Climate Change 2001: Working Group III: Mitigation

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The Costs and Ancillary⁹ Benefits of Mitigation Actions

11. Estimates of cost and benefits of mitigation actions differ because of (i) how welfare is measured, (ii) the scope and methodology of the analysis, and (iii) the underlying assumptions built into the analysis. As a result, estimated costs and benefits may not reflect the actual costs and benefits of implementing mitigation actions. With respect to (i) and (ii), costs and benefits estimates, inter alia, depend on revenue recycling, and whether and how the following are considered: implementation and transaction cost, distributional impacts, multiple gases, land-use change options, benefits of avoided climate change, ancillary benefits, no regrets opportunities¹⁰ and valuation of externalities and non-market impacts. Assumptions include, inter alia:

• Demographic change, the rate and structure of economic growth; increases in personal mobility, technological innovation such as improvements in energy efficiency and the availability of low-cost energy sources, flexibility of capital investments and labour markets, prices, fiscal distortions in the no-policy (baseline) scenario.
• The level and timing of the mitigation target.
• Assumptions regarding implementation measures, e.g. the extent of emissions trading, the Clean Development Mechanism (CDM) and Joint Implementation (JI), regulation, and voluntary agreements ¹¹ and the associated transaction costs.
• Discount rates: the long time scales make discounting assumptions critical and there is still no consensus on appropriate long-term rates, though the literature shows increasing attention to rates that decline over time and hence give more weight to benefits that occur in the long term. These discount rates should be distinguished from the higher rates that private agents generally use in market transactions.
  (Sections 7.2, 7.3, 8.2.1, 8.2.2, 9.4)

12. Some sources of greenhouse gas emissions can be limited at no or negative net social cost to the extent that policies can exploit no regrets opportunities (Sections 7.3.4, 9.2.1):

• Market imperfections. Reduction of existing market or institutional failures and other barriers that impede adoption of cost-effective emission reduction measures, can lower private costs compared to current practice. This can also reduce private costs overall.
• Ancillary benefits. Climate change mitigation measures will have effects on other societal issues. For example, reducing carbon emissions in many cases will result in the simultaneous reduction in local and regional air pollution. It is likely that mitigation strategies will also affect transportation, agriculture, land-use practices and waste management and will have an impact on other issues of social concern, such as employment, and energy security. However, not all of the effects will be positive; careful policy selection and design can better ensure positive effects and minimize negative impacts. In some cases, the magnitude of ancillary benefits of mitigation may be comparable to the costs of the mitigating measures, adding to the no regrets potential, although estimates are difficult to make and vary widely (Sections 7.3.3, 8.2.4, 9.2.2-9.2.8, 9.2.10).
• Double dividend. Instruments (such as taxes or auctioned permits) provide revenues to the government. If used to finance reductions in existing distortionary taxes (“revenue recycling”), these revenues reduce the economic cost of achieving greenhouse gas reductions. The magnitude of this offset depends on the existing tax structure, type of tax cuts, labour market conditions, and method of recycling. Under some circumstances, it is possible that the economic benefits may exceed the costs of mitigation (Sections 7.3.3, 8.2.2, 9.2.1)
  

13. The cost estimates for Annex B countries to implement the Kyoto Protocol vary between studies and regions as indicated in Paragraph 11, and depend strongly upon the assumptions regarding the use of the Kyoto mechanisms, and their interactions with domestic measures. The great majority of global studies reporting and comparing these costs use international energy-economic models. Nine of these studies suggest the following GDP impacts ¹² (Sections 7.3.5, 8.3.1, 9.2.3, 10.4.4):

Annex II countries¹³ : In the absence of emissions trading between Annex B countries¹⁴, the majority of global studies show reductions in projected GDP of about 0.2% to 2% in 2010 for different Annex II regions. With full emissions trading between Annex B countries, the estimated reductions in 2010 are between 0.1% and 1.1% of projected GDP¹⁵. These studies encompass a wide range of assumptions as listed in Paragraph 11. Models whose results are reported in this paragraph assume full use of emissions trading without transaction cost. Results for cases that do not allow Annex B trading assume full domestic trading within each region. Models do not include sinks or non-CO₂ greenhouse gases. They do not include the CDM, negative cost options, ancillary benefits, or targeted revenue recycling.

For all regions costs are also influenced by the following factors:

• Constraints on the use of Annex B trading, high transaction costs in implementing the mechanisms, and inefficient domestic implementation could raise costs.
• Inclusion in domestic policy and measures of the no regrets possibilities¹⁰ identified in Paragraph 12, use of the CDM, sinks, and inclusion of non-CO₂ greenhouse gases, could lower costs. Costs for individual countries can vary more widely.
  

The models show that the Kyoto mechanisms are important in controlling risks of high costs in given countries, and thus can complement domestic policy mechanisms. Similarly, they can minimize risks of inequitable international impacts and help to level marginal costs. The global modelling studies reported above show national marginal costs to meet the Kyoto targets from about US$20/tC up to US$600/tC without trading, and a range from about US$15/tC up to US$150/tC with Annex B trading. The cost reductions from these mechanisms may depend on the details of implementation, including the compatibility of domestic and international mechanisms, constraints, and transaction costs.

This reflects opportunities for energy efficiency improvements not available to Annex II countries. Under assumptions of drastic energy efficiency improvement and/or continuing economic recessions in some countries, the assigned amounts may exceed projected emissions in the first commitment period. In this case, models show increased GDP due to revenues from trading assigned amounts. However, for some economies in transition, implementing the Kyoto Protocol will have similar impact on GDP as for Annex II countries.

14. Cost-effectiveness studies with a century timescale estimate that the costs of stabilizing CO₂ concentrations in the atmosphere increase as the concentration stabilization level declines. Different baselines can have a strong influence on absolute costs. While there is a moderate increase in the costs when passing from a 750ppmv to a 550ppmv concentration stabilization level, there is a larger increase in costs passing from 550ppmv to 450ppmv unless the emissions in the baseline scenario are very low. These results, however, do not incorporate carbon sequestration, gases other than CO₂ and did not examine the possible effect of more ambitious targets on induced technological change ¹⁶. Costs associated with each concentration level depend on numerous factors including the rate of discount, distribution of emission reductions over time, policies and measures employed, and particularly the choice of the baseline scenario: for scenarios characterized by a focus on local and regional sustainable development for example, total costs of stabilizing at a particular level are significantly lower than for other scenarios¹⁷ (Sections 2.5.2, 8.4.1, 10.4.6).

15. Under any greenhouse gas mitigation effort, the economic costs and benefits are distributed unevenly between sectors; to a varying degree, the costs of mitigation actions could be reduced by appropriate policies. In general, it is easier to identify activities, which stand to suffer economic costs compared to those which may benefit, and the economic costs are more immediate, more concentrated and more certain. Under mitigation policies, coal, possibly oil and gas, and certain energy-intensive sectors, such as steel production, are most likely to suffer an economic disadvantage. Other industries including renewable energy industries and services can be expected to benefit in the long term from price changes and the availability of financial and other resources that would otherwise have been devoted to carbon-intensive sectors. Policies such as the removal of subsidies from fossil fuels may increase total societal benefits through gains in economic efficiency, while use of the Kyoto mechanisms could be expected to reduce the net economic cost of meeting Annex B targets. Other types of policies, for example exempting carbon-intensive industries, redistribute the costs but increase total societal costs at the same time. Most studies show that the distributional effects of a carbon tax can have negative income effects on low-income groups unless the tax revenues are used directly or indirectly to compensate such effects (Section 9.2.1).

16. Emission constraints in Annex I countries have well established, albeit varied “spillover” effects ¹⁸ on non-Annex I countries (Sections 8.3.2, 9.3).

• Oil-exporting, non-Annex I countries: Analyses report costs differently, including, inter alia, reductions in projected GDP and reductions in projected oil revenues ¹⁹. The study reporting the lowest costs shows reductions of 0.2% of projected GDP with no emissions trading, and less than 0.05% of projected GDP with Annex B emissions trading in 2010 ²⁰. The study reporting the highest costs shows reductions of 25% of projected oil revenues with no emissions trading, and 13% of projected oil revenues with Annex B emissions trading in 2010. These studies do not consider policies and measures ²¹ other than Annex B emissions trading, that could lessen the impact on non-Annex I, oil-exporting countries, and therefore tend to overstate both the costs to these countries and overall costs.

The effects on these countries can be further reduced by removal of subsidies for fossil fuels, energy tax restructuring according to carbon content, increased use of natural gas, and diversification of the economies of non-Annex I, oil-exporting countries.

• Other non-Annex I countries: They may be adversely affected by reductions in demand for their exports to OECD nations and by the price increase of those carbon-intensive and other products they continue to import. These countries may benefit from the reduction in fuel prices, increased exports of carbon-intensive products and the transfer of environmentally sound technologies and know-how. The net balance for a given country depends on which of these factors dominates. Because of these complexities, the breakdown of winners and losers remains uncertain.
• Carbon leakage ²². The possible relocation of some carbon-intensive industries to non-Annex I countries and wider impacts on trade flows in response to changing prices may lead to leakage in the order of 5%-20% (Section 8.3.2.2). Exemptions, for example for energy-intensive industries, make the higher model estimates for carbon leakage unlikely, but would raise aggregate costs. The transfer of environmentally sound technologies and know-how, not included in models, may lead to lower leakage and especially on the longer term may more than offset the leakage.