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Climate Change Policy Post 2012
Warwick J McKibbin
CAMA, Australian National University& The Lowy Institute for International Policy, Sydney
& The Brookings Institution, Washington DC
2008 Giblin Lecture presented in Hobart October 28, 2008
Overview
• Climate Science and Policy• The current state of climate policy globally
and in Australia– The diabolical policy process
• Why Prices Matter• Lessons from Kyoto • Post Kyoto Policy • Stability of the policy framework• Conclusion
What do we know?
• Climate is a complex system that is always changing
• Natural variability and human induced change coexist
• Average global temperatures have risen 0.6 degrees in the past century
What do we know?
• Increasing evidence that there is a warming problem but predicted impacts highly uncertain
• We are pumping enormous amounts of greenhouse gases into the atmosphere
• Policy uncertainty is causing economic losses
Figure 2: Global Temperature Record, Vostok Ice Core Data
-12
-10
-8
-6
-4
-2
0
2
4
050,000100,000150,000200,000250,000300,000350,000400,000450,000
Years Before Present
Dif
fere
nce
in M
ean
Tem
per
atu
re, C
Bathtubs
• What matters for the climate are the concentrations of greenhouse gases in the atmosphere not the flow of emissions in any year
• Concentrations are the accumulation of greenhouse gas emissions from all sources over time less sinks
Long and Variable Lags
• Will require both mitigation and adaptation
• Mitigation today reduces adaptation in the future
• Gains for mitigation are on a different time frame to gains from adaptation
Climate Science
• “Science” does not tell us exactly what the global concentration target should be - but it guides us
Climate Science
• Suppose we know the concentration target.
• “Science” does not tell us which of the many paths for global emissions should be followed for a given concentration target
Climate Science
• Suppose we know the global path for emissions.
• “Science” has nothing to say about what target an individual country should follow
Climate Change Policy
• Is all about managing risk and dealing with climate uncertainty
• Has moral, social, scientific, technological and economic dimensions
Climate Change Policy
• Should be about enabling the whole society to manage the risks associated with climate change
• Should be about creating long term institutions and clear policy frameworks that can steer the global economy towards a less carbon intensive future
What is Needed
• A change in the behaviour of energy users and other greenhouse gas emitters
• Technologies to – reduce greenhouse gas emissions– reduce energy demand – increase energy efficiency
Lessons from the Global Financial Crisis
• “Expecting the Unexpected: Macroeconomic Volatility and Climate Policy”
• McKibbin, Morris and Wilcoxen
• www.CAMA.ANU.EDU.AU
Lessons from the Financial Crisis
• Expected costs and benefits of a policy should not rely on our ability to forecast
• Critical to get global and national governance systems right
• Shocks will occur and some firewalls between national climate policy systems is critical to prevent contagion
The Global Policy Process
• Framework Convention on Climate Change (1992)
• Conference of the Parties (COP)– COP 3 Kyoto December 1997
– COP 13 Bali, December 2007
– COP 14 Poznan, Poland, December 2008
– COP 15 Copenhagen, December 2009
The Diabolical Policy Process in Australia
• Many reports to government from 1995
• 2007 Shergold Report of the Howard Government
• 2008 Garnaut Review originally commissioned the States
• 2008 Green Paper on Carbon Pollution Reduction Scheme from Department of Climate Change with Treasury input
• 2008 Treasury Report on model scenarios
Figure 3: GDP, Energy Use, CO2 EmissionsUSA
1
1.2
1.4
1.6
1.8
2
2.2
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
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1987
1989
Ind
ex 1
965=
1
GDP
Energy Use
CO2 Emissions
Figure 4: GDP, Energy Use, CO2 EmissionsJapan
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1.5
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3
3.5
4
4.5
1965
1967
1969
1971
1973
1975
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1979
1981
1983
1985
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1989
Ind
ex 1
965=
1
GDP
Energy Use
CO2 Emissions
The Role of a Price on carbon
• The long term carbon price drives technology and is an opportunity
• The short term carbon price is an input cost and is an economic loss
The Role of a Price on carbon
• Long term credible carbon prices are crucial for encouraging– Demand side management– The emergence of alternative technologies– The adoption and diffusion of alternative
technologies
Alternative Philosophies
• Negotiate a global system from the top down– The Kyoto approach
• Created a global system by starting with national policies but coordinate to build a global system
Alternative Philosophies
• Pick an emissions target based on the expected costs and expected benefits – Targets and timetables (politically popular)– Stern and Garnaut
• Require firms have a permit each year (based on a target) for each unit of emissions (permits and emissions are capped)– Trade permits in the market– Revenue goes to permit owner– Emissions certain (targets and timetables) but cost is uncertain
Alternative Philosophies
• Pick a carbon price based on how much society is willing to pay for insurance against climate change and adjust the price over time
• Charge a fixed preannounced tax for each unit of emissions– Revenue goes to the government– Emissions uncertain but cost (i.e. the tax) is certain
Alternative Philosophies
• Create a flexible system with long term targets to tie down credibility but control the short term carbon price with flexibility as we learn about costs and benefits
• Create a Hybrid system similar to the monetary policy framework with long term carbon prices determined by long term targets but short term prices controlled by a central bank of carbon.
Climate Policy should be like monetary policy
• Need clear long term targets (not necessarily timetables) with an independent central bank of carbon charged with reaching those targets at lowest cost to the economy
• Need clear long term prices to drive investment
• Need fixed short term prices to minimize costs
The McKibbin Wilcoxen Hybrid
• The intellectual basis of the Shergold Report and the Green Paper– Clear long term targets– Short term cost management– Flexibility as new information emerges– Flexibility to evolve into whatever global system
emerges
• Major difference is how much you tie the hand of government
McKibbin Wilcoxen Hybrid
• A hybrid of emissions trading and carbon taxes
• A way to implement climate policy as monetary policy
• A national system or a global system
• Aim – Impose a long term carbon goal for the world and
distribute across economies– Generate a long term price for carbon in each country to
guide energy related investment decisions– Keep short term costs low– Provide a way for corporation and households to manage
climate risk– Each country adopts nationally and cooperate globally
McKibbin Wilcoxen Hybrid
Components of the Policy - 1
• Long-term permits– A bundle of annual permits with different dates for
each permit and which expire on that date
– Quantity of permits over time is the long run goal
– Supply is fixed (and diminishing) and allocated to households and industry
– Traded in a market with a flexible price
– NOT tradable across countries
Why long term permits?
• Lock in long term goal
• Provide financing on the balance sheets of industry and households– Not provided by a tax or a permit auction (how do you
pay for the technologies for abatement and adaptation? Apply to a bureaucrat?)
• Act as a constraint on backsliding by governments by valuing the credibility of the policy where the assets are held by the voters
Long Term Emission Permit
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CO
2 E
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n
Current Emissions = 100
2020
2030
2050
Components of the Policy - 2
• Annual permits– Must be acquitted against carbon emissions in the
year of issue– Expire in year of issue– Elastic supply from national government– Price fixed for five (or ten) years and then reset
given information available– Act as a “safety valve” to cap the cost each year but
adjusted over time to hit the target
Short term Carbon price
• In any year companies will use a mix of an annual coupon from the long term permit and annual permits printed by the government for a fixed price to satisfy their emissions
• The price of permits in any year will be fixed at the price of the annual permits
• The long term carbon price is determined in a market
Fig 1: Long Term Permits in Annex B country
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0
20
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100
2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
Em
iss
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/all
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long term permits
Fig 2: Emissions and Long Term Permits
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120
2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
Em
iss
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long term permits actual emissions safety valve price reset
Fig 3: Annual permit Sales - Australia
0
1
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2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100
Em
iss
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s a
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rge
t
Figure 3 : Annual Permit Price
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2014
2019
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$US
200
2
Figure 4 : Stylized Value of Long Term Permits(Assuming r=5%)
0
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3000
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2015
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2027
2033
2039
2045
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2057
2063
2069
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2087
2093
2099
2105
$US
200
2
Coordination of National Markets
• Independent but coordinated via fixed annual carbon price (P)
Japan
US
EU
Australia
P
Lessons from Kyoto Experience
• A system of rigid targets and timetables is difficult to negotiate because it is a zero sum game
• It is problematic for countries to commit to a rigid target for emissions under uncertainty about costs
• Even the most dedicated countries may be unable to meet their targets due to unforeseen events out of their control
A Reality Check on the Global Debate
• Countries will develop their own systems
• There will never be a global market for permits because permits are like money – they are the promise of a government to hit an emission target
Some critical but ignored Issues
• How well does the climate policy framework withstand shocks in the global economy?
• How does the climate policy framework transmit shocks in the global economy?
Conclusions
• Dealing with climate change uncertainty will be a major change to the Australian and global economy
• Still a great deal unresolved about where the world is heading
Surprise Growth in Developing countries
• Positive growth spillover
• Negative carbon price spillover as world carbon prices rise to fix world emissions
• For Australia the net is negative
Global Financial Crisis
• Emissions unchanged under cap and trade
• Emissions fall substantially under a price based system – Large low cost abatement foregone.
Conclusions
• Australia must create a system that
– Encourages long term investment in carbon reduction and adaptation
– Enables long term risk management of climate uncertainty
– Is flexible enough to evolve as the global system evolves and as we get more information on the global climate.
Conclusions
• For any policy to survive it is critical to get the balance between long run environmental issues and short run economic costs right.
• Flexibility, credibility and sustainability of the policy framework are key