Working Paper Series,
Swedish University of Agricultural Sciences, Department Economics

Abstract: This paper applies the replacement cost method for calculating the value of stochastic carbon sequestration in the EU climate policy for mitigating carbon dioxide emissions. Minimum costs with and without carbon sequestrations are then derived with a safety-first approach in a chance-constrained framework for two different scenarios; one with the current system for emission trading in combination with national allocation plans and one with a hypothetical system where all sectors trade. The theoretical results show that i) the value of carbon sequestration approaches zero for a high enough risk discount, ii) relatively low abatement cost in the trading sector curbs supply of permits on the ETS market, and iii) large abatement costs in the trading sector create values from carbon sequestration for meeting national targets. The empirical application to the EU commitment of 20% reduction in carbon dioxide emissions shows large variation in carbon sequestration value depending on risk discount and on institutional set up. Under no uncertainty, the value can correspond to approximately 0.45% of total GDP in EU under current policy system, but it is reduced to one third if all sectors are allowed to trade. The value declines drastically under conditions of uncertainty and approaches zero for high probabilities in achieving targets. The allocation of value among countries depends on scenario; under the current system countries make gains from reduced costs of meeting national targets, under a sector-wide trading scheme buyers of permits gain from reductions in permit price and sellers make associated losses.

Keywords: carbon sequestration value; replacement cost method; uncertainty; safety-first; chance-constrained programming; EU emission target

JEL-codes: C61; D81; Q40; Q48; Q50

42 pages, February 18, 2013

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