Carbon Tax and Carbon Trading Solutions

If you look at the indirect costs, a gallon of gas wouldn’t cost $3 but $12. The challenge is to get the market to be honest and that means restructuring the tax system to incorporate those indirect costs. We can lower income tax and raise a carbon tax. We wouldn’t change the amount of tax we would pay but we would adjust the cost of carbon to reflect the real cost to society, not just the direct cost.  If we can do that, the world economy can begin to restructure itself.

- Lester Brown, Founder Earth Policy Institute, Author of World on the Edge

Socialism collapsed because it did not allow the market to tell the economic truth, Capitalism may collapse because it does not allow the market to tell the ecological truth

- former vice president Exxon, North Sea

If China, Brazil, Chile, and the other emerging economies eyeing these (carbon trading) mechanisms are included, carbon pricing initiatives could…cover almost half of total global emissions

- Niklas Hohne, co-author, World Bank 2013 report - Mapping Carbon Pricing Initiatives: Developments and Prospects

Introduction

Ultimately, global warming comes down to a social and political problem. If we had the political, governmental, investment and social motivation, we could reduce emissions to a safe level. As extreme weather and its impact become a global norm and predictions only growing worse by the day, policy and trade mechanisms are now aggressively being pursued in both carbon taxation and trading schemes. This movement to reflect real environmental costs of fossil fuel on the bottom line is gaining momentum rapidly. Ultimately, businesses in the old economic paradigm have to be compelled and guided by governmental, social and scientific institutions to act in the best interest of humanity.

Divestment and Stranded Assets

Two synergistic movements are Stranded Carbon Assets, spearheaded by the Carbon Tracker initiative and Fossil Fuel Divestment, initiated by 350.org. A recent study by Oxford’s Smith School of Enterprise and the Environment indicate that the fossil fuel divestment campaign is growing faster than any previous divestment campaign. Another recent sign that the investment community is paying attention is the March 20, 2014 announcement by Exxon-Mobil, the world’s largest fossil fuel company, that it will to publish a report on “carbon asset risk”, in response to a shareholders resolution filed by Arjuna Capital. The company will disclose data regarding the risks to their business model posed by stranded assets, as well as their corporate plan to deal with new potential climate regulations.

The campaign, built on research by the British group Carbon Tracker, aims to put pressure on companies to get out of coal, oil and gas holdings on the grounds that potential regulations could reduce the value of fossil fuel reserves.
Market forces such as carbon-reducing regulations, weakening demand for oil and coal in many parts of the world and rapid growth of renewables clearly show that energy leaders of tomorrow will be those that address carbon asset risks today.
These reserves are not only the most carbon intensive, risky, and expensive to extract, but the most vulnerable to devaluation.

 
cover-stranded-assets-and-the-fossil-fuel-divestment-campaign
The oxford study found that 350.org’s fossil fuel divestment campaign has gained traction faster than previous divestment efforts against Apartheid, tobacco, and pornography, and therefore poses a serious reputational risk to the world’s biggest fossil fuel companies.The research question which the report sought to answer was this: Can the efforts of fossil fuel divestment campaigns create a direct impact on some of the world’s richest and most powerful fossil fuel companies? The answer is intriguing: directly no, but indirectly yes. That is, dollar-wise, no, but reputation-wise, yes and the loss of reputation can actually translate to significant dollar impact.

The study compared the current divestment campaign with others of the recent past and analyzes the campaign impact on three consecutive groups:

  1. religious groups and public organizations
  2. universities, cities, and public institutions
  3. international market

It found that comparatively speaking, the fossil fuel divestment campaign has achieved a lot in the relatively short time since it’s inception. As of the time of the report, it has impacted:

  • 6 colleges and universities
  • 17 cities,
  • 2 counties,
  • 11 religious institutions,
  • 3 foundations,
  • 2 other institutions

stranded assests figure

Figure 1: Divestment campaign with South Africa Apartheid regime and the three sectors approached

Direct Capital Impact of Divestment Campaign is Small

The report concludes that of the $12 trillion in assets among university endowments and public pension funds, the largest potential limit of divestment is between $240-600 billion, with another $120-300 billion in debt, which translates to:

  • 2-3% fossil fuel equity exposure for US university endowments
  • 4-5% for UK university endowments
  • 2-5% of public pension funds

An analysis by Aperio Group analysis called Building a Carbon-free Portfolio found fossil fuel divestment only increases ordinary market risk for higher education investors by less than 0.01%. With the exception of coal,  direct impacts of fossil fuel divestment on equity or debt for fossil fuel companies will be limited at best, and their share prices are “unlikely to suffer precipitous decline” because divested stock will likely find neutral investors. Coal companies only represent a small fraction of overall fossil fuel market capitalization but due to being less liquid and the scarcity of alternative investors, they are at greater risk.

But Indirect Impact due to Reputation Loss is Large

The outcome of the stigmatization process, which the fossil fuel divestment campaign has now triggered, poses the most far reaching threat to fossil fuel companies and the vast energy value chain.

- Oxford Smith School of Enterprise and the Environment - Stranded assets and the fossil fuel divestment campaign: what does divestment mean for the valuation of fossil fuel assets

The study finds a cascading or multiplying effect on the larger campaign by:

  1. driving away suppliers, subcontractors, potential employees, and customers,
  2. leading shareholders to demand management changes
  3. barring stigmatized firms from competing for new business or completing mergers
  4. leading to restrictive new legislation by governments – a trend found in every existing divestment campaign

For fossil fuel companies, this could bring about a carbon tax or other laws that could reduce their corporate valuation, and the study finds that a handful of fossil fuel companies are likely to become scapegoats, bearing the brunt of the devaluation.

 World Bank report finds growing number of national carbon markets

cover-mapping-carbon-pricing-initiatives-2013

The World Bank study Mapping Carbon Price Initiatives: Developments and Prospects finds that in 2013, there are 60 carbon trading schemes worldwide. Rachel Kyte, World Bank VP for sustainable development feels optimism in the shadown of the UN’s failure to create an international carbon market. She says that  “Even as the first generation of the carbon market stutters…it is progress at the country level that gives hope,”

These regional markets are growing while international carbon prices are at historic lows and the prospect of coordinated international emissions reduction measures uncertain. Kyte believes that “Carbon pricing is emerging and carbon markets have a future.” These emerging schemes can have a significant impact on global emissions – at the same scale that the failed UN Kyoto

 Protocol aimed to achieve. As of 2013, the countries with functioning carbon pricing mechanisms scheduled to start within the next few years collectively emit 10 gigatons of CO2 per year – equal to about 20% of global emissions, or the combined annual emissions of the US and EU.

world bank report 2013 - mapping carbon pricing initiatives - figure 1 - emerging trading schemes

 

Figure 2: World Bank map of 60 regional carbon trading schemes in 2013

The report is a collaboration between the World Bank and consultancy Ecofys. The Bank report highlights cap and trade systems in:

  • EU,
  • California,
  • Kazakhstan,
  • New Zealand,
  • Quebec,
  • the Regional Greenhouse Gas Initiative,
  • regional markets in Japan,
  • South Korea’s developing system
  • Australia,
  • British Columbia,
  • Denmark,
  • Finland,
  • Ireland,
  • Norway,
  • South Africa,
  • Sweden,
  • Switzerland,
  • United Kingdom

The report does not fully consider China, which has is already taken concrete steps to reduce pollution and has begun pilot programs in major cities, with expectations to roll out nationally in 2020. “If China, Brazil, Chile, and the other emerging economies eyeing these mechanisms are included, carbon pricing initiatives could…cover almost half of total global emissions,” said Niklas Hohne of report co-author Ecofys.

James Hansen and 17 other scientists propose a 6 % Carbon Tax to Avoid Disaster

In the paper Scientific case for avoiding dangerous climate change, Hansen and 17 top scientists propose an immediate carbon tax to avert looming disaster. The 17 other experts, including climate scientists, biologists and economists calls for an immediate 6% annual cut in CO2 emissions, and a substantial growth in global forest cover, to avoid catastrophic climate change by the end of the century.

The paper argues that our current emergency situation has arisen due to the emissions to date of just a small fraction of the total potential emissions from known reserves and potentially recoverable resources. The teams research shows that the fossil fuel industry receives 450 Billion USD of subsidies a year – $45 USD from each person on the planet.

Figure 3: CO2 emissions by fossil fuels (1 ppm CO2 ~ 2.12 GtC). Estimated reserves and potentially recoverable resources are from EIA (9) and GAC (10). (Source: Hansen et al. Scientific Case for Avoiding Dangerous Climate Change to Protect Young People and Nature)

Although there are uncertainties in reserves and resources, ongoing fossil fuel subsidies and continuing technological advances ensure that more and more of these fuels will be economically recoverable. Burning all these reserves of fossil fuels would create a very different and potentially unsurvivable planet than the one that humanity currently knows.

We conclude that initiation of phase-out of fossil fuel emissions is urgent. For example, if emission reductions begin this year the required rate of decline is 6%/year to restore Earth’senergy balance, and thus approximately stabilize climate, by the end of this century. If emissions reductions had begun in 2005, the required rate was 3%/year. If reductions are delayed until 2020, the required reductions are 15%/year. And these scenarios all assume a massive 100 GtC reforestation program, essentially restoring biospheric carbon content to its natural level.

The implication is that we must transition rapidly to a post-fossil fuel world of clean energies. This transition will not occur as long as fossil fuels remain the cheapest energy in a system that does not incorporate the full cost of fossil fuels. Fossil fuels are cheap only because they are subsidized, and because they do not pay their costs to society. The high costs to human health, food production, and natural ecosystems of air and water pollution caused by fossil fuel extraction and use are borne by the public. Similarly, costs of climate change and ocean acidification will be borne by the public, especially by young people and future generations.

Thus the essential underlying policy is for emissions of CO2 to come with a price that allows these costs to be internalized within the economics of energy use. The price should rise over decades to enable people and businesses to efficiently adjust their lifestyles and investments to minimize costs. Fundamental change is unlikely without public support. Gaining that support requires widespread recognition that a prompt orderly transition to the post fossil fuel world, via a rising price on carbon emissions, is technically feasible and may even be economically beneficial apart from the benefits to climate. The most basic matter is not one of economics, however. It is a matter of morality – a matter of intergenerational justice. As with the earlier great moral issue of slavery, an injustice done by one race of humans to another, so the injustice of one generation to all those to come must stir the public’s conscience to the point of action. (Source: Hansen et al. Scientific Case for Avoiding Dangerous Climate Change to Protect Young People and Nature)

Fossil Fuels are only Cheap because they are Subsidized 

The implication is that the world must move expeditiously to carbon-free energies and energy efficiency, leaving most remaining fossil fuels in the ground. Yet transition to a post-fossil fuel world of clean energies will not occur as long as fossil fuels are the cheapest energy. Fossil fuels are cheap only because they are subsidized and do not pay their costs to society.

Air and water pollution from fossil fuel extraction and use have high costs in human health, food production, and natural ecosystems, costs borne by the public. Huge costs of climate change and ocean acidification also are borne by the public, especially young people and future generations.

(Source: Hansen et al. Scientific Case for Avoiding Dangerous Climate Change to Protect Young People and Nature)

Price per Ton of CO2 Emitted Strategy is Supported by Policy Director of Republicans for Environmental Protection – Use Legal System to Protect our Grandchildren

Thus the essential underlying policy, albeit not sufficient, is for emissions of CO2 to come with a price that allows these costs to be internalized within the economics of energy use. The price should rise over decades to enable people and businesses to efficiently adjust their lifestyles and investments to minimize costs. The right price for carbon and the best mechanism for carbon pricing are more matters of practicality than of economic theory.

Economic analyses indicate that a carbon price fully incorporating environmental and climate damage would be high (96). The cost of climate change is uncertain to a factor of 10 or more and could be as high as ~$1000/tCO2 (97). While the imposition of such a high price on carbon emissions is outside the realm of short-term political feasibility, a price of that magnitude is not required to engender a large change in emissions trajectory.

An economic analysis indicates that a tax beginning at $15/tCO2 and rising $10/tCO2 each year would reduce emissions in the U.S. by 30% within 10 years (98). Such a reduction is more than 10 times as great as the carbon content of tar sands oil carried by the proposed Keystone XL pipeline (830,000 barrels/day) (99). Reduced oil demand would be nearly six times the pipeline capacity (98), thus rendering it superfluous.

Relative merits of a carbon tax and cap-and-trade have long been debated (100). A cap-and-trade system for CO2 emissions was implemented in Europe, but not in the U.S., where opponents of any action on climate won the political battle by branding cap-and-trade as a devious new tax. However, a gradually rising fee on carbon emissions collected from fossil fuel companies with proceeds fully distributed to the public, was praised by the policy director of Republicans for Environmental Protection (101) as: “Transparent. Market-based. Does not enlarge government. Leaves energy decisions to individual choices… Sounds like a conservative climate plan.”

A rising carbon emissions price is the sine qua non for fossil fuel phase out. However, it is not sufficient. Governments also should encourage investment in energy R&D and drive energy and carbon efficiency standards for buildings, vehicles and other manufactured products. Investment in global climate monitoring systems and support for climate mitigation and adaptation in undeveloped countries are also needed.

Despite evidence that a rising carbon price and these supplementary actions would drastically shrink demand for fossil fuels, governments and businesses are rushing headlong into expanded extraction and use of all fossil fuels. How is it possible that large human-driven climate change is unfolding virtually unimpeded, despite scientific understanding of likely consequences? Would not governments – presumably instituted for the protection of all citizens – have stepped in to safeguard the future of young people? A strong case can be made that the absence of effective leadership in most nations is related to the undue sway of special financial interests on government policies aided by pervasive public relations efforts by organizations that profit from the public’s addiction to fossil fuels and wish to perpetuate that dependence (102, 103).

A situation in which scientific evidence cries out for action, but a political response is impeded by the financial power of special interests, suggests the possibility of an important role for the judiciary system. Indeed, in some nations the judicial branch of government may be able to require the executive branch to present realistic plans to protect the rights of the young (104). Such a legal case for young people should demand plans for emission reductions that are consistent with what the science shows is required to stabilize climate. Judicial recognition of both the exigency of the climate problem and the rights of young people, we believe, will help draw attention to the need for a rapid change of direction.

(Source: Hansen et al. Scientific Case for Avoiding Dangerous Climate Change to Protect Young People and Nature)

Putting Carbon Tax on Consumption

 It is a stark and frightening fact that, despite more than two decades of international effort — including enormous time and energy expended on the Kyoto Protocol — and significant economic costs, carbon emissions are now rising even faster than they were in 1990. Back then they were going up by about 1.5 parts per million (ppm) per year. Now it is 2 ppm. The critical 400 ppm global threshold will shortly be crossed, and there is little reason to believe that this trend is likely to be halted any time soon.

- Dieter Helm, professor of energy policy at the University of Oxford, Fellow in Economics at New College, Oxford, and author of The Carbon Crunch: How We Are Getting Climate Change Wrong and How to Fix It.

Dieter Helm cites a frightening statistic – China and India together currently add around three new coal stations a week, and between now and 2020 around 400 to 600 gigawatts of new coal is likely to come onto the world’s energy systems if there is no effective policy tool to prevent it. Helm warns us, however to think a little before blaming China and India.  China’s phenomenal economic growth has been based on exports of mostly energy-intensive goods, from steel and petrochemicals to a host of manufactured products – we all know where our iphones and iPADs come from. These have been bought largely by the U.S. and Europe, which together account for nearly 50 percent of world GDP.

What Helm suggests is a Carbon Consumption tax, not a Carbon Production tax. It is carbon consumption that measures the actual carbon footprint and hence the responsibility. Remarkably the Kyoto framework does not take consumption into account but instead focuses on carbon production. This incorrect focus explains anomalies such as how carbon production can be falling in Europe in line with its Kyoto targets, while global carbon emissions continue rising.  Deindustrialization in Europe and the collapse of the former Soviet Union made compliance to Kyoto Protocol targets easy. For example, the UK’s carbon production fell by more than 15 percent between 1990 and 2005, but once imported carbon is taken into account, carbon consumption increased by more than 19 percent.

Unless people pay the cost of their pollution, they will not do much about it, and this is best measured by carbon consumption, not carbon production. There must be a tax for carbon consumption, complete with border adjustments to ensure that imports of carbon-intensive goods from countries without a carbon price are treated on the same basis as domestic production. If you want an iPAD, you should be prepared to pay the carbon consumption tax for it. Then it represents the real previously externalized costs of the product. This high cost will economically force manufacturers such as Apple to redesign their products to truly have a low carbon footprint and in turn, to reduce the burning of carbon in Chinese coal plants.

Eliminating Fossil Fuel Industry Subsidies

The International Energy Agency estimates that cost of government subsidies for fossil fuels has increased from $311 billion in 2009 to $544 billion in 2012. According to IEA’s Fatih Birol, ballooning government deficits, rather than worries about climate change are driving companies to begin eliminating these costly petrol subsidies and pass on the real cost to consumers. Governments have been struggling to keep up with escalating energy costs which saw the price of oil double between 2009 and 2012. In many countries, the petrol subsidies account for a hefty 5% of GDP. According to an IMF report, if lost tax revenues are included, this figure increases to a whopping  $2 trillion, or over 8% of government revenues. Why does the wealthiest and dirtiest industry in the world need all these subsidies? The high level of public subsidies is costing society in two significant ways:

  1. contributing to continual reliance of dirty energy and lowering incentives for clean energy
  2. contributes to ballooning government debt

Aside from leveling the playing field for clean energy, there are other compelling reasons for eliminating subsidies:

  • Countries that subsidize fossil fuels significantly increase national budget deficits and make them vulnerable to external shocks such as rising interest rates
  • Expensive subsidies means less money available to invest in public services like infrastructure, health or education
  • Subsidies promote inequality because they mostly benefit the rich. IMF research shows that a measly 7% of fuel subsidies in poor countries end up in the hands of the bottom 20% of households while 43% end up in the pockets of the richest 20%. Put simply, richer people are the ones most likely to drive cars.

In June 2013, Indonesia cut its annual $20 billion subsidy bill by increasing petrol prices by 44%. Malaysia soon followed suit; in an attempt to reduce its budget deficit of 4.5% of GDP, it has reduced its petrol subsidies. As a result, household energy bills immediately climbed by 15%. Egypt’s 2014 deficit stands at 14% of GDP and is considering following suit.