Dr. Athanasios Dagoumas & Dr. Terry Barker Implementing the G8 80% target with the macro-econometric E3MG model: The case of the UK Dr. Athanasios Dagoumas & Dr. Terry Barker Hellenic Transmission System Operator S.A. Cambridge Centre for Climate Change Mitigation Research (4CMR)

Outline E3MG model Theory and structure Energy system modelling within the E3MG Implementing the G8 80% reduction target Results presented for the UK Conclusions

Introduction E3MG is an integrated Economy-Energy-Environment (E3) model E3MG is one of a suite of E3 models: MDM-E3: Multisectoral Dynamic Model of the UK Economy, including energy-environment-economy (E3) interactions E3ME: E3 Model of Europe E3MG: E3 Model at the Global level All follow the same overall principles in their economics, construction and operation (Econometric, dynamic, structural, post-Keynesian, hybrid)

“New economics” modelling approach Simulation, econometric, dynamic, structural, “new economics” Structural: 20 regions, 42 industries, 19 energy users, 12 energy carriers Organized around a Social Accounting Matrix e.g. System of National Accounts Dynamic (behavioural equations with effects from previous outcomes: i.e. history matters) Estimated on cross-section & time-series data Forward-looking (projections annually or in 5 or 10 year steps) Social institutional groups (heterogeneous not representative agents) Hybrid (incorporates submodels e.g. Energy Technology Model) Demand driven, treatment of uncertainty Endogenous technological change, learning-by-doing and learning-by-researching Structured into regions of political importance Stochastic parameters are location and time specific Comprehensive (whole E3 system, all sectors, many policy instruments) Open as regards economic policy, i.e. no assumptions of full employment, budget balance, or balance of payments equilibrium

Engineering-Energy-Environment-Economy Interactions as in national accounts TECHNOLOGY specifications & costs ENVIRONMENTAL EMISSIONS as in environmental statistics ENERGY as in energy damage to health and buildings e.g. industrial emissions of SF6 funding R&D prices and activity low-carbon processes & products feedback energy-saving equipment etc fuel use pollution- abatement equipment

Energy system modelling within the E3MG

Energy system modelling The main energy submodel Determines aggregate and disaggregate energy demand by fuel user and prices of fuel use Provides feedback to main economic framework In E3MG this 'top-down' approach is supplemented by a set of 'bottom-up' engineering submodels the Energy Technology Model (ETM) provides fuel use for power generation that replaces the econometric estimates. the Transport submodel Provides fuel use for electric vehicles

Energy demand modelling No explicit production function 2-level hierarchy: aggregate energy demand equations and fuel share equations Aggregate demand affected by: industrial output of user industry, household spending in total, relative prices, temperature, technical progress indicator Augmented by time trends and/or accumulated investment to represent energy efficiency improvements Some users’ aggregate demands are affected by upward movements in relative prices only (ratchet or asymmetrical price effects) Fuel share (disaggregate energy demand) equations depend upon: activity, technology, relative price effects and temperature Error Correction Model (ECM) - in the econometric equations- distinguishes between long-term and adjustment parameters

The ETM submodel of the E3MG A simulation not optimization model where: Dispatch of electricity generation units is based on history besides economic, technical and environmental issues Electric system expansion considers Investment in new technologies from relative costs Learning curves from cumulated global investment

Market share & Frequency distribution of relative prices the smaller the standard deviation, the larger the α) Elasticity of substitution α (the narrower the distribution – Market share (1 means 100%) Relative price of marker to technology i (1 means the cost the same)

Implementing the G8 80% reduction target with the E3MG: The case of the UK

Policies Emission reduction and stabilization targets are considered as part of an international effort and are achieved through a portfolio of policies: Carbon pricing (Carbon trading for ETS sectors / Carbon Tax for rest of the economy). Revenue recycling (e.g. through auctioning carbon permits) to: Incentives for electricity technologies. Accelerated diffusion of electric plug-in vehicles through technological agreements and behavioural shift in transport. Incentives to energy-intensive industries to low-carbon production methods. Incentives for investments in energy efficiency in households, (by improving the energy efficiency of domestic dwellings and appliances and for introducing new ones such as low-emission dwellings and solar appliances). Accelerated carbon price increase at an earlier year e.g. 2030

Energy Efficiency Policies Considered no-regret options (low or negative cost): Investments are offset from gains due to reduced energy consumption Source: IEA/ETP2008

Primary Energy Demand for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Final and Primary energy demand is decreased significantly, by about 65%, for the G8 80% reduction scenario compared to the reference scenario. This comes from both efficiency improvements and from behavioural changes (which offset the rebound effect).

Final Energy Demand by fuel for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Electricity demand is increased during the electrification of transport Gas and oil demand is decreased

Final Energy Demand by sector for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Transport demand is decreased more compared to other sectors. This is attributed to shift to electric vehicles, which are more efficient to conventional fuel vehicles (and behavioural changes).

Installed Capacity for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Renewables, CCS and Nuclear penetrate significantly. Plug-in vehicles work in favour of renewables (wind)

Sectoral Emissions for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Power sector is almost decarbonised, affecting also transport emissions

Carbon Price for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario A very high carbon price is needed to boost green investments The carbon price is a price signal of the value needed (e.g. a guaranteed price) to address economic and climate uncertainty An alternative of the high carbon price is regulation (not modeled here)

Investments per sector for the UK for the period 2005-2050 Reference Scenario G8 80% reduction Scenario Investments are increased for the services, residential and transport sectors where the energy efficiency improvements are higher compared to other sectors e.g. industry and power sector. There already exist energy inefficiencies in the system (e.g. no regret options)

GDP, Investments and Consumers Spending for the UK Reference Scenario G8 80% reduction Scenario GDP is slightly increased for the 80% reduction scenario compared to the reference scenario. Revenue recycling helps economy to grow

Conclusions Emission reduction targets are implemented through a portfolio of policies. Carbon pricing should be accompanied with other policies (e.g. auctioning, revenue recycling, incentives, regulation, behavioural shift). Critical issues for meeting deep reduction targets are: “Decarbonisation” of power sector, Renewables, Nuclear and CCS can penetrate significantly. Electrification of transportation Help the penetration of renewables (wind) through tariff systems Energy demand reduction through price response, regulation, improved efficiency and behavioural shift. Inclusion of induced technological change significantly reduces the costs of stabilisation in a demand-led model, it generally leads to higher growth

Conclusions High carbon price signal If policies are successful in raising real carbon prices, the extra investment leads to higher global growth & welfare if inflation is unaffected and governmental fiscal rules are followed but uncertainties to be investigated Does not view higher carbon prices as necessarily a constraint on economic growth Pathways exist for meeting deep reduction targets and also boosting the economy.