From the RGE monitor:
Today we look at U.S. and global efforts to reduce carbon emissions and
slow global warming. Last Friday, June 26 2009, The U.S. House of
Representatives approved the landmark America Clean Energy and Security
Act
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by a narrow seven vote margin, including 44 no votes from Democrats. The
legislation, also known as Waxman-Markey after its sponsors, or the
climate bill, will face an even tougher audience in the Senate, where it
must meet a 60-vote threshold. The Minnesota Supreme Court’s decision to
seat Al Franken in the Senate may add to the Democrats’ leverage. The
bill aims to cut 2005 emissions levels by 17% by 2020 and has at its
core a Cap-and-Trade system which calls for mandatory caps on greenhouse
gas emissions. Any companies wishing to emit above a certain level will
need to purchase permits to do so. Additionally the bill requires large
utilities to increase their use of renewable energies such as hydro,
wind, solar and geothermal power generation.
The bill’s passage by the House is historic and will likely increase
President Obama's leverage in global climate negotiations as global
leaders try to replace the soon-to-expire Kyoto Protocol. Detractors
though point to its economic costs and the limited nature of the final
legislation
*How the Bill Works*
At the heart of the bill is a Cap-and-Trade system
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a market-based system which caps emissions at a certain level and allows
large emitters to buy permits for additional emissions from other
companies that emit less than the upper limit. The legislation calls for
the number of permits to be reduced over time to encourage lower
emissions. In practice, establishing a market for these permits will
increase the cost of using carbon-based energy (especially electricity
from coal), which will in turn reduce demand.
The revenue earned through auctioning would be distributed among
households to offset the negative effect on their purchasing power from
the higher cost of energy. Initial plans called for all or at least a
majority of the permits to be auctioned but the vote-getting process
increased the number allocated. The bill passed by the House calls for
85% to be allocated and 15% to be auctioned. Some of the allocated
permits will go to utility companies, the idea being that they will
either invest the proceeds in renewable fuels or temper price increases
for consumers. This change reduces the potential revenue generation of
the policy and runs the risk that low electricity costs could actually
encourage greater usage.
*Cost Estimates*
Estimates of the total economic costs of the U.S. Cap-and-Trade
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program have varied widely. According to the Congressional Budget Office
(CBO), the net annual economic cost
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of the Cap-and-Trade program in 2020 would be $22 billion—or about $175
per household. Analysis of the CBO results suggests that the implicit
tax is relatively progressive
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While this estimate has been accused of being understated (and it is
worth noting that the Environmental Protection Agency came to an even
lower estimate) it presented a baseline for analysis. Other estimates
put the ultimate cost much higher. An analysis from the Heritage
Foundation concludes
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that the Cap-and-Trade system described in the bill would cost the
economy $161 billion by 2020--or about $1,870 per household. Such
estimates do not necessarily account for changes in the price of energy
that would occur naturally as a lack of investment limits production of
fossil fuel based energy. Furthermore, they may not fully include the
technological and efficiency gains that the current legislation hopes to
encourage. For example, some of the allocations to utilities are granted
with the expectation that they will be auctioned off and the proceeds
will be used to fund renewable energy development. It’s worth noting,
however, that there’s no guarantee the utilities will do this in practice.
*Sector-By -Sector*
Where the United States is concerned, the likely impact of the new price
for carbon varies by sector
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Utilities are likely to the most affected, especially in those regions
that derive much of their power from coal-fired plants. The Midwest, the
country’s already-shrinking industrial and manufacturing base and the
home of many of its coal-fired plants, seems particularly vulnerable.
(The distribution of allowances in the legislation is intended to find
the funds to improve competitiveness of coal plants.)
The effects on agriculture are also varied. Recent Deutsche Bank
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research suggests that no-till agriculture, which limits disturbance of
the soil, as well as reforestation and planting of vegetative buffers
could derive significant carbon credits annually under a Cap-and-Trade
regime. By some counts up to 20% of U.S. carbon emissions come from the
release of carbon dioxide from farmland. However, the bill puts off to
the future one contentious issue--the promotion of agricultural land to
grow corn for ethanol
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which critics suggest is very inefficient and contributed to global food
shortages
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in 2008. The legislators also chose the Department of Agriculture, more
likely to be sympathetic to farmers concerns, rather than the EPA, to be
the regulator for approving carbon offsets.
The oil and metals sectors may also face vulnerabilities. Some analysts
worry that emissions standards would encourage companies to keep
inventories low and to import more refined fuels, contributing to idle
capacity in U.S. refineries. However, it may also encourage the creation
of cleaner processes or the development of carbon capture technologies,
which are as yet far from being commercial. Overall, businesses have
supported establishing a climate regime, given that clarity over
regulatory responses is key to planning. However, there are still many
uncertainties about how such a regime will be implemented.
*Trade Concerns*
There is also a growing fear that climate change policies could prompt
trade protectionist policies
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The risk that higher costs might accelerate a decline in the U.S.
manufacturing base as more production is moved offshore has contributed
to the suggestion that compensatory import taxes might be placed on
carbon-intensive imported goods. President Obama, in saluting the bill’s
passage, did insist that the U.S. not discriminate against imports.
Doing so might lead to retaliatory protectionism and a further hit to
trade. In a report released last week, the World Trade Organization
(WTO) suggested
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that import taxes might be WTO-compliant if they limit distortions. Paul
Krugman suggests
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that the WTO’s view is analogous to that for value added taxes. However,
Martin Feldstein notes
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that the system could be very complex. With different countries each
having country-specific caps and different tariffs, it could be very
difficult to assess how comparable the measures are and what remedies
might be needed. Thus the implications for international trade and trade
law could be quite significant. Moreover, developing countries are
petitioning for trade restrictions
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on carbon-reducing technologies to be lifted or for technology transfer
of such goods. The mostly advanced economy companies who developed such
expertise have been reluctant to cut prices.
*Other Efficiency Steps*
The administration’s energy policy more broadly tries to offset
potential costs with new opportunities and technological advances to
boost productivity growth. It aims to generate 25% of U.S. energy from
renewable sources by 2025, create “green jobs” and reduce dependence on
imported oil. Projects to develop renewable fuels and improve the
efficiency of the power grid received funding in the stimulus bill, in
part to offset the impact of the triple shock of lower energy demand,
lower credit and lower hydrocarbon prices on renewable producers.
President Obama’s team plans to spend $150 billion over the next decade
to promote energy from solar, wind and other renewable sources, as well
as energy conservation.
Other key steps include the May 2009 auto efficiency program
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which requires the American fleet to increase to an average mileage
standard of 39 miles per gallon (mpg) for cars and 30 mpg for trucks by
2016 – a jump from the current average for all vehicles of 25 miles per
gallon. Doing so would create a new national standard, after many states
have unilaterally taken more aggressive steps. A national standard could
make it easier for car companies to supply different jurisdictions.
Government estimates that oil consumption may fall 1.8 billion barrels
from 2012 to 2016 and greenhouse gas emissions may fall by 900 million
metric tons could be overoptimistic. They may, however, be more
effective than the recently announced “cash for clunkers
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program in which consumers receive a rebate for a new more fuel
efficient vehicle if they turn in a gas guzzler. Yet the required fuel
efficiency increase is rather low (only 4mpg) and the threshold is lower
than the current national average. As such, the latter policy, which has
been effective in stocking auto demand in countries like China, Germany
and South Korea, might have limited effect in the United States. However
the effects of such incentives may be temporary. If they elapse without
a sustained increase in consumption, demand for autos could fall quickly
especially in developed economies which already have a high number of
cars per household.
These initiatives together hope to reduce the amount of oil the United
States imports. The bulk of energy imports (oil, gas, electricity) come
not from the Middle East but from Canada. An increasing amount of the
oil supplied is bitumen from the oil sands
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which continues to bear an expensive environmental and economic cost per
barrel under current technology. Bitumen’s carbon footprint is improving
though through technological innovation – and the fuel expended in
transport is clearly lower than the amount needed to ship oil from Saudi
Arabia. Yet there is still a long way to go. Given the shift towards
energy efficiency and lower emissions fuel supply, Canadian authorities
and producers are struggling to improve production so that their largest
consumer will keep buying. On President Obama’s visit to Ottawa, his
first foreign trip as president, he and Prime Minister Harpe
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announced joint investment in carbon capture technology, adding to funds
already pledged by the province of Alberta. Such measures hope to help
the U.S. meet energy security needs without adding to environmental
insecurity. However, carbon capture technology is still far from being
commercial.
*Assessing Alternatives*
One of the biggest benefits of this legislation is that it provides a
mechanism to set a price for carbon over the mid-term. Doing so will
help households and businesses make investment and savings decisions.
However, economists have long argued that a carbon tax
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would be more efficient than a Cap-and-Trade system, as it would be less
complex and vulnerable to distortions. A carbon tax would set a specific
cost per unit of carbon dioxide, thus establishing a clear cost for
carbon. A Cap-and-Trade system, on the other hand, would set an upper
limit for emissions, but the prices it established for carbon might be
variable. Of course, introducing new taxes is rarely popular,
particularly not during a recession, even if the tax option would be
more efficient and have lower compliance costs.
The European Union’s experience with Cap-and-Trade
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over the past several years provides reason for caution. The first
iteration of the policy, issued too many permits, undermining demand.
With prices for carbon low, so was the incentive to reduce emissions. A
reformulation improved this balance and emissions have been reduced,
though European countries still have a significant space to reach their
targets. The EU system allows companies to bank or store their
allocations for the future or to borrow them from the future. The EU
system also illustrates an effect of the global recession. The drastic
reduction in industrial output has meant that many companies are
producing well lower than their quotas and are seeking to sell their
excess allocation. Several companies sought to raise cash by selling
their carbon certificates, causing the price of carbon to plummet. A
market-derived carbon price might actually be very volatile.
*The Road to Copenhagen*
World leaders will meet this December in Copenhagen
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to negotiate a replacement to the Kyoto Protocol, which expires in 2012.
The Kyoto Protocol aimed at reducing emissions of 1990 greenhouse gases
levels by 5.2% by 2012. The range that is now being discussed is around
25% to 40% of 1990 levels by 2020. The previous U.S. administration
withdrew from ratifying the Kyoto protocol, saying it deemed it unfair
for allocating reductions targets between developed and developing
countries. The reluctance of emerging market economies
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to make emissions cuts that might stunt their growth could again be an
obstacle to a deal later this year.
The United States and China
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are the world’s top two greenhouse gas emitters, together accounting for
more than 40% of annual emissions. If the United States and China can
become catalysts in bringing about a strategic transformation to a
low-carbon, sustainable global economy, the world will take a giant step
forward in combating climate change. Given the complexities of global
discussions, analysts like Kenneth Lieberthal
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suggest that climate change
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is yet another policy arena that could be best tackled by a G-2, that is
bilateral talks by the two countries. Despite its reluctance to take any
steps that might reduce economic growth, China, has been taking some
steps to curb emissions growth
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China rivals the United States as a carbon emitter, despite having low
levels per capita, but now has domestic interests to slowly make
changes. In particular, the increase in pollution-related illness is
taxing the Chinese health care system. Yet many of these measures, such
as China’s own cash for clunkers
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program, may be of limited effect given the potential demand for primary
energy. Coal remains the primary feedstock for Chinese electrical plants
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although the country is planning to build several nuclear power plants
and is sourcing more of its electricity from wind
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China is now the world’s largest assembler of solar technology, but
little is applied domestically. Should China choose to allocate a
greater share of infrastructure spending towards power generation from
renewable fuel sources, it could have a significant effect on global use
of such technologies.
Chinese heavy industry has been particularly hard hit by slumping global
demand, leading to emissions reductions. Electricity demand continues to
fall, year-on-year (as of May at least), despite the aggressive
government stimulus
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which has including new metals processing
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In fact, the persistent weakness in industrial electrical demand
suggests that overall growth could be weaker than some officials
suggest. Electricity demand has tended to be a proxy for economic
growth. A more domestically driven growth pattern might reduce the pace
of Chinese new energy demand growth over time, however, suggesting that
this correlation could change if more output is shifted to the services
sector.
Coming to a global consensus might therefore be difficult. Already many
European countries, including Sweden, which takes up the EU presidency
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today, may have hoped for a more aggressive commitment from Washington.
Emerging and frontier market economies like South Africa, Mexico and the
UAE
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are now taking measures to reduce their carbon footprint. Brazil has
moved to reduce the destruction of its rain forests. However these
countries continue to be wary of restrictions on emissions, arguing that
advanced economies should bear the bulk of the costs. They are also
pushing for more technology transfer from the companies and countries
that developed some of these techniques.
*
Higher Carbon Costs and the Global Economy*
A higher price for carbon-based energy could be one of several increased
taxes and costs which weigh on U.S. consumption in the near future.
Should the recovery in U.S. consumption be as sluggish as feared, such
higher costs could be a limitation in the absence of real investment
which might prompt productivity gains. Despite the risks of a new carbon
price, this cost, plus the allocation of government and private sector
funds, could spur innovation and energy savings technology that could
lead to productivity growth.
Moreover, the cost of energy could increase quite substantially even in
the absence of a carbon price. Even in 2009, there is a risk that higher
oil prices might dampen any economic recovery
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Further increases, perhaps to the $80-90 a barrel range, could keep the
economy well in recessionary territory this year. Given current and past
short-falls in oil investment, production growth might be quite sluggish
going forward. If petroleum demand returns to trend, this could
contribute to higher prices in 2010. Higher oil and coal prices could
encourage a change in behavior that could boost the position of
alternatives in the energy mix, even though carbon-based fuels – albeit
higher cost ones – are likely to fuel the economy for years to come.
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