The United Nations Framework Convention on Climate Change (UNFCCC) has as its ultimate goal the “stabilization of greenhouse gas concentrations in the atmosphere at a level that will prevent dangerous anthropogenic interference with the climate system.” Whereas mitigation costs play only a secondary role in establishing the target, they play a more important role in determining how the target is to be achieved. UNFCCC states that “policies and measures to deal with climate change should be cost-effective so as to ensure global benefits at the lowest possible costs.” This chapter examines the literature on the costs of greenhouse gas mitigation policies at the national, regional, and global levels. The net welfare gains or losses are reported, including (when available) the ancillary benefits of mitigation policies. These studies employ the full range of analytical tools described in Chapter 7, from the technologically rich bottom-up models to more aggregate top-down models, which link the energy sector to the rest of the economy.

Models can also be distinguished through their level of geographical disaggregation. Global models, which divide the world into a limited number of regions, can provide important insights with regard to international emissions trade, capital flows, trade patterns, and the implications of alternative international regimes regarding contributions to mitigation by various regions of the globe. National models are more appropriate for examining the effectiveness of alternative fiscal policies in offsetting mitigation costs, the short-term effects of macro shocks on employment and inflation, and the implications of domestic burden-sharing rules for various sectors of the economy.

To cope with their wide range of diversity, the studies are grouped into three categories. The first two focus on the near-to-medium term. In one of these, the focus is exclusively on domestic policies. In the other, the domestic/international interface is explored. The third category focuses on the long-term goals of climate policy and explores cost-effective implementation strategies. That is, what is the least-cost emission reduction pathway for accomplishing a prescribed goal? The major conclusions are summarized below.

For any class of models, the emissions baseline is critically important in determining mitigation costs. It defines the size of the reduction required for meeting a particular target. The growth rate in carbon dioxide (CO₂) emissions is determined by:

• growth rate in gross domestic product (GDP);
  
• decline rate of energy use per unit of output, which depends on structural change in the economy and on technological development; and
  
• decline rate of CO₂ emissions per unit of energy use.
  Much of the difference in cost projections can be explained by differences in these key variables.

Economic studies vary widely in their estimate of mitigation costs (both across and within countries). These differences can be traced to assumptions about economic growth, the cost and availability of existing and new technologies (both on the supply and demand side of the energy sector), resource endowments, the extent of “no regrets” options and the choice of policy instruments.

Virtually all analysts agree on the existence of “no regrets” options. Such options are typically assumed to be included in the reference (no policy) scenario by economic modellers. Even so, the overwhelming majority of emission baselines show that emissions continue to rise well into the future. This suggests that zero cost options are insufficient to reduce emissions in the absence of policy intervention.

Mitigation costs to meet a prescribed target will be lower if the tax revenues (or revenues from auctioned permits) are used to reduce existing distortionary taxes (the so-called “double dividend”). The preferred policy depends on the existing tax structure. Most European studies find that cutting payroll taxes is more efficient than other types of recycling. A significant number of these studies conclude that, within some range of abatement targets, the net costs of mitigation policies can be close to zero and even slightly negative. Conversely, in the USA, studies suggest that reducing taxes on capital is more efficient, but few models report negative costs.

Policies aimed at mitigating greenhouse gases can have positive and negative side effects (or ancillary benefits and costs, not taking into account benefits of avoided climate change) on society. Although this report overall emphasizes co-benefits of climate policies with other policies (to reflect the reality in many regions that measures are taken with multiple objectives rather than climate mitigation alone), the literature that focuses on climate mitigation uses the term “ancillary benefits” of specific climate mitigation measures. In spite of recent progress in methods development, it remains very challenging to develop quantitative estimates of the ancillary effects, benefits and costs of GHG mitigation policies. Despite these difficulties, in the short term, ancillary benefits of GHG policies under some circumstances can be a significant fraction of private (direct) mitigation costs. In some cases the magnitude of ancillary benefits of mitigation may be comparable to the costs of the mitigating measures, adding to the no regrets potential. The exact magnitude, scale and scope of these ancillary benefits and costs will vary with local geographical and baseline conditions. In some circumstances, where baseline conditions involve relatively low carbon emissions and population density, benefits may be low. For the studies reviewed here, the biggest share of the ancillary benefits is related to public health.

Mitigation costs are highly dependent on assumptions about trade in emission permits. Cost estimates are lowest when there would be full global trading. That is, when reductions are made where it is least expensive to do so regardless of their geographical location. Costs increase as the size of the emissions market contracts. In the case of Annex B trading only, the availability of excess assigned amount units in Russia and Ukraine can be critical in lowering the overall mitigation costs. Carbon trade provides some means for hedging against uncertainties regarding emissions’ baselines and abatement costs. It also reduces the consequences of an inequitable allocation of assigned amounts.

It has long been recognized that international trade in emission quota can reduce mitigation costs. This will occur when countries with high domestic marginal abatement costs purchase emission quotas from countries with low marginal abatement costs. This is often referred to as “where flexibility”. That is, allowing reductions to take place where it is cheapest to do so regardless of geographical location. It is important to note that where the reductions take place is independent upon who pays for the reductions. The chapter discusses the cost reductions from emission trading for Annex B and full global trading compared to a no-trading case. All of the models show significant gains as the size of the trading market is expanded. The difference among models is due in part to differences in their baseline, the cost and availability of low-cost substitutes on both the supply and demand sides of the energy sector, and the treatment of short-term macro shocks. In general, all calculated gross costs for the non-trading case are below 2% of GDP (which is assumed to have increased significantly in the period considered) and in most cases below 1%. Annex-B trading would generally decrease these costs to well below 1 % of GDP for OECD regions. The extent to which domestic policies relying on revenue recycling instruments can lower these figures is conditional upon the articulation of these policies and the design of trading systems.

Emissions constraints in Annex I countries are likely to have so-called “spillover” effects on non Annex B countries. For example, Annex I emissions reductions result in lower oil demand, which in turn leads to a decline in the international price of oil. As a response, non-Annex I countries may increase their oil imports and emit more than they would otherwise. Oil-importing non-Annex I countries may benefit, whereas oil exporters may experience a decline in revenue.

A second example of spillover effects involves the location of carbon-intensive industries. A constraint on Annex I emissions reduces their competitiveness in the international marketplace. Recent studies suggest that there will be some industrial relocation abroad, with non-Annex I countries benefitting at the expense of Annex I countries. However, non-Annex I countries may be adversely affected by the decline in exports likely to accompany a decrease in economic activity in Annex I countries.

The cost estimates of stabilizing atmospheric CO₂ concentrations depend upon the concentration stabilization target, the emissions pathway to stabilization and the baseline scenario assumed. Unfortunately, the target is likely to remain the subject of intense scientific and political debate for some time. What is needed is a decision-making approach that explicitly incorporates this type of uncertainty and its sequential resolution over time. The desirable amount of hedging in the near term depends upon one’s assessment of the stakes, the odds, and the costs of policy intervention. The risk premium–the amount that society is willing to pay to reduce risk–is ultimately a political decision that differs among countries.

The concentration of CO₂ in the atmosphere is determined more by cumulative rather than year-by-year emissions. A number of studies suggest that the choice of emissions pathway can be as important as the target itself in determining overall mitigation costs. A gradual near-term transition from the world’s present energy system minimizes premature retirement of existing capital stock, provides time for technology development, and avoids premature lock-in to early versions of rapidly developing low-emission technology. On the other hand, more aggressive near-term action would decrease
environmental risks associated with rapid climatic changes, stimulate more rapid deployment of existing low-emission technologies, provide strong near-term incentives to future technological changes that may help to avoid lock-in to carbon intensive technologies, and allow for later tightening of targets should that be deemed desirable in light of evolving scientific understanding.

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