1/47 An E3 Econometric Analysis of CDM and Technology Transfer between Japan and China Mitsuo YAMADA ECS/IIASA, Schlossplatz 1, A-2361 Laxenburg, Austria (Chukyo Univ., Nagoya, Japan) International Energy Workshop 2005, Kyoto, Japan, July

2/47 Contents 1 Introduction 2 Methodology 3 Features of the model 4 Some simulation results 5 Concluding remarks

3/47 1 Introduction Background and motivation –China is trying to attain the conflicting objectives of economic development and global environmental improvement, although it is not obliged to reduce GHG emissions under the Kyoto Protocol. –Japan has already built an energy-efficient society and complying with the Kyoto Protocol only with domestic efforts seems difficult. So, the usage of flexible mechanisms is attractive to Japan. –We develop an economy-energy-environment (E3) econometric model of China and Japan, both linked through international trade. –Using this model we analyze the effect of technology transfer between China and Japan, considering the Clean Development Mechanism (CDM), and a carbon tax option.

4/47 Figure 1: GDP and its Growth in China and Japan

5/47 Figure 2: Primary Energy Supply and Energy Intensity of GDP in China and Japan

6/47 Figure 3: Total CO 2 Emissions and Carbon Intensity of PES in China and Japan

7/47 Kaya Identity: High growth requires faster improvement in energy efficiency. Figure 4: Simple Prediction

8/47 Issues for China What sector improved in energy efficiency? –Final consumption of energy for Industry, Transport, and Residential/Commercial Change in the industrial structure Diffusion of energy-efficient commodities –Electricity Generation Sector Fuel shift from coal to natural gas Fuel efficiency improvement How attained? –Clean Development Mechanism (CDM) –Government-based cooperative activities –Technology transfer through Foreign Direct Investment (FDI)

9/47 Figure 5: Emissions of Greenhouse Gases in Japan

10/47 Table 1: Emission Targets of Greenhouse Gases in Japan

11/47 Issues for Japan Further improvement of energy efficiency –12% reduction in GHG emission is needed to attain the Kyoto target in –6.5% will be attained by domestic efforts like energy efficiency improvement. –5.5% is considered to be achieved by forest sinks and Kyoto mechanisms –A carbon tax is considered as another option to decrease GHG emission.

12/47 2 Methodology Three types of models for the analysis of Economy-Energy- Environment issues; Optimal Programming Model, CGE Model, and Econometric Model. –Optimal programming model MESSAGE(2000, 2001), AIM(2004), MARIA(2004), GRAPE(2004), DNE21(2004) etc. ERI, China developed this type model for China collaborating with the National Institute for environmental Studies (NIES), Japan. This model is integrated as China part of AIM. –CGE model, MERGE(2004), GTAP(2002) etc. For China, Jian Xie and Sindey Salzman (2000), Zhong Xiang Zhang (1998) applies CGE model. – Econometric model Li ZhiDong (2003), Wu, Nemoto, and Kinoshita (2004), Yamada (2004), Ueda et al. (2004) etc.

13/47 Model/AuthorsMacroSectorEnergyEnvironmentRegion Li ZhiDong(2003) Energy-intensive products Energy Balance Table/IEA Co2/So2China Inada, Yoshihisa(2004) --Energy Balance table/IEA CO2/SO2China F.G. Adams, Yasukazu Ichino, and P.A. Prazmowski(200 0) --Energy Balance Table/IEA Thailand Ge Wu, Jiro Nemoto, and Soshichi Kinoshita(2004) GDP determined from the supply side 3 sectors Energy balance Table/China CO2China Mitsuo Yamada(2004) sectorsEnergy balance Table/China CO2China Mitsuo Yamada(2005) sectorsEnergy Balance Table/IEA CO2China and Japan with international trade Table 2: Recent Econometric Models of China (and Thailand)

14/47 ZhongXiang Zhang (2004) investigates the role of China under the Kyoto Protocol, using marginal abatement cost functions. –Broadening the scope of the market of tradable permits from no emissions trading to full global trading, it is found that the gain of the OECD as a whole increases as the market expands. –The developing countries also benefit from such an expansion (through financing and emission reduction). –Inclusion of China in the emission trading framework increases the total supply of emission permits, so decrease the price of the emission permits. –China is expected to emerge as the dominant host country of CDM projects. –According to his study, the US and Japan are required higher emission reductions than the EU, so the gains of the two countries depend on the expansion of the emission permits trading market. This study shows the importance of China in the global trading market of CO 2 emission permits. China is expected the dominant host country of the CDM projects, and Japan is also recognized as one of the important potential investing countries for the CDM projects. We will focus on the international cooperation between China and Japan through the CDM projects for the challenging reduction of GHG emissions, using an E3 econometric model.

15/47 3 Features of the Model Our model( KeYMERIT-E3 ) consists of –two sub-models, one for Japan and China each, and a sub-model of international trade. –Each country ’ s sub-model is developed as an E3 multi- sectoral model, which integrates a macro model and an input-output model into one model, including energy and environment parts. –There are 21 sectors in each country ’ s model »KeYMERIT-E3: Kinoshita-Yamada Multi-sectoral and Multi-regional Econometric Model for the Research on Industry and Trade – E3 version

16/47 Figure 6: The structure of the Model: KeYMERIT-E3

17/47 Figure 7: Economy (Macro & Sectors) Part

18/47 Input-output Structure

19/47 RAS Method in Input-Output Analysis These equations are estimated, however they are set as constant for the following simulations

20/47 Figure 8: The Energy & Environment Parts

21/47 Energy and Environment Parts Our main interest is in coal, oil, petroleum products, natural gas, and electricity, but nuclear, hydro, geothermal & solar & wind, combustible renewable and waste & others, and heat are also treated in the model. The final consumption of energy is explained from each sectoral production activity. The energy transformation mechanism is explained in the model. The carbon dioxide emitted from the industries and household is explained by energy use in each country

22/47 International Trade Sub-model There are 14 commodities and nine countries and regions; Japan, China, Korea, Hong Kong and Taiwan, ASEAN 5 countries, the US, EU 15 countries, the other developed countries, and the rest of the world. In this study, we focus on the relation between Japan and China Only key variables like GDP and GDP deflator and the exchange rate appear as exogenous variables for the other countries and regions. These countries and regions ’ sub-models are planned to be developed step by step in the next phase.

23/47 Table 3: Classification of Sectors

24/47 Table 4: Data Sources Table 5: Size of the Model

25/47 Baseline Simulation Table 6: Assumptions Table 7: Estimated values of representative endogenous variables

26/47 Figure 9: Industrial Structure of Japan

27/47 Figure 10: Industrial Structure of China

28/47 4 Some Simulation Results The introduction of energy-efficient technology is important to attain the goals of economic development and global environment improvement for China. Japan has incentives to cooperate because of her own interest in the compliance of the Kyoto Protocol. Simulations –Case-1: China introduces new technologies (NGCC and IGCC) in the electricity sector to improve energy efficiency. –Case-2: A carbon tax (2400Yen/tC – approximately 5Euro/tCO 2 ) is introduced in Japan and China.

29/47 An Outlook on the Electricity Demand in China According to the 10 th Five Year Plan ( ) in China, demand of electricity is estimated to expand from 1387 TWh (2000) to 4813 TWh (2030). The efficiency of coal-fired fuel plants is about 32%. For this increasing demand, more than 20 of 600 MW- class power stations must be constructed every year. The cost of a large station, which is constructed by five major companies with the foreign partner like Japan and others, is half or one-third lower than the cost in Japan. »From Agency of natural Resource and Energy, METI, Japan

30/47 Case-1a NGCC in China Efficiency improvement( ) in thermal power stations by energy shift from coal to natural gas in China –NGCC (Natural gas-fired Combined Cycle ) –600 MW x 20 units per year for 10 years –Construction Cost 500$/kW (in 2000 US dollars) –Thermal efficiency 53.6% –Operation starts five years after construction –The first construction starts in 2006 –After operation, old coal thermal stations are replaced at the same volume. –Main equipment, combustion turbine, (27.7% of total cost) is imported from developed countries. –Import share from Japan is 20% (the US 50%, EU15 30%).

31/47 Case-1b IGCC in China Efficiency improvement ( ) in thermal power stations by introducing new Clean Coal technology –IGCC (Integrated Coal Gasification Combined Cycle) –600 MW x 20 units per year for 10 years –Construction Cost 1,262$/kW (in 2000 US dollars) –Thermal efficiency 43.1% –Operation starts after 5 years construction –The first construction starts in 2006 –After operation, an old coal thermal station is replaced at the same volume. –Main equipment, gasifier and combustion turbine (42.4% of total Cost), is imported from the developed countries. –Import share from Japan is 20% (the US 50%, EU15 30%).

32/47 Figure 11: Increases in Investment and GDP Unit: 100 Mil. Yuan in 2000 market prices

33/47 Figure 12: Change in CO 2 Emissions Unit: Mt-CO2

34/47 Figure 13: Primary Energy Supply and Coal Production Unit: % Unit: ktoe

35/47 Table 8: GHG Reduction Cost of NGCC and IGCC for 10 Years

36/47 NGCC directly reduces CO 2 emission by 30% more than IGCC; 1560 Mt-CO2 and 1190 Mt-CO 2 for ten years respectively. Investment cost of NGCC is 40% of that of IGCC. GHG reduction cost of NGCC investment is 30% cost of IGCC, though we ignore the operational cost. If we consider social effect, the cost difference exaggerates up to 10% Investment increases GDP in both case. Investment brings CO 2 increase, which offsets partly the CO 2 reduction brought by introduction new technology. Coal production reduces in both cases, but high reduction appears in the NGCC case because of its energy shift to natural gas. Restructuring in the coal industry will be required especially in NGCC case.

37/47 Figure 14: Effects on Machinery Products and GDP in Japan Unit: %

38/47 The impact on Japan is higher for IGCC, because its higher investment induces larger volume of machinery trade directly. Effect on Japan is mainly positive on GDP and machinery production. The induced CO 2 increase in Japan is 0.4 Mt-CO 2 and 3.1 Mt-CO 2 for ten years respectively, which is almost negligible compared to the value in China.

39/47 Case-2: Carbon Tax A carbon tax is another option for the reduction of GHG emissions –Case2a: 2400 Yen per ton-C (22.27 US dollar per ton-C and Yen per ton-CO 2 ) tax is considered by the Ministry of Environment, Japan –Case2b: Same tax (50.28 Yuan per ton-CO 2 ) for China –Case2c: Lower tax for China (a quarter, considering the difference in economic scale between two countries) –The tax is introduced in 2007 for each case. –The tax is imposed on the final consumption of coal, petroleum, natural gas, and electricity. –No allowance or exemption is considered.

40/47 Figure 15: Impacts in Japan Price increases in energy sectors are 3 or 5 % points. GDP deflator increases up to 3 %. GDP deceases by 0.14% or 0.43%. The difference in primary- energy supply and CO 2 reduction will be 1% or less.

41/47 Figure 16: Impacts in China, “ Same Value ” case and “ Lower Tax ” case

42/47 Figure 17: CO 2 Reduction in Each Case For Japan, the proposed carbon tax reduces 11 and 16 Mt-CO 2 in 2010 and 2020 respectively. This value is higher than that of government ’ s estimate, using the AIM model; 6 Mt-CO 2 in For China, the same rate tax brings larger reduction in CO 2, 95 Mt-CO 2 and 58 Mt-CO 2, than Japan. Lower (one quarter) tax rate in China of reduces China ’ s emissions by 24 and 14 Mt-CO 2.

43/47 5 Concluding Remarks Developing an E3 econometric model, we evaluate the impacts of technological transfer from Japan to China, which might be possible future CDM projects. The basic idea of usual CDM is how much GHG will be reduced if the project is installed, comparing with the GHG emission level of typical alternative, called a baseline, if the project is not installed. Our evaluation is economy-wide, not just CDM project evaluation. Our study addresses the social evaluation in the sense that GHG emission from the initial investment activity is included and that the change in GHG emission stemmed from the other sectors ’ production and household consumption is also considered.

44/47 Two technology transfer, NGCC and IGCC, are compared. –NGCC reduces CO 2 emission more effectively than IGCC. –However, NGCC requires primary-energy demand shift from coal to natural gas. –Coal production reduces in both cases, but high reduction appears in the NGCC case. –Restructuring in the coal industry will be required strongly especially in NGCC case.

45/47 –Japan receives stronger impact from IGCC, because its higher investment induces larger volume of machinery trade directly. –The effect on Japan is positive mainly on GDP and machinery production. –The induced CO 2 increase in Japan is 0.4 Mt-CO 2 and 3.1 Mt-CO 2 for ten years respectively, which is almost negligible compared with the reduction in China. But they might be not negligible in the Japan ’ s economy. –Japan considers to reduce 20Mt-CO 2 by Kyoto Mechanisms. Compared with this value, our scenario gives 31.2 Mt-CO 2 reduction per year for NGCC and 23.8 Mt-CO 2 per year for IGCC, assuming that Japan ’ s contribution is 20 % in each project. –For this project Japan needs and billion yen per year respectively, which might be financed by carbon tax revenue.

46/47 Carbon tax effects –For Japan, the proposed carbon tax reduces 11 and 16 Mt-CO 2 in 2010 and 2020 respectively. –This is higher than the estimate of the Government, 6 Mt-CO 2, using the AIM model. –The difference is explained by our ignoring some tax exemptions. Actually our estimate of the tax revenue is 742 billion Yen, which is 1.5 times larger then the government estimate, 490 billion Yen. –The tax reduces GDP by 0.14% and 0.43% in 2010 and 2020 respectively. This would be reduced by using the tax revenue effectively. –For China, the same rate tax brings larger reduction in CO 2, 96 Mt- CO 2 and 58 Mt-CO 2, than Japan. –One quarter rate Tax of Japan reduces 24 and 14 Mt-CO 2 in China. –A given carbon tax in China saves GHG gas emission more effectively than the same tax in Japan.

47/47 Remaining issues –Our simulation ends at 2020, this is a somewhat short to evaluate the issues after Kyoto. We would like to extend the simulation period up to –The RAS structure is one of the main features in our model. This is constrained as constant in our simulation, which has to be released. –Adding the country and region sub-models, which are set as exogenous in the current model, for Korea, ASEAN, Hong Kong and Taipei, the US, EC15, other developed countries, and the rest of the world. –IIASA has a lot of knowledge and experience in the field of energy and environment researches, so we are going to extend our research cooperatively.