The case of Air Pollution

Xavier Timbeau
xavier.timbeau@sciencespo.fr

OFCE, Sciences Po Paris

Anissa Saumtally
anissa.saumtally@sciencespo.fr

OFCE, Sciences Po Paris

Some history

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

Industrial revolution

  • Industrial revolution started in England first (1750-);

  • Before industrial revolution: agricultural revolution ; commercial capitalism ; proto-industry

  • Around 1800 in continental Europe and the US but much later elsewhere in Asia, India, or Africa

    • Early exit of the Malthusian trap due to early better institutions (magna carta) and technical advances (somehow proven inexact)

    • predatory capitalism from the Western world choking development in colonies

    • availability of near ground coal (surface coal), specific to England and some places in Europe. Surface coal is the source for energy and frees wood resources (plus brick) for other uses (food, tools, boats, other constructions).

    • Elsewhere, fossil energy was usable only with later technologies: steam machine to dig deeper, train to transport coal, other fossil fuels

Industrial revolution: an energy revolution


Industrial revolution: modern times


The decrease in the cost of energy

  • Before: human or animal mechanical energy

    • to produce 1kWh (1,000 Watts for one hour), one needs 5 persons pedalling for an hour
    • at current minimum wage, that would cost ? 5 * 15 € = 75 €/kWh

  • Today: electricity provider

    • what’s the cost of 1 kWh from EdF ? 0.2€/kWh, 1€/kWh, 10€/kWh ?
    • 0.2€/kWh

  • Application

    • 6 minutes of a hair dryer : 1500W x 1/10h = 150Wh costs around 0.30€ now, +10€ then
    • A 10 minute hot shower (or a hot bath) : 1kcal/L/°C to heat water, 150L for a (long shower), from 10°C to 39°C, 1350kcal = 1500Wh costs around 3€ now +100€ then

incredible luxury with human generation, very affordable with modern technology,

a price decrease by at least 150 (not even accounting for capital costs)

Birth of environmental policies


Since the beginning of the Industrial revolution:

  • there was a concern with the environment, its destruction or pollution as Serge Audier describes.

  • Anti progress, romantic, naturalist intuition of destruction and distance from true nature of human beings

  • Effect of health and conditions of workers in factories and cities, heavily polluted and with dangerous places to work

  • A “pact” was made eventually between worker trade unions and “progress”. Material wealth could compensate for environment degradation

Some illustrations of the industrial revolution way of life

Some illustrations of the industrial revolution way of life

Acid Rain

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

First environmental acts: the London Smog

After industrial revolution and growth in the first part of the XX century, pollution is higher and higher.
More energy consumption, more domestic use of energy (heating, cooking, density of cities).

  • An example of the Coase theorem: Private arrangement and contracts will follow the demand as long as transaction costs are small enough.

  • Corollary, transaction costs will determine the institutional solution.

    • UK : Clean air act 1956, solution to the London Smog (1952, 4,000 deads, 100,000 declared ill)   early concerns starts back in 1853-56, see Sanderson J.B., 1961. “the National Smoke Abatement Society and the Clean Air Act (1956)”, Political Studies, 9(3)
    • US : Noise control Act (1972) ;
    • Clean Air Act (1963, 1967), and in many countries
    • Clean Water Acts (1972, 1977, 1987)
    • Natural environment Act 1969

Polluter Payer Principle



From clean air act to acid rains


Reduction of pollution in cities is made through:

  1. displacement of factories outside of cities, helped by new transportation technology

  2. lighter smokes, polluting particles are filtered, combustion is optimized
    smoke goes away, far away from the emitter

  3. shelter heating and cooking switch from coal to gas and electricity

Major change in the role and structure of cities, deindustrialization of cities, gentrification

Still a scar as housing prices are lower on the East side than on the West side of the city.

Acid rains


Lighter smokes provoke concentration of pollution in clouds, and fall back as acid rain:

  • Lighter pollution means more diffuse

  • Mixed in clouds, travel long distances,

  • Creates diffuse downfall and large scale acidification with consequences on water, forests and buildings

  • Appeared everywhere, but very visible in Germany (black forest)

  • Starting in the 1970’s, a major concern in the 1980’s

  • A spillover from initial reduction of cities pollution

Cap-and-trade

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

Cap-and-trade


The solution to acid rains is to reduce SO2 and NO2 emission by mostly electricity power plant (coal and gas)

  • In the USA – where the problem is the same as in Europe – the first Cap-and-Trade mechanism are implemented with some success:

    • some old power plants can be removed (decommissioned) and replaced at a low cost, some newer, but polluting, one have still a long life span and are costly to decommission

    • instead of brutally decommissioning all power plant and replacing them by new ones (unrealistic, costly, overshooting)

Cap-and-trade: How is it working ?


  • In order to provide a smooth and cheap solution a Cap-and-Trade system is implemented:

    • a cap on global emissions (of SO2, NO2) is set

    • allowances (right to pollute) are given (or sold) to the industry, every year, the sum of all allowances equaling the cap

    • to emit (a ton of) SO2 or NO2 you need an allowance. Failing to do so expose you to a fine.

    • Allowances are tradable (you can buy or sell, at a market freely defined price)

    • Free allowances are given, following a grandfathering rule: part of your past emissions or production gives you a right to pollute. A 100% grandfathering means that you have per unit of production a free allowance of you previous year emissions

The producer’s choice

A producer has a portfolio of factories emitting SO2 and NO2

To fulfill their production plan, the producer needs rights to pollute equal to their emissions

  1. they can use the free allowances

  2. complement with bought allowances

  3. invest in depollution technology

  4. or equivalent to 3, decommission an old factory and invest in a new one, more efficient

  5. reduce their production

All solutions are acceptable , and, if applied by all producers, guarantees that total emissions will be equal to the cap.

With a lower cap, allowances (even free) will be scarcer, their price is going to be non zero, and some producers are going to consider 3 or 4. By investing in depollution, their allowances can be in excess of their needs. They will sell allowances to other producers at a price that make 2. more profitable than 3. or 4.

What happens if all producers respond by 5 ?

The magic of cap-and-trade



2 firms having a different abatement curve. For a given target, one can find the price for the optimal cost of reduction.

A tax on both units would have as an effect that both reduce their production, increasing the total cost

A cap on each unit (“Command & Control”) could achieve the same as a cap or a tax but asks for a lot of information, plus updates on how the production and cost is evolving.

ban or tax ?

ban or tax ? with numbers

Paris to Barcelona, 1,000km, roundtrip,

  • by plane 360kg CO2; 2x2h; 200€

  • by train 5kg CO2; 2x6h30; 300€

  • by bus 60kg CO2; 2x15h;100€

What is the price of carbon to equalize plane and train ? 280€/tCO2

What is the price of carbon to equalize bus and train ? 1,800€/tCO2

According to the Lazard & Roland Berger LCOE report (ref below), in 2024 minimal LCOE of coal (0,98tCO2/MWh) is 69$/MWh, gas (combined cycle 0,3tCO2/MWh) is 45$/MWh, maximum price of wind off shore electricity is [74-139]$/MWh. Coal to wind saves 0.98 and costs [5-70]$/MWh or [5-70]$/tCO2 ; Gas to wind saves 0.33tCO2 and costs [29-94]$MWh or [88-282]$/tCO2.

Banning plane, in favor of train, increase cost of travel, reduce emissions by 0.355tCO2, if the trip is done, and by an unknown amount if the money is spent elsewhere (spillover) as new spending will emit CO2.

Taxing plane to equalize train (plane will be still preferred as quicker, so expect no train trip, price increase will decrease somehow trip demand with spillover elsewhere), does not change more demand than banning (except for bus, adding 17€ to the trip cost), but brings 100€ in revenue, which can be used to reduce [0.35-1,25]tCO2 if gas to wind is performed, [1.4-20]tCO2 if coal to wind is performed.



A Solution to the European Acid Rain Crisis

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

Shared Diagnosis & Burden

Contrary to the USA, Europe was fragmented. Who was responsible ? Who were the victims ? What were the costs ?

  • Step 1: information

    • EMEP (European Monitoring and Evaluation Program), under the Convention on Long-range Trans-boundary Air Pollution (UN Economic Commission for Europe 1979)
    • Data and modelling, on sources, movement and impacts of air pollution
      (grid made of 820 squares, every 6 hours, measuring mvt of air, pollution in and out)
      sophisticated at that time, but crude, partial and unrealistic probably dead wrong

  • Step 2: efficient cost abatement

    • Reducing SO2 and NOx emissions has not the same cost nor the same efficiency in reduction of impact (in Europe)
    • Market based instruments versus Command & Control

  • Step 3: international Cooperation

    • possibly compensation of polluted by polluters
    • exchanges between countries
    • distribution of hot air

Polluters vs Polluted

Cost of abatement

Abatement cost curve

Marginal cost curve versus Abatement curve


The standard economic analysis of optimal pollution









Marginal cost of depollution = Abatement cost of depollution


2 arguments and a bonus

  • Tradable rights are more efficient than non tradable (tax or quantity constraints): a common price and tradable rights will allow a transfer from Germany to UK: instead of reducing emissions Germany buys rights to pollute to UK. The total cost is lower for Germany and for UK it is more efficient and it reaches the same target.

  • And a bonus: tradable markets allow to reveal information, are efficient and can accommodate for free allowances. It is therefore possible to have no impact on (average) costs compared to business as usual (BAU). No impact on relative prices as well, i.e. on consumers, reducing the internalization of the cost and the discontent). Useful negotiation tools with industries or between countries.

Pricing Carbon

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

Main Carbon Markets


Stavins, R. (2019). The Future of U.S. Carbon Pricing (NBER working paper No. 25912)

Adding one important argument:

  • cap’n trade is under competition jurisdiction (technical, non qualified majority, not taken in account in tax burden) when taxes are under finance committees

  • easier to decide and vote

Carbon Price around the World

ETS price of carbon

State and Trend of Carbon Pricing



  • EU ETS remains the highest carbon pricing around the world

  • China and other Asian markets are still very low

  • California and Alberta carbon market are catching up with EU ETS

  • Germany ETS is an TS for waste, transport, building and industry, anticipating ETS2

Revenue from ETS



  • ETS and Carbon taxes are rising

  • World GDP (2024) is over 100,000 bUS$, carbon revenues are less than 0.1% of world GDP

  • EU ETS 2023 are 47.4 bUS$ in 2023, (0.235% EU GDP), nearly 50% of carbon revenues around the world, 65% of all CTS.

ETS2 and the Green Deal

Following the 2023 revision of the ETS directive, inside the Green Deal framework, the EU ETS is going to be extended :

  • Starting in 2024, boat and plane emissions are under ETS, including non CO2 emissions

  • Extension to fuel combustion in buildings, road transport and small industry not covered by the existing EU ETS

  • Reporting and allowances provision will be done upstream (by suppliers)

  • After phasing in progressively, ETS2 is supposed to be fully implemented by 2027

  • EU ETS prior to 2023 is covering 38% of CO2 emissions, EU ETS2 could cover close to 75% (nearly doubling the coverage)

  • Under strong discussions because of the anticipation of social consequences and competitiveness issues

  • CBAM is limited in scope and will not insure fair pricing

  • Some complex mechanisms can provide delay or exception when the member state is already taxing carbon

  • Social funds are notably underprovisioned (20€/per capita/year)

  • Inflation Reduction Act (plus Trump) and China agressive subsidies put a lot of pressure on ETS, ETS2 and Green Deal. The new European Competitiveness Compass is softening the Green Deal strategy.

Tax vs Cap-and-Trade: wrap up

Taxation Cap'n Trade Command&Control
Cost effectiveness
Yes, under condition Yes under conditions: No, very different implicit prices
If applied to all, with same price If applied to all (high t.c.) Unless cost & transaction costs are low
No free allowances
Uncertainty of cost uncertainty of quantities
Superior in simple framework, as quantities are a stock Inferior, but quantités are a stock and investment is also Very (too?) flexible,
Price stability is key to long term decision Second order depends on comparative slope of marginal cost and marginal benefit Long term efficiency (through banning)
Central bank type monitoring of market can stabilze price and mimick tax
Governance
Tax legislation, in the hand of finance committee in parliament, not green usually Specific legislation committees Very specific legislation up to arbitrary and opaque decisions
Use of receipts symbolically important (not relevant however) no unanimity needed in the EU open to lobby influence, hard to commit in the long term
very flexible to changes in technology
International agreements
In the UE tax legislation requires unanimity international agreement and linkage possible National only except trhough norms applied to imported products
International binding agreements impossible due to principle fiscal sovereignty Free allowances can induce carbon leakage (hard to compensate with BTA)
BTA
Possibility of capture or fraud
Strong institutions for tax compliance Market manipulation possible, but not likely to be an issue Impossible to equilibrate pressure
Manipulation of outcomes
Principle of equal taxation Frauds due to different juridictions and linkage Monitoring costs and frauds high
Small number of units under trade scheme, caputure by lobbies likely (similar to interbank market)
Inter state compensation (hot air)
Information, monitoring and compensation
Low costs if taxation is upstream for CO2 emissions Low for large units, nearly impossible for small ones – taxes and t&c must coexist Very difficult to monitor
High if monitoring is downstream International markets raise taxation cooperation issues and free rider with another policies interactions Compensation at the cost of higher emissions (tradeoff between target and compensation)
Compensation is difficult (downstream, high information and monotoring cost) or compensation is lumpsum kind (average compensation, double dividend) Upstream compensation very easy
Heterogenity
One size fits all Easily reveal social cost Very suited to tailored policies, with efficiency loss unquantifiable
Potentially corrected with BTA, with loss of efficiency Limit extreme pressure on high polluters

Cap-and-Trade discussion

Appendices

Some history

Acid Rain

Cap-and-trade

A Solution to the European Acid Rain Crisis

Pricing Carbon

Appendices

Expected EU ETS Carbon Price