Constructing a high efficiency, lowcarbon coalition: pricing and
international financing dimensions
Professor Michael Grubb
Chair, Climate Strategies
Senior Research Associate, Faculty of Economics, Cambridge University
& Editor-in-Chief, Climate Policy Journal
Presentation to CAGE/CCCEP workshop
Developing policy regimes for combating climate change
London, Tuesday 25 January 2011
Faculty of Economics
Hard times
– US non-participation, Japan clearly unwilling to proceed without US
– Shifting economy and trade patterns reduce role of EU & Annex I
emissions globally
– Recession and accumulated debt impedes financing & willingness
– Cancun – a political success and measure of the ‘art of the possible’,
that thereby highlights the lack of substantive commitment ..
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Evolution & Conclusions
Energy is an evolutionary system ..
Global
Energy
Costs
Time
Current
emissions
Future
emissions
scenarios
Present
Global
Energy
Costs
Future
Low
carbon
Global
Emissions
High
carbon
Global
Emissions
.. And future costs divide on the ridge of oil depletion
Low Carbon
Number of
potential energy
futures near
‘minimum’ cost
High Carbon
The clustering of ‘low cost’ energy futures
around higher and lower emission levels,
rather than in the middle, reflects the
fundamental options in the face of oil
depletion
Global
energy
costs
We are
here
Time
Low carbon futures
•An integrated energy
system
•Electricity in transport
•Low-carbon electricity
•High capital costs….
•……but low operating costs
Annual
global
emissions
High carbon futures
•A continued dependence on fossil fuels
•Unconventional and synthetic oil in
transport
•Low capital costs…
•…but high operating costs and a host of
environmental issues beyond carbon
The three policy pillars of solutions
Core
Solutions
Public-led
Investment
Prices
Consumer
engagement
PILLAR II
PILLAR III
Innovation
&
Infrastructure
Substitution
Behaviour
PILLAR I
Hard times
– US non-participation, Japan clearly unwilling to proceed without US
– Shifting economy and trade patterns reduce role of EU & Annex I
emissions globally
– Recession and accumulated debt impedes financing & willingness
– Cancun – a political success and measure of the ‘art of the possible’,
that thereby highlights the lack of substantive commitment ..
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Evolution & Conclusions
UK CO2 emissions from a consumption perspective
Domestic emissions have been reduced but UK carbon footprint still risen
Production emissions1
Consumption emissions
632MtCO2
Household
energy: 32%
17%
International
aviation & shipping
Other
Industry (Heat
and Industrial Processes)
Residential &
Commercial Heat
22%
Domestic
Transport
31%
Electricity
Generation
7%
4%
18%
2004 Data
845MtCO2 Other
consumption: 68%
Imported
emissions
54%
Domestic
emissions
46%
Household Household
direct emissions2
electricity
Household
Transport (fuel)
Fuel3
Public Retail &
Electronic
sector4 Hospitality5
equipment
Business
Transport (non-fuel)9
6
Machinery & Equipment8
Services
Clothing
Food & Beverages
Note 1: CO2 only – excluding non CO2 emissions and land use change
Construction Chemical based products7
1. Based on split of emissions from Committee on Climate Change (CCC) 2. All direct combustion of fuel in households for heating, cooking, etc 3. Includes all non-domestic Air, Rail, Sea & Road
transport operation 4. Includes Defence, Health & Public Administration 5. Includes Retail, Hotels, Restaurants 6. Includes Financial Services, Communication Services and other business services
7. Includes household chemicals, cosmetics, pharmaceuticals 8. Includes domestic appliances and industrial machinery 9. Includes automotive, aviation, rail, road and marine
Source: CT Analysis; CICERO / SEI / CMU GTAP7 MRIO Model (2004); CCC
General pattern of ‘embodied carbon’ flows to ICs
Percentage change in territorial emissions
to reflect impact of consumption of CO2
Unilateral carbon pricing may exacerbate with carbon leakage
2004 Data
120%
80%
60%
40%
20%
Non-Annex 11 EU
Other Annex 11
Hong
Kong
Sweden
France
UKSpain
Germany
Italy
Japan
Wedge between
consumption & production
of embodied carbon
USA
0%
-20%
-40%
-60%
India
Brazil
Canada
Russia
Poland Czech
Rest of West
Republic
Asia
China
Ukraine
South
Africa
2004 territorial CO2 emissions (27Gt)
1. Annex 1 to UNFCCC
Note 1: Includes CO2 emissions from production, process, transport and household sources only (27Gt in 2004); excludes non-CO2 emissions, and emissions due to land-use-change
Note 2: Based on an MRIO (multi region input/output) model allocating emissions to regions of consumption
Source: Carbon Trust Analysis; CICERO / SEI / CMU GTAP7 MRIO Model (2004)
Carbon leakage v.sector-dependent, modest, but ….
Modeling of three key sectors for EU ETS Phase III (EU 20% target)
-
biggest emissions impact on cement, mainly through clinker reduction and trade
biggest leakage as % of overall emission reductions in steel (40%)
cement and aluminium have similar leakage rates (c.20%) relative to reductions
emission gains from finding solutions that preserve incentives biggest in cement
Though absolute scale of leakage is small, it is
significant for some sectors and has enormous
impact on design (free allocation) & ambition
Source: Climate Strategies (2009): Droege et al., ‘Tackling carbon leakage in a world of
unequal carbon prices’
Projected production & consumption of EU ETS traded sectors
By 2020, ETS caps only half of EU ‘carbon footprint’ in energy-intensives,
& EU total (production) emissions maybe 10% of global total?
Evolution of EU ETS
Production & Consumption
Drivers of change between
2005 and 2020 emissions
GtCO2
GtCO2
~2% of emissions 'leak‘
1.6
1.6
1.4
1.4
1.4
1.4
1.4
1.4
0.2
1.4
1.4
0.04
1.2
0.5
1.2
0.6
0.7
1.0
0.7
Imports (ETS)
0.2
0.5
Leakage
in-flow
1.0
0.7
Imports
0.5
Production
(net of exports)
0.2
Production
(exported)
0.8
0.8
0.6
0.6
0.7
0.7
0.6
0.4
0.5
Production (ETS
ex electricity,
net of exports)
Production (ETS,
exported)
0.2
0.7
0.4
0.2
0.2
0.2
0.2
0.2
2005
2010
2015
2020
0.0
0.2
0.0
2005
Abatement
Leakage
Flows
2020
Note 1: Declining production emissions based on expected contribution from non-electricity sectors to declining ETS cap (CASE II Model)
Note 2: Growth in imported emissions based on continuation of historic growth in gross imports, and varying degrees of decarbonisation in the exporting countries. In the displayed scenario, it is
assumed that the emissions intensity of exports from Brazil, Russia, India and China (BRIC nations) decline in line with 50% of the targets noted in the Copenhagen Accord (2009), that exports
from the EU and other Annex I nations decline in line with the EU’s target to reduce emissions by 20% from 1990-2020, and that exports from the rest of the world achieve decarbonisation of
the order of half that achieved in the BRIC countries.
Source: Carbon Trust Analysis based on data from: Addressing leakage in the EU ETS: Results from the Case II Model (Climate Strategies, 2009); CICERO / CMU / SEI GTAP 7 MRIO/ EEBT
Hard times
– US non-participation, Japan clearly unwilling to proceed without US
– Shifting economy and trade patterns reduce role of EU & Annex I
emissions globally
– Recession and accumulated debt impedes financing & willingness
– Cancun – a political success and measure of the ‘art of the possible’,
that thereby highlights the lack of substantive commitment ..
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Evolution & Conclusions
What fundamentally needs to change?
• Most major international regimes have grown out of a small
core of committed countries taking action
– Eg. WTO, WIPO
• This looks harder for climate change if viewed just as ‘burden
sharing’ – hence importance of an evolutionary perspective
that integrates energy economics & geopolitics
• Broad tendency has been for stronger action in importer / less
energy-intensive regions (eg. EU, CA, SIDs, India ..)
• No way to solve CC by a pure focus on production emissions of
the developed / consumer regions:
– Inherently unstable (production moves, caps declining share)
– Exacerbates the divide – widens gulf between producer v consumer
• Key is to move towards a more consumption-based structure
over time, with attention to benefit-sharing and incentives
Fundamental options for addressing carbon leakage
- Level down, wait to level up everywhere, or adjust at border?
Adjust costs
downwards
Adjust global costs
upwards
Adjust costs at
border
Conditional allocation
Global carbon pricing
Border Levelling
Price with carbon
cost
Imports into
ETS
Exports from
ETS
Price without carbon
cost
ETS
Rest of
World
ETS
Rest of
World
ETS
Rest of
World
CARBON LEAKAGE – MYTHS AND REALITIES
We have two profoundly different Border Adjustment discussions
Trying to deter ‘inadequate’ action by other countries is very
different from focused objective to tackle carbon leakage by
protecting domestic carbon pricing
• Threatening trade measures against countries not taking
‘comparable’ action
– Extra-territorial judgement on ‘adequate’ action
– Explicitly discriminatory
• Tackling carbon leakage through border levelling
– In principle, cost-levelling between domestic and international
where a specific problem can be demonstrated
– Generally non-discriminatory
CARBON LEAKAGE – MYTHS AND REALITIES
Myth 5. “The best general solution is to protect our economies and pressurise other
countries using border adjustments”
The feasibility, effectiveness and economic and political consequences of border
adjustments varies according to sector characteristics
- Diverse production processes and products increase potential for distortions
and abuse
- Different legal and practical issues for imports vs exports
Any border measures need justification on sector-specifics not generalities
Myth 6. “All Border adjustments are discriminatory, threaten trade & political relations”
We already do it … (eg. excise taxes on petroleum, and VAT)
For imports, benchmarked ‘Best Available Technology’ border levelling is compliant
with GATT Articles I and III - no need to negotiate exemptions
Border leveling is particularly relevant to sectors that are:
• Energy intensive and operate in international markets
• Relatively homogenous products - operates on price competition
• Relatively homogenous production processes – benchmarks are useful
• High operating carbon cost impacts (plants might otherwise part load)
Sectoral approach to border leveling
Charging embodied carbon on sector-by-sector basis as appropriate
Global emissions from different
industrial processes
Iron and Steel
- direct 15.2%
Other electricity
23.7%
Other - direct
17.6%
Chemicals
and
petrochemica
l - electricity
7.2%
Key criteria
• Scale of emissions
• Scale of leakage concern:
Iron and Steel
- electricity
5.8%
•
•
Relative impact of carbon costs
Scale of existing trade barriers
• Availability of policy alternatives
Cement direct 15.3%
Cement electricity
2.7%
Non-ferrous
metals direct 2%
Non-ferrous
Chemicals
metals and
electricity
petrochemical
4.8%
- direct 5.9%
•
•
Effectiveness and losses associated
with free allocation
State of international sectoral
agreement
• Feasibility of border leveling
•
•
Diversity of products
Diversity of production processes
• Cement is the most obvious sector
initially
Hard times
– US non-participation, Japan clearly unwilling to proceed without US
– Shifting economy and trade patterns reduce role of EU & Annex I
emissions globally
– Recession and accumulated debt impedes financing & willingness
– Cancun – a political success and measure of the ‘art of the possible’,
that thereby highlights the lack of substantive commitment ..
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Evolution & Conclusions
International finance - challenge
• Most sources of international public finance have to pass
through the sieve of domestic politics in developed
countries
– The hand of the Treasuries, subject to high-level political commitments
• Under sever pressure from national debt
– The court of public opinion
• Impact of recession and fear of the emerging economies as economic
competitors
• Additional sources of finance will increasingly have to
circumvent these constraints, ideally
– Be outside the scope of existing sources of national finance, and
preferably not fall naturally under any specific national jurisdiction;
– Be visibly connected with climate change, and preferably contribute
directly to mitigation of climate change; and
– Carry mutual incentives that could facilitate all sides agreeing to use
it as a funding source
Source: M. Grubb (2010), ‘International climate finance: the case for international use
of border levelling charges,’ forthcoming in Climate Policy 11:3
Border levelling charges
– Incidence & ‘ownership’
Incidence – net economic effects
– Relatively low demand sensitivity in energy intensive commodities
means almost all cost increases passed to consumers
– Ie. mainly paid by consumers of energy intensive products in the
importing (ETS) countries
Ownership
– There is no clear ‘moral’ basis of ownership/responsibility for emissions
between producers and consumers
– Emissions from production of goods for export logically exist in an
‘international’ space, like international bunker fuels, their assignment is
a matter of political decisionmaking
– Either producer or consumer countries could charge border leveling:
• Consuming countries – could offer the revenues to international expenditures eg. to
fulfil multilateral goals and reduce potential trade-related tensions
• Producer countries – would benefit from a multilateral framework to address loss of
competitiveness vis-à-vis other producers *
Source: M. Grubb (2010), ‘International climate finance: the case for international use of border levelling
charges,’ forthcoming Climate Policy 11:3; * See B. Mueller and A.Sharma, Trade tactic could unlock climate
Table 1. Indicative carbon revenues from cement and steel
- Revenues from Production and border levelling on imports trade, US$m/yr
@$30/tCO2
Europe
OECD
Produc Impo Produc Impo
tion
rts
tion
rts
Cement Volume
(Mt)[1]
Carbon emissions benchmarked @ 0.7 tCO2/tonne
cement
Revenue if paid at €30/tCO2
Steel Volume
(Mt)[2]
Carbon emissions benchmarked @ 1.8 tCO2/tonne
steel
Revenue if paid at €30/tCO2
250
35
175
5250
24.5
735
120
70
216 126
6480 3780
560
70
392
49
11760 1470
250
130
450 234
13500 7020
Source: Grubb (2010) ‘International climate finance: the case for international use
of border levelling charges’, in review for Climate Policy
Hard times
– US non-participation, Japan clearly unwilling to proceed without US
– Shifting economy and trade patterns reduce role of EU & Annex I
emissions globally
– Recession and accumulated debt impedes financing & willingness
– Cancun – a political success and measure of the ‘art of the possible’,
that thereby highlights the lack of substantive commitment ..
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Evolution & Conclusions
Carbon added charging in north-south coalition
– Reiterate: Most major international regimes have grown out of a small
core of committed countries taking action; key challenges leakage & finance
Within coalition
– Revenues raised at the border returned, used for international
expenditures or returned to producers in the coalition under agreed
procedures to support low carbon development plans
– Agreement on evolution from fixed border benchmarks to verified
embodied carbon charging
– Carbon that is charged at source deducted at the border, ie. evolution of
a ‘carbon added’ structure analogous to VAT
Outside coalition
– No basis for returning revenues to producers
– Revenues raised at the border put into to international climate
expenditures
Climate policy in a world of unequal participation
Requires structuring solutions to support the three pillars of domestic policy
• Investment for innovation and infrastructure
– International finance for low carbon infrastructure and avoiding
carbon lock-in
– Networks of innovation centres to facilitate learning, cost-sharing,
and supportive IP regimes
• Carbon and efficiency pricing
– Negotiated systems of border levelling for trade in primary
commodities, with recycling of associated revenues
– Development of ‘carbon added’ pricing strucutres within and
between countries
• Consumer, business and voter engagement
– Standardisation of product efficiency and carbon footprint labelling
– Sectoral agreements, consumer norms ..
Welded together by long-term agreement to form public price expectation
This needs to be seen as an evolutionary journey
- With border leveling as a key part of journey towards broadening action
Bottom line: Why we need a mature debate about
consumption accountability and border levelling
• The problem is ultimately one of consumption, so it makes sense to hold
consumers accountable for the emissions of their consumption choices
– & Why should consumers discriminate against their own producers in favour of imports?
• Leakage fears are messing up cap-and-trade schemes around the world
– free allocation is a poor solution and even this is insufficient to forestall debate as caps
tighten (or precludes tightening of action)
• Money: Using the European cement sector as an example,
– 100% free allocation could increase sector profits by between €2.5-4bn per annum
to 2010. Equivalent funds could be generated for the public sector if these allowances
were auctioned, this will only happen if there is border leveling
– Revenue from the border component would be several €100ms annually and use of
these revenues could be subject to international negotiation
– Steel bigger, especially the international component
• If regions that are willing to take stronger action are expected to suffer
unnecessary economic losses that are not even associated with saving any
emissions, there is no way to solve climate change
Hard times
–
–
–
–
US non-participation, Japan clearly unwilling to proceed without US
Shifting trade patterns reduce role of EU emissions globally
Recession and accumulated debt
Global uncertainty about future of regime, UNFCCC deadlocked
• Strategic economics of the global energy system
• How effective is EU domestic action to 2020?
• How can regions pursue stronger action (/carbon prices) in
a world of unequal participation?
• Trade-related sources of climate finance?
• High efficiency, low carbon coalitions
• Technical annex material
– Mostly from CS & Carbon Trust report “Tackling Carbon Leakage”
CARBON LEAKAGE – MYTHS AND REALITIES
After Copenhagen, sustaining action in a world of unequal carbon prices
– and raising revenue for ‘greening growth’ at home and abroad - is of
fundamental importance, ‘carbon leakage myths’ need to be dispelled
Myth
Reality
Carbon leakage is a major
economic & environmental
problem
… so if aggregate numbers are
small it is not a big problem
Free allocation is an effective
solution
Free allocation is free
At the present level of ambition, even with purely unilateral action and
no free allocation or border protection, leakage would be only a few
percent of EU emissions
Politically impossible (and unreasonable) to ignore loss of important
and powerful industries without even saving any emissions
Free allocation can help tackle investment leakages in some sectors,
but is far from a panacea
Free allocation increases costs to the rest of business and to a much
greater extent than most models predict, due to a basic modelling
omission
Border adjustments in many sectors are technically difficult, legally
debateable and politically explosive – but an evolutionary approach to
leveling costs in appropriate sectors is viable
… border leveling in the right sectors is non-discriminating, the only
effective approach, could raise funds for international purposes, and a
reasonable and necessary part of evolving global responses
The best solution is to protect
economies with border
adjustments
Border adjustments threaten
world trade etc
CO2 emissions heavily concentrated in a few primary activities
Common fact, though national differences in structure, eg. Compared to UK:
Germany has higher % Value Added in the most cost-impacted sectors, US refining sector
exceptionally large
Source: Grubb, Brewer, Houser & Sato, ‘Climate policy and industrial competitiveness:
ten lessons from the EU ETS’, German Marshall Fund – US, Washington DC, 2009
28
But:
• without countermeasures
may be significant for key
sectors (eg. 40% of steel
“emission savings” are due to
offshoring)
• leakage rises with the
degree of effort (eg. EU move
to 30%)
• effects may vary a lot
between different regions,
facilities
• “all politics is local”
• growing international carbon
flows undermine impact of
domestic measures anyway
Myth 2. “… So if aggregate leakage is modest it is not a big problem”
Carbon flows lesson impact, and economic loss with no environmental benefit is never politically acceptable
Source: Carbon Trust / Climate Strategies
Myth 1: “EU faces large scale carbon leakage from the EU ETS”
Technically speaking, border leveling clearly more effective
Free allocation cuts leakage but increases carbon price
- Border levelling cuts leakage without significant efficiency loss, and greater scope
Source: Carbon Trust / Climate Strategies
CARBON LEAKAGE – MYTHS AND REALITIES
Tackling carbon leakage
Available at: www.climatestrategies.org
Available at: www.carbontrust.co.uk
PUBLICATIONS
Own academic papers: http://www.econ.cam.ac.uk/faculty/grubb/index.html
Forthcoming : Grubb with Hourcade and Neuhoff, The carbon connection (Earthscan, 2011)
EU ETS design
and Incentives
Competitiveness
and carbon
leakage
Global Carbon
Mechanisms &
international
linking
CS Academic Synthesis Reports*
www.climatestrategies.org
Derived Carbon Trust Insights publications
www.carbontrust.co.uk
National allocation plans in the EU
ETS (2006)**
Grubb, Neuhoff et al.: Submission to
EU ETS review
Neuhoff et al. paper on Auctioning
EU ETS Phase II allocation: implications and
lessons (2007).
Cutting Carbon in Europe: The 2020 plans
and the future of the EU ETS (2008)
Emissions trading and
competitiveness (2006)**
Hourcade et al, Differentiation and
dynamics of EU ETS industrial
competitiveness (2007)
Droege et al., ‘Tackling carbon
leakage’ (2009)
The European ETS: implications for industrial
competitiveness (2004)
Allocation and competitiveness in the EU
emissions trading system: options for Phase
II and beyond (2007).
EU ETS impacts on profitability and trade: a
sector by sector analysis (2008).
Tackling carbon leakage (Sept 2009)
Series on the Kyoto Mechanisms (GIS,
JI and CDM) trading schemes
Tuerk et al., Linking emission trading
schemes**
The Global Carbon Mechanisms: evidence
and Implications (Feb 2009)
Linking emissions trading schemes (July
2009)
** Key papers published as Special Issue of the Climate Policy journal, www.climatepolicy.com