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Policies to Address Climate Change: Opportunities and Challenges Catherine Wolfram UC Berkeley CEA 42nd Annual Meetings June 7, 2008 University of British Columbia, Vancouver Starting point for economics of climate change: science 2 Source IPCC Economic Research on Climate Change For the most part, economists take as given that anthropogenic GHG emissions are leading to climate change. Given that we want to mitigate climate change, economic research has focused on: - Marginal Benefits of Abatement. - Marginal Costs of Abatement. This talk will focus on the marginal cost side. Optimal regulation of greenhouse gases $/ton MCA MBA A* Abatement (tons) Outline of Talk • Overview of work on damages. • Background statistics to frame ideas on costs of abatement. • Policies to abate greenhouse gases: - Market-based (cap-and-trade and taxes). - Standards. - Implementation issues: leakage and reshuffling. • Conclusions. Economic research on marginal benefits of abatement • Sector-specific analyses: - Effects of climate change on US agriculture (Deschenes and Greenstone, AER, 2007; Fisher, Hanemann and Schlenker, AER, 2005). - Effects of climate change on mortality, energy use, conflict. • Macro-level analyses of impacts of rising temperatures. • Proper discounting of benefits of future avoided damages in the future. Where GHGs come from - sector US CO2 Emissions by Sector Industrial NG & Oil Industrial Coal Transportation Commercial NG & Oil Household NG & Oil Electricity Generation Where GHGs have come from – geography Overview of policies to mitigate climate change 1. Cap and Trade 2. Taxes 3. Renewable Portfolio Standard 4. Low Carbon Fuel Standard 5. Energy Efficiency Overview of policies to mitigate climate change 1. Cap and Trade 2. Taxes Multi-sector 3. Renewable Portfolio Standard 4. Low Carbon Fuel Standard 5. Energy Efficiency Single-sector Cap-and-trade policies to reduce GHGs Cap-and-trade has become the darling of policy-makers. • Used in Europe (EU Emissions Trading Scheme). • Both US presidential candidates favor it. • Part of Lieberman-Warner, leading US climate change legislation. • Two leading regional US initiatives will use it - California (all sectors, 1990 levels by 2020). - Regional Greenhouse Gas Initiatives (RGGI) in the Northeast (just electricity sector, stabilize at early 2000 levels beginning in 2009). Why is cap-and-trade so popular? • Economic efficiency. • Environmentalists like it because it achieves a given emissions level. • Past success stories (SO2 Acid Rain Program). • Not a taxx. Challenges to achieving real emissions reductions 1. Leakage. Regulations cause economic activity to move to less regulated regions. 2. Reshuffling. Regulations cause buyers and sellers to adjust their counterparties, without changing the location of the economic activity. *Bushnell, James, Carla Peterman and Catherine Wolfram, “Local Solutions to Global Problems: Climate Change Policies and Regulatory Jurisdiction,” Review of Environmental Economics and Policy, forthcoming. Example of leakage Previous work has shown that polluting industries grew less quickly in nonattainment counties than in attainment counties (Becker and Henderson, JPE, 2000). Possible examples of leakage in the GHG context Source-based regulation of electricity sector could cause an increase in the amount of power generated outside California. • Under a source-based cap, nearly 70% of the reductions within California could be offset by increases in out-of-state emissions.* Industry could leave California or the US for developing countries. *Fowlie, Meredith, “Incomplete Environmental Regulation, Imperfect Competition, and Emissions Leakage,” CSEM WP #175. Reshuffling mechanics To mitigate leakage, it is tempting to impose regulations on consumers. Potential for reshuffling. Reshuffling is different from leakage as it does not involve any change in where the economic activity takes place. Like an ineffective boycott, it simply involves a change in who transacts with whom. Reshuffling example Diamond market before boycott Homogenous good Homogenous buyers Reshuffling example Diamond market with boycott Red = subject to boycott Green = participant in boycott Reshuffling example Diamond market with boycott Red = subject to boycott Green = participant in boycott Reshuffling example Diamond market with boycott Red = subject to boycott Green = participant in boycott Reshuffling example Diamond market with boycott Red = subject to boycott Green = participant in boycott An effective boycott Diamond market with boycott Red = subject to boycott Green = participant in boycott An effective boycott Diamond market with boycott Red = subject to boycott Green = participant in boycott Boycotts are effective when the fraction of participating buyers is greater than the fraction of “clean” sellers. Reshuffling in California’s electricity industry Importing Clean Power 200 All WECC Sources Eligible for Import into California 100 150 CA Forecast Demand 0 50 CA Emissions Target 0 *Bushnell, 200 400 Electricity Output [TWh] 600 James, Carla Peterman and Catherine Wolfram, “California’s Greenhouse Gas Policies: How Do They Add Up?” CSEM WP # 166. Which policies are most vulnerable to leakage & reshuffling? Leakage • Cost-imposing standards provide economic actors with an incentive to engage in activities that lead to leakage. Reshuffling • Reshuffling is made easier if: - Regulations are imposed on consumers (upstream). - Regulations allow for flexibility in compliance (market-based). Leakage and reshuffling are both less problematic the larger the regulator’s jurisdiction. Other issues in implementing cap-and-trade Allocation of allowances - Advantages of allocation: get political buy-in from regulated companies. - Advantages of auctions: raise revenues. Whether and how much to rely on offsets. - Advantages of heavy reliance: cost efficiencies (many opportunities for GHG mitigation in developing countries). - Disadvantages of offsets: “additionality” question. Overview of policies to mitigate climate change 1. Cap and Trade 2. Taxes 3. Renewable Portfolio Standard 4. Low Carbon Fuel Standard 5. Energy Efficiency Greenhouse gas taxes Possible advantages over cap-and-trade: • No price volatility: marginal damages related to stock of CO2, marginal costs related to current emissions. • Less room for corruption because it does not create artificial scarcities. • Revenue generating (double-dividend). Still vulnerable to leakage and reshuffling if implemented regionally. Why aren’t they being considered? *Nordhaus, Political non-starter. William, “To Tax or Not to Tax: Alternative Approaches to Slowing Global Warming” Review of Environmental Economics and Policy, 2007. Alternatives to market-based policies Several other types of regulation are being actively considered in conjunction with cap-and-trade policies: - Renewable Portfolio Standard for electricity generation. - Low-Carbon Fuel Standard for transportation. - Energy efficiency standards and subsidy programs. Why are these are even on the table? - Solve additional market failures (IP protection for new technologies, principal agent or behavioral problems). - Subsidies are politically more viable. - Transport sector wants to be left out of any cap-and-trade scheme. What is a Renewable Portfolio Standard? Mandates that retail electricity providers buy a certain percentage of their electricity from renewable resources. - Exist in 25 states and DC. - Some talk about a federal RPS. - Some states have carve-outs for particular technologies. - Vary in their definition of renewable (e.g., many exclude largescale hydro) Together with the production tax credit, RPS’ are the main drivers of renewable capacity additions. - 93% of binding RPS’ have been met with wind. *Wiser, Ryan and Galen Barbose, “Renewable Portfolio Standards in the United States: A Status Report with Data Through 2007” Lawrence Berkeley National Labs working paper. DSIRE: www.dsireusa.org June 2008 Renewables Portfolio Standards MN: 25% by 2025 (Xcel: 30% by 2020) *WA: 15% by 2020 ND: 10% by 2015 WI: requirement varies by utility; 10% by 2015 goal MT: 15% by 2015 OR: 25% by 2025 (large utilities) 5% - 10% by 2025 (smaller utilities) ☼ OH: 25%** by 2025 *UT: 20% by 2025 IA: 105 MW IL: 25% by 2025 ☼ CO: 20% by 2020 (IOUs) *10% by 2020 (co-ops & large munis) ME: 30% by 2000 10% by 2017 - new RE ☼ NH: 23.8% in 2025 MA: 4% by 2009 + 1% annual increase RI: 16% by 2020 SD: 10% by 2015 ☼ *NV: 20% by 2015 CA: 20% by 2010 VT: (1) RE meets any increase in retail sales by 2012; (2) 20% by 2017 MO: 11% by 2020 ☼ NC: 12.5% by 2021 (IOUs) ☼ AZ: 15% by 2025 10% by 2018 (co-ops & munis) CT: 23% by 2020 ☼ NY: 24% by 2013 ☼ NJ: 22.5% by 2021 ☼ PA: 18%** by 2020 ☼ MD: 20% by 2022 ☼ *DE: 20% by 2019 ☼ DC: 11% by 2022 ☼ NM: 20% by 2020 (IOUs) *VA: 12% by 2022 10% by 2020 (co-ops) TX: 5,880 MW by 2015 State RPS HI: 20% by 2020 State Goal ☼ Minimum solar or customer-sited RE requirement * Increased credit for solar or customer-sited RE **Includes separate tier of non-renewable “alternative” energy resources Solar water heating eligible Leakage and reshuffling in the RPS? As a subsidy program, the RPS is not vulnerable to leakage. It could be vulnerable to reshuffling, except that there is very little existing renewable capacity. Table 1: Renewable Supply in the West State 2006 Renewable Supply TWh AZ CA CO ID MT NV NM OR UT WA WY *Bushnell, .1 23.9 .9 .7 .5 1.3 1.3 1.9 .2 2.5 .8 % of state load .1% 9.1% 1.8% 3.1% 3.8% 3.9% 6.0% 3.9% 0.8% 2.9% 5.1% Target Renewable Supply % 15% 10-20% 10% -15% 20% 10-20% 5-25% -15% -- Future Renewable Supply TWh (1) 2020 13.5 55.1 6.1 -2.6 8.5 4.3 12.0 -15.7 -- Date Target to be Met 2025 2010 2020 -2015 2015 2020 2025 -2020 -- James, Carla Peterman and Catherine Wolfram, “California’s Greenhouse Gas Policies: How Do They Add Up?” CSEM WP # 166. Advantages and disadvantages of the RPS The RPS is relatively flexible as a standard. • Renewable technologies compete against one another. The RPS is input-based, not output-based. • Does nothing to encourage the development of carbon capture and sequestration technologies, nuclear power. • Certain technologies have not been included (biomass cofiring). Low Carbon Fuel Standard An intensity standard: • Limits the carbon emissions per unit of output. Proposed in California, discussed on a national scale. Proponents argue that biofuel producers need assurance of given market size. Opponents argue that, as an intensity standard, it will not necessarily lead to lower GHG emissions. Implementation on a regional level may lead to reshuffling. *Holland, Stephen, Jonathan Hughes and Chris Knittel, “Greenhouse Gas Reductions under a Low Carbon Fuel Standard?” working paper. United States Refrigerator Use v. Time Annual Drop from 1974 to 2001 = 5% Per Year Energy Efficiency Since the 1970s, standards have helped to promote energy efficiency improvements. • CAFE, appliance standards, building codes. Standards may continue to be needed to overcome market failures. • Principal-agent problems, behavioral. = energy efficiency measure = electric sector measures = transport sector measures Conclusions • Even well designed, market-based regional policies to address climate change are subject to leakage and reshuffling. • Regions (states, provinces, small countries) can “export” two things: - Regulatory infrastructure. - Technology. • Different policies are better suited to those two goals. • National (US) legislation is an enormous undertaking.