less sweeping conclusion about Canada, and believed there might be some potential even though none of the existing studies gave a convincing basis for their actual estimates. We compromised on the wording that was quoted in part by Mr. Romm. The complete paragraph states that "... there has not been enough empirical work on either hidden costs or on market imperfections to decide which view of the conservation paradox is more correct. This means that, even if a general agreement that cost-effective policies to reduce market imperfections can be safely introduced into a climate strategy, it is impossible to determine accurately how far those policies would go toward satisfying any particular target for emission reductions and how much they would actually cost." The Five-Lab study fails to analyze the nature and magnitude of market imperfections or to propose policies to remedy them. Therefore, applying the reasoning of our article, there is no reason to believe anything the Five-Lab study says about the possibility of costless emission reductions. My co-author and I have learned a great deal more about the possibilities for costless energy conservation since writing the cited article. Dr. Jaccard has reported to me that in his recent research, which provides some of the empirical work that was lacking when we wrote the cited article, he finds no support for the notion that there are unexploited possibilities for cost-effective energy conservation. Unfortunately, the Five-Lab study adds little to older studies of conservation potential and pays no attention to the issues of market behavior and hidden costs that really matter for designing sound policies to address market imperfections. The Five-Lab study claims that 20% reductions in energy use will be cost effective without diagnosing market imperfections or proposing any specific policy remedies. Although, as pointed out in our article, there could in principle be some policy measures that would remedy market imperfections at low cost and achieve cost-effective savings, nothing in the Five-Labs report identifies what they are or what they could accomplish. Therefore I see no inconsistency in stating that following the recommendations of the report will impose costs on the U.S. economy. Least-Cost Regulatory Policies Q6. Your testimony says that your study assumed that regulators would use the most economical, least-costly policies possible, and yet there would still be great economic costs to country. What were these least-cost policies you assumed in your study? A6. Literally, our study assumed that the United States imposed a cap on carbon emissions and created a uniform and universal emission trading system to equalize the marginal cost of emission reduction across all sources and sectors. Our model finds the least cost way to reduce emissions in order to meet this cap, by choosing the options with the lowest marginal cost. This produces the same results as a uniform carbon tax on oil, natural gas, and coal. We assumed that the revenues from the taxes or permit sales were recycled costlessly, so that the only economic costs come from the cost of using more expensive fuels, investing in energy conservation that would not be cost-effective at baseline prices, or doing without energy. We also assumed short term management of the economy by the Fed to tolerate inflationary impacts and maintain full employment. Regulatory measures, such as fuel economy standards, mandatory efficiency standards, or mandates for renewable fuels have proven, when proposed in the past, to have far higher costs per ton of carbon removed than those market based policies. Impacts of an Emissions Trading Policy on Costs of Gasoline or Home Heating Oil Q7. A7. Your testimony suggests that if an emissions trading policy is implemented, the price for a permit would have to reach $150 to $200 per ton to induce sufficient fuel switching. Could you please translate that into an increase in the price of a gallon of gasoline or home heating oil? This permit price would be equivalent to an increase of 42 to 56 cents per gallon in the price of gasoline or heating oil. U.S. Greenhouse Gas Emissions Q8. A8. It is estimated that the average American produces more than five times the greenhouse gas emission of the average person on Earth. Concerning this: Q8.1. How much does the average American produce in economic output compared to the average person on Earth? Q8.2. Is the U.S. average of CO2 emissions per unit of economic output above, below, or equal to the world average? US GDP per capita in 1995 was $20,698 compared to world GDP of $2,579 (excluding the US). US CO2 emissions are 0.261 metric tons per thousand dollars of output compared to a world average (excluding the US) of 0.342 metric tons per thousand dollars of output. The latter figure includes Europe and Japan, which have smaller emissions per dollar of output than the U.S. Thus the developing countries have even larger emissions per dollar of output compared to the U.S. It is our high standard of living, toward which all those countries are striving, not our relative energy inefficiency, that leads to higher emissions per capita in the U.S. than in the rest of the world. Efficiency of U.S. Energy Markets Q9. You testified that “energy markets work very efficiently in the United States," and you cite deregulated oil and natural gas prices and restructuring of electric power that, in your view, "largely eliminated regulatory distortions on prices and inappropriate incentives for energy consumption." However, Mr. Romm testified that "Dr. Montgomery seems to wave away the entire regulatory regime of the utility system and say were moving to a deregulated environment. The entire utility system of this country was set up over a period of decades in a regulated A9. environment that, in some sense, discouraged efficient production of energy Dr. Romm's comments suggest that he has not paid attention to utility regulation for at least 20 years, nor read the economic literature on utility regulation that has been published over that period of time. By the late 1970s, utilities were in a position of needing to achieve every possible cost saving because fuel prices and generating costs were rising and regulatory commissions were disallowing "imprudent" costs and setting allowed rates of return below costs of capital. These regulatory biases gave utilities an incentive to avoid new construction and load growth. On the customer side, cost escalation in nuclear powerplants and other unexpected changes in accounting costs led to a situation where there was no longer a presumption that the price of electricity was below marginal cost. In many systems, the regulated price of electricity substantially exceeded the cost of new generating capacity to cover cost overruns on nuclear and coal-fired powerplants. Then State regulators, encouraged by the Federal government, began paying electric utilities to encourage energy conservation and to requiring utilities to purchase energy from independent generators at inflated prices (PURPA). These programs, as documented in work by Joskow and Marron and others, led utilities to encourage uneconomic levels of conservation, that were paid for by ratepayers not gaining from the subsidies. Over the last 20 years, utilities have had no incentives to encourage inefficient use of energy and a number of incentives to discourage load growth and to encourage levels of energy conservation that could not be justified based on the marginal cost of generation. Competition is already a reality in electricity generation, creating strong incentives to find the lowest cost methods of generating electricity. There is no reason to expect that restructuring or deregulation will lead to higher prices - almost all analysts expect that it will lower prices by weeding out inefficient generators, forcing pricing on an economic rather than accounting basis, and making high levels of energy efficiency less costeffective. Concern about stranded assets is in itself presumptive evidence that delivered electricity prices in some systems are higher than the costs of new generating capacity, and that competition will reduce electricity prices. That implies in turn that in systems that will have stranded assets, there is too much energy conservation produced by the current regulatory environment, not too little. Regional Economic Impacts Q10. Your testimony details some of the energy industries you think will be hardest hit, such as coal, oil & gas, electricity, and oil refining. Could you provide a breakdown on what regions these industries are concentrated in and where the likely impacts will be felt the greatest? A10. The following states include large percentages of energy industries, or industries that are vulnerable to energy cost increases, and will be among the hardest hit. The table below gives our estimates of the percent reduction in Gross State Product due to a policy of limiting U.S. carbon emission to 1990 levels from 2010 onward. The charts below illustrate which industries are affected in some of the most heavily impacted states. |