the 1990-3% case, but in 2020 it is about 1.8 quadrillion Btu higher. Somewhat lower energy prices induce higher consumption in all sectors, and the availability of more carbon-free nuclear generation allows the carbon reduction target to be met with higher end-use consumption.

Uncertainties in the Analysis

The reference case projections in both AEO98 and this analysis represent business-as-usual forecasts, given known trends in technology and demographics, current laws and regulations, and the specific methodologies and assumptions used by EIA. Because EIA does not include future legislative and regulatory changes in its reference case projections, the projections provide a policy-neutral baseline against which the impacts of policy initiatives can be analyzed.

Results from any model or analysis are highly uncertain. By their nature, energy models are simplified representations of complex energy markets. The results of any analysis are highly dependent on the specific data, assumptions, behavioral characteristics, methodologies, and model structures included. In addition, many of the factors that influence the future development of energy markets are highly uncertain, including weather, political and economic disruptions, technology development, and policy initiatives. Recognizing these uncertainties, EIA has attempted in this study to isolate and analyze the most important factors affecting future carbon emissions and carbon prices. The results of the various cases and sensitivities should be considered as relative changes to the comparative baseline cases.

In addition to the uncertainties concerning the final interpretation and implementation of the Kyoto Protocol, specific actions that might be taken to reduce greenhouse gas emissions in the United States have not been formulated. Actions taken by other Annex I countries to reduce emissions, future growth in worldwide energy consumption and emissions, and the opportunities for reducing emissions through joint implementation and

the CDM are unknown, and they are likely to have important impacts on the international trade of carbon permits and the carbon permit price. This analysis assumes that auctioned permits will constrain carbon emissions and raise the price of fossil fuels, with revenues from the auction recycled to consumers either through personal income tax or social security tax rebates. Alternative carbon reduction programs and fiscal policies would be likely to change the cost of carbon reduction from the costs in this analysis. The timing of carbon reduction programs and the amount of adjustment time allowed could also be important in determining costs.

Future technology development also cannot be known with certainty and may have a significant effect on the cost of achieving carbon reductions. The technology sensitivity cases in this analysis explore some of the potential impacts, but even the high technology sensitivity does not include possible breakthrough or speculative technologies. On the other hand, even the reference case technology assumptions include continued development of more energy-efficient and renewable technologies, which serve to mitigate the costs of carbon reduction. Those technology improvements are likely, but not certain.

Finally, consumer response to carbon initiatives is uncertain. Because energy price changes that have occurred in the past may not provide sufficient evidence about the reaction of consumers to sustained high energy prices, changes in demand as a result of the higher carbon fees cannot be projected with confidence. In addition to price-induced changes, consumers might also respond to climate change initiatives and a national commitment to reduce emissions by adopting more energy-efficient or renewable technologies sooner than expected. Finally, public acceptance of large-scale renewable technologies or the continuation of nuclear power-both of which make important contributions to the achievement of the carbon emissions reductions at the costs projected in this analysis-cannot be known with certainty.

Background

The Greenhouse Gas Effect

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 are anthropogenic, resulting from human activities.

Over the past several decades, rising concentrations of greenhouse gases have been detected in the Earth's atmosphere. Although there is not universal agreement within the scientific community on the impacts of increasing concentrations of greenhouse gases, it has been theorized that they may lead to an increase in the average temperature of the Earth's surface. To date, it has been difficult to note such an increase conclusively because of the differences in temperature around the Earth and throughout the year, and because of the difficulty of distinguishing permanent temperature changes from the normal fluctuations of the Earth's climate. In addition, there is not universal agreement among scientists and climatologists on the potential impacts of an increase in the average temperature of the Earth, although it has been hypothesized that it could lead to a variety of changes in the global climate, sea level, agricultural patterns, and ecosystems that could be, on net, detrimental.

The most recent report of the Intergovernmental Panel on Climate Change (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

U.S. Greenhouse Gas Emissions

In 1990, total greenhouse gas emissions in the United States were 1,618 million metric tons carbon equivalent, according to 1997 estimates published by the Energy Information Administration (EIA). Of this total, 1,346 million metric tons, or 83 percent, was due to carbon emissions from the combustion of energy fuels-the focus of this report. 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 1,577 million metric tons in 2000, 17 percent above the 1990 level. Projected emissions continue to rise at an average annual rate of 1.5 percent a year from 1996 to 2010, reaching 1,803 million metric tons of carbon emissions in 2010, 34 percent above the 1990 level. Because energy-related carbon emissions are a large portion of total greenhouse gas emissions, any efforts to reduce greenhouse gas emissions will likely have a significant impact on the energy sector; however, as discussed later, there are a number of factors outside the domestic energy market that also affect emissions levels.

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 6.6 billion metric tons, as noted in EIA's International Energy Outlook 1998 (IEO98). Although continued increases in carbon emissions are expected for the United States and other industrialized countries, much

more rapid increases are projected for the developing countries of Asia, the Middle East, Africa, and Central and South America. As a result, global carbon emissions from energy use 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 would contribute about 22 percent.

The Framework Convention on
Climate Change

As a result of increasing warnings by members of the climatological and scientific community about the possible harmful effects of rising greenhouse gas concentrations, the 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. A series of international conferences followed, and in 1990 the United Nations established the Intergovernmental Negotiating Committee for a Framework Convention on Climate Change. After 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 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, implement, . . . and . . . update ... programmes containing measures to mitigate climate change by addressing anthropogenic emissions by sources and removals by sinks and to prepare periodic emissions inventories, promote development and diffusion of technologies for emissions control, and cooperate in adaptation. In addition, the developed country signatories agreed to "adopt national policies and take corresponding measures on the mitigation of climate change" and to "communicate. ..detailed information on its policies and measures . with the aim of returning individually or jointly to their 1990 levels these anthropogenic emissions of carbon dioxide and other greenhouse gases." 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.

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." In 1995, the first Conference of the Parties met in Berlin and issued the Berlin mandate, an agreement to "begin a process to enable it to take appropriate action for the period beyond 2000. The second Conference of the Parties, held in Geneva in July 1996, called for negotiations on quantified limitations and reductions of greenhouse gas emissions and policies and measures for the third Conference of the Parties in Kyoto, Japan, in December 1997.

The Climate Change Action Plan

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), published in October 1993, which consists of a series of 44 actions to reduce greenhouse gas emissions. The actions include voluntary programs, Industry partnerships, 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 it enumerated would reduce total net emissions' of these greenhouse gases in the United States 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." Also, Section 1605(b) of EPACT established the Voluntary Reporting Program, permitting corporations, government agencies, households, and voluntary organizations to report to EIA 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, which reports 1995 activities. 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 U.S. Environmental Protection Agency and the U.S. Department of Energy to foster reductions in greenhouse gas emissions by industry and electricity generators. Voluntary activities for 1996 and 1997 will be available in the fall of 1998.

The Kyoto Protocol

Prior to the third Conference of the Parties, at the June 26, 1997, Earth Summit+5 Conference at the United Nations, President Clinton pledged U.S. support for binding emissions targets and announced three initiatives: a pledge of $1 billion over 5 years by the United States for the development of more energy-efficient and alternative energy technologies in developing countries; the strengthening of environmental guidelines for U.S. companies investing overseas; and a partnership with private industry to install solar panels on 1 million rooftops in the United States by 2010.

On October 22, 1997, President Clinton proposed that developed countries should stabilize emissions at 1990 levels between 2008 and 2012, with reductions below 1990 levels in the following 5-year period. He also indicated his support for joint implementation projects and international emissions trading and declared that par!!cipation by developing countries was necessary for the United States to assume binding obligations. At the same time, the President announced additional initiatives to address greenhouse gas emissions: a $5 billion program of tax incentives and research and development spending for energy-efficient and lower-carbon technologies; the establishment of an emissions trading system with credit for early reductions; the restructuring of the electricity industry; and reductions of emissions from Federal sources. Funding for the program was increased to $6.3 billion in the Administration's 1999 budget request.

10

Representatives from more than 160 countries met in Kyoto on December 1 through 11, 1997. The resulting Kyoto Protocol established binding emissions targets for developed nations, relative to their emissions levels in 1990, for an overall reduction of about 5 percent. 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 10-percent increase allowed for Iceland. Australia and Norway also are allowed increases of 8 and 1 percent, respectively,

11

while New Zealand, the Russian Federation, and the Ukraine are held to their 1990 levels. Other Eastern European countries undergoing transition to market economies 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. Although atmospheric concentrations of greenhouse gases ultimately have the potential to affect the global climate, the Protocol establishes targets in terms of annual emissions.

The greenhouse gases included in the targets are carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride." For the latter three gases, individual nations have the option of using 1995 as the base year from which to achieve reductions, instead of 1990. The aggregate target is established using the carbon dioxide equivalent of each of the greenhouse gases. Other greenhouse gases are not limited by the Protocol, although CFCs and HCFCs are controlled by the Montreal Protocol. This analysis focuses on carbon emissions from the combustion of energy fuels, which constituted 83 percent of all U.S. greenhouse gas emissions in 1990. Carbon dioxide emissions from sources other than energy use are not included in the analysis, nor are emissions of the five other gases covered by the Kyoto Protocol; however, reductions in those gases may lessen the required reductions in energy-related carbon emissions, as discussed below.

The established targets must be achieved over the period 2008 to 2012, the first commitment period. Essentially, each country can average its emissions over that 5-year period to establish compliance, smoothing out short-term fluctuations that might result from economic cycles or extreme weather patterns. Each country must have made demonstrable progress by 2005. No targets are established for the period after 2012, although lower targets may be set by future Conferences of the Parties.

Sources of emissions include fuel 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 technologles, 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.

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 will also be used in meeting the commitment, however, these are limited to afforestation, reforestation, and deforestation since 1990. Emissions trading among the Annex I countries is permitted. No rules for trading are established, however, and the Conference of the Parties is required to establish principles, rules, and guidelines for trading at a future date. Joint implementation projects are also allowed among the Annex I countries, whereby a nation could take emissions credits for projects that reduce emissions or enhance sinks in other 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 take emissions 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 compliance in the 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 those countries that are particularly vulnerable to climate change. Banking-the 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. Under the Protocol, Annex I countries, such as the nations of the European Union (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 in entering into an umbrella trading arrangement.

Non-Annex I countries have no targets under the Protocol, although it reaffirms the commitments of the Framework Convention by all parties to formulate and implement climate change mitigation and adaptation programs and to promote the development and diffusion of environmentally sound technologies and processes. Developing countries can voluntarily enter into the Protocol by full amendment of the Protocol.

The Protocol became open for signature on March 16, 1998. for a 1-year period. Under its provisions, it enters into force 90 days following acceptance of at least 55 Parties, including Annex I countries accounting for at least 55 percent of the total 1990 carbon dioxide emissions from Annex I nations. Signature by the United States would need to be followed by Senate advise and consent to ratification.

There are a number of uncertainties and issues to be resolved at future Conferences of the Parties. As indicated in the Protocol, 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. This issue was directed to the IPCC by subsequent climate change talks in Bonn in June 1998. In addition, rules and guidelines must be established for emissions trading, joint implementation projects, and the CDM.

Other issues covered in the Protocol but deferred to subsequent sessions include flexibility for Annex I countries undergoing transition to market economies, commitments for subsequent periods, climate change adaptation actions, sanctions for failure to meet commitments, guidelines for the reporting and review of emissions and sinks, and international cooperation in education, research and development, and technology transfer.

Emissions Trading

Even before the Kyoto Protocol, many analyses of the impacts of greenhouse gas emissions reductions have favored emissions trading programs, including joint implementation programs, as a means of achieving emissions reductions. In the United States, the Clean Air Act Amendments of 1990 (CAAA90) established a trading program for emissions of sulfur dioxide (SO) by electricity generators in order to reduce emissions to fixed specified levels. Permits issued to electricity generators allow them to emit up to a specified level of SO2. with the total number of issued permits equal to the national limit on emissions. Generators may reduce emissions by using lower-sulfur coals, installing scrubbers, or increasing the utilization of cleaner-generating plants. Generators that reduce emissions below their allowed levels can sell excess emissions permits, which can be purchased by other generators for whom it is more cost-effective to purchase permits at the prevailing market price than to reduce emissions. Emissions permits can also be banked for future use. Compared with traditional control programs that mandate specific compliance options or require uniform reductions, this SO2 trading program is credited with reducing the overall cost of compliance by allowing reductions to be made in the most cost-effective manner.