Europe’s phase out of coal

Europe is progressing with phasing out hard coal and lignite in power generation, but needs to move further faster, especially in Germany and Poland

Reducing coal use in power generation and replacing it with renewables (and in the short run with natural gas) remains one of the best ways of reducing emissions simply, cheaply and quickly at large scale.  Indeed, it is essential to meet the targets of the Paris Agreement that the world’s limited remaining cumulative emissions budget is not squandered on burning coal and lignite in power generation.

Europe is now making progress in phasing out coal.  The UK experience has already illustrated what can be done with incentives from carbon pricing to reduce coal generation.  Emissions from coal have reduced by more than 80% in the last few years, even though coal plant remains on the system[i].  However, many countries, including the UK, are now going further and committing to end coal use in power generation completely in the next few years.  The map below shows these commitments as they now stand.  Most countries in western Europe now have commitments in place. (Spain is an exception.  The government is expecting coal plant to be phased out by 2030, but currently does not mandate this.)

Map: Current coal phase-out commitments in Europe[ii]

Source: Adapted from material by Sandbag (see endnotes).

In some countries there is little or no coal generation anyway.  In other countries plants are old and coming to the end of their life on commercial grounds, or are unable to comply with limits on other pollutants.  In each case phase-out is expected to go smoothly.

However, the largest emitters are mainly in Germany and Poland and here progress is more limited.  Germany has now committed to coal phase-out.  But full phase-out might be as late as 2038.  Taking another 20 years or so to phase out such a major source of emissions is simply too long.  And Poland currently looks unlikely to make any commitment to complete phase out.

This means the Europe is still doing less than it could and should be doing to reduce emissions from coal and lignite.  As a result, EU emissions are too high, and the EU loses moral authority when urging other nations, especially in Asia and the USA, to reduce their emissions further, including by cutting coal use.

Several things are needed to improve this situation, including the following.

• Further strengthening the carbon price under the EUETS by reducing the cap. I looked at the problem of continuing surpluses of allowances in another recent post, and accelerated coal closure would make the surplus even greater.  Although the rise in the EUA price in the last 18 months or so is welcome, further strengthening of the EUETS is necessary to reduce the risk of future price falls, and preferably to keep prices on a rising track so they more effectively signal the need for decarbonisation.
• Continuing tightening of regulations on other pollutants, which can improve public health, while increasing polluters’ costs and therefore adding to commercial pressure to close plant.
• Strengthening existing phase out commitments, including be specifying an earlier completion date in Germany.
• Further enabling renewables, for example by continuing to improve grid integration, so that it is clear that continuing coal generation is unnecessary.

As I noted in my last post, making deep emissions cuts to avoid overshooting the world’s limited remaining carbon budget will require many difficulties to be overcome.  There is no excuse for failing to make the relatively cheap and easy reductions now.   Reducing hard coal and lignite use in power generation in Europe (and elsewhere) continues to require further attention.

Adam Whitmore – 18^th June 2019

[i] See https://onclimatechangepolicydotorg.wordpress.com/2018/01/17/emissions-reductions-due-to-carbon-pricing-can-be-big-quick-and-cheap/

With and updated chart at:

https://onclimatechangepolicydotorg.wordpress.com/carbon-pricing/price-floors-and-ceilings/

[ii] Map adapted from Sandbag:

https://sandbag.org.uk/wp-content/uploads/2018/11/Last-Gasp-2018-slim-version.pdf

and data in:

https://beyond-coal.eu/wp-content/uploads/2018/11/Overview-of-national-coal-phase-out-announcements-Europe-Beyond-Coal-November-2018.pdf

and https://www.eia.gov/todayinenergy/detail.php?id=39652

Increasing the political acceptability of carbon taxes

Straightforward, practical measures can make carbon taxes more acceptable to voters.

Carbon pricing often faces political obstacles due to public opposition …

Carbon pricing has spread widely in recent years, with around 40 systems now in place[i].  However, most emissions are not yet priced, and, even where they are, most prices remain too low.

Both expanding coverage and increasing price levels face political obstacles.  Overcoming these is essential for carbon pricing to play the role that it should in reducing emissions.  Fortunately, evidence is now emerging on what can be done to reduce opposition from voters – overcoming opposition from powerful lobbies such as industry warrants separate approaches.

A study by researchers at the LSE’s Grantham Research Institute, based on reviewing 39 existing empirical analyses, describes people’s objections to carbon pricing and other kinds of environmental taxes, and suggests specific actions to overcome them.  (The study focusses on carbon taxes, and most evidence is from North West Europe and North America, so the conclusions may not extend fully to emissions trading systems or to other cultural contexts.)

The study identifies several reasons people oppose carbon taxes:

• The personal and wider economic costs of a tax are seen as too high.
• Carbon taxes are seen as regressive, having a disproportionately negative effect on low-income households.
• Carbon taxes are not believed to be an effective way to reduce emissions.
• Governments are seen as having a ‘hidden’ motive to increase fiscal revenue rather than curb emissions.

However the study noted that people’s aversion to carbon taxes decreases over time after they have been introduced, particularly if the effects of the tax are measured and communicated.

There are various design options for reducing public opposition …

The study then identifies a range of measures for addressing the objections

• Phasing in carbon taxes over time, introducing the tax at a low rate but having commitment devices to subsequently increase the rate to more efficient levels.
• Redistributing revenues to ameliorate the regressive effects of taxes.
• Earmarking revenues for emission reduction projects, which is popular with voters and improves the perceived effectiveness of carbon taxes.
• Ensuring revenue neutrality of carbon taxes.
• In all cases, policymakers need to gather and communicate the objectives and design of the carbon price to improve trust and credibility, before and after the introduction of a carbon tax. This includes communicating emissions reductions achieved and co-benefits of reductions in other pollutants[ii].

Drawbacks to these options seem limited …

The study notes that these recommendations may diverge from “first best” tax designs recommended in the economics literature.  However, while the study does not assess the implications of this, it is not clear to me that, even where they exist, these divergences are very significant.  They seem to me likely to be easily outweighed by the increased acceptability (a “sub-optimal” carbon tax that can be implemented is usually better than an “optimal” one that can’t).  And there are likely to be benefits often omitted in modelling of “first best” designs. This is especially the case as once a tax is in place it can be modified to over time as experience is gained and acceptance increases.

For example, phasing in a carbon tax is likely to produce economic benefits by reducing economic dislocation due to a price shock from sudden introduction at its full level, which may at least partly counterbalance the inefficiencies from prices being below optimal levels for an initial period.  Similarly, redistribution of revenue to poorer households may provide an economic stimulus benefits as poorer households are more likely to spend the revenue than richer households.  It may also increase social solidarity in ways which are conducive to economic welfare and growth.

Other emissions reductions, for example improving building insulation and deploying new technologies, may be funded at more nearly optimal levels where there are currently restrictions.  However, caution is needed here, and there may often be a stronger case for dispersing funds to citizens.

Revenue neutrality can take different forms.  One approach is to use revenues to reduce other taxes.  This is the approach adopted for the introduction of the carbon tax in British Columbia.  Economists tend to favour this type of approach because existing taxes are seen as distortionary.  However this approach often lacks transparency and credibility even if accompanying tax cuts are publicised – for example if other taxes are reduced they may be increased again in future.  This appears to be one reason why voters tend not to prefer this option.

And the current Canadian experiment with “tax and dividend” approaches appears promising …

A stronger guarantee is provided when revenue is explicitly returned to citizens.  This approach is usually referred to as “tax and dividend” (or “fee and dividend”, or “cap and dividend” in the case of any emissions trading system).  I’ve previously noted the advantages of this approach (see here).  It has been implemented for the Swiss carbon tax in the form of rebates on health insurance costs.  Four provinces in Canada are now working on implementing dividends in the form of direct financial payments to citizens.  This will make most citizens better off as the result of the tax, because they will also benefit from revenue raised from businesses.

There is an argument made in the environmental economics literature that a lump-sum dispersal to citizens is economically suboptimal, because it is better to use funds to reduce other taxes and so reduce distortions.   There is little if any empirical support for this argument as far as I am aware.  But in any case taking a view that citizens have more of a natural claim on property rights to the atmosphere than governments makes the limitation of the argument clear.  From this perspective, not providing citizens with any of the proceeds from pricing emissions is in effect a 100% tax on those proceeds imposed on everyone.  This is indeed non-distortionary – it applies the same tax to everyone irrespective of circumstances – but a fixed per-capita tax is not regarded by governments or their citizens as a good idea anywhere, for sound reasons.

A larger objection to returning all revenue directly to citizens, or using it to reduce current taxes, is that emissions run down natural capital for the benefit of current generations at the expense of future generations.  Intergenerational justice would, as I’ve previously argued (see here and here), be better served by some combination of preserving natural capital and investing revenue from carbon pricing in a “carbon wealth fund” analogous to a sovereign wealth fund.  However this would be unlikely to increase the political acceptability of carbon pricing compared with immediate dispersal of revenues to citizens.

Overall, the study makes a range of recommendation that are well justified on a range of grounds, and seem likely to help establish carbon pricing more widely and effectively.  It is to be hoped that governments everywhere take note of the findings.

Adam Whitmore – 5^th March 2019 

Thanks to Maria Carvalho for useful discussions about the background to the study covered by this post.

[i] See the World Bank’s State and Trends of Carbon Pricing report here.  The definition of carbon pricing adopted in that report is quite broad, but even excluding some of the systems included in the report there remain over 40.

[ii] Please see World Bank’s  Guide to Communicating Carbon Pricing here for more information on developing an effective communications strategy.

 

Fixing the starting price of allowances in an ETS

Fixed price allowances can be a useful way of establishing emissions trading gradually.

I have previously looked at the relative advantages of carbon taxes and emissions trading systems (ETSs), including in the videos on this site.

Among the drawbacks of emissions trading systems is that they tend to be more complex to administer than carbon taxes.  An emissions trading system requires surrender of allowances, which need to be issued, often by both auction and free allocation, and tracked as they are traded.  There is a range of administration needing for this, including maintaining a registry of allowances and ownership.  In contrast, a tax simply requires a payment to be made per tonne emitted.

The administrative cost of emissions trading is unlikely to be a significant proportion of the costs of a system for a large jurisdiction with high administrative capacity, for example the EU.  However it can be daunting for smaller jurisdictions with more limited administrative capacity.  Even a large jurisdiction may be concerned about the time needed to establish an emissions trading system.

There may also be concern about the economic the risks.  For example, there will always be uncertainty about price when the cap is first set.

These difficulties can be reduced by including an initial phase of fixed price allowances.  Under this approach emitters pay a fixed price per tonne.  However rather than simply paying a tax they are required to surrender allowances.  An unlimited number of allowances is available from the regulatory authorities at a fixed price.

This approach has the advantage that it puts in place much of the administrative infrastructure necessary for emissions trading.  Allowances are issued and a registry is established.  From there it is a more straightforward path to limiting the number of allowances to impose a cap, and allowing them to be traded.

It has the further advantage that it can introduce a carbon price, perhaps gradually through and escalating price, and the effect of this can be assessed when setting  a subsequent the cap.  The additional information can further reduce risks.

The Australian example

This approach of issuing fixed price allowances was implemented in Australia, starting in 2012.  An initial 3 year phase was originally planned with emitters required to surrender allowances.  An unlimited number of allowances was available each year at a fixed price.  This was AU$23/tonne in the first year, escalating at 2.5% plus the rate of inflation each year. This was intended to be followed by a transition to an emissions trading system with a cap and a price floor.

The chronology in practice was as follows.  Legislation to introduce carbon pricing was passed in 2011.  The fixed price came into effect ion 1^st July 2012, with unlimited allowances available at AU$23/tonne.  Full trading was originally scheduled to being in 2015.  In 2013 it was announced this would be brought forward a year to 2014.  However this did not happen, as the incoming Abbott government, which took office in September 2013, repealed the carbon pricing scheme with effect from July 2014.

In the Australian political context that prevailed at the time the similarity to a tax was seen as a drawback politically.  It allowed the opposition to label it a tax, which the previous government had committed not to introduce.  A very sensible approach was therefore abandoned.  However this was a feature peculiar to Australian politics at the time, and not a more general problem.

The EU and the Western Climate Initiative have both shown that it is possible to establish emissions trading systems directly, without the need to go through an initial fixed price phase (the WCI systems were delayed by a year from their originally intended start date, but have generally worked well since).  And some jurisdictions will choose a tax in any case.

Nevertheless, if there is a desire to put an ETS in place in a way which lowers the initial administrative burden and some of the risks of establishing an ETS, then transitioning to an ETS through issuing fixed price allowances can be a valuable approach.

Adam Whitmore – 13^th June 2018

Five years on

The past five years have given many reasons for optimism about climate change

I have now been writing this blog for just over five years, and it seems timely to step back and look at how the climate change problem appears now compared with five years ago.

In some ways it is easy to feel discouraged.  In the last five years the world has managed to get through about a tenth of its remaining carbon budget, a budget that needs to last effectively forever.

However, in many ways there seem to be reasons for much greater optimism now than five years ago.  Several trends are converging that together make it appear that the worst of the risks of climate change can be avoided.

There is increasing action at the national level to reduce emissions, reinforced by the Paris Agreement …

Legislation is now in place in 164 countries, including the world’s 50 largest emitters.  There are over 1200 climate change and related laws now in place compared with 60 twenty years ago[i].  And this is not restricted to developed countries – many lower income countries are taking action.  Action at national level is being supported around the world by action in numerous cities, regions and companies.

This trend has now been reinforced by the Paris Agreement, which entered into force in November 2016, and commits the world to limiting temperature rises and reducing emissions.

There is increasing evidence of success in reducing emissions …

Many developed countries, especially in Europe, have shown since 1990 that it is possible to reduce emissions while continuing to grow their economies.  Globally, emissions of carbon dioxide from energy and industry have at least been growing more slowly over the past four years and may even have reached a plateau[ii].

Carbon pricing is spreading around the world  …

Among the many policies put in place, the growth of carbon pricing has been especially remarkable.  It has grown from a few small northern European economies 15 years ago to over 40 jurisdictions[iii].  Prices are often too low to be fully effective.  However, carbon pricing has also been shown to work spectacularly well in the right circumstances, as it has in the UK power sector.  And the presence of emissions caps in many jurisdictions gives a strong strategic signal to investors.

Investors are moving out of high carbon sources and in to lower carbon opportunities …

Companies are under increasing pressure to say how their businesses will be affected by climate change and to do something about reducing emissions.  And initiatives such as the Climate Action 100+, which includes over two hundred global investors controlling over $20 trillion of assets, are putting pressure on companies to step up their action.  This will further the trend towards increasing investment in a low carbon economy.  Meanwhile, many funds are divesting from fossil fuels, and vast amounts of capital are already going into low carbon investments.

Falling costs and increasing deployment of renewables and other low carbon technologies …

Solar and wind power and now at scale and continuing to grow very rapidly.  They are increasingly cost-competitive with fossil fuels.  The decarbonisation of the power sector thus looks likely to proceed rapidly, which will in turn enable electrification to decarbonise other sectors.  Electric vehicle sales are now growing rapidly, and expected to account for the majority of light vehicle sales within a couple of decades.  Other technologies, such as LED lighting are also progressing quickly.

This is not only making emissions reductions look achievable, it is making it clear that low carbon technologies can become cheaper than the high carbon technologies they replace, and can build whole new industries as they do.  As a reminder of just how fast things have moved, in the last five years alone, the charts here show global generation from wind and solar since 2000.

Falling costs of low carbon technologies, more than anything else, gives cause for optimism about reducing emissions.  As lower carbon alternatives become cheaper the case for high carbon technologies will simply disappear.

Charts: Global Generation from Wind and Solar 2000 – 2017

Sources:  BP Statistical Review of World Energy, Enerdata, GWEC, IEA

Climate sensitivity looks less likely to be at the high end of the range of estimates …

The climate has already warmed by about a degree Celsius, and some impacts from climate change have been greater than expected.  However, the increase in temperature in response to increasing concentrations of greenhouse gases has so far shown few signs of being towards the top end of the possible range, although we can never rule out the risk of bad surprises.

Taking these trends together there is reason to be cautiously optimistic …

There will still be serious damage from climate change – indeed some is already happening.  And it is by no means clear that the world will act as quickly as it could or should.  And there could still be some nasty surprises in the earth’s reaction to continuing emissions.  Consequently, much effort and not a little luck is still needed to avoid the worst effects of climate change.

But compared with how things were looking five years ago there seem many reasons to believe that things are beginning to move in the right direction.  The job now is to keep things moving that way, and to speed up progress.

Adam Whitmore – 10^th April March 2018 

[i] http://www.lse.ac.uk/GranthamInstitute/publication/global-trends-in-climate-change-legislation-and-litigation-2017-update/

[ii] http://www.pbl.nl/sites/default/files/cms/publicaties/pbl-2017-trends-in-global-co2-and-total-greenhouse-gas-emissons-2017-report_2674.pdf

[iii] https://openknowledge.worldbank.org/handle/10986/28510

There should be few reservations about auction reserve prices

The auction reserve price in California has proved successful in maintaining a minimum carbon price.  However it shows the importance for an emissions trading system of political commitment and stability. 

This is the second of two posts looking at experience of carbon price floors.  My previous post looked at UK carbon price support, which guarantees a minimum price by means of a tax.   This post looks at an alternative approach, which is used in California  and the other Western Climate Imitative systems, Quebec and Ontario.  Here, instead of imposing a tax, the floor is set by specifying a reserve price in auctions of allowances.  If bids in auctions stay below the reserve price the allowances are not sold.  Reserve prices such as this are common in practice in many commercial auctions, including those held by major auction houses and online.

Reserve prices give what is often called a “soft” floor.  The market price can go below the auction reserve, but eventually the need to buy allowances at auction is likely to ensure that the price recovers.

The chart below shows the auction reserve price in the California system (green line), which started at $10/tonne in 2012 and is increased each year by 5% plus the rate of inflation.  The California market price (blue line) has generally stayed above this level.  However it did dip below the reserve price for a while in 2016, illustrating that the floor is soft.  This price dip reflected a combination of legal challenges to the system, and political uncertainty about the continuation of the system after 2020, which together reduced the demand for allowances.  Once those uncertainties were resolved the market price recovered.

Chart: Auction reserve prices and market allowance prices in the California cap-and-trade system to end of 2017

Source:  http://calcarbondash.org/ and CARB

The Regional Greenhouse Gas Initiative (RGGI) has similar arrangements but with a much lower reserve price, and there too the price has been above the floor.

The environmental effectiveness of price containment mechanisms depends in large part on what eventually happens to any unsold allowances.  In the case of California this issue particularly affects the upper Price Containment Reserve, from which allowances are released if prices go above defined thresholds.  Allowances from this reserve appear most unlikely to be required in the current phase, as prices seem highly unlikely to reach the threshold levels.  If these unsold allowances in the reserve are cancelled, or otherwise put beyond use, cumulative emissions will be lower.  However if they eventually find their way back into the system, and enable the corresponding quantity of emissions to take place, the environmental benefit may not be realised, or at least not it full.  Some sort of cancellation mechanism is therefore needed, for example cancelling allowances that have been in the reserve for more than a specified number of years.

So price floors can work, however in the case of the California system at least two things need to be agreed as the rules for the system after 2020 are debated this year.

First, continuation of the escalation of the floor price needs be confirmed at least at the current rate, and ideally the rate should be increased.

Secondly, rules for cancelling unsold allowances from the Price Containment Reserve need to be defined.  The cancellation of allowances from the Market Stability Reserve included in the recent reforms to the EUETS sets a valuable precedent in this respect.

The theoretical advantages of a floor price in an ETS are well known.  The experience of auction reserve prices now proving effective in practice over a number of years should encourage other jurisdictions, especially the EU, to introduce similar arrangements.  And those jurisdictions such as California where they are already in place need to continue to develop and enhance them.

Adam Whitmore – 15^th February 2018

Emissions reductions from carbon pricing can be big, quick and cheap

The UK carbon tax on fuel for power generation provides the most clear-cut example anywhere in the world of large scale emissions reductions from carbon pricing.   These reductions have been achieved by a price that, while higher than in the EU ETS, remains moderate or low against a range of other markers, including other carbon taxes.

The carbon price for fuels used in power generation in the UK consists of two components.  The first is the price of allowances (EUAs) under the EUETS.  The second is the UK’s own carbon tax for the power sector, known as Carbon Price Support (CPS).  The Chart below shows how the level CPS (green bars on the chart) increased over the period 2013 to 2017[i].  These increases led to a total price – CPS plus the price of EUAs under the EUETS (grey bars on the chart) – increasing, despite the price of EUAs remaining weak.

This increase in the carbon price has been accompanied by about a 90% reduction in emissions from coal generation, which fell by over 100 million tonnes over the period (black line on chart).   Various factors contributed to this reduction in the use of coal in power generation, including the planned closure of some plant and the effect of regulation of other pollutants.  Nevertheless the increase in the carbon price since 2014 has played a crucial role in stimulating this reduction in emissions by making coal generation more expensive than gas[ii].  According to a report by analysts Aurora, the increase in carbon price support accounted for three quarters of the total reduction in generation from coal achieved by 2016[iii].

The net fall in emissions over the period (shown as the dashed blue line on chart) was smaller, at around 70 million tonnes p.a. [iv] This is because generation from coal was largely displaced by generation from gas. The attribution of three quarters of this 70 million tonnes to carbon price support implies a little over 50 million tonnes p.a. of net emission reductions due to carbon price support.   This is equivalent to a reduction of more than 10% of total UK greenhouse gas emissions.  The financial value of the reduced environmental damage from avoiding these emissions was approximately £1.6 billion in 2016 and £1.8 billion in 2017^[v].

Chart:  Carbon Prices and Emissions in the UK power sector

The UK tax has thus proved highly effective in reducing emissions, producing a substantial environmental benefit[vi].  As such it has provided a useful illustration both of the value of a floor price and more broadly of the effectiveness of carbon pricing.

This has been achieved by a price that, while set at a more adequate level than in the EU ETS, remains moderate or low against a range of other markers, including other carbon taxes.  CPS plus the EUA price was around €26/tCO₂ in 2017 (US$30/tCO₂).  The French the carbon tax rose from €22/tCO₂ to €31/tCO₂ over 2016-2017. In Canada for provinces electing to adopt a fixed price the carbon price needs to reach CAN$50/tCO₂ (€34/tCO₂) by 2022[vii].  These levels remain below US EPA 2015 estimates of the Social Cost of Carbon of around €40/tCO₂ [viii].

This type of low cost emissions reduction is exactly the sort of behaviour that a carbon price should be stimulating, but which is failing to happen as a result of the EU ETS because the EUA price is too low.  More such successes are needed if temperature rises are to be limited to those set out in the Paris Agreement.  This means more carbon pricing should follow the UK’s example of establishing an adequate floor price.  This should include an EU wide auction reserve for the EUETS.  The reserve price should be set at somewhere between €30 and €40/t, increasing over time.  This would likely lead to substantial further emissions reductions across the EU.

Adam Whitmore – 17^th January 2018

Notes:

[i] Emissions date for 2017 remains preliminary.  UK carbon price support reached at £18/tCO₂ (€20/tCO2) in the fiscal year 2015/6 and was retained at this level in 2016/7.  In 2013/4 and 2014/5 levels were £4.94 and £9.55 respectively.  This reflected defined escalation rates and lags in incorporating changes in EUA prices. https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/293849/TIIN_6002_7047_carbon_price_floor_and_other_technical_amendments.pdf and www.parliament.uk/briefing-papers/sn05927.pdf

[ii] http://www.theenergycollective.com/onclimatechangepolicy/2392892/when-carbon-pricing-works-2

[iii] https://www.edie.net/news/6/Higher-carbon-price-needed-to-phase-out-UK-coal-generation-by-2025/

[iv] Based on UK coal generation estimated weighted average emissions intensity of 880gCO2/kWh, and 350gCO₂/kWh for gas generation.

[v] 50 million tonnes p.a. at a social cost of carbon based on US EPA estimates of $47/tonne (€40/tonne).

[vi] There is a standard objection to a floor in one country under the EUETS is that it does not change of the overall cap at an EU level so, it is said, does not decrease emissions.  However this does not hold under the present conditions of the EUETS, and is unlikely to do so in any case.  A review of how emissions reductions from national measures, such as the UK carbon price floor, do in fact reduce total cumulative emissions over time is provided was provided in my recent post here.

[vii] The tax has now set at a fixed level of £18/tonne.  It was previously set around two years in advance, targeting a total price comprising the tax plus the EUA price.  There was no guarantee that it would set a true floor price, as EUA prices could and did change a good deal in the interim.  Indeed, in 2013 support was set at £4.94/tCO2, reflecting previous expectations of higher EUA prices, leading to prices well below the original target for the year of £16/tCO2 in 2009 prices (around £17.70 in 2013 prices). See https://openknowledge.worldbank.org/handle/10986/28510?locale-attribute=en.  The price is also below the levels expected to be needed to meet international goals (see section 1.2), and below the social cost of carbon as estimated by the US EPA (see https://onclimatechangepolicydotorg.wordpress.com/carbon-pricing/8-the-social-cost-of-carbon/ and references therein).

[viii] Based on 2015 estimates.

Half way there

The UK has made excellent progress on reducing emissions.  But the hard part is yet to come.

The UK’s Climate Change Act (2008) established a legally binding obligation to reduce UK emissions by at least 80% from 1990 levels by 2050.  This is an ambitious undertaking, a sixty year programme to cut four in every five tonnes of greenhouse gas emissions while simultaneously growing the economy.

The story so far is, broadly, an encouraging one.  2016 emission were 42% below 1990 levels, about half way to the 2050 target[1].  This has been achieved in 26 years, a little under half the time available.  And it has been achieved while population has grown by about 15%[2] and the economy has grown by over 60%.  The reduction in emissions from 1990 to 2015 is shown on the chart below, which also shows the UK’s legislated carbon budgets.   There is of course some uncertainty in the data, especially for non-CO₂ gases, but uncertainties in trends are less than the uncertainty in the absolute levels, and emissions of CO₂ from energy, which is the largest component of the total, are closely tracked.

The UK is half way towards its 2050 target, in a little under half the available time …

Source: Committee on Climate Change

The chart below shows the sectoral breakdown of how this has been achieved, and this raises some important caveats.

Progress in some sectors has been much more rapid than others …

Source: Committee on Climate Change

The largest source of gains has been the power sector, especially if a further fall of a remarkable in emissions from power generation in 2016 is included (the chart only shows data to 2015).  While renewables have made an important contribution, much of this fall has been due to replacing coal with gas.  This been an economically efficient, low cost way of reducing emissions to date, to which UK carbon price support has been a major contributor.  However coal generation has now fallen to very low levels, so further progress requires replacing gas with low carbon generation – renewables, nuclear and CCS.  This is more challenging, and in some cases is likely to prove more expensive.

The next largest source of gains, roughly a third of the total reduction, is from industry.  However, while detailed data is not available, a large part of this reduction may have been due to broader economic trends, notably globalisation of the world economy leading to heavy industry becoming more concentrated in emerging economies.  This trend may also have had some effect on electricity demand and thus emissions.  The aggregate reduction in global emissions may thus be smaller than indicated by looking at the UK alone.  Reducing global emissions still requires a great deal more progress on industrial emissions, especially in emissions intensive sectors notably iron and steel and cement.

Progress in reduction of emissions from waste, especially methane from landfill, has been a third important contributor.  Again, this has been highly cost-effective reduction.  However about two thirds of emissions have now been eliminated so further measures will necessarily make a smaller contribution, though there is much that can still be done with the remainder such as eliminating organic waste from landfill.

Other sectors have done much less, and will need to do more in the years to come.  Progress on f-gases may be helped by the recent international agreement on HFCs, although more will still need to be done.  Transport emissions have made only slow progress in recent years.  It is essential that electrification is encouraged so that a large change similar to that achieved in the power sector can be achieved in transport.  The buildings stock remains an intractable problem, and the first priority must be to at least make sure that new buildings are built to the highest standards of insulation.

So continuing the trend of falling emissions in future will be difficult and will require new and enhanced policy measures.  But in 1990 the prospects of achieving what has already been achieved doubtless looked daunting, and progress to date should encourage further efforts in future.

Adam Whitmore -25^th April 2017

Material in this post draws on a presentation by Owen Bellamy of the Committee on Climate Change at a British Institute of Energy Economics seminar on 5^th April 2017.

[1] The UK’s domestic emissions need to go down slightly more rapidly than the headline target would suggest due to the role of international aviation and shipping.  This is shown on the chart.  However the broad message is the same.

[2]https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/populationestimates/articles/overviewoftheukpopulation/mar2017

A wealth of ideas about wealth funds

There are many ways of designing a wealth fund based on revenues from carbon pricing.  Debate about these is necessary, but should not distract from the merits of the broader proposal. 

Last month I outlined the value of the carbon emissions, and the possibility of establishing a wealth fund based on revenue from carbon pricing.  This post provides some brief responses to questions that have been raised in response to this proposal.   There are many good design options to choose from.

Would the fund necessarily be national?

No.  There are many national wealth funds in operation, and national carbon wealth fund may well be a pragmatic way forward in many cases.  However, the Alaskan wealth fund is an example of a state based scheme, and others would be possible.  In the EU a fund could also be established either at EU or Member State level.  An international fund would be difficult and perhaps impossible to establish, but would appropriately reflect global nature of the climate change problem.

How would such a fund be governed?

There are many options here.  The most important criterion is that governance should benefit the ultimate owners of the asset, namely citizens, rather than the state or special interest groups.  This implies some independence from government.  Other criteria such as transparency and ethically sound investment will also be important[1].  Some have advocated a fully independent trust fund.  However in practice some degree of government oversight is likely to be required[2].

How would this global public good be allocated internationally?

The distribution between nations of access to the atmosphere has proved a major point of contention in global negotiations on limiting climate change, and this situation appears unlikely to change[3].  However existing carbon pricing regimes – or simply emitting free of charge – already use up a global public good.  Giving citizens and governments a greater stake in increased carbon prices is likely to decrease the quantity of emissions, and so the proportion of the global commons used[4].  This makes the approach I have proposed more compatible with good stewardship of the global commons than existing arrangements, at least for the next 50 years until revenues start to decline.

What would the macro-economic effects be?

These effects would probably not be large, at least for a national UK fund.  The payment into a UK fund would be at most around £16 billion p.a. assuming much greater coverage and higher carbon prices than at present, a little under 1% of GDP per annum[5].  Even this would be unlikely to cause major economic dislocation, especially if phased in over a few years.  The fund would grow large over time, reaching around £860 billion by the end of the century, depending on many factors including which other environmental taxes were included  [6].  However this is not vastly larger than the Norwegian fund today, which is for a very much smaller economy.  Furthermore any fund would have the effect of redirecting revenue from consumption to investment, which would probably have a positive macroeconomic effect in the context of historic UK underinvestment.

Would such a measure be socially regressive?

The concern here is that poorer households spend a larger proportion of their income on energy than richer households, and so energy taxes, and thus carbon taxes, tend to hit them disproportionately harder.  However poor households still spend less on energy, and therefore carbon, in absolute terms than richer households, so an equal dividend, as I’ve proposed, would have a net progressive effect.   Furthermore, households account for only a minority of energy use, but would get the full benefit of dividends (or at least a large proportion), increasing the extent to which it is progressive.

However there are some important intergenerational issues to consider.   The proposal for a fund takes the view that present generations should safeguard capital assets so they retain value to future generations.  This is in line with the standard definition of sustainable development[7].  However there are distributional issues here which need to be addressed.  Some present citizens will be worse off.

How would it fit with other green taxes?

The proposal is clearly consistent with using green taxes more widely as a policy instrument.  What’s different from the standard approach to green taxes is the suggestion of placing revenue in capital fund rather than using revenue to fund current expenditure.  The landfill tax to which I referred in my original post currently raises around a billion pounds per annum[8].  It would be natural to add this revenue to a UK wealth fund.

Would distribution to citizens be the only use for funds?

There is no reason some of dividends from the fund should not be used to fund things like R&D.  As I have previously discussed there are many legitimate calls on revenue from carbon pricing.  However there are many compelling arguments for allocation direct to citizens, and this should in my view be a priority for the fund.

Each of these questions requires further elaboration of course, and there are many other questions to be resolved.  The design of any major new institution such as a carbon wealth fund will require a great deal of consideration of a range of issues.  However further examination appears to strengthen rather than weaken the case for such a fund.

Adam Whitmore – 22^nd  March 2017

Thanks to John Rhys for raising some of these issues.  A variant of this post, responding to John’s points, was published on his website. 

 

[1] See Cummine (2016) cited in my original post for further details For a specific proposal for a UK wealth fund:  http://www.smf.co.uk/press-release-conservative-mp-calls-for-uk-sovereign-wealth-fund-to-address-long-term-and-structurally-ingrained-weaknesses-of-the-economy/

[2] See Barnes, Who Owns the Sky (2001)

[3] This problem does not arise for the conventional resources (such as oil and gas) that typically provide the income for sovereign wealth funds of the nations where the resources are located. There is an interesting question as to whether countries should have full property rights to natural resources within their territories, as is often assumed at present, but this is too large a subject to go into here.

[4] The assumption here is that increasing prices from current low levels will increase revenue.  Carbon prices would increase by a factor of say five or more in many cases, and it is unlikely that emissions would decrease by an equal factor – though if they did it would be very good news.

[5] This assumes 400 million tonnes of emissions are priced, compared with 2015 totals of 404 million for CO₂ emissions and 496 total greenhouse gases (source: BEIS), implying a high proportion of emissions are assumed to be priced.  The carbon price is assumed to be £40/tonne, roughly the Social Cost of Carbon at current exchange rates and well above current price levels.  This would give total revenue of £16 billion in the first year based on both volumes and prices substantially greater than current levels, but still less than 1% of UK GDP of approximately £1870 billion in 2015. (source: https://www.statista.com/statistics/281744/gdp-of-the-united-kingdom-uk-since-2000/ )

[6] Assuming that the UK reduces its emissions in line with the Climate Change Act target of an 80% reduction from 1990 levels by 2050, and then to zero by the end of the century, and that 80% of emissions are priced at the Social Cost of Carbon as estimated by the US EPA, converted at current exchange rates of $1.25/£.

[7] Sustainable development is usually characterised as meeting the needs of present generations without compromising the ability of future generations to meet their own needs.

[8] https://www.uktradeinfo.com/Statistics/Pages/TaxAndDutybulletins.aspx

How not to squander $130 trillion

Carbon pricing should be used to establish wealth funds from which current and future citizens can benefit. 

The world has a limited carbon budget …

Climate change depends on the cumulative total of emissions of greenhouse gases, so total cumulative emissions globally must be limited by the need to limit climate change.  This limited total of cumulative emissions is sometimes referred to as a global carbon budget.  Specifically, if global mean surface temperature rises are to be limited to two degrees centigrade, as now mandated in the Paris Agreement, total cumulative CO₂ emissions from now on must be limited to around 1600 billion tonnes of CO₂[1]. From this perspective the atmosphere is a finite resource that can only be used once, rather like any exhaustible natural resource, with the important caveat that (unlike many natural resources) no more atmosphere remains to be discovered.

But currently the value of this resource is being squandered …

At the moment only a very small proportion of greenhouse gas emissions is priced adequately.  Most emissions remain unpriced, and the growing proportion that is priced is mostly sold at well below both the cost of damages, and well below the value of an increasingly scarce resource.  A valuable scarce resource is thus being given away or sold below cost, subsidising emitters.  Huge natural wealth is being squandered.  And once gone it can never be replaced[2].

It would be better to use revenue from carbon pricing to create a wealth fund to benefit both current and future generations …

So is there a better approach to managing this precious resource?  It seems to me that there is. It would be much better to realise value of emissions in the form of a fund for citizens, with proceeds from carbon pricing (the sale of allowances or taxes) paid into the fund.  Carbon pricing should be comprehensive, with prices at adequate levels.  The finite volume of the resource implies it is best used to establish a wealth fund, where financial capital is built as natural capital is used up.  The fund would belong to all citizens.  Granting its value to citizens would surely encourage better management of the atmosphere, and thus the climate, and higher carbon prices than generally prevail at present.

Such a fund would be analogous to a sovereign wealth fund based on oil and gas reserves, of which the Norwegian fund is the leading example[3].  Wealth is invested in productive activity, with the income from this available to fund pensions and other expenditure. So, how much might this resource be worth in purely financial terms?

Such a fund could be enormously valuable …

Each tonne of CO₂ emitted to the atmosphere should be priced at a minimum of the cost of damages from climate change – the social cost of carbon. This is currently around US$50/tonne, and rising over time.  Emissions may be more valuable than this, either because of the limitations in estimates of the social cost of carbon (see here), or because the value of the emissions in terms of the economic activity they enable is greater than their cost in environmental damage.  But evaluating the resource at its cost at least puts a lower bound on its value, unless the economic value of those emissions is below the cost assumed here, which seems unlikely with such a constraining budget[4].

The profile of emissions also matters.  For simplicity I’ll assume current emission levels to 2020, then a linear decrease to the end of this century[5].  This is broadly similar to many emissions tracks that have been modelled as consistent with 2 degree warming, and (consistent with this) the cumulative total is close to the 1600 billion tonnes budget I mentioned above.  It is also consistent with the Paris Agreement goals of reaching net zero emissions at some point in the second half of the century[6].

The annual value of emissions is then estimated from multiplying the (rising) cost of emissions with the (falling) quantity of emissions.  This is shown in the chart below.  The effects of rising prices and falling emissions roughly balance over the next 50-60 years or so, with revenues remaining roughly similar at close to $2 trillion p.a..  Revenues then fall rapidly in the last quarter of the century as emissions fall to zero.  The eventual value of the fund, excluding investment returns and dividends paid out, is the sum of these annual revenues (the area under the curve).

Chart: Potential annual revenue into carbon funds globally …

On this basis, the total value of the remaining carbon budget is a staggering $130 trillion.  This is equivalent to $13,000 for each person in the world, assuming world population of 10 billion people later this century.  A 3% annual dividend from this would generate about $400 p.a. for everyone.

Towards a citizens’ dividend …

Dividends from the fund could be used in many ways.  One approach with a range of advantages is distributing benefits to all in the form of a “citizen’s dividend”.  There is already a feature of the Alaskan wealth fund derived from oil revenues, where distribution is in the form of a Permanent Fund Dividend to all citizens.  This is widely considered to have helped build and maintain public support for the scheme[7].

This approach is closely related to the idea of “tax and dividend” carbon pricing.  I have previously argued that such approaches have merit, and indeed tax and dividend has recently been advocated by senior Republicans in the USA[8].  However, there is an important difference between a fund and tax and dividend as often presented, in that revenues are used to establish a fund that is intended to be permanent, whereas tax and dividend proposals often assume revenues to be distributed in full.

There is also a relationship between the idea of a citizen’s dividend and a universal basic income, which is much discussed at the moment and subject to a few trials.  However, there is a crucial difference in that the citizen’s dividend does not seek to provide an adequate income.  Rather it is simply a return on funds invested.  Instead, it is likely to be one component of any universal basic income.

Who would benefit?

There is a natural case for distributing dividends equally, as all have equal rights to the atmosphere.  The atmosphere is a global resource, and climate change knows no borders, so it is natural to make any fund global.  However establishing such an arrangement is likely to be too great a political challenge.

A bottom up approach with individual nations pricing carbon and establishing their own funds is likely to be much more tractable.  Such a national approach would have other advantages.  For example, it would allow other environmental taxes, such as those on landfill, and indeed other sources of revenue to contribute to the fund.  A series of national funds would not stop any fund being used to finance activities of international benefit – indeed such uses would be highly desirable.

Establishing national funds will have many challenges.  However the prize seems large enough to be worth pursuing.  The current system of simply allowing emissions to be dumped into the atmosphere, often free of charge and almost always too cheaply, is a waste of a unique and irreplaceable asset.  Irreplaceable natural wealth such as the atmosphere should be managed carefully, not squandered recklessly.

Adam Whitmore – 13^th February 2017 

[1] Based on “Warming caused by cumulative carbon emissions towards the trillionth tonne”.  Allen et. al. Nature vol. 458 (2009), adjusted for emissions since the publication of that paper.

[2] Many people, including me, would also wish to note the ethical dimension here.  It is not appropriate to treat the atmosphere only as mere resource for people to use as they wish, and all decisions about its management must reflect ethical considerations, including responsibilities to future generations, and the duty of care to the world’s natural heritage.  I am simply arguing here that treating it as valuable resource would be a major step forward from treating it as a resource to be used as though it were unlimited and emissions were inconsequential, as is often the case at present.

[3] For an excellent review of Sovereign Wealth Funds and how they could be better managed and used for the benefit of citizens see Angela Cummine, Citizens’ Wealth, Yale University Press, 2016.

[4] If the price would be lower than the SCC with this emissions track it implies that the 2 degree target is too loose and 1.5 degree or lower would be preferred.

[5] This is a rough and ready calculation, taking CO₂ emissions from energy and industry only.  It ignores the effect of other gases and effectively assumes other sources of CO₂, mainly deforestation, are approximately net zero cumulatively over the century after taking into account the role of sinks and deforestation.  This may be optimistic.  Adjusting for these would lead to a higher starting point and steeper decrease in emissions, reducing somewhat the value of the fund.

[6] In this scenario emissions are low enough to be balanced by a small quantity of negative emissions by the last decade of the century.

[7] See Angela Cummine, Citizens’ Wealth, Yale University Press, 2016., p.140-2.

[8] See “US Republican elders push for carbon tax”, Carbon Pulse, 8^th February 2017

Can emissions trading produce adequate carbon prices?

Prices under emissions trading schemes have been low to date.  Sometimes this may be because systems are new, but the EUETS is long established and needs to demonstrate that it can now produce adequate prices. 

Prices under emissions trading systems around the world have so far remained low.  The chart below shows carbon pricing systems arranged in order in increasing price, with prices on the vertical axis shown against the cumulative volume covered on the horizontal axis.  Carbon taxes are shown in purple, emissions trading systems in green.  It is striking that all of the higher prices are from carbon taxes, rather than emissions trading systems.

Prices under Emissions Trading Systems and Carbon taxes in 2016

Source:  World Banks State and Trends of carbon pricing report[1].  Prices are from mid-2016.

Prices in the largest emissions trading system, the EUETS have been around $5-6/tonne, and prices in the Chinese pilot schemes have been similar and in some cases even lower, although with little trading.  The price under the California and Quebec scheme (soon to be joined by Ontario) is somewhat higher.  However, this is supported by a floor set in advance and implemented by an auction reserve price.  If this price floor were not present a surplus of allowances would very likely have led to lower prices.  The Korea scheme has had very low trading volumes, so does not provide the same sort of market signal found under more liquid schemes.

In contrast, a wide range of carbon taxes are already at higher levels and in some cases are due to increase further.  The French carbon tax, which covers sectors of the economy falling outside the EUETS, is planned to reach €56/tCO₂ (US$62/tCO₂) in 2020 and €100/tCO₂ (US$111/tCO₂) in 2030[2].  In Canada a national lower limit on carbon prices for provinces with an explicit price-based system (not shown on the chart) is due to reach $50 per tonne in 2022[3]. The UK carbon price floor, which covers power sector emissions, was due to rise to substantially above current levels, but is currently being kept constant by the Government, mainly because the price under the EUETS is so low.

Increases such as those due in France and Canada will bring some carbon taxes more in line with the cost of damages, and thus to economically efficient prices.  The cost of damages is conservatively estimated at around $50/tonne[4], rising over time (see here for a discussion of the social cost of carbon and associated issues).  The increases will also bring prices more into line with the range widely considered to be necessary to stimulate adequate low carbon investment[5].

Low prices under emissions trading systems have been attributed to a range of factors, including slower than expected economic growth and falling costs of renewables[6].  However these factors do not explain the consistent pattern of low prices across a variety of systems over different times[7].

While it is difficult to derive firm evidence on why this pattern should be present, two factors seem plausible.  The first is systematic bias in estimates – industry and governments will expect more growth that actually occurs, costs will be overestimated, and these tendencies will be reflected in early price modelling, which can often overstate likely prices.

But the second, more powerful, tendency appears, based on anecdotal evidence, to be that there is an asymmetry of political risk.  The political costs of unexpectedly low prices are usually perceived as much less than those of unexpectedly high prices, and so there will always be tendency toward caution, which prevents tight caps, and so leads to prices being too low.

This tendency is difficult to counteract, and has several implications for future policy.

First, it further emphasises the value of price floors within emissions trading systems.  Traditional environmental economics emphasises the importance of uncertainty around an expected level of abatement costs or damages.  If decision makers are not in fact targeting expected average levels, but choosing projections of allowance demand above central expectations then the probability of very low prices is increased, and the case for the benefits of a price floor is stronger.

Second, it implies that it is even less appropriate than would anyway be the case to expect the carbon price alone to drive the transition to a low carbon economy.  Measures so support low carbon investment, which would in any case be desirable, are all the more important if the carbon price is weak (see here for a fuller discussion of the value of a range of policy measures).   While additional measures do risk further weakening the carbon price, they should also enable reduced emissions and tighter caps in future.

Third, it requires governments to learn over time.  Some low prices may reflect the early stage of development of systems, starting slowly with the intention of generating higher prices over time.  However this does require higher prices to eventually be realised.

The EUETS has by some distance the longest-established system, having begun eleven years ago and with legislation now underway for the cap to 2030, by which time the system will be 25 years old.  The EU should be showing how schemes can be tightened over time to generate higher prices.  However it now looks as though the Phase 4 cap will be undemanding compared with expectations (see previous posts).  The recent vote by the European Parliament’s ENVI committee failed to adopt measure that are adequate to redressing the supply demand balance, with tweaks to the market stability reserve unlikely to be enough.  This undermines the credibility of cap-and-trade systems more generally, rather than setting the example that it should.  Further reform is needed, including further adjustments to supply and preferably auction reserve prices.

The advantages of cap-and trade systems remain.  Quantity limits are in line with the international architecture set by the Paris Agreement.  They also provide a clear strategic signal that emissions need to be reduced over time.

However there is little evidence to date that emissions trading systems can produce adequate prices. The EU, with by far the most experience of running an ETS, should be taking the lead in substantially strengthening its system.  At the moment this leadership is lacking.  Wider efforts to tackle climate change are suffering as a result.

Adam Whitmore – 23^rd January 2017

[1] https://openknowledge.worldbank.org/handle/10986/25160

[2] World Bank State and Trends in Carbon Pricing 2016.  See link in reference 1.

[3] http://news.gc.ca/web/article-en.do?nid=1132169  Canadian provinces with volume based schemes such as Quebec with its ETS must achieve emissions reductions equivalent to these prices.

[4] $40/tonne in $2007, see https://www.epa.gov/climatechange/social-cost-carbon, escalated to about $50 today’s dollars.

[5] See this recent discussion: https://www.weforum.org/events/world-economic-forum-annual-meeting-2017/sessions/the-return-of-carbon-markets

[6] Ref: Tvinnereim (2014) http://link.springer.com/article/10.1007%2Fs10584-014-1282-1#page-1

 

[7] The South Korea ETS may be a partial exception to the pattern.  However it is unclear due to the lack of liquidity in the market.