Think Global, Act Profitably – Questerre CEO Michael Binnion

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Michael Binnion

Canadians concerned about the health of the planet have been repeatedly told the solution inevitably demands plenty of sacrifice and self-denial. When it comes to lowering carbon emissions and fighting climate change, there can be no progress without pain. But what if Canada could do far more good for the world by acting in its own best interests? What if we can help save the global environment and get paid for it?

According to intriguing new environmental research, Canada could become a leader in lowering global greenhouse-gas emissions by taking a broader and more pragmatic approach to its climate change policies. We already have some of the world’s toughest emissions standards and practices in numerous areas of manufacturing, processing and resource extraction, delivering very high rates of productivity per unit of greenhouse gas emissions. One could say Canada enjoys a “comparative advantage in carbon.” But current policies are also making Canadian firms less competitive than their global competitors. Adopting policies to reverse this trend could lure more production in emission-intensive industries away from inefficient foreign suppliers and into Canada. Doing so would lower overall global emissions while delivering jobs and wealth to this country.

The world faces the triple challenge of coping with a growing population that, along with increased prosperity and life expectancy, is also consuming more of everything, especially energy, all while managing intensifying concerns about anthropogenic global warming. All three challenges deserve our attention. We can no more afford to ruin our social environment through energy poverty than we can afford to ruin the natural environment with over-development. Our future wellbeing thus depends on the ability to balance social, economic, and natural environmental impacts. When it comes to our climate, leaders around the world should focus on policies with the least overall cost to the economy per tonne of reduction to

Canada’s problem of carbon leakage

Where does Canada fit in? The Canadian economy is heavily reliant on trade, it specializes in many energy-intensive sectors, and Canada is a very large country with a cold climate, all of which make climate policy decisions of singular importance. According to research by University of Ottawa economist Nic Rivers, we are twice as reliant on trade as the United States and we use approximately 50 percent more energy per dollar of GDP. Canada’s energy-intensive, trade-exposed economy is therefore particularly vulnerable to the phenomenon of “carbon leakage.”

Many Canadian industries are energy-intensive and trade-exposed, making them especially vulnerable to “carbon leakage”.Carbon leakage occurs when climate change-related policies – such as carbon taxes or related fees, burdensome regulations, emissions caps, artificially high energy pricing or drawn-out permitting processes – raise  a domestically-based company’s costs to the point where it can no longer afford to adapt its domestic operations and simply moves production to another jurisdiction with less stringent policies. But the associated emissions move as well. While Canada is able to chalk up a climate “victory” in recording a large reduction in domestic emissions, those emissions don’t disappear. They just occur somewhere else. If every country had, on balance, the same climate policies, including taxes, this would not occur. But they don’t, so it does – and at a massive scale. That’s carbon leakage at its simplest.

In spite of Canada’s economic vulnerability and environmental advantages, there’s been little overall study of carbon leakage’s impacts. The Conference Board of Canada’s September 2017 paper, The Cost of a Cleaner Future, discussed carbon leakage’s potential Canadian impacts and its relevance to well-designed climate policy. This was a rare exception, however, and little work has been done on the practical aspects of carbon leakage. One initial attempt to mitigate carbon leakage were the so-called output-based allocations, also known as free allocations to emit. These are very valuable carbon tax exemptions and have been allocated in response to industry lobbying and/or imprecise and unclear relative domestic measurements. Without proper data from dedicated studies, however, there’s no reliable and fair way to distribute the free permits based on actual carbon leakage. The current method has clearly proved unsatisfactory.

In fact, at times it has seemed as if the imposition of domestic economic pain has been a feature and not just a bug of climate policies. Certainly, numerous environmentalists and politicians are on record calling for emissions reductions to take place here at home no matter what. The underlying premise seems to be that it’s immoral for Canadians to avoid pain even if we achieve the same or greater environmental benefits offshore. But if we accept that the overarching goal should be minimizing total global emissions, it follows that production should be carried out in the jurisdiction with the lowest embedded emissions per unit of output. Embedded emissions are all of the emissions directly and indirectly associated with producing a given product, service or other unit of economic output, such as the energy used in running a factory that makes washing machines.

This points to the need for a “common sense climate policy” that exploits Canada’s comparative advantage in embedded emissions to compete internationally while reducing global emissions. And to achieve that, we need Canadian policymakers and voters to understand what carbon leakage is, how damaging it has become to Canada’s economy, and how we can stop it dead.

Plugging the leak and reversing the flow

Reversing Carbon Leakage in the Aluminum Sector by Vancouver-based Navius Research is Canada’s first comprehensive study focused on an industry segment using economic modelling and international data. It modelled only one industry to illustrate the concept and highlight the opportunity. In so doing, the study demonstrates why this type of examination is needed for all our energy-intensive, trade-exposed industries. There are many of them, collectively generating a large proportion of Canada’s GDP, and all are vulnerable to the effects of carbon leakage.

“Exporting” 1 tonne of CO2 emissions to a high-polluting foreign country can increase global emissions by 7 tonnes.

Previous Canadian economic modelling studies of climate policy have either ignored carbon leakage or used production losses as a surrogate – meaning that they have, at best, assumed that shifting production from Canada to a carbon-friendlier country results in a one-for-one shift in emissions. This underestimates the true size and cost of carbon leakage. The problem with this approach is that the same unit of production will generate varying amounts of emissions depending on the energy source used to power the production facilities, the technology used in production, and the environmental practices applied, all of which vary greatly between jurisdictions. Because we know the embedded emissions for Canadian products but data is not easily available for other jurisdictions, the models have simply assumed that all production has uniform emissions intensity. Even Navius acknowledges its past studies of carbon leakage have taken this approach. The consequences of this flawed approach for Canadian climate policy are material.

In its currents study, Navius chose the aluminum industry primarily due to the availability of international data. This is also a sector in which Canada has a clear advantage in emissions over its main competitors. Aluminum produced in British Columbia and Quebec, for example, uses zero-emission hydroelectric power whereas China and the Middle East rely mainly on coal-fired electricity. The result is that, for each tonne of Canadian aluminum production lost to another country, Canadian emissions would fall by much less than they would rise in the location of replacement production.

“China’s emissions intensity during aluminum production is estimated to be as much as seven times greater than Canada’s,” reports Navius. “So, [a] one tonne reduction in emissions in Canada could be offset by an increase of 7 tonnes in China.” This is carbon leakage in its starkest form, demonstrating the futility of policies that crush Canadian industries while spurring production abroad. Canadian carbon leakage leaves the world unequivocally worse off. Past economic modelling approaches grossly underestimated carbon leakage for the aluminum industry. This has very likely contributed to some poor policy choices affecting Canadian industries that generate many thousands of jobs and many billions of dollars of GDP.How does a negative carbon tax sound?The challenge to reversing this effect is to make our already low-emissions aluminum producers more cost-competitive in order to increase our international market share. Unfortunately, much of Canada’s current climate policy does the opposite. To illustrate the benefits of shifting aluminum production away from high-emissions centres in China and the Middle East and into Canada, Navius modelled the effect of an income tax reduction on the Canadian aluminum industry. Navius was not advocating or taking a position on any particular policy option, and other competitiveness-enhancing policy tools might also be available.Navius’ results reveal that boosting the competitiveness of the Canadian aluminum industry through tax policy could create 1,400 new jobs and result in a net economic benefit of $27 million across the entire economy, as gains in the aluminum industry more than offset losses to other sectors caused by the tax policy changes. The impact on emissions, however, would be much larger.Shifting more aluminum production to Canada by making our domestic industry more competitive would increase Canadian carbon emissions by 0.6 megatonnes of CO2 equivalent per year by 2030. Under current policies, that would be a big disadvantage – a non-starter, in fact. But in doing so, greenhouse gas emissions in the rest of the world would fall by an estimated 2.1 megatonnes per year. The net result of making Canada’s aluminum industry more competitive – and of onshoring production and a significant number of well-paying jobs – would be a net annual global emissions decrease of approximately 1.6 megatonnes. (Figures do not add exactly due to rounding.)While the federal government’s carbon tax is set to rise to $50 per tonne by 2022, Navius calculates the global abatement cost of carbon leakage reversal under this scenario at negative $70 per tonne by 2030. This figure includes worldwide rather than just domestic emissions reductions. In sum, by focusing on reversing carbon leakage we could achieve substantial net reductions in global greenhouse gas emissions while generating net new wealth. Fighting climate change never sounded so sweet.

Climate change policies should be reformed to account for carbon leakage and reward efficient Canadian industries.

The Navius study further notes that Canada’s aluminum industry has reached its limit under current technology to further reduce emissions. Because all possible abatements have already been maximized, additional carbon taxes or regulations would have little beneficial impact. The only way to further cut emissions is simply to reduce production, i.e., to scale back or close existing facilities. This would not only kill Canadian jobs and reduce government tax revenue, it would significantly increase net global emissions. The world’s insatiable demand for manufactured goods isn’t going down just because Canada is on an anti-carbon tear. Aluminum will continue to be produced; it will simply happen in other countries. As production is shifted abroad, emissions will rise due to carbon leakage. That is a very poor outcome for the global environment; it clearly makes much more sense for Canada to retain or import greater aluminum production. Given Canada’s ample supply of low-emissions electricity, these findings very likely apply to many other industries as well.

The world could use more Canada

Standing in the way of such a common-sense approach are perverse incentives embedded in international climate agreements. For example, jurisdictions are required to account for emissions based on the production source, irrespective of where the product is consumed. In Canada, this means provinces keep separate books on emissions and don’t generally cooperate on emissions reduction projects. This is why Quebec in 2011 chose to import natural gas rather than producing its own supply, thus avoiding the need to account for the production-related emissions. But the gas Quebec consumes and the associated emissions are still being produced somewhere. Taken to their illogical conclusion, current emissions accounting procedures encourage importing everything and producing nothing locally. Luckily, these accounting standards are non-binding and Canada could lead the way in developing a more logical international approach to reporting changes in emissions.

Rather than relying on a system of federal and provincial carbon taxes plus expensive regulatory mandates, Canada should urgently consider targeted tax reforms and deregulation that encourage greater competitiveness in Canada’s important trade-exposed sectors. Reversing carbon leakage by attracting high-emission offshore production in areas where Canada is a lower-emissions producer will generate a double dividend of new economic benefits and lower global emissions. It makes no sense to introduce domestic policies that reduce production in industries that actually enjoy an advantage in embedded emissions versus our international competitors.

Finally, Canada should begin reporting the actual net global emissions results from its climate initiatives – and that must include the effects of carbon leakage. This can be reconciled with the non-binding international accounting rules for international reporting purposes. Most important, it will bring needed clarity for voters and policymakers concerning the actual effects of federal and provincial climate change policies.

For Canada’s economy – and for Canadian workers – the economic stakes could hardly be higher. Far more than a few aluminum smelters are under threat. If unchecked, current climate policies are likely to drive a hollowing-out of key, carbon-intensive domestic industries – not just oil and gas extraction but petrochemicals, pulp and paper and many areas of manufacturing – as more and more companies run out of economically viable emissions abatement measures and begin to shut down facilities. We are sleepwalking towards disaster. Tens of billions of dollars in economic value and tens of thousands of jobs depend on recognizing the damage already being done by carbon leakage, and the vastly greater damage that awaits if we don’t reorient Canada’s climate change policies.

We won’t save the planet with less Canada. Canadians are already among the best in the world at addressing many pressing challenges. What the planet really needs is more Canadian-made, low-emission products.

Michael Binnion is President and CEO of Questerre Energy Corporation, based in Calgary, Alberta, which commissioned the Navius study on carbon leakage discussed in this article.

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