Emissions Trading: For Real or Is It Hot Air?
Energy Discussion Forum III Summary Report 25 January 2007
Civic Exchange Room 701 Hoseinee House 69 Wyndham Street Central Hong Kong Tel: 2893-0213 Fax: 3105-9713 www.civic-exchange.org
TABLE OF CONTENTS Background
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Section 1: Expert Presentation (transcript)
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Roger Raufer, Director, Engineering Services, International Environmental Trading Group (IETG)
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Presentation: Market-based Pollution Control: Hong Kong & the International Marketplace Introduction
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I. Engineers vs Economists
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II. International Environmental Marketplace
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III. Hong Kong Challenges and Opportunities
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Section 2: Audience Question and Answer
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Moderated by Christine Loh, Chief Executive Officer, Civic Exchange
For the full set of slides, see http://www.civic-exchange.org/publications/2007/raufer.pdf
Civic Exchange is a non-profit public policy think-tank that helps improve policy and decision-making through research and analysis. The opinions expressed in this report represent those of the speakers and do not represent those of Civic Exchange. This summary is based on transcripts recorded at Civic Exchange’s 3rd Energy Forum Discussion Series held on 25 January 2007.
Energy Forum III: Emissions Trading BACKGROUND Civic Exchange is interested in the relationship between energy, air pollution and climate change and has organized a discussion forum series on energy issues. Energy, which is a critical driver of economic growth, is also a key driver of air pollution and climate change The first forum (20 June 2006) featured an overview of energy supply and investment issues relating to Hong Kong and Guangdong. 1 The second (20 October 2006) focused on China’s future energy constraints and solutions within the context of international developments. 2 The aim of the third forum was to provide an overview of emission trading as an increasingly important market mechanism to reduce air pollution, as well as carbon emissions, and to explore its relevance in Hong Kong-China. Civic Exchange invited Dr. Roger Raufer, Director of Engineering Services of the International Environmental Trading Group (IETG), to discuss marketbased pollution control in Hong Kong and the international marketplace. Emissions trading is receiving considerable attention lately because of carbon credit trading under the Kyoto Protocol, but its implementation has actually evolved over a period of some thirty years. Dr. Raufer described the evolution of this concept, the key role that both engineers and economists have played in its development, and the manner in which the physical nature of the pollutants affects the development of such economic instruments. He discussed its potential application in Hong Kong and China, including the current dynamics of markets in emissions at both the national and international level, and the potential role of “clean energy” technologies in emissions trading applications. A copy of the presentation and a report written by Ms. Loh and Dr. Raufer titled The Emissions Game: How markets can help save the planet are available on the Civic Exchange website. 3 The following is an edited transcript of the presentation and discussion that followed. Civic Exchange plans to organize further discussions on different aspects of energy in the future. Dr. Roger Raufer: Director, Engineering Services International Environmental Trading Group (IETG) Roger Raufer, a consulting engineer with the International Environmental Trading Group (IETG), has more than thirty years of experience in dealing with the environmental impacts of the energy industry. In addition to extensive private sector experience, he also served as Technical Advisor for the United Nations’ Division for Sustainable Development in New York for four 1
http://www.civic-exchange.org/publications/2006/EnergyForum.pdf http://www.civic-exchange.org/publications/2006/Oct06EnergyForum.pdf 3 http://www.civic-exchange.org/publications/2007/raufer.pdf and http://www.civicexchange.org/publications/2007/ET.pdf 2
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Energy Forum III: Emissions Trading years (2001-2005), and has worked as a consultant for the U.N. addressing environmental issues in China since 1990. He has similarly worked on energy/environmental projects for the World Bank and U.S. AID in numerous countries around the world. Dr. Raufer holds a Ph.D. in Energy Management and Policy from the University of Pennsylvania, and has taught there for more than twenty years. In addition to Penn, he also teaches at the Institut Français du PÊtrole in Paris, and has done so since 1989. He holds degrees in chemical engineering, environmental engineering, and political science, and is a registered Professional Engineer in a number of U.S. states. He has written two books on the role of emissions trading in environmental management. Further information about Dr. Raufer, including a list of his key works can be found at: http://www.roger-raufer.com
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Energy Forum III: Emissions Trading Section 1: EXPERT PRESENTATIONS (This transcript has been edited for easy reading) Christine Loh, Chief Executive Officer, Civic Exchange I am the CEO of Civic Exchange. Thank you very much for coming today. As you can see we have a big crowd. I think emissions trading is ‘hot’ and we are going to find out whether it is just hot air or whether it is something worth doing. It is my great pleasure to introduce my partner in crime, Roger Raufer. We were commissioned to write a report for CLSA on emissions trading, and I must say I can’t have had a better co-author. We wrote the report over Christmas and New Year! He actually responds overnight. And the other thing about Roger is that he understands trading. I was a commodities trader in my previous, previous, previous life, so I have a certain view about markets. I think they work. Of course we need to get the rules right. Roger has been involved over the last thirty-plus years in helping to design trading systems, he has also done private consulting, worked at the UN, and teaches at universities. I can’t think of a better person to take us through emissions trading. I know why you are all here. You are interested to see about the growth of the emissions trading market. So, if I were to put my hat on now as a non executive director of Hong Kong stock exchange, we have now put out as part of our three-year strategic plan the idea of looking at trading in what I call environmental products. This could include carbon. The stock exchange is now going to be looking at how we actually put that trading platform together. So, something new and exciting. You know the Hong Kong Government has already announced that they intend to put in place a pilot emissions trading scheme for up to three pollutants. They said the scheme was going to be in place by the end of last year but there has been some delay. It is good, actually, that it is delayed, so hopefully they are ironing out some problems. We hope that they will make an announcement of what the scheme will be some time maybe around the end of February. So, that is why I think we all have a high level of interest in emissions trading because it is now going to happen in this territory. As far as carbon is concerned, I think you are seeing carbon trading now spreading in different parts of the world as well, so I think it is a very good day for you, Roger, to share with us how it all happened and where are we going to go, and I think most particularly what are really the circumstances we need to make trading systems work. It is not just about making money in this particular case. We actually want to lower emissions. Thank you very much, Roger. Over to you.
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Energy Forum III: Emissions Trading Roger Raufer, Director, Engineering Services IETG Introduction Thank you, Christine, for that kind introduction. I obviously knew about Civic Exchange from their emissions trading reports back in 2001, and so it was very interesting for me to come here finally to Hong Kong and meet Christine. She noted that I responded to her queries -- but she had put in so much work on the report that I really felt I absolutely had no choice but to quickly respond! If only there were many more Christines in Hong Kong! But thank you very, very much for the invitation to come here today. One of the things that Christine didn’t say about my background is that I was actually an emissions broker, way, way back in 1981. We had these kinds of emissions trading systems in place in the U.S. back in the late 1970s. And one of the things you learn as a broker is that: “If you live by the market, you die by the market too!” I would go to people and talk about these wonderful ideas about buying and selling pollution, and their reaction was: “What the hell are you talking about? That’s the most bizarre thing I have ever heard. Absolutely bizarre!” My brokering career, as you might suspect, didn’t last very long. I thought: “I am not going to be able to stay in business very long when no one knows what I am talking about!” So it is obviously very exciting for me today, to look at this market, and what is happening out there. On the first couple of slides I just have a couple of points about what is going on, and the way this market is currently exploding. Figure 1: Rapidly Growing Carbon Markets
Rapidly growing market
Carbon market size 2004: 2005: 2006: 2010:
<$1 bn $9-11 bn $25-30 bn $40+ bn?
Kyoto Protocol "shortfall" 2008-2012: 4.5 - 5 bn tonnes Growing emissions problem Source: WB & IETA, 2006; IPCC, 2001
R. Raufer, IETG
You can see that this whole carbon market is very exciting. Even in the last year and a half, the market has expanded from less than a billion dollars to about 25 or 30 billion dollars this past year, and in the next couple of years it
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Energy Forum III: Emissions Trading might be 40 billion -- but even then, we don’t know. It might become even larger. We see this expansion in terms of projects as well. This slide shows the CDM, the Clean Development Mechanism – which is part of the Kyoto Protocol. You can see that this curve represents different kinds of projects, and this is just the pipeline of projects that are coming along under Kyoto. Obviously there are many other areas. There are also voluntary programmes that we should talk about. Figure 2: Strong CDM Project Growth
Strong project growth
CDM “pipeline”
• 489 registered CDM projects • 1300 in "CDM pipeline" • CERs issued: 28.2 m • 1.5 b tonnes CO2eq. through 2012 • 17 approved DOEs • 112 countries have established DNAs
Sources: OECD & IEA, 2006; UNFCCC, 2007
R. Raufer, IETG
Figure 3: Strong Asian Focus
Strong Asian focus
Regional Distribution of CERs to 2012 from Confirmed + Probable Projects Source: UNDP, 2006
R. Raufer, IETG
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Energy Forum III: Emissions Trading And much of it is happening in Asia. This slide is a pie chart showing the certified emissions reductions (CERs) from confirmed and probable projects, and you can see a lot of this activity is happening right here. Much is also happening in Latin America. And you can pick up newspapers every day and read about investment banks scrambling to participate – Goldman Sachs had $23 million, buying into the climate exchange in London-- and of course this article is already outdated. Figure 4: Active markets worldwide
Active markets worldwide
INVESTMENT BANKS SCRAMBLE TO JOIN CLEAN ENERGY MARKET By REBECCA BREAM 3 January 2007
....banks are also investing heavily in carbon trading desks and establishing a position in this new market. Last year, Goldman said it was investing Dollars 23m in a 10 per cent stake in the London-listed Climate Exchange, which trades carbon future permits in Europe and the US. Morgan Stanley plans to invest Dollars 3bn (Pounds 1.52bn) in the carbon trading market over the next five years, buying carbon credits around the world and also setting up its own low-emission energy projects.....
R. Raufer, IETG
Just in the last couple of days, they have doubled their position. They have also announced that they are spending a billion dollars on global energy efficiency and renewable energy projects building up the carbon markets. This is radical, a radical change. It is happening very, very quickly. What I want to do today is to try to talk about this market in three different parts. Christine has mentioned that I am an engineer by training. I am not an economist. Sometimes, when I talk about economics, my economist friends get a little bit nervous -- but I do think about the world like an engineer. Virtually everything I think about has always been implementation oriented – how do you make this stuff work? That is really the base I come from, and I think the way that engineers think about the world versus the way economists think about the world leads to very different approaches – well, hopefully we will see that today. Then we will talk about the international market, and then finally we will talk about Hong Kong.
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Energy Forum III: Emissions Trading Figure 5: Overview
Overview
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Engineers vs. Economists
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International Environmental Marketplace
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Hong Kong Challenges & Opportunities
R. Raufer, IETG
I Engineers vs Economists So, if you want to compare an engineer and an economist -- the first thing to recognize is that engineers usually have pocket protectors! Of course, it is probably protecting a rather garish shirt -- as this slide also shows. Years ago, when I was a student, we actually used slide rules too. That was before we had calculators. We used to have a slide rule hanging on our belt too, as a sort of “cool” badge of distinction. Most other people didn’t seem to see it that way, but that too was a part of the engineering world view. Figure 6: Engineers vs. Economists
I. Engineers vs. Economists
vs.
R. Raufer, IETG
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Energy Forum III: Emissions Trading
There is also an economists’ world view, and of course what I should be showing you is an invisible hand -- but how does one show a picture of an invisible hand? Well, I did the next best thing: I have invisible ink on a very visible hand. And of course, since we are dealing with economists, I have put a nice smiley face on it! So, these are two world views that are out there for pollution control -- the engineers’ and the economists’ world views. Let’s start with the engineers. Basically we always think about the world in terms of black boxes. This slide shows a box, a black box, and whatever that black box represents – it might be a car engine; it might be a power plant or a refinery; it might be a city – that doesn’t really matter. There are things going in and things going out. So as an engineer, you can try to control what is going in, or control what is coming out – or you can go to the black box itself, and try to affect what is going on in there. The slide shows how these work, in terms of emission standards – the output; or fuel standards – the input; or design standards – the black box itself. Figure 7: Engineering “Command/Control” Regulation
Engineering “Command/Control” Regulation Goals
Environmental Quality Standards
physical modeling
Regulatory Means
A. Prohibitions
B. Technology-Based Standards X
Emission Standards Performance Standards X
Input/Fuel Standards Design Standards
X
X
R. Raufer, IETG
Or we might do something like the performance standard shown here as well. The performance standard links the outputs with the inputs. We do this in the U.S. for power plants. We have new source performance standards, which say you can have so many pounds of SO2 coming out per million BTU going in. You can thus make that kind of linkage on performance. But this is a black box way of thinking about the world – inputs and outputs. There are thousands and thousands and thousands of these kinds of environmental regulations. We can think about limits on sulphur in fuel oil, for example. I know, for example, there is sulphur in coal, and so we can limit it through fuel standards, much as we have in many cities. Every state, every
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Energy Forum III: Emissions Trading province, every country has thousands and thousands and thousands of these kinds of environmental regulations and standards for dealing with air pollution. Now, if you are a really, really hard-core engineer, you would want to use something like the best available technology, the best available control technology – what the British used to call the “best practical means” of pollution control. And then if you do the best you can, then whatever happens to the environment -- then that is what happens. After all, everyone is doing the best that they can. This was the philosophy years ago in Britain, after the Alkali Act of 1863. That law in effect says “use the best technology, and then whatever happens, happens”. But we don’t buy that any more, because we know technology isn’t static. Technology changes over time, and we don’t really care about the black boxes anyway. Engineers do, but nobody else does. What we really care about is what is going on in the environment. So, what we end up doing now is setting environmental quality standards as the goals that we are trying to accomplish. Those are our environmental goals. How do we set those goals? Well, we worry about public health; we worry about eco-systems; we worry about damage to buildings and crops and trees and forests and butterflies, and those sorts of things. So, we set health standards and welfare standards, and then somehow we have to link all of our black boxes with what is going on in terms of those standards. We do that through physical modelling, dispersion modelling, and now that computers have advanced so much, it makes that task a lot easier. This is the world I grew up in. This is the seventies, when I we were studying air pollution. This is an important way of world, and it did a lot for cleaning things up. But there is thinking about reality out there. That way suggests that different goal. And what is that new goal?
was a student and thinking about the a different way of we might have a
That goal might be to be at the point where marginal cost equals marginal benefits. What do I mean by that? This says that the next dollar that I spend on pollution control should buy a dollar’s worth of environmental benefits. What are these marginal costs? That means, again, the next dollar we are going to spend for pollution control. Where do we get those costs? Well, as we make changes and add technology to get closer and closer to 100 percent control, it becomes harder and gets more and more expensive to accomplish that. And what is this? This is the marginal benefit curve. Where does this come from? Well, this is going to be a bit of a problem. All of those things we talked about earlier – public health, crop damage, forests and butterflies and all of those things – somehow we are going to have to get that into that marginal benefit curve. Let’s come back to that in a moment. That is a tough task, obviously. Once we know that our goal is that marginal costs equals marginal benefits, it would be nice if there was something like Adam Smith’s invisible hand that
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Energy Forum III: Emissions Trading would take us to the point where marginal cost equals marginal benefits. But it doesn’t work that way. It takes a government fist. There is no invisible hand. It takes a fist. Figure 8: Economic Regulatory Approach
Economic Regulatory Approach
Marginal Costs (MC) = Marginal Benefits (MB)
Goals
$/ton
MB
MC
⊗ % reduction
Regulatory Means
Pollution Taxes (Price-based)
Pollution Markets (Quantity-based)
Pigouvian taxation
Emissions Trading
P Q
R. Raufer, IETG
Economists, however, have come up with two different ways of getting us there; one of them through the price mechanism, and one of them through a quantity mechanism. The price mechanism is call Pigouvian taxation after Professor Arthur Pigou at the University of Cambridge. In 1920 he wrote a book called The Economics of Welfare. He is the one who laid out that idea of setting an externality tax. And what happens when a government sets a tax? People who have low marginal costs of control do the controls because it cheaper than paying the tax. People who have high marginal costs of control pay the tax because that’s cheaper than putting on a control mechanism -- so we end up exactly at the point where marginal cost equals marginal benefits. Simple, rational, elegant, and so obviously everybody in the world in 1921 was utilizing Pigouvian taxation, right? This did not happen. Let’s come back to that in a minute as well. There is a different approach, though, and that is -- instead of coming at it from the price side, let’s come up from the quantity side. The quantity side has a very nice intellectual history that people argue about all the time. How far back does it go? Some people go back to Lord Marshall and the beginnings of the neo-classical school. But the really important piece was John Dale’s work in 1968, Pollution, Property and Prices. Dales was a Professor at the University of Toronto, and his work basically introduced the idea of introducing a quantity-based scenario, which says that -- instead of thinking about percent control, we can think about units of pollution. If you have 100 percent pollution control, then you also have zero units of pollution. We can put a limit on the number of units of pollution, and we can then construct a market. People can buy and sell these pollution units.
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Energy Forum III: Emissions Trading
Now, assume that initially you might start off with 100 units of pollution -- but the government might decide to say “we are going to cut emissions in half,” since this will take us to that point where marginal costs equal marginal benefits. So, the new allowable amount is 50. If you have a market, and it has only 50 licences -- but there are 100 units of pollution chasing those 50 licences, what happens to the cost of a licence? It keeps going up and up and up and up. Eventually what happens, of course, is that people start making rational decisions and, if their control costs are low, it might be a cheaper to do the pollution control than to buy a licence. And exactly the same thing then happens, with the people with low marginal costs of control putting on the pollution control. The people who have the high marginal cost of control pay for the licences -- and you end up at exactly the same point, where the marginal costs equals the marginal benefit. So, this is another way of solving the problem, but coming at it from a different way. This is a very abstract, theoretical economic approach, however. I will talk about what is going on in the real world shortly. You have these two competing world views -- engineering and. economics -, and I would suggest to you that there are two transitions going on today. One of them is a transition from engineering to economic means. You will notice that in the title of slide 10 I talk solely about the regulatory means. I don’t talk about shifting goals as well. It is only in the bottom half that the transition is going on. It isn’t in the top half -- and that brings us back to that question: how we should quantify all those butterflies and things in the marginal benefit curve? And the answer is, we don’t currently do it very well. Economists have been working for 40 or 50 years now on various kinds of tools, and they have contingent valuation and hedonic pricing, and they have surrogate markets, and various other kinds of techniques that they use to do that -- but the bottom line is that it is really tough to determine such things. We really don’t know particularly well how to do such calculations, and so, to a certain extent, we are working in the real world with one arm held behind our back. We know that we can get a pretty good handle from the engineers about the marginal cost curve, but the marginal benefit curve is pretty tough to calculate. So, what is happening today is that we keep the goals from the engineering side – the environmental quality standards, based on what the engineers and scientists are telling us; but then we use economic tools – pollution taxes and emission markets – to help us accomplish those goals from the engineering side. Now, an important question is: “Why is this transition happening?” It is happening for several reasons. One of them is that -- look what that government has to do on the left-hand side. The government is in there with black boxes, telling people “Stop this on that output, and stop this from this input, and do this on that design”, and similar kinds of things. You get the government doing all these types of tasks with the black boxes. But
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Energy Forum III: Emissions Trading governments are simply not good at black boxes. They just aren’t good at that. What they are good at is setting collective goals --but you don’t want the government telling you what valve to turn in order to get pollution reductions. What this transition accomplishes is -- it moves governments away from things they do poorly, such as black box thinking, and moves it into things they do well, such as collective decision-making about how much pollution we should reduce. People that are actually operating the equipment can make much better decisions about how far to turn the valve to get pollution reductions! Figure 9: Engineering vs. Economic Worldviews
Engineering vs. Economic Worldviews Engineering
Economics
EQ Standards
MC = MB
Goals
Regulatory Means Technology-Based Standards
Economic Mechanisms Pollution Taxes (Price-based)
Pollution Markets (Quantity-based) Pigouvian Taxation Emissions Trading
X
Emission Stds. Performance Stds. X
Input/Fuel Stds.
X
P Design Stds.
Q
X
R. Raufer, IETG
We can therefore move governments away from doing things they don’t do well, towards things that they do do well. That is the first reason for the transition. And when we do that, then all of a sudden things become quite efficient. It ends up costing us a lot less money to accomplish the same environmental goal. And if we are using resources wisely, if we are doing things the right way and becoming efficient economically and resource-wise, then that means also we can become more aggressive in protecting the environment -- because we really don’t know what the marginal cost and marginal benefits look like, and so we end up making these decisions in other ways. We end up setting pollution control goals in the real world, and what we can do in the real world is be a lot more aggressive in cleaning things up if we are using economic instruments. These are important reasons. If you move the government to do things that they can do well instead of poorly, and you become efficient, then you can be more aggressive towards protecting the environment. But there is one other important reason as well -- and that other reason is, under this right-hand economic scheme on the slide, if you want to pollute, then it is going to cost you money. On the left-hand side, if you do what the government says --
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Energy Forum III: Emissions Trading then the government goes away, and you say, alright, forget about that pollution stuff because I did what the government told me to do. But under this right-hand economic approach, if you are going to have to pay a pollution tax, or if you have to purchase a pollution licence, then every bit of pollution costs you money -- and you are constantly, constantly, constantly trying to figure out ways to get rid of that damn pollution, because you don’t want to pay the government for taxes or licences on that pollution. Figure 10: Regulatory Means Transition#1: Engineering to Economics Regulatory Means Transition #1: Engineering to Economics Engineering
Economics
EQ Standards
MC = MB
Goals
Regulatory Means Technology-Based Standards
Economic Mechanisms Pollution Taxes (Price-based)
Pollution Markets (Quantity-based) Pigouvian Taxation Emissions Trading
X
Emission Stds. Performance Stds. X
Input/Fuel Stds.
X
P Design Stds.
Q
X
R. Raufer, IETG
There is thus a very, very strong push on the right-hand economics approach to reduce pollution, which unfortunately doesn’t exist under the left-hand engineering approach. That is a major reason for transition number one. At the same time there is a second transition happening, which is price to quantity. Now, governments know how to collect taxes. Governments know how to collect taxes very, very well. They have been doing it for millennia. They really know how to take money. They are very good at that, and they are very comfortable with that. And around the world most governments have, therefore, tended to think about Pigouvian taxation as the way that -- if you are going to use an economic instrument, hey, that’s the way to do it. And we’ll be getting additional revenue to boot!. But this is also the reason why there has been so much resistance in the private sector to pollution taxation -- there is also a large wealth transfer. You might get efficiency but there is also a distributional effect, a wealth effect. So, economists have tried to wrestle with this problem. They say, well, maybe we can collect the tax with this hand, and then give the money back with that hand -- so we might tax on the tons per year of pollution and then subsidise on the kilowatt hours, various schemes like that. You can come up with a variety of such approaches, and there are numerous ways of tweaking it.
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Energy Forum III: Emissions Trading
Figure 11: Regulatory Means Transition#2: Price to Quantity Regulatory Means Transition #2: Price to Quantity Engineering
Economics
EQ Standards
MC = MB
Goals
Regulatory Means Technology-Based Standards
Economic Mechanisms Pollution Taxes (Price-based)
X
Emission Stds.
Pigouvian Taxation
Performance Stds.
Pollution Markets (Quantity-based) Emissions Trading
X
Input/Fuel Stds.
X
P Design Stds.
Q
X
R. Raufer, IETG
For the most part, this idea of pollution taxation hasn’t been tremendously successful, but it has been employed in Europe; and even countries like China use a pollution levy system, utilizing price-based instruments to accomplish pollution reductions. Americans, on the other hand, don’t like taxes at all. They don’t like being taxed. You can go all the way back to the Boston Tea Party – we will throw the tea in the harbour rather than pay a tax on it. Years ago, in 1988, I got a call from the Dukakis presidential campaign. They said, in effect: “We know you are working on market-based acid rain approaches. Would you please put together a position paper for us on acid rain, utilizing all those economic ideas?” So I said, “Sure, I’d be pleased to do that, and I will talk about price-based approaches like Pigouvian taxation, and quantity-based approaches like emissions trading and markets, and all that sort of thing.” And they said “Taxes? Did you say pollution taxes?” And I said, “Yes, you know, price and quantity instruments – these are different sides of the same coin.” And they said: “No, no, no….. No, no, no. What you have to understand is: Tax, bad -- Markets, good. That is what your paper should say. Tax, bad; markets, good.” So, I ended up writing a paper that focused on trading. I didn’t say that taxes were bad; I just ignored them. But that whole mentality, that is very much an American kind of mentality. You don’t tax. We just don’t like such wealth transfers and taxes. What is happening now is a very interesting transition. Many European countries have used taxation, and when I first started talking about using markets for emissions trading there in the 1980s – I told you I was an emissions broker – they used to say: “You are trying to buy and sell pollution? That is a horrible, horrible idea.” That is what I used to hear in Europe, and it
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Energy Forum III: Emissions Trading is very interesting to me now to see the Europeans out there driving this whole market approach under the Kyoto Protocol. I mean, this has been incredible! All the drive for CDM credits today is coming out of Europe. This is all from European markets!! So, there has been a tremendous shift in thinking, and you will see later on that the same kind of shift has been happening for renewable energy as well. This second price to quantity transition is occurring, and it is a political one, because it also has to do with distributional concerns. You have probably heard about allocation issues associated with emissions trading, and questions concerning the use of auctions. If you require auctions, then you have the same kind of wealth transfer that occurred under Pigouvian taxation, with the same kind of wealth transfer. But politicians have also found that by “grandfathering” emissions for existing polluters, or by giving them allowances for free, it is possible to minimise political resistance to stringent pollution control. And that is a political fact of life. Political representatives are also giving away part of the air resource when they do that, but recognise that these kinds of things are political realities. If you want to have very stringent pollution control, this is one way of bringing it about. So, this is another reason that such a quantity shift has been occurring. So, we now have two approaches: an engineering approach and an economics approach. The U.S. government didn’t simply say: “Oh, those economist guys are real smart guys. Let’s go do that.” What happened, of course, is that the economics approach has evolved over decades. It started back in 1976, when we introduced the idea of using emission “offsets” -- which were targeted at urban air pollution, the dirty air basically, in Los Angeles, New York, and places like that, that were not meeting ambient air quality standards. In 1990 we then had a big shift, which was a shift towards the economics model, with the quantity-based acid rain programme. Probably many of you have already heard about the acid rain programme. It has been very successful. It has cut the emissions roughly in half at a price about half as much as it would have cost under the command-control, blackbox kind of thinking. It worked so well for acid rain that we Americans said: “Let’s do it for ozone control as well”. Even though this was a bit of a bandwagon effect, because acid rain is a long-term, cumulative type of pollutant loading problem. Ozone is a short-term, episodic summertime problem -- but we said in effect: “Hey, these things work great. Let’s go do it.” There were actually a number of concerns about doing it this way. Some people, including myself, said “No, price is a better approach than quantity.” But nobody wanted to hear that. As I said earlier, the mantra seemed to be: “Markets good; tax bad.” Those ozone markets have subsequently been working as well – primarily because of the very significant level of NOx control required.
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Figure 12: The U.S. Q-based Economic Transition
The U.S. Q-based Economic Transition
− 1976
Urban air pollution
− 1990
Acid rain
− 1999
Ozone
− 2005
SOx/NOx expansion Mercury
– Forthcoming
Greenhouse gases Ö RGGI, etc. Ö California, etc. Ö Federal??
R. Raufer, IETG
We are now expanding those domestic markets because -- even though we were successful and there was 100 percent compliance with the acid rain programme -- we want to do more. Under the acid rain control programme we were allowing 8.95 million tons of SO2 -- that was the Q -- but now we are moving tighter and tighter. We are also introducing new markets in mercury for power plants, and that is an interesting application, and one which is highly contentious. The acid rain programme was so successful that we also pushed it into the international arena – into the Kyoto Protocol. Americans were the ones pushing for markets at that time, and I guess the Europeans were still rather sceptical. Today, of course, everyone is interested in the carbon market – and this is how we began this talk. The US is developing domestic markets in greenhouse gases – in addition to the European-based markets. But this is a key point. You can see this is a transition that we are still in -- we are using these markets, but developing more and more, in newer and newer areas as well, and expanding the markets we have. So this is not just a matter of carbon. That is one thing I want you to consider, that it is not just the carbon market. We have markets in all these different pollutants and they are all very sophisticated -- and for the most part they have worked pretty well. As I mentioned earlier, when we introduced the economists’ ideas and theories in the mid 1970’s, we didn’t just say: “Oh, those economic ideas are great”. What we did was introduce a very deliberate transition. We basically kept all the engineering thinking, all the environmental quality standards, all the prohibitions, and all of the black boxes. We kept it all. We didn’t get rid of
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Energy Forum III: Emissions Trading any of it, but what we did do was we added this thing called the emissions trading programme, which generated so-called “emission reduction credits.” When I was a broker in 1981, I was brokering emission reduction credits. That is all we had at that time. Figure 13: U.S Emissions Trading Program –mid 1970s
U.S. Emissions Trading Program – mid 1970s
Goals
Environmental Quality Standards
Regulatory Means
1. Prohibitions
2. Technology-Based Standards X
Emission Standards Performance Standards
Emissions Trading Program
X
Input/Fuel Standards Design Standards
Brokerage Opportunities
X
X
Emission Reduction Credits (ERCs)
R. Raufer, IETG
The emissions trading programme had four different components. It had something that we called “offsets,” which basically said that if you were going to build a new plant in a dirty area you had to get rid of some of the pollution in that dirty area. If you are going to build a new factory in Los Angeles, for example, you had to first of all stringently, stringently control that plant. But even if you stringently controlled it, you were still putting out some pollution. So before you could go into Los Angeles, you had to get rid of pollution in Los Angeles to cover whatever you were introducing. And, in fact, it had to be more than a one-for-one. If you are going to introduce 100 tons, you had better get rid of some greater amount – say 105 tons, or some number above that -- to help clean it up. Now, how do you get rid of pollution in Los Angeles? There were two ways: you could buy a polluting factory and shut it down. Or you could over-control on an existing emissions source. You could take some emission source that had a black box requirement, and then move it up the marginal cost curve to make it more stringently controlled. Those were the two options available to generate an emissions reduction credit. We also had bubbles, and this slide shows an example of that. We had what were called “SIP” controls – SIP stands for “state implementation plan” – which was a state plan that told you what you had to do under the black box requirements. And it might say: “Well, you are putting out 145 units. You had better get that down to 100.” Under the bubble policy, you could pretend that there was an invisible bubble over your plant. As long as you were getting the same pollution control results – and in fact this is a little bit
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Energy Forum III: Emissions Trading misleading, because it had to be better than one-for-one, and you had better get that emission down to 98 or 97 -- you could figure out your own way to do it. Figure 14: ETP Components
ETP Components
Bubbles
• Offsets • Bubbles • Netting • Banking
R. Raufer, IETG
And what are we really saying here? What we are really saying is that under the bubble you can do your own marginal cost analysis. You could figure out how to reduce the pollutants cheaper and do it your own way -- and in fact it had to be better than the government’s black box approach as well. We also had something called netting. Netting was really just a simplified permit approach where we traded the emissions between an old and new plant. If you put in a new boiler and shut down the old boiler we treated that as though we were trading emissions. And that became part of the emissions trading programme. Finally we had banking. Banking was a situation which started because of the offsets. Remember I told you if you wanted to move into Los Angeles, you might shut down an old factory to obtain offsets? You would come in and you would negotiate your permit to get your offset, and the EPA said: “On the day that you turn on your new plant, you have to turn off the old plant.” That made a lot of sense. And what happened was that people said, “Well, wait a minute, because here is what I have got to do. I have got to negotiate a permit and then I buy this old factory, and now you are telling me I have to keep the old factory on-line while I am building my new factory -- so that we can turn the switches on the same day. That is really stupid. Let me buy the old factory. I will shut it down today. It is going to take me eighteen months to build my new plant. I will turn on my new plant and now you have got eighteen months with no pollution at all. So, you should allow me to “bank” the emissions.”
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Energy Forum III: Emissions Trading
But these banks are not normal banks, in the sense that you put a dollar in the bank today and when you come back a year later you expect to get a dollar two or a dollar three, or whatever the interest rate is. For emissions you put a hundred tons of pollution into the emissions bank and you go back a year later and you get 102 tons? No, no, no. It doesn’t work like that. In fact it is just the opposite. You discount over time. You go in and a year later maybe you have only got 95 tons -- the pollution in the bank is discounted over time. These are the kind of things that we structured under the US EPA’s emissions trading program. This was all happening in the late 1970s – offsets were introduced in 1976; bubbles and netting in 1979. We consolidated all of these in 1982 into a draft regulatory package. As I said earlier, in 1981 I was running my brokerage, trying to make a living out of this program. But it was 1986 before it was all finally adopted – and it is still in place today. All of this remains in place today. Figure 15: Engineer’ Approach: Credit trading from baseline
Engineers' Approach: Credit trading from baseline
R. Raufer, IETG
You will notice, though, I talked about this thing called an emissions reduction credit. That was what was in the bank. That was what was used in the bubbles. That was what was used in the offsets. These were things that were, basically, changes from the base-line approach. We had some sort of black box limit, and then if we did things better -- we could get credit for it. Wherever that black box was, if we do things better than the base line, better than the black box, you could get credits and maybe sell that to someone else who couldn’t meet the baseline. That was the basic idea – the engineers’ way of thinking about trading. It depends on the technology in the black box as the baseline.
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Energy Forum III: Emissions Trading That is different from the economics approach I talked about earlier, when I was talking about this quantity-based scheme. Remember that under the quantity-based scheme, you have allowances. All of them, everything up to the level you are allowed to pollute, you can trade. Remember we talked about “cap and trade”? That is the quantity-based idea: cap and trade. We cap it at Q, and then all of the emissions allowances underneath that cap can be traded. This is a different way of thinking about the problem, not like the engineer’s ideas about credits. Figure 16: Economist’s Approach: Trade in allowable budget
Economists' Approach: Trade in allowable budget
R. Raufer, IETG
The big environmental problem that was happening in the eighties, then, was acid rain. And here too we had all the same sort of issues about one side of the border vs. the other. The slide shows that the people in Pennsylvania were blaming the people in Ohio for all that acid rain that is coming in and affecting them. There are always cross-border issues -- everywhere in the world. This was a big air quality concern of ours in the eighties, and so what happened was -- we ended up developing an approach for acid rain that used both credits and allowances. Now, my brokerage went down in flames in 1981 after a few months, as no one was really quite sure exactly what it was that I was selling. I had actually received some financial support from the U.S. EPA in setting it up, and what happened was -- I thought, well, now, the EPA was very nice to help support me in setting up a brokerage. Maybe now they will give me some more money to try to figure out why it didn’t work! But I was also thinking about the acid rain problem, and how these economic ideas might work for that. Then I realized, well, if I studied that, I bet the academic community would be interested in that as well. So, what ultimately happened was that I went to the University of Pennsylvania, and EPA funded all my dissertation research,
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Energy Forum III: Emissions Trading and what I focused on was: how could we use these ideas of bubbles and banking, offsets and emissions trading, to tackle this big acid rain problem? What I found was very surprising for the EPA and a lot of people: the market wasn’t going to clear, it wasn’t going to work. All of the proposed legislation in those early years was based upon the existing emissions trading programme. My approach was to use those credits as well. But what I found in my research was that nobody was going to sell their credits. They were going to hoard them. None of the utilities were going to sell their credits because they needed them in the future to use for offsets, and they weren’t really sure they’d be able to buy them back in the future, or what the price might be. So EPA said to me: “Well, that’s great, you are telling us we have got a problem. Don’t just tell us we have got a problem; tell us what to do about it. That is what we are really interested in.” So I came up with a great idea, which was that -- instead of buying and selling these emission reduction credits, these ERCs -- the utilities should lease them. This was a more complicated ERC scenario, but nobody had to give up their property rights. In other words, they could keep their credits, but they could let somebody else use them in the interim period until they needed them. I did this complicated modelling and I was able to show that, yes, I could get the market to clear with this kind of leasing approach. And, of course, the academics loved this, and so they gave me my Ph.D. based on that -- but everyone else in the world hated it, especially the utilities. The first thing those guys said was: “Wait a minute. We sell electricity. We are not in the air quality increment leasing business. This is really strange.” And of course the environmental NGO’s didn’t like it either -- they didn’t like all of this market-type thinking, buying and selling pollution. Figure 17: The Acid Raid Problem
The Acid Rain Problem
R. Raufer, IETG
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Energy Forum III: Emissions Trading
But I then received a phone call from one of the environmental NGO’s, from a guy by the name of Dan Dudek. He is now spending a lot of time in China helping promote the idea of emissions trading – but he is basically the intellectual father of the acid rain market in the United States. He called me one time in the mid-eighties and said to me, in effect: “Look, you are thinking about this like an engineer. Think about it like an economist. Forget about all that credit stuff. Think about this in terms of quantity-based thinking; do it through cap and trade.” He then said, “What do you think about my proposed approach?” I said, “Well, that’s really great technically on paper. It is a wonderful idea -- but you will never get it going. Look at all the hassles I am getting for my air credit leasing idea.” What then happened was -- he ignored me, and he got it adopted! He got the right timing, with all the stars aligned. Reagan had left and Bush was going to be the new environmental president – Bush No. 1, that is – and everything came together. Figure 18: U.S. Acid Rain Control Program – 1990
U.S. Acid Rain Control Program – 1990
Goals
Regulatory Means
Localized SO2 Levels
+
Pollution Markets (Q-based)
1. Prohibitions
Q Nation-wide Market (Allowance Tracking System)
2. Technology-based Standards
Emission Stds. Performance Stds.
Total SO2 Loading
Emissions Trading Program
Input/Fuel Stds. Design Stds.
Brokerage Opportunities
ERCs
Emission Allowances
R. Raufer, IETG
So it all came together, and in 1990 we got the Clean Air Act Amendments, which have these two components. We have the credit trading scheme, still in place, which deals with the localised pollution. And then we have the total loading, which is addressed through the quantity-based scheme. This is the system that has evolved in the United States. It has been tremendously successful, as I said, and what is particularly interesting is that this template, this idea of the credit trading and the quantity-based scheme, working together, is also the template you will see when we talk about the Kyoto Protocol. We use both of those mechanisms in the Protocol as well.
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Energy Forum III: Emissions Trading Figure 19: U.S. Ozone Control Program – late 1990s
U.S. Ozone Control Program – late 1990s Goals Regulatory Means
Environmental Quality Standards
1. Prohibitions
Pollution Markets (Q-based)
2. Technology-based Standards
City/Regional Markets
Q
Examples:
Emission Stds. Performance Stds.
Northeast U.S. “NOx Budget”
Emissions Trading Program
Input/Fuel Stds.
Los Angeles “RECLAIM” Program Illinois “Clean Air Market”
Design Stds.
Brokerage Opportunities
ERCs & Discrete Emissions Reductions (DERs)
NOx/VOC Emission Allowances
R. Raufer, IETG
We have also used it for ozone control. The acid rain was a national programme, affecting more than 2,000 electric utility units around the country. In the ozone control programmes, we did it on a city and regional basis instead – but we’re now expanding that. On the slide you can also see individual city and regional markets listed. The North East U.S. had the NOx budget. Los Angeles had the RECLAIM programme. Chicago also had a market. We moved away from focusing solely on SO2, and began to have allowances as well for NOx and volatile organics. We also introduced new ideas about different types of credits as well, including discrete emission reductions (DER). On the credit scheme slide I showed you earlier, that was actually a DER, it wasn’t an ERC. So there are now distinctions about the types of credits, and furthermore, these were only summertime markets. Basically, they only operated between May and September. Again, these have been pretty successful. And today, what is happening is that we are making the ozone markets broader in geographical scope; the reductions are becoming deeper and deeper; and we are moving now from summertime to year-round control for NOx as well. So there are now prices out there for externalities, and you can go to brokers or to the marketplace, and you can track these prices. If you are going to build a power plant in the United States today, you are likely to borrow money from a bank. The bank is going to come to you and say: “OK, where are you buying your boiler? Where are you buying your combustion turbine?” You’ll have to show them the equipment contract. Then they are going to say: “Where are you getting your fuel from?” And you’ll show them the fuel contract. And the next question is going to be “Where are your emissions coming from?” So, you have to cover the emissions as well, just like the other plant components. It is now a cost of doing business in these markets. It is just a fundamental component of the business. It is no different than the
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Energy Forum III: Emissions Trading others. You can do futures, puts, calls, options, derivatives, all kinds of financial actions like that, any way you want to, to be able to cover your costs. But the fact is, it is now a cost of business -- just like your boiler is a cost, just like your fuel is a cost, your emissions are a cost too, and you had better cover them. So, that is of the way that regulation has evolved in the U.S., particularly in the power sector. We now have sophisticated markets for SO2 and other pollutants as well. It is now just a cost of doing business. Figure 20: Price Signals for Emissions
Price Signals for Emissions
SO2
NOx
Source: Evolution Markets
R. Raufer, IETG
I want to introduce one other idea which is kind of interesting, and which is also changing the regulatory structure. You can think about emissions trading as saying, well, we have a certain level of pollution, and we want to reduce it using a market mechanism. But we can think about a mirror image of that, in which we have relatively low levels of renewable energy, we want to kick them up. You can use the same kind of thinking to create a different kind of market. Basically, all these markets, everything I have been talking about here today-- all of these markets are artificial. Artificial markets are created by the government, and the demand is coming from the government. Never lose sight of that fact. These are not like cell phone markets. People donâ&#x20AC;&#x2122;t buy emission credits because they want to. They buy them because they have to. So, these are artificially constructed markets.
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Energy Forum III: Emissions Trading Figure 21: New Markets: Transferable Renewable Energy Credits
New Markets: Transferable Renewable Energy Credits
Emissions Trading
Pollution levels
Renewable Energy Credit (REC) Trading
RES levels
Zero base
R. Raufer, IETG
But we can artificially construct other markets too, in fact mirror images of the emissions trading kind. Suppose we say we are at two percent of renewable energy and we want to get it to fifteen percent. Well, we can raise a mandate of fifteen percent and say everybody has got to do fifteen percent -- but we in fact don’t really care whether they individually do fifteen or eighteen or twelve, as long as the total amount of renewable energy meets the fifteen percent goal. So, someone might do eighteen percent and sell three percent to someone who is down at twelve percent. And we can structure instruments called T-RECS – transferable renewable energy credits – to do that kind of thing. And what’s interesting is -- just like I talked about the U.S. having a quantitybased scheme and Europe typically going for a price-based scheme -- you see the same kind of approach happening in this case as well. Feed-in tariffs, which are basically price-based systems, are heavily used by Germany, and they were also used by Denmark and Spain -- all the countries that have big wind-turbine vendors. In fact, where we have a lot of wind power capacity is exactly in those countries that are heavily subsidising renewable energy -and basically coming in with feed-in tariffs. The United States, on the other hand, went with RPS -- renewable portfolio standards -- which often use tradable RECs, such as those in Texas and other states. What is happening today is that those European countries have been very successful in using price-based instruments -- but they have now realised that it is costing a lot of money for such subsidies. A lot of those windmills maybe wouldn’t have been built where they are, except for the high feed-in tariff. Germany now has lots and lots of kilowatt hours coming out of windmills, but it was also very expensive -- and in fact by putting in such a
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Energy Forum III: Emissions Trading high subsidy, developers are going to put windmills everywhere whether they belong there or not. So, what happens is that this drives up the cost of the power. So the countries in Europe began to look at these costs, and began to think; “Hey, maybe we should be moving to a market-based type of system instead.” But this renewable energy transition has not been as successful as the pollution trading transition from price to quantity, and there is a very fundamental reason for that. The reason is that is you are dealing with new technology, and the markets tend to be too small and too volatile. So, this is a problem. China is wrestling with this as well, whether they should use price or quantity, whether they use feed-in tariffs on the wind side, or whether to use a renewable portfolio standard. Figure 22: Similar European P –Q Shift for RES
Similar European P
Q Shift for RES
EFFECTIVENESS
P-based Q-based Feed-In Spain France Austria Luxembourg Greece Portugal
Obligation + TGCs Netherlands Denmark UK Italy Norway Belgium Sweden
Green Pricing Finland
Tender Ireland
ECONOMIC EFFICIENCY
Source: RECerT, 2001
R. Raufer, IETG
But this is an interesting issue, because such markets can also strip out different components of the electricity production. For example, if you build a windmill, you are going to sell the electricity -- you sell that right in the local market. But now you can begin to strip out other things like carbon credits, and sell those in the international marketplace. And maybe you can sell the local SO2 and NOx reductions on the local Hong Kong market, if you build that windmill in Guangdong. And all of a sudden you have different tiers of products that are being generated by that windmill, and you have got to start worrying very, very much about double counting, and triple counting and perhaps quadruple counting. There is one study at Tuffs University that looked at one particular project which theoretically could generate six different products. You might be selling green electricity here, and you are selling carbon credits there, and selling something else in CDM, and so on, at
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Energy Forum III: Emissions Trading multiple levels. There are multiple tiers, and it is all being generated by one plant! So, these are real concerns that governments have. It’s great to have artificial markets, and believe me, if you are a developer you want as many of those income streams as you possibly can – I’ll sell this and I’ll sell that and I’ll sell something else too. That’s wonderful. And it helps, because renewable energy is expensive. But you have also got to be very careful when you structure artificial markets that you are not overlapping and double counting and triple counting and quadruple counting. There are numerous opportunities to do so. II. International Environmental Marketplace Let’s talk now about the international marketplace for CO2. In this slide, we see the Keeling Curve, with rising CO2 levels. We see the so-called “hockey stick” temperature rises, and we can see the IPCC scenarios – which are pretty scary. So let us look at the Kyoto Protocol, which is designed to address these problems. Figure 23: International Environmental Marketplace
II. International Environmental Marketplace
CO2 at Mauna Loa
1000 years of temperatures
IPCC scenarios R. Raufer, IETG
The Kyoto Protocol has three economic “flexibility” mechanisms, and I know that many of you are already familiar with this. Two of them are projectbased, and one is budget-based. One is called joint implementation, which generates ERUs – emissions reduction units. That is a project-based mechanism, applied from 2008 to 2012, and you would do that within Annex 1 countries. So, suppose you were going to do an energy efficiency project in Ukraine, and you were going to sell the carbon credits to Japan. That would be joint implementation, and the ERUs that you would be selling would occur between 2008-2012. Because they only operate within that window, you
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Energy Forum III: Emissions Trading haven’t heard a lot about JI yet -- it hasn’t really started yet. It is going to start next year. The Clean Development Mechanism, on the other hand, you have heard lots and lots and lots about. The Clean Development Mechanism – or CDM -generates certified emission reductions – CERs -- after the year 2000. You have to use them within the first commitment period, 2008-2012 – but they are being generated now. In fact, the reason you hear so much about CDM is because Europe has set up a phase 1 emissions trading market, running from 2005 to 2007. Thus, you can generate CDM credits today – but you can also sell them today. There is a market out there, and that is obviously the market people are talking about. It is growing quite rapidly. Figure 24: Emissions Trading in the Kyoto Protocol
Emissions Trading in the Kyoto Protocol Project-based
• Article 6: Joint Implementation – Transfer of “emission reduction units” – Project-based, effective 2008-2012
• Article 12: Clean Development Mechanism – Transfer of “certified emission reductions” – Banked after 2000, used during 2008-2012 Budget-based
• Article 17: International emissions trading – Transfer of “assigned amount” units – Annex I countries, 2008-2012 – + Post-Marrakesh “removal units” R. Raufer, IETG
The other flexibility mechanism is international emissions trading, which is the budget-based trading approach. That is essentially a quantity-based scheme for the annex 1 countries. It too will begin to operate in 2008 to 2012. The units of international emissions trading are “assigned amount units,” or AAUs. It represents a budget, like the NOx budget we spoke about earlier, or Qbased schemes. So, if you think about this in the same way that we have talked about our previous trading systems, you have project-based systems which have a certain base line. You can then make improvements, and generate these credits, much like we discussed before. Or you have a quantity-based kind of system, budget-based, which has an international market buying and selling AAU’s. This kind of framework is the same sort of template that I just mentioned that we use for acid rain. It is a combination of credit trading and budget-based trading as well.
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Energy Forum III: Emissions Trading Figure 25: KP Q-Based Program
KP Q-Based Program Goals
Reduction of GHG Emissions Project-based
Regulatory Means
Budget-based
1. Prohibitions
Pollution Markets (Q-based)
2. Technologybased Stds.
Emission Stds. Performance Stds.
International Emissions Trading JI , CDM & LULUCF GHG Improvements
Q
Annex I Countries “Hot Air”
Input/Fuel Stds. Design Stds.
Baseline Conditions
Brokerage Opportunities
AAUs
ERUs, CERs, & RMUs
R. Raufer, IETG
There are important differences, however -- especially when we talk about the base-line conditions. Because instead of having that nice black box that I talked about with the government telling you to do certain things -- as our base line in SO2 ERC trading, for example, or any other kind of credit trading in the U.S. -- in this case, we instead have a “What would have happened in China if we didn’t build a windmill?” as our base line. Which obviously introduces a lot of questions. Because what would have happened in China? Well, they would have built another coal fired power plant probably, but now the question becomes one of “If I am going to generate the credits, what do those credits represent? If I build a windmill I am not putting out any CO2 -but what I am getting the credits for?” The answer is what would have happened versus what does actually happen -- and it is that difference that now becomes a credit that I can sell in the market place. But you can see immediately that now I am talking about getting a base line from a counter-factual situation. This is something that would have happened. Well, who knows what would have happened? But somehow we have to document that, and we have to make sure that it is real, because that is how we set the baseline – and it becomes the foundation for our credit system. So, what has happened is we have had to set up a very, very complicated system. Many of you, I know, participate in this market, and just trying to figure out how it works can be difficult, because of the complexity. But the bottom line is that you need that complexity to deal with the nature of the problem as it is currently defined. I worked in the U.N. for four years, and I learned all about U.N. acronyms and U.N. speak -- and of course it didn’t surprise me when I found out that the auditors of the U.N.’s trading system would have a name like ”designated operational entities,” or DOEs. The DOEs under the Kyoto Protocol are essentially the auditors. They are the
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Energy Forum III: Emissions Trading people that really have to make sure this thing is for real. On the slide, you can see that they come in at a very early stage and they basically look at the whole project. There are base-line methodologies that have been approved by the CDM Executive Board, and the DOEs have to make sure that those are used correctly, and that all of the calculations have been done properly. They have to validate the project, and then it goes back to the Executive Board. Further down, they are going to come back in at a second stage, in the verification stage, to make sure that everything was done properly. Credits are just like the electricity in the project. You have to build the windmill. You generate electricity. But you donâ&#x20AC;&#x2122;t have anything to sell until you generate the electricity later on. Well, the same thing happens with the carbon credits. In fact, the credits for the carbon are directly linked to the electricity, because you are selling electricity that was generated by a windmill instead of by coal. So, what happens in the project development is that you donâ&#x20AC;&#x2122;t start generating carbon credits until you are generating the electricity. Figure 26: Clean Development Mechanism Project Cycle
Clean Development Mechanism Project Cycle
Source: UNFCCC
R. Raufer, IETG
This is important because a lot of people tend to think of CDM as a nice pot of gold, and you can then use all of that money to build a nice windmill. Well, no. The fact is this is one income stream into the project, and CDM is not a pot of gold. What it is, however, is a line on your pro-forma sheet that represents an income stream. You are generating credits over time, just like you are generating electricity over time -- and you can then sell them both. Hopefully, you can finance that project based upon these income streams -but it represents an income stream, and what is crucially important are the energy services that that project is providing. Another thing that makes CDM very, very difficult is that if it was economical to build the windmill in China-- then it would have happened anyway, and so CDM would not apply. So in order to meet CDM criteria, the project has to be
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Energy Forum III: Emissions Trading what we call “additional.” It has to be additional because we are offsetting here. We are basically doing a credit-based scheme where I am allowing more pollution in one country because of that windmill in China. So that means it had better not have happened anyway. If it was going to happen anyway, then there should be no credit for it. That is what was in the base line. So you need to show that the project is in fact additional, that it wouldn’t have happened -- except that now, with this extra income stream from the CDM credits, you are going to be able to build this facility. As you can imagine, a big, big part of the transaction costs in all this is trying to figure out if this project is additional or not. You have to prove that, and the DOEs are particularly interested in you proving that these credits are real, and that the project is additional, and it just wouldn’t have happened anyway. So, we have this rather complicated system. But eventually, after you have met all of these criteria, and have actually generated the certified emissions reductions, they can then be sold in the international marketplace. Figure 27: CERs from registered projects
CERs from registered projects
Source: http://cdm.unfccc.int; 30/11/06
Expected annual average; 104,445,772 tonnes CO2e/yr
R. Raufer, IETG
The CERs have to be used within the first five year commitment period of the Kyoto Protocol. What happens in 2013? Today we just don’t know. We know that we will be generating credits, because the methodologies are in place with one-time ten year baseline determinations, -or three seven-year baseline determinations. We also know that the EU has said they are going to continue their market after 2013; so we do know that there is probably going to be a market. We know that there are countries out there today buying 2013 credits. So we can believe that the market is likely to continue -- but if you are an investor, you have to be very, very careful because theoretically that whole CDM market could come to a halt at the end of 2012.
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Energy Forum III: Emissions Trading There are a lot of different CDM projects out there, and maybe during the Q & A we can talk about some of the HFC-23 destruction projects, and other facets of the market. It has not quite evolved the way we anticipated. It has gone much more towards chemical plants instead of energy efficiency. In terms of total numbers of projects, you are seeing a lot of windmills and projects like that. But in terms of actual credits, the credits are heavily skewed towards chemical plants because of the fact that it is not just CO2 that is covered in this market. There are six chemicals that are covered, including methane, which has a global warming potential of 21 to 1. So, at 21 to one, for every ton of methane you control, you have earned the equivalent of 21 tons of CO2. Chemical plants have emissions which tend to have very high global warming potentials. HFC-23 has a global warming potential of 11,700 to one, so every time you get rid of one ton of that pollutant, then you are reducing the equivalent of 11,700 tons of CO2. And it is relatively cheap to get rid of HFC-23, so the markets are heavily skewed towards that. Perhaps we can come back and talk about that during the Q & A. I should also mention here the EU emissions trading scheme (ETS), and in particular the so-called “linking directive.” This links CERs generated today with the European Union Allowances (EUAs) in Europe’s quantity-based scheme designed to achieve compliance with the Kyoto Protocol. You will see that that market already exists today. It has about 10,000 emission sources - the major point sources -- and about 44 percent of the CO2 emissions are covered in the ETS marketplace. They have gone after the big power plants, and the big industrial facilities in the ETS. They don’t have transport in there. They also don’t have the residential or commercial sectors in there yet either. Not yet, but they are tightening up. Figure 28: Emissions Trading in the Kyoto Protocol
EU Q-Based Emissions Trading System EU Kyoto Protocol Compliance (i.e., GHG reduction)
Goals Regulatory Means
Q
Energy Projects Pilot phase now (2005-2007)
National Allocation Plans (NAPs)
JI & CDM
10000 sources: ~44% of EU25 CO2 emissions
No LULUCF No nuclear
Baseline Conditions
Brokerage Opportunities
“Linking Directive”
EUAs
ERUs & CERs
R. Raufer, IETG
In the U.S., we had lots of time to put together that acid rain market. We took five years to structure it, and the acid rain market took place in a utility
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Energy Forum III: Emissions Trading sector which was already highly regulated. We were regulating the utilities closely, and already had very detailed emissions data. Europe did everything in a period of about eighteen months. They tried to put together the whole market for ten thousand sources, instead of the two thousand units that we had, and they did it without having any emissions data. They were attempting to deal with all of the complicated allocation issues that we talked about. They were having to make decisions about how much power plants should be controlled to meet Kyoto targets versus other sectors – such as the transport sector. And then they had to take the power plant emissions numbers and divide them up for individual plants. They did all of these things, utilizing highly uncertain data, in about an eighteen month period. Well, I think they realised – I know they realised – that this EU Phase I market, from 2005 to 2007, was going to be, in effect, an experiment to get them up and running. And that is exactly what it turned out to be. They learned a couple of things. One of the things they learned is that markets can crash, and that’s what happened last April, because basically the quantity limits weren’t set stringently enough. They also learned that environmental people didn’t think much about the financial implications of releasing emissions data. But all of a sudden, they realized that the manner in which these data get released can have financial consequences. So, they learned that maybe they had better tighten up a few things in that respect. This has been a very strong learning experience -- but the markets are out there today, and they are working. Prices are very low for this year’s emissions allowances, primarily because it is a cap that is not very tough to meet. But these are real markets. There are penalties if sources don’t comply. The penalties are now 40 Euros per ton, and they move to 100 Euros per ton in Phase II. But, if you look at it as preparation for the Kyoto Protocol, they have learned a lot. These markets are big. In the past year there has been $19 billion dollars in EUA trading, so this is a big market and it is going to get even bigger next year when Kyoto’s first commitment period goes into effect. This slide shows the crash that I talked about, which occurred in April 2006. You can also see on this slide that prices are relatively low in terms of Euros – three or four Euros now in terms of the spot market. But an interesting point here is that there are six European exchanges. The biggest one is linked to the Chicago Climate Exchange (CCX). That is the one that Goldman Sachs is buying into. Those six exchanges were linked primarily to energy exchanges that already existed, so basically energy exchanges have moved into the emissions side -- but obviously that is particularly interesting for Hong Kong, which is considering setting up such an exchange. Most of the exchanges in terms of emissions trading have been located in Europe because of the ETS, but recall that most of the credits under CDM have been in Asia.
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Energy Forum III: Emissions Trading Figure 29: EUA Market
EUA Market
€ Spot market last 30 days
2005 EUA Exchanges Source: Point Carbon, 2006; 2007
(Volume %)
R. Raufer, IETG
III. Hong Kong Challenges & Opportunities We are now talking specifically about Hong Kong, and you guys have been getting a lot of bad press recently. We read about runners collapsing, and all kinds of news stories like that, and that’s a real problem. During one recent visit here, I read that they were running editorials about Hong Kong’s air quality in the New York Times. The editorial page of the New York Times is taking a position about Hong Kong’s air quality! So, there really is international interest in this topic, as well as some – well, let’s just say “concern” -- about the way that Hong Kong has been moving in terms of air quality. Figure 30: Hong Kong Challenges & Opportunities Hong Kong Challenges & Opportunities
Thickening haze blotting life from 'Asia's World City' Monday, August 07, 2006
Runners' collapse brings calls for Hong Kong to clean up smog act Time is GMT + 8 hours Posted: 21-Aug-2006 14:00 hrs
Hong Kong was cloaked in dangerously high levels of thick smog on July 25 when Chief Executive Donald Tsang launched the Action Blue Sky campaign to reduce pollution.
A pall of pollution hangs over Hong Kong harbour. Environmentalists have called for a rethink on how Hong Kong monitors air pollution after five more athletes collapsed while racing in thick smog and scorching temperatures Source: Singapore’s TODAY On-line
R. Raufer, IETG
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Energy Forum III: Emissions Trading Obviously you guys have been working on the problem and doing things. You have taken a lot of pollution control actions. Again, the base line here is the 2002 agreement with Guangdong. If you look at the reductions, what has actually happened compared with the 2010 target, you have had significant reductions in NOx and respirable suspended particles (RSP) and volatile organic compounds (VOC) -- but you have also had a big increase in SO2. Figure 31: Hong Kong Side
Hong Kong's Side Actions taken....
.....but expensive next steps Power Sector 20.5-27 bn HK$ Transport 7.4-23.6 bn Industry 0.2-0.4 bn Source: HK Council Sust. Dev., 2006
R. Raufer, IETG
SO2 emissions have been going up instead of down, so that is a major concern. And obviously, since we have talked about marginal cost issues, as you move up the marginal cost curve, it becomes more and more expensive to get additional reductions. Meanwhile, on the other side of the border, you have tremendously rapid growth â&#x20AC;&#x201C; particularly in terms of the power sector in China -- with significant increases in emissions in Guangdong. This slide covers the entire Guangdong Province, not just the Pearl River delta. But you see those emissions numbers going up and up, very, very quickly. Like the rest of China, Guangdong has a very, very inefficient energy infrastructure. There is a lot of energy being added for economic growth compared to the worldâ&#x20AC;&#x2122;s average, or especially compared to countries like Japan which are much more energy efficient.
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Energy Forum III: Emissions Trading Figure 32: Guangdong Side
Guangdong's Side
Rapid growth.....
& increased SO2 emissions 1200K
TWh 200
800K Nuclear Hydro
400K
Gas Oil 100
0 Coal
0
2001
2005
....with an inefficient energy infrastructure (Per unit GDP, China energy consumption: 2.4 x world avg.; 8.7 x Japan avg.)
Source: Zhang et al, 2005; Guangzhou Daily, 2006
R. Raufer, IETG
I spent several weeks up in Beijing last October, and was part of an engineering delegation that went to talk about SO2 and NOx control in Beijing. We visited a number of power plants with scrubbers, and I know that there is a big scrubber construction programme in Guangdong. The country as a whole has a couple of hundred thousand megawatts of FGD currently under construction, and some of that is in Guangdong. There are big issues associated with China’s power sector growth, and tremendous interest – and concern – about it internationally. China is adding well over a thousand megawatts of capacity every single week. Big massive power plants – boom!, one week; boom!, another one; boom!, another one. That is tremendous, tremendous growth, and you know that most of it is coal fired. They haven’t got a lot of oil. They don’t have a lot of gas. What they have got is coal, and they are burning a lot of coal, and so that is a real, real problem in China. In the Q & A we can talk about some of these issues, like the role of scrubbers, and pollution control. It is a fascinating problem -- but it is also a very worrisome problem for China and the world. So we see here a situation where one side has done considerable pollution control and their marginal costs are increasing, and then on the other you have an inefficient system, expanding rapidly. That potentially represents an important opportunity, with large marginal cost differentials. Since SO2 control is a problem within the region, then this opportunity warrants attention. You have talked to the World Bank, and to people in the US EPA. In order to implement emissions trading to take advantage of such opportunities, there is a whole series of things that are necessary. The slide lists important components in structuring an emissions trading programme: for example, realism, gradualism, and legal flexibility. Compliance is a very big issue: how do we ensure compliance?
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Energy Forum III: Emissions Trading When we started that emissions credit trading programme in the United States, as I said, there were a lot of people who were very sceptical about using markets. We didn’t call it emissions trading initially; we called it “controlled” trading. That is what it was called for years -- controlled trading - and every single transaction was scrutinised heavily by the government. That is exactly what it was. It was controlled trading. It wasn’t really much of a market. It was really a very stringent system that evolved into markets over time. We were able to incorporate measures to ensure that technology was used, in the form of continuous emissions monitors, to help ensure compliance. We can also talk about third party enforcement and other reporting mechanisms that can be employed to assure compliance as well. So, obviously, these are all program components that you have to be thinking about, and programs will be different in every part of the world. You can’t just take the American model, and force it to fit. Obviously you have a very different situation here; the laws are different; the customs are different; everything is different. So, you have to be thinking about these kinds of issues within a Hong Kong setting as well. Figure 33: Key Components to make ET Work
Key Components to make ET Work
World Bank
• • • • • •
Realism Gradualism Legal Flexibility Leadership Participation Market Reliance
& Civic Exchange added a few more.... • • • • •
Simplicity Commitment Verification Compatibility Cultural specificity
R. Raufer, IETG
So, let me wrap this up by saying that obviously there is now a very strong, growing, active international marketplace for emissions trading. For people like me, it is wonderful to see this happening, because I really do believe that -- when you are dealing with pollution control -- you really have to be thinking in economic terms about how to get this kind of work done properly. It is not enough to just have the government say: “do this”. You really have got to get the market forces aligned to get the job done properly. We are now seeing these economy-based policy shifts occurring on a worldwide basis. I don’t know if you have seen our CLSA report yet, but in there
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Energy Forum III: Emissions Trading we talk about Madisonian systems. That is a question about whether it is necessary to have one big international Kyoto marketplace, as opposed to lots of smaller markets bubbling up. That way, different countries can do different things. We haven’t talked much about AP6 yet either. That is another approach, which some people say it is complementary to Kyoto, because it has a strong focus on technology. AP6 is the Asian Pacific Partnership on Clean Development and Climate, which has got the big polluters involved: China, India, and the U.S., as well as Japan, South Korea and Australia. The AP6 countries are taking a pro-technology kind of focus, and again we can spend some time on that. I am very fascinated by it -- but then I am an engineer. I like thinking about some of these types of approaches, about how we might use some pretty esoteric systems in China -- in terms of high temperature gas cooled nuclear reactors and that kind of new technology, to help tackle climate change concerns. Perhaps we might discuss these issues as well in the Q & A period. Figure 34: Final Thoughts
Final thoughts
• Strongly growing, active international marketplace • Worldwide Q-based policy shift (and "Madisonian" market convergence?) • 30 years international ET experience • Significant local environmental concerns R. Raufer, IETG
But I’d like to close by saying that we now have a lot of experience in doing this – in using emissions trading and market-based approaches to pollution control. These markets really work. We know they work. We know they work well, in fact, and so we want to see them being used more and more, in places that need help tackling pollution concerns. China is an obvious place -but also, when you look out of the window right here, we have some things that have to be dealt with. Obviously, to the extent that we can use such markets and develop a system that works, we want to do it. And that links to the last point on this slide. We have significant local environmental concerns here. Hong Kong should definitely be looking at market-based solutions to address them.
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Energy Forum III: Emissions Trading So, with that, I’d like to thank you very much for your attention. Hopefully in the Q & A session we will be able to get into further details about emissions trading and market-based approaches. Thank you once again. Section 2: Audience Question and Answer Question: Going back to one of the things that you talked about at the beginning, you said that there is a need for a fist, the government fist. There have been a number of pilot projects for emission trading experiments in mainland China, and I wonder if you would talk a bit about those experiments. But in talking about it, perhaps if you could talk about what the role of the government regulatory culture was in whether those pilots were successful or not. Could they implement monitoring? Could they implement enforcement? Were there penalties that were sufficient? And what is happening in the mainland in that regard? How do you see that evolving, whether the mainland can implement those critical ingredients that would support an emissions trading regime and a market? And then turning to Hong Kong, where historically the special flexibility of Hong Kong and the light hand of regulation have been its key competitive edge, one wonders whether that regulatory culture exists to make Hong Kong a very important place in the world of emissions trading or whether in fact, although many people would like to see Hong Kong be a special city, a special place for the carbon emissions trading market, maybe there is a question whether it will have any particular role because of the absence of a regulatory culture and philosophy that might underpin it. So, mainland China and Hong Kong? Answer:
Wow -- what a simple question! Really easy, yes!
I did mention the government fist. It does take a government fist, and this has really been a major force in the development of these markets. In the United States, we had the Clean Air Act of 1970 – and it was only when we started running into problems with the implementation of that law that we developed emissions trading. Offsets came about not because of the brilliant ideas of economists. It came about because we ran into some problems with the way our law was written. When we tried to actually implement it, they said you couldn’t build any new facilities in Los Angeles, because the air was already too polluted. And so people said: “Wait a minute. What about new jobs? What about growth?” So EPA thought “What are we going to do about this?” And the answer they came up with was the offset policy. This offered a means of getting rid of pollution in Los Angeles while still allowing the economic growth. Governments have to worry about jobs and growth, and the offset policy was consistent with the legal system we have. Now, when you get into dealings with other countries, right away you introduce all kinds of questions about the fundamental legal structures in the
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Energy Forum III: Emissions Trading country, about the cultural aspects. A couple of years ago I wrote a paper entitled “Air Pollution Engineering as Cultural Experience.” [Ed. Note: this appears in the book Smoke and Mirrors: The Politics and Culture of Air Pollution, E.M. DuPuis, Ed., NYU Press, NY, 2004.] I used China as an example in the paper. I noted that I did a lot of work in the United States for a power plant in the city of Philadelphia. I was working on a new combustion turbine, and what was unique for me was that I had three bosses -- the electric utility, the steam host, and the developer. It was very difficult dealing with the negotiations amongst these three parties -dealing with the regulator was actually pretty simple in comparison. When I came to China, I compared this with the Three Kingdoms -- the power utility was like the Wei Kingdom; the steam host was the Wu Kingdom; and my independent developer who was going out of business at the time was like the Shu Kingdom. And I was Kongming! So it really is necessary to address the cultural aspects, to get into the legal system, and to deal with the way the system works in Asia. You may have seen the book The Geography of Thought. [Ed. Note: The Geography of Thought: How Asians and Westerners Think Differently… and Why, by Richard Nisbett, Free Press, 2004] It talks about how Westerners think versus how Asians think, particularly about things like contracts. It gives an interesting example: I will give you three words, and I want you to tell me which two words go together. The three words are: monkey, panda, banana. Which two words go together? Westerners tend to say monkey and panda, while people from Asia tend to say monkey and banana. Westerners tend to think in terms of abstract categories – the type of thinking that goes all the way back to ancient Greece and Platonic ideals. Asians tend to have a Confucian type of thinking, where everything is defined in terms of relationships. So, when you sit down to write a contract or to enforce a law, those differences can matter. When you are a Western power company and you have a power purchase agreement, you tend to think; “OK, that is cut and dried, and specific, just the way it is at home.” But of course it isn’t. Asians sometimes consider contracts as milestones in a relationship. As the situation and the relationship change, then of course the contracts should change as well. You get very different ways of thinking, and this can permeate environmental situations as well. If you have a regulation or a standard, is it something that can be negotiated or is it absolute? Is it a black and white determination? That is typically what we have in the United States. In some respects that makes it difficult for building plants utilizing new technologies. If you don’t get the standards exactly right, you could be shut down. The other part of the issue deals with economics and economic growth. Those of you who know economics will have heard about the Kuznets Curve -which basically holds, in effect, that things are going to get worse before they
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Energy Forum III: Emissions Trading get better. We are going to grow our way into pollution control -- but we’re likely to get dirtier in the meantime. So, things are going to get worse, but then we will get wealthy and then we will take care of it. That is the fundamental belief of a lot of people. Certainly if you talk to many people in China, there is a strong belief in the Kuznets Curve. Academically, there is a real debate about this. The World Bank has reported that the Kuznets Curve is different for different pollutants. So, yes, NOx is a tougher pollutant to control than SO2, and SO2 is a tougher pollutant to control than particulates. So you have these curves that say that when you reach a certain level of wealth, you should be able to control different pollutants. But one of the problems that we see, for example, is that China should be pretty far along the road for particulate control by now. But in fact, you just can’t count on development to buy you environmental protection. What you also need is institutional infrastructure to obtain it as well. There are thus multiple tiers of control requirements in your question – in terms of culture, in terms of legal systems, in terms of economic growth -and then you try to impose some kind of foreign, novel idea like emissions trading on top of all of these components. I have already told you that a lot of cultures tend to think in terms of price-based systems as opposed to quantity-based systems. Europeans have been moving from price to quantity. My gut reaction is that eventually China will do that as well, and most of the countries of the world will ultimately employ these kinds of markets as well -but it is going to take a while to get there, in slow steps, and in different ways. I really do think that this has to take place over time, in a transition. I recently wrote another paper addressing energy in Chinese cities [Ed. Note: “Sustainable Urban Energy Systems in China,” NYU Environmental Law Journal, Spring, 2007]. I noted that there are a lot of opportunities to tweak China’s price-based system to make their pollution levy system work, as opposed to going automatically to quantity-based systems. I don’t say they should forget about quantity-based systems; in fact, they should be learning from the Kyoto Protocol. If you look at the Kyoto Protocol and those transactions, the DOEs, the enforcers, the auditors are outside of the domestic economies of the developing countries. Plus, there is also an extremely high level of transparency under Kyoto. You can go to the internet and download all those project details. You can know everything about that project – almost as much as the DOE does. There are tremendous, tremendous levels of transparency which I think is one of the most valuable aspects of the Kyoto Protocol. It gets people and countries that have not normally thought about environmental management thinking about it in those terms -- about transparent terms, and being subjected to this sort of international auditing, if you will, that is coming in and opening the doors, so to speak. “You want to take money for carbon credits for that project? Then you had better make sure it is real.”
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Energy Forum III: Emissions Trading I personally think that China is in a situation where it should develop the enforcement mechanisms of its price-based measures. It should raise the pollution levies, for example, even while it can be learning from pilot projects on the quantity side. But let me tell you, I was up in China a few months ago for a meeting with people from SEPA, and there was tremendous interest about Hong Kong’s emissions trading pilot scheme. China recognises that this is a place that has a very strong legal system, and very strong pollution control measures have already been undertaken -- and so this represents an opportunity to take trading to the next step within China. It might not be a perfect step. It may take a while to get this kind of transition going -- but the problem is real, as I said, and this can help Guangdong a lot just as it helps Hong Kong. I have covered a lot of ground in trying to answer your question, talking about culture, economics and legal systems, but that is the very nature of the problem. It really is. Question: Thanks for really a fantastic talk. I think the challenge for us professionals who work in this area is how difficult it is to communicate a lot of these concepts very simply and I will come back to the simplicity point, especially what you were just talking about, the first question. We have this proposal in Hong Kong which we are not entirely sure what it is, but it is likely to focus on voluntary emissions trading, focusing on sulphur dioxide or there are two other pollutants that are mentioned for the Pearl River delta, which is obviously between two jurisdictions. What do you see as the best starting point for us to solve the pollution problem from our side? Because we have debated emissions trading to a certain degree but others, including some Europeans funnily enough, have talked about the fact that they have brought sulphur dioxide under control really by hard regulation. So, should we have a blend, a blended approach that includes getting in some hard regulation that works and also bring in the voluntary scheme so that we are gearing people up to the whole idea, eventually transiting to what you were talking about, for emissions trading on a regulatory basis, simplicity being the key. Answer: Again, these are tough questions you are giving me. I don’t personally think you can totally divorce emissions trading from the command/control regulatory scheme. These markets that we have developed in the U.S. are really sitting on top of an existing regulatory scheme. So any trading scheme in Hong Kong is going to be built on top of what is already there in terms of regulations. I do think it is a little tough to talk about separating them. One of the problems that you face here is that we in the U.S. and Europe cleaned up our cities by shifting fuels. The problem that China faces and that Hong Kong faces is that there is not a lot of natural gas here to make such a transition. You might say: “Well yes, just use regulations,” but the fact is that economics plays a key role in this. If you don’t have a lot of gas, it is going to push you very far up the marginal curve. And usually what that means is that your costs become very critical and very expensive -- and you really want to be using a market mechanism to accomplish what you are
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Energy Forum III: Emissions Trading doing. You can still have very stringent goals but the fact is you want to use economics any way you can to help you accomplish that. In Philadelphia near where I live we have reduced more than 93 percent of the SO2. Yes, we can get more control in Philadelphia, but getting last amount is pretty difficult. So you want to use economic instruments at that point to try to help you make any improvements. It can definitely help. In other words, you should always be thinking of economic instruments as being useful tools – but ones which are superimposed upon a regulatory infrastructure. As your goals become more stringent, or as the nature of your fuel condition imposes constraints, those tools can become increasingly useful. Question: Thank you. So, a very heavy coal base line is the problem. In Philadelphia it would suggest that they could change to gas quite easily. I am just thinking out loud. Answer: In terms of that, that’s basically how we cleaned up our cities. That is what we have done. We have simply gone up the fuel ladder. And that really, that was fundamentally how Europe cleaned up as well. We went to cleaner fuels. Today, people say: we don’t want any fossil fuels. We want to use wind and other renewables. There is also some potential for high-tech kinds of things, like gasification, carbon sequestering and other kinds of technologies like that -- but those things tend to be very expensive. So I think trading is a good idea to help in this transition. It is not an “either/or” world. You’ll have to use everything you have got to help clean up. Question: Can you talk a little bit about what lessons the carbon credit market, particularly the European one in particular, needs to learn from the way in which money supply is controlled in the States? In the U.S. you have got an excess of monetary liquidity. The Fed goes and puts up the interest rate and the whole thing gets controlled. In Europe at the moment there is an excess of carbon credits and the price is just going down, and the government, as far as I can see, is just sitting there and saying “oh, what a pity”, and not being able to do very much about it. Answer: I do think, first of all, that the Europeans recognize that this was an initial effort, and that there was a tremendous learning curve. They tried to do an awful lot in a very short period of time. I do think they have learned a lot, including the two items that I have mentioned: the first is how tight the regulatory requirements are. I mean, when you start to design an emissions market but you don’t know what the emissions are, you are starting off at a pretty low point. So now they have a much better feel for that. The second point is that the way you release emissions data, when and in what form, is also significant. There are a number of people -- like David Victor, at Stanford -- who have discussed the currency-like nature of these instruments. I tend to think of it
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Energy Forum III: Emissions Trading in terms of a quantity of pollution, almost like a commodity, but others talk about it very much in terms of a currency system. Their focus is where currencies are strong and how they work. So, it mirrors this question about working within infrastructures in the U.S. and in Europe right now. That is where we have pretty strong institutional structures. As we move into other parts of the world, institutions might be weaker and governmental markets may not work as well. Victor also makes the point that, just as you are going to have strong currencies and weak currencies out there in the market place, so will you have strong and weak emissions trading systems. He suggests that a “Madisonian” approach, that we talked about in our report, might be appropriate. Instead of trying to have one global system like a top-down Kyoto, you might have the market bubble up with numerous systems at work. There are arguments for both sides, I think. The Stern Report says just the opposite, that a global system should be developed -- so economists can argue about these particular points. But I do think these markets are evolving. They are learning, and obviously here in Hong Kong you want to be looking at all those things, what has been learned already in the U.S. and Europe. Question: I am from the Central Policy Unit of the Government, but these are my personal views. I think to put it simply emissions trading involves bad guys paying the good guys, otherwise you become the good guys. In Hong Kong we are facing a very specific situation where in the Pearl River delta and Hong Kong we have different jurisdictions. We have different emissions standards. Those are subject to the same reduction targets, and now the power plants in Hong Kong, the relatively good guys are required to pay the relatively bad guys in China, which looks very much like you said, a controlled trading kind of scheme. So, what is your opinion? How is it going to work in the Hong Kong context? Answer: It is interesting to hear about the good guys and the bad guys, because I used to be called a bad guy when I was talking about buying and selling pollution. Everyone said, “Oh, you are a bad guy.” It was really tough. Years ago Bill Ruckelshaus was the US EPA Administrator, and he was asked what was the biggest problem in managing the EPA. He noted that the biggest problem had shifted. When EPA was just starting up, it was helpful to have people talking about pollution in moralistic terms, because it helped to get things going. But later on, he felt that this approach became an impediment - because pollution is a fact of life. It just is. We are polluting entities. So it always going to be there. The same kind of problem arises when you talk about marginal costs equals marginal benefits. What does that say? When you say that you want marginal costs to equal marginal benefits, that means that what you want is an “optimal” level of pollution. Environmental groups immediately say “Wait a minute. How can you have optimal pollution?
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Energy Forum III: Emissions Trading Pollution is dirty, and degrading, and contaminating.” That is what it is. To pollute is to contaminate, to make impure. And here we are, economists, talking about optimal levels -- optimal levels of impurity! But we like warm houses and warm food, and things like that -- and we are going to get some pollution out of it. Hopefully technology is shifting over time and we will be able to minimise it. But I really think you have to think of this in terms of-- not so much moralistic terms -- but rather coming up with realistic kinds of ways of addressing the problem. This means things like enforcement, and legal compliance, and making things happen in a real way. That is what it really comes down to. In other words, yes, OK, there is this problem. We don’t live in a perfect world. I can say: “I’m the good guy and you’re the bad guy,” and most people in fact tend to think that way. I showed you a slide earlier with the people in Pennsylvania blaming the people in Ohio, and that is the way people tend to think. But the fact of the matter is that both sides pollute, and you have got a lot of pollution right here in Hong Kong. It is certainly a problem in Guangdong, but there is a lot here too. A lot of what you breathe is local pollution. So you have to figure out ways to make these things work. Hopefully, using economic incentives can help move you in that direction. There is no easy answer. If there was a real simple answer, it would already have been done. That is a fact of life. But I do think that you want to use economics as much as you can, because there is a lot of work to be done out there -- and as I said earlier, you can be a lot more aggressive if you are doing things right. Question: The question I have is a kind of a follow-on to the point you were just making, and that is the growing awareness of market-based mechanisms by the general public has been pretty effective at getting people to understand, not just the environmentalists, but mom and pop, that there is a value associated with this and there is a cost associated with it. As we look at carrying on the debate, the intellectual debate about what is the best way to achieve this, and not just market-based mechanisms but other things, how do we keep that debate in a positive vein so that we don’t have the same economists that wrote these protocols are now often quoted as - and they make great sound bites - saying that they don’t work for this problem or that. And mom and pop, who are now starting to shut their lights off or maybe look at efficiency in their factory, are kind of discouraged by it all. What are the lessons you have had about keeping the general public enthusiastic about this debate? Answer: I wish I had a blackboard that I could draw on because I am going to refer back to that cultural model that I talked about earlier.
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Energy Forum III: Emissions Trading Figure 35: Cultural Model
[Ed. Note: the cultural model aboce can be found in: Schwarz, M. and Thompson, M., Divided We Stand: Redefining Politics, Technology and Social Choice, U. of Pennsylvania Press, Philadelphia, PA, 1990; this figure was not shown during the presentation.]
I want you to imagine an upside-down U with a pea on top of it. And you move that pea a little bit, what happens? The system just collapses. Now I want you to imagine another model which is a U with a pea in the bottom, and now you move that pea and it rolls right back to where it was. So, that is a different way of thinking about the world. And now I am going to give you a third model, which is a camel’s hump. So, you have got a camel’s hump – it is a double hump – with a pea in the middle, and now, as long as that pea stays within the hump, everything is OK. Outside the hump you have got a problem. That’s the third model. I am now going to give you a fourth and final model: a flat line. There’s a pea just sitting there on the flat line. Those are four ways of thinking about environmental problems, four different cultural models of thinking about environmental problems. And we call the ones that gave us the upside-down U with a pea on top the egalitarians. And who are these egalitarians? Greenpeace, environmental NGO’s, and so on. They are very worried -- if you move that pea the least little bit, then the whole world is going to collapse. The second model I gave you, the U with the pea in the bottom -- who is that? That’s the economists, of course. They talk about a nice stable world, and basically what happens is that they talk about pollution as an externality - that is external to the market transaction, by definition. If you think about
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Energy Forum III: Emissions Trading it, pollution as an externality -- it lies outside of what they even think about. Basically, in the figure, the market works and everything is fine within that framework. Now, what does the camel’s hump represent? The camel’s hump are all the administrative types -- the environmental protection agencies and the governments and the police and the cops. They keep the world operating within that proper range. As long as things stay within that range, everything’s fine. If you get outside of the range, then you have a problem. Finally, who’s the flat line? That’s the public. That’s the general public. That is the general population that doesn’t even think about the environment most of the time. These are what we call the fatalists. So, you have one passive group, the fatalists, and three active groups: the hierarchists – those are the guys in the camel humps; the egalitarians, which are the environmental NGO’s; and the individualists, which include the economists. Now this cultural model says that there are three active groups, and one passive group. The three active groups are the hierarchists, the egalitarians, and the individualists. These three groups are fighting with each other all the time, and all three of them are trying to influence the passive fatalists. And what this cultural model says is: from any given position, the other folks appear to be crazy -- but it is the strength of countries like those in Western Europe and the United States that they have developed institutional systems where these people can fight. But a key point is that they all need each other. The environmentalists need the wealth that is driven by the economist types and the markets, and they need the contract law and the environmental enforcement that the hierarchists provide. And the same time the individualists need the environmentalists complaining all the time to create new needs, and the hierarchists to enforce the law. You can’t have markets in anarchy. So everyone needs the others. I do a lot of work in China and Russia and the formerly centralised economies, and Schwarz and Thompson, who developed this model, suggested that what happened in those countries was that they basically tried to wipe out two of the groups – the individualists and the egalitarians. They tried to eliminate the market people and the complainers. OK, who are you left with? You are left with the hierarchists – the army and the police and bureaucrats – and the fatalists. That’s all you have. So, now what is happening is that the other two groups are now making a come-back. So, the answer to your question - a very long-winded way of answering that question! – is that basically I don’t think you are ever going to get away from conflict about these different views. NGO’s are different from economists. They tend to think about the world very differently. But the fact is that constant conflict within the proper institutionalised setting can accomplish tremendous social change.
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Energy Forum III: Emissions Trading
Question: In an ideal world, we would have some form of cross-border environmental energy management with Guangdong, but it seems unlikely to happen any time soon. So, I wonder what you see in terms of prospects of Hong Kong to have its own local cap-and-trade system? Could it work? Would it have any impact in terms of pollution abatement? When you look at Hong Kong in a comparative context, say compared to Los Angeles or any other cities that have made huge improvements, what kind of lessons and parallels do you see or not see? Answer: I guess you are basically saying in terms of trying to just tackle it individually here within Hong Kong, without necessarily worrying about the cross-border type of thing -- or how much you should work internally on those systems? Question:
If Hong Kong establishes its own cap-and-trade system.
Answer: Well, in terms of Hong Kong, it seems to me that the goals at the moment, you haven’t accomplished them with the pollution control stringency that you need. The other problem is, of course, that goals should change over time too. As we learn more and more in terms of science, in terms of public health, we become more and more aware of the need for more stringent targets. In the United States, for example, we routinely change the ambient air quality standard. In the late nineties we changed the ozone standard. We changed the particulates standard. We are focusing more and more on smaller particulate. So, we are making that transformation. But I would assume that -- just coming here as an outsider -- that you still have a problem here in terms of accomplishing the original air quality goals. Now, you’ll have to become increasingly stringent, in terms of the kinds of regulations that you implement, and you can use the black box type of thinking to accomplish that. But we are suggesting that you try to use economics as much as you can. I think that you should also realistically recognise that you are also being affected by the outside world. I think you would be naïve if you just tried to ignore that situation. So, it is a combination of both things. You have got to do more here to try to control pollution, but on the other hand you have also got to try to figure out ways to affect those outside influences as well. You have to help them accomplish compliance, and to improve their own local air quality as well. Air pollution is a tough problem. You have got to fight many, many different sources emitting many different pollutants, with very different economic implications – as well as long-range transport, chemical transformations that happen in the atmosphere, all kinds of things! You have got to wrestle with all of those factors. It is not easy. It really isn’t easy anywhere in the world. So, I don’t think there is any easy answer. I don’t think you can separate Hong Kong from the rest of the world -- but you still have to pay attention to what
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Energy Forum III: Emissions Trading you are doing yourself. You have to use the black boxes, and the market instruments as well to the extent you can. Question: I am very optimistic about the emissions trading programme. I am an optimist but I could also see that it is a very, very long journey that we have to take. Given China is one of the greatest polluters in the world, and it is going to become even greater, and given that Hong Kong probably has one of the largest pool of speculators in the world – outside of New York or London – and then if you look at the situation in Europe with its excessive credit problem, how would you, just taking a stab at it – I don’t expect you to give us the answer because I don’t think we know the answer to it – just taking a stab at it, how would you put all the pieces together? How would you get the government to have the will to force compliance so that you could create demand to provide economic incentive for speculators to jump in? Because essentially you are talking about a commodity-based market where you have lots of speculators and without the pricing structure available in the market, if you look at Europe, with its excessive credit meaning low prices, I mean theoretically that means there is no pollution problem, but that is not the case. So, what would you do if you were Adam Smith and you had the tight fist, what would you do to put the pieces together? What would you tell the government to do? What would you tell the brokerage industry to do? And how would you make this a thriving market like the financial futures market? What would you do? Answer: What would I do? Well, I think first of all you have to remember that the European market situation, the pollutant allowances in the ETS phase 1 which is currently giving us very low-priced carbon -- that’s a very shortterm phenomena associated with our learning curve. Basically that’s what happened. They learned they were too easy, but now they are already doing something about that in phase II, which starts in January. If you look at the price today for next year’s CO2, it is not at three or four Euros; it is at fifteen Euros or so. They have already learned from the market’s initial operation – which is what they were trying to do in the first place. Now, when you start talking about solving the whole problem, obviously there several kinds of carbon markets are out there – the CDM markets for the Kyoto protocol, and the EU’s ETS, for example. There are also other voluntary kinds of schemes. You can go decide to become carbon-neutral and go to the internet.. The website will ask you what type of car you have, and how far you drive it, and how old it is -- and then it will tell you where to send your cheque so you can become carbon-neutral. There are these kinds of schemes – which are all voluntary schemes – readily available out there. When we developed the system in the United States, we focused on setting up the proper design – and then all of the brokers and speculators and others
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Energy Forum III: Emissions Trading came into the marketplace by themselves. As the government, you have to worry about getting the design right, getting Q right, and doing enforcement properly. But the market itself will basically take care of the other issues. One of the things I always try to make clear is that these are economic instruments that are designed to affect a physical problem, and it is the physical problem that sets how we structure the market, as opposed to the other way round. We had very different markets for SO2, for NOx, and for other pollutants. The marginal costs of control were different, so the pricing of the allowances and credits were also very different. The size of the bubbles for volatile organics was different than those for particulates. There were many, many such differences in the design of these markets. That is what makes CO2 so wonderful. It is almost the perfect pollutant for such an international market! The right way is to just focus on the pollution problem, and make sure that you use the right kind of structure in terms of getting the reductions that you think are necessary to accomplish whatever your goal is. That might require a local market, or a regional market, or a national market, or an international one. But then the market will take care of itself, and all of the derivatives and all of the speculators and everybody in the world will be in there -- if you design it right. But you have to start with the physical nature of the problem -- the rest will follow. Question:
So, it would appear the answer is really the regulator?
Answer: These are artificial markets, and so it is very important how you structure the market. The physical nature of the problem should drive that structure. That is the bottom line. That is exactly the way it is. Question: So, the real question is, what kind of regulator should there be or what kind of qualification should the regulator have in order that they can structure the perfect market mechanism? Answer: The regulator has to worry about the pollution problem. You want regulators who know, who understand whatâ&#x20AC;&#x2122;s going on physically in their area -- so they have to have good emissions data, they have to have dispersion modelling, you have to have meteorological data, you have all the kinds of information to understand whatâ&#x20AC;&#x2122;s happening. When they have that, they can set constraints -- and then you can use market forces to accomplish those constraints. But basically you are right, it is a physical problem. These are artificial markets, and they have to be designed to accomplish the environmental goal. Question:
But who should the regulator be in China and Hong Kong?
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Energy Forum III: Emissions Trading Answer: You already have them. You already have regulatory bodies here and in China too. Moderator: If I could add perspective here? This is a political process that nobody has talked about but Roger has alluded to. I think the issue about the role of environmental regulation - where you set the standards, how tough the standards are - is critical and don’t forget in Hong Kong right now air quality standards, called AQO’s, are extremely lax. So, we don’t have the policy driver to do some of the things that are necessary. So, how tight should that be? Do we want the government now to tighten it to WHO standards? That is one strand of discussion that is on-going in Hong Kong right now. Question: We purchase carbon credits from carbon centre projects in developing countries, among other things, and guarantee them. My question is really I would like to know your view on how you see things evolving postKyoto, and which systems and mechanisms will come into play, and if you think people will act fast enough to make a difference? And also how you see the voluntary market evolving? You mentioned it just earlier. Will we need the mechanisms to verify guaranteed credits? How can that be done in a way that doesn’t have a huge transaction cost for the small or big firm in China that Kyoto does? Answer: Those are good questions in terms of what is going to happen after 2012, post-2012. I really do wish I knew. I mentioned some of the things that are positive in my mind – for example, the fact that the Europeans have already said they are going to continue their market. When they first developed the market, they said they would do it even if Russia didn’t ratify Kyoto, and Kyoto didn’t come into effect. So, the Europeans have been very serious in terms of doing this. They indicated that post-2012 their market is going to continue, and there are countries, as I mentioned, already buying credits post-2012 -- so I think these are very good signs. Nobody here has asked me about the U.S. and Kyoto yet. I always get that! But I think there are very good signs about things that are happening in the U.S., at the state and local level, that many of you are probably not familiar with. In fact, there is tremendous activity in the Northeast part of the country, with the RGGI programme that will go well past the 2012 timeframe. Those markets currently under development are real. They are going to happen. We are going to be using emissions trading in the state of California, and they are now developing systems that are going to go far beyond 2012. From my point of view, there is bound to be a continuation of markets in some form, mainly because of the fact that there has been so much interest generated and there is so much movement in this particular area, and it is effective. Like I said, I think we should be doing it anyway. So, the question is, will the markets be big enough and fast enough market to solve the global warming problem? And that is a little tougher question because the whole of Kyoto gives you about a five percent reduction, 5.2 percent reduction, over
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Energy Forum III: Emissions Trading the 1990 base line. And scientists say we need somewhere between 60 or 70 or 80 percent reduction -- so we are basically saying we need twelve Kyoto’s to make this thing actually have the physical effect that we are trying to accomplish. Now, you can see the problem we’ve had getting even one Kyoto and making that work. To get twelve Kyoto’s is problematic. It really is a problem. So I think that several layers of things have to happen to accomplish that goal. One of them is the fundamental, obvious one which we always talk about -which is market efficiency. Markets working in a country like China, for example. Obviously they have had tremendous economic growth, but they still don’t make decisions necessarily in the energy sector based upon markets. Second, is the price and quantity mechanisms. We have already talked about those approaches today. But some economists are now looking at this problem and saying: “When you are trying to get twelve Kyoto’s, you are almost in a situation where you have to begin thinking that it is not simply a market efficiency problem any more. You had better begin to examine how you might provide energy differently. What we really need is induced technological change.” So, in some economic circles today, “ITC” is the latest buzzword. So you might very well have to add economic programmes designed to accomplish ITC as well as those to reduce emissions. Question: We have been talking about pollution as a cost pretty much all day and I am curious about your thoughts about how we talk about how to factor into these discussions about the benefits of pollution control, because it is not like there are no numbers on this. We have got the Civic Exchange numbers on Hong Kong, saying pollution damages are $21 million a year, and the UA talks about eight to sixteen percent of Chinese GDP per year in damages. Nicholas Stern talks about the damages of business-as-usual carbon dioxide at $85 a ton. So, we know that there are substantial benefits associated with pollution control. Maybe factoring these into our discussions in a more explicit way gets us over some of the hurdles that you have talked about – the public perception that tackling the environment is somehow inconsistent with economic development – or even your description of the world as the sort of debate where really competing higher ideologies could actually coalesce around a discussion about true marginal cost and benefit. How do you start factoring the benefits of pollution control into a debate, into an economics debate, in a manner that then allows you to set meaningful air quality goals? Answer: That gets us back again to the question I hedged a little bit earlier. I talked about marginal costs, but then I pretty much pooh-poohed the marginal benefit curve. What you are saying is exactly right, however. When we have looked at the benefits associated with all of the legislation in the United States - of the Clean Air Act, of all the follow-ups, of the more
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Energy Forum III: Emissions Trading stringent kinds of constraints that we introduced in 2005 - the numbers are very, very heavily weighted in the form of benefits. In other words, everything we have done on the air pollution control side has made tremendous economic sense in terms of doing it – the benefits of control are much higher than the costs. I think that you do face a problem in terms of some of the analytics of doing this, however. We can put good numbers on crop damage and health effects and things like that. But as you move further and further way into what we call non-use values - and non-use values are things like sympathy for other species and the kind of world we want to leave behind for our grandchildren and those kinds of things - you really, at that point, begin to face the problem that the tools that economists use are rather poor. It is very, very difficult to put realistic economic values on such things. There is an old joke about a drunk looking for his car keys underneath a street lamp. Someone comes along and says “What are you doing?” The drunk replies, “I have lost my keys”, and he asks the passer-by to help. After searching for a while, the passer-by says “We can’t seem to find them anywhere.” And the drunk says “That’s probably because I lost them about a block away.” The passer-by then says, “Well, what are you doing looking for them here?” And the drunk says: “Well, the light is much better!” I’ll be honest and tell you that that is the way I think about environmental economics. The light might be good on crop damage and health effects, but that is not the real issue, from my point of view. The real issue is the whole environmental eco-system. Question: Surely the real issue is how to get a discussion about it. At the moment we haven’t even realised we have lost our keys! The real issue is actually recognising we have lost our keys in the first place and have some kind of process to find them rather than discussing about the perfect. How do we have a real discussion? Moderator: I think it is a little unfair to ask Roger that question. It is down to us in Hong Kong to think about emissions trading. Answer: Well, I think it does get back to that question in terms of the cultural model as well. There are different views of the world and people focus on different kinds of things, and I am not arguing with you. I agree with you that in the context of everything I have seen economically, the benefits are way up above the costs of pollution control. I think that is something that you can introduce into the debate. There are a lot of people out there writing a lot of reports, like the Stern report and other kinds of analyses like that, trying to make those points. And certainly NGO’s try to make those points politically. But not everybody always buys in, and you have different world views. The political systems that incorporate these various kinds of views tend
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Energy Forum III: Emissions Trading to be better than ones that ignore them. And I think that is a given fact as well. So to the extent that we can try to make political systems become more aware of such data and analyses, and suggest that they should be using that kind of information -- I don’t discount what the economist says. I just believe that you shouldn’t try to set goals simply based upon what the economist says. You should try to use that as input, along with all the scientific data and the other kinds of information out there -- and try to set goals accordingly. Question: I am a great believer in markets and emissions trading, but my perception is that it is difficult to graft on or make it work unless your underlying economy is basically competitive and based on trading. But I think that’s the problem I see here in getting a cross-border emission trading scheme working because there are two fundamental sources, at least acrossborder pollution. One is factories and the other are power plants. Now, the factories are already across the border in Guangdong and there is no way that by building efficient, clean, non-polluting factories in Hong Kong we will ever compete with that because the land is too expensive and the labour is too expensive. So, there is no cross-border trading in terms of factory output. That will still be based in Guangdong, based on whatever regulatory standards they set over there. Now, we have power plants in Hong Kong and they have power plants over there. But only one of the power companies in Hong Kong is in a position to trade. For the other one, the one which is supplying our lights here, there is no inter-connection with China. There is no inter-connection, or very little inter-connection, with CLP across the harbour. And the problem I see is that I think you are going to have a problem with a cap-and-trade type of system focusing primarily on the power sector, although I understand both governments are looking at that, unless you have a real market in the underlying commodity, the real commodity, which is power. We don’t have that and we are still some way away from that. In your time line you started your discussion this morning, you were talking about the success of these mechanisms in the U.S., and I found the time-line quite interesting because, as you had the grand success of dealing with SO2 and NOx, which are produced in large part from power plants, you also had a growing and very efficient underlying wholesale power market in the U.S., which allowed those costs that are being generated through your emissions trading regime to actually influence the underlying power market and give an advantage to the new gas-fired power plants, to compete against the dirtier, more polluting, coal-fired ones. I am not sure that that condition exists here yet and will not exist for some time. And I was curious to get your views as to how serious a problem that is to an emissions trading regime.
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Energy Forum III: Emissions Trading
Answer: If you take a pure economist’s world view, what matters in terms of emissions trading is the difference in the marginal cost of control as opposed to any linkage of power systems, for example. When I talk about a credit trading scheme in Los Angeles or something like that, the fact of the matter is that there are all kinds of different players in Los Angeles. There are power plants, there are refineries, there are all kinds of manufacturing facilities, a different mix of things. And you literally get trading across all those different kinds of facilities. That is what economists love. They don’t actually like to see trading just within power plants, say, because they all tend to have similar marginal costs of control. They like a mix, and the more robust the mix with different types of sources, the better off you are in terms of being able to do trading. So, I think in terms of exactly how you structure the regulations here, the fact that, for example, one utility may not be linked to another one in the mainland or anything like that -- that really doesn’t particularly matter in the context of designing a system that is focusing on air pollution. Now you certainly have all kinds of compliance issues. You have to define these things relatively narrowly. Our total loading sulphur dioxide control program just affects power plants. We are not mixing power plants with shoemakers and bakeries and other sources like that. But in the credit trading scheme we did. It doesn’t matter whether you are a power plant or a bakery, or whatever. As long as you have the black box regulations that you change your emissions from the baseline, you will be able to buy and sell credits. So, we can have different designs for different programs. You have basically a cap-and-trade on one side here, but then you have got credit generation on the other side, and you can link those – just like Kyoto did. Again, you have to get your compliance right, and you can’t do things like the double-counting that I mentioned earlier. So, it may well be that the designers of the system will have credits over there and caps over here, for different mixes of polluters. I’m afraid that I just don’t know what they are going to come up with. Question: But I think the distinction between those two is important because the credit schemes generate new projects, and that’s a decision you make when you are building a new factory or building a new power plant, whereas the cap and trading scheme is building in incentives to operate efficiently and with as little pollution as possible. Answer: But the credit trading scheme we use for existing sources too, not just new sources. We did it for offsets, but we also did it through bubbles, and bubbles are in existing units. You can get credit schemes to work with existing base line requirements. Question: But the problem is, take Hong Kong Electric. It has effectively one power station. It has a demand. There is very little integration except on
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Energy Forum III: Emissions Trading an emergency basis. There is nothing it can do to change the amount of pollution it generates because that is driven by the technology that it has plus its demand, and it has got no control except once in a blue moon when it has a decision as to where it is going to build a new power plant, which is every twenty years. There is nothing it can do. There is nothing it can do to respond to those market signals because it has no choice. It generates all of its power. If it could take power from CLP then it would have a choice, a choice whether to buy power from China or from CLP, or from one of its own complexes. It doesn’t have that choice. Answer: Again, you have to worry about the physical air quality impacts when you are designing the system. Maybe you get larger reductions across the border that more than compensates for the localized effect. I haven’t gone into the specifics of where the SO2 comes, and how you might address localised versus total loading concerns, and similar issues. Those all have to be addressed in the structure of the market. I just don’t know enough about the physical nature of the specific air quality problem here to tell you exactly how to design the system. But you can see that structurally you should be able to reach the goal, the air quality goal, with sufficient reduction and in a cheaper manner. Maybe it is just cheaper to do it in Hong Kong. I can’t tell you. I am just saying that structurally these kinds of markets are designed to address exactly those kinds of problems. Moderator: Thank you very much, Roger. You are probably exhausted. Thank you for answering so many questions in your presentation. Most of the questions people asked you point to a number of interesting phenomena that we have locally. I think one of the problems that we have is, since most of the pollution sources are from across the border, Hong Kong people generally have felt debilitated. We have asked ourselves again and again what improvements we can make locally that will have a significant improvement on our air quality. The other is in terms of what role emissions trading and market mechanisms can play. I think what Roger has reminded us today, this is a different order of challenge in terms of how to design and use these systems. It combines science, engineering, you have to put in the health, and the environment. It is not simple. So, I think the question that we have to ask ourselves in Hong Kong is: will these systems work? We have seen how it works elsewhere – how can it work here? And then Roger has reminded us that there is a cultural aspect to it. Do we have a culture here where we value innovation? Do we have a culture here where we can work across disciplines? Obviously to design the system, you can’t just have the engineer there. Now we can’t just have the economist there either. We have to have many different types of expertise sitting together to help us find the mix. And what is interesting about the U.S. system is they decided to be very aggressive from the start in using stringent
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Energy Forum III: Emissions Trading regulation to drive down pollution. We donâ&#x20AC;&#x2122;t have that here yet. So, for us what will drive us to tighten standards? I think there are many issues here that we need to grapple with. I think it is not going to be that simple. The final comment I wish to make is, it does require leadership, and having leadership in this particular area in the private sector isnâ&#x20AC;&#x2122;t going to be enough. We are going to need significant public sector leadership to drive some of these measures. Roger, thank you very much for telling us the whole story of how emissions trading has worked outside Hong Kong, and we hope you will come back and share your knowledge with us again.
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