Wednesday, December 12, 2018

Some Year-end Thoughts on Two Major BC Energy and Climate Policy Issues

B.C.’s recently-announced climate plan and GHG reduction targets clearly attempt to balance an industrial policy that incorporates major expansion of the gas industry, including LNG and other downstream processing, with a commitment to markedly reduce GHG emissions in the province. As many have noted, a critical element of the plan is electrification in transportation and gas industry and other industrial processes.

Whether the targets as set out in the climate plan are achieved will depend very much on exactly what this electrification will entail, how much it will cost and how those costs, in the many billions of dollars, will be paid for. Industry won’t be able to pay for all of their electrification costs and still remain globally competitive. Households will not want to absorb all of the costs of the electrification they are called on to do. The government won’t want to increase pressure on BC Hydro rates by forcing Hydro to absorb all of those costs. And it also will not want to crowd out other important social and infrastructure spending with large electrification subsidies. 

There is a long history of governments announcing bold GHG reduction targets but abandoning them as it becomes apparent what they require. It remains to be seen whether this climate plan will meet the same fate. This is not to say that B.C. won’t make considerable progress in reducing carbon emissions. There are many elements of the plan that will go forward and have significant effect. But whether BC will and should achieve the specific numbers and dates in the plan is very much in doubt. 

On the pipeline wars, it was unfortunate B.C. chose simply to oppose any expansion of pipeline capacity from Alberta instead of seeking common ground on port location, marine safety and all the other issues the project proposals raised. Perhaps if there was common purpose and effort to get a project built in the most safe and responsible way we might not have seen:

-the federal government feeling compelled to take over the Kinder Morgan project, exposing taxpayers to great financial risk not only with respect to project completion but also long term pipeline utilization if and when, as expected or at least widely hoped, the global demand for crude oil significantly declines;
-increased shipment of Alberta crude oil by rail with the added cost and environmental risks that entails;
-lower netback prices for Alberta crude oil because of pipeline constraints, higher rail shipment costs and near complete dependence on the US midwest market;
-less resources and commitment to needed marine safety improvements if the quid pro quo, pipeline expansion, does not proceed.

As for GHGs, it is not clear to what extent pipeline expansion would increase global emissions - that depends on how it would affect Alberta production and on the differences in the GHG intensity of the oil that would replace any reduction in Alberta supply. However, one thing is very clear. Opposition to all efforts to expand pipeline capacity has set back the progressive policies the Alberta government introduced to reduce GHG emissions, including carbon taxes, the phase-out of coal-fired electricity generation and a cap on oil sands emissions. Just like British Columbia, Alberta too was trying to balance industrial policy with commitments to reduce GHG emissions, but we are already seeing how implacable B.C. and other opposition to the former will undermine Alberta resident and government commitment to the latter.

Sunday, October 7, 2018

GHG Policy in BC - Need for a Different Approach

If it wasn’t clear before the LNG Canada announcement, it should be clear now that there is a problem with British Columbia’s greenhouse gas (GHG) policy – a problem that will become even clearer and more acute if LNG Canada or others propose additional liquefaction facilities in the province.

The policy sets out fixed GHG emission reduction targets by specified dates. The problem is that government set these targets without careful consideration of what we would have to do to meet them and what costs that would entail.

British Columbians are prepared to incur significant costs to reduce GHG emissions and contribute to the fight against global warming and climate change. Widespread acceptance of the carbon tax is evidence of that. For most people, however, the costs have to be demonstrably well-considered and reasonable. But there is little reason to believe that the emission targets the government has established, particularly with new and potentially growing liquefaction activity in the province, are either well-considered or reasonable.

The government has stated that to make room for the GHG emissions from liquefaction and related gas industry activity, BC households and industry will have to ‘tighten’ their belt – reduce their emissions even more than they would have without the LNG Canada project. Exactly what that requires and what it will cost is as yet unclear. All we know for sure is that whatever we would have done without LNG, we will have to do more with it. And if there are other new LNG developments in the province, we will have to do even more still. Whether all of the additional measures will be feasible and reasonable to implement, and if they are, why they weren’t called for in the first place, with or without LNG, is unclear.

The problem is not just that we don’t know what the required ‘belt-tightening’ will entail or cost, we’re not even sure why we should be called on to do it. Government policy may set out fixed emission reduction targets for British Columbia. But what people logically care about is our contribution to global emissions because it is global, not just B.C. emissions that will determine the extent and consequences of global warming and climate change.  

There is some uncertainty as to the impacts that LNG exports from B.C. will have on global emissions. LNG proponents have argued B.C. LNG will enable recipient countries to displace higher GHG-emitting coal-fired generation. Opponents say LNG could displace emission-free renewable power. Arguably the most likely scenario, assuming BC production does not significantly affect world gas prices and recipient country energy plans, is that LNG exports from B.C.  will displace natural gas and LNG production elsewhere.  If that is the case, there would be no increase in global emissions as a result of LNG exports from B.C.; indeed there would likely be some reduction because of the relatively low carbon intensity of LNG Canada as compared to alternative global sources of gas supply.

The question naturally arises: why should British Columbians be called on to tighten their belts, whatever that may mean and cost, to accommodate a project that may not cause any increase in global GHG emissions – that may in fact contribute to reducing them? Why should we be governed by emission reduction targets that were set without well-considered regard to their implications for British Columbians and their link to global emissions?

British Columbia needs to take a fresh look at its GHG policy in light of recent and possible future gas industry developments. We need to recast our commitment in terms of what costs we are willing to incur to reduce emissions, and be clear it is reduction in global emissions, not just emissions in B.C., that we want to achieve.

A major improvement for the efficiency and transparency of our emission reduction efforts would be for government to establish a dollar cost of carbon that will govern a ‘reasonableness’ test for its GHG reduction policies and measures. Public debate will be required to determine exactly what that cost should be – whether it should be $50/tonne, $100/tonne or more. It certainly will have to take account of the amount of emission reductions we are seeking by specified dates, but it will also have to take into account what opportunities there are to reduce, capture or offset emissions; what technological improvements are expected; what other leading jurisdictions are doing; and other factors.

An explicit determination of the cost we are willing to incur to reduce carbon emissions will enable government to move forward in a rational, understandable way. The dollar cost will inform people of the adequacy of and need for increases in our carbon tax. It will help government allocate its GHG policy expenditures to the most cost-effective emission-reduction electrification and other initiatives. It will help screen regulatory initiatives to bring some consistency with what is being called for in different sectors.

Most importantly, an explicit dollar cost of carbon will preclude a call for ‘belt-tightening’ without regard to what that may mean or cost. And it could be applied, with appropriate policy and tax design, to the cost of British Columbians’ contributions to global emissions, not simply emissions in B.C.

British Columbians want to be leaders in the fight against climate change. That doesn’t have to mean leaders in the establishment of targets that aren’t well-considered or reasonable. We can be leaders in the development and application of very thoughtful policy that will significantly contribute to reductions in global emissions and at the same time promote widespread public understanding and support.

Saturday, April 7, 2018

A Closer Look at the Tax Benefits from LNG

In support of LNG development, the provincial government stated that even with its latest tax concessions, the development and operation of the LNG Canada project in Kitimat would generate $22 billion in tax revenues. Though not the windfall the previous government originally touted, it is still a seemingly impressive amount, enough in itself to justify the government’s enthusiasm.

The government did not release the analysis underlying its $22 billion estimate, nor did it explain the methodology and assumptions it used.  However, as I suggested in my last blog and confirmed in discussions with a senior official involved in the calculations, this number does not in fact indicate what the net benefit for taxpayers would be – what additional tax revenues the government could expect to receive should this project proceed.

The $22 billion includes an estimate of all of the income taxes that workers for the plant, pipeline and related natural gas industry activity would pay to the provincial government. But that doesn’t indicate what additional or incremental income tax revenue government would receive because it fails to take into account what those workers would otherwise have done and amount of taxes they would have otherwise have paid if Canada LNG did not go ahead.

It is the difference in the taxes workers would pay with versus without the project that measures the additional revenue and net benefit for government. Unless one makes the incorrect assumption that all of the workers involved with LNG would otherwise be unemployed, the additional income tax revenue due to the project would be a much smaller number than what the government included in its $22 billion estimate

Also included in the $22 billion is an estimate of all of the royalties that BC natural gas operators would pay on the gas they produce and deliver to the LNG plant. But that fails to take into account how much of that gas would have been produced for the North American market and how much royalties would have been paid without the Canada LNG project. Again, it is not the total royalties that measures the additional revenues for government, it is the difference between the royalties that would be paid with versus without the LNG project going ahead.

Finally, the $22 billion includes an estimate of all of the corporate income taxes, sales taxes and motor fuel taxes paid in the construction and operation of the plant, pipeline and related activity. The problem here is that this ignores what economists term general equilibrium effects. There are constraints on what any economy can produce and major increases in investment and activity in one sector will have some offsetting impacts on other sectors. The mechanisms by which this takes place are varied, including for example, upward pressure on wages and resulting labour market constraints in other industries; upward pressure on the exchange rate and resulting competitive pressures for exporters and firms facing import competition. The net effect requires some complex modelling to estimate properly. What one can be certain of, however, is that estimates that don’t consider these effects will overstate the net gain for government.

The fact is that the $22 billion figure simply does not provide any indication of the value of the project to taxpayers. It does not attempt to estimate what the increase in government revenues would be.

Even if the $22 billion had some validity, which it doesn’t, the number in itself fails to indicate the present value significance of the impacts in dollars with the same purchasing power or value as dollars have today. The $22 billion is the sum of tax impacts over a 45 year period, without any adjustment for inflation or the time value of money. With much of the tax impact in the later years of the project, the equivalent present value (what those impacts would be worth today) would be markedly less.

The problem in all of this is not just that there are serious methodological errors in the government's tax estimate -- a matter more of an annoyance for economists than anything else. The problem is that the number itself, unqualified and uncorrected, seriously distorts the public policy debate. If the gain for taxpayers really was $22 billion, that could provide a strong case for proceeding regardless of the GHG emissions that gas liquefaction and related activity entails and without any careful consideration of how those emissions should be addressed. 

The government has suggested, and its Green partners have demanded, that British Columbia would still meet its existing GHG reduction targets even if LNG goes ahead. British Columbians would have to further reduce their GHG emissions in order to 'make room' for the emissions from LNG and related gas industry activity. But as I said in my last blog, that would impose great costs on British Columbia households and industry -- costs that would almost certainly swamp a valid estimate of the additional tax revenues government could expect from LNG development and operations. 

My own view is that if LNG projects are to proceed we need to modify our GHG emission reduction targets to recognize the impact of LNG exports from BC on emissions elsewhere. There wouldn't then be the same costly need for British Columbians to further reduce their emissions in order to 'make room' for LNG.

However, one thing a methodologically correct estimate of the tax benefits from LNG would make very clear. If BC is not prepared to modify its emission targets to take into account the global impacts, one has to ask: what is the public policy rationale for proceeding. There almost certainly would be significant net costs for the general public -- for those not directly involved in the project. 

Sunday, March 25, 2018

Addressing the Costs of LNG Development in BC

While there would be clear benefits from the development of major LNG plants in British Columbia for workers and businesses directly involved in project construction, operation and upstream gas industry activity, and for First Nations and communities with business partnerships or benefit agreements, the net effects for the general public are less certain.

Though originally promoted as a great windfall for taxpayers, LNG development would provide a more modest amount of revenues to government. The recently announced tax concessions, as well as the gas royalty and other concessions previously offered to attract these projects, make clear that there is not a lot of residual value -- resource rent in economic terms -- that government could capture from even the largest of these projects.

The government has estimated that the LNG Canada project in Kitimat would generate $22 billion in tax revenues over 40 years of operation -- some $500 million per year. It is not clear that estimate  correctly indicates the incremental net revenues government would in fact receive. The economic impact studies government often relies on to develop these estimates do not consider the taxes the government would have received in any event (for example from the workers employed elsewhere or the gas shipped to other markets). And almost certainly this tax estimate does not indicate the net gain after deducting the incremental expenses that government would face, whether for the project itself or for the infrastructure and services required as a result of any project-induced influx of workers and families.

In any event, though there would be some benefit for taxpayers, it would not be a bonanza. And against that benefit one has to recognize the potential for significant costs. There are potential financial losses that BC Hydro and its customers would face as a result of the government's offer to supply electricity to LNG projects at the standard industrial tariff. And there are the costs associated with project-related greenhouse gas (GHG) emissions -- estimated at some 4 million tonnes of CO2e per year for LNG Canada operations and upstream gas production.

There would be potential losses for BC Hydro because the standard industrial tariff is less than its estimated cost of new supply. The current industrial rate for energy averages $46/MWh. However BC Hydro's estimated cost of new supply delivered to industrial customers is $92/MWh, as indicated in the BCUC-approved  two-step industrial customer tariff with its second tier rate intended to signal the long run marginal cost of new supply.

In the first five to ten years of operation of a new LNG plant and with Site C coming onstream, BC Hydro would not have to develop new sources of supply. It would be able to use the surplus it would otherwise sell in export markets to supply the plant. For that period of time there would be no loss -- in fact there could be a small gain. However, even without any use of electricity for the liquefaction process itself, the ancillary electricity requirements for a major plant like LNG Canada are very large -- they could amount to some 500 to 1000 GWh per year (up to one fifth the output of Site C).  With growing provincial requirements absorbing the surplus, BC Hydro would sooner or later have to develop new supply to meet the LNG load. And it would do so at some considerable financial loss.

The difference between the industrial rate and the cost of new supply is likely to fall, both as a result of rising rates and falling costs of new supply. But the discrepancy could still be considerable, resulting in losses of tens of millions of dollars per year.

With respect to GHGs, it is not clear to what extent LNG plants in British Columbia would contribute to an increase in total global emissions. There would be a significant increase in emissions in British Columbia, but those emissions would be offset by the reduction or avoidance of emissions elsewhere. Unless British Columbia's supply of LNG were to affect the world price and demand for natural gas, LNG from B.C. would in all likelihood displace the supply of gas from other sources. The net impact on global emissions would therefore depend on the carbon intensity of B.C. supply as compared to the displaced sources. Independent experts would be required to develop specific estimates but suffice to say the net impact, positive or negative, would likely be relatively small.

The cost of the GHG emissions from new LNG plants would not, therefore, derive from the social costs of global warming. If the plants' contribution to global emissions is small, so too would its contribution to global warming. Nonetheless, there would still be significant costs for British Columbians if the province were to maintain fixed total provincial emission reduction targets without any recognition and credit for the impact of B.C. LNG sales on emissions elsewhere.

If, as the Premier seemed to suggest, British Columbians would have to tighten their belt -- further reduce their own emissions -- to offset the GHGs from a new plant, the costs would be very high. One way to gauge this cost for LNG Canada is to consider what level of carbon tax would be needed to reduce GHG emissions by 4 million tonnes per year over and above the reductions British Columbians were already going to have to make in accordance with provincial emission targets.  Many experts suggest that carbon tax would have to be over $100/tonne, possibly $200/tonne. On that basis, the cost to British Columbians to accommodate (make room) for the GHG emissions from LNG Canada would be over $400 million, possibly $800 million per year.

The government, of course, could choose to achieve those GHG reductions with regulations and other measures as opposed to a markedly higher carbon tax. But that wouldn't change the magnitude of the cost borne by British Columbians, just the manner and transparency of achieving it.

As stated at the outset, there would be clear benefits of LNG development for those directly involved. But if the government wants the support of the general public it must recognize and address the significant costs it could entail.

With respect to electricity, the government should limit the offer of BC Hydro supply at the standard industrial rate to a period of 5 to 10 years after which the plant would have to develop or acquire from independent power producers its own new sources of supply, or enter into a contract with BC Hydro for continued supply at prices that reflect the costs BC Hydro would face to make that supply available. BC Hydro and its customers should be protected from the losses it would otherwise face.

And with respect to GHGs, British Columbia should develop a new framework for establishing emission reduction targets. We need targets that are based on our net contribution to global emissions, not simply the amount of emissions that take place in British Columbia. That requires establishing emission reduction targets that take into account the impact of our exports on GHG emissions elsewhere. Otherwise we will either be imposing major costs on British Columbians to offset the carbon content of our exports, regardless of the impact of those exports on carbon emissions elsewhere. Or we will feel compelled to forego major projects in order to avoid their GHG emissions in B.C. even though that will simply result in greater emissions elsewhere.