Course:ECON371/UBCO2009WT1/GROUP6/Article8
Group 6: Carbon Tax in Canada
Article 8: Be patient on carbon policy, Raitt counsels
Cited Reading:
- Robert Pindyck - Uncertainty in Environmental Economics
- Thomas Sterner - Policy instruments for environmental and natural resource management
Summary
This article discusses Alberta's actions surrounding climate change. The Federal Resources Minister, Lisa Raitt, justifies the suggested inaction surrounding greenhouse gas reductions due to oil sand investments. She claims that the government has clear goals for emission reduction and that they have invested in the research of new, cleaner energy production technologies, as well the investigation of carbon capture and storage. The president of an oil sands consulting firm, Bob Dunbar, discusses the uncertainty surrounding costs to clean up emissions, as well as the uncertainty surrounding which responsive policy will be chosen by the province's government. He does not criticize the idea of a carbon tax but he does say that a fair policy, that responds to each firm according to their production and emissions, must be agreed upon and implemented soon. He also expresses worry surrounding the proposed American Clean Energy and Security Act; the establishment of a nationwide carbon market with prices that are correlated with large industrial corporations' emissions.
Analysis
The overarching theme behind this Calgary Herald article is uncertainty and its consequences. For the matter of this discussion there are two fronts uncertainty is of importance. First, Industry has billions of dollars to invest and, because of uncertainty in which policy the government will adopt, some firms are holding off investment decisions; the question that will attempted to be answered in this analysis is why. Second, uncertainty again is of importance in relation to the policy the government does choose to adopt; because there are various factors that are unknown, analysis must be made of the preference or selection of a policy.
Uncertainty And Industry Decision-Making
Heavy industry, particular firms in Alberta, is waiting anxiously to know what carbon pricing policy, if any, is going to be adopted by the federal government so informed investment decisions can be made. In holding back billions of dollars worth in investment, the decisions firms will eventually make will depend on the carbon pricing policy Canada adopts.
In theory there is no difference in results between a carbon tax and a cap and trade system, as both are market oriented policies that place a price on carbon. What the oil industry in Alberta is most likely waiting for is information regarding how high that price on carbon will be set.
Uncertainty And Carbon Policy Selection
Federal Resources Minister Lisa Raitt in her interview with the Herald stated that the national government is currently working with the "Science side" to create policy instruments that will enable Canadians to reduce their emissions.
In a perfect world, where we have complete information, a carbon tax or a cap and trade system will have the same effect; however we do not have complete information, and uncertainty exists. Robert Pindyck in his paper Uncertainties in Environmental Economics describes three sources for uncertainty in environmental policy: nonlinear cost and benefit functions, irreversibilities, and long time horizons. He goes on to differentiate three compounding factors of uncertainty: uncertainty in physical or ecological processes, uncertainty over economic impacts of climate change, and uncertainty over technological change.
Most benefits of reducing carbon emissions will occur in the future, but the problem is we can't know what those benefits will be. Relationships between GHG concentrations, temperatures, and climate patterns are "inherently random" (pg 1 pindyck), and even if we know what those changes in temperatures and climate patterns will be, we can't know their economic and social impact because we don't know how people will adapt. Environment cost and benefit functions are typically nonlinear. That is, damage likely to be caused by air or water pollution does not increase linearly with the amount of pollution or emissions. At low levels, there is relatively little damage to the environment, but at higher levels, this damage increases extremely quickly. The threshold point where barely noticable damage caused by emissions suddenly becomes severe with an increase in emissions is unkown. We don't know where the "tipping point" is where the impact of a pollutant becomes catastrophic and irreversible. It is possible to render a population's numbers low enough that it no longer has the regenerative capacity even to cope with deaths from its natural predators, and the species will eventually simply die out as a result. The same can be said of plants and trees, and the reality is that we simply don't know where these points are, or how far we can push nature before it collapses; all we know is that nature's regenerative properties are not infinite. Because of this uncertainty, most suggest environmental policy should be "precautionary," preferring earlier and more intense intervention. But how early, and how intense of intervention? Intervening will most certainly hurt the economy, but not intervening could potentially have far more devastating consequences. Ideally we could find where the costs of are equal to the benefits, unfortunately it is almost impossible to know the true costs before they occur.
Pindyck suggests that for factors that are uncertain in value, some studies rely on subjective analysis, while others assess uncertainty using subjective analysis and expert opinion. pg 9
Discount Rates
Discount rates are used to put future benefits or costs into present value terms.
One dollar 50 years from now is not of the same value as one dollar today, and as such, needs to be discounted accordingly such that values are the same. There is no exact science when deciding what discount rate(s) should be used to calculate present values of future benefits or costs. Environmental policies often involve very long term time horizons. These long time horizons makes discount rate uncertainty even more important, as the chosen discount rate can have very large effects on the present value. How we choose the discount rate is often a question of ethics. While a dollar in the future may not be worth much to us now, and therefore emissions costs of the future also not worth much to us today, those values may be worth much more to the generation that comes after us. Do we have a responsibility to our children to leave them a healthy, clean environment? If so, the discount rate should perhaps be a small one, or even zero, where future impacts have a great deal of weight when it comes to our decision/policy making.
An example, with two rates, .5% and 2% and a future benefit of $250 in 25 years, the present value with the 2% rate is $152.38 while the present value with the rate of half a percent is $220.69. Now with 100 years with a future benefit of $1000, with those same two rate, we arrive at a present value of $138.03 with a rate of 2%, and with .05% we get a present value of $607.29. This shows that with a short term time horizon the difference in rates had a drastically smaller effect, a difference of around only $70 or around 31% of the largest value; while over a longer time horizon the same rates caused a far greater disparity, the difference between the two present values being more than $450 or around 77% of the largest value.
-We don't know the discount rate, it is uncertain
Price Elasticity
The size of a carbon tax depends on how responsive fossil fuel demand would be to tax-induced price changes, and this will vary from sector to sector (pindyck pg 10). Each sector's reponsiveness of fossil fuel demand to price changes depends on long-run price elasticity of energy demand in that sector and long-run price elasticity of substitution between fossil and non-fossil energy sources. We have adequate knowledge of the former but not of the latter. This is because the ability to substitute from a fossil fuel to a non-fossil energy source, coal to wind, depends on cost and availability of the latter. This depends on technological change, which is hard to predict. With long time horizons, policy costs depend on technological change, which is difficult to predict as technology often increases in leaps and bounds, rather than in a steady, linear progression.
Policy Instrument
Uncertainty affects policy, in regards to CO2, whether emissions are better controlled through a price-besed instrument
(emissons tax) or a quantity-based instrument (emissions quota aka cap and trade). If marginal benefit function is steeply sloped, but marginal cost function is relatively flat, a quantity-based instrument is preferable, and that's because an error in the amount of emissions can be quite costly, but not so for an error in the cost of the emissions reduction. The opposite is true if marginal cost function is steeply sloped and marginal benefit function is flat.
However no need to choose just one policy, studies have shown with uncertainty, "hybrid policies" that combine both instruments generally dominate the use of a single instrument.
Prof's Comments
Nice job. I appreciate how you have gone above and beyond, citing other sources.