Wednesday, 25 November 2009

Climate Agreement

There is a problem at the heart of cap and trade, how to allocate the permits to emit or the revenue from auctioning them. It is clear from the response of oil and coal price to minor excess demand just before the boom turned to crunch that we are prepared to pay almost anything to sustain our energy consumption. The rights to emit will be worth trillions of dollars and sustainable worldwide agreement on who is entitled to sell them will therefore be extremely difficult.

A carbon tax has some of the same problems once you try to go worldwide (who gets the revenue, fuel producing nation, fuel consuming nation or worthy cause?). Furthermore there is no way of knowing what rate you need the tax to be at to get emissions down to the desired level. The price consumers need to see to persuade them to change is the same whether you manipulate it with a tax or with cap and trade.

There is a further problem with cap and trade if the permits are allocated to existing emitters rather than auctioned. Those emitting carbon dioxide have their marginal cost increased by the tradable value of the permits even though their total costs are unchanged. Basic microeconomics tells us that prices go up to equal marginal cost, and profits with them of course at the consumer’s expense.

Without other measures, legislating for new coal fired power stations to incorporate carbon capture would deliver too little too late. Carbon capture is costly to build and to operate so utilities would also be discouraged from investing in much needed new capacity and from operating it once built, the old dirty plants would cost less to run.

Insisting that all new and existing power plants capture their carbon would deliver very substantial emission reductions if adopted worldwide, but if done abruptly would probably make the lights go out and miss opportunities for evolutionary improvement in process design. Moreover carbon capture only becomes economic if power price rises relative to fuel, while the long-term aim must be to reduce low carbon electricity price relative to fuel to encourage people to switch to electricity for heating, transport etc.

There is a way of avoiding all these problems that every nation should find attractive and could agree to without protracted negotiation.

Fossil fuel producers and importers would contract for the capture and sequestration of a quantity of carbon dioxide equal to a proportion of that produced from the fuel they supply. The proportion would start at a few percent and build up. This would increase fuel price gradually, encouraging energy saving, nuclear, renewables, electric cars etc. It would also provide full, immediate funding for carbon capture and storage. Carbon tax or cap and trade schemes on the other hand only provide sufficient incentive to capture carbon when tax rate or permit price has reached a high level, which may be too late.

Energy saving, nuclear, renewables, electric cars etc. are only ways of filling the energy gap that cutting carbon dioxide emissions will create, and mankind has been effectively filling energy gaps for centuries without the aid of agreed national or global strategies, taxes or caps. Carbon capture is different. It is a way of stopping pollution and will always add cost. You can legislate to stop pollution or you can use market forces by giving credit in a cap and trade system, credit against a carbon tax or by paying directly in fuel prices as above. If carbon capture is driven in any of these ways all the other things will happen too.

The contract might permit capture to be delayed for a year if the quantity captured were increased by 10%, and for another year for another 10% etc. This would not only help with plant problems, but would also allow contracts to be placed today, providing a huge incentive to get carbon capture and storage up and running as soon as possible. It is not lack of know-how that is holding back carbon capture but the lack of an incentive to apply it widely, except as a demonstration of the technology.

To contain global warming we must soon stop carbon emissions from power generation, cement manufacture etc. and substitute electricity for fuel use in many domestic, industrial and transport applications. Taxing carbon, capping emissions or contracting for carbon capture when fuel is produced could all provide the economic incentive, but unless the world joins in they will not solve the problem.

Contracting for carbon capture is certain to reduce carbon dioxide emissions to whatever annual target is set (if the contracts are honoured) and is relatively easy for everyone to agree to because:

 It will appeal to rapidly growing and mature countries alike. There are no national caps to restrict relative growth.

 It will allow all industries in all countries to compete on a level playing field. There are no carbon tax or emission cost differentials.

 Because there is only one number to agree, the global annual target, extensive international negotiations will be unnecessary. There will be no national targets to haggle over and perhaps never meet. There will be no issue about who gets the revenue from a carbon tax or what the rate should be or who gets free allowances (or the revenue from an auction) with cap and trade.

 Enforcement is straightforward and does not rely on the co-operation of every country. The contracts would be traded and recorded centrally, mostly placed and paid for by the international energy companies. If countries were uncooperative and used their own fuel internally without contracting for carbon capture, a central monitoring organisation could impose an increased capture proportion on imports or exports of fuel for that country to compensate.

Put simply, carbon capture and storage could typically cost 50 euros per tonne of carbon dioxide emission avoided. This is equivalent to $32/barrel of oil and the contract would only be for a proportion of that. This is modest compared to price changes over the last few years.

The major complication is that it is only practical to capture carbon dioxide from large point sources like power stations. Forcing 75% capture on the global market through this scheme would drive fuel price up and electricity price down until we switched from fuel to electricity for many industrial, domestic and transport applications. Once nearly all power stations etc. had captured their emissions there would be an incentive to build new power plants simply to create more carbon dioxide to capture and to dump the electricity they generated onto the market at a low price. Fossil fuel power generation with carbon capture would collect payment for all the captured carbon but only pay back 75% in its fuel price, giving it an unfair advantage over nuclear and renewables. It would be perverse to tax carbon capture while we were trying to encourage it, but as we approached the endgame national governments could tax away the 25% of the capture contract price that was not being paid in the fuel price. The revenue could then be paid out per kilowatt-hour to subsidise power from all clean generators.

Eventually we could define the proportion of carbon to be captured, based on fossil fuel production at the time, such that global emissions were contained at the level that the oceans absorb annually. That is about 2.2 billion tonnes of carbon per year (25% of current emissions). Atmospheric carbon dioxide concentration would then stop rising, assuming zero net contribution from deforestation and other land based sources and sinks.