• Simon Upton


Thank you for welcoming me here today to discuss what I think we all agree is a vitally important issue both to business and to the wider community -- the issue of climate change policy.

This occasion comes at a time of hectic activity in the lead-up to the third Conference of the Parties to the Framework Convention on Climate Change, at Kyoto in December. In the arena of climate change policy, we are obliged to operate to distant horizons. Kyoto is not the end of the road. It could be the starting point of a long evolutionary path to more environmentally sustainable energy systems. Or it could be a complete fiasco, seriously undermining the Convention. There will be those who believe the risk of climate change is real enough to warrant substantive progress in Kyoto. And there will be those who are sceptical about the whole issue and hope -- more or less privately -- that a divided international community will fail to agree on anything and that the whole issue will go away. I am firmly in the first camp.

Kyoto is important because it is an opportunity to tie down some durable and cost-effective steps towards weaning our economies away from fossil fuels -- and, in addition, reducing anthropogenic emissions of those other gases such as methane, which could destabilise the climate system. So far, Parties to the Convention have only had 'aim to' targets -- and most of the emission reductions we have seen have been fortuitous. 'Aim to' targets have meant different things for different countries. One of the perverse outcomes thus far is that the most profligate and environmentally destructive energy users, such as Russia or Poland, have made effortless reductions in emissions as 'basket case' industries have closed with the arrival of market disciplines. Meanwhile, countries endowed with substantial renewable energy resources like my own have struggled to make progress in the absence of easy windfalls.

When countries are dealing with soft 'aim to' targets, it makes sense for action to be essentially 'behind borders' and on a no regrets basis. But once targets become legally binding, and more stringent, the stakes are raised and it becomes imperative to act together to establish less costly ways of reducing emissions. We have now reached the point where, if we are to go beyond superficial actions, it becomes essential to set up innovative mechanisms to allow us to cut our emissions without incurring high costs.

Today, I want to sound a number of notes of concern about the lead-up process to Kyoto and some of the risks we face. I have three major concerns: the preoccupation with targets rather than mechanisms; the insufficient attention to durable and comprehensive arrangements; and the matter of a sense of urgency about making an early start.

Targets versus mechanisms
A number of countries' current negotiating positions, and the emphasis of the world's media, centre around the size of proposed emission reductions. I consider this focus is myopic and risks sidelining much more critical issues. In my view, innovative mechanisms to achieve emission reductions are more important, in the long run, than the overall numbers.

There are two key reasons for this. First, the more cheaply we can reduce greenhouse gas emissions, the more we will be able to do. If we neglect intelligent mechanisms, or -- worse -- impose costly and prescriptive means for reducing emissions, then we dramatically limit the sort of cuts we can achieve. Such cuts would not be sustainable. If people see, however, that mechanisms for reducing emissions are not too costly, and furthermore will allow innovation and provide new market opportunities, then they will get in behind them and use their creativity to drive low-cost and effective responses.

Second, if developed countries are able to pioneer innovative and effective mechanisms such as emissions trading -- and I will say more about trading in a moment -- then they will give developing countries encouragement to join in, and come on board. This, in my view, is essential if we are to make real global progress on the climate change issue. Moreover, it is only when developing countries make real commitments themselves that developed countries will make deep commitments.

Why emissions trading is important
It is of course obvious that not all Parties to the FCCC are alike: our natural resources and wealth differ, our economies have different configurations, and some Parties emit more than others -- either per capita or per unit of GNP. New Zealand, for instance, has modest CO2 emissions when compared with countries like Australia or the USA. That reflects the very high level of renewable energy used to generate our electricity -- hydro and geothermal (and, increasingly in future, wind).

Accordingly, abatement costs will vary among countries. Some evidence suggests that New Zealand, Japan and, to a lesser extent, Australia, all have high abatement costs. Only when we start seriously trying to abate emissions will the actual costs, and their diversity, become very clear.

Because abatement costs are bound to vary among countries, it makes sense -- if we are to pursue a global least cost approach -- to take up the cheap abatement opportunities first. This would mean that emissions reductions would be greater in some countries that in others, at least initially. Broadly speaking, this can be achieved either by trading emission reductions, or by differentiating commitments. In my view, trading is the most logical approach, since the likelihood of being able to agree on a coherent basis for differentiating commitments is small.

I would like to take a moment to juxtapose trading and the European Union's bubble approach. As you know, the EU's composite target for 2010 is a 15% reduction in greenhouse gas emissions. Even the achievement of 10% involves a range of member state commitments, from -30% off a high base for Luxembourg (it had the highest tonnes/capita gross GHG emissions in 1990) to +40% for Portugal.

The EU has indicated that it is opposed to differentiation of commitments for other Annex I parties, at least for now, i.e. within the Berlin Mandate protocol. (Differentiation in future, when deeper targets are being discussed, is more open). But, clearly, the EU's approach is a crude form of trading -- but it involves political horse-trading rather than trading with price signals.

My view is that the bubble is a sensible means to minimise political costs internal to the EU and preserve EU unity. It amounts to an agreed distribution of economic costs, largely on the basis of GDP per capita, and recognises national circumstances (willingness or ability to pay, and marginal abatement costs). In effect, then, the bubble amounts to trading without resource transfers. It is also likely to have been facilitated by implicit or explicit trade-offs among member states with respect to other objectives.

Now the EU is an institution that facilitates non-cash trading of positions, in part through greater trust and familiarity arising from established close contact. Among other countries, however, such deals are likely to be harder to achieve. In a sense, the EU deal leaves them out in the cold. Therefore, alternatives are needed to assist in discovering different acceptable positions -- in particular, to discover just how much countries can reasonably abate at a given cost. My proposition here today is that a market -- emissions trading -- is a highly efficient means for discovering least cost options. It is also likely to be more successful in achieving least cost reductions than politicians with limited knowledge of abatement opportunities.

Given that trading really leaves the key implementation decisions to industry, it is important that business gets its mind around what is involved. To this end, it is pleasing to discover the World Business Council for Sustainable Development promoting these sorts of flexible options.

Possible obstacles to trading
Before I leave the key mechanism of trading, let me touch on two possible obstacles to trading. The first is the matter of trading what have been called `paper tonnes' -- the concern that emissions in countries such as the US might rise if Russia was able to sell to the US permits arising from Russian emission levels being lower than 1990 levels.

I do not see any cause for concern here. After all, the EU bubble constitutes internal aggregation within the EU, which allows East German emission reductions to be treated as an implicit credit to offset emissions either elsewhere in Germany or elsewhere in the EU. If this is acceptable within the EU, why not outside?

In addition, surely we want to recognise that Russia is producing dramatically less CO2 than it used to. It's in a parlous economic state, and we would be happy to see it benefit from selling permits. After all, its emissions in future will be constrained. Meanwhile, the Russian economy needs more capital, if only for further environmental clean up and the adoption of newer, cleaner technology, such as state-of-the-art energy systems.

Moreover, as other countries (the Czech Republic, for example) join the EU over the period to 2010, the EU will reap windfall gains. In effect this allows the EU to set a deeper target -- which is desirable. The same logic applies internationally: giving credit for paper tonnes allows the international target to be set at a deeper level.

Another obstacle to incorporating trading within the Kyoto protocol is said to be the complexity of trading and the time required to design trading arrangements. However, the aim should simply be to agree at Kyoto on a permissive framework that would accommodate trading. Unresolved detail can and should be worked out after Kyoto. Moreover, it needs to be remembered that a lot of the requirements for trading are mechanisms (for monitoring and verification, for example) which would have to be put in place anyway to achieve compliance with reduction commitments.

A wider consideration here is that eager-to-trade countries should not be held back: it is important that they have, as an extra incentive to trade, the clear signal that trading is likely to be encouraged or at least permitted in future.

Another potential obstacle is the legal accountability issue for the EU -- should member states trade separately or should there just be one EU trading agent? However, this is really just the same problem that arises for any accountability and monitoring arrangement -- even without trading.

Before I move on I wish to make just one more comment concerning mechanisms. This is simply that a prescriptive approach, as presently advocated by the EU, will not be 'least cost'. New Zealand does not favour mandatory coordinated policies and measures -- simply because they are with few exceptions likely to push economies away from lower cost abatement options. Mandatory coordinated policies might maintain the competitive position of EU countries -- but this would be at a cost for the world as a whole.

Durable and comprehensive arrangements
Another concern I want to raise today is that of ensuring that any resolution we come to at Kyoto is durable and comprehensive. On the matter of comprehensiveness first, my point is that if we are to pursue a global least cost approach, then we should be exploiting the cheapest greenhouse gas abatement opportunities wherever these arise -- whether through abating methane emissions, for example, or planting forests which absorb carbon.

You may already be aware that, as an agricultural country with large ruminant livestock industries, New Zealand's methane emissions are very substantial. For New Zealand, then, how we tackle our methane emissions will have far more impact on our contribution to global emissions than what we do with CO2. Fortunately, the removal of agricultural subsidies in the 1980s and the decline in livestock numbers that has resulted mean that between 1990 and 2000, methane emissions will decline by around 10 percent. There will, on the other hand, be an increase in CO2 emissions of around 22 percent over the same period. Our overall increase in greenhouse gas emissions for the decade is likely to be + 2 percent -- not stabilisation as was hoped for, but a good deal better than many developed countries.

On the matter of durability, my government takes the view that climate change is a truly global problem requiring a truly global buy-in to a solution. When the climate change convention was negotiated in 1992, it was agreed that developed countries (like New Zealand) should have to do more than developing countries. Indeed, developing countries like China and India only signed on the basis that reduction commitments should not apply to them. They demanded unconstrained freedom to develop. Since elevated greenhouse gas levels have been largely caused by today's developed countries, this was a problem for developed problems to tackle first, they argued.

There is a certain logic to this, and New Zealand has supported the Annex I/non-Annex I distinction to date. Present negotiations under the Berlin Mandate only seek to impose legally binding targets on Annex I countries. New Zealand's view is that this is necessary to demonstrate good faith to developing countries but following any agreement in Kyoto, future negotiations have to include these countries. That is because some 'developing' countries are already richer than some `developed' countries. For example, Singapore is richer than New Zealand and has emissions over twice as high as New Zealand's. As an AOSIS country, it supports a 20 percent reduction by 2005 target -- but is not prepared to adopt that target itself apparently because it is not yet fully 'developed'. Other countries like South Korea and Mexico are rapidly approaching developed world living standards. A number of cities in booming East Asia already emit more CO2 than New Zealand does. This is not a reason for New Zealand to do nothing but it is a reason to insist on a genuinely global formula from here on.

It's the global nature of any solution that's the key. Unless the vast majority of countries are included, industrial production that emits CO2 will tend to migrate to countries that don't accept obligations. Countries that did reduce emissions might then just import products from a country that wasn't imposing emission reduction measures. So the world's climate wouldn't be helped -- and neither would the economy taking emission reduction measures. In other words it would be neither morally nor economically justifiable.

Concerns of this nature have recently led the US Senate to put the Administration on notice that it should not sign any protocol negotiated at Kyoto that would limit Annex 1 emissions unless it 'mandates new specific commitments to limit or reduce greenhouse gas emissions for developing country Parties within the same compliance period'.

This would be a particularly demanding negotiating position if adopted by the Administration. It effectively rejects the Berlin Mandate and runs counter to the spirit of the Convention's evolution to date. Given that the United States is the world's biggest emitter - and continues to increase its emissions - an uncompromising position on developing country commitments could seriously undermine the negotiations.

On the other hand, it puts everyone on notice that progress of the evolution of commitments has become doubly urgent. It is hard to disagree with the view that unless there is some certainty of progressive engagement by the rapidly growing developing economies, there will be no real progress; and that without real progress time that could be used to make progress in a measured and undisruptive way will be lost.

The world community has never before tackled an environmental issue of this scale. The nearest example we have is the Vienna Convention on Ozone Depleting Substances. It covers a small group of compounds for which there were affordable replacements already to hand. The Climate Change Convention is concerned with the core fuels of the world's energy generation and transport systems. Emissions from the use of these fuels by rapidly developing countries will swamp developed world emissions within a few decades. The need for a genuinely global buy-in is acute, if we are to attain a durable solution.

Early action
That brings me, finally, to the case for early action in the face of uncertainty. In this, I want to take the long view and dwell for a moment on the uncertain science of global climate fluctuations.

My first observation here is that we are having to act before we have answers to some very important scientific questions about how climate change occurs. We are also having to take policy decisions before we can pin down crucial parameters such as the 'temperature sensitivity' of the atmosphere. For example, whether a doubling of CO2-equivalent gas concentrations since pre-industrial times, from 280 parts per million by volume (ppmv) to around 550 ppmv, will kick up global equilibrium temperatures by around 2.5 degrees C (the current mid-point estimate) or by some other increment, is not yet known.

So what course is a prudent decision-maker to follow? In essence, we have a choice between waiting for absolute certainty or not. We can wait years for the evidence to come in, or we can take action in advance of complete knowledge. A prudent approach in this context is, I believe, one which would ensure that neither ecosystems nor economic and social systems were subject to unreasonable strain, if that could be avoided by taking early action. In short, risks to both environmental and social/economic systems need to be carefully managed.

There is, as you know, a vibrant debate about the sensitivity of the climate system and the extent of the risks we are facing. Some evidence suggests, for example, that atmospheric CO2 equivalent concentrations above the 400-500 ppmv range may represent a significant risk. A recent article in Science, for example, noted that should the climate system turn out to be sensitive to CO2 increases in the IPCC's upper range, then a concentration of only 550 ppmv "will be sufficient to yield a change in average global temperature of a magnitude approaching that which occurs during the transition to an ice age." Azar, C and Rodhe, H (1997) 'Targets for Stabilization of Atmospheric CO2', Science, 276, pp1818-1819 (20 June 1997). As yet, we cannot exclude this sort of scenario, given the uncertainties over climate sensitivity. But there are of course, other views, and we need to keep our minds open to further changes in the scientific evidence.

A key point in thinking about climate risks is that we need to be aware of what happens to the tail on the distribution of extreme climatic events. The tail matters. As temperatures rise, the number of extreme events (associated with the tail of the distribution curve) can increase disproportionately fast. These non-linear changes have the potential to cause dramatic dislocation in some places and to some people.

An additional point to bear in mind is that the case for action is not predicated on observed changes in climate. Some lobby groups are too eager to divine the hand of climate forcing in the weather record. Having followed the scientific debate for over a decade, I believe the jury is still out on this claim. But that is of secondary importance. The more important point is that among climatologists, even sceptics, there is widespread agreement that the enhanced greenhouse effect will lead to some warming, perhaps around 1 degree C, perhaps more. That may not sound like much but even 1 degree C as a global average warming could well be significant in terms of some impacts.

All in all, I believe there is reason for being cautious. Prudent risk management would suggest policies which, through early emission reductions, at least keep the risk to low levels, and preserve our options. If climate sensitivity should turn out to be at the low end of the likely range, so much the better: we have lost little. If climate sensitivity should turn out to be high, we will have avoided some very large costs.

I would add to this a remark about what is called 'path dependence' and technological inertia in economic systems. Path dependence is the notion that the path along which an economy develops depends on historical choices and influences. If, for example, a government decides to establish incentives for emission abatement, then technology in that economy is likely to develop over time in a way which reflects that choice. In particular, there is clear evidence that technological development does respond to emission abatement efforts. The US experience of abatement assisted by trading in sulphur dioxide allowances is the sort of example that gives me heart: the experience there was that as people faced market prices and market opportunities to trade to redu ce the costs of abatement, the costs did actually fall substantially (and were considerably less than initial gloomy predictions of abatement and adjustment costs).

Michael Grubb, in a recent article in Energy Policy Grubb, M (1997) 'Technologies, energy systems and the timing of CO2 emissions abatement', Energy Policy, 25(2), pp159-172., put it well in writing that "abatement efforts generate market opportunities, cash flows and expectations that enable industries to orient their efforts and learning in the direction of lower carbon technologies". Furthermore, since we cannot know at present the CO2-equivalent concentration at which the atmosphere should be stabilised, inertia in technology and economic systems is important: "There are potentially very high industrial and economic costs if the initial response proves to be much too relaxed" and drastic action is needed in future.

My conclusion from these considerations is that we need to keep giving serious thought to the best way of handling the risks of climate change, and the best emissions trajectory to follow, and meanwhile take actions that keep our options open and limit our exposure to serious biophysical and economic risk. Whatever our view on the climate science, we need to act, since not acting would be to lock our economies into an unnecessary degree of dependence on fossil fuels. To this end, I view Kyoto as a critical opportunity to gain agreement on mechanisms that will allow us to begin moving up the learning curve and explore low-cost abatement actions, so that we can gradually steer our economies onto less fossil fuel intensive development paths.

Thus far, Kyoto has been treated by the news media and some politicians as an environmental beauty contest, in which each country's bids will be lined up on the podium at Kyoto for approval or excoriation by NGOs and industry lobby groups. I would like to see the Parties at Kyoto agree on targets, even if they are very modest targets, rather than deferring action until later. Agreement on even modest actions soon would allow an earlier start to the process of learning; i.e. Parties could begin gradually to put in place incentives to reorient their economies, even if they take only modest actions to begin with. I personally hope and expect that there will be an opportunity to develop options such as international emissions trading during this early period. But the main point I wish to emphasise here is that there are strong arguments that early action is likely to be the most prudent course if we are not to incur substantial biophysical risks on the one hand, and substantial economic risks on the other.

In my estimation, the prospects for Kyoto at this stage range from very modest progress at best to complete failure and the undermining of the Convention. There are probably some countries which hope nothing will be agreed at Kyoto. The New Zealand Government isn't one of them. I am working hard to try to arrange a meeting of Annex I countries prior to Kyoto to make some progress at the political level. But you should be in no doubt that an agreement that does not allow for a flexible least cost approach, that fails to foreshadow the inclusion of rapidly developing countries in the near future, and that does not allow for innovative mechanisms such as emission trading, will not be a durable one.