Tuesday, September 22, 2009

Part V: Impact of 2020 limits

The previous posts showed the calculations for the revenue collected in the short-run (up to 2012), where the time frame is too short for the producers to change the means of production (no changes in the supply curve) and the consumers respond only to the price, but cannot alter their demand habits (i.e., no shift in the demand curve, just going up and down) . Over the longer time-frame, the consumer habits can certainly change, and the long-run elasticity has been estimated to be 0.7 for electricity. The emissions reduction is expected to be 17%. If we assumed that the producers are unable to change their production mix at all (not a realistic assumption, but this will provide the worst case, highest cost answer), then once again, the price of carbon can be estimated using the relationships described in part IV.

Interestingly, even though the limits for 2020 are ~6X the limit for 2012, the price increases from $24.5 to only $39.5, ~60%. The reason for this significantly lower increase is the higher value of elasticity of demand for electricity over the long run.

Tuesday, September 8, 2009

Part IV: Elasticity of Demand and the Price for CO2

In this section, the carbon price is evaluated using the elasticity of demand of electricity*. The elasticity of demand for electricity has been estimated to be ~0.2 in the short run, and ~0.7 in the long run. In subsequent calculations, the short-run value of 0.2 is assumed for calculations, providing a conservative estimate of the reduction in the emissions. In the short-run (2009-2012), it is unlikely that there will be significant deployment of any new technology for electricity generation, and therefore, the entire reduction in emissions has to occur through a reduction in consumption. The WM targets are a 3% reduction in the emissions, and therefore, we have:

DQ/Q (for electricity) = 0.03
Elasticity =0.2

--> DP/P (for electricity) =0.03/.2=0.15

Therefore, electricity is 15% more expensive due to WM. Since this 15% increase in electricity price is entirely due to the carbon price, the price of carbon may be estimated as:

DP/P=0.15 ==> DP = 0.15*P = 0.15*0.1 ($/KWhr)= $0.015 /KWhr

1KWhr = 1.35 pounds of CO2 = $0.015
1 Ton = 2204 pounds of CO2 = 2204*0.015/1.35 = $24.5/Tonne of CO2.

This value is clearly higher than the floor price used in earlier calculations ($10), indicating that the "fundamental value" of a CO2 permit is ~$25 in the period up to 2012. The estimates for periods beyond 2012 are fraught with uncertainty, because of the following reasons:
(1). Higher (and uncertain) elasticity of demand
(2). Possible role for deployment of new technologies (though 10 years seems relatively small from a utility context. However, other possibilities, such as plug-in hybrids could indeed be deployed faster, resulting in faster changes in demand).

Since the actual CO2 price is $25 per tonne, the price increase per household is now 24.5/10*73.5 ~ $180 per household per year.

*Elasticity of demand refers to the % change in demand of a good due to a specific % change in price. For details, see here.