Aldyen Donnelly: What the CIMS model does and does not do

Dr. Jaccard’s CIMS model of the Cdn economy does not have the capacity to reflect the critical and large differences between the impacts carbon taxes, quota-based cap and trade rules or legally-binding product standards (the three key GHG management options) might have on the Canadian economy. Given a commitment to cut GHGs (I know that is problematic for you, but stay with me at least for now), "cap and trade" kills the Canadian economy and jobs, while a product standard-type regulatory strategy (like those we used to get the lead out of gasoline, reduce sulfur in diesel, get CFCs out of power transmission systems, over time) potentially lets the Canadian economy flourish. I do not intend this as a general attack on the CIMS model. The model is of some value in other applications. The problem is the CIMS model does not have the capacity to differentiate between any two different policy measures to which Jaccard might assign the same short term retail price effects. Because the model cannot differentiate between the measures, it always finds that any two policies that have the same retail price impacts will have the same impacts on the economy as a whole. Futher, by definition, any policies that have higher price impacts will generate more emission reductions than policies with lower price impacts. It is not possible, in the model, for a low price policy to be more effective–or generate more "green jobs"–than a high price policy. Of course, in real life the oppositie is actually true (see lead gasoline example below and attached).

The CIMS model simply converts every policy option into short and medium-term retail commodity price impacts. The price impacts relect Dr. Jaccard’s (often unrealistic, in my view) assumptions about normal capital stock turnover rates, elasticity of demand for the taxed commodities, and unknowable future innovation rates. For example (but this is not, certainly, the most important problem with the CIMs model), Dr. Jaccard assumes that Canada’s vehicle stock turns over ever five years. In fact, the turnover rate is now over 11 years.

Dr. Jaccard recommends we implement the California New Vehicle tailpipe emission standard for GHGs. The CA new car standard increases new car prices. But the CIMs model appears not to anticipate any signficant change in vehicle stock turnover rates will result if we do so (probably because he has gasoline prices increasing faster than new car prices) but he does forecast reductions in Canadian vehicle fleet emissions. will directly result from implementation of the CA new car regulation.

This aspect of the modelling ignores the facts revealed since California first implemented more stringent new car tailpipe emission standards in 1991 (they do not address GHGs, but they still correlate with fuel efficiency and GHGs). Yes, California has had more stringent tailpipe emission standards than the rest of the US and Canada since 1991. The direct result of the standards has been a dramatic slow down in the CA vehicle stock turnover rate. CA state-wide on-road fleet average tailpipe emissions are now almost 20% higher than the US/Canadian average on a per passenger-mile of car use basis. That is because over 37% of CA cars in use are now over 10 years old (and high emitting) and the fastest growing cohort in the fleet is in the 15+ age class. CA residents react to the new/used car price differential by delaying capital replacement decisions. The postponed capital spending makes room in their budgets to afford higher fuel prices, and emissions go up, not down. This slow down in the vehicle stock turnover and fleet average emission rates is a direct result of the CA new car regulations. In fact, we see exactly the same phenom playing out in the UK, as a direct result in their changes in car performance standards in the late 1990s. These real-life outcomes are impossible to discover using the CIMs model. They are, however, easy to see in publicly available fuel use, car ownership, car use and emissions data.

Also, the CIMs model anticipates that any investment that will generate a positive financial return will attract the capital it needs in Dr. Jaccard’s imagined world. All it has to do is generate a positive return and a better return than business as usual in Canada. The investment/innovation does not adequately reflect real-life international competition for capital. So the model seriously underestimates the risk of capital and job flight associated with any given policy-driven commodity price impact.

Unexplainably, the model forecast that in all but Canada’s power sector, Canadian labour productivity will decline 4% in real terms between 2011 and 2020 in the base/no GHG policy case. In the GHG Policy cases, labour productivity skyrockets, without explanation. In spite of these productivity increases. I find this rather strange.

In the table below I divide CIMs estimates of labour expenditure growth by the estimate of the value of output growth, by sector. (MKJS report for Pembina Institute and Suzuki Foundation, December 2008.)

 

  BAU Policy – Labour Productivity Change 2011 to 2020 BAU Policy – Labour Productivity Change 2011 to 2020
Agriculture 0.95 1.04
Pet. Crude Extraction 0.94 1.40
Natural Gas Extraction 0.93 1.42
Coal Mining 0.95 1.65
Other Mining 0.97 1.09
Electricity 1.42 0.66
Construction 0.98 1.03
Other Manufacturing 0.96 1.02
Pulp and Paper 0.95 1.04
Petroleum Refining 0.94 1.15
Chemicals 0.95 1.05
Industrial Mineral 0.96 1.03
Iron and Steel 0.96 1.02
Warehousing 0.98 1.07
Freight Transport 0.95 1.06
Services 0.96 1.09
Government 0.98 1.06
Total 0.96 1.07

 

 

 


The CIMs model simply cannot detect the critically different economic implications of different policy strategies. If after he applies his (questionable) fixed elasticiy of demand estimates to his model economy with fixed stock turnover and innovation rates, any policies that have the same modelled price impacts have the same effects on Canadian employment, capital investment and GDP. Read, below, my outline of the critical difference between quota-based cap and trade and product standards. In fact, the former kills the Canadian economy, while the Canadian economy probably has to launch the latter as a strategic economic defence mechansim–a mechanism under which our economy could potentially flourish.

Taxes Versus Product Standards
On emission taxes, everyone should study the leaded gasoline phase out. (I have written about this before, but attach the full detailed case study for your information anyway.)

With a product standard (and tradable, bankable overcompliance credits) Canadian gasoline distributors got the lead out of our gasoline supply chain on schedule. The lead elimination order added $0.021 to the price of gasoline at a time when the oil price was declining. This was 1/10th the cost impact all the best economist’s forecast before the regulation was promulgated. The European nations committed to the same lead elimination schedule we did. But they introduced a "lead differential tax" and revenue recycling strategy (exactly analagous to Dr. Jaccard’s current recommendations re GHGs) to get the job done. Twleve years after lead had disappeared at Cdn gas pumps there was still lead in every litre of petrol sold in the UK, even though the lead differential tax was CAD$1.11/litre. Finally, the UK promulgated a Cdn-style product standard to get the lead out.

It is not possible for the CIMs module to anticipate and reveal the failure of the UK tax system to get the lead out at a $1.11/litre price impact (which was more than 35% of the total retail price of leaded fuel) when Canada got the lead out for $0.021/litre (less than2.5% of the total retail price). I explain why the tax measure did not work (and never have worked, in any other case study) in the attached. This reality does not fit into the CIMs model.

"Cap and Trade" Versus Product Standards
Every US GHG "cap and trade" bill that has been tabled in the Senate or House since January 1 2006 is HIGHLY protectionist, as were each of the US cap and strategies that were implemented to phase lead out of gasoline, CFCs out of refrigerant, HCFCs out of commercial freezer units and–yes–the SO2 allowance programme. The CIMS model does not reflect the strategic control differences between cap and trade–quota-based supply management similar to the market control regimes that govern our dairy and taxi markets–and free market product standards.

If Canada aligns our GHG policies with the US cap and trade proposal we will lose complete sovereign control of our national resources, forever. Integrating cap and trade in our domestic GHG management strategy does not defend us against the US protectionist play…it give the US everything they are going for on a platter.

The US bills say that starting in 2012, US distributors (inluding importers) of petroleum products, natural gas, and electricity have to "surrender" US GHG quota to the US EPA covering their full upstream supply chain emissions, including Canadian emissions arising from the production and transport of their imported feedstocks, intermediate and finished products. The US EPA then freely allocates US GHG quota to US coal producers equal to 300% to 600% of their production and coal shipping emissions. Importers of regulated products don’t get any free quota allocation. The US Treasury will auction 25% of the US quota supply. The US aggregate quota supply is about 60% higher than the GHGs from the covered US sources but about 20% below the global US supply chain emissions. So while all US producers of regulated products will hold substantial quota surpluses from day one, the total US quota supply will be short of US demand because the rules make distributors cover foreign upstream emissions with quota remits. This means that from day one US importers of carbon-based goods have to buy quota from US producers of those same goods or the US Treasury, and the price of quota will not be low.

In the Congressional bills, the free US quota allocation to US coal producers exceeds their US covered emissions by 300% to 600% (depending on the bill). The free US quota allocation to US oil refineries is over 250% of their refinery and product shipping emissions. The free US quota allocations to US aluminum, iron & steel, cement, paper, glass and fertilizer producers is about 150% of their energy and process emissions. (These allocations have been spelled out in detail in every bill.)

The day after the US cap and trade rule is law, any US electric utility or manufacturer that imports clean Canadian electricity or natural gas has to buy US GHG quota from a US coal, petroleum, aluminum, cement, etc. producer to buy the right to continue to import the cleaner Canadian fuel. One older US Treasury Department analysis says that less than 30% of our exporters’ cost of aquiring US GHG quota to maintain our export market shares will be passed through as price increases to US consumers, and 70% will be eaten out of our export margins.

Some of the US bills, alternatively, say that the US importers have to buy International Reserve Allowances (IRAs) from the US Treasury to cover the upstream Cdn GHGs associated with their imports. Then the US Treasury has to distribute 100% of the IRA revenues to US fossil fuel producers and manufacturers. The US will accept Cdn GHG allowances (the quota units Dr. Page wants Canada to issue to large Cdn emitters) in the US compliance markets ONLY IF:

(1) ALL Cdn power and mfg plants over a certain size (not just those that export) report all of their fuel consumption, operating hours, product output, by combustion unit and describe, in detail, any propreitary processes or technologies that are using in their Canadian plants in reports that they deliver DIRECTLY TO THE US EPA (not Environment Canada…but don’t worry, says the EPA, they promise to keep commercially sensitive information confidential!); and
(2) the owners of the Canadian plants allow US EPA enforcement officers to enter and inspect the Canadian plants as if they were on US soil. They are also proposing that Cdn plant owners who wish to export Cdn GHG quota to the US have to agreed to waive sovereign immunity against US prosecution if the Cdn plants are found to be in breach of US (not Cdn) environmental regulations. This sound like fantasy? The requirement that Cdn exporters agree that US law applies and US officers have enforcement (including arresting) authority on Cdn soil, and that Cdn plant owners waive sovereign immunity HAS BEEN US LAW SINCE SEP 1 2007 for all Canadian biofuel exports. Cdn ethanol producers can legally export ethanol to the US any time without agreeing to those terms. But if they refuse to waive sovereign immunity, their ethanol is rated as a fossil fuel. US gasoline distributors cannot–under current law–count Cdn ethanol towards compliance with their US biofuel content mandates unless the Cdn exporter agrees that US officers can arrest them in their Cdn plants.

 

100% of the US’s potential ability to damage the Canadian economy and expropriate our resource assets at high discounts derives from our agreement to participate in a North America-wide GHG quota-based supply management regime (that is what "cap and trade" is). The Us dicates that our initial national quota limit must be absolute, but also a function of our recent GHG INTENSITIES (YES…I said "intensities"…anyone who says the US regulatory proposals are not intensity-based clearly has not read them.)

 

The average US kWh of electricity is almost 4 times as GHG intensive as the Cdn one. The average US aluminum smelter discharges double the GHGs per unit of aluminum produced as Cdn smelters do. The average Cdn oil refinery discharges less GHGs/barrel of diesel produced. But, as in every quota-based supply management regime, the corporations and countries with the highest emissions per unit of output in the "cap and trade" base year locks in their current global market share in perpetuity. Think about Canada’s dairy quota regime. Over 35% of the limited right to make milk and butterfat products in Canada resides in Quebec. BC farmers cannot access more than 5% of the quota, even though they serve 13% of the national market. In the same way that the Cdn quota regime holds regional milk production market shares where they were 40 years ago–now way out of date with regional milk sales patterns– GHG cap and trade delivers perpetual market share windfalls to the companies and nations with the highest GHG intensities in the base year that is selected for the first quota allocation. Once/if Canada says yes to "quota", its over.

Also think about our dairy quota regime from another perspective. All provinces auction 100% of their quota every year. But no one is allowed to participate in the auction who does not produce milk in the auction-hosting province. Milk quota can’t be sold to the highest
international bidder–of course, we all recognize, that would kill the Canadian dairy industry. But all of the Canadian advocates for GHG cap and trade argue that once the governmetn of Canada releases Canadian carbon quota to the market, any corporation should be free to
export any Canadian carbon prodcution or consumption quota to the highest international bidder without restriction. How truly bizarre that anyone considered such a thing, even for a minute.


How Should Canada Respond?
There is a solution, but it requires Canadians to abandon the religion of "cap and trade". Again, "cap and trade" is quota-based supply management. In a cap and trade market, we trade government-issued quota certificiates, and as with any currency, the issuing governments can use the money printing and distribution processes to manipulate markets.

Many, many times in the past, however, we have successfully eliminated or reduced pollutants or pollution precursors–and spawned real secondary markets for pollution reductions–without putting any quota in the mix. Canada does need to act quickly and to do so in a manner that preempts the protectionists’ agenda. When we wanted to get the lead out of gasoline, we ruled that gasoline distributors had to cut the lead content (by weight) in the fuel the sold (not made) in North America, gradually, over time. Any distributor that used less than the product-standard implied lead content limit in any one year could bank it or sell it. Government does not issue any quota, the environmental objective is embedded in a legally binding product standard, a real secondary market for unused lead right emerges which generates surplus revenues for market participants who reduce carbon in their supply chain ahead of the regulated schedule.

This looks SOOOO much like cap and trade many people can hardly see the difference. But the difference is everything. NO GOVERNMENT QUOTA. No trade in quota. In GHGs, the answer is to regulate declining carbon content and/or supply chain GHG standards for electricity, natural gas, petroleum product, cement, aluminum, iron & steel, paper, glass, fertilizers, etc. The product standards give all regulated product distributors the option of buying renewable energy to earn credits applicable towards their carbon/GHG limits. This approach gives all carbon-intensive commodity vendors legally binding carbon reduction objectives, but huge flexibility to achieve them anywhere in their global supply chain.

This product standard approach is how we got the lead out of gasoline, cut sulphur levels in diesel, got CFCs out of our refrigerant supply chain, got PCBs out of our electricity transmission systems, etc. Let’s go back to the aluminum example. In the US cap and trade proposal the US gets to start with double the national quota units per unit of aluminum produced than Canada does. Inevitably, therefore, the US effectively commits US aluminum producers to cut GHGss by 20% from 12 to 10 TCO2e/unit of aluminum produced, or buy quota from other sectors. They start generating quota surpluses if they get under 10TCO2e before 2020, while the 6TCO2e aluminum that Cdn smelters produce will be subject to a carbon tariff if we don’t buy US quota to offset 1 TCO2e or get their emissions down to 5TCO2e/TAl. Obviously, this rule will drive all new Al sector investment into US and rendering the 85% of Cdn output that is currently exported to the US uncompetitive.

When the US Al supply from the newly modified US plants displaces Canadian Al exports, global GHGs actually go up, not down–from 6TCO2e/TAl to 9 or 10TCO2e/TAl. Alternatively, Cda should publicly, graciously and persistently announce in international meetings our proposal that North American and European regulators promulgate new Al product standards limiting global supply chain GHGs for all Al sold within our boundaries to, say, 10TCI2e/TAl sold in 2015 and 5 TCO2e/TAl in 2020. One product standard for all sales, with bankable and tradable over-compliance. (I don’t know what the standards should be…this is for illustration purposes.) All distributors can still buy Al from high emitting plants, but to meet the new standard on a sales portfolio average basis they would have to offset their purchases from high emitting plants with more purchases from low emitting plants.

Then we do the same for electricity, petroleum products, cement, etc. If we were all operating rationally–given the assumption that global warming and man-made GHGs is a priority concern the way that ozeon depletion and CFCs once were–the big international debate playing out in the front pages of our newspapers should be over what those product standards should be to achieve what global GHG reductions on what kind of timetable.

If the US does not agree to play this game, Canada has to go it alone and implement some key product standards (NO QUOTA), even though–in the short term–it is less efficient for us to regulate our product markets alone. Then, when the US launches its protectionist quota allocation and trading rules and discriminates against lower GHG Cdn aluminum exports because we have not introduced a US-style quota regime, we move to defeat the US regulations IN US DOMESTIC COURTS (not just under world trade rules).

Under US law the US courts have tol throw out a US environmental standard if it can be proved to have no sound emission reduction or science basis.

But if Canada agrees, in any preliminary agreement, to build a common GHG quota market with the US, the simple existance of such an agreement defeats all of our US and international law defences against the US protectionist measures.

I should note that not all Canadian carbon intensive goods exports have a GHG advantage under a set of fair product standards the way that Cdn aluminum does. But a fair set of product standards immediately rewards producers who already have cleaner global supply chain and production profiles where we do, and rewards those who cut emissions fastest in their supply chains where we don’t. The secondary carbon credit markets spawned by product standards have complete enviornmental integrity and those who innovate best, win–as opposed to those most favoured by the US Congress.

Read Aldyen Donnelly’s bio

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