1)the economic impact of strengthening fuel quality regulation—reducing sulfur content in diesel...

8/12/2019 1)the Economic Impact of Strengthening Fuel Quality RegulationReducing Sulfur Content in Diesel Fuel

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Energy Policy 34 (2006) 25722585

The economic impact of strengthening fuel quality

regulationreducing sulfur content in diesel fuel

H.J. Changa,, G.L. Chob, Y.D. Kimc

aSejong University, 98 Gunja-dong, Gwangjin-gu, Seoul, KoreabNational Assembly Budget Office, 27-1 Yeouido-dong, Yeongdeungpo-gu, Seoul, Korea

cPusan National University, 30 Jangjeon-dong, Geumjeong-gu, Busan, Korea

Available online 9 June 2005

Abstract

This paper investigates the impact of strengthening vehicle emission regulation on economic activities. The government attempts

to use three regulation measures to protect air quality from transportation emission. The measures include the aggregate limit

(bubbles), the vehicle emission standard, and the fuel quality standard. Especially, we focus on the economic impact of reducing

sulfur content in diesel fuel quality standard. Sulfur content in diesel fuel is one of the main factors in worsening local air quality.

The emission from diesel vehicle accounts for 51.8% of total vehicle emission in Korea. If sulfur content reduction regulation is

implemented, then the petroleum industry should build more facility to produce low sulfur content diesel, leading to additional

production costs and increasing prices and decreasing outputs. We use computable general equilibrium model to analyze how the

sulfur reduction regulation affects economic activities and trace out local emission reduction cost and GDP loss. And we suggest the

tax-recycling mechanism to mitigate the negative economic costs due to the sulfur reduction regulation.

r 2004 Published by Elsevier Ltd.

Keywords: Transportation; Regulation on fuel quality and emission

1. Introduction

In Korea, local pollution from the transportation

sector is increasing and threatening peoples health and

welfare. Especially, cars and trucks using diesel fuel are

thought as a cause of worsening air quality. According

to air pollution emission published by Ministry of

Environment (1999), the emission from the transporta-

tion sector takes 55.8% of total emission and diesel fuel

is responsible for 51.8% of the transportation emission.In order to improve air quality and welfare, reduction of

emission from the transportation sector, especially diesel

fuel, is necessary.

The Korean government has attempted to reduce

local emission, trying to use some measures to reduce

local emission in the transportation sector. Strengthen-

ing emission standard for vehicles and fuel quality

standard are considered as an efficient policy tool.

However, strengthening regulation on fuel quality

requires additional investments for refining facility,

additional production costs, and finally increases in fuel

prices in petroleum and automobile industry. In turn,

such increases in costs and prices may cause sluggishnessin economic growth and advance in the price level.

In this paper, we ask some questions about how we

can minimize the adverse economic impact from the

regulation enforcement to obtain the environmental

target and who can pay the costs. And we attempt to

provide some answers to the above questions. In this

sense, we investigate the impact of strengthening fuel

quality standard on the economic activities and measure

the overall economic costs incurred over the various

ARTICLE IN PRESS

www.elsevier.com/locate/enpol

0301-4215/$ - see front matterr 2004 Published by Elsevier Ltd.

doi:10.1016/j.enpol.2004.08.017

Corresponding author.

E-mail addresses: [email protected] (H.J. Chang),

[email protected] (G.L. Cho), [email protected] (Y.D. Kim).
http://www.elsevier.com/locate/enpolhttp://www.elsevier.com/locate/enpol


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regulation scenarios. Then we suggest some plausible

measures minimizing economic costs incurred from

enforcing the regulation on fuel quality.

In Section 2, we explain computable general equili-

brium (CGE) model for economic impact of strengthen-

ing fuel quality standard. Section 3 explains the results

and introduces some measures for economic costminimization. Section 4 gives concluding remarks.

2. The model of transportation fuel and environmental

regulation

The propriety of environmental taxation and regula-

tions has been agreed widely on the air pollution. Not

only Korea but also most of industrialized countries try

to improve the air quality along with total emission

control and enforcement regulation on industrial

activities such as tightening vehicle emission standard

and improving fuel quality.

There are lively discussions on the Sustainable

Development saying to pursue both continuous eco-

nomic growth and clean environment for the future

generations. In this point, the environmental improve-

ment and economic growth is not a matter of choice but

of a compulsory policy objective to carry out together.

But in case that the government regulation leads to any

distortion on investment, it may cause social loss such as

rising prices and weakening industrial competitiveness.

In this context, we also recognize the importance of

minimizing adverse effects.

This study aims to analyze the economic benefit andcost of environmental regulations on fuel quality control

and vehicle emission standard and, in the end, to find

the efficient way to achieve satisfactory environmental

quality. To evaluate the policies and suggest the

appropriate policy options, we develop the dynamic

CGE model, taking the backward and forward linkage

effect among industries into consideration.

Carbon monoxide (CO), hydrocarbon (HC), nitrogen

oxide (NOx

) and particulate matter (PM) are the target

pollutants to analyze, which are currently the regulated

air pollutants of vehicle emission. It is analyzed for the

period from 2001 to 2012 toward oil industries,

transportation industries, service industries and car

industries. The oil products include gasoline, diesel,

LPG, other oil products and alternative fuel (50 ppm

diesel, 15 ppm diesel). We classify the transportation

industry according to the emission pattern of the fuel

and vehicle type. The vehicle includes passenger car, van

and truck, also as gasoline, diesel and LPG car by the

fuel, and classified further as small, medium and large

car by the volume of a car. The detailed division is good,

in the sense that it makes possible the analysis of the

substitution effect among the conventional cars and

from conventional cars to new cars.

Therefore, this model has an advantage to consider

the various linkage effects over the national economy, as

well as the substitution effect of vehicles from the

government regulation (Table 1).

2.1. Data and model structure

2.1.1. Data

Fuel consumption for transportation use1

The gasoline consumption is estimated to be

10,090 kl, diesel 15,153 kl and LPG 6022 kl in 2001.2

The average fuel price of 2001 is applied as 1280 won

for gasoline, 645 won for diesel and 440 won for

LPG. The consumption expenditure for transporta-

tion fuel amounts to 12,916 billion won for gasoline,

9773 billion won for diesel, 2649 billion won for LPG

(Table 2).

Number of registered vehiclesThe total number of registered vehicles in 2001 is 12

million and new vehicles hold about 10%. Gasoline

vehicles take up 60%, diesel vehicles about 32% and

LPG about 8%. The share of diesel and LPG vehicles

rises in new vehicles in 2001 as 42% for diesel and

18% for LPG vehicles, due to the low fuel price and

benefits on tax deduction (Table 3).

Environmental pollution of transportation sectorThe amount of air pollution by vehicles is estimated

with the estimating method of moving emission

source by the Ministry of Environment in Table 4

Emissionton=yr number of registered carnumber

mileage by vehicle typekm=a car day

emission coefficientg=km

365 day=yr 0:0000001ton=g:

2.1.2. The model structure

2.1.2.1. The basic features. The CGE model we

applied has an interrelated structure among production,

consumption and government sectors so that it is good

at explaining the linkage effect of a policy change in the

other sectors. The production sector is assumed to try to

maximize profit with labor, capital, energy and inter-

mediate goods. The consumption sector uses its income

from labor income and capital revenue as saving and

expenditure to maximize its utility. The government

sector has tax revenue from production and consump-

tion activities and spends it for government expenditure

ARTICLE IN PRESS

1Hereafter, the fuel indicates the fuel for transportation use.2They are somewhat different from the real data in the Monthly

Energy statistics, however, for the consistency of data, we use the

estimated fuel consumption data which are obtained from the number

of registered car, mileage and fuel consumption ratio.

H.J. Chang et al. / Energy Policy 34 (2006) 25722585 2573


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and household transfer. The export and import goods

make domestic final consumption goods with competi-

tion in international trade. The export and import are

controlled by exchange rate.

The CGE model focuses on deriving the equilibrium

price of demand and supply, with regards to the

producers profit maximization and consumers utility

maximization. Therefore, the policy variance in a

specific field intrinsically affects the overall economy of

consumer, producer and international trade. For in-

stance, the regulation on sulfuric fuel affects the

production cost of fuel and price of output products.

At first the oil refinery industry is affected, then the

transportation service industry, car industries and the

household in the end. The variance in other industries

and consumption sector continues to affect the oil

refinery industry again as a circular reaction.

The air pollution regulation may affect the market

with the following procedure. Once a government sets

the total amount of emission permit and chooses

environmental tax or emission trade as a policy

instrument, a consumer encounters a condition to

choose buying a new car satisfying the environmental

regulation or keeping a conventional car with some

additional payment (environmental tax or emission

permit purchase). If the additional payment is big

enough to cover up the expense for the new car, then

the regulation will cause more new cars to be

introduced.

Our model classifies a car in detail by vehicle type, fuel

type and volume. Furthermore, it takes into considera-

tion the substitution effect not only among conventional

cars, but also between conventional cars and new cars

which satisfy the EURO4 standard.

ARTICLE IN PRESS

Table 1

Industries in model

Oil industry Gasoline

Tran spo rt i ndu stry Di ese l

LPG for transportation

Other oil products

Alternative fuel

Alternative fuel vehicle 430 ppm sulfuric fuel (diesel)

80 ppm sulfuric fuel



Car industry Passenger car Gasoline Small and medium Below 2000 cc

Large Above 2001 cc

Diesel Small and medium Below 2000 cc

Large Above 2001 cc

LPG Small and medium Below 2000 cc

Large Above 2001 cc

Van Gasoline Small and medium Less than 710 passengers

Large BusDiesel Small and medium Less than 710 passengers

Large Bus

LPG Small and medium Less than 710 passengers

Large Bus

Truck Gasoline Small and medium Below 5 ton

Large Above 6 ton

Diesel Small and medium Below 5 ton

Large Above 6 ton

LPG Small and medium Below 5 ton

Large Above 6 ton

Other industry

Table 2

Fuel consumption for transportation use (2001)

Gasoline Diesel LPG

Consumption (1000 kl) 10,090 15,153 6022

Price (won/L) 1280 645 440

Consumption (billion won) 12,916 9773 2649

Source: Korea Energy and Economics Institute (2002).

H.J. Chang et al. / Energy Policy 34 (2006) 257225852574


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However, the new car and cleaner fuel would

generate the additional production cost such as

R&D and capital investment, which probably cause

the increase of car and fuel price and, furthermore,

the output price which use them as intermediate

goods. Therefore, the strong environmental regula-

tion may induce the positive effect of better environ-

ment but at the same time, the negative effect of

weakening industrial competitiveness and price increases

(Fig. 1).

2.1.2.2. The sectors in the model structure

ConsumerIt is a good feature of our model that classifies

the vehicles in detail and makes consumers choose

ARTICLE IN PRESS

Table 3

Number of registered vehicles in 2001

New vehicle Conventional vehicle Total

Small and medium Large Small and medium Large

Passenger car Gasoline 490,773 85,047 6,820,624 206,200 7,602,644

Diesel 72,967 148,588 2976 455,960 680,491LPG 225,224 16,141 748,950 130,580 1,120,895

Van Gasoline

Diesel 51,816 6770 765,366 65,972 889,924

LPG

Truck Gasoline

Diesel 305,432 4153 2,148,631 55,406 2,513,622

LPG

Total 1,146,212 260,699 10,486,547 914,118 12,807,578

Source: Number of registered car 2001, Korea Automobile Manufacturers Association, Korea.

Note: The gasoline and LPG van and trucks are combined as a passenger car for the convenience of analysis, since their numbers are insignificant.

Table 4

Emission by vehicle type in 2001 (unit: ton/yr)

CO HC NOx

PM Total

Passenger car Small and medium Gasoline 300,598 (2.56) 50,491 (0.43) 52,839 (0.45) (0.00) 403,928

Diesel 3028 (1.66) 1149 (0.63) 2699 (1.48) 1131 (0.62) 8007

LPG 307,557 (6.36) 37,236 (0.77) 40,621 (0.84) (0.00) 385,413

Large Gasoline 11,974 (2.56) 2011 (0.43) 2105 (0.45) (0.00) 16,090

Diesel 144,759 (9.97) 19,456 (1.34) 172,781 (11.9) 28,022 (1.98) 365,018

LPG 48,321 (6.36) 5608 (0.77) 6118 (0.84) (0.00) 58,047

Van Small and medium Gasoline (6.21) (0.5) (1.43) (0.00) Diesel 44,166 (1.66) 16,762 (0.63) 39,377 (1.48) 16,496 (0.62) 116,800

LPG (6.17) (0.75) (0.82) (0.00)

Large Gasoline

Diesel 79,414 (9.97) 10,673 (1.34) 94,786 (11.9) 15,373 (1.93) 200,248

LPG

Truck Small and medium Gasoline (6.21) (0.5) (1.43) (0.00)

Diesel 132,633 (1.66) 50,337 (0.65) 118,251 (1.48) 49,538 (0.62) 350,758

LPG (6.17) (0.75) (0.82) (0.00)

Large Gasoline

Diesel 39,078 (12.00) 4624 (1.42) 39,795 (12.22) 6448 (1.98) 89,945

LPG

Total 1,109,527 198,347 569,372 117,007 1,994,254

Source: Air pollution emission, 1999, Ministry of Environment.

Note: Number in ( ) indicates the emission coefficient by vehicle type.



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either new car or conventional car, so that it is

possible to analyze the substitution effect comprehen-

sively. With the introduction of environmental tax or

emission trading, consumers face the following

choices:J Purchase a new car (substitution between vehicle

type) and sell the emission right.J Shorten the mileage with an existing car (decrease

of transportation service demand) and sell the

emission right after reducing the consumption of

transportation service.J Purchase emission right or pay the environmental

tax without changing the consumption style

(increase of environmental cost).

Consumers choose one of the four options to

maximize their utility under the budget constraint.

A few details are assumed to reflect the consumers

choice in the model.

J The transportation service is interpreted as mileage

and consumers pay the fee by mileage.J The transportation service is composed of passen-

ger car service, van service and truck service with

the elasticity of substitution of 0.25.J Each service is formed with the identical composi-

tion. For instance, the passenger car service

has gasoline car service, diesel car service and

LPG car service with the elasticity of substitution

of 0.25.J The passenger car service has two sizes with the

elasticity of substitution of 0.25: small and medium

vehicle, large vehicle.J The fuel consumption ratio per km and emission

are fixed by vehicle size with 0 elasticity of

substitution. This assumption implies no substitu-

tion among pollutants, that is, it is not possible to

emit more of a pollutant and less of another one.

ARTICLE IN PRESS

Oil Product marketil Product marketTransportation fuel: Gasoline,

Diesel, LPG

Non-transportation fuel: Other oil

products

Low sulfuric fuelow sulfuric fuel the fuel with low sulfuric

concentration

low economic efficiency at present

be introduced with environmental

regulation in the future

Total Emission Controlotal Emission Control& Emission TradingEmission Trading

New Vehicle Market

by fuel: Diesel car,

Gasoline car, LPG car,

bus and t ruck

by vehicle volume:

Small&medium car,

Large Car

Future Vehicle

The new vehicle which

is not in the market but

will be introduced with

stricter environmental

regulation in the future

Old Vehicle Market

The number of

vehicles(t) =

old car(t-1)

- retired car(t-1)

+ new vehicles(t)

Fig. 1.



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Production sectorProducers aim to maximize their profit in producing

the output with factor input (labor, capital, energy)

and intermediate goods.

Government sectorGovernment has the revenue from income tax on

labor and capital, consumption tax on commodity

consumption, tariff on imported goods and environ-mental tax or emission permit upon environmental

regulation scenarios. On the other hand, the govern-

ment expenditure includes government consumption,

household transfer and subsidy (for an alternative

energy scenario) (Fig. 2).

2.2. Environmental regulation and fuel control

2.2.1. Total emission control

We apply Emission Trading system to achieve the

total emission control. The level of permitted emission is

set at the year 2007 level which is estimated with

EURO4&ULEV emission coefficient. The emission level

of business as usual (BAU) scenario by vehicle type, the

permitted emission level and abatement amount are

shown in Tables 510. CO is permitted to emit by

396,000 ton, HC 83,000 ton, NOx

124,000 ton and PM

10,000 ton annually from 2007. Therefore, the abate-

ment amount is 1,091,000 ton of CO, 182,000 ton of HC,

639,000 ton of NOx

, 147,000 ton of PM in 2007,

compared to the BAU scenario. The amount of emission

abatement is supposed to consistently increase by 2012.

The EURO4&ULEV emission coefficient is indicated in

Table 11. ULEV is applied to gasoline and LPG cars

and EURO4 to diesel cars.

2.2.2. Vehicle emission and fuel quality regulations

Vehicle emission regulation

We assume to put in effect the vehicle regulation andfuel regulation with the total emission control. Under

the vehicle regulations, diesel cars with EURO4 level

are gradually introduced from 2007 and replace the

conventional cars by 1/7 annually. There may be 910

billion won of additional investment cost to develop

cars with EURO4 level (Table 12)3.

Fuel regulationThe fuel regulations have three scenarios to supply

low sulfuric fuel (current 430 ppm) from 2007J Instant switch to 50 ppm from 2007.J Instant switch to 15 ppm from 2007.J Gradual switch to 50 ppm from 2007 to 2009 and

to 15 ppm from 2010.

The Association of Oil Industry presumes that the

initial investment cost to produce the low sulfuric fuel

amounts to 824, 3965 and 3141 billion wons for the

three scenarios. The cost of the third scenario is derived

from the difference of the other two scenarios. In spite

of the initial investment, additional investment is

necessary as suggested in Table 13, regarding the

depreciation rate (0.06) and economic growth rate

(0.05).

The National Environment Institute suggests that not

only the new vehicles but the conventional vehicles emitmuch less when they use the low sulfuric fuel. The new

vehicles are assumed to emit at the same level of

EURO4 with 50 ppm diesel and less than the EURO4

level with 15 ppm diesel. The ratio of emission abate-

ment is shown in Tables 14 and 15 by vehicle type.

3. The result of analysis

3.1. The economic impact

3.1.1. The permit price of pollutantIt is our objective to fix the total emission level from

2007 with introducing new vehicles and low sulfuric fuel

through Emission Trading. The price of permit may

take a main role to affect the consumers choice and

market. Table 16 shows the change of permit price,

according to the three scenarios of fuel regulation.

In Table 16, we can see the permit prices of all the

pollutants are positive. Consumers have to choose

among pollutants by choosing between gasoline and

ARTICLE IN PRESS

Utility

Transportation Service (km) Other goods and service

Van Passenger car Truck

Gasolince Vehicle Diesel Vehicle LPG Vehicle

Small& Medium Large New Vehicles

fuel& mileage CO HC NOx PM

Fig. 2. Consumer choice.

3There are not yet any official data about additional investment cost

for developing diesel vehicle with EURO4 standard.



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diesel cars and by reducing their transportation service.

If consumers with a diesel car like to reduce a specific

pollutant like NOx

or PM, then they have to choose an

option: use the existing diesel car and purchase permit of

the pollutant or purchasing a gasoline car which emits

less pollutant than the existing diesel car. It is because

the emission coefficients of gasoline car differ from those

of diesel car. In this situation, all the permit prices can

be positive.

In the first scenario of fuel regulation, instant switch

to 50 ppm of sulfuric fuel, the permit price may be about

808.5 thousand won for CO, 1177.1 thousand won for

HC, 1266.1 thousand won for NOx

, and 1942.6

thousand won for PM in 2007. As the introduction of

new vehicles, the permit price will gradually decrease to

489.3 thousand won for CO, 871.7 thousand won for

HC, 1040.7 thousand won for NOx

and 1383.8 thousand

won for PM in 2012. Since new vehicles emit

less pollution than the conventional vehicles, consumers

will face the decision of buying more expensive new

car or keeping the conventional car with the environ-

mental expenditure. The more new vehicles, the less

demand for the emission permit, then the permit price

decreases.

ARTICLE IN PRESS

Table 5

Permitted emission and abatement by vehicle type (2007)

BAU Amount with permits Abatement amount

CO HC NOx

PM CO HC NOx

PM CO HC NOx

PM

Passenger car Gasoline Small 402.8 67.7 70.8 0.0 166.8 0.8 4.9 0.0 236.0 66.9 65.9 0.0

Large 16.0 2.7 2.8 0.0 6.6 0.0 0.2 0.0 9.4 2.7 2.6 0.0Diesel Small 4.1 1.5 3.6 1.5 1.2 0.7 0.6 0.1 2.8 0.8 3.0 1.5

Large 194.0 26.1 231.5 37.6 14.4 9.0 7.6 1.2 179.6 17.1 224.0 36.4

LPG Small 412.2 49.9 54.4 0.0 68.7 0.3 2.0 0.0 343.5 49.6 52.4 0.0

Large 62.1 7.5 8.2 0.0 10.3 0.0 0.3 0.0 51.7 7.5 7.9 0.0

Van Diesel Small 59.2 22.5 52.8 22.1 26.4 16.4 13.9 2.1 32.8 6.1 38.9 20.0

Large 106.4 14.3 127.0 20.6 16.0 4.9 37.4 0.2 90.4 9.4 89.7 20.4

Truck Diesel Small 177.7 67.5 158.5 66.4 79.2 49.3 41.8 6.4 98.5 18.2 1 16.7 60.0

Large 52.4 6.2 53.3 8.6 6.5 2.0 15.3 0.1 45.8 4.2 38.1 8.6

Total 1486.9 265.8 763.0 156.8 396.3 83.4 123.9 10.1 1090.6 182.4 639.1 146.7

Note: The amount with permits is the amount that, the model predicts, each type will emit, given the overall limits at the bottom of table.

Table 6



CO HC NOx

PM CO HC NOx

PM CO HC NOx

PM


Large 16.8 2.8 3.0 0.0 6.6 0.0 0.2 0.0 10.2 2.8 2.8 0.0

Diesel Small 4.3 1.6 3.8 1.6 1.2 0.7 0.6 0.1 3.0 0.9 3.2 1.5

Large 203.7 27.4 243.1 39.4 14.4 9.0 7.6 1.2 189.3 18.4 235.5 38.3

LPG Small 432.8 52.4 57.2 0.0 68.7 0.3 2.0 0.0 364.1 52.1 55.1 0.0

Large 65.2 7.9 8.6 0.0 10.3 0.0 0.3 0.0 54.8 7.8 8.3 0.0

Van Diesel Small 62.1 23.6 55.4 23.2 26.4 16.4 13.9 2.1 35.8 7.2 41.5 21.1

Large 111.7 15.0 133.4 21.6 16.0 4.9 37.4 0.2 95.7 10.1 96.0 21.4

Truck Diesel Small 186.6 70.8 166.4 69.7 79.2 49.3 41.8 6.4 107.4 21.6 124.6 63.3

Large 55.0 6.5 56.0 9.1 6.5 2.0 15.3 0.1 48.4 4.5 40.7 9.0

Total 1561.2 279.1 1561.2 279.1 801.2 164.6 396.3 83.4 123.9 10.1 1164.9 195.7




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The permit prices of pollutants become lower in use of

15 ppm sulfuric fuel than that of 50 ppm during the

studied period. Consumers with 15 ppm diesel like to

demand new cars more than with 50 ppm diesel. Since

new cars emit pollutants less than existing cars,

consumers with 15 ppm diesel will purchase less permits

of pollutants than with 50 ppm diesel. Then permit

prices with 15 ppm diesel will be lower than with 50 ppm

diesel.

The permit prices of the gradual switch are lower than

the instant switch to 15 ppm, which may be caused by

the low adjustment cost from policy-forecasting effect.

Therefore, if it is intended to tighten the fuel regulation,

it would be better to switch gradually to minimize the

adverse effect of instant switch.

Han (2000) suggested the social cost of air pollutant

as follows. The unit social cost of each pollutant may

provide intuition as to how much benefit can occur with

the fuel regulation in this study (Table 17).

3.1.2. Total abatement cost

The permit price can be interpreted as the abatement

cost of a pollutant which is paid by a company to

achieve the total emission control standard. Therefore,

the total abatement cost is the permit price of

Table 16 times the amount of abatement to satisfy the

ARTICLE IN PRESS

Table 7



CO HC NOx

PM CO HC Nox

PM CO HC NOx

PM


Large 17.7 3.0 3.1 0.0 6.6 0.0 0.2 0.0 11.0 2.9 2.9 0.0Diesel Small 4.5 1.7 4.0 1.7 1.2 0.7 0.6 0.1 3.3 1.0 3.4 1.6

Large 213.9 28.7 255.3 41.4 14.4 9.0 7.6 1.2 199.5 19.8 247.7 40.2

LPG Small 454.4 55.0 60.0 0.0 68.7 0.3 2.0 0.0 385.7 54.7 58.0 0.0

Large 68.4 8.3 9.0 0.0 10.3 0.0 0.3 0.0 58.1 8.2 8.7 0.0

Van Diesel Small 65.3 24.8 58.2 24.4 26.4 16.4 13.9 2.1 38.9 8.4 44.3 22.2

Large 117.3 15.8 140.0 22.7 16.0 4.9 37.4 0.2 101.3 10.9 102.7 22.5


Large 57.7 6.8 58.8 9.5 6.5 2.0 15.3 0.1 51.2 4.8 43.5 9.4

Total 1639.3 293.1 841.2 172.9 396.3 83.4 123.9 10.1 1243.0 209.6 717.3 162.8


Table 8



CO HC NOx

PM CO HC NOx

PM CO HC NOx

PM


Large 18.6 3.1 3.3 0.0 6.6 0.0 0.2 0.0 11.9 3.1 3.1 0.0

Diesel Small 4.7 1.8 4.2 1.8 1.2 0.7 0.6 0.1 3.5 1.1 3.6 1.7

Large 224.6 30.2 268.0 43.5 14.4 9.0 7.6 1.2 210.2 21.2 260.5 42.3

LPG Small 477.1 57.8 63.0 0.0 68.7 0.3 2.0 0.0 408.4 57.4 61.0 0.0

Large 71.9 8.7 9.5 0.0 10.3 0.0 0.3 0.0 61.5 8.7 9.2 0.0

Van Diesel Small 68.5 26.0 61.1 25.6 26.4 16.4 13.9 2.1 42.1 9.6 47.2 23.5

Large 123.2 16.6 147.0 23.8 16.0 4.9 37.4 0.2 107.2 11.6 109.7 23.6


Large 60.6 7.2 61.7 10.0 6.5 2.0 15.3 0.1 54.1 5.2 46.5 9.9

Total 1721.2 307.7 883.3 181.5 396.3 83.4 123.9 10.1 1325.0 224.3 759.4 171.4




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economic growth like a double-edged sword. The

environmental regulations such as total emission control

bring the additional cost to every economic activity

which emits air pollutants. Furthermore, the fuel and

vehicle regulations may require additional investment

for fuel improvement and R&D cost of new vehicles.

The increase of production cost may induce the price

rise of fuel and vehicles. The industries which use them

as intermediate goods raise the output price as a chain

reaction. The domestic goods may lose the price

competitiveness in international market. The labor and

capital income may decrease and, in the end, GDP will

decrease as shown inTable 19.

In the first scenario of fuel regulation, the GDP loss is

estimated as 0.49% in 2007 and 0.62% in 2012, which is

equivalent to 2977 billion won in 2007 and 4807 billion

won in monetary unit. The economic loss becomes

bigger in the instant switch to 15 ppm sulfuric fuel as

4434 billion won in 2007 and 8838 billion won in 2012. It

is found that the gradual fuel switch is more desirable in

the aspects of GDP loss. Compared to the instant switch

scenario, it has the effect of reducing the GDP loss by as

ARTICLE IN PRESS

Table 11

Emission coefficient of EURO4 and ULEV by vehicle (unit: g/km)

CO HC NOx

PM

Passenger car Small and medium Gasoline 1.060 0.005 0.031 0.000

Diesel 0.500 0.300 0.250 0.025

LPG 1.060 0.005 0.031 0.000

Large Gasoline 1.060 0.005 0.031 0.000Diesel 0.740 0.460 0.390 0.060

LPG 1.060 0.005 0.031 0.000

Van Small and medium Gasoline 1.060 0.005 0.031 0.000

Diesel 0.740 0.460 0.390 0.060

LPG 1.060 0.005 0.031 0.000

Large Gasoline 1.060 0.005 0.031 0.000

Diesel 1.500 0.460 3.500 0.020

LPG 1.060 0.005 0.031 0.000

Truck Small and medium Gasoline 1.060 0.005 0.031 0.000

Diesel 0.740 0.460 0.390 0.060

LPG 1.060 0.005 0.031 0.000

Large Gasoline 1.060 0.005 0.031 0.000Diesel 1.500 0.460 3.500 0.020

LPG 1.060 0.005 0.031 0.000

Source: Korea Automobile Manufacturers Association (2002).

Table 12

Investment cost by car manufacturing companies (unit: billion won)

Company A B C D E Total

Investment cost 250.0 250.0 250.0 160.0 250.0 910.0

Table 13

Additional investment cost for low sulfuric fuel (unit: billion won)

2007 2008 2009 2010 2011 2012

50 ppm diesel 824.1 90.7 95.2 99.9 104.9 110.2

15 ppm diesel 3964.9 436.1 457.9 480.8 504.9 530.1

50 and 15 ppm diesel 824.1 90.7 95.2 3240.7 356.5 374.3

Note: The equilibrium investment increases as much as growth rate every year.Equilibrium investment=(depreciation rate+growth rate) capital.



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ARTICLE IN PRESS

Table 14

Emission abatement rate of diesel vehicles

Vehicle type Sulfuric concentration (ppm) Abatement rate (%)

CO HC NOx

PM

Small and medium diesel car 430 0.00 0.00 0.00 0.00

50 0.42 13.58 5.85 8.0715 0.46 21.19 9.12 12.58

Large diesel car 430 0.00 0.00 0.00 0.00

50 4.67 7.53 1.49 3.79

15 5.10 8.22 1.62 4.14

Table 15

Emission abatement rate of new vehicles with 15 ppm sulfuric fuel

Vehicle type Sulfuric concentration (ppm) Abatement rate (%)

CO HC NOx PM

Small and medium diesel car 50 0.00 0.00 0.00 0.00

15 0.04 7.61 3.27 4.51

Large diesel car 50 0.00 0.00 0.00 0.00

15 0.43 0.69 0.13 0.35

Table 16

Emission permit price by sulfuric concentration (unit: won/ton)

2007 2008 2009 2010 2011 2012

50 ppm CO 808,550 783,210 643,620 555,650 506,860 489,360

HC 1,177,180 930,510 879,590 859,820 859,150 871,770

NOx

1,266,170 1,206,750 1,123,970 1,073,470 1,047,400 1,040,770

PM 1,942,620 1,621,920 1,512,200 1,445,140 1,405,040 1,383,840

15 ppm CO 684,290 586,440 483,120 417,560 390,740 366,860

HC 814,910 636,820 589,940 567,740 560,890 564,700

NOx

965,680 882,240 819,020 779,610 758,220 751,130

PM 1,428,390 1,190,950 1,105,320 1,051,820 1,018,800 1,000,130

50 and 15 ppm CO 807,270 781,800 642,290 416,570 379,710 365,730

HC 1,156,330 911,670 859,230 552,720 543,930 545,190

NOx

1,250,810 1,193,290 1,109,640 768,250 745,600 736,840PM 1,889,690 1,571,410 1,458,380 1,009,040 971,440 947,000

Table 17

Social cost of air pollution (unit: 1000 won/ton)

CO HC NOx

PM

Social cost per unit 1408.5 1495.3 1747.7 2171.6

Adjusted social cost per unit 1408.5 2112.7 7042.5 14,085.0

Adjustment ratio 1.0 1.5 5.0 10.0

Note: Study on the long-term standard of transportation fuel, 2000, Association of Oil Industry.



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much as 61 billion won in 2007 and 233 billion won in

2012.The impact on GDP by fuel switch is classified as

private consumption expenditure, investment expendi-

ture and government expenditure in Table 20.

It is found that the fuel switch to 15 ppm induces more

economic loss than that of 50ppm. Since 15ppm

sulfuric fuel emits less pollutant, it has less abatement

cost but requires more investment cost and higher fuel

price. The higher fuel price results in higher output price

which may weaken the industrial competitiveness. The

net economic effect of fuel switch regarding the

low abatement cost and high GDP loss is indicated in

Table 21.

3.2. Tax revenue recycling

So far we have assumed that the government revenue

from permit sales is used only as fiscal expenditure

expansions. But if the government instead uses the fund

to increase the investment tax credit, it will work to

decrease the economic cost. So the negative impact can

be offset by the investment cost effect and income effect.

This is known as the double dividend hypothesis. If the

government introduces the environmental taxes (emis-

sion trading with auction) and uses the revenues towards

reducing pre-existing distortionary taxes, we may expect

environmental improvement and other welfare improve-ment at the same time.5

The strict environmental regulation is a double-edged

sword which has positive effect of improving environ-

mental quality and negative effect of weakening

economic growth. Therefore, it should aim to minimize

the negative effect while satisfying the initial policy

objective. We considered tax revenue recycling for that

purpose. Provided that the government owns the

emission rights and sells them to industries, the total

abatement cost in Table 18 becomes the government

revenue of emission permits.Table 22shows how much

GDP loss can be diminished, when the revenue is

recycled to the new vehicles development and low

sulfuric fuel investment.

ARTICLE IN PRESS

Table 18

Comparison of total abatement costs (unit: billion won)

Scenario Cost 2007 2008 2009 2010 2011 2012 Annual average average

50 ppm Total 2190.7 2162.4 2036.8 1992.0 2016.4 2105.3 2083.9

15 ppm Total 1721.6 1589.3 1491.6 1452.9 1464.8 1523.7 1540.7

Improvement to 50 ppm 469.1 573.1 545.2 539.0 551.5 581.6 543.2

50 and 15 ppm Total 2167.9 2140.2 2011.9 1432.3 1440.6 1494.8 1781.3Improvement to 50 or 15 ppm 22.8 22.3 25.0 20.6 24.2 28.9 24.0

Note: The reduced cost of gradual switch scenario is compared to instant switch to 50 ppm scenario from 2007 to 2009 and to instant switch to

15 ppm scenario from 2010.

Table 19

GDP loss for the environmental regulation

2007 2008 2009 2010 2011 2012 Annual average

BAU GDP (billion won) 607,447 637,819 669,710 703,196 738,355 775,273 688,633

50 ppm GDP loss (%) 0.49 0.58 0.6 0.6 0.61 0.62 0.58

GDP loss (billion won) 2976.5 3699.4 4018.3 4219.2 4504.0 4806.7 4037.3

15 ppm GDP loss (%) 0.73 1.02 1.07 1.09 1.12 1.14 1.03


Additional loss to 50 p pm scenario 1457.9 2806.4 3147.6 3445.7 3765.6 4031.4 3109.1

50 and 15 ppm GDP loss (%) 0.48 0.57 0.59 1.06 1.09 1.11 0.82


Additional loss to 50 or 15 ppm scenario 60.7 63.8 67.0 211.0 221.5 232.6 142.8

Note: The additional loss of gradual switch scenario is compared to instant switch to 50 ppm scenario from 2007 to 2009 and to instant switch to

15 ppm scenario from 2010.

5See, for example, Bovenberg and Mooij (1994), Fullerton (1997),

Goulder et al. (1997, 1999). They underlie two welfare effects. The tax-

interaction effect produces the negative welfare impact since the

environmental tax compounds the pre-existing tax distortion. On the

other hand, the revenue recycling effects partially offset the distortions

caused by the pre-existing tax. According to the results of many

empirical tests, the tax-interaction effect dominates the revenue-

recycling effect, which implies the rejection of double dividend

hypothesis.



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Under the tax revenue recycling, the GDP of 50 ppm

sulfuric fuel decreased by 0.24% in the BAU

scenario, compared to 0.58% GDP loss of no revenue

recycling scenario in annual average. The revenue

recycling of 15 ppm sulfuric fuel is estimated to reduce

the GDP loss by about 0.15% in 2007, 0.2% in 2008

and 0.17% in 2012 in comparison with no revenue

recycling.

ARTICLE IN PRESS

Table 20

Impact on GDP by fuel switch (billion won)

2007 2008 2009 2010 2011 2012 Annual average

BAU scenario

GDP 607,447 637,819 669,710 703,196 738,355 775,273 688,633

Private consumption 377,419 396,290 416,105 436,910 458,756 481,694 427,862

Investment 167,460 175,833 184,624 193,856 203,549 213,726 189,841Government expenditure 62,567 65,695 68,980 72,429 76,050 79,853 70,929

Instant switch to 50ppm scenario

GDP 604,470 634,120 665,692 698,976 733,851 770,467 684,596


Investment Total 168,193 174,588 183,219 192,373 201,910 211,969 188,709

Fuel 824 90 95 99 104 110 220

Vehicle 130 144 145 146 146 146 143

Others 167,238 174,353 182,978 192,127 201,659 211,713 188,345

Government expenditure Total 61,613 65,460 68,739 72,183 75,799 79,597 70,565

Permit revenue 2190 2162 2036 1992 2016 2105 2083

Others 59,422 63,298 66,702 70,191 73,783 77,491 68,481

Instant switch to 15ppm scenarioGDP 603,012 631,313 662,544 695,531 730,086 766,435 681,487



Fuel 3964 436 457 480 504 530 1,062

Vehicle 130 144 145 146 146 146 143

Others 167,243 174,964 183,650 192,815 202,412 212,514 188,933


Permit revenue 1721 1589 1491 1452 1464 1523 1540

Others 58,684 63,396 66,644 70,103 73,591 77,300 68,287

Gradual switch to 50 an d 15 ppm scenario

GDP 604,531 634,184 665,759 695,742 730,307 766,668 682,865



Fuel 824 90 95 3,240 356 374 830Vehicle 130 144 145 146 146 146 143

Others 167,273 175,375 184,127 192,649 202,243 212,329 188,999


Permit revenue 2167 2140 2011 1432 1440 1494 1781

Others 60,565 63,431 66,852 66,474 72,870 76,506 67,783

Table 21

Net loss under the fuel switch scenarios (unit: billion won)

2007 2008 2009 2010 2011 2012 Average

15 ppm Reduced abatement cost to 50 ppm 469.1 573.1 545.2 539.0 551.5 581.6 543.2

GDP loss to 50 ppm 1457.9 2806.4 3147.6 3445.7 3765.6 4031.4 3109.1

Net loss to 50 ppm 988.8 2233.3 2602.4 2906.6 3214.1 3449.9 2565.9

50 and 15 ppm Reduced abatement cost to 15 or 50 ppm 22.8 22.3 25.0 559.7 575.7 610.5 302.7

GDP loss to 50 or 15 ppm 60.7 63.8 67.0 211.0 221.5 232.6 142.8

Net loss to 50 or 15 ppm 83.5 86.0 91.9 770.6 797.2 843.1 445.4

Note: The figures in the gradual switch scenario are compared to those in the instant switch to 50 ppm scenario from 2007 to 2009 and to instant

switch to 15 ppm scenario from 2010.



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Therefore, the tax revenue recycling is strongly

recommended to minimize the economic adverse effect

and to achieve environmental regulation successfully.

4. Concluding remarks

Air quality improvement is a target to improve

peoples health and welfare. To obtain the target, thegovernment cannot but use some regulatory measures

such as vehicle emission standard and fuel quality

standard. However, the measures bring about the

economic costs, which impose a heavy burden on

consumers as well as the petroleum and automobile

industries. In this sense, we consider plausible policy

measures to obtain the environmental target with

consideration of minimizing the economic cost incurred

by the regulation.

This paper investigates the impact of strengthening

fuel quality standard on the economic activities with the

CGE model, which characterizes the transportation

services as the main transmission mechanism of the

impact. As a result of this analysis, we suggest that

50 ppm sulfur content in diesel fuel should be better than

15 ppm in minimizing the economic costs to obtain the

equivalent environmental target, and that gradual

reduction of sulfur content in diesel fuel should be

recommended. To minimize consumers economic bur-

den, we also consider use of tax-recycling mechanism.

That is, the government puts the environmental tax on

transportation fuels and uses the tax revenue to support

the industries and consumers who are affected by the

strengthening of fuel quality standard.

There are many ways in which the government uses

the tax-recycling mechanism. In the current situation,

we need more advanced study on that issue. This will be

our future work.

Acknowledgments

We are pleased to thank a referee for helpful

comments and K.H. Huh for valuable research assis-

tance. We retain responsibility for all errors and

omissions.

References

Bovenberg, A.L., de Mooij, R.A., 1994. Environmental levies and

distortionary taxation. American Economic Review 84, 10851089.

Fullerton, D., 1997. Environmental levies and distortionary taxation:

comment. American Economic Review 87, 245251.

Goulder, L.H., Parry, I.W.H., Burtraw, D., 1997. Revenue-raisingversus other approaches to environmental protection: the critical

significance of preexisiting tax distortions. The RAND Journal of

Economics 28 (4), 708731.

Goulder, L.H., Parry, I.W.H., Williams III, R.C., Burtraw, D., 1999.

The cost-effectiveness of alternative instruments for environmental

protection in a second-best setting. Journal of Public Economics

72, 329360.

Han, H.J., 2000. A long-run view on the establishment of the fuel

quality standard for vehicles. Korea Petroleum Association (in

Korean).

Korea Energy Economics Institute, 2002. Monthly Korea energy

review.

The Ministry of the Environment, 1999. Air pollution emission (in

Korean).

ARTICLE IN PRESS

Table 22

Environmental regulation and revenue recycling effect

GDP loss to BAU 2007 2008 2009 2010 2011 2012 Average

50 ppm No recycling % 0.49 0.58 0.60 0.60 0.61 0.62 0.58

Billion won 2976.5 3699.4 4018.3 4219.2 4504.0 4806.7 4037.3

Recycling % 0.18 0.21 0.23 0.26 0.27 0.27 0.24

Billion won 1093.4 1339.4 1540.3 1828.3 1993.6 2093.2 1648.0Effect % 0.31 0.37 0.37 0.34 0.34 0.35 0.35

Billion won 1883.1 2359.9 2477.9 2390.9 2510.4 2713.5 2389.3

15 ppm No recycling % 0.73 1.02 1.07 1.09 1.12 1.14 1.03

Billion won 4434.4 6505.8 7165.9 7664.8 8269.6 8838.1 7146.4

Recycling % 0.58 0.82 0.89 0.92 0.95 0.97 0.86

Billion won 3523.2 5230.1 5960.4 6469.4 7014.4 7520.2 5952.9

Effect % 0.15 0.20 0.18 0.17 0.17 0.17 0.17

Billion won 911.2 1275.6 1205.5 1195.4 1255.2 1318.0 1193.5

50 and 15 ppm No recycling % 0.48 0.57 0.59 1.06 1.09 1.11 0.82

Billion won 2915.7 3635.6 3951.3 7453.9 8048.1 8605.5 5768.4

Recycling % 0.18 0.21 0.23 0.89 0.92 0.94 0.56

Billion won 1093.4 1339.4 1540.3 6258.4 6792.9 7287.6 4052.0Effect % 0.3 0.36 0.36 0.17 0.17 0.17 0.25

Billion won 1822.3 2296.2 2411.0 1195.4 1255.2 1318.0 1716.3


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