The worst kind of climate policy is an uncertain one

Climate and Energy

Smart policy can help Canada reach its GHG emission targets with minimal economic costs. But even if we use the most economically-efficient tools available, there’s a factor that can still increase costs: policy uncertainty. When the direction of future climate policy is unclear—or worse, when policy reversal is a significant risk—the costs of meeting Canada’s targets rise. In this blog, I’ll look at the consequences of policy uncertainty and what we might do about it.

The challenge of policy uncertainty

I recently discussed the Ontario government’s 2018 repeal of cap-and-trade with an executive from a large multinational manufacturer. At the time of repeal, his company was on the verge of making a large investment to reduce the GHG intensity of its Ontario facilities. Following repeal, they cancelled this investment. Repeal was a possibility that the company had anticipated; it was part of the reason it had not yet proceeded. Nevertheless, the resources that went into planning the investment could have been put to more productive use elsewhere—repeal had real costs for the company. Moreover, Ontario didn’t get to benefit from the investment and GHG reductions that would have been associated with the project.

While the new Ontario government is working on an output-based pricing system that will treat his company similarly to how it was treated under cap-and-trade (and thereby provide a similar business case for retrofitting), the executive said it was not clear his company would reconsider once the new policy was instituted. The possibility of yet more future changes in policy would make the case for investment less compelling relative to other investments it could make elsewhere.

This uncertainty around future policy is one of the hidden costs around our polarized climate policy discussion.

Policy uncertainty is bad for business

Policy uncertainty can paralyze businesses’ investment decision-making. When climate policy is uncertain, companies that sell emissions-intensive products (or emissions-reducing products) have little way of knowing how large the demand for their products will be. And those with emissions-intensive production don’t know whether investing in a lower-emitting production technology will prove to be a competitive advantage or a competitive disadvantage.

The chilling effect that policy uncertainty can have on low-carbon innovation is especially worrying. When companies don’t know how stringent future climate policy will be, there is a weaker business case for R&D focused on developing low-carbon goods and services. Technological innovations that could lower Canada’s GHG mitigation costs (as well as present export opportunities) risk going unrealized.

The worst of the worst: Policy reversal

Uncertain medium- to long-term climate policy is bad enough. But the most challenging kind of uncertainty is uncertain near-term policy. When there is a risk governments will abruptly change or reverse climate policy course, there can be significant economic consequences.

As my conversation with the executive illustrates, suddenly repealing a previous government’s climate policies with little to no compensation for affected parties, reduces the credibility of a new government’s own, future policies. Businesses lose confidence that the jurisdiction is a stable place to invest. Not only does this impede investment in GHG mitigation, it impedes investment generally. In this way, climate policy reversal can have significant costs to the broader economy.

Easier said than done

Having stable, credible climate policies with clear, planned stringency increases will reduce the economic costs of Canada’s low-carbon transition. Nevertheless, climate policy remains uncertain. Carbon prices, for example, are set to rise to $50/tonne by 2022. It’s uncertain whether they’ll continue to rise any further. Moreover, it’s not clear they’ll even get that high. Depending on the outcome of the federal election this fall, there may not even be a federal carbon price.

We ought to be having political debates about climate policy choices, including whether Canada should have a national price on carbon and what we should do with the revenues. We’re not likely to have much policy certainty until these debates get resolved. It may be tempting to get more certainty by taking shortcuts in these debates; for example, by locking policies in and making them hard for future governments to change. But we want future governments to be able to respond to new information and circumstances. Tying their hands is not the answer.

Politics makes climate policy certainty tough to get in practice. However, just because we can’t have full policy certainty doesn’t mean we can’t improve it.

Designing policy to reduce uncertainty

There are a number of ways governments can improve climate policy certainty. Here are a few things they can do:

Build on areas of agreement

Despite sharply diverging views on carbon pricing in Canada, one type of climate policy actually has broad agreement: output-based pricing (OBP). OBP applies to large emitters that are vulnerable to competitiveness challenges and GHG leakage (see here for an explainer). Governments of all stripes across Canada are implementing it. But despite this emerging consensus, policy uncertainty often remains. Alberta, for example, is planning a system that will be its third iteration of OBP.

Empower objective, neutral third parties

Governments can also appoint neutral bodies that provide advice to governments and help set policy. The UK’s Committee on Climate Change (CCC) provides a good example. The CCC provides independent advice to the government on setting and meeting carbon budgets, monitors progress against goals, and does independent analysis of climate change science, economics and policy. It is expert-driven, has cross-party support, and a role enshrined in legislation. Actors across the political spectrum trust the CCC. As a result, businesses have greater confidence that policymakers will continue to take up its analysis and advice, making pendulum swings in policy less likely.

Institute transparent and predictable processes

Creating clear and predictable processes for policy changes can also increase certainty. For example, the Manitoba government’s Carbon Savings Account (CSA) requires the provincial government to set five-year budgets for GHG emissions and enact policies to reach them. If the province overshoots a five-year budget, it subtracts the corresponding amount from the next budget, creating more certainty about the stringency of future policy. This kind of process doesn’t preclude policy changes in the future. But it does send the signal that changes will take place in a more predictable, transparent way.

Certainty? Certainly

Policy uncertainty isn’t in anyone’s interest. It increases the cost of Canada’s low-carbon transition and risks causing us to lose out on the export opportunities. And in the case of policy reversal, it makes businesses less likely to invest in Canada.

Eliminating policy uncertainty is a tall order. But we should do what we can to reduce it.

 

3 comments

  1. Avatar
    Doug Sanden

    Talking statistically might help: while large emitters may have staff to compute probabilities for future carbon prices, and so can see beyond short term policy uncertainty, the rest of the economy could benefit from a statistical estimate of future carbon price (or equivalent) for 2030, 2040, 2050:
    1) Probability distribution of sufficient political will to meet current NDCs
    2) Probability distribution of carbon price (or equivalents) given current NDC targets are to be met
    3) Probability distribution of NDC targets themselves, which may need to change if the world is to hit 2C or 1.5C target
    Having these estimates could/would/might help more of us avoid the cost of stranded assets -including human capital such as training, business arrangements/contracts, and capital expenditures.
    To get started, I’ll give my unprofessional guesstimate based on various figures I’ve read, and others -such as Canada’s future independent carbon auditors- can chime in with better estimates
    Probability of Carbon Price (or Equivalent) Given current NDCs, my first guess
    Pr $/tonne 2030
    .05 less than $50
    .2 $50 to $100
    .5 $100 to $200
    .25 greater than $200

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