In this chapter, the policy and analytical foundations upon which this project is based are presented.
Two main considerations influenced the NRTEE?s new work on carbon pricing policy, both in this document and in the Advisory Note: (1) building on Getting to 2050; and (2) recognizing short-term uncertainties, but planning for the long-term. These considerations provide important context for this report, and are intended to ensure that the NRTEE?s research will remain credible and relevant to policy makers for years to come.
Getting to 2050 established the need for carbon emissions pricing policy in Canada to meet the government?s targets of reducing emissions relative to 2006 levels by 20% by 2020 and 65% by 2050. Getting to 2050 also identified the policy stringency, or the strength of the policy, required to meet the targets as the fast and deep emissions pathway. Under this pathway, the economy-wide price of carbon would start at $15 per tonne of CO2e (CO2 equivalent) and gradually rise to a long-term price of $300/tonne, as illustrated in Figure 1.2
While uncertainty underscores any forecasts of the future, 2008 provides a sharp reminder of just how rapidly events change and how inaccurate forecasts can be. In 2008 there were significant shifts in virtually all major drivers that influence climate policy and emissions growth: record high oil prices dropping to less than a third of their high-point value; major swings in economic growth forecasts; and large revisions to Canada?s national GHG inventory.
These short-term shifts highlight the uncertainty in any long-term analysis. However, if an attempt were made to fully reflect these events in this long-term advice, a highly reactive and myopic focus on the short-term would be the result. Instead, this report focuses on the need to influence long-term investment and behavioural decisions in the pursuit of the Government of Canada?s long-term targets. Getting to 2050 highlighted the need for a long-term transition, necessitating a long-term view of climate policy. Some factors that influenced this report, and how the issues were addressed, are discussed in detail below.
Changing Carbon Policies
The political landscape for carbon pricing policy in Canada has changed since the publication of Getting to 2050:
These events have implications for the short-term political appeal of alternative carbon pricing policies, and longer term implications for carbon pricing in North America. The NRTEE has taken these changing political conditions into account in its consideration of long-term carbon pricing policy for Canada, and believes that the case for carbon pricing in Canada is stronger now than it was when Getting to 2050 was published. Specifically, thought needs to be given to how these emerging carbon policies will interact and possibly integrate.
Changing Economic Conditions
The global economic outlook has also changed since the publication of Getting to 2050. The global economic slow-down will likely lead to short-term emission reductions, as output and economic activity contracts. However, the short-term downturn does not reduce the urgency of carbon pricing. Business continues to make investment decisions, and these should be guided by an expectation of a long-term price on carbon if they are to reflect society?s need to reduce emissions.
The modelling work underpinning the NRTEE?s policy uses long-term forecasts of economic growth to 2050. In doing so, it assumes that periodic downturns will take place, as well as periodic booms. As a result, the conclusions of this work are robust in the face of short-term economic uncertainty.
Similarly, when oil prices are high, some people feel that efforts to price carbon are unnecessary, because fuels like gasoline are already expensive and further price rises will do nothing to change behaviour and investment decisions. However, experience shows that high oil prices are not enough to drive emission reductions. There are three main reasons for this:
Nevertheless, oil prices do have an impact on investment decisions and consumer behaviour. In order to take account of revised long-term oil price expectations since the publication of Getting to 2050, the analysis in this report used the US Energy Information Administration?s forecast world oil price of $68/barrel (compared with $50/barrel used in Getting to 2050).6
Evolving climate science
The science of climate change is robust: there is a high degree of scientific confidence that climate change is occurring, and anthropogenic emissions are a major cause of that change. It is this strong level of confidence in climate science that makes the case for the reductions in greenhouse gas emissions to which Canada is committed. However, there is uncertainty in the rate of climate change, and the potential mechanisms that will slow or accelerate warming.
In 2007, the Intergovernmental Panel on Climate Change (IPCC) provided a major synthesis of scientific knowledge about climate change in its Fourth Assessment Report (AR4).7 In this report, it provided ranges of likelihood for various climate change outcomes, and noted the potential for feedback mechanisms that could lead to more rapid warming. Since the publication of the AR4, further scientific evidence has emerged that suggests more rapid warming is possible, and that as a result deeper emission reductions may be necessary. Lenton et al (2007) have identified a number of possible ?tipping points?, at which warming would lead to major changes in natural systems.8 Examples include:
New evidence on all or any of these could substantively change society?s assessment of the risks of climate change, and may mean that deeper targets are necessary. It is also possible that climate change may occur more slowly than current scientific knowledge suggests, and that Canada and the world can decrease efforts to reduce emissions.10Carbon pricing policy must be adaptive to such changes, while maintaining the short-term certainty that is essential if low carbon investments are to be made. Importantly, while the NRTEE?s recommendations for carbon pricing policy design were developed to meet the Government of Canada?s current targets, the design recommendations remain relevant for more or less stringent levels of mitigation targets.
Extensive quantitative and qualitative analysis was commissioned or carried out by the NRTEE under the auspices of the Carbon Emissions Pricing Policy Project. This combination of both qualitative and quantitative research provides a strong evidence base and reference for carbon pricing policy design in Canada. Three core methods were followed in developing the research for this report:
Each of these is discussed below.
A common thread throughout all the work was the use of a standard set of policy evaluation criteria. These criteria form the basis for assessing and ultimately selecting the elements of the policy. The five evaluation criteria common throughout this report are consistent with those used by Finance Canada, and have been used by the NRTEE in a number of climate change and energy-related projects including Getting to 2050:
By employing a standard set of policy evaluation criteria across all of the research undertaken for this project, the NRTEE arrived at a better understanding of the implications of alternative policy design options as revealed by the diverse research initiatives.
Quantitative analysis in this report relies on three different economic models: CIMS, D-GEEM, and TIM. Results from these analyses corroborate each other. Given the inherent uncertainty associated with economic modelling, consistency between models provides credibility for the overall analysis. Further, different models have different strengths; for example, CIMS provides a good representation of technology and investment in technology, while D-GEEM and TIM can provide better projections of macroeconomic costs and trade impacts. Short summaries of the three models follow:
The models informed different elements of the report. CIMS modelling was used to inform the assessment of distributional impacts, to develop the technology forecast scenario, and to assess options for complementary regulations. CIMS outputs were also linked to the TIM and D-GEEM models which were used to assess macroeconomic implications for pricing policy and to empirically assess competitiveness and leakage issues. D-GEEM was also used to evaluate policy options for revenue recycling, border adjustments, and international purchases.
Limitations of Economic Modelling
Economic models can be very useful tools for understanding complex systems like the Canadian energy-economy system and the likely impacts of policy. In the analyses in this report, the best modelling available has been used. Combining models with different strengths and weaknesses has allowed the NRTEE to generate more improved forecasts than those resulting from one model or another. Comparing forecasts from different models leads to greater confidence in the conclusions drawn from modelling. Finally, using stakeholder and expert elicitation processes to test the results of modelling improves the credibility of the results.
It is important to remember that all model forecasts are inherently uncertain. They should not be considered as exact predictions of what will occur. These complex models depend on assumptions about technology, consumers, trade, and the economy. Uncertainty in the forecasts, however, does not preclude the usefulness of the models. Forecasts can provide a directional indication of the likely impacts of policy and can be very useful in comparing relative impacts of different policy options. In an effort to be as transparent as possible, throughout this report the assumptions and different combinations of models underlying each of the different modelling analyses are described.
The NRTEE undertook and commissioned substantial qualitative analysis and research to inform and test its conclusions. This qualitative research included:
The next chapter discusses the main elements of the carbon pricing policy, starting with its goals.