WPS4563. Pol i c y Re s e a rc h Wo r k i n g Pa p e r 4563

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1 Publc Dsclosure Authorzed Publc Dsclosure Authorzed Publc Dsclosure Authorzed Publc Dsclosure Authorzed Pol c y Re s e a rc h Wo r k n g Pa p e r 4563 A General Equlbrum Analyss of Demand Sde Management Programs under the Clean Development Mechansm of the Kyoto Protocol Govnda R. Tmlsna The World Bank Development Research Group Sustanable Rural and Urban Development Team March 2008 WPS4563

2 Polcy Research Workng Paper 4563 Abstract Ths paper analyzes the economc and envronmental consequences of a potental demand sde management program n Thaland usng a general equlbrum model. The program consders replacement of less effcent electrcal applances n the household sector wth more effcent counterparts. The study further examnes changes n the economc and envronmental effects of the program f t s mplemented under the clean development mechansm of the Kyoto Protocol, whch provdes carbon subsdes to the program. The study fnds that the demand sde management program would ncrease economc welfare f the rato of unt cost of electrcty savngs to prce of electrcty s 0.4 or lower even n the absence of the clean development mechansm. If the program s rato of unt cost of electrcty savngs to prce of electrcty s greater than 0.4, regstraton of the program under the clean development mechansm would be needed to acheve postve welfare mpacts. The level of welfare mpacts would, however, depend on the prce of carbon credts the program generates. For a gven level of welfare mpacts, the regstraton of the demand sde management program under the clean development mechansm would ncrease the volume of emsson reductons. Ths paper a product of the Sustanable Rural and Urban Development Team, Development Research Group s part of a larger effort n the department to study clmate change and clean energy ssues. Polcy Research Workng Papers are also posted on the Web at The author may be contacted at gtmlsna@worldbank.org. The Polcy Research Workng Paper Seres dssemnates the fndngs of work n progress to encourage the exchange of deas about development ssues. An objectve of the seres s to get the fndngs out quckly, even f the presentatons are less than fully polshed. The papers carry the names of the authors and should be cted accordngly. The fndngs, nterpretatons, and conclusons expressed n ths paper are entrely those of the authors. They do not necessarly represent the vews of the Internatonal Bank for Reconstructon and Development/World Bank and ts afflated organzatons, or those of the Executve Drectors of the World Bank or the governments they represent. Produced by the Research Support Team

3 A General Equlbrum Analyss of Demand Sde Management Programs under the Clean Development Mechansm of the Kyoto Protocol Govnda R. Tmlsna * Keywords: Demand sde management, general equlbrum analyss, clean development mechansm * Senor Research Economst, Development Research Group, The World Bank, 1818 H Street, NW, Washngton, DC 20433, USA, e-mal: gtmlsna@worldbank.org. The vews expressed n ths paper are those of the author only, and do not necessarly represent the World Bank and ts afflated organzatons. The author sncerely thanks Ian C. Porter, Country Manager and the Envronmental Team of the Tha Country Offce of the World Bank and Prof. Subhes Bhattacharyya, Unversty of Dundee, UK for ther valuable comments and suggestons.

4 1. INTRODUCTION The energy crses of the 1970s and hgh energy prces accompaned wth hgh nflaton and nterest rates led to energy conservaton or demand sde management (DSM) programs all over the world (Gellngs 2000). Electrc utltes n the US and European countres launched DSM programs n the 1980s. In the Unted States, about US$23 bllon was nvested for DSM programs between 1989 and 1999 (Laughran and Kulck, 2004). Growng envronmental concerns, partcularly over the ncreasng emssons of ar pollutants from energy producton and consumpton actvtes, further encouraged DSM programs (Wrl, 2000). In Asa, DSM programs were started n the early nnetes. In Thaland, the Electrcty Generatng Authorty of Thaland (EGAT) mplemented a fve-year DSM program durng , whch resulted n reductons of 468MW of peak demand, 2,194GWh of electrcty generaton and 1.64 mllon tons of CO 2 emsson (EGAT, 2000). There exsts a large potental for reducng energy consumpton as well as envronmental emssons from varous DSM programs, ncludng energy effcent lghtng, refrgeraton and ar-condtonng, and energy effcent motors and other electrcal applances n developng countres (DC) n Asa (See e.g., ALGAS, 1999b; Shrestha et al, 1998a,b). Accordng to ALGAS, 1999b, mplementaton of DSM programs n eght Asan countres (.e., Chna, Myanmar, Mongola, Pakstan, Phlppnes, South Korea, Thaland and Vetnam) could reduce 17.4 bllon tons of CO 2 emsson durng perod wth net economc benefts n addton to the clmate change benefts. In Thaland alone, DSM programs have the potental to mtgate 142 mllon tons of CO 2, durng the perod wth net economc benefts (ALGAS, 1999a). Despte the large potental of GHG mtgaton and other envronmental and economc benefts, DSM programs are not beng mplemented n many DCs due to the lack of fnancal resources. 2

5 Usng partal equlbrum analyss 1, exstng studes, such as Shrestha et al. (1998a, b), Schpper and Meyers (1991), Hsueh and Grener (1993), fnd DSM actvtes economcally attractve 2. On the other hand, studes, such as Dufournaud et al. (1994) and Rose and Ln (1995) argue that DSM optons, whch are economcally attractve from a partal equlbrum approach, may not necessarly be attractve f they are examned usng general equlbrum models 3. A queston may, however, arse: would all DSM optons, no matter how economcally attractve they are n a partal equlbrum settng, lead to negatve welfare effects n a general equlbrum settng? Would DSM programs wth hghly attractve nternal rate of returns (IRR) be stll welfare regressve f ther economy wde mpacts are consdered? Ths queston s a crucal one for countres whch are mplementng DSM programs (e.g., Thaland). Moreover, even f DSM programs are found welfare regressve from a general equlbrum perspectve; are there ways to offset these negatve mpacts? The clean development mechansm (CDM) of the Kyoto Protocol could be an nstrument to resolve ths ssue because the CDM not only enhances the economc attractveness of a DSM program, but also helps reduce fnancal barrers to DSM programs. By the end of December 2007, 52 energy effcency projects have already been regstered by the Executve Board of the CDM (CDMEB) and more than 250 smlar projects are n ppelne (UNEP RISØ Centre, 2007; UNFCCC, 2007). In ths paper, we examne the welfare effects of a potental DSM program n Thaland, under whch exstng less effcent electrcal applances n the household sector are replaced wth ther effcent counterparts, by usng a general equlbrum model. We frst assess the welfare mpacts f the DSM program s mplemented n the absence of a CDM 1 A partal equlbrum analyss accounts for only drect costs and benefts of a project or a program n consderaton, t does not account the ndrect costs and benefts that would ncur due to lnkages between varous agents of the economy (e.g., ndustry, household, government, nternatonal trade). Thus, t can not estmate the economy-wde mpacts of the project or program (e.g., mpacts on economc welfare, GDP, trade balance). 2 Note also that economc analyses of DSM programs often neglect socal benefts of reducng envronmental pollutants (e.g., oxdes of sulfur, oxdes of ntrogen, suspended partculate matters, volatle organc compounds, etc.). If such benefts are quantfed and accounted for, DSM programs would be further attractve. 3 A general equlbrum model accounts for all drect and ndrect mpacts of an actvty to an economy. 3

6 scheme. Ths wll be followed by an analyss of the roles for CDM to mprove the welfare effects of the DSM program. We show that not all DSM optons are welfare regressve. It depends on three factors: () the rato of unt cost of electrcty savngs to prce of electrcty (CPR), () prce of certfed emsson reductons (CERs), and () rate of substtuton of less effcent applances wth ther effcent counterparts. We fnd that the DSM program would result n postve welfare mpacts as long as the CPR s smaller than 0.4 (or IRR > 23%) even n the absence of CDM. Implementaton of the DSM program under the CDM would result n postve welfare effects when CPR s hgher than 0.4 (or IRR < 23%) dependng on the prce of CERs. The paper s organzed as follows: Secton 2 brefly presents the general equlbrum model developed for the purpose of the study and the source of the data. Secton 3 dscusses results from model smulatons (.e., the economc welfare and envronmental mpacts of the DSM program), followed by senstvty analyses of key parameters. Fnally, the major conclusons of the paper are summarzed. 2. A BRIEF DESCRIPTION OF THE CGE MODEL A statc general equlbrum model has been developed for the purpose of ths study. In ths secton, we brefly present approaches to modelng varous economc agents (e.g., producers, households, the government and the foregn sector) The producton sector The study consders 21 producton sectors (see Table 1), of whch seven produce energy goods and servces, and the rest materal goods and servces. The producton behavor of each sector s represented through a four level nested structure (see Fgure 1a and 1b). In each sector, gross output (XD) s a nested functon of captal (K), labor (L), materal (G k ), fossl fuel (G f ) and electrcty (G EL ): 4 Not all equatons of the model are presented here. Please see Tmlsna (2007) for more detaled descrptons of the model. 4

7 XD = β[ θ( K, L), ϕ{ γ ( G1,.., G k ), ν( φ( G1,.., G f), G EL)}] (1) where θ s the constant elastcty of substtuton (CES) composte of prmary factors; ϕ s the CES composte of the materal aggregate (γ) and the composte of the fuel aggregate (φ) and electrcty (ν). φ s the CES aggregate of fossl fuels and γ s the Cobb-Douglas aggregate of materals. The CES functonal form of XD can be wrtten as follows: 1 / σ ( σ 1 )/ σ 1 / ( )/ /( ) θ ϕ σ σ 1 σ σ σ 1 (2) XD = [ λ. θ + λ. ϕ ] where λ s the share parameter and σ s the elastcty of substtuton between θ and ϕ. Smlar functonal forms could be wrtten for θ, ϕ, γ, ν and φ. θ and ϕ are derved as follows: xdp XD = pθ θ = λ θ θ. XD.( xdp ) pθ σ (3) xdp XD ϕ = pϕ ϕ = λ ϕ. XD.( xdp ) pϕ σ (4) where xdp s the output prce, and p θ and p ϕ are prces of θ and ϕ respectvely. xdp s derved from a cost functon, whch s dual to the producton functon n Equaton (2) and s gven as: ( 1 σ ) ( 1 ) /( θ θ ϕ ϕ σ 1 1 σ) ] xdp = [ λ p + λ p (5) Table 1: Economcs Sectors and Electrcty Sub-sectors Consdered n the Model (a)economc Sectors, Goods and Servces Non-Energy Sector and Good Energy Sector and Good 1. Agrculture & Forestry 1. Fuel Wood 2. Constructon 2. Coal 3. Mnng (Except Energy) 3. Crude Ol 4. Food and Beverage 4. Petroleum Products 5. Textle and Apparel 5. Natural Gas 6. Pulp and Paper 6. Electrcty 7.Chemcals & Fertlzers 8.Non-Metallc Mnerals 9. Prmary Metals 10. Fabrcated Metals 11.Electrcal Machnery 12.Other Manufacturng 13. Commercal Servces 14. Transportaton Servces 15.Other Servces 5

8 (b) Electrcty Sub-Sector or Technology Prmary Electrcty Secondary or Thermal Electrcty Hydro Steam Turbne Combned Cycle & Gas Turbne Internal Combuston Engne Coal Ol Ol Ol Natural Gas Natural Gas All other demand varables, as ndcated n Fgure 1a, are determned n a smlar manner to Equatons (3) and (4), whle the prce varables are determned n a smlar manner to Equaton (5). Fgure 1: Nested Structure of the Producton Sectors XD=CES(θ,ϕ) Ter 1 XD=CES(α,χ) θ = CES(K,L) ϕ =CES(γ, ν) Ter 2 α =CES(K, φ) χ =CES(L, μ) γ =CD(G 1,..,G k ) ν =CES(φ, G EL ) Ter 3 K φ =CES(G 1,..,G f ) L μ =CES(γ, G EL ) φ =CES(G 1,..,G f ) G EL Ter 4 γ =CD(G 1,..,G k ) G EL G f G G 1 1 G k (a) Sectors except electrcty generaton (b) Electrcty generaton sector One of the key features of the model s that t treats the electrcal sector n a dfferent manner than most exstng studes. Frst, the electrcty sector s dvded nto seven subsectors based on technologes used for electrcty generaton (see Table 1b) 5. Ths allows the substtuton possbltes between varous technologes used for electrcty generaton. Secondly the nested CES structure used for the electrcty sector dffers from those used n the rest of the sectors to allow drect substtuton between captal and fuel n the electrcty generaton ndustres. It s very mportant to treat the electrcty sector wth specal attenton 5 Some studes such as Brown et al. (1999) also consder dfferent technologes to generate electrcty whle modelng the electrcty sector n GTEM model. 6

9 n GE models for envronmental polcy analyss n countres where electrcty generaton based on fossl fuels s one of the man sources of GHG emssons. The gross output of the electrcty ndustry g s gven as: XDg = β[ ω{ Kg, φ( G g, 1,.., G gf, )}, χ{ L, μ( γ ( G g, 1,.., G gk, ), G gel, )}] (6) where ω s the composte of captal and the fuel aggregate used n electrcty ndustry g and χ s the composte of labor and the materal-electrcty composte (μ). The demand and prce varables n the case of the electrcty ndustres are determned n a smlar manner to the other sectors dscussed above. Electrcty generated wth dfferent types of technologes s aggregated as shown n Fgure 2. Fgure 2: Aggregaton of Electrcty Outputs Produced by Dfferent Electrcty Generaton Technologes XD EL =CES (XD HY, κ) Ter- 1 κ =CES (υ, Ω, XD IC ) XD HY Ter- 2 υ= CES (XD STC, XD STO, XD STG ) XD IC Ω =CES (XD CGO, XD CGG ) Ter- 3 XD STC XD STO XD STG XD CGO XD CGG As can be seen from Fgure 2, the total electrcty output (XD EL ) can be expressed as: XD EL =Λ[ κ{ υ( XDSTC, XDSTO, XDSTG ), Ω( XDCGO, XDCGG ), XDIC}, XD HY ] (7) where Λ s the CES composte of the outputs of the hydropower ndustry (XD HY ) and the thermal power ndustry (κ). κ s the CES aggregate of the outputs of the steam turbne electrcty ndustry (υ), the combned cycle/gas turbne electrcty ndustry (Ω) and the nternal combuston electrcty ndustry (XD IC ). υ s the CES aggregate of the outputs of the coal fred steam turbne electrcty ndustry (XD STC ), the ol fred steam turbne electrcty ndustry (XD STO ) and the gas fred steam turbne electrcty ndustry (XD STG ), whle Ω s the 7

10 CES composte of the outputs of the ol fred combned cycle/gas turbne electrcty ndustry (XD CGO ) and the gas fred combned cycle/gas turbne electrcty ndustry (XD CGG ). The demand for electrcty generated from varous types of technologes as well as the demand for prmary factors, energy, and materal nputs are derved as dscussed n other ndustres above. For example, demand for and prce of thermal electrcty are gven as follows: xdpel κ = λ κ. XD EL.( ) pκ σ HYTH TH TH TH TH ( 1 κ υ υ σ ) ( 1 σ ) ( 1 σ ) 1/( 1 σ ) p = [ λ p + λωp Ω + λicxdpic ] (9) where p κ s the aggregate of unt costs of electrcty generaton from steam turbne (p υ ), combned cycle/gas turbne (p Ω ) and nternal combuston technologes (xdp IC ). σ HYTH s the elastcty of substtuton between electrcty generated from hydro and thermal power plants, and σ TH s the elastcty of substtuton between electrcty generated from steam turbne, combned cycle/gas turbne and nternal combuston technologes. (8) 2.2. The household sector Household demand Ths study consders a representatve household that follows a fve-step herarchcal optmzaton process to maxmze ts utlty as shown n Fgure 3. At the left hand sde of the bottom of the nested structure (.e., Ter 5 n Fgure 3), household consumpton of electrcty (CH EL ) and electrcal applances (CH DG ) are combned through a Cobb-Douglas functon to get electrcal servces for the households (η) 6. At the rght hand sde of the same ter, a fuel aggregate (φ) s obtaned through a CES aggregaton of dfferent fuels, such as coal, ol, gas and fuelwood. The aggregate energy servce (ν) n the household sector s derved through a CES combnaton of the electrcal servces and the aggregate fuel consumpton (φ) (please 6 A senstvty analyss s also presented later (Secton 5), consderng an alternatve functonal form (.e., CES) to combne consumpton of electrcty and electrcal applances n the household sector. 8

11 see left part of Ter 4). In the rght hand part of Ter 4, a materal aggregate (γ) s derved from the Cobb-Douglas aggregaton of dfferent materals. The energy-materal composte (ϕ) s combned wth lesure (LS) to gve the present consumpton (ζ) at the second ter of the nested structure. Fnally, at the top most ter of the nested structure, households trade off between present consumpton and savngs (S) whle maxmzng ther utlty. The household utlty functon s expressed as follows 7 : U = ψ[ ς{ ϕ( ν( η( CHEL, CHDG ), φ( CH1,.., CHf )), γ ( CH1,.., CHk )), LS}, S] (10) Fgure 3: Nested Structure for the Household Sector to Model the DSM Opton U=CES (ζ,s) Ter 1 ζ=ces (ϕ, LS) S Ter 2 ϕ =CES (ν,γ) LS Ter 3 ν =CES (η,φ) γ =CD (CH 1, CH k ) Ter 4 η=cd(ch EL, CH DG ) φ =CES (CH 1, CH f ) Ter 5 CH EL CH DG CH 1.. CH f The CES functonal form for U s gven as follows 8 : 7 A smlar approach has been used n a number of exstng general equlbrum models (e.g., Jorgenson and Wlcoxen 1993; Bohrnger and Rutherford 1997; Shoven and Whalley 1992 and Ballard et al. 1985). 8 The dfference n household utltes between the base and counterfactual smulatons s used as the measure of the change n economc welfare n ths study. 9

12 H H H H H H H H 1/ σ ( σ 1)/ σ 1/ σ ( σ 1)/ σ σ /( σ 1) U = [ α. ς + ( 1 α ). S ] ς ς (11) where α ζ s the scalng factor and σ H s the elastcty of substtuton between present consumpton and household savngs. ζ and S are derved from the frst order condton of maxmzng utlty under budget constrant, I = ς. pς + S. p S, as follows: H ς = α ς. I ( pς σ. Z) H (12) and S= ( 1 α ). I ( p S. Z) ς σ (13) H H 1 ς ς σ 1 σ ς S wth Z = α. p + ( 1 α ). p where p ζ and p S are prces of present consumpton and savngs. I s the full ncome of households. In the same manner, other demand and prce varables n the household model are derved through the dfferent levels of the nested structure shown n Fgure Incorporaton of the DSM nto the model The DSM program s ncorporated nto the model whle modelng household behavor. Ths s because the DSM program consdered here refers to electrcal applances n the household sector. It s also possble to nclude electrcal applances n other sectors, such as manufacturng and servce sectors. Ths could be a further expanson of the study because the end-use demand for electrcty n the manufacturng sector dffers sgnfcantly from the household sector 9. Modelng demand sde optons n a general equlbrum framework s often constraned by data lmtatons. For example, an analyss of the substtuton of ncandescent lamps by compact fluorescent lamps would requre detaled nformaton on the ndustres producng these applances (e.g., labor, captal and materal nputs). In other words, we need an nput-output table (I/O table) that treats the lamp ndustry as a separate sector. However, n the exstng I/O tables of Thaland, nformaton s avalable only at an aggregated electrcal applances/machnery ndustry level. Because of ths lmtaton, we ncorporate the DSM 9 Whle most of the electrcty demand n the manufacturng sector s for motve power (.e., electrcal motors), household demands for electrcty s for lghtng, ar-condtonng and refrgeraton etc. 10

13 optons n our model by assumng an aggregate end-use applance nstead of ndvdual applances. Ths approach now looks more relevant as the CDM Executve Board has developed, n ts 28 th meetng, gudance on the regstraton of a program of actvtes as a sngle CDM project actvty (CDM EB, Dec. 2006). Accordng to the gudance, a number of GHG mtgaton actvtes, such as effcent lghtng, refrgeraton, ar-condtonng, energy effcent electrc motors, etc., can be packaged and regstered as a sngle CDM project. In other word, the DSM program such as the one consdered n ths study can now be regstered as a sngle CDM project. Effcent applances have relatvely hgher captal costs than ther neffcent counterparts. On the other hand, effcent applances use less electrcty than ther neffcent counterparts, leadng to savngs n fuel costs. In the general equlbrum modelng context, ths mples a substtuton of electrcty costs wth the captal costs. The ncreased use of effcent electrcal applances reflects a stuaton where households allocate hgher expendture on applances (.e., purchase effcent applances) and less expendture on electrcty. It s assumed that the use of effcent electrcal applances provdes at least the same level of end use energy servces (e.g., lghtng) as before (.e., pror to replacement of the neffcent applances). The ncorporaton of the DSM aspect n the CGE model can be descrbed wth the help of Fgure 3. As llustrated n the fgure (bottom ter n the left hand sde of the nested structure), electrcty (CH EL ) and electrcal applances (CH DG ) are combned through a Cobb- Douglas functon to get electrcal servces (e.g., heat, ar-condtonng, lght), η, for the households. The household maxmzes ts utlty from the use of the electrcal servces subject to the budget constrant: α 1 α Max η = CH EL CH (14) s.t.. DG 11

14 DI SAV = CH EL. gp EL f CH.(1 + ndt f. gp EL f.(1 + ndt ) + CH DG f ) +. gp DG k CH. gp k.(1 + ndt k DG.(1 + ndt In the case of the CES functonal form, the utlty functon to maxmze s expressed as: 1/ σ ( σ 1) / σ EL 1/ σ ) ( σ 1) / σ DG k σ /( σ 1) ) (15) Max η = [ α.ch + (1 α).ch ] (16) The constrant s the same as n Equaton (15). Here, α s the share of electrcty n the total expendture on electrcal servces (.e., sum of expendture on electrcty and electrcal applances). CH f s the household consumpton of other fuels (e.g., natural gas, fuel wood, petroleum products); CH k s the household consumpton of goods and servces except electrcal applances (e.g., food and beverage, health care, educaton); gp EL, gp f, gp DG, and gp k are the prces of electrcty, other fuels, electrcal applances and other goods and servces, respectvely; ndt EL, ndt f, ndt DG, and ndt k are the correspondng ndrect tax rates. DI s dsposable ncome; t also ncludes revenue generated from exports of CERs. As we mentoned earler, an mprovement n the end-use energy effcency of electrcal applances mples that households derve at least the same level of electrcal servces as before, usng smaller amount of electrcty. Ths aspect of energy effcency s ncorporated nto the model through the addton of the followng constrant: 0 η = η (17) where η 0 s the electrcal servces that the household s dervng n the base case (.e., before mplementaton of the DSM program). Equaton (17) mples: (1 α ) 0α 0 (1 α ) DG = CH EL. CH DG α CH. CH (18) EL where CH 0 EL and CH 0 DG are household consumpton of electrcty and electrcal applances n the base case. By rearrangng Equaton (18), we get: CH CH 0 α DG CH EL (1 α ) = ( ) 0 DG CH EL (19) Let, CH CH DG 0 DG = θ (20) 12

15 θ s the polcy varable here and exogenous to the model. It represents the rate of replacement of neffcent applances wth ther effcent counterparts. In the base run, θ has a value of 1. In polcy smulaton runs (counterfactual runs), θ s assgned to dfferent values. For example, f θ s equal to 1.25, t can be nterpreted as households spendng 25% more to buy effcent applances than n the base case. Increasng the consumpton of electrcal applances would cause a reducton of electrcty consumpton for dervng the same level of electrcty servces. New electrcty demand s then calculated as: 0 CH EL CH EL = (1 α ) (21) α θ The rate of replacement also represents the level of emsson reductons; a low rate of replacement would generate small amounts of emsson reducton and vce versa. Our model s a sngle year statc model, but the DSM program generates costs and benefts for multple years. In order to deal wth ths stuaton, we calculate annuty of the total nvestment over the economc lfe of the DSM program. The annuty s compared wth the annual electrcty savngs n the absence of CDM, and wth the sum of annual electrcty savngs and annual CDM revenue when the DSM program s consdered under the CDM. Alternatvely, we start wth an exogenous unt cost of energy savngs, whch s equal to the total costs of the DSM program dvded by electrcty savngs throughout the economc lfe of the program. We then dvde the unt cost of electrcty savngs by an average electrcty prce to get a rato of unt cost of energy savngs to electrcty prce (CPR). If the CPR s smaller than 1, the DSM program wll have net savngs. The smaller the value of CPR, the hgher wll be IRR of the DSM program. Thus, the model fully accounts for the overall costs and benefts of the DSM program. The net savngs of the DSM program (DSMSAV) s calculated as follows: 0 DSMSAV = ( CH CH ).(1 CPR) (22) EL EL The economcs of a DSM project s senstve to two factors: () cost of ts mplementaton and () prce of electrcty, whch s used to estmate DSM benefts. Hence nstead of assumng fxed values ether on DSM cost or electrcty prce (.e., DSM beneft), we used a 13

16 rato lettng both DSM cost and electrcty prce to vary. Moreover, the use of the rato ensures the results of study are not-senstve to approaches (.e., economc or fnancal) used n the partal equlbrum analyss. Ths s because, f the DSM cost (.e., the numerator used for the calculaton of the rato) s a commercal or fnancal cost, electrcty tarff s used n the denomnator. On other hand, f the DSM cost s an economc cost, the electrcty tarff s replaced wth the economc cost of electrcty supply. Use of rato helps the study to have generc results otherwse the results are subject to assumptons on DSM costs and electrcty prces Household ncome Total household ncome (THI) conssts of captal ncome, labor ncome, and net transfer from the rest of the world. Captal ncome also ncludes deprecaton. Labor ncome conssts of not only salary and wages but also socal securty benefts to households. Total household ncome s then expressed as: K L THI = [ K. kp.(1 + τ ) + L. wr.(1 + τ )] + NTRH + DSMSAV CDMREV (23) + where wr and kp are the gross tax prces of labor and captal, respectvely. NTRH s the net transfer from the rest of the world to households and s expressed as a constant fracton of total exports. DSMSAV s net household savngs due to the DSM program and CDMREV s revenue generated from the sales of GHG mtgaton as certfed emssons reducton (CER) unts (hereafter the CDM revenue ) and Equaton 22 s modfed as: The CDM revenue (CDMREV) s calculated as follows: 0 ( CO2 CDMREV = adf cerp TPOL TPOL CO 2 ) (24) where adf s the fracton of total CDM revenue that s requred to cover admnstratve costs and adaptaton fees 10. The prce of CER s represented by cerp, and TPOL 0 CO2 and TPOL CO2 are emssons of carbon doxde (measured n tons of carbon) n the base and polcy smulaton cases, respectvely. 10 Artcle 12.8 of the Kyoto Protocol states that a share of the proceeds from certfed project actvtes s used to cover admnstratve expenses as well as to assst developng countres that are partcularly vulnerable to the adverse effects of clmate change, to meet ther costs of adaptaton (UNFCCC, 1998). 14

17 Consderng the wde range of transacton actvtes under the CDM project cycle (e.g., project valdaton, regstraton and montorng; and credt verfcaton and certfcaton), 25% of the total CER revenue derved from the DSM program s allocated to cover transacton costs. Besdes, we also carry out senstvty analyses later, at varous levels of transacton costs (e.g., 10%, 20% and 30% of the total CER revenue). The prce of carbon credts s another key factor n determnng the economc mpacts of a CDM project actvty. In 2006, CERs were traded n the secondary markets at a prce range between US$14/tCO 2 and US$20/tCO 2 (Capoor and Ambros, 2007). Instead of settng a prce for CERs, our model smulates the DSM program for a prce range from zero to US$50/tCO 2. Total ncome tax pad by the household (ITAX) s gven by: ITAX = ( K. kp. τ + L. wr. τ ) K L We assume here that households do not pay tax on ncome generated from net transfer from rest of world to households and CDM revenue. Total household ncome (I) corresponds to dsposable ncome and the mputed value of lesure, and s gven as: I = THI ITAX + LS. wr (26) (25) 2.3. The government sector Total government revenue (GI) conssts of ndrect taxes pad by frms, drect taxes pad by households, mport dutes, and net transfers from the rest of the world (NTRG). GI s allocated to government expendture (GCE) and government savngs (SAVG). GI = G. gp. ndt + M. mp. mpt + ITAX + NTRG (27) SAVG = GI CG * gp *(1 + ndt (28) ) where G and M are demand for the composte good and mported good respectvely, and gp and mp are the correspondng prces; ndt and mpt are ndrect tax and mport duty rates, 15

18 respectvely. Government consumpton of good (CG ) s kept constant at the same level as n the base case The foregn sector Import demand Followng Armngton (1969), we assume domestcally produced and mported goods to be mperfect substtutes. The total domestc demand for a good or a servce (G) s assumed to be a CES composte of domestcally produced (G D ) and mported components (G M ). It can be expressed as: 1/ σ DM D( σ DM 1)/ σ DM 1/ σ DM M( σ DM 1)/ σ DM σ DM /( σ DM 1) D M G = [ α G + α G ] where α D and α M are scalng factors of G D and G M respectvely, and σ DM s the elastcty of substtuton between G D and G M. The dual functon of Equaton (22) s used to derve gp : (29) DM ( 1 σ ) ( 1 DM ) /( DM D σ 1 1 σ ) M gp = [ α xdp + α { gpw. ER.( 1 + mpt )} ] (30) where gpw s the world prce of good, and ER s the exchange rate. Both of them are exogenous to the model Export demand The model calculates export demand as follows: EX = α gpw. ER ε ( ) (31) xdp EX where α EX s the share of good n total export demand and ε s the prce elastcty of exported good wth respect to the world prce of the same good 12. Smlar to a number of exstng general equlbrum models such as Dervs et al (1982) and Benjamn (1994) the nomnal exchange rate s kept fxed; domestc prces fluctuate aganst the fxed foregn prce level, whch serves as the prce numérare n the model. 11 Smlar approach also adopted n most exstng general equlbrum models (e.g., Xe 1996 and Zhang 1997). 12 Smlar approach s followed by a number of exstng studes such as Dervs et al. (1982), Proost and van Rogermorter (1992) and Naqv (1999) to model export demand. 16

19 Current balance The current balance (TBAL) refers to the dfference between total value outflow (e.g., mports of goods and servces) from the country to the total value nflow (e.g., exports and transfers from the rest of the world) to the country. TBAL = [ M. mp EX. ep ] NTRH NTRG (32) j j j j j 2.5. Investment demand The model assumes that the total current nvestment n an economy s equal to the total captal goods delvered to the economy n the prevous year (Capros et al. 1997). Current nvestment n the sector (INV ) s gven as follows: INV = K K kp.( 1+ τ ).[( + gr dpr nvp.( r + dpr) ) σ.( 1 ) ( 1 ) ] (33) where, nvp s prce of nvestment n sector ; r, dpr and gr are nterest rate, deprecaton rate and growth rate of sectoral producton, respectvely. Although the rate of deprecaton and producton growth rates can vary across the sectors, the model assumes them the same for all the sectors. Delvery of nvestment good (INVD ) s assumed to be a fxed share of total nvestment goods delvered to the economy. INVD = a. INV (34) INV where, a INV s the share of nvestment demanded by sector n total nvestment demand Market clearng Total producton of good s the sum of the domestc consumpton of domestcally produced good and exported good. XD = G D + EX (35) 17

20 Total domestc demand (G) conssts of ntermedate (ZA) and fnal demand (.e., household consumpton CH, government consumpton CG, captal goods INVD, and nventory goods STK). G = ZA + CH + CG + INVD + STK (36) Inventory demand for good (STK ) s mantaned as a fxed fracton of output from sector before and after the carbon tax. It s assumed that the total tme endowment (.e., the actve populaton) n the economy does not change due a polcy change. Ths assumpton mples that the total labor supply to the economy depends on the wage rate and labor supply elastcty. Followng the Walrasan approach t s assumed that the total labor supply (TLS) n the economy s equal to the total demand of labor n the economy. Ths gves us the followng relatonshp: TTE TLS = = ξ j L j where TTE s the total tme endowment, ξ s the rato of total hours to workng hours, ether on a daly bass or a weekly bass. The model allows captal moblty across the producton sectors. However, the total captal stock n the economy (TK) s assumed to be unchanged as a result of a polcy change. (37) 2.7 Emsson estmaton Emssons of a pollutant p from sector n (POL n,p ) (p = CO 2, SO 2 and NO x ) can be estmated as follows: POLnp, = FFfn,. cf. effp, (38) f where n represents 20 ndustral sectors (except the electrcty sector), the household sector and the government sector; FF f,n refers to use of fossl fuel f (n monetary unt) n sector n; c f, converts FF f to energy unt (e.g., Gga Joule, GJ) and can be expressed as GJ/Baht; and ef f,p s the emsson factor of pollutant p for fuel f, expressed n kg of pollutant per GJ unt fuel consumpton. Emssons from the electrcty sub-sectors are also calculated n a smlar manner. 18

21 The man data needed for the study ncludes a socal accountng matrx (SAM) of Thaland and elastcty parameters as mpled by Fgure 1 to Fgure 3. The SAM was taken from Tmlsna and Shrestha (2002) and elastcty values were taken from Tmlsna and Shrestha (2006). 3. RESULTS FROM MODEL SIMULATIONS 3.1. Impacts on economc welfare Welfare mpacts of the DSM program are presented n Fgures 4(a) to 4(c). In each fgure, the curve desgnated by No CDM represents welfare effects of the DSM program n the absence of the CDM, whereas the other curves represent the welfare effects of the DSM program under the CDM wth varyng CER prces. Fgure 4(a) assumes that the unt cost of electrcty savngs s 40% of the prce of electrcty (.e., CPR =0.4). Fgure 4(b) and 4(c) assume CPR to be equal to 0.6 and 1.0, respectvely. Fgure 4: Welfare Effects of the DSM Opton Welfare change (%) NO CDM US$5/tCO2 US$10/tCO2 US$25/tCO2 US$50/tCO3 Welfare change (%) NO CDM US$5/tCO2 US$10/tCO2 US$25/tCO2 US$50/tCO3-0.8 Replacement rate (%) -0.8 Replacement rate (%) (a) η = 0.4 (b) η =

22 Welfare change (%) NO CDM US$5/tCO2 US$10/tCO2 US$25/tCO2 US$50/tCO3 Replacement rate (%) (c) η = 1.0 The fgures llustrate quanttatvely how the welfare mpacts of the DSM program change wth: () the rate of substtuton of less effcent applances wth ther more effcent counterparts, () the rato of unt cost of electrcty savngs to electrcty prce and () the prce of CERs. For a gven value of CPR and CER prce, the welfare mpacts decrease wth the rate of substtuton as the margnal cost of energy effcency mprovements s ncreasng. If CPR equals 0.4, the welfare mpacts of the DSM program would be slghtly postve when the rate of substtuton s 10% even f the DSM program s mplemented n the absence of CDM. A 10% substtuton of neffcent electrcal applances n the household sector results n approxmately 0.91% reductons of natonal CO 2 emssons per year. If the rate of substtuton s ncreased to 20%, the DSM program would reduce approxmately 1.63% of natonal CO 2 emssons per year. Ths would, however, cause a welfare loss, even f CPR equals 0.4, unless the DSM program s mplemented under the CDM and CERs are sold at a prce greater than US$10/tCO 2. Smlarly, f CPR ncreases to 0.6, CDM revenues would be requred to have a postve welfare effect even at 10% substtuton rate. Ths result mples that the rato of unt cost of electrcty savngs to prce of electrcty s hghly crtcal to economy wde effects of a DSM program. 20

23 The study fnally demonstrates how the welfare mpacts of a DSM program mprove f the DSM program s mplemented under the CDM. For example, for 0.4 CPR and 20% rate of substtuton, the welfare mpact of the DSM program would be -.036% n the absence of the CDM; t would ncrease to 0.018% f the program s mplemented under the CDM and CER prce s 25/tCO 2 (see Fgure 4a). Ths s because an mplementaton of the DSM program sgnfcantly enhances ts proftablty. We fnd that the IRR of the DSM program ncreases from 13% to 26% f CER prce ncreases from zero to US$50/tCO 2 when CPR s 0.6. At a lower value of CPR (0.4), the IRR ncreases from 24% to 41% when CER prce ncreases from zero to US$50/tCO 2. Even f CPR equals 1 (.e., net savngs from the DSM program s zero), a CER prce of US40/tCO 2 could cause postve welfare mpacts as long as the rate of substtuton s below 10%. Thus, CDM could play an nstrumental role n enhancng the attractveness of DSM programs n Thaland as t helps mprove the welfare mpacts of the programs. Moreover, CDM would not only mprove economc attractveness of a DSM program, t could also help reduce delverable barrers to DSM programs (e.g., fnancal barrers). Dealng wth delverable barrers s crucal n Thaland because only a lmted number of DSM projects have been mplemented n the country despte beng hghly attractve economcally (IRR > 25%) (du Pont, 2005). Unless the rato of unt cost of electrcty savngs to the prce of electrcty s suffcently low (or IRR of the DSM programs s suffcently hgh, greater than 23% n the case of Thaland), the DSM program mght lead to negatve welfare mpacts from a general equlbrum perspectve. Ths s because the replacement of neffcent applances wth effcent applances would cause an ncreased demand for electrcal applances servces and reduce the demand for electrcty. To meet the ncreased demand for applances, ther producton (.e., gross output) and mports would ncrease. The ncrease n the producton of electrcal applances would mean an ncrease n the producton and mports of those goods used n the electrcal applances ndustry. On the other hand, as demand for electrcty decreases, electrcty generaton together wth demand for fuels and materals used for electrcty generaton also decrease. Snce the ncrease n sectoral outputs of the electrcal applance ndustry and of those ndustres supplyng goods to the electrcal applance ndustry s hgher than the reducton n sectoral outputs of the electrcty and fuel sectors, there would 21

24 be a net ncrease n total gross output of the economy. The ncrease n the total gross output s also accompaned by hgher labor demand as well as hgher labor supply n equlbrum. An ncrease n labor supply mples a decrease n lesure as a household s total tme endowment s fxed. There would also be reductons n factor prces n equlbrum. The reductons n factor prces and lesure would result n the reducton n full ncome of households, whch n turn causes a reducton n welfare. For lower values of CPR and hgher CER prces, the postve feedback mpacts from fuel savngs and CDM revenue would be greater than the negatve feedback mpacts of the DSM program, thereby resultng n postve welfare mpacts Envronmental mpacts Table 2 presents the mpacts of the DSM program on emssons of CO 2, SO 2 and NO x. As can be seen from the table, percentage reductons n emssons would ncrease wth the rate of replacement of neffcent electrcal applances wth effcent ones. On the other hand, the prce of CER and the rato of unt cost of electrcty savngs to electrcty prce do not have notceable mpacts on emsson reductons. One nterestng fndng s that the DSM program would reduce SO 2 emssons at a hgher proporton than CO 2 emssons. If the value of local ar pollutants are also accounted for, the welfare mpacts of the DSM program would be hgher than that we report n ths study. Combnng the welfare and envronmental mpacts yelds some nterestng nsghts. The household sector DSM program consdered here would result n postve welfare mpacts even n the absence of CDM whle reducng natonal level CO 2, SO 2 and NO x annual emssons by 0.91% 1.31% and 0.64%, respectvely, as long as the unt cost of electrcty savngs to electrcty prce s smaller than 0.4 (.e., IRR > 23%). At 0.4 CPR, a CDM scheme wth a CER prce greater than US$10/tCO 2 would ncrease CO 2, SO 2 and NO x reductons to 1.6%, 2.4% and 1.2% whle mantanng the postve welfare effects; f the prce of CER s greater than US$25/tCO 2, the correspondng emssons reductons would be 2.8% 3.9% and 22

25 2.0%. The CDM regstraton would be more nstrumental when the DSM program s not economcally attractve otherwse. If the DSM program has a CPR greater than 0.6 (IRR < 12%) and s mplemented n the absence of the CDM, t would reduce economc welfare by 0.02% to acheve the same level of emsson reductons when CPR was 0.4. The welfare loss would be offset f the DSM program s mplemented under the CDM and CERs are sold at a prce slghtly greater than US$10/tCO 2 ; welfare mprovement would be 0.01% f CERs are sold at US$25/tCO 2. The CDM wth CER prce US$25/tCO 2 would reduce CO 2, SO 2 and NO x emssons by 1.6%, 2.4% and 1.2% wthout reducng welfare even f the DSM program has CPR 0.6. Table 2: Impacts of DSM Program on Total CO 2, SO 2 and NO x Emssons (% change from the base case) Rate of replacement of neffcent applances wth effcent counterparts CPR = 0.4 CPR = % 20% 40% 80% 10% 20% 40% 80% CO 2 Emsson NO CDM US$5/tCO US$10/tCO US$25/tCO US$50/tCO SO 2 Emsson NO CDM US$5/tCO US$10/tCO US$25/tCO US$50/tCO NO x Emsson NO CDM US$5/tCO US$10/tCO US$25/tCO US$50/tCO Although reductons of SO 2 and NOx have been calculated n the analyss, the monetary values of these pollutants have not been ncorporated n welfare mpacts. If ncluded, the economc welfare of the DSM programs would be hgher than those reported 23

26 here. Moreover, mpacts of the DSM program on fne partculate matters (e.g., PM 10, PM 2.5 ) have not ncluded n the study. Reducton of the fne partculate matters can be perceved as an mportant sde beneft of a DSM program partcularly n country lke Thaland, where lgnte (.e., brown coal) s one of the prmary sources of electrcty generaton. If the benefts of fne partculate reducton are also accounted for, the welfare of DSM program would be further hgher. Further analyss ncludng monetary benefts of SO x, NO x and PM 10 could be an nterestng future extenson of the study. 3.3 Senstvty analyss The senstvty analyses focus on the elastcty of substtuton parameters for the household sector as the demand sde CDM opton consdered here corresponds to the household sector. Moreover, we also carry out the senstvty analyss usng an alternatve functonal form (.e., CES) to combne electrcty and electrcal applances, to derve household electrcal servces. The senstvty analyses on parameter values under the demand sde CDM opton focus on the followng elastctes of substtuton n the household sector: () present consumpton and savngs (σ FCS ) () the composte of the aggregate fuel and the electrcal servce, and the aggregate materal goods (σ HDEM ) 13 ()the fuel aggregate and electrcty servce (σ HDFEL ). The changes n emsson mtgaton and welfare loss due to the changes n elastcty of substtutons are found to be very small In the man analyss, we represent the households trade off between electrcty and electrcal applances by usng a Cobb-Douglas functonal form (see Equaton 14). We now replace the Cobb-Douglas functonal form by a CES functonal form (See Equaton 16). We consder dfferent values of elastcty of substtuton between electrcty and electrcal 13 Electrcal servce here represents composte of electrcty and electrcal applances, whle aggregate materal represents the composte of all materal goods used n the households except electrcal applances. 24

27 applances. These values are smaller than 1 (.e., consdered n the man analyss under the Cobb-Douglas specfcaton). As expected, for all levels of CER prces consdered (.e., from 0 to US$50/tCO 2 ) and at each rate of substtuton of neffcent electrcal applances by ther effcent counterparts (.e., from 10% to 80%), the welfare cost of the DSM program s found to ncrease as the value of the elastcty of substtuton between electrcty and electrcal applances s decreased. However, the changes n welfare mpacts as well emsson reductons are not sgnfcant unless the values of elastcty of substtuton are lowered by 50%. 4. CONCLUSIONS We examne, usng a CGE model, the welfare effects of a potental DSM program that can replace neffcent electrcal applances wth ther effcent counterparts n the household sector n Thaland. Our study shows emprcally that the welfare mpact of a DSM program depends on three key factors: () the rato of unt cost of electrcty savngs to electrcty prce, () CER prce and () the rate of substtuton of less effcent applances wth ther effcent counterparts (or volume of emsson reductons). Although the exstng lterature, such as Dufournaud et al. (1994) and Rose and Ln (1995), argue that a DSM program would lead to negatve welfare mplcatons, we fnd that not all DSM programs cause a welfare loss. In ths study, we fnd that the DSM program would ncrease economc welfare f the rato of unt cost of electrcty savngs to prce of electrcty (CPR) s 0.4 or lower even n the absence of CDM. If the DSM programs are mplemented under the CDM, welfare effects would mprove further. The CDM regstraton of DSM projects would also ncrease the volume of GHG mtgaton along wth prce of CERs whle achevng a gven level of welfare mpacts. The welfare functon consdered n the study does not account for benefts of local ar polluton reductons; f these benefts are ncluded, welfare mpacts would be hgher than that found n ths study. 25

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