August 8, 2009

Climate Targets in an Uncertain World

by Matthias G.W. Schmidt, Alexander Lorenz, Hermann Held and Elmar Kriegler

- In this article, we explore how to base mitigation policies on climate targets when uncertainty and learning about uncertainty is being taken into account. Climate targets under uncertainty are most naturally formulated as safety constraints on the risk to violate the target. Cost-effective mitigation strategies can then be found by minimizing costs under this constraint. We show that, for very intuitive reasons, this leads to major conceptual flaws if learning is being taken into account: Costless information might be rejected and climate targets become infeasible. Therefore, we explore other ways than cost-effectiveness to base decisions on climate targets and show their respective strengths and limitations.

Schmidt, M.G.W., A. Lorenz, H. Held and E. Kriegler (2009). "Climate Targets in an Uncertain World." Potsdam Institute for Climate Impact Research, July 2009.

CO2 Regulations and Electricity Prices: Cost Estimates from Coal-Fired Power Plants

by Ozge Islegen and Stefan J. Reichelstein

- This study examines the changes in electricity prices that are likely to result if in the future coal-fired power plants are regulated for their CO2 emissions. We focus on carbon capture and storage (CCS) technologies that new power plants may adopt either because of a direct regulatory requirement or because the market price of CO2 emission permits is sufficiently high. Our analysis takes explicitly into account that in some jurisdictions the supply of electricity at the wholesale level (generation) is organized competitively, while in other jurisdictions a regulated monopolist (utility) provides both generation and distribution services. We find that for both the competitive and the regulated monopoly scenario an emission price in the range of $25-30 per tonne of CO2 would make it advantageous for coal-fired plants to adopt CCS capabilities rather than buy emission permits.

Islegen, O. and S.J. Reichelstein (2009). "CO2 Regulations and Electricity Prices: Cost Estimates from Coal-Fired Power Plants." Available at SSRN, July 2009.

The Analysis of Country-to-Country CDM Permit Trading using the Gravity Model in International Trade

by Haifeng Wang and Jeremy Firestone

- In this paper, we evaluated the current CDM projects based on econometric models in international trade theory and concluded that while the CDM was suffering from such imbalance, the primary determinant of the CDM replied on the total GHG emissions from host and credit countries. They were positively and consistently related to the CDM projects. The degree of openness, infrastructure and colony were important if all CDM projects were considered, but not significant when only accepted projects were included. We calculated that if the degree of openness and the infrastructure increased from 25 percentage to 75 percentage, the host country could attract 73% and 4% more CDM respectively. Our paper shows that the CDM projects distribution did not just imbalance towards some big countries, but a response to current environmental, economic and domestic policy situations.

Haifeng, W. and J. Firestone (2009). "The Analysis of Country-to-Country CDM Permit Trading using the Gravity Model in International Trade." Available at SSRN, July 2009.

The Effects of Rent Seeking over Tradable Pollution Permits

by Nick Hanleya and Ian A. MacKenzie

- The establishment of a tradable permit market requires the regulator to select a level of aggregate emissions and then distribute the associated permits (rent) to specific groups. In most circumstances, these decisions are often politically contentious and frequently influenced by rent seeking behaviour. In this paper, we use a contest model to analyse the effects of rent seeking effort when permits are freely distributed (grandfathered). Rent seeking behaviour can influence both the share of permits which an individual firm receives and also the total supply of permits. This latter impact depends on the responsivenessof the regulator to aggregate rent seeking effort. Using a three-stage game, we show that rent seeking can influence both the distribution of rents and the ex post value of these rents, whilst welfare usually decreases in the responsiveness of the regulator.

Hanley, N. and I.A. MacKenzie (2009). "The Effects of Rent Seeking over Tradable Pollution Permits." Center for Economic Research, ETH Zürich, Economics Working Paper Series, Working Paper 09/112, July 2009.

Controlling Externalities in the Presence of Rent Seeking

by Ian A. MacKenzie

- Contests are a common method to describe the distribution of many different types of rents. Yet in many of these situations the utilisation of the prize plays an important role in determining agents' payoffs and incentives. In this paper, we investigate the incentives to expend effort for a prize that produces consumption externalities and consider alternative regulatory policies. We find relatively more global consumption externalities will increase (decrease) rent seeking when con-sumption externalities are negative (positive). We show how introducing Pigouvian taxation (possibly with revenue transfer) and Coasean bargaining alters equilib-rium effort and payoffs.

MacKenzie, I.A. (2009). "Controlling Externalities in the Presence of Rent Seeking." Center for Economic Research, ETH Zürich, Economics Working Paper Series, Working Paper 09/111, July 2009.

Linking Reduced Deforestation and a Global Carbon Market: Impacts on Costs, Financial Flows, and Technological Innovation

by Valentina Bosetti, Ruben Lubowski, Alexander Golub, Anil Markandya

- This paper analyzes the effects of linking Reduced Emissions from Deforestation and Forest Degradation (REDD) to a global market for greenhouse gas emission reductions. We supplement a global climate-energy-economy model with alternative cost estimates for reducing deforestation emissions in order to examine a global program for stabilizing greenhouse gas concentrations at 550 ppmv of CO2 equivalent. Introducing REDD reduces global forestry emissions through 2050 by 20-22% in the Brazil-only case and by 64-88% in the global REDD scenarios. At the same time, REDD lowers the total costs of the climate policy by an estimated 10-25% depending on which tropical countries participate and whether the "banking" of excess credits for use in future periods is allowed.

Bosetti, V., R. Lubowski, A. Golub and A. Markandya (2009). "Linking Reduced Deforestation and a Global Carbon Market: Impacts on Costs, Financial Flows, and Technological Innovation." Fondazione Eni Enrico Mattei Working Paper No 56.09, July 2009.

Cost Containment in Climate Change Policy: Alternative Approaches to Mitigating Price Volatility

by Gilbert E. Metcalf

- Cap and trade systems are emerging as the front-running policy choice to address climate change concerns in many countries. One of the apparent attractions of this approach is the ability to achieve hard limits on emissions over a control period. The cost of achieving this certainty on emission limits is price volatility. I discuss and evaluate various approaches within cap and trade systems to reduce price volatility. A fundamental trade-off exists between certainty of emission limits and price volatility. A pure carbon tax sacrifices certainty of emission limits in favor of price stability. I discuss how a hybrid carbon tax can be designed to achieve a balance between price stability and emissions certainty. This hybrid, dubbed the Responsive Emissions Autonomous Carbon Tax (REACT), combines the short-run price stability of a carbon tax with the long-run certainty of emission reductions over a control period.

Metcalf, G.E. (2009). "Cost Containment in Climate Change Policy: Alternative Approaches to Mitigating Price Volatility." NBER Working Paper No. 15125, July 2009.

Flexible Global Carbon Pricing: A Backward-Compatible Upgrade for the Kyoto Protocol

by Steven E. Stoft

- This paper proposes a system, "flexible global carbon pricing," designed to upgrade the Kyoto Protocol by allowing a carbon tax in place of a carbon cap. It provides backward-compatibility with the Kyoto Protocol by allowing un-modified cap and trade as well. Instead of many national caps, the proposal sets a global target price for carbon and specifies a pair of incentives. The Pricing Incentive rewards nations that set their carbon price higher than the global target and penalizes nations that underachieve. These rewards and penalties sum to zero by design. The strength of the Pricing Incentive is adjusted automatically so that the global average carbon price converges to the global target price. The Clean Development Incentive (CDI), free from the gaming problems that plague the U.N.’s Clean Development Mechanism, encourages full participation by low-emission countries. An example, based on a $20 price target, causes transfers from the United States of only seven cents per capita per day. Nevertheless, India’s CDI receipts cover its compliance costs. The example shows that low costs can be guaranteed.

Stoft, S.E. (2009). "Flexible Global Carbon Pricing: A Backward-Compatible Upgrade for the Kyoto Protocol." European University Institute Working Paper No. RSCAS 2009/35, July 2009.

Life’s a Breach! Ensuring ‘Permanence’ in Forest Carbon Sinks Under Incomplete Contract Enforcement

by Charles Palmer, Markus Ohndorf and Ian A. MacKenzie

- As carbon sinks, forests play a critical role in helping to mitigate the growing threat from anthropogenic climate change. Forest carbon offsets transacted between GHG emitters in industrialised countries and sellers in developing countries have emerged as a useful climate policy tool. A model is developed that investigates the role of incentives in forestry carbon sequestration contracts. It considers the optimal design of contracts to ensure landowner participation and hence, permanence in forest carbon sinks in a context of uncertain opportunity costs and incomplete contract enforcement. The optimal contract is driven by the quality of the institutional framework in which the contract is executed, in particular, as it relates to contract enforcement.

Palmer, C., M. Ohndorf and I.A. MacKenzie (2009). "Life’s a Breach! Ensuring ‘Permanence’ in Forest Carbon Sinks Under Incomplete Contract Enforcement." CER-ETH, Center of Economic Research at ETH Zurich, Economics Working Paper Series, Working Paper 09/113, July 2009.

Consequences of Alternative U.S. Cap-and-Trade Policies: Controlling Both Emissions and Costs

by Warwick J. McKibbin, Adele Morris, Peter J. Wilcoxen, and Yiyong Cai

- The U.S. Congress continues to debate a potential cap-and-trade program for the control of greenhouse gas emissions. The economic effects of such a bill remain in dispute, with some arguing that a cap-and-trade program would create jobs and improve economic growth and others arguing that the program would shift jobs overseas and hit households with large energy price increases. This report applies a state-of-the art global economic model to the question and offers insights to policymakers about how to design the program to achieve long-run environmental goals at minimum cost and with low risk to the economy. The report analyzes a range of possible cap-and-trade policies for the U.S. The seven policy scenarios we analyze meet similar long run environmental objectives, but differ in their emissions trajectories and costs. The report concludes that a policy similar to the Obama proposal, augmented by a price collar or safety value, could achieve very significant long-term reductions in emissions while imposing a firm upper bound on compliance costs.

McKibbin, W.J., A. Morris, P.J. Wilcoxen and Y. Cai (2009). "Consequences of Alternative U.S. Cap-and-Trade Policies: Controlling Both Emissions and Costs." Brookings, July 2009.

Implications of Limited Foresight and Sequential Decision Making for Long-term Energy System Planning: An Application of the Myopic MESSAGE

by I. Keppo and M. Strubegger

- This paper presents the development and demonstration of a limited foresight energy system model. The presented model is implemented as an extension to a large, linear optimization model, MESSAGE. The motivation behind changing the model is to provide an alternative decision framework, where information for the full time frame is not available immediately and sequential decision making under incomplete information is implied. While the traditional optimization framework provides the globally optimal decisions for the modeled problem, the framework presented here may offer a better description of the decision environment, under which decision makers must operate. We further modify the model to accommodate flexible dynamic constraints, which give an option to implement investments faster, albeit with a higher cost. Finally, the operation of the model is demonstrated using a moving window of foresight, with which decisions are taken for the next 30 years, but can be reconsidered later, when more information becomes available.

Keppo, I. and M. Strubegger (2009). "Implications of Limited Foresight and Sequential Decision Making for Long-term Energy System Planning: An Application of the Myopic MESSAGE." IIASA Interim Report IR-09-006, March 2009.

Assessing the Transaction Costs of Firms in the EU ETS: Lessons from Ireland

by Jurate Jaraite, Frank Convery and Corrado Di Maria

- This paper measures the transaction costs incurred by Irish firms under the European Union’s CO2 Emissions Trading Scheme (EU ETS) during its pilot phase (2005 - 2007). Our analysis provides evidence that such costs were mainly administrative in nature. We emphasize the existence of sizeable economies of scale, as the costs per tonne of CO2 were lower for participants with larger allocations. Trading costs were not significant and, hence, not trade inhibitive. Other factors, self-sufficiency in compliance and low allowance prices, played a major role in the decision whether to trade or not during this phase.

Jaraite, J., F. Convery and C. Di Maria (2009). "Assessing the Transaction Costs of Firms in the EU ETS: Lessons from Ireland." Available at SSRN, March 2009.