Transcript Dynamic Revenue Estimation

Why Australia Should Take Early
Action on Climate Policy
Warwick J. McKibbin
Lowy Lunch Lecture Dec 13, 2006
1
Acknowledgement
• Much of this lecture is from joint research
with Professor Peter Wilcoxen from
Syracuse University
2
Overview
• The Climate Policy Issue
 What makes climate change policy so hard?
• Key Features Needed in any Approach
• Price Signals are critical but are not all the
same
• The McKibbin-Wilcoxen Blueprint for
national and global action
• A case for early action
• Conclusion
3
Emissions versus Concentrations
• What matters for the climate is the
concentration of greenhouse gases in the
atmosphere
• Concentrations are the accumulation of
annual greenhouse gas emissions
• Emissions is any particular year are not
critical but the path over time is
4
What makes climate policy difficult?
1.
Committed warming
 Need both mitigation and adaptation
2.
Geography
 Broad range of sources of emissions, caused by decisions
made by a diverse range of households and firms
 Many jurisdictions - coordination problem
(international, national, state, local)
3.
Time scales
 Exceptionally long-lived problem and policy
4.
Uncertainties
 Numerous, large and intractable
5
What’s uncertain?
Emissions Levels
CO2 Concentrations
Temperature Change
Ecological Effects
Economic Damages/benefits
6
What to do Given Uncertainty?
• Uncertainty and Risk management are not
new concepts
• For example if the probability of a bush
fire rises significantly, do you?:
 A) do nothing
 B) burn down the house so it doesn’t burn down in a
fire
 C) take measures to reduce the probability of a bad
outcome including taking out insurance
7
Some Issues in Policy Design
•
•
•
•
•
•
Coverage
Equity
Politics
Institutions
Fundamentals
Flexibility
8
Coverage
• Need major current and future emitting
countries involved not necessarily all
countries
• Need all of the economy involved not just a
particular sector
• Need to change the sources of demand and
supply of greenhouse gas emissions
9
Some Issues in Regime Design
•
•
•
•
•
•
Coverage
Equity
Politics
Institutions
Fundamentals
Flexibility
10
Equity
• A climate policy will probably lead to
winners and losers
• Need to deal with the distributional issues
within countries and between countries
 Within country distribution is up to governments within
countries
• Need to recognize the differences across
countries’ stages of development and
relative contributions to current climate
problems
11
Some Issues in Regime Design
•
•
•
•
•
•
Coverage
Equity
Politics
Institutions
Fundamentals
Flexibility
12
Politics
• Need to build constituencies across society
that support the policy in their own
financial self interest
 Fossil fuel producers facing reduced demand for their
products
 Consumers facing higher energy prices
 Politicians with an incentive to lobby to reject a policy
in favor of a narrow constituency
13
Some Issues in Regime Design
•
•
•
•
•
•
Coverage
Equity
Politics
Institutions
Fundamentals
Flexibility
14
Institutions
• Build on existing national institutions
 Legal, accounting, financial, market experience
 Developing new international institutions will delay
action and will likely be infeasible
15
Some Issues in Regime Design
•
•
•
•
•
•
Coverage
Equity
Politics
Institutions
Fundamentals
Flexibility
16
Fundamentals
• Need to
 establish clear property rights over carbon
emissions over a long period of time to provide
incentives for all involved within a country to want
to reduce carbon emissions
 create a capacity for individuals and companies to
manage climate risk
 Encourage the emergence, adoption and diffusion
of existing and new technologies to reduce emissions
17
Fundamentals
• Need to
 Manage the demand side of energy use while waiting
for technologies to emerge
 Enable compensation for those hurt by higher energy
prices if technology is expensive or slow to emerge
18
The Role of Prices
19
Would raising prices work?
US Energy Consumption, 1949-2003
Actual
2000
1995
1990
1985
88
1980
1975
1970
1965
1960
1955
1950
1973
2005
200
180
160
140
120
100
80
60
40
20
0
1945
Quadrillion BTU
Projected
Year
22
The Role of Prices
• Price signals should be both short term
and long term
• Price signals should be credible
 Otherwise investment will not be forthcoming
• Price signals are crucial for encouraging
 Demand side management
 The emergence of alternative technologies
 The adoption and diffusion of alternative technologies
• Short run prices can more easily be used
than emission targets to line up costs with
expected benefits
23
Flexibility is important
• Need to be able to start in individual
countries with known costs
• Need to be able to add countries over time
• Need to be able to adjust the system as
information is revealed
• Need to allow for particular national
circumstances
24
Ways to give price signals:
• Carbon tax
• Subsidies
• Binding targets with penalties for noncompliance
• Cap and trade Permit trading
• McKibbin Wilcoxen Blueprint – a hybrid of
the above approaches
25
A carbon tax:
• A fixed price for carbon with revenue going
to the government
• Emission outcome is unknown in any given
year but the cost of carbon is known with
certainty
• Problems
 Tax payments are enormous
 If optimal reduction is 20% of emissions, firms must
pay tax on 80% of original output.
 Fossil fuel intensive industries and consumers worse
off (depending how revenue is used)
26
Cap and Trade permit trading:
• Quantity of emissions is certain and fixed at
the quantity of permits
• Price of carbon is uncertain and depends on
marginal abatement costs given the target
• Benefits:
 emissions are fixed with lowest costs to achieve those
emissions
• Problems:
 Price of permits (i.e. cost to the economy) might be very
large and highly variable
 Costs might substantially exceed the benefits
27
The McKibbin Wilcoxen Blueprint
• Aim
 Impose a long term carbon goal for economies
 Generate a long term price for carbon to guide
energy related investment decisions
 Line up short term economic costs with expected
environmental benefits
 Provide a way for corporation and households to
manage climate risk
 Can be an internationally coordinated system or a
national system that evolves into an international
system
28
Components of the Policy
• National permits
 Required to embody carbon in energy
 Good only in country of issue
• Long-term permits
 Allow 1 ton of emissions each year
 Quantity is the long run goal
 Fixed supply (can be diminishing)
• Annual permits
 Allow 1 ton of emissions in year of issue
 Elastic supply from national government
 Price fixed for ten years
29
Why National Permits?
• Use existing institutions
 Legal system for enforcing property rights
• Small loss of sovereignty
 No need to cede authority to an international body
 No direct international transfers of wealth
 Enforcement maintains rights of domestic residents
• Robustness and stability
 Easy to join the agreement
 Robust to withdrawal by some participating countries
 Compartmentalization lowers transmission of shocks
30
Why Long-Term Permits?
• Credibility
 Build constituency supporting the policy
 Owners: vested interest in maintaining system
 Reduce the time-consistency problem
• Additional benefits
 Can tailor distributional effects via permit allocation
 Reduces risks (long term vs. short term bonds)
31
Why Annual Permits?
• Acts like a carbon tax at the margin
• Efficient
 A price-based policy is preferable to a qnatitative
target given flat damage curve
• Pragmatic
 Governments don’t have to agree to hit a fixed target
in any year regardless of cost
• Flexible
 Government can mandate who can issue annual
permits
32
Allocation
• Those who need permits are not
necessarily the same as those who own
the permits
• Allocate long term permits freely to fossil
fuel intensive industry and households
• Only those who embody carbon in energy
need a permit each each.
33
Overall
• Creates incentives for investment
 Raises the marginal cost of emissions into the future
• Incentives are credible
 Built-in constituency of long term permit holders
 Robust to accessions and withdrawals
 Operates within existing institutions
• Provides a foundation on which to build
 Completely consistent with technology policies
 Provides incentives for adoption and diffusion
34
Expandable
• Because it is a domestic system, other
abatement activities can be included as a
way to generate annual permits with the
revenue going to these activities instead
of the government
35
Main Concept
 The long term permits are the medium term goals for
emissions without a timetable of when they are
reached
 The short term permits are the economic costs to the
economy
 Move through a low cost path from the short run to
the longer run in decadal steps with profit incentives to
reduce emissions wherever cost effective
36
A Partial Analogy – Bond markets
 Long term government bond market prices interest
rates over long horizons given a stock of government
debt (like long term permits)
 Central banks set the short term interest rate - the
supply of financial liquidity is generated by the market
(like annual permits).
 The long term interest rate (which is flexible) is the
expected value of future of short term interest rates
(which are fixed in any period)
37
Encouraging Non Fossil Fuel Energy and
carbon capture technologies
 Relative price of carbon higher in the short term and
the longer term
 Clear pricing over long time periods gives a clear
signal of the return to investment in non-fossil fuel
energy sources or capture of carbon from fossil fuels
 Could allow non-fossil fuel energy producers and
carbon capture to generate annual permits in
proportion to the amount of carbon not emitted (does
not require international negotiation while the price
cap is binding)
38
Is early action a good idea?
• Australia could adopt the Blueprint today
in advance of the rest of the world both
for a direct economic gain and to
encourage the rest of the world to adopt
similar policies
• Most models ignore uncertainty and
therefore do not incorporate wealth
generated from risk management
39
What about competitiveness?
•
The cost of carbon is not the largest cost even in
aluminium production – the cost of capital is more
important
•
Under the Blueprint, the cost of carbon that affects
direct competitiveness is controlled by the
government and is kept low until other countries
impose carbon prices in which case the
competitiveness issue disappears over time
•
The increased ability to manage asset risk will be
more positive for a company’s balance sheet than
the negative effect of a slightly higher short term
carbon price
40
What about carbon leakage?
• Why would a fossil fuel intensive industry
move away from an economy in which the
risk to their capital is hedged, into an
economy with greater political risk and no
carbon policy when you know that over
the next decade or so carbon policy will be
inevitable.
• A small rise in the carbon price will be
more than offset by the gains of risk
reduction on protecting capital
41
Early Action is critical
• Australia should act now in creating
markets with long term price signals that:
 That enable energy generators and energy intensive
industries to protect their capital value against
change in the climate and changes in climate policy
 Give clear profit signals to alternative generating
technologies and other technologies such as carbon
capture and storage
• R&D in only a partial but a necessary part
of the solution
 but without a market price there is little incentive for
technologies to be implemented and diffused through
the economy
42
Conclusions
• Substantial climate uncertainty implies
responding now in terms of institutional
design
• Need long term price signals to encourage
development, adoption and diffusion of
carbon saving technologies and to manage
energy demand
• Need short term price signals capped at
expected benefits to minimize economic
cost
43
Conclusion
• The solution to reducing emissions will
require a portfolio of different policy
strategies not reliance on a single
strategy
• The technological solution will likely
involve a range of different technologies
all suitable for different circumstances
• A foundation of clear price signals will
help minimize the economic costs of
addressing what is probably the most
important policy issue of our time
44
Background Papers
www.sensiblepolicy.com
45
An Example: Australia and China
• What would the markets look like in
Australia versus China?
• Suppose China receives double versus
triple 2002 emissions
46
20
06
20
11
20
16
20
21
20
26
20
31
20
36
20
41
20
46
20
51
20
56
20
61
20
66
20
71
20
76
20
81
20
86
20
91
20
96
21
01
$US 2002
Annual Permit Price
160
140
120
100
80
60
40
20
0
Annex B
China double
China triple
47
Value of Long Term Permits (r=5%)
3000
2500
1500
1000
500
0
20
06
20
11
20
16
20
21
20
26
20
31
20
36
20
41
20
46
20
51
20
56
20
61
20
66
20
71
20
76
20
81
20
86
20
91
20
96
21
01
$US 2002
2000
Annex B
China double
China triple
48
• The same approach can be applied in
countries at different levels of
development
49