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Olga Diukanova, visiting research fellow, Oxford Institute for Energy Studies
The paper, following the publication of this overview, is now available.
The current debates on GHGs emissions reduction may have a substantial impact on the future development of Ukrainian economy. The country could reap the major benefits of the Kyoto Protocol implementation. First, it has 1.7 billion tone of CO2 equivalent headroom compared to its 1990 emission level. Second, it has tremendous potential for cheap emissions reduction (around 750 Mt of CO2 could be reduced during the first commitment period at the cost below 8 $/t).
However, Ukraine has to address the problem of economy restructuring, since its industrial production is characterized by high material and energy intensity, obsolete capital stock, significant share of coal in energy balance, high probability that coal will remain major domestic energy source. The energy-intensive sectors have the greatest share in national export as well as in formation of the national GDP, and their share continues to increase, but at the same time they are heavily depended on imported oil and gas, prices for which are constantly grows.
There are various concerns that Ukraine may turn into a permit buyer if a transition to per capita or per unit of GDP emission rights would be maid during the next Kyoto Protocol commitment periods. All of the basic documents and studies that outline and/or govern future structural changes in Ukrainian economy and the national energy policy ignore so-called “Kyoto issues”:
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Energy Strategy of Ukraine till 2030 Ministry of Fuel and Energy of Ukraine and the Institute of Energy of National Academy of Science of Ukraine;
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The Agreement between the Goverment of Ukraine and the World Bank on preparation of the Energy Sector Reform and Development Program;
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Long-term Development Strategy of Ukraine and Governmental Priorities for 2006-2007;
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Strategy of Sustainable development of Ukraine – project – Supreme Council of Ukraine – Verkhovna Rada – 2004.
Also, it should be stressed that GhG emissions in Ukraine have never been regulated.
The uncertainty in the design of the next Kyoto regimes makes the reform measures in the Ukraine even more urgent. These reforms would help promote structural changes towards the less energy-intensive industries, boost energy efficiency and attract investments that will reduce Ukraine’s vulnerability in the long run. The country badly needs the strategy aimed at “environmentally friendly” structural changes in economy.
 One of the most leading options for achieving both cost-effective emission reduction and promoting energy efficiency is to implement the emission-trading (Ellerman, Joskow, and Harrison p. iv, and Parry, Pizer, and Fisher p. 2 n. 5). The very idea of domestic emissions trading scheme (ETS) implementation is to allow more abatement to be undertaken where the marginal abatement cost is the lowest. Although market instruments tend to be preferred for the control of GhG emissions because of their cost-effectiveness, some of them have undesirable economic consequences (e.g. distributional and competitiveness impacts, possible substantial increase in production cost in some industries, as underlined in Harrison, D. And D.B. Radov, 2002, “Evaluation of Alternative Initial Allocation Mechanism in a European Union Greenhouse Gas Emissions Allowance Trading Schemes”. NERA report prepared for DG Environment, European Commission and Butraw, Dallas, Karen Palmer, Ranjit Bharvirkar, Anthony Paul, 2001, “The effect of Allowance Allocation on the Cost of Carbon Emission Trading”, Resources for the Future, August).Therefore the greatest challenge lies in the design of an effective and at the same time politically acceptable emissions control policy that minimizes economic costs and negative impacts on the industries that are potentially hardest hit at the same time ensuring the environmental efficiency of the regulation and correspondence with sustainable growth and desirable structural changes in Ukrainian economy.
The main purpose of this study is twofold:
1) to address the issue of the domestic emissions trading scheme design in terms of permits allocation options and its openness/restriction to the international emissions trading market;
2) analyse how the ETS may help Ukraine to promote sustainable economic growth based on energy-efficiency and environmentally benign structural changes.
The methodology employed for national policy simulation is based on the computer general equilibrium (CGE) model of the Ukrainian economy.
To explore the implication of different permit allocation schemes on key economic indicators the following basic allocation options were employed.
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Output based grandfathering: permits allocated in proportion to the benchmark market share of the energy intensive sector in the total EIS output. As the allocation is tied to the level of production, this allocation rule corresponds to a sector-specific ad-valorem subsidy to output, which is equal to the value of the permits allocation per unit of revenue in the base period.
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Emissions-based grandfathering: permits are allocated in proportion of base-year emissions of the energy intensive sector to the total EIS emissions. Such allocation option subsidies energy consumption, and the input subsidy would be equal to the average emission assignment factor per unit of emissions.
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Auctioning of permits: energy-intensive sectors buy permits from government. In fact, the auctioning is similar to the setting of the emission tax. On the one hand, the auctioned quotas or emission taxes would generally be an attack on property of regulated entities – though a selective one, which most of the governments try to avoid. On the other hand, auctioning of permits raises the governmental revenues, which may be used to reduce, for example, the distortion taxes, or the other market inefficiencies. In the model the assumption is tested that sectors do not receive any revenue rebate, which is transferred to a representative household as a lump-sum transfer.
The critical issue of the ETS design lies in the question whether the scheme is open for the international emissions trading market with fully elastic supply and demand or whether it is restricted for the domestic emissions trading only. The “openness” to the international emissions trading market perspective is particularly relevant taking into account Ukrainian huge potential of the cheap emission reduction, which may be directly sold on the world market, and also the provision of flexible instruments under the Kyoto Protocol.
The model tests three approaches to the permits’ allocation based on two cases of the ETS design. It results in six model scenarios associated with the two market-based regulations:
The choice of the total quantity of distributed permits (i.e. an emission cap) for the domestic ETS is another crucial element in the emissions trading scheme design. Taking into account substantial national potential for low-cost emissions reductions, on the one hand, and the considerable governmental subsidization of the energy-intensive industries, on the other hand, the tested assumption is that total quantity of permits for domestic trading scheme is 10 % less than the base-year emissions of the energy-intensive sectors.
In order to address the flexibility gains from trade, the results of the simulations are compared with the scenario under the absence of emissions trade when emissions of the energy-intensive industries are taxed at the rate sufficient to achieve the 10% emission reduction. Then results of all the model scenarios are compared with the BAU (baseline scenario) when no emissions regulation measures are implemented. So the model has total of 8 scenarios.
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