AN INTEGRATED MODEL OF ENERGY USE AND CARBON EMISSIONS YOUNGHO CHANG DEPARTMENT OF ECONOMICS NATIONAL UNIVERSITY OF SINGAPORE INTERNATIONAL ENERGY WORKSHOP 2005 Pa-lu-lu Plaza, Kyoto, Japan July 2005

2 AN INTEGRATRED MODEL OF ENERGY USE AND CARBON EMISSIONS PROLOGUE MOTIVATION MODEL STRUCTURE DATA SIMULATION RESULTS –BASELINE AND FIVE SCENARIOS FINAL REMARKS

3 PROLOGUE: DEBATE ON GLOBAL WARMING AND THE KYOTO PROTOCOL ACCUMULATION OF CARBON DIOXIDE IN THE ATMOSPHERE –A MAIN CAUSE OF GLOBAL WARMING AND CLIMATE CHANGE MELTING ICE OF ANTARCTICA AND CORRESPONDING SEA LEVEL RISE HOWEVER, CAUSES AND EFFECTS ARE STILL CONTROVERSIAL THE KYOTO PROTOCOL IS NOW A BINDING AGREEMENT –HOWEVER, THE U.S. HAS WITHDRAWN FROM THE KYOTO PROTOCOL –AUSTRALIA IS ANOTHER COUNTRY WHO HAS NOT RATIFIED SIMPLY TOO COSTLY –RUSSIA HAS RATIFIEDTHE KYOTO PROTOCOL BENEFITS AND COSTS CLEAN DEVELOPMENT MECHANISM (CDM) IS EXTENSIVELY USED BETWEEN THE EU AND ASIA-PACIFIC COUNTRIES

4 MOTIVATION ECONOMICS OF CLIMATE CHANGE BOTTOM-UP APPROACH –MOSTLY ENGINEERING-BASED –SECTOR-SPECIFIC ENERGY DEMAND FUNCTIONS –NO FEEDBACK BETWEEN ECONOMIC GROWTH AND ENERGY DEMAND NOT EXPLICITLY CONSIDER THE SHADOW PRICE OF CARBON TOP-DOWN APPROACH –ECONOMIC MODEL –ADOPTS A FEEDBACK RELATIONSHIP OF EMISSION AND ITS DAMAGE UPON AN ECONOMY –LACK OF DETAILS IN REPRESENTING END-USES OF ENERGY INSUFFICIENT REFLECTION OF THE IMPACT OF MORE EFFICIENT END-USE TECHNOLOGIES

5 TOP-DOWN APPROACH WITH BOTTOM-UP MODEL COMBINES THE ECONOMIC GROWTH MODEL WITH THE SECTOR- SPECIFIC ENERGY USE –A TWO-SECTOR GROWTH MODEL – THE UZAWA-TYPE ENERGY RESOURCES WITH CAPTIAL AND LABOR ENDOGENIZE ENERGY USE THE MODEL CONSISTS OF THREE PARTS –AN OPTIMAL GROWTH-DAMAGE FRAMEWORK FEEDBACK BETWEEN ECONOMIC ACTIVITY AND CLIMATE CHANGE –A SIMPLIFIED VERSION OF GENERAL CIRCULATION MODELS CARBON DYNAMICS –A SECTOR-SPECIFIC ENERGY-TECHNOLOGY FRAMEWORK ENDOGENOUS SUBSTITUTION

6 ECONOMY, ENERGY, AND ENVIRONMENT ECONOMY, ENERGY, AND ENVIRONMENT ARE INTERCONNECTED HOW ARE THEY CONNECTED? –ECONOMY-ENERGY THROUGH THE PRODUCTION FUNCTION UNDER A TWO-SECTOR GROWTH FRAMEWORK –ENERGY IS A THIRD INPUT FOR PRODUCTION ALONG WITH EXISTING TWO PRODUCTION FACTORS, CAPITAL AND LABOR –ENERGY-ENVIRONMENT THROUGH A CARBON DYNAMICS –LIFE CYCLE OF CARBON –WHEN ENERGY IS USED, IT EMITS CARBON DIOXIDE AMONG OTHERS, AND CAUSES EVENTUAL ACCUMULATION OF CARBON IN THE ATMOSPHERE –ECONOMY-ENVIRONMENT THROUGH POSSIBLE DAMAGE FROM THE ACCUMULATED CARBON IN THE ATMOSPHERE OR CARBON-ABATING ACTIVITY

7 TWO-SECTOR ENERGY MODEL MAXIMIZES THE DISCOUNTED SUM OF UTILITY FROM PER CAPITA CONSUMPTION SUBJECT TO –CAPITAL STOCK –RESOURCE STOCK –CARBON STOCK THE OBJECTIVE FUNCTION –u(c): THE UTILITY FROM PER CAPITA CONSUMPTION –c(t): THE PER CAPITA CONSUMPTION –  : THE PURE RATE OF SOCIAL TIME PREFERENCE –POPULATION GROWS EXOGENOUSLY –MULTIPLYING POPULATION, L(t), BY THE UTILITY FROM PER CAPITA CONSUMPTION YIELDS THE TOTAL UTILITY

8 CAPITAL BALANCE EQUATION THE CAPITAL GOOD –IS PRODUCED IN THE FIRST SECTOR –IS PERFECTLY MALLEABLE –IS USED IN BOTH SECTORS –DEPRECIATES EXPONENTIALLY OVER TIME THE CAPITAL GOODS PRODUCING SECTOR –BEARS ALL RESOURCE COSTS EXTRACTION AND CONVERSION COSTS THE CAPITAL BALANCE EQUATION –K: THE TOTAL CAPITAL STOCK –  ij : THE UNIT RESOURCE COST FOR THE RESOURCES USED IN EACH SECTOR (R i ) –  : THE RATE OF DEPRECIATION OF THE CAPITAL STOCK

9 RESOURCE (ENERGY) AN ENERGY-TECHNOLOGY FRAMEWORK –REPRESENTS ENDOGENOUS SUBSTITUTIONS AMONG ENERGY RESOURCES –REFLECTS HETEROGENEOUS DEMAND BETWEEN SECTORS AND SIMULTANEOUS EXTRACTION OF ENERGY RESOURCES ACROSS SECTORS –PROVIDES ENERGY PROFILES FOR PRODUCTION PROCESS –SETS INTO A CARBON DYNAMICS STRUCTURE –EXTRACTION COST (RESOURCE PRODUCTION COST) –CONVERSION COST COST TO MEET THE CRITERIA OF EACH END-USE –STOCK CONSTRAINT SET AVAILABILITY OF THE RESOURCE PROVIDE TRANSITION FROM ONE RESOURCE TO ANOTHER SCARCITY RENT: IMPLICIT PRICE

10 RESOURCE CONSTRAINTS THE UNIT RESOURCE COST –THE SUM OF EXTRACTION AND CONVERSION COSTS  ij = e j + z ij, where i = end-uses, j = resources  ib = z ib (t), where b = backstop technology –  ij : THE UNIT RESOURCE COST OF OIL, COAL, AND NATURAL GAS BY SECTOR i (END-USE) –z ib : THE CONVERSION COST OF SOLAR ENERGY BY SECTOR i STOCK BALANCE EQUATION –S p (0): THE INITIAL STOCK OF OIL –S a (0): THE INITIAL STOCK OF COAL –S g (0): THE INITIAL STOCK OF NATURAL GAS

11 RESOURCE COST FUNCTION THE RESOURCE COST,  ij, –DEFINED AS THE SUM OF EXTRACTION COST AND CONVERSION COSTS  ij = e j + z ij. AND  ib = z ib WHEN WE TAKE INTO ACCOUNT HETEROGENEOUS DEMAND, CONVERSION COST, AND EXTRACTION COST, WE HAVE A RESOURCE COST MATRIX,  ij (2x4) –i : THE SECTORS (END-USES) THE CAPITAL GOODS PRODUCING SECTOR THE CONSUMPTION GOODS PRODUCING SECTOR –j : THE RESOURCES OIL COAL NATURAL GAS SOLAR ENERGY (BACKSTOP TECHNOLOGY)

12 ENDOGENOUS SUBSTITUTION: THE CHEAPEST RESOURCE COST FIRST WHEN WE CONSIDER ENERGY BEHAVIOR IN THE INTERACTIONS BETWEEN ENERGY AND ECONOMY, THE LEAST COST RESOURCES ARE USED FIRST –KEMP and LONG (1982) –LEWIS (1982) –CHAKRAVORTY and KRULCE (1994) THE CHEAPEST RESOURCE COST SHOULD MEAN THE PRICE OF THE RESOURCES AND THE MARGINAL DAMAGE COSTS  ij =  ij [e j (S j (t)), z ij ], –  ij : THE UNIT RESOURCE COST (END-USE i, RESOURCE j) –e j : THE EXTRACTION COST OF RESOURCE j –S j (t): THE EXISTING STOCK OF THE RESOURCE j AT TIME t –z ij : THE CONVERSION COST OF THE RESOURCE j FOR EACH END-USE i –ASSUME THAT (  ij /  S j )  0, (  2  ij /  S j 2 )  0, and (  ij /  z ij )  0.

13 ENVIRONMENT CARBON DYNAMICS –AN AGGREGATE REPRESENTATION OF GENERAL CIRCULATION MODELS (GCMs) –AN OPTIMAL GROWTH-DAMAGE FRAMEWORK –CAPTURES FEEDBACKS FROM EMISSION CONTROLS THROUGH THE CARBON DYNAMICS TO THE ECONOMY –DAMAGES ARE QUANTIFIED AS SOME FRACTIONS OF THE GLOBAL OUTPUT STRUCTURE –EMISSIONS –ATMOSPHERIC CONCENTRATION OF CARBONS a.k.a. CARBON STOCK –RADIATIVE FORCINGS –TEMPERATURE CHANGES –AN OUTPUT SCALING FACTOR

14 WORKINGS OF CARBON DYNAMICS WHEN ENERGY RESOURCE IS USED IN AN ECONOMY, IT PRODUCES –OUTPUTS (GOODS & SERVICES) –CARBON EMISSIONS WITH OTHER GREENHOUSE GASES A FRACTION OF THE EMISSIONS INCREASES –ATMOSPHERIC CONCENTRATION OF GHGs –RADIATIVE FORCINGS –EQUILIBRIUM TEMPERATURE EVENTUALLY IMPOSES A CERTAIN LEVEL OF DAMAGE TO THE ECONOMY DUE TO THE HIGHER TEMPERATURE A FEEDBACK RELATIONSHIP BETWEEN CLIMATE AND ECONOMIC VARIABLES IN A MACROECONOMIC STRUCTURE –AN ECONOMIC MODEL IMPACT OF TEMPERATURE RISE ON THE ECONOMY AS A WHOLE –AN ENERGY MODEL –A CARBON CYCLE/TEMPERATURE MODEL FLOWS OF CARBON DIOXIDE EMISSIONS BY ECONOMIC ACTIVITIES AND TEMPERATURE CHANGE

15 DAMAGE FROM CLIMATE CHANGE POSSIBLE DAMAGE FROM CLIMATE CHANGE –VERY ELUSIVE –A MAJOR SOURCE OF CLIMATE CHANGE TEMPERATURE CHANGES DUE TO HIGHER CONCENTRATIONS OF GREENHOUSE GASES –THE IMPACT OF CLIMATE CHANGE CAN BE EXPRESS AS A FUNCTION OF THE CHANGE IN GLOBAL MEAN TEMPERATURE FROM PRE-INDUSTRIAL TIMES, T(t). D(t) : THE LOSS OF GLOBAL OUTPUT –  1 : A PARAMETER REPRESENTING THE SCALE OF DAMAGE, OBTAINED BY ESTIMATING SECTORAL DAMAGE COMPRISING THE BALANCE OF MARKET OUTPUT AS WELL AS NON-MARKET IMPACTS IN EACH COUNTRY (TAKING THE U.S. AS A REPRESENTATIVE CASE) AND BY APPLYING THEM TO DIFFERENT COUNTRIES –  2 : AN EXPONENT REFLECTING NON-LINEARITY IN THE DAMAGE FUNCTION (TAKES ORDER OF 2)

16 COSTS OF REDUCING EMISSIONS COSTS OF REDUCING GREENHOUSE GAS EMISSIONS –PROLIFIC STUDIES ON THE CALCULATION –MUCH UNCERTAINTY AND ROOM FOR FURTHER ANALYSIS –TWO GOODS CARBON-BASED NON-CARBON-BASED CARBON-BASED SECTOR –THE STANDARD ISO-ELASTIC DEMAND AND SUPPLY –APPROPRIATE APPROXIMATION PRODUCES AN EQUATION THE COST OF REDUCING CARBON EMISSIONS –ADOPT THE EQUATION ESTIMATED WITH DATA USING ORDINARY LEAST SQUARES (NORDHAUS, 1991) –INVERSE TO DEMAND ELASTICITY –QUADRATIC IN THE FRACTIONAL REDUCTION –PROPOTIONAL TO THE TOTAL EXPENDITURE ON CARBON OUTPUT

17 TOTAL COSTS FUNCTION TC(t) : THE TOTAL COSTS OF REDUCING CARBON DIOXIDE EMISSIONS –  : THE FRACTIONAL REDUCTION IN GREENHOUSE GAS EMISSIONS –b 1 : THE SCALE FACTOR –b 2 : REPRESENT NON-LINEARITY OF THE COST FUNCTION –THE INITIAL REDUCTION IN THE CARBON DIOXIDE EMISSIONS IS RELATIVELY INEXPENSIVE –FOR EXAMPLE, IF THE FRACTIONAL REDUCTION IN GREENHOUSE GAS EMISSIONS IN THE YEAR OF 1995 IS 12 % (0.12), THEN THE TOTAL COST OF REDUCING EMISSIONS IS % OF THE GLOBAL OUTPUT

18 DAMAGE AND TOTAL COSTS LINK DAMAGE AND TOTAL COSTS OF REDUCING TO GLOBAL OUTPUT –AN OUTPUT SCALING FACTOR,  (t). –A DEFINITION OF  THE RATIO OF GLOBAL OUTPUT LESS THE TOTAL COST OF REDUCING EMISSIONS TO THE GLOBAL OUTPUT PLUS POSSIBLE DAMAGES FROM CLIMATE CHANGE A NUMERATOR –REFLECTS THE COST INCURRED TO THE ECONOMY FROM GHGs ABATEMENTS A DENOMINATOR –REPRESENTS A POTENTIAL OUTPUT UNDER NO DAMAGE FROM CLIMATE CHANGE

19 OUTPUT SCALING FACTOR A FINAL FORM OF OUTPUT SCALING FACTOR –b 1 and b 2 : PARAMETERS OF EMISSION REDUCTION COST FUNCTION –  1 and  2 : PARAMETERS OF DAMAGE FUNCTION EXAMPLE –IF WE ASSUME A 3-DEGREE INCREASE IN AVERAGE TEMPERATURE AND 12% REDUCTION IN EMISSIONS, THE VALUE OF  IS –THE PROJECTED GLOBAL OUTPUT IS 1.28% LESS THAN WHAT IT WOULD BE OTHERWISE

20 WORKINGS OF OUTPUT SCALING FACTOR DAMAGE YESNO COSTSYES<< 1< 1 NO < 1 1

21 DATA ECONOMIC- AND CLIMATE-RELATED DATA –NORDHAUS (2000) –IPCC REPORT (1990) TECHNOLOGY- AND ENERGY-RELATED DATA –CHAKRAVORTY, ROUMASSET AND TSE (1997) PARAMETERS ON TWO-SECTOR PRODUCTION FUNCTION –UZAWA (1961) –SOLOW (1961) –SHENG CHENG HU (1978) –EISMONT (1994)

22 SIMULATION RESULTS WITH GAMS SIMULATION PERIODS – (400 YEARS) SIMULATION SCENARIOS –BASELINE –TECHNOLOGY RELATED COSTS OF CONVERTING SOLAR ENERGY INTO ELECTRICTY DECREASE AT 5%; 10%; 30%; 50% PER DECADE –POLICY-RELATED CARBON EMISSIONS LEVEL IS STABILZED AT 10 BILLION TONS OF CARBON PER YEAR ENERGY USE PATTERN BY SECTOR AND CARBON EMISSIONS GLOBAL MEAN SURFACE TEMPERATURE CHANGE CARBON TAXES –THE SHADOW PRICE OF CARBON IMPACT OF DIFFERENT SCENARIOS ON DISCOUNTED CONSUMPTION

23 ENERGY USE PATTERN BY SECTOR

24 CARBON EMISSIONS

25 GLOBAL MEAN SURFACE TEMPERATURE CHANGE

26 CARBON TAXES

27 CARBON EMISSIONS: BASELINE AND STABILIZATION

28 GLOBAL MEAN SURFACE TEMPERATURE CHANGE: BASELINE AND STABILIZATION

29 CARBON TAXES: BASELINE, 50% AND STABILIZATION

30 CARBON EMISSIONS: BASELINE, DICE AND OTHER MODELS

31 GLOBAL MEAN SURFACE TEMPERATURE CHANGE: BASELINE, DICE, IPCC AND OTHER MODELS

32 CARBON TAXES: BASELINE VS DICE

33 IMPACT OF PROGRAM ON DISCOUNTED CONSUMPTION

34 FINAL REMARKS SWITCHING TO NON-CARBON EMITTING FUELS WOULD BE A SOLUTION FOR MITIGATING ATMOSPHERIC ACCUMULATION OF CARBON –HOWEVER, COSTS NEEDED FOR REALIZNG SUCH TECHNOLOGIES ARE NOT VERIFIED POLICIES LIKE STABILIZING CARBON EMISSION AT A CERTAIN LEVEL ARE NOT EFFECTIVE IN MITIGATING TEMEPARTURE RISE AND COSTLY. THE DIFFERENCE BETWEEN A CLIMATE-CHANGE AND A NO- CLIMATE-CHANGE SCENARIO WOULD BE THINNER THAN THE PENCIL NEEDED TO DRAW THE CURVES. –THOMAS SCHELLING (1983)