Professor Michael Grubb Chair, Climate Strategies

Professor Michael Grubb

Chair, Climate Strategies

Senior Research Associate, Faculty of Economics, Cambridge University

& Editor-in-Chief, Climate Policy Journal

Presentation to CAGE/CCCEP workshop

Developing policy regimes for combating climate changeDeveloping policy regimes for combating climate change

London, Tuesday 25 January 2011London, Tuesday 25 January 2011

Constructing a high efficiency, low-carbon coalition: pricing and

international financing dimensions

Faculty of Economics

Hard times– US non-participation, Japan clearly unwilling to proceed without US– Shifting economy and trade patterns reduce role of EU & Annex I emissions

globally– Recession and accumulated debt impedes financing & willingness – Cancun – a political success and measure of the ‘art of the possible’, that

thereby highlights the lack of substantive commitment ..

• Strategic economics of the global energy system• How effective is EU domestic action to 2020?• How can regions pursue stronger action (/carbon prices) in a world

of unequal participation?• Trade-related sources of climate finance? • High efficiency, low carbon coalitions• Evolution & Conclusions

Time

Global Emissions

Global Energy Costs

Global Emissions

Global Energy Costs

Present

Future

Low carbon

High carbon

Current emissions

Future emissions scenarios

Energy is an evolutionary system ..

Global energy costs

Annual global emissions

TimeLow carbon futures

•An integrated energy system•Electricity in transport•Low-carbon electricity•High capital costs….•……but low operating costs

High carbon futures•A continued dependence on fossil fuels•Unconventional and synthetic oil in transport•Low capital costs…•…but high operating costs and a host of environmental issues beyond carbon

We are here

Number of potential energy futures near ‘minimum’ cost

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

5 10 15 20 25 30Ranges, GtC

Re

lativ

e F

req

ue

nc

y

Near-optimal set of 53 technology dynamics

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

5 10 15 20 25 30Ranges, GtC

Re

lativ

e F

req

ue

nc

y


0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

5 10 15 20 25 30Ranges, GtC

Re

lativ

e F

req

ue

nc

y


Low Carbon

High Carbon

The clustering of ‘low cost’ energy futures around higher and lower emission levels,

rather than in the middle, reflects the fundamental options in the face of oil

depletion

.. And future costs divide on the ridge of oil depletion

Public-led Investment Prices

Consumer engagement

InstrumentsChallenges

Innovation &

Infrastructure

Substitution

Behaviour

CoreSolutions

PILLAR I PILLAR II PILLAR III

The three policy pillars of solutions






UK CO2 emissions from a consumption perspective

Electricity

Generation

Domestic

Transport

Residential &

Commercial Heat

Industry (Heat

and Industrial Processes)

Other

International

aviation & shipping

31%

22%

17%

18%4%7%

632MtCO2 845MtCO2

Production emissions1 Consumption emissions

Note 1: CO2 only – excluding non CO2 emissions and land use change1. Based on split of emissions from Committee on Climate Change (CCC) 2. All direct combustion of fuel in households for heating, cooking, etc 3. Includes all non-domestic Air, Rail, Sea & Road transport operation 4. Includes Defence, Health & Public Administration 5. Includes Retail, Hotels, Restaurants 6. Includes Financial Services, Communication Services and other business services 7. Includes household chemicals, cosmetics, pharmaceuticals 8. Includes domestic appliances and industrial machinery 9. Includes automotive, aviation, rail, road and marineSource: CT Analysis; CICERO / SEI / CMU GTAP7 MRIO Model (2004); CCC

2004 Data

ConstructionFood & Beverages

Business

Services6

Retail &

Hospitality5Public

sector4Machinery & Equipment8

ClothingChemical based products7

Fuel3 Electronic

equipmentTransport (non-fuel)9

Householdenergy: 32%

Otherconsumption: 68%

Householdelectricity

HouseholdTransport (fuel)

Household -

direct emissions2

54%

Importedemissions

46%

Domesticemissions

Domestic emissions have been reduced but UK carbon footprint still risen

Unilateral carbon pricing may exacerbate with carbon leakage

80%

60%

-40%

-60%

-20%

0%

120%

20%

40%

SouthAfrica

ChinaRussiaCzechRepublic

Rest of West Asia

PolandCanada

France

JapanItaly

UK

USA

SpainGermany

Ukraine

IndiaBrazil

Non-Annex 11 EUOther Annex 11

Per

cen

tag

e ch

ang

e in

ter

rito

rial

em

issi

on

s to

ref

lect

imp

act

of

con

sum

pti

on

of

CO

2

2004 territorial CO2 emissions (27Gt)

1. Annex 1 to UNFCCCNote 1: Includes CO2 emissions from production, process, transport and household sources only (27Gt in 2004); excludes non-CO2 emissions, and emissions due to land-use-changeNote 2: Based on an MRIO (multi region input/output) model allocating emissions to regions of consumptionSource: Carbon Trust Analysis; CICERO / SEI / CMU GTAP7 MRIO Model (2004)

Hong Kong

Sweden

2004 Data

General pattern of ‘embodied carbon’ flows to ICs

Wedge between consumption & production of embodied carbon

Carbon leakage v.sector-dependent, modest, but ….

- biggest emissions impact on cement, mainly through clinker reduction and trade- biggest leakage as % of overall emission reductions in steel (40%)- cement and aluminium have similar leakage rates (c.20%) relative to reductions - emission gains from finding solutions that preserve incentives biggest in cement

Source: Climate Strategies (2009): Droege et al., ‘Tackling carbon leakage in a world of unequal carbon prices’

Modeling of three key sectors for EU ETS Phase III (EU 20% target)

Though absolute scale of leakage is small, it is significant for some sectors and has enormous impact on design (free allocation) & ambition

Projected production & consumption of EU ETS traded sectors

GtCO2

0.8

0.6

0.4

0.2

1.6

1.4

1.2

1.0

0.0

Production (ETS,

exported)

Production (ETS

ex electricity,net of exports)

Imports (ETS)

2020

1.4

0.2

0.5

0.7

2015

1.4

0.5

0.2

0.6

0.7

2010

1.4

0.2

0.7

0.6

2005

1.4

0.2

0.7

2005

1.4

0.7

0.5

0.2 0.2

Production

(net of exports)

Imports

2020

1.4

0.5

0.7

0.2

GtCO2

1.2

0.6

1.0

0.4

0.0

0.2Production

(exported)

1.6

0.8

1.4

0.04

Leakage

0.2

FlowsAbatement

~2% of emissions 'leak‘

Leakage in-flow

Evolution of EU ETS Production & Consumption

Drivers of change between 2005 and 2020 emissions

Note 1: Declining production emissions based on expected contribution from non-electricity sectors to declining ETS cap (CASE II Model)Note 2: Growth in imported emissions based on continuation of historic growth in gross imports, and varying degrees of decarbonisation in the exporting countries. In the displayed scenario, it is assumed that the emissions intensity of exports from Brazil, Russia, India and China (BRIC nations) decline in line with 50% of the targets noted in the Copenhagen Accord (2009), that exports from the EU and other Annex I nations decline in line with the EU’s target to reduce emissions by 20% from 1990-2020, and that exports from the rest of the world achieve decarbonisation of the order of half that achieved in the BRIC countries. Source: Carbon Trust Analysis based on data from: Addressing leakage in the EU ETS: Results from the Case II Model (Climate Strategies, 2009); CICERO / CMU / SEI GTAP 7 MRIO/ EEBT Model (2004); Cutting Carbon in Europe: The 2020 plan and the future of the EU ETS, Carbon Trust (CTC734, 2008)

By 2020, ETS caps only half of EU ‘carbon footprint’ in energy-intensives,& EU total (production) emissions maybe 10% of global total?






What fundamentally needs to change?

• Most major international regimes have grown out of a small core of committed countries taking action– Eg. WTO, WIPO

• This looks harder for climate change if viewed just as ‘burden sharing’ – hence importance of an evolutionary perspective that integrates energy economics & geopolitics

• Broad tendency has been for stronger action in importer / less energy-intensive regions (eg. EU, CA, SIDs, India ..)

• No way to solve CC by a pure focus on production emissions of the developed / consumer regions:– Inherently unstable (production moves, caps declining share)– Exacerbates the divide – widens gulf between producer v consumer

• Key is to move towards a more consumption-based structure over time, with attention to benefit-sharing and incentives

Price with carbon cost

Price without carbon cost

ETS ETS ETSRest of World

Rest of World

Rest of World

Adjust costs downwards

Conditional allocation

Adjust costs at border

Border Levelling

Adjust global costs upwards

Global carbon pricing

Imports into ETS

Exports from ETS

Fundamental options for addressing carbon leakage- Level down, wait to level up everywhere, or adjust at border?

We have two profoundly different Border Adjustment discussions

• Threatening trade measures against countries not taking ‘comparable’ action– Extra-territorial judgement on ‘adequate’ action– Explicitly discriminatory

• Tackling carbon leakage through border levelling– In principle, cost-levelling between domestic and international where a

specific problem can be demonstrated– Generally non-discriminatory

Trying to deter ‘inadequate’ action by other countries is very different from focused objective to tackle

carbon leakage by protecting domestic carbon pricing

CARBON LEAKAGE – MYTHS AND REALITIES

Myth 5. “The best general solution is to protect our economies and pressurise other countries using border adjustments”

Myth 6. “All Border adjustments are discriminatory, threaten trade & political relations”


The feasibility, effectiveness and economic and political consequences of border adjustments varies according to sector characteristics - Diverse production processes and products increase potential for distortions and abuse- Different legal and practical issues for imports vs exportsAny border measures need justification on sector-specifics not generalities

We already do it … (eg. excise taxes on petroleum, and VAT) For imports, benchmarked ‘Best Available Technology’ border levelling is compliant with GATT Articles I and III - no need to negotiate exemptions

Border leveling is particularly relevant to sectors that are:• Energy intensive and operate in international markets• Relatively homogenous products - operates on price competition• Relatively homogenous production processes – benchmarks are useful• High operating carbon cost impacts (plants might otherwise part load)

Sectoral approach to border leveling

Global emissions from different industrial processes

Charging embodied carbon on sector-by-sector basis as appropriate

Key criteria

• Scale of emissions• Scale of leakage concern:

• Relative impact of carbon costs• Scale of existing trade barriers

• Availability of policy alternatives• Effectiveness and losses associated

with free allocation • State of international sectoral

agreement• Feasibility of border leveling

• Diversity of products• Diversity of production processes

• Cement is the most obvious sector initially






• Most sources of international public finance have to pass through the sieve of domestic politics in developed countries– The hand of the Treasuries, subject to high-level political

commitments• Under sever pressure from national debt

– The court of public opinion• Impact of recession and fear of the emerging economies as economic

competitors

• Additional sources of finance will increasingly have to circumvent these constraints, ideally– Be outside the scope of existing sources of national

finance, and preferably not fall naturally under any specific national jurisdiction;

– Be visibly connected with climate change, and preferably contribute directly to mitigation of climate change; and

– Carry mutual incentives that could facilitate all sides agreeing to use it as a funding sourceSource: M. Grubb (2010), ‘International climate finance: the case for international use

of border levelling charges,’ forthcoming in Climate Policy 11:3

International finance - challenge

Incidence – net economic effects– Relatively low demand sensitivity in energy intensive

commodities means almost all cost increases passed to consumers

– Ie. mainly paid by consumers of energy intensive products in the importing (ETS) countries

Ownership – There is no clear ‘moral’ basis of ownership/responsibility for

emissions between producers and consumers– Emissions from production of goods for export logically exist in an

‘international’ space, like international bunker fuels, their assignment is a matter of political decisionmaking

– Either producer or consumer countries could charge border leveling:

• Consuming countries – could offer the revenues to international expenditures eg. to fulfil multilateral goals and reduce potential trade-related tensions

• Producer countries – would benefit from a multilateral framework to address loss of competitiveness vis-à-vis other producers *Source: M. Grubb (2010), ‘International climate finance: the case for international use of border levelling

charges,’ forthcoming Climate Policy 11:3; * See B. Mueller and A.Sharma, Trade tactic could unlock climate negotiations, SciDev, 23 June 2005

Border levelling charges– Incidence & ‘ownership’

Europe OECD

Production

Imports

Production

Imports

Cement Volume (Mt)[1] 250 35 560 70 Carbon emissions benchmarked @ 0.7 tCO2/tonne cement 175 24.5 392 49 Revenue if paid at €30/tCO2 5250 735 11760 1470 Steel Volume (Mt)[2] 120 70 250 130 Carbon emissions benchmarked @ 1.8 tCO2/tonne steel 216 126 450 234 Revenue if paid at €30/tCO2 6480 3780 13500 7020

Table 1. Indicative carbon revenues from cement and steel

- Revenues from Production and border levelling on imports trade, US$m/yr@$30/tCO2

Source: Grubb (2010) ‘International climate finance: the case for international useof border levelling charges’, in review for Climate Policy






Within coalition–Revenues raised at the border returned, used for international expenditures or returned to producers in the coalition under agreed procedures to support low carbon development plans –Agreement on evolution from fixed border benchmarks to verified embodied carbon charging–Carbon that is charged at source deducted at the border, ie. evolution of a ‘carbon added’ structure analogous to VAT

Outside coalition–No basis for returning revenues to producers–Revenues raised at the border put into to international climate expenditures

Carbon added charging in north-south coalition

– Reiterate: Most major international regimes have grown out of a small core of committed countries taking action; key challenges leakage & finance

• Investment for innovation and infrastructure

– International finance for low carbon infrastructure and avoiding carbon lock-in

– Networks of innovation centres to facilitate learning, cost-sharing, and supportive IP regimes

• Carbon and efficiency pricing– Negotiated systems of border levelling for trade in primary

commodities, with recycling of associated revenues – Development of ‘carbon added’ pricing strucutres within

and between countries

• Consumer, business and voter engagement – Standardisation of product efficiency and carbon footprint

labelling– Sectoral agreements, consumer norms ..

Climate policy in a world of unequal participationRequires structuring solutions to support the three pillars of domestic policy

Welded together by long-term agreement to form public price expectation

This needs to be seen as an evolutionary journey - With border leveling as a key part of journey towards broadening action

Bottom line: Why we need a mature debate about consumption accountability and border levelling

• The problem is ultimately one of consumption, so it makes sense to hold consumers accountable for the emissions of their consumption choices

– & Why should consumers discriminate against their own producers in favour of imports?

• Leakage fears are messing up cap-and-trade schemes around the world

– free allocation is a poor solution and even this is insufficient to forestall debate as caps tighten (or precludes tightening of action)

• Money: Using the European cement sector as an example,– 100% free allocation could increase sector profits by between €2.5-4bn per

annum to 2010. Equivalent funds could be generated for the public sector if these allowances were auctioned, this will only happen if there is border leveling

– Revenue from the border component would be several €100ms annually and use of these revenues could be subject to international negotiation

– Steel bigger, especially the international component

• If regions that are willing to take stronger action are expected to suffer unnecessary economic losses that are not even associated with saving any emissions, there is no way to solve climate change

Hard times– US non-participation, Japan clearly unwilling to proceed without US– Shifting trade patterns reduce role of EU emissions globally– Recession and accumulated debt– Global uncertainty about future of regime, UNFCCC deadlocked


of unequal participation?• Trade-related sources of climate finance? • High efficiency, low carbon coalitions

• Technical annex material– Mostly from CS & Carbon Trust report “Tackling Carbon Leakage”

Myth Reality

Carbon leakage is a major economic & environmental problem

At the present level of ambition, even with purely unilateral action and no free allocation or border protection, leakage would be only a few percent of EU emissions

… so if aggregate numbers are small it is not a big problem

Politically impossible (and unreasonable) to ignore loss of important and powerful industries without even saving any emissions

Free allocation is an effective solution

Free allocation can help tackle investment leakages in some sectors, but is far from a panacea

Free allocation is free Free allocation increases costs to the rest of business and to a much greater extent than most models predict, due to a basic modelling omission

The best solution is to protect economies with border adjustments

Border adjustments in many sectors are technically difficult, legally debateable and politically explosive – but an evolutionary approach to leveling costs in appropriate sectors is viable

Border adjustments threaten world trade etc

… border leveling in the right sectors is non-discriminating, the only effective approach, could raise funds for international purposes, and a reasonable and necessary part of evolving global responses

After Copenhagen, sustaining action in a world of unequal carbon prices – and raising revenue for ‘greening growth’ at home and abroad - is of fundamental importance, ‘carbon leakage myths’ need to be dispelled


28

Common fact, though national differences in structure, eg. Compared to UK:Germany has higher % Value Added in the most cost-impacted sectors, US refining sector exceptionally large

Source: Grubb, Brewer, Houser & Sato, ‘Climate policy and industrial competitiveness: ten lessons from the EU ETS’, German Marshall Fund – US, Washington DC, 2009

CO2 emissions heavily concentrated in a few primary activities

But:• without countermeasures may be significant for key sectors (eg. 40% of steel “emission savings” are due to offshoring)• leakage rises with the degree of effort (eg. EU move to 30%)• effects may vary a lot between different regions, facilities• “all politics is local”• growing international carbon flows undermine impact of domestic measures anyway

So

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Tru

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Cli

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Myth 1: “EU faces large scale carbon leakage from the EU ETS”

Myth 2. “… So if aggregate leakage is modest it is not a big problem”Carbon flows lesson impact, and economic loss with no environmental benefit is never politically

acceptable

Free allocation cuts leakage but increases carbon price- Border levelling cuts leakage without significant efficiency loss, and greater scope

Source: Carbon Trust / Climate Strategies

Technically speaking, border leveling clearly more effective

Available at: www.carbontrust.co.uk

Tackling carbon leakage

Available at: www.climatestrategies.org


http://www.carbontrust.co.uk/

PUBLICATIONS

CS Academic Synthesis Reports* www.climatestrategies.org

Derived Carbon Trust Insights publicationswww.carbontrust.co.uk

EU ETS design and Incentives

National allocation plans in the EU ETS (2006)**Grubb, Neuhoff et al.: Submission to EU ETS review Neuhoff et al. paper on Auctioning

EU ETS Phase II allocation: implications and lessons (2007).Cutting Carbon in Europe: The 2020 plans and the future of the EU ETS (2008)

Competitivenessand carbon

leakage

Emissions trading and competitiveness (2006)**Hourcade et al, Differentiation and dynamics of EU ETS industrial competitiveness (2007)Droege et al., ‘Tackling carbon leakage’ (2009)

The European ETS: implications for industrial competitiveness (2004)Allocation and competitiveness in the EU emissions trading system: options for Phase II and beyond (2007).EU ETS impacts on profitability and trade: a sector by sector analysis (2008).Tackling carbon leakage (Sept 2009)

Global Carbon Mechanisms & international linking

Series on the Kyoto Mechanisms (GIS, JI and CDM) trading schemesTuerk et al., Linking emission trading schemes**

The Global Carbon Mechanisms: evidence and Implications (Feb 2009)Linking emissions trading schemes (July 2009)

** Key papers published as Special Issue of the Climate Policy journal, www.climatepolicy.com

Own academic papers: http://www.econ.cam.ac.uk/faculty/grubb/index.html

Forthcoming : Grubb with Hourcade and Neuhoff, The carbon connection (Earthscan, 2011)

http://www.econ.cam.ac.uk/faculty/grubb/index.html

Documents

Professor Michael Grubb Chair, Climate Strategies