The Business Case for Putting a Price on Carbon
Many leaders in business, academia and civil society are calling for the move, but will the federal government see fit to clear the smoke?
by Michael Ganley
The debate around humankind’s contributions to climate change rages on, particularly in the U.S. But those who take the position that changes to the climate are the result of greenhouse gases spewing into the atmosphere because of the burning of fossil fuels seem to be – surprisingly, and for now – winning the day. From the halls of academia to the White House lawn to the C-suites of Calgary, the environmental, economic and political stars are aligning as they have never done for the implementation of a broadly based, widely effective price on carbon.
Many of the international oil firms have given support to a carbon price. Last November, in advance of the United Nations’ climate change talks in Doha, Qatar, more than 100 companies – including multi-national oil giants BP, Royal Dutch Shell and Statoil and global re-insurance company Swiss Re – signed the Carbon Price Communiqué, which calls for “a clear, transparent and unambiguous price on carbon,” and states that “a clear, stable, ambitious and cost-effective policy framework is essential to underpin the investment needed to deliver substantial GHG emissions reductions.”
Global banking giant HSBC has warned investors about the need to take carbon pricing into account when making decisions. “Strategically, we expect the long-term carbon risks facing fossil fuel assets to become more widely understood in the market,” HSBC analysts wrote in January. “Our research on coal suggests that these risks are material, but capital markets have yet to price them in.”
The insurance industry has been tepid in calling for a price on carbon, but tends to take an aggressive stance on the need to address climate change. In particular, the massive re-insurers – the companies that insure the insurance companies – are on board because they get vivid across-the-board views of the costs of a changing climate with each passing mega-storm.
By and large, the domestic oil and gas companies have been unwilling to contribute to the public discussion. Brian Ferguson, the CEO of Calgary-based Cenovus, was quoted last year as saying that a carbon tax is “probably the most effective means of regulating and addressing the cost of carbon,” but declined an interview request for this story. Imperial Oil, majority-owned by global giant ExxonMobil, advocates some broad general principles. “We believe that any system designed to address greenhouse gas emissions should be predictable, transparent and maximize the use of market instruments,” says spokesman Pius Rolheiser.
The industry’s leading lobby group, the Canadian Association of Petroleum Producers, is perennially working on its position on carbon, but there is little consensus among its 100-plus members. That group includes the big international players that have taken a position on carbon abatement as well as many smaller, domestic companies that are not interested in touching the issue. CAPP therefore makes a case on the most general of terms. It argues for a made-in-Canada carbon policy underpinned by two fundamental concepts. “The first would be our ability to compete for investment dollars,” says CAPP spokesman Travis Davies. “There’s a risk in being out too far and increasing your relative cost of doing business.
The second key piece would be technology and innovation, the on-the-ground solutions to mitigating carbon and improving performance.”
The world has now witnessed more than two decades of jurisdictions trying different strategies to reduce carbon emissions. They come down to three basic mechanisms: a broadly-based tax on carbon emissions; a cap-and-trade system for the largest emitters; and regulations on specific industries. Each has attributes that make it more or less attractive to the parties with interests in the matter. The tax, for instance, gives businesses the greatest price certainty and will do the most to reduce energy consumption by the public. Cap-and-trade systems can more easily reach across borders, an important consideration given the global nature of climate change. Regulatory tinkering comes at the lowest political cost.
Jack Mintz, a tax specialist and the director of the University of Calgary’s School of Public Policy, is a strong advocate for a carbon tax. He says there are good reasons for Alberta’s oil patch to prefer a tax over the other two options. “When you’re making investments in very expensive technologies you tend to like carbon taxes because you do get price certainty for carbon,” he says. “You can plan investment decisions around that.”
Many companies already do factor a tax on carbon into their planning through “shadow pricing.” An Ottawa-based think tank, Sustainable Prosperity, recently asked 10 energy sector companies operating in Canada (BP, Shell, Suncor, Statoil, Devon, Cenovus, Penn West, Enbridge, Ontario Power Generation and SaskPower) if they used shadow carbon pricing. All 10 had some experience using it, seven of them formally. The price ranged from $15 per tonne to $68 per tonne and is used for financial planning and risk management needs for large projects and specific greenhouse gas reduction plans. Last spring, the CEO of Shell, Peter Voser, told Maclean’s that his company assumes there will be a $40-per-tonne price on carbon within 30 years and does not proceed with any project for which the economics do not work with that price.
Of course Alberta does have a carbon tax in place: In 2007 the province became the first jurisdiction in North America to put a price on carbon, using a “soft” cap-and-trade system under which any company that annually emits more than 100,000 tonnes of greenhouse gases (there are currently 109 such companies, mostly oil sands producers and coal-fired power plants) must either reduce the intensity of their CO2 emissions, purchase carbon offsets or pay a $15-per-tonne penalty. That penalty (which amassed about $70 million in 2012) makes its way to the Climate Change and Emissions Management Fund, which supports emissions-reduction research and the development of new, associated technologies in Alberta.
Ed Whittingham, the executive director of the Pembina Institute, an environmental lobby group, says Alberta’s current tax could be tinkered with in order to accomplish many of the same results as a broad-based carbon tax, by increasing the rate-per-tonne, increasing the intensity target (right now companies are supposedto reduce their rate of CO2 production per unit of output by 12 per cent from a 2005 baseline) or by eliminating the use of offsets. The drawback is that the cap-and-trade model fails the test of universality and, if the tax is not seen and felt by consumers, it will not be effective at changing behaviour.
Eric Newell, the chair of the CCEMC and former Syncrude CEO, says the poster child for carbon pricing done right is the tax that B.C. introduced in 2008, one that is applied at the point of consumption of fossil fuels. “That hits everyone and that’s an important message,” he says. “If we’re going to hit these targets in an overall sense, everyone has to take a role, and to get the consumer involved, it takes a price.” The province also followed the carbon tax textbook by setting out a five-year implementation plan, with the price of carbon starting at $10 per tonne and going up by $5 each year until it maxed out at $30 in 2012. That allowed businesses to plan around the cost.
The tax adds about 6.7 cents to a litre of gasoline and helped reduce the province’s per-capita emissions by almost 10 per cent between 2008 and 2010. Fossil fuel use in the province has declined while it has risen in the rest of the country. But the real headline story out of the B.C. tax, says Alex Wood, the senior director of policy and markets at Sustainable Prosperity, is that the provincial economy has grown at a rate consistent with the rest of the Canadian economy. The tax has neither generated an economic boom nor cratered the economy. “They’ve decoupled their economic growth from fossil fuel use,” he says. “When you think about the volatility of the price of oil and natural gas and the ongoing risk that creates for any economy, that kind of decoupling is a big story.”
The politicians selling the B.C. tax to a wary public back in 2007 and 2008, primarily Premier Gordon Campbell, claimed that it would be – and it has proven to be – revenue neutral. The revenue raised has replaced revenue from other sources, such as personal and corporate income taxes, which have correspondingly been lowered. The B.C. system has been praised in the New York Times and the Economist, and has been attracting attention from south of the border. Alternatively in the U.S., with its fiscal house in such disarray, revenues from a carbon tax could be used to reduce the deficit.
The question of how much a carbon price would cut into a company’s margins is a tough one to answer because it’s a by-the-project calculation and the companies jealously guard that information. Newell says he’s never had a CEO complain to him about Alberta’s current $15-per-tonne price. “It’s become quite manageable,” he says. In 2010 the Globe and Mail estimated that a $40 carbon price would have added between $2 and $3 dollars to the $30- to $40-per-barrel production costs of an oil sands project.
With a solid case for a carbon tax on the economic and business side of the ledger and several prior systems in place to learn from, the fate of a carbon tax rests in the political arena. The government of Prime Minister Stephen Harper has (at least since taking office) been a steadfast opponent to a price on carbon, a position that explains in part the reticence of the domestic producers to come out in support of one. The Conservatives successfully skewered Liberal leader Stéphane Dion for his carbon-shift plan in 2008 and view that election as a plebiscite on carbon pricing. And after non-stop repetition from the Conservative caucus it’s difficult to consider the NDP’s current carbon tax proposalwithout having your thought interrupted by “job-killing.”
But the politics on this one may be shifting beneath Harper’s feet. China recently introduced a price on carbon emissions in that country. President Barack Obama spoke at length on the need to address climate change in his February State of the Union address. He has tried to paint the Republicans into a corner by telling the Republican-held Congress that either it must deal with carbon through a market-based approach, or that he will regulate it through the Environmental Protection Act. And Obama has some Republican allies. Bob Inglis, a former Republican representative from South Carolina who lost his seat in a primary fight in 2010 partly because he acknowledged that global warming exists, now heads a group advocating a carbon tax. Alberta Premier Alison Redford, in a recent guest column in USA Today, expressed a “strong desire to address climate change,” but insisted it must be done through cooperation. “We are prepared to work with our federal government and our American friends to push the bar higher,” she wrote. Of course the broader the tax base – from a provincial setting to a national and international scope – the more effective and equitable the tax will be.
It’s not that a carbon tax can’t be sold to the voting public. Gordon Campbell won an election in B.C. after introducing the tax there. We’ve seen politicians in Australia and Sweden get them through. Ireland introduced a carbon tax almost four years ago – when the country’s economy was in tatters – and it has helped the government narrow its budget gap and avert an increase in income taxes. The International Monetary Fund has suggested that Ireland “expand the well-designed carbon tax.” In Norway, the oil and gas industry is taxed at $71 per tonne and nobody blinks.
Canada’s government, like so many before it, has proven adept at altering course when the winds of change begin to blow, and there’s the political equivalent of a Chinook blowing right now. Perhaps Inglis summed it up best last November when speaking to the Associated Press: “I think the impossible may be moving to the inevitable without ever passing through the probable.”
Alberta’s Carbon Tax
Under Alberta’s current carbon tax, which launched in 2007, a facility that emits more than 100,000 tonnes of greenhouse gases per year (there are now 109 of them) must either reduce the intensity of its CO2 emissions by 12 per cent from a 2005 baseline, purchase carbon offsets or pay a $15 per tonne penalty. Through the end of 2011, about $312 million was raised under the tax and analysts expect another $70 million for 2012.
“I think we have the formula,” says former Suncor CEO Rick George. “If the goal of society is to emit less carbon, then having a carbon tax like Alberta’s, where the tax goes back into innovation, technology and R&D, serves everyone well.”
It’s Pigovian, You Know
A carbon tax falls under the rubric of a Pigovian tax. Named for the British economist Arthur Pigou, who championed such taxes in a 1920 book, a Pigovian tax is intended to balance the costs imposed on society by actions that are generally considered to be private. Smoking is one example. If you choose to smoke, you and the cigarette maker each get what you’re after, but society at large is left with the health bill. The Pigovian “sin tax” on cigarettes is meant to help correct this imbalance.
It’s the same with a carbon tax. Each of us that fills our car up with gas (or heats our home) is foisting the costs imposed by having the carbon dioxide emitted while burning fossil fuels on the public. A Pigovian tax therefore has the dual purpose of raising revenue and decreasing activities that society deems a burden.