Does uncertainty justify intensity emission caps?

Environmental policies often set ‘‘relative'' or ‘‘intensity'' emission caps, i.e. emission limits proportional to the polluting firm's output. One of the arguments put forth in favour of relative caps is based on the uncertainty on business-as-usual output: if the firm's production level is higher than expected, so will be business-as-usual emissions, hence reaching a given level of emissions will be more costly than expected.As a consequence, it is argued, a higher emission level should be allowed if the production level is moreimportant than expected. We assess this argument with a stochastic analytical model featuring two randomvariables: the business-as-usual emission level, proportional to output, and the slope of the marginalabatement cost curve.We compare the relative cap to an absolute cap and to a price instrument, in terms ofwelfare impact. It turns out that in most plausible cases, either a price instrument or an absolute cap yields ahigher expected welfare than a relative cap. Quantitatively, the difference in expected welfare is typically very small between the absolute and the relative cap but may be significant between the relative cap and the price instrument.Uncertainty; Policy choice; Environmental taxes; Tradable permits; Intensity target

The Employment Potential of Site Remediation Policies: A Micro-Economic Simulation

This paper deals with the impact on employment of a particular environmental protection policy: contaminated site remediation. We provide quantitative results on the employment level and also on qualifications in the case of France, by making different assumptions regarding the number of sites to be cleaned up and the decontamination level. We use a composite methodology: the engineering estimation method to obtain costs and direct jobs and a reversed input-output matrix to assess indirect employment, i.e., jobs incurred by the production of inputs. Given the high diversity of contaminated sites, we have selected two case studies, the first gathering gasworks and coke ovens and the other dealing with petrol filling stations. As regards the level of decontamination for each site, labour intensity follows a 'bell curve' with the highest labour intensity for intermediate levels of decontamination. By contrast, an increase in the number of sites to be treated has an important positive net effect on employment. Hence, a programme of site remediation of a large number of sites, preferably with an intermediate level of decontamination, would lead to a significant increase in employment, even when we take into account the jobs destroyed elsewhere in the economy by the funding of the clean-up.

Prices vs Quantities in a Second-best Setting

The choice between taxes and tradable permits has been independently analysed by two distinct research traditions. The first proceeds from Weitzman's partial equilibrium stochastic model and concludes that a tax should be preferred if the marginal abatement cost curve is steeper than the marginal environmental benefit curve. The second utilises deterministic general equilibrium models with pre-existing distortionary taxes. It concludes that non-revenue-raising instruments (e.g., grandfathered tradable permits) are costlier than revenue-raising ones (e.g., a tax on every unit of pollution or auctioned permits). To build a bridge between these two traditions, we introduce in Weitzman's model a positive cost of public funds due to pre-existing distortionary taxes. The tax admits a greater comparative advantage over the permits, as compared to Weitzman's classical result. Then, we assume that the regulated industry blocks any proposal that poses it too high an expected burden. This may require a transfer to firms, in the form of freely-allocated permits or lump-sum tax rebate. It turns out that if this acceptability constraint is binding, then the comparative advantage of taxes over permits is still reinforced. Quantitatively, even if the marginal benefit function is 50% more steeply sloped than the marginal cost function, the price instrument should be preferred.We also compare the expected net benefit of these two instruments to a contingent instrument which leads to the ex post optimum. The superiority of the contingent instrument over the quantity one is higher than in first-best.Environmental taxes; policy choice; tradable permits; second best,;uncertainty

Relative Quotas: Correct Answer to Uncertainty or Case of Regulatory Capture

There is a tendency among policy-makers and industry lobbyists toward "specific", "relative" or "output-based" quotas, i.e., freely distributed to firms proportionally to their output. With a stochastic analytical model, we demonstrate that relative quotas are dominated either by absolute quotas or by price instruments as regards expected social cost. Furthermore, price instruments entail a lower expected compliance cost than relative quotas. Why, then, do industry lobbyists favour quantity instruments over price instruments? A possible explanation is that if the industry anticipates that the State will underestimate output and overestimate the MAC curve slope, it has an interest in defending relative quotas. The problem is that in such a case, both the environmental damage and the social cost are higher with relative quotas than with absolute ones. The choice of relative quotas over price instruments or absolute quotas may thus be a case of regulatory capture, to use Stigler's vocabulary.Uncertainty, policy choice, environmental taxes, tradable permits, regulatory capture

Addressing leakage in the EU ETS : Border adjustment or output-based allocation ?.

The EU ETS has been criticised for threatening the competitiveness of European industry and generating carbon leakage, i.e., increasing foreign greenhouse gas emissions. Two main options have been put forward to tackle these concerns : border adjustments and output-based allocation, i.e., allocation of free allowances in proportion to current production. We compare various configurations of these two options, as well as a scenario with full auctioning and no border adjustment. Against this background, we develop a model of the main sectors covered by the EU ETS: electricity, steel, cement, and aluminium. We conclude that the most efficient way to tackle leakage is auctioning with border adjustment, which generally induces a negative leakage (a spillover). This holds even if the border adjustment does not include indirect emissions, if it is based on EU (rather than foreign) specific emissions, or (for some values of the parameters) if it covers only imports. Another relatively efficient policy is to combine auctioning in the electricity sector and output-based allocation in exposed industries, especially if free allowances are given both for direct and indirect emissions, i.e., those generated by the generation of the electricity consumed. Although output-based allocation is generally less effective than border adjustment to tackle leakage, it is more effective to mitigate production losses in the sectors affected by the ETS, which may ease climate policy adoption.Emission trading; border adjustment; output‐based allocation; competitiveness; carbon leakage;

How to design a border adjustment for the European Union Emissions Trading System ?.

Border adjustments are currently discussed to limit the possible adverse impact of climate policies on competitiveness and carbon leakage. We discuss the main choices that will have to be made if the European Union implements such a system alongside the EU ETS. Although more analysis is required on some issues, on others some design options seem clearly preferable to others. First, the import adjustment should be a requirement to surrender allowances rather than a tax. Second, the general rule to determine the amount of allowances per ton imported should be the product-specific benchmarks that the European Commission is currently elaborating for a different purpose (i.e. to determine the amount of free allowances). Third, this obligation should apply when the imported product is registered at the EU border, and not after the end of the year as is the case for domestic emitters. Fourth, the export adjustment should take the form of a rebate on the amount of allowances a domestic emitter has to surrender. Five, this rebate should equal the above-mentioned product-specific benchmarks, not the emissions of the particular exporting plant or firm. Finally, the adjustment does not have to apply to consumer products but mostly to basic products.Carbon leakage; border adjustment; border tax adjustment; EU ETS; competitiveness;

How to Design a Border Adjustment for the European Union Emissions Trading System?

Border adjustments are currently discussed to limit the possible adverse impact of climate policies on competitiveness and carbon leakage. We discuss the main choices that will have to be made if the European Union implements such a system alongside with the EU ETS. Although more analysis is required on some issues, on others some design options seem clearly preferable to others. First, the import adjustment should be a requirement to surrender allowances rather than a tax. Second, the general rule to determine the amount of allowances per ton imported should be the product-specific benchmarks that the European Commission is currently elaborating for a different purpose (i.e. to determine the amount of free allowances). Third, this obligation should apply when the exported product is registered at the EU border, and not after the end of the year as is the case for domestic emitters. Fourth, the export adjustment should take the form of a rebate on the amount of allowances a domestic emitter has to surrender. Five, this rebate should equal the above-mentioned product-specific benchmarks, not the emissions of the particular exporting plant or firm. Finally, the adjustment does not have to apply to consumer products but mostly to basic products.Carbon Leakage, Border Adjustment, Border Tax Adjustment, EU ETS, Competitiveness

Changing the Allocation Rules in the EU ETS: Impact on Competitiveness and Economic Efficiency

We assess five proposals for the future of the EU greenhouse gas Emission Trading Scheme (ETS): pure grandfathering allocation of emission allowances (GF), output-based allocation (OB), auctioning (AU), auctioning with border adjustments (AU-BA), and finally output-based allocation in sectors exposed to international competition combined with auctioning in electricity generation (OB-AU). We look at the impact on production, trade, CO2 leakage and welfare. We use a partial equilibrium model of the EU 27 featuring three sectors covered by the EU ETS – cement, steel and electricity – plus the aluminium sector, which is indirectly impacted through a rise in electricity price. The leakage ratio, i.e. the increase in emissions abroad over the decrease in EU emissions, ranges from around 8% under GF and AU to -2% under AU-BA and varies greatly among sectors. Concerning the overall economic cost, OB appears to be the least efficient policy, even when taking into account its ability to prevent CO2 leakage. On the other hand, this policy minimises production losses and wealth transfers among stakeholders, which is likely to soften oppositions. GF and AU are the most efficient policies from an EU perspective, even when leakage is accounted for. From a world welfare perspective and whatever the emission reductioEmission Trading, Allowance Allocation, Leakage, Spillover, Climate Policy, Kyoto Protocol, Border Adjustment

Leakage from climate policies and border tax adjustment:lessons from a geographic model of the cement industry

We present a spatial international trade model, GEO, which computes transportation costs bynot treating markets as dimensionless points and explicitly represents capacity shortages andinvestment decisions in new production capacities. We link it to CEMSIM, a partialequilibrium model of the world cement industry developed by the IPTS. We assume that theKyoto Protocol Annex B countries (except the USA and Australia), create a CO2 tax at 15euros per tonne. This policy entails significant emissions reductions (around 20%) in thesecountries. A significant leakage occurs, with an emissions increase in the rest of the world ofaround 20% of the emissions reduction in Annex B-USA&Australia. We thus run twoscenarios combining a CO2 tax with border-tax adjustments (BTA). With the more ambitiousBTA tested, not only is there no leakage, but emissions in the rest of the world decreaseslightly. However, compared to business-as-usual, non-Annex B price-competitiveness andproduction decrease a little and these countries loose some market shares, so they couldattack this system as distorting competition in favour of Annex B countries. A less ambitiousBTA is thus tested, which cannot be criticised on this ground and prevents almost all leakage.The only drawback of both BTA policies is that the cement price in Annex BUSA&Australia increases a little more than without BTA, further impacting the cementconsumers in these countries.Cement; leakag;, spillover; climate change mitigation;Kyoto Protocol; border-tax adjustment;international trade; transportation cost

CO2 abatement, competitiveness and leakage in the European cement industry under the EU ETS: Grandfathering vs. output-based allocation

A recurrent concern raised by the European GHG Emissions Trading System (ETS) is the fear of EU industry competitiveness loss: a loss in domestic production and a loss in profits. This paper analyses how production and profits in the European cement industry may depend upon allocation approaches. We analyse two contrasting allocation methods of free allowances. Under "grandfathering", the number of allowances a firm gets is independent of its current behaviour. Under "output-based allocation", it is proportional to its current production level. Whereas almost all the quantitative assessments of the EU ETS assume grandfathering, the real allocation methods used by Member States, notably because of the updating every five years and of the special provision for new plants and plant closings, stand somewhere between these two polar cases. We study the impacts of these two polar allocation methods by linking a detailed trade model of homogeneous products with high transportation costs (GEO) with a bottom-up model of the cement industry (CEMSIM). The two allocation approaches have very different impacts on competitiveness and emissions abatements. Grandfathering 50% of past emissions to cement producers is enough to maintain aggregate profitability (EBITDA) at its business-as-usual level, but with significant production losses and CO2 leakage. For an output-based allocation over 75% of historic unitary (tCO2/tonne-cement) emissions, impact on production levels and EBITDA is insignificant, abatement in the EU is much lower but there is almost no leakage. Policy needs to recognise to what extent different allocation approaches may change the impacts of emissions trading, and adopt approaches accordingly.Grandfathering, Output-based allocation, competitiveness, leakage