Energy Probe

(Mar. 25, 2010) I would be very surprised if the Supreme Court (SC) rules in favour of Friends of the Earth (FOE). The problem is that the law of the land allows the PM to sign an international treaty without Parliamentary oversight. But to balance that power, the PM-signed/ratified treaty does not become law of the land unless/until Parliament passes domestic legislation that enacts the treaty in full.

The Kyoto Protocol Implementation Act (KPIA) fails to implement the Kyoto Protocol in its entirety. Further, a private member’s bill (the KPIA) is not binding on a minority government if it has budget implications. I don’t think it is possible for the Supreme Court to find that the government of Canada has a legally binding obligation to comply with the Kyoto Protocol, because Parliament has not passed a law to make the KP the law of the land.

And let’s put any potential ruling that the KP is the law of the land in context, as well.

The KP states that any party that fails to comply with its First Commitment (FC) Period (2008-2013) national target will: (1) bear a 30% penalty, i.e. the FC period emission exceedance is multiplied by 1.3 and added to any second commitment period reduction obligations the party accepts, and (2) the party has to buy Kyoto Protocol compliance instruments (AAUs, CERs or ERUs) to address the penalty at the earliest opportunity.

Canada’s FC period exceedance will be at least 1.2 billion TCO2e. It is fair to estimate that the market price for KP compliance instruments will increase to CAD$40 to 80/TCO2e in the event that Canada remains in the KP market and is assigned the non-compliance penalty. So the one-time cost to Canadian taxpayers of any such a Canadian court ruling would be between CAD$48 billion and CAD$96 billion.

What would Canadian taxpayers buy for that price? We can only comply by acquiring hot-air AAUs that were originally issued to Russia, Ukraine, Belarus, etc. and/or CDM/JI Board-issued CERs. 77% of CERs issued to date have been issued to Asian HCFC22 manufacturing plants. HCFC22 is a highly potent ozone-depleting substance and GHG that is illegal to make or import into Canada, due to its significant environmentally-damaging effects.

CERs from HCFC22 manufacturing so dominate the UN/CER credit market that it is not possible for Canada to implement a Kyoto compliance strategy while avoiding HCFC22 plant-originating CER purchases. Though on a side note, it is impossible to stop brokers from laundering HCFC22 CERs through CER/AAU swaps with market participants—most notably the World Bank—who are heavy traffickers in HCFC22 plant-originating CERs.

How do you think Canadian taxpayers will react to a ruling that compels us to subsidize 30 Asian plants that make a chemical that is so damaging to the global environment that it is illegal to make or import into Canada?

At this time, largely due to the largesse of the World Bank Carbon Fund, Asian HCFC22 manufacturers are earning $2 for CER sales for every $1 they earn for product sales. One US EPA study found that the UN CDM/JI Board’s decision to approve this massive new KP-based subsidy for HCFC22 production will add some 2 billion TCO2e to the earth’s atmosphere by 2020, which incremental GHGs would not have been discharged in the absence of the UN decision to issue these CERs.

And while the UN/CDM-JI Board is comfortable issuing CERs to HCFC22 manufacturers, they have decided not to issue CERs to developers of wind power in China.

How are these decisions rationally explained to Canadians?

Does FOE really think that the Canadian taxpayers will support any political party or NGO that acts to impose such a large cost on the Canadian tax base—a cost that can only be mitigated by hot-air Kyoto compliance instrument purchases? I think Canadians do want to finance environmental progress. But CAD$50+ billion for no global environmental gain?  I don’t think so.

Note that under the provisions of the KP, Canada does not have any alternative compliance options—meaning the treaty does not permit us to elect to address the KP penalty by, say, committing to deliver CAD$50 billion in funding to mitigate climate change impacts in developing nations over, say, a 10 year-period.

Note, as well, that (theoretically) if we shut down 100% of oilsands production, we would reduce Canada’s KP liability by less than 5%. To the extent that oilsands sales are replaced by new crude oil sales from Nigeria, and or California heavy oil sales, global GHGs go up, not down, as a result of the decision to shut down the oilsands.

My guess is that any ruling that backs Canada into the KP penalty situation—especially given that the EU27’s Copenhagen commitment is to cut GHGs only 2.7% from 2005 levels by 2020, after increasing EU27 GHGs every year since 1994—will turn the majority of Canadian voters entirely against both the Kyoto and Copenhagen processes.

Regardless how the Supreme Court rules, it seems to me that Canada’s PM (Conservative or Liberal) has no choice but to formally file the permitted one-year’s notice of Canada’s intention to withdraw from the Kyoto Protocol—and do so pretty soon. The only question is whether or not this necessary and inevitable administrative action will garner good or bad polls for the PM/party that initiates it.

My guess is that if/when Canadian voters understand the CAD$50+ billion liability associated with the KP, as well as the HCFC22/CER story—both easy stories to tell—there will be general support for withdrawal from the KP. But the risk is that Canadians will also lose faith in our ability to address GHGs. This is the worst possible environmental outcome.

It would be best, I feel, for Canada and the global environment for the FOE to back off and for the parties to the KP to agree that the Copenhagen accord is a new treaty, replacing and not an extension of the KP.  Then the FOE and others should focus on what parliament needs to do to ensure that Canada keeps our Copenhagen commitment.

Aldyen Donnelly, Marych 25, 2010

(Mar. 22, 2010) Question: If Canada stopped selling leaded gas in 1986, and stopped making leaded gas in 1989—what happened in the intervening years when access to the US market was restricted? Why would our refiners eat the 30% premium to enter the US market? Is it just because they had to exhaust their leaded gas capital, or is there another story here?

The Canadian and US regulatory stories differ in the way they treat production facilities in the leaded gasoline case, just as they do in the ultra low sulphur diesel context. While no Canadian refinery was making leaded gasoline in 1990, most had actually cut out the production of lead ahead of 1986—even though Canadian law did not require early refinery changes.

Our primary leaded gasoline market was the US, and the US allowance-based tariffs on our leaded gas exports made the economics of producing lead in Canada unfavourable. The small volume of leaded fuel that was still made in Canada in 1990 that was not marketable to domestic specialty markets (car racing, for example) was exported to US refiners who blended it in with the leaded fuel they then exported to developing nation markets.

Despite being net exporters, could we mirror the protectionist scheme in the US if it ends up happening?

No, and that is the problem. Let’s say Canada and the US agree to the same national GHG reduction schedules and the same GHG quota allocation scheme. The problem is that we are net exporters and they are net importers. 70% – 80% of the GHGs for the transportation fuel life-cycle is in the form of tailpipe emissions. 60% of the natural gas life-cycle GHGs occur at the point of end use. 80% to 90% of coal life-cycle GHGs occur at the point of end use. So every time the US, EU, Japan or South Korea cut back coal, petroleum, natural gas or LNG consumption, they cut back imports from Canada. The result is:

• Canada loses export revenues,

• the Canada-other nation trade balance shifts in favour of the other nation and

• for every TCO2e in global GHG reductions, Canada gets 0.2 to 0.4 TCO2e in credits bankable to the Canadian GHG inventory and the traditional carbon commodity importing nation gets 0.6 to 0.8 credits bankable to the their national GHG inventory

And:

• in a closed, global cap-and-trade market (such as the one that the UN proposes), if Canadian exporters wished to divert carbon-based commodity exports from the US to a new export market, Canada’s new foreign customers would have to buy GHG quota from the open market to cover the GHGs arising from their consumption of new Canadian imports. In that closed global cap and trade market, Canada’s new customers would likely have to source their GHG quota requirement from the US customers who would be sitting on surplus GHG quota due to their declining dependence on Canadian carbon-based products.

In a fairer quota market, 100% of the global GHG emissions associated with our domestic production would be booked to Canada’s national GHG inventory and 100% of the global reduction credits associated with a Canadian reduction in output/sales would also be booked as reductions in Canada’s GHG inventory if/as Canadian petroleum product sales decline over time.

The reason the US does not propose this fair accounting method is the method the US proposes delivers a systematic wealth transfer to the US from all energy, food and building product exporting nations on which the US currently depends.

While I do acknowledge that a way does exist to construct a fairer quota market system, I still oppose quota as a GHG control mechanism because any quota regime introduces significant inefficiencies to any market. Continental or wider-reaching product standards without any quota allocation—like the ultra low sulphur diesel product standard—can spawn efficient, fair and free secondary markets for emission reduction credits.

Remember, “cap and trade” for carbon-based commodities is really no different from how Canada’s dairy quota market works.

In 1970, Canadians agreed that, in perpetuity, each province’s continuing share of total Canadian milk and butterfat production quota would reflect their shares of total national dairy product consumption in 1970.  So, today, Quebec gets 37% of all Canadian dairy quota/production rights. BC gets only 2.7%.  But BC’s share of total dairy product consumption has grown to 13% and Quebec’s share is now down below 25%.

The net result is that BC is forced to be inefficient and import 30% of the milk products we consume in BC from Quebec, because the national quota regime precludes us from producing locally to meet our needs.

If/when we agree to introduce a similar quota regime to govern the location of the production of all carbon-based products (energy, food and building products) and if/when we agree to assign national and sub-national carbon production quota allocations based on historical consumption levels, we achieve the same highly inefficient outcome for energy, food and building products that we currently live with in the dairy market.

This quota system favours, over time, any regional economy with high carbon product consumption and import levels in the base year for quota allocation, at the expense of any economy that is more efficient, has a smaller population and is a net exporter of the soon-to-be-quota-governed products in that same base year.

Is this case study written up in a journal somewhere? Would be nice to pass more formal docs around?

I have not seen it written up in a journal article, though the topic is indirectly addressed in Reitze, Arnold. “Mobile Source Air Pollution Control.” Environmental Lawyer 6 (2000): 309–27.

All of the data and information in the slides I have attached is from official government sources and in the public domain. So to contradict my slides one would have to use data that contradicts the official information provided by the governments involved.

One big problem, in my view, is that our academic community tends to have their eyes on modelling and not facts. Most of the relevant work in academic peer-reviewed journals fails to consider actual data and deals only in modelled (and often unrealistic) outcomes.

I also find that the mainstream academic community is not receptive to evidence that consumption taxes may not always be efficient behavioural change mechanisms.

On the question of how quota affects markets, I find the track record of mainstream academia quite puzzling. To date, most leading western economists quickly describe “cap and trade” as a mechanism that will lead to market efficiencies. However, most of the very same academics have documented the inefficiencies of the Canadian dairy market that derives directly from the quota regime. I cannot explain why they recognize the inefficient nature of the exact same market mechanism in one application but not in the other.

On taxes, I should note that the issue is not the economic theory, but the modelling techniques that our leading economists have adopted. General Equilibrium economic theory suggests that consumption taxes are the most efficient mechanisms for incenting consumer behavioural change if/when:

• the tax is applied at the point of a primary consumption decision and

• demand for the taxed commodity or service is price elastic.

But Canada’s (and many other) ”leading” economic modellers describe a world in which:

• the tax is applied at the point of a secondary consumption decision (most energy purchases derive from the home and vehicle purchase decisions we have made, and are, therefore, not primary consumption decisions); and

• the taxed commodity income, not price, is elastic, and then

• project that consumers will behave as if the tax was applied at a primary consumption decision and demand for the commodity is price and not income elastic.

Since most of the models we are now using to project consumer behaviour are inconsistent with the economic theory they purport to represent, it should not be a surprise to use that the modelled projections will fail to be realized.  As far as I can see, the economic theory is pretty sound. The problem, as I see it anyway, is that many of the econometric models we have come to rely on for projections have abandoned the theory in critical areas.

And we have also come to confuse “model projections” with “forecasts”. These are very different things.

Aldyen Donnelly, March 22, 2010

(Mar. 15, 2010) According to my research, Canada is the only country that experienced any growth in goods producing jobs between 1990 and 2007. In fact, Canada is the only country in the entire developed world that in 2007 had more goods-producing jobs than were in place in 1990.

While Canada has certainly lost goods-producing jobs since 2007—as a result of the global recession—our overall goods-producing job losses were relatively small, compared to other countries. Still, immediately post-recession, Canada’s goods-producing jobs count was still substantially above 1990 levels, while every other developed OECD nation is currently looking at a goods-producing jobs count well below 1990 levels.

“Goods-producing” includes: agriculture, forestry, fishing, mining, quarrying, manufacturing, enegy and water utilities and construction.

100% of the “green jobs growth” in Europe since 1990 has been jobs in the taxpayer and health care premium-financed sectors.

This is a cautionary tale.

While among the nations examined, only Germany’s goods-producing sectors carry fewer public service wages-earners than Canada’s (even the US number is worse than Canada’s, because of the US health care situation), and while Canada is the only western nation that has realized increases in goods producing employment since 1990, Canada has also experienced the second highest rate of growth in public sector/taxpayer-financed services among the sampled nations.

Clearly, Canada’s trend to public sector/service job growth is no more sustainable than any other country’s. The good news is that we have not yet devastated our goods producing sectors the way the other nations have.

The key question here is: how many public sector jobs can governments ask goods-producing taxpayers to support before the whole market crashes?

I do not know the answer to this question. But, clearly, the trend is not sustainable.

I have also produced a little graph that shows that except for the US and Denmark, net foreign direct investment (private capital) has fled the European government-centric, jobs-growing nations for Canada, in a big way, over the last two decades. The message here, is that it would be unwise for Canada to implement the very European tax and energy policies that have resulted in capital flight from Europe to Canada.

Key Problems With the Economic Modelling That Favours Carbon Taxes

A tax shift in which income tax cuts are financed with carbon tax revenues, by definition, results in an increase in government spending as a % of GDP.

When any specific government debt-to-revenue or debt-to-GDP ratio appears to be constant over time, but government spending/wages and services are increasing as a % of GDP, the economy is actually becoming weaker. Focusing on GDP and debt as a % of GDP, without considering shifts in the mix of taxpayer-funded and private investment-supported economic activity, is a large mistake. But that mistake characterizes most of the economic analysis that results in recommendations that our governments introduce carbon taxes and recycle the revenues to cut income taxes.

Also, the economic model (MKJA’s CIMs model) favoured by the Canadian environmental movement and the National Round Table hold that there is no negative impact when taxes and social transfers are increased relative to overall economic activity. In those economic models, there would be no negative impact on GDP if, tomorrow afternoon, our leaders decided to expropriate privately-held assets and convert Canada into an entirely government-controlled and owned economy.

Of course, the CIMs and other models fail to anticipate that private investment will decline as the economy becomes more centrally-managed by government.

Note that the Economic Modelling Equates “Cap and Trade” to Carbon Taxes

As you know, “cap and trade” is simply a fancy name for quota-based supply management.

All of the leading and most cited Canadian economic models equate cap and trade to carbon taxes.  For any given market price for quota, the models anticipate that the market will react to a “cap and trade” regime in exactly the same way that it will react to consumption taxes of equivalent price. The models fail to recognize that a quota-based supply management regime is far more than/different from a production or consumption tax.

Think of Canada’a quota governed dairy markets, or most municipal taxi markets. Every quota regime, no matter how administered (and even if/when quota is 100% auctioned) delivers unprecedented market power to market incumbents with large pre-quota regime market share and or large cash positions, usually at the expense of innovators and new market entrants. None of the Canadian economic models anticipate the market distortions and inefficiencies that we all know can be attributed to quota regimes, in their analysis of the carbon quota regime proposal.

Aldyen Donnelly, March 15, 2010

(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