Climate change policies

1
Climate change policies

• Session 9
• Macroeconomic Concepts and Issues
• MSc Economic Policy Studies
• Alan Matthews

2
Learning objectives

• Valuing the threat of global warming and the
  social cost of carbon
• Implications of the EUs climate change targets
  for the Irish economy
• How can Ireland meet its GHG emission reduction
  targets at least cost?

3
Valuing the social cost of carbon

• Section 1

4
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

5
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
  pre-industrial 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)

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Source EEA SOER 2010
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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

8
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.

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Areas of uncertainty in IAMs, leading to
different results for social cost of carbon
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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 2-4.5C, with best estimate of 3C.

12
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

13
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

14
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 ? ?g
• where ? is the pure rate of time preference, ? 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

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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

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Social cost of carbon estimates (Tol, 2009)
Note SCC estimates can be converted into CO2e
costs by dividing by 3.66
17
  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.
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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

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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.

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Policy approaches

• Command-and-control
• Use of regulation
• Market-based approaches
• Carbon tax
• Cap and trade
• Advantages and disadvantages

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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
  cap-and-trade) at a low initial rate, increasing
  subsequently in real terms

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Regulation vs tax to reduce pollution
Profits, costs of pollution, /unit
MP
MSC
Tax
Q
Q
Output of paper mill
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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-and-control 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

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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

25
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?

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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).

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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)

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The International response

• Section 2

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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)

31
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

32
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)

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The eu response

• Section 3

34
Initial EU responses

• Committed to goal of limiting global mean
  temperature rise to 2C
• 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

35
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

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Price of ETS allowances
Source www.eex.com/en
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EU Climate change 202020 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

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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?

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Irish targets for ghg emission reductions

• Section 4

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Irish policy commitments

• Second highest per capita emitter in EU
• EU Kyoto target was to reduce emissions by 8 by
  2012 over 1990
• Under EUs burden-sharing agreement, Irelands
  target was to limit to 13 increase
• Irelands emissions in 2006 25.5 above 1990,
  almost 13 above its Kyoto target

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Source EPA 2010
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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?

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Source EPA 2010
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Source EPA 2010
45
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

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ESRI projections for ETS sector, low growth
scenario
Source ESRI 2010
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Source EPA 2010
48
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

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ESRI projections for non-ETS sector, low growth
scenario
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Irish Climate change policies

• Section 5

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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

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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)

53
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

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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
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Source McKinsey 2009 for SEAI
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Source McKinsey 2009 for SEAI
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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

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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)

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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

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Designing a carbon taxTol 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?
• What are the effects on emissions?
• Substitution vs growth effects

61
Designing a carbon taxTol 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?

62
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)

63
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

64
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

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Follow up and further information

• Institute for International and European Affairs,
  Climate Change Group
• EPA, Climate Change
• DOEHLG, Climate Change
• European Environment Agency, Data Viewer