1 E-Modeling By: Energy Group Advisors: Mark Gehlhar Thomas Hertel and Robert McDouglas

2 Introduction and Motivation - Modeling 3E’s –Trade Linkages is an important objective in applied economic policy analysis. - GTAP-E model (extended version of GTAP) is used to implement this approach. - The policy relevance of GTAP-E is illustrated by alternative Simulations of the implementation of the Kyoto Protocol.

3 Experiments Base Experiments - KP without emission trading and fixed trade balance - KP with Annex1 emission trading - KP with worldwide emission trading Extended Experiments - Exp1: USA excluded from KP - Exp2: Deviations from the Kyoto protocol - Exp3: Increase in Elasticity of Substitution Between Coal and non- Coal (ELCO) - Exp4: Different Elasticities of Substitution between Capital and Energy

4 Marginal Costs of Achieving the Kyoto Targets with and without Using the Flexibility Mechanisms Kyoto with No Use of the Marginal Costs Kyoto with Emission Trading Kyoto with Worldwide Marginal Costs % Reduction of Emissions (1997 USD per Ton of Carbon) % Reduction of Emissions (1997 USD per Ton of Carbon) % Reduction of Emissions (1997 USD per Ton of Carbon) USA EU EEFSU JPN RoA EEx CHIND RoW Annex Non- Annex 21-19

5 Results Scenario 1(Kyoto with No Use of the Marginal Costs) Emission reductions range from 20 to 40%. Carbon Leakage Emissions are reduced in Annex Countries but increases in other countries like EEFSU The marginal abatement costs range from 126USD in the US to 233USD in Japan. Note: Marginal cost in US are lower than in other Annex1 countries despite the higher reduction rate US uses relatively more coal and taxes energy less heavily. Scenario 2 (Kyoto with Emission Trading) A substantial reduction of the marginal abatement costs from around 150 USD in the no-trade case to 78 USD in this case. It implies that the burden of the reduction shifts away from oil products in the relatively carbon-efficient economies towards coal in the Former Soviet Union. EEFSU sells carbon permits to other annex countries, of which larger share is purchased by USA. Scenario 3 (Kyoto with Worldwide Marginal Costs) The world marginal abatement cost does not exceed 30 USD per ton of carbon. The Annex1 countries account for less than half of the world reductions. China-India gains a lot. It is the biggest seller of carbon permits, while US is the largest buyer. Because Implies

6 Macroeconomic Impact of Implementing the Kyoto Protocol: Percentage change in welfare and TOT Kyoto with no use of the Flexibility Mechanism Kyoto with ET among Annex1 Kyoto with Worldwide Emission Trading UtilityTOTUtilityTOTUtilityTOT USA EU EEFSU JPN RoA EEx CHIND RoW

7 Experiment 1:  Net energy exporters A1 economies experience higher cost the degradation of the terms of trade.  EEFSU loss is due to the fall of the energy exports value. Because of

8 Experiment No:2 A reduction in the losses in all A1 countries and a generation of substantial gains in the EEFSU region the emission trading among A1 countries. Because of

9 Experiment No 3: A reduction in the economic costs for A1 countries and energy exporters and a net gain in China and India and the EEFSU region the worldwide emission trading system. Because of

10 Extended Experiment No: 1 USA excluded from Kyoto Protocol Why do this? US decided to withdraw from Kyoto Protocol in March Excluding US from the Annex 1 countries is more realistic. The results of this simulation might have major policy implications. Modifications in KYONOTR (Kyoto without emissions trading and fixed trade balance): Closure:  !swap gco2t("USA")=RCTAX("USA"); (Growth of Emissions by USA is endogenous, taxes being exogenous) Shocks:  !Shock gco2t("USA") = -35.6; Other two experiments: Attempted, but without results! How did we do this?

11 Results: An Overview U EV tot USA EU EEFSU JPN RoA EEx CHIND RoW Overall losers: EU, JPN, RoA1, EEx, EEFSU Overall Gainers: USA, RoW. ToT: US, EU, JPN, and RoW gain, while EEFSU, RoA1, EEx and CHIND lose.

12 Welfare Decomposition Huge Allocative efficiency Losses in most regions ToT: US, EU, JPN, and RoW gain, while EEFSU, RoA1, EEx and CHIND lose.

13 Further Decomposition of Allocative Efficiency Inferences: Almost no change in agriculture and oil. Fall in most countries for coal, gas, oil products, electricity, energy-intensive Industries and others. Extensive fall in AE has outweighed uniform rise in ToT! US has not suffered from any AE loss, rather it has gained in oil products!

14 Decomposition of ToT Changes Inferences: All import prices have increased and all export prices have increased, except in EEx, EEFSU. RoA1, CHIND have higher rise in import prices than in export prices Why????

15 Further Decomposition of Price Changes Inferences: Remarkable increases in the prices of electricity, energy-intensive products, in major Annex-1 countries (except US, EEFSU) and fall in oil, oil products, gas. Most prices have fallen for the rest. Similar trends for both import and export prices. This explains the ToT changes.

16 Change in Emissions and Fuel Prices Inferences: Fall in Emissions, due to all fuels, is exogenous for non-US Annex-1 countries, while it has risen for USA, EEFSU, EEx & RoW. This is a result of huge rise of emission taxes in EU,JPN and R0A1(135,220 and 170, respectively!) Prices of all fuels, especially, coal and gas, have risen in all non-US Annex1 regions, while they have marginally fallen in others, explaining the trends in emissions.

17 Inferences from This Experiment US gains little (in terms of welfare) by not ratifying Kyoto Protocol, even when there is no flexibility! EU, Japan, the rest of Annex-I, Energy-exporting countries and EEFSU lose a lot in this case. This is due to loss in allocative efficiency in most countries for coal, gas, oil products, electricity, energy-intensive Industries and others. ToT: US, EU, JPN, and RoW gain, while EEFSU, RoA1, EEx and CHIND lose  AE loss in non-US regions outweighs ToT gain! ToT changes are well-explained by relative prices of imports and exports of various regions in different sectors. Prices of all fuels, especially, coal and gas, have risen in all non-US Annex1 regions, while they have marginally fallen in others, explaining the rise in emissions in non-Annex1 countries.

18 Extended Experiment No: 2 Deviations from the Kyoto protocol Committed towards Kyoto (K): The Annex 1 countries reduce carbon emissions by 5 percent upto 2012 relative to their 1990 level emissions under the “no trade” case. Deviation1 (K_1/2): The Annex 1 countries aim for only one half of the committed reductions under the “no trade” case. Deviation (K_1/5): The Annex 1 countries aim for only one fifth of the committed reductions under the “no trade” case. Variable name- gco2t: growth of emissions by region (region specific) Committed reduction in growth rates under different scenarios RegionKK_1/2K_1/5 USA European union Japan Other Annex1 countries

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20 Observations/ Interpretations The allocative efficiency effect drives the regional welfare as compared to the terms of trade effect in all Annex 1 countries under both the scenarios, except for EEFSU where the tot effect dominates. USA specific observations Allocative efficiency improves under scenario K_1/5 as compared to the fully committed scenario, though still negative. Input and consumption taxes are major contributors to the allocative inefficiency under both the scenario. Further, input taxes on firm consumption of domestically produced coal used by the electricity sectors and oil products, namely petroleum and coal products, are the main elements that witness the change under the two scenario. Lowering of carbon taxes in USA improves allocative efficiency, but not so in EU.

21 EXTENDED EXPERIMENT NO: 3 Increase in Elasticity of Substitution Between Coal and non- Coal (ELCO) VERSION: KYOTO WITH ANNEX 1 EMISSIONS TRADING Why do this? As coal is more carbon-emitting, we examine the case of higher substitution elasticity of coal by other non-coal energy inputs. How did we do this? We edit the parameter file of the base model of the experiment named – ‘KYOTO WITH ANNEX 1 EMISSIONS TRADING’. The initial ELCO between coal and non-coal was 0.5. We change it to 1.5 for all regions.

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26 Reduction in RCTax RCTAXSub=0.5Sub=1.5 USA EU EEFSU JPN RoA

27 Before Simulation qdemUSAEUEEFSUJPNRoA1EExCHINDRoW Coal Oil Gas Oil Products Electricity After Simulation qdemUSAEUEEFSUJPNRoA1EExCHINDRoW Coal Oil Gas Oil_Pcts Electricity

28 Observations of this Experiment Emission of CO2 has fallen to a significant extent. Derived demand for coal has fallen in all the regions. Price of Coal has come down in all the regions. We observe reduction in the percentage change of demand for coal and increase in the percentage change of demand for all other energy inputs (viz. oil, gas & electricity). Cost share of coal in total cost for all the industries has been reduced. The most interesting result in regarding imposition of carbon emissions tax (RCTAX). As coal is being substituted by non-coal inputs which are emitting less CO2, lesser intervention is now required in terms of RCTAX. We end up by analyzing the welfare effect of the changes we make.

29 Extended Experiment No:4 Sensitivity of Capital Energy Substitution Parameter (ELKE) In GTAP-E substitution parameter 0.5 Green argues that it can range between 0.0 for old capital and 0.8 for new capital Analyse the effect of changing this parameter between the two extremes Welfare effect ranges between -ELKE 0.0: US -$ ELKE 0.8: US -$97488 Variation is predominantly due to changes in allocative efficiency, as tot are relatively unaffected by changes in ELKE

30 Why does welfare fall as substitution parameter becomes more inelastic? Inability to switch away from energy towards capital results in a greater carbon tax required to reduce energy use to Kyoto levels. Less optimal uptake of energy as firms substitute more towards less carbon intensive fuels then when the substitution parameter is more elastic United States Welfare has significantly more variation then Europe Welfare Change $US millionELKE = 0.8ELKE = 0.1 USA Europe

31 Why does Europe’s Welfare fall as ELKE substitution parameter falls? This is due to an improvement in the allocative efficiency of refined oil use in “energy intensive sector” and “other industries and services sector.” Welfare change of Refined Oil Use in Other Industries and Services Sector welcntvoltaxratebtaxrateu EU elke EU elke Total Welfare Change USA elke USA elke Total Welfare Change

32 Conclusions World wide emission-trading system increases the welfare world wide (according to GTAP paper). Non-ratification of KP by USA has negative welfare consequences for the other regions, especially, non-US Annex-1 countries. When the countries deviate from their KP commitments, the allocative efficiency effect drives the regional welfare as compared to the terms of trade effect in all Annex 1 countries, except for EEFSU where the tot effect dominates. With a high elasticity of substitution between coal and non- coal, lesser intervention is required in terms of RCTAX. Welfare falls as substitution elasticity between capital and energy falls, as inability to switch away from energy towards capital results in a greater carbon tax required to reduce energy use to Kyoto levels. Less optimal uptake of energy as firms substitute more towards less carbon intensive fuels than when the K-E substitution parameter is more elastic