Potential Impacts of a Global Cap and Share Scheme on South Africa

The BRICSA countries (Brazil, Russia, India, China and South Africa) are likely to play key roles in deciding the type of climate agreement that follows Kyoto. How likely are they to favour Cap and Share? Feasta intends to produce studies of the effects that Cap and Share might have on each. The pilot study, of the likely effects on South Africa, has just been completed by Jeremy Wakeford of South African New Economics. It will be used as a model for the remaining four reports.

This study sought to identify the initial impact that a global Cap and Share scheme might have on South Africa, based on a set of limiting assumptions. In particular, it attempted to quantify the immediate impact – i.e. before behavioural responses take effect – on energy prices, the macro economy, household expenditure and income, industries and the competitiveness of renewable energy sources.

Introduction, Summary and Conclusions included below or download the entire document.
Discussion about this document

INTRODUCTION

Stabilising the world’s climate system and preventing a climate catastrophe requires urgent and co-ordinated international action to reduce the atmospheric concentration of global greenhouse gases (GHGs) (see IPCC, 2007; Stern, 2006; Hansen et al, 2008). The Cap and Share (C&S) scheme proposed by the Feasta, the Ireland-based Foundation for the Economics of Sustainability, provides a potential framework for achieving a rapid reduction in the rate at which further emissions add to that concentration.

1.1 Overview of the Cap & Share scheme
Cap and Share was developed to meet the twin challenges of climate change and the peak in the world supply of easily-extracted oil. It works by imposing a limit – a cap – on global emissions from the use of coal, gas and oil and then charging fuel users whatever price is necessary to balance their demand with the capped supply. The bulk of the payments made by the fossil fuel users are then shared amongst the whole human population on an equal-per-capita basis. This compensates people, at least in part, for the increase in energy prices caused by the scarcity created by both the decline in oil production from its peak and the limited production of gas and coal as a result of the emissions restrictions. In this way, it shares out the benefits from using fossil fuel amongst everyone in the world.

Essentially, then, C&S is a way of capturing the scarcity rent – the extra that consumers are prepared to pay when whatever they are consuming gets scarce – and redistributing it. If C&S or some equivalent system is not introduced, the scarcity rent as a result of the restricted supply of oil will continue to go to the oil producers and to the producers of gas and coal because of the increased prices they have been able to charge as a result of oil’s scarcity. Recent reports indicate that these rent payments are already leading to an extreme concentration of wealth and threatening global financial stability (see for example Llewellyn, 2006).

Under C&S, the level of emissions permitted under the cap would be reduced year by year at whatever rate the international community decided was necessary to guarantee climate stability. As Appendix A explains, this rate would need be to be at least as fast as oil production was declining if the maximum amount of scarcity rent was to be available for distribution. This is because, to capture the most rent, the emissions permits issued under the cap would have to be a scarcer resource than the oil supply.

It is important to recognise that, if adopted globally, C&S would only increase fossil fuel prices by an amount based on the additional scarcity it had created for climate reasons. All of the extra money that people paid for their fuel because of this climate surcharge would be returned to them in one way or another. It would not be a tax. Moreover, C&S would retrieve some of the money currently being paid to fossil fuel producers as scarcity rent and distribute it around the world. It has therefore the potential to make millions of poorer people better off.

C&S shares the scarcity rent by distributing most of the emissions permits issued under the cap directly to individuals, who then sell the permits, known as Pollution Authorisation Permits, or PAPs, at whatever is the current market price, to financial intermediaries such as banks and post offices. The intermediaries then consolidate the PAPs and sell them on to fossil fuel producers who would be required to buy sufficient permits each year to cover the emissions from the fuel they had produced. Inspectors would ensure that they complied.

1.2 Aims of the study
This study aims to assess the initial impact that the introduction of a global C&S scheme would have on South African households and industries. The word initial needs to be emphasised because the introduction of C&S would generate a new set of relative prices. In particular, it would create a climate within which people believed that energy prices would not only remain high but get higher over the years and that they should therefore develop ways of living and working which required as little fossil energy as possible. They would also want to invest in developing non-fossil energy sources. In other words, C&S would initiate such a flood of investment and change that conditions after it has operated for a little while are impossible to predict.

Because C&S would not only enable poorer people to spend more but can also be expected to touch off a wave of energy-intensive capital investment, it could increase fossil energy demand and, consequently, energy prices. It is impossible to say how high these prices might be on its introduction and what proportion of the price it would be possible to capture to redistribute to people. The study therefore suggests what would happen to South African prices and incomes for a range of energy prices with varying proportions of those prices being captured by Cap and Share. The initial effects it explores are those on:

the prices of energy products and the prices of energy-intensive goods;
the current account of the balance of payments;
the aggregate macroeconomy;
household expenditure, income and inequality;
energy-intensive industries; and
opportunities for developing renewable energy sources.

1.3 Scope
This report is limited both by current availability of data and by time. It is not intended to be a comprehensive analysis. The report covers potential impacts of C&S on the macroeconomy, households (at income deciles and by rural or urban residence) and major sectors of the economy.

1.4 Assumptions
The analysis in this study is based on the following assumptions about the implementation of C&S:

C&S is introduced globally now (mid 2008). This is to allow current data to be used.
PAPs are allocated on a per capita basis rather than a per adult basis to allow household data to be used.
The possible prices of oil, including the Cap and Share element, range from $60 per barrel to $400 immediately after C&S’s introduction. Appendix A sets out the estimates for the shares of the scarcity rent that C&S might be able to capture at the various prices. It also converts the scarcity rents into prices per tonne of CO2. These range from zero to $780 or €500. The benchmark prices used in this study are €25, €50, €100, €200 and €400.
The prices of coal and gas are assumed to maintain their current relationship with the oil price after allowing for the effects of the CO2 price.
Prices around the world are assumed to adjust instantaneously to the new level of energy prices brought about by C&S. In actual use, of course, prices would adjust over a period of months or years and economic behaviour and production processes would change as well. This assumption consequently exaggerates the price changes that would occur.
The global per capita CO2 emission allowance is assumed to be 3.71 tonnes per capita. This figure is based on the EIA’s (2005) estimate of average global emissions of 4.37 tonnes of CO2 per person, less 15% (5% for the Transition Fund, 9% for sequestration and 1% for overheads). This includes CO2 emissions from the burning of fossil fuels only (not from land use, waste, agriculture, etc.).

1.5 Methodology
The study employs a mix of quantitative and qualitative analysis. Wherever suitable data permit, quantitative projections are made. No attempt is made at formal modelling as it is considered beyond the scope of this exploratory report.

1.6 Data
This study utilises data from a variety of international and South African sources, including the following:

International Energy Agency (IEA)
US Energy Information Administration (EIA)
Statistics South Africa (SSA)
Department of Minerals and Energy (DME)
South African Petroleum Industry Association (SAPIA)
Eskom (Annual Reports)

The data are mostly taken at face value and are assumed to be sufficiently reliable, or at least the most reliable data sources that are publicly available. The most recent available (annual) data are utilised. In the case of energy and emissions, as well as household income and expenditure, the most recent publicly available data are for 2005. Energy prices are available as of July 2008.

SUMMARY AND CONCLUSIONS

South Africa is considerably more carbon-intensive than the world average in both per capita and per economics output terms. Emissions are dominated by those from coal, and have been on a rising trend for decades.

Putting a price on CO2 emissions would have a major impact on the price of electricity, a notable impact on the price of coal, and a lesser relative impact on the prices of liquid fuels in South Africa. Higher energy prices would also feed through into higher producer and consumer prices given that energy is embodied in the production process for many goods, and many goods and services have a transport cost component.

Because of South Africa’s high energy intensity relative to the world average, the net impact of C&S, taking into account the total cost of emission permits after adjusting for the balance of emissions embodied in trade as well as national income from PAPs, is a substantial, negative percentage of GDP. This might make the adoption of C&S by the South African government politically difficult if there is no compensation for South Africa’s developing country status.

At the household level, C&S would effect a substantial degree of income redistribution within South Africa given the existing extent of inequality in energy consumption and income. In particular, the richest three income deciles are net losers from C&S while the bottom seven deciles are net winners. In proportional terms, C&S has a progressive impact on inequality. Any policy intervention that produces winners and losers is bound to encounter political obstacles, and in this case the hurdles are likely to be substantial given that the elite have the most to lose. However, the adoption of C&S could assist the South African government’s commitment to poverty alleviation.

Certain energy-intensive industries would be hard hit in terms of their international competitiveness, especially manufacturing which relies heavily on coal-powered electricity. Other energy-intensive industries, such as mining and metal production, have similar energy-intensities to their direct competitors in other countries, but could lose out to less energy-intensive competitors where those exist. Over time there is likely to be a relative decline in long-distance international trade so that opportunities for import substitution will improve.

Renewable sources of energy become much more cost competitive than coal-fired electricity even at moderate CO2 price levels. This suggests that C&S would help to kick-start a domestic renewable energy industry.

In sum, this report has indicated that C&S would have a substantial impact on the South African economy and society, even in immediate terms. This exploratory study has hopefully demonstrated that more extensive research and analysis into the potential impacts of C&S is worth undertaking. For instance, more complex economic modelling could be applied to estimate some of the dynamic responses of industrial sectors and households to higher energy prices.

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