Modelling a UK 80% Greenhouse Gas Emissions Reduction by 2050

Transcription

1 Modelling a UK 80% Greenhouse Gas Emissions Reduction by 2050 A short modelling exercise for New Scientist 3 December 2009 Hector Pollitt, Chris Thoung Cambridge Econometrics Covent Garden Cambridge CB1 2HT Tel ( ) Fax ( ) ct@camecon.com Web

2 Revision and Authorisation History Version Date Authorised for release by Description 1.0 3/12/09 R Lewney Merged documents into a single report ii

3 Contents Page 1 Introduction Measuring performance against targets The model 1 2 Approach Scenario specification Indicators of interest 3 3 Results Baseline trends Scenario results 5 4 Conclusion 8 Appendices Appendix A 10 iii

4 1 Introduction This report presents the results of a short modelling exercise undertaken by Cambridge Econometrics (CE) for New Scientist to assess the economic impacts of meeting the UK target of an 80% reduction in greenhouse gas (GHG) emissions by 2050, compared to the 1990 level. This target was set in the UK Climate Change Act (2008) and the UK is the first country in the world to set such a long-term legallybinding target. This report is broken down into four brief chapters. This first defines the basis on which UK GHG emissions are now typically measured and gives a brief description of the model used. The second chapter describes the baseline and scenario specification. The results are presented in the third chapter. The final chapter offers some conclusions from the work. Appendix A details the percentage differences in consumer prices between the scenario and the baseline projections in 2020 and Emissions are measured on a net carbon account basis E3ME is an energyenvironmenteconomy model covering 29 European countries 1.1 Measuring performance against targets UK performance against GHG emissions-reduction targets is now typically measured on a net carbon account basis to account for trading of emissions allowances eg under the EU Emissions Trading System (ETS). The components of this measure are: CO2 emissions from installations participating in the EU ETS (which must, by definition, equal the UK s allocation in each year, with any deficit or surplus reflected in the purchase or sale of emissions allowances); known as the traded sector(s) CO2 emissions from non-participants; the non-traded sector(s) all other non-co2 Kyoto GHGs (which are not presently covered by any form of trading system) 1.2 The model The analysis was undertaken using the computer model E3ME 1 (Energy-Environment- Economy Model of Europe), which produces annual projections to 2050 for 29 European countries, including the UK. The model has been used for a variety of analyses including greenhouse-gas mitigation policies, incentives for industrial energy efficiency and sustainable household consumption. A multi-country model is desirable for this kind of analysis because it captures the effects of international climate-change mitigation effort (eg from participation in the EU ETS) and the impacts on the UK economy through trade 2. E3ME offers a high level of detail distinguishing, for example: 42 economic sectors 41 categories of consumer goods An example might be an energy tax in another country. This raises the price of energy faced by producers which would to some degree be passed on to consumers through higher retail prices. The price of such goods exported to the UK would also be higher. 1

5 12 types of fuel 14 emissions, including the six GHGs covered by the Kyoto Protocol Relationships between variables (eg the impact of changes in income or prices on consumer demand) are estimated from historical data using econometric regression techniques; behavioural relationships observed in the past are assumed to hold over the projection period. 2

6 2 Approach Two projections are compared: a baseline projection incorporating current trends and existing policies in EU Member States; the baseline is consistent with current European Commission projections 3 (but not including the current crisis), extrapolated to 2050 a scenario in which the UK 2050 target is met The results from the modelling are generally presented in terms of percentage differences between the scenario and the baseline. Two market-based instruments were applied to achieve the emissions reductions supplemented by two technological assumptions 2.1 Scenario specification It was originally envisaged in the design of the modelling that the main instruments for reducing emissions would be market-based, consisting of: a rapid tightening of the EU ETS caps over the projection period to curb tradedsector emissions (leading to a higher EU ETS carbon price), by 3% per annum (pa) over a UK carbon tax on non-traded sectors to reduce the incentive to consume fossil fuels; continental Europe is assumed to take no further action to reduce emissions beyond that required under the EU Regarding other emissions, the following assumptions were made: non-co2 GHG emissions are reduced at the same rate as CO2. Such reductions are principally in emissions of methane and N2O from agriculture and reflect measures to curtail end-of-pipe emissions non-energy CO2 (ie industrial process) emissions fall by 80% although these account for a very small share of total GHG emissions (projected to be 0.3% of the total in 2050) The ambitious nature of the target required further technological assumptions to be made. In the modelling, it is implied that the government uses revenues from the auctioning of EU ETS emissions allowances and from carbon taxes to help encourage the following measures: the switch from gas to electricity in the domestic sector the increased market penetration of electric vehicles, to 90% by 2050 The rest of the revenues are assumed to be used to reduce public debt and so do not affect consumer prices. 2.2 Indicators of interest The main objective of the analysis is to assess the impact of climate-change mitigation policies on UK consumers, specifically the prices they face for goods and services. 3 European Commission, DG Tren (2008), European Energy and Transport Trends to 2030 Update Available at 4 It is obviously very difficult to anticipate future policy on this kind of time horizon but the net carbon account measure requires some assumption to be made on the future caps and the rate of tightening was selected to help meet the 80% reduction target. 3

7 Given the specification of the scenarios, prices would be expected to rise because manufacturers are likely to face higher costs of using energy (from the higher EU ETS price and carbon taxes) and these higher input costs may be passed on to consumers through higher retail prices. The extent of the price rises may be mitigated somewhat depending on sectors abilities to switch to less carbon-intensive production practices. 4

8 3 Results The baseline is characterised by consumer-price inflation of around 2¼% pa UK GDP in 2050 is projected to be around 1.4% lower in the scenario The technological assumptions shift some of the emissionsreduction burden to power generation Energy products see the largest price increases 3.1 Baseline trends In the baseline, the EU ETS price post-2030 is held constant in nominal terms although price inflation leads to a general fall in the price of carbon in real terms. The UK s allocation of allowances is also held constant in the baseline. The baseline indicates that consumer prices in 2050 are three times higher than in 2000, implying average price inflation of around 2.25% pa. Not all prices increase at the same rate: the increase in prices varies by consumption item from as little as 1.15% pa over to almost 3% pa in the case of some fuels, such as gas. 3.2 Scenario results By 2050 UK GDP is projected to be around 1.4% lower in the scenario than in the baseline, reflecting the economic costs to achieving large emissions reductions. This figure is well within the range of GDP reductions associated with an 80% reduction in emissions found in the literature 5. The EU ETS allowance price in the scenario rises to almost 410/tCO2 in 2050 (in today s prices), nearly 33 times the price in the baseline, owing to the lower number of caps driving up the price of allowances. The UK carbon tax faced by the non-traded sectors rises to nearly 210/tCO2 by 2050 (also in today s prices). The difference in the carbon prices faced by the traded and non-traded sectors is in part a result of the technological assumptions. Shifting non-traded-sector energy consumption from fossil fuels to electricity puts the onus on power generation, a traded sector, to reduce its emissions. Power generation must thus increase the number of emissions allowances it needs and this drives up the EU ETS allowance price. Because all participants in the EU ETS face a common allowance price, shifting the burden of UK emissions reductions has implications for the rest of Europe. Traded sectors in other participating countries will also face the higher EU ETS price and other European consumers are likely to face higher prices, too. Continental Europe is effectively also paying for the decarbonisation of the UK economy. If it were assumed that the rest of Europe is also pursuing additional mitigation action, such as electrification, the allowance price would be expected to rise even further. Conversely, the value of carbon tax on the non-traded sector is lower than might be expected in the absence of technological shift because emissions at source are reduced as a result of electrification. Given the scenario specification, unsurprisingly the largest increases in consumer prices are seen for energy products. When compared to the baseline levels in 2050, double-digit price increases are seen for, inter alia, gas, petrol and electricity as a result of the emissions-reduction efforts. Gas prices in particular rise substantially; in 5 For example, see the meta-analysis reported in the IPCC s Third Assessment Report (Chapter 8 of Working Group III: Mitigation), which finds that the average GDP reduction associated with an 80% emissions reduction by 2100 for the majority of analyses reviewed is in the range 0-3%: 5

9 Higher energy prices can impact on retail prices through a number of pathways the scenario the price is around 2½ times greater compared to the baseline in Large increases in the price of air travel are also seen in the scenario, a reflection of the difficulty in moving to less emissions-intensive technologies. Consumers expenditure on gas and air travel falls substantially although, in the case of the former, this is largely by design. Consumption of electricity in the scenario is much higher, despite 2050 prices being almost 15% above the baseline as a result of power generation facing higher production costs from a higher EU ETS carbon price. The increase is likely to be higher if the sector were not regulated; in the modelling, the restrictions on electricity suppliers price setting lead to a greater negative impact on their profits because they must absorb more of the cost increase. The higher electricity consumption is necessary because households and vehicles are more dependent on electricity in the scenario (by assumption). Lower consumption of products with high costs somewhat mitigates the rise in the general price level, which is 5.1% higher in 2050 in the scenario than in the baseline; the implied rate of inflation rate over is 2.35% pa, 0.1 percentage points (pp) higher each year than in the baseline. Price increases seen in other consumer products depend on the extent to which energy is used as an input to production and the extent to which sectors are able to adopt more energy-efficient production techniques. Energy prices faced by producers can be transmitted through a number of pathways: power generators pass some of their higher costs (because of the higher EU ETS allowance price) on to their customers through higher electricity retail prices producers in the traded sector face higher costs from the consumption of fossil fuels because they must keep their emissions within the limits of the EU ETS caps producers in the non-traded sector face higher costs from using fossil fuels because of the UK carbon tax imposed all producers see their costs increase and some of the increase will be passed on to purchasers of their products. This includes trade between industries eg higher prices for agricultural products will mean that food manufacturers will have to pay more for inputs and some of the increase will be passed on to consumers A possible secondary effect is that the higher overall price level in the scenario may lead to workers bargaining for higher wages; the per-unit cost of labour in production may rise, driving up prices. This effect differs greatly by industry and an example of one in which such an effect occurs is insurance. Similar effects are seen in hotels and catering and business services and lead to higher accommodation and rent costs, respectively. Among the groups of consumer goods distinguished in E3ME, other categories to see (somewhat) larger increases in prices (at least relative to other consumption categories: % higher in 2050 compared to the baseline) include: drink tobacco electronics goods household appliances glassware and tableware 6

10 The price increases are relatively low as a result of the emissionsreduction policies These are sectors that, relatively speaking, cannot easily switch to less energyintensive production techniques. The rate of increase, however, is not especially large - in the region of 0.04 pp pa and may reflect low levels of cost pass-through in the UK economy; because the UK is relatively open to trade, prices cannot be raised too much because they will become less competitive compared to the rest of Europe. In that case, although consumers do not face the full impact of higher costs, producers experience a reduction in profits. The results may also be related to the more servicesoriented structure of the UK economy and a tendency for manufactured goods to be imported from overseas; as a whole, UK business is not as energy-intensive as other economies because it engages in less heavy production. 7

11 4 Conclusion The increases in consumer prices were found to be relatively small Firm and detailed policies will be required to meet the government aspirations on emissions reductions The analysis suggests that the policies modelled may lead to lower profits for UK firms In the analysis E3ME, a computer model of the energy-environment-economy systems of 29 European countries, was used to examine the possible price effects of predominantly market-based measures to reduce UK GHG emissions by 80% on the 1990 level, as set out in the UK Climate Change Act. However, it was found that additional regulation on the household and road transport sectors was required for the targets to be met. The results indicate that the tightening of the EU ETS caps and levying of carbon taxes leads to substantial increases in energy prices (a direct impact of the policies) but the extent to which these increases are passed on to consumers in higher prices of other consumer goods that require energy for production is much smaller. While the particular choice of policies is not intended to be prescriptive, the strength with which they have to be applied (high carbon prices and almost complete decarbonisation of the domestic and transport sectors) illustrates the scale of the challenge faced by the UK if it is to meet the target. To achieve the target, a substantial change in energy-consumption patterns in the domestic and transport sectors, from fossil fuels to electricity, had to be imposed in the UK, shifting a substantial proportion of the emissions-reduction burden to the power sector, which is required to meet the emissions caps set under the EU Emissions Trading System (ETS). The higher costs of low-carbon power generation are paid for by the users of energy in the form of higher energy prices, with the revenues accruing to government through high carbon allowance prices and other carbon tax revenues. These revenues are available to help encourage the switch from fossil fuels to electricity or to mitigate impacts on low-income households, although in the modelling they are mostly used to pay off the national debt. The extent of this change in the pattern of energy consumption highlights the importance of reducing emissions from sectors not covered by the EU ETS (particularly households and transport) in meeting the UK target. This is recognised by the UK government in the UK Low Carbon Transport Plan and in the Renewable Energy Strategy, both published in July 2009, which consolidate the government s proposed path to a low-carbon UK economy. It is now important that the government s aspirations, outlined in these two documents, are followed up with firm and detailed policies to facilitate the transition. More stringent regulation of other, non-co2 greenhouse gases will also be necessary 6. The shift to more costly, low-carbon power generation technologies imposes costs on the economy. The scale of these depends in part on the extent to which the cost of those technologies falls as take-up increases, and on the use of the carbon allowance and other tax revenues (which can help to offset the costs). The modelling indicates that UK GDP in 2050 will be around 1.4% lower if the policies to reduce emissions are implemented compared to a business-as-usual case without the policies. One concern is that UK industry could lose competitiveness against producers operating in a country where such stringent policies are not applied. For producers covered by the EU ETS, the relevant competitors are outside of the EU (since EU competitors will 6 In the modelling we assumed that non-co2 GHG emissions fall at rates related to the reduction in CO2 emissions, but in many cases the policies that achieve cuts in CO2 emissions will not have a direct impact on non-co2 GHG emissions (for example, methane emissions from agriculture). 8

12 face the same increase in the EU ETS allowance price). For firms in the non-traded sector, we have not assumed that comparable policies are applied elsewhere in the EU and so the scope for a loss of competitiveness is greater (although in reality it is politically unlikely that the UK would proceed alone with such a radical programme). In the modelling, the UK s relative openness to trade suggests that producers accept lower profits rather than raise their prices, to preserve price competitiveness. If an effective way could be found to use some of the carbon allowance revenues to accelerate investment in R&D in energy-efficient technologies, or to bring down the cost of renewable energy, this would lower the cost increase faced by energy users and help to mitigate the impact on profitability. 9

13 Appendix A Table A following shows the percentage difference in consumer prices between the scenario (with the 80% emissions reduction) and the baseline (without) in 2020 and

14 TABLE A: PERCENTAGE DIFFERENCES FROM BASELINE Sector Food Drink Tobacco Clothing and Footwear Actual Rent Imputed Rentals Maintenance & repair Water and Misc. serv Electricity Gas Liquid Fuels Other Fuels Furniture and Floor Household Textiles Household Appliances Glassware Tableware Tools and Equipment Household Maintenance Medical Products Medical Services Purchase of vehicles Petrol etc Rail Transport Air Transport Other Transport Communications Electronics goods Other rec. durables Other rec goods Recreational Services News, Books, Stationery Package Holidays Education Catering services Accommodation Personal Care Pers. effects n.e.c Social Protection Insurance Financial Serv n.e.c Other Services n.e.c Note(s) : Package Holidays were originally distinguished in dummy data used to define the model classification, in preparation for the transition to a new set of accounts, but were no longer separately identified when actual new data were published. Source(s) : Cambridge Econometrics. 11