Economy wide emission impacts of carbon and energy tax in electricity supply industry: A case study on Sri Lanka

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Abstract

This paper presents the results and analysis of a study conducted with the objective of investigating the impact on economy wide emissions due to carbon and energy taxes levied within the electricity generation sector of Sri Lanka. This exercise is mainly based on the input–output table developed by the national planning department. An input–output decomposition technique is used to analyze four types of effects that contribute to the overall reduction in equivalent carbon, NOx and SO2 emissions. These four effects are: fuel mix effect (i.e. the change in emissions due to variation I fuel mix), structural effect (i.e. change in emissions due to changes in technological coefficients with taxes compared to that without taxes), final demand effect (i.e. the change in emissions associated with changes in final demand) and joint effect (i.e. the interactive effect between or among the fuel mix, structural and final demand effects).

The polluting fuel sources and low energy efficiency generation technologies are less preferred under these tax regimes. Of the four effects, a change in fuel mix in thermal electricity generation and a change final demand for electricity were found to be the main contributors in achieving economy wide emission reductions. It was found in the analysis that a minimum of US$ 50/tC tax or US$ 1.0/MBtu of energy tax is required to have a significant impact on economy wide emissions in the Sri Lankan context. This translates into an overall increase in electricity generation cost of approximately USCts 0.9 kW−1 h−1 and USCts 0.6 kW−1 h−1 under the carbon and energy tax regimes, respectively. The reduction in emissions is also strongly coupled with the value of the price elasticity of electricity.

Introduction

Excessive CO2 (carbon dioxide) emission is a global problem calling for international coordinated actions. Therefore, to achieve a certain target for CO2 emissions requires creation of incentives to reduce CO2 emission by country and sector in a cost effective way.

Carbon and energy taxes have attracted attention and are commonly recognized as an economic instrument to achieve greenhouse gas (GHG) emission mitigation. Also, the GHG mitigation potentials of such policy measures are yet to be assessed in the case of most Asian countries. Therefore, it is imperative to assess the potential role of carbon and energy taxes for GHG and other harmful environmental emissions in Sri Lanka.

By levying tax on CO2 emissions and, thus, on the burning of fossil fuels, consumers are motivated to utilize energy more efficiently and to substitute away from the most CO2 intensive fuels in the power sector. Also, imposition of a tax leads to a cost effective allocation of CO2 emissions. The taxes, in addition to reducing GHG emissions, are the additional revenue generation that can be utilized to subsidize power generation using renewable energy sources.

The electricity generation system in Sri Lanka is gradually moving toward domination of thermal generation, mainly based on petroleum fuels and coal. This situation results in a gradual rise of GHG and other harmful environmental emissions in the power sector.

The objective of this study is to investigate the impact of a possible carbon tax or energy tax imposed on the electricity generation sector on the overall emission levels of the country.

After Leontief and Ford’s [1] introduction of the use of the input–output (I–O) model for computing pollutant emissions from energy consumption, Miller and Blair [2] extended the model to include multiplier effects and inter-industry activities. A few studies have used an input–output decomposition method in the energy sector. Out of those studies; Chang and Lin [3] and Marpaung [4] have done similar work. Chang and Lin have studied the variation of CO2 emissions in Taiwan from 1981 to 1991, and Marpaung’s work deals with emissions constraints and taxes in the Indonesian power sector. Both of these studies have found the final demand effect to be the largest contributor for emission reduction. Also, Rose and Chen [5], Chen and Wu [6], Han and Lakshmanan [7] and Labandeira and Labeaga [8] provide useful examples of applying input–output decomposition methods.

Section snippets

Methodology

The basic equation used in the input–output method [2] is the following:X=AX+Y,AX=IntermediateDemand,where ‘X’ is the vector of output of producing sectors in financial terms (US$) and ‘A’ is the matrix of technological coefficients while ‘Y’ contains the final demand in financial terms (US$) in each of those producing sectors∴X=(I-A)-1YandifL=(I-A)-1,X=LY,where ‘I’ is the identity matrix and ‘L’ is known as Leontief’s matrix.

If ‘C’ is the matrix of direct fuel requirement coefficients defined

Assumptions

Exports are treated as part of final demand and imports are ignored; this was also adopted by Gay and Proops [9] and Proops et al. [10]. Further, the change in electricity demand resulting from all economic feedbacks is not considered in this study. That is, multiplier effects are ignored. The study presented in the paper used the I–O table of 1994 in the absence of a later version.

The value of fuel used per unit output is assumed constant except for thermal electricity generation throughout

Existing generation capacity

Existing generation capacity consisted of all the grid connected power plants in the country. They amount to [11],

  • Hydropower – 1185 MW (large and small grid connected)

  • Thermal – 828 MW (diesel, steam, gas and combined cycle)

  • Wind – 3 MW (pilot wind farm established in 1999)

Candidate plants

All the candidate thermal and hydroplants considered by the Ceylon Electricity Board (CEB), Long term Generation Expansion Plan [11] were used. Demand forecasts were also based on the same reference [11].
Thermal

  • •

    Oil, coal and fuel

Results and analysis

Table 2 shows that when a carbon tax regime is in place within the Sri Lanka power sector, the economy wide reduction in emission becomes significant only for a tax above US$ 50/tC in the case of the carbon tax regime. This occurs due to two main reasons. One is due to the change in electricity price becoming significant only above this level of carbon tax to decrease the final demand, causing a drop in emissions. The second reason is that the tax is high enough to move the technology structure

Conclusions

From this case study, using an I–O decomposition analysis, it can be concluded that carbon taxes above $50/tC in the electricity sector cause a visible reduction in economy wide emissions at moderate values of the price elasticity of demand. This value is $1.0/MBtu in the case of energy taxes. However, it is important to note that the reduction in emissions is also strongly coupled with the value of price elasticity. Further, it is concluded that these figures are reflected in the final

Acknowledgements

This study was conducted jointly by the Sri Lanka Energy Managers Association, the University of Moratuwa and the Asian Institute of Technology, Thailand under ARRPEEC III funded by the Swedish International Development Corporation Agency (Sida). The authors are thankful to all these institutions for their valuable assistance in different forms.

Also, the assistance extended by Mr. Sudharshana Perera and Ms. Chethiyangani Kulatunga of the National Planning Department, Sri Lanka, and Mrs. Kamani

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