Introduction, Study Goals and Design The Kyoto Protocol would legally bind the US to reduce GHG to 93% of 1990 levels by 2008-2012. In December 1997, some 200 countries including the US completed negotiation of the Kyoto Protocol. If signed and ratified, the Kyoto Protocol would legally bind the U.S. to reduce GHG emissions 7% below the 1990 level on average over the period 20082012. Further reductions for succeeding years are under discussion. Developing countries have not agreed to either binding or voluntary targets. The main features of the Protocol are listed below. Summary of the Kyoto Protocol • Countries. The Protocol would bind the Annex B countries to quantified emission limits. The Annex B countries, defined in the Protocol, are: US, Canada, Japan, Australia, New Zealand, European Community countries, the countries of Eastern Europe, Russia and the Ukraine. With the exclusion of Turkey and the addition of a few smaller European countries, this is the same group of countries referred to as Annex B of the UN Framework on Climate Change (UNFCCC). • Greenhouse Gases Emissions and Sinks (Carbon Sequestration). The Kyoto Protocol set quantified emission limits on the "aggregate anthropogenic carbon dioxide equivalent emissions" of six greenhouse gases: carbon dioxide (CO), methane (CH), nitrous oxide (NO), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF). To establish the emission target for each country, the first three gases use a 1990 base year and the last three gases may use a 1990 or 1995 base year for the commitment period 2008-2012. The Kyoto Protocol also requires that changes in emissions, relative to 1990 levels, from direct human-induced land use changes and forestry activities which impact this sequestration is counted. These activities have been restricted to afforestation, reforestation, or deforestation. Later, other agricultural soil, land use or forest related sinks might be added Quantified Emissions Limits. The Clinton Administration has committed the U.S. to reduce greenhouse gas emissions to 93% of 1990 levels on average over the period 2008-2012. Other industrialized nations have committed to cap greenhouse gas emissions at the following multiple of 1990 emissions for this period. Tightened emission limits for subsequent periods have not yet been specified. • European Union nations Canada 94% 94% 108% Russia Warsaw Pact Countries 92% 100% 100% 92%-95% • Emission Banking, As a concept, banking emission credits is allowed from the date that the Protocol becomes effective. • Emission Trading, Emission trading between Annex B countries is allowed, at least conceptually. However, all details, such as the principles, modalities, rules, guidelines, verification, reporting and accountability are yet to be decided. • Bubbles. Groups of countries are allowed to treat their aggregate quantified emission limits as a single party (acting under a "bubble”). For example, this provision allows the EU countries to operate under the long-declared EU “bubble" - individual country emissions can be above or below the 92% of 1990 level target as long as the EU aggregate achieves the targeted level. • Joint Implementation (JI). Joint Implementation (JI) among Annex B countries is allowed These are project-specific emissionreduction efforts undertaken by one Party in another Annex B country. JI projects must be approved by the parties, and generally entail a transfer of a stream of emission credits over time from one Annex B Party to another. (The concept of 'additionality' has been discussed with reference to JI; it refers to adding on to "what otherwise would have been." This is clearly a problematic concept) • Clean Development Mechanism (CDM). The CDM would allow project-specific reduction efforts in non-Annex B countries. The resulting emission "credits" could then be sold to Annex B countries. A new UN/FCCC body that will certify all CDM and JI projects has been proposed. A share of the proceeds from the CDM projects is to be collected by this body to cover administrative costs and to help developing countries with the costs of adaptation to climate change. • Compliance. All compliance issues have been left to future discussions and negotiation. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL The Kyoto Protocol contains no commitments for developing countries to reduce greenhouse gas emissions. In fact, China and India have emphatically stated that they would not bind their countries to GHG restrictions. To assess the economic consequences the US faces if it implements the Kyoto Protocol, WEFA has analyzed the economic cost of reducing carbon emissions from the energy sector to 7% below 1990 levels on average over the period 2008-2012. The Kyoto Protocol has been called a "work in progress" by members of the Clinton Administration. While the US has not signed the Protocol and few congressional leaders have agreed to support its ratification, the Protocol is an amendment to the United Nations Framework on Climate Change (UN/FCCC), which means that the terms (or articles) of the Protocol cannot be changed and new articles cannot be added. The Protocol is available for countries to sign as of March 1998. It becomes a legally binding treaty when two criteria are met: • 55 Parties to the Framework Convention on Climate Change sign the Protocol • 55% of the greenhouse gases subject to restrictions under the Protocol are committed The Kyoto Protocol contains no commitments for developing countries to reduce greenhouse gas emissions. In addition, the developing countries did not agree on a voluntary process for reducing or limiting their emissions. In fact, China and India emphatically opposed such voluntary commitments, saying that they would not bind their countries to GHG emission restrictions. Countries that are not included in the Kyoto Protocol (though they are free to sign it) include: • All Latin American countries, including Mexico, Argentina, Brazil, Venezuela, Colombia. • Most Asian countries, including South Korea, Taiwan, Indonesia, Malaysia, Singapore. Study Goal: Assessing the Economic Risk of The objective of this study is to assess the economic consequences — at the national, state and selected county/MSA level – of implementing the Kyoto Protocol. Previously, WEFA has studied the much less ambitious goal of the U.S. reducing carbon emissions to the 1990 level'. The Kyoto Protocol is an international agreement with no provision for modification before it is signed by the requisite number of countries. Signing the Kyoto Protocol would legally bind the US to achieve the specified targets over the period 2008-2012. To assess this risk, WEFA has analyzed the economic cost of reducing carbon emissions from the energy sector to 7% below 1990 levels on average over the period 2008-2012 and maintaining the emission limit. The Economic Risk Assessment Excludes Several Provisions of the Kyoto Protocol While the Kyoto Protocol includes several international market-based mechanisms that potentially could alleviate some of the devastating impact on the economy of meeting the negotiated target and timetable through indigenous action, these provisions are currently only conceptual and remain to be negotiated among the parties. Further, under the Protocol, they are to be supplemental, not means of achieving the goals, and many countries have expressed hostility to their use. The following provisions of the Kyoto Protocol have not been included in this analysis due to these uncertainties in their structure or implementation: "Global Warming: The Economic Cost of Early Action", WEFA, Inc. 1997. This two volume study on the National and State Impacts of the Administration's proposed plan for reducing greenhouse gas emissions was funded by the American Petroleum Institute, although the views expressed are strictly those of the authors. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL • the sequestration of carbon through forest management policies. ▪ emission trading between Annex B countries, ⚫ and the inclusion of several other greenhouse gases. Sinks While the Protocol identifies sinks as a mechanism to adjust the target limit on greenhouse gases, these are currently limited to forestry initiatives subject to restrictions that have not been fully specified. Other initiatives, such as land-use changes, remain 'on the table,' but are even less clearly defined. There are several issues that need clarification before the opportunity for using sinks to achieve the target emission reduction can be assessed, including: There is limited lead-time for growing trees and substantial uncertainty regarding the Population in the U.S., for example, is expected to increase by about 50 million people • The rules for this category of emissions have yet to be written, and their potential significance will depend critically on those rules. Emission Trading between Annex B Parties The WEFA analysis does not include international trading of carbon emission permits. International trading of carbon emission permits could potentially reduce the cost of achieving carbon emission targets. In concept, the Kyoto Protocol allows inter-country trading of carbon emission permits between Annex B Parties. Details such as the principles, rules, verification, reporting and accountability are not addressed. Until these details are addressed it is not possible for trading to take place. Given the diverse and strongly held views about trading that were expressed in the negotiations leading to the Protocol and that prevented the inclusion of trading rules in the Protocol, it is unclear if and when an effective inter-country carbon emission trading program would be implemented. Further, the benefits that would actually be realized from such a program could be limited because trading would be limited to Annex I Parties only. Working out these details to allow trading to actually take place will require overcoming difficult political, administrative and technical hurdles. To illustrate the difficulties of implementing such a system, the following briefly describes some of the details that need to be addressed. · Initial Allocation of Permits: A carbon permit system would probably be implemented by issuing permits to the first seller of a product. Each country would have to determine who will get these permits and how. Permits could be issued by a lottery, auctioned off, or allocated based upon historic emissions. These permits will have substantial value and it is likely that the allocation of these permits will cause substantial political conflict within each country. • Verification. Monitoring and inspection systems will have to be set up to assure that carbon emissions do not exceed the level allowed by the carbon permits owned. Each owner of a carbon permit would have to have a record keeping system with checks and balances that could GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL Further, the benefits that Developing countries have resisted committing themselves to binding limits on their emissions. The cost of reducing these If so, even greater reductions in emissions from the energy sector may be required. be audited, to assure compliance with the permit system. Both physical audits of the business facilities and accounting systems would be required. If the owner of carbon permits were the government, the government would have to be audited. Controls would have be implemented to assure carbon based products are not imported from a non-participating country and sold on the black market. Given the potential magnitude of the carbon permit fees there will strong incentives to circumvent these fees. Control of Permits: Controls would have to be implemented to assure that countries do not issue more permits than allowed. Record Keeping: A central record system will have to be kept to track ownership of carbon permits. This systern will have to assure that the seller is a legitimate owner of a carbon permit and track transactions as ownership changes. Transactions costs: While accomplishing the goals above, the administrative system must assure the cost of trading carbon emissions is low enough allow the possibility of substantial benefits from trading If these hurdles can be overcome it still is unknown how large the benefits from international trading of emission permits would be. As proposed in the Kyoto Protocol emissions trading is limited to Annex I Parties only. This will greatly reduce its cost effectiveness. Developing countries have resisted committing themselves to binding limits on their emissions. Yet developing countries generally have the least cost opportunities for reducing carbon emissions. If these countries do not participate in the plan, marry businesses may move rather than pay for carbon permits. Also, the results of previous intra-country permit trading systems are unclear. The cost of SO2 acid rain, emissions permits dropped substantially under a trading system. However, a very large part of the decline in these permits was a result of: 1. lower railroad rates, a result of de-regulation, which allowed low-sulfur Western coal to be transported to power plants at a low cost, and 2. the fact that companies invested in Phase-2 controls, thus over-committing to Phase I and artificially reducing permit prices. Other Gases Finally, the impact of other gases was not included in this analysis. The impact of the other gases on achieving the Kyoto goals is highly uncertain. While several analyses, notably the US Government's 1997 Interagency Task Forces analysis?, have presumed that reductions in the other gases could exceed their individual target of 7% below the 1990 level (1995 for three of the gases), no independent study has demonstrated the opportunity for reductions nor the cost of reduction. In fact, the cost of reducing these gases may exceed the cost of reducing carbon through the energy sector. If so, even greater reductions in emissions from the energy sector may be required. 1 "Economic Effects of Global Climate Change Policies," Results of the Research Efforts of the Interagency Analytical Team, June 1997. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL Study Design: Key Parameters Target and Timetable: The Kyoto Protocol has established a goal of reducing GHG emissions to 93% of 1990 emission levels over the 2008-2012 period, and stabilizing emissions at that level. To investigate the risk the US must face if it agrees to sign the Kyoto Protocol, WEFA has analyzed the cost to the economy of reducing carbon emissions from the energy sector to 7% below 1990 levels and maintaining this carbon emission limit. Participation: The signatory countries of the Organisation of Economic Co-Operation and Development (OECD) will adopt the target and timetable for limiting GHG emissions. Neither the non-signatory OECD countries (such as Mexico, South Korea), plus newly industrialized countries (such as Taiwan, Philippines, Singapore, Brazil) nor developing countries would participate, except through project specific programs that tie developed country investments to reductions in carbon emissions. Emission Trading: The State Department has proposed inter-participating-country tradable emission permits as a mechanism for reducing carbon emission in the short-run. This would involve large resource transfers among countries. While economically efficient, the ability of the countries to take advantage of inter-country trading and banking over the next decade is unlikely. First, there is strong international resistance to trading -- the reason no rules were included in the Protocol. Second, there is a lack of infrastructure for the administration of such a program. Third, changes of such magnitude take a significant amount of time to implement. Therefore, this provision may not be instituted for some time. Implementation: For this analysis, WEFA has assumed intra-country tradable permits at the first point of purchase. Analytically, the intra-country tradable permits are similar to a carbon tax or fee. As a fee/tax directly associated with the emission to be controlled represents the marginal cost of abatement, it theoretically is the least cost means of reducing carbon emissions. As a result, the macroeconomic results can be interpreted more broadly. given that carbon taxes/fees are the most efficient means of reducing carbon emissions, the results measure the minimum economic impact of imposing a carbon emission abatement policy. Revenue Recycling: Carbon permits/taxes, small or large, raise enormous sums of money. To avoid distorting the analysis through effects of the revenue collection, the revenues are recycled to the economy. For this analysis, WEFA has chosen to return the carbon revenue in its entirety to consumers through an annual lump-sum repayment. In general, higher energy prices result in higher prices for all goods and services. Recycling of the revenue from the carbon permit/tax helps to ameliorate the effects of increased prices. However, the lump-sum payment is not used to ease distributional inequities; it is an equal dollar value per household. GLOBAL WARMING: THE HIGH COST OF THE KYOTO PROTOCOL |