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1
Macroeconomic Impacts ofEU Climate Policy in 2008-2012
AIECE
November 5, 2008
Olavi Rantala - Paavo SuniThe Research Institute of the Finnish Economy
ETLA
2
Macroeconomic baseline scenario
Financial crisis dampens strongly world economic growth in 2008-2012- United States falls into recession, Japanese growth is slow
- Developing countries, esp. China hit hard, but continue growing relatively rapidly
- Commodity producers’ surpluses diminish, which lags their investments
EU countries face a severe slowdown - Many EU countries going into recession as EU as a whole
Growth getting stronger in the course of 2010, but slowly- Previous 5-year period was especially strong
After the current turmoil growth rates recover back to potentialbut below the recent record strong growth
3
World economic growth by region, %
Share of total, %
2005
2002 - 2007
2007* 2008f 2009f 2009 – 2012f
World 100.0 4.6 4.5 3.3 2.4 3.4 Asia 29.0 7.6 7.5 6.1 5.4 5.7 China 9.6 11.0 11.9 10.0 9.0 8.6 Middle East 3.7 5.9 5.9 6.2 5.5 5.6 Africa 2.9 5.8 6.3 5.5 5.5 5.8 North America 24.4 2.8 1.8 1.3 0.0 1.5 United States 22.4 2.8 1.7 1.3 -0.1 1.4 Latin America 8.2 5.1 5.6 4.5 3.0 3.8 EU (baseline scenario) 23.5 2.7 2.9 1.4 0.4 1.7
4
World economic growth 2002-2012
-1
0
1
2
3
4
5
6
7
8
9
10
11
12
World Asia China Middle East Africa NorhAmerica
UnitedStates
LatinAmerica
EU (baselinescenario)
%
2002-2007 2008f 2009f 2009-2012f
5
Primary energy prices
Energy prices have peaked in 2008 at record levels- Oil: peaked at close to 150 USD/b,
by mid-October below 70 USD/b - Coal: fiscal year prices doubled in case of steam oil
- Gas: prices follow oil and oil product price decline with a lag
In the longer term, the availability of energyis one of the key risks for global growth
6
World market prices of oil and coal and gas price in Europe
10
20
30
40
50
60
70
80
90
100
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Year
1
2
3
4
5
6
7
8
9
10
Oil (Brent, € / barrel, lhs.) Coal (Australia, € / ton, lhs.) Gas (import price in EU, € / Mbtu, rhs.)
7
The baseline scenario of CO2 emissions
In the forecasting model the baseline scenarioof CO2 emissions is based on energy demand in four sectors:industry, transport, households and the rest of the economy
CO2 emissions reflect electricity supply generated by fossil fuels
and other consumption of fossil fuels
CO2 emissions of electricity generation are increasedby the demand for electricity in the four sectors
and decreased by the clean electricity generatedby means of renewable energy sources
and nuclear power
Recent Eurostat data indicates a reboundin electricity consumption and estimated CO2 emissions in the EU
in spring 2008
8
CO2 emissions in baseline scenario
Output by sector
Electricityconsumption
Heatconsumption
Transport
Temperature
Clean electricity generation
Energy producedby fossil fuels
CO2 emissionsRainfall
Industrial processes
9
Increase of CO2 emissions in the EU baseline scenario
-200
-150
-100
-50
0
50
100
150
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Year
Mill
ion
to
nn
es
Electricity generation Other consumption of fossil fuels CO2 emissions
10
Recent increase of CO2 emissions in EUChanges from corresponding month of prevous year
-15
-10
-5
0
5
10
15
2005
/1 4 7 10
2006
/1 4 7 10
2007
/1 4 7 10
2008
/1 4
Year / month
%
-15
-10
-5
0
5
10
15
%
Emissions Consumption of fossil fuels
Oil consumption Electricity produced by fossil fuels
11
Climate policy and the electricity market
The cornerstone of EU climate policy isthe reduction of CO2 emissions in electricity generation and industry
under the European Union Emission Trading Scheme (EU ETS)
CO2 emissions result largely from electricity generation
More than 50 % of electricity is produced by fossil fuels in the EU
There are hardly any substitutes for fossil fuelsin electricity production in the short run
The price of emission allowances createsan extra marginal cost in electricity production
Increases in the price of emission allowancesare largely passed through to the price of electricity
12
Supply and demand for electricity in EU
Gas
Price of emission allowance
Coal
Price of emission allowance
Nuclear powerHydro and w ind pow er
Demand curve
Producer price
Price including taxes
0
20
40
60
80
100
120
140
0 500 1000 1500 2000 2500 3000
Output 2006, TWh
Va
ria
ble
pro
du
cti
on
co
sts
an
d p
ric
e
13
Channels to macroeconomic developments
The price of emission allowances has become an important determinant of the price of electricity
The price of electricity is the main channel of the impacts ofclimate policy on macroeconomic developments
The price elasticity of the demand for electricity is rather low(-0.1 for industry and -0.2 for households)
The downward adjustment of the demand for electricity and CO2 emissionsmay necessitate a large increase in the price of emission allowances
and in the the price of electricity
This leads to increasing costs in industry, higher consumer prices for householdsand decreasing macroeconomic activity
The macroeconomic adjustment finally leads tolower demand for energy and reductions in CO2 emissions
14
Macroeconomic adjustment to climate policy
(+)
(–) (–)
(+)
(–) (–)(+)
(–)
(–) (+) (–)
(+)
(+)
(+) (+)
World economic growth
EU economic growth
Energyconsumption
Domestic demand Exports
CO2
emissions
Price of emission allowances
Price of electricity
Emission allowances
Industryproduction costs
Householdreal income
Consumerprices
15
Baseline scenario of CO2 emissions in EU ETS
CO2 emissions in the EU emission trading sector under the EU ETS grew by about 4 per cent in 2007
According to our baseline scenariothe emissions will decrease in 2008-2012
CO2 emissions will exceed the emission allowances
on average by about 100 million tonnes annually in 2008-2012
Uncertainties in the baseline EU ETS emission scenario:- macroeconomic developments and energy demand
- clean electricity supply
16
Baseline scenario of CO2 emissions
in the EU emission trading sector
2000
2100
2200
2300
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Year
Mill
ion
to
nn
es
Emissions Baseline scenario Emission allowances
17
Primary energy sources of EU electricity generation
0
500
1000
1500
2000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Year
TWh
Nuclear power Hydro power Wind Biomass Clean electricity Fossil fuels
18
Assumptions in policy scenarios
Emission allowances for the Kyoto period 2008-2012have been cut by some 10 percent as compared to the first emission trading period 2005-2007
Our most stringent policy scenario - “maximum impact policy scenario” - assumes that the CO2 emissions of EU ETS
must be reduced to the allowed cap in 2008-2012
Emission trading and other Kyoto mechanisms (Clean Development Mechanism, CDM, and Joint Implementation, JI)
allow flexibility in the adjustment of the CO2 emissions
The other extreme policy scenario - “minimum impact policy scenario” - assumes a perfectly elastic supply of emission reduction units
(Certified Emission Reductions, CER)from developing countries at the minimum price of 10 €/t
(roughly the minimum price set by China)
Our forecast for the emissions of the EU emission trading sector in 2012 lies in the middle of the two extreme scenarios
19
Adjustment of CO2 emissions in the EU emission trading sector
1800
1900
2000
2100
2200
2300
2005 2006 2007 2008f 2009f 2010f 2011f 2012f
Year
Mill
ion
to
nn
es
Possible adjustment paths Forecast Emission allowances
20
Emission allowance price and electricity prices
The increase in emission allowance price will be gradually passed on to electricity prices
In the minimum impact policy scenariothe emission allowance price is assumed to be only 10 €/t
and the impact on electricity prices is rather small
The maximum impact policy scenarioimplies a sharp rise in emission allowance price
and electricity prices
21
Price of emission allowances
0
50
100
150
200
2005 2006 2007 2008f 2009f 2010f 2011f 2012f
Year
€ /
t
Possible adjustment paths Forecast
22
Electricity price for European industry
0
100
200
300
400
2005 2006 2007 2008f 2009f 2010f 2011f 2012f
Year
€ /
MW
h
Possible adjustment paths Forecast
23
Electricity price for European households
0
200
400
600
800
2005 2006 2007 2008f 2009f 2010f 2011f 2012f
Year
€ /
MW
h
Possible adjustment paths Forecast
24
Macroeconomic impacts of EU climate policy
The increase in emission allowance and electricity priceswill weaken export competitiveness and export performance
especially in export markets outside the EU area
Rising electricity prices will also raise consumer pricesand slow down household real income and consumption growth
The negative impact on exports and domestic demand will be reflected on GDP and employment
Macroeconomic impacts may be strongerin the small open energy-intensive EU countries
than in the major EU countries
25
Macroeconomic impacts of climate policy in the EU area in 2012 as compared to the baseline scenario, %
Policy impact in 2012, %
Baseline scenario in 2012,
2007=100
Minimum impact
Forecast Maximum impact
Industry: Price of electricity 153 20 75 157 Output costs 120 0.5 2.3 5.1 Households: Price of electricity 172 20 75 157 Consumer prices 113 0.3 1.0 1.8 Macro economy: Exports 117 -0.2 -0.8 -1.5 Industrial production 109 -0.2 -0.7 -1.3 Domestic demand 110 -0.2 -0.5 -0.8 GDP 108 -0.2 -0.6 -1.0 Employment 104 -0.1 -0.3 -0.5
26
Differences in the macroeconomic impactsbetween countries
Exports in relation to GDP, especially exports outside EU
Energy-intensity of industry
Impact of temperature on energy demand
27
Exports / GDP in 2005
0
20
40
60
80
100
120
140
160
Slova
kia
Luxem
bourg
Sweden
Belgiu
m
Finla
nd
Nether
lands
Irela
nd
Czech
Rep
ublic
Slove
nia
Unite
d Kin
gdom
Austri
a
Hungar
y
Denm
ark
Estoni
a
Bulgar
ia
Polan
d
Cypru
s
France
Lithuan
ia
Germ
any
Latvi
aM
alta EU
Portu
gal
Roman
iaIta
ly
Spain
Greec
e
%
Exports outside EU Exports to EU
28
Manufacturing industry electricity consumption / output volumein 2005
0
100
200
300
400
500
Luxem
bourg
Finla
nd
Sweden
Latvi
a
Eston
ia
Portu
gal
Austri
a
Lithua
nia
Slova
kia
Spain
Belgi
um
Unite
d Kin
gdom EU
Nethe
rlands
Franc
e
Polan
d
Ger
man
yIta
ly
Czech
Rep
ublic
Denm
ark
MW
h /
mill
. €
29
Household electricity consumption and temperaturein EU countries 1990-2000
Austria
Latvia
Belgium
France
Germany
Romania
Denmark
EstoniaSpain
Italy Greece
PortugalCyprus
Malta
Sweden
Finland
0
1
2
3
4
5
0 2 4 6 8 10 12 14 16 18 20 22
Annual mean temperature, oC
An
nu
al c
on
su
mp
tio
n p
er
ca
pit
a, M
Wh
30
Greenhouse gas developments in EU
EU total greenhouse gas emissions meetthe Kyoto commitment target in 2008-2012
according to our baseline scenario
Emissions will fall clearly below the Kyoto targetaccording to our policy scenario
EU climate policy seems to beunnecessarily stringent in 2008-2012
31
Greenhouse gas emissions in EU
4800
5000
5200
5400
5600
5800
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008f 2010f 2012f
Year
Mill
ion
to
nn
es
Emissions Baseline scenario Forecast Kyoto Protocol target
32
Conclusions
EU climate policy dampens the medium-termeconomic growth in the EU area
EU climate policy seems to beunnecessarily stringent in 2008-2012
in terms of the Kyoto commitment targeton greenhouse gas reductions
Uncertainties in the scenarios:- The baseline macroeconomic scenario
- The flexibility in CO2 emissions allowed by the Kyoto mechanisms,especially the supply of clean development (CDM) credits
from China and other developing countries