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curve shows that, except for a limited number of peak hours, the price of generating electricity is relatively constant. Therefore, in a fully competitive market, the generation price is similar for all customer classes.

Although both transmission and distribution are assumed to be regulated, there is reason to believe that the unbundling of generation from transmission and distribution may provide medium and large consumers with a greater ability to obtain price concessions from the operator of the distribution system. Specifically, under the new market structure, some consumers may have the ability to bypass the distribution system at relatively low cost by connecting directly to the transmission system or building an on-site generator. Concessionary pricing, i.e., changes in the allocation of fixed costs among the customer classes, may be necessary to retain such customers.

Figure 21 compares the industrial price in the reference case with that in the fully competitive case, including concessionary pricing of transmission and distribution. As a counterpoint, another projection is shown, based on the assumption that industrial customers would be unable to obtain any additional concessions from the operators of the transmission and distribution system (no concessionary pricing). If average generation prices by customer class tend to converge, it is possible that industrial prices could rise significantly above the reference case price without reallocation of costs within the regulated transmission and distribution sector. Prices would be modestly higher than those in the reference case if such reallocation occurred.

Figure 22 compares national sectoral prices in the fully competitive market case with those in the reference case. Given that similar efficiency improvements are assumed in the reference and full competition cases, it is not surprising that the price paths are similar. However, this analysis assumes that, if pricing is nondiscriminatory in the generation market, larger customers will nonetheless maintain their ability to achieve lower rates through market pressures on the remaining regulated portions of the industry.

Figure 22. U.S. electricity prices by end-use sector in the reference and full competition cases, 1999-2020 (1997 mills per kilowatthour)

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Although the approach toward analyzing sectoral prices represents an advance over previous ELA analyses, a great deal of uncertainty remains. Clearly, the precise market structures that evolve will have a significant effect on price, as will the extent and speed at which new technologies, as well as market forces, influence the ratemaking process. Moreover, the validity of these projections depends on the consistency between ELA's assumptions about market structures and their actual

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performance. Finally, any assumptions about regulators' behavior are subject to changes in the overall regulatory environment.

Gasoline Sulfur Reduction

In early 1999, the U.S. Environmental Protection Agency (EPA) is expected to propose tighter restrictions on the amount of sulfur allowed in gasoline. Because gasoline sulfur and automotive emissions are linked, the proposal will be issued in conjunction with the new "Tier 2" vehicle exhaust emissions standards that would take effect between model years 2004 and 2007 (see "Legislation and Regulations," page 11). Sulfur reduces the effectiveness of the catalyst used in the emissions control systems of advanced technology engines, increasing their emissions of hydrocarbons, carbon monoxide, and NO.. As a result, gasoline with significantly reduced sulfur levels will be required for the control systems to work properly and meet the new Tier 2 standards.

The EPA has been considering lowering the average annual sulfur content of gasoline to between 150 and 30 parts per million (ppm), from the existing standard of 1,000 ppm. The current national average gasoline sulfur content is 340 ppm [31]. The existing limit for all gasoline in California is an annual average of 30 ppm, with a cap of 80 ppm, or a flat (unaveraged) limit of 40 ppm. Discussions of California-like sulfur limits may be framed in terms of a "30 ppm" or a "40 ppm" limit, but for all intents and purposes, the two are the same.

A joint study by the EPA and the U.S. Department of Energy (DOE) put preliminary sulfur reduction costs for East Coast and Gulf Coast refiners at 5.1 to 8.0 cents a gallon for 40 ppm gasoline and 1.1 to 1.8 cents a gallon for 150 ppm gasoline. A study sponsored by the American Automobile Manufacturers Association estimated the cost of reducing sulfur to 40 ppm at 5.5 cents a gallon for refiners in the eastern half of the country. Another study sponsored by the American Petroleum Institute (API) estimated the costs of sulfur reduction at 5.1 cents a gallon for 40 ppm gasoline and 2.7 cents a gallon for 150 ppm gasoline [32].

Although there is a broad consensus that gasoline sulfur must be reduced, the level of reduction and the application of the requirement have been intensely debated. In addition to determining the

Issues in Focus

appropriate sulfur level, the EPA is considering whether to make sulfur reduction a national or regional requirement. The range of sulfur reduction options under consideration by the EPA is bounded by proposals from two groups: automakers-the American Automobile Manufacturers Association and the Association of International Automobile Manufacturers and gasoline producers the American Petroleum Institute (API) and the National Petrochemical and Refiners Association (NPRA). AEO99 includes the two proposals as alternative cases to explore their potential impacts on the long-term projections of gasoline supply and prices.

The automakers propose to reduce the average allowable sulfur content of gasoline in the United States to 40 ppm, which is equivalent to the current standard in the State of California. The API/NPRA submitted a less stringent regional proposal in which all gasoline in Federal reformulated gasoline areas, in 23 States, and in East Texas would meet an annual average of 150 ppm [33]; gasoline in California would continue to meet the State's gasoline requirements, including the 40 ppm annual average sulfur limit; and gasoline in all other parts of the country would have an annual average of 300 ppm. API/NPRA proposes further sulfur reductions by 2010 in areas that require year-round NO, control. The areas of coverage and the level of sulfur reductions would be determined by an EPA study. In the API/NPRA analysis case, all the areas required to use 150 ppm gasoline in 2004 were assumed to require further reductions to 40 ppm by 2010.

As expected, the price impact is greater in the case based on the automakers' proposal (which is a more severe, nationwide plan) than in the API/NPRA case. Both cases assume that the additional costs associated with sulfur reductions would be passed on to consumers. Relative to the AEO99 reference case, the API/NPRA scenario increases the average price of gasoline by 1.3 cents a gallon in 2004 and by 4.9 cents a gallon in 2010. The automakers' scenario increases the price by 8.3 cents a gallon in 2004 and 6.8 cents in 2010. The API/NPRA scenario increases total consumer spending for gasoline by $1.8 billion in 2004 relative to the AEO99 reference case and by $7.6 billion in 2010. In the automakers' scenario, the corresponding increases are $11.7 billion in 2004 and $10.5 billion in 2010. In both cases, the price

Issues in Focus

increases reflect investments in sulfur reduction processes at refineries, as well as changes in the selection of refinery inputs.

Before 2010, the cost of sulfur reduction is lower in the API/NPRA scenario because sulfur reduction to the 300 and 150 ppm levels can be achieved largely by adjustments in refinery processes. On the other hand, sulfur reduction to the 40 ppm level, reflected in the automakers' scenario and after 2010 in the API/NPRA scenario, can only be achieved by more costly refinery upgrades, including naphtha hydrotreating, gas oil desulfurization, alkylation, and hydrogen units.

An interesting feature of both scenarios is that they lead to a projected increase in domestic production of gasoline and blending components relative to the reference case projections, with a corresponding reduction in projected imports. On the other hand, the reductions in imports of gasoline and blending components are more than offset by increased requirements for crude oil imports. The net result is that imports represent the same share of total projected petroleum requirements in the API/NPRA scenario as in the AEO99 reference case and a slightly higher percentage in the automakers' scenario.

The Kyoto Protocol and

Carbon Emissions

Greenhouse Gas Emissions and the
Framework Convention

The greenhouse effect is a natural process by which some of the radiant heat from the sun is captured in the lower atmosphere of the Earth, thus maintaining the temperature of the Earth's surface. The gases that help capture the heat, called "greenhouse gases," include water vapor, carbon dioxide, methane, nitrous oxide, and a variety of manufactured chemicals. Some are emitted from natural sources; others result from anthropogenic, or human, activities. Over the past several decades, rising concentrations of greenhouse gases have been detected in the Earth's atmosphere, and it has been suggested that this may lead to an increase in the average temperature of the Earth's surface and consequently to detrimental effects.

In 1988, the Intergovernmental Panel on Climate Change (IPCC) was established by the World Meteorological Organization and the United Nations Environment Programme to assess the 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 magnitude and patterns of long term natural 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 sug. gests that there is a discernible human influence on global climate" [34].

Following a series of negotiating sessions, 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, Brazil, 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 sig natories agreed to formulate programs to miti gate climate change. Furthermore, the developed country signatories agreed to adopt national policies to return anthropogenic emissions of greenhouse gases to their 1990 levels. The Convention excludes chlorofluorocarbons (CFCs) and hydrochlorofluorocarbons (HCFCs), greenhouse gases that are deemed to cause damage to the Earth's stratospheric ozone and are controlled by the 1987 Montreal Protocol on Substances that Deplete the Ozone Layer.

Responding to the Framework Convention, on April 21, 1993, President Clinton called upon the United States to stabilize greenhouse gas emissions by 2000 at 1990 levels. Specific steps to achieve U.S. stabilization were enumerated in the Climate Change Action Plan (CCAP) [35], published in October 1993, which consists of a series of 44 actions to reduce greenhouse gas emissions. These actions include voluntary programs, industry partnerships,

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government incentives, research and development, regulatory programs, including energy efficiency standards, and forestry actions. Greenhouse gases affected by these actions include carbon dioxide, methane, nitrous oxide, hydrofluorocarbons (HFCs), and perfluorocarbons (PFCs). At the time CCAP was developed, the Administration estimated that the actions in CCAP would reduce the total net emissions [36] of these greenhouse gases to 1990 levels by 2000.

In addition to the climate-related actions of CCAP, the Energy Policy Act of 1992 (EPACT), Section 1605(a), provided for an annual inventory of U.S. greenhouse gas emissions, which is contained in the EIA publication series, Emissions of Greenhouse Gases in the United States [37]. Also, Section 1605(b) of EPACT established the Voluntary Reporting Program, permitting corporations, government agencies, households, and voluntary organizations to report to ELA on actions that have reduced or avoided emissions of greenhouse gases. The results of the Voluntary Reporting Program are reported annually by EIA, most recently in Mitigating Greenhouse Gas Emissions: Voluntary Reporting 1996 [38]. Entities providing data to the Voluntary Reporting Program include some participants in government-sponsored voluntary programs, such as the Climate Wise and Climate Challenge programs, which are cosponsored by the EPA and DOE to foster reductions in greenhouse gas emissions by industry and electricity generators.

The Kyoto Protocol

The Framework Convention established the Conference of the Parties to "review the implementation of the Convention and... make, within its mandate, the decisions necessary to promote the effective implementation." 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 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 for greenhouse gas emissions for developed nations. In the resulting Kyoto Protocol, emissions targets were established for these nations, the Annex I countries

Issues in Focus

[39], relative to their emissions in 1990, to achieve an overall reduction of about 5.2 percent [40].

The individual targets for the Annex I countries range from an 8-percent reduction for the European Union (EU) (or its individual member states) to a 10percent increase allowed for Iceland. Australia and Norway are also allowed increases of 8 and 1 percent, respectively, while New Zealand, the Russian Federation, and the Ukraine are held to their 1990 levels. Other Eastern European countries undergoing transition to a market economy have reduction targets of between 5 and 8 percent. The reduction targets for Canada and Japan are 6 percent and for the United States 7 percent. Non-Annex I countries have no targets under the Protocol, although the Protocol reaffirms the commitments of the Framework Convention by all parties to formulate and implement climate change mitigation and adaptation programs.

The greenhouse gases covered by the Protocol are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride [41]. The aggregate target is established using 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. Sources of emissions include energy combustion, fugitive emissions from fuels, industrial processes, solvents, agriculture, and waste management and disposal. The Protocol does not prescribe specific actions to be taken but lists a number of potential actions, including energy efficiency improvements, enhancement of carbonabsorbing sinks, such as forests and other vegetation, research and development of sequestration technologies, phasing out of fiscal incentives and subsidies that may inhibit the goal of emissions reductions, and reduction of methane emissions in waste management and in energy production, distribution, and transportation.

The targets must be achieved on average over the commitment period 2008 to 2012, the first commitment period. Each country can average its emissions over that 5-year period to establish compliance, smoothing out short-term fluctuations that might occur due to economic cycles or extreme weather patterns. Countries must have made demonstrable

Issues in Focus

progress by 2005, but no targets are established for the period after 2012 (although lower targets may be set by future Conferences of the Parties). Banking-carrying over of unused allowances from one commitment period to the next-is allowed; however, the borrowing of emissions allowances from a future commitment period is not permitted.

Several provisions of the Protocol allow for some flexibility in meeting the emissions targets. Net changes in emissions by direct anthropogenic landuse changes and forestry activities will also be used in meeting the commitment; however, they are limited to afforestation, reforestation, and deforestation since 1990. Emissions trading among the Annex I countries is permitted. According to EIA's International Energy Outlook 1998 (IEO98) [42], the amount of carbon that may be available for trade from the Annex I countries of the former Soviet Union as a result of the economic decline in those countries in the 1990s is estimated at 165 million metric tons in 2010. Also, additional carbon permits may be available. Joint implementation projects are allowed 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. It is specifically indicated that trading and joint implementation are supplemental to domestic actions.

The Protocol also establishes a Clean Development Mechanism (CDM), under which Annex I countries can earn credits for projects that reduce emissions in non-Annex I countries provided that the projects lead to measurable, long-term benefits. Reductions from such projects undertaken from 2000 until the first commitment period can be used to assist with compliance in the first commitment period. This provision calls for the establishment of an executive board to oversee the projects. In addition, an unspecified share of the proceeds from the project activities must be used to cover administrative expenses and to assist with adaptation in countries that are particularly vulnerable to climate change.

Annex I countries, such as the EU, may create a bubble or umbrella to meet the total commitment of all the member nations. In a bubble, countries agree to meet the total commitment jointly by allocating a share to each member. In an umbrella arrangement,

the total reduction of all member nations is met collectively through the trading of emissions rights. There is potential interest in the United States entering into an umbrella trading arrangement.

The Protocol became open for signature on March 16, 1998, for a one-year period. It enters into force 90 days following the acceptance by 55 Parties, including Annex I countries accounting for at least 55 percent of the 1990 carbon dioxide emissions from Annex I nations. Signature by the United States would need to be followed by Senate ratification. As of September 29, 1998, 57 countries had signed the Protocol, including 26 Annex I nations that accounted for about 38 percent of Annex I carbon emissions in 1990.

In 1990, total greenhouse gas emissions in the United States were 1,633 million metric tons carbon equivalent. Of this total, 1,346 million metric tons, or 82 percent, was due to carbon emissions from the combustion of energy fuels. By 1997, total U.S. greenhouse gas emissions had risen to 1,791 million metric tons carbon equivalent, of which 83 percent, or 1,480 million metric tons, were carbon emissions from energy combustion. EIA now projects that energy-related carbon emissions will reach 1,790 million metric tons in 2010, 33 percent above the 1990 level, increasing to 1,975 million metric tons in 2020. Because energy-related carbon emissions constitute such a large percentage of the total greenhouse gas emissions, any action or policy to reduce emissions will affect U.S. energy markets; however, there are a number of factors outside the domestic energy market that influence emissions and may offset the impacts on domestic energy.

To put U.S. emissions in a global perspective, the United States produced about 24 percent of the worldwide energy-related carbon emissions in 1996, which totaled 6.0 billion metric tons, according to IEO98. Although carbon emissions continue to increase in the United States and other industrialized countries, they are increasing at a much more rapid rate in the developing countries of Asia, the Middle East, Africa, and Central and South America. As a result, global carbon emissions from energy are expected to increase at an average annual rate of 2.4 percent from 1996 through 2010, reaching 8.3 billion metric tons, to which the United States is expected to contribute about 22 percent.

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