A sectoral approach balancing global efficiency and equity June 2010 Guy Meunier Jean-Pierre Ponssard Ecole Polytechnique 1 Département dÉconomie

The empirical context Copenhague showed the limitations of an approach based on uniform carbon price worldwide Developping countries intensity targets Unilateral policies such as EU-ETS deliver little in terms of effectiveness – In principle, leakage – In practice, special treatments for sensitive sectors 2

Agenda A conceptual framework to structure a proposal: the Chilchilnisky controversy Literature on sectoral approaches The proposal Next steps

BLS applied to uniform versus differentiated carbon prices Chichilnisky, G. and G. Heal (1994), Who should abate carbon emissions?: An international viewpoint." Economics Letters, Sheeran, K.A. (2006), Who should abate carbon emissions? A note." Environmental and Resource Economics, 35, Tirole, J. (2009), Politique climatique : une nouvelle architecture internationale. CAE. Godard, O. (2009), Quelle architecture internationale pour la politique climatique ? Ecole Polytechnique, Paris. 4

5 MAC and WMUC MAC if WMUC EU China 1 2 Preliminaries MAC if WMUC WMUC MAC

Preliminaries 6

Figure 4 7 A B B BAU Unique CO2 price with transfer Differentiated CO2 prices Sectoral approach C

Literature on sectoral approaches Center for Clean Air Policy (2010), Global Sectoral Study: Final Report. World Business Council for Sustainable Development (2009), A sectoral approach: Cement Sustainability Initiative. International Energy Agency (2009), How the energy sector can deliver on a climate agreement in Copenhagen. Special delivery excerpt of the World Energy Outlook 2009 for the Bangkok UNFCCC meeting." OECD/IEA, Paris, octobre. Baron, R., B. Buchner, and J. Ellis (2009), Sectoral Approaches and the Carbon Market." IEA/OECD paper for the Annex I Expert Group on the UNFCCC, OECD/IEA, Paris. Hamdi-Cherif, M., C. Guivarch, and P. Quirion (2009), Sectoral targets for developing countries: Combining Common but differentiated responsibilities with Meaningful participation". Working Paper CIRED. 8

The proposal For industrialized countries: cap and trade at all times without free allocations For emerging countries: intensity commitments to allow economic growth Carbon intensive sectors subject to international trade: firms abide to the local rules in the countries they sell Financial transfers from industrialized countries to developing countries in proportion to revenues collected to the permits 9

The simulation Model The framework – Two regions : EU and China – Three sectors: Electricity, Cement and Steel – Static for the horizon Three scenarios to be compared to BAU – Sectoral Approach For EU: Cap and trade without free allocations, 30% transfer of revenues to China for NAMAs (electricity) For China: NAMAs (electricity) and integration of Cement and Steel in the EU- ETS for exports, OBA for domestic production – Global Cap (first best) – EU-only For EU: Cap and trade with free allocations for Cement and Steel (OBA) For China: BAU 10

The model: multi-sector static linear demand, linear MAC 11 Source: interviews from industry experts

Abatement costs c (u) = c° + (u – u°) 2 c°,, u° industry and country dependent

Comparison of scenarios Sectoral approach – Set a carbon price for EU Emissions in elec in EU Emissions in steel and cement for consumption in EU Total emissions in EU 20% -Revenues in EU transfers in elec in China -Total emissions worldwide -Global cap with identical total emissions 13

CO2 Impact of the scenarios 14 CO2 priceCap CO2 impact scenario /tTotal EU Global cap % China 22 30% All 26% EU Sectoral approach 38 20% China 27% All 26%

Equity issues for consumers 15 eleccementsteel Consumption scenario price increase % quantity decrease % price increase % quantity decrease % price increase % quantity decrease % EU Global cap 22 12%5%19%5%7%4% China 31%6%28%8%7%4% EUSectoral approach 20%8%32%9%12%7% China 0% 5%1%2%1%

Welfare comparisons 16

17

Financial flows Global Cap 18 Financial flows MM EleccementSteeltotal EUChinaEUChinaEUChinaEUChina consumers budget change (price*quantity) - 15,3- 68,0- 2,4- 10,0- 2,0- 3,4- 19,6- 81,4 firms variation sales 15,3 68,0 2,6 9,8 2,3 3,2 20,1 81,0 cost w/o CO2 9,4 1,1 0,1 3,2 0,9 5,1 10,4 9,4 CO2 cost dom - 26,1- 73,6- 2,9- 15,2- 3,6- 9,1- 32,6- 97,9 CO2 cost export ,4 -- 1,1 -- 1,5 free allocation financial transfers profit change - 1,3- 4,5- 0,3- 2,6- 0,4- 2,0 - 9,1 state revenues from permits 26,1 73,6 2,9 15,5 3,6 10,3 32,6 99,4 free allocation financial transfers internal tax abatement 32,6 99,4

19 Financial flows Sectoral Approach Financial flows MM EleccementSteeltotal EUChinaEUChinaEUChinaEUChina consumers budget change (price*quantity) - 24,2 -- 3,7- 1,8- 3,1- 1,0- 30,9- 2,8 firms variation sales 24,2 - 4,2 1,4 3,6 0,5 31,9 1,8 cost w/o CO2 14,8- 15,3- 0,1- 1,4 1,0 0,4 15,7- 16,3 CO2 cost dom - 41,2 -- 4,6- 25,8- 5,2- 13,9- 50,9- 39,7 CO2 cost export ,5 -- 1,5 -- 2,0 free allocation ,8 - 13,9 - 39,7 financial transfers - 15, profit change - 2,2 -- 0,5 - 0,6- 0,7- 3,3- 1,2 state revenues from permits 41,2 4,6 26,3 5,2 15,4 50,9 41,7 free allocation -- 25,8 - 13,9 - 39,7 financial transfers 15, ,3 - internal tax abatement 35,7 2,0

ScenarioGlobal cap w/o tranfers Differentiated CO2 prices Sectoral Approach Equity- +++ Cost efficiency Welfare comparisons

Comparing sectoral approach with EU-only and BTA EU-only – EU-target at 20% – Free allocations (« capacity based » as output based) for sensitive sectors – Border tax adjustment Leakage Imports Revenues for permits

Competitiveness issues 22

Double dividend 23

Next Steps A proposal which takes the constraints seriously – growth in emerging countries – competitiveness in industrialized countries A proposal which identifies – the limited loss of efficiency relative to a first best option – The substantial gains in terms of equity – The elimination of the competitiveness issue – the double dividend associated with the elimination of the leakage issue Who should make the next steps for implementation? 24

A sectoral approach balancing global efficiency and equity Thank you 25