Joint implementation and cost-effectiveness under the Framework Convention on Climate Change

r~UTTERWORTH I 1 1 E , N E M A N N

Joint implementation and cost-effectiveness under the Framework Convention on Climate Change

Etter,t,y Poli¢ v. Vol. 23, NiL 2. pp. I 17-138. 1995 Copyrighl © 1995 Elsevier Science Lid

Printed in Great Britain. All rights reserved 0301 ~4215/94 $ I 0.00 + 0.00

Tim Jackson Centre for Environmental Strategy. University of Surrey, Guildford, GU2 5XH, UK

The concept of ' joint implementat ion ' is the subject of ongoing negotiations under the Framework Convention on Climate Change. Proponents argue that allowing joint implementation of the objectives of the Convention will increase the cost-effectiveness with which those objectives are achieved. Opponents argue that allowing trade in carbon emission credits will reduce the incentive for domestic greenhouse gas emissions reductions, and may undermine the commitments of the developed nations to take the lead in achieving climate stabilization. This paper examines the argument for joint implementation from the standpoint of cost-effectiveness. It addresses the determination of incremental costs for abatement options, and the assessment of cost-effectiveness under complex systemic conditions. Using national greenhouse gas abatement costing studies f rom four different nations - two developed nations, on economy in transition and one developing nation - the paper examines both the general claim for cost- effectiveness of joint implementation and the implicit assumption that emissions reductions will be easier and cheaper in developing nations and economies in transition than they are in developed countries. The results indicate firstly that benefits from joint implementation may be highly dependent on the level of associated transaction costs and secondly that greenhouse gas emission reductions may be considerably cheaper for some developed countries than they are for developing countries. The paper stresses the need for well developed methodological guidelines under which both cost and cost-effectiveness can be assessed, and points to the dangers inherent in allowing ad hoc trading in emissions credits by a heterogeneous community of private investors.

Keywords: Jo in t implementa t ion ; Cos t -e f fec t iveness : C l ima te Change . F ramework C o n v e n t i o n

The objective of the Framework Convention on Climate Change (FCCC) is (Article 2) the 'stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interfer- ence with the climate system'. The concept of 'joint implementation' has been incorporated into the Convention with the specific intention of improving the cost-effectiveness of implementing that objective. In support of this intention, however, there is as yet little in the documentation surrounding the convention to indicate how exactly joint implementation is to be defined, by whom it will be carried out, or the means whereby it will ensure that the aim of cost-effectiveness is achieved.

Article 3 of the convention requires that Parties be guided, inter alia, by the principle that 'policies and measures to deal with climate change should be cost- effective, so as to ensure global benefits at the lowest possible cost'. To this end, the same article allows efforts to address climate change to be 'carried out co- operatively by interested parties'. This theme is reiterated in Article 4 which sets out the commitments of Annex 1 parties I to the convention. Article 4.2(a)

IThe parties listed under Annex I of the FCCC include the developed country parties and the economies in transition.

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Joint implementation and cost-effectiveness: T Jackson

allows that '[Annex I] Parties may implement such policies and measures jointly with other Parties and may assist other Parties in contributing to the achievement of the objective'. And Article 4.3 states that Annex I parties 'shall provide such financial resources, including for the transfer of technology needed by the developing country Parties to meet the agreed full incremental costs of implementing measures' covered by Article 4.1.

The theme of cost-effectiveness is also implicitly vis- ited by Article 21 which entrusts the Global Environment Facility (GEF) with the operation of the financial mechanism of the convention. The most important operating principles of the GEF are that it will provide funding for the agreed incremental costs of achieving global environmental benefits, and do so in a cost-effective manner. All of these provisions fall short of answering crucial questions about the mechanism for joint implementation, about the determination of cost- effectiveness, and about the exact interpretation of the term 'incremental costs'.

Nor is much light shed on these issues by international precedent.

Joint implementation has been discussed (either implicitly or explicitly) within several other major international conventions. The Montreal Protocol on the Control of Ozone Depleting Substances effectively allows countries to trade their individual obligations regarding the production of listed substances, and also provides a funding mechanism under which developed country parties can provide for the incremental costs incurred by developing country parties in meeting the objectives of the Protocol (Barrett, 1993; Markandya, 1992). J~)int Implementation was implicit in the negotiations behind the EC's Large Combustion Plant Directive to limit sulphur and nitrogen oxide emissions in member states and has recently emerged explicitly within the international negotiations for the Second Sulphur Protocol of the Convention on Long-Range Transboundary Air Pollution (CLRTAP) (Klaasen, 1994). The concept of incremental cost is also included in the Convention on Biological Diversity.

A number of difficulties prevent any direct extrapola- tion of these experiences to the context of the FCCC. In the first place, many of the relevant concepts remain both undefined and even undecided within other international conventions. Secondly, there are some very clear senses in which the environmental parameters of other conventions differ from those of the FCCC, and these differences have implications for cost, for cost-effectiveness and for joint implementation. Finally, and perhaps most importantly, the relative ambiguity of the Climate Convention means that trading, in the sense for instance of the Montreal Protocol, cannot take place, since the commodity of a tradable allowance is undefined under

the convention (Barrett, 1994) and must remain so in the absence of specific emission targets in both donor and host countries.

In the absence of conditions which might provide for a fully fledged system of tradable emission allowances - which has sometimes been referred to as 'closed' joint implementation - advocates of the concept have pro- posed that there is a role nevertheless for an 'open' form of joint implementation. As presently envisaged 2 open joint implementation would allow one party to seek 'credit' (towards its commitments in terms of greenhouse gas emissions) for investments which lead to reductions in greenhouse gas emissions within the geographical boundaries of another party. Credit to the first party may be full or partial (or shared with the second party). The basis of this 'trade in emissions credit' from the second party to the first would be a financial transfer from the first party to the second.

Advocates of joint implementation argue that this trading of emission credits would allow for improved flexibility and cost-effectiveness in fulfilling commitments under the convention. In support of the argument for cost-effectiveness they point out that the costs of reducing emissions differ considerably from country to country, and that the least expensive route to emissions reductions would be to implement those options first which are least expensive, irrespective of their geographical location (see eg Barrett 1992).

Implicit (and sometimes explicit) in the argument for joint implementation is the claim that emissions reductions are often least expensive in developing countries or in countries with economies in transition. Since capital scarcity often renders these countries the least able to take advantage of such investment opportunities, joint implementation - it is argued - represents a means of directing available capital resources to the cheapest options for greenhouse gas abatement.

Opponents of joint implementation argue that such arrangements might reduce the willingness of the developed countries to 'take the lead' (Article 4.2) in addressing the threat of climate change, compromise the sovereignty and national interests of the 'host' nations, decrease the incentive for technological innovation in the 'donor' nations, impair the ability of 'host' nations to harness indigenous resources and develop their own markets, increase the transaction costs as well as the monitoring and verification costs associated with combating climate change. Open joint implementation has been criticized - perhaps most damningly of all - for directly undermining the objective of the convention. Nauru's submission to the 9th session of the Inter-

2See for example INC documents A/AC.237.49 and A/AC.237.33(Misc) and Ramakrishna, 1994)

118 Energy Policy 1995 Volume 23 Number 2

governmental Negotiating Committee (A.AC/237.33MISC) argues for example that allowing Annex I Parties to offset their own commitments to emissions reductions or stabilization by investment in non-Annex I nations will simply lead to uncontrolled global emissions growth.

Much of the validity of these claims and counter- claims will depend on the complex international and national mechanisms under which joint implementation is set up, operated, monitored, and enforced. It will also depend, of course, on the development of future commitments by all parties under the FCCC, and the impact which these have on questions of joint implementation. These issues are discussed in considerable detail in other publications (FIELD, 1993; Hanisch et al 1993; Mintzer, 1994; Newcombe and DeLucia, 1993; Parikh, 1994) and will also be central to negotiations on criteria for joint implementation at the first Conference of the Parties to the FCCC in Berlin in 1995.

The purpose of this paper is to investigate the primary motive for joint implementation, namely the question of cost-effectiveness. The principal argument of the paper, which is scarcely contentious, is that questions of cost- effectiveness should be resolved by reference to a considered and well specified methodology for costing greenhouse gas abatement options. In the absence of such a methodology, arguments for joint implementation on the grounds of cost-effectiveness risk rhetoricism.

This paper sets out the basis for such a methodology, and examines some of the implications of this methodology for 'project based' joint implementation. Using a simplified version of the methodology, it then illustrates some of the arguments for and against joint implementation by using existing data on greenhouse gas abatement costs from a number of different countries.

In the absence of defined management and institutional structures this task remains at best exploratory. For the purposes of this study, as few assumptions as possible are made about particular institutional arrangements under which joint implementation might operate. Rather, the paper concentrates on determining a methodology for analysing de fac to cost-effectiveness which might or might not form the basis for negotiation of joint implementation targets. In particular, the question of cost-effectiveness is determined in relation to a specific notion of incremental cost (set out in more detail below). But this does not preclude the possibility that joint implementation credits are negotiated on some basis other than the specified notion of incremental cost.

Combating the threat of climate change has implications in a number of different economic sectors, and for a number of different kinds of human activities. For the purposes of clarity in this paper, however, the following discussion is restricted to the abatement of greenhouse gas emissions arising from the energy sector, and in par-


ticular to the reduction of carbon dioxide emissions from the combustion of fossil fuels. 3

Costs of greenhouse gas abatement

Assessing the costs and benefits of greenhouse gas emission abatement is complex. Different kinds of costs and benefits are involved. For some of these costs a good deal of reliable data exists. For others, reasonable estimates can be made on the basis of collective wisdom. Other cost streams rely, however, on counteffactual assumptions about the future which are subject to enor- mous uncertainty. Among these 'difficult' costs we can include the price of fossil fuels, the magnitude of transaction costs and monitoring and verification costs, the environmental impacts of climate change, the future costs of adaptation measures, and the dynamic patterns of economic demand and supply which will determine fossil fuel consumption. In spite of these complexities and uncertainties, it is at least possible to identify most of the cost parameters with reasonable accuracy, and to provide a relatively transparent framework for assessing the broad dimensions of cost-effectiveness.

Broadly speaking, it is possible to identify two main avenues of analysis for estimating the economic impacts of greenhouse gas emissions reductions. On the one hand there are top-down, macroeconomic models which predict economy wide impacts on the basis of price elas- ticity, resource intensities, growth parameters and fuel prices. These models tend to present their calculations in terms of the incremental impact of abatement scenarios on GDP. On the other hand, bottom-up, microeconomic models use technological cost data to construct economic estimates on a technology by technology basis. The results of such models are usually presented in terms of specific incremental project costs, but may also be aggregated to the system level or indeed to the level of the economy as a whole. When aggregated, these project level costs may or may not include some allowance for system impacts and macroeconomic impacts.

In practice there are a wide number of variants both within and between these different kinds of analysis, but until recently the main variation between them has been that the macroeconomic models have predicted considerable economic costs associated with reducing emissions of greenhouse gases (Manne and Richels, 1991; Barker and Lewney, 1991), whereas the micro

3The question of offsetting these emissions against afforestation is also beyond the scope of this paper. Although discussed in detail elsewhere (Houghton and Woodwell, 1994), the concept of joint implementation through afforestation has received more criticism than other kinds of joint implementation for reasons discussed in more detail in (Fritsche, 1994).

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economic models have identified considerable potential for the introduction of technological measures which are cost-effective even now and would lead to substantial economic benefits for the implementing party. 4

Each of these approaches is subject to particular limitations. The microeconomic approach tends to underestimate the impacts of intersectoral and economy wide impacts, and overestimate the efficiency of the market mechanism in allowing for the uptake of eco- nomically cost-effective measures. The macroeconomic approach tends to be locked into existing institutional structures by historical price elasticities and underestimate the potential benefits associated with structural change.

More recently however, the two approaches have been brought closer together. This convergence is partly due to the development of mixed, 'meso-level ' analyses which incorporate both technological data and sectoral economic impacts, 5 but in part a result of revised use of the macroeconomic models. Early econometric attempts to model the cost of greenhouse gas abatement used largely historical price elasticities to identify the level of taxation required to reduce demand and then predicted the impacts of such taxes on industry and consumers. The models tended to predict very large tax levels (as a result of historically low elasticities of demand) and concluded that severe economic disruption would follow from the introduction of such measures. The later macroeconomic models have increased the sophistica- tion of the approach, first by attempting to account for the impact of measures other than purely fiscal ones in improving energy efficiency (Barker, 1993), and second by looking at the specific effects of 'revenue recycling' to reduce the impacts of carbon and energy tax rates. It is now realized that it is the 'tail ' of revenue recycling which wags the 'dog ' of carbon taxes - or in other words that the question of revenue recycling has a significant impact on the macroeconomic costs of energy and carbon taxes. A number of studies now indicate that carbon taxes can be used effectively to reduce the distorting impacts of taxes elsewhere in the economy, and could provide positive economic benefits (rather than costs) at the same time as reducing greenhouse gas emissions (Jorgenson and Wilcoxen, 1993; Laroui and Velthuijsen, 1993; Proops et al, 1993; Sondheimer, 1991)

4See for example, Coherence, 1991; Jackson, 1989; Jackson, 1991; Mills et al 1991; Haites, 1990; Krause et al, 1993; Maya et al, 1993; Morthorst, 1993; Schipper et al, 1992; Sitnicki et al, 1990; Sitnicki et al, 1991; UNEP, 1992, 1994a, 1994b, 1994c. 5Examples of such models are provided by a one or two of the country case studies in the UNEP project (UNEP 1994a, 1994b, 1994c).

Almost all of the discussion of funding the costs of greenhouse gas abatement (and indeed the parallel discussion on ozone depletion and sulphur) now focuses on the question of the incremental costs , 6 namely the costs of a particular strategy or measure over and above the costs that would have been incurred in the absence of that strategy or measure. This procedure requires the development of a counterfactual reference scenario: ie what would have been the costs, if a certain measure or strategy had not been implemented. In the context of the climate convention, this counterfactual reference scenario has usually been called the 'baseline'. This baseline is necessary not only to provide the system costs implied by the counterfactual scenario - against which abatement costs can be assessed - but also to assess the incremental abatement - the extent of the reduction in carbon emissions over what would other- wise have been emitted.

It is of interest to note here (although beyond the scope of this paper to discuss in detail) that a require- ment to provide national baselines is currently beyond the commitments of either the developed or the developing country parties to the convention. This fact may reduce the ease with which parties to the convention are able to calculate incremental costs or to identify differences in cost-effectiveness between nations.

Generally speaking greenhouse gas abatement costs may be incurred at three different levels: the project level, the system level, and the level of the economy.

At the project level, the costs involved are largely the costs associated with implementing a particular technology. These costs include the investment capital - usually taken to be levelized over the lifetime of the technology, the operation and maintenance costs, and, where appropriate, the fuel costs or savings. In addition, implementation and transaction costs may appropriately be considered at this level. Monitoring and verification costs could also be allocated as project level costs, although there are clearly system implications involved in assessing such costs. 7

It is the fact that each project interacts within a particular economic subsystem, which gives rise to the system cost level. This is illustrated clearly by the energy sector. The introduction of a particular technology into the energy system changes the technological basis of that system, and in consequence it also changes the economic base of the system. For instance, investment in

6In addition to its dominance of cost discussions under the Montreal Protocol, the Second Sulphur Protocol, the Global Environment Facility and the UNEP Greenhouse Gas Abatement Costing Study, the concept of incremental cost is also the subject for an international working group (PRINCE), aimed at developing and clarifying definitions. 7Fritsche's 1994 paper discusses these costs in more detail.


electricity supply changes the declared net capacity on the system, alters the system load factor and the capital utilization factor, places new demands on the distribution network, and modifies the economics of every other existing and prospective capital investment in the system. This is of particular importance when analysing cost-effectiveness, because an inadequate assessment of the systemic impacts can lead to investments which pro- foundly reduce the potential for cost-effectiveness investment in the future.

Finally, economic costs may be incurred at the economy level. These costs include direct costs to the economy from the system level costs, multiplier effects arising from cross-sectoral linkages and the economic impacts of the policies and instruments used to implement different measures.

In keeping with the different levels of costing, it is clear that there are different levels of incremental cost. Each of these different kinds of incremental cost is based in the difference between a particular strategy or measure and the cost incurred under the baseline scenario. At the economy level, the incremental costs of an abatement strategy tend to be measured in terms of changes in the gross domestic product (GDP). At the system level the incremental costs can be defined by the difference between the total system costs for the abatement scenario minus the total system costs for the baseline scenario.

At the project level one can define the incremental cost c i of an investment in the energy sector (say) as the difference between the cost c o of the abatement project and the cost c h that would have been incurred in order to provide the same demand for energy services under the baseline scenario. So we have:

c i = c - ct, (1)

The cost methodology employed in calculating such costs must of course take into account that there is a stream costs and benefits incurred at different times over the project life. Generally, this dynamic aspect is dealt with by calculating levelized annual costs for a particular 'snapshot ' year using a declared discount rate. Specific incremental project costs (ie incremental costs per tonne) sc i can then be calculated by dividing the incremental project costs by the difference between the carbon emissions e a incurred by the project and the carbon emissions e h that would have been incurred by meeting the same demand under the baseline scenario. Thus, the formula

sci = c - G l ( e o - el,) (2)

provides a way of measuring project costs in terms of incremental costs in US dollars (say) per tonne of incremental emissions abatement.

Joint implementation and cost-effectiveness: T.lackson

It is clear from this formula that the specific incremental cost for a particular technological option (or set of options) may be negative, so long as the costs G of the baseline scenario are greater than the costs c of the abatement scenario. In other words the abatement option represents a net benefit rather than a cost. This benefit may be in the form of reduced costs from the exploita- tion, import, distribution and consumption of fossil fuels, reduced emissions of other pollutants (sulphur and nitrogen, for instance), improved economic performance from reducing the distorting effect of taxes in the economy, long-term economic benefits from technological innovation, and of course the avoided costs of adaptation to the impacts of global warming.

Another implication of the definition above is that - although defined on a project level basis - the specific cost comparison relies inherently on system level effects. To take an example, the costs of investing in a domestic energy-efficiency option such as double glaz- ing or wall insulation are relatively straightforward to calculate as a levelized annual investment cost. But the costs of providing the same demand for energy services under the baseline scenario will depend on the system costs associated with meeting the heating demand. Furthermore, the carbon savings implied by such a measure cannot be calculated without taking into account the delivered fuel mix in domestic heating as well as the primary fuel mix in the electricity sector. Even at the project level, therefore, an accurate assessment of the incremental cost of a particular measure requires some knowledge of the energy system as a whole.

In practice, many of the costs and flow parameters are relatively easy to account for on a simple snapshot basis. Other difficulties arise however, once dynamic and interactive aspects of the energy system are taken into account. Some of these difficulties are discussed in more detail below. Moreover, some at least of the cost and benefit streams are generally excluded in the analysis, in part because the associated costs and benefits are non- monetarized in the economic system. Among these costs we can include, for example, the costs of associated pol- lutant emissions (such as sulphur or nitrogen oxides) and the costs of depletion of natural resources. The future mitigation costs of global warming are also generally excluded from the analysis. Even though different nations are highly likely to suffer differently from greenhouse impacts, it is generally assumed that the environmental cost (to each nation) of a unit of carbon emissions is constant across national boundaries. In the absence of reliable means of estimating such costs this assumption is inevitable, although it may provoke some recalcitrance among those parties who feel they are likely to be winners rather than losers in the game of climate change.

Energy Policy 1995 Volume 23 Number 2 121


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Figure 1 Illustrative abatement cost curve

It is probably fair to say that the early message of the macroeconomic analysis has been more influential in determining the political perceptions of greenhouse gas abatement costs than either the early microeconomic analyses or the later, more considered application of macroeconomic analysis. The idea that reducing greenhouse gas emissions incurs high economic costs has been one at least of the motivations for joint implementation in the climate convention. It is assumed that developed economies operate at or close to the limits of economic energy efficiency, and that further potential for low-cost emission reductions is severely limited. By contrast the relatively inefficient state of developing economies, and economies in transition is supposed to offer opportunities to reduce greenhouse gases at costs which will be less punitive on the developed economies. Later in this paper, this argument is closely examined through the use of some illustrative examples using real world data. Before proceeding with that analysis however, the following section describes the argument for cost-effectiveness in more detail and outlines the development of a least-cost methodology aimed at ensuring cost-effectiveness greenhouse gas abatement.

C o s t - e f f e c t i v e n e s s

Generally speaking, one can describe the marginal costs of reducing the next tonne (say) of carbon dioxide emissions by means of an abatement 'cost curve' such as the one shown in Figure 1. The x-axis of the graph represents the total quantity of carbon dioxide abatement and the y-axis represents the costs of abatement. The curve illustrates what might be called a 'least-cost path' for abatement options. It is clear from Figure 1 that the costs of carbon abatement rise along such curve. A large part of what is meant by cost-effectiveness is that abatement should follow such a least-cost path - in other words the

cheapest abatement options are implemented first, before the more expensive ones.

It should be noted that some part of the least-cost path lies below the x-axis. In other words, some part at least of the potential abatement is available at net negative cost. This reflects the fact that under certain conditions carbon abatement measures can lead to net economic savings, and improved economic performance. In line with the remarks in the previous section, there are two different kinds of reason for this. On the one hand, technological abatement options may offer substantial fuel savings (for instance) over conventional supply options. On the other hand, the recycling of revenues from carbon or energy taxes can reduce the distorting influence of taxes elsewhere in the economy.

The total costs of abatement are provided by the (arithmetic) area under the curve (where areas below the x-axis are counted as negative). Thus the total cost of achieving a target reduction of Q tonnes of carbon dioxide (along the least-cost path) is given by the area xYQ minus the area Oxy. It is easily observed that the overall costs of achieving the same reduction could be much higher, if the least-cost path were not followed. As an example, suppose that the same reduction target of Q tonnes is met by implementing measures between Q and X on the curve with X = 2Q. The overall costs are then determined by the area QYY'X which is substantially larger than the area representing the costs incurred by the least-cost path.

From this analysis it is clear that - at the national level - the costs of carbon abatement depend on the abatement path. National abatement which does not follow a least-cost path will be more expensive than abatement which does. A considerable part of what is meant by cost-effectiveness in reducing greenhouse gas emissions is that least-cost paths are chosen at the national as well as the international level. But there is of


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course no guarantee that a country will necessarily follow such a least-cost path. In this case, some low-cost opportunities may be lost altogether - because the relative economics of those options will change as other more expensive options are implemented - and the overall cost of achieving greenhouse gas emission reductions may be considerably increased. It will be seen therefore that national cost-effectiveness should be a prerequisite of participation in joint implementation schemes if global cost-effectiveness in meeting the objective of the convention is to be achieved. But aside from the vagaries of national policy, it is also clear that different countries are faced with different ranges of costs in meeting greenhouse gas emission abatement targets.

These differences arise from differences in climate, differences in the existing technological base, differences in the historical structure of energy markets, differences in the availability of indigenous fuels, and differences in labour costs. These differences might be called 'economic ' cost differences. Differences in 'financial' cost might also need to be taken into account. Financial costs are determined in part by economic costs, but in part by aspects of the economic and fiscal infrastructure such as the social discount rate, the availability of capital, and the regime of taxes and subsidies under which projects operate. Generally speaking, it is deemed appropriate to make international comparisons on the basis of economic rather than financial costs. In some cases, however, it is difficult to distinguish between the two: the choice of discount rate, for example, is an inherent element of economic cost accounting, and differences in national discount rate provide a chal- lenging obstacle to meaningful comparison of economic cost-effectiveness. Nevertheless, in what follows, it will

generally be assumed that we are dealing with economic costs, and that taxes and subsidies will be absent from economic calculations.

The overall impact of these kinds of differences is that some countries will find the reduction of greenhouse gases more costly than other countries. It is this fact which informs the cost-effectiveness argument for joint implementation. To illustrate the argument in more detail, consider the following hypothetical example. Suppose that two countries A and B, have exhausted the negative cost (or no-regrets) options for greenhouse gas abatement, and the least-cost paths for further abatement are illustrated by the cost curves shown in Figure 2. It is evident that country A can meet a further target reduction Q at a considerably cheaper cost (given by the area OXQ) than the cost to country B (given by the area OYQ) of meeting the same target. 8 As a result there is an economic incentive for country B to invest in abatement options in country A once its own low-cost options are exhausted.

Another way of looking at the same issue is to postu- late a 'joint cost curve' for countries A and B as shown in Figure 3, in which least-cost options are ranked in order of cost effectiveness irrespective of which country they are implemented in.

The general form of the cost-effectiveness argument for joint implementation is that the joint cost (ie the area under the joint cost curve) for achieving a combined target reduction of 2Q tonnes of carbon dioxide is lower

sit is not clear from this diagram whether Q represents a physi- cal quantity of emission reductions or reductions in percentage from some baseline. The choice of a common reduction target Q for both countries is therefore purely illustrative.



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than the cost for achieving a target reduction of Q tonnes in each country individually. Some important caveats need to be made however concerning this general argument.

In the first place, the total national abatement costs are determined not only by the economic costs of the positive cost options but also by the economic benefits of implementing negative cost options. Looking only at the cost of positive cost options distorts the picture of the overall economic burden of meeting a particular target in a particular country and obscures comparisons of cost between countries. The economic assumption made by some authors 9 that no regrets options will be imple-

mented in any case under the baseline scenario belies the reality of energy markets which are historically oriented towards increasing supply and against the implementation of energy efficiency measures. ~° It also ignores the relevance of economic benefits attainable from implementing options with negative incremental cost. In the example used above, the total costs of abatement for country B may be lower than for country A (despite the smaller potential for low positive cost options) if there is a larger potential for negative cost abatement options in the former country than the latter. Figure 4 illustrates this situation.

9See Barrett (1992) for instance. 1°See for example Jackson, 1992; Williams, 1989.

1 2 4 Energy Policy 1995 Volume 23 Number 2

Joint implementation and cost-effectiveness: T .laekson 30

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When country A is a developing country and country B is a developed country, this situation has important repercussions in terms of equity and burden sharing. It is clear therefore, that abatement cost comparisons between countries must take account of the potential for national economic benefits from negative cost abatement options.

Equally important is the question of what exactly is represented both by the national cost curves and by the joint cost curves. Recalling the distinctions of the previous section between project cost, system cost and economy level cost, the simplest representation of a cost curve is one which identifies on a partial equilibrium basis (ie assuming the rest of the energy system remains more or less the same) the incremental costs of each abatement technology type. There are clearly limitations to this simple partial analysis. In particular the analysis measures costs for individual technologies against a reference scenario which is assumed constant. This is evidently a simplification, since the introduction of any one project onto the energy system would change the nature of the counterfactual reference scenario and the basis for the incremental costs of other technologies. A more sophisticated option is to pursue an iterative partial approach tt in which the system interactions associated with implementing each least-cost option is taken into account in assessing the costs of the subsequent options. These simple and iterative partial analyses gives a first basis for comparison of technological abatement options, as illustrated in Figure 5.

A more complete analysis can be provided by using a

t I M o r t h o r s t ( 1993 ) ca l l s th i s i t e r a t i ve pa r t i a l a p p r o a c h the

' r e t r o s p e c t i v e a p p r o a c h ' .

fully integrated systems approach to look not at individual projects but at baskets of technologies which provide for a cost curve looking something like Figure 6 (Morthorst, 1993).

When we turn to the joint cost curves a further level of complication arises, because we now need representa- tions not simply for one relatively self-consistent national energy system, but for two potentially interactive systems. The extent to which the implementation of a particular technology in one country affects the comparative economics of further implementation in another country is dependent on a variety of geographical, institutional and economic factors including the availability of indigenous resources, the relative interaction between the two energy systems and the price mechanisms in the fuel markets shared by the two countries. For two geographically and politically separated countries, the problems of system interaction are likely to be smaller than those encountered within one country or between two countries which are politically and geographically close. On the other hand, the economic comparability between two geographically and politically disparate countries may be far more problematic. In addition, it should be reiterated here that investment in any country has a systemic influence on the economic viability of future abatement investments in that country. Joint implementation which fails to respect the least-cost principle in both the host and the donor countries is therefore likely to jeopardize rather than enhance overall cost-effectiveness in achieving the aims of the convention.

Despite the limitations of the partial approach - some of which can be compensated for in a semiquantitative fashion during the analysis - the simple and iterative

Energy Policy1995 Volume23 Number2 125


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Figure 6 Illustrative integrated cost curve

partial approaches offer a starting point for embarking on an analysis of the cost-effectiveness of greenhouse gas abatement options, provided that certain basic limitations to the method are respected, and the underlying assumptions are relatively transparent. There are now a number of studies which have used this methodology specifically to address the question of cost and cost- effectiveness in the context of greenhouse gas abatement. ~2 In the following section, some of these studies are used to construct joint cost curves between potential joint implementation partners and to examine illustratively the question of cost-effectiveness in the context of joint implementation of greenhouse gas abatement.

Finally, attention should be drawn to a number of less tangible cost issues which are not included in the simple joint cost curve analysis discussed above. Among these issues are the question of transaction costs, potentially large monitoring and verification costs, the economic benefits of reduced distortion in the taxation system and the long-term economic advantages associated with technological innovation. Although these costs are difficult to quantify in a joint cost curve analysis, they may nevertheless be significant. In the following section therefore, some attempt will be made at least to relate the magnitude of savings from joint implementation to the likely magnitude of transaction costs.

Joint implementation and cost-effectiveness: some examples

The basis of the analysis in this section will be an

J2See papers in Ref 4.

attempt to use cost curves provided by four country case studies to construct joint cost curves with which to examine the cost-effectiveness of hypothetical joint implementation partnerships. The exercise undertaken here is limited by the limitations of the studies employed, and should be regarded at best as illustrative. On the other hand, the process of attempting such an exercise is also useful in highlighting the difficulties involved in carrying out a robust cost-effectiveness analysis across national boundaries.

Case study countries

The chosen countries are Denmark, the UK, Poland and Zimbabwe. There is no political reason for choosing these particular countries, other than the fact that two of the countries are developed countries, one has an economy which is in transition, and another is a developing country. The overriding circumstantial reason for this choice, has been the availability of broadly similar studies providing cost curves for each of the countries. It is these cost curves which will form the basis for the examination of joint implementation in this section. Other studies exist. Most of them show similar charac- teristics to the studies employed here, although each differs in its assessment of the availability and cost of abatement technologies. Many of the cost curves indicate some potential for negative cost abatement options.

Two of the studies used here (Denmark and Zimbabwe) were developed in the context of the UNEP Greenhouse Gas Abatement Costing Study (UNEP, 1994a, 1994b, 1994c) and these two studies show the closest methodological resemblance one to another, having been subject to specific methodological guide-


Table I Some of the principal parameters for the four country baselines


End GNP Final Final Carbon Carbon Coal Oil Discount year growth energy energy emissions emissions price price rate

demand demand at start at finish at start at finish

(% pa) (P J) (P J) (Mt CO z) (Mt CO z) (US$/tce) (US$/bbl) (%)

Denmark a 2005 1.6 564 589 56.2 53.4 49 c 21 e 7 UK b 2005 2.5 6230 7432 560 690 49 f 17 h 10 Poland c 2005 3.2 5130 5980 425 474 60g 18g n.k. i Zimbabwe a 2010 4.2 240 481 16.3 32.7 49 e 22 e 10

a References for Denmark: Morthorst, 1993; UNEP, 1994b. b References for UK: Jackson, 1989; Jackson, 1991. c References for Poland: Simicki et al, 1990, 1991. d References for Zimbabwe: Maya et al, 1993; UNEP, 1994b. e US$1990 prices based on UNEP guidelines (UNEP, 1994c). f £1.3/GJ (1987 prices) for 25 GJ/tonne coal: exchange rate US$1.5 = £1. g Taken from Table A.5 in Simicki et al (1990). h £2/GJ for 42 GJ/tonne oil and assuming 1 bbl = 0.136 t. i The discount rate is not specified in either paper, but other papers in the Battelle series (Sitnicki et al, 1990) appear to employ a 5% discount rate.

lines developed by UNEP. Even so the end-date on the Danish study (2005) differs from that on the Zimbabwe study (2010). Of the other two studies, both share the Danish time frame of 2005, but there are some differences in underlying assumptions about fuel prices, autonomous energy efficiency uptake and so on. All of the studies are partial assessments rather than fully integrated system cost curves. For illustrative purposes, the partial approach possesses the advantage of clarity. It should nevertheless be remembered that a robust assessment of cost-effectiveness demands a systems analysis.

The Polish study (Sitnicki et al, 1990, 1991) should be regarded with the greatest caution because it was carried out in the early stages of an economic transition which is likely to prove more drastic than anything experienced by the other three countries. Two aspects of this study are of particular concern. First, there is the question of defining a suitable baseline scenario in the presence of dramatic and far-reaching structural change. Second, there is the question of absolute costs. Costs in the study were measured in Polish zlotys. For the purposes of this exercise these costs have been converted to dollars using the 1989 exchange rate. 13 In the intervening period the zloty has been subject to something like a tenfold devaluation in relation to the dollar. Rather than using the devalued zloty costs, it is assumed here that actual technological costs have remained in line with the 1989 dollar equivalents. It should be recognized however that the question of currency exchange and purchasing power is a complex one with considerable bearing on the potential cost-effectiveness of international investments.

The countries chosen for examination in this study have different populations, different economic and

131dentified by Sitnicki et al (1990, 1991) at US$1 = 2930 zlotys.

Table 2 Baseline carbon dioxide emissions for case study Countries

CO 2 CO 2 Reductions emissions emissions required for a in 1988/90 in 2005/10 20%

target (Mt) (Mt) (Mt)

Denmark 56.2 53.4 8,4 UK 560.0 690.0 242.0 Poland 425.0 474.1 134,0 Zimbabwe 16.3 32.7 19.7 ~

6+5 b

Reduction required if Zimbabwe were to meet the Toronto target. b Reduction required for Zimbabwe to reduce emissions 20% below 2010 baseline.

technical bases, and different emission intensities. Furthermore, the studies themselves have not been carried out on a uniform, equitable basis. Different cost years are used for prices, different discount rates are employed, 14 different assumptions about autonomous energy efficiency uptake are adopted, and some differences in avoided fuel costs are also evident. Some of the key technical, economic and demographical features of each of the studies are set out in Table 1. All of these differences make international comparison extremely difficult. In what follows differences have simply been taken as read, and little attempt has been made to place all studies on an entirely comparable footing. For this reason, the analysis in the following section should be regarded as illustrative rather than exact. Nevertheless it

14For national studies it is appropriate to use a discount rate

equal to the social discount rate in that country. When interna-

tional comparisons are being made, particularly in the context

of external investment it is not immediately clear what dis-

count rate should be used to assess the cost of abatement

projects. There are complex issues about the sharing of costs

and benefits involved in this discussion which deserve serious

further consideration.

Energy Polio3" 1995 Volume 23 Number 2 127


may serve to elucidate something of the relationship between cost-effectiveness and joint implementation of measures to combat climate change.

Table 2 shows the predicted carbon dioxide emission levels in the baseline for each country. Of the four countries examined, the UK has the highest emissions, but also the largest population. Poland has the highest emissions per capita, Zimbabwe has the lowest emissions and the lowest emissions per capita. The UK and Denmark (although differing in population by a factor of ten) are perhaps the most similar countries in terms of economic structure. On the other hand, baseline emission scenarios are quite different. In Denmark, assumptions of autonomous energy efficiency improvement are higher than those assumed for the UK, leading in fact to a reduction in the baseline emissions for 2005. In the UK, by contrast, baseline emissions are predicted to rise by almost 25%. 15 Polish carbon emissions are predicted to rise by a little less than 10%. 16 The steepest rise in baseline emissions is in Zimbabwe, where carbon dioxide emissions are predicted to double (by 2010) as a result of economic and industrial development.

~5It should be noted here that the UK study was carried out prior to the UK government's commitment to stabilize greenhouse gases at 1990 levels by the end of the century, prior to the introduction of natural gas on the electricity system in any considerable proportion, and prior to revisions in transport policy which are now emerging. A revised scenario would undoubtedly have lower baseline emissions. This would have some impact on the analysis of the subsequent stages of this paper. It would be reflected particularly in the opportunities and costs for reduction of greenhouse gases as a proportion of the totals in the 2005 baseline. On the other hand, it would not necessarily affect the calculation of the potential or the cost for proportionate reduction below the 1990 level. It is simply that some of the potential illustrated in Figure 8 would be absent because it had already been incorporated into the baseline scenario. 16This baseline prediction is based on the structural change with interfuel substitution scenario from Sitnicki et al (1990, 1991). This scenario predicts a modest (13%) increase in primary energy demand, with carbon emission increases offset by substitution of nuclear power for coal in the electricity generation sector. Simicki's own 'base case' scenario predicts much higher levels of primary fuel demand and carbon emission, but this early prediction has now clearly been superseded by the structural changes witnessed in Poland in the intervening years. More recent energy balance predictions for Poland (UNECE, 1993) indicate a smaller increase in primary energy demand for 2005 of around 5%, leading to a stabilization of carbon dioxide emissions by the year 2005. In order to com- pensate partly for this situation, the structural changes illustrated in Table 2 of Sitnicki et al (1991) are assumed to be available over and above the baseline prediction, and are included in the cost curve Figure 9 (option 11) as additional reductions over the baseline.

The final column in Table 2 shows (for Denmark, Poland and the UK) the absolute reductions in emissions which would be required in order to reduce the carbon emissions predicted by these studies to a level 20% below the level of 1988-89 emissions. This target has been chosen for illustrative purposes only, and to form the basis of discussion of the possibilities for joint implementation in what follows. On the other hand it should be remembered that this was the target set out by the Toronto Conference agreement of 1988, and would represent a significant step towards the 60% reduction in anthropogenic emissions which will be required to stabilize atmospheric concentrations of CO 2. If the percentage reduction over the 2005 baseline emissions is taken as an indication of the ease or difficulty with which such a target might be met, it is clear that the easi- est task lies with Denmark (partly as a result of considerable existing investment in energy efficiency) who would require a reduction of 16% over the baseline emissions for 2005.

Zimbabwe is under no commitment through the FCCC or any other formal agreement to reduce its CO 2 emissions. Indeed if Zimbabwe were to attempt a target of 20% reduction in emissions over 1988 levels, it would have to reduce carbon emissions by an amount greater than their existing carbon budget (and over 60% of the baseline emissions in 2010), if the target was to be met! An easier target for reduction in Zimbabwe is also quantified in Table 2. The lower figure under the third column is the absolute amount by which carbon dioxide emissions would have to be reduced if a more realistic target of 20% below the 2010 baseline is set in place of the 20% reduction below 1988 levels. Of course, it is precisely because of the difficulty of achieving CO 2 reductions in develop.ing countries without compromis- ing economic development that the burden of reducing greenhouse gas emissions should not at the present time lie with the developing countries, and this paper does not intend to suggest that the Toronto target or any other is appropriate as a commitment by a developing nation under the Convention.

Country cost curves

Figures 7-10 show the cost curves for the four example countries. Marked on each of the first three curves is the line indicating the extent of the measures that would have to be implemented (in least-cost order) if the Toronto target were to be met. It is clear from the fourth curve on Zimbabwe that there are insufficient abatement opportunities (at least under this analysis) to support the required Toronto reduction, even if this were an appropriate target. Instead, the less demanding target of a 20% reduction below the 2010 baseline emissions is illustrated.


150

100

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Figure 7

60

50

40

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o

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11

~ | 9

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t J "- Average cost


a Option 1 Connection to district heating network; 2 Electricity conservation in households; 3 Electricity conservation in services; 4 Increased use of CHP; 5 Conservation in industry; 6 Conservation in agriculture; 7

12 Combined cycle (natural gas); 8 Biogasification; 9 Wind turbines; I 0 Decentralized CHP bio-combustion; 11 Solar collectors; 12 Insulation in buildings.

I I I 2 4 6

Million Tonnes CO 2

Denmark: CO 2 abatement cost curve a

I

17 242 mT

15

14

j J ............. 1 ~ ] 3 4 S 7 i . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 9

Average cost

510 i i i i 0 100 150 200 250

Million Tonnes CO 2

I

300 350

Option 1 Fuel switching (electric heating to gas); 2 Improved appliance efficiency; 3 Industrial-scale CHP; 4 Energy efficient light- ing; 5 Small-scale CHP; 6 Improved efficiency in cooking; 7 Services space heating efficiency improvements; 8 Combined cycle (natural gas); 9 Water heating efficiency gains; 10 Improved industrial motive power efficiency; 11 Domestic space heating efficiency improvements; 12 City-wide CHP; 13 Renewable energy technologies; 14 Improved process heat efficiency; 15 Industrial space heating efficiency improvements; 16 Nuclear power; 17 Advanced coal technology.

F igu re 8 UK: CO 2 abatement cost curve a

Several features of these cost curves are worth remarking on. Firstly, all of the countries - but most particularly the UK and Denmark - possess considerable potential for negative cost emission reductions. In fact, the analysis here indicates that both the developed countries can achieve the Toronto target for quite substantial net economic savings - around US$380 million for Denmark and US$2,130 million for the UK. These represent around 0.3 and 0.4% of the projected respec- tive GDPs of the two countries (in 2005). By contrast, these calculations estimate that achieving the Toronto target in Poland would incur a net positive cost of around US$120 million (0.06% of GDP). Zimbabwe cannot achieve the Toronto target at all, according to

these results, and even achieving a 20% reduction over the 2010 baseline would incur net positive costs of over US$100 million (5.3% of projected GDP).

These results lend little credence to the notion that developing countries or economies in transition offer vast potential for low-cost abatement. It may be true that in the positive cost segments of the curve, Poland (for example) possesses some slightly lower cost options than either the UK or Denmark. However, the opportunity for negative cost options is correspondingly reduced and the overall cost of achieving the Toronto target in Poland is considerably higher than the cost in either Denmark or the UK. The positive section of Zimbabwe's cost curve rises as steeply as Denmark's



10-

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100

134 mT

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11

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Poland: CO 2 aba tement cost curve ~

I I I

140 160 180 200

80

60

o 40

20

0

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-40

6

~ Average cost i

6.5 mT- --H

':9

I I I I I I

0 1 2 3 4 5 6 7 Million Tonnes CO 2

F i g u r e 10 Z imbabwe: CO 2 aba tement cost curve a

and, again, negative cost options are limited. It has already been remarked that insufficient options exist to achieve a Toronto-like target in Zimbabwe, and even achieving 20% reduction over baseline emissions would have considerable positive costs.

It is possible that these results are the exception rather than the rule. Even if this were the case however, it would suggest (at least) that care is necessary in general- izing about the cost-effectiveness of investing in developing countries or economies in transition. It cannot simply be assumed that such investments are more cost-effective than those in developed economies. Rather, the analysis needs to be based on sound methodological examination. On the other hand, there are some heuristic reasons to suggest that these case studies are

" Option 1 Space heating management; 2 Reductions in distribution and transportation losses; 3 Building insulation; 4 Automation and monitoring improvements; 5 Improved efficiency in existing industrial equipment; 6 Cogeneration (CHP); 7 Railway electrifica- tion; 8 Coal quality improvement; 9 Shift to diesel in light trucks; 10 New industrial technology; 11 Changes to industry structure.

" Option 1 Efficient boilers; 2 General savings in industry; 3 Efficient motors; 4 Power factor correction; 5 Biogas for domestic use; 6 Afforestation; 7 Solar geysers; 8 Efficient fur- naces; 9 Coal for ammonia•

not simply exceptions to a general trend, but illustrate effects which might easily be shared by other countries. For instance, much of the potential for negative cost options arises as a result of replacing less efficient technologies with more efficient technologies in a well developed energy system delivering high levels of per capita energy demand. Where the demand for energy is lower and the existing energy system is less extensive (as is the case with Zimbabwe), it is to be expected that opportunities for efficiency improvement - although still important - are limited by the extent of the energy system. The same explanation cannot be true of the economies in transition however, where it is well known that extensive and highly inefficient energy systems have been developed. In theory, these systems should


Joint implementation and cost-effectiveness. T Jackson 60

376 mT UK 5 0 -

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40 UK

30 i u~1- :: U UK 20

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0 100 200 300 400 500

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Figure 11 150

100~

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UK and Poland: joint cost curve for 2005

', 8.4 mT 15 mT Dk Dk ._E N

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Average cost

-150 o ~ ~, ~ ~ 1'o 1'2 1'4 1'6 1'8

Million Tonnes CO 2 20

Figure 12 Denmark and Zimbabwe: joint cost curve for 2005/10

provide considerable opportunity for cost-effective energy savings. But in this case, the difficulty is an economic one: the economic benefits of improved efficiency can only be enjoyed if the market conditions are appropriate. When new capital is scarce, historical capital has been heavily subsidized and fuel prices are low, the economic benefits from efficiency investments will be substantially reduced.

These kinds of effects would lead us to expect that neither the developing countries nor the economies in transition necessarily possess the same opportunity for negative cost abatement measures as do the developed economies. This feature of the economic terrain has largely been neglected both in the political negotiations

and in the theoretical considerations over joint implementation: the argument from cost-effectiveness may sometimes make sense in the region of positive cost options; but it is the net costs of achieving specific targets which should determine who invests where and by how much. The developed countries may be much better placed than is generally supposed to reduce greenhouse emissions nationally, without recourse to investment in potentially limited, low-cost options in less developed countries.

Nevertheless, this argument does not preclude the possibility that economic savings are to be made (to the benefit of all concerned) by some kind of joint implementation. This possibility is examined further in the next subsection.

Energy Policy 1995 Volume 23 Number 2 1 3 1

Joint implementation and cost-effectiveness: T Jackson 100

80-

I 262 rnT

Zim ~

Zim ~ U K [ UK

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UK and Zimbabwe: joint cost curve for 2005/10

385 mT Dk \ h

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500 600

Figure 14 Denmark, Poland and UK: joint cost curve for 2005

Joint cost curves

The basis for the discussion in this subsection is to construct joint cost curves (as discussed above) for five different hypothetical partnerships between the selected case study countries. 17

17These hypothetical examples reflect essentially 'closed' joint implementation arrangements, because it is assumed here that certain target reductions are to be met, and the question is asked how can this be done with the least cost. The same general arguments would apply to open joint implementation arrangements however, under which cost-effectiveness would have to consist in asking how much carbon abatement could be achieved for a certain amount of money.

Case study 1. Case study 1 illustrates a partnership between the UK and Poland. The 'joint cost curve' for such a partnership is displayed in Figure 11. The combined reduction required to meet the Toronto target in both countries is marked on the figure at 376 Mt of carbon dioxide. It is readily observed from Figure 11 that achieving this joint target on the least-cost curve would result in net economic benefits, despite the net economic cost that would be experienced by Poland in meeting the Toronto target individually according to the analysis in Figure 9. In Figure i I, the UK may be seen to be implementing slightly less of its own abatement options and Poland slightly more. This happens in spite of the greater potential in the UK for negative cost options,


because at the margin (ie near the 20% target) we are looking at options in the positive section of the joint cost curve where there are some slightly cheaper options in Poland than appear in the UK.

Who pays how much for which of these options depends of course on what kind of management structure is set up for such a partnership, but the economic principle of joint implementation as an instrument of cost-effectiveness is demonstrated by the following illustrative result. The combined economic benefits of both countries implementing the target separately are (according to this analysis) US$2009 million - slightly lower than the net benefits to the UK because of the net costs to Poland. Under the joint cost curve, the net economic benefits increase by US$153 million to just over US$2160 million. Thus joint implementation produces a relatively small net increase in benefits of around 7.5% over the separate implementation.

Of course it should not be assumed from the positive economic result of this illustrative case study that the case for this kind of joint implementation is water tight. There are a number of reasons for caution.

In the first place this analysis ignores transaction costs and the costs of monitoring and verification. It has been pointed out in a number of places that transaction costs may become a significant influence over the economic feasibility of joint implementation. Barrett (1994) has identified transaction costs of around 10% of the project costs in the joint implementation 'pilot projects' between Norway as an investor and Poland and Mexico as hosts (Norwegian Funding of Pilot Demonstration Projects). Other estimates of transaction costs based on expe~ience of tradable emission permits in the USA put the transaction costs for interfirm trade between 10 and 30% of the investment costs (Hourcade and Baron, 1993, p 24). It has been pointed out (Klaasen, 1994) that transaction costs are particularly problematic when no

~SThis is likely to be the situation in the context of the FCCC for reasons already discussed. 19The question of the potential magnitude of monitoring and verification costs is discussed in Fritsche (1994). It is not immediately clear from the source document whether the estimate of 10-30% transaction costs includes monitoring and verification costs or not. Clearly, if monitoring and verification incurs significant costs over and above the level of these transaction cost estimates, the argument of additional cost constraints is even stronger. On the other hand, there is a general difficulty in assessing the appropriate level of monitoring and verification costs: how much of these costs should be regarded as incremental to joint implementation? Clearly the question of allocating credit for CO z reduction entails already some monitoring and verification costs, even in the absence of joint implementation. In the context of the discussion in this paper it is only appropriate to consider incremental monitoring and verification costs.


clear targets are set and no clear allocation of permits is made, t8 and the same is certainly true of monitoring and verification costs. ~9

It is possible therefore that high additional costs might override the apparent economic advantages of the UK-Poland partnership. On the other hand, this problem is dependent on the particular context in which partnership is explored. If all implementation (ie each technological option along the least-cost curve) is subject to joint venture the consequent transaction costs are likely to be higher than those incurred when the primary responsibility for implementing domestic measures is taken by each country itself, and joint venture only occurs at the margin. This latter course of action may not however address the urgent needs of economies in transition for development capital. In practice, success- ful partnership in reducing greenhouse gas emissions will require careful development and may in the end depend on trading off certain kinds of costs against certain kinds of benefits.

Beyond the question of transaction costs there are other reasons for caution. This first case study results in Poland increasing its implementation of measures and the UK decreasing its own. This seems to bear out the classic argument that developed countries should seek out low-cost options in less developed ones or economies in transition. But from Poland's perspective this may cause some concern. Further options for greenhouse gas abatement in Poland are considerably more limited (at least under this analysis) than those for the UK. Moreover, Poland is faced with higher costs than the UK in implementing the target individually. Certainly therefore the economic compensation for Poland to engage in this kind of transaction might need to be based on some greater incentive than de facto incremental cost.

Case study 2. The joint cost curve for case study 2 is depicted in Figure 12 and illustrates a hypothetical partnership between Denmark and Zimbabwe. Zimbabwe is not committed under the FCCC to any reduction targets, and is not likely in the short term to be subject to such commitments. On the other hand, the long-term aims of the FCCC entail substantial reductions in global greenhouse gas emissions. This suggests that prudence should be exercised with respect to cost-effectiveness in both donor and host countries, and the long-term implications of short-term joint implementation strategies should also be assessed. For these reasons, two variants of case study 2 are discussed. In one variant, Denmark under- takes joint implementation with Zimbabwe which seeks credit for meeting its own domestic target reduction (taken as 20% by 2005) from investments made in Zimbabwe. No restrictions on emissions from

Energy Polio3' 1995 Volume 23 Number 2 133


100

80

60

C o 40

t -

g ~ 20

-20

-40 0

404 mT O , \

UK\

Po,an, OKgK' II \ OK F]II OK

iZim Poland Dk \ iZi'~r[ I I I Dk UK DE ~ \ \ Zim ~ I I I I

. . . . . . . . . . . . . . . . .

f I I I I

1 O0 200 300 400 500 Million Tonnes 002

Figure 15 Denmark, Poland, UK and Zimbabwe: joint cost curve for 2005/10

600

Zimbabwe are envisaged. The second variant looks at the implications of a hypothetical attempt to restrict emissions in both host and donor countries simultaneously.

Accordingly, two emission targets are quantified in Figure 12. The first of these, ie the lower of the two targets, corresponds to a 20% reduction over 1988-89 emission levels in Denmark, with no reduction over baselines achieved in Zimbabwe. It is readily seen from Figure 7 that Denmark could achieve its own target of 20% reduction (8.4 Mt) with net economic savings (of around US$378 million). Figure 12 reveals that these savings would be increased (by around 13.5%) if Denmark invests preferentially in CO 2 reduction options in Zimbabwe at the margin. This example characterizes the often cited advantage of this form of joint implementation: a developed country reduces its abatement costs by seeking credit for investments made in a developing country. There is an issue here as to whether the particular projects at the margin are legitimate joint implementation investments (at least as joint implementation is currently conceived), because their levelized incremental costs are negative. Theoretically, this means that if the transfer of the trade in emission credits were based strictly on incremental cost, Zimbabwe would end up paying Denmark for the investment! There is nothing in principle however to preclude a contract under which the economic 'efficiency gains' illustrated by this example are shared between Denmark and Zimbabwe: if the next available option in Denmark carries net positive cost, it might still be cheaper in the short-run for Denmark to invest at a zero rate of return in Zimbabwe (allowing Zimbabwe to profit from the economic savings) than to invest at home in Denmark.

A note of caution must be injected into the debate at this point however. Perhaps the most important issues surrounding not only the concept of joint implementation but also the Climate Convention in general are those of equity and the sharing of technical and economic bur- dens. The question of who bears what long-run costs for abatement measures depends on what long-term commitments to abatement are made. At this point in time, we simply do not know what these long-term commitments are likely to be. What is clear however is that the aim of the convention is to stabilize atmospheric concentrations of greenhouse gases. This cannot be achieved in the absence of a global emissions cap, and will require substantially greater reductions either than present commitments under the convention or than the targets discussed in this paper. Prudently, therefore, we should investigate both the economic impacts and the consequences for equity at a margin which lies beyond existing commitments, and which accords with the declared aim of global emissions reductions.

It is for these reasons that a second variant on the hypothetical relationship between Denmark and Zimbabwe is discussed. This variant corresponds to an attempt to meet a higher emissions reduction target under which Denmark meets the Toronto target, and Zimbabwe simultaneously achieves a domestic reduction of 20% over the baseline projection. Meeting the higher combined target of 15 Mt is also considerably cheaper through joint implementation than it would have been through separate implementation. Figure 12 shows that this combined target could be achieved at net negative cost despite the relatively high positive costs (Figure I 0) which Zimbabwe would have experienced in meeting the 20% reduction over baseline projections.


Estimated total economic benefits of around US$270 million achieved by separate implementations are increased by more than 40% to just under US$400 million by the collaboration.

Ironically however, in the second variant of this case study the classic argument for joint implementation - in which the developed country explores low-cost abatement options in the developing country - is reversed. In this case study variant, Denmark implements more of its own domestic options because the costs of abatement in Zimbabwe are higher than they are in Denmark! This example illustrates that the economics of emissions reduction strategies are highly specific to individual countries and to individual partnerships, and underlines the need for careful case by case analysis under a well defined methodology.

There is no suggestion here that Zimbabwe should seek to pay Denmark to engage in such a partnership. On the other hand, this example illustates a potential role for the developed nations to increase their own domestic reductions in order to share the burden of meeting global greenhouse gas emission targets. Since Denmark's own investment in emission reductions still retains a net economic benefit, this course of action offers a way of combating climate change whilst encour- aging the development.

Case study 3. These ideas are explored further in case study 3, which looks at a potential partnership between the UK and Zimbabwe. Because the UK is considerably bigger than Denmark, the reduction potential allows the UK not only to meet its own target of 20% reduction but also to make further reductions which effectively achieve the same Toronto target in Zimbabwe and still allow for net economic benefits (Figure 13). In this case, there is an overall loss (of around 5%) in the benefits of the joint partnership over what might have been achieved separately. On the other hand far more has been achieved under this arrangement than could have been achieved had Zimbabwe attempted to act alone, and there are still net economic savings.

Again it should be emphasized that no emission reduction commitments are currently envisaged for developing countries in the short term, and there is no suggestion that Zimbabwe should contribute financially to the development of carbon emission reductions in the UK. Rather the suggestion is for the UK to use the economic benefits associated with domestic emission reductions to increase its own share of the burden of global emission reductions.

Case studies 4 and 5. Finally two case studies are presented (Figures 14 and 15) which show multilateral partnerships. In Figure 14, the joint cost curve for


Denmark, Poland and the UK is presented. This analysis suggests that both Poland and Denmark marginally increase their contributions to emissions reduction over what they might have implemented individually, while the UK slightly reduces its own national contribution. The implication here is that the UK might buy emissions credits from Poland and Denmark to the mutual benefit of all three countries. However the economic advantages of this complex sharing of emissions reductions is relatively limited, offering only an estimated 6.5% increase in the net benefits. As previously mentioned, these benefits may be offset by transaction costs unless the main burden for emissions reductions is taken nationally.

Figure 15 extends the previous ideas of partnership to include all four of the example countries in a single cost curve. In this case study, it is assumed that total emissions reductions are equivalent to each of the example countries including Zimbabwe achieving the Toronto target - this reduction being marked on the Figure at just over 400 Mt. But the burden of domestic reductions in Zimbabwe has been relieved by the participation of the other three countries. This burden is shared principally by Denmark and Poland, suggesting that additional financial contributions would be due from the UK. Despite the fact that the total joint benefits are less than those enjoyed under case study 4, it should be noted that the net economic benefits of this multilateral partnership are considerably increased (by an estimated 13%) over the sum of benefits and costs associated with meeting individual targets, and more has been achieved,

Limitations

The analysis in the previous sections is only illustrative, and any quantitative conclusions drawn from it should be treated with caution. To summarize, there are two principal kinds of limitations which might affect the robustness of particular conclusions. First, none of the illustrative cost curves employed in this analysis represents the fully integrated systems analysis needed to provide a fully accurate assessment of cost-effectiveness. Rather, these curves are technology rankings which remain to some extent partial. 2° Second, the differing underlying economic, technological and institutional assumptions render international comparison - and the use of joint cost curves - problematic. A quick glance at Table 1 shows the different discount rates, different fuel price assumptions, and different cost years which complicate inter-country analyses. In addition, implicit technical and institutional assumptions - for instance about the level of economic development

2°The same would be true of course of any priority cost-effectiveness 'list' held by a central clearing house for joint implementation projects.



and the degree of autonomous uptake of energy efficiency obscure straightforward comparisons. In particular, the Polish study is subject to a number of caveats and reservations because it was carried out during the early stages of an economic transition which has since outpaced the predictions made in it.

Some of these limitations could be overcome under a more sophisticated and more integrated study. But there are also some inherently complex problems which would dog any such analysis: for example, the question of an appropriate discount rate to apply to cost-effectiveness comparisons on an international basis, and the necessity to construct counterfactual reference scenarios for each participating nation. On the other hand, the existence of methodological limitations does not necessarily diminish the reliability of the whole analysis. Some conclusions will be robust under the most likely changes in sensitive variables. For instance, the use of a lower coal price in Poland (either in line with other studies or in line with local prices) would have the effect of reducing the economic savings from efficiency measures and increasing the incremental costs of abatement in Poland relative to (say) the UK.

In any case, it is clear that without some kind of methodology for assessing and prioritizing cost-effective capital investments in abatement technology, there is considerable danger of jeopardizing both national and global cost-effectiveness.

Summary and conclusions

This study has examined the concept of joint implementation in terms of the question of cost-effectiveness. It has examined existing methodologies for assessing both the cost and the relative cost-effectiveness of abatement measures; and it has used some of these existing studies to provide illustrative examples of possible joint implementation arrangements.

One of the principal conclusions of this analysis is that assessment of the comparative cost-effectiveness of technological abatement measures is a complex issue, even on a national basis. It implies the need for a well established cost methodology based on agreed, consistent methodological, technical and economic assumptions. In particular, such comparison requires the establishment of a counterfactual reference scenario or 'baseline' against which incremental emissions reductions and incremental costs can be measured. Ideally, the comparison also requires a fully integrated, dynamic model of the energy systems involved. Some prelimi- nary lessons can however be learned from the pursuit of partial (technology based) cost curves. The paper has described some of these partial and integrated approaches to cost comparison, and described the main

methodological assumptions and limitations of such approaches.

When international comparisons are to be made, the complexities of making accurate comparative cost assessments are exacerbated by differing social discount rates, by price exchange factors and by the systemic linkages between different energy systems operating in a global market.

In spite of such complications there are some very compelling reasons to suggest that such comparative cost assessment is an essential prerequisite for cost- effective implementation of the aims of the climate convention. The main argument for joint implementation is tliat allowing trade in emission credits will ensure that the lowest cost options are implemented, irrespective of geographical location. But this argument assumes that it is possible to identify such low-cost options, and it is precisely for this reason that there is a need for an agreed cost methodology. In addition, of course, the argument requires (1) that the results of comparative cost assessments are continuously accessible to any interested investors; and (2) that different kinds of investments are assessed in an equitable fashion. These requirements pose quite specific institutional criteria on joint implementation procedures, such as the need for some kind of clearinghouse to process and publicize abatement cost assessments, the need to account for differing fiscal structures between participating nations and the need for efficient monitoring and verification procedures.

Some illustrative examples based on recent studies of cost-effectiveness in different countries have been used to investigate the potential benefits of and limitations to joint implementation. The existence of limited economic benefits from joint implementation arrangements has been verified using these examples. But it has been pointed out that transaction costs and additional costs for monitoring and verification may obscure these benefits unless the primary responsibility for abatement investment is taken domestically.

The paper has also examined the question of burden- sharing in relation to the costs of greenhouse gas abatement. In particular, it has raised the issue of the national benefits associated with negative cost options, and the effect which these have on the overall costs of achieving national abatement targets. It has been argued that there is a number of particular dangers in allowing developed countries to pursue joint implementation of low positive cost options in developing countries or economies in transition. First, such a course of action is likely to remove the impetus to pursue negative cost options in the donor country. Second, low-cost options may be considerably more limited in the host countries than they are in the donor countries particularly when

|36 Energy Policy 1995 Volume 23 Number 2

negative cost options are taken into account. Third, pursuit of positive cost options in developing countries or economies in transition may preempt cost-effective implementation of negative cost options in those countries. Finally, the overall costs for achieving a particular reduction target in a developed country may be considerably lower in the donor country than they are in the host country (and perhaps even negative) once domestic negative cost options have been taken into account. In these circumstances, it would be far from appropriate to allow a developed country to invest preferentially in low positive cost options in a developing country or an economy in transition. Rather, the net benefit to the developed country of pursuing low or negative cost options domestically is an argument for such a country to share the burden of global greenhouse gas abatement by extending its own national commitment to greenhouse gas emission reductions. Some illustrative examples in which such circumstances arise have been examined using existing cost studies based on real world data.

Finally, it is worth summing up some of the implications of this analysis for the political negotiations on joint implementation in the context of the Framework Convention.

First, cost-effectiveness in achieving the objectives of the convention cannot simply be assumed to result from the opening up of trade in emission credits or permits. Rather it needs to be based on an analytic framework which identifies least-cost paths for greenhouse gas abatement nationally, bilaterally and where necessary multilaterally. In particular, there are good grounds for requiring that national cost-effectiveness in implementing abatement options should be a prerequisite for participation in joint implementation projects.

Second, the development of such a framework is dependent on the construction of baselines from which to measure both the incremental abatement and the incremental costs of abatement. No commitments currently exist concerning the provision of such baselines by parties to the Convention. Furthermore, the need for such baselines opens up the possibility of 'strategic behaviour' in relation to them (see eg Ghosh et al, 1994), and implies the need for careful institutional development to reduce such behaviour to a minimum.

Additionally, such a framework requires the development of an agreed, transparent and consistent methodology for costing technological abatement options. Since cost-effectiveness is the primary motiva- tion for joint implementation, there is an onus on those seeking credit for joint implementation arrangements to ensure that cost-effectiveness is achieved. In particular, care concerning the systemic upstream and downstream effects of energy related investments should be demon-


strated in both the host and the donor countries. Finally, it should be clear from the preceding analysis

that allowing joint implementation to be pursued on an ad hoc project by project basis by a heterogeneous community of private investors - far from promoting cost-effectiveness - may run the risk of hampering and hindering least-cost paths to global warming abatement both nationally and globally.

Acknowledgements

I am grateful (without any abdication of authorial responsibility) to Lise Backer, Peter Bailey, Lynne Clarke, Uwe Fritsche, Gordon MacKenzie, Felix Matthes, Katrin Millock, Poul-Erik Morthorst, Jim Sweet, Joel Swisher and Farhana Yamin for intellectual help, extensive critical comment and invaluable advice at various stages of writing of this paper. I also acknowl- edge the financial assistance of Climate Network Europe and the Stockholm Environment Institute in the preparation of this work. This paper was originally prepared for Climate Network Europe and an earlier version of the paper appeared in 'Joint Implementation from a European NGO Perspective, Climate Network Europe, July 1994. At the time of writing this paper the author was with the Stockholm Environment Institute, Box 2142, S-103 14 Stockholm, Sweden.

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Joint implementation and cost-effectiveness under the Framework Convention on Climate Change