Archive for Economics

Is carbon still following oil?

Posted in Climate Change with tags , , , , on August 23, 2009 by Dan

In January I looked at European oil and carbon prices to show how they were reacting to the economic recession. Today I had another look at these two markets to see what’s happened over the past six months.

The graph below (click to expand) shows the December 2009 EUA contract (from ECX) and the Europe Brent spot price (from the Energy Information Adminstration, converted in Euros using currency data from OAndA). The prices have been indexed to January 2007. Historically, carbon has largely followed oil.

In 2009 the trend seems unclear. While daily trading news is full of headlines like “carbon nudges higher on strong energy complex”, carbon seems have recovered less than oil. In January 2009, the nominal prices of oil and carbon were both around 70% of January 2007. At the end of last week, oil was at 110%, while carbon was at 80%.

Performance of EUAs vs crude oil

Performance of EUAs vs crude oil

I don’t have any clear commentary to offer just now. Glancing at the graph, it looks like carbon has fallen behind oil by about three weeks, but that doesn’t feel like a very plausible theory. I’d be interested to hear any thoughts.

Cap and trade in the context of shrinking production

Posted in Climate policy with tags , , , , , , , , , on December 28, 2008 by Dan

Questions are being asked of the two working installation-level cap and trade schemes in light of economic recession. The EU ETS – the world’s largest carbon market – is trading at about 16 Euros per tonne and is volatile because no-one is quite sure of the impact of shrinking production. Analysts believe that all reductions could now be met through purchase of CERs. Essentially this means that industry within the EU ETS has lowered its output and can comply with the cap by offsetting rather than making additional internal reductions.

The other scheme, RGGI, a scheme covering power plants in north-east US, held its second pre-compliance auction on 18 December and sold 31.5m allowances at a price of $3.38 per short ton (up 31c from the first auction, which is surprising given the commentary that follows). An article on BusinessGreen says:

… the auction came amid fears that the economic downturn meant the US scheme could repeat the mistakes evident in the first phase of the EU’s emissions trading scheme by setting the cap too high – a scenario that led to a glut of available emission permits and a collapse in the price of carbon.

Non-profit policy thinktank Environment Northeast released RGGI Emissions Trends & the Second Allowance Auction, a report which said emissions were currently 16 per cent below the cap. It pointed to skyrocketing fossil fuel prices earlier in the year as the primary reason for a lower than expected emissions rate.

“RGGI was negotiated back in early 2003 through 2005, and at that time everybody thought the trend would be up,” said Derek K Murrow, director of policy analysis at Environment Northeast. “Since it was negotiated we’ve seen a signfiicant decline, which is really a good thing. Now the question is whether that trend will continue as the programme starts up in 2009, in which case the cap might need to be bought down more quickly after the first compliance period. Or will emissions return to their historic levels, in which case the cap would be constraining?”

Comments like this suggest that cap-and-trade must deliver a carbon price that is neither zero nor unbearably high, and also force emission reductions beyond anything that happens ‘naturally’ (as a result of lower consumption or developments in eco-efficiency, for example). These characteristics sound more like tax than cap and trade. Cap and trade provides an absolute limit for emissions and a price crash indicates that the limit can be met with no unusual investment. Equally, if emissions rise unexpectedly, a cap and trade market will force decisions about where additional reductions will be made.

That’s the strength of cap-and-trade: unforeseeable events that effect emission levels are reflected in the permit price. If the price crashes due to unforeseen cuts in emissions, the cap and trade scheme is not a failed policy.

UK should ringfence EUA auction proceeds

Posted in Climate policy with tags , , on September 18, 2008 by Dan

HM Treasury just announced that Defra is going to hold the UK’s first EUA auction on 19 November. I’m not sure how many will be auctioned on that day, but over phase 2 the government will auction 85 million (7% of the UK’s total allocation). Assuming an average price of EUR 25, that’s over EUR 2 billion of revenue.

The UK government is consistently opposed to any type of hypothecation (ringfencing of revenue for particular purposes) and will not promise to use this money for any climate-related purpose. The EUR 2 billion is ultimately passed down to consumers. Given that the government has no obvious ownership of the climate, EUAs do not seem like an appropriate source of general public funds.

In an economist’s perfect world, the money would be recycled to consumers who pay the EUR 2 billion through embedded carbon costs. This is difficult to do, of course, and the next best thing is to use the money for environmental projects.

Two good options for the money would be

  • a fund for retrofitting domestic property with insulation and energy efficient heating systems. This would be a reasonable way to compensate for the incremental increase in energy bills resulting from emission trading. It would not create net emission reductions (energy generation is within the EU ETS, so lower domestic energy use means that other sectors can use the EUAs no longer required), however.
  • investments in public transport. This would be my favourite option. While it has less symmetry with the costs imposed by the trading scheme, it does encourage reductions outside the EU ETS.

Are long-life products too expensive, or do we just want new ones?

Posted in Other with tags , , , , on August 20, 2008 by Dan

I like the suggestion from the House of Lords Science and Technology Committee (Waste Reduction – pdf) that the government should cut VAT on products with long life-cycles and on repair services.

But why is it necessary at all? Given that sturdy products are generally cheaper in the long run, why don’t people just buy them?

Two reasons:

  1. People’s discount rate is sufficiently high (or their access to capital is sufficiently low) that they don’t want to pay higher upfront costs despite long term savings.
  2. In many sectors goods depreciate quickly because they go out of fashion or new, more attractive versions come onto the market.

The tax cut addresses the first reason. The Committee’s chair, Lord O’Neill says:

Currently a lot of people can not justify spending a huge amount on a product just because it lasts longer but if this recommendation is followed through, it should encourage modern electronics manufacturers to produce more sturdy products.

I wonder about the extent to which a tax cut would address the second reason. If it makes longer-life products affordable for more people, many of those people will not believe they save money if the products are not worth anything after a few years. Someone who wants a bigger TV or a faster laptop is unlikely to value several extra years of life in the old one.

Obviously, taxing or otherwise pricing the pollutants we ultimately care about would produce a similar impact to differential VAT with lower risk of unintended environmental consequences or errors in categorising products as ‘sustainable’.

As an aside, there are lots of other (non-tax) things in the report too.

Are aviation taxes too high already?

Posted in Climate policy with tags , , , , on August 4, 2008 by Dan

Apparently the government has concluded that tax paid by the aviation industry is worth more than the environmental damage it causes. The British Air Transport Association commented:

The Government now admits that UK air travel more than covers its climate change costs. But they still seem intent on increasing the environmental taxes that air travellers are forced to pay.

Does the aviation industry more than cover its climate change costs? Asking two questions might indicate that the statement does not have a lot of meaning:

  1. Do the taxes have an appropriate impact on the level of aviation consumption? The airlines are arguing that the increases in Air Passenger Duty (or other tax) mean aviation should not be included in the EU ETS. Cap-and-trade delivers defined emission reductions – the effect of taxes on pollution depends on demand elasticity, which is unpredictable.
  2. If the taxes do cover the ‘climate change costs’, are they redistributed to the people upon whom the costs are imposed?

These questions a bit facetious, of course – the point is that climate change mitigation can only be measured in emission reductions, not just charges.

Finally, APT and other aviation taxes are not really environmental taxes. Although they are often framed in environmental terms their actual purpose is unclear. They are essentially sales taxes.

Australia – combining fuel tax cuts with cap and trade

Posted in Climate policy with tags , , , , on July 19, 2008 by Dan

The design of Australia’s cap-and-trade scheme is emerging. It is likely to include petrol and among the details is a “cent for cent” fuel tax cut to balance the costs for motorists:

If motorists pay 5c extra a litre for petrol as a result of the scheme, fuel taxes will also be cut by 5c under the measure that will be reviewed in 2013.

If retail petrol prices don’t reflect carbon costs consumption won’t respond. This is not necessarily an environmental issue (unless you think the car culture is a problem beyond its current emissions) because the cap will ensure cuts are made elsewhere instead. The inflation that the tax cut purports to address will simply be pushed to other parts of the economy. To be fair: the tax cut is designed to sweeten the pill rather than make economic sense economic so perhaps this criticism is a bit crass.

As a micro-aside, the question I’d ask is how are they going to make fuel taxes so dynamic that they can respond to moves in the carbon costs embedded in petrol?

As a macro-aside, we should step back and look at how far Australia – recently a maligned Kyoto-dodger – is now blueprinting a scheme that by its own estimates will increase the average price of goods by 1% within a year of implementation.

Policy Exchange on CCS

Posted in Energy markets with tags , , , , , on June 17, 2008 by Dan

Policy Exchange has published a report arguing that carbon capture and storage (CCS) is essential to meeting our emission reduction targets. The report explores various ways that the government could support CCS.

If there is a strategic case for CCS the mechanism that I believe to make most sense is:

5. Government underwrites the EU-ETS minimum base price.
This involves a risk for Government, to provide baseline funds of €30 to 60/ton CO2 if the EU-ETS market remains low. It is not clear how the Government recoups its money, except by waiting to sell EU-A at a high price some years later, or by cross-subsidy from the new Phase 3 Auction revenue.

I would argue that the base price be set by auction. The CCS developer that offers the lowest base price would be given by Ofgem the difference between that price and the EUA price for each tonne of CO2 it avoids. This approach is economically similar to the feed-in tariff that Policy Exchange favours but is more likely to determine an appropriate subsidy. Unlike Policy Exchange’s other preferred option – allocating one or two free EUAs to plants for each tonne of CO2 they capture – it maintains the environmental integrity of the EU ETS (see this post for more on multiple EUA allocation).

The government would risk depressing the EUA price by subsidising CCS and thereby inflating the subsidy it would pay for further CCS generation – but this cost would also be borne in the feed-in tariff model. The reduction in the EUA price would filter through to the wholesale energy market, making the feed-in tariff represent a larger subsidy.

The real question is whether there is a strategic case for CCS. New CCS will not create net emission reductions in the short term (unless CCS remains unrecognised in Phase 3 of the EU ETS), so it should only be supported if it is considered integral to decarbonisation in the long term. As Policy Exchange points out, it looks like we will be dependent on coal for decades to come. Perhaps our resources should be concentrated on reducing our dependence.