11.7.5 Effect of mitigation on energy prices

As discussed in 11.7.2, perhaps one of the most important ways in which spillovers from mitigation action in one region affect the others is through their effect on world energy prices. When a region reduces its fossil fuel demand as a result of mitigation policy, it will reduce the world demand for that commodity and so put downward pressure on the prices. Depending on responses from producers of fossil fuels, oil, gas or coal prices may fall, leading to losses of revenue for the producers, and lower import costs for the consumers. Demand for alternative, low-carbon fuels may increase. Three distinct spillover effects have been identified for non-mitigating countries. First, income for producers of fossil fuels will decline as the quantity sold is reduced, causing welfare losses and unemployment along with associated problems. Second, consuming nations will face lower prices for imported energy and may reduce subsidies or allow domestic energy prices to fall so that they tend to consume more, leading to carbon leakage as discussed above. Third, those non-mitigating countries producing low-carbon or alternative fuels will see an increase in demand and prices, with potentially positive effects on the markets for bioenergy.

11.7.5.1 Effects of Annex I action reported in the TAR

The TAR reviewed studies (based on CGE models with no induced technological change) of Annex I action in the form of a carbon tax or emissions trading schemes. The TAR (pp. 541–6) reported that, for abatement in Annex I, ‘it was universally found that most non-Annex I economies that suffered welfare losses under uniform independent abatement suffered smaller welfare losses under emission trading’ (p. 542). The magnitude of these losses is reduced under the less stringent Kyoto targets compared to assumptions about more stringent targets in pre-Kyoto studies. Some non-Annex I regions that would experience a welfare loss under the more stringent targets experience a mild welfare gain under the less stringent Kyoto targets. Similarities in regions identified as gainers and losers were quite marked. Oil-importing countries relying on exports of energy-intensive goods are gainers. Economies that rely on oil exports experience losses, with no clear-cut results for other countries.

The TAR considered the effect of OPEC acting as a cartel (pp. 543-4) and concludes that any OPEC response will have a modest effect on the loss of wealth to oil producers and the level on emission permit prices in mitigating regions. Analyses pertaining to the group of oil-exporting non-Annex I countries report costs differently, and the costs include, inter alia, reductions in projected oil revenues. Emissions trading reallocates mitigation to lower-cost options. The study reporting the lowest costs shows reductions of 0.2% of projected GDP with no emissions trading and less than 0.05% of projected GDP with Annex B emissions trading in 2010. The study reporting the highest costs shows a reduction of 25% in projected oil revenues with no emissions trading, and 13% in projected oil revenues with Annex B emissions trading in 2010. These studies did not consider policies and measures, other than Annex B emissions trading, that could lessen the impact on non-Annex I, oil-exporting countries, and therefore tend to overstate both the costs to these countries and overall costs. The effects on these countries can be further reduced by the removal of subsidies for fossil fuels, energy tax restructuring according to carbon content, the increased use of natural gas, and diversification of the economies of non-Annex I, oil-exporting countries (IPCC, 2001, p. 60).