Coasta Rica Carbon Tax

Background

As a pioneer in reforestation carbon credit, Costa Rica sold 200,000-carbon credits at $10.00 tC to the Norwegian government in 1996.  In 1997, after the establishment of Kyoto Protocol, Cost Rica attempted to sell 1,000,000-carbon credit in auction with a reserve price of $20.00 tC and received no bids.  With a new government in power and contemplating selling additional carbon credits I recommend the following actions:

• sell 4,000,000 carbon credits now rather than waiting
• participate in CDM and price credits at $14.00 per tC

Problem

Costa Rica is facing increase competition and a maturing of carbon trading markets. With the increasing amount of greenhouse gases in the atmosphere, the international community eventually agreed on a framework to reduce emissions, Kyoto Protocol. As an incentive to reduce emissions, provisions in the Kyoto Protocol created a framework for the trading of emission credits.  As a direct result, these provision provided opportunities for Annex A countries to reduce potential abatement costs by trading emission credits. More important, one provision, Clean Development Mechanism (CDM), incentivized Annex B countries to reduce their emissions by selling ‘additional’ carbon credits to Annex A countries.

Key Issues

An important component of Kyoto Protocol was the ability of Annex A and Annex B countries to trade carbon credits.  The trading provisions in Kyoto Protocol created a global legal and responsible framework for how carbon credits would be sold and bought. The international summits in Rio (1992) and Berlin (1994) provided little guidance on emission reductions.  Without understanding abatement costs, strategy for emission reduction, and binding targets there was little guidance on carbon credit products and pricing.  In the vacuum of an international agreement and global pricing, Costa Rica was a pioneer and sold the first reforestation carbon credits to Norway in a bilateral agreement.

In 1997, Costa Rica attempted to sell 1,000,000 carbon credits in an auction market (on the back of success and criticism of prior year’s sale).  Without performing any price discovery and understanding the macroeconomic implications^[1] of carbon pricing a floor price of $20.00 tC was established – double price prior year’s sale.  Unlike the prior year’s sale, a bilateral agreement between national governments (didn’t include any price discovery), Costa Rica entered an auction market and opened bidding to both public and private sectors.  

In order to alleviate the cost burden of Annex A countries and to entice Annex B countries in reducing emissions, the Kyoto Protocol included a provision known as Clean Development Mechanism (CDM), which allows Annex B countries to earn saleable carbon credits. There are two direct consequences of CDM.  First, CDM provided a path for Annex B countries to participate in a global emission reduction scheme. Bolivia was offering 4,000,000 carbon credits of reforestation at $15.00 - $20.00 per tC) while Brazil and other countries were planning to offer reforestation carbon credits. Aside from CDM, the Kyoto Protocol included additional provisions for carbon trading between Annex A countries. Aside from competing with Annex B countries, Costa Rica would also compete against Annex A countries. An important advantage with Annex A countries pertained to their ability to offer carbon credits base on technology as well as of reforestation. Costa Rica’s carbon credits from the 1996 and 1997 sales were base on emission reduction programs from reforestation programs.  Didn’t appear Costa Rica took into consideration competitive products.  Besides carbon credits base on reforestation, other carbon credit products where being offered base on non-reforestation programs – e.g., solar power, wind turbine, etc.  It is feasible non-reforestation base carbon credits provided a lower abatement cost to buyers than Costa Rica’s carbon credits generated from reforestation.

Alternative Solutions

 The trading provisions of the Kyoto Protocol galvanized the international community to participate and create a liquid market for carbon credits. Participation in CDM provides Costa Rica access to large pool of carbon credit buyers.  Access to larger pool of buyers reduces the impact of microeconomics events. More important, in a global market Cost Rica has supply and pricing information.

Even with the increase competition in sellers, Costa Rica has advantages that distinguish itself from its competitors.  Uncharacteristic of a lot of Annex B countries, Costa Rica has a long history of environment protectionism and a stable government.  One aspect of a market system that is important is transparency and trust.

Given Costa Rica relative small size and existing utilization of land usage for conservation and forests (40% from Exhibit 2), it should explore alternative projects for carbon credits.  With its advance-manufacturing base (electronics), Costa Rica has the infrastructure and capability to transition to emission reduction technologies. With initiatives to transition to new technologies Costa Rica can reduce its carbon emissions and generate additional excess credits.

Evaluate each alternative solution