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Unformatted text preview: Economic assessment of the U.S. Cap & Trade system
Kate Kokosinski Christina Tsiarta ESM 286 2/29/08 Background
US cap & trade (C&T) scheme will have implications in both the short and long term wrt costs benefits (particularly challenging) distributional impacts These need to be evaluated empirically from an economic perspective Implications will inevitably affect the short-term cost effectiveness and long-term dynamic incentives for innovation the C&T scheme offers Issue 1: Cost assessment of C&T
The C&T scheme offers opportunities for cost savings through:
`what, where and when' flexibility `what': encourages emissions reductions through whatever measures are the least-costly `where': exploits variation in costs across households, firms, countries to encourage reductions where it is least-costly to do so `when': allows flexibility in timing of emissions reductions as emissions accumulate over long periods of time; allows for banking and borrowing of allowances for future use; facilitates implementation as allows firms time to adapt In both technologies and how fossil fuels are used Incentives for long-term technological change Issue 2: how to empirically evaluate costs of C&T
2 empirical models: National Energy Modeling System (NEMS); U.S. Department of Energy Emissions Prediction and Policy Analysis (EPPA); MIT's Joint Program on the Science and Policy of Global Change Models differ in their structure, assumptions and hence results Factors found to have greatest effect on cost-estimates are: Background emissions; business-as-usual (BAU) Policy stringency and its trajectory Scope of policy coverage across economy Ability to switch fuels Energy efficiency improvements Availability of offsets Uses of revenue from auctioned allowances Issue 2 continued...
Assumptions, characteristics and limitations of EPPA model: Does not allow Impacts
for biological C overestimated Assumes Models emissions sequestration as model perfect, reductions, not policies analyzes frictionless GHGs not just markets, Assumes CO2 with 0 Ignores similar transition other state climate Underestimates Overestimates costs and full and policies costs costs employment regional elsewhere of resources programs in the world; effects on fuel prices Excludes Does not Ignores Assumes no etc. uncertainty and allow for costs of linkage and no risk, assuming nuclear monitoring or perfect international power; transactions information trading in safety allowances Issue 2 continued...
Reduction in CO2 emissions from BAU level under each scenario Stabilize at 2008 level (a) -Millions of metric tons -Percent of BAU Reduce to 50% of 1990 level (b) -Millions of metric tons -Percent of BAU 2005 2025 2050 0 0 1783 23 4481 38 0 0 3001 38 8711 75 Most cost-effective solution: Reduce CO2 emissions well below the cap in the early years, and bank allowances to be used in the future
(a) (b) Proposed by the National Commission on Energy Policy (2004, 2007b) - NEMS - Proposed by the U.S. Climate Action Partnership (2007) EPPA Issue 3 Impacts on Various Stakeholders
Industry Price of fossil fuel Costs of using fossil fuel Electric power production Electric Power Sector Government Economy Aggregate costs to economy (1) Industry
Allowance and fossil fuel prices As required emissions reductions increase over time, the market prices of the allowances will increase Cap-and-trade system will raise the price of fossil fuel Cost of using fossil fuels With higher prices, the cost of using fossil fuels will increase Depends on product...greatest impacts are on the users of coal (most carbon-intensive fuel) Petroleum sector less affected because demand for these products (gasoline) is price insensitive Effect on natural gas unclear - could potentially increase or decrease demand (2) Electric Power Sector
Increases in cost depend on carbon intensity of sources of electricity and regional output Impact of costs depend on state regulation...who will bear the burden of costs? Less regional variation across restructured markets (cost internalized by generator) than across markets regulated by cost-of-service (cost passed onto consumer) Coal-fired generation price will increase. Some costs may be offset by increased electricity price, but profitability will still be reduced. (3) Government
Federal and state governments will bear some cost of an emissions cap Increases price of providing government services Higher government spending on programs whose outlays are adjusted for inflation (social security) Government will receive more corporate tax revenue for firms that raise profits under cap-and-trade system (4) Economy
GDP is slightly reduced under cap-and-trade systems compared to what would otherwise be expected (business as usual) Less aggressive trajectory = 0.5% reduction in each year of program More aggressive trajectory = up to 1% reduction in each year of program. Changes in labor income (job losses) and investment income Low-income vs. high income Issue 4 Auction vs. Free
Potential revenue from allowance auctions Aggregate value of allowances would exceed total cost burden to economy use revenue for public Distributional impacts Free allocation increases firm profitability, but does not benefit consumers, suppliers, employees, etc. Amount of allowances distributed for free should decline over time Distribute to most cost burdened sectors first Gradual phasing in of policy allows firms time to adapt Lessons learned
Hard to quantify and compare benefits with costs; perhaps further work can focus more on empirically measuring benefits to be able to sell political feasibility of C&T scheme To cost-effective reduce emissions, need to carefully plan when, where, what and how Impacts to several parties, not only industry (government, economy, etc.) Stresses importance of developing an appropriate policy Seems like this policy just makes everything more expensive (govt. services, energy, goods). Can this be made attractive to consumers, and does their opinion matter? Discussion questions
Do you think that the benefits of the scheme are comparable to the costs, and if so, are they greater or less? Is the use of just 2 empirical models enough to base their economic analysis of the costs and benefits of the C&T? Where will revenues from allowances be allocated? How do we know revenue is used for public good? Gradual phasing in of policy allows firms to adapt, but is this the point? Should we take the alternative approach of introducing a stringent cap all at once? ...
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This note was uploaded on 08/06/2008 for the course ESM 286 taught by Professor Cerf during the Winter '08 term at UCSB.
- Winter '08
- Energy Policy