The Kyoto Protocol Is Cost-effective

Marino Gatto¹, Andrea Caizzi², Luca Rizzi², and Giulio A. De Leo³

• Abstract
• Responses to this Article
• Literature Cited

Despite recent advances, there is a high degree of uncertainty concerning the climate change that would result from increasing atmospheric greenhouse gas concentrations. Also, opponents of the Kyoto Protocol raised the key objection that reducing emissions would impose an unacceptable economic burden on businesses and consumers. Based on an analysis of alternative scenarios for electricity generation in Italy, we show that if the costs in terms of damage to human health, material goods, agriculture, and the environment caused by greenhouse gas emissions are included in the balance, the economic argument against Kyoto is untenable. Most importantly, the argument holds true even if we exclude global external costs (those due to global warming), and account for local external costs only (such as those due to acidic precipitation and lung diseases resulting from air pollution).

KEY WORDS: cost-benefit analysis, electric power generation, environmental costs, externalities, greenhouse gasses, Italian economic impacts, Kyoto Protocol.

Published: May 13, 2002

Three years ago Holling and Sommerville (1998) reported on a study conducted by Standard & Poor’s DRI (Data Resources, Incorporated) to evaluate the impact of limiting greenhouse gas (GHG) emissions on Canada’s GDP (gross domestic production). They considered different scenarios involving the use of tradable permits or a carbon tax to stabilize GHG emissions to a percentage (90% or 100%) of 1990 levels. Holling and Sommerville pointed out two main problems with this kind of study. (1) There is a high degree of uncertainty concerning the climate change resulting from the increase in atmospheric GHG concentrations, and this is responsible for slowing down the public policy decision-making process. (2) The important challenge of quantifying the economic benefits of reducing GHG emissions is not addressed.

Our recent studies (De Leo et al. 2000, 2001) are a partial response to these two points. We started from the target set for Italy by the third Conference of the Parties in Kyoto (cutting GHG emissions by 6.5% in 2010) to check whether the compliance with the Kyoto Protocol should necessarily imply a high economic burden for our country. To this end, we have considered the electricity production sector in Italy, which accounts for about one-third of GHG emissions. We have made a monetary balance of all costs and benefits (technically these latter are calculated as savings, i.e., negative costs) resulting from the implementation of different power production technologies. These can be based on oil, solid fossil fuels, gas, renewable sources, and co-generation (combined production of heat and electricity). To circumvent the objection that climate change mitigation would imply a lower energy production, which would benefit the environment but would depress the market, we have set the currently estimated energy demand of Italy in 2010 (353 terawatt-hours, TW-h) as a constraint for our problem. Then we have searched for the mix of technologies that minimizes the total cost to Italy. In our study, we have made an important effort to consider all costs: not only those of energy production, but also the “external” costs, namely those related to damages to human health, material goods, agriculture, and the environment. Obviously, lower costs of, e.g., cleaning monuments or providing for health care are actually benefits to the society. Estimates of external costs are available as a result of important studies conducted in Europe, notably the European Union Project ExternE (European Commission 1995) and the United States (Russell 1994, Rowe et al. 1995). In terms of the analysis of pollution pathways from sources of emissions to potential targets, the ExternE study is probably the most complete: impact assessment has been performed by using first a comprehensive software package called Ecosense, which employs a database of emission factors for each technology, a small-scale air pollution model (ISC), and a regional air quality model (the Harwell Trajectory Model) to compute diffusion of pollutants at the European level, and second a number of dose-response functions to estimate the actual impact on human health as well as the damages to infrastructures and agricultural production. As for damages to infrastructures, “replacement costs” are usually accounted for in such studies; damages to agricultural production due to air pollution and acidic precipitation are computed in terms of yield reduction; as concerns human health (mortality and morbility), several methods have been adopted that are based either on Contingent Valuation (Turner 1993, Bateman and Willis 1999) or on epidemiological surveys and analyses to evidence the “years of life lost” (MMWR 1986), the reduced productivity due to morbility, and the consequent cost increase for the National Health System. Usually, damages to biodiversity and ecosystem services have not been accounted for by the cited studies, so the costs anticipated by ExternE are likely to be only an underestimation of the actual costs. In addition to these local and regional impacts, which are usually quite certain, there are global impacts associated with the Earth's climate change. These impacts and the related damages are much less certain. In fact, using specific models, ExternE has estimated that these global costs can range between 4-140 euros per ton of CO₂.

We have compared three alternative scenarios: in the first, the goal is to minimize only the sum of energy production costs (business as usual, BAU); in the second, we minimize energy production costs with the constraint that the Kyoto Protocol should be satisfied (BAU + Kyoto); and in the third, we minimize the sum of social costs (MSC; namely, the sum of industrial costs and local and global environmental costs). Using the average global cost of 30 euros per ton of CO₂ suggested by ExternE, we have found out that it would be advantageous for Italy to change its power-generation strategy to comply with the Kyoto Protocol. In fact, with respect to BAU, the scenario BAU + Kyoto would imply a 17% reduction of GHG emissions, about 1800 x 10⁶ euros per year saved in reducing environmental costs, and a cost of about 300 x 10⁶ euros per year in increased industrial outlay. Therefore, we could obtain a net annual saving of 1500 x 10⁶ euros in addition to all the intangible benefits associated with decreased emissions. This could be achieved by producing the same amount of energy with a different mix of technologies. In particular, we should employ more gas, less coal, more renewable sources, and use more co-generation (combined production of electric and thermal energy). Implementing the MSC scenario would entail an even larger saving, about 2 billion euros per year.

These results, however, still do not address the important point of uncertainty in the emission impacts on climate change. To solve this problem, we have conducted a sensitivity analysis to determine the influence of different global costs on the optimal mix of energy-production technologies and the corresponding economic balance. Fig. 1 reports the main outcomes of the sensitivity analysis. The striking point is that, even if the cost associated with global warming were set to zero, it would pay to comply with the Kyoto Protocol. In fact, we would have a net savings of about 918 x 10⁶ per year, as the increase of industrial costs (+548 x 10⁶ euros) is more than compensated by the decrease of local external costs (-1466 x 10⁶euros).

Fig. 1. Results of the analysis of sensitivity to the global cost of greenhouse gas (GHG) emissions for the problem of minimizing total social costs of Italy’s energy production in 2010.

In conclusion, reducing local and regional air pollution and the related social and environmental costs is a sufficient reason to cut the combustion of those fuels that are also responsible for global warming. This means that, although scientists do not know how much the climate of our Earth will be affected by GHG emissions and how fast the change will occur, this uncertainty should not be taken as an excuse by decision makers to sabotage the Kyoto Protocol. In other words, whatever decision makers believe about global warming and its costs, they should redesign their power production strategies now, if nothing else to avoid the much more certain local socio-environmental costs.

A possible objection to our results is that we have performed only an equilibrium analysis that does not take into account the need for specific policies to trigger the technological shift (for instance, fossil fuel taxation or subsidies to alternative sources of energy). As a consequence, the initial transition costs required to move toward cleaner technologies may be substantially larger than those we have predicted in our work. On the other hand, more detailed macroeconomic studies such as that published by the US Oak Ridge National Laboratory (ORNL 2000) clearly show that (a) innovative and well-tuned public policies in the industry, construction, transportation and energy production sectors can significantly reduce not only carbon dioxide emissions, but also air pollution, petroleum dependence, and inefficiencies in energy production and use; b) the overall economic benefits of these policies appear to be comparable to their overall costs, even without accounting for socio-environmental external costs; c) uncertainties are unlikely to alter the overall conclusions. These arguments, together with our explicit account of socio-environmental costs, further strengthen the convenience of embracing the Kyoto Protocol.

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