Economics & Policy Sessions– Economics primer 2-28

• Economic Growth and Emissions 3-5– Economics of the global commons 3-7

• GHG Emissions Control 3-12– Introduction to the “Toy” IGSM 3-14– Allowance trading systems 3-21– Mitigation benefits 4-4

• Climate Policy Analysis 4-9• Kyoto and Post-2012 Options 4-30

GHG Emissions & Policy CostsToday’s Agenda

• Review of concepts, terminology, issues • Example using price only• The use of MAC curves• CGE models + sample applications

– Trade effects (Kyoto)– Long-term stabilization (CCSP)

• Technology costing approaches– Grass again– Auto example

• Issues in the handling of technology– Endogenous change & “new” technology– Low-hanging fruit, free lunches, etc.

Cost/Welfare Concepts• Emissions price• Area under marginal abatement curve• Simple macroeconomic aggregates

(models with one non-energy output)– GDP– Consumption (e.g., Homework #2)

• Equivalent variation (economic welfare)– Income compensation to restore consumers to

pre-constraint level of welfare (≈ consumption)

What to Include?• What greenhouse substances?

– CO2 only?– CH4, N2O, HFCs, PFCs & SF6

– Aerosol precursors (e.g., SO2)– O3 precursors

• Carbon sinks?• Ancillary benefits of GHG controls?

– Urban air pollution– Other?

Cost to Whom?• What unit of analysis?

– Nation– Global, or Annex I vs. Non-Annex I– Other?

• Issues of aggregation– Of nations– Of sub-national components

Approaches to the TaskShrt Long Trade Tech’nterm term effects detail

Carbon price √ √

MAC curves √

Market-based (CGE) ≅√ √ √

Technology-Cost √ √

HybridsMARKAL-Macro √ √ √

U.S. NEMS √ √

Others (e.g., EPPA) √ √ √ ≅√

Example Using Price Only(The MIT Coal Study)

Scenarios of Penalties on CO2 Emissions ($/t CO2 in constant dollars)

100

80

60

40

20

02005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Low CO2 Price

High CO2 Price

CO2 P

rice (

$/t)

Figure by MIT OCW, based on MIT Coal Study.

Global Primary Energy Consumption under High CO2 Prices(Limited Nuclear Generation and EPPA-Ref Gas Prices)

Energy Reduction from ReferenceNon-Biomass RenewablesCommercial BiomassNuclearCoal w/ CCSCoal w/o CCSGas w/o CCSOl w/o CCS

2005 2010 2015 2020 2025 2030 2035 2040 2045 205020000

200

400

600

800

1000

EJ/Y

ear

Figure by MIT OCW.

Global Primary Energy Consumption under High CO2 Prices(Expanded Nuclear Generation and EPPA-Ref Gas Prices)

Energy Reduction from ReferenceNon-Biomass RenewablesCommercial BiomassNuclearCoal w/ CCSCoal w/o CCSGas w/o CCSOl w/o CCS

2005 2010 2015 2020 2025 2030 2035 2040 2045 205020000

200

400

600

800

1000

EJ/Y

ear

Figure by MIT OCW.

Exajoules of Coal Use (EJ) and Global CO2 Emissions (Gt/yr) in 2000 and 2050 with and withoutCarbon Capture and Storage*

Coal Use: Global

Global CO2 Emissions

CO2 Emissions from Coal

U.S.

China

Business As Usual Limited Nuclear Expanded Nuclear

2000 2060

2060 2050

With CCS With CCSWithout CCS Without CCS

100

24

24

24

27

9 9

448

58

88

62

32

161

40

39

28

5

116

28

32

121

25

31

26

3

78

13

17

29

6

* Universal, simultaneous participation, High CO2 prices and EPPA-Ref gas prices.

Figure by MIT OCW.

Marginal Abatement Curve (MAC)

AbatementkjO

Marginal Cost

p

Total cost

How to Construct?

Aggregating Gases

O

pC

O

pOT

O

pCOM

CO2 Other GHG or sink

Total

kC kOT kCOM

Aggregating Sources

O

pA

O

pB

O

pMKT

Country A Country B Market

kA kB kMKTA B

MACs and Banking

O

2004

O

$10/ton

k04

$20/ton

k05 Cut

MAC MAC

2005

Cut

Discount rate = 5%/year

5%

Shortcomings of MACs

kjO Abatement

Marginal Cost

p

Trade effects

Distortions in markets

CGE (EPPA): What Tradeoffs?• Multiple objectives in design

– Analysis of policy cost, short and long term– Drive the climate portion of the IGSM

• Characteristics– CGE model (market interaction vs. specific

technologies)– Short-term detail vs. long-term structure– CO2 and non-CO2 GHGs gases all endogenous

• Two versions– Recursive-dynamic (the workhorse)– Forward-looking (some simplifications)

Factors Determining Results• Population growth• Labor productivity growth• Energy efficiency change (AEEI)• Substitution elasticities• Vintaging assumption• Costs of future technologies• Non-CO2 gas assumptions• Fossil energy resources

ToyToy

Examples of Cost Analyses• Short-term mitigation targets

– Trade effects– Intensity vs. absolute targets – Emissions trading– Inefficient policies– Multi-gas strategies vs. CO2 only

• Long-term atmos. goals• Studies of particular technologies

– Carbon capture and storage– Biomass, solar and wind, nuclear

Cap-&-trade bills (3-21)

Kyoto Protocol

CCSP study

Examples of Cost Analyses• Short-term mitigation targets

– Trade effects– Intensity vs. absolute targets – Emissions trading– Inefficient policies– Multi-gas strategies vs. CO2 only

• Long-term atmos. goals• Studies of particular technologies

– Carbon capture and storage– Biomass, solar and wind, nuclear

Cap-&-trade bills (3-21)

Kyoto Protocol

CCSP study

Effects Through TradeAnnex I Constrains CO2, OPEC view)

• Penalty on CO2 emissions in Annex I– Price of Annex I energy use rises– oil world oil demand: export volume– cost of manufacture of energy-intensive

goods in Annex I• Change in the “terms of trade”

– Oil prices fall– Price of energy-intensive imports rises

• Net of all welfare effect

& view from US?

Kyoto ExampleFigure 1. Reference and Kyoto Carbon

Emissions

0

1000

2000

3000

4000

5000

6000

7000

1995 2000 2005 2010 2015 2020 2025 2030

Time

MtC

Annex BNon-Annex BAnnex-B, Kyoto

Transfer of Costs to LDC’s

-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.50.00.51.0

KOR

IDN

CHN

IND

MEX

VEN

BRA

RME

RNF

SAF

Non-Annex B

EV%

Figure 3. Welfare Effects of Kyoto Protocol: EV% (NT-D, 2010)

-4.0-3.5-3.0-2.5-2.0-1.5-1.0-0.50.00.51.0

USA

JPN

EEC

OO

E

FSU

EET

Annex B

EV%

Cost of Long-Term Targets• Total reduction required

– Reference emissions growth– Carbon cycle (ocean/land uptake)

• The role of technological change– Ease of substitution– Autonomous change– Endogenous change (policy influenced)

• Sources of endogenous change– AEEI, σ = f(carbon price)– Explicit modeling of R&D, and its effects– Learning by doing: Cost = f(∑Q)

• Specification of a “backstop” technology

-Why different?TechnologySum of emissionsOcean uptake

(550 ppmv)

8%

0%

5%

4%

3%

2%

1%

6%

7%

2020 2040 2080 21002000 2060

IGSM_Level2

MERGE_Level2

MNCAM_Level2

Level 2 Scenarios

Perc

enta

ge L

oss i

n C

ross

Wor

ld P

rodu

ct

Figure by MIT OCW.

Relation of Carbon Price to Percentage Abatement

Price vs Percentage Abatement 2050

$0

$400

$800

$1,200

$1,600

$2,000

0% 20% 40% 60% 80% 100%Percentage Abatement

Pric

e ($

/tonn

e C

)

EPPA 2050

MINICAM 2050

MERGE 2050

Price vs Percentage Abatement 2100

$0

$400

$800

$1,200

$1,600

$2,000

0% 20% 40% 60% 80% 100%Percentage Abatement

Pric

e ($

/tonn

e C

)

EPPA 2100

MINICAM 2100

MERGE 2100

CCSP stabilization scenarios

2000 2020 2040 2060 2080 21000

5

10

15

20

25

IGSM Scenarios

IGSM_Level2IGSM_Level3IGSM_Level4

IGSM_Level1IGSM_REF

Gt C

/yr

2000 2020 2040 2060 2080 21000

5

10

15

20

25

MERGE Scenarios

MERGE_Level2MERGE_Level3MERGE_Level4

MERGE_Level1MERGE_REF

Gt C

/yr

2000 2020 2040 2060 2080 21000

5

10

15

20

25

MiniCAM Scenarios

MNCAM_Level2MNCAM_Level3MNCAM_Level4

MNCAM_Level1MNCAM_REF

Gt C

/yr

Figure by MIT OCW.

Figure by MIT OCW. Figure by MIT OCW.

Ocean uptake

2000 2020 2040 2060 2080 2100

0

IGSM Scenarios

-10

-12

-8

-4

-6

-2

IGSM_Level2IGSM_Level3IGSM_Level4

IGSM_Level1IGSM_REF

Gt C

/yr

2000 2020 2040 2060 2080 2100

0

MERGE Scenarios

-10

-12

-8

-4

-6

-2

MERGE_Level2MERGE_Level3MERGE_Level4

MERGE_Level1MERGE_REF

Gt C

/yr

2000 2020 2040 2060 2080 2100

0

MiniCAM Scenarios

-10

-12

-8

-4

-6

-2

MNCAM_Level2MNCAM_Level3MNCAM_Level4

MNCAM_Level1MNCAM_REFG

t C/y

r

Figure by MIT OCW.

Figure by MIT OCW. Figure by MIT OCW.

Technology Costing Approach(Cutting Grass Again)

Csis

Cpush

Cpower

Cride

# Hectares

GHGs

L, PL

E, PE

K, PK

Conventional Oil

Renewable Oil

With limited L, K—cost of cutting emissions

GHG

Cost

Reference Energy SystemEnergy process model (MARKAL)

ResourceExtraction

Refining andConversion Transport Conversion Transmission

and DistributionUtilizingDevice End Use

Renewables

Nuclear

Coal

Natural Gas

Crude OilDomestic

Electric

Heat

Solid

Gas

Liquid

Misc. ElectricAluminumIron and SteelAgriculture

Space and WaterHeat

Process HeatPetrochemicalsAutomobileBus, Truck, Rail

and Ship

Air Conditioning

Figure by MIT OCW.

Hybrid: EPPA & MARKALModalSplit

Models

MARKAL(Technology)

EPPA(Economy)

Tran

spor

t Dem

and

TechnologyDynamics

Technology Data Base

StructuralC

hange

Fuel Prices

Mode Shares

Transport Demand

Substitution Elasticities, AEEI

Alternative Auto TechnologiesInvestments, US$Vehicle Measures Vehicle

Fuel Use(MPG)

Cumulative Annualized + gas cost

0026.8Baseline95 Flt

-824432.6Material Substitution, Interior5LoCost-1221532.2CVT4-38-1329.0Lower Drag Coef., Tire Roll Resistance3-38-7027.9Engine Management2-32-8727.2Packaging Improvements1

13586536.8Elec. Pow. Steering, Parasitic Losses9PowTrn9169436.0VVLT and Cylinder Deactivation82440443.1Higher Compression Ratio71335033.6High-Strength Steel Unibody6

4602,10242.1Aluminum Intensive Vehicle10Alum

1,0634,34253.6ICE-Hybrid (≈Gas Fuel Cell)11Hybrid6242,71945.2VVLT & Cyl. Deactivate, No Brake Drive10

U.S. FTP-75 Driving Cycle. Capital recovery factor = 30%, gasoline price = $1.20 per gal., annual driving of 10,000 mi.

Auto Technology Penetration(“Kyoto” + 20% by 2030)

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

1995 2000 2005 2010 2015 2020 2025 2030

Bill

ion

Pas

seng

er-k

m

Total Fleet (Reference Case)

Total Fleet (Kyoto+ Case)

Demand Loss

95 Flt

LoCost

+PowTrn

+Alum

Hybrid

Preliminary: Do not cite.

Thinking about Technology• What is technology, and tech. change?• What leads to change?

– Does change tend to economize on one factor or another, in response to prices?

– What is the role of R&D expenditure?– To what degree is it ad hoc or random?

• How to distinguish tech change from– Change in inputs (in response to price)– Economies of scale

“New” Technologies• Carbon capture and storage

– From electric power plants– From the air

• Renewables– Wind & solar– Biomass– Tidal power– Geothermal

• Fission and fusion• Solar satellites• Demand-side technology

– Fuel cells and H2 fuel– Other? (lighting, buildings, ind. process, etc.)

What determines the likely contribution of each?

Explaining Why Technologies Are Not Used

• Market failures: decision-makers don’t see correct price signals– Lack of information– Principal-agent problems (e.g., landlord-

tenant)– Externalities & public goods

• Market barriers– Hidden costs (e.g., transactions costs)– Disadvantages perceived by users– “High” discount rates