7.6.6.4 Critical Assumptions in the Energy Sector

Table 7.4 provides an overview of the key assumptions behind mitigation cost studies for the energy sector. It is based on SAR (IPCC, 1996a, Chapter 8) and Halsnæs et al. (1998). Some of the new modelling areas that have important implications include assumptions on technology change, transaction costs and barrier removal policies, alternative demand projections (including lifestyle), and ancillary benefits. Similarly, assumptions related to climate change mitigation policies with major implications on costs include timing of the emissions reduction policies, and extent and function of global markets for emissions reduction projects.

The input assumptions are linked between the baseline case and the climate policy case in a complex way. There is the potential for many assumption combinations in baseline and mitigation scenarios, and the full set of assumptions in these two scenarios impacts the assessment of mitigation potential and related costs.

An OECD workshop in September 1998 (Mensbrugghe, 1998) concluded that the emissions reduction costs rely on baseline assumptions. Factors that lead to high cost estimates include high population and GDP growth rates, a relatively clean fuel mix, and relatively high energy costs. Among model parameters two areas were emphasized: the ability to substitute labour for energy, and the interfuel substitution elasticity. Low elasticities lead to high costs.

Table 7.4: Input assumptions used in energy sector mitigation studies
Input assumptions	Meaning and relevance
Population	All else being equal, high growth increases GHG emissions.
Economic growth	Increased economic growth increases energy-using activities and also leads to increased investment, which speeds the turnover of energy-using equipment. Various assumptions on GHG emissions and resource intensities can be used for alternative scenarios.
Energy demand
– structural change	Different sectors have different energy-intensities; structural change therefore has a major impact on overall energy use.
– technological change	This “energy-efficiency” variable influences the amount of primary energy needed to satisfy given energy services required by a given economic output.
– “lifestyle”	Explains structural changes in consumer behaviour.
Energy supply
– technology availability and cost	Potential for fuel and technology substitution.
– backstop technology	The cost at which an infinite alternative supply of energy becomes available; this is the upper bound of cost estimates.
– learning	Technology costs related to time, market scale, and institutional capacity.
Price and income elasticities of energy demand	Relative changes in energy demand through changes in price or income, respectively; higher elasticities result in larger changes in energy use.
Transaction costs	Implementation, administration, scale of the activity.
Policy instruments and regulation
– instruments	Economic versus regulatory measures.
– barriers	Implementation costs, including costs of overcoming barriers either in the form of institutional aspects or improvements in markets (including capacity building and institutional reforms); behavioural assumptions.
Existing tax systems and tax recycling	Recycling of carbon taxes; substitution of distortionary taxes decreases costs.
Ancillary benefits	Integration of local and regional environmental policies in most cases generates secondary benefits.
	Social policy goals, like income distribution and employment, can result in different policy rankings.

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