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 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

US Carbon price

US CO2 Emissions

Cumulative US CO2 Emissions

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