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Economic effects of emission cuts

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  1. 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

  2. 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

  3. Abatement targets The policy cases involve different targets







  10. 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

  11. 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

  12. 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

  13. 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


  15. 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





  20. ET and renewables - share of renewables in energy production

  21. 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

  22. 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

  23. ET and electricity generation

  24. 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

  25. 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?




  29. 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

  30. GTAP-E results Implementation of EU-wide ET

  31. GTAP-E results Price of permits abatement

  32. 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

  33. 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

  34. Equilibrium and welfare measures

  35. Equilibrium and welfare measures • 3. Equilibrium in all markets

  36. 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

  37. ET and CHP - share of CHP in electricity production


  39. 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

  40. 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