(Mar. 10, 2010) I have pointed out, previously, that every nation that relies heavily on carbon taxes and/or feed-in tariffs as GHG mitigation/climate change measures has ended up delivering massive and continuing green subsidies to industry—while passing more than 100% of the incremental cost of carbon taxes, cap-and-trade compliance costs and Feed-in Tariffs (FITs) to their residential customer bases.

I anticipate that the Ontario industrial subsidy outlined in this Toronto Star article is just the beginning of a long line of industry subsidies that will become necessary, given the climate change policy package that Ontario has embraced.

Belgium, Sweden and Norway no longer report “industry average” electricity rates to the International Energy Agency because, they say, any “average” is meaningless given the fact that a number of energy intensive businesses in those countries now enjoy the benefits of government-backed power supply agreements with below-the-cost-of-generation, firm, long term prices, as well as subsidies to implement efficiency measures.  When those nations’ carbon taxes, cap-and-trade compliance costs and FITs were included in industrial power prices, this simply accelerated capital and industrial job flight.

The net result of maintaining the carbon tax/FITs/cap-and-trade regime and delivering subsidies/exemptions to industry is escalating residential power rates. And just like Ontario, residential customers account for about 1/3 or less of total electricity demand.

When you find you have to pile 100% of the incremental policy cost increase on the residential rate base you get a rather massive incremental increase in residential utility bills. This, in turn, has resulted in the “Fuel Poverty” program in the UK, for example.

I estimate that the cost of administering the necessary subsidies to curb industrial job losses and addressing the impact of the carbon tax, cap-and-trade and FIT policies in Europe actually costs governments more than the carbon taxes and FITs raise in new revenues. Of course, that is the key reason governments are now quite focused on auctioning CO2 allowances to raise new revenues.

But CO2 allowance auctioning will exacerbate the problem.

Remember, any real market price that attaches to a CO2 allowance is directly deducted from the market value of the assets that are no longer permitted to operate without allowances. So free CO2 allowance allocation is just a method through which governments expropriate asset value from shareholders and redistribute that value to a different combination of shareholders.

When governments introduce CO2 allowance auctioning, they are simply saying that the government is going to retain a portion of the expropriating market value of existing assets for the benefit of the government treasury. But whether CO2 allowances are freely allocated or auctioned, the fact is that the simple act of implementing a cap-and-trade regulation results in expropriation of market value from the regulated assets.

By definition, this means that production costs in the affected sectors have to go up to recover shareholder returns, or shareholders have to write off the expropriated value.  Either way, capital flight from the regulated sectors is inevitable.

The question is: how much capital flight?

I should note that in Canada, all shareholders are not equal. It is very likely that US owners of Canadian assets that will be covered by any Canadian cap-and-trade regime will be able to successfully sue for compensation under NAFTA Part 11 if they can demonstrate that the government’s expropriation of their de facto right to discharge GHGs resulted in asset devaluation. They’ll be able to do this if the free allocation of GHG allowances is not equal to or greater than the de facto discharge rights that were expropriated.

It is unclear, however, if Canadian owners of otherwise identically affected assets will have an equivalent right to compensation.

I first raised this important inequity and its implications for Canadian policies with Environment Canada (EC) in 1997. At the time, EC lawyers agreed with my assessment that NAFTA provides for compensation for affected US investors. But at that time, EC officials expressed the view that this is an equity issue that will be easy to address. I have not seen any discussion of this issue since then and I have never been party to any discussion of EC’s proposed solutions to this major equity issue.

In the meantime, if you look at the data you will see that there appear to be no GHG reductions associated with these tax measures/policies, other than the reductions that directly correlate with industrial job losses and reductions in industrial output. In fact, the reality that the variation on EU-style tax and policy package modelled by Dr. Jaccard’s M.K. Jaccard and Associates (MKJA) has done for the National Round Table and TD Bank leads to reductions in Canadian industrial output, jobs and increases in production costs.

In the MKJA modelling exercise, the only sectors in Canada that grow are electricity, oil and natural gas production. In other words, in the modelled future, Canada adds less value to our raw resources domestically, but becomes even more economically dependent on raw resource (including fossil fuel) and electricity exports than ever before.

This forecast for Canada exactly parallels the Danish experience to date, where the value of fossil fuel and petroleum product exports is currently 35 times what it was in 1990, while the value of green technology and electricity exports is only 6 times what it was in 1990. The value of Danish fossil-based exports is currently 12 times the value of green tech and electricity exports, combined.

100% of incremental job increases in Denmark, Sweden, the UK, Belgium and Germany, since 1990, are in the public sector.

Figure 12, below, is from the Technical Report for the National Round Table on the Environment and the Economy (NRTEE) “Getting to 2050…” climate change action plan report. Look at the changes in sectoral output levels that derive from the policy package that the NRTEE prescribes.

These forecast post-policy reductions in industrial output (which, by definition, means job losses in those sectors that cut output from BaU levels) and large increases in the sectors’ production costs are relatively consistent with the European experience. What the NRTEE reports do not disclose is the high likelihood that any/all new jobs in Canada will have to be taxpayer and residential electricity rate-based financed if we proceed to implement the group’s recommendations.

Where the NRTEE and TD report findings also differ greatly from the actual experience in Europe is that the Canadian analysts suggest that we can impose these production constraints and production cost increases on Canadian industry and energy producers without a major impact on GDP.

Real life is another matter.

For example, the UK experienced zero-net GDP growth from 1990 through 1997.

Germany experienced zero-net GDP growth from 1999 through to mid-2006, and only had 18 months of positive net GDP growth before falling back below zero again in late 2008.

I remain curious how our National Round Table and other expert sources can recommend that Canada implement the same tax and policy packages that were implemented in Europe, and forecast similar declines in industrial output and production costs, but then forecast a minimal negative impact on Canadian GDP—when the negative impact on the GDP of European nations was, obviously, rather dramatic.

The only EU member states that did not experience significant negative GDP impacts from the implementation of these policies are nations that have massively increased their fossil fuel and refined petroleum product exports—most notably, Denmark, the Netherlands, and Sweden. Yes, I know Sweden does not have any fossil fuel reserves.  But Sweden exports more refined petroleum products than Alberta does.

And, from day one, the fuel used by Sweden’s oil refineries, electricity generators and industrial chemical producers have been fully exempt from ALL of the country’s energy taxes—meaning they are exempt from all duties, excise tax, CO2 tax, NOx tax, sulphur tax on energy, not just the CO2 tax.

To see, in detail, the impact of European tax/policy sets—a variation of which is essentially the set of measures recommended by NRTEE and in the Suzuki Foundation Report for TD—just take a look at the “tax included” electricity prices for each of the different classes of consumer in the Eurostat database, found here.

Note, in particular, that in most of the EU member states that have carbon taxes and/or FITs, the tax-included rate paid by the smallest residential customers is as much as 5 or 6 times higher than the rate paid by the most energy-intensive industrial customer.

To see the large (but not all) of the environmental and energy tax exemptions that are in place in European national tax regimes, go here, and click on “Exemptions in Environmentally Related Taxes” near the bottom of the page.

Aldyen Donnelly, March 10, 2010