MRF CoP - do we need it?

My previous post suggested that economic theory doesn't necessarily support the case for a mandatory MRF code of practice (CoP). While I believe that this is the case, and would maintain that - contrary to Defra's stated belief - current market signals do work (just not necessarily in domestic reprocessors' favour), I might still support the introduction of a CoP in practical terms.

My reason being that we have an obligation to meet European legislative requirements, in that we must demonstrate that a co-mingled approach to recycling can meet Waste Framework Directive objectives. In this context, the introduction of a mandatory code may be a necessary evil.

Is the CoP really necessary to guarantee high quality recycling? I don't think so, but I do think it may be necessary to placate a noisy domestic reprocessing sector, and also to offset the objections of an equally vocal wider set of campaigners for "real recycling".

I also think that the end result will be to push costs from (both domestic and overseas) reprocessors on to waste producers (local authorities and householders). Where these costs were previously borne by overseas reprocessors, the net effect will be negative for the UK economy.

Whether the implementation of a mandatory CoP will be sufficient to offset other macro-economic issues affecting the domestic reprocessing sector remains doubtful to me.

Recycling markets as a model of asymmetric information and quality uncertainty

George Akerlof wrote a famous economics paper on the "market for lemons", which took the used car market as an example of where asymmetric information coupled with quality uncertainty leads to market failure and the need for government intervention.

In the paper, used car customers are only willing to pay for average quality, which results in high quality vehicles being unable to attract a sufficiently good price to enter the market. The end result is a race to the bottom in terms of quality with the market ultimately delivering a 'no-trade equilibrium'. The way to avoid this is of course through government regulation that helps to ensure customers of the quality of the vehicle they are purchasing.

This is exactly the rationale behind Defra's proposals to introduce a mandatory MRF code of practice. The recycling industry is an apparently perfect example of where there is asymmetric information between different parts of the supply chain and there is quality uncertainty at point of purchase (beyond crude visual inspection). Good performing MRFs are unable to differentiate themselves from poor ones, and reprocessors are incentivised to pay a price that perversely only attracts lower quality material.

Defra's case for intervention seems compelling. But is that actually the case in the real world?

No prizes for guessing that my personal view is that there isn't in fact a strong case of market failure in recycling markets. Instead I think we are in a game theory world of repeated games and repeated bargaining. In this reality MRFs have a strong incentive to meet customers' quality specifications in order to secure repeat business. This results over time in a market equilibrium where quality is differentiated according to price and there is no need for government intervention. I wonder whether Prof Akerlof would agree.

FOE calls for even more difficult targets

I see via Lets Recycle that FOE Europe has published a new report claiming that Europe is wasting its resources.

I can't actually seem to download the report itself as their web site is struggling for me at the moment, but apparently FOE is complaining that  - across Europe as a whole - we are well short of the current recycling targets.

Their brilliant solution to this predicament is apparently to increase the targets even more, which to me doesn't seem to address how we might improve the worst performers in practice.

EP0W conference highlights industry contradictions

I was at the European pathway to zero waste conference on Monday, which again highlighted the increasingly common divergence between policy wonks - who believe that the UK's waste and resources sector is on the verge of unlocking hiterto unrealised huge potential value from discarded materials (i.e. rubbish) - and those who have to deliver new projects in the sector in practice.

Lower than previously anticipated waste volumes are putting downward pressure on gate fees at the front end of the industry, while falling commodity prices are also hurting revenues at the back end. This reality is a far cry from the fantastic figures bandied around for the supposed billions of dollars of opportunities to be made from secondary resources.

To an outsider, waste projects must look like a high risk, low return proposition. It's no wonder we need the Green Investment Bank's support in the debt market, and the help of public grants for many smaller-scale projects.

WRAP finds that deliverable business models are deliverable

I see that WRAP has published another relatively lengthy report looking at textiles.

Sure enough, it shows that business models which already exist in the marketplace (one-off hire for formal and evening wear, and second-hand clothing) can generate a return under certain scenarios, while others which have not been delivered by the market don't offer returns. Stunning insight there.

At least this research did consider consumer demand for these alternative business models. To me, WRAP sometimes seems to forget that there is no point supplying materials/goods/whatever if there is no end market for it.

WRAP's original remit was to support end markets for recyclates and I personally don't think they do anywhere near enough on this front. Almost all the policy levers are driving up supplies of secondary resources with little helping on the demand-side.

EMF report assumes policy is optimal

Further to the discussion in the previous two posts, I am sorry to say that I still disagree with McKinsey's analysis, in that the whole purpose of the circular economy is to realise real benefits to society as a whole. The McKinsey riposte on this scale seems to be based on an assumption that landfill taxes and renewable subsidies are 'optimal' in that they internalise environmental costs. I couldn't disagree more. In reality the taxes and subsidies are far from optimal levels and are instead set with the explicit intention of meeting (arbitrary) government targets for landfill diversion and renewable energy penetration.

My personal view is that optimal landfill tax levels should be in the order of £30/t. I haven't done a similar analysis for renewable subsidies but Decc's stated policy is to levelise costs between different technologies, rather than set an optimal support regime for low carbon generation. It is widely acknowledged that meeting EU carbon reduction targets through very high renewable generation is in fact an expensive way of meeting our environmental goals and is therefore sub-optimal policy.

Going back to my original post: This was a brief attempt to look at the issue from the perspective of the 'public authorities' (using the boundary set out below). McKinsey suggest that if the cost of landfilling in this scenario is $24/t or more then society has made a profit. My post looked at the figures in the report which showed landfill costs of $105/t (including taxes). I took away the taxes (currently $100/t) and came to the conclusion from their numbers that society was making a loss, based on landfill costs of $5/t. (I am of course willing to be corrected if I have misread their figures.)

In reality (non-tax) landfill costs may be closer to $30/t (but could easily be not be far off, or below, $24/t in various regions). This to me doesn't lead to the conclusion that large benefits are realisable from the switch to AD at a wider level (and not just from landfill but from energy from waste too - another point would be whether their analysis includes consideration of energy revenues from efw or landfill gas). And this is before my challenge to their assumption that government intervention is optimal.

I would also note that McKinsey refer to an 'advanced scenario' which is presumably based on improved AD efficiency. As efficiency improves over time though, Decc policy will be to correspondingly reduce renewable support. Scope for additional 'benefits' here may therefore be constrained.

AD: response from the Ellen MacArthur Foundation

My previous post criticised part of the recent Ellen MacArthur Foundation (EMF) report into the benefits of moving to a circular economy. In particular, I suggested that their estimates of the benefits of switching food waste processing to Anaerobic Digestion (AD) were overstated.

EMF has responded to the post and asked McKinsey, the original report authors, to set out how they reached their conclusions. This is reprinted with permission as follows:

AD and food waste: real savings

The model used for the food waste case is based on actual cost data from AD plants in the UK, interviews on waste handling and treatment costs in the UK (WRAP), and UK energy prices. The report looks at the situation as it is today as well as at an “advanced scenario” that takes into account some cost improvements that can be realized from larger operations, such as bulk order discounts of technology if several plants are built at once. These benefits are realized already today in bigger projects, as confirmed for example by Tamar Energy. 

It seems that the main point of criticism made in the article is that the taxpayer loses out if food waste is put through AD instead of landfilling it - which needs to be examined in a bit of detail. 

One can look at the profits of the food waste case from the point of view of different stakeholders with different “system boundaries”, starting from an entrepreneur and going all the way up to society as a whole. The case made in the report shows that there is an overall positive profit pool to be distributed, so that the profitability of the case does not depend on creating a loss elsewhere in the system. The problem can be seen from the point of view of four (successively larger) systems, including the public authorities' point of view which seems to be the focus of this blog entry.

- The “smallest system” is the entrepreneur: Today, the business case of putting a tonne of food waste with an initial value of 0 USD through AD would be slightly negative in the UK (-24.00 USD/tonne) if landfill was free and no energy subsidies existed. In an advanced scenario, the profit would already be USD 6, without considering energy subsidies or landfill cost and tax. This is still a very small profit but it could become easily higher with rising energy prices, sinking costs through further economies of scale, etc.

- Perspective of a municipality: Municipalities collect rubbish and have to pay landfill costs and tax. Alternatively they can use the food waste to generate energy and fertilizer and earn revenues from energy and energy subsidies. Both the cost and revenues are real costs and income, so the full profit of USD 142 today and USD 172 in an advanced scenario described in the report would be realized. 

- Perspective of the "public authorities" (the combined system of the central government, responsible for setting landfill costs and tax and the municipalities). In this system, the municipality would bear the cost of AD, profit from selling energy and the energy subsidy and avoiding landfill cost and tax, while the central government would pay out the energy subsidy and miss out on landfill tax. The net effect can be found when comparing the cost of AD with the revenue from the sale of energy and cost of landfilling. If the cost of landfilling is more than the 24.00 USD/tonne - society has made a profit. 

- Society as a whole: Subsidies on renewable energy and taxes on landfilling aim to internalize external costs that are otherwise indirectly and indiscriminately borne by society as a whole, e.g., through health care costs in the case of pollutants, the costs for the impact of climate change or the erosion of ecosystems services. Energy subsidies and landfill taxes thus reflect actual cost and benefit to society.

I personally remain in disagreement with McKinsey's analysis and will set out why in my next post.