Energy Probe

In my first response, I focused on the relevance of Dr. Jaccard’s plan and costing model from a rather theoretical perspective.  In this message, I try to take the debate to the ground.

Dr. Jaccard’s model puts his compliance cost and GDP estimates in a very general setting. One question I asked myself was: which Canadian communities will be most impacted, and how much?

Remember, you can only reduce GHG emissions where they physically occur.

So I looked up the list of Canada’s largest GHG-emitting plants. I saw that that 2005 through 2007 reported GHGs for Canadian industrial facilities that discharge more than 100,000 TCO2e/year. Reporting large plant emissions account for about 80% of total industrial GHG emissions and 37% of the entire Canadian GHG inventory.  Then I sorted the large GHG plant list by federal riding, using federal riding as a proxy for "community".  At call the communities at risk under GHG regulation.

Slide 2 in the attachment shows you that 80% of the large industrial plant GHGs in Canada originate in only 30 ridings. 11 of those communities are in Alberta, and 18 are in other provinces. 5 are in Ontario. 3 are in New Brunswick and 2 each are in Nova Scotia and Newfoundland.

Then I asked: if the GHG regulation-vulnerable plants operating in these communities have to pay $40/TCO2e (the lowest rate suggested by Dr. Jaccard) to buy Canadian GHG quota or international credits to offset ONLY THE INDUSTRIAL GHG discharges in the communities, and the reduction objective is the higher of the two reduction targets examined in the TD/Jaccard/Suzuki/Pembina study: (1)  what does this mean in new taxes in these communities and (2) what is the likelihood the newly taxed plants would continue to operate (and generate new federal tax revenues) as opposed to shut-down?

The table on slide 2 shows you the value of only a portion of the tax impact on the listed communities given the Jaccard plan. Remember, the Jaccard plan calls for an economy-wide reduction. So IN ADDITION to the new taxes on industrial activity that the Jaccard plan proposes, every person in Canada also has to cut personal and household energy consumption and economy-wide vehicle use over 40% from current levels by 2020 to meet the higher of the two examined GHG reduction objectives.  In the table on page 2 I account only for the industrial employer indirect GHG tax liabilities, and none of the cost of compliance with the personal/household/transport sector GHG reduction mandates that are also incorporated in the Jaccard plan.

How to read the "Communities at Risk" Table

The numbers in the 6th column in the table on slide 2 are simply the total GHGs reported in 2007 by facilities that are legally obliged to report GHGs under existing law.  More than just the currently legislated reporting businesses will be impacted by any final Canadian GHG legislation, so this gives you a conservative, potentially regulated/taxable/quota-covered industrial GHG estimate, for each of the listed communities.

In the 7th column, I asked: how many TCO2e in reductions/offset credit purchases per year would have to be assigned to the plants in this database for Canada to achieve the Bill C-311 (higher of the two 2020 targets assessed in the Jaccard report) objective for 2020, assuming these large industrial facilities will be obliged to cover only "their fair share" of national GHGs, under the regulations. This is conservative because most regulatory proposals, including the plan outlined in the TD/Jaccard/Pembina/Suzuki report propose to assign a disproportionately large share of national reduction obligations to large industrial facility operators.

In the 2nd last column, I multiplied the industrial emission reductions required, relative the 2007 actual discharges, by CAD$40/TCO2e, the lowest cost of compliance suggested in any scenario in the TD/Pembina/Suzuki report.  In the last column, I multiplied the reduction mandate by CAD$200/TCO2e—the highest price proposed by Jaccard—just for a point of reference. Then I divided these new tax costs by the populations in the communities at risk.

So, this table tells you that if, for example, the government of Canada obliges all large industrial GHG emitters to buy Canadian GHG quota ("allowances") or foreign offset credits to cover 100% of their GHG emissions every year (as generally proposed in the TD/Pembina/Suzuki report), and the plant operators can either acquire these compliance certificates or find a way to cut emissions in their operations at a cost no more than CAD$40/TCO2e, then  proposed industrial legislation/regulation will cost the regulated companies operating in, say, David Christopherson’s Hamilton Ontario riding, the equivalent of $1,225 in new industrial taxes per year per man, woman and child living in the riding.

For the citizens of Restigouche, New Brunswick, it means $440 per year in new taxes per man, woman and child resident in the community.  For Kenora, Ontario, it is $552/person per year

The only condition under which the government of Canada can raise the new revenues required to execute the Jaccard GHG plan is that the 30 listed communities remit these new tax amounts to Ottawa starting in 2012, with the tax rate increasing 5 times by 2020.

This table raises many, many questions.
 
Slide 3 shows you that only 25 corporate entities own facilities that account for 78% of reported Canadian industrial GHG emissions and 30% of nation-wide GHG emissions.  Remember, there are no industrial GHG reductions unless/until the equipment in the plants that these corporations own is removed and replaced (or not replaced).

If we add 10,000 MW of wind power generation capacity to Canada’s electricity supply, we achieve not one single TCO2e in GHG reductions.

To achieve GHG reductions, we have to decommission equipment and vehicles that burn fossil fuels. How much government infrastructure and payroll does the Jaccard/Suzuki/Pembina plan put in place (at what cost) to achieve the decommissioning of/expropriate and eliminate at least 50% of the Canadian assets of these 25 corporations?

Does it make sense to build a $70 billion per year federal spending initiative for the sole purpose of restructuring 25 companies?

Slide 4 shows you tables from the official UK 2006 Budget documents that explain why the British Parliament reversed its high fuel tax policies of the 1990s in 2000.  The official budget documents show that financing income tax cuts with new energy taxes made the UK tax regime much more regressive and also highly inefficient. This has happened everywhere else in Europe and is why all but one EU nation started cutting back carbon/CO2 taxes sometime between 1998 and 2004. 

The one nation that did not cut back carbon/CO2 taxes froze the tax rate. What the large table shows is that all consumption taxes (including VAT/GST) eat up way more of poor families’ disposable incomes than wealthy families’ incomes. So when you shift the tax system from income to energy consumption taxes, you shift tax burden from rich to poor.

Jaccard says that we can address this by feeding tax rebates to the low income families from the revenues from GHG quota sales. The small table on slide 4 shows you that the UK did just that. But high energy prices lead to industrial plant shut downs and job losses, and new government energy tax revenues never met budget expectations. 

More importantly, the new industrial tax revenues were never sufficient to fully finance the rebates required to rebalance the increasingly regressive tax regime to neutral or progressive. By 2006, the UK taxman was delivering more value in cash and benefits to families in all of the bottom 3 quintiles of income earners than they were collecting.

How does that happen?  If the tax system operates efficiently it costs about 10 cents on the dollar to collect taxes and 20 cents on the dollar to administer the process of rebating these taxes right back to 3/5ths of the families from whom they were just collected. This is a highly, highly inefficient process. 

At this time, UK government deficits would decline if the UK Parliament simply exempted 3/5ths of families from all taxes (income, sales, property, etc.) AND cut the marginal tax rate for the top 2/5ths of income earners. The reason they could raise revenues while cutting tax rates for the top 2/5ths is that after they eliminate cost of administering the tax revenue collection and turnaround programmes, the government’s operating costs (fully financed by the top 2/5ths of income earners at this time) would actually go down.

Dr. Jaccard’s recommendations take Canada to the very picture on slide 4 that the UK Parliament has been trying to get out of since 2000.

The "green jobs" promise?  Look at slide 6.

How has the EU found it so easy to comply with their Kyoto commitment?  Look at slide 7.

Read Part 1 here. 

In his recent study, Dr. Jaccard has rather subjectively decided that certain policies and regulations must be incorporated in Canada’s GHG reduction plan. His study applies the same combination of policies and measures ("the plan") to both targets he assesses in the TD study. So it is Jaccard’s plan that is costed—for two different proposed targets—in this study. 

It is the case that a good/the right national GHG reduction plan should prove to be efficient and effective for any given target. If you have to change the core reduction policies and measures if/as you increase the reduction targets, you definitely don’t have the policy package right. So, to the extent that we are looking at the application of one core plan/policy package to two different reduction objectives, Dr. Jaccard has got that right  But, unfortunately, that is about all he has right.

Dr. Jaccard’s recommended set of GHG reduction policies and measures, as constructed does not stand up to any real scrutiny. I agree that the "cost of carbon" has to be at least $200/TCO2e (or even higher) by 2020 to achieve a 20% GHG reduction from 2006 levels by 2020, if we implement Dr. Jaccard’s recommended plan. 

But that is because his plan relies heavily on some very inefficient, ineffective measures.

A Straightforward Asset Expropriation and Replacement Plan

To put $200/TCO2e in context, let’s say we were to offer TransAlta’s and Saskpower’s and Ontario Generation’s and New Brunswick Power’s and Nova Scotia Power Inc’s shareholders a 40% premium over current market value for all of their coal-fired power generation capacity. Then we’d own all of the debt that is currently secured by those assets and shutdown the plants. Then we pay the full cost of replacing those plants with 20-year-old natural gas-fired power generation technology including combined heat and power generation technology (again, to be conservative…in real life I would use newer, more expensive, more efficient technology, but using older, cheaper, less efficient technology removes all risk from my calculation).

If we amortize the cost of building the new capacity over 30 years and the old plant write-offs and debt repayment over the first 10 operating years of the new replacement assets, we could cut some 80+ Million TCO2E per year (more than 10% of total national GHGs in 2007 and more than 1/3 of government’s 2020 reduction target), out of the Canadian GHG inventory for under $40/TCO2e.

I won’t go further from here, for now, but with 2 or 3 more major market interventions government could bridge the rest of the 2020 GHG gap, at a total cost I estimate to be well under $70/TCO2e.

I am NOT arguing that government should simply expropriate TransAlta’s and other corporations’ coal-fired assets, compensate the shareholders at the current market value for their assets and then set up Crown corporations to build and operate the new gas-fired combined heat and power generation capacity. But I do argue that the asset expropriation and replacement option should represent our reference GHG reduction cost case. 

Obviously any package of policies and measures that will cost more than the expropriation/compensation option is an inefficient policy package.

Obviously, if we really buy Jaccard’s arguments that it will cost us up to $200/TCo2e to achieve the reduction goal through his recommended set of policy and regulatory measures, it would be imprudent for our government not to just go the traditional and markedly less expensive expropriation/compensation route. After all, expropriation/compensation was the method our governments employed when society needed us to build highways, bridges and transit through citizen’s front yards and farms to achieve new social objectives.

I repeat, I don’t proposed that we consider asset expropriation, because I think that our own history demonstrates that there are more robust policy and regulatory packages that would cost even less than the expropriation/compensation option. More importantly, the policies I would recommend encourage the private sector to innovate, rather that taking the private sector out and putting government in charge of building our new economy, as both the Jaccard wealth transfer plan and expropriation/compensation option would do.

But, obviously, however opposed I might be to expropriation and government control of new development, there is no excuse for adopting the policies and regulatory strategies that Dr. Jaccard recommends when his plan would obviously cost society multiples of the expropriation/compensation option.

By the way, corporate annual reports tell us what the market values of the plants (or shares, for the investor-owned entities) are and how much debt we would have to retire when we write off the plants.  We know how much it costs to build new plants that use different fuels and well-proved technologies. This is not guesswork.

So while Jaccard’s cost study likely reasonably estimates the cost of implementing Jaccard’s GHG reduction policy recommendations, it massively overstates what it should cost Canadian taxpayers to achieve government’s 2020 target through more rational planning and implementation than the good doctor prescribes.

Study Overstates the $/TCO2e Cost of Hitting the 2020 objectives, While Understating the Potential GDP impact/job Losses

Dr.  Jaccard’s General Equilibrium economic model (called CIMs) assumes that: (1) Canada enjoys access to an unlimited supply of investment capital and (2) there is limited competition for that capital.

So in his cost impact modeling, any time government raises taxes on anything, the result is flood of new capital investment into Canada. In the model, almost any move government makes to increase private industry’s and households’ operating costs will result in a flood of new capital investment by a private sector that wants to avoid the new government-dictated price increases. If an energy efficiency investment will generate a positive return, banks will lend to even the least credit worthy firms and families to fund a project that will reduce energy demand.

If you buy the logic of Dr. Jaccard’s model in this context, the easiest way to develop a new, vibrant auto manufacturing sector in Ontario is simply for government to tax the heck out of glass, plastic, iron, aluminum and any other key components of a car.

There is also little to no risk of capital flight in Jaccard’s model. Of course Canada does not have an unlimited supply of capital and the risk of capital flight in response to aggressive new direct or indirect tax increases is high. 

I should note that while I oppose both direct carbon taxation and "cap and trade"—which is simple quota-based supply management as we see operating in our dairy market—as GHG management strategies, even the policies I do recommend will drive energy prices in Canada up, just less than Dr. Jaccard’s plan will drive them up.

That is why, even though I am confident that I prescribe a package of GHG mitigation policies and measures that is much more efficient that anything Dr. Jaccard has been willing to consider to date, even my plan must be considered/executed with caution. One wrong step and all that happens is that our economy follows Japan’s lead—negative GDP growth for more than a decade.

You know I believe Canada needs to take significant action to cut GHGs. But even the best and most reasonable policy/regulatory plan is risky, especially if our key trading partners are not equally sincere about GHG reduction.

Trade Protection Threat

I feel it is important to point out  that the the US Congress and EU are not particularly sincere about global GHG reduction. Congress’ climate change bills are all trade protectionism and very little environmental protection—as are the EU proposals that dominate the draft Copenhagen agreement. This means is that Canada no longer has the option of doing nothing about GHGs.

Our exports are most vulnerable to proposed new US and EU tariffs if we elect to do nothing to control Canadian GHG discharges, regardless what the state of scientific consensus about climate change is.

But any policy/regulatory move we make has to meet the three equally important tests of:
(1) being efficient,
(2) bearing low risk of capital flight and minimizing jobs losses and
(3) erecting a solid legal and practical defence against the highly protectionist elements in the US climate change bills and EU treaty proposals.

The only reason we still have a little time to decide what the Canadian GHG management plan should look like is that, to date, the US and EU have proposed conflicting approaches to GHG-based trade protectionism. But I anticipate they will resolve their conflicts within 12 months. So Canadian decision-makers have to take this file seriously and do not have a great deal of time to get their acts together.

I believe that my policy/regulatory recommendations more-or-less meet the 3 tests. By comparison, Dr. Jaccard’s plan hands the Canadian economy to the US and EU protectionists on a platter.

No Prudent Government Would EVER Auction Perpetually Bankable GHG Quota: But the Quota Auction is the Primary Wealth Transfer Mechanism in the Jaccard Plan

Remember, "cap and trade" is simply a fancy new name for a very old centralized market control strategy we traditionally call "supply management".  "Cap and trade" laid over the energy, building products and food sectors will work in the carbon-based commodity markets more or less the same way quota regimes work in the dairy or municipal taxi markets. 

One key difference, however, is that, as proposed, GHG quota is perpetually bankable and tradable. In Canada’s dairy market there are very tight restrictions on quota banking and quota is not traded between provinces—for very good reasons, which reasons also apply in the GHG/carbon commodity market contexts.

Dr. Jaccard, Suzuki Foundation and the Pembina Institute propose that the government of Canada establish a series of absolutely limited national GHG/carbon quota budgets for every year starting in 2011. In the dairy quota regime, each province gets a fixed share of the national dairy quota supply, but the national dairy quota supply is reset every year to achieve revenue/price targets that will enable Canadian farmers to sustain their operations. 

Quebec’s share of Canada’s diary quota is 37%, while BC’s share is under 5%. By definition, any quota distribution makes for inefficient markets if it precludes BC from meeting its own milk demand and forces BC consumers to ship milk all the way from Quebec, as the existing Canadian milk quota system does. While it is easy to prove and well-documented in academic economic literature that quota regimes make for highly inefficient markets, Dr. Jaccard states without evidence that quota-governed markets are highly efficient.

Then, Jaccard/Suzuki/Pembina stipulate that our government should eventually auction 100% or nearly 100% of Canada’s GHG/carbon quota, every year, at an open auction in which our quota goes to the highest international bidders. Most provinces do auction their annual provincial dairy quota allocation. But only in-province dairy farmers are allowed to bid for quota and they cannot use their quota purchases to force other in-province dairy farmers out of business. A Quebec farmer cannot buy milk quota at the BC dairy quota auction and take the BC quota to expand their production in Quebec.

But Jaccard’s model says that Canada’s limited energy, building product and food quota supply should be sold, annually at and open auction and—to achieve the highest possible government revenues from quota sales—that the government of Canada should allow any bidders to take Canadian quota—and the jobs that are lost if quota is exported—anywhere they want.

Of course, if cash-rich multinational firms that pay limited taxes in Canada scoop all of our GHG quota, then every Canadian fossil fuel-based energy, building product (paper, wood products, cement, aluminum, steel) and food (livestock and grains) producer may no longer operate in Canada at all, unless they buy GHG quota from the foreign quota holders who were successful at Canada’s auction. How do you think the Quebec separatist movement will react if/when Quebecers have to buy GHG quota from Alberta—or Houston, Texas—to be allowed to continue to produce aluminum in Quebec?

Because Jaccard proposes a new GHG quota auction every year, no operator of any Canadian GHG-emitting plant can tell their shareholders what their operating costs might be, from year-to-year, because the key determinant of their operating costs will be the annual GHG quota auction. Large multi-nationals, operating prudently, will hoard quota supply to force Canadian asset values down, then they will acquire the Canadian resource assets at a high discount.

Economic Rents that Attach to GHG Quota are Rents that Are Expropriated from Existing GHG-Emitting Assets

This is a very important point. Dr. Jaccard’s model assumes that the market price for the quota comes entirely out of thin air. So any freely allocated quota is a financial "windfall" for recipients. In reality, in every existing quota market (including but not limited to Canada’s existiing quota-governed dairy, chicken, fisheries and taxi markets and the US SO2 and NOx allowance markets) any real economic rent/market price that attaches to quota is rent/value that has been expropriated, by the law that obliges plant owners to hold quota, from the newly regulated emitting production facilities.

If the GHG quota supply is so large as to not cause a devaluation in the newly quota-governed production facilities (as is the case in the RGGI—northeast US states’ GHG market), the quota has little to no real market value. But if the quota supply is short, any price the market will pay for quota is reflected as an equivalent devaluation of the market value of existing regulated production assets (and the asset owners’ equity). 

Dr. Jaccard’s model fails to recognize that reality. His cost study says that the government of Canada will raise over $70 billion in new revenues, year after year, from GHG quota sales. It assumes that shareholders whose assets currently deliver less than $50/TCO2e discharged per year in value to their owners (in the form of dividends and equity) will pay $40 to $200/TCO2e per year at the federal auction to buy the right to continue to operate their GHG-emitting assets.

Of course, they won’t do that. 

They will write the Canadian assets off. All the Canadian GHG quota auction is a mechanism to expropriate all of the market value of those existing production facilities and convert that value into government revenues. Obviously, it is most likely that after such an aggressive indirect government expropriation of shareholder value, with no compensation to plant owners, few investors are likely to elect to ever build new production facilities—reen or brown—in Canada again, unless they are offered substantial government subsidies and guarantees.

Ironically, under Part 11 of NAFTA, it is most likely that US owners of Canadian GHG-emitting plant can successfully sue the government of Canada for compensation for this asset value expropriation. But Canadian owners of Canadian production facilities have no such protection under Canadian property law.

Remember, if these assets are only worth $50/TCO2e/year to their owners today—before those assets are covered by a quota-based supply management regime—those assets will be worth $50/TCO2e minus the market price for quota after the quota regime is put in place. You can see what those assets are worth today and pre-recession in corporate annual reports.

Privatizing the Public Realm That is the Upper Atmosphere

The introduction and sale of GHG quota should be considered not just from an investor point of view. We should also take some to debate this unprecedented proposal to privatize public realm.

Remember, the reason we are considering these extreme measures at all is that we have determined that the earth’s upper atmosphere is a storage facility that has a fixed, limited capacity to hold GHGs. When we try to pump too many GHGs into this storage facility, it heats up with potential negative implications for the earth and the people who populate it. So nations are slowly reaching an agreement that we have to cut back the amount of GHGs we are jointly ship to be stored in the atmosphere. 

The Kyoto/Copenhagen/Suzuki/Pembina proposal is that all of the nations of the world should divide the upper atmosphere—that most precious public realm—into national shares. Each nation’s share is represented as an annual quota supply. If any nation does not use up its entire allocation of atmospheric GHG storage capacity, that nation can sell that capacity to another nation or bank it for its own future use. But once we put GHGs into the storage shed, they must stay there for 150 years. 

So if/when we export one unit of national  GHG quota, we give up that unit of our share of the atmosphere’s storage capacity for 150 years.

First question of Principal: under what circumstances would it ever make sense for the government of Canada to privatize or export any of Canada’s sovereign GHG quota allocation to another nation? The Answer: None.

Canadian GHG quota should always remain a public asset. Government could lease some of the national GHG quota allocation under a number of conditions, all of which would lead to the exclusive use of a Canadian GHG quota to create jobs and create wealth in Canada.

Jaccard/Suzuki/Pembina are not even talking about whether the government of Canada should or should not export this most precious public resource: 150 years worth of the right to produce GHGs and the jobs associated with GHG production. The revenue side of the Jaccard plan requires the full privatization of Canada’s national sovereign quota (storage capacity) allocation, with a commitment that the corporation can take/use/sell that quota anywhere they say fit. 

What I cannot explain is how a community that calls itself "the environmental movement" could even contemplate such an historically unprecedented privatization of this most essential global public realm….especially when it is not necessary to privatize this public asset to get the market to value it.

The Global GHG Offset/CER Market Creates the Credit Default Swap Market All Over Again

Finally, I find the study’s support for Canadian purchases of UN-certified "carbon emission reductions" or "CERs" most astonishing.

First, over 50% of the CERs that the UN will issue by the end of 2012 originate in chemical production facilities that make products that are currently illegal to manufacture in Canada and will be illegal to import after 2010, under environmental regulations that have been in place in Canada since 2000. 

These chemical products are illegal in Canada because they are both ozone-depleting substances and chemicals with high global warming potential and more sustainable substitute products are commonly available.

Canada can rule that Canadians cannot import CERs arising from the production of these illegal chemicals, but with the CER market so dominated by that one class of CERs will prove impossible for the government of Canada to prevent brokers and aggregators from CER-swapping that would undermine any Canadian attempt to prevent direct and indirect Canadian investment in the production of these chemicals.

Note that the US EPA has found that the decision of the UN CDM/JI Board to issue CER to offshore producers of CFCs and HCFCs will result in an addition of as much as 2 billion TCO2e to the earth’s atmosphere by 2020 that would not have been discharged for storage in the atmosphere in the absence of the UN’s approval of these projects. 

At a price of CAD$6/TCO2e per CER, the Asian manufacturers of these chemicals can maintain better-than-historical profit levels while they GIVE AWAY THE CHEMICAL FOR FREE, due to the very high value of CERs relative to the cost of producing the chemical.

More importantly, the UN-administered international carbon market does not employ the discipline of double-entry book-keeping. When the UN approves a developing nation CDM project, the UN creates CERs (credits) and deposits those credits into the national quota accounts of the importing nations (e.g. Canada). The credits purport to represent a reduction in the project’s host nation’s GHG inventory.

But the UN accounting process does not book any emission charges to the originating nation’s GHG inventory or trading account.  So while a credit is issued to Canada, real interest in the emission reduction also remains in the project host nation’s GHG inventory.  In other words, UN-issued CERs have no underlying GHG reduction value because there is never an emission charge booked to the originating inventory when real interest in the "reductions" realized by the approved project is transferred to Canada.

Of course, this is the primary reason CERs are less expensive than real reductions in reportable GHG inventories.  But the lack of double entry-bookkeeping discipline in the UN-administered market is also the primary reason any nation that uses CERs as compliance units will be inevitably compelled to write them off—increasing long term national GHG cap compliance costs.