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Replace Carbon Taxes with Emission Trading

“Why not just put a tax on carbon?”, asked my Dad last Sunday. It was Father’s Day. We had organized a family video call, and somehow ended up talking about climate.

Economists believe pricing schemes are an important tool to fight climate change. They advocate for the use of market mechanisms which reduce emissions by pricing the costs of those emissions at the source. In other words, polluters should pay for the negative impact their emissions have on the planet.

According to the World Bank, at the start of 2021, globally there were 61 carbon pricing schemes in operation or planned. The largest planned is in China, which will come online fully in December of this year. As you might expect, the sheer number of schemes means there are many variations.

Carbon Pricing Approaches

There are two broad approaches to pricing carbon that are in common use today. These are carbon taxes, and emissions trading systems.

Carbon taxes are consumption taxation models. They encourage consumers to choose products that are more emissions efficient by levying a tax on those that aren’t. Need a litre of fuel? Maybe it will cost an additional 15% in tax. The taxing jurisdiction promises to put that money back into energy efficient or climate transition projects, further accelerating the transition to a decarbonized economy. In some jurisdictions (British Columbia, Canada for example) the carbon tax collected is offset by a reduction in other taxes. The promise is that the carbon tax will be revenue neutral, which satisfies at least some of the folks who object to new taxes.

Emissions trading systems (sometimes called “Cap and Trade” systems) use a different approach to driving emissions reductions. Emissions trading systems price the emissions directly. The government sets a cap on the total emissions permissible in a given period, and then allocates emissions quotas to companies that need them. Stiff penalties are imposed for exceeding the quota. Companies can then choose to become more emissions efficient, or continue to emit. If they continue to emit, they can purchase unused quota from another emitter who may be more efficient or pay the penalty. Over time, the government reduces the cap which creates pressure to be more efficient.

Sometimes emissions trading systems are also connected with an auction, as I wrote about Nova Scotia last week. When an auction is used, the quota allocation is done via auction rather than through some other scheme, which should lead to more optimal outcomes. An auction also has the benefit that it raises money for the government to spend on climate transition or energy efficiency projects, just as a carbon tax does.

Which is better?

So why choose one over the other? There are some major differences.

  1. Carbon taxes are easy, broad, blunt tools. If you’re buying fuel, they make a lot of sense. But how do you tax the carbon content of a new home, a car, a pair of jeans, or even a carrot? Each will have differing Scope 1,2, and 3 emissions depending on the efficiency of the producers supply chain. To tax the carbon content of a consumer product accurately, you need to know the contributions at each stage of the manufacturing process. We can’t do that accurately today. Emissions trading systems overcome that limitation. Each company in the supply chain has a quota for emissions, and has to live within the quota. (note: in today’s early stage emission trading systems it’s common to only make the largest emitters comply. Hopefully that will change.)
  2. Carbon taxes may also not be an accurate reflection of the true carbon emissions cost of a given product or service. They are simply implemented as a percentage of the end retail price. An emissions trading scheme allows the market to set the price. To return to the Nova Scotia example from last week, the government set a reserve price of $21 per ton, but the actual price paid was 74% higher, reflecting market demand.
  3. Carbon taxes are also impractical to implement across borders. How should we tax two vehicles, one made in China in a factory powered by coal/electric, and the other made in Detroit? One of China’s competitive advantages has been their willingness to use cheap, and dirty, coal power to power industry. Again, emissions trading schemes make this easier, since they target the emitters directly.
  4. And finally, carbon taxes do not create direct incentives to reduce emissions because there is no cap on emissions. With a carbon tax, you could conceivably have a rapidly growing economy with growing emissions. So long as the rate of growth is high enough, then the emissions tax is simply another tax. In a cap and trade emissions market, the government sets the amount of carbon allowed, and reduces that allowance each year, which creates incentives for companies to emit less.

For those reasons, emissions trading systems are preferable to carbon tax systems. Your thoughts?

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Why I am encouraged

“From January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets, a 96% increase over the whole of 2019. I believe that this is the beginning of a long but rapidly accelerating transition – one that will unfold over many years and reshape asset prices of every type. We know that climate risk is investment risk. But we also believe the climate transition presents a historic investment opportunity.”

2021 letter to CEOs, Larry Fink, Chairman and CEO BlackRock Investments, Jan 2021

There is no company or individual anywhere which will not be profoundly impacted by the transition to a net zero emissions economy.  Today, investors have finally gotten comfortable with that fact. The pace of sustainable investments has accelerated dramatically, and so has the pace of adoption of sustainable products.2020 hit multiple new records for global investment in energy transition, despite the existence of a global pandemic.  

For the first time ever, annual investment in decarbonization passed a half a trillion dollars as companies and governments put record sums of money into everything from renewable energy capacity ($303B) to electric vehicles and charge infrastructure ($139B), energy efficient heat pumps ($50B), storage technologies ($3B) and more. 

On June 10th, 2021, Bloomberg reported that a cumulative $3T in sustainable debt has been issued.  It had taken 12 years for the first trillion to be issued, two years for the second, and just 8 months for the third. This is significant because debt is typically used to finance infrastructure.

In 2019, $16B was invested in climate-tech companies, representing 6% of the VC pie that year and growing at an annual rate of 84%. $60B has been invested cumulative since 2013, growing 3,750% since then. Investors have been richly rewarded.  Today, there are 43 climate-tech unicorn companies.

Similarly, this month the number of passenger EVs on the road hit 12 million, globally.  1% of the vehicles on the roads on planet Earth are now electric.  70% of those vehicles were sold in the last three years.  EVs have hit the “hockey stick” curve, as the number of vehicles on the road is now doubling every 18 months.

Businesses in many markets are approaching the climate transition inflection point now.   Sustainability has become a business opportunity, and not just an ESG “speed-bump” that must be managed.

There is still much to be done. But what’s happening is encouraging.

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Nova Scotia Carbon Lots Price at 74% Premium

Nova Scotia has implemented a “cap and trade” program in order to price emissions. Twice a year, the province auctions off emissions allowances, which give the purchasers the rights to emit a fixed amount of green house gases. Each allowance is equivalent to one ton of emitted CO2. As a business you may emit up to the limit of the allowances you purchased. Any emissions beyond that are priced at a stiff 3x price of the auction price. The funds from the auction are paid into the provincial Green Fund, which is then used to make investments into sustainability projects.

Over time, the allowances made available reduce in number, increasing the price of emissions and providing the emitters an incentive to run cleaner business. This paper from Osler has more details.

  • 13,683,000 in 2019
  • 12,725,000 in 2020
  • 12,258,000 in 2021
  • 12,148,000 in 2022

That’s how it works.

On Wednesday, the province announced the results of their July 9 auction, which is the third since the program was implemented. The headline was that the settlement price was C$36.71/ton, a premium of 74% over the reserve price of $21.09. Two other facts:

  • 767,000 allowances were offered.
  • There were an average of 1.23 bids per allowance.

Although this is an encouraging result, it is also a very limited experiment. Three ways that Nova Scotia could improve their program are:

  • As mentioned above, Nova Scotia’s program creates a fixed number of allowance’s annually, but distributes most of them free of charge to qualifying companies. Only 6.25% of 2021’s allowances went to auction. However, this is also increasing over time. A year ago, at the July 10, 2020 auction, 640,000 allowances were offered which represented 5.1% of the annual allowances. It appears that the province is creating fewer allowances, and charging for more of them, which is driving the auction price to market competitive levels.
  • Link their carbon market with other carbon markets like California and Quebec, so that a more open market for emissions can be created. Right now, Nova Scotia’s program is limited to the province.
  • Expand the scope of companies covered. At this point, only businesses emitting more than 50,000 tons of CO2e in any year are required to participate.

Cap and trade programs make sense, versus carbon taxes. A carbon tax is a blunt tool, penalizing consumers for the emissions of the business they’re buying from. Proponents of carbon taxes like to point out that they can be used to fund governmental green energy initiatives, which is true. Cap and trade programs, however, create incentives for the business to reduce emissions directly and also raise money for green initiatives, which is a double benefit. Nova Scotia is moving in the right direction.

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Scope. 1, 2, 3

Getting to a zero carbon footprint, globally, is a hard concept to wrap your mind around. The scale of what’s required is intimidating!

Today’s post is about a carbon accounting concept called emissions scope. Emissions scope helps businesses to account for where emissions occur in supply chains. Then they can focus on where improvements are possible. Businesses that want to perform carbon accounting use these concepts, but we as individuals can also use this them as a framework to think about decarbonizing our own lives.

Emissions Scope. Scope 1 emissions are associated with the operations of the business directly. Scope 2 emissions are from the energy used to run the business. Scope 3 are emissions upstream from business inputs and procured products, and downstream from the use of the products.
Emissions Scope

Definition

  • Scope 1 emissions are from the direct operation of the business, and the assets that the business owns or controls. Scope 1 emissions include the operation of facilities, manufacturing plants and more. They can also include emissions from fuel combustion used to run operations.
  • Scope 2 emissions are from energy purchased to run the business. Buying power or heat from a utility creates scope 2 emissions.
  • Scope 3 emissions come in two categories: upstream and downstream. Upstream emissions are from the inputs needed to run the business — the raw materials used to build products, the capital expenditures to buy equipment, and even the transport of those supplies to the business. Downstream emissions are created after the outputs of the business leave the business — the emissions from the transport of the products to market, the usage of the sold products, and even the disposal of those products.

Impact

When world leaders talk about getting to zero, they are talking about decarbonizing these supply chains. Commitments like the NDCs, and individual country level regulatory actions are fairly blunt tools. They create a framework for businesses to operate within, but ultimately businesses face the hard work of gathering scope level emission data, building governance and reporting into processes, and delivering sustainable products. It’s a daunting transformation. The good news is that these kinds of transformations appear to be achievable with very little impact on the final price for products that we consumers pay. According to World Economic Forum Net Zero Supply Chain analysis, many businesses can get to a net zero supply chain with an impact of between 1% and 4% on final consumer price.

As individuals, and families, we can also apply the same kind of thinking. Scope 2 emissions would be emissions from the energy we purchase to use in our day to day lives. Scope 3 emissions would be from the things we buy, and the things that we throw away. And if you heat or cook with wood, oil or natural gas, or run a creative business like woodworking from your home, these are the actions which are creating scope 1 emissions.

So what can we as individuals do? Here are two suggestions:

  1. We can assess our own carbon footprints. Our scope 1 emissions are likely to be small, because most of us don’t build products ourselves. But we all have scope 2 emissions. All of us consume energy at home. So what are the emissions associated with our own lives? How can we reduce them? Can we buy clean energy instead?
  2. We can make choices about scope 3 emissions in our lives. When we purchase products — cars, houses, computers, food — we can choose to look at the emissions content of the products we are buying. For example, buying locally grown food creates fewer emissions than buying fruits and vegetables out of season from distant countries, which then have to be transported to us. Choosing to bring reusable shopping bags to carry our purchases home reduces plastic waste, and hence emissions. Those are easy and obvious. But the next time you go to make a major purchase, look at the sustainability of the products you are buying, and the commitment of the company to sustainability. More companies are starting to publish reports like this one from Microsoft. More and more, business is responding to customers who “vote” at the cash register for a cleaner future.

Getting to Carbon Zero is a huge task for human society. We all have a role. Let’s not leave it to government, or to business alone. Let’s also reduce at home, and shift our purchasing dollars to companies that value sustainability.

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Climate outcomes at the G7 meeting

Did the G7 meeting in Cardiff achieve anything of significance on the climate crisis? Some say yes, and some no. Let’s dig into it a little and see, shall we?

In this excerpt from the final communiqué we read:

Protect our planet by supporting a green revolution that creates jobs, cuts emissions and seeks to limit the rise in global temperatures to 1.5 degrees. We commit to net zero no later than 2050, halving our collective emissions over the two decades to 2030, increasing and improving climate finance to 2025; and to conserve or protect at least 30 percent of our land and oceans by 2030. We acknowledge our duty to safeguard the planet for future generations. 

CARBIS BAY G7 SUMMIT COMMUNIQUÉ, June 13, 2021

And then beginning at paragraph 37 of the communique, it provides more details.

  • Domestically, the member countries have committed to “overwhelmingly decarbonized power” by the mid-2030’s. Internationally, they commit to “phase out new direct government support for international carbon-intensive fossil fuel energy as soon as possible”. Note the use of “overwhelmingly” and “as soon as possible”, rather than hard commitments.
  • Recognizing that coal power generation is the single biggest cause of greenhouse gas emissions, they call for the immediate cessation of international investments in “unabated” coal, and commit to an end to new direct government support for unabated international thermal coal power generation by the end of 2021. This appears to be a hard commitment, but is their a difference between “unabated” coal and plain old coal?
  • In transport, they commit to decarbonizing the roads “throughout the 2020s, and beyond”. This includes accelerating the roll out of infrastructure, like charging stations.
  • In industry, the commitments are “to take action to decarbonize areas such as iron and steel, cement, chemicals, and petrochemicals” and to launch the “G7 Industrial Decarbonization Agenda”.
  • And in homes and building, and land use sectors like forestry and agriculture, the “commitments” were similar to industry. Soft.

Press coverage was mixed, as might be expected. In a relatively balanced piece, the NY Times wrote “G7 Nations Take Aggressive Climate Action but Hold Back on Coal“, and quoted energy experts saying that the leaders failure to set an end date for coal made negotiating with China to end its use of coal more difficult. The hard end date was the signal that activists had been hoping to see.

Personally, I would have liked to see harder commitments on decarbonizing power generation, including that hoped-for date to phase out coal. I found the statements on industry encouraging. Industrial use of energy is one of the toughest challenges to solve, and it was important for the G7 leaders to say that they would make it a focus.

All of this is a prelude to COP26 in November. When the global community meets, and not just the G7, there will be an opportunity to set global commitments. It begs the question “Should the G7 have led now, or waited until November?”. Time will tell.

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Your Carbon Footprint

Have you wondered how to reduce your household carbon footprint? It turns out that it’s not hard to do.

First, start by getting a baseline. What do you use today? There are any number of websites that make this easy for you to calculate. For this example, I’ve used the EPA’s carbon footprint calculator. You’ll need your monthly heat and electricity bills, plus the mileage on your car if you want to do this yourself.

The EPA calculator starts by asking about your household, and how you heat. We’re a two-person household, heat with electricity, and use an average of 1,465 kWh each month. According to the EPA calculator, that equates to 14,890 lbs of CO2e annually. That’s 36.4% higher than the average in our zip code, which is 10,910 lbs. Ouch! The calculator makes some suggestions, like switching to ENERGY STAR lighting and appliances, but we’ve already done many of those things.

Next the calculator ask about driving habits. We have two vehicles. I drive about 10,000 miles annually, and Joanne around 2,500. The calculator also wants to know what the fuel mileage for your vehicle is. If you don’t know it yourself, the Department of Energy maintains a handy site at fueleconomy.gov where you can look it up. The DOE rates my Tesla Model Y at 125 mpg, and Joanne’s Audi at 30 mpg, which equates to another 3,245 lbs of CO2e. That moves us to 18,135 lbs of CO2e annually, but now we’re ahead. The average household in our zip code clocks in at a whopping 31,878 lbs annually! Apparently, they drive big gas guzzling vehicles…

“Wait, wait”, I hear you saying. “Isn’t your Tesla an EV? Why is it rated in mpg?”. Yes, it is. However the DOE rates it at 125 mpg because there is a cost to generating the electricity that powers it. They use a fairly crude measure, which is the amount of gasoline required to deliver the same kWh of energy used by the Tesla to drive a specific distance. More on that in a minute.

The last part of the EPA calculator is to give you credit for recycling. The average two-person household in our area sends waste to the landfill equivalent to 1,383 lbs of CO2e annually. We recycle aluminum, glass and paper but not all plastic, so they give us a credit of 511 lbs, meaning our waste CO2e is reduced to 872 lbs. We’d like to recycle more plastic, but Recology restricts the types we can recycle.

The calculator produces us a report like the one below. It shows our emissions at 19,007 lbs of CO2e annually, primarily from household electricity consumption. Note that I haven’t taken any of the suggested “planned actions”. Most of them, like replacing old appliances and lightbulbs, we’ve already done.

Next, try to reduce your footprint. You could use the EPA calculator suggestions, but as I mentioned above, we’ve already done most of them. Given that the bulk of our CO2e footprint comes from electricity consumption, it makes sense to try and focus on making the electricity we use cleaner. The answer is renewable energy. Alas, we live in a condo and it would require other owners to all agree in order to install solar panels on the roof of our complex. Plus, we live in the Pacific Northwest which has prolonged periods of cloud cover in the winter, which might make solar less efficient. However, it turns out that Puget Sound Energy provides us the option, for an extra $.01/kWh, to buy “Green” energy. This is 95% generated by wind and solar, and 5% from biogas.

So we did this, with dramatic results. It costs us less than $15/mo on the electricity bill, and basically eliminates the CO2e footprint for our home, and for the Tesla. Returning to the EPA calculator, I calculate that we have now reduced our annual household CO2e footprint to just 3,352 lbs. That’s 10% of the average CO2e footprint of similar households in our neighborhood. Sweet!

This method is imperfect. The EPA calculator only calculates household impacts. It doesn’t take into account things like food or air travel, and it uses assumptions about average households that probably will vary somewhat for most individuals. But it’s a good start.

So what’s your household carbon footprint? Grab your utility bills, head over to the EPA website to find out. Can you reduce it? Tell us how you did, below.

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Another Day… Another Corporate Call for Action

Yesterday, we saw The Investor Agenda call on government to step up with more comprehensive commitments to meeting Paris Accord climate change targets. The World Economic Forum’s CEO Alliance for Climate Change also issued a similar call for action. The CEO Alliance represents roughly 400 of the top 2000 publicly traded global companies. The letter, signed by 78 of the CEOs participating in this group, called on governments to deliver policy changes including:

  • Publish new NDCs, aligned to a 1.5C target, and halving emissions by 2030.
  • Commit to net-zero by 2050, with roadmaps to get there.
  • Ensure that developed countries meet and exceed their $100B commitment to support developing countries mitigate and adapt to climate change.
  • Develop broadly accepted carbon pricing mechanisms, with escalating carbon prices to drive the transition.
  • Compel all business to establish credible decarbonization targets, and fully disclose all emissions.
  • Eliminate fossil fuel subsidies, and cut tariffs on green goods.
  • Boost R&D spending.
  • Invest in climate adaptation. This means resilient cities and infrastructure.
  • Create and implement sector-specific incentives for power, transport, buildings and cities, industry, land and agriculture, and finance.

It encompasses the same policy actions as the Investor Agenda open letter, and then takes them a step further asking government to provide incentives and R&D as well.

Both the Investor Agenda letter, and the CEO group letter ask for the elimination of fossil fuel subsidies, and for synchronized carbon pricing mechanisms to be introduced. What would this do?

  • Direct fossil fuel consumption subsidies are substantial, according to the IEA, at about $320B annually. The incentives and R&D asked for could be funded by the elimination of these subsidies.
  • Similarly, carbon pricing mechanisms send a signal to markets that low-carbon investments will be valuable and also create incentives for companies to be more efficient. Carbon pricing has momentum. According to the World Bank’s 2020 State of Carbon Pricing report, there are now 61 carbon pricing initiatives scheduled or implemented, and to-date some 14,500 projects registered. One challenge for business is the diversity of models. 30 of these initiatives are carbon taxes and 31 are carbon exchange trading systems.

Taken together, these two open letters are a strong endorsement by business. Rather than fight climate change efforts and regulation by government, they are calling for public/private partnerships to make progress more quickly.

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Investors Group Asks Governments to Step Up

The Investor Agenda is a policy advocacy organization with the mission of accelerating a net-zero emissions economy. Today 457 of their members with a combined $41 trillion in assets asked governments to do more than meet their Paris Agreement commitments. Specifically, they are asking government to:

  1. Strengthen their NDCs to align with a 1.5 C target for 2030. NDCs are simply the commitments that governments made at the Paris conference.
  2. Commit to mid-century (2050, presumably) net-zero emissions targets, and outline the interim steps to get there.
  3. Implement policies to deliver these targets, including phasing out fossil fuel subsidies, carbon trading systems and more.
  4. Use COVID-19 recovery plans to double down on the transition to net-zero.
  5. Commit to mandatory climate risk disclosure requirements.

One of the misunderstood stories of the climate transition is the opportunity in it. The capital and operation costs of both solar and wind power are now well below corresponding fossil fuel generation, creating massive opportunities for investment. You can see this in the financial performance of renewable assets as a class. These investors are saying “we have the capital to make help make this transition”. They’re asking governments to commit with them, to require disclosure of climate risk by business, and to remove the subsidies that artificially support the fossil fuel industry.

Transforming the global economy will be a hugely expensive, but hugely profitable opportunity. This is a relatively small, entirely understandable, and fair ask on the part of the investment community.