Greenhouse Gases

and the Kyoto Protocol

Over the past several decades, rising concentrations of greenhouse gases have been detected in the Earth's atmosphere. It has been hypothesized that the continued accumulation of greenhouse gases could lead to an increase in the average temperature of the Earth's surface and cause a variety of changes in the global climate, sea level, agricultural patterns, and ecosystems that could be, on net, detrimental.

The Intergovernmental Panel on Climate Change (IPCC) was established by the World Meteorological Organization and the United Nations Environment Programme in 1988 to assess the available scientific, technical, and socioeconomic information in the field of climate change. The most recent report of the IPCC concluded that: "Our ability to quantify the human influence on global climate is currently limited because the expected signal is still emerging from the noise of natural variability, and because there are uncertainties in key factors. These include the magnitudes and patterns of long-term variability and the time-evolving pattern of forcing by. and response to, changes in concentrations of greenhouse gases and aerosols, and land surface changes. Nevertheless, the balance of evidence suggests that there is a discernable human influence on global climate."1

The text of the Framework Convention on Climate Change was adopted at the United Nations on May 9, 1992, and opened for signature at Rio de Janeiro on June 4. The objective of the Framework Convention was to

achieve... stabilization of the greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system." The signatories agreed to formulate programs to mitigate climate change, and the developed country signatories agreed to adopt national policies to return anthropogenic emissions of greenhouse gases to their 1990 levels.

The first and second Conference of the Parties in 1995 and 1996 agreed to address the issue of greenhouse gas

emissions for the period beyond 2000, and to negotiate quantified emission limitations and reductions for the third Conference of the Parties. On December 1 through 11, 1997, representatives from more than 160 countries met in Kyoto, Japan, to negotiate binding limits on greenhouse gas emissions for developed nations. The resulting Kyoto Protocol established emissions targets for each of the participating developed countries-the Annex I countries2-relative to their 1990 emissions levels. The targets range from an 8-percent reduction for the European Union (or its individual member states) to a 10-percent increase allowed for Iceland. The target for the United States is 7 percent below 1990 levels. Although atmospheric concentrations of greenhouse gases are thought to have the potential to affect the global climate, the Protocol establishes targets in terms of annual emissions. Non-Annex I countries have no targets under the Protocol, but the Protocol reaffirms the commitments of the Framework Convention by all parties to formulate and implement climate change mitigation and adaptation programs.

Should the Protocol enter into force, the emissions targets for the developed countries would have to be achieved on average over the commitment period 2008 to 2012. The greenhouse gases covered by the Protocol are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride. The aggregate target is based on the carbon dioxide equivalent of each of the greenhouse gases. For the three synthetic greenhouse gases, countries have the option of using 1995 as the base year.

Several provisions of the Protocol allow for some flexibility in meeting the emissions targets. Net changes in emissions by direct anthropogenic land-use changes and forestry activities may be used to meet the commitment, but they are limited to afforestation, reforestation. and deforestation since 1990. Emissions trading among the Annex I countries is also allowed. No rules for trading were established, however, and the Conference of the Parties is required to establish principles, rules, and guidelines for trading at a future date. According to estimates presented by the Energy Information

Press, 1996).

Administration (EIA) in its International Energy Outlook 19983 there may be 165 million metric tons of carbon permits available from the Annex I countries of the former Soviet Union in 2010. Greenhouse gas emissions for those countries as a group are expected to be 165 million metric tons below 1990 levels in 2010 as a result of the economic decline that has occurred in the region during the 1990s. Additional carbon permits may also be available, depending on the "carbon price" that is established in international trading.

Joint implementation projects are permitted among the Annex I countries, allowing a nation to take emissions credits for projects that reduce emissions or enhance emissions-absorbing sinks, such as forests and other vegetation, in other Annex I countries. The Protocol also establishes a Clean Development Mechanism (CDM). under which Annex I countries can take credits for projects that reduce emissions in non-Annex I countries. In addition, any group of Annex I countries may create a bubble or umbrella to meet the total commitment of all the member nations. In a bubble, countries would agree to meet their total commitment jointly by allocating a share to each member. In an umbrella arrangement, the total reduction of all member nations would be met collectively through the trading of emissions rights. There is potential interest in the United States in entering into an umbrella trading arrangement with Annex I countries outside the European Union.

In 1990, total greenhouse gas emissions in the United States were 1,618 million metric tons carbon equivalent. Of this total, 1,346 million metric tons, or 83 percent, consisted of carbon emissions from the combustion of energy fuels. By 1996, total U.S. greenhouse gas emissions had risen to 1,753 million metric tons carbon equivalent, including 1,463 million metric tons of carbon emissions from energy combustion. EIA's Annual Energy Outlook 1998 (AEO98) projects that energy-related carbon emissions will reach 1,803 million metric tons in 2010, 34 percent above the 1990 level. Because energyrelated carbon emissions constitute such a large percentage of the Nation's total greenhouse gas emissions, any action or policy to reduce emissions will have significant implications for U.S. energy markets.

At the request of the U.S. House of Representatives Committee on Science, EIA performed an analysis of the Kyoto Protocol, focusing on the potential impacts of the Protocol on U.S. energy prices, energy use, and the economy in the 2008 to 2012 time frame. The request

specified that the analysis use the same methodologies and assumptions employed in the AEO98, with no changes in assumptions about policy, regulatory actions, or funding for energy and environmental programs.

Methodology

The international provisions of the Kyoto Protocol. including international emissions trading between Annex I countries, joint implementation projects, and the CDM, may reduce the cost of compliance in the United States. Guidelines for those provisions, however, remain to be resolved at future negotiating meetings, and rules and guidelines for the accounting of emissions and sinks from activities related to agriculture, land use, and forestry activities must be developed. The specific guidelines may have a significant impact on the level of reductions from other sources that a country must undertake. Reductions in the other greenhouse gases may also offset the reductions required from carbon dioxide. A fact sheet issued by the U.S. Department of State on January 15, 1998, estimated that the method of accounting for sinks and the flexibility to use 1995 as the base year for the synthetic greenhouse gases may reduce the target to 3 percent below 1990 levels. A similar estimate was cited by Dr. Janet Yellen, Chair, Council of Economic Advisers, in her testimony before the House Committee on Commerce, Energy and Power Subcommittee, on March 4, 1998.7

Because the exact rules that would govern the final implementation of the Protocol are not known with certainty, the specific reduction in energy-related emissions cannot be established. This analysis includes cases that assume a range of reductions in energy-related carbon emissions in the United States. Each case was analyzed to estimate the energy and economic impacts of achieving an assumed level of reductions.

A reference case and six carbon emissions reduction cases were examined in this report. The cases are defined as follows:

• Reference Case (33 Percent Above 1990 Levels). This case represents the reference projections of energy markets and carbon emissions without any enforced reductions and is presented as a baseline for comparisons of the energy market impacts in the reduction cases. Although this reference case is

1See web site www.house.gov/commerce/database.htm.

based on the reference case from AEO98, there are small differences between this case and AEO98, in order to permit additional flexibility in response to higher energy prices or to include certain analyses previously done offline directly within the modeling framework, such as nuclear plant life extension and generating plant retirements. Also, some assumptions were modified to reflect more recent assessments of technological improvements and costs. As a result of these modifications, the projection of energy-related carbon emissions in 2010 is slightly reduced from the AEO98 reference case level of 1,803 million metric tons to 1,791 million metric tons.

⚫ 24 Percent Above 1990 Levels (1990+24%). This case assumes that carbon emissions can increase to an average of 1.670 million metric tons between 2008 and 2012, 24 percent above the 1990 levels. Compared to the average emissions in the reference case, carbon emissions are reduced by an average of 122 million metric tons each year during the commitment period.

⚫ 14 Percent Above 1990 Levels (1990+14%). This case assumes that carbon emissions average 1,539 between 2008 and 2012, approximately at the level estimated for 1998 in AEO98, 1,533 million metric tons. This target is 14 percent above 1990 levels and represents an average annual reduction of 253 million metric tons from the reference case.

⚫9 Percent Above 1990 Levels (1990+9%). This case assumes that energy-related carbon emissions can increase to an average of 1,467 million metric tons between 2008 and 2012, 9 percent above 1990 levels, an average annual reduction of 325 million metric tons from the reference case projections.

• Stabilization at 1990 Levels (1990). This case assumes that carbon emissions reach an average of 1,345 million metric tons during the commitment period of 2008 through 2012, stabilizing approximately at the 1990 level of 1,346 million metric tons. This is an average annual reduction of 447 million metric tons from the reference case.

⚫ 3 Percent Below 1990 Levels (1990-3%). This case assumes that energy-related carbon emissions are reduced to an average of 1,307 million metric tons between 2008 and 2012, an average annual reduction of 485 million metric tons from the reference case projections.

⚫ 7 Percent Below 1990 Levels (1990-7%). In this case, energy-related carbon emissions are reduced from the level of 1,346 million metric tons in 1990 to an average of 1,250 million metric tons in the commitment period, 2008 to 2012. Compared to the reference case, this is an average annual reduction of 542 million metric tons of energy-related carbon

emissions during that period. This case essentially assumes that the 7-percent target in the Kyoto Protocol must be met entirely by reducing energy-related carbon emissions, with no net offsets from sinks, other greenhouse gases, or international activities. In each of the carbon reduction cases, the target is achieved on average for each of the years in the first commitment period, 2008 through 2012 (Figure ES1). Because the Protocol does not specify any targets beyond the first commitment period, the target is assumed to hold constant from 2013 through 2020, the end of the forecast horizon (although more or less stringent requirements may be set by future Conferences of the Parties). The target is assumed to be phased in over a 3-year period, beginning in 2005, because the Protocol indicates that demonstrable progress toward reducing emissions must be shown by 2005. The phase-in allows energy markets to begin adjustments to meet the targets in the absence of complete foresight; however, a longer or more delayed phase-in could lower the adjustment costs-an option that is not considered here. In this analysis, some carbon reductions are expected to occur before 2005 as the result of capacity expansion decisions by electricity generators that incorporate their expectations of future increases in energy prices.

fuels relative to its carbon content at its point of consumption. Electricity does not directly receive a carbon fee; however, the fossil fuels used for generation receive the fee, and this cost, as well as the increased cost of Investment in generation plants, is reflected in the delivered price of electricity. In practice, these carbon prices could be imposed through a carbon emissions permit system.

In this analysis, the carbon prices represent the marginal cost of reducing carbon emissions to the specified level, reflecting the price the United States would be willing to pay in order to purchase carbon permits from other countries or to induce carbon reductions in other countries. In the absence of a complete analysis of trade and other flexible mechanisms to reduce carbon emissions internationally, the projected carbon prices do not necessarily represent the international market-clearing price of carbon permits or the price at which other countries would be willing to offer permits.

The projections in AEO98 and in this analysis were developed using the National Energy Modeling System (NEMS), an energy-economy modeling system of U.S. energy markets, which is designed, implemented, and maintained by EIA. The production, imports, conversion, consumption, and prices of energy are projected for each year through 2020, subject to assumptions on macroeconomic and financial factors, world energy markets, resource availability and costs, behavioral and technological choice criteria, costs and performance characteristics of energy technologies, and demographics. NEMS is a fully integrated framework, capturing the interactions of energy supply, demand, and prices across all fuels and all sectors of U.S. energy markets. NEMS provides annual projections, allowing the representation of the transitional effects of proposed energy policy and regulation.

NEMS includes a detailed representation of capital stock vintaging and technology characteristics, capturing the most significant factors that influence the turnover of energy-using and producing equipment and the choice of new technologies. The residential, commercial, transportation, electricity generation, and refining sectors of NEMS include explicit treatments of individual known technologies and their characteristics, such as initial cost, operating cost, date of commercial availability, efficiency, and other characteristics specific to the sector. Unknown technologies are not likely to be developed in time to achieve significant market penetration within the time frame of this analysis. Higher energy prices, as a result of carbon prices, for example, do not alter the characteristics or availability of energy-using technologies. However, higher prices induce more rapid adoption of more efficient or advanced technologies, because

consumers would have more incentive to purchase them.

In addition, for new generating technologies, the electricity sector accounts for technological optimism in the capital costs of first-of-a-kind plants and for a decline in the costs as experience with the technologies is gained both domestically and internationally. In each of these sectors, equipment choices are made for individual technologies as new equipment is needed to meet growing demand for energy services or to replace retired equipment. In the other sectors-industrial, oil and gas supply, and coal supply--the treatment of technologies is somewhat more limited due to limitations on the availability of data for individual technologies; however, technology progress is represented by efficiency improvements in the industrial sector, technological progress in oil and gas exploration and production activities, and productivity improvements in coal production.

Carbon Reduction Cases Carbon Prices

In 2010, the carbon prices projected to be necessary to achieve the carbon emissions reduction targets range from $67 per metric ton (1996 dollars) in the 1990+24% case to $348 per metric ton in the 1990-7% case (Table ESI and Figure ES2). In the 1990+24% case, carbon prices generally increase from 2005 through 2020 (Table ES2 and Figure ES2). In the 1990+14% and 1990+9% cases, the carbon prices increase through 2013 and then essentially flatten.

In the three other carbon reduction cases, the carbon price escalates more rapidly in order to achieve the more stringent carbon reductions in the commitment period. The carbon price then declines as cumulative investments in more energy-efficient and lower-carbon equipment, particularly in the electricity generation sector. reduce the marginal cost of compliance in the later years of the forecast. These investments reduce the demand for carbon permits over an extended period of time. offsetting growth in energy demand and moderating the carbon prices. Figure ES3 shows the average carbon prices required to achieve the average carbon reductions.

Sectoral Impacts

As a result of the carbon prices and higher delivered energy prices, the overall intensity of energy use declines in the carbon reduction cases. Energy Intensity, measured in energy consumed per dollar of gross

domestic product (GDP), declines (i.e., improves) at an average annual rate of 1 percent between 2005 and 2010 in the reference case due to the availability and adoption of more efficient equipment. In the carbon reduction cases, higher rates of improvement are projected-from 1.6 percent a year in the 1990+24% case to triple the reference case rate at 3.0 percent a year in the 1990-7% case.

In 2010, reductions in carbon emissions from electricity generation account for between 68 and 75 percent of the total carbon reductions across the cases. Electricity consumption is projected to be lower than in the reference case, with more efficient, less carbon-intensive technologies used for electricity generation. In all the carbon reduction cases except the 1990+24% case, carbon emissions from electricity generation in 2010 are lower than the actual 1990 level of 477 million metric tons of carbon emissions from the electricity supply sector. Electricity generators are expected to respond more strongly than end-use consumers to higher prices because this industry has traditionally been cost-minimizing, factoring future energy price increases into investment decisions. In contrast, the end-use consumers are assumed to consider only current prices in making their investment

decisions and to consider additional factors, not only price, in their decisions. In addition, there are a number of more efficient and lower-carbon technologies for electricity generation that become economically available as the cost of generating electricity from fossil fuels increases.

Total electricity generation is lower in the carbon reduction cases because electricity sales range from 4 to 17 percent below the reference case in 2010 (Figure ES4). Reduction in electricity demand in response to higher electricity prices is somewhat mitigated by the change in relative prices. In 2010, electricity prices are between 20 and 86 percent above the reference case across the carbon reduction cases; however, delivered natural gas prices are higher by between 25 and 147 percent. With a smaller percentage price increase, electricity becomes more attractive in those end uses where it competes with natural gas, such as home heating.

Although reduced demand for electricity and efficiency improvements in the generation of electricity contribute to the total reductions in carbon emissions from electricity generation, fuel switching accounts for most