About the book: Over the last decade, market-based incentives have become the regulatory tool of choice when trying to solve difficult environmental problems. Evidence of their dominance can be seen in recent proposals for addressing global warming (through an emissions trading scheme in the Kyoto Protocol) and for amending the Clean Air Act (to add a new emissions trading systems for smog precursors and mercury--the Bush administration's "Clear Skies" program). They are widely viewed as more efficient than traditional command and control regulation. This collection of essays takes a critical look at this question, and evaluates whether the promises of market-based regulation have been fulfilled. Contributors put forth the ideas that few regulatory instruments are actually purely market-based, or purely prescriptive, and that both approaches can be systematically undermined by insufficiently careful design and by failures of monitoring and enforcement. All in all, the essays recommend future research that no longer pits one kind of approach against the other, but instead examines their interaction and compatibility.

Climate change is a threat that could be mitigated by introducing new energy technologies into the electricity market that emit fewer greenhouse gas (GHG) emissions. We face many uncertainties that would affect the demand for each of these technologies in the future. The costs of these technologies decrease due to learning-by-doing as their capacity is built out. Given that we face uncertainties over future energy demands for particular technologies, and that costs reduce with experience, an important question that arises is whether policy makers should encourage early investments in technologies before they are economically competitive, so that they could be available in the future at lower cost should they be needed. If society benefits from early investments when future demands are uncertain, then there is an option value to investing today. This question of whether option values exist is investigated by focusing on Coal-fired Power Plants with Carbon Capture and Storage (CCS) as a case study of a new high-cost energy technology that has not yet been deployed at commercial scale.

A decision analytic framework is applied to the MIT Emissions Prediction Policy Analysis (EPPA) model, a computable general equilibrium model that captures the feedback effects across different sectors of the economy, and measures the costs of meeting emissions targets. Three uncertainties are considered in constructing a decision framework: the future stringency of the US GHG emissions policy, the size of the US gas resource, and the cost of electricity from Coal with CCS. The decision modeled is whether to begin an annual investment schedule in Coal with CCS technology for 35 years. Each scenario in the decision framework is modeled in EPPA, and the output measure of welfare is used to compare the welfare loss to society of meeting the emissions target for each case. The decision framework is used to find which choice today, whether to invest in CCS or not, gives the smallest welfare cost and is therefore optimal for society. Sensitivity analysis on the probabilities of the three uncertainties is carried out to determine the conditions under which CCS investment is beneficial, and when it is not.

The study finds that there are conditions, specified by ranges in probabilities for the uncertainties, where early investment in CCS does benefit society. The results of the decision analysis demonstrate that the benefits of CCS investment are realized in the latter part of the century, and so the resulting optimal decision depends on the choice of discount rate. The higher the rate, the smaller the benefit from investment until a threshold is reached where choosing to invest becomes the more costly decision. The decision of whether to invest is more sensitive to some uncertainties investigated than others. Specifically, the size of the US gas resource has the least impact, whereas the stringency of the future US GHG emissions policy has the greatest impact.

This thesis presents a new framework for considering investments in energy technologies before they are economically competitive. If we can make educated assumptions as to the real probabilities we face, then extending this framework to technologies beyond CCS and expanding the decision analysis, would allow policymakers to induce investment in energy technologies that would enable us to meet our emissions targets at the lowest cost possible to society.

To what extent do the welfare costs associated with the implementation of the Burden Sharing Agreement in the European Union depend on sectoral allocation of emissions rights? What are the prospects for strategic climate policy to favor domestic production? This paper attempts to answer those questions using a CGE model featuring a detailed representation of the European economies. First, numerical simulations show that equalizing marginal abatement costs across domestic sectors greatly reduces the burden of the emissions constraint but also that other allocations may be preferable for some countries because of pre-existing tax distortions. Second, we show that the effect of a single country's attempt to undertake a strategic policy to limit impacts on its domestic energy-intensive industries has mixed effects. Exempting energy-intensive industries from the reduction program is a costly solution to maintain the international competitiveness of these industries; a tax-cum-subsidy approach is shown to be better than exemption policy to sustain exports. The welfare impact either policy — exemption or subsidy — on other European countries is likely to be small because of general equilibrium effects. © 2003 Kluwer Academic Publishers

In 2007 the US Congress began considering a set of bills to implement a cap-and-trade system to limit the nation’s greenhouse gas (GHG) emissions. The MIT Integrated Global System Model (IGSM) — and its economic component, the Emissions Prediction and Policy Analysis (EPPA) model — were used to assess these proposals. In the absence of policy, the EPPA model projects a doubling of US greenhouse gas emissions by 2050. Global emissions, driven by growth in developing countries, are projected to increase even more. Unrestrained, these emissions would lead to an increase in global CO2 concentration from a current level of 380 ppmv to about 550 ppmv by 2050 and to near 900 ppmv by 2100, resulting in a year 2100 global temperature 3.5–4.5°C above the current level. The more ambitious of the Congressional proposals could limit this increase to around 2°C, but only if other nations, including developing countries, also strongly controlled greenhouse gas emissions. With these more aggressive reductions, the economic cost measured in terms of changes in total welfare in the United States could range from 1.5% to almost 2% by the 2040–2050 period, with 2015 CO 2-equivalent prices between $30 and $55, rising to between $120 and $210 by 2050. This level of cost would not seriously affect US GDP growth but would imply large-scale changes in its energy system.

© 2008 Earthscan

Supersedes Report 146.