Climate Policy For New Zealand After Kyoto Warwick J. McKibbin Centre for Applied Macroeconomic Analysis ANU, & The Lowy Institute for International Policy & The Brookings Institution 2007 A.W.H. Phillips Memorial Lecture

2 Overview The Climate Policy Problem  What makes climate change policy so difficult? What Needs to be Done?  The Role of Prices What Has been done so Far  Why the Kyoto Protocol Approach has stalled The New Zealand Situation The McKibbin-Wilcoxen Blueprint for national and global action  an Application to New Zealand  the recent Australian application Conclusion

5 Emissions versus Concentrations What matters for the climate is the concentration of greenhouse gases in the atmosphere Concentrations are the accumulation of annual greenhouse gas emissions Emissions is any particular year are not critical but the path over time is

6 What makes climate policy difficult? 1.Committed warming è Need both mitigation and adaptation 2.Geography è Broad range of sources of emissions, caused by decisions made by a diverse range of households and firms è Many jurisdictions - coordination problem (international, national, state, local) 3.Time scales è Exceptionally long-lived problem and policy 4.Uncertainties è Numerous, large and intractable

7 What’s uncertain? Emissions Levels CO2 Concentrations Temperature Change Ecological Effects Economic Damages/benefits

8 Climate Policy is about Managing Uncertainty

9 Issues in Regime Design Coverage Equity Politics Institutions Fundamentals Flexibility

10 Coverage Need major current and future emitting countries involved not necessarily all countries Need all of the economy involved not just a particular sector Need to change the sources of demand and supply of greenhouse gas emissions

11 Issues in Regime Design Coverage Equity Politics Institutions Fundamentals Flexibility

12 Equity A climate policy will probably lead to winners and losers Need to deal with the distributional issues within countries and between countries  Within country distribution is up to governments within countries Need to recognize the differences across countries’ stages of development and relative contributions to current climate problems

13 Some Issues in Regime Design Coverage Equity Politics Institutions Fundamentals Flexibility

14 Politics Need to build constituencies across society that support the policy in their own financial self interest  Fossil fuel producers facing reduced demand for their products  Consumers facing higher energy prices  Politicians with an incentive to lobby to reject a policy in favor of a narrow constituency

15 Some Issues in Regime Design Coverage Equity Politics Institutions Fundamentals Flexibility

16 Institutions Build on existing national institutions  Legal, accounting, financial, market experience  Developing new international institutions will delay action and will likely be infeasible

17 Some Issues in Regime Design Coverage Equity Politics Institutions Fundamentals Flexibility

18 Fundamentals Need to  establish clear property rights over carbon emissions over a long period of time to provide incentives for all involved within a country to want to reduce carbon emissions  create a capacity for individuals and companies to manage climate risk  Encourage the emergence, adoption and diffusion of existing and new technologies to reduce emissions

19 Fundamentals Need to  Manage the demand side of energy use while waiting for technologies to emerge  Enable compensation for those hurt by higher energy prices if technology is expensive or slow to emerge

20 Flexibility is important Need to be able to start in individual countries with known costs Need to be able to add countries over time Need to be able to adjust the system as information is revealed Need to allow for particular national circumstances

21 The Role of Prices

24 Ways to give price signals: Carbon tax Subsidies Binding targets with penalties for non- compliance Cap and trade Permit trading McKibbin Wilcoxen Blueprint – a hybrid of the above approaches

25 The Role of Prices Price signals should be both short term and long term Price signals should be credible  Otherwise investment will not be forthcoming Price signals are crucial for encouraging  Demand side management  The emergence of alternative technologies  The adoption and diffusion of alternative technologies Short run prices can more easily be used than emission targets to line up costs with expected benefits

26 What has been Done so far?

27 The UN Framework Convention on Climate Change Negotiated at the Earth Summit in 1992 in Rio Set Goals (not targets)  “preventing dangerous anthropogenic interference with the Earth’s climate system”  Annex I countries (industrial countries) were to adopt policies to “aim” to reduce their emissions  Entered into force in March 1994 Set in process a series of meetings of the “Conference of the Parties” (COP)

28 The Kyoto Protocol Protocol to the 1992 UN framework Convention on Climate Change, negotiated at COP3 in 1997 Annex 1 countries agreed to reduce emissions of 6 greenhouse gases to 5.2% below 1990 levels on average between 2008 and 2012 Entered into force February 2005.

29 The Kyoto Protocol No commitments for Developing Countries (countries such as China ratify but have no targets!) Some flexibility allowed through  permit trading  clean development mechanism (CDM)  joint implementation

30 Kyoto Protocol There are many problems with Kyoto The most obvious problem is the approach of targets and timetables  Hit an emission target independently of what it costs

31 Permits are ultimately promises of governments whose value depends on the credibility of governments There is a reason why there is not a single world currency Problems With International Permit Trading

32 The Kyoto Protocol New Zealand together with most countries have ratified Australia and the United States have not

33 Are there any other alternatives? Need a policy with best features of permits, taxes and subsidies Like a tax:  Should guarantee that costs won’t be excessive Like permits:  Should avoid huge transfers to the government Like subsidies:  it should encourage the search for technological solutions

34 The Situation in New Zealand 1997 report McKibbin and Pearce “Impact on the New Zealand economy of commitments for abatement of carbon dioxide emissions” Found marginal abatement cost in NZ amongst the highest in the world. From 1990 projected quickly rising emissions under BAU emissions from energy at mt

35 The Situation in New Zealand Recommended a uniform carbon tax but better still the McKibbin Wilcoxen Blueprint NZ climate policy announced in 2002 with reviews in 05, 07, 010 Like most countries NZ has a large range of policies aimed at energy efficiency and conservation, public awareness and other factors. Review in November 2006 – asked the right questions but the December discussion paper ignored a key policy option. NZ government was to implement a carbon tax in 2007 but it has been postponed

36 The Situation in New Zealand New Zealand’s Kyoto Target is 1990 levels 2005 emissions  77.2 million tonnes CO2e % above 1990!  48.5% of emissions from agriculture  43.4% of emissions from energy (33.5mt) As in most countries ratifying Kyoto is not sufficient to reduce emissions Source: Ministry of Environment – NZ Greenhouse Gas Inventory

37 The McKibbin Wilcoxen Blueprint Aim  Impose a long term carbon goal for economies  Generate a long term price for carbon to guide energy related investment decisions  Line up short term economic costs with expected environmental benefits  Provide a way for corporation and households to manage climate risk  Can be an internationally coordinated system or a national system that evolves into an international system

38 Components of the Policy National permits  Required to embody carbon in energy  Good only in country of issue Long-term permits  Allow 1 ton of emissions each year  Quantity is the long run goal  Fixed supply (can be diminishing) Annual permits  Allow 1 ton of emissions in year of issue  Elastic supply from national government  Price fixed for ten years

39 Long Term Permit Looking at the policy in more detail: z Allows one unit of emission per year for a long period z Distributed once at enactment z Can be leased or sold within a country z Quantity can set by treaty: Q T z Price will be set by the market Annual Permit z Allows one unit for one year z Sold by government as demanded z Price set by treaty: P T

40 Why National Permits? Use existing institutions  Legal system for enforcing property rights Small loss of sovereignty  No need to cede authority to an international body  No direct international transfers of wealth  Enforcement maintains rights of domestic residents Robustness and stability  Easy to join the agreement  Robust to withdrawal by some participating countries  Compartmentalization lowers transmission of shocks

41 Why Long-Term Permits? Credibility  Build constituency supporting the policy  Owners: vested interest in maintaining system  Reduce the time-consistency problem Additional benefits  Can tailor distributional effects via permit allocation  Reduces risks (long term vs. short term bonds)

42 Why Annual Permits? Acts like a carbon tax at the margin Efficient  A price-based policy is preferable to a qnatitative target given flat damage curve Pragmatic  Governments don’t have to agree to hit a fixed target in any year regardless of cost Flexible  Government can mandate who can issue annual permits

43 Allocation Those who need permits are not necessarily the same as those who own the permits Allocate long term permits freely to fossil fuel intensive industry and households Only those who embody carbon in energy need a permit each each.

44 Overall Creates incentives for investment  Raises the marginal cost of emissions into the future Incentives are credible  Built-in constituency of long term permit holders  Robust to accessions and withdrawals  Operates within existing institutions Provides a foundation on which to build  Completely consistent with technology policies  Provides incentives for adoption and diffusion

45 Expandable Because it is a domestic system, other abatement activities can be included as a way to generate annual permits with the revenue going to these activities instead of the government

46 Main Concept  The long term permits are the medium term goals for emissions without a timetable of when they are reached  The short term permits are the economic costs to the economy  Move through a low cost path from the short run to the longer run in decadal steps with profit incentives to reduce emissions wherever cost effective

47 A Partial Analogy – Bond markets  Long term government bond market prices interest rates over long horizons given a stock of government debt (like long term permits)  Central banks set the short term interest rate - the supply of financial liquidity is generated by the market (like annual permits).  The long term interest rate (which is flexible) is the expected value of future of short term interest rates (which are fixed in any period)

48 Coordination of National Permit Markets Independent but coordinated via P T Japan US EU New Zealand PTPT

49 McKibbin Wilcoxen in New Zealand

54 The New Australian Approach McKibbin-Wilcoxen with political compromise

55 Key differences Long term permit bundles are 40 years Windows every five years  Additional medium term permits can be auctioned Safety valve  is a penalty rather than an annual permit Initial allocation  all to affected industry or auctioned

56 How to Bring in Developing Countries ? The MWB approach can be applied in countries at different levels of development

57 Developing Countries Negotiate a long term permit allocation that is larger than current emissions Price of annual emission permits (or economic cost) is zero in the short run because more permits than needed

58 Developing Countries Price of long term emission permits will be non zero giving important signals for investment projects Over time the permit price in countries will equalize as developing countries “ability to pay rises”

61 Conclusion Climate policy at the global level is in a state of considerable flux and a new direction away from targets and timetables is needed New Zealand should consider a variant of the McKibbin Wilcoxen Blueprint for climate policy both as a way to deal with the Kyoto dilemma and to be at the forefront of the post 2012 debate.

62 Background Papers