Global climate policy Lennart Hjalmarsson. Distributional dimensions important Who are going to pay?...
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Transcript of Global climate policy Lennart Hjalmarsson. Distributional dimensions important Who are going to pay?...
Global climate policy
Lennart Hjalmarsson
Distributional dimensions important
Who are going to pay?• We or our children? (Discount
rate)• Rich - or poor countries?• High-emitting or low-emitting
countries?• Vulnerable or less vulnerable
countries?
Important reports
UN:s Climate report 2007: IPCC• Scientific analysis• Almost unanimous
The Stern report 2006: The Economics of Climate Change
• Economic analysis• Very controversial
Key parameter: Discount rate
Max ∫U[C(t)]e-δtdtRamsey equation:r = δ + ηgDiscount rate = pure time preference rate +
value of increased consumption x increase in consumption
Very controversial issue. Big debate today.
Discount rate
δ and η capture preferences
g captures technology
δ discounts utility
r discounts consumption
r derived from all three parameters both taste and technology
η curvature of the utility function
Discount rate
η • elasticity of the marginal utility• relative risk aversion
measure of aversion to interpersonal inequality and
measure of personal risk aversion
Discount rate
The big issue: How much should we save (sacrifice) today for future generations?
T = 200 years
Close long-term link between r and s, discount rate and savings rate:
g = sr balanced optimal growth rate with constant savings rate and permanent income rW
s = (r-δ)/ηr
Discount rate
Standard assumptions:
δ + ηg = 2 + 2x2 = 6
s = (r-δ)/ηr = 4/12 = 1/3 = 0,33
Savings rate = 33%
Discount rate
Stern’s assumption:
δ = 0,1
η = 1
g = 1,2
r = 1,3
But then
s = (r-δ)/ηr = 1,2/1,3 = 0,92
92% savings rate!!
Important debate
Journal of Economic Literature 2008:• Weitzman• Nordhaus• DasGupta
Excellent discussion about discounting
Conclusions about discount rate
Weitzman:Uncertainty about g (thick tail) may
lead to a lower discount rate:r ≈ 3%
Nordhaus:Do not adjust the discount rate! Limit
climate change directly by taxes or caps (and trade)
Policies and measures
• Carbon taxes• Cap and trade (Kyoto)• (Green certificates)• Standards, regulations and energy
conservation• Technology agreements
Important aspects
• Economic efficiency:Same marginal abatement cost everywhere
• Distribution – burden sharing• Monitoring• Enforcement• Incentives for R&D : Endogeneous
technical progress
Carbon taxes
• Most efficient instrument when stock pollutant
• No distribution (but redistribution) of assets across countries
• Difficult to monitor real impact of taxes
• Requires strong international institutions
Carbon taxes, cont.
• Energy prices extremely high in most poor countries even at subsidised world market prices
• Energy taxes regressive
• Politically impossible in many countries
EU experience
• Extremely difficult to harmonise taxes: Sweden and UK totally against
• Very low minimum taxes: 0.05 Eurocents/kWh for coal and gas
• Exemptions even from these taxes (LTA)
Cap and trade
• Efficient solution to threshold problem • Difficult to negotiate worldwide
allocation• Very large asset values: EU
2 billion ton at 20 Euro/ton yields
an asset value of 40 billion Euro per year
• Easy to monitor permit trade in case of CO2 only
• Can rely on national legal systems in ”decent” countries
EU-Kyoto experience
• Grandfathering may be necessary although auctions preferable
• Grandfathering creates incentives for ”industrial policy”
• Regional solution – industry relocation to ”pollution havens”??
EU-Kyoto experience, cont
• Limited efforts: Kyoto 5% reduction, 20% of the world, ETS 8% ≈ BAU
• No incentives to comply – and some countries will not comply
• Success stories not due to Kyoto (UK, Germany)
• Difficult to predict CO2-prices
Standards
Might be good in some cases. Ex: Catalytic converters:• Economies of scale and learning –
low cost production• Product market international• Consumer network externalitiesBut:Strong incentives for pressure
groups
Energy conservation
Subsidies cost inefficient: Large variation in marginal abatement costs
Ambiguous impact on energy demand:
• Selection effect• Rebound effect• Vintage effect
23-04-21
Typical industrial structure
Average practice vs best practice over time
Technology agreements
R&D:• Extend the nose vs cutting off
the tail• Rich countries only• Difficult to coordinate even
within countries• Industrial policy – R&D races...• Picking winners difficult
Technology agreements, cont
Productivity in knowledge production
Experience from 1973/74- US synfuel program inefficient Swedish government-funded R&D
inefficient (De stora programmens tid.)
Only success story: Not governement-funded heat pumps
Cap and trade vs carbon taxes
In principle the same outcomeParadox:Why so difficult to agree on low-
level minimum taxes?Why so easy to agree on EU-ETS
with huge potential impact on electricity and fuel prices?
Smart or stupid politicians?
The text book model
Efficiency ≠ equityAllocation of permits of no
importance.Hidden assumption:• Allocation (grandfathering) foreveror• AuctioningIn EU-ETS allocation for a short
period: updating problem
Asset allocation in EU
EU 2008-12: At least 90% grandfathering – in practice >95%.
• Old plants: Historical emissions• New plants: Benchmark emissions
Permit allocation = industrial policyNational allocation plans
EU-ETS: Heavy industry and energy
Industry: Very high price sensitivity, competes in the world market. (η≈8)
Energy: Very low price sensitivity (η≈0.1– 0.3) and substantial restrictions on technology choice esp. hydro and nuclear.
ETS Efficiency: Incumbent plants
No emissions – no permits
Industry: Annual free permit allocation eliminates the increase in marginal production cost for industry: No incentives to reduce production or close down
Energy: Small incentives to reduce production or close down
Putty-clay technology.
EU-ETS: What will happen?
Extremely low flexibility
Where will adjustment take place?
What will happen to CO2 prices?
CO2 -price explosion? Not yet but..?
Electricity-price explosion?
Electricity-price induced adjustment outside the trading sector.
Very difficult to predict!
ETS Efficiency: New plants
No emissions – no permits
Coal and gas plants: permits
Hydro, nuclear and wind: no permits
Investment subsidy to emitting plants
Weak investment incentives
• Volatile CO2 prices• Time horizon 2012• Annual free-permit allocation• Less CO2- emissions – less
free-permit allocation• Huge intra-industry profits in
electricity and very concentrated el. markets
ETS Equity
Political aspects:• Most capital owners in the trading
system more than compensated • No capital owners outside the trading
system compensated and esp. not in the electricity intensive industry
• High electricity prices• Huge intra-industry profits in
electricity
What will happen?
Decrease in profitability esp in electricity-intensive plants
Relocation Political pressure for:
• Exemptions of some industries (e.g. Steel)
• Regulation of the electricity market
Global impact of EU climate policy
Impact through global markets: price changes through decrease in demand for fossil fuels
What about supply of fossil fuels?
Oil and gas ≈ no impact
Coal: less supply
Electricity: The key sector
• 25 % of global CO2-emissions
• Interfuel substitution coal/gas
• Increased thermal efficiency
• CHP: Combined heat and power
• CO2-free technologies
CO2-free electricity technologies
• Hydro: • Controversial • To a large extent already exploited except for
Himalaya
• Wind: • Surface intensive• NIB large scale (millions) location problem• Expensive• Stochastic supply
CO2-free electricity technologies
• Geothermal• Location specific• Limited cheap • Abundant very expensive
• Solar and wave• Still very expensive• Location specific• Surface intensive
CO2-free electricity technologies
• Wood• CHP otherwise expensive• Limited resources – deforestation• Competition from forest industry• Competition from biomass fuels in the
future
CO2-free electricity technologies
• Nuclear• Cheapest large scale technology• Not surface intensive – few locations• Very compact waste – small deposit
problems• Requires strong regulators• Proliferation problem (Iran, North
Korea)• Some countries political comparative
advantages (France, Finland, UK, ....)
Comparative generating cost in EU - 10% discount rate
2005$c/kWh
Projected 2030with € 20-30/t CO2 cost
Gas CCGT 3.4-4.5 4.0-5.5
Coal - pulverised 3.0-4.0 4.5-6.0
Coal - fluidised bed
3.5-4.5 5.0-6.5
Coal IGCC 4.0-5.0 5.5-7.0
Nuclear 4.0-5.5 4.0-5.5
Wind onshore 3.5-11.0 2.8-8.0
Wind offshore 6.0-15.0 4.0-12.0European Commission, January 2007
Future solution
Most attractive GHG-free solution:
Nuclear and hydrogen: Electricity and fuel cells
Nuclear and hydrogen
Problems:• Nuclear regulation in weak
states• Fuel reprocessing• Nuclear proliferation• R&D:
• Fuel cells• Hydrogen storage
Nuclear and hydrogen
Attractive properties:
• No GHG emissions
• Large scale – global feasibility
• Low cost
• Not surface intensive
• Not location specific
Nuclear and hydrogen
Political aspects:
• Little reallocation of assets
• Little industrial restructuring
• Still cheap electricity
• Foreign technology
• Foreign control and ownership
• Capital intensive investments
Major political obstacle to climate policy
Nobody should get hurt: Very expensive policy (subsidies, regulations) with a lot of variation in marginal abatement costs.
Low productivity in climate policy
Low productivity example
Potential Swedish railroad investments:
5 Billion Euro – 1 Mton CO2
4% - 60 years – 0.064 in annuity:
320 MEuro per year i.e.
320 Euro/ton CO2 in abatement costs (10 times too expensive)