7.0 What were the findings of the analysis?

The key findings presented below are from section 6.0 of the full report on quantitative assessment.

The cost-effectiveness analysis provides a number of insights that are useful to reaching conclusions on the relative merits of using economic instruments compared with regulation:

1. In the regulatory scenario, the objective of 1-percent sulphur by weight in HFO was significantly exceeded under both the real-time limit (140 percent of the policy objective) and the averaging limit (113 percent of the policy objective). This was due to fuel switching (in particular, the replacement of HFO with NG) by facilities, as well as to adoption of flue gas desulphurization (installation of abatement equipment) by refiners. Both switching to NG and the use of abatement equipment result in large reductions (99 percent and 90 percent in SO₂ emissions respectively) that exceed the policy objective. This overcompliance may result in higher compliance costs than is justified by the policy objective.
   
2. Investigation of the ACCA demonstrated limited savings to industry relative to overall compliance costs. Thus, the ACCA alone would not provide sufficient incentive to industry to invest in technology (e.g., abatement equipment) to reduce sulphur emissions from HFO use. However, the ACCA is capable of lessening the financial impact of increased tax or regulation. The ACCA may also help to address unequal regional impacts.
   
3. The combination of increased product tax with emissions reduction rebate may result in more uncertainty in achieving the policy objective compared with the regulatory scenario. This is due in part to the significant uncertainty that exists in demand elasticity, which is key to setting a tax rate that achieves the policy objective. If the demand elasticity is too high, then the tax increase will not be sufficient to trigger reductions in the demand for HFO sufficient to achieve the policy objective. Conversely, a demand elasticity that is too low will result in a tax rate that is high and in overshooting the policy objective. In turn, exceeding the policy objective results in higher compliance costs relative to the costs of the policy objective However, the tax can be used flexibly to achieve the desired policy objective, mitigate the inherent uncertainty in the tax instrument and reduce unnecessary compliance costs.
   
4. In the modelling, a tax schedule (function) was estimated as the basis of a national tax rate to achieve the objective of 1-percent sulphur by weight in HFO. Given the ability to alter the tax rate to affect the policy outcome, the tax schedule can be modified in response to observations about the effectiveness of the tax-rebate combination. Flexibility in the tax schedule allows for flexibility in the tax-rebate scenario — that is, the tax schedule can be altered over time if response to the tax measures overachieves or underachieves the desired 1-percent objective. Furthermore, the tax-rebate scenario also allows firms flexibility. They can pay tax and do nothing to reduce emissions or they can avoid the tax burden by investing in pollution abatement equipment at a more opportune time.
   
5. In the tax-rebate scenario, adjusting the tax rate can shift sulphur emissions from HFO use closer to the 1-percent objective; however, the effectiveness of this option is constrained by the price differential between LS HFO and HFO — the higher the price differential, the greater the ability for the tax to be used to offset compliance costs and more closely achieve the policy objective. In the model, the low assumed price differential resulted in an outcome for the tax-rebate scenario that was identical to the outcome for the regulatory scenario.
   
6. Without a rebate mechanism, the tax-alone option (e.g., just a tax on HFO or a tax on emissions for refiners is only slightly less cost-effective than the regulatory option, since firms are faced with both a tax increase on the HFO they continue to burn and fuel switching/abatement equipment costs. Emissions are not reduced as much relative to the regulatory base case or the tax-rebate option. Thus, the tax-rebate option is preferable to the tax-alone option.
   
7. Refiners present a special case and should be accommodated within the tax-rebate scenario. Since the cost of residual fuel oil is lower for refiners who generate the fuel as a by-product of the refining process, special consideration is required for refiners. Specifically, the tax instrument must determine the price point for changing behaviour (i.e., investing in abatement equipment) to provide an incentive to reduce emissions rather than just pay the tax and continue to burn residual fuel oil.
   
8. A note on elasticities: the literature indicates that demand responses to changes in fuel oil prices in the residential sector are greater with price increases and smaller with price decreases. As prices (taxes) increase, investments in abatement equipment or boiler conversions are made in response to the price increase. However, as prices drop, the investments and gains have already been made and cannot be reversed. Thus, the demand response to a subsequent price decrease may be less (i.e., the demand elasticity is smaller for a price drop than for a price increase). In applying this observation to our scenarios, an understanding of this differentiation in demand elasticities would be important to facilities that would be making capital investments; however, it would not apply to facilities that retain the ability to fuel switch between HFO and NG.
   
9. The implication of this observation is that tax rates should not be set high initially if there is uncertainty in the demand response, since subsequent downward adjustments may not erase economic inefficiencies resulting from the high tax rate. Instead, taxes should be phased-up and demand responses observed. Tax increases can then be used to achieve the policy objective and minimize compliance costs.
   
10. A product tax may be faster to implement than a regulation. Results in Europe have shown that a sulphur tax can achieve the environmental target within a relatively short time.
    
11. This analysis has shown that emissions trading may be cost-effective relative to taxes and regulations, and may allow maximum flexibility to achieve the environmental target. However, results from other jurisdictions suggest the need to further examine transaction costs and the capacity to develop regional markets before deciding on the feasibility of an emissions trading program for HFO.
    
12. The flexibility inherent in the tax-rebate and emissions trading scenarios also provide for a more measured response by industry in the event that regulators wish to achieve more stringent policy objectives in the future.

Next: 8.0 What can be concluded from these findings?