Energy and Climate Change CommitteeMemorandum submitted by Professor Michael Grubb

Summary

This short submission makes a simple but important point for the Committee to consider. The debate is usually posed as a choice: production or consumption perspective/accounting, at a national level. The Committee Questions reflect this perception.

Building upon earlier work, this submission suggests the development of dual accounting initially for key sectors, which would provide some clarity and potentially provide a basis for evolutionary development of policy as needs indicate and systems allow.

The underlying point is that consumption accounting is not a strict alternative to, but is an addition to production accounting, adding the tracing of emissions through successive stages of the supply chain irrespective of national borders. Which sectors, and how far down the chain to trace emissions, is a choice that can (and should) evolve over time

(A) Responses to Specific Committee Questions

The Committee will have received many submissions on the pros and cons of consumption based accounting, and extensive data relating to these different approaches. Our submission offers some propositions, with supporting evidence, on a subset of questions as follows.

Question 2 Is it possible to develop a robust methodology for measuring emissions on a consumption rather than production basis and what are the challenges that need to be overcome to deliver this?

The robustness of the method needs to be informed by the purpose for which the method is used. As a basis for informing policy, or parallel reporting alongside traditional production-based accounts, the existing models offer excellent insights into the effect of a consumption view on national and sectoral emissions.

For other applications, there first needs to be clarity about the objective being sought; following this, the appropriateness of existing methods and mechanisms can be evaluated. For example, the inclusion of aviation emissions in the EU ETS has similarities to a consumption-based approach to emissions pricing. Setting aside for the moment the international political concerns that have been raised, the methods for measuring emissions from aviation are sufficiently robust for the objective of including this particular sector in the EU ETS: other sectors would need to be evaluated separately.

Proposition: The robustness of available methods must always be evaluated against the objective being sought.

Question 3 What are the benefits and disadvantages associated with taking a consumption-based rather than production-based approach to greenhouse gas emissions accounting?

Consumption accounting advantages: shows the real impact of consumption decisions; shows the limits of domestic environment policy; shows the importance of a supply-chain view; provides a data platform for policies that address consumption as the root driver irrespective of location of production

Consumption accounting disadvantages: much more data intensive; more complex analysis; internationally may be politically challenging; concerns over MRV (monitoring, reporting and verification) of whole-of-economy/world methods

Proposition: The balance of advantages and disadvantages differs radically for different main sectors and products.

Question 5 Would it be (a) desirable and (b) practicable for the UK to adopt emissions reduction targets on a consumption rather than production basis?

Desirability: most desirable for large industrial sectors which account for a sizeable share of embodied emissions trade and where a production-only target—or associated cost—has greatest potential to be misleading and/or have the greatest risk of provoking carbon leakage

Practicability: progressively more difficult the longer the supply chain involved. Accounting for carbon intensive primary commodities or immediate derivatives is likely to be much more practicable as a first step than advanced manufactured products.

Proposition: Adopting a national Target across all sectors is going from one extreme to the other. As a first step, parallel reporting to extent reasonably feasible would be hugely beneficial in terms of a) driving greater understanding of the link between consumption and global impact, and b) greater understanding of the opportunities and limitations of government policy in this area

Question 6 What are the potential implications at the international level of the UK adopting a consumption- rather than production-based approach to greenhouse gas emissions accounting?

Moving to a consumption accounting framework would be inconsistent with the main present intergovernmental accounting systems, though there is alignment with business supply chain analysis. It requires use of data—or assumptions or estimated data—about “process and production methods” in other countries, the source of long-running WTO debate. There is some alignment with the call from many developing countries to pay greater attention to consumption.

However, adoption of parallel production and consumption accounting mechanisms would allow policymakers to benefit from understanding the consumption implications of actions, while current production based policies are retained.

Proposition: It may be most feasible to progress incrementally. The benefits would be much greater if procedures were agreed through bilateral if not multilateral accounting arrangements. Substantively, consumption accounting with a fully MRV trail could be adopted for specific agreed commodity trades, in which all countries involved could register the credits and debits to their consumption accounts relative to production accounts. Accounting for final “downstream” products might best build upon ISO-related work. Only through a route of international agreement(s)—whether global or bilateral with trade partners—could all risks of double counting be removed.

(B) Evidence

The main evidence is drawn from previous work that we conducted for Climate Strategies and the Carbon Trust. Figure 1 shows original results on the carbon intensity of UK manufacturing industry, in terms of carbon emissions per unit of value added plotted against value added. The area of each block thus represents emissions. Out of more than 150 product classes analysed, the top twenty account for more than half UK manufacturing emissions. Many of these are quite heavily traded, and carbon intensity is also one index of potential exposure to effects of carbon price on potential leakage.

Source: Climate Strategies (2007): Hourcade, Neuhoff, Demailly and Sato, Differentiation and dynamics of EU ETS industrial competitiveness impacts

Figure 2 shows such data for Europe set in the wider context of the production side of the EU economy. This underlines how emissions are heavily concentrated in primary commodity activities.

The present difference between production and consumption accounting would reflect emissions intensity of production and trade value. Obviously, trade value is much larger for manufactured products than primary commodities, but the complexity of consumption accounting is orders of magnitude larger. The Carbon Trust study on Carbon Flows estimated that about half of all embodied carbon trade is in the trade of carbon intensive commodities.

In terms of addressing embodied emissions trade per unit of effort (and precision), accounting for commodity flows accurately would be orders of magnitude easier than for products further down supply chains. It would also target the sectors over which there is greater practical concern about the economic implications of the difference between production and consumption accounting. If carbon pricing policy could start to target consumption of carbon-intensive commodities like cement or steel, for example, it would alleviate concerns about carbon leakage in those commodities with relatively little data effort (compared to manufactured products).

Source: M.Grubb et al, Planetary Economics, forthcoming 2012, Chapter 7.

Establishing effective and agreed international systems for consumption accounting in commodities could also help to substantially reduce the uncertainties, and increase the credibility of, independent business supply-chain accounting of products and their “GHG footprint”, since it would radically reduce the uncertainties associated with the carbon intensity of primary commodity inputs.

Of course, consumption accounting for commodities but not their use in manufactured products creates discrepancy. The significance of this difficult would depend on the sector, and products concerned. There is, for example, very little trade in cement-based products. There is far more in steel products, but the data show a very big gap in the carbon intensity of commodities or semi-finished steels (like long and flat slabs), and final products (like vehicles). As a first step, it would then appear quite practical to apply de minimus principles, that apply in many areas of public policy.

(C) An Evolutionary Approach

Starting with consumption accounting for primary commodities would create pressure for consumption-based systems to evolve to more products, in terms of both accounting and policy.

Accounting. Dual accounting could and should be developed, starting to trace the carbon intensive primary commodities through successive stages of the supply chain. Over time, more products, further down the supply, could be added to national accounting systems that would present both production and consumption views.

Policy. A sensible approach to concerns of production, consumption and carbon leakage should also follow an evolutionary pattern. This is illustrated in Figure 3, where the horizontal axis shows the breadth of sectoral coverage, and the vertical shows the degree of international coverage. The aim, ultimately, is to arrive at the bottom right hand corner—with global participation covering all sectors. At that point—if it involved similar levels of carbon pricing everywhere—it would in fact not matter much (from an economic perspective) whether the architecture was based on production or consumption. However, any such perspective is likely to be decades away (or unachievable, since national policy is driven by domestic economic and political circumstances and these differ).

Figure 3: An evolutionary approach towards controlling CO2 emissions internationally

Source: Carbon Trust (2010), Tackling carbon leakage: sector-specific solutions in a world of unequal carbon pricing

The challenge is therefore to find a way to evolve towards greater sectoral coverage with more countries participating:

For many less carbon intensive sectors, this does not pose a substantial challenge, for as long as carbon-related costs are negligible compared to other cost drivers. These are sectors that any region can treat by moving directly to the right hand side of the Figure (top right). Accounting methodology may be significant in terms of attribution and information to consumers, but it is not of much economic significance.

The most carbon intensive sectors cannot be treated in this way. They need to chart a course through the central parts of the diagram. The “easy” approach goes down the left-hand side of the diagram—either exempting such sectors, or otherwise “leveling down” carbon-related costs for example through free allocation. The harder—but ultimately far more effective approach—traces down rightwards—introducing carbon pricing including importers (and reimbursing exports), through different degrees of complexity presented by the extent to which other countries, “Accept” simplified methods, “Provide” data, or “Act” themselves to introduce carbon pricing (and thus keep the revenues that would otherwise be raised by the importing country, in the case of including importers in the EU ETS).

This points to the value of the UK developing accounting systems which, by adding trade-related data to production-based GHG statistics, would introduce consumption accounting in ways that could support such an evolution of policy.

March 2012

Prepared 17th April 2012