ETS = Market Failure

I don't know about you, but I worry about the Emissions Trading Scheme. The idea of it. That it is the best way to stop our atmosphere from changing back to what it was before life on earth....

Good old Wikipedia defines the ETS like this:

Emissions trading is a market-based approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants.^[1]

A central authority (usually a governmental body) sets a limit or cap on the amount of a pollutant that can be emitted. The limit or cap is allocated or sold to firms in the form of emissions permits which represent the right to emit or discharge a specific volume of the specified pollutant. Firms are required to hold a number of permits (or carbon credits) equivalent to their emissions. The total number of permits cannot exceed the cap, limiting total emissions to that level. Firms that need to increase their emission permits must buy permits from those who require fewer permits.^[1]

The transfer of permits is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions. Thus, in theory, those who can reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest cost to society.

Yes I know, already the shutters are clanging down. Who wants to read this stuff...

And that's the point. It is a very complex market system that is being devised, which is motivated by money and profit. The very motives that are intensifying the human contribution to the problem. It disturbs me that so many environmentalists are supporting the ETS, and giving credibility to it. Especially here in New Zealand.

Where is the economic evidence that controlling the impact of externalities such as carbon emissions is more effective by charging for it than by direct regulation? Economic theory suggests that by charging a tax equivalent to the social cost of the externality the demand curve will shift to where the socially acceptable quantum of permissible damage lies.

But that's the theory. Consider the various tragedies of the commons. Look at what intensive sheep farming did the NZ highlands (removed vegetation and let the soil wash away into the sea). Look at what diary farming is now doing to our rivers. Even though we can see those changes we seem powerless to do anything about it. Rivers are being damaged in front of our very eyes. But we are told the Resource Management Act and the market will fix it. Yeah right.

We can't see what we are doing to our atmosphere. But we know it's changing. That the level of Carbon dioxide and methane is increasing. Interestingly we do know what the earth's atmosphere was like in the past. See this blog: Thinking about Air Composition. This shows how much carbon dioxide was in our atmosphere long ago. When it did not sustain life. It charts changes to our atmosphere, which, through plant life over millions of years, took carbon dioxide from the atmosphere, and turned it into soil, coal and oil. Returning oxygen to the atmosphere.

This process is reversing now.

Economic theory states that for a free market to work efficiently there must be perfect information to the market. You'd think there was enough information in the NZ market for farming to sort out its act when it comes to rivers. But even if there was, there is still the desire to maximise return and profits over the short term - no matter what the environmental cost is.... human nature....

Economic theory is just that. Theory. Milton Friedman's economic theory is essentially that the market is the most efficient way to allocate resources. His supporters argue - many of them in ACT - that the theory has not been applied rigorously enough to work properly - that it should be applied to housing, health, education, unemployment, retirement, science. The list goes on.

All down to money.

But given the financial turmoil created by the lack of regulatory oversight of the derivative markets, why should we be confident that creating a trading scheme for carbon emissions - with all sorts of derivatives and securities and issues - will be any more successful?

Can we really trust the merchant banks to be able to manage something as esoteric as carbon derivatives, and something as important as the air we breath?

I'm one of the majority who believe that economic rationalist theory is wrong for social welfare, health, and education, and for things like community building. And I have no confidence that it is the best or most responsible way to address environmental issues.

The emission trading scheme is to environmental protection what the trickle down policies of the New Right were to social welfare reform. The invisible hand of the market cannot be relied upon to maintain the life-supporting qualities of our water and air.

Climate Change - NZ Response

Climate Change is another area of study in the Auckland University "Legal and Institutional Context of Planning" paper. Here is some useful background, in the form of a short essay. What I've done here is look at the way the Resource Management Act has been changed, and cover some of the case history relating to applications to establish new power stations in New Zealand...

I start with the Vienna Convention for Protection of Ozone Layer - 1985 - part of what was known as the Montreal Protocol. (When I was at University of Canterbury, NZ atmospheric physics was leading the way measuring ozone in the atmosphere.) In response to this international agreement NZ introduced domestic law, the Ozone Layer Protection Act - enacted in 1990 - to control related activities here.

In 1992 there was the Earth Summit held in Rio de Janiero, Brazil. This led to the Rio Declaration on Environment and Development, Agenda 21, the UN Convention on Biological Diversity, and the UN Framework Convention on Climate Change - sometimes referred to as FCCC. This starts like this:

The Parties to this Convention,

Acknowledging that change in the Earth’s climate and its adverse effects are a common concern of humankind,

Concerned that human activities have been substantially increasing the atmospheric concentrations of greenhouse gases, that these increases enhance the natural greenhouse effect, and that this will result on average in an additional warming of the Earth’s surface and atmosphere and may adversely affect natural ecosystems and humankind,

You can download the 25 page FCCC.

Around this time, the Electricity Corporation of New Zealand made application for discharge consents for a proposed Stratford Power Station in the Taranaki Region. ECNZ applied to the Regional Council for consents to establish and operate a gas-fired power station in 1993. However, citing "National significance" (due to NZ's position on the FCCC), Minister Upton called the application in. This meant that the application could be considered by a Board of Enquiry, but the Minister would make the decision.

The Board recommended consent be granted, subject to ECNZ committing to around 4,000 hectares each year of forestry planting to mitigate the CO2 emissions from the power station. It also recommended that the Minister issue a National Policy Statement on Climate Change.

The Minister – in his decision – which considered the Board's recommendation – granted the consent, but gave ECNZ open licence pretty much to deal with any net increase in CO2, in ways they think fit…(which might include carbon sinks without specifying what those might be, and noting that the Stratford Power Station would be more efficient than ECNZ's other stations and could mean the old ones were used less....).

The Minister's decision was in 1995 and caused considerable disquiet.

Negotiations on what was to become the Kyoto Protocol to the FCCC were started in Berlin in 1995. The draft text was prepared toward the end of 1997, and countries began lining up first to sign it (done by representatives), and then to ratify it (done by Parliament's Executive). New Zealand signed it in 2002. (Click here for a fascinating insight into the tortuous process that was involved in arriving at the text of the Kyoto Protocol.)

At the time, Contact Energy made application to Auckland Regional Council to establish a gas-fired power station in Otahuhu, Auckland. Contact Energy obtained necesary consents to operate the power station. However the Environmental Defence Society (EDS) appealed the decision to the Environment Court, seeking a condition requiring tree planting to mitigate the CO2 emissions. Judge Whiting agreed with EDS deciding that NZ’s signature to the FCCC was a relevant matter, even though at the time NZ had not ratified the Kyoto Protocol. The decision makes reference to the need for a National Policy Statement on Climate Change, and while the appeal was dismissed, it served a useful purpose in focussing attention on NZ's obligations. In passing I note also what the judge had to say about tree planting:

[92]...to the extent that the condition imposes sequestration planting outside the Auckland region, even if the Regional Council has jurisdiction to impose such a condition, we doubt that it can legally monitor and enforce such a condition. Quite apart from the legal position, if such a condition were imposed, the Regional Council would, be confronted with considerable practicable difficulties in monitoring and enforcing it. (The whole decision is here.)

After NZ ratified the Kyoto Protocol NZ set about giving effect to its commitments. This included enacting the NZ Climate Change Response Act 2002, and making changes to the RMA via the enactment of Resource Management (Climate Change) Amendment Act 2004.

According to the MfE website:

The Climate Change Response Act 2002 puts in place a legal framework to allow New Zealand to ratify the Kyoto Protocol and to meet its obligations under the United Nations Framework Convention on Climate Change.

The Act includes powers for the Minister of Finance to manage New Zealand’s holdings of units that represent New Zealand’s target allocation for greenhouse gas emissions under the Protocol. It enables the Minister to trade those units on the international market. It establishes a registry to record holdings and transfers of units. The Act also establishes a national inventory agency to record and report information relating to greenhouse gas emissions in accordance with international requirements. Full text of CCRA

Part 4 of this Act introduces the NZ Emissions Trading Scheme (ETS), which has had a difficult passage, and many critics. The changes to the RMA, via the Resource Management (Energy and Climate Change) Amendment Act 2004 are summarised here from MfE's Quality Planning website:

Under the Resource Management (Energy and Climate Change) Amendment Act 2004, three new matters were inserted into section 7 under Part II of the RMA:

"(ba) - The efficiency of the end use of energy;�
(i) - The effects of climate change; and
(j) - The benefits to be derived from the use and development of renewable energy".

In the context of the RMA, there are two ways in which particular regard may be given to the effects of climate change:

1. As an integral part of making decisions on resource consent applications and notices of requirement under the RMA for which the effects of climate change may be significant; and
2. In proactively assessing RMA policy statements and plans, as they come up for review or other changes are proposed, to identify whether more explicit and/or up-to-date policies are needed to address the effects of climate change than are currently provided.

The second point directly relates to Council's broader strategic planning initiatives. The effects of climate change can be integrated into local authorities ' longer term planning under the Local Government Act, as part of their mandate to take a sustainable development approach.

What this summary does not state is that it required Councils to plan for climate change (mostly adaptation), and that the power of regional councils to consider effect of greenhouse gas emissions on climate change when making rules in plans or deciding discharge resource consents was removed. However the way these changes were made to the RMA meant that the issue was far from settled.

Ambiguity led to a string of legal actions in regard to Mighty River Power's application to locate the Marsden B coal fired power station near the mouth of Whangerei Harbour. After 2004 RMA changes which incorporated Climate Change, Greenpeace challenged the Marsden B Power stataion consents.

The Environment Court accepted Mighty River Power’s arguments - that essentially Parliament had decided that climate change gas matters would be dealt with by National Government. Not by Regional Council authorities. Greenpeace appealed to the High Court, which upheld Greenpeace’s arguments in 2006. This decision was then appealed to the Court of Appeal. And Greenpeace lost that case, though the decision called for a Government National Policy Statement on Climate Change.

Finally, triggered by the possibility of a gas-fired power station in Rodney District, Greenpeace sought a Supreme Court declaration as to what the RMA provisions actually meant. That decision was in 19 Dec 2008 and it upheld the Court of Appeal decision.

On the opposite side of the Green Energy ledger, was the Franklin District Council vs Genesis Power Environment Court decision in 2005. The application related to 18 wind turbines on the south side of Manukau Harbour. The court was required to weight the various competing issues. On one side were visual effects, Maori cultural issues, noise effects, and effects relating to horses. One the other side were benefits derived from renewable energy, reduced greenhouse gases, contribution to the renewable energy target and others. The court held that "an overall broad judgment" was required and "such a judgement allowed for comparison of conflicting considerations and the scale or significance of them...". In his decision the Judge refers to "relevant matters" arising from Section 7 which included the newly added renewable energy matters. Judge Whiting allowed the appeal against FDC, and granted the consents to Genesis.

In the last few months the Government has issued The Renewable Energy Generation National Policy Statement. This requires responsible authorities to: recognise benefits; acknowledge constraints (incs env compensation for adverse effects that cannot be avoided, remedied, or mitigated – inc measures or compensation which benefits communities and for local environments that are affected); practical implications; manage reverse sensitivity; incorporate provisions in Regional Policy Statements, RPs and DPs.; within timeframe.

So that's something. But with CO2 levels almost at 400 parts per million and climbing, and the general scientific consensus being that global levels need to be around 350 ppm to avoid the risk of further warming of the planet, a lot more needs to be done. And it sure won't be solved by planting trees in mitigation.

Making Sense of Emission Trading

At last there is real effort being made by media to understand Climate Change and one of the mechanisms proposed to deal with it: Emissions Trading. There seems to me a sea change happening. The public want to know more. They want to understand more.

It's good that PM Key is off to Copenhagen.
And it's good that China and the USA seem to have made significant decisions about their response to Climate Change just days before Copenhagen. All good.

I guess I've always been something of a skeptic. An Emissions Trading Sceptic. From time to time I'll run something here that throws a bit of light on the subject. In this blog I'll try to explain what emissions trading is (using stuff from the experts), and introduce some of the difficulties:

Explanation of Emissions Trading

This comes from an Australian economist writer for several Aussie newspapers. Peter Martin. It's a helpful explanation of how it might work for power stations in Australia....

"...To simplify, let’s suppose that the only emitters of carbon in Australia are power stations. Lets say that this year they have been emitting 100 units each.

If an emissions licensing and trading scheme were introduced next year the government might only hand out enough licences to allow the emission of 90 units.

Obviously each power station could comply if it cut its emissions by 10 per cent. It would be the same as if the government had legislated for a station-by-station 10 per cent cut.

But it would be a bad way of cutting total emissions by 10 per cent. Some power stations would find it difficult if not impossible to meet the10 per cent cut. They would be crippled. Others might find it easy. At little cost they might even be able to cut by 20 per cent.

Without trading in permits the stations that found it hard to cut would suffer, while the stations that could easily cut by more than required would be given no reason to do so.

Trading removes those problems. In the language of the economists, whatever the target for cutting emissions is, trading allows industry to meet it in the least damaging way possible.

Here’s how. A firm that can easily cut its emissions (perhaps because its coal-fired generator is nearing the end of its life and it can easily be replaced with a wind one) will find it has permits to spare. It might have been issued nine but only need seven, having two to sell.

Another firm, that can’t cut emissions without incurring a tremendous cost will find it cheaper to buy spare permits from the firm that no longer needs them. Its cost of producing power will go up but by nowhere near as much as it would have had it had no choice but to meet a target. Over time that firm will find that business case for switching to cleaner technology increasingly persuasive. But not all at once.

The firm that can easily cut emissions will have discovered a new way of making money, and the cleaner it makes its business the more money it will make. As a former Liberal Party leader used to say, it will become “incentivated”.

That’s the theory. It was put to the test in 1990 in the United States when President George Bush senior signed into law a new act designed to combat acid rain, caused by the emission of sulphur.

In a sharp break with the approach of the past the Bush administration issued annual permits to allow the continued emission of sulphur, but not quite as much as before. Then it encouraged the Chicago Board of Trade to set up an exchange on which those permits could be traded.

Each year the administration handed out fewer annual permits. Over ten years the price of a permit on the exchange climbed from $US100 to $US800 a ton. The polluters who could cut back easily found themselves rich. Those that couldn’t found business increasingly expensive — but not so expensive as to force them out of business straight away.

Over that decade sulphur emissions halved throughout the US. In some parts of the country acid rain declined 25 per cent. The annual saving in healthcare costs was said to top $US20 billion.

That’s the promise held out the promoters of emissions trading schemes for carbon.

Any the wiser? I hope so. Now here's a few comments from the other side. I quite like this one from John Blakeley that appeared in NZ Herald 19th November this year. He writes:

Carbon Trading: an indulgence we can't afford. He asks why parts of NZ's economy should be given credits for their sins of emission. "....Michael Kinsley, writing in Time Magazine in an article entitled: 'Credit for bad behaviour' in July 2007, suggested that the purchase of carbon credits to offset greenhouse gas emissions could be compared with the Middle Ages practice of buying indulgences for the forgiveness of sins. Martin Luther King (1487-1546) was a leader of the Protestant Reformation in Germany. His idea of revolt occurred when he saw indulgences being sold, a practice he openly condemned - leading to his eventually being excommunicated. In a similar manner to indulgences, purchasing carbon credits to offset greenhouse gas emssions can be seen as an alternative to making the hard decisions to reduce emissions. It is much easier for politicians to tell people they must pay a little extra for their electricity and petrol than to try and persuade them that they must cut back on their energy use...."

"...So from July 1, 2010, we will be asked to pay more for our electricity and petrol for a scheme which is likely to have no effect on reducing our gross greenhouse gas emissions. And it is unlikely that the average consumer is going to be happy to pay this extra cost as "indulgence money", especially at a time of considerable constraint on wage increases...."

"...I believe that it is now time to "go back to square one" and start again, to define the best, most cost-effective way for New Zealand to control future increases in greenhouse gas emissions. Purchasing indulgences by way of carbon credits is not the best way to go." (John Blakeley is a programme director in the Department of Civil Engineering at Unitec in Auckland.)

That's an interesting argument. It's one I feel empathy with because - for me - the important thing has to be actual reductions in carbon emissions. Not just some scheme which has got the banks, financiers, money lenders and economists all in a lather. Some of the other arguments are more sophisticated and go to the heart of actually implementing emissions trading. There is some very interesting information in Wikipedia for example (whose entries seem to be changing minute by minute as Copenhagen approaches) :

Emissions Trading Scheme Critics

Critics argue that emissions trading does little to solve pollution problems overall, since groups that do not pollute sell their conservation to the highest bidder. Overall reductions would need to come from a sufficient reduction of allowances available in the system....

Critics of carbon trading, such as Carbon Trade Watch, argue that it places disproportionate emphasis on individual lifestyles and carbon footprints, distracting attention from the wider, systemic changes and collective political action that needs to be taken to tackle climate change. Groups such as the Corner House have argued that the market will choose the easiest means to save a given quantity of carbon in the short term, which may be different to the pathway required to obtain sustained and sizable reductions over a longer period, and so a market-led approach is likely to reinforce technological lock-in. For instance, small cuts may often be achieved cheaply through investment in making a technology more efficient, where larger cuts would require scrapping the technology and using a different one. They also argue that emissions trading is undermining alternative approaches to pollution control with which it does not combine well, and so the overall effect it is having is to actually stall significant change to less polluting technologies....

The Financial Times published an article about cap-and-trade systems which argued that "Carbon markets create a muddle" and "...leave much room for unverifiable manipulation"...

And it is the mechanics of manipulation and actual implementation that make interesting reading as well. From wikipedia again:

Measuring, reporting and verification (MRV)

Meaningful emission reductions within a trading system can only occur if they can be measured at the level of operator or installation and reported to a regulator.... For greenhouse gases all trading countries maintain an inventory of emissions at national and installation level; in addition, the trading groups within North America maintain inventories at the state level through The Climate Registry. For trading between regions these inventories must be consistent, with equivalent units and measurement techniques.

In some industrial processes emissions can be physically measured by inserting sensors and flowmeters in chimneys and stacks, but many types of activity rely on theoretical calculations for measurement. Depending on local legislation, these measurements may require additional checks and verification by government or third party auditors, prior or post submission to the local regulator.....

Enforcement

Another significant, yet troublesome aspect is enforcement. Without effective MRV and enforcement the value of allowances are diminished. Enforcement can be done using several means, including fines or sanctioning those that have exceeded their allowances. Concerns include the cost of MRV and enforcement and the risk that facilities may be tempted to mislead rather than make real reductions or make up their shortfall by purchasing allowances or offsets from another entity. The net effect of a corrupt reporting system or poorly managed or financed regulator may be a discount on emission costs, and a (hidden) increase in actual emissions.

So, going back to the Aussie economist's simple example, someone would have to actually measure what comes out of the exhaust chimneys of each of these power stations. All the time. And keep detailed records. And these measurements would need to be credible and independent. It's the whole thing about verification. The devil in emissions trading is in the implementation detail. Sounds good to economists, but becomes more and more of a practical nightmare the closer you get to nuts and bolts implementation.

Imagine doing it with cows!

That's enough for now. Just to get your interest, and perhaps suggestions for further explanation or "making simple"....