Economic Instruments as a Tool for Greenhouse Gas Emissions Reduction –

1. Economic Instruments as a Tool for Greenhouse Gas Emissions Reduction – the perspective of EU countries Stefan Speck International Conference on Green Growth and Official Statistics 6-8 July 2011 Seoul, Republic of Korea

2. Content Introduction – the challenges of emission reduction Economic instruments – the reasons for their application • Carbon/energy taxation – a snapshot of the current situation • Emission trading – the EU Emission Trading System • Interactions between economic instruments – coherent policy framework is required Summary The views expressed in this presentation are those of the author and may not in any circumstances be regarded as stating an official position of the European Environment Agency

3. Reduction of greenhouse gas – an exceptional policy challenge • The Stern Review states that climate change is the greatest and widest-ranging market failure ever seen, presenting a unique challenge. • Stern Review provides prescriptions/policy measures • Carbon pricing – carbon taxes, emission trading schemes • Technology policy – low-carbon energy sources, incentivistaion of investment programme • Removal of other barriers and promote behaviour changes • The environment / climate - a public good

4. The rationale for applying economic instruments • GHG emissions impose external costs on society – an “externality” in economic terms • External costs are not reflected in the prices of goods and services  this is a “market failure” • “Market failure” leading to excessive pollution and environmental destruction •  Markets do not always provide the most efficient means of allocating scarce resources; eg they do not automatically provide the right type and quantity of public goods

5. Market failure and economic instruments • “Market failure” is the rationale for government policy intervention, eg. implementation of the polluter pays principle (PPP): making the polluters pay for the costs they impose on others — good both for efficiency and for equity reasons • Government intervention can be done by building on existing or creating new markets to correct market failures by using the following instruments: • Environment taxes – levied on energy/GHG emissions • Emission trading schemes • Subsidy reform – fossil-fuel subsidies

6. Economic instruments – the reasons for their application For economic instruments: • More efficient than regulation; more effective than voluntary agreements and information • Static and dynamic efficiency gains • Raising revenue Main concerns hampering the widespread application of economic instruments: • Competitiveness issues • Distributional implications (impact on low-income households)

7. Energy and carbon taxation For energy / carbon taxation: • Rich countries must achieve a minimum of 80% decarbonisation by 2050 • Energy demand increases with income (income elasticity of +0.5) • Energy demand decreases with price (elasticity of -0.6) • Carbon pricing (taxing or trading) - stimulate the diffusion and development of low-carbon and efficiency technologies, and reduction in the demand for carbon-based fuels • Improvements in energy efficiency lead to a rebound effect, and therefore save less energy than anticipated (up to 70%)

8. Energy and carbon taxes – current situation • CO2 taxes – implemented in several European countries since the early 1990s • Finland, Sweden, Denmark, Ireland, etc • CO2 taxes cannot be considered independent of the overall energy taxation scheme • CO2 tax rates differ widely between countries – must be seen in the context of existing energy taxes • Under discussion in different countries – including South Africa, Australia, South Korea, China and proposal of revising the EU Energy Tax Directive

9. Energy/carbon taxation • Revision of the EU Energy Tax Directive (spring 2011) • New structure of energy taxation • A part based on energy content per GJ, regardless of the energy product • A part based on CO2 emission of the energy product  complement to the EU Emission Trading System (EU ETS); i.e. no double burden for business • Tax rate based on energy content (motor fuels): gradual increase to 9.6€/GJ by 2018 (0.15 €/GJ for heating purposes, etc. in 2013) • Tax rate based on CO2 emissions: 20€/t CO2 (2013)

10. Energy and carbon taxes • CO2 taxes – implemented in European countries • Sweden: about 110 Euro per ton CO2 • Finland: 30 Euro per ton CO2 (heating fuels) and 50 Euro per t CO2 (transport fuels) • Denmark: 20 Euro per ton CO2 • Ireland: 15 Euro per ton CO2  increase to 30 Euro per ton CO2 until 2014 (part of the National Recovery Plan 2011-2014) • Proposed EU directive: 20 Euro per ton CO2

11. Energy/carbon taxation Tax level – distinction between energy and CO2 part Source: Speck 2011; Note: Gas oil for heating purposes

12. Emission Trading System (ETS) • ETS – a rather new economic instrument implemented in a range of countries/regions (or are under political discussion): • European Union (plus Iceland, Liechtenstein and Norway, eg covering 30 countries); Alberta, Canada; Regional Greenhouse Gas Initiative (RGII), United States; New Zealand; Korea; China; etc. • EU ETS commenced in 2005 and is the largest multi-country, multi-sector greenhouse gas emissions trading system in the world. It includes around 11,000 installations accounting for about 45 per cent of EU carbon dioxide (CO2) emissions

13. EU Emission Trading System (EU ETS) • EU ETS follows the cap and trade principle - certainty of environmental outcome • Third phase will start in 2013 (2013-2020): • A centralised, known, EU-wide cap on emissions: in 2020 emissions will be 21% lower than in 2005,eg. annual decrease of 1.74% average annual total quantity of allowances issued by the Member States in 2008-2012 • Aviation will be included as well as additional industries • A cap on the permissible level of emissions reductions from outside the EU • Fundamental change as auctioning of allowances will be the rule rather than the exception. No allowances will be allocated free of charge for electricity production, with only limited and temporary options to derogate from this rule • About half of the allowances are expected to be auctioned in 2013 and by 2027 100% auctioning is foreseen

14. Emission Trading System New Zealand Emission Trading Scheme – passed into law in September 2008 Some characteristics of the New Zealand scheme: • transition phase between July 2010 and December 2012: the stationary energy, industrial processes and liquid fossil fuels sectors will now enter the ETS on 1 July 2010 – when fully phased in, it will have the most comprehensive coverage • will include all sectors of the economy and all greenhouse gases by 2015 • no explicit cap or domestic target for emission reductions • international market price will be brought into the New Zealand economy and stimulate appropriate levels of emissions reductions

15. Interactions between economic instruments • Need for a long-term consistent framework that governments stick to  sending the right price signal and providing certainty for economic actors • Coherent policy framework regarding different economic instruments is not always guaranteed  implications are that they impair the effectiveness • Subsidies and taxes • ETS and other policy instruments and policies

16. Energy subsidies and taxation • Reform / phasing out of energy subsidies (fossil-fuel and electricity) is important • Carbon reduction when reducing fossil-fuel subsidies over period 2011-2020 would reduce global energy-related CO2 emissions by 5.8% as compared to baseline (IEA, OECD, World Bank, 2010) • Effectiveness of energy and carbon taxes is impaired by energy subsidies but also by regulated prices: • Proposing to introduce a carbon price while retaining existing fossil fuel subsidies is analogous to driving a car with the accelerator and the brake both pressed to the floor (Denniss and Macintosh, 2011)

17. Interactions between economic instruments • Trade-off between ETS and other policies • discussions on the implications of new efficiency regulations (i.e. improving energy efficiency) for industrial sectors covered under the EU ETS – duplication of policy measures could reduce carbon market prices (allowance price)  less incentive to invest in low-polluting technologies. • similar issues can arise in the interplay between Feed-in-Tariff (renewable energies) and the EU ETS •  low allowance prices can be seen as a bottleneck for the transition towards a low-carbon economy

18. Interactions between economic instruments • UK budget 2011/12 – introduction of carbon floor price • Purpose: to encourage additional investment in low-carbon power generation by providing certainty to the carbon price; fossil fuels used for electricity generation will be liable to this economic instrument • The carbon floor price start at £16 per tonne CO2 in 2013 and raise to £30 per tonne CO2 in 2020; carbon price support rates will reflect the differential between the future market price of carbon and the carbon floor price •  hybrid emission trading scheme combining carbon taxes with emission trading scheme

19. Comparison of carbon taxes and emission trading schemes

20. Summary: Green Economy and Economic Instruments • Markets provide the most efficient means of allocating scarce resources – however this allocation is not always the most efficient and equitable one! • Economic instruments give flexibility to choose how to respond to the price signal, and they do so at least costs and the allocation of pollution reducing effort among firms is efficient • Carbon taxes: overcome rebound effect when increased over time and provide investment signals decisive for the transition to a low carbon economy and green growth • Fiscal policy plays a critical role in a Green Economy (UNEP Green Economy report and OECD Green Growth Strategy)

21. Thank you for your attention! Stefan Speck European Environment Agency email: stefan.speck@eea.europa.eu http://www.eea.europa.eu