COMMITTEE ON SCIENCE U.S. HOUSE OF REPRESENTATIVES Hearing on The Road from Kyoto-Part 4: The Kyoto Protocol's Impacts on U.S. Energy Markets and Economic Activity October 9, 1998 Post-Hearing Questions Submitted to Dr. W. David Montgomery Vice President Charles River Associates, Incorporated Questions Submitted by Chairman F. James Sensenbrenner. Jr. Criticism of EIA's 2005 Start for Emissions Reductions Mandated by the Kyoto Protocol Q1. A1. Mr. Geller is very critical of EIA assumption that the U.S. wait until 2005 to begin emissions reductions and say that it is both “dumb” and “would be contrary to the Protocol." What is your realistic assessment of the time it will take to work out all of the Kyoto Protocol details, including the developing country participation issue? Is 2005 pessimistic, realistic, or optimistic? Also, what “start” date do you use in your modeling? The EIA assumption that the U.S. will wait until 2005 to begin emissions reductions is not unreasonable, given current disputes about how the Kyoto Protocol should be implemented. The Administration has stated that the United States will not introduce an emissions trading program in the United States until the 2008 to 2012 budget period. The Administration's proposed subsidies are generally agreed to be insufficient to produce much progress in reducing emissions in the next few years. Using other regulatory programs to provide earlier emissions reductions would increase the cost of compliance, because domestic emissions trading or an equivalent program is required to accomplish emissions reductions at least cost, and has been prohibited by Congress in the recent reconciliation bill. It took about 50 years, from the end of World War II to the creation of the World Trade Organization (WTO), to establish an effective system to monitor and enforce global trade agreements. The economic stakes in the climate treaty are on the same scale as those of recent trade negotiations, such as the Uruguay Round, and also require strong international institutions for monitoring and enforcement. To assume that all this can be country participation are to begin by 2005, is extremely optimistic. In this sense, the EIA starting point of 2005 for global permit trading may well be optimistic. In our modeling, we assume that there is no enforcement of emissions limits until the 2008-2012 budget period, but we assume that agents can foresee these limits and begin to take actions in anticipation of the limits as early as 2000. However, we conclude that relatively little is likely to be done to reduce emissions before 2005, because savings from allowing the capital stock to turn over at its normal rate and discounting of future costs make early emissions reductions relatively costly. Comparison of EIA and Charles River Analyses of the Kyoto Protocol Q2. A2. How do the EIA Kyoto Protocol modeling results compare with those of Charles EIA's modeling results are broadly consistent with those of Charles River Associates (CRA), when certain differences in the scope of the studies are taken into account. Three of our cases--no international trading, full Annex I trading, and full global trading-correspond approximately to the EIA Cases: 1990 - 7%, 1990 + 14%, and 1990 + 23%. The table below compares estimates of required emissions reductions from baseline, GDP loss, and permit prices for these three cases in 2010 and 2020. It includes estimates from EIA and CRA and also from studies recently released by DRI and Battelle (based on the SGM model used by the Administration). EIA's 2010 carbon permit prices are somewhat larger than ours, due at least in part to the fact that the NEMS model has only limited foresight and that EIA appears to have relatively low end-use demand elasticities. Our assumptions are different, but those of EIA are also plausible and defensible. GDP losses in the early years are larger in the EIA study because EIA uses a short-term macro model that includes effects of an energy price shock on the performance of the economy under specific assumptions about the management of monetary policy. These transitional costs are likely, and are not included in our results. The one area where we differ significantly is on the low side. The estimates of potential GDP loss reported by EIA in their report underestimate the minimum cost of the Kyoto Protocol, because of deficiencies in how the DRI model used by EIA captures the real resource cost of limits on energy use. If the direct cost of the Kyoto Protocol in the EIA 1990 - 7% case were calculated using the formula used in the Administration's analysis and EIA's estimates of the price of permits and required emissions reduction, the result would be a cost of about $100 billion in 2010. The potential GDP loss reported by EIA is so far below this minimum estimate that it must be due to the highly simplified Q3. A3. On page 5 of your testimony, you briefly mention the phenomenon of “leakage”, Leakage is measured as the ratio of emissions increases in developing countries to Replicating the Results of the Administration's Economic Analysis Q4. A4. In order to replicate the Administration's carbon emissions permit prices of $14 to $23 per metric ton, how much would U.S. emissions be reduced domestically versus how much would accomplished by purchasing permits abroad? To replicate the Administration's carbon emissions permit prices of $14 to $23 per metric ton, the U.S. would have to purchase from 82 to 88% of its required emissions reduction overseas. This implies domestic emissions reductions of only 12 to 18% of the requirement of 550 million metric tons, or 66 to 99 million tons in 2010. These calculations are documented in the CRA analysis of the Administration estimates submitted with my written testimony. The Second Generation Model (SGM) Q5. A5. The Administration's cost estimates are based on the Second Generation Model (SGM), developed by Pacific Northwest National Laboratory. What are the SGM's limitations, if any, in analyzing near-term economic impacts, such as those that would occur if the Kyoto Protocol were implemented? The SGM is a component of an ambitious and well-respected integrated assessment model developed at Battelle Laboratories. It was designed to drive climate models for analysis policy and technology issues over a 100 to 200 year time horizon. Something must be sacrificed to deal with these long time horizons, and in the case of the SGM it was the short-run dynamics and transition issues required to analyze the full range of near-term impacts. The SGM relies on long -term end-use demand elasticities, and assumes that almost all coal used to generate electric power can be replaced by natural gas by 2010. Moreover, the model measures only direct costs, not the full GDP or welfare impact of reducing emissions, and does not include any macroeconomic impacts of rapidly rising energy prices or costs of shifting resources between sectors or unemployment. It assumes perfect foresight and action beginning now. The chart below is reproduced from the October 1997 analysis performed with the SGM by Jae Edmonds and his colleagues and PNNL. It shows the carbon price required to reduce emissions in the United States by the amounts shown. Based on this cost curve, a carbon price of $7 to $14 per ton (in 1997 dollars) would lead to emissions reductions of about 65 to 100 metric tons in 2010- or 82% to 88% of the U.S. obligation. The chart also shows that to achieve the full reduction required of the U.S. without emissions trading, 550 million tons, would require a carbon permit price of $193 per ton (in 1997 dollars or $170 in 1992 dollars) — exactly the same as the permit price implied by Dr. Yellen's testimony. The measure of direct cost reported by the SGM is computed by integrating under the marginal cost curve or approximating the area under the marginal cost curve by a triangle that has an area equal to one-half of the emissions abated times the permit price (0.5 * 0.550 Billion Metric Tons *$193/Metric ton = $53 Billion 1997 250 200 150 Carbon Price (1992 $ per MT) 100 50 2 Carbon Abatement (Millions of MT) Source: "Return to 1990: The Cost of Mitigating United States Carbon Emissions in the The formula used in the SGM is a well-known formula for calculating the direct economic cost of a tax in a single market, plus the international transfer required to purchase permits from overseas. However, it leaves out costs in all other sectors of the economy, as well as all the dynamic and disequilibrium effects of a sudden shock in the form of higher energy prices or lower availability of energy. Edmonds' SGM is a widely respected ambitious integrated assessment model that covers a Model Structure The SGM was designed as a long-term energy model, assuming costless, instantaneous 10 |