Policy BriefCanada and Germany as Global Economic Policy Actors

ISSUE 11 | SEPT 2009

North America’s Best (Feasible) Foot Forward: Emissions Trading in the US and CanadaResearched and written by Andrew Gertge. Andrew is an MA candidate and graduate research assistant at the IES

Prepared under the supervision of Dr. Kurt Hübner. Kurt Hübner is a Professor of European studies and

the director of the Institute for European Studies at UBC. Central to Hübner’s re-search are topics of global and European currency regimes, international regimes of foreign direct investment, and the re-lations between innovation and sustain-ability. His latest research focuses on the economic and socio-political foundations of technical innovations in a transatlantic perspective. Currently he is working on a project on currency competition and currency co-operation, which analyses the relations between the U.S. Dollar, the Euro and the Japanese Yen.

Project Sponsor:

The Transatlantic Program of the Federal Republic of Germany funded by the Eu-ropean Recovery Program (ERP) of the Federal Ministry of Economics and Tech-nology (BMWI)

The era of freely emitting carbon into the atmosphere is coming to a close. Scientific consensus on the climate-altering effects of human-related release of greenhouse gases (GHGs) is translating to political consensus that GHG emissions should be peaked, then curbed. Since such emissions spout from the very core of consumption activities, authorities on both sides of the Atlantic face the delicate task of promulgating polices that incrementally (yet assuredly) reduce GHG release.

With the razor-close passage of the American Climate and Energy Security (ACES) Act, the United States is moving toward adopting an Emissions Trading Scheme (ETS) with remarkable similarities to the EU-ETS.

Much like the debate over the EU-ETS in Europe, ACES has drawn fire principally for its perceived cost, potential threat to economic competitiveness and environmental laxity after relentless industrial lobbying. With its economy badly bruised by the recent economic backslide, US leaders are vehemently pushing for low-cost, if not protectionist, policies. Canada, inept at devising its own nationwide reduction scheme (c.f. IES Policy Brief ISSUE 8), persists in its stance as a policy-taker, while its provinces await North American climate policy harmonization,.

This policy brief examines the North American context of the current climate and energy policy debate, arguing that even

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with its caveats, cop-outs and inefficiencies, ACES constitutes an invaluable pathway for moving North America toward its environmental and efficiency aims.

Wherefore Cap and Trade?

An effective climate change policy changes the way people think. It puts in place the incentives and drivers needed to assist a society as it searches to determine and incorporate the costs of its GHG emissions, and transition to thriving with fewer of them. This societal transition is nothing short of revolutionary and does not occur seamlessly.

One of the primary difficulties in this transition is translating scientific findings to an economic narrative with clear costs for climate change. The UN Intergovernmental Panel on Climate Change (IPCC) and works like the Stern Review on the Economics of Climate Change have done more than a little to advance this discussion. The recently agreed G20 target to limit global temperature rise to 2ºC reveals remarkable political consensus that the costs to world economies would be unacceptable were temperatures to exceed this scientifically set mark.

Nonetheless, projected future costs can be only estimates. It is government policy that creates present costs on the ground, as it were. Policy makers have at their disposal a variety of policy instruments that are

designed to incrementally incorporate the costs of GHG emissions, inducing the changes needed for a steady restructuring of their economies. Among these policy tools, taxation and ETS have garnered the most support for their potential to combine economic efficiency (keeping costs low) with environmental effectiveness (keeping emissions low).

Using market forces to help the environment, through taxes or an ETS, is not new. As early as 1920, A.C. Pigou postulated that, in lieu of imposed regulation, a tax could be levied to correct negative externalities. T.D. Crocker in the US and J. H. Dales in Canada published papers in the 1960s that laid the foundation of cap and trade—negative externalities could be corrected in the most cost effectively if the governing body were to cap the amount of permissible pollution and then sell the rights to pollute. Indeed, since the 1960s, taxation and ETS have become more sophisticated and effective policy tools. To this day,

though, climate policy specialists continue to debate whether a tax or an ETS is more desirable. The table shown summarizes the principle arguments of the tax v. ETS discussion. In summary, taxing emissions has the potential for greater price certainty while an ETS offers the potential for greater environmental certainty.

Even best-case theory, of course, must run the proverbial gauntlet of real-world policy making. And it is the political process that exposes the

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determining difference between the tax and the ETS in North America: who sets the price. For a tax, the government chooses the rate and collects the revenues. For an ETS, the government creates a market—through an emissions cap and allowance allocation method—but it is market forces that establish the final price of emission allowances within that market.

More so than their European counterparts, North Americans are more apt to trust market efficiencies,—accepting their irrationalities—than to trust government rationalities, with their inefficiencies. Not surprisingly, then, the climate policy forming in US Congress—and likely to be replicated to some degree in Canada and Mexico—has confirmed the ETS as the most politically popular environmental pricing tool. While ACES represents a remarkable about-face for federal-level politics in North America, a quick glance at climate policy initiatives at lower levels of government reveals that much had been done already to pave the way for national ETS legislation.

As do member states within the EU, North American states and provinces vary in their climate policy stance. For want of binding reduction targets at the national level, vanguard states and provinces have forged regional emissions reduction programs. At present, 24 US States and 4 Canadian provinces are active members of an ETS program, and an additional 8 US states, 5 Canadian provinces and 6 Mexican states have signed on as official observers.1 These regional ETS initiatives, especially New England’s Regional Greenhouse Gas Initiative (RGGI), drew inspiration from the highly successful US Acid Rain program.

The Acid Rain Program birthed from the 1990 Clean Air Act. This Environmental Protection

Agency (EPA) program sought to to combat acid rain in the northeastern US by capping and trading annual SO2 emissions until they were reduced to 10 million tons below 1980 levels. The program, covering 110 mostly coal-burning power plants in

21 eastern and midwestern US states, deployed its efforts in two phases: Phase 1 which began in 1995 se 2 which began in 2000.

Phase 1 exceeded expectations by reducing the cost of SO2 abatement by more than half

of EPA predictions and much more than costs predicted by the power industry. Phase 2 followed by expanding the Acid Rain Program ETS to include NOx emissions and four times the number of utility units, even smaller ones that operated on oil and gas. In 2007, the EPA reported that SO2 emissions had been reduced to 41% below 1980 levels, and NOx emissions to 57% below 2000 levels. The success of the Acid Rain Program won political and industrial support for the cost effectiveness of the ETS as a policy tool, albeit on a smaller scale than a regional or national ETS.

Another reason for the prominence of the ETS in North America is that federal taxation and energy, save a few exceptions, have been politically disastrous bedfellows. A proposed national carbon tax made its way to the heart of Canadian national elections last year but was defeated soundly. In the ACES debate in the US, opponents expressly referred to it a tax, making reference (incorrectly) to a failed initiative during the Clinton administration 16 years ago—proving the lingering potency of failed energy taxation. While the energy tax proposed by Democrats in 1993 was intended to correct a budgetary deficit and had no link to reducing foreign dependence on oil or address climate change, its failure cost the Democrats crucial congressional seats in the next election.

One significant similarity between the 1993 energy

...North Americans are more apt to trust market efficiencies—accepting their ir-rationalities—than to trust government rationalities, with their inefficiencies.

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tax and the climate bill debated now in Congress, though, is the role played by Democrats representing central and midwestern states where the bulk of heavy industry and coal production occurs. These ‘Blue Dog Democrats’ ultimately defeated the 1993 energy tax and will undoubtedly shape the final version of the US energy and climate bill.

ACES in a Full House

While handfuls of national emissions reduction proposals have been introduced to Committees of the House of Representatives in recent years, ACES is the first nationwide ETS bill to be approved by the full US House and make its way to the US Senate. Procedurally, ACES will now serve as reference to the Senate as it votes on its own climate and energy bill—when the furry of the national health care debate subsides. Any discrepancies between the Senate version and ACES will be ironed by a joint committee from both the House and the Senate before the combined bill arrives at the President’s desk for his pledged approval.

Yet, ACES scarcely escaped the House—by the slimmest 219-217 margin. And, it didn’t escape unscathed. The sweeping scope of the bill (jobs, foreign security, climate security and energy) and the recent economic recession led to a massive lobbying effort and heightened concern for the cost-burden ACES would place on emissions-intensive industry. Just as fierce lobbying in the European Parliament led to the ‘December Compromises’ in Phase III of the EU-ETS, compromises to ACES—most aimed at appeasing Blue Dog Democrats—appended exceptions and drilled derogations into the bill. Understanding these dynamics are important, for they are sure to resurface

in the Senate’s debate and color final legislation.

O n both sides of the issue, special interest lobbying took novel turns during the ACES debate in the House. Over 1,150 interest groups lobbied the House in the second quarter (12 weeks prior to the final vote in June) alone. Manufacturing and Power and Utility companies had the greatest share, with over 330 groups representing their interests. Petroleum companies, though, injected the most new money to their lobbying partners: Chevron doubled its expenditures from last year to reach USD $6 million, and ConocoPhillips also roughly doubling its payments to USD $3.3 million.2

Perhaps more intriguing than the sheer number of participants and dollars dumped into the debate—indeed, the domestic health care bill has surpassed ACES on both counts—is the creation of unlikely

l o b b y i n g bedfellows. The Blue Green Alliance, a new coalition uniting the Sierra club with the United S t e e l w o r k e r s Association, spent almost USD 750,000 in the

three months prior to the vote (the most money of any new group) to spin the bill as a green jobs generator. In the same way, agriculture and renewable energy lobbyists worked in tandem to include solid waste in the definition of renewable biomass--making ACES more appealing to Representatives from farm states.

Blue Dogs to Dominate the Senate

The lumps of money and litany of lobbying are flowing into the Senate debate, as well. Yet the Senate traditionally takes a more structured approach. In

Just as fierce lobbying in the European Par-liament led to the ‘December Compromises’ in Phase III of the EU-ETS, Compromises to ACES—most aimed at appeasing Blue Dog Democrats—appended exceptions and drilled derogations into the bill.

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the House, amendments and revisions quickly inflated the bill to over 1500 pages, including the final amendment introduced just hours before the final vote—this one to erect tariffs on imported good from regions with softer climate restrictions. Whereas only the House Energy and Commerce Committee vetted the entirety of the bill, the Senate has already begun to carefully scrutinize the bill in the Environment and Public Works Committee and will include highly edited portions from at least five additional committees—Agriculture, Commerce, Energy and Natural Resources, Finance and Foreign Relations. This Senate procedure is much more transparent and hampers eleventh-hour amendments to the bill.

The most significant dynamic disparity in the Senate, though, is its strategy of the Democratic Party to obtain 60 out of the 100 possible votes to prevent a potential filibuster—a tactic to defeat the bill by dint of endless stalling. Keeping all 60 Democrats in the fold will mean even greater concessions to Blue Dog Democrats from the Midwest, though. Very recently, ten such Senators wrote a letter announcing that border-tariffs provisions were a sine qua non to voting for any climate bill. These Senators are sure also to push for greater laxity in the near-term emission reduction targets (say, 14% lower from 2005, not 17%), ask for increased allowance allocations to energy-intensive industries and greater inclusion of nuclear energy.

A Silver Lining for a Cloudy Climate Bill

Despite its enfeebled environmental bite and shrinking efficiency benefits, the final US climate bill is likely to have its merits. To start, ACES covers all six GHGs the IPCC attributes to global warming, or 86% of all US GHG emissions. Phase III of the EU-ETS covers only three GHGs and only 52% of all EU emissions. US Climate policy will make extensive use of domestic offsets—reductions

made within a regional climate initiative, for example. Under the EU-ETS, only in Phase III will domestic offsets be accepted and how these offsets will be handled remains to be decided.

Second, unlike the first phase of the EU-ETS, ACES will prevent companies from experiences windfall profits and work to offset price increases to consumers by extensively earmarking the free emissions allowances. By 2012, 75% of profits from free allowances will automatically be redirected to consumers or for use in green energy R&D. Earmarking auctioned allowances will become increasingly important as auctioning becomes the dominant allowance allocation method in the EU-ETS and the US climate scheme. This increased auctioning transforms the ETS from a cap-and-trade to cap-and-invest scheme, allowing fees collected from the auctioning to be reinjected into the economy to ease the burden of the hardest hit households and companies, or to pay for ETS administration, cut taxes or reduce the deficit. ACES stipulates that auctioning funds also be earmarked. Phase III of the EU-ETS, however, has only begun to discuss the earmarking of auction revenues.

As the image above illustrates, auctioning will become much more prominent in the EU-ETS before it does in the ACES, with nearly 75% of emissions allowances

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being bought under the EU-ETS Phase III in 2013.

This disparity speaks volumes on how long the political process requires to tweak its implementation of the ETS, to gradually transition to the price-setting ability of the auctioning process. While the use of EU-ETS auctioning revenues remains within the jurisdiction of each member state, innovative countries like Germany are providing examples of the success of the cap-and-invest scheme. Germany, a country with heavy industrial lobbying against auctioning initially, now boasts the highest rates of auctioning (8.8%) and generated just under EUR 1 billion in 2008.

The administration of US climate policy will also benefit from centrality, and scientific oversight. The Federal Energy Regulatory Commission will regulate the cash market in allowances and offsets and the Commodity Futures Trading Commission will oversee the derivatives market. Under the EU-ETS, derivatives trading remains unharmonized, left to individual national regulators. An Offsets Integrity Advisory Panel, reporting to the EPA, will handle domestic offsets, which will be discounted 1.25 starting from 2018. This discount is an incentive to increase emissions reductions projects in North America.

Finally, a stipulation in ACES known as the “scientific look-back” clause will ensure timely and informed assessments of the ETS performance. Beginning in 2013, this clause requires the EPA to present a progress report to Congress, followed by an assessment from the National Academy of Sciences as to whether or not the EPA report justifies altering existing climate change targets. Some scholars suggest that establishing a Global Climate Change

Index, or a North American Carbon Index, will bring a stronger bite the these reports, making them more compelling for legislators to increase future emission reduction targets.

Can Canada Comply?

The US policy turnaround has left Canadian laggardness on Climate Change all the more glaring. The recalcitrance of its minority government, with its quick ear to tar sands oil lobbying and the country’s institutional reluctance to harmonize climate policy nationally, have thwarted successful nation-wide implementation of emissions-reduction policy. Indeed, the Canadian influence in North American climate policy has often been more of a hindrance

than a help.

Despite its official “wait and see” stance, the Canadian government has been actively lobbying to protect tar sands oil production from current US legislation. These efforts have resulted in an

amendment currently before the Senate that reverses Section 526 of the 2007 Energy Independence and Security Act (EISA). Section 526 of EISA prevents federal agencies to sign contracts for fuels that have higher GHG emissions than conventional petroleum. Petroleum from the tar sands would have fallen under this provision. Canadian ambassadors opposed initial drafts of ACES in Congress, and argued against including tar sands oil as part of the “lifecycle” assessment in the Low Carbon Fuel Standard.

Canada’s chief challenge is enforcing compliance at the national level. Unlike the US, Canadian federal government cannot preempt provincial cap and trade initiatives and has historically failed to enforce anything more than efficiency standards. Provincial sovereignty over forestry, natural resources

The US policy turnaround has left Canadian laggardness on Climate Change all the more glaring...[Its] influence in North American climate policy has often been more of a hin-drance than a help.

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and energy efficiency make formulation nationwide offset standards one of the more prickly parts of harmonization. The most emblematic example of this is, of course, tar sands operations in northern Alberta.

Nevertheless, the torpor of the federal government regarding climate policy solutions has become so egregious that Canadian provinces are devising increasingly creative plans to respond to climate change. British Columbia’s innovative revenue-neutral carbon tax is making Canadians more comfortable with the idea of taxation as a policy response. While the tax burden is quite light, and its ability to reduce carbon emissions still questionable, the tax has warmed to voters across Canada with its administrative ease and bearable cost. The provinces of Ontario and Québec very recently began to collaborate on a common ETS, stating specifically that it will comply with eventual US policy.

Despite the courage and creativity of these provincial plans, they remain piecemeal. To keep its credibility in the climate policy arena from diminishing entirely, Canada must muster common political conviction at the federal level. Binding federal policy is needed not only to drive effective policy throughout its provinces. It is also needed to ensure collaboration and compliance with climate policies as they develop worldwide. The challenges of climate policy require initiative and until it evinces some at the federal level, Canada will not be taken seriously, and be perceived as simply an annex to the US.

Solace from the Signals: Moving in the Right Direction

North American Climate policy developments thus far disappoint on both economic and environmental grounds. Nonetheless, The value of the ETS framework--as proven by Phase 1 of the EU-ETS--is that it is flexible enough to weather the initial vagaries

of politically enforced inefficiencies, to function with increasing economic and environmental effectiveness as its credibility is established. On it own right, though, a national policy similar to ACES presents several encouraging perspectives.

It is bringing greater policy convergence in North America at the federal level. It offers several improvements relative to Phase III of the EU-ETS despite lacking the environmental stringency of the latter. And while not a best-case outcome, ACES is a signal to the world, specifically the developing world (and more specifically, China) that serious political consensus is building in the developed world for longer term action to reduce GHG emissions. The strength of this signal will be seen during climate policy negotiations Copenhagen this December. Irrespective of Copenhagen, though, it is is the fine tuning going forward—such as transitioning from a cap-and-trade to cap-and-invest scheme—that policies on both sides of the proverbial pond will prove themselves.

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The Institute for European Studies at UBCThe Institute for European Studies at the University of British Columbia offers an academic forum within which students and scholars alike come together to engage in rigorous enquiry into the structures, actors, and institutions that shape contem-porary and historical Europe. Following clear-cut principles of interdisciplinarity and intellectual curiosity, we provide methodologically and theoretically based insights into the processes of Europe.

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