efficiency improvements that are purely autonomous and thus independent of both energy prices and energy policies. In modeling energy efficiency improvement, these three components are addressed in different ways. For the autonomous energy efficiency factor (AEEI), a plausible assumption is an improvement of about 1.0 percent per year. The developers of the Second Generation Model employ an AEEI of 0.96 percent per year as their default energy efficiency assumption. Similarly, the Energy Information Administration analysis (see Energy Information Administration 1997a) assumes a pace of energy efficiency improvement of 0.9 percent. In this analysis, we used the SGM default assumption concerning the autonomous energy efficiency parameter. For priceinduced changes in energy efficiency, the model generates its own forecasts of changes in energy consumption that reflect the effects of greenhouse gas permit prices on energy prices. Economists have traditionally had difficulty in modeling non-price policy-induced shifts in energy efficiency. For example, it is hard to assess the likely future pay-off from investments in energy R&D, although historical estimates of the rate of return to society from such investments are substantial. Similarly, the series of policy measures proposed by the Administration -- such as the Administration's electricity restructuring proposal, the Climate Change Technology Initiative, its voluntary sectoral initiatives, the federal sector's own energy efficiency program or other measures that could be adopted to spur the diffusion and adoption of existing technologies -- could substantially reduce the cost of mitigation and increase the amount of reductions achieved domestically. However, models like the Second Generation Model do not have the capacity to quantify these potential payoffs. Some authorities in the field of energy policy, using an engineering approach rather than an economic paradigm, have sought to quantify the extent to which policy initiatives could spur more rapid improvements in energy efficiency. Experts at five national laboratories managed by the Department of Energy found that a third of the emissions reductions necessary to return to 1990 levels by 2010 could be achieved through the adoption of existing energy-efficiency technologies at no net resource cost. This translates into a non-price policy related efficiency contribution of 0.3% per year (Interlaboratory Working Group on Energy-Efficient and Low-Carbon Technologies 1997). The National Academy of Sciences reached qualitatively similar conclusions in a 1992 report. As reflected in the Department of Energy study, if a higher rate of energy efficiency improvement were achieved, the United States could meet a correspondingly larger fraction of its commitment through domestic reductions potentially at lower permit prices. 15(...continued) policy-induced components. Trading Scenarios Intergas Trading We assumed that trading occurs across all gases based on 100-year global warming potential values. Trading Blocs The Administration assessed three different industrialized country trading blocs. Annex I implies trading among all Annex I countries. Umbrella without Eastern Europe refers to trading among a subset of Annex Umbrella with Eastern Europe refers to trading among a subset of Annex I countries, excluding participation by the European Union. In addition, we assessed two forms of developing country participation in conjunction with the industrial country trading blocs. Developing countries generate emissions credits through the Clean Development Mechanism and sell them internationally. The CDM is assumed to provide 20% of emissions reductions that a country would otherwise undertake if it agreed to a target at business as usual and participated in international trading. Key developing countries are assumed to adopt emissions growth targets equal to their 2010 business as usual emissions level and participate in international emissions trading. Trading across Time This analysis assessed the permit price in 2010, the midpoint of the first commitment period. Since SGM is a computable general equilibrium model, all outputs are predicated on the full use of the economy's resources, so the analysis implicitly assumes an averaging out of business cycles, weather induced energy use fluctuations, and other short-term phenomena. This smoothing out is consistent with the effect of the five-year averaging period between 2008 and 2012. The permit price estimates for 2010 therefore provide a reasonable representation of the average permit price over 2008-2012. Banking This analysis did not incorporate the banking provision in the Kyoto Protocol. To model banking behavior, it is necessary to know the emissions targets for subsequent commitment periods. Since these targets have not been established yet, any assumption about future emissions targets would be speculative. Identifying market clearing prices for trading blocs After developing the baselines and cost functions, we calculated the market clearing prices for the trading blocs. Market clearing prices were estimated by constructing functions for the marginal cost of abatement of greenhouse gas emissions in each trading bloc. Given the greenhouse gas emissions reductions required by the Kyoto agreement for the countries within the trading bloc, these functions allow for the identification of marginal cost of abatement, and the unique price for permits traded among the countries comprising the bloc. Calculating the Effects on Energy Prices Reducing greenhouse gas emissions, in particular carbon dioxide emissions, would, in effect, modestly raise energy prices. At the same time, these higher prices would have the effect of reducing energy consumption by a modest amount, as firms and households cut back on some low-value uses of energy. Tradable greenhouse gas permits would also cause some shift in the fuel mix, away from carbon-intensive fuels like coal, and toward carbon-lean and carbon-free fuels, like natural gas, nuclear, and hydropower. Households would hardly notice this fuel mix shift, however, as most of it would occur at power plants. Summary of Assumptions of Illustrative Analysis The following list summarizes the assumptions in the illustrative modeling analysis described in the preceding section on methodology. Efficient and effective domestic trading of emissions allowances. International trading of emissions allowances (within each of three possible blocs). Efficient and effective Annex I trading. Efficient and effective Umbrella trading. Efficient and effective trading with developing countries that adopt emissions targets. Trading across all six categories of greenhouse gases. Autonomous energy efficiency improvement (AEEI) value of 0.96% per year. No banking of emissions allowances to second or later commitment periods. Emissions targets are expressed in terms of all six categories of greenhouse gases. Marginal abatement costs for carbon dioxide from SGM outputs. Marginal abatement costs for non-carbon dioxide greenhouse gases for U.S. Marginal abatement costs for non-carbon dioxide greenhouse gases for other countries assumed to be the same as the costs for carbon dioxide. No emissions mitigation through carbon sinks for any country included in the analysis (see p. 62). No emission reductions from the Administration's electricity restructuring proposal included in the analysis (see p. 64). No emissions reductions from the Climate Change Technology Initiative included in the analysis (see p. 64). No emissions reductions from industries' voluntary plans through the No emissions reductions from the Federal government's energy efficiency initiative included in the analysis (see p. 66). No estimate of the benefits of addressing risks associated with climate change (see p. 69). Economic Cost of the Administration's Policies to Reduce Greenhouse Gas Emissions in the Illustrative Analysis The flexibility measures embodied in the Kyoto Protocol and the Administration's climate change approach could dramatically reduce the costs of complying with the Protocol (see Figure 19 and Table 4.) An effective international market for trading emissions permits among industrialized countries -- even without taking into account the added benefit of including key developing countries -- would potentially lower the resource cost to the United States of climate change policy by more than half relative to a scenario in which all abatement is performed domestically and would lower the price for emission permits (expressed as carbon equivalent) by nearly three Figure 19. Percentage Reductions in Resource Costs Relative to "Domestic |