A Copenhagen Collar: Achieving Comparable Effort Through Carbon Price Agreements

1. A Copenhagen Collar: Achieving Comparable Effort Through Carbon Price Agreements Warwick J. McKibbin Adele Morris Peter J. Wilcoxen Prepared for Wednesday Lowy Lunch, 2 September 2009

2. Overview • Update on policy developments • Implications of the GFC for climate negotiations • The need for a better basis for negotations • Ingredients for an agreement • A price collar • An illustrative price collar for the United States • Conclusion

3. Policy debate - global • Copenhagen in December for country commitments for the 2012-2020 period. • G-20 has agreed to 80% reduction by 2050 but no base year agreed and no 2020 target • EU has called the US to cut 25% below 1990 by 2020 (35% below 2005) • Developing countries have called for the US to cut 40% by 2020

4. Policy debate – United States • President Obama proposed cuts of 14% of 2005 by 2020 (83% by 2050) • US House has passed the Waxman Markey bill which has gone to the Senate – proposes 15% of 2005 by 2020

5. Policy debate in most countries • Attempted compromise in a system of national targets and timetables causes • Not deep enough cuts so environmental lobby object • Not enough risk management on costs so industry object

6. Implications of the GFC for Copenhagen • Anxieties about reducing emissions when unemployment is rising • Downturn has increased uncertainty about the costs of future sharp emissions reductions • Economic slowdown but hard to get capital to invest in emission reductions • Demonstrates how uncertain the future is

7. The goal of a global climate agreement • Stabilize carbon concentrations in the atmosphere • Try to achieve this via “comparable effort” and acknowledging the difference between developed and developing countries

8. What is comparable effort? • A similar reduction target from a baseyear is not comparable effort. • This reflects either a misunderstanding of the real world or a political deception

9. A common target for emissions is not comparable effort • Emissions of a country over time depends on: • Endowments (particularly of energy) • Economic structure • Population growth • Productivity growth • Stage of development (consumption pattern) • Technology availability • Etc etc etc • Kyoto Protocol was a clear example of the problems – New Zealand, Japan, Europe

10. Comparable effort • A good measure of effort is the price of carbon in the economy • Carbon prices and economic costs are highly related

11. The need for a better basis for policy • Two parts • A pre commitment to cut global emissions towards a concentrations goal allocated across countries • A mechanism for ensuring equal efforts across countries (can be measured as the same carbon price)

12. Lessons from Kyoto Experience • A system of rigid targets and timetables is difficult to negotiate because it is a zero sum game • It is difficult for countries to commit to a rigid target for emissions under uncertainty about costs – harder for rapidly growing economies • Even the most dedicated countries may be unable to meet their targets due to unforeseen events out of their control

13. Why Copenhagen will not deliver • Copenhagen is heading into the same trap at the Kyoto Protocol • Targets and timetables without allowing for enormous uncertainty about the future

14. A way forward • Emissions targets so politicians can feel good pledging x% by year 2020 and 2050 • Combined with a clear compliance mechanism for a country that exceeds an agreed target emission reductions.

15. How to achieve this? • The same idea as a global McKibbin Wilcoxen Hybrid • Negotiate a target reduction path for each country • Negotiate a price collar for carbon prices

16. What is a Price Collar? • Set an initial upper and lower price bound for national carbon prices - the same across all countries • Increase the upper and lower price band by 4% per year

17. Compliance • A country must demonstrate that it has both reached its target and maintained carbon prices above the floor price through the budget period • A country that exceeds the emissions target must demonstrate that the national price of carbon was at the ceiling price during the period where the target was exceeded

18. Implementation • Each country implements it’s carbon policy however it likes • Carbon tax • Emissions trading • Hybrid • Direct regulation • Wishful thinking

19. What is needed? • A way to measure the carbon price across all systems that countries might use • Create a carbon price equivalence like a tariff equivalent measure for WTO compliance.

20. Developed countries • Can propose deep cut targets and if it can’t be done then the costs will be limited by riding up the ceiling price • (same as the McKibbin Wilcoxen Hybrid)

21. Developing Countries • Allow initially just to have a price floor without a target • But if possible - better to allow a generous target with a price collar

22. What does this mean in practice?

23. What matters • A policy that reduces uncertainties of extreme outcomes is more likely to be implemented and to stabilize concentrations than a policy that is precise but can’t be negotiated because no-one is willing to commit because of uncertainty. • How much is lost by reducing uncertainty on the cost side?

24. McKibbin W.J. Morris A. , Wilcoxen P and Y. Cai (2009) “Consequences of Alternative US Cap and Trade Policies: Controlling Both Emissions and Costs”, The Brookings Institution, Washington DC

25. US Carbon price

26. US CO2 Emissions

27. Cumulative US CO2 Emissions

28. Conclusion • It is possible to deal with the politics within a country of • Deep cuts for the environmental lobby • Cost control for industry

29. Conclusion • It is possible to deal with the politics of international negotiations of • The fixation with targets and timetables • The need to ensure comparable effort

30. Conclusion • The reality of Copenhagen is that the United States will do what it will do domestically. • The domestic debate in the US is not about legislating the deep cuts being negotiated at Copenhagen. • The price collar is a way to square the apparent inconsistencies in the domestic versus international debate.

31. Conclusion • In Australia a price collar around a deep cut path is a much better way forward than the CPRS for managing climate and political uncertainty

32. www.sensiblepolicy.com