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Economic effects of emission cuts Computable general equilibrium models (CGE) can evaluate and illustrate effects of policy at several levels of the economy Economic equilibrium models take into account interconnections between sectors in the economy

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Economic effects of emission cuts l.jpg

Economic effects of emission cuts

Computable general equilibrium models (CGE) can evaluate and illustrate effects of policy at several levels of the economy

Economic equilibrium models take into account interconnections between sectors in the economy

ADVANTAGES: econ. theory, macroeconomic consistency

DRAWBACKS: good for comparison of economic regimes, less convincing for estimating the level of technology-related costs

COMPLEMENTS disaggregated analyses of national industries

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4 policy simulations

An example – effects of EU emission trade on in 4 different trading scenarios

Rise in electricity costs

Kyoto with no Emission trade – EU countries each abate alone

Kyoto with EU trade but no hot air

Kyoto with EU trade and hot air

Results illustrate what happens in

Electricity sector (permit prices, energy costs)

Households (equivalent variation)

Firms (competitiveness)

Economy as a whole (GDP)

Based on a global trade model (GTAP)

OECD bilateral trade data, IEA energy data, NA data, updated National progress reports to EU

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Abatement targets

The policy cases involve different targets

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  • The CGE methodology

  • In CGE models, economic behaviour stems from theory of firms and consumers

    • Profit maximizing firms

      • Given available technology, market structure, supply of inputs, govt.

    • Utility maximizing consumers

      • Given utility function, wealth, demand for labour, govt.

  • Equilibrium results when each good has a price such that producer’s and consumer’s maximising problems are solved and supply equals demand – lots of output

  • Evaluated numerically

  • Hence, the name – Computable, General Equilibrium - CGE

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  • The CGE methodology

  • Model calibrated to base-year data

  • results often compared to an economic baseline (business-as-usual)

  • Effects of policies or structural changes can be reported at many levels

    • Macroeconomic effects – GDP, public sector etc.

    • Sectoral effects – production, profits, rents

    • Effects on consumer – consumption, employment

  • Money metric measures for welfare changes = how much money consumers should be given to compensate for changes caused by price/income changes induced by new policies

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  • CGE-models cover national and international issues

  • International: the GTAP-model

    • Takes into account

      • International trade in goods, energy, investment

        • Emissions trade and competitiveness can be studied!

      • Based on bilateral trade data so very accurate

        • Effects of market integration etc. can be studied

      • Top-down technology

        • Energy sector simplified, effects of ET on pricing of electricity

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  • CGE-models cover national and international issues

  • National: the EV-model

    • takes into account

      • Electricity pricing!

      • Power production technologies (18 in all)

      • Process technologies (forest, chemical and metal industries)

      • Most fuels

        • All fossil fuels

        • Most biofuels

    • Energy taxes

    • Prices and competitiveness

    • Labour markets

    • Capital markets

    • Energy efficiency scenarios

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ET in Finland - Policy assumptions

Reference:

(preliminary) WM-scenario ~ CO2-abatement target around 11 % from baseline 2008-2012 (latest version: 13 % - i.e. here a bit lower costs)

nuclear capacity increases by 2008

Initial allocation: grandfathering based on estimated ”go it alone”- sectoral emission reductions (hence only indicative)

KIO A: current energy taxes are incseased (CO2 tax around 17 €t/CO2 with some execptions, fuel taxes just above EU average, average el taxes)

implies a 13 % reduction target for ET sectors and 9.1 % for non-ET sectors

”status quo”

KIO B: CO2-taxes imposed

implied target for ET sectors 16 % cut, and for non-ET sectors, a 3.9 % cut

”cost-effective”

NOT A FINAL NAP allocation!

alternative tax scenarios:

ET1. Current taxes in ET-sectors, increases based on current tax structures in non-ET sectors.

ET2: No fuel taxes in ET-sectors, increases based on current tax structures in non-ET sectors, income taxes used to compensate for lost revenue.

ET3: No fuel taxes in ET-sectors, increases based on current tax structures in non-ET sectors, electricity taxes used to compensate for lost revenue.

Permit price: 10 or 20 € / tonne CO2

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Conclusions

Is ET useful?

ET cheaper than abatement with domestic measures (at least if permit prices not too high)

ET more effective if many countries

Does initial allocation matter?

”Cost-effective” allocation cheaper for the economy as a whole

”Status quo” allocation may be cheaper for ET-sectors if permit prices are high

There is a real risk of getting grandfathering wrong because permit price not known in advance; consequences more serious for non-ET sectors than for ET-sectors

Energy taxes: is there ground for using taxes with ET?

With ET, taxes do not increase efficiency

effectiveness: (3-1-2) recycling via el, current, recycling via income taxes

But: revenue neutrality may prove important – giving up taxes can entail costs

Changing taxes affects other targets

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ET and the electricity markets

Nordic electricity markets are fully integrated (Nordpool)

The system price is determined by the marginal costs of the most expensive technology

Average cost do not rise much at all! (less than 1 per cent)

Electricity prices have risen during the spring, while permit price has risen from 6-7€/tCO2 to close to 20€/tCO2

Electricity market models predict 10-25% increase in electricity prices with 20€/tCO2

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ET and electricity prices

The system price is determined by the marginal costs of the most expensive technology

Coal (/gas) most expensive – CO2 prices should go to el prices

Electricity prices have risen during the spring, while permit price has risen from 6-7€/tCO2 to close to 20€/tCO2

Electricity market models predict 10-25% increase in electricity prices when permit prices approach 20€/tCO2

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Econometrics: ET and electricity prices

Simple test: is there an equilibrium relationship between el price and permit price?

Causality?

El price and CO2 price appear to be cointegrated (based on Nordpool data from February to July)

(What) Other determinants should be considered?

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Evaluation of costs of EU ETS with the GTAP-model

baseline from Primes/Poles/EDGE

Shared Cost-results

EU reduction target 2010: 14 % from baseline

Finnish target: 22 % from baseline

only CO2

GTAP-E

Global model

Top-down

IEA energy data

problems with coverage (GTAP 4)

used in some EU projects

GTAP-E provides

estimate on permit price

Effects of ET on electricity and energy prices

Effects on welfare (household utility)

Effects on price competitiveness (relative export prices)

Effects on exports and production

Effects on GDP

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GTAP-E results

Implementation of EU-wide ET

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GTAP-E results

Price of permits

abatement

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GTAP-E results

Abatement targets for Finland

Comparisons

FIN,SWE,DEN & EFTA CO2 (Mt)

100

80

FIN

60

SWE

CO2 (Mt)

DEN

40

EFT

20

0

BAU

EU

EU+EEA

Finland

Scenarios

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The use of economic models of climate policies

Implementing climate policies involves both technological and economic measures

Energy taxes, Kyoto mechanisms, energy policies

Apparent dichotomy between CGE and bottom-up:

Technology effects often not covered in detail, or:

Only technology effects covered

Two approaches often create confusion and unnecessary debate – but:

The “conflict” stems from a misperception

Technology models usually partial equilibrium

Economical models usually general equilibrium

Top-down: choice of technology exogenous and emissions endogenous

Bottom-up: demand for energy services exogenous and technology choice endogenous

Both approaches useful

Approaches can be combined to answer more questions

Can answer specific technology questions

Can introduce economic measures

Can handle broad cost concepts

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Energy saving from engineering models

Energy saving consists of detailed policies that increase energy efficiency

Energy saving may benefit users of energy

Costs evaluated on the basis of required investments

Heating: CLIMTECH

Electricity and fuels: EFOM

Administrative costs: mostly n.a.

Renewable energy targets

Targets:

Wood-based CHP +15 %

Wood-based HP +75 %

Wind (and water) +15 %

Costs stem from investment on new capacity

EV estimate

Tax breaks and subsidies for renewable energy

Budgeted amounts

Wood: around 100m € by 2010

Wind, water 2-3m€ by 2010

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P.S. How about those oil prices?

What will be hit?

Transport sectors, foreign trade

Price for natural gas could affect the energy sector

Will there be an oil crisis?

No - OECD energy intensity has dropped from 2 to 1 per cent of GDP since the early 1980s

OECD and IEA have tended to regard price hikes temporary but are in the process of changing their minds

Will there be changes

Yes – permanent changes in energy prices will affect production and also trade patterns

Simulation results

Under construction

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Discussion

What’s going on?

GTAP-results: ET improves overall efficiency

EV-results: ET not necessarily cost-improving

Other measures’ interaction

Initial allocations favour ET sectors - not efficient

EV-results look better for ET if initial allocation based on climate strategy-implied targets

is there a prisoner’s dilemma here?

Allocation based on CO2-tax not better than climate strategy-based allocation

1st best policy may not work under 2nd best instruments

GTAP-E assumes 1st best instruments!

How to allocate cost-efficiently when you don’t have efficient instruments??

Can we trust results that do not take actual instruments into account?

Mistakes can be costly with 5-year commitment to allocation plans

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