Thomas-Olivier Léautier ( [email protected] ) with Claude Crampes ( [email protected] ) Limiting Green House Gas emissions: an economist’s perspective Les Houches, February 2014
Jan 02, 2016
Thomas-Olivier Léautier ([email protected])with Claude Crampes ([email protected])
Limiting Green House Gas emissions: an economist’s
perspective
Les Houches, February 2014
2
Outline
1. Clean Energy Policy for Europe
2. Basic microeconomics for externalities
3. The European Emission Trading System
4. Microeconomics for cap-and-trade
EU Green-House Gas emissions towards an 80% domestic reduction (100% =1990)
Source: European Commission, “A Roadmap for moving to a competitive low carbon economyin 2050”, March 2011
0%
20%
40%
60%
80%
100%
1990 2000 2010 2020 2030 2040 2050
0%
20%
40%
60%
80%
100%
Current policy
Power Sector
Residential & Tertiary
Non CO2 Other Sectors
Industry
Transport
Non CO2 Agriculture
3
quantity
0
price
q market
Demand
Supply
Equilibrium
2. Basic microeconomics for externalities
p market
4
GHG emissions as a negative externality
Negative externality associated with GHG emissions: ● emitters do not face the full social costs of emissions,
including their impact on the environment (global warming).
Without intervention, the market would emit excessive pollutantsSource: IPCC (2007) 5
qmarketquantity0
price
demand
supply=
private marginal cost
social marginal cost
qoptimum
cost of the negative externality
equilibrium
optimum
Negative externality and market failure
6
A series of complex issues
● Physics (climate science): ● What is the impact of temperature increase?
● Engineering● What technical progress can be expected?
● Economics: ● What is the cost of temperature increase?● What is the cost of decarbonization?
● What weight for future generations versus current ones?● How to split the burden between developed and developing countries? between industries?
● How to limit opportunistic behavior?
7
Controlling GHG emissions: what is the right method?
• Overall objective: minimizing the cost of reducing carbon emissions o Set of policies that directly address the market failures
associated with climate change, and only intervene where market failures are present
o Technology- and sector-neutral approach to carbon abatement: carbon reduction in sectors which have the lowest cost of reducing emissions
• Potential policies
o Direct regulation: Command & Control, prohibition, quotas, standards…
o Incentive regulation: carbon pricing (cap-and-trade, carbon taxes), subsidies and R&D incentives
8
qmarketquantity0
price
demand
supply=
private marginal cost
social marginal cost
qoptimum
equilibrium
optimum
How to create a carbon price? i) tax
9
carbon tax
modified private marginal cost
How to create a carbon price? ii) tradable permits
quantity0
price
demand
qconstrained
volume cap
Optimum
price of the good
price of the permit
supply=
private marginal cost
10
social marginal cost
Market vs. tax
• Principle of responsibility: the polluter must pay (article 174-2 of the Treaty); Is the producer or the consumer the true polluter? Is cost pass-through acceptable?
• Carbon tax : Who is in charge? How is it calculated? Who receives the cash? What to do with revenues?
• Tradable permits : Who decides? How many allowances? If given for free, to whom? If sold, who benefits from sale?
• Theory (Weitzman, 1974): quantity control is more efficient than price control when supply is more inelastic than demand
11
Price vs. quantity regulation
quantity0
price
Average demand
q*12
social marginal cost
Net Surplus
p*
Welfare loss under quantity regulation
quantity0
price
Average demand
q*13
social marginal cost
p*
Realized demand
Surplus loss under quantity regulation
q**
Welfare loss under price regulation
quantity0
price
Average demand
q*14
social marginal cost
p*
Realized demand
Welfare loss under price regulation
q**
15
• Political economy: potential for regulatory capture produces first-order effects
• Concerning CO2 emissions, Directive 2003/87/CE has set the framework: the EU-ETS, a cap-and-trade system
Price vs. quantity regulation 2
3. The European Emission Trading System
• Directive EU ETS (European Emission Trading Scheme) in 2003 before the commitment from the Kyoto protocol.
• Three compliance phases• Now 28+3 heterogeneous States participate
2008 2012
1 Jan. :ETS Phase I
1 Jan. : ETS Phase II
2005 2007
1 Jan. : beginning of first Kyoto protocol period
Feb. : Kyoto protocol comes into force
2020
1 Jan. : ETS Phase III
Dec. : end of first Kyoto protocol period.
3x20 European Objectives
2013
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Cap-and-trade principles
● Binding cap is set on emissions during a given period● Emission permits are allocated to polluters:
o auction or free allocation based on grandfathering or benchmarkingwww.eex.com/en/Market%20Data/Trading%20Data/Emission%20Rights/EU%20Emission%20Allowances%20%7C%20Spot
● Emission permits can be traded (wholesale or, mainly, OTC):
o Regardless of the initial allocation (if no transaction costs), trading allows for an optimal distribution of abatement efforts across sectors and countries (Coase principle)
o The initial allocation of permits only has a wealth effecto If the allocation is auctioned, second hand market is just for efficient adjustment
● Polluters not allowed to emit more than initial allocation + permits bought on the market; otherwise, they pay a penalty.
17
European Environmental Policy: 2013-2020
The ETS Directive (2009/29/EC): ● From 2013 onwards (Phase III), emission allowances in
the ETS will be reduced by 21% below their 2005 levels by 2020
● Full auctioning for the power sector, and a gradual phasing out of free allowances for other sectors
● The ETS is also set to be expanded from 2013, to also include the aviation sector. But …
18
Allocations by sector
1919
Allocations by country
2020
Total allowances
21
BankingEmissions permits can be used in periods subsequent to the one in which they were allocated. Inter or intra-phase?
– in Phase I, only intra-phase– now also interphase (Phase II => Phase III)
BorrowingAllows regulated emitters to use part of their future allocations to cover their present emissions– de facto allowed intra-phase (February 28 => April 30)
Credits offset:- Clean Development Mechanism- Joint Implementation
Flexibility
22
Low carbon price
23
juin-05
oct.-05
févr.-06
juin-06
oct.-06
févr.-07
juin-07
oct.-07
févr.-08
juin-08
oct.-08
févr.-09
juin-09
oct.-09
févr.-10
juin-10
oct.-10
févr.-11
juin-11
oct.-11
févr.-12
juin-12
oct.-12
févr.-13
juin-13
oct.-13
0
4
8
12
16
20
24
28
Prix spot 2005-2007 Prix spot (depuis 2008)
24
4. Microeconomics for cap-and-trade
,max ( ) ( )
: input = gross emissions, unit price
(.) : output ' 0, '' 0, unit price
: abatement effort
(.) : abatement cost , ' 0 , " 0
: residual polluting emissions
x ypQ x wx g y
x w
Q Q Q p
y
g g g
e x y
' 1FOC: '( ) demand for input ( , ) ( ) and 0def w
pQ x w X w p Q yp
Assume the emissions without constraint ( , ) ,
where is the social optimum level.
oe X w p e
e
24
25
Permits
• The authority limits to the emissions allowed (cap)
and open a permits exchange (trade)
e
0 demand ( 0 supply) of allowances
unit price of allowancesa a
a
q q
p
• , ,
max ( ) ( ) . . ( )a
a a ax y q
pQ x wx g y q p s c x y e q
• FOC: '( ) 0x pQ x w
: '( ) 0 ( 0 if 0)y g y y
: 0a aq p
•
26
Trading
When 0, we have 0. Then 0a ap q x y e is the demand for rights derived from the firm’s optimal production.
2
Assume first that '(0) ; then 0. From the two other FOC,
we obtain the gross demand for emitting COag p y
( , , ) ( , , ) 0a a aq w p p X w p p e
The firm is a net demander of allowances if is small,
a net supplier otherwise.ap
' 1'( ) 0 ( , , ) ( ).def
aa a
w ppQ x w p X w p p Q
p
abatement effort and market of allowances
Assume now '(0) ; the firm fixes so that '( ) .a ag p y g y p ' 1Let ( ) ( ); it is increasing in since '' 0.
def
a a aY p g p p g
We then have
ap
traded permits
effort quota
e ,e x
( , , )a aq w p p
( , , )aX w p p
where ( ) 0 for 0,a a aY p p p
27
( ,0, )aq w p
Equilibrium
*The market equilibrium is reached at such thatap
( , , ) ( ) i a i a ii i i
X w p p Y p e
For two « price-takers »
ap
*ap
1 2,a aq q
At equilibrium, 2 is a seller and 1 is a buyer.
28
comparative statics
1
- the initial total endowment ,
not the allocation ( ,..., ) : R. Coasen
e
e e
- the shape of the functions of abatment cost (.)g
- input(s) price(s) : coal, natural gas, fuel, etc.w
The market equilibrium varies with
- product(s) price(s) : electricity, aluminium, steel, etc.p
29
Paying for allowances
* The marginal conditions remain the same as et are exogeneous.s e
* Risk of foreclosure if the global "tax" is too high.s e
*Assume that firms have to pay for each ton initially alloweds
30
Auctionning allowances
• Under the first Directive, only four countries have used the possibility to sell (at most 5 %) allowances : Denmark (5 %), Hungary (2.5 %), Lithuania (1.5 %) and Ireland (0.75 %).
• Under the 2009 Directive, it is 100% mandatory for the electricity producers from 2013 on. Partial obligation in the other industries.
• Then, to produce output q, a firm can now obtain permits from
free allowances, (cost 0)eauctionned permits, (unit cost )a s
abatement effort, (total cost ( ))y g y
traded permits, (unit cost )a aq p31
Conclusions
• For the EU authorities, it takes (at least) three tools to reach objective:
― one for cleaning (Directive 2009/29/EC: mandatory ETS),― one for greening (Directive 2009/28/EC: optional green
certificates, or FIT, or green potfolio, or …),― one for saving (Directive 2012/27/EU: optional white
certificates, or energy efficiency, or load-shedding, or demand response, or …).
• Actually:― as the objective is to cut GHG emissions, one tool is
sufficient― combining several tools produces negative side-effects.
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An economist perspective
Cap and trade for CO2 is a right answer becauseo it fixes a negative externality;o it sends a scarcity signal;o it allows firms to adjust volumes;o it (now) generates public revenues.
Independent quantitative targets for energy saving and renewables are wrong answers becauseo they are viewed as genuine objectives instead of mere means;o they increase the cost of reaching the CO2 target;o they require large amounts of red tape and (distortive) State
aids.
33
Appendix
EU-ETS timeline
30 March 30 April
beginning of year N
Installations submit their verified emissions for year N-1 to the national authority.
28 Feb.
Year N allocation on installations accounts in their national registry.
31 déc.
end of year N
Installations surrender the allowances covering their N-1 emissions in the national authority.
1st Jan. 15 May
double allocation period
Publication of year N-1 emissions by the EC
35
36
• •
w
w
,x e ,x e
'( )pQ x '( )pQ xw
w
'( ) apQ x p '( ) apQ x p
• • • •
( , , )aX w p p oee
oe( , , )aX w p p
eap
( , , ) 0a aq w p p ( , , ) 0a aq w p p net supply net demand
,aq x
net demand
net supply
( ,0, )aq w p ( ,0, )X w p
ˆap
( , , )a aq w p p ( , , )aX w p p
e
( , , ) ( , , )a a a
a a
q w p p X w p p
p p
ˆ( , , )aX w p p e
ˆ : switching thresholdap
ap
ap
Timeline
Firms will be active on both the initial sale and on the permits exchange only if there is some randomness (on p and/or w)
,,
max max ( ) . .a
p w a a aa x q
E u sa pQ x wx p q s c x e a q
e
auction a
p and w certain trading (choice of )
time
quota checking
37
* Ex post, knowing p and w we have that
'' ( )
and ( ) 0ai i i i
i ai i i ai i a
q x e apQ q e a w p
pQ x w p
' 1* Individual net demands , aai i i i
w pq Q e a
p
, , and the net demands , , . a i i ai i ii i
p e a w p q e a w p
* Remark : If most firms are net suppliers ( ) [for example because is larger than expected] there is no 0 suc the equilibrium prih ce that is 0 : nil.
i i i
a
aii
x e aw p
q
are agregated for all to give the price on the permit exchangei
38
,
* We still have to determine how much to buy in the initial auction
max (.) (.) (.) (.)i
p w i i i ai i i ai i i a aia
E u sa pQ q e a w q e a p q
,max (.) (.) (.)i
p w i i ai i i i a ai ia
E u pQ q e a s w a p w q we
* The FOC is
' ', (.) (.) 1 ( ) ( (.) ) 0ai ai
w p i i ai i
q qE u pQ s w p w
a a
(with 0)a
i
p
a
39
or
40
* Equilibrium is given by ( ) supply.ii
a s
',* Since 1, we get (.) (.) 0ai
w p i ai
qE u p s
a
to determine the initial demand for permits ( ).ia s
• Remark 1:
Then• if risk neutral, i buys on the initial auction only if
• if risk averse, we have
meaning that i is ready to pay a risk premium.
',
',
(.) (.)
(.)w p i a
w p i
E u ps
E u
, (.)w p as E p'
,,'
,
(.) (.)(.)
(.)w p i a
w p aw p i
E u ps E p
E u
41
* Remark 2:• If the initial auction of permits is not followed by trading possibilities, it
is a private value auction : each firm bids a price only based on its own characteristics.
• Opening an ex post exchange for permits transforms the auction into a common value auction : the total number of allowances and the technical characteristics of all obliged firms.
' depends on that depends oni aiQ q
Dynamic opportunism
• During the first round (2005-2007), the EC has announced that future quotas would not be based on the observed performances of the current round, to reduce opportunism.
• Actually, “it is useful to learn from the most recent data”,
• Finally, the expected individual emissions for 2008-2012 have been based on declared emissions of 2005 multiplied by an expected growth rate until 2010.
• What is the risk?42
Grandfathering: internalizing the review rules
( , )
0
max ( )a
T
a ax q
p Q x w x p q
s.t. 0,..., .ax e q T
gives FOC1 21 2 1 1
1 1
0 ( ' ( ) ) ...a
de de d x depQ x w p
dx dx de dx
With just a one-period effect' 1( ) a a
depQ x w p w p
dx
''1As 0 and ( ) 0, the firm chooses a larger
de
Q x xdx
1which means larger emissions than if is fully exogeneous. e
Not the case when allowances are auctioned.
43