ECBI 2008

ECBI 2008

THE MICROECONOMICS OF POST 2012 CDM

5 September 2008

Dr Cameron HepburnDeputy Director, Smith School of Enterprise and the Environment

5 September 2008 1Dr Cameron Hepburn

5 September 2008

SMITH SCHOOL

Demand from business

Critical 21st century environmental challenges

Smith School of Enterprise and

the environment

Interest and input from academics and students

Demand from policy makers

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OTHER RELEVANT INTERESTS

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1. What are the CDM’s objectives?2. The two key challenges3. Some microeconomics4. Evaluating the options for reform

AGENDA

Dr Cameron Hepburn

5 September 2008

1. CDM OBJECTIVES

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• Economics: Keep costs down of reducing emissions• Deliver subsidy to developing countries

• Philosophy: “Common but differentiated responsibility” (equity)

• Politics: Reality is that developing countries will not pay otherwise

• Enhance “sustainable development”• Encourage buy-in to the UNFCCC process

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CATEGORISING THE CDM

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1. What are the CDM’s objectives?2. The two key challenges3. Some microeconomics4. Evaluating the options for reform

AGENDA

Dr Cameron Hepburn

5 September 2008

TWO KEY CHALLENGES

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• Additionality• Asymmetric information generates adverse selection and moral

hazard• Ultimate solution is a global cap and trade scheme

• Scaling up the mechanism• Project-by-project mechanism is very micro• A “wholesale” approach is needed to increase scale of support for

developing countries and also to reduce emissions more rapidly

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ADDITIONALITY CONCERNS

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– Blue: New Chinese Capacity Red: Applying for CERs

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ADDITIONALITY CONCERNS

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PriceEUR/t

Quantity of CERs

Demand for CERs

Supply of CERs

Subsidy paymentif scheme works

P*

Q*

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ADDITIONALITY CONCERNS

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PriceEUR/t

Quantity of CERs

Demand for CERs

Supply of CERsPayment for

additional projectsPayment for non-additional projects

P*

Q*

Pn

Qn

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1. What are the CDM’s objectives?2. The two key challenges3. Some microeconomics4. Evaluating the options for post 2012

AGENDA

Dr Cameron Hepburn

5 September 2008

SOME MICROECONOMICS

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• Optimal subsidy design• How can given quantity of funds be used to do the most good?

• Additionality results for different sector benchmarks• Minimise Type 1 errors (false positives)• Minimise Type 2 errors (false negatives)

• Scaling up the mechanism• Project-by-project mechanism is very micro• A “wholesale” approach is needed to increase scale of support for

developing countries and also to reduce emissions more rapidly

5 September 2008

OPTIMAL SUBSIDY DESIGN

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PriceEUR/t

Quantity of CERs

Demand for CERs

Supply of CERs

Subsidy payment

5 September 2008

OPTIMAL SUBSIDY DESIGN

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PriceEUR/t

Quantity of CERs

Demand for CERs

Supply of CERs

Profit to project participants

MAC

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OPTIMAL SUBSIDY DESIGN

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PriceEUR/t

Quantity of CERs

Demand for CERs

Supply of CERs

Purchase more emission reductions

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MODEL ASSUMPTIONS

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UNCERTAIN ABATEMENT COSTS

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RESULTS: TYPE I AND TYPE II ERRORS

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SCALING UP: HOW

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SCALING UP: INTERMEDIARIES

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SCALING UP: TRADE OFFS

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1. What are the CDM’s objectives?2. The two key challenges3. Some microeconomics4. Evaluating the options for post 2012

AGENDA

Dr Cameron Hepburn

5 September 2008

EVALUATING THE OPTIONS

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CER discounting − Reducing the CER price signal faced by project developers− Disadvantages: perverse selection effects− Advantages: aggregate environmental additionality, provision of an

incentive to transition to cap and trade. − Shift from the commodity to the currency conceptualisation of CERs.

Programmatic CDM− Continue to be supported and streamlined;

Government deals− Reduce emissions through infrastructure development − Welcomed if rich countries will provide the finance!

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EVALUATING THE OPTIONS

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Sectoral CDM − Provides incentives directly to firms in a manner that is consistent with

overall environmental objectives. − In contrast, Policy CDM and Sectoral no-lose targets face the major

challenge of leaving implementation to national governments; − Benchmarks trade-off between Type I and Type II errors;

− Optimal benchmark will be different for different sectors, and individual country and technology characteristics (e.g. new or old build) will probably need to be taken into account;

CER procurement auctions − Likely to play an increasing role as national governments seek value for

money from projects earlier on in the development stages, − Potential role for reverse auctions in paying for emission reductions

currently outside the Kyoto framework (Montreal gases, forestry).

5 September 2008

THANK YOU

Thank you

Comments and questions welcome!

26Dr Cameron Hepburn