Canada’s Emissions Trends

Environment Canada
July 2011

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Annex 3:

Methodology for Development of Emissions Scenarios

The scenarios developed to support Environment Canada’s GHG emissions projections derive from a series of plausible assumptions regarding, among others, the level of continuing population and economic growth, prices, demand and supply of energy, and the evolution of energy efficiency technologies. The projections also assume no further government actions to address greenhouse gas emissions beyond those already in place or imminently pending as of November, 2010.

The emissions projections presented in this report cannot be viewed as a forecast or prediction of emissions at a future date. Rather, this report presents a simple projection of the current structure and policy context into the future, without attempting to account for the inevitable but as yet unknown changes that will occur in government policy, energy supply, demand and technology, or domestic and international economic and political events.

The emissions projections have been developed in line with generally recognized best practices. It incorporates IPCC standards for estimating greenhouse gas emissions across different fuels and processes, relies on outside expert views and the most up-to-date data available for key drivers such as economic growth, energy prices, and energy demand and supply, and applies an internationally recognized energy and macroeconomic modelling framework in the estimation of emissions and economic interactions. Finally, the projections and underlying assumptions have been subject to peer review by leading external experts on economic modelling and greenhouse gas emissions projections, as well as vetted with key stakeholders.

The approach to developing Environment Canada’s Emissions Trends involves three main features:

• Using the most up-to-date statistics on GHG emissions and energy use, and sourcing key assumptions from the best available public and private expert sources
• Developing scenarios of emissions projections using a detailed, proven Energy, Emissions and Economy Model for Canada
• Consulting with industry experts on detailed results, and engaging external experts for peer review of overall results and methodologies

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Up-to-date Data and Key Assumptions

Each year, Environment Canada updates its models using the most recent data available from Statistics Canada’s Report on Energy Supply-Demand and Environment Canada’s National Inventory Report. For these projections, the most recent historical data available were for 2008.

In addition to the most recent historical information, the projections are based on expert-derived expectations of key drivers (e.g. world oil price). These assumptions are based on the latest energy and economic data, with key modeling assumptions aligned to Government of Canada views:

• Economic growth from Finance Canada’s October 2010 Update of Economic and Fiscal Projections
• productivity growth projections estimated in consultation with Finance Canada officials,
• Statistics Canada’s population growth projections,
• National Energy Board and/or Natural Resources Canada’s (NRCan) views on energy prices and large scale energy projects).

Even with the benefit of external expert assumptions, there is considerable uncertainty surrounding energy price and economic growth assumptions, particularly over the medium- to long-term. As such, a range of emissions is presented representing a series of sensitivity analyses. These cases were based on high and low GDP growth as well as high and low oil prices and productions levels.

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Energy, Emissions and Economy Model for Canada

The projections presented in this chapter were generated from Environment Canada’s Energy, Emissions and Economy Model for Canada, also known as E3MC. This represents a departure from previous reports, which were based on projections developed by Natural Resources Canada. Although the modeling structure used to generate the emissions forecast is different, the methodological approach is similar.

E3MC has two components: Energy 2020, which incorporates Canada’s energy supply and demand structure, and The Informetrica Model (TIM), a macroeconomic model of the Canadian economy.

• Energy 2020 is an integrated, multi-region, multi-sector North American model that simulates the supply, price and demand for all fuels. The model can determine energy output and prices for each sector, both in regulated and unregulated markets. It simulates how such factors as energy prices and government measures affect the choices that consumers and businesses make when they buy and use energy. The model’s outputs include changes in energy use, energy prices, greenhouse gas emissions, investment costs and possible cost savings from measures, which are used to identify the direct effects stemming from greenhouse gas reduction measures. The resulting savings and investments from Energy 2020 are then used as inputs into TIM.
• The Infometrica Model is used to examine consumption, investment, production, and trade decisions in the whole economy. It captures the interaction among industries, as well as the implications for changes in producer prices, relative final prices, and income. It also factors in government fiscal balances, monetary flows, and interest and exchange rates. More specifically, TIM incorporates 133 industries at a provincial and territorial level. It also has an international component to account for exports and imports, covering about 100 commodities. The model projects the direct impacts on the economy's final demand, output, employment, price formation, and sectoral income that result from various policy choices. These, in turn, permit an estimation of the effect of climate change policy and related impacts on the national economy.

E3MC develops projections using a market-based approach to energy analysis. For each fuel and consuming sector, the model balances energy supply and demand, accounting for economic competition among the various energy sources. This ensures consistent results among the sectors and regions. The model can be operated in a forecasting mode or an analytical mode. In forecasting mode, the model generates an annual energy and emissions outlook to 2050. In analytical mode, it assesses broad policy options, specific programs or regulations, new technologies or other assumptions.

The model’s primary outputs are tables showing energy consumption, production and prices by fuel type, year and region. The model also identifies many of the key macroeconomic indicators (e.g., GDP or unemployment) and produces a coherent set of all greenhouse gas emissions (such as carbon dioxide, methane, and nitrous oxide) by sector and by province.

Figure A3.1 shows the general structure of E3MC. The component modules of E3MC represent the individual supply, demand, and conversion sectors of domestic energy markets and also include the macroeconomic module. In general, the modules interact through values representing the prices of the energy delivered to the consuming sectors and the quantities of end-use energy consumption.

Figure A3.1 Energy, emissions and economy model for Canada

Text Description for Figure A3.1

To develop this projection of energy use and related emissions, it was necessary to provide a view of the Canadian economy to 2020. The level and composition of energy supply and demand, and the resulting greenhouse gas emissions, are determined based on many assumptions that influence the overall size and growth rate of the economy.

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Treatment of Interaction Effects

Estimates of the net impact of government measures incorporated in the modelling scenarios need to take into account major interaction and behavioural affects. The analytical approach permitted by E3MC addresses these key modeling challenges, namely additionality, free ridership, rebound effects, and policy-interaction effects.

• Additionality. This issue relates to the question of what would have happened without the initiative in question. Problems of additionality arise when the stated emissions reductions do not reflect the difference in emissions between equivalent scenarios with and without the initiative in question. This will be the case if stated emissions reductions from an initiative have already been included in the reference case—emissions reductions will effectively be double-counted in the absence of appropriate adjustments. The E3MC model controls for additionality by basing its structure on incremental or marginal decision-making. The E3MC model assumes a specific energy efficiency or emission intensity profile at the sector and end-use point (e.g., space heating, lighting, or auxiliary power). Under the E3MC modeling philosophy, if the initiative in question were to increase the efficiency of a furnace, only the efficiency of a new furnace would be changed. The efficiency of older furnaces would not change unless those furnaces are retired and replaced with higher efficiency ones. As such, any change in the model is incremental to what is reflected in the business-as-usual assumptions.
• Free ridership. A related problem, free ridership, arises when stated reductions include the results of behaviour that would happen regardless of the policy. This can occur when subsidies are paid to all purchasers of an item (e.g., a high efficiency furnace), regardless of whether they purchased the item because of the subsidy. Those who would have purchased the product regardless are termed free riders. In the E3MC model, the behaviour of free riders has already been accounted for in the reference case. Thus their emissions are not counted toward the impact of the policy. Instead, the E3MC model counts only the incremental take-up of the emissions-reducing technology.
• The rebound effect. This describes the increased use of a more efficient product resulting from the implied decrease in the price of its use. For example, a more efficient car is cheaper to drive and so people may drive more. Emissions reductions will generally be overestimated by between 5 per cent and 20 per cent unless estimates account for increased consumption because of the rebound effect. Within the model, we have mechanisms for fuel choice, process efficiency, device efficiency, short-term budget constraints, and cogeneration, which all react to changes in energy and emissions costs in different timeframes.²⁴ All these structures work to simulate the rebound effect—in the example above, the impact of extra kilometres that may be driven as a result of improved fuel efficiency are automatically netted out of the associated emissions reduction estimates.
• Policy interaction effects. This describes impacts on the overall effectiveness of Canada’s emissions-reduction measures when they interact with each other. A policy package containing more than one measure or policy would ideally take into account this impact to understand the true contribution that the policy package is making (in this case, to emission reductions).

E3MC is a comprehensive and integrated model focusing on the interactions between sectors and policies. In the demand sectors, the fuel choice, process efficiency, device efficiency, and level of self-generation are all integrally combined in a consistent manner. The model has detailed equations to ensure that all the interactions between these structures are simulated with no loss of energy or efficiency. For example, the electric generation sector responds to the demand for electricity from the energy demand sectors, so any policy to reduce electricity demand in the consumer sectors will impact the electricity generation sector. The model accounts for emissions in the electricity generation sector as well as for emissions in the consumer demand sectors. As the electricity sector reduces its emissions intensity, policies designed to reduce electricity demand in the consumer sectors will cause less of an emissions reduction. The natural gas and oil supply sectors similarly respond to the demands from the consumer sectors, including the demands for refined petroleum products for transportation. The model also simulates the export of products by supply sectors.

Taken as a whole, the E3MC model provides a detailed representation of technologies that produce goods and services throughout the economy and can simulate, in a realistic way, capital stock turnover and choices among technologies. The model also includes a representation of equilibrium feedbacks, such that supply and demand for goods and services adjust to reflect policy. Given its comprehensiveness, E3MC covers all the greenhouse gas emissions sources, including those unrelated to energy use.

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Simulation of capital stock turnover

As a technology vintage model, E3MC tracks the evolution of capital stocks over time through retirements, retrofits, and new purchases, in which consumers and businesses make sequential acquisitions with limited foresight about the future. This is particularly important for understanding the implications of alternative time paths for emissions reductions.

The model calculates energy costs (and emissions) for each energy service in the economy, such as heated commercial floor space or person-kilometre traveled. In each period, capital stocks are retired according to an age-dependent function (although the retrofitting of unretired stocks is possible, if warranted by changing economic conditions). Demand for new stocks grows or declines depending on the initial exogenous forecast of economic output (i.e., a forecast that is external to the model and not explained by it) and the subsequent interplay of energy supply–demand with the macroeconomic module. A model simulation iterates between energy supply–demand and the macroeconomic module until there is a convergence. The global convergence criterion is set at 0.1 per cent between iterations. This convergence procedure is repeated for each year over the simulation period.

The E3MC model simulates the competition of technologies at each energy service node in the economy based on a comparison of their cost and some technology-specific controls, such as a maximum market share limit in cases where a technology is constrained by physical, technical, or regulatory means from capturing all of a market. The technology choice simulation reflects the financial costs as well as the consumer and business preferences, revealed by real-world technology acquisition behaviour.

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Model Limitations

While E3MC is a sophisticated analytical tool, no model can fully capture the complicated interactions associated with given policy measures between and within markets or between firms and consumers. Unlike computable general equilibrium models, however, the E3MC model does not fully equilibrate government budgets and the markets for employment and investment. That is, the modeling results reflect rigidities such as unemployment and government surpluses and deficits. Furthermore, the model, as used by Environment Canada, does not generate changes in nominal interest rates and exchange rates, as would occur under a monetary policy response to a major economic event.

 

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²⁴ A shift in energy prices will cause cogeneration to shift in the short to medium term, device efficiency to adjust over the short to mid-term, process efficiency to adjust in the mid term, and fuel choice to react in the mid- to long-term. The actual adjustment times depend on the particular sector.

 

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