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1 FEEM newsletter REPORTS ON LATEST RESEARCH Report on the Side Events organised by FEEM within the Activities of the COP 9, Milan 2003, B. Buchner Insuring Against Disruptions of Energy Supplies, V. Costantini, F. Gracceva, G. Vicini Tourism and Sustainable Economic Development. Macro and Micro Economic Issues, V. Bosetti EEE - Ecological and Environmental Economics Programme: a Joint FEEM, ICTP and Beijer Initiative, F. Bosello, M. Lazzarin Auctions and Market Design: Devising Optimal Rules, G.L. Albano, B. Bortolotti How does E-business affect Sustainable Development? C. Maignan Organisation Design, Corporate Governance and Regulation, M. Manera The Economics of Biodiversity: Valuation, Method and Policy Applications, P. Nunes The Mulino Project Report n HIGHLIGHTS OF RESEARCH PROGRAMMES Climate Change Modelling and Policy International Energy Markets Corporate Social Responsibility and Sustainable Management Natural Resources Management Sustainability Indicators and Environmental Valuation Knowledge, Technology and Human Capital Privatisation, Regulation, Antitrust FEEM newsletter RESEARCH TALKS TO POLICY Increasing Participation and Compliance in International Climate Change Agreements Biodiversity and Globalization On Biology and Technology: the Economics of Managing Biotechnologies...83 Special Interests and Technological Change The Political Economy of Privatization CONFERENCES PUBLICATIONS Equilibri Books MULTIMEDIA LIBRARIES ANNOUNCEMENTS RAPPORTI SULLO SVILUPPO SOSTENIBILE FEEM IN SSRN WORKING PAPER SUMMARIES

2 GOALS Fondazione Eni Enrico Mattei was founded by Eni and its major companies and recognised by the President of the Italian Republic in It is a non-profit, non-partisan research institute specialising in energy, environmental and development issues, on an international scale. The goal of the Fondazione is to promote interaction between researchers, industry and policy makers and, through research, to improve the rigour, credibility and quality of recommendations for public and private decision making regarding energy and environmental issues. RESEARCH PROGRAMMES The Fondazione s research agenda is approved by the Board of Directors, with the guidance of the Scientific Advisory Board. In the execution of its various programmes, the Fondazione operates with its own staff as well as involving a world-wide network of outside researchers. The main research areas are: - Climate Change Modelling and Policy - Global Governance - Sustainability Indicators and Environmental Valuation - Natural Resources Management - Knowledge, Technology and Human Capital - International Energy Markets - Corporate Social Responsibility and Management - Privatisation, Regulation and Antitrust ORGANISATION BOARD OF DIRECTORS: Guglielmo Moscato (President), Gilberto Callera, Stefano Cao, Carmine Cuomo, Carlo Grande, Vittorio Mincato, Luigi Patron, Roberto Poli, Salvatore Russo, Luciano Sgubini, Franco Tali SCIENTIFIC ADVISORY BOARD: Domenico Siniscalco (President), Carlo Carraro, Partha Dasgupta, Adriano De Maio, Enrico Giovannini, David Landes, Massimo Livi Bacci, Daniel Yergin AUDIT COMMITTEE: Giovanni Zanetti (President), Adriano Propersi, Luigi Puddu EXECUTIVE DIRECTOR: Alessandro Lanza RESEARCH DIRECTOR: Carlo Carraro SUPPORT ACTIVITIES CO-ORDINATOR: Andrea Marsanich ADMINISTRATION CO-ORDINATOR: Luigi Serina INTERNATIONAL PROJECTS AND RELATIONS CO-ORDINATOR: Dino Pinelli COVER S PHOTO by Rocco Fatibene The views expressed in the articles are those of the authors and not necessarily those of the editors or publisher.

3 Report on the Side Events organised by FEEM within the Activities of the COP 9, Milan 2003 Barbara Buchner* *FEEM The Ninth Conference of the Parties bridging the differences between several unresolved economic and (COP 9) to the United Nations science and policy and at policy issues characterise the Framework Convention on Climate introducing current research to a climate change problem. The Change (UNFCCC) was held in broad level of audience. difficulties in implementing an Milan, Italy, from 1-12 December effective climate policy - and the Over 5000 participants attended the session. The negotiations were aimed at strengthening and building on the original UNFCCC treaty and at completing some technical issues related to the UNFCCC and the Kyoto Protocol. However, only modest results were expected given the inertia of the political situation. Indeed, although the international infrastructure for the Kyoto Side event on Climate Change Beyond the Kyoto Protocol The first side event in which FEEM was involved was co-organised with the Italian Ministry for the Environment and Territory and the Istituto Nazionale di Geofisica e Vulcanologia (INGV) and tackled questions going beyond the Kyoto resistance towards a mild approach to climate change like the one contained in the Kyoto Protocol - are a clear demonstration of how complexities and uncertainties may delay the adoption of mitigation and adaptation strategies. Climate change thus clearly is a serious challenge to mankind. A further reason to look beyond the narrow perspective of the Kyoto Protocol stems from the current reports on latest research Protocol s entry into force is to a Protocol. political situation. In particular, the large degree in place, the In particular, this side event was probability that the Kyoto Protocol implementation of the protocol has motivated by the insight that may not be implemented in the near been delayed while awaiting that climate change is a large-scale future has recently increased Russia ratifies the agreement 1. As a problem which cannot be resolved because of Russia s delaying strategy. consequence, also the formal by concentrating only on a short- This raises concerns about the negotiations on major next steps in term approach. Indeed, there is feasibility of the first commitment the international climate effort and growing consensus among period targets. Some researchers on broader post-2012 perspectives scientists that human activities start suggesting that more attention are behind time. directly or indirectly increased GHG should be devoted to the second Given this situation, a major focus concentrations and that the commitment period targets and at COP 9 was devoted to a large ongoing anthropogenic climate more generally to a new policy number of high quality side events change may trigger a new period of architecture that could find a which were meant to stimulate the climatic instability with relevant solution to the problems that the discussion both on topics which negative impacts on economic Kyoto Protocol has not been able to were already on the agenda and activities and ecosystems. The solve. also on issues which have proved interplay of the global and Given these considerations, this side too hot for official talks. potentially very serious implications event was devoted to analyse climate Following up on intense research in of climate change and the policy beyond Kyoto, namely beyond the field of climate change policy uncertainties still prevailing with the first commitment period but and modelling, FEEM took the respect to its emergence and its also, more drastically, beyond the opportunity provided by COP 9 and consequences make climate Kyoto policy architecture. In organised in cooperation with change a complex problem to deal particular, some famous scientists several other organisations seven with. In addition to scientific not necessarily involved in the side events which were aimed at uncertainties and complexities, climate policy debate gave their 3

4 views on climate policy. Avoiding further discussions on the details of the Kyoto Protocol, these scientists rather provided fresh outside perspectives on climate change control and on what needs to be done and can be done to tackle this problem. Side event on Energy Efficiency against Climate change. Upsides and Potential for Citizens, Industry and Public Administration. The Role of NGOs and of the Bank of Climate In order to provide a first possible solution to cope with the problem of climate change, FEEM organised together with the World Wildlife Fund (WWF) and Vita Magazine (VITA) a side event on the potential role and benefits of energy efficiency. This session emphasised the importance of energy efficiency policies, pointing out that they represent a cheap and safe (if applied throughout the system) way of preventing black-outs, promoting technological innovation and foremost to achieve the goals set by the Kyoto Protocol. FEEM, Vita Magazine (VITA) and WWF opened a discussion on energy efficiency policies with representatives of the public, industry and business spheres, setting up three appropriate structures inside the conference space to collect information on expectations and to broaden the knowledge on the so-called best practices. Side event on Policies to Advance Climate Mitigation Technologies The third side event co-organised by Resources for the Future (RFF) and FEEM aimed at specifying one further way of going beyond the Kyoto Protocol, as has been suggested at the first side event. In particular, it has been acknowledged that large-scale technological changes in the energyeconomic system will be necessary to substantially lower greenhouse gas emissions. In this side event, a panel of experts therefore shared perspectives on the potential for different technology and policy options to mitigate greenhouse gas emissions, discussing the role of domestic and international research, development, and deployment policies supporting renewables, energy efficiency, carbon sequestration, and related climate change mitigation technologies. Panelists explored how technology considerations including research, development, and deployment for renewable energy sources, greater energy efficiency, carbon sequestration, and advanced vehicles should be incorporated into the design of climate policy. Considering that governments spend billions of dollars each year on climate-related technology development, panelists discussed the best courses of action to ensure that the money is well spent. In addition, the panelists exchanged views on how domestic and international policies directly promoting climate-friendly technologies could be used in conjunction with emission policies to respond to the threat of global climate change. In this context, consideration was given to: (i) the motivation for considering technology when designing climate policy; (ii) the technological opportunities; (iii) the policy options; (iv) past experiences; and (v) best courses of action for designing climate policy that harnesses technology. Side event on The Future of the Kyoto Protocol: Alternatives for the Second Commitment Period and Beyond Concentrating upon alternatives for the second commitment period of the Kyoto Protocol, this side event organised jointly by FEEM and RFF addressed an additional key issue outlined during the first side event. Indeed, after the recent announcements at the Moscow conference on Climate Change, there is general consensus that the Kyoto Protocol is unlikely to come into force in the near future. If and when it does, it will do so without the United States and without commitments from key developing countries. As a consequence, a new, more effective policy strategy is required to involve these key countries in the international effort to control climate change. This side-event was therefore intended to draw from the experience of negotiators, stakeholders, and academics to provide insights aimed at increasing the efficiency of future negotiations on climate change control. The starting point for the discussion was threefold: (i) a recognition that 4

5 the current architecture of binding In order to recognise new, taken place during the last decades. absolute targets has proven difficult additional policy measures, the Indeed, a number of initiatives has for key countries to accept, (ii) the identification of the positive been started in various countries, understanding that the negotiating elements of the available policy most notably in different European process itself often has been bundle can be helpful. For this countries and the US, but also in frustratingly slow, and (iii) the reason, the fifth side event deeper some major developing nations. realisation that the second analysed a part of the available Representatives of different countries commitment period represents an policy instruments. shortly introduced the main opportunity to re-think the components of the domestic actions framework for international commitments. These considerations begged a range of questions related to the way commitments are defined, compliance is measured, and negotiations are conducted. Accordingly, both the nature of future commitments, longer-term goals as well as LDCs participation were discussed at this side event. In addition, it has been emphasised Side event Roundtable on Domestic Actions in Major Countries The Kyoto Protocol establishes a series of international flexibility measures ET, JI, CDM which enable countries to meet their targets in a flexible, cost-effective way by cooperating on emission in their own country and then discussed the first experiences obtained with respect to the environmental and economic implications of the single components. In particular, the strengths and weaknesses of these activities have been discussed, endeavoring to draw lessons for future international climate policy. The panel discussion emphasised that international climate policies reports on latest research that a promising emission reducing reductions across country borders. represent only one part of the strategy crucially depends on the However, these mechanisms are available policy bundle to control instruments which are available to only meant to assist countries in climate change, and concentrated on implement reduction requirements. meeting their emission targets as the so-called winning elements of Given the current difficulties of the protocol specifies that they current domestic actions which could climate policy, other measures "shall be supplemental to domestic be helpful in making future climate additional to the ones included by actions". Given that the rules of the policy more successful. the Kyoto Protocol needed to be flexibility mechanisms have been identified. For example, incentives negotiated, the main question is to to technological innovation, the design of trade and agricultural policy, the role of the market and of multinationals, and the link between climate and development _ these all deserve further attention which domestic activities these flexibility mechanisms will be additional to. In order to shed light on this aspect of climate policy, FEEM organised in cooperation with RFF a side event focused on Side event on EU-US Cooperation on the Economics of Climate Policy. Preliminary Convergence and the discussion indicated that national climate efforts. Climate The sixth side event organised by they could be highly beneficial for policy experts from all over the FEEM in cooperation with RFF, the the design of climate policy. The world were asked to give an MIT Global Change Forum and the latter focus was shown to be overview of the major domestic Centre for European Economic particularly relevant given the actions currently implemented and Research (ZEW) addressed a further growing importance of developing forthcoming in the industrialised key issue in climate policy, the countries, whose participation in and developing world. relation and potential convergence climate agreements hinges on The side event confirmed a strong of EU and US climate efforts. climate-friendly strategies for increase in national programs aimed As has clearly been shown in the economic development. at GHG emission reduction which has previous side event on domestic 5

6 actions, the current approaches to climate-change control taken in the U.S. and in the EU differ considerably. This difference is most obviously demonstrated by the US withdrawal from the Kyoto Protocol and the Climate Change Initiative introduced in the U.S. Nonetheless, all the previous side events coincided in providing general consensus that any attempt to effectively cope with the risk of climate change needs to be truly global in the longer term. In particular, the large GHG emitters, above all the U.S., are to be involved in international cooperative effort to control GHG emissions. The main question is therefore whether the gap between the EU and the U.S., which currently continues to widen with respect to climate policy, can be bridged in the near future to guarantee an efficient next round of climate talks. In order to verify whether a EU-U.S. collaboration is realistic in the near term, leading experts from four international research centres discussed the role of these two major players in the future negotiations on climate-change control, highlighting possibilities and probabilities for potential future collaborations. In particular, the panelists tried to make a link between the research and policy aspects related to climate change control. They therefore first presented the major research focus of each centre and explained in which way relevant policy issues are addressed. Then, the current status of climate policy approaches inside the U.S. and the EU was discussed, taking also into account local and corporate initiatives in these countries. A further issue addressed by the panel concerned emissions trading and in particular the question whether a US permit market could be linked to the EU emission trading scheme. Given the state-of-art of climate control measures, panelists finally discussed the likelihood of a convergence on climate policy between the EU and the U.S., focusing in particular on the when and the how of such a collaboration as well as on the policy architectures which could support it. This side event was also the occasion to present a new EU_US initiative: the Climate Policy Network. This network, formed by MIT, RFF, FEEM and ZEW, aims at fostering cooperation on economic research designed to support climate policy. Final discussion on After COP 9. What Are the Next Steps? The final side event jointly organised by FEEM and RFF was aimed at drawing the first conclusions on the success of the climate talks in Milan and at highlighting the key priorities needed to develop a Post-2012 policy architecture. Leading science and policy experts were invited to discuss possible implications of COP 9 and open issues in order to identify the next steps on the climate policy agenda. On the one hand, short-term issues regarding the first commitment period were analysed, while the experts gave on the other hand their views on climate policy in the medium and longer run, identifying the priorities for a successful long-term approach. Addressing a number of key issues that have been discussed at the various side events in which FEEM was involved, particular attention was given to the attitude of three major players during the negotiations: Russia, the U.S. and the developing countries. Given Russia s importance for the implementation of the Kyoto Protocol, its position and the indications of its delegates at COP 9 have triggered new expectations with regard to the road map for the ratification of the Kyoto Protocol. On the other hand, the standpoints of the U.S. and the developing countries have been thoroughly analysed given their crucial role in preparing an effective long-term approach towards climate change control beyond the first commitment period. In this context, panelists discussed the deadlock in activating a constructive dialogue between developed and developing countries, which is in general considered as one of the key items on the future climate policy agenda. This final side event, benefiting clearly from its informal nature, was characterised by a wide spectrum of views and provided a forum for fruitful discussions on the issues at the forefront of everyone s mind. After COP 9, there was general consensus that the side events convened provided truly valuable 6

7 outcomes. Indeed, the COP 9 was characterised as a new type of meeting in the climate negotiation process. On one hand, the official negotiations aimed at strengthening the UNFCCC treaty and the Kyoto Protocol produced modest progress on some technical issues. However, the negotiations basically remained deadlocked when broader aspects related to next major steps in international climate policy were addressed. On the other hand, though, there was a so-called second face of COP 9, reflected by over 100 side events organised by numerous observer constituencies, as e.g. developed and developing country delegations, intergovernmental and nongovernmental organisations, research institutions and the private sector. As demonstrated by the selection of FEEM events described above, the side events addressed both pertinent issues related to the official negotiations, and explored a number of highly important aspects which did not yet receive a lot attention in the negotiations given that they have proved simply too hot to be handled by the COP. In short, the side events tackled issues related to meeting the UNFCCC s ultimate objective and demonstrated that efforts to address the adverse effects of climate change are already underway. While resolving differences in the official negotiations remains complex, the significant number of side events at COP 9 signals a change towards a more positive outlook for future COP sessions. In that sense, FEEM has contributed to demonstrate that economic research can provide important inputs for the design of effective climate change control and is gaining momentum in the policy process. Note 1 A condition for the Kyoto Protocol to come into force is that at least 55 Parties to the Convention, representing at the same time at least 55% of 1990 carbon dioxide emissions of Annex B Parties, must have ratified the treaty. Given the US withdrawal from the treaty, the Kyoto Protocol can only become operational if Russia ratifies. reports on latest research 7

8 Insuring Against Disruptions of Energy Supplies Valeria Costantini, Francesco Gracceva, Giorgio Vicini* *FEEM Social Costs of Energy Supply Disruptions There is general agreement within the international literature about the nature of the costs of supply disruptions, affirming that they go well beyond the economic measure of national accounts. Energy use pervades daily life in such a constant and ubiquitous way that it is very difficult to identify all the real negative effects in the short and long run (IEA, 2001; Toman, 2002). Generally speaking, the social costs of supply disruptions can be classified into the category of economic externalities. Security social costs are those that accrue to others in the economy, generating a need for governments to step in and take protective measures (IEA, 2001). To identify the main components of social external cost it is necessary to clearly separate internal (or private) costs from external (social) costs. According to different kind of risks, such as an oil physical shortage or a prolonged interruption in electric power (quantity risk), or a sudden rise in oil price (price risk), social costs of energy disruption can be classified into different categories. Usually oil disruptions (especially quantity shortages) have both direct and indirect effects, with a short and medium run horizon. Regarding power generating shortages, the economic effects for society are both direct and indirect, but the temporal lag is shorter than for oil disruptions. Following these characteristic, it is possible to analyse separately the economic impacts of oil crises and power generation or distribution interruptions. In any case, a perfect distinction between internal and external costs (i.e., private and social costs) is a very difficult task. Social Costs of Oil Disruptions Considering specific oil disruptions, energy security is defined in terms of the physical availability of supplies to satisfy demand at a given price. Oil shocks can be split into several categories, notably price, quantity and technology (Helm, 2002). Price shocks are the most common; quantity shocks relate to physical constraints; technology shocks relate to new concepts and ideas, to failures (i.e., the discovery of nuclear design faults), or to new constraints (i.e., an unanticipated technical advantage of nuclear over oil with the discovery of the climate change problem). The security problem therefore has also a long-term and short-term component: the effects on the economy of long-term rising prices for oil imports are different from those of sudden price hikes or price volatility. Looking at the past, after the main oil crises OECD countries and the world were stricken by high inflation, trade and payments imbalances, high unemployment and weak business and consumer confidence. Generally speaking, an increase in oil prices leads to a transfer of income from the importing to the exporting country through a shift in the terms of trade. For net oil-importing countries, an increase in oil prices directly reduces real national income because spending on oil rises and there is less national income available to spend on other goods. For net oil-exporting countries, a price increase directly increases real national income through higher export earnings. The boost to economic growth in oil-exporting countries provided by higher oil prices is generally less than the loss of economic growth in importing countries, that the net effect on the global economy is negative. Oil supply disruptions have occurred rather frequently: over the past half century there have been at least 14 significant disruptions involving a loss of 0.5 mb/d or more of crude oil. Most of these disruptions were related to political or military upheavals, especially in the Middle East. Since 1973, four major crisis the 1973 Arab-Israeli War, the 1978/9 Iranian Revolution, the 1980 Iran-Iraq War and the Gulf War resulted in initial shortfalls of between 4.0 and 5.6 mb/d. Virtually all past oil disruptions have been short, typically lasting maximum nine months. 8

9 Following the main literature on noticeable output growth, while an However, it is important to observe this subject (Clô, 2000; IEA 2001; increase can have a negative impact that the duration of macro Pedde, 2000), the politically-based on output growth. Furthermore, economic impacts of oil shocks is disruptions can be grouped into disruptions in oil market not only generally limited to two years after two categories: give rise to higher prices, but also the price change. Thus, it is Random shocks, caused by increase oil price volatility (Ferderer, important to distinguish between a internal unrest in OPEC countries, 1996). And Chaudhuri (2001) sharp and high increase and a such as the Iranian revolution in recently found that non-stationary steady rise in the price of oil. 1978/79, the Nigerian civil war of commodity prices could be Generally speaking, an increase in 1967/70 or the Iran/Iraq War and the 1990 Iraq invasion of Kuwait. Strategic shocks involving willful exercise of market power by Middle Eastern oil producers such as the Arab oil embargoes of 1957, 1967 and (Table 1) To evaluate at which point an oil shortage becomes a crisis is not an easy task. Trying to identify a reference value for oil price variation and oil consumption reduction from attributed to the non-stationarity in oil prices. In other words, real oil prices and real commodity prices are co-integrated, so that oil shocks have a negative impact on economic performance. Other studies, focusedon the role of fiscal and monetary policy, suggested that recessions in the oil importing countries were less the direct result of higher prices and more the consequence of the the world oil price leads to an increase in the OECD import prices, with three major effects: direct effect because more spending will be allocated to energy costs; financial effect because of the rise of inflation and interest rates; trade effect because of the oil import bill increase which worsens the trade balance. Apart from losses in GDP and reports on latest research past shocks (figure 1 and table 1), a economic policies adopted to balance of payments, other indirect possible minimum value for price alleviate the price shock (IEA, effects at macroeconomic level and consumption variation could be 2001). In any case, looking at real could be a fall in tax revenues and, 100% and 4 million barrels per day 1 data, oil shocks have produced due to rigidities in government respectively. Considering these limit significant economic impacts in oil- expenditure, an increase in the values to identify relevant past crises, importing countries. budget deficit, driving interest rates various studies have attempted to The magnitude of economic costs up. Furthermore, because of establish whether or not there are of an oil price increase depends on resistance to real declines in wages, linkages between oil shocks (higher many factors: an oil price increase typically leads oil prices) and reduced economic the main two determinants are to upward pressure on nominal growth rates. At first, it was widely obviously the level and the duration wage levels. Wage pressures believed that the recession of the price increase; together with reduced demand and the emergence of stagflation the response of the oil markets tend to lead to higher - a combination of inflation and to an oil price hike also contributes unemployment. These effects are rising unemployment - in the in determining the level of the greater the more sudden the price industrialised countries was caused economic costs (Birol, 1998); increase and the more market primarily by the oil price increase of other critical factors regard the labour is inflexible, and are But there is no general characteristics of the economy that magnified by the impact of higher agreement on negative impacts of is hit by the shock: firstly the weight oil prices on consumer and business an oil crisis on the whole economy. of energy costs on GDP, which is confidence. Along this line, on one side there are directly linked to the share of The increase in inflation rate and studies such as Huntington s (1998), energy intensive sectors in the unemployment may represent the which demonstrates an asymmetric industry; secondly, the flexibility of main causes of social costs, while relationship, where a reduction the the energy sector, i.e. its capacity to other factors such as lost of GDP oil prices does not necessarily lead to shift from one source to another. and balance of payments are more 9

10 TABLE 1 - WORLD OIL SUPPLY DISRUPTIONS Dates Supply Disruption Magnitude World Oil Oil Price of Supply Consumption change Shortfall (mb/d) (mb/d) (%) Mar Oct Iranian Fields nationalised a (cum) Nov Mar.1957 Suez War a Dec.1966-Mar.1967 Syrian Transit Fee dispute n.a. Jun.1967-Aug.1967 Six Day War n.a. Jul.1967-Oct.1968 Nigerian Civil War n.a. May1970-Jan.1971 Lybian Price Controversy a Apr.1971-Aug.1971 Algerian-French Nationalisation Struggle n.a. Mar.1973-May1973 Lebanese Political Conflict a Oct.1973-Mar.1974 October Arab-Israeli War a May 1977 Damage of Saudi oilfield n.a. Nov.1978-Apr.1979 Iranian revolution a Oct.1980-Jan.1981 Outbreak of Iran-Iraq War a Mar.1989-Apr.1989 Exxon Valdez Accident < b Apr.1989-Jun.1989 UK Cormorant Platform n.a. Aug.1990-Jan.1991 Iraqi Invasion of Kuwait b Jun Jul 2001 Iraqi Oil Export Suspension n.a. Dec 2002 Venezuelan Strike b a Oil price increase on annual basis b Oil price increase on monthly basis Source: our. Elab. on IEA, 2001; BP, 2003; EconStat, 2003 FIGURE 1 - MAGNITUDE OF SUPPLY SHORTFALL (MB/D), Dec 2002 Jun- Jul 2001 Aug Jan 1991 Oct Jan 1981 Nov Apr 1979 Oct Mar 1974 May Jan 1971 Jun Aug 1967 Nov Mar 1957 Source: Harks, 2003 Venezuelan Strike Iraqi Oil Export Suspension (rejection of UNSC R1352) Gulf Crisis Iran-Iraq War Iranian Revolution Arab-Israeli War Lybian Price Controversy Six-Day War Suez Crisis

11 difficult to perfectly spread into their private and social components. As stressed in many recent contributions, the impact of oil price shocks on the macroeconomy is enhanced by the economic and energy-policy response to a combination of higher inflation, higher unemployment, lower exchange rates and lower real output. Although government policy cannot eliminate the adverse impacts described above, it affects the overall impact on the economy over the longer term and it should aim at minimising then. Highly contractionary monetary and fiscal policies to contain inflationary pressures could instead exacerbate the recessionary income and unemployment effects (Birol, 1998). As underlined in Clô (2000), other country specific factors can deeply influence the economic effects of an oil price increase: economic policies applied before the crisis; specific institutional mechanisms, particularly for the industrial relationships and the labour market (wage and salaries formation); real increase of energy prices in each country, in relation to fuel mix, specific fuel consumption and level of petroleum products taxation; response capacity of the energy system, in terms of industrial and institutional flexibility; macroeconomic trends acting before and during the oil shock. Some quantitative estimates While the general mechanism by which oil prices affect economic performance is generally well A COMPARISON BETWEEN TWO OIL SHOCKS In particular after the 1973 and oil price crises there were various negative effects in terms of GDP and balance of different magnitude of price variation. In the first one imported oil prices increased by 250% while in the payments losses each period from the end of 1978 to representing a substantial terms of trade deterioration for the OECD as a whole equivalent to around 2 per cent of GDP. Due to the rather low price elasticity of oil in the short term the increase in the net oil import bill has in both cases been very large even though total oil demand has the end of 1980 imported oil prices increased by about 120% (see table 1). Even with regard to the inflation rate, although the two oil price shocks were similar, inflation was lower in the second oil shock. Inflation reacted more strongly in 1973 when the spread of private declined due to lower GDP consumption deflator growth growth resulting from the oil price rises. However it has to be considered that there are some differences rates more than doubled between the second half of 1973 and the first half of 1974 than in the early 1980s because of the change of between the 1973 and the monetary policy in many 1980 oil price shock due to the countries. ENERGY SECURITY AND SUPPLY DISRUPTION To assess the social costs caused Therefore, a supply disruption by a supply disruption, it is first occurs when the physical necessary to have a precise definition of what a supply disruption is. It seems useful to start from the definition of energy security: energy security is defined in terms of the physical availability availability of the resource falls under some defined threshold (for a sufficient length of time) and/or its price overcomes some other threshold, with the obvious consequence that the definition of supplies to satisfy demand at a of disruption becomes quite given price. So, the security problem involves a quantity risk and a price risk. And it has a longterm and a short-term component (a long term trend of rising prices arbitrary, as it depends on the assumed thresholds. Besides, it is also important to understand that the social cost of a primary energy supply crisis tends to be heavily for energy imports has a different influenced by the specific implication for an economy than a historical setting and the sudden price hike or price geopolitical situation in which it volatility). occurs (IEA, 2001, p. 76). reports on latest research 11

12 understood, the precise dynamics and magnitude of these effects - especially the adjustments to the shift in the terms of trade - are uncertain. Quantitative estimates of the overall macroeconomic damage caused by past oil-price shocks and the gains from the 1986 price collapse to the economies of oilimporting countries vary substantially. This is partly due to differences in the models used to examine the issue. Nonetheless, the effects were certainly significant: economic growth fell sharply in most oilimporting countries in the two years following the price hikes of 1973/1974 and 1979/1980. The impact of the first oil shock was undoubtedly accentuated by inappropriate policy responses. Conversely, economic growth in importing countries was boosted by the fall in prices in 1986, with the full economic impact becoming apparent in 1987/1988. Looking at GDP growth rate compared with the real oil price trend (net of GDP deflator rate) in the European Union, a general correlation between higher oil price and lower GDP growth rate with one or two years lag is quite clear (figure 2). A general assessment of magnitude in GDP loss could be built on variation of GDP growth rate after the three main oil crises, with a minimum value of 0.25% in 1993 (two years lag after last main oil price shock). Considering these results, even if recession after the first crisis could be exacerbated by fiscal and monetary policies by oil importing countries, a negative influence on GDP is in any case evaluable. Further evaluation of negative effects on the economic performance, with more direct impacts in terms of social costs could be based on trend of inflation rate and unemployment (figure 3). These two factors affect directly governments and citizens through higher public expenditures for welfare measures such as increasing subsidies for unemployment and reduced market power for consumers. Besides, due to inelasticity of oil demand, especially in the transport sector, lower income households would pay a big bill for oil price shocks. Looking at real data, different effects in terms of inflation and unemployment emerge. Inflation rate has a sudden response to an oil price increase due to direct market transmission mechanisms. On the contrary, an increase in the unemployment rate constitutes the result of an indirect mechanism, due to the rigidity of the EU s nominal wages on the labour market, with possible lags (one or two years) after the oil shock: wage pressure and a diminishing GDP growth rate tend to lead to higher unemployment only in successive periods. In any case, such negative impacts in terms of increasing unemployment should take into account typical medium-term economic cycle and other structural factors. Looking at the figure 3, it can be noticed that negative effects after 1991 appear higher than after 1981, while both inflation rate and oil price have increased much less. In order to represent different effects of past oil shocks and to develop an analytical tool to evaluate supply disruption scenarios, it is useful to analyse the elasticity of GDP with respect to the price of crude oil, occurred to OECD during past oil crisis, with a focus on the European Union (Birol, 1998). The price elasticities described in table 3 underline the asymmetry between the growth due to price decline and the demand reactions experienced over the past price increases. More precisely, part (a) compares the percentage of oil consumption variation while (b) and (c) relate this change to variations in economic activity and real crude oil prices. Finally, the implicit price elasticities for the assumption of unitary income elasticities have been derived in part (d). Estimation of the economic impact of a crisis requires extensive analysis of macroeconomic reactions to increase in petroleum prices. The amount of oil reserves available at country level and import dependence should be included among the most influent factors. Higher oil reserves and lower import dependence could produce a significant reduction in elasticity of GDP with respect to oil price. (Razavi, 1997). Another issue to be addressed is the asymmetric behaviour and different magnitude in GDP elasticity that occur considering a negative or a positive variation of oil price. Looking at table 3, wich compares price elasticities obtained from the two crisis and from the period , it is clear that the effects are opposite. During price elasticities are either positive or very low and in any case not comparable with the values relative to the two high price cases. Therefore, the dynamic 12

13 FIGURE 2 - OIL PRICE AND GDP GROWTH RATE IN EUROPEAN UNION, GDP Growth Rate Real Oil Price Unemployment/Inflation Rate (%) explain the reduced negative effects in terms of GDP losses, due to a higher reduction in oil consumption and consequently reduced negative effects on the economic system. The third crisis during the period has been characterised by a reduced increase in oil prices due to utilisation of oil stocks within OECD FIGURE 3 - INFLATION RATE AND OIL PRICE IN EU, EU Inflation Rate 16- Crude Oil Price EU Unemployment Rate Source: our elab. on World Bank (GDP growth rate); EconStats (oil price) Source: our elab. on World Bank data (Inflation rate); BP data (oil price) Oil Price (US $ 2002 per barrel) reports on latest research pattern of energy demand appears to be asymmetrical with respect to the sign of a large change in oil prices tend to induce larger demand adjustment than a comparable price decline 2. Considering the general changes occurred in the second crisis ( ), higher price elasticities could countries, so the percentage change in oil consumption was not negative, but at the same time the GDP growth was even positive and higher than the period The estimation of GDP elasticity with respect to oil price could be a simple tool to evaluate negative economic effects of an oil crisis (Razavi, 1997). 13

14 TABLE 2 - IMPACTS OF OIL SHOCKS ON MAIN ECONOMIC DIMENSIONS, EU Years % change of real price of imported crude % change of oil consumption GDP growth rate Source: our elab. on World Bank data; BP data. Within the international literature, there are some supply/demand models capable of generating forecasts of near-term price movements (weeks or months ahead) or simulating supply disruptions. They provide some help in predicting price responses to supply crisis by determining the baseline around which prices will fluctuate according to expectation and speculative factors. For example, DRI/McGraw-Hill maintains a largescale econometric model of the world spot oil market and produces regular near-term price forecasts and simulation for clients (reference founded in IEA, 2001). The U.S. Department of Energy (DOE) also maintains a spreadsheet model designed explicitly to predict oil price and demand responses in the event of a major supply disruption (reference founded in IEA, 2001). Based on the DRI model, a sudden cut in oil production of around 1 mb/d leads approximately to an average increase in crude oil price of US$ per barrel within about three months, assuming prices in the US$ per barrel range. In the DOE model, prices are more sensitive to supply losses. Each 1 mb/d of lost supply increases spot crude oil prices by US$ per barrel during the first quarter and progressively less for the second and third quarters. The lack of a clear correlation between initial supply losses and the resulting oil price increases occurs because during past crisis those losses were in most instances rapidly offset by production increases in countries not affected by the crisis (IEA, 2001). 14 Inflation rate Unemploym. rate (%) Balance of Payments (current bilus$)

15 Other studies have focused the analysis on the economic effects of oil price increase. For instance, in one of the official documents of the European Union about security of oil supply, there have been estimates that an increase of $10 in the price of a barrel of crude oil is likely to reduce economic growth in the industrialised countries by around 0.5% (EU, 2002/0219 COD). Another study produced by the International Monetary Found (IMF, reference founded in EU document) estimates that a $10 per barrel increase in oil price, if sustained for a year, reduces global GDP by 0.6% ignoring the secondary effects on confidence, stock markets and policy responses. Other studies suggest that a sustained increase of $10 in the crude oil price would reduce economic growth by around 0.5% in the industrialised countries and by 0.75% in the developing countries. The US Department of Energy estimates that an annualised external cost for the period lies in the range of US$ per barrel of oil consumed, and in the range of US$ taking into account the Strategic Petroleum Reserve. Using those estimates, the security externality for the United States amounts to some 1-3 per cent of current US crude oil spot prices (DOE, 1990, Report of the NES Oil Externality Subgroup, draft manuscript; GAO, Evaluating US Vulnerability to Oil Supply Disruptions and Options for Mitigating their effects, US General Accounting Office, DC). TABLE 3 - IMPACTS OF OIL PRICE CHANGES ON OIL DEMAND Social Costs of Electricity Shortage Social costs of energy disruptions due to electricity shortage are easier to identify due to immediate negative effects, and relatively small indirect and successive impacts. Generally, social costs of an electricity disruption depend on quality and entity of various factors: the extension of the disruption in terms of people and area affected (and demographic density of the territory); 75/73 82/79 88/85 92/89 (a) % change of oil consumption OECD North America OECD Europe OECD Pacific European Union (b) % change of real GDP OECD North America OECD Europe OECD Pacific European Union (c) % change of real price of imported crude OECD North America OECD Europe OECD Pacific European Union (d) oil price elasticities (a-b)/c OECD North America OECD Europe OECD Pacific European Union Source: our elab. on Birol, 1998; World Bank; EconStats. the presence of alternative energy sources that could or could not replace the missing energy (i.e., the solar energy disposals in a small area in New York has guaranteed to their inhabitants continuous energy flow during last disruption, 14th August 2003); the duration (time) and the continuity of the disruption; the specific moment of the day (morning, afternoon, night); the season, because the climate factor is very important both on the consequences side, and on the magnitude of the disruption (usually reports on latest research 15

16 summer black outs are more serious due to air conditioning); the availability of advance warning and information. In order to evaluate all public and civil sectors affected by an energy shortage, it is useful to overview what happened during last blackouts in North America and in Europe. A possible list of social costs that could occur after an energy disruption follows: 1. Expenditure for military, police and emergency actions (excluding health): Cost of activating the counterterrorism machine, due to lack of immediate black out warning. Cost for emergency requests to police and public order forces (arrests, riots). Cost for emergencies for fire workers (i.e., elevators, closing doors, subway, fires, etc.). 2. Expenditures for public transport: Costs for public railway due to interruption: reduced revenues, increased emergencies, delays (effects on both the public system and consumers), risk of accidents (computers stopping in the traffic system programming). Cost for subway interruptions: reduced revenues, increased emergencies, risk of accidents, delays (effects on both the public system and consumers). Cost for flights, increased emergencies, delays (effects on consumers), risk of accidents. 3.Health and Sanitary Expenditures: Immediate costs for health facilities (hospitals, emergencies, laboratories): emergency surgery, emergency medical-service calls; loss of medicines, organs, blood and analysis (and experiments) due to reduced refrigerating capacity (prolonged shortage) Post blackout health expenditure (for violence, for intoxications due to fires or food poisoning, for panic attacks, due uncomfortable temperature inside buildings). Cost for flights, increased emergencies, delays (effects on consumers), risk of accidents. 4. Sanitation and Waste disposal: Immediate costs for interruption in sanitation services and waste disposal, as recycling systems or composting/incinerator disposals. Further costs due to excessive waste accumulation in deposits. Possible sanitary costs due to reduced capacity of wastewater treatment disposals. 5. Other Public services: Costs for interruption of classes and lessons in public schools (and universities) Costs for damaged food due to reduced refrigeration capacity in all public administrations. Social costs for illness (reduced work capacity). Costs for loss of leisure time, personal injury, fear and panic. Costs for interruption of other public administrative services (Councils, assistance, etc.). Loss of museum revenues. Political fallout. 6. Human life values: Costs for deaths (human life value). Costs for illness (reduced work capacity). Costs for loss of leisure time, personal injury, fear and panic. All of the sectors described above could face additional high costs linked to (Rios et al., 1999): - idle but paid-for resources such as labour or capital; - equipment damage; - process restart costs; - spoilage of resources; - utilities restoration costs. Some quantitative estimates In order to analyse linkages between direct and indirect effects due to energy disruption, a classical example could be represented by the negative impacts of electricity shortage to farmers, and consequently to consumers. In this case the time lag of consequences could be longer, up to one year. The example taken from the US experience can be perfectly adapted to the EU situation, due to the high subsidies that characterise the agricultural sector in the two areas. Economic losses of farmers in terms of reduced income are partly replaced by public subsidies, changing the private cost (farmers) into a social cost (taxes for citizens). Looking at disruptions of the energy supply to agriculture of even short duration, the effects on farmers could be a substantial reduction or even a complete loss of an entire growing season (i.e. shortage of electricity to pump water during drought season, or to milk cows, etc.). Following studies from the U.S. National Council of Farmer Cooperatives (NCFC) and the U.S. Agriculture Department, agriculture and the rest of the rural sector are 16

17 typically at the end of the energy distribution chain, with fewer supply options and greater vulnerability to disruptions. A first direct effect could be the shortage of energydependent services (i.e. irrigation or milking cows) and a consequent loss of crops. A second indirect effect depends on energy price increases. In the event of energy price spikes, farmers, as price-takers for their commodity, are unable to pass energy or fertilizer price increases on to the consumer, and therefore get an even lower return on their products. The U.S. Department of Agriculture recently estimated that price increases (due to energy disruptions) during the past few months in California for energy inputs and fertiliser, if projected into the year, could result in a 1-2% increase in total production costs. This might not seem significant, but it becomes a serious matter considering that this cost increase would translate into a one-third decrease in net farm cash income. improvement, energy policies of the OECD governments, asymmetrical depreciation, transaction costs associated with conservation programmes etc. may explain this asymmetrical evolution. Moreover, the consumers can have an expectation that the oil prices will increase again. If the consumers expect higher fuel prices in the (not too long) future and if adjustment is costly, then it may not be advisable to opt for the short term opportunities offered by the low price. reports on latest research Notes 1 An analysis based on total value of oil shortfall ignores any evaluation about the relative magnitude of crisis compared with total demand. Just as an example, during the Gulf War (1991) the percentage of reduction in oil supply compared to world demand was much higher (9%) than the reduction during the Iranian Revolution (7%). From the analysis of total value there emerge opposite results, with a higher magnitude of shortfall for the 1979 crisis. 2 Different reasons, such as the irreversibility of technological 17

18 Tourism and Sustainable Economic Development Macro and Micro Economic Issues 1 Valentina Bosetti* *FEEM 1 Organized by CRENoS and by Fondazione Eni Enrico Mattei, sponsored by World Bank Chia, Sardegna, September 2003 The Conference on Tourism and Sustainable Economic Development has received great attention not only from the academic world, but also from policy makers, local authorities, individuals and institutions more generally interested in issues related to the sustainable development of the tourism industry. All the papers presented at the conference can be downloaded from the CRENoS web site Overall, the paper presented at the Conference, identify several issues that typically emerge throughout the development process of the tourism industry. Some of the papers contribute to the definition and characterisation of the data which should be available in order to properly guide development and manage the natural resources involved. Some of the papers discuss and evaluate tools which enable to define costs and benefits deriving from alternative development scenarios. Finally, some of their evaluate economic and policy instruments which might be adopted in the management of the tourism sector. The following are the main issues which have emerged from the Conference discussion. Sustainability of Development: what are the conditions? Many studies have given their contribution to the definition of a realistic framework of conditions necessary for a sustainable tourism development. Among other things, development should be based on the continuous growth of the supply side of the tourism industry, without adversely affecting the quality level. Indeed, a rapid and continuous expansion of the supply side could lead to promising economic results in the short run, although it might negatively and irreversibly affect both the environment and the economy in the long run. Thus, the main goal of sustainable tourism development should be to create and to maintain conditions for growing per capita expenses undertaken by tourists, rather than for a growing number of tourists. Policy related guidelines. It is not an easy task to satisfy conditions for sustainable tourism development just on the grounds of market mechanisms. The public sector thus plays a crucial role, as it is responsible for guiding the decision and the information processes, for creating and establishing norms in order to protect the environmental sector, for identifying guidelines for individual firms operating in the sector. Coordination of decentralised initiative. What is the optimal decentralisation level of development decisions? When environmental goods are perceived as public goods, tourism development paths become unsustainable thus it becomes essential to have a central planner operating in line with the guidelines previously described. Should traditional activities, which are jeopardised by tourism development, be protected? And, more importantly, if the answer to the question is yes, how can this be done? The main issue here, is the importance of a tourism industry which supports, rather than substitute, the development of traditional activities. When this happens, in the long run the profitability of traditional activities tends to line up with that of the tourism sector, reaching a market equilibrium where the existence of one activity preserves (rather than jeopardises) the existence of the other. Among several possible forms of tourism development, some can produce the mentioned effect, some cannot. In particular, a tourism industry exclusively concentrated, space-wise, in areas located on the coastlines of a region and, time-wise, in a very dense high season, will typically produce disequilibrium on the inland, rather than a profitable synergy effect. How can we measure tourism volatility? There are several sophisticated tools producing very detailed and reliable forecasts. In this context, however it is necessary, as in several others, to systematically and carefully monitor the tourism phenomenon, in order to obtain high quality and high frequency datasets. 18

19 Is a tax on tourism a useful policy tool? The introduction of an eco-tax produces two opposite effects. On one side, the direct effect is to decrease demand; on the other side, the higher environmental quality deriving from the tax might inversely produce an increase in demand. It can be argued that the introduction of an eco-tax might increase, and not decrease, the profitability of the tourism sector, if the tourists are willing to pay for an increase in environmental quality. However, the conditions for the application of a tax are extremely case-dependent and should be carefully designed according to the problem at stake. Conclusively, we briefly summarise the data and analysis tools presented during the Conference. General computable Equilibrium Models. They represent an important tool to analyse the consequences of exogenous shocks on the tourism sector and to compare the consequences of alternative economic policies and interventions. To correctly apply this tool it is crucial to have detailed intersector data, which might still be unavailable for many Italian regions. Data series econometric analysis. This technique, commonly applied to financial phenomena, can be fruitfully applied to the analysis of tourism demand volatility. However, there is a clear problem related to the scarce availability of sufficiently detailed data, as it is for example in the case of Sardegna. Tourism Satellite Account. Istat is studying a new methodology which will allow to understand the economic dimension of the tourism sector as well as its economic and social effects. In the future, on the basis of the information produced by this Satellite Account system, it will be possible to design policies targeted to accomplish the sustainable paradigm, both from an economic as well as from an environmental perspective. What do tourists want? There are several methodologies allowing to accurately investigate tourists preferences, in order to understand how they perceive each single attribute composing the sustainable tourism experience. This information is fundamental in order to estimate the total economic value of an environmental good in its preserved state, in order to better design a sustainable development strategy. Moreover, this analysis should be used in order to guide market operators and institutions towards the identification of ways of producing a more appealing and complete tourism good. In the mean time, from an environmental regulation perspective, this analysis should be used to identify which tourism activities should be encouraged and which should be discouraged. Note Rinaldo Brau, Davide Cao, Fabio Cerina, Emanuela Marrocu, Francesco Pigliaru (coordinator), Federica Rosina. Sintesi dei lavori della Conferenza: Tourism and Sustainable Economic Development Macro and Micro Economic Issues Equilibri, 3, reports on latest research 19

20 EEE - Ecological and Environmental Economics Programme: a Joint FEEM, ICTP and Beijer Institute Initiative Francesco Bosello* and Marco Lazzarin* *FEEM and EEE Program ICTP Since 2002 FEEM is involved together with the Abdus Salam International Centre of Theoretical Physics, Italy and the Beijer International Institute of Ecological Economics, Sweden, in a three-year research programme whose final aim is to study the interrelations between climatic, environmental and socioeconomic systems. This programme, with a strong orientation to the formation of young researchers especially in developing countries, taking advantage from the multidisciplinary competence of the institutions involved, focuses on three key research areas: dynamic ecological models, sustainable development indicators and integrated modelling in climate change impact assessment (IAM). FEEM is particularly committed to this third topic with the final aim to evaluate the various consequences of climate change, adopting a global or integrated perspective. Integrated assessment can be defined as a procedure in which - through the coherent fusion of knowledge coming from different disciplines - all the complex causeeffect links characterising a given phenomenon can be traced and disentangled. This approach is particularly necessary and productive if applied to climate change and climate-change impact assessment, which give rise to a set of impulses and responses within and between complex dynamic systems. The Present Work In practice what is currently being done is to interlink a reducedform general circulation model predicting future temperature trend, climate impacts modules - translating the increase in temperature into different environmental consequences and an economic model to finally evaluate in term of welfare or gross production these consequences at the country and sectoral level. All this requires work in two different but strictly correlated directions: one is the building of interfaces among modules, the other is to improve the flexibility and suitability of the structure of the different modules, in particular the environmental and economic ones, to reach a final, consistent evaluation. Two consequences of climate change are currently under investigation: sea level rise and climate change impacts on health. The exercise consists in contrasting a baseline without climate change with a scenario with climate change to appreciate the difference in terms of physical impacts and subsequently in terms of economic consequences of these impacts. To do this a sea-level rise module calculating the amount of land lost due to climate change and a health module- computing mortality and morbidity associated to diseases affected by climate change (malaria, schistosomiasis, dengue, cardiovascular and respiratory illnesses) have been interfaced with a global circulation model calculating future temperature from emissions trends endogenously produced by an economic model, and with this general equilibrium economic model. Preliminary outcomes concerning both the results and the methodology have been presented in different conferences, workshops and seminars (e.g. in Istanbul, Hamburg, Venice and Trieste, for a detailed description see EEE initiatives). Future Developments In the near future more socioeconomic and environmental impacts will be studied. On schedule is the development of a tourism module in order to take into account the impact of different climatic changes on tourist demand and supply, an energy impact module to consider the effect of temperature increases on energy demand and supply, and finally a land use module in order to simulate climate-change impacts on crops productivity. 20