Archive for Environment

Carbon trading game – understanding the difference between the three basic types of environmental policy

Posted in Climate policy with tags , , , , , , , on September 29, 2009 by Dan

I’ve developed a game that explains the differences between three key policy options for reducing emissions: command and control, tax and cap-and-trade. There are other games like it, but I think this one works really well and we like to use it with clients to explain the rationale behind the current preference that many governments have for cap-and-trade policies.

‘Command and control’ is when the government simply tells industry to reduce emissions by a set amount. ‘Tax’ involves levying a charge on each tonne of pollution. ‘Cap-and-trade’ is a policy type that allows companies to buy and sell emission credits, and therefore choose who makes the necessary reductions. Here’s how the game works:

Up to six participants (or six teams of two or three) are cast as the CEOs of large, carbon-intensive companies. They have asked their business analysts to prepare reports on how they can reduce their carbon emissions. These reports are shown at the top of each worksheet (you can download the worksheets here). Each company can implement two projects. You don’t have to implement an entire project – you can do half of it for the half the cost.

The facilitator (who is cast as the government), then asks each company to work out how much it will cost them to meet emission reductions under a command and control regime (i.e. you must meet the reduction target, and you can only implement your own projects). The facilitator asks each company to report how much money they spent and the emission reductions they achieved, and writes totals up on a flipchart.

Next, a tax regime is used. Each company will be charged £40 for every tonne of carbon that they miss their target by. Again, they report the results.

Finally a cap-and-trade scheme is used. Each company decides how many credits they would buy or sell at four price points (using auction ‘order books’, which you can download here). The data is fed into a spreadsheet that works out the optimal clearing price and shows who buys and who sells (the spreadsheet is available here). It’s called a French auction and it’s just like real carbon markets.

The exercise shows that:

  • Command and control achieves the desired emission reductions, but at a high price;
  • Tax is cost efficient, but unpredictable in terms of emission reductions; and
  • Cap-and-trade is cost efficient and achieves the desired reductions.

The game involves huge simplifications, of course, but does outline some basic economics behind these policy choices.

EU should insure long term carbon prices to push the climate and energy package through

Posted in Climate policy with tags , , , , , on December 1, 2008 by Dan

Some industries are claiming that carbon costs could lead them to move outside the EU, which would harm the internal economy and prevent emission reductions. Eurogypsum – the trade body of gypsum manufacturers – is claiming this, but it’s not clear whether the issue is the absolute cost of carbon or the uncertainty over price.

In an interview with Euractive the president of Eurogypsum said:

I cannot challenge the fact that we have to decrease the energy content in our product. But I can also say that in the thirty years that I have been in the industry, we divided the cost of energy in our products by two. And there is still room for progress. So, it is our job in managing the business. Having an incentive to push us to accelerate is okay.

What I am afraid of is the free market for the CO2 tickets because it is out of control. We do not know. When we make a simulation at a certain level, we have no vision of the carbon price. So that is one of the main issues is that the system that they are going to adopt is a system that will give us no vision of what could happen. Maybe it will cost nothing. Maybe it will cost a big amount. So we may take decisions on something that will never happen? They should be conscious about that…

When you have to choose in between certainty or uncertainty, you avoid the uncertainty.

EUAs trade out to 2012 on derivative markets, but not ten years out like Eurogypsum is thinking, and there are no readily available financial products that can transfer that sort of risk.

Over the next few months, as traders speculate on the extent of the recession and talks in Poznan and Brussels hopefully provide some clarity on Phase III, the EUA price is going to be volatile and those pushing back against the climate and energy package are likely to use this as a lever.

France (as EU Council president) is putting together a big package of concessions for industries in central and eastern Europe in an attempt to push the package through. One that I would throw into the mix is a publicly backed long-term carbon hedge. This would hopefully knock on the head the argument “we’re all environmentalists and we don’t mind paying for carbon, it’s the uncertainty that messes with our business models”.

Animation – Carbon Retirement

Posted in Offsetting with tags , , , , , on November 2, 2008 by Dan

We’ve just produced a short animation about how Carbon Retirement works. Carbon Retirement is a new company I’m involved in. We remove EU Emission Allowances from the EU’s Emission Trading Scheme, reducing the volume of CO2 that can be emitted.

Check out our animation (on the Carbon Retirement homepage, Youtube or below) – we’re really happy with it.

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.

Windfall profits to power generators do not mean that the Emission Trading Scheme is not working

Posted in Energy markets with tags , , , , on April 11, 2008 by Dan

The WWF and Point Carbon published a report (pdf) earlier this week estimating that power generators in Germany, the UK, Spain, Italy, and Poland will make a windfall profit between 23 and 71 billion Euros in Phase 2 of the EU ETS.

The windfall is made when power generators pass the market value of freely allocated allowances onto their customers. They do this because the allowances have an opportunity cost: once the allowances have been allocated, one option open to the power companies is to shut down or scale back their trading and sell the surplus. Customers must pay the generators the value of the credits to persuade them not to do so.

Point Carbon is probably right about the windfall – the calculations look as good as any – and WWF is right to feel that the windfall is unmerited. Environmental Capital calls it a “cautionary tale about how not to fight climate change” and that it “undermines the fight to curb emissions”.

Actually, the windfall problem does not damage the environmental integrity of Phase 2 – the cap remains the same. The problem is around who the cost imposed on carbon ends up with. The government is probably the best we can hope for, which is where the money will go when allowances are auctioned.

One way out of the windfall profit problem while credits are still freely allocated would be to impose a fine on companies that reduce their trading activities. The fine would be based on an estimate of the market value of EUAs that would have been required to cover the reduced trading.

ASA’s ruling on Npower’s Wembley ad questions all green electricity packages

Posted in Energy markets with tags , , , , on November 22, 2007 by Dan

wembley-stadium.jpgThe Advertising Standards Authority today upheld a complaint about an Npower advert. The ad claimed that Npower, Wembley’s electricity supplier, “powers the arch and stadium with renewable energy”. This was considered confusing by the watchdog because what Npower (and every other supplier with a green product) really does is ‘match’ the stadium’s electricity with renewable power supplied to the grid. As Wembley is connected to the grid, it is impossible to control the source of the energy that the stadium actually uses.

RWE Npower must have been surprised by the ruling, because it has been supplying retail customers on Juice, its green electricity package, on exactly this basis for six years.

The reason that many green electricity products, including Juice, are confusing is not that they match energy through the grid, but that they do not lead to any additional investment in renewables. Npower already purchases sufficient renewable electricity under its Renewables Obligation to match the electricity used by Wembley.

The ASA’s decision questions the concept of matching different types of generator with end users and pricing their energy accordingly. And – short of a huge expansion in local generation – suppliers do not have any other option for harnessing consumer demand for green electricity.