Napoleon warned us: “China is a sleeping giant. Let her sleep, for when she wakes she will move the world.” Recent events suggest that Napoleon may well have been referring to China’s role in global climate change policy and carbon pricing.
Last week Li Hejun, the founder of Chinese solar power group Hanergy, made it to the top of Forbes’ China rich list. Alongside other Chinese renewable energy companies, Li Hejun’s rising star indicates the extent to which the Chinese economy is already pivoting towards a low carbon future.
The need to maintain economic competitiveness combined with public outrage at environmental degradation points to a comprehensive climate policy that will drastically reduce the energy intensity of the economy.
In the same week that Hanergy topped the stock charts, “Under the Dome,” a documentary on the hazards of air pollution, racked up more than 100 million views and counting on Chinese social media networks.
The loss of economic productivity due to air pollution-related health problems costs the economy many billions of dollars each year. With the government obliged to act, it is already putting a price on carbon and will be ramping up efforts to curb CO2 emissions across the national energy system.
The Chinese carbon pricing system is still under development, with pilot emissions trading systems in place in five major cities and two provinces. Given the tendency for government policy to translate into rapid action across Chinese industry, we can expect a rapid roll-out of similar carbon pricing efforts at the national level to begin in 2016.
Chinese economic planners are well aware that we live in a highly competitive, innovative global economy, where first movers get great advantages. This first mover’s advantage applies to new products, innovative policy, and competitive market regulations like carbon pricing.
Why does a decision to price carbon taken in Beijing matter to Canada?
China is now one of the global market makers for energy. On its own, the country accounts for 22 per cent of global energy use every day, and its energy consumption is expected to rise by 70 per cent over the next 20 years. How China prices carbon will have an impact on its trade partners — including Canada, a major fossil fuel exporter.
Policy experts have already outlined how China could build the 13th Five Year Plan (2016-2020) around the International Energy Agency’s (IEA) two-degree warming carbon budget — a budget that states how much carbon can be burned while still ensuring a prosperous human society, and the environmental services necessary for economic growth.
Chinese industrial changes in line with a two-degree carbon budget, combined with the phase-in of a modest US$30/ton price on carbon across the energy sector, would have ripple effects around the world. Once China prices carbon at home, it would likely apply carbon import tariffs to ensure that all players were responding to the same market pricing signals.
If China structures their national carbon tax as a carbon-added tax, carbon exporters like oil companies in unregulated countries like Canada would have to produce a receipt demonstrating that an equivalent carbon tax had been paid, or pay the difference, in order to sell their products into the Chinese market.
If Canadian energy firms could not produce receipts for carbon taxes paid on the carbon produced in the extraction and production process, then a tax would be levied that assumes it was produced in the most carbon-intensive way (which is correct in the case of oil-sands).
This would provide strong incentives for Canadian firms to reduce the carbon intensity of their production in order to access Chinese markets.
France has long proposed implementing border carbon taxation but has backed down under pressure from trade partners. As one of the world’s largest economies with a deep knowledge of the WTO regulatory system, and the lawyers to back up their approach, China would have no such trouble.
The stars are aligned for China to move ahead with decarbonising its economy and competing on the global renewable energy stage. The question for Canada is whether our own economy will survive the transition to a low-carbon world.
Managing economic uncertainty: hedging lessons for Ottawa
The question to ask ourselves is: what would a $30/ton price on carbon in 2016 mean for Canada’s fossil fuel exports, and for the national economy? The answer is: serious changes. The largest energy companies continue to operate as if the world existed in a climate-policy vacuum. The fact that our current federal and western provincial governments operate as facilitators to an out-of-date and non-competitive oil and gas system means that it could be a rude awakening for the national economy.
International oil market analysts indicate that nine out of 10 barrels of oil sands production would be uneconomic at lower oil prices. Investors should take note: Chinese buyers of Canadian oil sands assets are already feeling buyer’s remorse based on the most recent fall in oil prices.
With a carbon tax on fossil fuel imports to markets like China, Canadian producers would no longer be able to compete with a growing renewable energy sector and lower-cost producers in Russia and Central Asia, and the mother of low-cost oil producers, Saudi Arabia.
Given the likelihood of rapid Chinese action on carbon repricing, are Canadian corporate leaders adequately prepared for the future? Considering that there is no national climate policy to speak of, and that Canada’s energy majors have actively undermined any attempts to build a domestic or international carbon pricing regime, prudent investors should be worried.
Even the most forward-thinking of Canadian energy players refers to a theoretical $68/ton shadow price on carbon by 2040 (compared with current estimates that a realistic price today would be $50/ton). This is willful blindness to the reality of policy progress in China and other jurisdictions. The energy sector is not ready for Chinese climate policy action that could have cascading impacts on commodity pricing in other key markets for Canadian producers, including the United States.
Uncertainty, carbon re-pricing risk and Canadian economic stability
In response to carbon re-pricing risk, central bankers in countries like England are already examining the readiness of their economies for a low carbon future. If Canada wishes to remain a globally competitive economy, and to protect investors from carbon re-pricing risks, then investment industry leaders, including pension funds, need to carry out similar stress-testing on the implications of carbon re-pricing on the share values of Canada’s largest energy companies.