Assignment: The Economics of Global Warming

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l8_2013_policies_that_directly_target_ghgs1.pdf

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L8 Putting a Price on GHG Emissions and Natural Carbon Sink Destruction.

CO2

N2O CH4

F-gases

- (c) Ruth Forsdyke, 2013, * Draft version only. Not for widespread distribution. All copyright permissions not attained so limited distribution under Dalhousie Copyright Agreement. No copyright claim on public domain or any copyrighted material due to no permissions acquired.

Topics List: 1.Introduction 2.Nova Scotia’s Global warming policy, targets & progress to date 3.Policy Analysis Using MAC - MD Framework

- carbon tax - emissions standard - abatement subsidy

4.Equity, the Price of GHG intensive goods and guiding the invisible hand (to make it “green”) 5.Summary 6. Practice Questions

* note that answers to last page of the the MAC MD worksheet can be found under topic 3.

1-Introduction:

Now that we have illustrated how the MAC MD framework is related to the underlying demand and supply framework, we will use it to illustrate how policies that directly target GHG emissions work.

Q baskets bill/year

M C P

MACP

M C S

PSE=85

PM= 60

MSP

ESE

=15

MCE

EBAU

=40

$/good

baskets bill/year

GHGs (tonnes CO2e/year) /year

100

QMQSE

- Assume baskets are average bundles of real goods, services and inputs produced in the world economy as a whole. - Recall, we assumed each average basket of goods, services and inputs caused 1 tonne of GHGs. ~ year 2000 net emissions = 42 gT - Assume baskets are average bundles of real goods, services and inputs produced in the world economy as a whole - in very short run, the only available means to abate is to reduce output of goods, services and inputs.

Recall, we have shifted our focus from policies that directly target goods, services and inputs to those that target the GHGs.

Similar to the case of “goods” targeting policies, GHG targeting policies can be categorized as either price, quantity or quality mechanisms.

1) Carbon Taxes 2) Emissions Standards 3) Emissions Abatement Subsidy 4) Cap and Trade (briefly discuss)

- Firstly, we look at the price policies in Nova Scotia and characterize according to whether they target “goods” or GHGs & whether they are price, quantity, or quality mechanisms.

- Then, we look at individual policies giving examples.

- Next, we briefly compare two policies, emissions standards & carbon taxes, based on the possible welfare criteria of government revenue generation, and ability of producers and consumers to finance abatement costs.

2-Examples of GHG reduction policies (case study: Nova Scotia)

you are here!

- Source of Contour Graph= NovaNet News - Nova Scotia Today

- Full sea level rise > 70 metres - High prob. eventually under BAU - Timing Uncertain (100s to 1000s yrs)

Canadian Provincial per Capita Production GHG Emissions (2010)

Ne w fo un dl an d

PE I

NS NB Q ue O

nt M an

Sa sk

Al ta BC

Province

to n

n e s C

O 2

e /

p e rs

o n

Nova Scotia’s per capita production GHG emissions are 23 tonnes CO2e/capita, slightly higher than the national average of 21 but about more than double that of Quebec at 10 & about 1/3rd of Saskatchewan’s footprint. Why are the production carbon footprints different?

- The footprints of BC, Quebec and Ontario are low due to high use of low GHG energy sources for electricity production. B.C., Quebec, and Ontario have plentiful hydro resources. - The high footprints of Alberta and Saskatchewan are due to heavy use of fossil fuels to make electricity and heavy use of energy for mining activities including Tar (Oil) Sands.

Note: Our consumption carbon footprint will be different because we import and export carbon intensive goods.

Source: Canada’s National Inventory of GHGs/ Stats Canada Population Data

http://climatechange.gov.ns.ca/doc/ccap.pdf

The biggest single source of GHGs in Nova Scotia is the electricity sector. As there are already available low GHG electricity sources, electricity GHGs are considered relatively cheap to abate and so they are our primary Copenhagen 2020 target focus.

- many transport emissions could be replacing private passenger vehicles with efficient public transit. - there is so much traffic congestion in Halifax that buses move slowly and are often unreliable. - the #20 is mainly used by low income people living in Spryfield with higher income types mainly driving their cars. This contrasts with large Canadian cities in which transit is used by a wide range of income types. - an efficient transit system could save people time as the buses or skytrain would run more frequently and buses would not get stuck in traffic jams.

Nova Scotia’s CO2 Emissions from Large Emitters (2009):

Imperial Oil (Exxon Mobil)

Oil Refining (Dartmouth)

.74 NSPI (Emera)

Lingan 3.94

Point Aconi 1.45

Point Tupper 1.02

Trenton 1.82

Tufts Cove 1.14

9.37

Oil Extraction (Thebaud Platform)

.15

Pulp and Paper

Northern Pulp NS Corp

0.08

Maritimes Pipeline North

East Ltd Partner

Natural Gas Transmission

Electricity (Dartmouth)

co a l

gas

Tot. elec.

0.05

Minas Basin Pulp & Paper Co.

0.04

Imperial Oil (Exxon Mobil)

Tot. P&P

0.12

Tot. fossil fuel 0.95

Total All = 10.4 Mt

Data Source: Canadaʼs Greenhouse Gas Inventories

- Nova Scotia generates and consumes more than 12,000 GWh (gigawatt-hours) of electricity per year (amount of energy). - The average power is 12,000 G Watt/8760 = 1.4 GW (i.e. 1.4 billion Watts).

- the electricity units are very ugly due to the hour second component. - a Watt is a Joule per second (energy per unit time). A Watt hour is a watt multiplied by an hour, so it is the amount of energy that a 1 Watt energy source will provide over a one hour period. - a one Watt light bulb is very small. We are all familiar with a 100 Watt light bulb. - over one hour, the amount of energy is 100 Watts* 1 hour = 100 Joules/second * 3600 seconds = 360000 Joules.

$/tonne

E (mT CO2e

year)

18.2 19

M A

C 1990

A nnex 1 E

B A

U 1

9 9

E A

ct u

a l

21.5

18 %

Nova Scotia’s Kyoto Target is 18.2 megatonnes (6% 1990 level of 19 mT). Today, our emissions are about 21.5 megatonnes (18 % above target)..

E T

a rg

e t

- The MAC is drawn as linear for schematic purposes. I do not know the intercept. - The blue shaded area is the total abatement costs (TAC). Recall, it is the area under the MAC curve corresponding to the total consumer and producer surplus given up by abating. Note that the MAC will have shifted over the period and so my yearly TAC representation (blue triangle) has incorrectly assumed “no shifts” for heuristic purposes. - Note also that I have ignored the win - win region of the MAC (below x axis) for heuristic purposes. Abatement can be a net private benefit in many cases such as insulating a home with owners not being aware of how much money they can save on heating bills. - Notice the y axis does not intercept the x-axis at 0 given scale shown.

$/tonne

Emissions (mT CO2e

year)

18.2 19

M A

C 1990

E B

A U

1 9

9 0

E A

ct u

a l

~21.5

18 %

However, since our MAC has shifted, it would be incorrect to use the 1990 MAC to estimate our total abatement costs to reach the target.

E T

a rg

e tM

A C 2012

- We look at shifts in our next lecture. I have drawn the shift as linear and also the lines as linear based on a lack of knowledge as to what these curves actually look like. - note that we have climate change policy so our BAU emissions should be higher than our actual emissions. This is why my x-intercept is drawn above the BAU level. For example, we have a tax on gasoline, even though it is much lower than Europe’s (see last lecture).

$/tonne

Emissions (mT CO2e

year)

18.2 19

M A

C 1990 E

B A

U 1

9 9

E A

ct u

a l

~ 21.5

20 %

Our new target set under the ESPGA (2007) is 17.1 mT by the year 2020.

E K

y o

to -t

a rg

e t

M A

C 2012

17.1

E C

o p

e n

-t a rg

e t

- Note that the EU’s Copenhagen target is also 20%, but they made progress under Kyoto while we didn’t. Also, note that the EU has offered to abate by 30% unconditionally but is willing to make a commitment to 30% if other countries do. - Nova Scotia intends to make most of the cuts in electricity sector (almost 50% of our GHGs) and so, get ready to watch the wind turbines go up!

In the next few slides, I have posted, Nova Scotia’s overall EGSPA target and some specific policies to reach the targets.

When you read these think about whether they are price, quantity or / and quality mechanisms. Then check your answers.

After that, we move back to our more abstract MAC - MD framework.

NS Kyoto Target * 18.2

22.3

1990 201020001995 2005 2015 2020

BA U

E m

iss io

ns Projection

Reduction Trajectory 17.1

EGSPA target

(e) greenhouse gas emissions will be at least ten per cent below the levels that were emitted in the year 1990 by the year 2020, as outlined in the New England Governors and Eastern Canadian Premiers Climate Change Action Plan of 2001;

mT/ year

- this policy is referred to as an emissions standard, a quota on emissions at the level of the province. It is non exchangeable which is the main reason it differs from cap and trade; we are required to reduce the emisions ourselves; we can not pay others to offset our emissions. - The EGSPA target is also our Copenhagen target for 2020. - Many provinces including Nova Scotia have set targets that are tighter than the national Copenhagen target of a 17% reduction in emissions relative to the 2005 level by 2020 (a laxer target than Canada’s failed Kyoto Target). - Nova Scotia’s 2020 target: Reduce emissions by 5.2 megatonnes (5.2 billion kg) to EGSPA target of 10% below 1990 levels for annual emissions of 17.1 tonnes. This is a 22% reduction relative to the current level. We will still need to reduce by 78 % more to become carbon neutral. - Data based on graph on Pg. 4, Towards a Greener Future, Nova Scotia’s Action plan - my estimation of Kyoto target based on assumption that Nova Scotia’s goal was 6% so as to take an equal share of the Canadian target reduction of 6% relative to the 1990 baseline. Click here: http://climatechange.gov.ns.ca/doc/ccap.pdf )

0 2050

currently 22 % above Kyoto Target

C arbon N

eutral

Econom y,

this w ay...

mT/year

Kyoto Copen -hagen

2008- 2012 (period to meet the Kyoto target by)

2050 Target

- Putting a different y-axis which goes all the way to 0, provides us with a better view of how far we need to reduce - Way to calculate very rough estimate of reparations owed if carbon was priced. Say NS pays for all excess GHGs over the 5 year commitment period, I get ~ 3.3 mT/year * 5 years = 16.5 mT (eyeballing graph estimate) - at Carbon Price of $10/tonne CO2e, reparations about $165 million (reasonable as same as EU ETS price). At a higher Carbon Price of $50/tonne CO2e, reparations about $825 million GDP of Province = $36.352 bill/year (2010), so reparations based on this calculation would be 2.3 % of the GDP. This will allow us to get a better sense of how much reparations would cost us and also what damage we have done to the world at these prices. Question: Do you think Canada should have to pay some reparations for exceeding our Kyoto Target? Why or why not?

(b) the Province will adopt emissions standards for greenhouse gases and air pollutants from new motor vehicles, such as the standards adopted by the State of California by the year 2010;

b) This is enacted by a fuel efficiency standard, a type of performance standard. (kg per Litre of gas/ the US and Canada have national standards under the Corporate Average Fuel Efficiency Standards. In absence of strong national action, California set higher standards.

(a) twelve per cent of the total land mass of the Province will be legally protected by the year 2015;

Ecosystem Carbon Sink Floors

a) This is a quantity mechanism -- it is a floor on land mass -- which is related to a floor on natural carbon sinks and biodiversity. - setting aside natural areas like Provincial Parks (quantity floors) protects biodiversity and carbon sinks and provides areas for recreation and teaches people about nature. More biodiversity increases ecosystem health so they capture more CO2 emissions helping with mitigation. Also, more biodiversity increases the ability of ecosystems to adapt to climate change and is an important and essential component of our adaptation strategy. So conserving biodiversity is an end in itself but also a means to helping us mitigate and adapt to climate change. http://en.wikipedia.org/wiki/Provincial_parks_in_nova_scotia

Tidal Wind

(g) eighteen and one-half per cent of the total electricity needs of the Province will be obtained from renewable energy sources by the year 2013;

Biomass

Renewable Energy Quota’s

g) This is called a renewable energy quota in a specific sector of the economy (electricity--almost half of the provinces total emissions). It is a technology standard specifying a specific mix of technologies to be used to produce 18.5 % of electricity). It is also a quantity standard as it imposes a quantity on the share of electricity to be produced by renewable energy. - solar, wind and to a lesser extent tidal have serious problems in that the energy source is intermittent. If the wind drops, natural gas turbines are rapidly ramped up to keep the electricity flowing. - The basic problem is that of storing the electricity. If a grid gets above 30% intermittent energy sources, there will be problems. - some solutions include massive high voltage DC super-grids, which smooth out renewable energy over large areas (ex. if wind is not blowing in place X, it may be in place Y). (cost around 4 trillion for the EU with North Africa becoming a major solar energy exporter). - smart grids are another solution such that when the wind and solar power drop, the price of electricity rises providing people with a signal and incentive to defer doing things like your laundry until the price drops. You need an electricity price monitor. You can buy your power at rates based on time of day and get lower rates at non-peak hours, so you help smooth out the grid from the demand side. - batteries are going to add to costs and have mining impacts. Lots of R&D being conducted. - water gravity batteries in which wind is used to pump water uphill where it is stored until the wind drops and then is allowed to run over a hydro turbine to generate power is another option. This is being used in the Fjiords of Norway. Another interesting option is are underwater air balloons which are pumped up by wind turbines and then released later to make power.

Feed in Tariffs (Control Access Price): cents/ kwh

- Emera forced to buy power from smaller scale generators through two-way metering.

- these are needed because Nova Scotia Power has a monopoly on electricity transmission services and a near monopoly on generation. In absence of regulation, it is expected charge entering renewable energy companies high access prices in order to deter entry which would complete with its near monopoly in renewable energy.

- the Nova Scotia Utility and Review Board is charged with regulating prices charged by NS Power. - NS Power was a public company until the 1990s when it was privatized. The privatization of these public assets was a common occurrence in the 1990s.

Tidal = 65.2cents/kwh

- this would be expensive for NS Power. Hence, it is trying to develop its own turbines as are other countries. - Our tides in the Bay of Fundy are the strongest in the world making it very challenging to harness the power. There have been problems with blades breaking due to ice and mud flows at the bottom of the bay.

Wind > 50 kw==> 13.1 cents /kwh < 50 kw==> 49.9 cents per kwh

- wind power (current costs around 7 cents per kWh. - Care is required in siting wind turbines due to killing birds and bats. A solution to this problem is radar systems which turn turbines off when flocks approach. Increases costs. - biofuels

left: > 1 MW right: around 300 Watts.

- average household uses about 1 kW but this varies according to whether they heat with electricity. Heating with electricity is expensive and takes up a large chunk of the household’s bill in the winter but not in the summer. - if you test out the NS Power energy calculator, you will find heat devices in the home are big electricity heaters.

Run of the River Hydro = 14 cents/kwh- Lower Churchill River Muscrat falls imported from Labrador (fixed cost estimated $ 6.2 billion for underwater cables and dam) - NSPI will buy enough for 10% of NS’s electricity (and up to 30%)

- hydro (not much in the province but under consideration is the Lower Churchill Falls project) which requires building an underwater cable from Labrador to Nova Scotia. - Harper guarantees $6.2 billion loan --is this Green Monetary Stimulus? --it is from the perspective of GHGs ...BUT....there are other serious environmental impacts here. - threats to biodiversity including migratory caribou with one deer-like species threatened with extinction as there are only 100 left. See picture above illustrating effects of water diversion. - loss of traditional way of living to First Nations People of Labrador. - 824 megawatts (20% to Nova Scotia for 35 years = 8 to 10% of provinces energy supply)--Emera would build the cable as part of the contract). - complex contractual arrangements here. Read more: http://www.cbc.ca/news/canada/story/2011/04/01/f-lower-churchill-development.html history and source of lefthand picture: http://www.ieee.ca/millennium/churchill/cf_history.html right hand picture: http://en.wikipedia.org/wiki/Churchill_Falls#Hydroelectric_power_project

- Combined Heat and Power (CHP) Biomass - 17.5 cents/ kwh - branches/ wood from saw mills. - fast growing grass like switch grass. - potentially carbon neutral BUT fertilizer emissions and loss of natural carbon sinks can make it worse than fossil fuels.

Biofuels are potentially carbon neutral--grow plants --make fuel --combust fuel (CO2 released). Plants grow back taking the CO2 out of the air. - but some studies of biodiesel find its footprint is higher than regular diesel. These take into account the full life cycle including estimates of sink reduction. Ex. more forest clearing. - problem with land being used to grow crops for food being replaced to grow crops for biofuels --cars for rich vs. food for poor. - Less land is now available for natural ecosystems with loss of carbon sinks and biodiversity loss--ex. replace natural rainforest with palm oil plantation monoculture. Also, the fertilizers and pesticide energy currently made from fossil fuels. One student brought up interesting topic of algae biofuels in class. Photo source: http://en.wikipedia.org/wiki/Biofuels

tracking mirrors = heliostats

Mirrors reflect sunlight to tower--heats water--turn turbine--generates electricity

- solar energy (photovoltaic cells and solar collectors--also solar is used to heat water to heat buildings with no electricity intermediate) Photo Source: Solar Thermal Collector http://en.wikipedia.org/wiki/ Solar_thermal_collector - Here is an example of a company in Nova Scotia called ProSolarTech which is using solar power to melt metal for metal work. This is really interesting because it provides us with a low GHG way to make the metal required to build the green economy. click here to see: http://www.prosolartec.com/

Source Photo: Photovoltaic cells http://en.wikipedia.org/wiki/ Photovoltaics

(n) a policy of preventing net loss of wetlands will be established by the year 2009

(q) a sustainable procurement policy for the Province will be developed and adopted by the year 2009

(t) a government facility will be constructed as a demonstration facility in accordance with a leading standard for building energy efficiency and sustainability, such as the Leadership in Energy Efficiency and Environmental Design (LEEDs standard) by the year 2015; and

(u) the Province will adopt strategies to ensure the sustainability of the Province's natural capital in the areas of forestry, mining, parks and biodiversity by the year 2010.

n) quantity floor but no specifics given. Related to 1) carbon sinks, 2) biodiversity & 3) adaptation to climate change as acts as buffer against storm surges. Uses a natural vs. engineering method of adaptation. Recall, wetlands are the best carbon sinks on average. q) sustainability performance but no specifics given (possible example all wood for desks would be purchased from firms that are certified to use sustainable logging practices). t) a performance standard (LEEDS) u) This is a performance standard for sustainable production. It is not specified how the goal will be achieved. Reducing electricity GHGs is one component. Natural capital is the “capital stock” of the natural production systems --like the ecosystems, the quality atmosphere, the quality oceans (normal pH)

- provincial strategies depend heavily on quantity and quality mechanisms (ex. emissions standards and renewable energy quotas) - Simple and has advantage of hitting caps if enforced (vs. carbon tax), is liked by firms because they don’t have to pay to pollute if below cap...this helps with financing renewables, BUT....

1) Unlikely to be cost effective in comparison to price mechanisms - not flexible across technology so more expensive technologies may be implemented. - not flexible across time. Ex. may be cheaper to pay global south to save rainforests.

2) Low marginal incentives to invent and adopt low GHG technology (environmental textbooks tend to ignore financing very high fixed costs -- ex. nuclear tens billions $)

3- Policy Analysis Using MAC - MD Framework

Now, le ts use th

e MAC - MD f

ramewo rk to

investiga te a vari

ety of p rice and

quantit y

mechan isms. N

ote, the MAC

is the sa me as

our long running

exampl e, appro

ximately

global emissi

ons for the yea

r 2000 .

You can check t

he last f ew ques

tions on the

worksh eet..

- Our first policy to investigate is a “carbon tax” which is short hand for a tax on GHGs measured in CO2 equivalents. Efficient carbon taxes fall on all GHGs not just carbon dioxide.

As we will see later, carbon taxes are highly recommended by economists due to predictions that they are 1) money cost effective (allow us to meet aggregate target as cheaply as possible (in money but not necessarily happiness) ) and 2) they provide high incentives to adopt and invent lower GHG technologies in order to escape the tax and they provide firms with flexibility of timing to reduce emissions*.

One drawback is firms are taxed which may make it difficult to finance the adoption and research and development. However, taxes can be returned as a lump sum to producers and consumers making the tax “revenue neutral”. Also, taxes may be set incorrectly such that target is not met.

- we will look at pros and cons more carefully later after you become familiar with the framework. * firms can choose to pay tax or to abate depending on which is cheaper. - globally harmonized taxes prevent free-riding countries from getting a comparative advantage in pollution intensive goods thereby causing pollution havens.

3-i) Taxes on Net Greenhouse Gas Emissions

We will put the tax on carbon and take it off

income

- It was the fall of 2008 when Stéphane Dion, the Liberal Party leader who named his dog Kyoto, ran for Prime Minister on a “Green Shift” platform but was defeated. His policy platform contained a carbon tax. People were likely afraid about the effect this would have on prices given the US economy had just collapsed. He was defeated by Stephen Harper who wanted to replace Canada’s Kyoto obligation with a “Made in Canada Plan” which would include a cap and trade system but with a safety release valve to discuss later. The cap and trade system was never implemented nationally. The NDP ran on a policy platform of a Cap and Trade without a safety cap, while the Greens favoured the carbon tax. -Prior to the election, Canadian Academic economists signed a petition supporting a carbon tax policy and urging the government to take action (led by Professor Chris Green of UBC).

- British Columbia has a carbon tax of 30$/tonne CO2e but it is not applied on all sources or gases.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE = 50

What marginal carbon tax would you recommend to get the private parties to abate from EBAU to ESE?

M A C

Recall that marginal (heights of marginals curves) refers to the tax on an additional unit of emissions, while total (areas under curves --add up infinitely thin rectangles which respond to marginals) refers to the tax on all units.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE

marginal carbon tax = $50/ tonne.

t = 50 =

Find total tax?M A C

- Start at the “business as usual” (BAU) level of emissions. The Private Party Polluters have a choice: 1) pollute the tonne and pay tax of $50 per tonne = marginal benefit of abatement OR 2) abate and save the marginal abatement cost = net marginal cost of abatement (marginal private surplus given up). - we see that above 15 gT, the marginal tax saved by abating exceeds the MAC and so, private parties have an incentive to abate. - we see that below 15 gT, the marginal tax saved by abating is lower than the MAC and so private parties will not abate below 15 gT. Hence, the money socially efficient tax is $50/tonne.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE

total carbon tax = Area B = $50/ tonne * 15,000,000,000 tonnes = $ 750 billion

t = 50 =

Find total tax saved?MA

- Note that the polluter pays tax only on the net emissions that are emitted. They abated from 40 billion tonnes to 15 billion tonnes and hence do not have to pay tax on these emissions because they were not made. The tax agrees with “moral precepts” that polluters should pay called “the polluter pays principle”. The externality is internalized with the tax. Question: Suggest ways to ensure that the tax is equitable (fair and just)? Answers: Progressive income taxes with reductions on low and middle income people. Lump sum rebates to poor within and between countries (Climate Superfund). - Taxes can be used to subsidize renewable energy adoption and research and development, education (helping to counteract the Koch Brothers), healthcare, food aid, birth control, etc.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE

total tax saved (C+D) = $50/ tonne * 25,000,000,000 tonnes = $ 1250 billion

t = 50 =

How much total tax do private parties save by abating from BAU emissions to the SE emissions level?

M A C

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE t = 50 =

What are the private parties total abatement costs (TAC) = total loss in private surplus?

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE t = 50 =

The private parties total abatement costs (TAC) = area C (this is the total consumer and total producer surplus given up) by abating from 40 to 15 gigatonnes per year.

M A C

Question: What is the private parties overall total surplus gain from abating?

Answer: They save the total tax of C+D but incur the abatement costs of C. Hence they make a surplus of D by abating.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE t = 50 =

M A C

Surplus change

Private Parties - (C + B) = (TAC + total tax

Third Parties D+C

Government + B (total tax)

Society as a Whole + D ($ TSS gain)

All groups changes in net benefits:

Notice that if we started at 0 and increased to 15, Private parties would get A +B at a cost of B to the third parties. So, Ese = 15 has a higher TSS than E = 0 baseline by area A.

Note: Curves will be shifting about as renewables enter. My graphs assume that the only way to abate GHGs is by reducing output. This is true in the very short run only. We will see in next lesson that renewable energy adoption which displaces fossil fuel sources is expected to shift the MAC inward since Ebau will fall.

3-ii) Quotas on Net Greenhouse Gas Emissions

- Rough picture of what Halifax would look like if all ice caps melt (80 meters)! - This may happen hundreds to thousands of years in the future if we combust all the fossil fuels.

- Quotas on emissions that are not tradable are called emissions standards.

- Polluters are required to abate to the standard and if above it they are fined.

- Ex. Nova Scotia Power

- Ex. Kyoto Protocol targets (but lacked enforcement mechanism).

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE = 50

What Quota would get the private parties to abate from EBAU to ESE ?

M A C

EBAU = 40

$/tonne

ESE = 15

Emissions (gT CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE = 50

Set Quota at ESE = 15 gigatonnes per period.

Fines and jail sentences for exceeding quota

M A C

Question: What is the minimum marginal fine applied on emissions above 15 gigatonnes which will achieve abatement to the SE level? Answer: $50/ tonne.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

$ MD = 50

BAU

B C D

PSE = 50

Total Government Quota rent if auctioned = 15 billion quotas * $50/ tonne = $ 750 billion

M A C

- To understand, recall that the height of the MAC is the marginal private surplus of emissions (for consumers plus producers). This is the most people are WTP for an additional right to pollute a tonne of CO2e and so the MAC is the demand curve for emissions. For the 15th gigatonne, they are willing to pay $50 per tonne and so if the quotas are all sold at one price in a perfectly competitive auction, they will each sell at $50/each.

As with quotas on goods, services, or inputs, quotas on emissions can be auctioned or given away or a mixture.

auctioned or given away or a

mixture

- Nova Scotia (emissions standard) - EU ETS first stage

- Nova Scotia (emissions standard) - EU ETS second stage

EU ETS = European Union Emissions Trading Scheme. - Give away is obviously preferred by polluters because they are given a valuable right. This may help them to finance adoption of low GHG technologies and research and development (R&D). - NS Power fine is 500,000/day for exceeding the emissions standard. - Auction generates revenue for the government similar to the tax. If the auction is perfectly competitive, the quotas theoretically sell for $50 each (assumes all sell at same price). This is the most polluters are willing to pay for the last permit to emit 1 tonne of emissions (at Ese = 15). If auctions are not competitive (ex. few buyers or collusion to bid rig), then quotas may sell for less. If government takes bribes, some of the total value of the quotas (quota rent) will escape to corrupt officials.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

80 M A C

$ MD = 50 BAUA

B C D

PSE = 50

Total Quota rent is equal to the number of quotas sold * how much they sell for = B = $750 billion.

-The quota rent goes to firms under give away while it goes to government under competitive auctions and it is divided up between the two (and possibly the corrupt officials) under non-competitive corrupt auctions.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50

BAU

B C D

PSE t = 50 =

M A C

Surplus change

Private Parties - C

Third Parties D+C

Government 0

Society as a Whole + D ($ TSS gain)

All groups changes in net benefits:

- same result as tax assuming the policies are set correctly.

carbon tax or perfect quota auctions

emissions standards (give away

Private Parties - (C + B) = (TAC + total tax

- C

Third Parties D+C D+C

Government + B (total tax) 0 (if given away)

Society as a Whole

+ D ($ TSS gain) D

Policy Comparisons based on distribution of costs and benefits of the policy

- clearly firms like the emissions standards better.

Quotas

tradablenot tradeable “Cap and Trade” (ex. EU ETS)

Emissions Standards

- global target - Kyoto Target for Annex 1 countries as a group (5.2 % relative to 1990). - Kyoto country and EU group targets - Nova Scotia - quantity mechanism

Ex. - EU ETS - Quebec and California - quantity mechanism and price mechanism

Ex.

- Taxes are price mechanisms, emissions standards are quantity mechanisms while cap and trade are both, the quantity is set and then the price of the permits to pollute is adjusted in markets.

- If enforced, a merit of emissions standards and cap and trade is that the cap is hit while with a tax, if the government does not adjust the tax to meet the target, there is not guarantee of meeting the target.

Under the cap and trade system, the total amount of emissions for a particular group (ex. the European Union under the EU ETS) is capped and quotas (permits) for the right to emit a given amount of greenhouse gases are allocated to the private parties (ex. firms, households or even entire countries).

Private parties can then trade permits with those with high abatement costs buying permits from those with low abatement costs.

Can be used on producers or consumers (ex. carbon debit card runs out when permits are used up and consumers buy more from consumers with excess).

CA P left over permits

ex ce

ss CO

pe rm

its

TRADE

permits

- For example, suppose these two firms are each are allocated permits allowing them to emit 10 tonnes CO2e per year. Firm ONE has installed renewable energy like tidal power while firm TWO does not. In order to produce the excess emissions, firm TWO needs to buy permits from ONE. ONE gets money and hence makes a profit helping to finance the adoption of even more renewable energy. - Firm TWO might not have been in a place rich in renewable energy and so found it more expensive to abate than ONE. So, the theoretically expected result is that the firm with the lowest abatement costs abates first making the cap and trade market theoretically cost effective....i.e. the aggregate abatement target is met as cheaply as possible. We will also show that carbon taxes are theoretically cost effective in money. We will do this carefully later. This is a preview.

Pros and cons of tax vs quota?

- go back over previous note to make a list.

3 iii) Marginal Subsidies to Reduce Net GHG Emissions

200 Mt 150 Mt

Suppose Canada’s electricity firms are required to reduce their emissions by 50 megatonnes over the year.

∆ECan_electricity = - 50 Mt

- recall that a megatonne is 1,000,000 tonnes, i.e. 1 million tonnes (these are metric tonnes).

200 metatonnes

∆ = - 50 megatonnes

They are given the option of reducing their emissions directly or paying other parties to reduce their emissions, a process called “offsetting”.

Ex: Companies in places without wind, solar and could pay electricity companies in windy and sunny places to reduce their emissions by closing fossil fuel plants and installing renewable energy.

- They could also pay people in other countries not to install fossil fuel generated electricity plants that would have been installed under BAU because this would reduce emissions relative to BAU. - Problems are that it may be very difficult to determine BAU emissions resulting in carbon leakage, a situation in which the 50 megatonnes are not abated but it looks like they have been. -Also, supposing the new fossil fuel plants would have been set up in low income countries and now are not, the firms in the high income countries now continue to pollute and the people in the poor country forgo cheaper electricity and the considerable benefits this brings (ex. internet access for all). -Also, the high income country is in a stronger position to carry out the R&D on renewable energies such that such an offsetting scheme can slow urgently needed technical change.

CO2CH4 NO2

Instead of paying other emitters like electricity companies to abate, the Canadian electricity companies could pay people NOT to convert forest carbon sinks into agriculture or to restore them. These are called forest offsets.

How much forest would need to be saved to absorb 50 Mt? Lets look at rainforest which sequesters a stock of 1000 t/ha in soil and leaves.

Land needed = 50,000,000 t / 1000t/ha = 500 km2

1000 t/ha

100 m

22.4 km

22.4 km 500 km2

50,000,000 t

- The numbers are taken from the sink sequestration graph for the various biomes (see lecture 1). - 1 hectare (ha) is 100m * 100m (think of a 400 meter track to get an idea of scale). - 1 km = 100 ha.

- only includes soil and plant carbon sequestration. Ex. will not include carbon sequestered by Amazon River. - You could also count the methane emissions from cows and or rice patties in the offset. - I should subtract off carbon sequestered by the pasture but have not done so here. It will take time for this carbon to be sequestered in the soil and so there is an important time element missing in my “back of the envelope analysis”. - To calculate the MAC, we would need to estimate the consumer and producer surplus from the agriculture finding numbers like steaks per km, prices and people’s WTP for steaks and so on.

Currently, it is possible to offset emissions by paying $10/ tonne CO2e to conserve rainforest. The rainforest owners are then receiving a subsidy (s = $10/tonne).

200 Mt $ 500 mill

offset = 50 Mt

- We could avoid the firm part and the government could just pay the forest people $10/tonne.

EBAU = 200

$/t CO2e

Net Emissions (Mt CO2e/y)0

MAC = 40 - E/5

s = 10

Suppose that 2000 km2 of rainforest is to be converted to agriculture. Suppose the MAC (i.e. marginal private surplus lost due to the reduced agriculture per tonne) is:

If agriculturalists are paid a marginal subsidy of $ 10/t, how much rainforest will be saved?

All farmlandAll rainforest

- this price is set in a global offset market.

EBAU = 200

$/t CO2e

Esubsidy = 150

Net Emissions (Mt CO2e/y)

MAC = s 40 - E/5 = 10 30 = E/5 Es = 150 Mt

B C D

s = 10

To solve for amount of abatement under subsidy, set:

∴ 1/4 of the forest will be saved (500 km2) preventing the escape of 50 Mt from the soil & plants.

All farmlandAll rainforest 0

Decision Rule of Private Parties with Subsidy Regulation in Place:

Abate a tonne ==> the marginal benefit to private parties = receive $10. Marginal cost is the MAC (i.e the private surplus given up abating that tonne). If MAC < s ==> abate the unit If MAC >s ==> don’t abate the unit When to stop? When MAC = $10/tonne which is SE.

- If this was the only forest in the world and the demand for offsets was 50 Mt, this would be the equilibrium price assuming a one period world.

EBAU = 200

$/t CO2e

Esubsidy = 150

Net Emissions (Mt CO2e/y)

Total subsidy = $10/t * 50 Mt = $ 500 = Area C + D

B C D

s = 10

Find the total subsidy paid by the Canadian firms to the agriculturalists.

All farmlandAll rainforest 0

- I constructed the MAC so as to ensure that we got 50 megatonnes of abatement.

EBAU = 200

$/t CO2e

Esubsidy = 150

Net Emissions (Mt CO2e/y)

Total subsidy = $10/t * 50 Mt = $ 500 = Area C + D

B C D

s = 10

Find the total subsidy paid by the Canadian firms to the agriculturalists.

All farmlandAll rainforest 0

EBAU = 200

$/t CO2e

Esubsidy = 150

Net Emissions (Mt CO2e/y)

40 A

C D

s = 10

Now suppose that the agriculturalists have been lying about the MAC and were only going to cut down half of the forest under BAU so the true MAC is:

All farmlandAll rainforest 0

MACTrue = 40 - E/2.5

EBAU_est = 200

$/t CO2e

Eactual = 75

Net Emissions (Mt CO2e/y)0

C D

s = 10

If the forest is not being monitored carefully, the agriculturalists will abate until the true MAC equals the marginal subsidy:

All farmlandAll rainforest 0

MACTrue = s 40 - E/2.5 = 10 EActual = 75 ∴ only 25 Mt emissions are abated relative to the true BAU.

EEst = 150

EBAU_True = 100

EBAU_est = 200

$/t CO2e

Eactual = 75

Net Emissions (Mt CO2e/y)0

C D

s = 10

The Canadian firms have overpaid. They paid $500 million for 50 Mt to be abated but only 25 Mt were abated. The carbon leakage equals the amount that the Canadian firms didn’t abate (50 Mt) minus the amount the agriculturalists actually abated (25 Mt) = 25 Mt.

All farmlandAll rainforest 0 EEst

= 150 EBAU_True = 100

A B

The Canadian firms should have paid area A +B = $250 mill.

EBAU_est = 200

$/t CO2e

Eactual = 75

Net Emissions (Mt CO2e/y)0

C D

s = 10

Even worse, now suppose that monitoring is perfect such that abatement to 75 reveals to the Canadian government monitors that the MAC estimate is incorrect. Suppose they reestimate the MAC to be the true MAC. Now the agriculturalists are paid A+B = $250 million.

All farmlandAll rainforest 0 EEst

= 150 EBAU_True = 100

A B

Will it pay the agriculturalists to lie about their MAC?

EBAU_est = 200

$/t CO2e

Eactual = 75

Net Emissions (Mt CO2e/y)0

C D

s = 10

If the agriculturalists pretend their true MAC is the fake one, they will cut down 3/4 of the forest and receive the $500 million subsidy. In this case, emissions increased from the true BAU (100 Mt) to 150 Mt. So not only have the Canadian firms not abated 50 Mt but the agriculturalists cut down the forest causing an additional 50 Mt of GHGs so the carbon leakage is 100 Mt !!!

All farmlandAll rainforest 0 EEst

= 150 EBAU_True = 100

A B

- Canadian firms don’t have a strong incentive to monitor the forest only caring that the $10/tonne is less than abating themselves. Yet, we can see that careful monitoring by government can lead to an even worse result. The problem is the difficulty in determining BAU emissions.

In the above, the subsidy was part of an offsetting policy.

However, subsidy payments could be made by the Canadian government as part of a government directed international offsetting scheme or by the rainforest country’s government in order to meet Copenhagen targets.

In this case, the subsidies need to be financed. The most efficient means to finance the subsidy is by taxes on GHG emissions.

- Costs Government $

- uncertainty in BAU level of emissions with possible “carbon leakage” and government over-paying.

- Carrots may provide better incentives than sticks.

Pros:

- Money Efficient and money cost effective if set correctly and enforced.

- Can be politically difficult to remove later due to job losses and loss of profits.

Cons:

- Gives polluters a property right to emit at BAU level which is not the socially efficient level.*

* conflict with the “polluters’ pay principle”. - it might be a better idea to tax forests based on the emissions the forests would have sequestered had they been in the natural state.

C A

P left over permits

ex ce

ss CO

pe rm

its

TRADE

permits

Can you see how cap & trade has both a tax & a subsidy within it?

- The big emitter is “taxed” because it has to pay for the extra permits while firm which has reduced its emissions and so can sell permits is effectively subsidized to reduce its emissions. - Cap and trade is theoretically money cost effective if markets are competitive, hits cap if monitoring and enforcement is perfect so as to get full compliance to the policy. It also provides a high incentive to adopt and invent low GHG technology because firms can sell excess permits for profit or avoid paying for extra ones! - In theory, cap and trade is a sort of best of both worlds of the quota and the carbon tax. There are some big drawbacks however. For example, since new markets are created and will need to be regulated since markets can be gamed to be discussed later. Hence, regulatory costs are higher. - cap and trade may also include sinks like forests called “forest offsets”. A problem here is determining the BAU amount of deforestation with potential for big emitters to pay “offsets” to save forests when the forest would not have been cut down anyway under BAU. In this case, net emissions need not change (or could even increase) so the cap and trade policy is ineffective and could even be harmful. - We can now see why James Hansen refers to such schemes as “loopholes” preferring simple systems like carbon taxes and fees and quotas on fossil fuels at the point of extraction (direct targeting of inputs which was described in the section on Pigouvian taxes and quotas).

Interpreting MAC & MD as Inverse Demand & Inverse Supply for Emissions

EBAU = 40

$/tonne

Emissions (Gt CO2e/

period)

MAC = 80 - 2E

Explain why the MAC is the inverse demand for emissions. Hint: Who is demanding the emissions and why?

- The MAC is the private surplus forgone by reducing emissions by one tonne (more generally, its the rate at which private parties forgo surplus due to abating). - Hence, it is the producer and consumer willingness to pay for the right to pollute an additional unit, i.e. the marginal WTP for the right to pollute such that MAC(E) = MWTPPrivate_Parties(E). - Hence, the MAC can be thought of as the inverse demand for emissions, i.e. the maximum price private parties are WTP for the right to pollute an additional unit.

EBAU = 40

$/tonne

Emissions (Gt CO2e/

period) 0

$ MD = 50PSE = 50

Explain why the MD is the inverse supply for emissions. Hint: Who is damaged?

- The third parties are damaged at a rate of $50/tonne CO2e. - Imagine that they could charge the private parties for the right to pollute. They would demand a minimum of at least $50/tonne as compensation. - Hence, $50/tonne is the minimum they will be WTA as compensation for damages. This is their opportunity cost and it is what they would be paid if there was not a missing market for GHGs. - Hence, we can think of the MD as the supply curve for emissions.

EBAU = 40

$/tonne

ESE = 15

Emissions (Gt CO2e/

period) 0

MAC = 80 - 2E

$ MD = 50 A

B C D

PSE = 50

Hence the MAC and MD are the demand and supply for emissions. These are said to be “derived” demand and supply curves as the GHGs are residual byproducts of the markets for goods, services and inputs.

D em

and

Supply

4 - Equity, the Price of Thneeds and guiding the invisible hand (to

make it “green”)

Coal generated electricity

Low GHG electricity

- Carbon taxes and emissions standards raise the relative cost of making GHG intensive goods, thereby raising the relative price and causing demand to fall (move along demand curve). The demand for the Low GHG goods rises since they are relatively cheap. This drives up the price of the low GHG goods making it profitable for firms to increase production which then lowers the price due to factors like scale economies, incentives to lower costs to make more profits, and market entry creating competition. - All of the policies of carbon taxes and subsidies to renewables guides the invisible hand in the low-GHG direction --towards the carbon neutral economy. - Informed ethical consumers will shift demand curve down for the dirty goods and increase the demand for the low GHG goods. - Education and moral suasion are important government policies to promote ethical consumption.

Policies like carbon taxes, emissions quotas, cap and trade raise the price of carbon intensive goods and services (most of them)

This can be very inequitable.

Income redistribution like Climate Superfund needed, rebates to low income people.

Progressive income taxes.

- Source picture starving child: http://www.prlog.org/ 11146863-can-we-end-poverty-new-group-believes-we- can.html

Too low to meet target and does not cover all sectors. - BC Target = 33 % below 2007 levels by 2020 - Too low! Jaccard estimates this will only bring BC 8% of the way towards its target.

- Ex. BC carbon tax ($ 30/tonne) is revenue neutral...this means that for all carbon taxes collected, taxes are removed elsewhere. - Efficiency enhancing.

1) income taxes reduced 2) corporate taxes reduced.

- lump sum rebates given to public.

Challenge Making Tax Fair:

This person will not get compensated for higher prices through this system.

- As low GHG alternatives are developed, prices would hopefully fall. - Policies need to be applied gradually to prevent large macroeconomic shocks.

- BCs Carbon Tax Act Can be found here: http://www.leg.bc.ca/38th4th/3rd_read/gov37-3.htm

Summary

- We looked at Nova Scotia’s policies which are mainly quantity and quality mechanisms.

- These include an emissions standard for the province, forest sink floors, fuel efficiency standards for ground transport, design standards like building codes, technology standards in the form of a renewable energy quotas, and feed in tariffs to encourage adoption of renewable energy since NS Power is forced to buy renewable energy at prices which are high enough to make it profitable to enter the renewable energy industry.

- We then looked at a variety of policies using the MAC & MD framework including carbon taxes, emissions standards, cap and trade (brief), and emissions reductions subsidies.

- We saw the subsidy system could result in carbon leakage, with the potential to cause emissions to increase. The problem is determining the true BAU emissions level.

- Also, cap and trade contains both a tax element and a subsidy element with the latter making it vulnerable to carbon leakage.

- If these policies are properly monitored and enforced and the BAU level of emissions is known, all of these policies are expected to raise the relative price of GHG intensive goods helping to guide the invisible hand to create the carbon neutral economy.

- Policies for equity need to be simultaneously considered.

6- Practice Questions: 1) List some of Nova Scotia’s policies? Are these quantity or price mechanisms? 2) Would you recommend a cap and trade system as a method of population control? Explain how this would work? Suggest some pros and cons? Do you think this would be equitable? 3) Under an emissions standard (quota on emissions), what area on the graph represents the firm’s total abatement costs (TAC)? 4) Do you think firms and consumers will prefer a carbon tax or an emissions standard. Explain. Show how much money they lose under each policy relative to BAU. 5) Will firms like taxes better or cap and trade (under permit give away) ? 6) Explain why the target may not be met such that there is “carbon leakage” under a subsidy system.

Answers: 3) C 4) tax-pay total tax + TAC = B + C emissions standard- pay TAC only as they get to pollute 15 for free. This is called the total cost of compliance to the policy and its lower for the emissions standard. Hence, we see strenuous lobbying against carbon taxes. 5) They will prefer cap and trade as they are given permits and so have to pay lower total cost of compliance under the cap and trade system than under a carbon tax.