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 time period of 200 years and includes a long-term technology assessment component as well as a sophisticated carbon cycle model that computes impacts on carbon concentrations in the atmosphere. Within this integrated assessment model there is a simplified model of international trade and national economic impacts. The trade model includes 12 regions and 9 sectors. Model Structure The SGM was designed as a long-term energy model, assuming costless, instantaneous 10 approach in a model that covers transitions among technologies and resources over a period of a century or more, but makes the model an inappropriate choice for investigating economic impacts over a period of little more than a decade. Indeed, the Interagency Analysis Team report suggested that the SGM was designed in a way that could underestimate costs. The model also has a simple representation of international trade, which makes it impossible for the SGM to address issues of international competitiveness. In simple terms, the only international market affected by emissions limits is the market for carbon emissions permits. Either the prices or the quantities of all other goods are fixed at baseline levels, so that, despite its disaggregation, the SGM does not allow for shifting of investment in energy-intensive industries out of Annex I countries. Cost Coverage The most important feature of the SGM for purposes of understanding why it reports lower costs than virtually any other well formulated economic model is that only direct costs in energy markets are measured. In reporting the costs of carbon limits, the SGM ignores adjustments and costs in the rest of the economy. This is why in the Yellen testimony economic losses are referred to as “direct cost as a % of GDP." Direct costs are calculated as one-half the price of carbon permits times the change in carbon emissions plus the price of permits times the number of permits purchased internationally. In a number of studies in which general equilibrium models have been used to analyze the overall economic impact of regulatory programs, it has been found that the total GDP loss reported by general equilibrium models typically exceeds direct costs by a factor of 3 to 4. This is true of work done by Jorgenson and Wilcoxen using the DGEM model to estimate the cost of air quality regulations, of work by Kopp and Hazilla done in the early 1980s, and of the CRA model. Thus, the reporting of costs in SGM, unless carefully qualified as to the limited nature of the costs being estimated, can appear to understate costs by a factor of two to four. Assumptions One of the most critical assumptions in the SGM deals with electric utilities. The technology choice model in the SGM compares the total cost of a new gas-fired powerplant to the cost of operating an existing coal-fired powerplant. The technology, fuel costs, and heat rates in the SGM database lead to the conclusion that, with a permit price of just between $100 and $200 per ton, utilities would convert all their existing coalfired powerplants to new natural gas combined cycle units. The SGM allows all these conversions to occur in 2010 and assumes some increase in cost as more conversions take place, but almost all existing coal capacity is assumed to be convertible by 2010 at a cost of no more than $2000 per ton. This means that the carbon permit price cannot exceed This is a very optimistic view of how rapidly utilities can or will scrap their existing coalfired generating capacity, especially in view of how uncertain the implementation of the Kyoto agreement is at present. If, in particular, international emissions trading does hold the cost of carbon permits under $25 per ton, there will be no incentives for utilities to engage in any replacement of coal with natural gas. Even if higher carbon prices come about, the replacement of the entire current stock of coal-fired generating equipment is a massive undertaking that will require an extensive permitting and approval process for land use and environmental impacts. Significant expansions of natural gas delivery capability would be required, as well as increases in gas exploration and development to make additional natural gas supplies available. Finally, coal producers and unions are likely to respond with price and wage reductions, or with enforcement of take-or-pay provisions in existing contracts. Either of these responses significantly changes the economics of natural gas replacement. Other models, such as MERGE developed by Alan Manne and Richard Richels, which also describe the process of electricity generation in some detail, place constraints on the amount of coal capacity that can be replaced by 2010. If only for balance and to present a full range of possible outcomes, a case in which less easy replacement of coal with natural gas should be considered. Role of Technology Q6. A6. Mr. Geller is very optimistic that a “technology-oriented approach” can create new industries and jobs, save consumers and businesses money, and greatly reduce greenhouse gas emissions without harming the economy. His testimony is very similar to what we heard from Department of Energy officials last year when they testified on the “Five-Lab” study. Would you please comment on the points made by Mr. Geller? If it were possible to achieve the kinds of costless improvements in efficiency alleged by Mr. Geller, these reductions would be taking place as consumers pursue their own economic advantage in response to price signals in competitive energy markets. The EIA baseline and ours assume considerable progress in improving energy efficiency, more than has actually been achieved recently during an era of stable energy prices. Mr. Geller is seriously mistaken on how long it takes technology to develop and diffuse through the economy. For example, recent reviews of the Partnership for a New Generation Vehicle done by the National Academy of Sciences concluded that, even if successful, the technologies under development would not make a significant different in automobile fuel consumption until 2020 or later. This is because of the time required to develop technologies, design new vehicles incorporating the technologies, build up capacity to produce the vehicles, and have new vehicles replace existing vehicles. With cars lasting 15 years or more, the fleet turnover makes any introduction of more efficient vehicles very |