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					 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?

     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
   Assessing the impact of climate
• Projections of CO2 concentration in atmosphere
• General circulation models (GCM) models
    Expected temperature and precipitation effects for different
• 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)
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
• Others argue that models take inadequate
  account of feedback effects and threshold
  mechanisms which could accelerate climate
 Integrated Assessment Models (IAMs)

• Seek to translate climate impacts into monetary
• 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
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
• 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
• Some benefits cannot be given monetary values
• Some „costs are better than others
    Costing the externality due to carbon
• 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
• 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
         Regulation vs tax to reduce
costs of



                        Q*   Q    Output of paper mill
       Rationale for market-based
• To correct for negative market externality
• Huge differences in abatement costs across different
• 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
   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)

             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
  – 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)
              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

 EU Climate change 20:20:20 package
              Dec 2008
• Overall EU target 20% reduction by 2020 (relative to 1990
• 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?
        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%
• Ireland‟s emissions in 2006 25.5% above
  1990, almost 13% above its Kyoto target
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
 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
• Cabinet Committee on Climate Change and
  Energy Security
              Climate strategy

By 2020, Ireland will have achieved
• 20% improvement in energy efficiency across all
• 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
                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
• Measures introduced include
  – Carbon tax
  – Reform of motor tax regime
  – New building regulations for new homes
  – New national energy efficiency standard for
  – Residential home insulation scheme grants
      Reading a marginal abatement cost

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
• 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
• 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,
  – 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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