Kyoto permits’ price will not be low: Exploring future commitments and the role of banking Vincent van Steenberghe UcL-IRES et CORE

Purpose (1) Main results of MacGEM (2008 – 2012) :

Purpose (2) Extend MacGEM model to future commitment periods in order to analyse –Future participation and commitments of Annex B and non- Annex B countries –Future burden sharing arrangements –The role of banking –The impact of these elements on Kyoto permits price MacGEM(+) is an ‘easy to use’ model based on Marginal Abatement Cost curves for CO2 emissions MacGEM+ offers large possibilities of sensitivity analyses and focuses on key parameters (technological progress, discount rate, baseline emissions, efficiency of domestic policies, …)

Content of the presentation Model of banking with MACs Set-up of MacGEM+ Possible scenarios Simulations –Reference scenarios –Participation structure –Allocation rules –Hot air issue Sensitivity analysis

Model of banking with MACs (1) Illustration of trading between countries without inter-temporal trades E i price2 Permits iPermits j TRADES 2 MAC i MAC j E j Total permits 2 price1 Permits iPermits j TRADES 1 MAC i MAC j E iE j Total permits 1 Period 1Period 2

Model of banking with MACs (2) Price(1,2) price2 Permits iPermits j MAC i MAC j E j Total permits 2 price1 Permits iPermits j BANK 1 MAC i MAC j E iE j Total permits 1 BANK 2 Period 1Period 2 Illustration of trading between countries with inter- temporal trades

Model of banking with MACs (3) Period 123 Price Period 123 Price Price (1-3) Period 123 Price Price (1-2) Period 123 Price Price (1-3) Price (1-2) No banking Banking 1-3 Banking 1-2

Model of banking with MACs (4) Why ‘two consecutive periods’ ? Because, if profitable, banking –Decreases price of last period (which does not impede on banking opportunities with ‘future’ periods –and even fosters it) –Increases price of first period (which does not impede on banking opportunities with ‘previous’ periods –and even fosters it) Period 123 Price Price (1-4) Price (1-2) Price (3-4) 4 Model solved by loops until only ‘decreasing steps’ Each loop: compute banking between two consecutive periods iff banking is profitable (and if so, consider then these two periods as a single one)

Model of banking with MACs (5) Remarks on the use of MACs: –Advantage of MACs: ‘easy to use’ model allowing much flexibility in, for instance, participation structure –Drawback of MACs: dynamics only via inter-temporal trades of permits (exogenous technological change)

Content of the presentation Model of banking with MACs Set-up of MacGEM+ Possible scenarios Simulations –Reference scenarios –Participation structure –Allocation rules –Hot air issue Sensitivity analysis

Set-up (1) 5 commitment periods of 5 years (2008 – 2032) 15 regions:

Set-up (2a) Baseline emissions, GDP and population: IPCC SRES scenarios (IMAGE2)

Set-up (2b) Population from SRES

Setup (3a) Marginal abatement cost curves in 2010 from GEM- E3-World (Annex B)

Set-up (3b) MACs in 2010 extended to subsequent commitment periods with –Increasing efficiency of domestic abatement policies: A set of MACs has been computed assuming some inefficiency in domestic abatement policies (same percentage of emission reductions in every economic sector rather than efficient abatement policy) Parameter of domestic efficiency which generates new MACs –Parameter of technological progress: Affects marginal absolute abatement costs in a multiplicative way Value differs across regions: from x% (min) to y% (max) according to rate of bau emissions increase between 2010 and 2030 Needs to be further analysed …!

Set-up (4) Discount rate: see US Acid Rain program (Ellerman, 2002) CDM: increasing accessibility and decreasing trans. costs Sinks in : free and up to limits negotiated in Bonn and Marrakesh

Content of the presentation Model of banking with MACs Set-up of MacGEM+ Possible scenarios Simulations –Reference scenarios –Participation structure –Allocation rules –Hot air issue Sensitivity analysis

Scenarios (1) In each period, set participation of –Annex B countries (+domestic policy when no participation) –non-Annex B countries Emission (reduction) objectives … –Set world emissions objective in periods 4 (2025) and 5 (2030) –Then world objectives in periods 2 (2015) and 3 (2020) are on linear trajectory between period 1 (Kyoto – 2010) and period 4 objectives –Possibility to set objectives for each (group of) region(s) … and their allocation –Several allocation rules are analysed: ‘Kyoto’, egalitarian, grandfathering, ability to pay, energy intensity, … and the ‘Jacoby et al.’ allocation-participation rule. Convergence towards egalitarian rule also possible.

Scenarios (2)

Scenarios (2 bis) Quotas in each region and world bau emissions

Content of the presentation Model of banking with MACs Set up of MacGEM+ Possible scenarios Simulations –Reference scenarios –Participation structure –Allocation rules –Hot air issue Sensitivity analysis

Simulations Reference scenario WEAK (1) Allocation: –Far from egalitarian in 2030 –Hot air for IND (0.292 GtCO2 in 2020 to GtCO2 in 2030) and for AFR (0.021 GtCO2 in 2020) Permits price and amount of banking:

Simulations Reference scenario WEAK (2) Trades

Simulations Reference scenario WEAK (3) Discounted costs periods 1 - 3

Simulations Reference scenario WEAK (4) Impact of banking on costs over the five commitment periods

Simulations Reference scenario STRONG (1) Allocation: –Hot air only for AFR in 2020 (0.045 GtCO2) Permits price and amount of banking:

Simulations Reference scenario STRONG (2) Impact of banking on costs over the five commitment periods

Assumption: participating countries receive amount of permits independent of participation structure Simulations Participation structure (1)

Significant change in world emissions (period 2) Limited effect on prices Banking –Stable in period 1 –Increase in period 2 and decrease in period 3 Simulations Participation structure (2)

Only on ‘strong’ scenario Changes in allocation rules: –‘Soft entry’ for non-Annex B countries –Change in year of convergence –Grandfathering (1990) towards egalitarianism –Jacoby, Schmalensee and Wing allocation-participation rule Simulations Other allocation rules (0)

‘Soft entry’ for non-Annex B countries: distribution of permits according their bau emissions for their first commitment period (2020) –World emissions over five periods increase: from to GtCO2 (x5) –Discounted permits’ price decreases: from 31.8$ to 27.7$ –Banking in period 3 increases considerably: from –0.143 to GtCO2, but decreases in periods 1 and 2 –Total discounted costs for Annex B regions: -5 to -10 % –Total discounted costs for non-Annex B regions: -50 %, with large gains in period 3 Simulations Other allocation rules (strong) (1)

Change in year of convergence Simulations Other allocation rules (strong) (2)

Grandfathering (1990) towards egalitarianism (in 2080) –Total disc. Costs for Annex B regions: -50% –Total disc. Costs for non-Annex B regions: +200% Jacoby, Schmalensee and Wing rule (calibration such that same total world emissions): –Participation structure very different from REF scenarios: MEA and SAM in period 2 ; ASI in period 3; ROW in period 4 and MED in period 5 (AFR, CHI and IND join later) –Permits’ price increases from 32.2$ to 39.6$ –Annex B total costs: decrease for USA and CEU; increase for the others (+50%) –Non-Annex B total costs: larger disparity with large gains for AFR, CHI and IND (all together: -45%) Simulations Other allocation rules (strong) (3)

Not an ‘issue’ anymore since no monopoly effect over all periods Simulations Market power from hot air (CEU in 2010)

Content of the presentation Model of banking with MACs Set up of MacGEM+ Possible scenarios Simulations –Reference scenarios –Participation structure –Allocation rules –Hot air issue Sensitivity analysis

Sensitivity analysis (1) Discount rate: 2% ; 8% (REF: 5%) –Strong effects on amount of banking and therefore on prices, but weak impacts on total discounted costs Baselines: SRES= A1F ; B1 (REF: Mean) –Important effect on emission reductions, on world total emissions and on prices –Sharp increase in total costs for non-Annex B countries and for CEU under the A1F (high) baseline Technological progress: from 7.5% to 30% ; from 2.5% to 20% (REF: from 5% to 25%) –No spectacular effect on prices –Decrease in tech. Progress  Increase in Banking –Similar variations of total costs in all regions

Sensitivity analysis (2) Efficiency of domestic policies: less efficient (50% in 2010 to 75% in 2030) ; full efficiency (100%) (REF: 75% in 2010 to 95% in 2030) –Limited impacts ; more on Annex B than on nAB total costs CDM efficiency: less efficient ; more efficient –Limited impacts ; very small impacts on Annex B total costs

Sensitivity analysis (3)

Sensitivity analysis (4)

Sensitivity analysis (5)

Sensitivity analysis (6)

Sensitivity analysis (7)

Conclusions Banking may have very important impacts on prices (especially in the Kyoto period) Level of banking in the Kyoto period may be well above CEU’s hot air Banking favours non-Annex B regions and CEU while it increases total costs for the other Annex B regions No monopoly effect of CEU due to hot air in the Kyoto period High sensitivity to discount rate and baseline emissions Need to calibrate technological progress…! (? function of actual previous reductions + baseline ?)