Ural Federal University: New Economic Model Will Help Assess the Effectiveness of Greenhouse Gas Regulation

An economist from UrFU, together with foreign colleagues, presented a computational model that can be used to simulate climate policy instruments and their impact on the economy and carbon emissions. It turned out that regulation at the fossil fuel extraction stage is more effective than regulation at the processing stage. Carbon taxes and “pollution permits” that can be traded proved to be the best: in contrast to government quotas for all businesses, in this case the consumer can be compensated for the costs of rising prices for goods responsible for high greenhouse gas emissions.

The work is published in the Technological Forecasting and Social Change journal. The research was supported by a grant from the Russian Science Foundation (RSF).

According to the press service of the Russian Science Foundation, emission of greenhouse gases into the atmosphere is one of the most important environmental problems, the solution of which will help to slow global warming. The biggest contribution to the greenhouse effect is made by burning, extraction and transportation of fuel. To prevent global warming, scientists suggested improving the system of payments for carbon emissions into the atmosphere. Developed countries already have two approaches to reducing emissions: a market-based mechanism and direct regulation. The first is a carbon tax – a fee on the carbon content of fuel – or emission allowances – permits that give a “right to pollute” – which firms can trade with each other. The second is based on giving allowances to all firms in the industry. In reality, such approaches tend to apply to companies that use fossil fuels but do not produce them.

“The model we present shows that it is more effective to impose regulation for carbon emissions not at the level of end-product producers, but at the level of companies that extract fossil energy sources. This is the case because often some firms are not subject to environmental policies and do not pay taxes, such as exporters and importers, the shadow market or small businesses. Controlling hydrocarbon production is preferable to controlling emissions at companies, because it leads to an increase in hydrocarbon prices for all producers of end products, and thus makes the instrument more efficient,” explains Ivan Savin, the main executor of the RSF project, professor of the Ural Federal University Department of Economics and researcher at the Institute of Natural Sciences and Technologies of the Autonomous University of Barcelona (Spain).

Scientists described a computational model of the economy and conducted numerical experiments. The experiments modeled 30 upstream companies and 30 downstream firms and estimated the cost of hydrocarbons and emissions before and after regulation. Economists studied six different options. Regulation differed in form: a carbon tax, a system of emission allowances (permits) sold between companies, or fixed quotas on production volumes. Control was introduced either at the stage of production or at the stage of production. This team of authors had previously used a similar model to compare certificate trading with a carbon tax on end-product producers. In the new work, they found out at what level it is more effective to use regulatory tools, including both market-based approaches and direct regulation.

The model developed covers most possible scenarios. The scientists’ work showed that regulation with the help of market mechanisms at the production level has important advantages. Such control increases the price of hydrocarbons throughout the economy, creating incentives to reduce consumption of environmentally harmful products. It also provides an opportunity to redistribute the taxes collected among consumers, reducing their economic costs. At the same time, direct control at the production stage can lead to negative consequences, including monopolization.

“The point of such a burden on extractive companies is to give a price signal to consumers and to reorient their preferences from “dirtier” products to “cleaner” ones. In the model, we assume that the state directs the collected funds from the applied instrument – in our case, the market mechanism – back to the end consumers, who can now spend them on relatively cheaper environmentally friendly goods. In contrast to market mechanisms, with direct regulation, the state does not collect money from producers directly, and thus does not return it to consumers. Prices rise due to the growing deficit and monopolization of the industry,” concludes Ivan Savin.

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