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

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Energy Policy 34 (2006) 2572–2585

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The economic impact of strengthening fuel qualityregulation—reducing 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 transportationsector is increasing and threatening people’s health andwelfare. Especially, cars and trucks using diesel fuel arethought as a cause of worsening air quality. Accordingto air pollution emission published by Ministry ofEnvironment (1999), the emission from the transporta-tion sector takes 55.8% of total emission and diesel fuelis responsible for 51.8% of the transportation emission.In order to improve air quality and welfare, reduction ofemission from the transportation sector, especially dieselfuel, is necessary.

e front matter r 2004 Published by Elsevier Ltd.

pol.2004.08.017

ing author.

esses: [email protected] (H.J. Chang),

.kr (G.L. Cho), [email protected] (Y.D. Kim).

The Korean government has attempted to reducelocal emission, trying to use some measures to reducelocal emission in the transportation sector. Strengthen-ing emission standard for vehicles and fuel qualitystandard are considered as an efficient policy tool.However, strengthening regulation on fuel qualityrequires additional investments for refining facility,additional production costs, and finally increases in fuelprices 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 wecan minimize the adverse economic impact from theregulation enforcement to obtain the environmentaltarget and who can pay the costs. And we attempt toprovide some answers to the above questions. In thissense, we investigate the impact of strengthening fuelquality standard on the economic activities and measurethe overall economic costs incurred over the various

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ARTICLE IN PRESSH.J. Chang et al. / Energy Policy 34 (2006) 2572–2585 2573

regulation scenarios. Then we suggest some plausiblemeasures minimizing economic costs incurred fromenforcing 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 resultsand introduces some measures for economic costminimization. Section 4 gives concluding remarks.

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.

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. Notonly Korea but also most of industrialized countries tryto improve the air quality along with total emissioncontrol and enforcement regulation on industrialactivities such as tightening vehicle emission standardand improving fuel quality.

There are lively discussions on the ‘‘SustainableDevelopment’’ saying to pursue both continuous eco-nomic growth and clean environment for the futuregenerations. In this point, the environmental improve-ment and economic growth is not a matter of choice butof a compulsory policy objective to carry out together.But in case that the government regulation leads to anydistortion on investment, it may cause social loss such asrising prices and weakening industrial competitiveness.In this context, we also recognize the importance ofminimizing adverse effects.

This study aims to analyze the economic benefit andcost of environmental regulations on fuel quality controland vehicle emission standard and, in the end, to findthe efficient way to achieve satisfactory environmentalquality. To evaluate the policies and suggest theappropriate policy options, we develop the dynamicCGE model, taking the backward and forward linkageeffect among industries into consideration.

Carbon monoxide (CO), hydrocarbon (HC), nitrogenoxide (NOx) and particulate matter (PM) are the targetpollutants to analyze, which are currently the regulatedair pollutants of vehicle emission. It is analyzed for theperiod from 2001 to 2012 toward oil industries,transportation industries, service industries and carindustries. The oil products include gasoline, diesel,LPG, other oil products and alternative fuel (50 ppmdiesel, 15 ppm diesel). We classify the transportationindustry according to the emission pattern of the fueland vehicle type. The vehicle includes passenger car, vanand truck, also as gasoline, diesel and LPG car by thefuel, and classified further as small, medium and largecar by the volume of a car. The detailed division is good,in the sense that it makes possible the analysis of thesubstitution effect among the conventional cars andfrom conventional cars to new cars.

Therefore, this model has an advantage to considerthe various linkage effects over the national economy, aswell as the substitution effect of vehicles from thegovernment regulation (Table 1).

2.1. Data and model structure

2.1.1. Data

�
Fuel consumption for transportation use1
The gasoline consumption is estimated to be10,090 kl, diesel 15,153 kl and LPG 6022 kl in 2001.2

The average fuel price of 2001 is applied as 1280 wonfor gasoline, 645 won for diesel and 440 won forLPG. 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 vehicles
The total number of registered vehicles in 2001 is 12million and new vehicles hold about 10%. Gasolinevehicles take up 60%, diesel vehicles about 32% andLPG about 8%. The share of diesel and LPG vehiclesrises in new vehicles in 2001 as 42% for diesel and18% for LPG vehicles, due to the low fuel price andbenefits on tax deduction (Table 3).
� Environmental pollution of transportation sector
The amount of air pollution by vehicles is estimatedwith the ‘‘estimating method of moving emissionsource’’ by the Ministry of Environment in Table 4

Emissionðton=yrÞ ¼ number of registered car ðnumberÞ

�mileage by vehicle type ðkm=a car dayÞ

�emission coefficient ðg=kmÞ

�365 day=yr� 0:0000001 ðton=gÞ:

2.1.2. The model structure

2.1.2.1. The basic features. The CGE model weapplied has an interrelated structure among production,consumption and government sectors so that it is goodat explaining the linkage effect of a policy change in theother sectors. The production sector is assumed to try tomaximize profit with labor, capital, energy and inter-mediate goods. The consumption sector uses its incomefrom labor income and capital revenue as saving andexpenditure to maximize its utility. The governmentsector has tax revenue from production and consump-tion activities and spends it for government expenditure

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Table 1

Industries in model

Oil industry Gasoline

Transport industry Diesel

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 7–10 passengers

Large Bus

Diesel Small and medium Less than 7–10 passengers

Large Bus

LPG Small and medium Less than 7–10 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 (1000kl) 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) 2572–25852574

and household transfer. The export and import goodsmake domestic final consumption goods with competi-tion in international trade. The export and import arecontrolled by exchange rate.

The CGE model focuses on deriving the equilibriumprice of demand and supply, with regards to theproducer’s profit maximization and consumer’s utilitymaximization. Therefore, the policy variance in aspecific field intrinsically affects the overall economy ofconsumer, producer and international trade. For in-stance, the regulation on sulfuric fuel affects theproduction cost of fuel and price of output products.

At first the oil refinery industry is affected, then thetransportation service industry, car industries and thehousehold in the end. The variance in other industriesand consumption sector continues to affect the oilrefinery industry again as a circular reaction.

The air pollution regulation may affect the marketwith the following procedure. Once a government setsthe total amount of emission permit and choosesenvironmental tax or emission trade as a policyinstrument, a consumer encounters a condition tochoose buying a new car satisfying the environmentalregulation or keeping a conventional car with someadditional payment (environmental tax or emissionpermit purchase). If the additional payment is bigenough to cover up the expense for the new car, thenthe regulation will cause more new cars to beintroduced.

Our model classifies a car in detail by vehicle type, fueltype and volume. Furthermore, it takes into considera-tion the substitution effect not only among conventionalcars, but also between conventional cars and new carswhich satisfy the EURO4 standard.

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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 455,960 680,491

LPG 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.

H.J. Chang et al. / Energy Policy 34 (2006) 2572–2585 2575

However, the new car and cleaner fuel wouldgenerate the additional production cost such asR&D and capital investment, which probably causethe increase of car and fuel price and, furthermore,the output price which use them as intermediategoods. 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 classifiesthe vehicles in detail and makes consumers choose

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Oil Product marketOil Product market

•Transportation fuel: Gasoline,

Diesel, LPG

•Non-transportation fuel: Other oil

products

Low sulfuric fuel Low sulfuric fuel

• the fuel with low sulfuric

concentration

• low economic efficiency at present

• be introduced with environmental

regulation in the future

Total Emission ControlTotal Emission Control

& Emission Trading & Emission 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.


either new car or conventional car, so that it ispossible to analyze the substitution effect comprehen-sively. With the introduction of environmental tax oremission trading, consumers face the followingchoices: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 theemission right after reducing the consumption oftransportation service.

J Purchase emission right or pay the environmentaltax without changing the consumption style(increase of environmental cost).Consumers choose one of the four options tomaximize 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 mileageand consumers pay the fee by mileage.

J The transportation service is composed of passen-ger car service, van service and truck service withthe elasticity of substitution of 0.25.

J Each service is formed with the identical composi-tion. For instance, the passenger car servicehas gasoline car service, diesel car service andLPG car service with the elasticity of substitutionof 0.25.

J The passenger car service has two sizes with theelasticity of substitution of 0.25: small and mediumvehicle, large vehicle.

J The fuel consumption ratio per km and emissionare fixed by vehicle size with 0 elasticity ofsubstitution. This assumption implies no substitu-tion among pollutants, that is, it is not possible toemit more of a pollutant and less of another one.

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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.


�
Production sectorProducers aim to maximize their profit in producingthe output with factor input (labor, capital, energy)and intermediate goods. �
3There are not yet any official data about additional investment cost

for developing diesel vehicle with EURO4 standard.

Government sectorGovernment has the revenue from income tax onlabor and capital, consumption tax on commodityconsumption, tariff on imported goods and environ-mental tax or emission permit upon environmentalregulation scenarios. On the other hand, the govern-ment expenditure includes government consumption,household transfer and subsidy (for an alternativeenergy scenario) (Fig. 2).

2.2. Environmental regulation and fuel control

2.2.1. Total emission control

We apply Emission Trading system to achieve thetotal emission control. The level of permitted emission isset at the year 2007 level which is estimated withEURO4&ULEV emission coefficient. The emission levelof business as usual (BAU) scenario by vehicle type, thepermitted emission level and abatement amount areshown in Tables 5–10. CO is permitted to emit by396,000 ton, HC 83,000 ton, NOx 124,000 ton and PM10,000 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 emissionabatement is supposed to consistently increase by 2012.The EURO4&ULEV emission coefficient is indicated in

Table 11. ULEV is applied to gasoline and LPG carsand EURO4 to diesel cars.

2.2.2. Vehicle emission and fuel quality regulations

�
Vehicle emission regulationWe assume to put in effect the vehicle regulation andfuel regulation with the total emission control. Underthe vehicle regulations, diesel cars with EURO4 levelare gradually introduced from 2007 and replace theconventional cars by 1/7 annually. There may be 910billion won of additional investment cost to developcars with EURO4 level (Table 12)3. � Fuel regulation
The fuel regulations have three scenarios to supplylow 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 theinitial investment cost to produce the low sulfuric fuelamounts to 824, 3965 and 3141 billion wons for thethree scenarios. The cost of the third scenario is derivedfrom the difference of the other two scenarios. In spiteof the initial investment, additional investment isnecessary as suggested in Table 13, regarding thedepreciation rate (0.06) and economic growth rate(0.05).

The National Environment Institute suggests that notonly the new vehicles but the conventional vehicles emitmuch less when they use the low sulfuric fuel. The newvehicles are assumed to emit at the same level ofEURO4 with 50 ppm diesel and less than the EURO4level 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 pollutant

It is our objective to fix the total emission level from2007 with introducing new vehicles and low sulfuric fuelthrough Emission Trading. The price of permit maytake a main role to affect the consumers’ choice andmarket. 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 thepollutants are positive. Consumers have to chooseamong pollutants by choosing between gasoline and

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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 0.0

Diesel 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 18.2 116.7 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





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


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



diesel cars and by reducing their transportation service.If consumers with a diesel car like to reduce a specificpollutant like NOx or PM, then they have to choose anoption: use the existing diesel car and purchase permit ofthe pollutant or purchasing a gasoline car which emitsless pollutant than the existing diesel car. It is becausethe emission coefficients of gasoline car differ from thoseof diesel car. In this situation, all the permit prices canbe positive.

In the first scenario of fuel regulation, instant switchto 50 ppm of sulfuric fuel, the permit price may be about808.5 thousand won for CO, 1177.1 thousand won for

HC, 1266.1 thousand won for NOx, and 1942.6thousand won for PM in 2007. As the introduction ofnew vehicles, the permit price will gradually decrease to489.3 thousand won for CO, 871.7 thousand won forHC, 1040.7 thousand won for NOx and 1383.8 thousandwon for PM in 2012. Since new vehicles emitless pollution than the conventional vehicles, consumerswill face the decision of buying more expensive newcar or keeping the conventional car with the environ-mental expenditure. The more new vehicles, the lessdemand for the emission permit, then the permit pricedecreases.

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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 0.0

Diesel 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





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



The permit prices of pollutants become lower in use of15 ppm sulfuric fuel than that of 50 ppm during thestudied period. Consumers with 15 ppm diesel like todemand new cars more than with 50 ppm diesel. Sincenew cars emit pollutants less than existing cars,consumers with 15 ppm diesel will purchase less permitsof pollutants than with 50 ppm diesel. Then permitprices with 15 ppm diesel will be lower than with 50 ppmdiesel.

The permit prices of the gradual switch are lower thanthe instant switch to 15 ppm, which may be caused bythe 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 theadverse effect of instant switch.

Han (2000) suggested the social cost of air pollutantas follows. The unit social cost of each pollutant mayprovide intuition as to how much benefit can occur withthe fuel regulation in this study (Table 17).

3.1.2. Total abatement cost

The permit price can be interpreted as the abatementcost of a pollutant which is paid by a company toachieve the total emission control standard. Therefore,the total abatement cost is the permit price ofTable 16 times the amount of abatement to satisfy the

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Table 9





Large 19.5 3.3 3.4 0.0 6.6 0.0 0.2 0.0 12.9 3.2 3.2 0.0

Diesel Small 4.9 1.9 4.4 1.8 1.2 0.7 0.6 0.1 3.7 1.1 3.8 1.8

Large 235.8 31.7 281.4 45.6 14.4 9.0 7.6 1.2 221.4 22.7 273.9 44.5

LPG Small 501.0 60.7 66.2 0.0 68.7 0.3 2.0 0.0 432.3 60.3 64.2 0.0

Large 75.5 9.1 10.0 0.0 10.3 0.0 0.3 0.0 65.1 9.1 9.7 0.0

Van Diesel Small 71.9 27.3 64.1 26.9 26.4 16.4 13.9 2.1 45.6 10.9 50.2 24.7

Large 129.4 17.4 154.4 25.0 16.0 4.9 37.4 0.2 113.3 12.5 117.0 24.8


Large 63.7 7.5 64.8 10.5 6.5 2.0 15.3 0.1 57.1 5.5 49.5 10.4

Total 1807.3 323.1 927.4 190.6 396.3 83.4 123.9 10.1 1411.0 239.6 803.6 180.5


Table 10





Large 20.6 3.4 3.6 0.0 6.6 0.0 0.2 0.0 13.8 3.4 3.4 0.0

Diesel Small 6.2 2.0 4.6 1.9 1.2 0.7 0.6 0.1 4.0 1.2 4.0 1.9

Large 247.6 33.3 296.6 47.9 14.4 9.0 7.6 1.2 233.2 24.3 287.9 46.8

LPG Small 626.0 63.7 69.6 0.0 68.7 0.3 2.0 0.0 457.3 63.4 67.6 0.0

Large 79.2 9.6 10.6 0.0 10.3 0.0 0.3 0.0 68.9 9.6 10.2 0.0

Van Diesel Small 76.6 28.7 67.3 28.2 26.4 16.4 13.9 2.1 49.2 12.3 63.4 26.1

Large 136.8 18.3 162.1 26.3 16.0 4.9 37.4 0.2 119.8 13.3 124.8 26.1


Large 66.8 7.9 68.1 11.0 6.6 2.0 15.3 0.1 60.3 5.9 52.8 10.9

Total 1897.7 339.2 973.8 200.1 396.3 83.4 123.9 10.1 1601.4 255.6 849.0 190.0

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


environmental regulation.4 In the case of 50 ppm sulfuricfuel, total abatement cost is equivalent to 2190 billionwon in 2007, 2162 billion won in 2008 and 2105 billionwon in 2012. As the sulfuric concentration is decreasedto 15ppm, the total abatement cost of air pollution fallsto 1722 billion won in 2007 and 1524 billion won in 2012.

4We assume that all of production technologies involving transpor-

tation services are constant returns to scale. The final composed

transportation service consists of various sub-transportation services

which also satisfies constant returns to scales. In order to maximize

utility, consumer equalizes the marginal cost of each service at the

equilibrium. Therefore, the marginal cost is considered as the average

cost and also permit price at the equilibrium.

The benefit of fuel shift from 50 to 15ppm is expected tobe as much as 543 billion won per year.

It is noticeable that the gradual fuel shift scenarioshows lower abatement cost of about 15% comparedwith instant shift scenario during the studied period.The policy-forecasting effect seems to affect the unitabatement cost. Table 18 shows the pollution abatementeffect by fuel switch.

3.1.3. GDP loss

It is a positive effect of the fuel shift that totalabatement can be decreased. There is adverse effect,however, that it weakens industrial competitiveness and

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 0.000

Diesel 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 0.000

Diesel 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.


economic growth like a double-edged sword. Theenvironmental regulations such as total emission controlbring the additional cost to every economic activitywhich emits air pollutants. Furthermore, the fuel andvehicle regulations may require additional investmentfor fuel improvement and R&D cost of new vehicles.The increase of production cost may induce the pricerise of fuel and vehicles. The industries which use themas intermediate goods raise the output price as a chainreaction. The domestic goods may lose the pricecompetitiveness in international market. The labor and

capital income may decrease and, in the end, GDP willdecrease as shown in Table 19.

In the first scenario of fuel regulation, the GDP loss isestimated as 0.49% in 2007 and 0.62% in 2012, which isequivalent to 2977 billion won in 2007 and 4807 billionwon in monetary unit. The economic loss becomesbigger in the instant switch to 15 ppm sulfuric fuel as4434 billion won in 2007 and 8838 billion won in 2012. Itis found that the gradual fuel switch is more desirable inthe aspects of GDP loss. Compared to the instant switchscenario, it has the effect of reducing the GDP loss by as

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 8.07

15 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 1,109,640 768,250 745,600 736,840

PM 1,889,690 1,571,410 1,458,380 1,009,040 971,440 947,000

Table 17

Social cost of air pollution (unit: 1000won/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.


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 1781.3

Improvement 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 ppm 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.


much as 61 billion won in 2007 and 233 billion won in2012.

The impact on GDP by fuel switch is classified asprivate consumption expenditure, investment expendi-ture and government expenditure in Table 20.

It is found that the fuel switch to 15 ppm induces moreeconomic loss than that of 50 ppm. Since 15 ppmsulfuric fuel emits less pollutant, it has less abatementcost but requires more investment cost and higher fuelprice. The higher fuel price results in higher output pricewhich may weaken the industrial competitiveness. Thenet economic effect of fuel switch regarding thelow abatement cost and high GDP loss is indicated inTable 21.

3.2. Tax revenue recycling

So far we have assumed that the government revenuefrom permit sales is used only as fiscal expenditureexpansions. But if the government instead uses the fundto increase the investment tax credit, it will work todecrease the economic cost. So the negative impact canbe offset by the investment cost effect and income effect.This is known as the ‘‘double dividend hypothesis.’’ If thegovernment introduces the environmental taxes (emis-sion trading with auction) and uses the revenues towards

reducing pre-existing distortionary taxes, we may expectenvironmental improvement and other welfare improve-ment at the same time.5

The strict environmental regulation is a double-edgedsword which has positive effect of improving environ-mental quality and negative effect of weakeningeconomic growth. Therefore, it should aim to minimizethe negative effect while satisfying the initial policyobjective. We considered tax revenue recycling for thatpurpose. Provided that the government owns theemission rights and sells them to industries, the totalabatement cost in Table 18 becomes the governmentrevenue of emission permits. Table 22 shows how muchGDP loss can be diminished, when the revenue isrecycled to the new vehicles development and lowsulfuric fuel investment.

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 167,460 175,833 184,624 193,856 203,549 213,726 189,841

Government expenditure 62,567 65,695 68,980 72,429 76,050 79,853 70,929

Instant switch to 50 ppm 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 15 ppm scenario

GDP 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 and 15 ppm scenario

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



Fuel 824 90 95 3,240 356 374 830

Vehicle 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.


Under the tax revenue recycling, the GDP of 50 ppmsulfuric fuel decreased by 0.24% in the BAUscenario, compared to 0.58% GDP loss of no revenuerecycling scenario in annual average. The revenue

recycling of 15 ppm sulfuric fuel is estimated to reducethe GDP loss by about 0.15% in 2007, 0.2% in 2008and 0.17% in 2012 in comparison with no revenuerecycling.

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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 1648.0

Effect % 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 4052.0

Effect % 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


Therefore, the tax revenue recycling is stronglyrecommended to minimize the economic adverse effectand to achieve environmental regulation successfully.

4. Concluding remarks

Air quality improvement is a target to improvepeople’s health and welfare. To obtain the target, thegovernment cannot but use some regulatory measuressuch as vehicle emission standard and fuel qualitystandard. However, the measures bring about theeconomic costs, which impose a heavy burden onconsumers as well as the petroleum and automobileindustries. In this sense, we consider plausible policymeasures to obtain the environmental target withconsideration of minimizing the economic cost incurredby the regulation.

This paper investigates the impact of strengtheningfuel quality standard on the economic activities with theCGE model, which characterizes the transportationservices as the main transmission mechanism of theimpact. As a result of this analysis, we suggest that50 ppm sulfur content in diesel fuel should be better than15 ppm in minimizing the economic costs to obtain theequivalent environmental target, and that gradualreduction of sulfur content in diesel fuel should berecommended. To minimize consumers’ economic bur-den, we also consider use of tax-recycling mechanism.That is, the government puts the environmental tax ontransportation fuels and uses the tax revenue to supportthe industries and consumers who are affected by thestrengthening of fuel quality standard.

There are many ways in which the government usesthe tax-recycling mechanism. In the current situation,we need more advanced study on that issue. This will beour future work.

Acknowledgments

We are pleased to thank a referee for helpfulcomments and K.H. Huh for valuable research assis-tance. We retain responsibility for all errors andomissions.

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

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