A Critique of "Cutting with both arms of the scissors.

The economic and political case for restrictive supply-side climate policies". Fergus Green & Richard Denniss, Climatic Change*

Gareth Morgan, April 2018

Greenpeace New Zealand CEO Russell Norman has kindly sent me an academic paper that supports the implementation of supply reducing policies on fossil fuels, as an effective weapon for combating climate change. I thank Russell for that, the following is my critique of that paper and why the conclusions it draws are simply wrong, except in the most unlikely scenario where significant global supply of fossil fuels is withdrawn.

The Green and Denniss* arguments for restricting supply of greenhouse gas (GG) -creating fuels are that;

Its economic advantages include

• low administrative and transaction costs,
• higher abatement certainty (due to the relative ease of monitoring, reporting and verification),
• comprehensive within-sector coverage,
• some advantageous price/efficiency effects,
• the mitigation of infrastructure

Its political advantages include

• the superior potential to mobilise public support for supply-side policies,
• the conduciveness of supply-side policies to international policy cooperation,
• and the potential to bring different segments of the fossil fuel industry into a coalition supportive of such policies.

In light of these attributes, Green and Denniss maintain that restrictive supply-side policies squarely belong in the climate policy toolkit^.

The authors’ argument begins that economists (in particular) don’t look at supply side restrictions upon emissions-generating processes. Rather, we prefer to look at policies that encourage the substitution of emissions-light for emissions-heavy industrial processes. In addition most common policies are those aimed at restricting demand for GGs (emissions trading schemes or taxes).

Next they argue that political circumstances make it easier to restrict supply than curb demand.

Green & Dennis conclude there are unique aspects – both economic and political – that make supply side restrictions a worthy addition to the climate change mitigation policy toolkit for any country.

Tobacco, CFCs, lead in petrol – are examples cited by the authors where prohibition or severely restricted supply has been used to prevent the consumption of such products. Prohibition of both the domestic production and importation of each has been an effective supply-induced approach to ending the trade. Why might not a similar stance on fossil fuels be effective?

The big difference with fossil fuels and emissions is that the detrimental effects are global. Prohibition of supply by no single country – especially a small one - can influence the global climate change effects. Compare that with tobacco for instance, where banning the supply in NZ reduces the harm from smoking in NZ. It certainly does nothing to the harm from smoking elsewhere. Same with lead in petrol. Both these examples then suffer from a fallacy of composition – the impacts of their use does not cross borders. To cite them as precedents for fossil fuels and climate change then is of limited to no relevance.

Putting aside the obvious detriment to our economy caused by banning the supply of fossil fuels, let’s just consider banning merely our own production of fossil fuels. We are such a small producer as to be a price taker in that global market so our withdrawal would have no impact on global supply and greenhouse gas emissions whatsoever. Further, we would simply see imports replace any NZ-produced product consumed here – unless the plan is to ban New Zealand’s imports of fossil fuels as well, which I’m sure it’s not.

Next let’s consider the comparison with the CFC situation – that is the one most similar to the challenge that fossil fuels present. With CFCs the thinning of the ozone layer had a global impact, much like climate change – and yet the Montreal Protocol was able to see the use of CFCs dramatically reduced. No such effective international cooperation has been achieved as yet with carbon emissions. Why was international cooperation so easy in that instance and yet so difficult with fossil fuels? The consensus is simply the costs of change – banning CFCs imparted very little cost and substitutes were readily available. Banning fossil fuels would collapse most economies, the substitutes are simply not yet sufficiently cheap enough. This difference is sufficient to render the CFC example useless as well as any precedent that supports the efficacy of banning fossil fuel supply.

Next Green and Denniss argue that demand side policies are most often complex and hard to administer, that simply banning the product would be far easier. With that it is not possible to disagree, they are correct. However the consequences of banning the supply of fossil fuels to New Zealand would be too destructive to consider. As pointed out above, all the Labour government is proposing with its oil and gas policy is to shut down an export activity and invite businesses and households to import foreign fossil fuels rather than use New Zealand produced ones. There is nothing in its policy that reduces the global demand and use of oil and gas at all. For sure, to the extent New Zealand consumes the oil and gas it produces then consumers will face higher prices in the absence of that supply and that will reduce our demand. The issue however is the “extent” is very small – local produced oil accounts for 2.5% of direct oil consumed here, and 89% of production is exported.  Gas meanwhile makes up only 14% of our energy needs. As a percentage of global consumption we’re talking negligible.

The authors argue that demand-reducing policies undertaken in one country will reduce the price of fossil fuels and thereby will stimulate demand in other jurisdictions. They then go on to suggest what’s needed is a global supply reduction to prevent that. Of course such a combination would work as they suggest, but no more than a reduction in global demand would anyway. To suggest that global supply reductions would be more likely than global demand reductions to lead to lower use of fossil fuels, has no basis as far as I can see. Neither it seems to me does their suggestion that a combination of globally-effective demand and supply restrictions is more likely than either one alone. Most likely is that neither are easy, there’s certainly no reason to advocate global supply reductions are more likely to be achievable. And technological advances are infinitely more likely to curb demand for fossil fuels than they are to curb supply! This is yet another reason economists prefer to see the emphasis on demand-side measures.

The next argument offered is that because producers produce until marginal cost equals price, mistaken producer expectations of the future carbon price will lead fossil fuel producers to over-produce. A clearer signal such as would arise from an undertaking to ban supply would ensure the price of fossil fuels does not persist at levels well below those that will ultimately prevail, and keep demand in check. I’m unsure why the authors posit a scenario where it is producers’ expectations of future prices alone that are mistaken and lead to a larger fossil fuel economy. I see no reason why producer expectations are more or less likely to be mistaken compared to those who buy the stuff. It seems to me the authors are contriving a scenario to fit their prior. Why couldn’t we equally likely have a scenario where buyers think fossil fuel prices are going to rocket and hence they curb their demand in anticipation of prohibitive costs of running on fossil fuels down the line? Surely that’s equally unlikely – and hence impossible to predict.

 Invoking ‘The Green Paradox’ in support of their advocacy of supply bans is an interesting approach. The paradox is where fossil fuel producers over-supply the market under the expectation that the world will soon wean itself off their product because of the climate change implications. The lower price results in greater emissions. The authors say banning supply would put an end to that. And they are correct. Actually implementing demand side policies more aggressively would do exactly the same  - there would be much reduced demand and the price would collapse. There is nothing in the Green Paradox that implies supply bans should be favoured. Again let’s remember that for supply bans to be effective they have to prevail across a significant portion of world supply – or even potential supply. Certainly banning supply in New Zealand simply hands our share to someone else. Contrast that to curbing our demand – that doesn’t stimulate demand anywhere else.

So we now move on to the political reasons for adopting supply-restricting policies on fossil fuels. The primary argument put forward here by the authors is that the public is so stupid it will swallow utterly the premise that if we stop the supply then the emissions will end. Of course that too is correct, so long as we stop all or most of the global supply. They cite “circumstantial empirical support” for the proposition that the public is a bit vague of climate consequences, but is very much of the view that Big Oil and its environmental damage, its self-serving lobbying, and its disdain for the little person is inherently evil. So a climate change policy that curbs supply can enlist the public’s antipathy to resource extraction businesses and get better traction than an ETS or carbon taxes will.  This is based on a heroic assumption that the public is unable to discern the difference in the issues and is predisposed toward doing away with resource businesses. With respect any thesis that holds that the public is irrational in both the short and the long run, is always going to struggle to be credible. Besides, this is not what New Zealand is doing. We are stopping only our own supply, insignificant as it is. That has absolutely no effect on global emissions (given we’re a price taker so an insignificant producer). Is the public too thick to understand that? From the column inches of support for Labour’s policy that has been written, you could be forgiven for concluding yes the public is that dense. However that would be a dangerous assumption unlikely to hold for long once people think through how emissions are not affected at all. Such is the cross to bear of public education – it can be frustratingly slow. But there is no evidence to suggest the public is permanently irrational.

The second political rationale forwarded is that if people think the costs of mitigation are going to fall on polluting industries rather than themselves, they’ll support such policies. And with supply bans the immediate victim is of course the producer. This argument holds that for the public there always has to be a villain in the story and if that enables someone else to take the rap then the public will vote for it. Whereas raising the price of fuel for my car is hurting me. Really? So closing down all those nasty polluting, exploiting, resource extractors is not going to affect my lifestyle so I’ll vote for it? Somehow I think the authors are grasping at straws if they think the public is this dumb, that the price at the pump will not rise as Big Oil is shut down.

Another political rationale is the demonstration effect. That a supply ban sets an example and others will grab the nettle and follow suit. The authors argue this will work when it comes to supply-focused policy but doesn’t when it comes to demand-limiting ones.  This reminds me of the unfortunate analogy our Prime Minister made with climate change being our “nuclear moment”. New Zealand’s anti-nuclear stance has been one of much feel-good, zero impact and revealed political hypocrisy. Surveys tell us New Zealanders in general feel good about our policy, the proliferation of nuclear weapons has accelerated since we adopted our policy (so we’ve had no measurable effect), and New Zealand is a member of Five Eyes which provides valuable intelligence information to the nuclear powers that constitute our de facto defence umbrella in the geo political sphere. It seems New Zealanders haven’t acknowledged the hypocrisy in our stance simply because it doesn’t suit us to.  Similarly, every day we conduct trade with countries that have political regimes that are abhorrent to New Zealanders. It is far fetched to imagine any moral stand we take will be followed by these countries. This type of regime-change think via taking the moral high ground is even more pitiful set against a background of our own double standards.

To be fair to Green and Denniss they are not advocating that supply side policies should be preferred over demand side ones. They use the analogy of a pair of scissors needing both blades to do the cutting. However, I find the case they present to only be credible in the unrealistic situation where countries that control a significant proportion of the global supply of fossil fuels pursue supply-limiting policies. Otherwise the attempts by any small group of producers to restrict supply simply hand over an opportunity to others to fill the gap. What is “significant proportion” in this context? It is the ability to influence price. Price takers can do nothing to influence price by definition.

In the context of the policy just announced by Labour on oil and gas, set against a backdrop where New Zealand has been a climate cheat in the international carbon credits market, has let net emissions rise inexorably since the 1990 baseline, and has contrived to ensure our ETS doesn’t work – the stunt on an impending ban on New Zealand production of oil and gas has to be seen for what it is,  simply another distraction from getting on and doing the job – that job is to set year by year reduction targets and run a demand side ETS regime that enables the market to set a carbon price to ensure those targets are met.

Under both Labour and National governments, our climate change mitigation and adaptation policies have been shameful; an insult to any intelligent observer. This latest policy distraction by the Ardern government does nothing to overcome that impotency. It is a mere tilt to the windmill of Far Left environmentalism that holds that our climate issues are the fault of evil business. They are not, they are a result of a dependence upon fossil fuels that is best served by having a coherent policy that steps those emissions down year by year in line with our international undertakings.

• “Cutting with both arms of the scissors: the economic and political case for restrictive supply-side climate policies”. Fergus Green & Richard Denniss, Climatic Change https://link.springer.com/content/pdf/10.1007%2Fs10584-018-2162-x.pdf