges of moving to an electricity system running with a large proportion of wind and solar is that electricity output from these sources is variable, because the wind does not always blow and the sun does not always shine at any particular location.  With small proportions of these sources on the system this is not much of a problem.  However as a system becomes more dependent on these variable renewables, production is potentially curtailed in periods of high output, while there is a shortage of power at other times.  I’ll refer in this post to wind and solar photovoltaic (PV) power, which is by far the predominant form of solar electricity.  The issues with concentrated solar thermal power are different because there is some potential for storage in the power plant.

Difficulties with balancing supply and demand typically begin to become more severe as each type of variable renewable power, for example wind, begins to supply more than (very roughly) around 15% of annual electricity.  In practice the extent of the challenge of integration depends on a range of factors.  One influence is the amount of inflexible generating capacity such as nuclear on the system.  Another influence is the correlation between variable supply and demand.  For example, there is some seasonal correlation between electricity demand and wind output in Europe (in winter demand is higher and it’s windier), and there is some daily correlation between electricity demand and solar PV output in Australia (the demand peak is in the daytime).  Nevertheless, in any case there will be challenges in reliably meeting demand while accommodating very large amounts of variable supply.

To address this problem variable supply can be moved to different times, using storage, and to different places via transmission capacityDemand management can help, especially for a demand peaks, and some thermal back-up capacity is likely to be needed anyway in most cases.

The extent to which transmission links can help system balancing depends on the extent to which generation in different places is correlated.  If distant power sources tend to produce power at different times then transmission can greatly help smooth out variations in production, because when output is low in one location electricity can be moved there from another.  But if distant sources tend to produce power at the same time the advantages of long distance transmission will be reduced, because if output is low in one place there will be little electricity in the other place to move to fill the gap.  This is especially so if patterns of demand are also similar in the different places

Typically, correlations of output across regions for solar PV are much higher than for wind, especially as distances increase (see chart).  This is because solar output tends to depend strongly on time of day and season, which is quite similar even across an area as large as Western Europe, whereas wind varies with weather systems, which are less strongly related over distance of the order of 1000 miles or so.  Looking at the correlations between hourly output in different countries in Western Europe shows that the correlation between solar output in Germany and France is 88%, much greater than for wind at 44%.  Moving further away, the correlation between output in Germany and Spain is close to zero for wind, but still as high as 84% for solar.  The match of solar output is is actually greater than these figures imply due to the large number of times when solar output is zero for both countries.

Correlations of hourly output between different Eastern European countries are much greater for solar than for wind …

Correlations chart

These factors mean that increasing interconnection will tend to enable higher proportions of wind more than it will enable higher proportions of solar.  (This is assuming transmission is for load balancing.  Interconnection to transport power from sunnier to less sunny regions may well be valuable.  Also, this conclusion would change if intercontinental of transmission of large amounts of power were possible, but this remains a distant prospect.)

Incidentally, the correlation between solar and wind output is negative (when it’s windy it tends to be less sunny and vice versa), so having some of each on the system tends to increase the combined total that can be accommodated, compared with a system only having either one or the other.

A recent study of the USA by the National Oceanic and Atmospheric Administration (NOAA) confirmed very large benefits from High Voltage Direct Current (HVDC) long distance transmission for systems with large amounts of variable renewables.   The study used very detailed weather and load data, and data on existing power plants.  It concluded that with optimistic projections of wind and solar costs it is possible to reduce CO2 emissions by 82% with somewhat lower electricity costs, provided sufficient transmission capacity is in place.  The study emphasised the importance of the transmission network encompassing a large geographical area, such as the 48 contiguous US states, due to the large geographical scales over which weather is variable.

However, interconnectors are not always quick, cheap or easy to build.  They often link or cross different jurisdictions – US States, Chinese provinces or European countries – and will often link different types of electricity trading arrangement.  This can impose substantial barriers around permitting, and also around operation.  Policy can help the growth of wind by reducing these barriers and recognising the growing role of internconnection, although the precise policy measures necessary will be quite locally specific.  Enabling increased transmission is likely to be an important step in enabling the continuing growth of wind power in particular, and is likely to become increasingly urgent as growth continues.

Adam Whitmore – 16th September 2014

References

Thanks to Mathieu Ecoifier for providing the correlation coefficients between wind and solar in Europe.  Correlation coefficients are a rough and ready indicator of independence.  Actual effects on system operation will depend on many factors.

For analysis of the inverse correlation of wind and solar see for example Correlations Between Large-Scale Solar and Wind Power in a Future Scenario for Sweden, Joakim Widén, IEEE Transactions on Sustainable Energy, Vol. 2, No. 2, April 2011

The US study mentioned is Alexander MacDonald et. al., NOAA Earth System Research Laboratory, Low Cost and Low Carbon Energy Systems Feasible with Large Geographical Size (2014) – Presentation at Imperial College London 27th May 2014

Could rising aviation emissions be good for the environment?

international aviation sector is likely to require a substantial number of offsets to meet its goal of achieving carbon neutrality above a 2020 baseline.  If these offsets are forestry related there is the possibility of generating substantial biodiversity co-benefits.

Emissions from international aviation are around 2% of total emissions, and are expected to roughly quadruple by 2050, well above the expected growth rate of other sectors.  Faced with this prospect, and challenged by measures attempting to include international flights within the EUETS, the governing body for aviation the International Civil Aviation Organisation (ICAO) last year decided to look at using market based measures to cap net international aviation emissions at 2020 levels globally, with agreement to be reached by 2016.  The chart below illustrates the scale of the action needed to achieve this.  The blue line shows a scenario with high growth in emissions, which already includes efficiency gains from introducing new aircraft.  The dashed green line represents a lower emissions growth scenario.  The light blue area shows the potential contribution of new technologies and processes such as additional maintenance.  There is also a contribution from running the system more efficiently, with improved air traffic management and airport operation, shown by the brown area.  Such measures can in total probably reduce emissions growth by about 40%.  However this still leaves around 60% of emissions growth which is difficult to avoid by technology changes except in the long term.   (Reducing the growth in aviation services would also reduce emissions of course, but any set of policies that severely caps the number and length of journeys is likely to prove politically intractable.)

chart

Source:  ICAO CAEP A38-WP/26, 2013

For this remaining emissions growth the only realistic option for capping net emissions at 2020 levels over the next few decades is likely to be the use of offsets.  Demand for offsets from aviation could reach some hundreds of millions of tonnes p.a. in the 2030s, and this demand would be reliable as well as large, given the steady growth in demand.  It could provide a much needed source of demand for international offsets, which is currently weak.  The cost of this to passengers is likely to be small.  Emissions from a transatlantic flight are very roughly around a tonne of CO2e per passenger, so this would add about $10 to the price of an economy class ticket assuming an offset price of $10/tonne, and less at current international offset prices, which are in the low single figures of dollars per tonne.

One source of offsets that looks particularly promising is reduced emissions from deforestation and degradation (REDD).  There has been a marked reduction in the rate of deforestation in Brazil (and some other jurisdictions) in the last decade, despite a slight increase last year.  The reductions in Brazil have been achieved through a variety of measures, including improved monitoring by remote sensing, new legal frameworks with better enforcement, more intensive agriculture and so forth.  But funding from governments, including Norway, Germany and the UK, has also played a useful role in reducing deforestation.  Future programmes will likely benefit from the additional funding that REDD offsets can provide. , although this funding will never be enough on its own.  And the scale of offsets available is potentially large.  For example, 500 million tonnes p.a. is equivalent to avoiding over 8,500sq. km of Amazon forest loss each year, compared with about 5,800 sq. km of forest currently lost in the Amazon region of Brazil last year (and an average annual loss of about 11,500 sq. km over the last ten years).

For a satisfactory scheme any offsets will of course need to be high quality, including meeting the usual tests of additionally, permanence and so forth, with adequate governance a prerequisite.  Buffers, exchange rates or risk premiums may be necessary to account for residual risks around permanence, leakage and other factors, or to realise an explicit goal of generating net benefits, with (for illustration) 1.5 tonnes of REDD offsets required for every tonne of aviation emissions.  This would somewhat increase the area protected for a given number of aviation emissions, assuming that REDD offsets are available at an appropriate price.

REDD programmes have the advantage that they help conserve biodiversity.  Indeed biodiversity benefits can be made an explicit criterion in programme design and selection.  This may, for example, include building on the current Climate, Community and Biodiversity (CCB) standard that is widely used in voluntary markets.  This would potentially allow an overall net gain for the environment if net carbon emissions were zero.  Reduced emissions from deforestation would match increased airline emissions, and biodiversity would additionally be preserved – hence the (deliberately provocative) title of this post.  Programmes can also provide opportunities for local communities, and the CCB standard is again relevant here.  Indeed appropriate community involvement in projects, ensuring local communities also benefit, is likely to be essential to any successful REDD programme.

Establishing that offsets issued now can be used after 2020 would provide valuable early demand for credits.  However given the early stages of development of proposals by ICAO it may be difficult to attract investors at present.

So far REDD has struggled to find adequate funding from carbon markets, despite discussion of allowing limited volumes of REDD credits under the California emissions scheme.  And significant challenges remain in any circumstances.  In particular, governance often remains difficult given the requirements for monitoring and permanence of REDD projects and programs.

Eventually some technical solution will be needed to enable aviation emissions to be reduced at source.  However in the meantime the chance to generate substantial additional benefits for biodiversity and other environmental goals by the judicious choice of forestry offsets to help meet aviation goals is an opportunity well worth further exploration.

Adam Whitmore – 10th July 2014

Thanks to Ruben Lubowski of Environmental Defense Fund for useful comments on this post.

Notes

The 1 tonne CO2e per transatlantic flight per economy class passenger figure is indicative, and depends on the multiplier applied to the CO2 emissions to represent other atmospheric effects of emissions at altitude.

 

The need for a trend break in the carbon intensity of energy use

Looking at past changes in each driver of total emissions emphasises the necessity of deploying very low carbon technologies. 

There has been some recent discussion about the Kaya identity, which breaks down emissions from energy use into four factors: population, income per capita, energy intensity of the economy (energy used to produce each unit of GDP), and carbon intensity of energy supply (carbon emissions per unit of energy), so:

Carbon emissions from energy use =

population x (GDP/capita) x (energy/GDP) x (carbon/energy)

This applies to energy, the largest source of man-made greenhouse gas emissions, but it’s not a useful tool for looking other sources of emissions such as deforestation, industrial process emissions, and other greenhouse gases.

Emissions from energy use have continued to grow to date because the growth in the first two factors in the identity has been greater than reduction in the last two.  The chart below shows the breakdown into the four factors of the change each decade in total global CO2 emissions  from fossil fuel combustion. Changes are measured in absolute terms – gigatonnes (Gt) of CO2 emissions per decade – rather than percentages.  The bar segments show the changes associated with each factor alone, holding the other factors constant.  Total changes, the net effect of the four factors, are marked by a triangle.  In each decade population has grown, as has income per capita.  This has been partially offset by a reduction in energy intensity.  The smallest effect to date has been the change in the carbon intensity of energy use.  There was a slight reduction in the emissions intensity of energy supply for three decades, reflecting in large part the growth of gas use, which has lower emissions per unit of energy than other fossil fuels, and, for part of the period, growth in electricity generation from nuclear.  However this trend reversed in the first decade of this century, mainly due to the growth of coal use in China.  This reversal, together with the larger effect of very strong per capita GDP growth and continuing population growth, resulted in an acceleration of the growth of emissions after the turn of the century.

Chart

Source: IPCC (see notes [1])

Globally, population will continue to grow in the coming decades, as will income per head, with the world economy likely to roughly triple in size by 2050 [2].  If historic trends continue then falls in energy intensity energy will balance some of this growth of GDP, resulting in total energy use growing by about 70% over the period to 2050.  There is doubtless more that can be done to reduce energy intensity, but even doubling this rate from its past level, which would be an extraordinary achievement, would only approximately stabilise energy use, and thus emissions if there is no change in carbon intensity.

This leads a huge amount needing to be done by reductions in carbon intensity to achieve emissions reduction targets.  Emissions need to more than halve globally by 2050 if the agreed target of limiting temperature rise to two degrees centigrade is to be reached, and emissions will need to continue reducing thereafter.  Global average carbon intensity needs to fall by a corresponding amount, even if huge gains in energy efficiency are sufficient to keep total energy use constant, which seems unlikely.  Less ambitious emissions reductions targets still in practice will require large reductions in carbon intensity,  especially if progress on reducing energy intensity is slower.  Such reductions are made all the more challenging by the huge inertia in the energy system due to the scale and long lifetimes of existing infrastructure, with high emission existing energy sources often lasting decades.  This in turn implies that increasingly most new infrastructure will need to be very low carbon if the required changes to carbon intensity are to be made in only a few decades

However carbon intensity of energy use is currently almost unchanged from its level a quarter of a century ago.  Of the four factors driving emissions this has had by far the least effect – the net effect of the red bars in the above chart is much smaller than the other three factors.  If emissions are to be reduced, this factor needs to become as large as, or larger than, the other three factors.  A transformation of the energy system towards much lower carbon intensity really is necessary.  In this respect the falling cost of renewables, especially solar, and progress in delivering batteries with improved technology and lower costs represent some of the most encouraging developments in securing a low carbon economy that we have yet seen.

Those who point out the urgency of the transformation to low carbon energy systems are right.  Those who point out the difficulty of achieving the huge required trend break in carbon intensity are also right.  The combination of urgency and scale of required reductions in carbon intensity, along with the need for faster improvements in the efficiency of energy use, is, at its simplest, what makes the problem of reducing emissions from the energy sector so challenging.

Adam Whitmore – 27th June 2014

Notes and references

[1] The chart is from IPCC, Fifth Assessment Report Working Group 3, and can be found here:

http://mitigation2014.org/report/summary-for-policy-makers

Income is converted into common units using purchasing power parity (PPP) exchange rates.

[2] The extrapolation of the formula to 2050 is indicatively as follows.   World GDP is expected grow at roughly 3% p.a., roughly tripling by 2050.  This comprises a 30% growth in population to just over 9 billion over the period, with GDP per capita growing at around 2.3% p.a. to more than double by 2050.  Data is from OECD modelling see http://www.oecd-ilibrary.org/environment/an-economic-projection-to-2050-the-oecd-env-linkages-model36-baseline_5kg0ndkjvfhf-en

With no change in energy intensity, energy use would also triple.  However, energy intensity has historically reduced at about 1.5% p.a. (based on World Bank data – other sources give broadly similar figures).  This would reduce growth in energy demand to around 70%.  Doubling the rate of energy intensity reduction to 3.0%, a huge increase, would only succeed in reducing the growth rate of emissions to around zero, thus stabilising emissions at their current level.  Any reductions in emissions would still need to come from changes in carbon intensity.

Types of carbon pricing (part 3 of 3)

This is the last of three posts summarising the differing features of carbon pricing instruments – emissions trading (cap-and-trade), carbon taxes, and hybrids – and commenting on some of the implications for existing carbon pricing schemes.  The three posts together can be found as a pdf file here.

This post looks at the benefits of hybrid schemes that include elements of both quantity and price management, and what this implies for the design of carbon pricing schemes around the world.  In practice most carbon pricing schemes are to some extent already hybrids, but here a preferred form of hybrid is suggested.

It has long been recognised there is no need to restrict policy to a pure price (carbon tax) or pure quantity (cap-and-trade) instrument, and that a hybrid of the two can have benefits[1].  In particular an emissions cap combined with a price floor can limit total emissions, and so reduce the risk of crossing cumulative thresholds where damage becomes very high, while ensuring that the price never falls below estimates of the current marginal cost of damage.  It is thus likely to form a better approximation to the cost of damages than either a tax or a cap alone, more closely conforming to the basic principle that carbon prices should approximate to the costs of damages[2].  It also allows the cap to specify a (global) social choice about the acceptable level of risk, while continuing to price emissions below that threshold so as to stimulate investment to abate emissions which, even if the worst of the risks are avoided, impose costly damage.  And it gives a clear signal about the scale of the challenge and the transformational change necessary to meet it.

A price ceiling may also make sense if it prevents unduly costly abatement that reflects only the particular circumstances of a regional ETS over a limited time horizon.  However a cap is there to prevent steeply rising damages above a particular threshold, so it is necessary that the integrity of an overall global target is maintained.  This can be supported by setting aside allowances from within the cap in a cost containment reserve, as is already done in California.

Also, the advantages of a tax may be better realised by a hybrid scheme than by a pure tax for simple pragmatic reasons.  Emissions trading schemes are already in place in many jurisdictions and it is likely to be easier to move to a hybrid scheme that at least gains some of the benefits of a tax than to abolish an ETS and replace it completely with a tax.  Indeed many ETSs already have elements of price management.

Price floors and ceilings can be stepped, creating a full price schedule, where additional emissions are considered to create different costs.  However estimates of the appropriate price levels are subject to large uncertainties.  And the stock of GHGs is the atmosphere varies relatively little with additional emissions over short time periods even in large jurisdictions.  This suggests that a stepped floor may imply a precision in the specification of desirable trade-offs which is not really justified by the precision of the available data.

There may be further advantages from introducing hybrids in enhancing stability and thus credible commitment with price containment mechanisms.  They can reduce the pressure to review a scheme because either prices or emissions levels are proving outside expected ranges.  On the other hand price containment may make linking of different emissions trading schemes more complex.

Implications for existing schemes

So what does a policy reflecting best design practice look like?  Larger jurisdictions should look to put in place an emissions trading scheme with a long term declining cap, consistent with long term goals for limiting the global stock of greenhouse gases.   This should be complemented by a lower limit on price in the form of an auction reserve price increasing over time.  For smaller jurisdictions a tax, or at least fairly tight bounds on the price under an ETS, may make more sense in the short term, probably with the eventual goal of moving towards an ETS linked (directly or indirectly) with other schemes.  Making additional allowances available at high prices (a ceiling) is likely to be beneficial if these can be drawn from a pool of allowances previously set aside.  However the quantity of additional allowances available at a higher price should be limited to protect the integrity of the overall cap, at least in larger schemes.

This rough outline gives a framework for a broad, high level assessment of current schemes.  The scheme that approximates most closely to best practice design at the moment is California.  Quebec offers an example of moving to an ETS linked to a larger scheme, in this case California, and also includes the good design features of the California scheme.  RGGI has broadly appropriate in structure, but the levels of both price floors and ceilings look much too low to adequately price the damages due to additional emissions.  Similarly the price ceiling in the Alberta scheme looks too low at present, and moves towards reform are welcome.

The EU ETS remains the world’s largest carbon pricing scheme, with a cap declining according to a long term goal, and as such is very valuable.  It would benefit greatly from a price floor, although this is unlikely to prove politically feasible.

British Columbia’s carbon tax seems appropriate to its circumstances and is at something like an appropriate level, although it could seek long term to integrate into an emissions trading scheme covering Canada and (preferably) the rest of North America.  In the meantime Mexico may be justified in choosing a tax due to its administrative simplicity, but the starting level looks much too low.  South Africa may also be right to favour a tax, at least at present, given its greater simplicity.  New Zealand would be justified in considering a carbon tax in place of its ETS, and certainly current low prices under the ETS look inappropriate.

China appears to be moving in the right direction with its preference for emissions caps including recognition of the need for price containment, though its particular approaches to price containment will take some time to become established.

So, much is being done, but there is potential for reform to improve the functioning of carbon pricing schemes.  Continuing expansion of limits on emissions in China is of enormous importance.  And the California scheme offers a model of good design which many could follow.

Adam Whitmore – 13th May 2014

[1] The original analysis in this area is Roberts M.J. and Spence M., 1976 Effluent charges and licenses under uncertainty.  Journal of Public Economics 5 193-208.

[2] Working Paper No. 48  See Climate Strategies Briefing Paper (www.climatestrategies.org) Grubb, M. (2012). Strengthening the EU ETS. Creating a stable platform for EU energy sector investment. Climate Strategies Full Report (www.climatestrategies.org) for a discussion of this issue in the specific context of the EUETS.