Download Lecture9 EU climate change

Climate change policies
Session 9
Macroeconomic Concepts and Issues
MSc Economic Policy Studies
Alan Matthews
Learning objectives
• Valuing the threat of global warming and
the social cost of carbon
• Implications of the EU’s climate change
targets for the Irish economy
• How can Ireland meet its GHG emission
reduction targets at least cost?
SECTION 1
VALUING THE SOCIAL COST
OF CARBON
The science of climate change
• What is the sustainable level of emissions?
• Scientific consensus on global warming
– Climate is warming
– The cause, with high probability, is GHGs
– These emissions are in large part due to human
behaviour, including fossil fuel consumption
– IIEA Occasional Paper on science of climate change
– IPCC Working Group 1 report summary for
policymakers
Assessing the impact of climate
change
• Projections of CO2 concentration in atmosphere
• General circulation models (GCM) models
 Expected temperature and precipitation effects for different
regions
• CO2 concentrations now 380 ppmv compared to preindustrial levels of 280 ppmv
• Projected to double by 2100 leading to temperature
increases of between 1.8 to 4° (faster warming when all
GHGs included)
• To have high probability of staying within the +2° target,
mainstream view is to limit C02 concentration to 400
ppmv (50% probability at 450 ppmv)
Source: EEA
SOER 2010
How likely are these trends?
• CGM models fit observed data from the past
quite well
• But their weakness is that the physics of natural
climate change is poorly understood and
therefore there is uncertainty about model
predictions
• Others argue that models take inadequate
account of feedback effects and threshold
mechanisms which could accelerate climate
change
Integrated Assessment Models (IAMs)
• Seek to translate climate impacts into monetary
damages
• Benefits of climate policy represent avoided
climate impacts that would otherwise cause
damages to society in the future.
• Used to calculate Social Cost of Carbon (SCC)
(monetary estimates of the damage done to
society in emitting one tonne of carbon today) for
use in domestic CBA decisions
• Used to determine ‘optimal’ policy using form of
global cost-benefit analysis.
Areas of uncertainty in IAMs, leading to
different results for social cost of carbon
Impact of differences in climate sensitivity
• Models differ in their climate sensitivity, the
long-term temperature increase associated
with a sustained doubling of carbon dioxide
concentrations in the atmosphere
• The higher the climate sensitivity, the greater
the damages
• IPCC (2007) presented ‘likely range’ for
climate sensitivity of 2-4.5°C, with best
estimate of 3°C.
Differences in climate impacts
• Impacts of climate change are modeled using climate
damage functions for each region
• Damage functions provide monetary estimates of
climate impacts as a function of average temperature
increase, often expressed as percentage loss of GDP
• Generally, damages assumed to rise non-linearly with
temperature – different models assume different
curvature and steepness of the rising damage function
• Damage estimates often based on single study which
is then scaled up or down for application to other
regions
Differences in adaptation assumptions
• The damages of global warming are a
function of how easily societies can adapt
to higher temperatures
• The lower the adaptation costs, the lower
the benefits of avoiding climate change
Differences in discount rates
• Some method of aggregating gains and losses from
different time period in required.
• In the ‘prescriptive’ approach presented by Ramsey
(1928), the discount rate r can be expressed as:
r = ρ + ηg
where ρ is the pure rate of time preference, η is the negative
of the elasticity of the marginal utility of consumption (the rate
at which additional consumption provides smaller increases
in welfare) and g is growth rate of per capita consumption
• The ‘descriptive’ approach uses the market rate of
interest
• Extensive debate about the appropriate values on
economic and ethical grounds
Discount rates and equity weights
• Higher rate of pure time preference lowers
calculations of benefits of climate change policy,
because future climate change damages are
discounted more heavily
• Value of the marginal utility of consumption can be
varied to reflect equity weights (giving more weight
to impacts in poor regions)
• Using purchasing power parity rates to aggregate
damages across regions (Stern, 2007) gives
greater weight to impacts in poorer regions where
majority of impacts will occur, producing effect
similar to equity weighting
Social cost of carbon estimates (Tol, 2009)
Note: SCC estimates can be converted into CO2e costs
by dividing by 3.66
“Climate change is a moral problem. The main reason to
reduce greenhouse gas emissions is a concern for
faraway lands (Schelling 2000), distant futures
(Nordhaus 1982), and remote probabilities (Weitzman
2009). The people who emit most are least affected by
climate change, and the benefits of their abatement
would be diffused. Carbon dioxide dwells in the
atmosphere for decades and the effects on temperature
and sea level play out over even longer periods. On
central projections climate change and its impacts are a
nuisance for rich countries and a problem for poor
countries. But there is a chance that things will go
horribly wrong. If you do not care about risk, the future,
or other people, then you have little reason to care about
climate change.”
Source: Anthoff and Tol, 2010.
Critique of SCC calculations
• “Conventional economic analysis is rapidly
replacing the arguments of the climate skeptics as
the principal justification for inaction on climate
change” (Ackerman, 2008)
• Interests of future generations should be more
highly valued (ethics)
• Prevention of worst-case risks should be
prioritised more than average outcomes
(insurance)
• Some benefits cannot be given monetary values
• Some ‘costs are better than others
Costing the externality due to carbon
emissions
• Social cost of carbon
– Measures the full global cost today of an incremental
unit of carbon emitted today, summing the cost of the
damage it imposes over its lifetime in the atmosphere
• Market price of carbon
– The value of traded emission rights in a market given
policy constraints on rights supply
• Marginal cost of abatement
– Reflects the cost of reducing emissions rather than
the damage imposed by creating emissions
• Under restrictive assumptions the three measures
will be broadly equal, at the margin.
Policy approaches
• Command-and-control
– Use of regulation
• Market-based approaches
– Carbon tax
– Cap and trade
• Advantages and disadvantages
The economic perspective
• Once target level of emissions set, what is the
least cost abatement strategy?
• Government policies often industry and
technology-specific
• Economists favour uniform price signals, on the
basis that the same value is attached to each
unit of emission reduction, whatever the source
• Optimal policy is a carbon tax (or equivalent capand-trade) at a low initial rate, increasing
subsequently in real terms
Regulation vs tax to reduce
pollution
Profits,
costs of
pollution,
€/unit
MP
MSC
Tax
Q*
Q
Output of paper mill
Rationale for market-based
interventions
• To correct for negative market externality
• Huge differences in abatement costs across different
options
• Use of market-based policy instrument can achieve GHG
emission reductions at lower cost than command-andcontrol approach
• Desirability of a uniform tax on all emitters as the
marginal value of abatement is equal
• Channels of market-based approaches
– Firms adapt by switching from higher to lower carbon fuels and
invest in energy saving technologies
– Consumers adapt by purchasing less energy-intensive goods
and change behaviour in ways that conserve energy
– GHG pricing policies also provide incentives to develop new
technologies
Comparison of GHG tax versus
Cap and trade
• Both are market or incentive-based systems
• Under perfect information, both approaches
would produce the same overall level of
emissions at the same level of aggregate costs
• But uncertainty over future cost of reducing
emissions can lead to different outcomes
• Compare approaches wrt environmental
effectiveness, cost effectiveness and
distributional equity
Environmental effectiveness
• Cap and trade provides emissions certainty,
whereas total emissions abatement effect of a
tax is uncertain when tax is set.
– Certainty may be important in climate change if there
are systemic thresholds
• Cap and trade provides certainty on emission
outcomes, but cost of meeting targets is
uncertain at firm level
• Competitiveness effects and leakages?
Cost effectiveness
• A tax is more flexible and allows firms to minimise their
compliance costs over time, although Cap and trade can
be designed to mimic this (e.g. shifting emissions
through time)
• Volatility of permit prices under Cap and trade schemes
• Tax raises revenue, although can be mimicked in Cap
and trade if permits are auctioned
• Carbon tax could have positive effects on GDP,
depending on how revenues are used
• Grandfathering permits can gain political acceptability,
but at cost of positive growth and distributional effects
from recycling revenue (inframarginal exemptions do the
same for carbon tax).
Distributional consequences
• Not obvious the poor are worst hit by
carbon taxes (motoring vs home heating)
• But proportionately poor will be hit more
• Distributional issues can be addressed by
compensation (easier to finance under
carbon tax)
SECTION 2
THE INTERNATIONAL
RESPONSE
UNFCCC RIO 1992
• UNFCCC came into force 1994
– Overall objective of “stabilisation of GHG
concentrations in atmosphere at a level that would
prevent dangerous anthropogenic interference with
the climate system”
– Establishes principle of “common but differentiated
responsibility”
– Commits to establishing inventories and reporting
standards for GHG measurement
– Commits to launching national strategies to mitigate
GHG emissions
– And to cooperate in preparing for adaptation to
climate change
– Convention governed by Conference of Parties (COP)
Kyoto Protocol 1997
• Annex 1 (developed) countries agreed to
reduction targets
• Groups (‘bubbles’) of countries can manage
their efforts in unison
• Defined three flexible mechanisms
– Joint Implementation, Clean Development
Mechanism and Emissions Trading
• US refused ratification
• EU ratified in 2002 and Protocol came into force
in 2005 following accession of Russia
Copenhagen 2009
• Agreed the Copenhagen Accord
– Set long term goal of limiting global warming to 2
degrees Celcius
– Called for new multilateral climate fund and set goals
of mobilising $30 billion in public finance 2010-2012
and €100 billion in public and private finance in 2020
– Further defined how countries’ actions are to be
reported and verified
– Called on countries to list mitigation pledges
(economy-wide targets for developed countries,
mitigation actions by developing countries)
SECTION 3
THE EU RESPONSE
Initial EU responses
• Committed to goal of limiting global mean
temperature rise to +2°C
• Accepted -8% target under Kyoto for EU-15
– Burden-sharing agreement
– Penalties
• Introduced ETS in Jan 2005
– First (pilot) phase 2005-2007
– Second phase 2008-2012
• Countries’ targets and strategies set out in
National Allocation Plans which must be
approved by Commission
EU ETS experience
• Initial pilot phase 2005-07. ETS covers about 40-50% of
EU emissions.
• Combination of generous allowances and abatement
produced an initial price of €30 per tonne, but fell to zero
in late 2007, some recovery since then.
• Market value of allowances was passed through in
electricity prices, even though allowances distributed
free, resulting in considerable windfall profits
• The Linking Directive allows firms to meet some of their
obligations by purchasing certified emission reductions
achieved in projects in developing countries and other
developed countries
Price of ETS allowances
Source: www.eex.com/en
EU Climate change 20:20:20 package
Dec 2008
• Overall EU target 20% reduction by 2020 (relative to 1990
levels)
• Increased to 30% if there is new international agreement
• Reduction effort split between ETS and non-ETS sectors
• ETS reduction (EU-wide) of 21% by 2020 (compared to 2005)
• Average EU non-ETS reduction target of 10% in 2020
(compared to 2005)
• Overall, averages out at 14% reduction (compared to 2005)
and 20% reduction (compared to 1990)
• Non-ETS effort is shared among EU countries according to a
formula based on GDP per capita.
• 20% energy from renewables by 2020
• 20% increase in energy efficiency by 2020
Long-term targets
• Spring European Council 2007 meeting
agreed indicative EU targets of 60-80%
emission reductions by 2050
• Economic activity by then needs to be
largely carbon-free
• Implications?
SECTION 4
IRISH TARGETS FOR GHG
EMISSION REDUCTIONS
Irish policy commitments
• Second highest per capita emitter in EU
• EU Kyoto target was to reduce emissions
by 8% by 2012 over 1990
• Under EU’s burden-sharing agreement,
Ireland’s target was to limit to 13%
increase
• Ireland’s emissions in 2006 25.5% above
1990, almost 13% above its Kyoto target
Source:
EPA 2010
Current situation
• EPA is charged with producing emission projections annually
• NCCS targets distinguish between (a) baseline (b) baseline
with existing measures and (c) baseline with additional
measures (post 2006)
• Under With Additional Measures scenario, government
purchasing requirement estimated to be 12.7mt CO2e over
Kyoto period.
• NTMA has acquired 8.3mt credits. Gap of 4.4mt to be met
from New Entrants Set-aside of around 5mt in ETS sector.
Therefore EPA views it as unlikely that further credit
purchases will be required.
• Impact of economic recession on next updates?
Source: EPA 2010
Source: EPA 2010
2020 targets
• For ETS sector Ireland is allocated 88% of its 2005
emissions which will be auctioned starting 2013
• The target for Ireland for non-ETS sectors is to reduce
emissions by 20% in 2020 relative to 2005 levels; the
limit has been provisionally calculated by the EPA as
37.1 Mtonnes of CO2e.
• In addition, Member States must annually limit non-ETS
greenhouse gas emissions in a linear manner between
2013 and 2020, including by making use of the
flexibilities provided for in the Effort Sharing Decision
ESRI projections for ETS sector, low
growth scenario
Source: ESRI 2010
Source: EPA 2010
Climate change bill
• Set 2020 reduction target of 30% below 2005
emissions (12% below 1990 emissions)
– Problematic as separation of ETS sector would oblige
Ireland to meet the gap between the EU target (-20%)
and the Irish target (-30%) through emission reduction
in the domestic non-ETS sector
• Very ambitious targets for 2030 (40% below
1990 levels) and 2050 (80% below 1990 levels)
• National Climate Change Expert Advisory Body
• Uninformative Regulatory Impact Assessment
ESRI projections for non-ETS sector,
low growth scenario
SECTION 5
IRISH CLIMATE CHANGE
POLICIES
National Climate Change Strategy
• Sets out in detail how Ireland will meet its GHG
commitments in period 2007-2012
• Carbon Fund established in 2007 managed by
NTMA to buy Kyoto Units with funding of €290m
• NCCS does not deal with post-2012 situation
• Programme for Government commitment to
reduce GHG emissions by 3% p.a. for period of
government.
• Cabinet Committee on Climate Change and
Energy Security
Climate strategy
By 2020, Ireland will have achieved
• 20% improvement in energy efficiency across all
sectors
• 33% energy end-use efficiency savings target for
the public sector
• 40% renewable electricity (RES-E) share
• 12% renewable heat (RES-H) share
• 10% renewable transport (RES-T) share
(including 10% electric vehicles penetration
target)
Carbon budgets
• First carbon budget presented in 2007
• Objectives to integrate climate change into
budgetary policy, to assess progress towards
targets and to help efforts to increase public
understanding
• Measures introduced include
–
–
–
–
Carbon tax
Reform of motor tax regime
New building regulations for new homes
New national energy efficiency standard for
lightbulbs
– Residential home insulation scheme grants
Reading a marginal abatement cost
curve
Issues: Need to avoid double counting with successive measures
Considers technical but not behavioural changes (e.g. modal shift in transport)
Source: McKinsey 2009 for SEAI
Source: McKinsey 2009 for SEAI
Source: McKinsey 2009 for SEAI
Policy outlook - ETS
• Removal of ETS sector from national inventories
changes the ground rules
• Irish tradable (ETS) sector covers around 34% of Irish
emissions (41% across EU)
• Reduction requirement across EU is -21% or -1.74% p.a.
• Price of CERs will reflect abatement cost to industry
• Irish operators exposed to competitive pressures will
continue to receive free allocation of permits (to extent to
be decided)
• The measures to increase renewables share in energy
and improve efficiency of powergen sector do not count
in national emission inventories
Policy outlook – non-ETS sectors
• 66% of overall Irish emissions, mainly transport and
agriculture
• Reduction of 20% on 2005 levels by 2020
• Use of flexible mechanisms limited to 3%
• Huge challenge, even if less than PfG target and targets
set out in NCCS
• Future position of carbon sinks still unclear
• Important flexibility introduced in EU package to allow
(some) trading in non-ETS sectors which will cap
marginal cost of abatement in Ireland
• Differences in marginal cost of abatement in the two
sectors could create incentives to ‘migrate’ emissions
(e.g. through electrification)
Renewable energy
• EU targets – 16% in total final energy use
and 10% in transport use
• Controversies over use of first-generation
biofuels
• Doubts over penetration of electric
vehicles and their impact on emissions
• Growing concern in other EU MS about
cost of meeting renewable targets
Designing a carbon tax
Tol et al 2008
• What level of tax?
– Set equal to ETS permit price as then uniform
tax applied to all emission sources
• Who should be taxed?
– All emission sources except those covered by
the ETS
• What is expected revenue?
–
€500 – 1,400m
• What to do with the revenue?
• What are macro-economic implications?
Designing a carbon tax
Tol et al 2008
• What will be distributional consequences?
– Poor/rich Urban/rural
– Possible to compensate relatively easily
• How to tax internationally traded goods
and services?
– ETS industries – cement and aluminium
– Non-ETS sectors – agriculture
• What about fuel tourism?
Assessing the NCCS
• Preference for quantitative targets vs
economic instruments
• Within economic instrument category, very
high reliance on subsidies (50% of overall
total emissions) – how to finance?
• Critique of individual measures –
McCarthy and Scott (2008)
Assessing the NCCS
• One-third of emissions regulated by
tradable permits mainly power
– But double regulation (subsidies for
renewables, peat)
• One-third of emissions regulated through
carbon tax and other instruments
– But exemptions for coal and peat for home
heating, subsidies for renewable heating
• One-third of emissions not regulated
Adaptation issues
• Various recent reports
– Forfás , Adaptation to Climate Change: Issues
for Business, 2010
– Irish Academy of Engineers, Critical
Infrastructure: Adaptation to Climate Change,
2009
– EPA, A Summary of the State of Knowledge
on Climate Change Impacts on Ireland, 2009
– Sweeney et al, Climate Change: Refining the
Impacts for Ireland, 2008
Follow up and further information
• Institute for International and European
Affairs, Climate Change Group
• EPA, Climate Change
• DOEHLG, Climate Change
• European Environment Agency, Data
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