Energy Probe

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.)

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

Here we have the latest installment in the debate over whether more taxes will actually result in less pollution.

At the NYT blogsite, Laurie Williams and Allan Zabel kindly responded to my entry into the debate. Their reaction to my first posting follows, as well as my response.

Laurie Williams:
I am responding to Aldyen Donnelly…about our website. You asked about real life experiences with carbon fees. In a Feb. 2009 paper on our website, Keeping Our Eyes on The Wrong Ball, we describe how a CFC tax was used in the U.S. effort to address stratospheric ozone. In that case, as in climate change, we needed to make the environmentally friendly alternatives price competitive with the damaging substances we are working to phase out. Here is a quote from then EPA Administrator William Reilly, on how the tax worked:

On January 1, 1990, a new tax went into effect in the United States, a tax on the manufacture of CFCs. This tax exceeds in value the cost of CFCs themselves and it will rise steeply in the years ahead, raising $400 million in new revenues this year, and raising $5 billion over the next five years. This added cost of CFCs sends a powerful signal: it says bring on the substitutes fast! And it reduces the comparative economic advantage CFCs would otherwise enjoy over the more expensive substitutes. This tax on CFCs has already caused the United States to reach the agreed targets for reduction earlier than required. See here.

The difference with climate change, is that fossil fuel energy is a huge percentage of our economy. As a result, equal monthly per capita rebates to all adults (less for children) are needed to provide a cushion during the transition.

Hope this is helpful. If you have additional questions about any of this, feel free to write to us at: williams.zabel@gmail.com.
Thank you for your efforts to study this critical issue. Laurie Williams and Allan Zabel

Aldyen Donnelly:
Laurie,

I appreciate your response. Your (and Administrator Reilly’s) description of the role of CFC taxes in the CFC phase out is consistent with the analysis I mourned over in my message. The analysis attributes the successful phase-out of CFCs to a tax measure, failing to mention the mandatory product standard-type mandatory production phase-out that was also embedded in US law in 1991. If the tax measure was all that was required, what was the need for the production limits?

See Section 7671c of Title VI of the Clean Air Act, Phase-out of production and consumption of class I substances� [this includes all CFC-based refrigerants] , which stipulates that “it shall be unlawful for any person to produce any class I substance in an annual quantity greater than the relevant percentage specified in Table 2. The percentages in Table 2 refer to a maximum allowable production as a percentage of the quantity of the substance produced by the person concerned in the baseline year.” The baseline year is 1990

1992 80%

1993 75%

1994 65%

1995 50%

1996 40%

1997 15%

1998 15%

1999 15%

“Effective January 1 2000, it shall be unlawful for any person to produce any amount of a class I substance.”

As I suggested [in my original posting], I can find you no examples in which a tax measure that, in isolation, can be demonstrated to have achieved the elimination or signficant reduction of the production or consumption of a pollutant or pollution precursor. There is a legally binding product standard-based reduction order associated with every success story, including the CFC example you offer.

To attribute the US’s successful elimination of CFC-based refrigerants to the production tax, without any reference to the legislated production caps, is to tell an incomplete story.

I respect your right to posit that CFC production would have been eliminated under the tax measure in the absence of the legally binding production caps. But, as I said before, that is pure theory. I remain unable to locate a single example of a tax measure, anywhere in the OECD world, that proved environmentally effective in the absence of a complementary mandatory production or sales reduction order. But, also as I said before, I can show you numerous successful production and sales reduction orders that did not benefit from a complementary tax.

Clearly neither the EPA Administrator of the day nor Congress had confidence that the CFC production tax measure, in itself, would achieve the desired outome. If they had, they would not have directly mandated production caps.

Also, a simple google search reveals that the US EPA relied heavily on CFC production limit enforcement orders to bring US CFC manufacturers in line. For example, see here. Of course, if the product standard was not a matter of law, the EPA would have had no capacity to enforce the desired production cuts. And if the production tax was as material a disincentive as your message suggests, these enforcement orders would not have been necessary.

I think it is worth noting that the Ozone Depleting Substance sections of the Clean Air Act created a limited exception for CFCs that were produced in the US for export to developing nation markets:

“(e) Developing countries (1) Exception. Notwithstanding the phase-out and termination of production required under subsections (a) and (b) of this section, the Administrator, after notice and opportunity for public comment, may authorize the production of limited quantities of a class I substance in excess of the amounts otherwise allowable solely for export to, and use in, developing countries that are Parties to the Montreal Protocol Any production authorized under this paragraph shall be solely for purposes of satisfying the basic domestic needs of such countries. (2) Cap on exception (A) Under no circumstances may the authority set forth in paragraph (1) be applied to authorize any person to produce a class I substance in any year [from 1991 through 1999] in an annual quantity greater than the specified percentage,PLUS an amount equal to 10 percent of the amount produced by such person in the baseline year. (B) Under no circumstances may the authority set forth in paragraph (1) be applied to authorize any person to produce a class I substance in the applicable termination year referred to in subsection (b) of this section, or in any year thereafter, in an annual quantity greater than 15 percent of the baseline quantity of such substance produced by such person.”

Presumably, the CFC tax applied to US production for export markets. I cannot find but would be interested in seeing what the US CFC export statistics look like. Obviously if US manufacturers continued to produce the maximum allowable CFC exports in spite of that tax, that fact would tell us something important about the effecitiveness of the production tax. (I am not saying that happened. I don’t know what the export numbers are. I am just saying they might be worth a review.)

April 16, 2010

“Depending on what comes out of Washington, the reality is the Americans may have the whip hand on this stuff,” [Doug Thomson, an environmental lawyer with McCarthy Tétrault LLP] said. “And if they do, it’s not going to be a matter of keeping all sides happy but reflecting the reality of the situation. … We may have no choice.”
(from “West rejects Ottawa’s emission plan,” SHAWN MCCARTHY AND DAWN WALTON , April 10, 2009, Globe & Mail)

My Response:

With all due respect to Mr. Thomson, I cannot agree that the US has the “whip hand”, though I do agree that US negotiators have worked and will continue to work hard to convince Canadian expert advisors that this is the case. I do agree that Canadian negotiators could still make critical errors that might hand the US the whip hand. But I have not yet seen evidence to suggest that such a Canadian negotiating failure is imminent, let alone inevitable.

At this time I think it is very important for all Canadian lawyers who are considering the trade implications of or advising the Canadian participants in the North American climate change negotiations to reread the 1997 WTO ruling in respect of the US’s 1993 “Reformulated Gasoline Standard”, and, in particular, how the WTO ruled regarding the US’s definition of “comparable measures”.

I addressed this issue, as well as my recommendations for Canadian negotiating strategy, in a message I originally wrote for other reasons, below.

What US document I would compel Canadian negotiators to read if I could only give them one.
The most important existing source our negotiators should consider is the attached September 18 2008 decision of the California’s Air Resources Board and Public Utilities Commission. The strategy and decisions that play out in this document will also play out for the US as a whole, not just to the state. This decision reports, in a nutshell:

• Four intensity-based mandatory product/performance standards–the California Renewable Portfolio/Energy Standard, a GHG intensity limit (roughy 0.55 kg/kWh) for new Power Purchase Agreements, the 2005 California Greenhouse Gas Tailpipe Emission Standard for New Vehicles and the 2008-proposed full fuel cycle Low Carbon Fuel Standard (LCFS) for gasoline and diesel fuels sold in the state–will ensure the state’s compliance with its 2020 goal of reducing GHGs, absolutely, by 15% from 2005 actual levels.
• The economy-wide increases in power, fuel and auto prices that will result from regulating these mandates should be under US$50/T of avoided GHG emissions. I actually percieve that this cost estimate is exaggerated, as I explain below.
• Adding a GHG quota allocation and “cap and trade” rule on top of the already-approved mandatory measures WILL NOT ADD ANY INCREMENTAL GHG REDUCTIONS BY 2020 UNLESS THE MARKET PRICE FOR GHG ALLOWANCES REACHES US$130/TCO2E. In the publshed decision, the regulators specifically say “If we were to use a market-based approach [cap and trade] approach alone, we may not be able to keep program costs low or support market transformation of desired technologies” (page 100).
• And “…modeling results reveal specific areas of concern where careful monitoring and verification will be needed to ensure that the cap-and-trade system functions as anticipated. In particular, these include monitoring to ensure that the cap-and-trade program does in fact achieve real reductions in emissions at reasonable cost and that significant revenue shifts unrelated to emission reductions between customers of different retail providers, or from retail providers to generators, are avoided” (page 108).

On its face, the CPUC/CARB decision to subject the CA electricty sector to cap and trade is irrational. The regulators endorsed their prior decisions to demand that the power sector bear GHG reduction obligations that are disproprotionate (high) compared to the sector’s contribution to the state GHG inventory, even as they acknowledge “It is challenging at this point to determine the cost-effective level of electricity and natural gas sector emission reductions because we have very little sense of the abatement opportunity and costs in other sectors” (page 112).

Also, after repeatedly asserting that the quota allocation and cap and trade rule will not add incremental GHG reductions at CO2 allowance prices under $130/TCO2e, and that there is material risk that the cap and trade market will not function as desired, the regulators decide that the state should impose a cap and trade regime on top of the existing mandatory measures and says “If electricity is included in the cap-and-trade program contemplated in the Draft Scoping Plan, and were to achieve the additional emissions reductions that ARB expects from the cap-and-trade program, the electricity sector could, in total, deliver as much as 55% of the required emission reductions in the State” (page 119).

Readers will not find an answer to the question “why”, in this document. The answer to that question is in the US “cap and trade” history, which is one that sacrifices efficiency for trade protectionism. But, hopefully, once our negotiators read the attached they will be motivated to investigate other sources.

(In this section of my message I am restricting myself to use the CARB and CPUC compliance cost estimates. It is pretty easy, however, to demonstrate that the CARB and CPUC mandatory measure compliance cost estimates are exaggerated. Go to **** below for an explanation of this statement.)

Given:

• The regulators’ reported findings that electricity sector will deliver 40% of the state’s required 2008 through 2020 reductions without the cap and trade regime at rate increases that are implied (by the plethora of other analyses available at the CARB and CPUC websites) to be less than US$50/TCO2e;
• the regulators’ reported findings that no incremental reductions can be associated with the cap and trade measure at CO2 allowance prices under US $130/TCO2e;
• the regulators’ reported findings that electricity sector could deliver 55% of the state’s required reductions if the sector is included under the cap and trade regime;
• one has to ask: what is the rationale for deciding that the cap and trade system should be implemented at this time?

Obviously, a rational analysis would ask and answer the following questions:

• what are the estimated incremental costs, in UA$/TCO2e, of ratcheting up any or all of the the RPS, EPS, LCF standards and ratcheting down the tailpipe GHG standards for new vehicles compared to the US$130/TCO2e floor at which the cap and trade regime will have an impact on state-wide GHG levels, and
• how do the compliance costs associated with making the existing mandates more stringent in the short term compare to US$130/TCO2e?

Further, the California product/performance standard incorporate credit trading and limited credit banking (also market measures, but not deemed to be :market measures” in the attached CARB/CPUC definition of the term in this decision). The CA regulators have not asked or answered the question: what might be the impact on long-term compliance costs if the terms of the product/performance standards were extended to 2035, with (1) increases in strigency built into the 2020, 2025, 2030, 2035 compliance years in the standards that will be made law in or before 2010, and (2) increases in the banking terms for over-compliance credits. At this time, the state regulators have approved proposals to limit REC (credits under the RPS rule) banking for as little as 3 years and have not yet approved the inclusion of a bankable over-compliance credit under the LCFS. Credits issued under the New Vehicle standard are perpetually bankable, but the state has a long history of unilaterally discounting banked ZEV and PZEV credits under its vehicle tailpipe emission regulations (which have been operating since 1991), so the auto manufacturers are unlikely to value the bankability of those credits without a formal long-term commitment from the state. Credit banking under a series of known and increasingly stringent product/performance standards is the only mechanism that rewards corporations for early overcompliance and innovation that results in quantum leaps in emission reductions. (The cap and trade system actually inhibits innovation, as do short limits on credit banking under product/performance standards.)

Canadian negotiators should ask: why are US regulators so quick to default to cap and trade when their own analysis clearly suggests that alternative measures (product/performance standards with longer series of increasingly stringent targets, complimented with longer credit banking provisions) would likely result in lower cost compliance with any given absolute GHG objectives?
What’s Going On?
My research suggests that the principal rationale for GHG quota allocation and cap and trade rules is to protect US plant operators’ interests at the expense of foreign suppliers of energy and carbon-intensive goods. Given the choice between the demonstrably more efficient, lower cost mandatory measures with credit trading provisions that will support free trade in equally GHG-intensive goods and services, and the cap and trade option–which protects US industry at the expense of foreign suppliers and resulting in higher costs for American consumers–the US regulators’ are revealing a consensus that favours the higher cost protectionist strategy over the lowe cost free market strategy.

Canadian regulators, decision-makers and negotiators should study the attached CARB/CPUC decision and consider the full strategic implications of the regulators’ decisions (1) not to analyze the cost impacts of further evolution of the product/performance standards, (2) to default to quota allocation and trading after implementing the first round of more efficient measures, and (3) to unecessarily limit crediting and credit banking terms in the product/performance standard rules.

Ensuring Canadian Success in the Future GHG Regulation-based Trade Dispute With the US
If Canadian regulators:

1. elect to implement more market-friendly and scientifically defensible intensity-based product/performance standards derived from but not identical to the California/US RPS/RES, New Source/Supply GHG Emission Performance Standards for Electriciy and Natural Gas, a new Canadian CAFE standard for vehicles (again derived from but more flexibile than either the proposed US federal or CA standards) and Canadian Low Carbon Fuel Standard that is scientifically more defensible than the inherantly protectionist CA proposal, and
2. incorporate over-compliance credit trading with lengty credit banking terms, then,
3. Canada can use existing US analysis of different measures–including the attached CARB/CPUC decision–to defeat any attempt of the US federal or state governments to protect US industry at the expense of Canadian industry through the US GHG quota allocation and trading rule, or the establishment of a US International Reserve Allowance requirement, or US disapproval of the nature and denomination of Canada’s 2020 and later national GHG targets under World Trade and NAFTA dispute resolution processes.

If Canada can demonstrate that our exports are less GHG intensive than US comparables, and/or that those of our exports which have higher GHG intensities are bearing a higher effective (direct or indirect) carbon charge under the Canadian regulations than is applied to US comparables under the US rules, then the international trade tribunals have to rule that any discrimination against Canadian exports breaches existing trade treaties.

The key to Canadian success at the international tribunals is the definition of “comparable”. The US always has and will continue to adopt the position that they can descriminate against imports originating in nations that have not implemented environmental protection measures that are “comparable” to US measures. The WTO has considered the US’s position on and definition of “comparable measures” on a number of occassions in the past, the most notable recent case being the 1997 WTO ruling on the US’s 1993 Reformulated Gasoline Standard.

In this and other precedents (and, I would argue, in the future…notwithstanding the precedents), US trade negotiators argue that under world trade rules the term “comparable measures” means that the US trading partner has to implement regulations (including reporting rules) that are identical to the US rules. So, for example, if the US elects to rule that US aluminum producers have to cut direct and electricity-related GHGs by 20% from 2005 levels by 2020, we can anticipate that the US will take the position that they can impose a carbon tariff on any aluminum imports that originate in a nation which does not promulgate the same 205 reduction obligation from the same base year. But US aluminum producers currently discharge between 10 and 11 TCO2e per tonne of aluminum they produce, while Canadian aluminum producers discharge between 6 and 9 TCO2e per tonne of aluminum produced (85% of which is currently exported to the US). Under the US proposed rule-making strategy, the US government attempts secure US aluminum market share for any US plant operators who cut GHG discharges from current levels to 10 TCO2e/TAl in 2020, at the expense of Canadian aluminum producers who might still discharge 6TCO2e/TAl in 2020, because the Canadian regulators failed to order or the Canadian aluminum producers failed to comply with the order to cut GHGs per unit of aluminum output by 20% from 2005 actual levels.

The good news is that every time (and there are a few) the US has attempted to apply this strategy to discriminate against imports, WTO trade tribunals have ruled that the US has erred in its definition of “comparable measures”. The WTO has consistently ruled that “comparable measures” are regulations that have comparable environmental outcomes or effects. Based on precedent, we know that the WTO will rule that the US breaches international trade rules by discriminating against the lower-GHG import in favour of the higher-GHG domestic supply.

The US can be anticipated to argue, in more general terms, the right to discriminate against Canadian exports if they deem Canada’s 2020 and later year nation-wide targets not as aggressive of the US targets, and on the basis that Canada’s facility-level reporting regulations are inadequate and, therefore, Canada’s aggregate GHG estimates are unreliable.

With respect to disputes base on future national targets–whether these targets are legally binding or not–Canadian negotiators must note that the neither the US nor any US state has never, in its history, physically complied with any emission target and timetable that has been embedded in law or policy. Canadian negotiators should argue that national targets are not “measures” for purposes of determining whether national actions to protect the environment are comparable.

With respect to facility-level emission reporting rules, the US negotiators have a valid point. However, Canadian negotiators must refuse to comply with existing US demands that Canada impose identical-to-US facility level reporting rules and to directly share facility-level data–including commercially sensitve operating information and information about proprietary processes–to the US EPA. Canada has to substantially revise existing pollution and GHG reporting rules. But Canadian rules should not ever become as invasive or administratively costly as existing and proposed US reporting obligations. It will be strategically important for Environment Canada to pre-empt US tariffs based on the inadequacy of our reporting requirements by implementing new Canadian air pollutant and GHG reporting regulations before the end of 2012. But while these new rules will be more invasive and costly to administer than existing Canadian rules, they must not go as far as existing and proposed US facility-level reporting requirements and Canadian negotiators must formally notify the US government that it is our government’s expectation that the US will accept the Canadian government’s assessment of facility-level GHGs and that the Canadian government will not remit raw plant data to the US EPA. In this context, the government of Canada should have asked the WTO to review the US Renewable Fuel Standard (RFS, which became law in full effect on September 1, 2007) as an international trade law breach, by now. Hopefully Canada will launch a US RFS challenge in the near future, as a signal for what is to come if the US elects to unfairly discriminate against Canadian exporters under GHG regulations that parallel the foreign supplier requirements outlined in the existing US RFS.

If the US Knows It Will Lose a Trade Dispute, Why Will Congress and State Governments Still Proceed to Misinterpret “Comparable Measures”?

US negotiators appear to have developed “Plan A” and “Plan B” negotiating strategies. First, US negotiators are still focussed on convincing Canadian negotiators to sign a preliminary agreement in which we agree: (1) to implement nation-wide 2020 and later GHG limits that meet with the US (not the WTO) definition of “comparable”, (2) to implement a Canadian GHG quota allocation and trading regime by a certain deadline, (3) that each party can freely allocate or auction up to 75% of its national quota allocation on any basis that nation deems appropriate, (4) at least 25% of each nation’s domestic quota will be auctioned to the highest international bidder, every year, without restrictions on auction participation and (5) that there will be North American free trade in any national GHG quota units that either pary assigns to any person. US negotiators hope to leave any discussion of the details of national strategies to further negotiations that will not commence unless and until after Canada signs this preliminary agreement to principals. If/when the Prime Minister of Canada signs a preliminary agreement that contains these principals, we will have undermined any future international trade rule defences against any demonstrably unfair and protectionist US quota allocation. So US negotiators currently perceive that an opportunity exist to convince Canada to give up keep rigthts we hold under current world trade rules. I percieve (but may be wrong) that Canada’s negotiators have recognized the risks associated with any US proposal to sign an agreement on principals in advance of seeing any details of the US domestic implementation plans.

Under “Plan B” the US will still implement domestic quota allocation and trading rules that unfairly discriminate against Canadina imports using the definition of “comparable measures” that WTO tribunals have already, repeatedly, rejected. The fact is that it will take 5 to 10 years for Canada to complete the WTO dispute resolution process (including appeals). The US’s ability to maintain discriminatory policies through the 10 year dispute resolution process should result in a massive redirection of value-adding investment and reinventment from Canada to the US, the capital loss from which Canada will not easily recover after the fact. A WTO ruling which will do no more than allow Canada to discriminate against US imports–a measure that increases the cost of living for Canadians, not Americans–does nothing to compensate Canada from the damage the US domestic cap and trade rules can inflict on our economy.

For this reason, Canadian should start formally, publicly, graciously, diligently explain to all publics (Canadian, US, European, Asian, UN, WTO, IMF) the full implications of US global GHG quota allocation and trading proposals for international trade and the related wealth transfer from energy, food and building products exporting nations to the wealthy import-dependent nations, as soon as possible. It is only through educating the general publics, environmental community and other key social stakeholders that Canada can mobolize major portions of the public–including the US public–against the US proposal to increase the US cost of living to protect the interests of multinational corporations who elect locate manufacturing facilities in the US (in exchange for a excessive US GHG quota advantage) instead of locating those facilities where they are best placed to manufacture low-GHG goods and services at least cost to US consumers.

Ensuring Canadian Success in the Future GHG Regulation-based Trade Dispute With the European Union and Japan
We anticipate that both the EU and Japan also plan to discriminate against Canadian exports, even though their targets are exports that may be less GHG intensive than their domestic product comparables. The EU and Japanese arguments will be that Canadian chemical, forest products, coal, aluminum and iron & steel exports enjoy a price advantage due to Canada’s failure to comply with our Kyoto First Commitment Period nation-wide emission limits. Under WTO and GATT rules, it appears that a tribunal should uphold Kyoto Protocol parties’ rights to impose tariffs on our exports reflecting the difference between our actual export prices and the prices our exporters would have had to charge to recover the costs of complying with meaningful GHG reduction objectives over the 2008 through 2012 period. Canada has to mobilize a different strategy to address the trade sanctions that will emerge from across the oceans, but a good defence exists in this context as well.

April 15, 2009