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

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

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

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

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

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

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

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

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

Comparable effort

• A good measure of effort is the price of carbon in the economy

• Carbon prices and economic costs are highly related

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)

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

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

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.

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

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

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

Implementation

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

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.

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)

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

What does this mean in practice?

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?

• 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

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Conclusion

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

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

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.

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

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