Economists support carbon price

I have to admit that it saddens me that we are in 2014 and still need to lobby Australian politicians for something so blindingly obvious than a price on carbon but here we are. Coordinated by the World Wildlife Federation, today a letter signed by 59 economists (including myself) has been released. The text is below.

2014 ECONOMISTS¹ OPEN LETTER SUPPORTING A PRICE AND LIMIT ON CARBON POLLUTION

We are writing this open letter as a group of concerned economists with a broad range of personal political views, but united in the judgment that a well-designed mechanism that puts a price and limit on carbon pollution is the most economically efficient way to reduce carbon emissions that cause global warming.

Such a mechanism is a necessary and desirable structural reform of the Australian economy, designed to change relative prices in a way that provides an effective incentive to consumers and producers to shift over time to more low-carbon, energy-efficient patterns of consumption and production. Australia’s major trading partners are acting on climate change and it is important to have an effective price and limit on pollution in place now to begin Australia’s transition to a low-carbon economy. A well-designed price and limit on carbon pollution has many benefits over alternative schemes, including:
• stable and long-term policy settings that improve certainty for business
• greater confidence that emission reduction targets will be met
• lower administrative cost and complexity
• the ability to link to other global schemes, such as emissions trading schemes operating in Europe, China and the United States
• incentives for consumers to reduce their demand for emissions-intensive goods
• incorporation of the cost of the damages caused by carbon emissions into business decisions, by requiring companies to pay to pollute.
The Intergovernmental Panel on Climate Change has made it clear that human influence, through activities such as accelerated and large scale burning of fossil fuels and clearing of forests, is warming the globe and that the impacts of climate change are being felt across the world. These findings are supported by the leading scientific bodies of the world, including the CSIRO and the Australian Academy of Science.

Australia can and should do its fair share to contribute to global emissions cuts, which will require Australia to make significant and sustained reductions in emissions and transition to a low-carbon economy. Clear short-, medium- and long-term targets to limit emissions would guide expectations. It is important therefore to provide stable, long-term policy that can meet deeper cuts in the future, and that improves certainty for business and investors to begin an orderly transition to cleaner technology.

We urge all Members of Parliament and Senators to work in the national interest towards lasting agreement on a fair, economically efficient and environmentally effective policy to price and limit carbon emissions.

Letter to IACO on Carbon Emissions

I put my name this week to a letter organised by the WWF on airline emissions. Basically, while, in general, I am in favour of markets that allow meaningful offsets of emissions I am concerned that, in this instance, they do not appropriately offset the emissions generated (as evidenced by the very low costs associated with emissions offsets on airline sites). The emission offsets themselves have to be priced into the market in an appropriate way or there is the possibility of abuse. Apparently, I am in good company being worried that the cost of carbon will not be reflected quickly enough with current proposals.

As the ICAO Council and its technical committees develop the global market-based measure over the next few years, the biggest question they must face is at what level to price that risk. That is, how large an incentive is needed for economic agents to cut back on the production of emissions by an appropriate amount? The answer is that for all these agents—whether consumers, businesses, entrepreneurs, or investors—the level of the incentive should equal the expected present value of the discounted damages that may be created by the production of emissions. In other words, the right price for every amount of carbon emitted into the atmosphere should reflect the expected cost of these emissions to society as a whole, taking into account the risks that they create.

Economists refer to this value as the social cost of carbon. Several reputable studies have attempted to calculate the social cost of carbon. The Stern Review estimated it to be about US$85 per metric ton of carbon dioxide emitted into the atmosphere. The recently revised official US government value is $37 per metric ton.

Unfortunately, all available evidence suggests that many countries within ICAO and the aviation industry support a type of market-based measure, which would allow airlines to buy emissions offsets in order to meet an already weak 2020 carbon neutrality target. If ICAO adopts this approach, it would not bend the aviation industry’s total emissions downward and thus would fall short of being a meaningful policy. Such a market-based measure that fails to create appropriate incentives could set a bad precedent and would waste a significant opportunity to move the global climate response forward.

Basically, there hasn’t been enough innovation in airlines to give us confidence as opposed to ensuring people substitute away from airline travel (especially for meetings) in the short and medium term.

Supply side effects of direct action

This is a guest post by Evan Calford, a PhD Student at UBC

This post seeks to describe one particular concern with the implementation of the Australian Government’s Direct Action policy, as laid out in the recent Green Paper. There are many concerns with the Green Paper that have already been pointed out which, in the interests of space, I shall ignore. I wish to focus solely on the potential change in producer behaviour induced by Direct Action. I shall call this change in behaviour the supply-side response to the policy.

Direct action works by providing incentives to producers to reduce their carbon dioxide equivalent (CO2-e) emissions; the Government will, through a reverse-auction tender process, pay companies for reducing their emissions beneath their historical emissions levels. This causes firms to face an effective marginal cost for emissions, when they are operating beneath their baseline emissions levels (the direct action plan will not include penalties for firms that exceed their historical emissions levels).

Some media coverage has been worried that the lack of upside penalties means that firms won’t make any emissions reductions. This seems backwards, as it implies that firms will leave cash on the table. The effect of using a reverse-auction tender process will be to pay firms more than the actual cost of their emissions reductions. If the tender process uses a second price approach (so that all firms will be paid at the rate of the most expensive reductions contracted for at that auction) then this conclusion is straightforward. Even in a first price auction (each firm is paid what they bid) the conclusion is still valid – in equilibrium, firms will bump up their asking prices above actual emissions reduction costs.

This implies that firms (and industries) who make emissions reductions are being subsidized relative to the rest of the economy. It is unclear, given the contents of the green paper, what the relationship between quantity of production and the size of subsidy will be. The exact accounting mechanism used for changes in production and new entrants will be critical in determining this relationship. This point should be obvious to anyone who has thought about how to design carbon pollution abatement schemes, and seems to be understood in the green paper. A more subtle point is that, in a dynamic world, even if changes in production and new entrants are accounted for in a manner which does not distort incentives the mere existence of a direct action plan, and associated subsidies, will increase production levels in high emissions intensity industries.

To understand why this is true, consider a simplified scenario in which a firm that reduces emissions is paid a for the costs of these reductions, plus an annual lump sum payment (to a first approximation, this is what a well-designed direct action scheme will achieve). Under a CPRS or carbon tax, some high emissions intensity firms would shut down due to the higher costs. These shutdowns may not occur under the direct action scheme because the annual lump sum payment will decrease the firm’s average variable costs and affect the shut down decision. The direct action plan will see less reallocation of resources from high emissions intensity sectors to low emissions intensity sectors.

Furthermore, the annual lump sum payment can influence future investment decisions by changing relative rates of returns between industries. In a competitive environment we would expect, in the long run, rates of returns to be equalized across industries; externally induced changes in rates of return can lead to changes in resource allocations between industries.

It is natural to ask “how much effect will the supply response have on emissions levels?” This is a very difficult question to answer. A paper published by ABARE (now ABARES) in 2010 tried to estimate the supply response effect for the agriculture industry [disclosure – I am the lead author of the ABARE paper]. The paper made use of a computable general equilibrium model, developed by ABARE and Treasury, called the Global Trade and Environment Model (GTEM) which embeds many assumptions (see the paper for details).

supplyeffect

The key graph in the paper is figure d on page 24. This graph demonstrates that, by 2030, applying an emissions offsets scheme to agriculture (the emissions offsets scheme modelled is roughly comparable to the Government’s Direct Action policy) would have reduced Australian agricultural emissions by almost 8 million tonnes of CO2-e, relative to 2030 emissions without any specific emissions reduction policies for agriculture. However, this 8 Mt conceals the fact that agriculture would have made efficiency improvements equivalent to a reduction of over 10 Mt of CO2-e. The difference between these two numbers (2.6 Mt of CO2-e, or roughly 25% of the efficiency improvements) is the effect of the supply response caused by subsidies to the agricultural industry. The subsidy causes overall agricultural production to increase and causes a substitution away from low emissions intensity cropping to high emissions intensity beef cattle and dairy production.

To put it another way, you need to pay for 10 million tonnes of `direct action’ to get 8 million tonnes of emissions reductions.

Note that these figures are specific to agriculture, and depend on a specific set of modelling assumptions. Even when viewed in context, these numbers are best thought of as an educated best guess rather than a pinpoint prediction. The supply response effect of the Direct Action plan could be bigger, or smaller, than the 25% estimated by ABARE for the agricultural sectors. I don’t know the answer to the question “how much effect will the supply response have on emissions levels?” But I do know that the Government (in particular, ABARES and Treasury) have the expertise to try and answer this question, and that knowing the answer is crucial for designing an effective Direct Action policy.

Bushfires and climate change: where’s the policy?

Ahh, Greg Hunt has got himself into a pickle by quoting Wikipedia on the causes of Australian bushfires. This amused me greatly and I wanted to write a post making even more fun of it. Sadly, I did what I am not expected to do as a blogger and listened to the whole BBC interview that caused this. Nothing takes the wind out of a blogger’s sails than context.

Here is the quote Hunt actually made:

Bushfires in Australia are frequently occurring events during the hotter months of the year due to Australia’s mostly hot, dry climate. Large areas of land are ravaged every year by bushfires, which also cause property damage and loss of life.

Damn. That doesn’t look like a wrong statement and those of us in academia would pretty much agree that is the standard way to open a discussion on bushfires. Hunt then went on to say that he did not think it was relevant right now whether to determine whether the current fire was caused by climate change or not. He said we need to deal with the crisis and then the longer-term policy later in which he did not dispute that climate change may be cause of the increase the frequency of bushfires. The science is pretty clear that there has been an increase in that frequency whether it has been caused by climate change or not. The BBC interview had a scientist on after Hunt that said pretty much just that.

Now the Greens and others would like to use this event as a motive for continuing to act on climate change. I think that is a legitimate avenue to push. Abbott and Hunt clearly, for similar political reasons, don’t want to allow the debate to go there. But I think we need to step back and consider this more dispassionately and I am worried that bringing the climate change equation into this will actually undermine action on a clear policy issue.

First, having now spent 4 years in North America, let me tell you that the Coalition have come a long way on environmental issues. Importantly, they now accept environmental damage is a bad thing. This is not true of the right-wing elsewhere who don’t necessarily care what happens to the environment. The issue in Australia now is how to get a clean environment not whether to have one. This is a big change from when I was growing up. Clearly, the Coalition are not acting on carbon pollution in a way that is effective or cheap but that is another matter.

Second, the climate change equation is irrelevant to how we manage bushfires. You can have a carbon tax in Australia or world-wide and the increased frequency of bushfires will remain a problem for a century or more. Mitigating climate change is not a solution to this. It would be best that we kept it separate.

Third, that means we need to focus on bushfire management strategy. Four years ago 176 people perished in the Victorian bushfires. Now I don’t know what was done after that in policy circles. As a blogger, I will exercise my expected charge not to bother to find out. But the NSW situation should at least put on the table that it isn’t enough. We have state-wide situations in October for goodness sake. How did this happen?

As I read the media today, I see column inches and web pages devoted to climate change and the politics of that and nothing devoted to the clearly central policy issue raised by the current crisis. While they may have political motives, what Hunt said was actually more consistent with focussing on the relevant issues than what many others seem to be doing. In social media, we need to get the focus back on the real issue. Bushfires are a problem. They require a solution regardless of causes. The rate of return for investment in this is likely to be very high. Do something.

The water you drink has been piss at least 10 times already!

Last thursday I posed the question of how often the water you drink has been pissed by a vertebrate already. If the number is very small, then those who baulk at drinking recycled water have more cause to complain than if the number is very high.

As some commentators to that post pointed out, in reality we are all drinking water that includes some recycled piss: every dam from which we drink has ducks, lizards, and all sorts of animals pissing and shitting in it, so it is already a bit of a myth to think one can drink water that has not been recently mixed with piss. Still, as another comment revealed, many think the idea of copying Singapore and drinking water that is officially recycled sewage is deemed ‘gross’. So the question how often water has been piss in the past still matters for the ‘yuk factor’.

The answer comes from a very simple formula, which requires a few guesstimates as inputs:

Piss ratio = (total water pissed)/(total water) = (total vertebrate biomass ever lived* piss rate)/ (total water) = (average biomass vertebrates * piss rate per year * years of vertebrates) / (total water)

This simple formula thus boils down to 4 inputs for which we can search for good guesstimates.

The amount of water on the planet (total water) is the easiest one because it is the sort of thing geologists and physicists are good at estimating. As this linked article computes, there is around 1.386 billion cubic kilometers of water on the planet. Whilst it is true that this water comes in various forms, that is not relevant for the calculation: since we are considering hundreds of millions of years, it doesn’t matter how much of that water is currently salt, fresh, stored in ice, or whatever: compared to such long time horizons it all circulates pretty fast so there is no problem in taking it all as one blob of water.

I can already say that my best guess for how much water we humans have pissed during our existence is around 800 cubic kilometers, meaning that only one 2-millionth of the atoms in the average water molecule will have been pissed out by a human. So we might be drinking reconstituted piss, but not much is reconstituted human piss.

Now, onto the other three inputs into our crucial equation. What is the average wet biomass of vertebrates? If we take the present as a reasonable guess for how much vertebrate biomass the earth continuously houses, then the answer we can gleam here is around 10% of total animal biomass (zoomass), or in the order of 5 billion tonnes of wet biomass (a lot more than dry biomass which you will often see reported). This includes up to 2 billion tonnes of dry-biomass fish, a little under half a billion tonnes of human, close to a billion tonne of things we might eat that walk on land (cattle and such), and 2 billion other wet biomass. In turn, this is in the order of one thousands of total biomass.

Admittedly, the estimate of 5 billion tonnes of wet vertebrate biomass may be out by a factor of 2 or so, but can easily be an under-estimate since I only found a dry biomass estimate for fish.

Then the next part of the equation: how much does a vertebrate piss per year? Again, this turns out to be a tricky question because only birds and mammals produce concentrated urine like we do. The rest pisses much weaker stuff, though things like fish still produce ammonia and the other normal elements of piss because the basic physiology is not that different between us and a fish. So the process and form of piss is not the same across species but the substances produced by our bodies and eventually excreted somehow are not that dissimilar.

So we need to slightly alter the definition of what we are looking for and think of piss as a ‘human-like’ substance. We can then again take a conservative approach and don’t count the watery piss that fish produce as ‘100% piss’ but rather as a much weaker variety of what we produce. We can then take ourselves as the measure of what a body produces and simply scale up, getting an easier question to start out with: how much do we humans piss in a year? The answer turns out to be that we piss around 1.5 liters per day, or 500 liters per year. Another way to put this is that we piss out 8 to 9 times our weight in wet biomass per year.

Then onto the last unknown, which is the number of years that vertebrates have been around in the abundant form of life we have now. Again, a tough one. The earth is now quite a bit cooler and probably less fertile than it was in the times of the dinosaurs, so the amount of biomass walking around now is probably quite a bit less than it was in the more productive phases of earth, but by the same token for much of the earth’s inhabited history the inhabitants were bacteria and not things with spines. If we concentrate on the period of the vertebrates, the best guess is that fish arose some 500 millions years ago, whilst land was conquered by vertebrates some 380 million years ago. Taking a conservative guess for the total period of time that the volume of vertebrates we have now has been present, this means that the wet vertebrate biomass we have now has occupied earth for around 350 million years.

We can now put the pieces together to compute our piss ratio: 350 million years of 5 billion tonnes of wet vertebrates pissing 8 times their body weight per year equals 14,000 million cubic kilometers of piss. This means the atoms in your average water molecule will have been concentrated piss some 10 times already. And that is a conservative estimate. In the more likely scenario, there would have been more like 10 billion tonnes of vertebrate biomass on average, pissing 10 times their own body weight, living 400 million years, equating to water having been piss around 25 times already.

Perhaps equally interesting I can give some idea how often the water has been piss from a particular group of vertebrates. Starting from the best guess estimate, water has been fish piss some 10 times, mammal piss around twice, and other forms of piss 13 times. Only a trickle has been monkey piss.

As per usual, champagne to all those who thought the answer was ‘often’ (which is all commentators game to give a guess). Unflavoured recycled filtered desalinated naturalised piss for the rest!

A carbon price on green energy?

I read with interest this piece in the Sydney Morning Herald about green consumers of ActewAGL who appear to be charged for the carbon tax on their bills despite being told that their electricity emissions were zero. The reason for the confusion is that green energy has never been about actually purchasing green energy. Instead, when you sign up for that you are paying extra for the retailer to do things that promote zero emissions energy — this could range from investing in solar or wind power to purchasing offsets. In principle, you net emissions are zero but your electricity emissions continue to be positive. Hence, the carbon tax.

This is one of the sticky issues associated with climate policy. If the government had been willing to charge consumers directly for the carbon tax, or, more to the point, had a properly operating cap and trade system where you could get credit of activities that offset emissions, then a consumer purchasing green power could avoid having to pay a carbon price. Instead, largely for political reasons, the government chose to charge suppliers. That means that an electricity retailer pays a carbon tax and passes it on to all consumers. That is what we are seeing here. To be sure, green consumers reduce the electricity retailer’s carbon bill but that benefits everyone. So they are, in effect, giving a donation to non-green energy consumers. That is something I am pretty sure they didn’t have in mind.

Of course, it might be easy to blame government climate policy for this but, in reality, it is likely a consequence of poor electricity price regulation. Specifically, it is too low for electricity retailers to really want to manage their carbon bills. The best way to do that would be to offer green energy consumers a price reflecting true costs of green energy and to offer non-green energy consumers a price that incorporated the carbon tax fully. I suspect that the reason that does not occur is, in fact, that green energy consumers were a great way of being able to charge consumers, “above cap” pricing and to rebalance would require them to raise prices on non-green energy consumers that are already at the cap. So they can’t actually do this or, more to the point, have no profit incentive to engage rebalance properly.

This is going to force regulator’s hands to finally deal with green energy in electricity retail pricing. But it will also require some thoughts about climate policy. Specifically, while wholesale electricity pricing is a pool, there is no scope for entry by green energy specialised generator-retailers because they too would be subject to a carbon tax. The fact that electricity markets exist and can be designed is an opportunity for sensible climate change policy. But from the looks of it, lots of people have dropped the ball.

Abbott and the Economists

At a high profile economics conference hosted by the Melbourne Institute, Tony Abbott said the following when speaking about his climate change policy:

Speaking at the The Australian-Melbourne Institute Growth Challenge conference in Melbourne, Mr Abbott said economists should not be taken in by Labor’s use of the term “market-based mechanisms’’.

“It may well be, as you say, that most Australian economists think that the carbon tax or emissions trading scheme is the way to go,’’ he said.

“Maybe that’s a comment on the quality of our economists.’’

Actually, the Australian did not complete the sentence which ended “rather than on the merits of the argument.”

Now I know what you are thinking. You are thinking that I should just let this go. You are thinking that it was actually Australian economists who educated Labor on the value of “market-based mechanisms” to control climate change. That when we did so, we had the overwhelming support of the Liberal party. And so it is hardly the case that Labor is duping economists.

And I know you are thinking that I had it right a year or so ago when I cast the Opposition leader as a market-hater. Why would I need to say such things again?

And surely it goes without saying that in the choice of a carbon price rather than direct action there is not one single economist in Australia who has advocated direct action. I mean we know Tony Abbott knows that and what conclusion he draws from it.

And I know what you are thinking, if you read Abbott’s full speech it really is a broadside against government creation of a market and the notion that it just can’t be done because ‘you can’t sell air.’ And I know that you are thinking that he doesn’t understand that a carbon permit is just a financial instrument or that measuring emissions for the purpose of taxation is just as hard an accounting exercise as measuring firm profit for company tax. And that we would draw the conclusion that he wants to give up entirely on these government facilitated markets too.

Yes, you are thinking all of those things as you read this post and that I, for one, should just let it go.

But I just can’t so I’m going to say it. Wait for it. OK, here it is.

It may well be that the Opposition leader truly thinks that direct action is the way to go.

So maybe that’s a comment on the quality of our Opposition leaders.