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«Abstract With federal policies to curb carbon emissions stagnating in the US, California is taking action alone. Sub-national policies can lead to ...»

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Inspection of fossil fuel prices reveals a decrease in the composite price of fossil fuels and

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a decrease in the price of coal relative to the price of gas. Leakage via the trade channel is mainly due to increased EU imports of Electricity, Iron and steel, and Metals nec.

In the CAnoTariff scenario, the Californian allowance price is $12/tCO2. The allowance price reduces Californian electricity production by 21% and there is a decrease in the demand for natural gas. A large proportion of the reduction in Californian electricity production is replaced by imported electricity, which results in leakage to electricity exporters.

The largest leakage sources are Arizona (24%), which experiences the largest increase in electricity exports to California, and Utah (15%), the most carbon-intensive electricity exporter.

Decreasing electricity production in California and increasing production in electricity exporters decreases the price of natural gas and increases the price of coal. These price changes drive changes in emissions in other US regions. In regions with a high propor

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tion of electricity generated from coal, the price changes reduce emissions from electricity.

The largest negative leakage rates are observed for the North Central and North East regions; however proportional changes in emissions is these regions are small. Although the Mountain region produces coal-intensive electricity, there is positive leakage to this region as the impact of the coal price is offset by increased electricity exports to regions supplying electricity to California.

Electricity emissions increase in regions producing a relatively large proportion of electricity from natural gas. In addition to increased electricity emissions, the large leakage rate for Texas (6%) is driven by increased exports of Chemical, rubber and plastic products to California. In the US, leakage to electricity exporters is 53% and leakage to other regions is -1%. Leakage to international regions is is -6%, as positive leakage via the trade channel is more than offset by negative leakage due to changes in fossil fuel prices.

Aggregate leakage in the the CAnoTariff scenario is 46%, more than double the leakage rate simulated for the EU-ETS. The large leakage rate is driven by increases in electricity

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production for export to California. Although there is negative leakage to regions that do not export electricity to California, our results indicate that without electricity tariffs California’s cap-and-trade program will not be very effective at reducing emissions.

4.3 The impact of electricity tariffs Tariffs with resource shuffling. When there are tariffs on imported electricity but no resource shuffling provisions, CAShuffling, the Pacific region has sufficient renewable and nuclear capacity to only export carbon-free electricity. Arizona can reduce the CO2 intensity of electricity exported to California by 83%, whereas Nevada and Utah, which are the most CO2 -intensive suppliers of electricity to California, can only reduce the CO2 -intensity of electricity exports by 50%. As a result, relative to the CAnoTariff scenario, Nevada and Utah export less electricity to California (and leakage to these regions decrease) and Arizona and the Pacific region export more (and leakage to these regions increase). Total leakage to electricity exporters decreases to 38% (from 54% in the CAnoTariff scenario).

Leakage to other US regions increases (from -1% to 11%) due to reduced demand for coal in Nevada and Utah and the higher permit price in the California. Leakage to international regions increases for the same reason. Aggregate leakage increases from 46% in the CAnoTariff scenario to 48% in the CAShuffling scenario, which indicates that electricity tariffs will not be an effective measure to reduce leakage if resource shuffling takes place.

Tariffs and no resource shuffling. We now consider a scenario that includes both the electricity tariff and a ban on resource shuffling, (CAnoShuffling ), as specified by California’s cap-and-trade legislation. In this scenario, the allowance price is $65/tCO2 and, due to the use of permits for imported electricity, the reduction in Californian emission is 13.4%. Electricity production in California is, on average, less CO2 -intensive than imported electricity, so the policy increases production of electricity in California at the expense of electricity imports. In aggregate, leakage to electricity exporters is -35%, which is driven by leakage to Arizona (-17%) and Utah (-9%).

Although there is negative leakage to electricity exporters, this is partially offset by positive leakage (29%) to other US regions due to changes in both trade and fossil fuel prices (see Table Table 7). Leakage due to changes in fossil fuel prices is driven by a decrease in demand for refined oil in California and a decrease in demand for coal in regions exporting electricity to California, which ultimately increases emissions from transportation and electricity generation in other US regions. The major sources of leakage to other US regions via the trade channel are increased Californian imports of Chemical, rubber and plastic products from Texas and the South Central region. Overall, positive leakage to other US and international regions is mostly offset by negative leakage to electricity exporters and the aggregate leakage rate is 1.5%. Our results indicate that although tariffs on imported electricity and a ban on resource shuffling significantly increase the price of CO2 allowances, these measures can essentially eliminate leakage.

4.4 Trading of permits between California and the EU International trading of emissions permits equalizes permit prices across the two systems.

The EU market for emissions permits is three times the size of that in California, so the common permit price is close to the EU autarky price, but the Californian electricity tariff still has an impact on the common permit price. As permit trading changes permit prices in both California and the EU, leakage rates will be influenced by production and consumption changes in both regions.

In the CA-TRDnoTariff scenario, there are only small changes in the permit price in California and the EU relative to the corresponding case without permit trading. Leakage to US regions increases (from 53% to 55%), mainly due to an increase in California electricity imports. Leakage to international regions falls due to the decrease in the permit price in the EU.

When there is an electricity tariff and no resource shuffling, permit trading decreases the price of emissions rights in California (from $65) and increases it in the EU (from $16) to $20. The decrease in the permit price in California decreases the tariff on imported electricity and ultimately increases emissions in regions exporting electricity to California.

However, there is also a decrease in emissions abatement in California (the denominator for leakage calculations), so there is only a small change in leakage to electricity exporters in the CA-TRDnoShuffling scenario relative to the CAnoShuffling case. Permit trading also increase leakage to international regions significantly (from 7% to 46%), which is driven by the increase in the permit price in the EU and associated fossil fuel price and trade effects.

The decrease in the price of coal increases electricity emissions in other regions so leakage due to changes in electricity production is 19%, even though there is negative leakage to regions exporting electricity to California. Overall, trading permits between the EU and California results in a small increase in leakage from the combined systems (from 22% to 23% with no electricity tariffs and from 18% to 19% when there is electricity tariffs an no resource shuffling).

4.5 Sensitivity analysis A key driver of our results is that changes in California have larger impacts on US regions than international regions. Accordingly, we consider “Low” and “High” alternative values for elasticities governing substitutability in US demand between domestic and imported

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Leakage rates and permit prices for aggregated regions in the CAnoTariff and CAnoShuffling scenarios are presented in Table 8. The first component of case labels convey values for

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and the permit price as changes in relative prices of imports from different sources are small. Increasing import elasticities (High-High) decreases abatements costs and also the permit price, and increases substitution towards imported electricity. As a result there is a larger increase in leakage to electricity exporters, which is partially offset by a decrease in leakage to other regions.

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cases for this elasticity do not have a large impact on changes in electricity emissions, so leakage in the Base-Low case (3%) is similar to that in the Base case (2%). Leakage in both the Low-Low and High-High cases is 10% and 11% respectively, but leakage rates are still much lower than in the CAnoSuffling scenario. Overall, the sensitivity analysis indicates that our findings are reasonably robust to alternative elasticity values in our specification for US imports and that the results are more sensitivity to variability in scenario assumptions than alternative Armington elasticity values.

5 Conclusions This paper considered leakage from California’s cap-and-trade program, the first such policy to be legislated in the US. Our analysis employed a global model of economic activity and energy systems that identified 15 US regions and 15 regions in the rest of the world.

The framework explicitly modeled bilateral trade flows among all regions.

Key features of California’s cap-and-trade policy include the requirement that allowances must be surrendered for emissions embodied in imported electricity, which is similar to an import tariff, and provisions to prevent resource shuffling. When these characteristics are not included, leakage from the policy was 46% of the decrease in emissions in California.

This was driven by leakage of 54% to regions exporting electricity to California. There was negative leakage to other US and international regions largely due to a decrease in the relative price of natural gas. Leakage was also significant when electricity tariffs were included but out-of-state generators could lower the incidence of the tariff by rerouting electricity transmission so that less carbon-intensive electricity is supplied to California.

When we included electricity tariffs and did not allow resource shuffling, leakage to electricity exporters was -35% and positive leakage to other resulted in total leakage of 2%.

These finding indicate that California’s cap-and-trade program will lead to very little leakage. This conclusion hinges on the enforcement of provisions to prevent resource shuffling, without them electricity tariffs will be not prevent substitution towards imported electricity. A corollary of this conclusion is that electricity tariffs are an effective way of expanding the scope of the program, although permits used for imported electricity increased the reduction in Californian emission beyond that mandated by the cap and increased the price of permits significantly. Another interesting finding was that leakage to international regions was small, as California is more closely linked to other US states than international regions. Finally, we considered leakage when there was trading of emission permits between California and the EU-ETS. We found that international permit trading resulted in a small increase in aggregate leakage from the two systems.

References Anderson, James E., and Eric van Wincoop. 2003. “Gravity with gravitas: A solution to the border puzzle.” American Economic Review, 93(1): 170–192.

Babiker, Mustafa H., and Thomas F. Rutherford. 2005. “The economic effects of border measures in subglobal climate agreements.” The Energy Journal, 26(4): 99–125.

Ballard, Charles. 2000. “How many hours are in a simulated day? The effect of time endowment on the results of tax-policy simulation models.” Working Paper, Michigan State University.

Bernstein, Mark A., and James Griffin. 2005. “Regional Differences in the Price-Elasticity of Demand For Energy.” The RAND Corporation Technical Reports.

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