Weathervane: A Climate Policy Blog from Resources for the Future

Apr14

Output-Based Rebates and Border Adjustments: Easing the Burden of Carbon Pricing

As recent events have shown, putting a price on carbon is no easy task. A host of issues must be addressed to ensure the viability of a comprehensive climate bill, including competitiveness and leakage concerns. Competitiveness questions primarily concern the impact that a carbon pricing policy has on industry output, employment, and profits. Leakage concerns tend to reflect two main components, the first being the desire to keep firms (and hence jobs) from shifting production to countries with less stringent carbon pricing policies. The second is the desire to prevent negative impacts on the environmental integrity of a cap-and-trade program that would result from carbon emissions increasing abroad from this shift in production.

There are two primary tools for dealing with these issues: output-based rebates and a border carbon adjustment. While the general idea of either is fairly simple, how effective each is at preventing adverse competitiveness and leakage impacts is not as straightforward. Fortunately, there are a number of researchers around the world examining these policies and their interplay with the cap-and-trade policies that could develop in the coming years around the world.

RFF recently gathered researchers from the United States, Canada, the EU, and Japan who are currently studying these policies. The goal was to provide a forum for discussing research results and for exploring some further topics for consideration. With the conference spanning several days, many issues were covered but in the course of the dialogue a few interesting themes cropped up:

Allocation design has important economic consequences. Not a surprise right? Of course, but for some more specifics, it was generally found that full auctioning is the most efficient way of allocating permits provided revenues are used to lower distortionary tax rates (here ignoring the political feasibility of full auctioning). Grandfathering was generally found to be the least efficient approach.

Output-based rebates help to mitigate short-run adverse impacts of a carbon pricing policy. The idea here is that setting a price on carbon is going to have the most adverse impacts at the inception of the policy because it is more difficult for firms to adjust production processes to reflect this new higher-cost reality. By establishing output-based rebates you can help mitigate some of the early shock to industrial output that could occur in the U.S. at the start of the program.

Time horizons matter for assessing the impacts of carbon pricing policies. In the near term the effects are likely to be more severe than the medium and long term, as firms change production processes and new technologies are developed.

Emissions leakage can occur from two main sources. The first is through the direct reallocation of production abroad. The second occurs when a country that is large enough to influence the world price of an energy commodity enacts a policy that will lower demand for the fuel in question. Here the lower demand that results from the carbon pricing policy lowers the world price and, as a result, raises the quantity demanded abroad.

And effectively dealing with these two different sources of emissions leakage requires two different approaches. To deal with firms leaving the country, some form of output-based rebating or a border carbon adjustment is necessary. In order to deal with the increase in emissions that could result from lower world fuel prices, the only real way to effectively deal with that is to get the world on board in establishing carbon prices.

Find a full summary of the workshop here.

Eric M. Moore is a research assistant with Resources for the Future.

Published: Apr-14-10 | 0 Comments

Aug20

Amidst Conflicting Reports, China’s Emissions Message Sets Positive Tone

Border Adjustments, COP-15, International

Given the history of global climate negotiations, it is no surprise that a lack of trust remains between developing and developed nations in ongoing discussions for a new international agreement. In the context of the U.S. domestic policy debate, this distrust has—rightly or wrongly—been concentrated on China, and has led to calls for strong measurement, reporting, and verification (MRV) provisions in U.S. climate legislation and international agreements. It even led lawmakers to include a provision in the House bill that would require the EPA to report on emissions in China and India (Title V, Sec. 3).

It doesn’t help matters when major media outlets publish conflicting reports so close together (The Financial Times here and China Daily here) about a crucial component to U.S. domestic and international agreements: China’s emissions peaking date. Given the pace of China’s growth this number is arguably much more important than the U.S mid-term target for protecting the global climate, and it is certainly just as important for reaching a new agreement in Copenhagen. It’s also a critical step on the path toward setting a long-term collective global goal.

So climate change and China watchers had a collective heart attack when they read the Financial Times article in which high-level Chinese official Su Wei said China’s emissions would not peak until 2050. This is the equivalent of Deputy Special Envoy on Climate Change Jonathan Pershing stating that the United States will reduce emissions 0 percent instead of 17 percent by 2020. It would basically kill any chance of a global deal.

Thankfully, China Daily followed-up shortly highlighting a recent report by influential Chinese climate policy scholars arguing that the country could and should reach its emissions peak in 2030. Everyone breathed a sigh of relief. The United States and other developed nations will and should ask for more, but this number is likely to be within the range that they could accept as part of a global agreement. Although it was not an official government position, it’s the next best thing in China. The think tanks that published this report are close government advisers. The fact that they were quoted and featured on one of the nation’s leading English-language news websites indicates that this is a message the government wants the world to receive. China is moving ahead on clean energy with or without you, and is willing to put strong climate goals on the table if others are. An even more recent article indicates that China’s top legislative body will consider a draft resolution on climate change next week lends further credibility to this position.

This is not the first and will certainly not be the last time conflicting reports come out of China on climate or other issues. Since it is in both of their best interests, one would expect that both the media and the Chinese government will continue to improve their MRV procedures inside and outside of a climate agreement. However, it’s important to take the time to sort through the facts and recognize that, in the end, the preponderance of evidence continues to show that China will both do what it takes to be seen as a responsible global citizen on climate change, and will give everything it has to win the race on developing clean energy industries of the future.

Gentlemen, start your wind turbines.

Andrew Stevenson is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Aug-20-09 | 0 Comments

Aug17

Lessons from the E.U.'s Emissions Trading Program

Border Adjustments, International, Cap and Trade, Carbon Market, Allocations

Image courtesy IFCCI Since 2005 major power generation and industrial emitters in the European Union have been monitoring their emissions and paying for the right to release CO₂ and other greenhouse gasses into the atmosphere. While a landmark moment in multi-national environmental cooperation, observers have found that in its early years the E.U.‘s emissions trading scheme (ETS) has not been without its flaws.

Most observers agree that excessive distribution of free allocation permits has led to windfall profits for some entities, and there have been inadequate measures in place to curb price volatility. But according to RFF Senior Fellow Dallas Burtraw in this Weekly Policy Commentary, many of those early problems have been addressed and will be changed in later phases of the program. And, importantly, substantial shifting of industrial production and jobs overseas—as has been feared by many under a U.S. system—has not occurred in the European Union.

Hopeful that U.S. policymakers could learn from the early missteps of the E.U.’s program—especially in the critical areas of allowance allocation and industrial competitiveness—the German Marshall Fund recently released this report offering 10 key lessons from the E.U. ETS.

The paper makes as strong a case for moving quickly from free allowances to full auctioning in the electricity generation sector. By handing out free allowances, the government has a choice between windfall profits if it allows costs to be passed through (which the E.U. initially chose), and a distortion of incentives for consumers to conserve energy if it does not (which the U.S. has essentially chosen with its allocation to local distribution companies). Burtraw made a similar argument in his recent testimony before the Senate Finance Committee, calling for auctioning permits and returning these revenues to protect low-income consumers in vulnerable regions of the United States that face energy price increases.

The report also addresses one of the hottest debates in climate policy design— border adjustments:

Discussion of border adjustments in Europe has been accompanied by extreme nervousness about their potential political impact, both on the world trade system and on the international climate negotiations. The issue was greatly down played in the negotiation of the EU ETS Phase III in favor of free allocation to exposed sectors (though a clause in the E.U. Directive could provide a basis for enacting border adjustments in the future). However, recognizing the imperfections of free allocation as a solution, the French government in particular has raised the issue again, particularly as a way of protecting the integrity of an international environmental treaty.

Although the European Union may not strictly need border adjustments to protect industry at the current low price of carbon, given their seeming inevitability in the U.S. bill, it may be worth considering whether they could be part of a “transatlantic climate partnership” for creating leverage in international negotiations.

As the details of U.S. domestic schemes and an international plan emerging, experience with emissions trading is clearly becoming a “public good” that will be of great value around the world.

Tiffany Clements is managing editor of Weathervane.

Published: Aug-17-09 | 1 Comment

Aug12

Climate Bill Success Can Equal Treaty Success, Even With Border Measures

Competitiveness, COP-15, Congress, International, Obama Administration, Waxman-Markey, Border Adjustments

President Obama and leaders of the U.S. Chamber of Commerce have spoken out against incorporating border adjustment measures in U.S. climate policy. Though there is great uncertainty about the economic and diplomatic value of leveling fees against nations who may not price carbon, 10 conservative Senate Democrats recently told the president such measures will be integral to their support of climate legislation. The challenge now is walking the fine line between the objective of these senators—not just maintaining, but strengthening the House measures—while respecting the concerns of the administration and Chamber about potential trade wars and international ill-will threatening the success of global climate cooperation. It will be a delicate balance, but one that can be achieved with a few key modifications.

The House bill (H.R. 2454) takes a three-fold approach to ensuring the global environmental integrity of U.S. climate policy by preventing emissions leakage. It exempts vulnerable industries from the first two years of the cap-and-trade program, provides output-based rebates until 2035, and introduces a border adjustment system in 2020 only if a multilateral agreement that meets certain conditions is not in place by 2018 and Congress and the president concur that border adjustments are necessary (with Congress given final authority).

The border adjustments are also intended to create leverage, by encouraging major-exporting and emitting developing nations to join an international agreement. Although the primary targets of the adjustments—China and India—have spoken out against this goal, South Korea actually cited it as one reason for being the first non-Annex I Kyoto country to announce a national target. Some have taken an optimistic view of the relationship between these measures and international agreements, while others are more skeptical.

While the House bill represents a compromise on border measures that most people could live with despite not being truly satisfied, the Senate is likely to push for stronger measures. In light of this political reality, the following changes could be introduced to both strengthen the measures and ensure they still reinforce, and are reinforced by, international agreements:

Provide incentives for a real negotiation. Large, developing countries are much more likely to accept the “sticks” (border measures) of U.S. climate legislation if they come with real “carrots” (financing and mitigation commitments) attached. Funding for adaptation and technology transfer in the House bill is well below what most estimates say is truly needed to solve the global climate problem. Although it is clearly concerned about upsetting domestic support, increasing recognition of the necessity for a global solution in Congress indicates the administration may be able to push further on these incentives, if they are properly structured and conditioned.

Improve the likelihood of World Trade Organization consistency. Border adjustments are likely to survive challenge in the WTO if they only enter into force after serious multilateral negotiations have failed, are targeted as clearly as possible at an environmental objective, and/or are backed by an agreement among several nations. Therefore, providing greater incentives for a real negotiation to take place—as discussed above—would likely improve the prospects in this area. Ensuring there are no references to specific countries or competitiveness concerns are also essential in the Senate bill. Finally, support from the nations of the European Union and other developed nations to adopt similar measures would also be helpful when standing before the WTO. These modifications should be in the interest of both those who want to see the measures implemented and those looking to avoid a trade war.

Make negotiating objectives flexible. From a global cooperation perspective, the worst thing Congress could do is to provide negotiating instructions that would be impossible to achieve, thereby ensuring a repeat of Kyoto. This means making them general enough—as the House bill does—that U.S. negotiators have flexibility about how, under what body, and with what conditions they will negotiate an international agreement on trade and climate, as long as it meets certain minimum requirements. Since the primary thing 100 Senators can agree upon is that they do not like the House bill, it is likely that some will want to make these objectives stronger. Instead of inserting additional specifics or calling for an explicit deal on border measures in Copenhagen, a more effective approach could be greater conditioning for U.S. financing and technology transfer on participation in an international agreement.

Adopt a “do no harm” approach on border measures in Copenhagen. From the perspective of U.S. domestic climate policy and global cooperation, the best possible outcome from Copenhagen on border measures is likely that nations do not condemn or even move to prevent them. In the unlikely event that a trade and climate agreement is struck within the UNFCCC or the UN, the issue is contentious enough that it will not come until the final stages of negotiations a few years off. The U.S.’ primary objectives for Copenhagen are likely to be gaining agreement on a long-term global goal, a broad framework for international financing, and potentially a recognition that all major emitters need to take legally binding actions if not now by a date certain. Throwing border measures into the mix will seriously threaten those already tenuous objectives.

Overall, by strengthening the House bill with more robust incentives, targeted framing, effective negotiating objectives, and realistic expectations the “hammer” of border measures desired by conservative Democrats can be compatible with the prospects for a new global agreement in Copenhagen.

Andrew Stevenson is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Aug-12-09 | 0 Comments