The Economic Modelling of Climate Change: Background Analysis for the Kyoto Protocol

Ratification of the Kyoto Protocol will have major medium and long term implications for the Australian economy and for the international community. The protocol is one of the most ambitious and far reaching environmental policy initiatives ever attempted. Greenhouse gas emission abatement targets agreed to by individual countries are set out in Annex B to the protocol. The protocol includes provisions for the use of flexibility mechanisms such as joint implementation, the clean development mechanism and emissions trading to help Parties meet their target commitments. These flexibility mechanisms allow emission abatement to take place in relatively low cost locations, thereby reducing the overall costs associated with meeting emission targets. No agreement was reached in the protocol on the principles and guidelines for the operation of these schemes and further negotiations are required before they can be implemented. In this paper ABARE’s Global Trade and Environment Model (GTEM) is used to analyse the potential of international emissions trading as a mechanism for helping to achieve the abatement commitments agreed to in the protocol. First, a detailed description of the key features of the model is presented. Second, analysis showing that a system of internationally tradable emission quotas would decrease the cost of achieving abatement commitments is presented. In addition, it is shown that emissions trading would improve the effectiveness of the protocol because the extent of carbon leakage would be reduced. Finally, the paper examines the sensitivity of the projected carbon emission penalties required under an international emissions trading scheme to key assumptions made in the model