Policy Considerations for Mandating Agriculture in a Greenhouse Gas Emissions Trading Scheme: A comment Stéphane De Caraa,∗, Bruno Vermonta a

INRA, UMR 210 Economie Publique INRA-AgroParisTech, Thiverval-Grignon, France

Abstract In a recent article, Ancev (2011) argues that mandating agriculture in a greenhouse gas (GHG) emission trading scheme (ETS) would not be socially beneficial, because of high abatement and transaction costs in agriculture. We re-examine this conclusion by assessing the costs and benefits of extending the coverage of the EU ETS to agriculture in the perspective of the EU 2020 GHG reduction target. As for marginal abatement costs in agriculture, our assessment is based on the results from a recent meta-analysis also used by Ancev. Taking Ancev’s assumptions regarding transaction costs, our results do not support the conclusion that costs offset the gains permitted by a greater flexibility across sectors. Moreover, we argue that transaction costs in agriculture may be lower than what is suggested by the extrapolation of results obtained for the sectors currently covered by the ETS, in particular if (i) the calculation of GHG emissions are based on the internationally-agreed IPCC guidelines, (ii) the monitoring and verification rely on the existing bodies and provisions under current agricultural policy, and (iii) participation of farmers to the ETS is subject to a (well-defined) minimum level of per-farm GHG emissions. Keywords: Greenhouse gas emissions, Agriculture, Marginal abatement costs, Trading scheme. JEL: Q18, Q54, Q58.

∗

Corresponding author. INRA UMR Economie Publique INRA-AgroParistech, BP01, F-78850 Thiverval-Grignon, France. Tél: +33(0)1 30 81 53 48. Email address: [email protected] (Stéphane De Cara) Preprint submitted to Applied Economic Perspectives and Policy

March 3, 2011

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Policy Considerations for Mandating Agriculture in a Greenhouse Gas Emissions Trading

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Scheme: A comment

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Abstract

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In a recent article, Ancev (2011) argues that mandating agriculture in a greenhouse gas (GHG) emission

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trading scheme (ETS) would not be socially beneficial, because of high abatement and transaction costs in

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agriculture. We re-examine this conclusion by assessing the costs and benefits of extending the coverage

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of the EU ETS to agriculture in the perspective of the EU 2020 GHG reduction target. As for marginal

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abatement costs in agriculture, our assessment is based on the results from a recent meta-analysis also

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used by Ancev. Taking Ancev’s assumptions regarding transaction costs, our results do not support the

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conclusion that costs offset the gains permitted by a greater flexibility across sectors. Moreover, we argue

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that transaction costs in agriculture may be lower than what is suggested by the extrapolation of results

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obtained for the sectors currently covered by the ETS, in particular if (i) the calculation of GHG emissions

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are based on the internationally-agreed IPCC guidelines, (ii) the monitoring and verification rely on the

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existing bodies and provisions under current agricultural policy, and (iii) participation of farmers to the ETS

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is subject to a (well-defined) minimum level of per-farm GHG emissions.

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Introduction

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In a recent article, Ancev (2011) questions the interest to include greenhouse gas (GHG) emissions

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from agriculture in an emission trading scheme (ETS). One of the main points developed in the paper is

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that agriculture has no cost advantage in reducing GHG emissions. The situation described by Ancev is

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illustrated in Figure 1.a, in which marginal abatement costs (MAC) are taken more than twice as high in

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agriculture (A) as in the sectors currently covered by the ETS (E).

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Yet, despite markedly higher MAC in agriculture than in the sector E, the inclusion of agriculture into the

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ETS enables to save on total abatement costs. As base-year emissions matter for the computation of total

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costs, the cost-savings are more easily visualized when the MAC curves are plotted against the absolute

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(rather than relative) abatement of the respective sector. This is done in Figure 1.b, in which base-year

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agricultural emissions are taken to be almost five times lower than that of sector E. Consider that the

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allowances in sector E are such that the total abatement target for this sector is aˆ 0 , whereas agriculture is

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not initially covered by the ETS. If the scope of the ETS is expanded while holding the overall abatement

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target aˆ 0 constant1 , the cheapest mitigation options in A (aA ) substitute to the most expensive ones in sector

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E (ˆa0 − aE ). For the same environmental outcome (ˆa0 = aA + aE ), the equilibrium emission price is thus

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reduced from p0 to p1 . Total abatement costs are unambiguously lower. The resulting cost-savings are

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represented by the sum of the two shaded areas in Figure 1.b. [Figure 1 about here.]

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The question then becomes: “Are transaction costs (TC) related to the inclusion of agriculture in an

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ETS large enough to negate the cost-savings permitted by a cost-effective allocation of abatement across

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sectors?”. We re-examine Ancev’s answer to this question (“yes”) in three steps. Firstly, we provide a

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quantitative assessment of the cost-savings permitted by the inclusion of agricultural GHG emissions into

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an ETS in the context of the EU climate policy. Secondly, we evaluate the value of the transaction costs

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necessary to fully offset these cost-savings and compare it to the figures proposed by Ancev. Thirdly, we

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discuss the assumption taken by Ancev regarding TC in agriculture relative to that in the industrial sector,

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and list some reasons why TC in agriculture may not be as large as suggested. 1

An alternative comparison would consist in holding total abatement costs constant and comparing the additional abatement

permitted by the inclusion of sector A into the ETS.

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A (simple) assessment of the cost-savings of including agricultural emissions into the EU ETS

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Averaging agricultural MAC across a range of abatement rates and comparing it to the current ETS

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price–as is done in Ancev (2011, p. 9)–gives in itself little indication about the potential cost-savings per-

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mitted by the inclusion of agriculture into an ETS. In this respect, the price elasticities of the abatement, the

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relative levels of base-year emissions, and the stringency of the overall abatement target are more relevant

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parameters. Moreover, the current price on the ETS market only gives an information about MAC in the

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currently covered sectors for the current abatement target. It is not indicative of the stringency of future

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abatement targets in a possibly expanded market. The simple assessment proposed in this section accounts

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for these elements. As the European Union ETS is the main market for emission trading currently in opera-

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tion in the world and is a key policy instrument in the EU climate strategy for 2020, we illustrate our point

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by focusing on the EU.

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MAC for the EU agricultural sector. Vermont & De Cara (2010) provide an estimation of a constant-

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elasticity abatement supply function of the form: αA (p) = KA pµA , where p is the emission price (in

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C/tCO2 eq), αA (p) is the abatement rate in agriculture relative to 2005 emission levels, µA is the price elas-

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ticity of the abatement rate, and KA is a positive constant. Note that the abatement rate only pertains to

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reductions in methane and nitrous oxide emissions from agriculture, and does not include the mitigation

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potential related to soil carbon sequestration, afforestation of agricultural land, nor the reduction in fossil

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fuel use in agriculture. Note also that the specification of the abatement supply precludes ’no-regret’ op-

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tions. Vermont & De Cara report an estimated value of the price elasticity of the abatement rate µA = 0.592

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(Model 6, p. 1381). KA is computed by taking all other variables used in the estimation at their mean values,

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except for the baseline year (BLYR set to 2020) and the spatial dummies (SPA=EU set to 1, all others to 0).

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This leads to KA = 0.0128. 2005 agricultural emissions (503 MtCO2 eq) are taken from the EEA (European

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Environment Agency, 2010).

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MAC for the EU ETS sector. We base our assessment on the results reported by Capros et al. (2008), which

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were used by the European Commission in the preparation of the climate-energy package. The target for

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the ETS implies that GHG emissions from this sector be 460 MtCO2 lower in 2020 than in 2005 (1880 and

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2340 MtCO2 , respectively, see Capros et al., 2008, Tables 2 and 4). If this target is to be obtained solely from

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the installations covered by the ETS, the reported corresponding emission price is 47 C/tCO2 (see Table 7,

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scenario RSAT). The cost-efficiency scenario (full flexibility across sectors) provides an additional point on

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sector E’s MAC curve (ETS abatement: 414.6 MtCO2 , emission price: 39.2 C/tCO2 price, see Tables 7 and

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9, scenario CES). We use these two points to calibrate a constant-elasticity abatement supply curve similar

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to that used for agriculture: αE (p) = KE pµE . This leads to µE = 0.573 and KE = 0.0217.2

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Cost-savings permitted by including agricultural emissions into the ETS. We first need to compute the

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equilibrium price after inclusion of agricultural emissions into the ETS by equalizing MAC in both sectors

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for a constant abatement target aˆ 0 = 460 MtCO2 eq. The resulting price is p1 = 37.6 C/tCO2 eq, a value

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about 20% below the initial price reported by Capros et al. (p0 = 47 C/tCO2 eq). The cost-effective sharing

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of the overall target aˆ 0 requires an abatement in sector E of only aE = 405 MtCO2 eq, the complement to

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460 MtCO2 being achieved in the agricultural sector (aA = 55 MtCO2 eq). Interestingly, the abatement rate

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in agriculture slightly exceeds the 10% reduction target decided by the EU in 2009 for the non-ETS sectors.

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The inclusion of agriculture into the ETS thus reduces the total abatement costs in sector E by more

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than 2320 MC or 30% of the initial costs (from 7875 to 5551 MC). The total abatement costs in agriculture

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amount to only 770 MC. The net cost-savings permitted by the extension of the ETS coverage are therefore

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approximately 1550 MC (20% of the total initial costs).

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Cost-savings and transaction costs

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Are TC likely to offset the cost-savings computed in the previous section? Even under the assumptions

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that TC are positive in agriculture but zero in sector E, this would require a TC of about 3.1 C for each ton

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of CO2 eq emitted by agriculture in 2005. This value is almost 25% higher than the 2.5 C/tCO2 eq figure

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proposed by Ancev (Table 2, p. 10). Under the same assumptions and taking the latter figure as the unit TC

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in agriculture would still leave a net cost-saving of about 300 MC.

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The reasoning above assumes that the equilibrium emission price and the cost-effective burden sharing

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across sectors are not affected by the presence of TC. Indeed, as noted by Ancev, the presence of TC

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may shift the abatement supply curve to the right, and therefore modify equilibrium prices and quantities.

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Consider that the agricultural abatement supply is modified so that it is zero as long as the emission price is

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below some threshold value vA , and takes a positive value α˜ A (p) = KA (p−vA )µA when p > vA . For simplicity,

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TC in sector E are assumed to remain zero. By construction, costs savings are maximal for vA = 0 and zero

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for vA = p0 . They are shown in Figure 2 for the values of the parameters found in the previous section.

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Ancev suggests that vA could range from 6-8 C/tCO2 eq to 20 C/tCO2 eq (p. 9). The cost-savings are still

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approximately 1140 MC if va = 8 C/tCO2 eq, and 615 MC if va = 20 C/tCO2 eq. Consider now that 2

The MAC curves in Figures 1 have been constructed by using these parameters. Note that, in accordance with the findings of

Vermont & De Cara (2010), the price-elasticities of the abatement rate in the two sectors are very close to one another.

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including agriculture in an ETS also involves additional costs that are independent of the level of abatement

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(F). Figure 2 indicates that F has to exceed 1140 MC if va = 8 C/tCO2 eq (615 MC if va = 20 C/tCO2 eq)

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for the expansion of the scope of the ETS not to be socially desirable. As a comparison, the total annual

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budget of the EU Commission for ’Environment and Climate Action’ is 470 MC (European Union, 2011). [Figure 2 about here.]

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On the value of transaction costs in agriculture

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One central argument used by Ancev (see Tables 2 and 3) is that unit TC in agriculture might be more

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than 2.5 times larger in agriculture than in the sectors currently covered in the ETS, chiefly because most

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of the agricultural entities covered by the scheme would be small emitters. This figure is extrapolated from

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various studies that examined TC in the ETS. In this section, we list several reasons why this assessment

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may be over-pessimistic.

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Early implementation costs. The creation of an ETS indeed entails some fixed costs that accrue to both

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regulatory bodies and private agents. However, at least in the case of the EU where the ETS has been in place

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for some years now, the fixed costs related to establishing the market have already been covered. Expanding

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the scope of the ETS, rather than creating a new one, may therefore benefit from substantial economies of

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scale, as the structures (registries, trading platforms, regulatory bodies, control entities, training structures,

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etc.) have already been created.

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Monitoring, reporting and verification annual costs. Measuring accurately real agricultural emissions is

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admittedly complex. It requires large amounts of data about soil, climate, management, etc. However,

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the internationally-agreed IPCC guidelines are much simpler and much less demanding with respect to the

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computation of agricultural GHG emissions. They rely on average relationships that may well provide

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an adequate approximation of agricultural emissions at the farm scale. The required data consist of the

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acreage in some crops (rice, N-fixing crops), the number of animals by category, the quantity of applied

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nitrogen fertilizer, the quantity of manure and how it is managed (liquid, solid, digester, etc.), and, optionally

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some information about animal productivity (milk and meat yields) and/or animal feeding (grazing, fodder,

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concentrates). In addition, relying on the IPCC guidelines has the advantage to align the reporting under the

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ETS with that made by the countries under GHG inventory requirements.3 3

Besides, most of the studies that have assessed MAC for agricultural GHG emissions rely on the IPCC guidelines.

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Most of the information required by the IPCC guidelines is often already collected as part of existing

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agricultural policy provisions, in Europe as well as in other countries. In the EU, various CAP instruments

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(decoupled payments, cross-compliance, second-pillar measures) impose that farmers keep track of this

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information and report some of it when filing for CAP payments. The extra cost of computing and reporting

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emissions based on the IPCC guidelines would thus be small. So would be the verification costs, although

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this may involve a strengthening of the already existing controls. Note that increased rates of control may in

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turn foster the efficiency of the CAP-related instruments.

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Trading costs. One important specificity of agricultural activities is that input use and production levels

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result from decisions that farmers make only a few times within the course of a year. Once the level of

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fertilization or animal numbers have been decided, they are not subject to many changes before the next

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crop year. The situation is very different for the sectors currently covered by the ETS. For instance, in the

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electricity production sector–a major player in the current EU ETS–, the possibilities of substitution between

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gas, oil, and coal involve an arbitrage between the price of the various fossil fuels and the price of the carbon

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permit. The volatility in fossil fuel prices and in energy demand thus leads to frequent changes in the energy

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mix and in the resulting GHG emissions. The number of transactions, which is an important determinant of

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total trading costs, is thus likely to be much lower in agriculture than in the sectors currently covered by the

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ETS.

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Can transactions costs be reduced?. One way to reduce TC in agriculture, which is mentioned by Ancev,

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consists of consolidating farmers’ allowances and participation to the ETS through, for instance, industry

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associations. In effect, agriculture has the advantage over other non-ETS sectors (transport, residential) to

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have such structures already operating in the sector.

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Another way to reduce TC would be to set a minimum level of emissions for a farm to be included

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the ETS. This would be similar to the current design of the EU ETS, in which the smallest emitters are

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exempted from the cap-and-trade system. Given the distribution of per-farm emissions in the EU, this

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has the advantage of reducing the number of participants in the market (and the costs that depend on this

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number) substantially more than the total emissions included in the scheme. Such a scheme could be easily

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combined with the two alternative coverage options proposed by Ancev (voluntary opt-in and agricultural

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offset credits4 ), which could be offered to farmers below the minimum per-farm emission level. 4

Note that these two options, although they may enable the realization of some of the low-cost mitigation options, raise spe-

cific issues such as the possibility of windfall profits and the difficulty to demonstrate additionality, which could undermine costeffectiveness and increase verification costs.

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Conclusion

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Ancev concludes that the benefits of mandating agriculture in an ETS are low and do not compensate

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transaction costs. Our conclusions are diametrically opposed, at least in the European case for which we

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provide a quantitative assessment. Three major reasons explain this difference. First, our assessment relies

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on the full agricultural MAC curve derived from the meta-analysis by Vermont & De Cara (2010), rather

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than on a single (average) point on the same curve. This permits to better represent the substitution of high-

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cost abatement options in the sectors currently covered in the EU ETS by low-cost abatement options in

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agriculture upon the extension of the ETS scope. Second, our assessment considers the EU 2020 target for

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GHG emission reductions, which is significantly more stringent than what is reflected in the current carbon

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price on the EU ETS market. This strengthens the role that agriculture could play in the cost-effective

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mitigation mix. Third, once specificities of the agricultural sector and GHG emissions are accounted for,

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transaction costs in this sector may be lower than what is suggested by the extrapolation of results obtained

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for the sectors currently covered by the ETS.

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Cost-effectiveness will be key to meeting the ambitious objectives in terms of GHG reductions that are

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contemplated in the EU and in other countries. Beyond the choice of the economic instrument (price or

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quantity) best suited to agricultural emissions, our results underline that the gains permitted by flexibility

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across sectors should not be overlooked when considering the role of agriculture in the GHG mitigation

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policy mix.

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References

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Ancev, T. (2011). Policy Considerations for Mandating Agriculture in a Greenhouse Gas Emissions Trading

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Scheme. Applied Economic Perspectives and Policy. DOI: 10.1093/aepp/ppq031.

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Capros, P., Mantzos, L., Papandreou, V., & Tasios, N. (2008). Model-based Analysis of the 2008 EU Policy

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Package on Climate Change and Renewables. Report to DG Environment, E3MLab, National Technical

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University of Athens, Athens, Greece.

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European Environment Agency (2010). Interactive data viewer. Web site, European Environment Agency, Copenhagen, Denmark. http://dataservice.eea.europa.eu/PivotApp/. European Union (2011). EU budget on line. Line by line, Section III, European Commission, Brussels, Belgium. http://eur-lex.europa.eu/budget/data/LBL2011/EN/SEC03.pdf. Vermont, B. & De Cara, S. (2010). How costly is mitigation of non-CO2 greenhouse gas emissions from agriculture? A meta-analysis. Ecological Economics, 69(7), 1373–1386.

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Sector A

Sector E

Emission price (EUR/t CO2eq)

Marginal abatement cost (EUR/t CO2eq)

p0

p1

aA Abatement rate, α (% of the sector's base−year emissions)

aE

a^0

Abatement, a (MtCO2eq)

1.a. The agricultural sector (A) has no cost advantage

1.b. Yet, the extension of the ETS to sector A enables

over the sector currently covered by the ETS (E).

cost-savings (shaded) for the same total abatement aˆ 0 .

Figure 1: Marginal abatement costs in the sector currently covered by the ETS (solid line) and in agriculture (dashed).

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1500 1000 500 0

Cost−savings (MEUR)

0

10

20

30

40

50

v A (EUR/tCO2eq)

Figure 2: Cost-savings (before accounting for fixed transaction costs) vs variable transaction costs

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