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Archived — Working Paper Number 34: Sectoral impacts of Kyoto compliance

by Randall Wigle, Wilfrid Laurier University, March 2001


Introduction

This paper looks at Canada's compliance with its Kyoto Protocol obligations, focusing on two questions:

  1. What sectors are likely to be the hardest hit (and, conversely, which might benefit) from various modalities of compliance with the Kyoto Protocol?
  2. How do the costs of compliance change when the domestic implementation plan exempts some sectors?

The analysis is conducted using a simulation model of the world economy. Specifically, a static CGE (Computable General Equilibrium) model based on the GTAP (Global Trade Analysis Project) data2 is used. A distinguishing feature of this analysis is the relatively detailed sectoral breakdown: 31 sectors and 11 regions are identified.

The study first looks at two "core" cost-effective policy approaches (national and global carbon permit trading) by way of placing the model's results in the context of other existing CGE carbon models. The central case welfare effects and carbon taxes presented have a very similar flavour to results surveyed in the May, 1999 special issue of the Energy Journalon the costs of the Kyoto Protocol in most respects.

Given the plethora of models available for the analysis of these issues, the focus of this paper is on sectoral effects and the relative compliance costs associated with different domestic implementation schemes, rather than the specific welfare effects or carbon taxes generated. It also looks at how the sector-by-sector impacts of compliance are affected by various modalities of domestic implementation. This allows us to see how compliance costs and carbon prices respond to the same issues in policy configuration.

Part of the analysis focuses on domestic implementation against the backdrop of a given international framework. In particular, we consider domestic implementation plans that only apply to some sectors of the economy. The key findings are as follows:

  1. If the Kyoto Protocol is implemented by reducing Canadian emissions by roughly 25 percent relative to business-as-usual (BAU) at 20103, Canada's most energy-intensive sectors can expect to decline markedly, though only dramatically for the energy sectors themselves. The energy-intensive sectors that don't decline will be those that enjoy energy or carbon-intensity advantages over their Annex B competitors (usually in the United States). This may reduce or reverse the decline of the sector. Canada's least energy-intensive sectors are likely to experience much more limited impacts and several may expand modestly.

    These conclusions assume a cost-effective domestic implementation scheme in Canada, such as an across-the-board carbon tax or a comprehensive carbon permits scheme. If such a domestic implementation scheme is adopted, the cost of compliance for Canada is estimated to be modest (less than 1.5 percent of GNP).

  2. If the Kyoto Protocol is implemented with significant international trading, the important negative sectoral impacts largely disappear. In some cases, energy-intensive industries may expand modestly even if their energy intensities exceed those of Annex B competitors. This is most likely to be the case when their energy intensities are still less than those of their non-Annex B competitors. In such sectors, exports may rise and imports may fall.
  3. Without sectoral exemptions, the broad conclusion is that, with or without global permit trading, Kyoto compliance is moderately costly. Extending broad sectoral exemptions or departing from cost-effective instruments of domestic implementation can alter that basic conclusion.
  4. If any carbon restrictions are focused narrowly, the resulting plans can be extremely costly when all abatement occurs within Canada. The narrower the focus of implementation plans, the higher the cost to Canada. In one extreme case where the energy-intensive sectors are all exempted, the welfare cost can be 4–6 times as high as under a comprehensive scheme.4 In the case where the most energy-intensive sectors alone are targeted, the welfare cost roughly doubles, but this result relies on the availability of a backstop technology which could provide added abatement at constant cost. Whether such a technology will be available at a feasible cost is an open question.
  5. Such sectoral exemptions can also radically alter the pattern of sectoral effects in the absence of international trading. Indeed, the sectoral impacts come to reflect the pattern of exemptions rather than energy intensities.
  6. In the presence of global trading, sectoral exemptions in the domestic implementation plan among buyer regions are typically more costly than cost-effective plans, but the consequences of the exemptions are dramatically less acute than without trading, even when these distortions are extended to all buyer regions. The narrower the focus of implementation plans, the higher the cost. One effect of such exemptions is to reduce the proportion of abatement achieved within Annex B regions with the exemptions.
  7. When sectoral exemptions are used without trading, the effect is to enforce higher proportions of emissions reductions on those sectors that do need to comply. This raises the marginal cost of abatement (carbon taxes). In some cases, these tax rates are astronomical. Note that these high tax rates can emerge even when there is a carbon-free backstop, if the electricity sector is exempted from compliance. These extreme carbon taxes are indicative of a very serious flaw in the logic of extreme exemptions. By contrast, with global trading of emissions permits, one of the main impact is to reduce domestic abatement.
  8. An exemption for final users appears to have significantly less welfare impact than sectoral exemptions, but does cause the required carbon tax for a given target to rise. This result is independent of the presence or absence of international trading. Further, when there is global trading of permits, it does not dramatically reduce the extent of the Kyoto commitment achieved through emissions reductions in Canada.
  9. If international trading of permits between Annex B and non-Annex B regions is pursued on a project-by-project basis, many opportunities for inexpensive abatement are likely to be missed. Such divergences from cost-effectiveness in seller regions are likely to increase the world carbon price and increase compliance costs.
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