Climate Policy For New Zealand After Kyoto

Climate Policy For New Zealand After Kyoto

Warwick J. McKibbinCentre for Applied Macroeconomic Analysis ANU,

& The Lowy Institute for International Policy& The Brookings Institution

2007 A.W.H. Phillips Memorial Lecture

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Overview

• The Climate Policy Problem What makes climate change policy so difficult?

• What Needs to be Done? The Role of Prices

• What Has been done so Far Why the Kyoto Protocol Approach has stalled

• The New Zealand Situation• The McKibbin-Wilcoxen Blueprint for national and

global action an Application to New Zealand the recent Australian application

• Conclusion

Figure 2: Global Temperature Record, Vostok Ice Core Data

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Figure 1: Global Carbon Dioxide Emissions from Fossil Fuels, 1751-2002

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Emissions versus Concentrations

• What matters for the climate is the concentration of greenhouse gases in the atmosphere

• Concentrations are the accumulation of annual greenhouse gas emissions

• Emissions is any particular year are not critical but the path over time is

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What makes climate policy difficult?

1. Committed warming Need both mitigation and adaptation

2. Geography Broad range of sources of emissions, caused by decisions

made by a diverse range of households and firms Many jurisdictions - coordination problem

(international, national, state, local)3. Time scales

Exceptionally long-lived problem and policy

4. Uncertainties Numerous, large and intractable

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What’s uncertain?

Emissions Levels

CO2 Concentrations

Temperature Change

Ecological Effects

Economic Damages/benefits

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Climate Policy is about Managing Uncertainty

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Issues in Regime Design

• Coverage• Equity• Politics• Institutions• Fundamentals• Flexibility

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Coverage

• Need major current and future emitting countries involved not necessarily all countries

• Need all of the economy involved not just a particular sector

• Need to change the sources of demand and supply of greenhouse gas emissions

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Issues in Regime Design


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Equity

• A climate policy will probably lead to winners and losers

• Need to deal with the distributional issues within countries and between countries Within country distribution is up to governments within

countries

• Need to recognize the differences across countries’ stages of development and relative contributions to current climate problems

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Some Issues in Regime Design


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Politics

• Need to build constituencies across society that support the policy in their own financial self interest

Fossil fuel producers facing reduced demand for their products

Consumers facing higher energy prices Politicians with an incentive to lobby to reject a policy

in favor of a narrow constituency

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Institutions

• Build on existing national institutions

Legal, accounting, financial, market experience

Developing new international institutions will delay action and will likely be infeasible

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Fundamentals

• Need to

establish clear property rights over carbon emissions over a long period of time to provide incentives for all involved within a country to want to reduce carbon emissions

create a capacity for individuals and companies to manage climate risk

Encourage the emergence, adoption and diffusion of existing and new technologies to reduce emissions

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Fundamentals

• Need to Manage the demand side of energy use while waiting

for technologies to emerge

Enable compensation for those hurt by higher energy prices if technology is expensive or slow to emerge

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Flexibility is important

• Need to be able to start in individual countries with known costs

• Need to be able to add countries over time

• Need to be able to adjust the system as information is revealed

• Need to allow for particular national circumstances

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The Role of Prices

Figure 3: GDP, Energy Use, CO2 EmissionsUSA

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Figure 4: GDP, Energy Use, CO2 EmissionsJapan

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Ways to give price signals:

• Carbon tax• Subsidies• Binding targets with penalties for non-

compliance• Cap and trade Permit trading• McKibbin Wilcoxen Blueprint – a hybrid of

the above approaches

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The Role of Prices

• Price signals should be both short term and long term

• Price signals should be credible Otherwise investment will not be forthcoming

• Price signals are crucial for encouraging Demand side management The emergence of alternative technologies The adoption and diffusion of alternative technologies

• Short run prices can more easily be used than emission targets to line up costs with expected benefits

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What has been Done so far?

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The UN Framework Convention on Climate Change

• Negotiated at the Earth Summit in 1992 in Rio

• Set Goals (not targets) “preventing dangerous anthropogenic interference

with the Earth’s climate system” Annex I countries (industrial countries) were to adopt

policies to “aim” to reduce their emissions Entered into force in March 1994

• Set in process a series of meetings of the “Conference of the Parties” (COP)

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The Kyoto Protocol

• Protocol to the 1992 UN framework Convention on Climate Change, negotiated at COP3 in 1997

• Annex 1 countries agreed to reduce emissions of 6 greenhouse gases to 5.2% below 1990 levels on average between 2008 and 2012

• Entered into force February 2005.

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The Kyoto Protocol

• No commitments for Developing Countries (countries such as China ratify but have no targets!)

• Some flexibility allowed through permit trading clean development mechanism (CDM) joint implementation

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Kyoto Protocol

• There are many problems with Kyoto

• The most obvious problem is the approach of targets and timetables

Hit an emission target independently of what it costs

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• Permits are ultimately promises of governments whose value depends on the credibility of governments

• There is a reason why there is not a single world currency

Problems With International Permit Trading

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The Kyoto Protocol

• New Zealand together with most countries have ratified

• Australia and the United States have not

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Are there any other alternatives?

• Need a policy with best features of permits, taxes and subsidies

• Like a tax: Should guarantee that costs won’t be excessive

• Like permits: Should avoid huge transfers to the government

• Like subsidies: it should encourage the search for technological solutions

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The Situation in New Zealand

• 1997 report McKibbin and Pearce “Impact on the New Zealand economy of commitments for abatement of carbon dioxide emissions”

• Found marginal abatement cost in NZ amongst the highest in the world.

• From 1990 projected quickly rising emissions under BAU - 2005 emissions from energy at 31.43 mt

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• Recommended a uniform carbon tax but better still the McKibbin Wilcoxen Blueprint

• NZ climate policy announced in 2002 with reviews in 05, 07, 010

• Like most countries NZ has a large range of policies aimed at energy efficiency and conservation, public awareness and other factors.

• Review in November 2006 – asked the right questions but the December discussion paper ignored a key policy option.

• NZ government was to implement a carbon tax in 2007 but it has been postponed

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• New Zealand’s Kyoto Target is 1990 levels

• 2005 emissions 77.2 million tonnes CO2e - 24.7% above 1990! 48.5% of emissions from agriculture 43.4% of emissions from energy (33.5mt)

• As in most countries ratifying Kyoto is not sufficient to reduce emissions

Source: Ministry of Environment – NZ Greenhouse Gas Inventory 1990-2005

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The McKibbin Wilcoxen Blueprint

• Aim Impose a long term carbon goal for economies Generate a long term price for carbon to guide

energy related investment decisions Line up short term economic costs with expected

environmental benefits Provide a way for corporation and households to

manage climate risk Can be an internationally coordinated system or a

national system that evolves into an international system

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Components of the Policy

• National permits Required to embody carbon in energy Good only in country of issue

• Long-term permits Allow 1 ton of emissions each year Quantity is the long run goal Fixed supply (can be diminishing)

• Annual permits Allow 1 ton of emissions in year of issue Elastic supply from national government Price fixed for ten years

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Long TermPermit

Looking at the policy in more detail:

Allows one unit of emission per year for a long period

Distributed once at enactment Can be leased or sold within a country Quantity can set by treaty: QT

Price will be set by the market

AnnualPermit

Allows one unit for one year Sold by government as demanded Price set by treaty: PT

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Why National Permits?

• Use existing institutions Legal system for enforcing property rights

• Small loss of sovereignty No need to cede authority to an international body No direct international transfers of wealth Enforcement maintains rights of domestic residents

• Robustness and stability Easy to join the agreement Robust to withdrawal by some participating countries Compartmentalization lowers transmission of shocks

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Why Long-Term Permits?

• Credibility Build constituency supporting the policy Owners: vested interest in maintaining system Reduce the time-consistency problem

• Additional benefits Can tailor distributional effects via permit allocation Reduces risks (long term vs. short term bonds)

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Why Annual Permits?

• Acts like a carbon tax at the margin

• Efficient A price-based policy is preferable to a qnatitative

target given flat damage curve

• Pragmatic Governments don’t have to agree to hit a fixed target

in any year regardless of cost

• Flexible Government can mandate who can issue annual

permits

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Allocation

• Those who need permits are not necessarily the same as those who own the permits

• Allocate long term permits freely to fossil fuel intensive industry and households

• Only those who embody carbon in energy need a permit each each.

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Overall

• Creates incentives for investment Raises the marginal cost of emissions into the future

• Incentives are credible Built-in constituency of long term permit holders Robust to accessions and withdrawals Operates within existing institutions

• Provides a foundation on which to build Completely consistent with technology policies Provides incentives for adoption and diffusion

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Expandable

• Because it is a domestic system, other abatement activities can be included as a way to generate annual permits with the revenue going to these activities instead of the government

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Main Concept

The long term permits are the medium term goals for emissions without a timetable of when they are reached

The short term permits are the economic costs to the economy

Move through a low cost path from the short run to the longer run in decadal steps with profit incentives to reduce emissions wherever cost effective

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A Partial Analogy – Bond markets

Long term government bond market prices interest rates over long horizons given a stock of government debt (like long term permits)

Central banks set the short term interest rate - the supply of financial liquidity is generated by the market (like annual permits).

The long term interest rate (which is flexible) is the expected value of future of short term interest rates (which are fixed in any period)

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Coordination of National Permit Markets

• Independent but coordinated via PT

Japan

US

EU

New Zealand

PT

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McKibbin Wilcoxen in New Zealand

Figure 1: Annual Permit Price in New Zealand

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Source: Author's Calculations

Figure 2: Value of NZ Long Term Permits (r=5%)

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Figure 3: Long Term Permits and Actual Emissions in New Zealand

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Figure 4: Annual permit Sales in New Zealand

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The New Australian Approach

McKibbin-Wilcoxen with political compromise

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Key differences

• Long term permit bundles are 40 years• Windows every five years

Additional medium term permits can be auctioned

• Safety valve is a penalty rather than an annual permit

• Initial allocation all to affected industry or auctioned

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How to Bring in Developing Countries ?

The MWB approach can be applied in countries at different levels of

development

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Developing Countries

• Negotiate a long term permit allocation that is larger than current emissions

• Price of annual emission permits (or economic cost) is zero in the short run because more permits than needed

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Developing Countries

• Price of long term emission permits will be non zero giving important signals for investment projects

• Over time the permit price in countries will equalize as developing countries “ability to pay rises”

Figure 5: Annual Permit Price

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China Triple


Figure 6: Value of Long Term Permits (r=5%)

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Conclusion

• Climate policy at the global level is in a state of considerable flux and a new direction away from targets and timetables is needed

• New Zealand should consider a variant of the McKibbin Wilcoxen Blueprint for climate policy both as a way to deal with the Kyoto dilemma and to be at the forefront of the post 2012 debate.

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Background Papers

www.sensiblepolicy.com

Climate Policy For New Zealand After Kyoto

Documents

climate policy difficult

climate change policy

international policy

policy uncertaintiesnumerous

climate riskencourage

new technologies

distributional issues

infeasiblesome issues