Rhein on Energy and Climate

The new US approach on climate policy has led American oil and energy companies to redefine their positions. Realising that it is no longer possible to block any action aiming at reducing C02 emissions they now accept working with the Administration with the objective of obtaining the most business-friendly solutions.

Their main concern is, of course, to avoid having to cut back their emissions too much or being subject to high carbon taxes.

The debate on the most appropriate instruments for reducing C02 emissions has hardly started in Washington. Quite a few influential voices plead for a cap and trade system like the one introduced in Europe. That would be logical. After all, the USA has invented the system almost 30 years ago for coping with sulphur emissions and acid rains; moreover it would make sense to go for a trans-Atlantic market for trading emission certificates.
But there are also voices in favour of a carbon tax.

Both approaches have their pros and cons.

A carbon tax would be more transparent and simpler to handle. It would suffice to impose it on all gas, oil and coal produced domestically or imported, differentiated according to their carbon content.
Its impact would be pervasive, as it hits producers, service companies and consumers alike, according to the energy they consume. It is easily adaptable according to changing market prices and energy demand. But the tax would need to be very high to constitute a sufficient incentive for investing in energy efficiency or switching to alternative energies, because of rigid consumer demand. It needs a real price explosion for consumers to reduce their consumption, as we have seen in early 2008 with the doubling of oil prices.

The main objection against a carbon tax is parliamentary approval. It is not sure that parliaments will vote for the very high carbon taxes needed to substantially reduce the demand for fossil fuels. They may rather listen to arguments from the oil, automobile or aviation industries for low carbon taxes, arguing the rise of the cost of living etc. Maybe that is a reason for some oil executives to plead for a carbon tax rather than emission caps combined with trading emission certificates, on which the parliaments have less direct say, as it is more opaque.

The cap and trade approach is not without drawbacks either.
Its effectiveness depends above all on the depth of the C02 reductions imposed on the main polluters and their perfect monitoring. Governments need to be strong to impose deep cuts on the main polluters. We have seen this during the negotiations on the EU climate package in 2008.

The tradability of the emission certificates constitutes only a sweetener, but does not contribute to the efficaciousness of the system. A 30 percent reduction, if duly monitored, is three times as efficient as a 10 percent reduction, with or without emission trading being possible.

The system is only applicable to big industrial emitters, utilities, oil, chemicals, cement, paper and pulp, metallurgy, accounting roughly half of C02 emissions in countries like USA or EU.

It therefore requires a complement for transport, services, buildings, agriculture and households. It would, indeed, exceed the administrative capacities of any government to distribute C02 emission rights to hundreds of millions of citizens and monitor their reduction.

Logically, the EU climate package therefore also foresees administrative standards for energy efficiency, for reducing emissions.
These are foreseen in three major sectors: automobiles, buildings and lighting. Tough energy efficiency standards are more effective to stimulate the necessary changes in energy consumption than either low taxes or weak emission curbs.

The most effective instrument for any country would to immediately ban the building of new fossil-fuelled power plants, except those with CCC technology, and to close all those in service by 2035. This would cut C02 emissions by some 30-40 percent, corresponding to the share of power generation in global emissions.

Last not least, all governments should impose high excise taxes on gasoline and diesel and grant substantial subsidies to renewable energies to promote the shift from fossil to alternative energies.

In conclusion, it is not the type of instrument that matters but rather their relative incentives to change behaviour and the direction of investments. As long as politicians are excessively afraid of “hurting” fossil energy business and consumers, any instrument will fail to be fully effective.

Politicians need a dramatic change of thinking: they have to understand that high energy prices do not hurt employment or the economy, provided everybody on earth pays them. High fossil energy prices are a precondition for the necessary transition of the energy system.

Each government will have to decide on the optimal mix of policy instruments in view of reducing green house gas emissions. There is no ideal recipe for all countries. The EU mix is hardly a good example for countries like China, Brazil or India, But OECD countries with well-functioning administrative machinery and a power sector accounting for a high share of emissions would do well to study the EU example.

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