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The Copenhagen conference is a bitter disappointment for European countries. While environment is one of the domains in which European integration is deepest, European countries failed to build and support a common position that would have weighed on the outcome of the conference, the Copenhagen Accord. Significantly, this outcome has been negotiated and signed at the national level and European countries had different position on its content. Moreover, this Accord appears at odd with the expectations of most European countries. In particular, this agreement gives up the “global governance” approach of the Kyoto Protocol, which set a collective goal in terms of reduction in greenhouse gas emissions and translated this collective goal into individual targets for each member country. In the Copenhagen accord, instead, each country announces unilaterally an individual target for its 2020 emissions, and the accord introduces a simple verification of individual commitments.

Compared to the Kyoto approach, four essential elements are lost. Firstly, the agreement is not legally binding and there is no provision in case of non compliance. Secondly, in a system where each country unilaterally announces its commitment to reduce emissions, there is no guarantee that individual efforts are of comparable magnitude, and we can only note that the Russian and American proposals are more modest than European ones. Thirdly, although the Copenhagen agreement recalled the objective of maintaining global warming below 2°C, there is no guarantee that the sum of individual commitments is sufficient to achieve this collective goal. And we know that in the current situation, the efforts announced drive us toward a 3°C-or-more warming. Finally, the Copenhagen agreement was negotiated by 28 countries only, and has not been validated by the 192 member countries that are parties to the Climate Convention of the United Nations. It is therefore a partial agreement to a problem that concerns all countries, and the way this agreement has been reached threatens the Climate Convention, a unique 17-year international negotiation process.

Forget Kyoto: Four European Answers

For all these reasons, the outcome of the Copenhagen conference is disappointing. But today, it appears that it was simply impossible to maintain the Kyoto approach. Instead of distributing blames and accusations to explain this failure, it seems more reasonable for Europe to forget the Kyoto Protocol and its philosophy and to recognize that it is an important progress to have included the United States and China in a unique agreement. From there, Europe could try to (re)construct a common position on how to build on the Copenhagen Accord to make it more ambitious and credible. Such a common European position could be based on answers to the four limitations mentioned above.

First, progress is needed on the fact that the accord is not legally-binding and lacks credibility. In the current situation, building a legally-binding framework seems impossible. But if all countries wish to fulfil their obligations, and their reluctance to accept stronger commitments suggests they do, then they can accept a control that is stronger than what is currently agreed on. To do so, an international organization could be created to control emissions of each country and verify that commitments are respected. This proposal was already supported by France and others at Copenhagen, but it met strong opposition. It could now be supported by the European Union, its chance of success increasing if a cap-and-trade law passes the US Congress in 2010. Of course, such an international organization would not make the agreement legally-binding, but it would give weight to the political agreement signed in Copenhagen.

Then, it seems clear that no country can agree to make efforts that are much greater than what other countries are doing, at the risk of disadvantaging its industry and losing jobs and market shares. From an ethical point of view, moreover, it seems unfair that the most ambitious countries suffer from their desire to protect a global public good. In absence of an international mechanism to share emission reduction efforts in a fair manner and in the framework of unilateral commitments, it appears unavoidable to recognize the right to establish fiscal compensation mechanisms. Countries with most ambitious climate policies, whose production costs would increase, would be allowed to introduce a border tax to maintain their competitiveness on their domestic market. The most publicized risk associated with such a tax, namely its use for pure and simple protectionism, could be mitigated if the commitment-control international organization were required to authorize the tax before its introduction. At a later stage, such fiscal mechanisms could even be used to ensure compliance: in practice, a border tax could be applied to exports of countries that do not meet their commitments, after proper analysis and control by the international control organization.

Third, a solution needs to be found to ensure that the sum of individual national efforts is sufficient to achieve the collective objective of maintaining global warming below 2°C. The lack of consistency between the collective goal and individual commitments is undoubtedly the most glaring weakness of the Copenhagen Accord. As the philosophy of this agreement makes it inadequate to impose additional emission reductions, an incentive-based system should be favoured. To do so, the Climate Convention or the IPCC could make a systematic evaluation of the sum of national commitments – in developed and developing countries – and provide an estimate of future emissions trajectories and of the corresponding climate projections. A comparison of these climate projections against the 2°C collective objective would allow to announce a “commitment shortfall,” i.e. the need for additional action to achieve the collective objective. Such an analysis has been done by Carlo Carraro and Emanuele Massetti, and published in Climate Science&Policy (“Two good news from Copenhagen?” January 7th, 2010). They show that the abatement plans proposed by major emitters in Copenhagen are inconsistent with the 2°C target, even if all the climate international finance proposed in the Accord is dedicated to mitigation in developing countries, and they discuss the need for additional effort, i.e. the commitment shortfall. From this type of information, a further mission of the annual Climate Convention conferences could be to announce this commitment shortfall, and to invite all countries to do more to reduce this deficit. The shortcomings of such a process are obvious, but it now seems difficult to do better, and hopefully public opinion pressure will encourage countries to make the necessary commitments.

Finally, it is essential to bring the Copenhagen Accord under the UN Climate Convention and ensure that all countries join its new approach. It could be possible to give up this global approach and work only among big emitters, like in the Major Economies Forum on Energy and Climate. But this approach is inadequate because the climate change issue will not be settled if the most vulnerable countries are not at the negotiation table. And even if mitigation commitments could be discussed in such a group, it is inappropriate to discuss mitigation and adaptation in different arenas, since these two topics are interlinked through financial flows, technology exchanges, and infrastructure design. The Copenhagen approach, based on the selection of a few “representative” countries is also flawed: on which basis should the Maldives be considered as representative of all small islands? In absence of any better solution, therefore, it is urgent to reinstall the Copenhagen agreement within the Climate Convention. And today, acknowledging the impossibility to save the Kyoto Protocol, it may be possible to convince all countries to join a new approach, provided that the three preceding issues are treated properly and that the Copenhagen Accord reaches an acceptable level of credibility.

The Financial Fluxes Issue

In addition to these four questions, it will be necessary to specify as rapidly as possible the modalities of the financial transfers planned by the Copenhagen agreement, i.e. $30 billion for the 2010-2012 period, and annual flows increasing to $100 billion per year in 2020. To make the agreement acceptable to all developing countries, these transfers will have to support emission reduction and adaptation to climate change effects. Supporting emission reductions in developing countries can be done through the financing of the additional costs due to climate policies. These fluxes will be mainly directed toward big emerging economies. Adaptation support, on the other hand, should target in priority the poorest countries through the financing of their infrastructure deficit, i.e. the required infrastructures to manage water, waste, energy, and natural hazards. Adaptation funding should help pay the cost of these basic infrastructures, and not only the additional cost due to climate change, since a poor country that cannot finance any dike system would have little use of a funding source that pay only the cost of upgrading it.

Furthermore, the Copenhagen Agreement puts on an equal foot the adaptation of Bangladesh to rising sea level and the adaptation of Saudi Arabia to climate-policy-driven reductions in oil consumption. Without reconsidering this agreement, financing arrangements have to be developed in such a way that oil-exporting countries do not capture too much funding, to ensure that aid is effective and directed towards the most vulnerable populations.

These five points provide for the year 2010 a European roadmap that is simple, realistic and potentially acceptable by all countries: the creation of an international institution to control country-level commitments, the recognition of the right for countries with particularly ambitious climate policies to introduce fiscal border-adjustment mechanisms, the annual publication of the commitment shortfall, the reinstatement of the strengthened Copenhagen Accord within the Climate Convention, and the development of efficient and fair financial transfer modalities. Rebuilding a European position could help make significant progress on these points over the year, and turn the Copenhagen failure into a Mexican success.

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Mitigation costs to reach ambitious stabilization targets are estimated below 5% of GDP (IPCC, 2007). Most models used represent a first based world (optimizing agents with perfect foresight, market clearing equilibrium in all markets, and full utilization of production factors). With such assumptions, the optimal policy is a carbon tax, or a cap and trade system to equalize marginal costs. Any deviation from this is supposed to lead to additional costs and to veer from the optimum. By nature, synergies between development and climate policies and no-regret potential are excluded. The world is on the contrary, full of imperfections that could lead to higher mitigation costs however, they can also provide opportunities for implementing synergies between climate and development. In this article, we analyze the potential for implementing these synergies in a case study focusing on the power sector sub-optimalities in India. To do this, we rely on the modeling framework, Imaclim-R, which is well suited to represent a second best world and to embark sub-optimalities, disequilibrium, and inertia in technical systems.

Institutional and Market Failures of the Indian Power Sector

The Indian power sector is characterised by many institutional and market failures. The most critical symptom of these failures is a restrained access to energy services for both households and productive sectors: while electrification covers only 60% of Indian households (the remaining 40% that are not connected to the grid rely mainly on traditional biomass or on diesel generators), capacity shortage in 2007 reached 9.6% of total demand from the grid reinforcing the use of diesel generators by households and industries.

These power cuts and capacity shortage are caused by structural underinvestment in the power sector. The opening of the sector to the private sector in 1991, failed in absorbing the shortage and in compensating for the constraints on public funding. Less than half of the additional power capacity that had been programmed in the 10th Plan has been built. This underinvestment is largely due to the critically low profitability of investments in this sector induced by a very expensive cross subsidy system.

In 2006, the average level of administrated price covered only 77% of the average production cost: tariffs for households and farmers covered respectively 56% and 12% of the generation costs while industries and the commercial sector were partly compensated because they paid respectively 108% and 122% of production costs. Between 1993 and 2000, subsidies to households and to agriculture more than tripled and reached respectively 0.4 and 1.1% of GDP. In 2000, agriculture uses represented 1/3 of electricity sales in volume but less than 5% of total revenues.

These subsidies are justified by positive externalities on development (access to cheap energy for irrigation to promote food production). Nevertheless, they have significant side effects:

• the combination of critically low prices and of frequent but unpredictable power cuts create a strong incentive to a continuous use of electric pumps for irrigation and induces over consumption (estimated at 30% at least of consumption in agriculture), which increases the magnitude of capacity shortage;
• low revenues from electricity sales induce maintenance under financing and increasing inefficiencies in transmission and distribution, which represented at least 30% of the production in 2005.

Moreover, power sector inefficiencies constrain economic growth: electricity shortages hamper productivity and competitiveness. This reduces government tax revenues, and therefore capital availability to invest in additional power capacity.

Source: Annual report 2008-2009. Ministry of Power, India Click to enlarge

These sub-optimalities namely, power generation shortage, under-investment, tariffs not reflecting costs and T&D losses¹ are implemented within the Imaclim-R² hybrid recursive modelling framework. Imaclim-R has been developed to account for sub-optimalities and inertia in technical systems. Underinvestment in the power sector is represented by a gap between the estimated need of investments and realised investments in the power sector. The induced power generation shortage is represented by over utilisation of generation capacities, as Imaclim-R allows for endogenous disequilibrium due to inflexible characteristics of equipment vintages available at each period (putty-clay technologies). In case of underinvestment, in the short term, the main available flexibility lies in the rate of utilization of capacities, which may induce shortage of production factors, entail extra generation costs³, and raise the electricity usage cost.
Whether these sub-optimalities will persist or not is a determining factor for defining climate mitigation strategies.

Deadlock of a Carbon Price

Even if the demand decrease in the power sector for a 450ppm CO2 stabilization objective is large enough to absorb the power shortage and to remove over costs of generation due to over-utilization of capacities, persisting energy inefficiency in power production, transmission, and distribution coupled with over-consumption habits for farmers will introduce a substantial delay in the potential pace of decarbonization in the power sector⁴. A carbon pricing policy will then impact for a longer time the usage cost of electricity for households and industry.

As a result, a carbon price only scenario will induce prohibitive macroeconomic costs for India (-20% of the baseline GDP in 2030) even if GDP losses decrease after 2030 because of a faster technical change induced by the carbon price and of less vulnerability of the Indian economy to oil prices rising. The increased usage cost of electricity has a very important eviction effect for households on other goods consumptions. It induces a decreased competitiveness of Indian production due to the higher energy share in industrial production costs compared to other regions.

Financial transfers from a cap and trade system could reduce these losses. Indeed, with a contraction and convergence rule, financial transfers amount to 1.5% of GDP in 2020, and more than 2% of GDP between 2030 and 2040. On the long term, GDP is 15% higher than in the baseline due to the income effect of financial transfers and to the induced technical change. But on the short term, transition costs persist and India still loses 6% of its GDP in 2015 compared to the baseline. Organizing higher financial transfers to alleviate transition costs have little chance to be accepted by industrialized countries.

Looking for Synergies Between Climate Policies and Development

An alternative approach is investigated to enlarge the spectrum of climate policies to domestic policies targeting sub-optimalities in the power sector:

• the progressive reduction of subsidies to electricity consumption for the agricultural sector, accompanied by demand side management (improvement of irrigation pumps, evolution of consumption habits⁵);
• the implementation of a program to reduce electricity T&D losses to 15% over a 20-year period;
• the revenues following the partial removal of electricity consumption subsidies in the agricultural sector are used to finance all of these components. Remaining additional revenues are rebated to households through lump-sum transfers.

These measures are implemented within the same contraction and convergence allocation and result in GDP losses limited to 2% of the reference scenario during the first three years after the implementation of policies. The main reason for this is the decrease in the electricity usage cost induced by the reduction of T&D (transmission & distribution) losses and by demand side management. These measures lead to a reduction of energy budget share for households and less crowding-out of other goods consumption; in industry these measures lead to a substitution from fossil fuels to electricity and a reduced share of the energy budget.

Therefore Indian products lose relatively less competitiveness than in other simulations, and salaries are less squeezed to restore commercial balance: wage levels are 9% higher in 2020 and 2030. A positive income effect stems from higher wage levels. More wages increase due to more overall activity, and transfers to households coming from the remaining revenues generated by subsidies decrease. They are not used to finance the policies. Climate policies focusing on the alleviation of sub-optimalities constitute a win-win solution for climate and development.

Conclusion

From a methodological point of view, modeling frameworks are able to represent second best world characteristics in order to embark specificities of each national economy and to exhibit no regret potential. Possible synergies between climate policies and development policies should be used for mitigation cost assessment.

From a political point of view, the future international climate agreement should support the implementation of specific policies such as no-regret potential and energy efficiency measures to account for the heterogeneity of the real world instead of only dictating the implementation of a cap and trade system.

1. By default, tariffs not reflecting costs and T&D losses are expected to persist until 2050
2. For a detailed description of Imaclim-R and of the implementation of sub-optimalities within Imaclim -R, please refer to Sassi et al. (2007) and to Mathy and Guivarch – under review
3. Mean generation costs increase when capacity is overused due to the existence of static decreasing returns due to higher labour costs and because less efficient units are switched on at the last aggregate level. By default, in our model, the increasing factor is attached to wages.
4. In India, 69% of electricity is produced with coal.
5. If the service is improved, the number of unpredictable power cuts will be lower, and farmers will not have to leave their pumps switched on all day long.