93619 CURRENT ANALYSIS September 2016 Further action needed on carbon pricing Canada’s annual carbon emissions are lower than prior to the 2008-09 recession, however they remain far higher per capita than the world aver- age and are projected to rise into the foreseeable future (2030). More stringent policy is required for Canada to achieve the target of re- Chart 1: Global temperature deviation from 1951-1980 average ducing greenhouse gas emissions to 30% below 2005 levels by 2030. Combined land-surface air and sea-surface water temperatures, annual, degrees celsius 1.0 Establishing a well-designed carbon price in the form of a cap-and-trade 0.8 system or carbon tax is essential for efficiently reducing emissions over 0.6 time. 0.4 Some of the key principles for a good carbon pricing system: the price 0.2 must be stringent; implementation should be gradual; coverage should be 0.0 broad; and pricing should be integrated with other policies. -0.2 Climate change presents environmental, social and financial challenges to -0.4 the Canadian and global economy while creating opportunities for innova- -0.6 1880 1887 1894 1901 1908 1915 1922 1929 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006 2013 tion and policy action. Source: RBC Economics Research, NASA Global action to address climate change is gathering pace and scope. During the 2015 United Nations Climate Change Conference in Paris, Canada pledged to reduce its greenhouse gas (GHG) emissions along with 185 other countries who together account for 96% of global emissions1. Canada is targeting emis- sion levels 30% below 2005 levels by 2030 and in pursuit of this goal, federal and provincial governments have undertaken a host of regulatory actions and a 2 number of provinces have created carbon pricing systems . While these poli- cies have contributed to lower emissions in recent years, if the goal is to be met further action is needed. Along with regulation and investment in green infrastructure and innovation, a key tool in the policy arsenal is an increasingly stringent and comprehensive carbon price. The importance of action on climate change Evidence is accumulating that humanity is having a sustained and growing impact on the earth’s climate. According to the Intergovernmental Panel on Climate Change (IPCC), from 1880 to 2012 the average global temperature rose by 0.8°C, or nearly halfway to the 2°C increase that governments have set 3 as a long-run target for the maximum allowable temperature rise (Chart 1) . Moreover, the first half of 2016 was the planet’s warmest half-year on record, with an average temperature 1.3°C warmer than the late nineteenth century. Globally, increasing temperatures have been linked to changes in global pre- cipitation patterns and crop yields, shifting deserts and monsoons, ocean acidi- Gerard Walsh fication, and more extreme weather events, all of which have a negative im- Economist pact on the environment, human health and the world economy. (416) 974-6525 [email protected] As a northern country, Canada is expected to face particularly large environ- mental changes as a result of climate change. According to the Canadian Gov- ernment, the annual average surface air temperature in Canada rose by 1.7°C Current Analysis | September 2016 from 1948 to 2012, approximately double the global average, and extreme 4 Chart 2: Insured catastrophic losses in Canada weather events have become more common and costly . Insured cata- Catastrophic losses plus loss adjustment expenses, billions 2015 $ 4.0 strophic losses have increased rapidly since the 1980s and this increase has Alberta Flood 5 3.5 been linked to climate change (Chart 2) . 3.0 2.5 Canada’s carbon footprint now and in the future Quebec Ice Storm Slave Lake Fire 2.0 In 2014 Canada emitted 732 megatons of carbon dioxide equivalent GHGs 1.5 into the atmosphere6. While this represents only a small share of world 1.0 0.5 emissions, Canada’s emissions on a per capita basis are among the world’s 0.0 highest. Canada’s relatively large carbon footprint is due to its size, climate, 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 and economic structure. In 2014, 12% of Canada’s GHG emissions were Source: Insurance Bureau of Canada, RBC Economics Research associated with heating or cooling buildings and the transportation sector produced a further 23% of total emissions reflecting Canada’s high standard Chart 3: CO2 emissions per dollar of GDP of living, large landmass and low population density. Canada’s resource- Kilogram per PPP $ of GDP, 2011 0.40 based economy is also highly carbon intensive. The oil and gas sector gen- 0.35 erates 26% of overall emissions and a further 10% of emissions are produced 0.30 by trade-exposed and emissions-intensive sectors such as mining, smelting 0.25 and refining, cement, and chemical production7. The upshot is that while the 0.20 carbon intensity of Canada’s economy — carbon emissions per dollar of 0.15 0.10 GDP — is low relative to many emerging markets, it is among the highest in 0.05 the industrialized world (Chart 3). 0.00 United States Canada Japan Germany United Italy France Kingdom In an effort to contain and ultimately reverse emissions growth, provincial Source: RBC Economics Research, World Bank and federal governments have introduced a mix of regulatory measures and carbon pricing systems. At the federal level these included setting standards Chart 4: Change in GHG emissions by sector 2000-2014, % for vehicles and electricity production and spending on renewable energy Annual, Megatonnes of CO2 equivalent and clean innovation. Provincial actions have involved mandating an in- Oil and gas creased share of electricity generation from renewables and, in several juris- Transportation dictions, putting a price on carbon. These actions have yielded substantial Agriculture reductions in emissions, particularly in the electricity sector. Between 2003 Buildings and 2014, policy action by the Ontario government shuttered the province’s Total coal-fired electricity units. This contributed to a large decline in Canada- Waste and others 8 wide GHG emissions from coal-fired electricity generation (Chart 4) . The Emissions-intensive and trade-exposed industries 2008-09 recession also contributed to reduced emissions from most sectors Electricity as economic activity declined. Especially hard hit was the emission- -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 Source: RBC Economics Research, Environment and Climate Change Canada intensive and trade-exposed sector which includes many manufacturing in- dustries. Chart 5: Canada CO2 Emissions Megatonnes equivalent, annual The result of regulatory action and the recession was a drop in emissions in 900 Actual Forecast the late 2000s, however, emissions began to grow in the years following and 850 815 Mt 800 according to a 2014 Government of Canada projection, overall GHG emis- 747 Mt 732 Mt 750 sions will rise by 9% by 2030 relative to their 2005 levels, a far cry from the 700 Paris target (Chart 5)9. The drivers of renewed growth in GHG emissions 650 600 are principally the oil and gas sector, where emissions continue to grow due Paris Target: 524 Mt 550 (30% below 2005 level) to rising production from the oil sands, and buildings as population growth 500 drives increases in the construction of housing and commercial structures. 450 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 2023 2026 2029 Meeting GHG emission targets will require further action by government to Actual Emissions Projection Target *including the impact of land use change and forestry Source: RBC Economics Research, Environment and Climate Change Canada reduce emissions and an increased reliance on well-designed carbon pricing systems is the least costly way to induce renewed emission declines. ECONOMICS | RESEARCH 2 Current Analysis | September 2016 Principles for a good carbon pricing system The essence of a carbon pricing system is that firms and households pay for the environmental consequences of their GHG emissions. A carbon tax or a cap-and-trade system introduces a price on GHG emissions leading firms and households to substitute away from carbon-intensive goods and services and incentivizes innovation to make existing economic activity less carbon intensive. The advantage of a carbon pricing system over regulation is that it leverages the market to give firms and households maximum leeway to re- duce carbon emissions at the lowest cost while also raising revenues for gov- ernments. These revenues in turn can be used to foster innovation toward green technology, lower taxes, reduce debt or boost social spending. Table 1: Carbon Pricing Systems Carbon Tax A carbon tax is a charge on the volume of GHG emissions typically levied per tonne of CO2 equivalent. The advantages of a carbon tax are that it is relatively easy to implement and that the price of GHG emissions is known giving firms and households certainty in their planning decisions and providing an ongoing incentive to innovate and reduce emissions. Cap-and-Trade A cap-and-trade, or emissions trading, system sets a limit on the amount of GHG emissions by requiring covered emitters to buy emission allowances of which there is a fixed supply. These allowances are auctioned to emitters who can trade them in a market which establishes the carbon price. A cap-and-trade system delivers certainty in terms of emissions produced, but depending on auction results may entail a volatile carbon price and uncertainty in government revenues. Typically a cap-and-trade system includes a price floor on allowances to limit price volatility and, at least initially, a large share of freely given Chart 6: World Carbon Prices allowances to limit the burden on industry.