Republic of Lithuania: Selected Issues
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International Monetary Fund. European Dept.
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Publication Date:
28 Jul 2022
eISBN:
9798400217333
ISBN:
9798400217333
Language:
English
Keywords:
B. climate change mitigation; mitigating climate change; price volatility; effects of climate change; reducing carbon dioxide; Greenhouse gas emissions; Climate change; Natural disasters; Global; Baltics
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1. After Russia’s invasion of Ukraine, energy security has added to the challenges posed by climate change. The global average surface temperature has increased by about 1.1 degrees Celsius (°C) compared with the preindustrial average during 1850–1900 (Figure 1). According to the latest assessment, if greenhouse gas (GHG) emissions remain on the current growth path, global warming is projected to reach 4–6°C by 2100. While 189 countries have committed to reducing carbon dioxide (CO2) emissions by 30 percent in 15 years until 2030, global CO2 emissions continued to increase since the 2015 Climate Accord by 2.3 percent to 36.3 billion metric tons in 2021. After the war in Ukraine, the price of crude oil has increased from an average of $68 per barrel in 2021 to as high as $124 in 2022, while the price of natural gas in Europe jumped to a record high of €345 per megawatt-hour, which is the oil equivalent of $600 per barrel (Figure 2). At the same time, price volatility has hit new heights because of the unprecedented output decline in renewable energy assets and a tight supply-and-demand balance in the European power system. Although it is still too early to know how events might unfold, the crisis will likely result in long-lasting changes in energy supply networks and energy sources in the generation of electricity. The latest bout of geopolitical tensions in Europe has rekindled policy discourse on the macro-critical importance of ensuring an adequate supply of energy at a stable and reasonable price.

Abstract

1. After Russia’s invasion of Ukraine, energy security has added to the challenges posed by climate change. The global average surface temperature has increased by about 1.1 degrees Celsius (°C) compared with the preindustrial average during 1850–1900 (Figure 1). According to the latest assessment, if greenhouse gas (GHG) emissions remain on the current growth path, global warming is projected to reach 4–6°C by 2100. While 189 countries have committed to reducing carbon dioxide (CO2) emissions by 30 percent in 15 years until 2030, global CO2 emissions continued to increase since the 2015 Climate Accord by 2.3 percent to 36.3 billion metric tons in 2021. After the war in Ukraine, the price of crude oil has increased from an average of $68 per barrel in 2021 to as high as $124 in 2022, while the price of natural gas in Europe jumped to a record high of €345 per megawatt-hour, which is the oil equivalent of $600 per barrel (Figure 2). At the same time, price volatility has hit new heights because of the unprecedented output decline in renewable energy assets and a tight supply-and-demand balance in the European power system. Although it is still too early to know how events might unfold, the crisis will likely result in long-lasting changes in energy supply networks and energy sources in the generation of electricity. The latest bout of geopolitical tensions in Europe has rekindled policy discourse on the macro-critical importance of ensuring an adequate supply of energy at a stable and reasonable price.

Climate Change and Energy Security: A Dilemma or an Opportunity?

1. After Russia’s invasion of Ukraine, energy security has added to the challenges posed by climate change. The global average surface temperature has increased by about 1.1 degrees Celsius (°C) compared with the preindustrial average during 1850–1900 (Figure 1). According to the latest assessment, if greenhouse gas (GHG) emissions remain on the current growth path, global warming is projected to reach 4–6°C by 2100. While 189 countries have committed to reducing carbon dioxide (CO2) emissions by 30 percent in 15 years until 2030, global CO2 emissions continued to increase since the 2015 Climate Accord by 2.3 percent to 36.3 billion metric tons in 2021. After the war in Ukraine, the price of crude oil has increased from an average of $68 per barrel in 2021 to as high as $124 in 2022, while the price of natural gas in Europe jumped to a record high of €345 per megawatt-hour, which is the oil equivalent of $600 per barrel (Figure 2). At the same time, price volatility has hit new heights because of the unprecedented output decline in renewable energy assets and a tight supply-and-demand balance in the European power system. Although it is still too early to know how events might unfold, the crisis will likely result in long-lasting changes in energy supply networks and energy sources in the generation of electricity. The latest bout of geopolitical tensions in Europe has rekindled policy discourse on the macro-critical importance of ensuring an adequate supply of energy at a stable and reasonable price.

Figure 1.
Figure 1.

Lithuania: Global Climate Change

Citation: IMF Staff Country Reports 2022, 252; 10.5089/9798400217333.002.A001

Source: NOAA.
Figure 2.
Figure 2.

Lithuania: International Energy Prices

Citation: IMF Staff Country Reports 2022, 252; 10.5089/9798400217333.002.A001

Source: IMF.

2. Changing the energy matrix and improving energy efficiency could bring a significant reduction in CO2 emissions and strengthen energy security. Most European countries including the Baltics are not on track to achieve the targeted reduction in CO2 emissions by 2030 and reach net zero by 2050, which will require more ambitious reforms to move away from fossil fuels and improve energy efficiency (IPCC, 2021). Using a panel of 39 countries in Europe over the period 1980–2019, the empirical analysis presented in this paper finds that increasing the share of nuclear, renewables, and other non-hydrocarbon energy and improving energy efficiency could contribute to a significant reduction in CO2 emissions and imported sources of energy. The results show that the share of non-hydrocarbon sources of energy and energy efficiency are associated with lower CO2 emissions and energy imports over the long run, after controlling for economic, demographic, and institutional factors. These statistically significant effects are particularly more pronounced in emerging European economies, indicating potentially substantial gains in both environmental outcomes and energy security.

3. This paper takes stock of policies and reforms countries are implementing to mitigate and adapt to climate change. Within Europe, the Baltic Sea basin is particularly vulnerable to global warming caused by climate change. The annual warming trend for the Baltics has been about 0.10°C per decade, which is twice as much as the global average of 0.05°C per decade (Ahola et al., 2021). Over the next century, the projected increase in annual mean surface temperature in the Baltics will remain above the global average under all different scenarios and reach as high as 4.3°C (Meier et al., 2022). Although global warming may initially provide a boost to economic activity in the northern hemisphere and notwithstanding the large uncertainty surrounding long-term climate projections, greater volatility in climatic conditions and a projected increase of as much as 75 percent in precipitation during winter in the Baltics bring significant downside risks. Accordingly, policies and reforms aimed at shifting away from hydrocarbons to alternative sources of energy and increasing energy efficiency in distribution and consumption are key to mitigating climate change, reducing energy dependence, and minimizing exposure to energy price volatility. To this end, environmental taxation, including a carbon tax and “feebates”—fees on products with high emissions combined with rebates on products with low emissions—on fossil fuels, could promote the transition to low-carbon source of energy and raise additional fiscal revenues, which can provide appropriate funding to compensate the most vulnerable households and invest in structural resilience.

Lithuania: Effects of Climate Change

Sea level increase. Sea level is rising at an increasing rate, worsening the extent of high-tide flooding and storm surge around the world. Even if global warming stays below 2°C, sea levels are projected to surge 2–3 meters by 2300 and by 5–7 meters with faster global warming. By 2100, once-in-a-century coastal flood events will occur at least once per year at more than half of coastlines across the globe.

Widespread flooding. Climate change is intensifying the risk of floods as well as droughts. While more intense evaporation will lead to more droughts, warmer air can produce extreme rainfall. On average, the frequency of heavy downpours has already increased by about 30 percent, and they contain about 7 percent more water.

Extreme heat waves. Extreme heat waves, such as the deadly one that occurred in many parts of North America in summer 2021, are already about five times more likely to occur with existing warming of 1.2°C. With global warming of 2°C, this frequency increases to 14 times as likely to occur. Heat waves are getting hotter, and with 2°C of global warming, the hottest temperatures would reach nearly 3°C higher than previous heat waves.

Severe droughts. Climate change is increasing the frequency and severity of droughts. Severe droughts that used to happen at an average of once per decade are now occurring about 70 percent more frequently. If global warming reaches 2°C above the preindustrial average, severe droughts will occur between two and three times as often.

Weather whiplash. Climate change is not just increasing the severity of extreme weather events, but it is also interrupting the natural patterns and creating a “weather whiplash”—wild swings between dry and wet extremes—destructive floods in one year and extreme droughts in the next.

Source: IPCC (2021).

A. Data Overview and Stylized Facts

4. There is considerable heterogeneity in the vulnerability to climate change among European countries. As presented in Figure 3, some countries in Europe are twice as vulnerable to threats associated with climate change than others. Furthermore, there is a significant relationship between climate change vulnerability and resilience. Countries with greater vulnerability also tend to be less resilient to climate change, according to the ND-GAIN indices. In the meantime, the evolution of CO2 emissions shows Europe’s greater progress relative to the rest of the world. There has been a clear downward trend since 1980 both in advanced and developing European counties. However, the prevailing trend in CO2 emissions, especially on a per capita basis, is still not consistent with the pathway to net zero emissions by 2050. In the case of Lithuania, the reduction in CO2 emissions has been slower than the EU average, largely because of the continuing increase in emissions in agriculture, transportation, services, and buildings. This is due to dependence on hydrocarbons as a major source of energy source, even as the share of non-hydrocarbon energy continues to increase. An important consideration with the energy mix is heavy reliance on imports, which account for over 60 percent of all forms of energy and as much as 90 percent in the case of natural gas. In this context, energy efficiency is a critical factor for reducing CO2 emissions and energy imports. Europe has made considerable progress—even more than the rest of the world—in energy efficiency and managed to reduce the amount of energy used to produce a unit of GDP by 46.4 percent over the past four decades. There is, however, still considerable cross-country variation, with the Baltics leading the rest in energy efficiency.

Figure 3.
Figure 3.

Lithuania: Climate Vulnerability, CO2 Emissions, Energy Efficiency

Citation: IMF Staff Country Reports 2022, 252; 10.5089/9798400217333.002.A001

Source: ND-GAIN; EIA; World Bank; author’s calculations.

B. Climate Change Mitigation

5. European countries still have ample opportunities to reduce CO2 emissions through broad-based policies and reforms. In particular, there are three key areas where more ambitious and comprehensive initiatives could make a significant contribution towards net-zero emissions throughout Europe: (i) eliminating distortionary energy subsidies; (ii) introducing a carbon tax and fees on high-emission products combined with rebates on low-emission products; and (iii) improving energy efficiency and decarbonizing the energy sector.

6. Fiscal policy measures, including a carbon tax on fossil fuels, are the most efficient tool for climate change mitigation. Even a modest carbon price can help mobilize investment in non-hydrocarbon sources of energy, encourage greater energy efficiency, and thereby induce significant abatement in CO2 emissions within a short period (IMF, 2020b; Black and others, 2021; Gugler, Haxhimusa, and Liebensteiner, 2021; Parry, Black, and Roaf, 2021). As long as CO2 emissions remain free, there is no effective incentive for the emitters to alter behavior. In contrast, imposing a tax on CO2 emissions relays a powerful signal throughout the economy. Carbon-intensive goods and services would become more expensive and rebalance consumption patterns toward low-carbon options. Black et al., (2021) proposes a range of carbon taxes for advanced, high-income emerging markets and low-income emerging markets—$75, $50 and $25 per metric ton of CO2 emissions, respectively.1 It is also necessary to consider other measures such as “feebates” in carbon-intensive sectors.2

7. Simulation exercises confirm the effectiveness of a carbon tax in reducing CO2 emissions in line with the Paris Agreement. The simulation analysis, based on the Climate Policy Assessment Tool (CPAT) framework developed by IMF and World Bank (IMF, 2019; Parry, Black, and Vernon, 2021), shows that fossil fuels are underpriced in European countries relative to negative externalities.3 A comprehensive carbon tax would therefore help attain the optimal price that takes into account negative externalities and leads to convergence towards the emissions reduction target.4 Table 1 presents the impact of an economy-wide carbon tax set to gradually increase to US$50 per metric ton of CO2 emissions by 2030. Assuming that a carbon tax of US$50 per metric ton of CO2 emissions is the only policy instrument used, the simulation results suggest that all Baltic countries would achieve—or even exceed—the climate mitigation targets by 2030. There is, however, considerable variation across countries. For example, while Estonia and, to a lesser extent, Latvia would need higher levels of carbon tax to cut CO2 emissions in line with the pledges, Lithuania would reduce CO2 emissions more than targeted with a carbon tax of US$50 per metric ton. This variation in the impact of a carbon tax reflects cross-country differences in emission-reduction targets and the existing energy mix, which lead to differences in the responsiveness of CO2 emissions to changes in fossil-fuel prices. Furthermore, since the CPAT uses price elasticity assumptions to determine changes to the energy mix, if a country initially has an exceptionally low level of renewable energy, changes in fossil-fuel prices will not elicit a large increase in renewables.5 Thus, non-tax policies are necessary to stimulate investment in alternative sources of energy, and these policies are not covered in the CPAT framework.

Table 1.

Lithuania: Impact of Carbon Tax in the Baltics and Beyond

article image
Note: The impact of a carbon taxes per ton of CO2 is determined according to the CPAT framework as outlined in IMF (2019) and Parry, Black, and Vernon (2021). Source: Author’s calculations

8. The economic impact of a carbon tax varies from country to country according to the initial energy matrix and upstream linkages in the energy sector. Simulations based on the CPAT model also show that there would be substantial revenue gains from the introduction of a carbon tax, with a moderate negative impact on economic growth. These macro-fiscal effects will vary from country to country according to the initial energy matrix and upstream linkages in the energy sector. For example, at US$50 per metric ton of CO2 emissions, a carbon tax would yield additional revenues amounting to 0.64 percent of GDP in Latvia and 0.75 percent of GDP in Lithuania and as much as 1.03 percent of GDP in the case of Estonia. The impact on economic growth, on the other hand, appears to be moderate (-0.4 percentage points for Lithuania, -0.35 for Latvia and -0.6 for Estonia). Assuming that additional revenues are recycled back into the economy through lower taxes or higher investment spending, the impact is lowered (-0.1 percentage points in Lithuania and Latvia and -0.2 percentage points in Estonia). Furthermore, compensatory policies designed to recycle additional revenue through lowering other taxes and increasing targeted cash transfers and public investment can alleviate adverse effects on disposable household income.

9. Decarbonization must start in the energy sector, which is responsible for about 80 percent of CO2 emissions in Europe as of 2019. CO2 emissions are a result of (i) population, (ii) GDP per capita, (iii) carbon content of energy resources, and (iv) energy consumption per unit of GDP. Reducing CO2 emissions requires the reduction of one or more of these four factors, which implies that policies should focus on decarbonizing the energy matrix (lower CO2 emissions per unit of energy) and enhancing energy efficiency (lower energy consumption per unit of GDP). While the amount of energy used to produce a unit of GDP declined by 55.4 percent across the world over the past four decades thanks to more energy-efficient production processes and greater energy efficiency of consumer goods and services, improving energy efficiency remains one of the most important factors to reduce CO2 emissions and strengthen energy security.

C. Empirical Analysis

10. Increasing the share of renewable, nuclear and other non-hydrocarbon energy should lower CO2 emissions and strengthen energy security. Moving away from fossil fuels can make a big contribution to efforts throughout Europe toward meeting the climate commitments by reducing CO2 emissions. Hence, the impact of nuclear, renewable, and other non-hydrocarbon energy on CO2 emissions in a panel of 39 countries in Europe over the period 1980–2019 is analyzed according to the following specification:

yi,t=β1+β2AEi,t+β3Xi,t+ηi+μt+εi,t

where yi,t denotes the logarithm of CO2 emissions in metric tons per capita or energy security measured by net energy imports as a share of GDP in country i and time t; AEi,t is the share of alternative sources of energy including nuclear, renewable and other non-hydrocarbons; Xi,t is a vector of control variables including the logarithm of real GDP per capita, trade openness, the logarithm of population, the share of urban population and a measure of institutional quality, which are commonly used in the literature (Narayan and Narayan, 2010; Piaggio and Pad illa, 2012; Özbuğday and Erbaş, 2015; Tajudeen, Wossink, and Banerjee, 2018; Xia et aL, 2020; Cevik, 2022a; 2022b). The ηi and μt coefficients denote the time-invariant country-specific effects and the time effects controlling for common shocks that may affect CO2 emissions and energy security across all countries in a given year, respectively εi,t is the error term. To account for possible heteroskedasticity robust standard errors are clustered at the country level.

11. Estimation results, presented in Table 2, confirm that the shift away from hydrocarbon sources of energy helps reduce CO2 emissions and bolsters energy security. The estimated coefficient on non-hydrocarbon sources of energy is economically and statistically highly significant. In the case of all European countries, a 10 percentage point increase in the share of non-hydrocarbon energy is associated with lower CO2 emissions of 3 percentage points in the long run, after controlling for economic, demographic, and institutional factors.6 The magnitude of this effect is even greater among emerging European countries, with a coefficient of -0.012 compared to -0.001 in advanced European economies. The analysis also shows that reducing reliance on hydrocarbon-based energy has a highly significant effect on energy security. For the full sample of countries, a 10 percentage point increase in the share of non-hydrocarbon energy is associated with a reduction of 6 percentage points in energy imports, after controlling for conventional factors. The magnitude of this effect is significantly greater with a coefficient of -0.022 among emerging European countries compared to -0.003 in advanced economies. All in all, these empirical findings confirm that decarbonization not only has a leading role in mitigating CO2 emissions, but also in bolstering energy security throughout Europe.

Table 2.

Lithuania: Non-Hydrocarbon Energy, CO2 Emissions, and Energy Security

article image
Note: The dependent variable is carbon emissions in metric tons per capita and energy security as measured by the share of net energy imports in total energy use. Robust standard errors, clustered at the country level, are reported in brackets. A constant is included in each regression, but not shown in the table. *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively. Source: Author’s estimations.

12. Greater energy efficiency brings a significant reduction in CO2 emissions and strengthens energy security. Improving energy efficiency—measured as energy intensity of economic activity—can make a big contribution to efforts throughout Europe toward meeting the climate commitments by reducing CO2 emissions per capita. There is anecdotal evidence indicating that countries with greater energy efficiency tend to have lower energy imports and CO2 emissions, as well as lower energy cost for consumers. Accordingly this paper also investigates the impact of energy efficiency on CO2 emissions and energy security, as defined above, in a panel of 39 countries in Europe over the period 1980–2019, employing the following specification:

yi,t=β1+β2EEi,t+β3Xi,t+ηi+μt+εi,t

where yi,t denotes the logarithm of CO2 emissions per capita or net energy imports as a share of GDP in country i and time t; EEi,t is energy efficiency as measured by energy consumption per unit of real GDP; Xi,t is a vector of control variables including the logarithm of real GDP per capita, trade openness, the logarithm of population, the share of urban population, and a measure of institutional quality As above, the ηi and μt coefficients denote the time-invariant country-specific effects and the time effects controlling for common shocks that may affect CO2 emissions and energy security across all countries in a given year, respectively εi,t is the error term. To account for possible heteroskedasticity, robust standard errors are clustered at the country level.

13. Estimation results, presented in Table 3, confirm that improving energy efficiency reduces CO2 emissions and strengthens energy security. The estimated coefficient on energy efficiency is economically and statistically highly significant. Broadly in line with previous studies, a 10-percentage point increase in energy efficiency is associated with lower CO2 emissions of 8.8 percentage points and energy imports of about 2 percent in the long run, after controlling for economic, demographic, and institutional factors. These effects of energy efficiency are significant across all country groups but appear to be stronger among advanced economies, which could reflect greater efficiency gains in advanced economies in the past. Nevertheless, these findings indicate that improving energy efficiency can play a fundamental role in mitigating CO2 emissions and strengthening energy security by reducing dependence on imported sources of energy. Therefore, to decarbonize economic activity, policies and reforms should aim to improve energy efficiency in commercial and residential use as much as shifting the energy matrix away from fossil fuels.

Table 3.

Lithuania: Energy Efficiency, CO2 Emissions, and Energy Security

article image
Note: The dependent variable is carbon emissions in metric tons per capita and energy security as measured by the share of net energy imports in total energy use. Robust standard errors, clustered at the country level, are reported in brackets. A constant is included in each regression, but not shown in the table. *, **, and *** denote significance at the 10%, 5%, and 1% levels, respectively. Source: Author’s estimations.

D. Conclusion

14. Well-designed policies and structural reforms would help reduce CO2 emissions and strengthen energy security. To guard against threats associated with climate change, countries need to proceed on two fronts: (i) climate mitigation, which refers to policies that help reduce CO2 emissions and (ii) climate adaptation, which refers to efforts to adapt to the effects of climate change including through minimizing damages from climate-related disasters as well as to adapt to the effects of economic transformations. Using a panel of 39 countries in Europe over the period 1980–2019, the empirical analysis presented in this paper indicates that increasing the share of nuclear, renewables, and other non-hydrocarbon energy and improving energy efficiency could lead to a significant reduction in CO2 emissions and improve energy security throughout Europe. From a risk-reward perspective, the benefits of reducing the risks of climate change and strengthening energy security clearly outweigh the potential cost of mitigation policies in the short run. Environmental taxes, including a comprehensive, economy-wide carbon tax on fossil fuels, could also raise considerable revenues, which can expand the post-pandemic fiscal space and provide additional funding to compensate the most vulnerable households, build a multilayered safety net, and strengthen structural resilience.

15. Baltic countries must also mainstream adaptation into development plans to strengthen resilience against climate change. On climate change mitigation, Lithuania has committed to cut its emissions by 80 percent—by increasing the share of renewables to 45 percent and improving energy efficiency—and remove 20 percent in order to achieve carbon neutrality by 2050. This is an ambitious target, especially considering the country’s decision to close its nuclear power plant as one of conditions to join the EU. With the removal of nuclear energy that had been generating more than 70 percent of electricity, Lithuania has moved from being a net exporter to a net importer of electricity and become more dependent on energy imports from Russia. While Lithuania has taken steps to strengthen energy security by liberalizing its energy market and acquiring alternative sources of energy7, the current pace of CO2 emissions is still not on track to achieve the country’s reduction pledge by 2030 and net zero emissions by 2050. Transportation and agriculture are the most significant sources of GHG emissions. The authorities have proposed to modernize motor vehicle taxation and adjust excise taxes on fossil fuel according to the level of CO2 emissions. Further broadening environmental taxes, which are low relative to other EU countries, and introducing a national carbon tax could provide necessary incentives throughout the economy for a faster green transition.

16. Long-term climate risks demand decisive action to strengthen physical, financial, institutional, and social resilience. While a variety of adaptation measures have been introduced to enhance resilience to climate change throughout Europe, there are still significant gaps that keep some countries, such as the Baltics, more vulnerable to threats associated with climate change. Enhancing structural resilience requires infrastructure and other ex-ante investments to limit the impact of disasters, while building financial resilience involves creating fiscal buffers and using prearranged financial instruments to protect fiscal sustainability and manage recovery costs. Although these measures will have upfront fiscal costs, the lack of inaction on the climate front would have an even greater cost for generations. Furthermore, strengthening physical and financial resilience would reduce damages from climate change and increase expected returns to private investment and output.

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1

Across the world, only 17 percent of emissions are covered by a carbon price, which remains at an average of US$3 per metric ton of CO2 emissions.

2

“Feebates” are fees on products with high emissions combined with rebates on products with low emissions.

3

The CPAT provides country-specific projections of fuel use and CO2 emissions by the energy, industrial, transportation (excluding international aviation and maritime), and residential sectors. The CPAT model is parameterized using data compiled from the International Energy Agency (IEA) on recent fuel use by country and sector. Real GDP projections are from the latest IMF forecasts. Data on energy taxes, subsidies, and prices by energy product and country is compiled from publicly available and IMF sources, with inputs from proprietary and third-party sources. International energy prices are projected forward using an average of IEA and IMF projections for coal, oil, and natural gas prices. Assumptions for fuel price responsiveness are chosen to be broadly consistent with empirical evidence and results from energy models.

4

The Baltics participate in the EU emissions trading system (ETS), which covers only about 30 percent of national CO2 emissions.

5

For example, in the case of Lithuania, both factors are significant and that is why the impact of a carbon tax appears stronger.

6

The estimated coefficients on control variables have the expected signs and some are also statistically significant.

7

Lithuania has built a modern LNG terminal in Klaipeda, allowing the country to become independent of natural gas imports from Russia.

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Cover IMF Staff Country Reports
Republic of Lithuania: Selected Issues
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2022: Issue 252
Publisher:
International Monetary Fund
ISBN:
9798400217333
ISSN:
1934-7685
Pages:
35
DOI:
https://doi.org/10.5089/9798400217333.002
Figure 1.

Lithuania: Global Climate Change
Figure 2.

Lithuania: International Energy Prices
Figure 3.

Lithuania: Climate Vulnerability, CO2 Emissions, Energy Efficiency