Published: Oilfield Pulse
Most people I talk to have never heard of 'carbon leaks', which is when carbon policy just causes emissions to be displaced to another jurisdiction. Yet, the recent election in the United States heightens the importance of 'carbon leaks' for Canada as a member of the North American Free Trade Act. 'Carbon leaks' could in fact be the most important factor for climate policy success.
Imagine this as an example: what if Canada decided to levy carbon pricing aimed at leaving more natural gas in the ground?
In the first instance, Canada's emissions would decrease due to less production of natural gas. Further, imagine the taxes were invested in new ground breaking energy technologies that successfully replaced the lost energy (with lower carbon emissions) and the economy grew as a result. Then, we would have a 'double dividend' of reduced emissions and economic improvement.
On the other hand, what if the United States, under its new President, responded by producing more natural gas and Canada simply imported it? In this scenario, our 'production leaks' across the border, along with jobs, taxes, and economic activity. As a result, America's emissions increase, meaning Canadian 'carbon leaks' across the border as well. This offsets the environmental benefits of Canada's climate action.
What if, due to the nature of the product and the trade relationship, the extra emissions in the United States were actually higher than the reductions in Canada? Perhaps, due to extra transportation or frac'ing of less efficient reservoirs or laxer environmental regulations in the U.S. Then, our policy at home, designed to reduce emissions, would have the opposite effect and create a 'green paradox'.
I was among the first in Canada to speak out on 'carbon leaks' and the 'green paradox'; though, it was only later I learned the terms.
It stemmed from my work in Quebec after our large natural gas discovery in the Utica shale. Our natural gas discovery is one of the top 'green' projects in Canada. It has the potential to materially reduce Canadian and global emissions by replacing higher-emissions natural gas imports. Our project represents the opposite of 'carbon leaks'.
I was dumbfounded when five years ago, in meetings with environmentalists in Quebec, I realized they were aware of these facts but still opposed local natural gas production. Their focus was on meeting Quebec based emissions from Kyoto targets, and somewhat ironically, given their position, Canada should have a national climate policy. Taking this approach to its illogical conclusion, it would be better to let foreigners produce everything for us, so we can say we don't have any emissions (not to mention any jobs).
"Good climate policy doesn't increase poverty nor carbon leaks."
When I tried to publicize this obvious problem, people generally wouldn't believe it was true. Canadian citizens paying money to reduce local emissions, when the result is an increase in overall global emissions, makes no sense. Yet, Quebec's Strategic Environmental Review took this view by only studying impacts of oil and gas development on Quebec based emissions. Our Federal Government does the same when it only considers Canadian based emissions for local projects, such as LNG plants and pipelines.
It is the production based accounting system embedded in the Kyoto Accord that creates this problem. It gives consumers a carbon incentive to import goods, because the producer is responsible for the emissions. Or, as Dale S. Rothman notes in Environmental Kuznets curves, "Consumers in wealthy nations have simply passed the buck to people in other places or other times." A consumption based accounting system would address concerns of 'carbon leaks' using the criteria of justice and economic efficiency according to Karl Steininger et al.
Since the production based accounting system is to the benefit of Europe and the United States, it is unlikely to be fixed. Thus, the issue of 'carbon leaks' is central to whether Canadian climate policy will achieve its global goals. Yet, this critical issue is poorly studied in Canada while carbon pricing hurtles ahead.
Climate policy and different related schemes to price carbon have come to Canada more than two decades later than Europe where there is a reasonable amount of study and experience. As discussed above, there are two prevailing theories on climate policy and carbon pricing.
One is the double dividend argument. This suggests, if we recycle carbon revenue effectively (a revenue neutral approach), emissions will decrease and economic growth will increase at the same time. This is the green economy argument based on new technology and innovation.
The second argument is carbon pricing will cost a lot and not make any difference. The argument extends to the risk that carbon pricing, for those industrial sectors where 'carbon leaks' are very high, can paradoxically make the global environment worse.
Much of the answer to double dividend or green paradox or somewhere in between depends on the rate of 'carbon leaks' by industrial sector. For example:
- Carbon leakage of less than 100% means for every ton of emissions reduced at home less than one ton of emissions is created elsewhere through shifting production offshore, meaning there is a net global reduction of emissions.
- Carbon leakage of over 100% means for every ton of emissions reduced at home more than a ton of emissions is created globally, which is the green paradox problem.
Another way to express this issue is that, at over 100% carbon leakage, 100% of the cost and effort of reducing emissions is simply wasted or worse. One could say the path to the green paradox is paved with good intentions. A question worth asking is what rate of carbon leakage under 100% is the cost to the local economy worth the net global reductions in emissions?
A small open economy with a strong component of resources, like Canada, is particularly vulnerable to 'carbon leaks' that create the green paradox. Per dollar, Gross Domestic Product Canada uses more energy than other OECD countries. According to the study by Nic Rivers of the University of Ottawa, "Canada's energy intensity of about 14 MJ per US dollar is significantly greater than that of the US (9.3 MJ/$), France (7.0 MJ/$), Japan (6.8MJ/$), and most other developed countries."
"In addition, Canada's economy is particularly open to international trade. While total trade is equivalent to roughly 70% of Canada's gross domestic product, it amounts to only about 55% in most European countries and less than 30% for Japan and the US."
Mustafa H. Babiker makes this point in his study in the Journal of International Economics, "The results suggest that significant relocation of energy-intensive industries away from the OECD may occur, depending on the type of market structure, with leakage rates as high as 130%, in which case GHG control policies in the industrialized countries actually lead to higher global emissions."
In Europe dozens of studies on the impact of climate policy on 'carbon leaks' are readily available to the public. Also in Europe, a carbon leakage study has been done by sector to support mitigation strategies. The research does not support the likelihood of a double dividend. It does suggest that with well designed policies production leaks can be mitigated though at the expense of also mitigating the environmental benefits.
Carbon pricing is now being mandated in Canada by the Pan Canadian Framework of 2016, in spite of there being very little publicly available to study in Canada on the rate of 'carbon leaks'.
Glaringly, when one thinks about it, there is no comprehensive environmental study of the new environmental policies on carbon pricing. It seems it is just assumed, and since it is an environmental policy with good intentions, it must ergo be good for the environment. But, good intentions do not guarantee good outcomes. The highly discussed precautionary principle surely dictates we invest in both comprehensive economic and environmental study of 'carbon leaks' before Canada goes it alone in North America on carbon pricing.
While there is very limited research on the risk of 'carbon leaks' in Canada, the Ecofiscal Commission and Enviro Economics reference private research by Navius Research. This estimates carbon taxes will cause leakage of approximately 28% economy wide. This is a comparatively high rate based on estimates for European economies. However, it fits with the high energy and trade components of the Canadian economy, and it reinforces the risks for Canada.
Nic Rivers study is of particular interest for impacted industrial sectors. It is call, "Impacts of climate policy on the competitiveness of Canadian industry: How big and how to mitigate?" He examines production leaks (though not rates of 'carbon leaks' on a sectoral basis. He finds agriculture, chemicals, refined products, oil and gas, and base metals are most likely to lose large international market share implying high rates of 'carbon leaks'. His study estimates an annual loss of 2.81% of GDP without mitigation and 1.79% with mitigation. This cost is large enough to pay off the federal debt in just over ten years.
The Ecofiscal Commission published sectoral figures of trade exposure by industry for four Canadian provinces based on research carried out with Navius Research. The figures unsurprisingly show, for a province like Alberta, most of its economy is at risk to lose international market share. Far more so than the national average. Thogh there is again no modeling of 'carbon leaks' to judge effectiveness of policy.
There is one Canadian sectoral study of 'carbon leaks' relating to a specific pipeline project in the oil and gas industry. Navius Research studied the TMX pipeline and found leakage rates of between 133% and 200%. This would mean environmentalists who oppose and delay the TMX arfe actually increasing global emissions.
Interestingly, the Navius Research study results are before taking in to account policy differences. There is very little data available on environmental policy differences between international jurisdictions. Yet, policy difference between developed and developing country environmental practices are almost certainly very material with respect to the carbon intensity of substitutable products. This could strongly undermine the 'go it alone' climate policy. Glen Peters and Edgar Hartwich highlighted this problem for the study of 'carbon leaks'. "Many previous studies have unrealistically assumed that imports are produced with the technology of the importing country." The better technologies of developed countries and the resulting lower carbon intensity should be considered in 'carbon leaks' study.
Based on the available study, 'carbon leaks' could be over 100% for several segments of the Canadian economy. In those segments, there is a strong possibility Canada already has a comparative advantage in carbon intensity and should be producing more not less. Thus, international bench marking studies of policy differences should be a Canadian imperative to support effective policy choices.
We are about to embark on a 'go it alone' climate policy with significant costs and risks with less study and debate than for a single pipeline project. Canada may have a comparative advantage in carbon in many industrial sectors. If so, Canada won't be a solution for the global environment. The planet may need more Canada, and its resources produced with Canadian social and environmental values in accordance with Canadian regulatory practices.
The Canadian economy is particularly vulnerable to the impacts of climate policy. Our policies have significant risks of increasing energy poverty and 'carbon leaks'.
Twenty five years of experience in Europe tells us the story is much more complicated than the current state of study in Canada would have us know. There is potential for serious adverse fiscal impacts and unintended environmental impacts potentially leading to the green paradox. A less rigorous study than we expect for a single pipeline project is not adequate.
Canadian policymakers have simply not adequately studied the issue. We need to know our 'carbon leaks' by region and sector to assess the global impact of our policies. As a net exporter of energy intensive goods, we should examine consumer based accounting and taxation for carbon. We need benchmarking to identify the impacts of policy differences on carbon leakage rates.
Sweden introduced carbon taxes in the 1990's ahead of the broader European Union, which is widely considered to have exacerbated their banking crisis. The Swedish experience of going it alone relative to its regional market in Europe is a warning for Canada. Unlike Europe, North America is not currently implementing a harmonized emissions trading or pricing plan. Or, as pro carbon pricing Ecofiscal Commission put it, "Policy in the United States is a key factor for carbon competitiveness pressures."
Good intentions and gut feel is not adequate. Going it alone is not always leadership. Sometimes, you just end up alone.