MIT OpenCourseWare
http://ocw.mit.edu
15.023J / 12.848J / ESD.128J Global Climate Change: Economics, Science, and Policy
Spring 2008
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Today in Context
Topics to date:
• Climate Science
• Politics and Institutions
• Economics
–
–
–
–
Emissions Projections
Mitigation Costs
Benefits
Policy Analysis (Certainty)
Today
Policy Instrument Choice
Regulatory Instrument Design
• Given a desired reduction in GHG emissions,
how do you design the regulation?
• What are the differences between alternative
designs?
• On what basis should the approach be chosen?
–
–
–
–
–
Environmental effectiveness
Cost-effectiveness
Distributional equity
Performance under uncertainty
Political feasibility
Alternative Instrument Types
• “Command-and-Control”
– Technology standards
– Performance
• “Market-Based”
– Cap-and-trade system
– Emissions fee (e.g., carbon tax)
• R&D Based
– Tax credits/subsidies
– Direct R&D Spending
CAC vs. MB
• Command-and-Control
– Administrative Ease
– Regulatory “certainty” (?)
• Market-Based
– Cost-effective -> Why?
• Equalizes Marginal Costs
Allocation Problem with 2 Sources
MAC2
$/ton CO2
MAC1
Abatement (tons CO2)
Allocation Problem with 2 Sources
$/ton CO2
MAC2
MAC1
A1: 0
A2: 10
5
5
10
0
Allocation Problem with 2 Sources
$/ton CO2
MAC2
assume
equal
allocation
MAC1
TC2
TC1
A1: 0
A2: 10
5
5
10
0
Allocation Problem with 2 Sources
$/ton CO2
MAC2
trade 1 unit
MAC1
net cost
savings
TC2
TC1
A1: 0
A2: 10
5
6
5
4
10
0
Allocation Problem with 2 Sources
$/ton CO2
MAC2
Trade until
MC’s are equal
MAC1
net cost
savings
TC2
TC1
A1: 0
A2: 10
5
x
5
10-x
10
0
Cost-effectiveness
• Cannot do better than equal marginal costs
• Same analysis holds for
– Different firms
– Different industries
– Different countries
Examples of Emissions Trading
• US experience
–
–
–
–
–
Phasedown of leaded gasoline in 1980s
CFCs/Montreal Protocol
CAAA 1990 SO2 permit trading
RECLAIM in S. CA (SO2 and NOx)
NOx emissions under Ozone Transport Commission
(OTC)
• International experience
– EU Emissions Trading Scheme
– Kyoto Protocol
Tax vs. Cap-&-Trade
• Pros for tax?
–
–
–
–
• Pros for cap-and-trade?
–
–
–
–
Tax vs. Cap-&-Trade
• Pros for tax?
– No price volatility
– Revenue allows for “double-dividend”
– Can address distributional effects
(consumers)
– Uncertainty argument (flat marginal benefits)
• Pros for cap-&-trade?
–
–
–
–
Emissions certainty
Can raise revenues through auctioning
Can address distributional effects (producers)
Political feasibility in U.S.
Efficient Abatement Under Certainty
$/ton
Marginal
damage
P
Marginal
cost
E
Emissions
Weitzman (1974)
• When uncertain, which should we use?
• Answer: Look at the relative slopes of
marginal costs and marginal damages
• If Marginal damages relatively STEEP, use
QUANTITY instrument
• If marginal damages are relatively FLAT,
use PRICE instrument
Steep MD: Price Uncertainty Bigger
Marginal
Damages/Benefits
Less Clear
what the
‘right’ price is
More clear what you should reduce
Uncertain
Marginal Costs
Flat MD: Quant. Uncertainty Bigger
Uncertain
Marginal Costs
More clear
what the
‘right’ price is
Less clear how much you should reduce
Marginal
Damages/Benefits
Dilemma for the U.S.
• Marginal Climate Change Damages are
FLAT
(in emissions, the relevant var. for policy)
• Given uncertainty, should use CARBON
TAX
• BUT…
• U.S. is “allergic” to taxes
• We like tradable permits (worked for SO2)
Modifications to Cap & Trade
• Safety Valve
• Emissions Intensity Target
• Banking and Borrowing
Issues in Cap-&-Trade Design
• Coverage
– Sectors
– Gases
•
•
•
•
•
•
•
Stringency of the target, and path
Method of allowance allocation
Banking and borrowing
Point of regulation
Safety valve
Revenue use
International linkage
– Trade in goods
– Trade in allowances
ETS Price History
€ 35
2005
2006
2007
€ 30
Euros
€ 25
€ 20
€ 15
€ 10
€5
Dec 07
Dec 08
€0
1/7/2005
4/7/2005
7/7/2005
10/7/2005
1/7/2006
4/7/2006
7/7/2006
10/7/2006
Weekly observations
1/7/2007
4/7/2007
7/7/2007
10/7/2007
Issues in Allowance Allocation
• Why does it matter?
• Auction vs. distribute for free
• Who should get permits if given away?
– Economics
– Politics
• Revenue recycling and “double dividend”
• Special issues of regulated utilities
Analysis of Current US Bills
• Simplified versions to span the range
– Emissions 2012-2050 for “core” examples
– Safety valve version (not handed out)
• Handling of actions abroad
– Europe, Japan, Canada, Aus & NZ decline
gradually from Kyoto period to 50% below
1990 by 2050
– All others begin in 2025, to 2015 level by
2030, hold 2000 level 2035-2050
• Ignore command-&-control features
Allowance Allocation: Congressional Bills and Core Cases
Emissions, mmt CO2-e
8000
6000
Udall-Petri 2006
Bingaman-Specter 2007 National
Sanders-Boxer 2007
Lieberman-Warner 2007*
Bingaman-Specter 2007*
Lieberman-Warner
2007 National
4000
2000
287 bmt
0
1990
1995
2000
2005
2010
203 bmt
2015
2020
Year
167 bmt
2025
Waxman 2007
2030
2035
2040
2045
2050
Figure by MIT OpenCourseWare.
GHG Emissions and Allowance Allocation
14000
Total GHGs, mmt CO2-e
12000
10000
8000
6000
4000
2000
0
2005
2010
2015
2020
2025
2030
2035
Year
203-A llo wances
203-Emissio ns
Ref
2040
2045
2050
ETS Price History
€ 35
2005
2006
2007
€ 30
Euros
€ 25
€ 20
€ 15
€ 10
€5
Dec 07
Dec 08
€0
1/7/2005
4/7/2005
7/7/2005
10/7/2005
1/7/2006
4/7/2006
7/7/2006
10/7/2006
Weekly observations
1/7/2007
4/7/2007
7/7/2007
10/7/2007
CO2-e Prices
200
287 bmt
150
203 bmt
100
Case with
banking
167 bmt
50
0
2015 2020 2025 2030 2035 2040 2045 2050
Year
Welfare Changes
0.00
-0.20
-0.40
Welfare Change, %
Price, $/tCO2-e
250
-0.60
-0.80
-1.00
-1.20
203 bmt
-1.40
-1.60
-1.80
2015
2020
2025
2030
Year
2035
2040
2045
2050
Effects on Petroleum Prices
Price Index, 2005=1.0
2.5
2
1.5
1
Ref
0.5
203 bmt
0
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Year
CO2-e Prices
250
Effect of
banking on
price & cost
203 bmt
150
203 bmt NB
100
50
0
2010
2015
2020
2025
2030
2035
2040
2045
2050
Year
Welfare Changes
0.00
-0.20
Welfare Change, %
Price, $/tCO2-e
200
-0.40
-0.60
-0.80
-1.00
203 bmt
-1.20
-1.40
-1.60
203 bmt NB
-1.80
-2.00
2010
2015
2020
2025
2030
Year
2035
2040
2045
2050
Primary Energy Use, 203 Case
200
Energy Use (EJ)
Reduced Use
Biomass Liquids
150
Renewable Elec.
Hydro
100
Nuclear
Gas
Shale
50
Petrol. Prod.
Coal
0
2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Year
Distribution of Reductions, 203 bmt Case
12000
mmtCO2-e
10000
8000
6000
4000
2000
0
2005
2010
2015
2020
2025
Non-CO2 emissions
2030
2035
2040
CO2 Emissions
2045
2050
Impacts on Temperature Change
Degree centigrade
5.00
4.00
CCSM3
3.00
2.00
1.00
0.00
2000
2020
2040
Reference
Developed only
Years
2060
2080
2100
Global participation, 203 bmt
Upper
287 bmt
Lower
167 bmt
Developing countries delayed
Figure by MIT OpenCourseWare.