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1
HARVARD UNIVERSITY
JOHN F. KENNEDY SCHOOL OF GOVERNMENT.
79 JOHN F. KENNEDY STREET
CAMBRIDGE, MASSACHUSETTS 02138
ROBERT N. STAVINS
PHONE: (617) 495-1820
Professor of Public Policy
ME:
MIK
7
FAX: (617) 495-1635
Faculty Chair, Environment
E-MAIL: [email protected]
and Natural Resources Program
http://ksgwww.harvard.edu/-rstavins
MEMORANDUM
TO:
Snowmass Workshop Participants
FROM:
Rob Stavins
no
DATE:
August 15, 1998
RE:
Carbon Sequestration
Following my whirlwind (and, I suspect, barely
intelligible) comments on Rob Mendelsohn's paper on "carbon
sinks" at last week's NBER-Yale Global Change workshop in
Snowmass, Colorado, a number of you asked me for copies of my
slides.
So, here are the slides, plus a forthcoming article to which
participating in the workshop.
I referred in my comments on Rob's CC:J4 paper. And thanks again for
Enclosure
Jut
Comments on
"Carbon Sinks: Management Tool or Bottomless Pit"
by Robert Mendelsohn
for
Workshop on Design of Climate-Change
Policy Instruments and Institutions
Yale University/NBER, Snowmass, CO, August 13-14, 1998
Robert N. Stavins
John F. Kennedy School of Government, Harvard University
Cambridge, Massachusetts 02138
Overview
Topic is important: cost and feasibility of carbon
sequestration policies
Four Parts of Paper:
I.
Examine two types of carbon sink programs
II.
Provide cost estimates of one means of forest carbon
sequestration: lengthening rotation lengths
III. Consider non-market effects
IV. Conclusions
2
I. Two Types of Sink Programs
Two types: "Physics-Based" and "Official Projects"
Neither is the Kyoto approach; it would be interesting to
learn RM's assessment of that.
1.
Physics-Based Approach: Total Terrestrial Stock of
Carbon as a Baseline
RM describes how difficult this would be.
But there's no reason to consider it.
Why worry about baseline of total stock of carbon in the
biological case any more than in the fossil fuel case?
We don't focus on estimating total coal, oil, and
natural gas reserves; rather, we focus on
estimating extractions.
Seems obvious to look at flows, not stocks; for example,
land-use changes
3
2.
Policy-Based Program: Measure "official projects to
store carbon"
Contrast between #1 and #2: stock vs policy-based
Better to think about: stock VS. flow vs. policies that
produce flows (ala Cooper)
RM identifies major disadvantage of #2 as difficulty of
defining adequate baseline: "it's difficult to know
what each country would have done in the absence of
an explicit carbon program"
But baseline issue not a problem of carbon
sequestration policy per se, but of voluntary opt-
in (reduction credit versus "cap and trade;" or
what H&S call poorly defined property rights)
No unobserved hypothetical with "cap & trade" or
other targeted programs with carbon seq
Likewise, no unobserved hypothetical with Cooper's
common actions (tax, tax credit)
For example, forested area increases, you receive a
point/acre; forested area decreases, you lose a
point/acre. (But not end of story)
Changes (flows) should be focus of policy attention;
motivation need not matter
4
So, RM "baseline critique" is not a critique of carbon
seq at all
It's a well-known and reasonable critique of JI or
any voluntary opt-ins of any env'tl policy
RM claims there would be an incentive for countries
to cut down trees and then enter bare land into
programs.
No, baseline must be in past, not future, as with
any environmental program.
Another conclusion in paper: sink program would
have (unfortunate) consequence of delaying time
at which countries had to take serious carbon
abatement actions.
True, but not a problem - allows energy-
generating and energy-using capital-stock to
turn over (Manne & Richels).
5
II. Cost Estimates
RM says other studies find extensive sequestration at "low
cost of $1 to $10 per ton" - major straw man
See table of some of best studies: AC: up to $70/ton;
MC: up to $140/ton (Plantinga et. al. 1998: ME
$225, SC $55; WI $90)
Paper notes correctly that preventing deforestation may be
better economically than forestation
But eliminates it as potential policy by stating there
will be no significant deforestation in future.
World Bank, UN, others: deforestation will continue
in developing world, due to demand for
firewood, cropland, and pasture (& hardwood).
Paper eliminates forestation as a potential policy route by
stating that "costs of reforesting substantial amounts
of temperate farmland are likely to be high."
See figure (AER). Not cheap, but should still be part
of c/e portfolio, even in the U.S.
Paper eliminates option of foresting marginal farmlands by
noting that they produce less carbon.
But marginal lands also have lower opportunity cost.
It's an empirical question.
6
Alternative to "retarded deforestation" and "forestation:"
intensifying forest management - lengthening forest
rotations, increasing stocking, stimulating growth
Empirical analysis focuses exclusively on lengthening
rotations beyond what is otherwise efficient
Present value numbers in text not in table. What's the
model? Can't comment.
Also, difficult to assess MC numbers in table
(expressed in $/MBD, not $/ton of carbon).
Interesting aspect of MC in table: beyond a certain point,
MC of lengthening rotations falls.
But there's a problem.
RM seems to treat a unit of carbon seq. next year the
same as a unit that occurs 60 years from now.
Can't make reasonable c/e comparisons this way; they
don't have same benefits (damages)
Considerable literature on how to measure
intertemporal carbon flows to calculate a MC
(Richards et. al.)
Consensus: discount carbon quantities
Assumes b's and c's should be discounted at
same rate, and mb constant over relevant
range
7
III. Non-Market Effects
There may be significant non-market (environmental)
effects of changing land management
Paper suggests (without empirical information) that
externalities are probably - on net - negative.
Maybe, maybe not (Hartman lit. may suggest
otherwise)
But RM may be correct that carbon seq would bring
negative net non-climate effects, and that these should
be counted in B/C calculations.
If so, then surely we should also include all of the
non-climate, environmental benefits of carbon
abatement programs, such as reduced SO₂,
particulates, ambient ozone, congestion, etc.
8
IV. Conclusions
Findings in parts I-III are very negative,
but is the analysis compelling?
Part IV ends with surprisingly upbeat conclusion:
"Managing terrestrial stocks of carbon can contribute to
greenhouse gas control in the long run, if the programs are
carefully designed today."
Comments on conclusion:
1.
Administrative costs of carbon sequestration policies
are likely to be significantly greater than
"equivalent" carbon abatement policies.
2.
Carbon sequestration may still be part of cost-
effective portfolio in many nations, particularly
in short run.
3.
It's hard to see how RM's final conclusion follows
from the paper, but I think it's basically correct
(in the short run).
9
THE COSTS OF CARBON SEQUESTRATION:
A REVEALED-PREFERENCE APPROACH
Robert N. Stavins
John F. Kennedy School of Government, Harvard University
and
Resources for the Future
Forthcoming in the
American Economic Review
April 30, 1998
THE COSTS OF CARBON SEQUESTRATION:
A REVEALED-PREFERENCE APPROACH
Robert N. Stavins'
The possibility of encouraging the growth of forests as a means of sequestering carbon dioxide has received
considerable attention because of concerns about the threat of global climate change due to the greenhouse effect. Would
this approach be as inexpensive as studies have suggested? A method is developed for estimating the costs of carbon
sequestration by estimating the opportunity costs of land on the basis of econometric evidence of landowners' actual
behavior. The marginal costs of carbon sequestration appear to be greater than previous studies have found. (JEL:Q23)
Increased attention by policy makers to the threat of global climate change has brought with
it considerable attention to the possibility of encouraging the growth of forests as a means of
sequestering carbon dioxide (National Academy of Sciences (NAS) 1992; Bruce, Lee, and Haites
1996). The Kyoto Protocol to the United Nations Framework Convention on Climate Change
(1997), which establishes emission reduction targets for the United States and other industrialized
nations, states that carbon sequestration can be used by participating nations to achieve their targets.
Moreover, even before the Kyoto agreement, this approach had become an explicit element of both
U.S. and international climate policies (U.S. Department of Energy 1991; William J. Clinton and
Albert Gore 1993; United Nations General Assembly 1992). This high level of interest has been due,
in part, to: suggestions that sufficient lands are available to use the approach to mitigate a substantial
share of annual carbon dioxide (CO₂) emissions (Greg Marland 1988; Daniel A. Lashof and Dennis
A. Tirpak 1989; and Mark C. Trexler 1991); and claims that growing trees to sequester carbon is a
relatively inexpensive means of combating climate change (Dudek and Alice LeBlanc 1990; NAS
1992; Roger A. Sedjo and Allen M. Solomon 1989). In other words, the serious attention given by
policy makers to carbon sequestration can partly be explained by (implicit) assertions about
respective marginal cost functions.
We develop and demonstrate a method by which the costs of carbon sequestration can be
estimated on the basis of evidence from landowners' behavior when confronted with the opportunity
costs of alternative land uses. The simplest of previous economic analyses derived single point
estimates of average costs associated with particular sequestration levels (Marland 1988; Sedjo and
Solomon 1989; Dudek and LeBlanc 1990; Edwin S. Rubin et.al. 1992; Omar Masera, Mauricio R.
Bellon, and Gerardo Segura 1995). Often it has been assumed that land (opportunity) costs are zero
John F. Kennedy School of Government, Harvard University, 79 John F. Kennedy Street, Cambridge, MA 02138, and
Resources for the Future. Richard Newell supplied excellent research assistance; and valuable comments on a previous
version were provided by Lawrence Goulder, William Nordhaus, Andrew Plantinga, Kenneth Richards, participants in
seminars at the Universities of California at Los Angeles and Santa Barbara, Maryland, Michigan, and Texas, Harvard,
Stanford, and Yale Universities, Resources for the Future, and the National Bureau of Economic Research, and two
anonymous referees. The author alone is responsible for any errors.
I After fossil-fuel combustion, deforestation is the second largest source of carbon dioxide emissions. Estimates of annual
global emissions from deforestation range from 0.6 to 2.8 billion tons, compared with slightly less than 6.0 billion tons
annually from fossil-fuel combustion, cement manufacturing, and natural gas flaring, combined (R. A. Houghton 1991;
T. M. Smith et.al. 1993).
(Robert K. Dixon et.al. 1994; New York State Energy Office 1993; J. K. Winjum, Dixon, and P. E.
Schroeder 1992; G. Van Kooten, L. Arthur, and W. Wilson 1992). Another set of studies --
essentially "engineering/costing models" -- have constructed marginal cost schedules by using
information on revenues and costs of production for alternative uses on representative types or
locations of land, and then sorting these in ascending order of cost (Robert J. Moulton and Kenneth
R. Richards 1990; Richards, Moulton, and Richard A. Birdsey 1993). Simulation models include
a model of the lost profits due to removing land from agricultural production (Peter J. Parks and Ian
W. Hardie 1995), a mathematical programming model of the agricultural sector and the timber
market (Richard M. Adams et.al. 1993), a related model incorporating the effects of agricultural
price support programs (J. M. Callaway and Bruce McCarl 1996), and a dynamic simulation model
of forestry (Susan Swinehart 1996). Lastly, an analysis by Andrew J. Plantinga (1995) adopts land-
use elasticities from an econometric study to estimate sequestration costs. We draw on some of the
best features of the previous studies, including the carbon levelization method of Adams et.al. (1993)
and Moulton and Richards (1990), and the intertemporal carbon yield curves of Richards, Moulton,
and Birdsey (1993).
Nearly all of the previous analyses are potentially limited by their inability to reflect the
actual preferences of landowners, as revealed for example -- by landowners' decisions regarding
the disposition of their lands in the face of relevant economic signals.² There are a number of
reasons why landowners' actual behavior might not be well predicted by "engineering" or "least cost"
analyses: (1) land-use changes can involve irreversible investments in the face of uncertainty (Parks
1995), and so option values may be important (Robert S. Pindyck 1991); (2) there may be non-
pecuniary returns to landowners from forest uses of land (Plantinga 1995), as well as from
agricultural uses; (3) liquidity constraints or simple "decision-making inertia" may mean that
economic incentives will affect landowners only with some delay; and (4) there may be private,
market benefits or costs of alternative land uses (or of changes from one use to another) of which
an analyst is unaware.
We seek to address at least some of these problems by employing an econometric model to
derive the costs of carbon sequestration. The paper is intended to be illustrative of how econometric
analyses of land use, which already exist for a number of countries, can be used to develop better
region-specific estimates of the marginal costs of carbon sequestration.³ In Part I of the paper, we
describe an econometric model of land use; in Part II, we develop a simulation model of carbon
sequestration; in Part III, we derive our marginal cost results; in Part IV, we compare our results with
other estimates of carbon-sequestration costs and with estimates of the cost of abating carbon
emissions through fuel switching and energy-efficiency enhancements; and in Part V, we offer some
conclusions.
²Plantinga's (1995) analysis of southwestern Wisconsin is an exception; it is similar in some respects to our method,
although the former model requires information on land characteristics (quality) within counties, whereas our approach
is based upon an econometric model in which the unobserved heterogeneity of land is parameterized and thus estimated
simultaneously with other structural parameters. Thus, the potential advantage of the present approach is simply that
its data requirements are less, which could be important if a nationwide land-use analysis were carried out.
3 Another possibility - in theory - would be to employ land sale price data, reflecting anticipated values of net returns
to alternative uses. But useful price data are not available for sufficiently diverse geographic areas over time.
3
I. Econometric Model of Land Use
In previous work with a distinctly different policy motivation, a dynamic optimization model
was developed of a landowner's decision of whether to keep his or her land in its status quo use or
convert it to serve another purpose (Robert N. Stavins and Adam B. Jaffe 1990; Stavins 1990).
Landowners are assumed to observe current and past values of economic and other factors relevant
to decisions regarding the use of their lands for forestry or agriculture,⁴ and on this basis form
expectations of future values of respective variables. Landowners are assumed to attempt to
maximize the expected long-term economic return to their land. Thus, a risk-neutral landowner will
seek to maximize the present discounted value of the stream of expected future returns:
(1)
max Mᵢⱼ(gᵢⱼₜ Vijt) - + + -
(2)
subject to:
(3)
≤
(4)
where i indexes counties,j indexes individual land parcels, and t indexes time; upper case letters are
stocks or present values; and lowercase letters are flows. The variables are:
Aᵢ₁ = present value of typical expected agricultural revenues per acre in county i and time t;
qᵢⱼ₁ = index of feasibility of agricultural production (including effects of soil quality and moisture);
giji = acres of land converted from forested to agricultural use (deforestation);
Vᵢⱼ₁ = acres of cropland returned to a forested condition (forestation);
Mᵢ, = expected cost of agricultural production per acre, expressed as present value of future stream;
Cᵢ₁ = average cost of conversion per acre;
⁴In both industrialized nations and in developing countries, nearly all deforestation is associated with conversion to
agricultural use (C. J. Jepma et. al. 1996). The previous work by Stavins and Jaffe (1990) focused on forested wetlands,
but that quantitative analysis was of all forested areas.
4
P₁₁ = Palmer hydrological drought index (to allow precipitation and soil moisture to influence
conversion costs);
fill = expected annual net income from forestry per acre (annuity of stumpage value);
Sᵢⱼ = = stock (acres) of forest;
r₁= real interest rate used by landowners for investment decisions, linked with their private pre-
tax rate of return;
Wᵢ, = net revenue per acre from one-time forest harvest (prior to conversion to agricultural use);
D₁₁ = expected present discounted value of loss of income (when converting to forest) due to
gradual regrowth of forest (first harvest occurs in year t + R, where R is rotation length);
giji = maximum feasible rate of deforestation; and
√ᵢⱼ= = maximum feasible rate of forestation.
As is described in by Stavins and Jaffe (1990), application of control theoretic methods yields
a pair of necessary conditions for changes in land use. Forestation (conversion of agricultural
cropland to forest) occurs if a parcel is cropland and:
(5)
where F₁,", delayed net forest revenue, equals Fᵢ, - Dᵢₜ, and Fᵢ₁ = fidr,. That is, a parcel of cropland
should be converted to forestry use if the present value of expected net forest revenue exceeds the
present value of expected net agricultural revenue. On the other hand, deforestation occurs if a
parcel is forested and:
(6)
(Aᵢ; Mᵢ, FNᵢ) > 0
where FNᵢ₁, net forest revenue, equals Fᵢ₁ - Wᵢ₁. That is, a forested parcel should be converted to
cropland if the present value of expected net agricultural revenue exceeds the present value of
expected net forest revenue plus the cost of conversion.
Inequalities (5) and (6) imply that all land in a county of given quality will be in the same use
in the steady state, but, in reality, counties are observed to be a mix of forest and farmland. Although
this may partly reflect deviations from the steady state, it is due largely to the heterogeneity of land,
particularly in regard to its quality (suitability) for agriculture. Such unobserved heterogeneity can
be parameterized within an econometrically estimatable model so that the individual necessary
conditions for land-use changes (equations (5) and (6)) aggregate into a single-equation model, in
5
which the parameters of the basic benefit-cost relationships and of the underlying, unobserved
heterogeneity can be estimated simultaneously:
(7)
FORCH₁ₗ = - FORCHᶜ Dᵢᵢ + 1, +
(8)
(9)
FORCHᶜ
=
I
(10)
(11)
(12)
where all Greek letters are parameters that can be estimated econometrically; FORCH is the change
in forest land as a share of total county area; FORCH," is forestation (abandonment of cropland) as
a share of total county area; FORCH,C is deforestation (conversion of forest) as a share of total
county area; Dii and Dᵢᶜ are dummy variables for forestation and deforestation, respectively; 1, is
a county-level fixed-effect parameter; Φᵢ, is an independent (but not necessarily homoscedastic) error
term; Yₐ and γc are partial adjustment coefficients for forestation and deforestation; F signifies the
cumulative, standard normal distribution function; qᵢᵢ is the threshold value of (unobserved) land
quality (suitability for agriculture) below which the incentive for forestation manifests itself; qᵢⁱ is
the threshold value of land quality above which the incentive for deforestation manifests itself; T,,
is total county area; Nᵢ is the share of a county that is naturally protected from periodic flooding; Eₗ,
is an index of the share of a county that has been artificially protected from flooding by Federal
programs (by time t); µ is the mean of the unobserved land-quality distribution; and σ is the standard
deviation of that distribution.
6
Using panel data for 36 counties in Arkansas, Louisiana, and Mississippi, during the period
1935-1984, the parameters of the model embodied in equations (7) through (12) were estimated with
nonlinear least squares procedures (Stavins and Jaffe 1990).⁵
II. Simulation Model of Carbon Sequestration
The initial step -- conceptually -- in moving from an estimated model of historical land use
to a model of carbon sequestration involves introducing relevant silvicultural elements: (1) the
possibility of "tree farming," that is, intensive management of forests, which brings with it significant
costs of establishment; (2) alternative species, in particular, mixed stands and tree farms (pine
plantations); and (3) alternative management regimes. Whereas the historical analysis assumed that
all forests were periodically harvested, one might also consider the possibility of establishing
"permanent stands" of biomass that are never harvested.
Next, simply as a means to generating a forest acreage supply function, consider a two-part
policy that combines a subsidy on the flow of newly forested land with a tax on the flow of (new)
deforestation. As a first approximation, the two price instruments can be set equal, although this is
not necessarily efficient. We can treat the subsidy as an increment to forest revenues in the
forestation part of the model (equation (8)) and treat the tax payment as an increment to conversion
or production costs in the deforestation part of the model (equation (9)). Letting Zᵢ, represent the
subsidy and tax, the threshold equations ((11) and (12)) for forestation and deforestation,
respectively, become:
(13)
(14)
where F₁₁ₛ* = delayed net forest revenue (Fᵢ₁ₛ - Dits), now subscripted by s to indicate species (mixed
stand or pine), and set equal to zero for the case of permanent (unharvested) stands;
Kᵢ, =
establishment costs associated with planting a pine-based tree farm.
⁵The time dimension of the panel had observations every five years; hence, the time series contained ten periods, and
the entire panel contained 360 observations. Estimated parameters were all of the expected sign, and nearly all estimates
were significant at the 90, 95, or 99 percent level. Both parameter and standard error estimates were robust with respect
to modifications of the specification, and the dynamic goodness-of-fit, based upon Henri Theil's (1961) measure, was
0.675.
7
A dynamic simulation, based upon equations (7), (8), (9), (10), (13), and (14), in which the
variable Z is set equal to zero, will generate a baseline quantity of forestation/deforestation over a
given time period. By carrying out simulations for various values of Z over the same time period,
and subtracting the results of each from the baseline results, we can trace out a forest acreage supply
function, with marginal cost per acre (Z) arrayed in a schedule with total change in acreage over the
time period, relative to the baseline.
Now we need to link carbon sequestration (and emissions) with forestation (and
deforestation). Figure 1 provides a representation of the time path of carbon sequestration and
emission linked with a specific forest management regime. In the example depicted in the figure,
the time profile is of cumulative carbon sequestration associated with establishing a new loblolly
pine plantation. Carbon sequestration occurs in four components of the forest: trees, understory
vegetation, forest floor, and soil (Birdsey 1993). When the plantation is managed as a permanent
stand, cumulative sequestration increases monotonically, with the magnitude of annual increments
declining so that an equilibrium quantity of sequestration is essentially reached within a hundred
years, as material decay comes into balance with natural growth.
The figure also shows the cumulative carbon sequestration path for a similar stand that is
periodically harvested (with 45-year rotations). In this case, carbon accrues at the same rate as in
a permanent stand until the first harvest, when a substantial amount of carbon is released as a result
of harvesting, processing, and manufacturing of derivative products. Much of the carbon sequestered
in wood products is also released to the atmosphere, although this occurs with considerable delay
6A central assumption underlying the use of an econometric approach to simulating carbon sequestration costs is that
estimated parameters remain valid with variable values employed in the counterfactual simulations; in particular, that
land owners can be expected to react to carbon taxes or subsidies the same as they have reacted to equivalent changes
in the relative revenues and costs associated with timber and agricultural crop production. A referee notes that -
depending upon the forces behind the partial adjustment coefficients - those coefficients may be sensitive to the change.
7 Although the shares vary greatly among forest types, reference points are: tree carbon contains about 80 percent of
ecosystem carbon, soil carbon about 15 percent, forest litter 3 percent, and the understory 2 percent. Soil carbon is
defined as all organic matter to a depth of one meter, excluding coarse tree roots larger than 2 millimeters in diameter
(which are classified as part of "tree carbon"). The variation in these shares is significant; for some species, soil carbon
accounts for nearly 50% of total forest carbon. Our calculations of releases from the understory, forest floor, soil, and
non-merchantable timber are based upon Moulton and Richards (1990) and Richards, Moulton, and Birdsey (1993).
8
as wood products gradually decay.⁸ As can be seen in the figure, in this scenario- the forest is
replanted, and the same process takes place again.
Although the carbon yield curve with harvesting in Figure 1 eventually moves above the yield
curve for a "permanent" stand, this need not be case. It depends upon the share of carbon that is
initially sequestered in wood products and upon those products' decay rates (plus the decay rate of
soil carbon). With zero decay rates, the peaks in the harvesting yield curve would increase
monotonically, but with positive decay rates, the locus of the peaks approaches a steady-state
quantity of sequestration, and that quantity can, in theory, lie above or below the level associated
with the equilibrium level of the "permanent" yield curve.⁹
The intertemporal nature of net carbon sequestration raises a question: how can we associate
a number -- the marginal cost of carbon sequestration -- with units of carbon that are sequestered in
different years? This is important if we wish to compare the costs of carbon sequestration with the
costs of conventional carbon abatement measures, such as fuel switching and energy-efficiency
enhancements. Previous sequestration studies have used a variety of methods to calculate costs in
terms of dollars per ton, the desired units for a cost-effectiveness comparison (Richards and Carrie
Stokes 1995). Our approach is to divide the discounted present value of costs by the discounted
present value of tons sequestered. This may be thought of as assuming that the marginal damages
associated with additional units of atmospheric carbon are constant and that benefits (avoided
damages) and costs are to be discounted at the same rate. Note that such an assumption of constant
marginal benefits is approximately correct if marginal damages are essentially proportional to the
rate of climate change, which many studies have asserted. We initially use a 5 percent real rate,
supplemented by sensitivity analysis.
By developing the constituent intertemporal yield curves (and net revenue streams) for
different species, location, and management conditions, we can calculate a set of present-value
equivalent carbon-sequestration measures. By way of example, we focus on periodically harvested
8 The share of forest carbon that goes into merchantable wood varies considerably. A reference point is about 40%.
Much of the remaining 60% is released at the time of harvest and in the process of manufacturing wood products (in both
cases through combustion), the major exception being soil carbon, which exhibits a much slower decay rate (reasonably
assumed to be zero in some cases). As Sedjo et. al. (1995) point out, examinations of the long-term effects of timber
growth on carbon sequestration are "highly dependent upon the assumptions of the life-cycle of the wood products" (p.
23). M. E. Harmon, W.K. Farrell, and J. F. Franklin (1990) found this to be the case in their scientific review. The two
critical parameters are the assumed length of the life-cycle of wood products, and the assumed share of timber biomass
that goes into long-lived wood products. Drawing upon the work of Clark Row (1992), Row and Robert B. Phelps
(1990), and D. P. Turner et. al. (1993), we develop a time path of gradual decay of wood products over time, based upon
an appropriately weighted average of pulpwood, sawlog, hardwood, and softwood estimates from Plantinga and Birdsey
(1993). The final profile is such that one year following harvest, 83 percent of the carbon in wood products remains
sequestered; this percentage falls to 76 percent after 10 years, and 25 percent after 100 years (and is assumed to be
constant thereafter). At an interest rate of 5 percent, the present value equivalent sequestration is approximately 75
percent, identical to that assumed by William D. Nordhaus (1991).
9 A potential scenario that we do not consider is that harvested wood is used for fuel. If this were used to produce
electricity or liquid fuels such as methanol, thereby substituting for fossil-fuel use, then the net impact on atmospheric
CO2 emissions of each unit of forestation would be significantly enhanced.
9
pine, and assume that when and if deforestation occurs, on-site merchantable timber is sold. 10 In this
case, the present value of net carbon sequestration associated with forestation is 41.05 tons per acre,
and the present value of carbon emissions associated with deforestation is 51.83 tons (Table 1).
Finally, we define the present values (in year t) of the time-paths of carbon sequestration and
carbon emissions associated with forestation or deforestation occurring in year t as QS,S and Q,E,
respectively. Thus, the total, present-value equivalent net carbon changes associated with a baseline
or policy simulation are calculated as:
(15) PV(SEQ) = - +
90
(16)
90
(17)
where CSₕ and CEₕ are, respectively, annual incremental carbon sequestration and carbon emissions
per acre, and is simulated with equations (7), (8), (9), (10), (13), and (14), above.¹¹
III. The Costs of Carbon Sequestration
It might be argued that since the policy intervention we model is a tax/subsidy on land use,
not on carbon emissions and sequestration, it does not lead to the true (minimum) carbon
sequestration marginal cost function. This criticism is not valid in a realistic policy context. It
would be virtually impossible to levy a tax on carbon emissions or a subsidy on sequestration,
because the costs of administering such policy interventions would be prohibitive. Looked at this
¹⁰For a comparison of sequestration costs under different management regimes and other conditions, see: Stavins 1995.
The growth curves that underlie respective yield curves are themselves a function, partly, of precipitation and
temperature, both of which are presumably affected in the long run by atmospheric concentrations of CO₂ and induced
climate change (Dixon et. al. 1994). We ignore this endogeneity to climate change in estimating sequestration costs, as
have all previous studies. Likewise, all studies have ignored potential economic endogeneity of relevant variables to
climate change (Brent Sohngen and Robert Mendelsohn 1995).
"A 90-year period was used to allow at least one rotation of each forest species. Given the consequences of discounting,
the results are not fundamentally affected by the length of the period of analysis, once that period exceeds 50 years or
so.
10
way, it becomes clear that such an instrument would likely be more costly per unit of carbon
sequestered than would the deforestation tax/forestation subsidy policy instrument.
A simulation of equations (15), (16), and (17) with the subsidy/tax, Z, set equal to zero (in
equations (13) and (14)) generates a baseline quantity of carbon sequestration/emissions. By
subtracting this quantity from the results of simulations employing positive values of Z, we trace out
a supply curve of net carbon sequestration, in which the marginal costs of carbon sequestration,
measured in dollars per ton, can be arrayed in a schedule with net annual¹² carbon sequestration.
Table 2 provides the results for a periodically harvested pine plantation, with the sale of
merchantable timber when/if deforestation occurs. Such a scenario is most directly comparable with
those examined in other studies. The relatively attractive forest revenues associated with this
management regime result in a small amount of net forestation taking place in the baseline
simulation, a gain of about 52 thousand acres (over the 90-year study period). Baseline net carbon
sequestration is approximately 4.6 million tons annually. Marginal costs of carbon sequestration
increase gradually, until these costs are about $66 per ton, where annual sequestration relative to the
baseline has reached about 7 million tons. This level of sequestration is associated with a land-use
tax/subsidy of $100 per acre and net forestation, relative to baseline, of 4.7 million acres.
Beyond this point, marginal costs depart more rapidly from a linear trend. Beyond about
$200 per ton, they turn steeply upward. Indeed, the marginal cost function is nearly asymptotic to
a sequestration level of about 15 to 16 million tons annually. This is not surprising, since such an
implicit limit would be associated with net forestation of about 10.5 million acres, for a total forested
area of 13 million acres, just shy of the total area of the study region.¹³
IV. Placing the Sequestration Cost Estimates in Context
In this section, we first seek to compare our estimated sequestration marginal cost function
with estimates of sequestration costs from previous studies using different methods. Then, we
compare our sequestration cost estimates with estimates of the costs of abating carbon emissions
through fuel switching and energy-efficiency enhancements.
First, to compare our results with those of other sequestration studies, we need to normalize
the results to some common set of standards (Table 3). Since the other studies of carbon
sequestration costs (and carbon abatement costs) are for the U.S. as a whole, one thing we need to
do is normalize our results for the U.S. In doing so, it is important to recognize that the marginal
12 Recall that both dollars of costs and tons of sequestration (and emission) are discounted. Hence, annual sequestration
refers to an annuity that is equivalent to a respective present value (employing a discount rate of 5 percent).
13 Because of the long time horizon employed, it is natural to ask how sensitive are the results to the assumed interest rate.
As the discount rate decreases, marginal sequestration costs decrease monotonically because the present-value equivalent
sequestration increases with decreased interest rates. Later in the paper, when we compare our marginal cost results with
those from other sequestration and abatement studies, we always normalize the results so that all, in effect, employ the
same discount rate.
11
costs of sequestration in the Delta states are not necessarily representative of nationwide
sequestration costs. 14 In effect, we re-scale the horizontal dimension of the estimated supply function
to represent the change from the study area to the relevant U.S. land base,¹ 15 and we normalize the
results from other studies by converting those results to appropriately discounted units.
The results of this process are provided in Figure 2, where our results are compared with
those of Richards, Moulton, and Birdsey (1993), Adams et.al. (1993), and Callaway and McCarl
(1996). All of these marginal cost functions lie within our 95 percent confidence interval, 16 at least
up to 300 million tons/year in the case of Adams et.al. (1993), but all are less steep than our central
tendency and lie well below it for most of their ranges. Other studies have not reported, indeed not
calculated, confidence intervals around their results, and so it is especially difficult to make
comparisons. Overall, the general impression is that our marginal cost estimates are at least as great
and may well be greater than others previously reported. Such differences may arise because several
of the factors previously identified as affecting land-use decisions - including non-pecuniary returns
to land and decision-making inertia - would tend to lead "engineering" or "least cost" analyses to
under-estimate sequestration costs.
Next, we turn to estimates of the costs of carbon emissions abatement. We use results from
Working Group 12 of the Energy Modeling Forum (EMF) (1995), which examined carbon
abatement costs for the United States. The EMF results are presented as time paths of predicted
carbon emissions under baseline and policy scenarios over hundred-year time frames, and include
estimates of the time paths of carbon taxes necessary under each of the policy scenarios.¹⁷
To construct comparable marginal cost estimates, we first calculate the present discounted
value of carbon abatement and the present discounted values of carbon taxes for each time-path of
taxes and emission reductions from baseline; from this set of numbers, we calculate an equivalent
annuity (at the 5 percent discount rate). Each of the time-paths for alternative policy scenarios then
constitutes a single point on a marginal cost function associated with a given model. These results
are plotted along with of our estimated carbon sequestration marginal cost function in Figure 3.
¹⁴It is likely that the difference is not very great. During the relevant time period, farm real estate prices in Arkansas,
Louisiana, and Mississippi have tended to be within about 15 to 20 percent of the U.S. average.
15 The scaling factor is equal to the ratio of total farm acreage in the continental U.S. (551 million acres in Richards,
Moulton, and Birdsey 1993) to total farm acreage in our 36 study counties (10.6 million acres). It is agricultural acreage
alone that is relevant for the normalization because in the scenario considered there is no deforestation in the baseline
(and hence all carbon sequestration is coming from planting trees on formerly agricultural land).
16 An advantage of the econometric approach is that we can provide a richer description of the marginal cost function
through the use of stochastic (Monte Carlo) simulations, drawing upon the relevant variance-covariance matrix from
the econometric estimation, but because there is also uncertainty associated with several variables employed in the
analysis, the confidence bounds in the figure may underestimate the true error bounds.
17 The policy scenarios are: 20 percent reduction from 1990 emission levels by 2010; a 50 percent reduction in annual
emissions by 2050; emission stabilization by 2000; 2 percent per year emissions reductions; and a phased-in carbon tax.
12
The central tendency of marginal sequestration costs lies everywhere above the estimated
marginal abatement costs, although the difference is small at low levels of carbon reduction. 18 As
we move beyond 400 million tons per year (30 percent of current U.S. emissions, and 12 percent of
estimated emissions in 2050), the two central tendencies depart more dramatically, as the marginal
cost function for sequestration begins to approach an implicit vertical asymptote, due to limited
availability of land. 19 Still, most of the abatement cost estimates lie within the confidence interval
for sequestration costs. Hence, we cannot conclude rigorously that sequestration costs are
systematically greater than abatement costs, particularly given the fact that the EMF abatement cost
estimates do not have associated confidence intervals.
On the other hand, there are two reasons why it is likely that the figure under-estimates the
difference between the sequestration and abatement cost functions. First, since the EMF scenarios
do not represent cost-effective time paths of achieving a given present-value of abatement at
minimum cost, the true carbon abatement marginal cost function is better thought of as constituting
the lower envelope of these points. Second, the partial equilibrium nature of our underlying
econometric estimates means that the true marginal cost function for sequestration likely lies above
the estimated function, because endogenous agricultural prices and endogenous forest product prices
would both lead to greater sequestration cost estimates. 20
In the long term, carbon sequestration costs are likely to increase further, relative to carbon
abatement costs, because of three factors: (1) there is a limited land base on which sequestration can
operate, in contrast with a much less limited emissions base -- due to economic growth -- on which
abatement operates; (2) the available land base for forestry may decrease due to population pressures,
driving up the opportunity cost of land; and (3) the magnitude of improvements in the silvicultural
domain (growing more biomass more quickly per acre) and the forest product domain (less decay
of wood products, for example) will probably be less than the magnitude of technological
improvements in the case of abatement, including increased efficiency of energy generation and use,
and decreased reliance on fossil fuels.
18 Forestation and retarded deforestation provide a set of secondary environmental benefits, and it has been argued that
these should be taken into account in a cost-effectiveness comparison with energy-efficiency enhancements (Sedjo et.
al. 1994). However, the same would need to be done for calculating the costs of energy efficiency (which may, for
example, bring about reduced emissions of sulfur dioxide).
19 These U.S. comparisons cannot simply be extrapolated to other nations. We can note, however, that at the global level,
Nordhaus (1991) has combined results from a number of studies, and provided a schedule of marginal costs associated
with percentage reductions in worldwide greenhouse gas emissions. As in our analysis for the United States, Nordhaus
finds an increasing departure between the global marginal cost functions for carbon abatement and carbon sequestration.
The sequestration marginal cost function rapidly becomes nearly vertical, while marginal abatement costs increase more
gradually.
²⁰In a general equilibrium context, a given conversion tax/forestation subsidy decreases agricultural production, thereby
increases agricultural product prices, and thus increases carbon sequestration costs (since the opportunity cost of the land
is increased). Likewise, a conversion tax/forestation subsidy increases forest production, thereby decreases timber prices,
and thus increases carbon sequestration costs (since the private benefits of forestry relative to agriculture decrease).
Thus, taking account of the potential endogeneity of agricultural and forest product prices may lead to greater
sequestration cost estimates.
13
Subject to the various caveats expressed above, this comparison between carbon
sequestration and abatement costs suggests that sequestration ought to be part of our overall
portfolio of greenhouse strategies in the short term, providing a significant fraction of overall carbon
reductions, although less than from conventional abatement activities (such as through carbon taxes
on fossil fuels or tradeable carbon rights). In the long term, however, the relative cost of carbon
sequestration in the United States is likely to be such that it should provide a smaller and smaller
share of overall reductions.
V. Conclusions
Our purpose was to develop and demonstrate a method by which the marginal costs of carbon
sequestration can be estimated for various regions of the world by drawing upon (existing) regional
econometric analyses of the factors affecting land use. Since our empirical application was intended
mainly to be illustrative, what conclusions -- if any -- can be drawn from the quantitative results?
First, focusing exclusively on our regional analysis, we found that the marginal costs of
carbon sequestration are by no means trivial, and that the heterogeneity of land brings sharply
increasing marginal costs of sequestration as higher quality agricultural lands are converted to
forested use. Therefore, studies that provide only single point estimates of average costs or even
linear estimates of marginal costs may be very misleading.
Moving beyond the regional cost estimates, what can we make of our illustrative comparison
with national cost estimates of sequestration and abatement costs from other studies? First, subject
to the necessary caveats regarding the results of any extrapolation, our sequestration cost function
is significantly less linear than ones previously estimated with engineering/optimization methods.
This becomes potentially important if one is interested in relatively high levels of annual
sequestration, i.e. greater than 300 or 400 million tons. Second, subject to the same caveats, our
implied sequestration costs for the United States as a whole are not very different from carbon
abatement costs for relatively low levels of carbon reduction, but marginal sequestration costs appear
to turn upward more rapidly than abatement costs. Further, we identified a set of reasons why our
estimate of the difference between sequestration and abatement cost is probably a lower bound, and
we identified another set of factors that suggest that this difference will likely increase over time.
Finally, we can reflect briefly on the analytical method we have employed. The model can
be improved along a number of dimensions. Primary among these is endogenizing some variables
currently treated as exogenous: agricultural and forestry product prices; the mix of cultivated crops
and forest species; and management regimes.² A general equilibrium approach should be possible,
both at the econometric stage and in simulations. This would not simply be desirable, but necessary,
21 For example, it would be desirable to allow for the economic endogeneity of the forest rotation length. In this regard,
a very different approach to thinking about the carbon supply function is found in a paper by G. Cornelis Van Kooten,
Clark S. Binkley, and Gregg Delecourt (1995). They examine the sensitivity of the socially optimal rotation length to
alternative values of carbon (dollars per ton), and thus develop a supply curve of carbon per acre. As timber prices
increase, the optimal rotation length decreases; and as carbon value increases, the (socially) optimal rotation length
increases.
14
if the general approach developed here were to be applied directly to estimate the carbon
sequestration marginal cost function for the United States as a whole.
Opportunities abound for the application of land-use econometrics to estimating sequestration
costs. 22 The major advantage of this approach is that simulations of marginal costs build directly
upon revealed-preference patterns of how landowners have actually responded to the economic
incentives they continually face regarding the alternative uses of their lands. Linking such regional
econometric models of land use with dynamic simulation models of carbon sequestration can provide
better estimates of the true costs of carbon sequestration, and thereby add significantly to our
understanding of the costs of addressing the threat of global climate change.
22 There is a growing literature of econometric analyses of forestation and deforestation (Theodore Panayotou and
Somahawin Sungsuwan 1989; Parks and Randall A. Kramer 1995; Alexander S. Pfaff 1997; Eustáquio J. Reis and
Rolando M. Guzmán 1992; and Douglas Southgate, Rodrigo Sierra, and Lawrence Brown 1991). The increasing
availability of digital land-use data derived from satellite images means that econometric analysis of the type described
in this paper can now be carried out at relatively moderate cost for large geographic areas.
15
TABLE 1:
DESCRIPTIVE STATISTICS
Variable
Mean
Standard Deviation
Gross Agricultural Revenue ($/acre/year)
259.04
44.58
Agricultural Production Cost ($/acre/year)
220.39
52.03
Forest Revenueb ($/acre/year)
Mixed Stand (prior to deforestation)
19.29
7.45
Pine Stand (subsequent to forestation)
58.96
23.38
Tree-Farm Establishment Cost ($/acre)
92.00
0.00
Conversion Cost ($/acre)
27.71
6.73
Fraction of County Naturally Protected
from Periodic Flooding
0.614
0.264
Index of Artificial Flood Protection
0.371
0.371
Palmer Hydrological Drought Index
0.74
0.84
Carbon Sequestration due to Forestationᶜ (tons/acre)
Pine Plantation Periodically Harvested
41.05
0.00
Carbon Emissions due to Deforestation,
with Sale of Merchantable Timber (tons/acre)
51.83
0.00
Interest Rate
5%
0.00
The sample is of 36 counties in Arkansas, Louisiana, and Mississippi, located within the Lower Mississippi Alluvial Plain.
All monetary amounts are in 1990 dollars; means are unweighted county averages.
b Gross forest revenue minus harvesting costs; an annuity of stumpage values.
ᶜPresent value equivalent of net life-cycle sequestration.
ᵈPresent value equivalent of net life-cycle emissions.
eThe historical analysis uses actual, real interest rates; simulations of future scenarios use the 5 percent real rate.
16
TABLE 2:
SIMULATED LAND CHANGES AND CARBON SEQUESTRATION
Periodically Harvested Pine Plantation, Sale of Merchantable Timber at Deforestation
Baseline Deforestation = + 51,654 acres
Baseline Carbon Sequestration = 4,578,202 tons
Forestation
Annual Carbon
Marginal Cost
Average Cost of
Marginal Cost
Relative to
Average Cost
Sequestration
of Carbon
Carbon
per Acre
Baseline
per Acre
Relative to Baseline
Sequestration
Sequestration
($/acre/yr)
(1,000s acres)
($/acre/yr)
(1,000s tons/yr)
($/ton)
($/ton)
0
0
0.00
0
0.00
0.00
100
4,653
57.32
7,045
66.05
37.86
200
6,579
105.63
9,961
135.97
69.77
300
7,484
129.15
11,332
202.03
85.31
400
7,897
142.25
11,957
268.05
93.96
500
8,212
155.98
12,434
334.11
103.03
600
8,470
169.22
12,825
400.18
111.77
700
8,689
182.74
13,156
466.22
120.71
800
8,874
195.72
13,437
532.20
129.28
900
9,038
208.21
13,685
598.31
137.53
1000
9,178
219.53
13,897
664.35
145.01
17
TABLE 3:
COMPARISON WITH RESULTS FROM OTHER STUDIES
Total Quantity
Average Cost
Marginal Cost
Study
Land
Carbon
Land
Carbon
Land
Carbon
(mil. acres)
(mil. tons/yr)
($/acre/yr)
($/ton)
($/acre/yr)
($/ton)
This Study
United States normalization
342
518
106
70
<200
<136
Delta States
5
7
58
38
<100
<66
Moulton and Richards (1990)
United Statesᵇ
269
690
--
27
<81
<37
Delta States Cropland
25
67
50
22
--
:
Richards, Moulton, and
Birdsey (1993)
United States
244
416
--
--
--
<41
Delta States Cropland
11
29
42
18
<52
<22
Adams et.al. (1993)e
274
700
--
:
--
<27
Nordhaus (1991)'
248
44
81
64
:
:
Parks and Hardie (1995)'
9
22
49
21
--
<24
Rubin et al. (1992)h
71
73
--
23
--
--
Dudek and LeBlanc (1990)
14
--
--
38
:
:
Plantinga (1995)
0.65
1.5
--
--
:
6-13
Callaway and McCarl (1996)*
187
280
:
:
--
<25
From Scenario #3, pine plantation, periodically harvested, at a 5% discount rate.
ᵇPermanent stands on cropland and pastureland only, i.e., not forest land.
°Figure for total U.S. carbon sequestration is an annuity calculated at 5% over 160 years.
ᵈThese figures were used, but not reported, in Richards, Moulton, and Birdsey (1993). Reference is to a permanent pine stand,
based on data provided in a personal communication from Richards (1994). Carbon costs and tonnages were
annualized over 160 years at a 5% discount rate.
Nationwide results for a scenario with harvesting and sale of timber (Table 1, p. 79 and Table 4, p. 83), recalculated at a 5%
discount rate.
⁺Permanent forestation of "marginal U.S. land" (Table 8, p. 60). For this and other studies, we have converted to acres at a
rate of one hectare = 2.477 acres and to short tons at a rate of one metric ton = 1.102 short tons.
Figures are for U.S. cropland-only scenario (Table 1, p. 127). Marginal costs were computed from marginal cost formula
for Figure 4 (p. 131) using 22 million tons per year and annualized using a 4 percent discount rate over 10 years.
"Nationwide results converted from original study (Table 3, p 261) at a rate of 3.67 tons of carbon dioxide (CO₂) equals one
ton of carbon, and into short tons from metric tons.
'An average permanent stand of U.S. tree species, from Table 3, p. 36; CO₂ converted to carbon.
Figures are for a 14-county region of Wisconsin for the scenario assuming a least-cost program at a 4% discount rate and
a constant annual sequestration rate of 2.25 tons of carbon per acre (Table II). Hectares converted to acres.
k
Calculations use a 5% discount rate, employ carbon yield functions from Birdsey (1992), and do not allow for farm programs.
18
FIGURE 1:
TIME PROFILE OF CARBON SEQUESTRATION
(Loblolly Pine in Delta States Region)
Cumulative Carbon
Sequestered (tons/acre)
160
120
80
40
20
40
60
80
100
Years
Periodically Harvested
Permanent
Source: Based on data from Moulton and Richards (1990) and Richards (1994).
19
FIGURE 2:
ALTERNATIVE ESTIMATES OF MARGINAL COST OF U.S. CARBON SEQUESTRATION
Marginal Cost ($/ton)
200
Expected value
95% confidence interval
Richards, Moulton, and Birdsey (1993)
150
Adams et al (1993)
Callaway and McCarl (1996)
100
50
0
0
100
200
300
400
500
600
700
Carbon Sequestration (million tons/yr)
20
FIGURE 3:
ESTIMATES OF MARGINAL COSTS
OF U.S. CARBON ABATEMENT AND SEQUESTRATION
Marginal Cost ($/ton)
Carbon Sequestration
250
This Study (expected value)
This Study (95% confidence interval)
Carbon Abatement
200
Manne and Richels / Global 2100
Goulder
Jorgenson and Wilcoxen / DGEM
150
X
OECD/GREEN
100
50
0
0
100
200
300
400
500
600
700
800
900
Carbon Reduction (million tons per year)
Source: Carbon abatement marginal cost estimates are annuities calculated from time-paths of 100-year
predicted baseline carbon emissions and predicted carbon emissions under alternative policy
scenarios presented in: Energy Modeling Forum (1995). See text of present study for detailed
explanation.
21
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24
Trexler, Mark C. Minding the carbon store: Weighing U.S. forestry strategies to slow global warming.
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25
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20/20
- DRAFT 9-14-98 for comments only -
Buyer Liability for Greenhouse Gas Trading is
Good for the Environment and Good for Emissions Trading
by
Juhn Palmisano
Enron International, Washington, DC
What is emissions trading? What is the liability issuc?
Under Article 17, the Kyoto Protocol an limiting greenhouse gases allows for the transfer of
"assigned amounts" of greenliouse gascs (GHG) among Annox I Parties. "Assigned
amounts" are internationally agreed upon levels of emissions for a Five year budget period
beginning in 2008 and ending in 2012. Anncx I countries are primarily the developed
countrics and the transitional economies, including the United States, Russia and Ukraine,
Europe, Australia, Canada, New Zealand, and Japan.
Under the rules of the Protocol, these countries will limit their emissions of greenhouse gases
by a certain percentage of 1990 levels of GHG emissions during the 2008-2012 interval.
If Parties emit less than their assigned amount during this time, they will be able to sell some
or all of these surplus "assigned amounts" to other countries or "hank" their surplus GHG
emissions for use during the next time period. Buyer companies or countries will he able to
use these surplus GHG emission allocations to meet their own GHG caps. Analysis predict
that the trading of emission allocations (usually called emissions trading or ET) will reduce
the cost of compliance with GHG reduction targets by billions of dollars.
While Annex I countries include the developed and transitional economies, non-Aunex I
countries are synonymous with the notion of "developing countries," still GUG trades can be
conducted between Annex I and non-Annex I countries. Trades between Annex I countries
differ from trades between Annex I and non-Annex 1 countries. While emissions trading
among Annex I countries is described in Article 17, trading between Annex 1 and non-Annex
I is described under Article 12 of the Kyoto Protocol -- the Clean Development Mechanism
(CDM). The CDM allows developing countries to trade GHG reductions that result from
specific projects. Trades of so-callod "certified emissions reductions" (CERs) will be based
on the difference bctween a project's GHG emissions and a baseline determined to he those
emissions that would have happened anyway. CERs that result from CDM actions can be
traded only after they are created and certified.
Besides trading CERs and emissions trading of assigned amounts, there is a third trading
initiative is called joint implementation. or Л. Л is described under Article 6 of the Kyoto
Protocol. л is similar to the CDM in that the focus of the trade is a surplus cmission
reduction that flows from a specific project. Any emissions credit that flows from a JT project
SEP 29 1998 06:48 FR ENRON WASHINGTON
202 828 3372 TO 3956870
is created after the fact -- it is certified after the emission reduction has been qualified,
quantified, and certified.
л and CDM-hased reductions are first certified then they arc traded or banked for future use.
Many people envision a system where surplus assigned amounts are traded first and
demonstrated to be surplus latter. The question, therefore, arises as to who is liable if the
traded "assigned amount" is not demonstrated to be surplus.
This paper addresses the mechanics of cmissions trading of assigned amounts between Annex
T Parties. The concern is that total emissions from Anncx I Parties will not hc subject to
verification tests until the end of the initial period between 2008 and 2012, and may not he
known until 2014. To preserve the integrity of the global greenhouse gas trading system.
cmissions trades of assigned amounts must only hc for surplus GHG emissions. Therefore,
GHG sellers must only be allowed to sell, and buyers must only buy, those allocations which
are left over after the seller's own cmissions control obligations have been met.
Purchasing countries or companies will want to buy GHG emissions allocations to help them
meet their own commitments during the initial period bctween 2008 and 2012. Since
country-specific inventories of GHG emissions will not be reported until as late as 2014,
huyers will be purchasing GIIG allowances before the seller's actual emissions are known.
Since there is a potential for noncompliance, there is a need to specify which party is liable if
a country determines that sold (so-called) surplus allocations are not, in fact. surplus.
Thcrefore, GHG trading rules must clarify which party in a emissions trade is liable for a
failure to perform -- the buyer or the seller or both.
Is the buyer or seller responsible for ensuring the surplus nature of traded CHGs?
Responsibility for validating the surplus nature of purchased assigned amount could rest with
sellers of emissions allocations, with buyers, or with some combination of the two. If sellers
are liable, they will hcld responsible for making sure they have sufficient parts of assigned
amount to cover their emissions after any sales are conducted, and would be subject to
domestic and international penalties for selling their assigned amounts that are not surplus.
On the other hand, since buyers would be using any purchased allocations to meet a domestic
GHG emission limit, domestic regulators can only sanction GHG buyers who attempt to
apply non-surplus reductions against a domestic cruission control obligation. Responsibility
could also bc imposed upon both the buyer and seller, as is done under certain US
?
cnvironmental regulations. The Conference of the Parties to the Framework Convention on
Climate Change will consider this issue when they meet in Buenos Aires in November. And,
while this is a complex Issue, Tables 1 and 2 provide some insight into how this problem
might be approached.
Making sellers liable is simple in concept, but difficult in practice. An allocation, once sold,
would retain its value as a portion of an assigned amount in the market no matter what the
seller finally emitted. At the cnd of the trading period, compliance would be confirmed and
sanctions invoked on those countries and companies that claimed to sell surplus GHG
emission reductions but failed to cstablish "surplusness."
2
SEP 29 1998 06:49 FR ENRON WASHINGTON
202 828 3372 TO 3956870
Table 1
Upon whom do we Impose liability?
On the buyer
When the huyer can best influence the integrity of the outcome or when the regulator or
public can only recover from the buyer. Consider the case of the person who has acquired,
or bought, counterfcit money. The buryer must beware and the buyer assumes complete
liability since any future "buyer" of the money cannot gct relief from the original seller.
On the seller
When the seller's behavior best influences the integrity of the outcome or when the regulator
can only recover from the seller; examples relate to property law where the seller has more
knowledge about the property than does the buyer; thus, full disclosure is required and
indemnification provisions are commonplace.
On both buyers and sellers
When there is an over-riding public policy reason for insuring fulfillment of a regulatory
obligation (i.e., Superfund).
While, in theory. seller liability provides punishment once noncompliance is discovered in
2013. it does withing to promote compliance along the way. In addition, seller liability works
only when sellers are accountable and punishable. But this is a bighly unlikely outcome
under any anticipated climate change negotiation.
Table 2
Whose behavior can we affect and what does that mean?
On whom does limbility for the integrity of the surplus reduction rest?
The crcater
The "user
Who is the
sufarces
(Seller company)
(Buyer company)
of liability
regulator in
seller
Regulator can affect
Regulators cannot
country
seller's behavior
affect behavior
regulator in
buyer
Cannot affect bchavior
Regulator can affect
country
huyer's behavior
3
SEP 29 1998 06:49 FR ENRON WASHINGTON
202 828 3372 TO 3956870
It is unlikcly that countries can be punishal if they sell GHG emission reductions that are
implied to be surplus and are subsequently found to be detective. It is virtually impossible
for a domestic regulator say, in Canada, to enforce sanctions against a GHG seller in Russia.
Therefore seller liability for yet-tu-be-proven surplus allocations is a functional impossibility.
The nccd for environmental and commercial integrity of traded "surplus" reductions dictatcs
rules that make Parties meet their emissions reduction obligations and attaiu the Protocol's
environmental goals. For the reasons discussed below, the best commercial and
environmental outcomes are achieved when it is the responsibility of buyers to ensure the
surplus nature of the GHG emissions they are purchasing.
Why doesn't seller liability create the right cconomic and environmental incentives?
The scale of emissions trading will be global; domestic sanctions may not provide a sufficient
deterrent for non-compliant behavior, and they may not be sufficiently enforced in all
countries. The United States has proposed two international methods of dealing with Parties
that sell non-surplus parts of assigned amount: sellers could be excluded from future
emissions trades or they would have to deduct the excess, with a penalty, from the next
period's assignment. The second option sounds very much like emissions borrowing, a
concept already rejected by the Conference of Parties.
While proposed "sticks" create penalties for non-compliance, they may not be sufficient
deterrents for Parties with a short-term outlook, and they do not provide "carrots" for
compliant behavior. La the two proposed methods for correcting illegal trades, damage to the
environment is irreparable because buyers have used non-surplus emissions to COVCI their
own. Damage is also imposed on the system of emissions trading by getting "counterfeit"
trades into the system. And even if the concept of emissions borrowing is accepted, there is
no guarantoc that borrowing behavior exhibited during the first commitment period will not
be repeated in future budget periods, thus emission control repayment is never achieved.
In addition, international trade sanctions are notoriously difficult to imposc, even for issues
(like weapons proliferation) that enjoy broad popular consensus. Because trades of GHGs
will cross international boundaries, legal and financial penalties for sale of emissions that are
not surplus will be problematic. With weak enforcement or insufficient penalties, sellers will
have a Financial incentive to sell an assigned amount that exceeds the penalties of non-
compliance. These sales could undercut prices from countries and tirms that legitimately sell
surplus assigned amounts. A system that builds incentives for compliance into the trading
program is preferable.
What is buyer liability and why is it better?
With buyer liability, the buyer would be responsible for ensuring the purchased "assigned
amount" is truly surplus. If the seller is found to have sold non-surplus assigned amounts,
these assigned amounts will be invalidated and buyers will not be able use them to meet their
emissions control obligations.
4
SEP 29 1998 06:49 FR ENRON WASHINGTON
202 828 3372 TO 3956870
If buyers are liable for a seller's failure to perform, the market for "assigned amounts" will be
differentiated by seller. Countries that act in ways to insure the surplus nature of the sold
assigned amounts will have more valuable assigned amounts since the likelihood of default
will be less than for low integrity assigned amounts. Since buyers will be responsible for
ensuring the surplus nature of the assigned amount they purchase, they will be vigilant about
who they buy from, and buyers will pay more for credits that have a high probability of being
surplus after the first budget period Buyers will bc willing to pay more for high-integrity
assigned amount and will pay less for low-integrity assigned amounts. With buyer liability,
the international GHG market will give value to the assigned amount that is likely to be
surplus. and devalue an assigned amount that is of low integrity. It will therefore provide
incentives to the seller to maintain the integrity of the parts of assigned amount they sell and
to stay within their cap.
The initial buyers of GHG emissions could also have the option of purchasing insurance from
the private sector or governments that allows for the replacement of a non-surplus assigned
amount, The insurance premium charged would be based on the risk associated with the
scller. If the seller runs a high risk of not having enough surplus emissions in cover its sales,
the premium will be high. Conversely, if the scller is likely to meet its emissions
commitments. the premium will hc low.
Because the price of insurance will be incorporated into the market price for GHG
allocations, sellers will have an incentive to keep their default risk low and sell only those
allowances they know to be surplus. To minimize this risk, sellers might also have an
incentive to control emissions below the required levels, thus maintaining a reserve to protect
against default. This is an environmental benefit of buyer liability that seller liability does
not provide.
There are a variety of remedies if, at the end of the budget period, a seller is found not to hold
a surplus allocations equal to the amount that they have sold. For example:
1. sales could be disallowed in reversc order (last in-first out), until the seller has
enough assigned amount to cover its needs, or
2. all traded allocations could be pro-rated downward to adjust for the amount
oversold, or
3. all traded allocations could be viewed as defective since it is impossible to
determine which unes were non-surplus.
Each remedy will have a different effect on the market for potentially non-surplus allocations.
Disallowing transactions in reverse order might create an incentive to begin trading early in
the commitment period and to register these trades as soon as possible but this option puts
- epends
little pressure on sellers of assigned amounts to maintain quality reductions. Pro-rating all
eductions downward provides some security for GHG allocation buyers and reduces the any
on
have
insurance premium. However, pro-rating may not provide a strong incentive for assigned-
10-
amount-selling countries to be rigorous in maintaining GHG surpluses. Option 3 puts the
5
3956870
most market pressure on sellers of GHG because buyers will demand higher guarantees of
surplusness. Option 3 provide the most environmental integrity and promotes the
development of the most rigorous GHG monitoring and reporting systems. Impounding all
traded allocations may be too strict of a system for some parties. but this system guarantees
the integrity of the GHG trading system while creating a complementary market for ancillary
insurance products.
All three systems could encourage the development of insurance services, information
services to provide information on huyer risks, and better GHG monitoring systems in seller-
countries. Any insurance product would likely follow the assigned amount even if the
assigned amount is resold. The insurance information would bc only two or three data items
in an emissions trading data-hase, hardly a big task. Bccause the insurance would be country-
and date-specific, the insurance premium and pay-out would be very specific, much the same
as is political risk insurance. If purchases are disallowed, insurers will provide valid assigned
amounts (or cash equivalents) as compensation.
Buyer liability promotes the market-based objectives by encouraging market-based risk-
management solutions. Buyer liability also promotes environmental objectives by
incentivizing countries to create high-integrity emission reductions via the avoidance of GHG
emissions shortfalls by over-controlling.
Is buyer liability tenable?
Organizations like the United Natious could provide information that tracks the probability of
sellers being in compliance. Annual reporting of progress towards Kyoto Protocol goals is
likely to be written into the rules for either liability scenario, and potential assigned amount
deficits will become obvious over time Emissions will be tracked by country, sector,
company, and facility. With buyer liability, sellers with potential deficits will not be able to
find buyers fur their assigned amounts, and insurance and information products will be
developed to help companies and countries manage their risk. The GHG emissions market,
like the bond and stock markets, will discriminate by quality.
In addition, because U.S. companies will be responsible for validating the surplus cmissions
they purchase, and would likely be subject to domestic sanctions if they do not. citizens,
regulators and environmental organizations will gain [aith in the international GHG trading
program.
What is at stake?
The stakes are hugc. A well designed international trading program will help participants
achieve the environmental objective of GHG emissions reductions while cutting the cost of
compliance billions of dollars over the coming decades. A successful trading program will
broaden and sustain international participation. A pourly designed program will encourage
non-participation and non-compliance. raise custs, and exacerbate environmental problems.
Once a trading program is designed, it will bc difficult to change. Buyer liability is one
critical piece of this complicated puzzle; it's important to put it in place the first time around.
6
** TOTAL PAGE. 07 **
WASHINGTON
202 828 3372 TO 3956870
P.01/07
John Palmisano
Director, Environmental
Policy & Compliance
Enron International
1775 Pyr. Street, NW Suite 800
Washington, DC 20005
(202) 466 9159
Tax (202) 331-4717
To: QUiNDi FRANCO
, CEA
FROM: JOHN PALMISANO
7 pages
Natural gas. Electricity. Endless possibilities.ᵀ
A. Denny Ellerman and Annelène Decaux
September 1998
Joint Program on the Science and Policy of Global Change
Massachusetts Institute of Technology
ANALYSIS OF POST-KYOTO CO2
EMISSIONS TRADING USING
MARGINAL ABATEMENT CURVES
ACKNOWLEDGEMENTS
We are greatly indebted to many colleagues and associates for consistent encouragement and critical
comment. Foremost among these are the faculty and research staff associated with MIT's Joint Program
on the Science and Policy of Global Change. particularly the EPPA Working Group. Particular thanks
are due to Henry Jacoby, Dick Eckaus, Loren Cox and David Reiner for their careful comments on
earlier drafts of this paper and to lan Sue Wing for invaluable help in running the model. The
encouraging response of participants of the RIIA/MIT Global Change Forum held at London in June
1998 gave much direction to the paper; and we are grateful to Nathalie Kosciusko-Morizet. Jean-
Charles Hourcade, Thierry Le Pesant and Ken Chomitz for their subsequent interest and helpful
comment. Finally, this research would not have been possible without the funding made available to the
Joint Program by a number of corporations in the U.S., Europe and Japan, by EPRI. and by agencies of
the Norwegian and U.S. Governments.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page I
A Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
ANALYSIS OF POST-KYOTO CO₂ EMISSIONS TRADING USING MARGINAL
ABATEMENT CURVES
I.
Background, Purpose of the Study
3
II.
Methodology: Using the MACs Generated by the EPPA Model for Trade Studies
5
a) What are Marginal Abatement Curves and What Do They Represent? (Fig. 1)
5
b) How Can MACs Be Used for Trade Studies? (Fig. 2)
5
c) How Can MACs Be Generated by the EPPA Model? (Fig. 3 and 4)
7
d) Assessing the 'Robustness' of MACs with Regard to the Policy Applied (Fig. 51
7
e) Analytical Approximations: a Simple Tool for Trade Studies (Fig. 6)
8
f) Aggregate Supply and Demand Curves (Fig. 7)
9
III.
Case Studies of Perfectly Competitive Trading
10
(1) A First Case Study: OECD Only
10
The No-Trading Case (Fig. 8, Table A)
10
The Trading Case (Fig. 9, Table B)
11
b) Trading with All Annex B Regions
11
No Trade / Trade within Annex B Regions (Fig. 10 and 11. Tables C and D)
11
How Much Difference Does the 'Hot Air' Make? (Table E)
12
c) Full Global Trading
13
Adding the Non-Annex B Regions (Fig. 12, Table F)
13
Hot Air and Leakage (Fig. 13, Table G)
14
d) Summary of the Three Competitive Trading Cases (Fig. 14 and 15)
15
IV.
Departures from Perfect Trading
16
a) The Effect of Quantitative Limits on Demand (Tables H and I. Fig. 16)
16
b) Non-Competitive Behavior in Supply
17
The FSU in the Annex B Market (Table J)
17
A Non-Annex B Cartel? (Tables K and L)
18
c) Transactions Cost and Other Inefficiencies in Supply (Tables M to O. Fig. 17 and 18)
19
V.
Conclusions
20
A Readily Available Technique for Analyzing Trading Issues
20
Emission Permit Trading: Implications for Policy
21
Suggestions for Future Research
21
VI.
Tables and Figures
22
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page 2
A. Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy of Global Change
1.
BACKGROUND, PURPOSE OF THE STUDY
At the Third Conference of the Parties (COP-3) to the United Nations Framework Convention on Climate
Change (UNFCCC), held in Kyoto in December, 1997. Annex B parties' agreed to CO₂ emissions
ceilings for the years centered on 2010. but left many details to be decided through further negotiations
and subsequent COPs. In particular. the extent to which parties could resort to emissions trading to meet
their commitments is to be addressed at COP-4 in Buenos Aires in November. 1998.
This paper provides an analysis of the importance of emissions trading by using marginal abatement
curves (MACs) generated by MIT's Emissions Prediction and Policy Analysis (EPPA) model. These cost
curves can be used to determine marginal, average and total cost, but more importantly they can indicate
the potential gains from emissions trading for various parties and the extent to which those parties would
wish to resort to emissions trading. The effect of constraints on the selling or buying of tradable carbon
permits can also be illustrated. Thus. this paper attempts to clarify what is at stake at in Buenos Aires and
in subsequent negotiations to determine the role of emissions trading in a global carbon regime.
EPPA is a multi-regional. multi-sectoral Computable General Equilibrium (CGE) model of economic
activity. energy use and carbon emissions. The acronyms for the twelve regions are indicated below. The
six regions listed on the left are Annex B regions: the other six are non-Annex B regions. The study takes
the year 2010 as representative of the first commitment period, which includes the years 2008 through
2012. The model keeps tract of five vintages of capital. Version 2.6 of the model, which is used here,
incorporates two backstop technologies: however, because these energy sources will not play a
substantial role in 2010. they are omitted from the calculations presented here.
ANNEX B REGIONS:
NON-ANNEX B REGIONS:
USA: USA
EEX: Energy Exporting Countries
JPN: Japan
CHN: China
EEC: European Union (EC-12 as of 1992)
IND:
India
OOE: Other OECD Countries
DAE: Dynamic Asian Economies
EET:
Eastern Europe
BRA: Brazil
FSU:
Former Soviet Union
ROW: Rest Of World
Notation of Regions in the EPPA Model
I
OECD countries. plus countries of Eastern Europe and the former Soviet Union. as listed in the Kyoto Protocol.
:
See Yang et. al. The MIT Emissions Prediction and Policy Analysis (EPPA) Model, Report #6. MIT Joint Program
on the Science and Policy of Global Change. Cambridge. MA. 1996.
Analysis of Post-Kvoto Emissions Trading Using Marginal Abatement Curves
Page 3
A. Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
The carbon emission reduction constraints used for this study are based on the commitments made by the
various Annex B parties to the Kyoto Protocol. Table 1 states these commitments for the regional
aggregates used in EPPA. indicates the reference (or business-as-usual) emissions for the year 2010 as
predicted by EPPA version 2.6. and calculates the absolute and percentage reductions required to meet
the Kyoto Protocol commitments.
USA
JPN
EEC
OOE
EET
FSU
Non An. B
Ref emissions 1990 (Mton)
1362
298
822
318
266
891
2022
Ref emissions 2010 (Mton)
1838
424
1064
472
395
763
4142
Kyoto commitments / 1990
93%
94%
92%
94.5%
104%
98%
NA
Hence Emissions Target in
1267
280
756
301
273
873
4142
2010 (Mton)
Mton
571
144
308
171
118
0
NA
i.e. Reduction / ref
%
31%
34%
29%
36%
30%
0
NA
'hot air' (Mton)
0
0
0
0
0
111
NA
Table 1: Emissions Levels Corresponding to Kyoto Commitments
The next section of this paper concerns methodology; it explains marginal abatement curves and how
they are generated by Computable General Equilibrium (CGE) models. such as EPPA. In particular. we
explore the robustness of these MACs, that is, whether the abatement costs for a given region are
invariant with respect to abatement in other regions.
Section III presents three illustrative cases in which the scope of the market is progressively widened
from no trading to full global trading. Perfectly competitive markets are assumed both to simplify the
presentation and to illustrate the maximum gains from emissions trading. We also discuss 'hot air' and
'leakage' in this section.
"
The correspondence between regional aggregates in EPPA and Annex B parties is not exact. For instance. Turkey
is included in OOE (Other OECD), but it is not an Annex B party. Similarly EET includes all of the former
Yugoslavia. but only Slovenia and Croatia are Annex B parties. Likewise. the Central Asian Republics are included
in the FSU. but they also are not Annex B parties. Furthermore. the Kyoto commitments indicated for these EPPA
regions depend upon our weighting of various constituent Annex B countries. Finally, the Annex B countries
constituting the EET committed to targets at Kyoto that were from 5% to 8% below baseline emissions: however.
these countries were allowed to choose an alternative to 1990 as the baseline year. Based on the national
communications to date. the change of baseline year appears to translate into a limitation that is 4% above 1990
emissions for this region as a whole. The term 'hot air' refers to the amount by which any country's emissions are
expected to be below the Kyoto Commitment. which is widely expected to be the case for the FSU.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page 4
A Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
In Section IV. we examine several departures from the simplifying assumptions of perfect competition to
impart a more realistic light on the potential gains from emissions trading. In particular. three departures
are examined: import limits. non-competitive behavior. and inefficiencies in supply.
The final section gathers the main findings of the study. in terms of both methodology and policy
analysis, and suggests future extensions of this research.
II.
METHODOLOGY: USING THE MACs GENERATED BY THE EPPA MODEL FOR TRADE STUDIES
a) What are Marginal Abatement Curves and What Do They Represent? (Fig. 1)
A CGE model will produce a shadow price for any constraint on carbon emissions for a given region R at
time T. An example would be a 10% reduction below the reference case for the USA in 2010. This price
indicates the marginal cost for reducing or abating the last ton of carbon required to meet the constraint.
As might be expected in a proper CGE
model. the shadow prices corresponding to
constraints of increasing severity rise as an
Shadow price of carbon
Region R, time T
increasing function of emissions reduction.
= Total cost of abatement
A Marginal Abatement Curve plots the
under constraint: q abated
shadow prices corresponding to constraints
of increasing severity at time T against the
P
MAC
quantity abated. One point (q, p) on the
curve thus represents the marginal cost for
plot
region R of abating an additional unit of
carbon emissions at quantity q in time T.
Fig. 1 shows such a Marginal Abatement
Curve.
The integral under the curve (hatched area)
represents the total abatement cost for
q
CO: abated
region R of carbon emission reduction q at
time T.
Fig. 1: Marginal Abatement Curves
b) How Can MACs Be Used for Trade Studies? (Fig. 2)
Any emission reduction for a region can be represented as a point on its marginal abatement curve. If
several regions commit to achieve emission reductions at the same time. and if the marginal costs
associated with those reductions are different. the aggregate cost of meeting the commitments will be less
to the extent that a region with higher marginal costs can induce a region with lower marginal costs to
Analysis of Post-Kyoro Emissions Trading Using Marginal Abatement Curves
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A Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
abate more on its behalf. By abating more, the
lower cost region creates rights to emit,' or
Shadow price of carbon
emission permits. which it can sell to the higher
Time T
cost region. The difference in the marginal costs
R₁
associated with each region's commitment in the
p1
A
absence of trade creates a potential gain to be
shared in some manner between the two regions.
R:
A'
B'
The aggregate emission reduction will be
p
I
achieved at least cost when the regions trade
P:
B
until their marginal abatement costs are equal at
what will then be the market clearing price for
the right to emit' carbon.
Q'É
Q₁
Q:
Q':
0
q'i
qi
q:
4:
CO₂ abated
Fig. 2 illustrates the gains from trading for two
regions. R₁ and R₂, subject to the constraints:
CO₂ abated = q₁ for R₁ and q₂ for R₂, and Table
Fig. 2: MACs Used for Trade Studies
2 below displays the cost calculations in the no
trading and trading cases.
No Trade
Trade between R₁ and R₂
Constraints
R₁: q₁ abated
R₁ and R₂: q₁ + q₂ abated
R₂: q₂ abated
Marginal Cost / Market Price
R₁: P₁
R₁ and R₂: p` such that p`₁(q`₁) = = p
R₂: P₂
and q'i + = q₁ + q₂
Abatement Cost
R₁: area AOQ,
R₁: area (A'OQ'₁)
R₂: area BOQ:
R₂: area (B'OQ'₂)
Emission Permits Trading
NA
R₁: buys right to emit qi-q'
R₂: sells right to emit q' 2-92 = qi-q
Imports (+) / Exports (-) Flows
NA
R₁: pays p` * (qi-q'₁) = area (A'I,Q,Q'₁ to R₂
R₂: receives p` * (q'2-q₂) = area (B'I₂Q₂Q'₂) from R₁
Total Cost
R₁: area AOQ,
R₁: area (A'OQ'₁) + area (A'I,Q₁Q'₁) < area (AOQ₁)
R₂: area BOQ:
R₂: area (B'OQ's) area (B'I₂Q₂Q'₃) < area (BOQ₂)
Savings from Trading
NA
R₁: area (AI₁A`) (hatched)
R₂: area (BI₂B') (hatched)
Table 2: Basics of Trade Studies
4
As is typically assumed in such analyses, and as is the case here. the environmental goal pursued - reducing
atmospheric concentration of a long-lived greenhouse gas like CO2, which is well-mixed globally - is not affected by
the location of the emission reduction.
Analysis of Post-Kvoro Emissions Trading Using Marginal Abatement Curves
Page 6
A Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
These cost calculations can easily be generalized to N regions, and they constitute the basis of this study:
we will calculate. under various trading assumptions. the volume of trade and the resulting savings for
the regions.
c) How Can MACs Be Generated by the EPPA Model? (Fig. 3 and 4)
To build the M.ACs. we run the EPPA model under different constraints corresponding to different levels
of carbon abatement. such as 10%. 20%. or 30% below reference emissions. For each set of constraints.
the corresponding. regional shadow prices of carbon are an output of the model. Then we plot the shadow
prices as a function of the level of abatement. for time T and region R. A line can then be fitted between
the plots to get the MAC of a region R at time T (for example. in the Kyoto case. we are interested in
time T = 2010).
As an example. Fig. 3 shows the results obtained for the four OECD regions in 2010 when the policies
applied are proportional reductions by all OECD regions (1. 5, 10. 15, 20. 30 and 40% of reference 2010
emissions) in 2010. and no reduction by other regions. Here. the shadow prices have been plotted as a
function of the percentages of carbon emission reductions (and not the absolute quantities). in order to
show the variations across regions without taking into account the size of the economy. We can see that,
for any equal percentage reduction. the abatement of the corresponding quantities would cost most in
Japan and least in USA and OOE among the OECD regions.
Similar curves can be obtained for all regions. For example. we can apply the same proportional
reductions. but to all of EPPA's twelve regions at the same time. 5 Fig. 4 displays the marginal abatement
curves thus obtained. It shows where it is the cheapest to abate carbon emissions (India and China) and
where it is the most expensive (Japan). Now, to allow trade studies like in Fig. 2, we need to re-scale the
x-axis of these curves to actual absolute quantities instead of percentages, and it is the way MACs will be
represented from now on.
d) Assessing the 'Robustness' of MACs with Regard to the Policy Applied (Fig. 5)
One question that arises immediately from our use of equal proportional reduction across regions to
generate the MACs is whether the location of these curves, or more generally. the cost associated with
any given level of carbon abatement, is affected by differing levels of abatement in other regions. For
instance, as can be seen in table 1, the levels of implied abatement corresponding to the Kyoto
commitment are not strictly proportional, and with emissions trading, we would not expect the
percentage reductions among regions to remain the same. Will region R₁`s MAC look different
depending on whether region R₂ reduces by 10% or 40%? In a model with international trade in all
goods. such as EPPA. there is the possibility that a 40% reduction by region R₂ would alter trade flows
such that abatement of, say, 100 Mton by R₁ would cost more (or less) than if R₂ reduced emissions by
"
In doing so. we do not imply that non-Annex B countries assume quantitative national constraints. but only that
when faced with the corresponding price for carbon emission reductions. they choose to abate emissions in the
proportions indicated. The result is similar. but the motivation is different.
Analysis of Post-Kvoto Emissions Trading Using Marginal Abatement Curves
Page 7
A. Denny Ellerman and Anneiène Decaux
MIT Joint Program on the Science and Policy of Global Change
only 10%. This fundamental question is that of the robustness of the MACs. And indeed, a drawing like
Fig. 2 and the simple method we have deduced from it assume this robustness (one curve for each region.
whatever the reductions in other regions). The answer: they are robust.
For example, Fig. 5 shows simultaneously the two sets of MACs corresponding to varying levels of
OECD abatement assuming no emissions trading and fully efficient emissions trading." The curves in
both sets are similar (less than 10% variation in price for any given level of abatement). thus showing
that the MACs are robust with regard to this change of policy. We have made similar comparisons for
Annex B trading and global trading. and we have examined one region's MAC (the USA) when all other
regions vary from reference to as much as a 60% reduction. In all cases. we have found the same
fundamental result: whatever the trading scheme, whatever the extent of the market. the marginal
abatement curves are almost identical. These model results indicate that abatement cost in a region is
largely independent of abatement efforts in other regions.
Our conclusion is that MACs. and more generally, the costs associated with a given level of domestic
abatement. are robust to different levels of abatement among regions and the scope of emissions trading.
Whatever the reductions of other regions. a MAC for a region R at time T looks the same.
e) Analytical Approximations: a Simple Tool for Trade Studies (Fig. 6)
Robustness implies that each region at time T has a unique marginal abatement curve. This fundamental
result validates the use of marginal abatement curves. and makes actual trade analysis straightforward
and simple. Analysis can be simplified even further if each curve could be described by a single
mathematical expression because, once we have the equations of the MACs, the cost calculations (i.e.
integration under the curves) are extremely simple and rapid.
Fig. 6 shows, for the OECD regions, that we can fit simple analytical curves to the sets of plots resulting
from the EPPA runs. and that those fits are very good (for each curve. R² is very close to 1). This result is
true for all the other regions as well. The curves that best fit the EPPA-generated plots are of the form: P
= aQ² + bQ. where Q is the amount of abatement in million metric tons of carbon (Mton) and P is the
marginal cost, or shadow price, of carbon in 1985 US$.⁷ By integration, the total cost of abatement is: C
= 1/3*aQ³ + 1/2*bQ²). The table below displays the coefficients a and b for each region in 2010, as well
as the coefficient of determination, R².
0
Note that. compared to figs. 3 and 4. the x-axis has been re-scaled to quantities.
Multiplication by 1.5 converts all price and cost data in this paper into current (1998) USdollars.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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A Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy of Global Change
Region
a
B
R²
Region
a
b
R²
USA
0.0005
0.0398
0.9923
EEX
0.0032
0.3029
0.9983
JPN
0.0155
1.816
0.9938
CHN
0.00007
0.0239
0.9992
EEC
0.0024
0.1503
0.9951
IND
0.0015
0.0787
0.9970
OOE
0.0085
- 0.0986
0.9981
DAE
0.0047
0.3774
0.9996
EET
0.0079
0.0486
0.9973
BRA
0.5612
8.4974
0.9997
FSU
0.0023
0.0042
0.9938
ROW
0.0021
0.0805
0.9967
Table 3: Coefficients of the Approximations of the MACs of the Form: P = aQ² + bQ
In using these approximations, analysts should keep in mind that the price of this simplicity is some loss
of the details of the general equilibrium features of the underlying model. The robustness of the curves
assures us that the relation between price and quantity of abatement is relatively fixed, but the curves do
not capture all the effects of emissions trading. Since the EPPA model remains our primary analysis tool,
we have run the model in every policy case we studied not only to ensure that the approximations are not
misleading, but also to check for any significant side effects. The prices and quantities for abatement
were all very close to the approximations. but there is a side effect that the MACs do not show:
"leakage." As will be discussed more extensively later, when only some regions' carbon emissions are
constrained. carbon emissions tend to leak to non-constrained regions. Nevertheless, these effects are not
essential to the analysis. and the analytical approximations are a powerful computational shortcut to
particular results. They provide a convenient way to graphically represent the results of the analysis of
trading. and we use them extensively for that purpose in the remaining sections.
f) Aggregate Supply and Demand Curves (Fig. 7)
Marginal abatement curves are the basis for
p
EXPORT
Higher
determining the demand and supply for
market
emission permits in any given market.
price
Emission permits represent 'rights to emit'
Autarkic
and these rights can be produced by some
marginal
party abating more than it is required to do. or
price
undertaking some abatement when not
Lower
required to do so. The willingness of any
market
IMPORT
party to purchase or to sell these permits is
price
illustrated by Fig. 7. The vertical dotted line
Kyoto
q
represents the amount of abatement required
for a region to meet its Kyoto commitment. In
Fig. 7: Willingness to Import / Export
the absence of any emissions trading it would
with Regard to Market Price of Permits
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page 9
A Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Pobey of Global Change
abate the amount indicated by the intersection of this line with the MAC. and the corresponding price
would be its autarkic marginal cost. If emissions trading were a possibility, the region would purchase or
sell permits according to the relation of the market price to its autarkic marginal cost.
If the market price is lower than its autarkic marginal abatement cost. this region would be willing to
buy emission permits corresponding to the quantity difference between the autarkic emission
reduction and the domestic abatement it would undertake at the market price.
Conversely, if the market price is higher than its autarkic marginal abatement cost. it would be
willing to undertake more abatement and supply the market with the right to emit' the corresponding
quantity.
Unconstrained regions. such as the non-Annex B regions or the FSU. are a special case. Their
autarkic marginal cost is zero. and they would be only suppliers to the market at any positive price.
For whatever market one is considering, we simply add up the quantities (x-axis) potentially supplied and
those potentially demanded at each price (y-axis) across the constituent regions. As we vary the price. we
describe the demand and the supply curves for this market. and their intersection indicates the market
clearing price on the y-axis and the total quantity traded in that market on the x-axis. Examples of
aggregate demand and supply curves for the Annex B and global markets will be introduced
subsequently.
III.
CASE STUDIES OF PERFECTLY COMPETITIVE TRADING
As a first step in illustrating how the cost of meeting Kyoto commitments for different regions is affected
by emissions trading, we consider a simple case consisting of only the four OECD regions (USA, JPN.
EEC. OOE). We then expand the scope of the market to include all Annex B regions, i.e., OECD + FSU
+ EET. Finally, to illustrate full global trading, we broaden the market to include the potential supply
from the non-Annex B regions. All the numerical results corresponding to different cases are displayed in
the tables at the end of the paper.
a) A First Case Study: OECD Only
The No-Trading Case (Fig. 8, Table A)
The MACs for the four OECD regions are all presented on Fig. 8. The black diamonds on the MACs
correspond to the quantity of abatement required to meet the Kyoto commitment for each region, on the
horizontal axis. and, on the vertical axis, the no-trading, or autarkic, marginal cost for that region. The
autarkic marginal cost of abatement for Japan ($584/ton) is much higher than the marginal costs of
abatement for the EEC ($273), the OOE ($233), or the USA ($186). The areas under the curves represent
the total costs of abatement for each region. The total cost for the OECD is $115 billion.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page 10
A Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy of Global Change
The Trading Case (Fig. 9, Table B)
Fig. 9 depicts what happens when there is emissions trading. Regional marginal costs equalize in such a
way that the total amount of carbon abated is the same as in the no-trading case (the arrows on the x-axis,
which represent the changes in quantities of carbon abated when trade occurs. sum to zero). The resulting
price is the market price of emissions permits ($240/ton). It is below the autarkic marginal costs for JPN
and the EEC. but above those for the OOE and USA. Consequently. JPN and EEC are importers of
permits equivalent to 86 Mton of higher-cost domestic abatement avoided. while the OOE and USA
undertake additional abatement in this amount to export the permits. Every region achieves some gains
through trading. and the total savings for the OECD are $13 billion. The areas representing the regional
savings from trade are displayed as the hatched areas on the graph for JPN and USA. Japan imports the
most. 65 Mton i.e. 45% of the reduction required by its Kyoto commitment. and benefits the most from
emissions trading ($10 billion). The USA is the principal exporter (83 Mton) and it draws the second
largest benefit from emissions trading in this market ($2 billion). The EEC imports and the OOE exports
smaller amounts of emission reductions. respectively. and each benefits by less than $1 billion. These
relationships point out an important feature of emissions trading: regions whose autarkic marginal cost is
farther from the trading equilibrium will import (or export) more and benefit more than those regions
whose autarkic marginal cost is closer to the trading equilibrium.
b) Trading with All Annex B Regions
No Trade / Trade within Annex B Regions (Fig. 10 and 11, Tables C and D)
Here we conduct the same analysis as above. except that the FSU and EET are included. In the no-trading
case. the marginal cost of meeting the Kyoto commitment for the EET is $116/ton and its total cost of
abatement is $5 billion. As for FSU, the commitment made at Kyoto would not result in a constraint on
its carbon emissions, according to our model and nearly all predictions. because its Kyoto commitment
corresponds to an emission level higher than the one predicted for 2010 (see Table 1). Therefore,
compliance with Kyoto would result in no cost whatsoever for the FSU. The cost of compliance for all of
Annex B would be $120 billion, i.e. the $115 billion for OECD regions. + $5 billion for EET.
In the emissions trading case with the FSU and EET included, the equilibrium market price is much
lower than in the OECD only case, $127/ton. The OECD regions are all importers of permits. since the
market price is lower than autarkic marginal cost for all of these regions: and the EET and FSU are
exporters. The FSU accounts for virtually all of the exports (98%). As shown in Fig. 10, about a third of
these consist of 'hot air,' with a cost of zero: but the remaining exports are generated by abatement
undertaken to earn additional export profits up to the point that marginal abatement cost equals the
market price. It costs the FSU $10 billion to abate the 234 megatons (Mton), but the permits can be sold
for $30 billion for a net gain of $20 billion. When added to the $14 billion earned for exporting 111
Mton of the unused Kyoto entitlement, the FSU's total gain from emissions trading is $34 billion.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page II
A Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy of Global Change
For the five Kyoto-constrained regions. the cost
P
of meeting the Kyoto commitment is reduced by
$32 billion. as illustrated in Fig. 11. The four
FSU
OECD regions avoid more costly domestic
abatement by importing permits. and the EET is
$127
able to reduce its costs by a small profit on its
Emissions
exported permits. The reductions in cost. that is,
HOT AIR
Reduction
the gains from emissions trading for the five
(111 Mton)
(234 Mton)
Kyoto-constrained regions. are distributed
Q
roughly in proportion to autarkic marginal cost.
The two regions with the highest autarkic
Optimal quantity of permits traded (345 Mton)
marginal costs. Japan and the EEC. benefit the
most from emissions trading in this market. Japan
Fig. 10: Trade with FSU: the 'Hot Air' Effect
imports 66% of its reduction requirement and
reduces its cost by $19 billion. The EEC imports
35% of its reduction requirement and reduces its
cost by $7 billion. These two regions account for about one-third of the total emission reduction
requirement for the five Kyoto-constrained regions. and about five-sixths of the gains from emissions
trading for these regions accrue to them. The other three regions are characterized by autarkic marginal
costs much closer to the Annex B market price; consequently, they trade much less. The USA and OOE
are importers for 19% and 25% of their respective requirements. and the EET abates emissions by 5%
more than required in order to export permits. The gains for these regions. which account for two-thirds
of the total reduction requirement. total $5 billion, about a sixth of the gains from trading for the Kyoto-
constrained regions. From the standpoint of world resource use. the aggregate cost of meeting the Kyoto
commitments is much lower with Annex B trade ($54 billion) than without ($120 billion). The total
gains from emissions trading are $66 billion, split about evenly between the FSU ($34 billion) and the
OECD + EET ($32 billion).
How Much Difference Does the 'Hot Air' Make? (Table E)
Part of the gains from Annex B trading results from a controversial feature that has come to be called
'hot air:' the difference between the FSU commitment at Kyoto and its predicted emissions level in 2010.
Since no abatement is undertaken to produce these permits, their export relaxes the aggregate constraint
faced by the five Kyoto-constrained regions by about 8%. As a result, many observers argue that such
exports should not be permitted, although admittedly, were the FSU's economy to grow faster than
predicted here. global emissions would rise equivalently. From this point of view, the FSU's commitment
represents a permissible level of emissions, which if unused is available for banking or export. as would
be the case for any other Annex B party.
3
In Figure 11. the OOE and EET MACs are virtually identical and thus superimposed.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page 12
A. Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
It is possible, of course. to model Annex B trading without the 'hot air`. i.e. without allowing the FSU to
sell permits that do not correspond to actual emission reductions. With less supply, the Annex B market
clearing price is higher. $150. so that the OECD regions + EET abate 90 Mton more domestically,
import correspondingly fewer permits. and pay more for those imports. At this higher price. the FSU also
abates more (20 Mton) and it sells 90 Mton less. hence 254 Mton. It is interesting to note that the
reduction in the gains from trade are shared about equally: $9 billion less for the FSU (-25%) and $7
billion less for the OECD + EET (-21%).
Nevertheless. the reduction in OECD compliance cost and the corresponding gains from emissions
trading. $51 billion. are still substantial and much greater than if trading were restricted to OECD regions
only. This result occurs because. so long as the FSU is not as severely constrained by a Kyoto
commitment as its potential trading partners are. it remains a very cheap source of emission reductions.
c) Full Global Trading
Adding the Non-Annex B Regions (Fig. 12, Table F)
To illustrate full global trading, we rely on aggregate supply and demand curves for emissions permits, as
explained earlier and now illustrated in Fig. 12. These curves indicate the total quantities of permits that
would be supplied or demanded at various price levels in a given market. In the figure. there is only one
demand curve because the Kyoto-constrained regions are the same in both the Annex B and the global
markets. This single demand curve intersects the horizontal axis at the quantity equal to the sum of the
emission reductions required to meet the Kyoto commitments, 1.31 Gton. This is the 'Kyoto cap'
represented by a vertical dotted line on the figure: it is also the quantity of emission permits that would
be demanded if the price were $0/ton. At this price, the aggregate supply is the quantity of permits
available at no cost: the FSU's 'hot air', 111 Mton.
As the price increases, the demand for permits diminishes. as more and more domestic abatement is
undertaken. and the supply of permits increases as more abatement is justified in the exporting regions.
As long as the market price is less than $116. the lowest autarkic marginal cost for the Kyoto-constrained
regions. these regions are always on the demand side; and the unconstrained regions are on the supply
side. When the price reaches the marginal cost for EET. $116, this region becomes an exporter. supply
grows faster. and the demand decreases more slowly, resulting in a 'kink' on all curves. which is almost
indiscernible because of the EET's small economic size. Such a kink is, however, readily seen on both
supply and demand curves when the price reaches $186, the autarkic marginal cost for USA. There will
be similar kinks at $233 when OOE becomes a supplier and at $273 when the EEC does. At $584, the
autarkic marginal cost for Japan meeting the commitment, the demand for permits will be zero.
9
In making this assumption for modeling purposes, we do not address the practical difficulties of distinguishing
'real' reductions from 'hot air.' nor whether such disallowance would upset diplomatic understandings that may
underlie the adherence of Russia, the Ukraine. and other potential beneficiaries of 'hot air' to the Kyoto Protocol.
10
Note that most of the equilibrium prices we have been considering are below this price.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
Page B
A. Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy ot Global Change
The ample supply of permits from non-Annex B regions causes a marked shift in the supply curve and
results in a market price that is much lower ($24/ton) than in the Annex B trading case. The total cost of
reducing global CO₂ emissions to achieve the Kyoto goals is astonishingly low: $11 billion vs. $54
billion with Annex B trading or $120 billion with no emissions trading!
At this price. the Kyoto-constrained regions depend far more on imports than when trading was restricted
to Annex B regions only. In the aggregate. 71% of OECD + EET commitments are met through
importing emission reductions from non-constrained regions: and the largest importers (proportionately)
are those regions facing the highest autarkic marginal cost: Japan. 92%: EEC. 76%: USA. 68%: OOE.
66% and EET. 56%. On the suppliers' side. three countries account for the bulk of exports: China
(47%). the FSU (23%) and India (11%). hence 81% altogether. Whether because of relatively small size
or high relative abatement costs. the remaining four non-Annex B regions are small suppliers of emission
permits to the Annex B regions.
With full global trading. the gains from emissions trading are much greater for the Kyoto-constrained
regions ($94 billion vs. $32 billion with Annex B trading). The non-Annex B regions gain $10 billion by
exporting permits. but their gains are much less than those of the Kyoto-constrained regions. The FSU is
the only party that is worse off by this widening of the market. At $24/ton. the FSU abates about half as
much as before. (101 Mton), and the 'hot air is worth much less. As a result. the FSU's net gain ($4
billion) in the global market is much less than when it does not compete with the non-Annex B regions
($34 billion). The distribution of the gains from emissions trading in the global market illustrates again
the feature of emissions trading we just noted: regions whose autarkic marginal cost is further from the
equilibrium price benefit more than regions whose marginal cost is closer to that price: in this global
trading case. the clearing price is much closer to the shadow price of the exporting regions when they are
not involved ($0/ton) than it is to the autarkic marginal cost of any of the importers.
Hot Air and Leakage (Fig. 13, Table G)
One of the arguments surrounding the use of emissions trading has been that it would increase global
emissions. unless the 'hot air' from the FSU (or elsewhere) could be kept out of the system. This
argument ignores an interesting feature of the general equilibrium solution of CGE models, to which we
alluded earlier: leakage. When only a sub-set of the regions of the world are constrained and there is no
emissions trading, emissions 'leak' to unconstrained regions; however, with emissions trading, there is no
leakage. since all regions face the same carbon price.
The compensating effects of leakage and hot air are shown in Fig. 13. If there were no leakage and no hot
air. the 1.312 Mton reduction of emissions required of the five Kyoto-constrained regions could be
expected to reduce 2010 global emissions from 9,098 Mton to 7,786 Mton. In the no trading case, a total
62 Mton of leakage (10 Mton to the FSU and 52 Mton to the non-Annex B regions) offsets a portion of
the Annex B emission reduction, so that global emissions are actually 7,848 Mton. When the FSU is
included in the trading regime. there is no leakage to the FSU since the carbon price is the same as in the
Kyoto-constrained regions. but there is still some leakage to the non-Annex B regions. This amount is
less, 35 Mton. because the price attached to carbon, and thus the incentive to leak. is less for all the
Analysis of Post-Kyoro Emissions Trading Using Marginal Abatement Curves
A. Denny Ellerman and Annelene Decaux
Page 14
MIT Joint Program on the Science and Policy of Global Change
Kyoto-constrained regions." Global emissions increase not by 111 Mton, the amount of hot air. but by 84
Mton (111 Mton less the reduction in leakage. 27 Mton). With full global trading. there is no leakage
whatsoever. as all regions face the same carbon price. and the net increase in global emissions associated
with emissions trading is only 48 Mton.
The particular numbers obtained in this model simulation are not what should be stressed. The important
point is that. when evaluating emissions trading, the effect of 'hot air on the global reduction of
emissions cannot be considered in isolation from leakage. Emissions trading would allow 'hot air' into
the system to the extent any party's Kyoto commitment is not binding. but it also reduces leakage to
countries with non-binding commitments or no commitment at all. The net balance depends upon the
amount of leakage and hot air. and both are sensitive to the model's emission prediction for countries
with non-binding Kyoto commitments and its specification of the trade sector. For instance. higher 2010
emissions for the FSU will reduce hot air without much effect on leakage, and more substitutability in
trade will lead to more leakage. Other assumptions than those presented here could easily yield results
that would indicate that emissions trading would lead to a net reduction of global emissions. In sum. the
interaction of leakage and emissions trading calls for a more nuanced treatment of 'hot air.'
d) Summary of the Three Competitive Trading Cases (Fig. 14 and 15)
Figs. 14 and 15 summarize the three competitive cases we have studied: no trade: trade within Annex B:
and world trade, with respect to both the quantity and cost aspects of meeting the Kyoto commitments.
In Fig. 14, the five constrained Annex B regions are represented by bars extending to the right
representing the combination of domestic abatement and imported permits that would be chosen by each
of these regions to meet the Kyoto commitment. For the two trading cases, the darker portions indicate
the amount of the commitment met by importing emissions permits. and the percentage of imports is
indicated. The quantities imported are progressively larger as the scope of the market is expanded (from
bottom to top for each region) to include more low cost sources of emission reduction. The exporting
regions - FSU and non-Annex B, and EET in the Annex B trading case - have bars both to the right and to
the left. The amount of emissions reduction they undertake is indicated to the right: and to the left. the
amount of emissions permits they export. 12 Those amounts are equal, except that the FSU disposes of a
quantity of permits it can sell without undertaking any reductions, namely, the 'hot air.' represented by
the striped segment of the bar. This 'hot air' shows up on the right-hand side in the smaller quantities of
reduction associated with the two trading cases for Annex B and the World.
Fig. 15 compares the effects of the Kyoto commitment, across cases, in terms of costs. that is. the
quantities of fig. 14 multiplied by prices. While trading benefits every region to some extent. two points
11 There is also some leakage from the FSU to the non-Annex B regions because the FSU faces a positive carbon
price while the non-Annex B regions do not. The general equilibrium solution provided by EPPA shows that
whatever that amount is. it is more than compensated by the reduced leakage from the Kyoto-constrained Annex B
regions.
12 Note that the results presented in this figure do not show the leakage effects discussed in the previous section.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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MIT Joint Program on the Science and Policy of Global Change
become quite clear from this graph. First. the Kyoto-constrained regions facing relatively higher marginal
costs derive relatively greater benefit from emissions trading. In both trading cases, Japan and the EEC
import more and benefit more than does the USA, because the latter faces lower marginal costs of
meeting the Kyoto commitment than the other regions. Second. the FSU exports more and benefits more
when it does not compete with the non-Annex B regions to satisfy the demand from the importing
regions. Notably. it is the only region that fails to gain from the expansion of the market to embrace
global trading. and its loss is striking.
IV.
DEPARTURES FROM PERFECT TRADING
All of the cases studied so far assume that potential participants in emissions trading are not impeded by
restrictions on trading. that competitive conditions apply. and that trading is conducted efficiently with
low or non-existent transactions cost. Such assumptions simplify the analysis and exposition of emissions
trading. but they are not necessarily realistic. In this section, we use the aggregate demand and supply
curves to evaluate the effects of departures from these simplifying assumptions.
a) The Effect of Quantitative Limits on Demand (Tables H and I, Fig. 16)
The Kyoto Protocol itself contains provisions relating to 'supplementarity' that suggest that a party's
ability to rely on emissions trading for meeting its Kyoto commitment may be limited in some manner.
This provision has been given further impetus by the call for a "concrete ceiling" by the EU
environmental ministers. The imposition of a limit on imports would affect the gains from trade: and in
this section. we illustrate the effects by assuming a limit of 33% on any Annex B party's ability to meet
its emission reduction requirement through imported permits.¹³
In the case of Annex B trading without restrictions. Japan would optimally realize 66% of its Kyoto
commitment through imports, well above the 33% limitation. and EEC 35%, slightly above the limit,
while none of the other importing regions would be constrained. As a result, Japan would import
commensurately fewer permits and have to abate more domestically, up to a marginal cost of $322/ton.
However. this is not all that happens.
As illustrated in Fig. 16. less demand shifts the aggregate demand curve downwards. so the market
clearing price is slightly lower than it otherwise would be: $114/ton. As an interesting result. all the
regions that are not affected by this limit import more in response to the cheaper price. and they reduce
domestic abatement by a corresponding amount. The USA would thus increase permit imports from 19%
to 23% of its emissions reduction requirement, OOE from 25% to 29%. Those regions are
unambiguously better off because the supplementarity condition removes the potential demand by higher
cost abaters from the emissions trading market. Japan accrues some benefit from the cheaper permit
13
The Kyoto Protocol specifies only that "trading shall be supplemental to domestic actions." We define this
potential limitation as a percentage relative to the emission reduction implied by the Kyoto commitment, given
EPPA's prediction of reference emissions.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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MIT Joint Program on the Science and Policy of Global Change
imports. but the savings are swamped by the higher costs for significantly more domestic abatement. 14
EEC imports also are affected by the limit. but it benefits slightly from the lower price for the permits it
does import. Overall. on the importers' side. the aggregate savings is practically the same. (99% of that
of the non constrained case), but the gains are redistributed. mostly from Japan that loses $4 billion of
potential gains. to USA. EEC. OOE. The two exporters. the FSU and EET. are hurt as well. The FSU
sells slightly fewer permits at a lower price. thus losing $4 billion of potential gains. EET's gains as an
exporter disappear. as it becomes a small importer. Overall. the aggregate gains from emissions trading
are only reduced from $66 billion to $61 billion.
The exact numbers and effects will vary of course depending on the supplementarity limit and on the
reduction required of various parties to meet the Kyoto commitment. The essential feature is that while
the global costs might be a little higher with the supplementarity constraint, such a restriction on imports
affects countries very differently. As a result, there is a significant redistribution of gains within
importing regions, from regions with relatively high abatement cost, who would otherwise depend more
heavily on imports, to regions with relatively low abatement cost.
The same 33% limit on imported permits would have a much greater effect with full global trading. Now,
all the importing regions are constrained by the limitation. The price of imports is much lower than in the
unconstrained case, $6 vs. $24. but for the constrained regions. the cheaper imports do not make up for
the higher domestic abatement cost required: all importing regions. except EET, are worse off. Thus. for
the OECD + EET. the aggregate cost for meeting the Kyoto commitments rises from $26 billion to $43
billion. The exporting regions gain virtually nothing in this situation ($1.7 billion compared to the $14
billion possible gains in the unconstrained situation), because of the restricted demand and the very low
market price.
b) Non-Competitive Behavior in Supply
It is premature to worry about non-competitive behavior in a market that is not yet created. but there are
dominant suppliers in each of the markets we have reviewed and we have examined the gains from
emissions trading only under the assumption that maximizes those gains: perfect competition. The FSU is
a particularly dominant supplier in the Annex B market and we turn to that case first.
The FSU in the Annex B Market (Table J)
As an unconstrained Annex B region with hot air, the FSU is the source of the significant gains
associated with Annex B trading and the almost exclusive supplier of permits in this market. The FSU is
no longer a single political entity, but for the sake of illustration we show what would be the effect if the
14 Of course. consumers will not receive the benefit of cheaper imports since the discrepancy between the internal
marginal abatement cost of $322 and the world market price of $114 creates a rent for the allowed imports that will
be collected somehow, perhaps through a government auction of the rights to import permits. Since this sum is a
internal transfer, we do not count it as a resource cost. We are indebted to Ken Chomitz of the World Bank for
pointing out this feature of our analysis.
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constituent nations were to take advantage of their dominant position by colluding to limit supply in
order to maximize their profit. 15 The effect is not great: the price of permits is raised slightly. to $142/ton
VS. $127 in the competitive case. The reason is that. as the price rises. the importing regions abate more
and import less. It makes sense for the FSU (or any monopolist) to restrict supply only so long as the
increase in price more than compensates for the decrease in quantity exported. In this case. the elasticity
of the aggregate demand curve is such that there is not much to gain for the FSU by restricting supply. As
a result. the gains from emissions trading are only slightly less than in the competitive case ($64 billion).
What is changed is the distribution of the gains from emissions trading. The FSU increases its gains by
$2.4 billion. while the gains for the importing regions is diminished by $4.7 billion. The benefits from
emissions trading for the importing regions are still significantly greater than when there is no trading.
A Non-Annex B Cartel? (Tables K and L)
In full global trading. there is no dominant supplier of permits; however, the Kyoto Protocol does specify
that non-Annex B emission reductions are to be provided to Annex B parties through a Clean
Development Mechanism (CDM). The role of the CDM is not yet established; however. part of the
rationale for it appears to be ensuring that non-Annex B countries receive acceptable prices (however
determined) for their permit exports. And indeed, as shown earlier, the prices under full global trading
would be very low. compared to other alternatives. Furthermore. at a price of $24 and a volume of trade
of 935 Mton of emissions reductions, elasticity conditions are more favorable to collusive behavior than
in the Annex B case. Nevertheless. assuming successful combination through the CDM or other means.
the non-Annex B nations do not enjoy as dominant a position as the FSU in the Annex B market. As a
group. the non-Annex B regions supply 77% of the permits in full global trading, whereas FSU supplies
98% in the Annex B market. Consequently. any attempt by the non-Annex B regions to restrict supply
would have to take into account the response of the FSU. We study below two cases: FSU competing
with the non-Annex B regions and FSU cooperating.
In the first case. only the non-Annex B regions are acting as a monopoly. The Annex B regions are all
price takers, OECD + EET as importers. and the FSU as an exporter. The market price is significantly
increased (to $63). so that the importers abate more and import 279 Mton less. Their gains from global
emissions trading are reduced from $94 billion to $59 billion. Non-Annex B regions more than double
their gains (now $22 billion) despite the reduction in exports by 342 Mton. As a competitive supplier,
the FSU benefits doubly, from the higher price and greater exports (+63 Mton). Its gains from trading
more than triple. to $14 billion. Overall. the global cost of meeting the commitment is still very low, $20
billion, but the gains from trade have shifted somewhat more in favor of the exporting regions (38% vs.
13%).
15 The results for non-competitive behavior have been derived using the Cournot model: one region/group of regions
is the price maker. the other regions are price takers.
16 For example. in reviewing possible roles for the CDM. Aslam. 1998. cites "offering an 'umbrella' security against
possible exploitation in an unequal bilateral negotiation scenario."
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When the FSU cooperates with the non-Annex B regions, the resulting price, $108/ton. is considerably
higher. What happens in the first case is here enhanced: the gains from emissions trading to the importing
regions are reduced another $24 billion. to $34 billion, while those to the suppliers are increased. by $4
billion for the FSU and by $8 billion for the non-Annex B regions. Both the non-Annex B regions and
the FSU cut back exports drastically compared to the fully competitive case. -24% for FSU. to 161
Mton. and -61% for non-Annex B regions. to 285 Mton. 18 The overall gains from trade are reduced to
$82 billion. which is still considerable. and shifted even more in favor of the exporters (58% of the total
gains). This case. the best possible one for the suppliers. provides the theoretical limit of the suppliers'
gains from trading emissions permits in a world market: $47 billion.
These two cases illustrate that. if it could be organized. there is ample room for non-competitive behavior
in the global emissions trading market, in contrast to the Annex B market. Such behavior leads to
significant redistribution of the gains from importing regions to exporting regions, whether the FSU
competes or cooperates with the non-Annex B regions. Furthermore, the gains to importing regions from
emissions trading would still be very large, and greater than would be the case if trading were restricted
to the Annex B regions only. For the FSU however, the gains would remain always lower than in the
Annex B trading case.
c) Transactions Cost and Other Inefficiencies in Supply (Tables M to O, Fig. 17 and 18)
A far more likely outcome in the global market, or the Annex B market for that matter. is that supply
would be limited by transaction costs or a more general failure to take advantage of the economic
opportunities provided by emissions trading. For instance, concerns about 'additionality' and the inherent
difficulty of identifying a counterfactual baseline for joint implementation projects may impose high
transaction costs and thereby limit the supply from non-Annex B regions. 19 Alternatively, potential
suppliers may not pursue available export opportunities with the complete economic rationality assumed
by EPPA. Such departures from the model's assumptions can be easily simulated by assuming that only a
certain share of what is potentially available at any given price would be supplied. If such were the case.
the aggregate supply curves would be shifted upward and the market clearing prices would be higher. as
shown in Figures 17 and 18.
Fig. 17 illustrates the effect of a 50% reduction in available supply from the FSU due to such
imperfections. in the Annex B trading case, assuming unfettered demand. 20 The price is raised to
$167/ton. compared to $127 when completely efficient supply is assumed. As a result, the role of EET as
17
In fact. a perfectly coordinated oligopoly acting as a monopoly.
18
The FSU reduces much less because of the implicit assumption in our analysis that the monopoly incurs the least
cost possible in producing the exported permits. Because of its hot air, the FSU has a proportionately much larger
share of low cost permits available.
19
These costs will be greatly reduced to the extent that non-Annex B regions accept emission caps that remove the
concern about additionality and more generally the necessity to establish a counterfactual baseline.
20
Note that the quantity of available hot air is also reduced to 50% of the theoretical quantity.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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A. Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
a supplier in increased (to 11% total). as well as its benefits. Importing countries whose autarkic
marginal cost is low, such as the USA. almost do not resort to trade. hence their gains decrease, while
emissions trading still conveys considerable benefits to the relatively high cost abaters. Japan and the
EEC. The FSU exports fewer permits than otherwise (now 190 Mton compared to 345 Mton). but at a
higher price. so it still benefits from this new export opportunity. although its gains are reduced. to $30
billion from $34 billion. The gains from emissions trading are less for all parties, but at $51 billion in
the aggregate. those gains are still important.
Fig. 18 depicts the market equilibrium when only 50% and 25% of the quantities available from the FSU
and non-Annex B regions are available. As was the case with Annex B trading, the price increases with
the reduced supply. from $24 to $52 and $94 respectively. As before. the gains from trade for the
importers are less than otherwise. especially for the low cost abaters. but still appreciable. The interesting
feature is what happens on the supply side. Unlike the case with Annex B trading with such
imperfections. the gains to the supplying regions are enhanced. The increase in the price more than
compensates for their limited ability to supply. and their gains are significantly increased (+85% and
+137% respectively for non-Annex B regions. +30% and +35% respectively for FSU). 22
V.
CONCLUSIONS
A Readily Available Technique for Analyzing Trading Issues
Emissions trading raises many issues concerning magnitude and distribution of the benefits from trade.
The primary purpose of this paper has been to explain a readily available technique for analyzing and
explaining these issues. Marginal abatement curves are often drawn illustratively, but for all their
heuristic value. good empirical estimates of these curves are hard to find. The MACs used here are not
empirically estimated. but they are derived from the complex economic models that are commonly used
to predict emissions and to evaluate the costs of various policies. As such, they are a compromise: better
than purely heuristic curves, but not as good as an empirically estimated relationship. They are in fact
only as good as the underlying models. which, for all their faults. are still commonly relied upon to
provide insight and estimates of costs and other effects. Analysts who lack such a model and who have a
slight aptitude for algebra can take the parameter estimates provided in Table 3 and conduct their own
analyses.
It can also be hoped that other modeling groups will make explicit the MACs that are generated by their
models. so that policy analysts will have the benefit of knowing how alternative representations of the
21
Note that in the efficient monopolistic case (Table J). the best case for FSU. the equilibrium price was only $142.
At a price of $167. the FSU is above the price that maximizes its gains.
22
These two cases can be compared with the case of a perfect supply monopoly (Table L). In that case. which
maximizes the gains for the supply side. the market price is $108. Thus. as long as the market price is below $108.
which is the case with the two constraints considered here. transaction costs and other imperfections in supply.
besides increasing global resource costs. increase the revenues received by suppliers.
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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A. Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
underlying economic reality will affect the magnitude and distribution of the gains from emissions
trading.
Emission Permit Trading: Implications for Policy
The object of any analytic exercise is to gain insight into policy issues: and many arise from this
exercise.
The most fundamental is almost trivial: any emissions trading, no matter how constrained or imperfect,
is better than none at all. The effect of trading is always to require less resources to achieve the same
environmental goal. and thereby to preserve resources for other useful social goals. There is no emissions
trading scheme in which all participating parties do not derive at least some benefit.
Second. the potential for gains from trading is huge. because of the considerable differences in
abatement costs across regions. This potential should certainly provide incentives to both Kyoto-
constrained and unconstrained regions to support emissions trading.
Third. from the standpoint of husbanding the world's limited resources. the fewer the constraints on
trading the better. Even though non-competitive behavior and other departures from perfect trading do
not eliminate the gains from emissions trading, they do inevitably increase costs.
Fourth, the gains from emissions trading will not be evenly distributed. As a general rule, regions whose
autarkic marginal cost of abatement is relatively far from the market price of permits for a given market
will derive the greatest benefit from emissions trading.
Fifth. unlike all other regions, the FSU is adversely affected by opening the market to non-Annex B
supply. The potential conflict of interest between the FSU and non-Annex B regions may influence future
negotiations over accession to Annex B or expanding trading to non-Annex B nations.
Finally. limitations and imperfections not only reduce the overall gains from trading, they also
redistribute the remaining gains, often in unsuspected ways. For instance, a quantitative limitation on
imports reduces the gains from emissions trading for exporters and for countries whose imports are
restricted: but it benefits importing countries that are not affected by the limitation. Also, transaction
costs and other forms of inefficiency might be expected to reduce the gains from trading for suppliers:
but when supply is ample and prices low, any increase of price increases export revenues and gains from
trading, whether due to strategic behavior or plain inefficiency.
Suggestions for Future Research
Our analysis has been limited to CO₂. yet another important dimension of the flexibility accepted at
Kyoto is inclusion of the enhancement of sinks and the reduction of other greenhouse gases in meeting
Kyoto commitments. Thus, another dimension for further research is broadening of the potential market
by the inclusion of sinks and other greenhouse gases. Given appropriate CO₂-equivalence. analogous
marginal cost curves could be constructed for the enhancement of sinks and the reduction of other
greenhouse gases. and any region's resort to CO₂ emission reduction, sink enhancement and other GHG
Analysis of Post-Kyoto Emissions Trading Using Marginal Abatement Curves
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A. Denny Ellerman and Annelene Decaux
MIT Joint Program on the Science and Policy of Global Change
emission reduction could be explored using these curves. While aggregate costs would undoubtedly be
reduced. it is quite unlikely that the distribution of the gains from trading would be the same as when
only carbon is included.
Little has been said about uncertainty. and the analysis presented here is based upon one view of the
future. that represented by the reference run in EPPA version 2.6. Other futures are quite possible. and it
is evident that the marginal costs faced by Annex B parties in 2010 depend as much upon such
predictions of economic and emissions growth as they do upon the relative positions of the MACs or the
commitments undertaken at Kyoto. Higher or lower emissions growth may not shift the MACs (as
opposed to moving along them). but such variations in growth will certainly affect regional supply and
demand for permits. and thus the market clearing prices and trade flows detailed above. An important
further research direction is the extent to which the conclusions drawn from this single forecast would be
modified by a richer treatment of uncertainty.
The relative position of the MACs constitutes the backbone of this analysis. The MACs generated from
EPPA are robust with respect to emissions trading policies and to variations in emissions growth. but we
doubt that this result would hold for variations in more fundamental assumptions such as technology and
substitution elasticities. The relative positioning of the MACs in EPPA - e.g. Japan as the highest cost
abater. EEC next then USA and OOE - seems plausible, but what makes costs in Japan twice as high as
in the EEC? And what makes China such a low cost supplier of emission reductions? We have tried to
make our conclusions general. and thus not overly dependent on the particular MACs generated by EPPA
2.6: but the practical interest of most policy-makers will remain the application of the general principles
to specific countries and regions. This calls for a better appreciation of what underlying characteristics
make certain countries relatively high or low cost sources of abatement.
VI.
TABLES AND FIGURES
Analysis of Post-Kyoro Emissions Trading Using Marginal Abatement Curves
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A Denny Ellerman and Annelène Decaux
MIT Joint Program on the Science and Policy of Global Change
Fig. 3: EPPA-Generated Marginal Abatement Curves - 2010
OECD Regions, Proportional Reductions, No Trading
$800
JPN
$700
$600
Shadow price of carbon ($/ton)
EEC
$500
$400
OOE
$300
USA
$200
$100
$0
0%
5%
10%
15%
20%
25%
30%
35%
40%
Carbon emissions reduction
Fig. 4: EPPA-Generated Marginal Abatement Curves - 2010
All Regions, Proportional Reductions, No Trading
$350
JPN
EEC
BRA
EEX
USA
$300
OOE
$250
Shadow price of carbon ($/ton)
$200
EET
FSU
DAE
$150
ROW
$100
IND
$50
CHN
8
$0
0%
5%
10%
15%
20%
25%
30%
35%
40%
Carbon emissions reduction
Fig. 5: EPPA-Generated Marginal Abatement Curves - 2010
OECD Proportional Reductions - No Trading / OECD Trading
$500
JPN
EEC
$450
$400
$350
Shadow price of carbon ($/ton)
$300
OOE
$250
No Trading
$200
Trading
-
$150
$100
USA
$50
$0
0
100
200
300
400
500
Carbon emissions reduction (Mton)
Fig. 6: Marginal Abatement Curves - - 2010
OECD Regions - Polynomial Approximations
$500
OOE
EEC
$450
JPN
y = 0.0085x² - 0.0986x
y -0.0024x2 + 0.1503x
$400
R² = 0.9981
R² = 0.9951
y = 0.0155x² + 1.816x
R² = 0.9938
Shadow price of carbon ($/ton)
$350
$300
$250
$200
USA
$150
y = 0.0005x² + 0.0398x
R² = 0.9923
$100
$50
$0
0
100
200
300
400
500
Carbon emissions reduction (Mton)
Fig. 8: OECD Regions Meeting their Kyoto Commitment, No Trading
700
JPN
OOE
Total Cost:
Abatement Cost
Abatement Cost
$115 billion
$34 billion
$13 billion
600
EEC
500
Shadow Price of Carbon ($/ton)
Abatement Cost
$30 billion
400
300
USA
Abatement Cost
200
$38 billion
100
0
0
100
200
300
400
500
600
700
Carbon Emissions Reductions (Mton)
Fig. 9: OECD Regions Meeting their Kyoto Commitment, No Trading /
Trading
700
JPN
OOE
Total Savings:
$13 billion
600
EEC
500
Shadow Price of Carbon ($/ton)
400
300
USA
$240
200
100
0
0
100
200
300
400
500
600
700
Carbon Emissions Reductions (Mton)
Fig. 11: Annex B Meeting their Kyoto Commitment, No Trading /
Trading
Total Savings for Kyoto
700
JPN
OOE
EET
Constrained Regions:
Savings:
Savings:
Savings:
$32 billion
$19 billion
$2 billion
$0 billion
600
—
USA
-
JPN
Shadow Price of Carbon ($/ton)
500
EEC
Savings:
-
EEC
$7 billion
OOE
400
—
EET
USA
Kyoto
300
Savings:
—
Trading
$3 billion
200
$127
100
0
0
100
200
300
400
500
600
700
Carbon Emissions Reductions (Mton)
Fig. 12: Aggregated Supply and Demand Curves - Kyoto - 2010
Annex B Trading / World Trading
Kyoto Cap
$200
Demand
Supply Annex B
-
$180
Trading
-
$160
$140
Allowance price
$120
$100
$80
$60
$40
Supply World
Trading
#
$20
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
Fig. 13: Actual Levels of Emissions in the Different Trading Cases:
Effects of Leakage and the FSU 'Hot Air'
World Trading
111
Annex B trading
111
35
No Trade
62
7750
7800
7850
7900
7950
World Aggregate Emissions (Mton)
Emissions, excluding Leakage
Hot Air
N
Leakage
Fig. 14: The effects of Trading: Emissions Reductions, Trade
Quantities, Hot Air
World
Non-Annex B
Order for Each Region:
Total Annex B
- Top: Global Trading
- Middle: Annex B
FSU
Trading
EET
Imports: 56%
- Bottom: No Trading
Total OECD
Imports: 73%
29%
OOE
Imports: 66%
25%
Emissions Reductions
EEC
Imports: 76%
35%
JPN
Permits Export (-) / Import (+)
Imports: 92%
(Hot Air Excluded)
66%
USA
Imports: 68%
FSU Hot Air Export
19%
-1000
-500
0
500
1000
1500
Quantities (Mton)
Fig. 15: The Effects of Trading: Regional Abatement Costs and Trade
Flows
World
Order for Each Region:
Non-Annex B
- Top: Global Trading
- Middle: Annex B
Total Annex B
Trading
- Bottom: No Trading
FSU
EET
Total OECD
Cost of abatement
OOE
Export (-) / Import (+) Flows
EEC
(Hot Air excluded)
JPN
FSU Hot Air Export
USA
-100
-50
0
50
100
150
Total cost ($billion)
Fig. 16: Annex B / World Supply and Demand - Kyoto - 2010
Demand from Each Importing Region Limited to 33% of Commitment
Kyoto Cap
$200
Demand
Supply Annex B
-
$180
Trading
$160
$140
Allowance price
$120
$100
$80
$60
Demand < 33%
Potential
Supply World
$40
Trading
$20
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
Fig. 17: Annex B Permit Supply and Demand - Kyoto - 2010
Inefficient Supply: Supply = 50% Total
Kyoto Cap
$250
Supply = 50%
of Total
.
.
Supply
I
$200
Allowance price
$150
$100
$50
Demand
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
Fig. 18: World Permit Supply and Demand - Kyoto - 2010
Inefficient Supply: Supply = 50% - 25% Total
Kyoto Cap
$160
1
Supply = 25%
$140
of Total
Demand
Supply = 50%
$120
of Total
$100
Allowance Price
$80
$60
I
Supply
$40
$20
-
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
NB: all the prices in the following tables are in 1985$
NAB = Non-Annex B regions
and II. BACKGROUND, METHODOLOGY
TABLE 1 bis: Reference emissions and Kyoto commitments
Reference emissions
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Ref 1990 (Mton)
1362
298
822
318
266
3066
891
2022
2022
508
833
183
115
63
320
Ref 2010 (Mton)
1838
424
1064
472
395
4193
763
4142
4142
927
1792
486
308
97
532
Kyoto
0.93
0.94
0.92
0.95
1.04
0.98
\
!
Emissions in 2010 (Mton)
1267
280
757
301
277
2881
873
4142
7896
927
1792
486
308
97
532
Reductions / ref 2010 (Mton)
572
144
307
171
118
1312
-111
0
1202
0
0
0
0
0
0
Marginal Costs ($/ton)
$186
$584
$273
$233
$116
\
TABLE 3 bis: MACs approximations coefficients (P = aR^2+bR)
USA
JPN
EEC
OOE
EET
FSU
EEX
CHN
IND
DAE
BRA
ROW
a
5.0E-04
1.6E-02
2.4E-03
8 5E-03
7.9E.03
3E-03
3.2E-03
7.0E-05
1.5E-03
4.7E-03
5.6E-01
2 1E-03
b
0.0398
1.816
0.1503
-0.0986
0.0486
0.0042
0.3029
0.0239
0.0787
0.3774
8.4974
0.0805
III. BASIC CASES
TABLE A: Kyoto OECD only no trading
USA
JPN
EEC
OOE
Oecd
Reductions / ref 2010 (Mton)
572
144
307
171
1194
Marginal Costs ($/ton)
$186
$584
$273
$233
Cost of Abatement ($billion)
37.62
34.37
30.29
12.81
115.09
TABLE B: Kyoto OECD only OECD trading
USA
JPN
EEC
OOE
Oecd
Reductions / ref 2010 (Mton)
655
79
287
174
1194
Market Price of Permits ($/ton)
$240
$240
$240
$240
$240
Cost of Abatement ($billion)
55.28
8.22
25.02
13.44
101.96
Permits exp(-)/imp(+) (Mton)
-83
65
21
-3
0
i.e % of commitment (import)
I
45%
7%
I
Flows exp(-)/imp(+) ($billion)
-19.95
15.66
4.94
-0.64
0.01
Total Cost ($billion)
35.33
23.88
29.96
12.80
101.97
Gains from trade ($billion)
2.30
10.49
0.33
0.01
13.12
TABLE C: Kyoto no trading
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
World
Reductions / ref 2010 (Mton)
572
144
307
171
118
1312
0
1312
Marginal Costs (S/ton)
$186
$584
$273
$233
$116
\
Cost of Abatement (Sbillion)
37.62
34.37
30.29
12.81
4.67
119.76
0.00
119.76
TABLE D: Annex B trading
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
World
Reductions / ref 2010 (Mton)
466
49
201
128
124
968
234
1202
'Hot air (Mton)
0
111
111
Market Price of Permits (S/ton)
$127
$127
$127
$127
$127
$127
$127
$127
Cost of Abatement ($billion)
21.16
2.82
9.51
516
5.36
44 01
9.95
53.96
Permits exp(-)/imp(+) (Mton)
106
95
106
43
-6
345
-345
0
i.e % of commitment (import)
19%
66%
35%
25%
26%
:
Flows exp(-)/imp(+) ($billion)
13.44
12.06
13.51
5 49
-0.73
43.77
-43 77
0.00
Total Cost ($billion)
34.60
14.88
23.02
10.64
4.64
87.78
-33.82
53.96
Gains from trade ($billion)
3.03
19.49
7.27
2.17
0.03
31.99
33.82
65.81
TABLE E: Annex B trading, No not air
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
World
Reductions / ref 2010 (Mton)
509
56
220
139
135
1058
254
1312
'Hot air' (Mton)
0
0
0
Market Price of Permits ($/ton)
$150
$150
$150
$150
$150
$150
$150
$150
Cost of Abatement ($billion)
27.10
373
12.21
6.60
6.86
56 51
12.73
69.23
Permits exp(-)/imp(+) (Mton)
63
88
87
33
-17
254
-254
0
i.e % of commitment (import)
11%
61%
28%
19%
19%
Flows exp(-)/imp(+) ($billion)
9.40
13.23
13.00
4.90
-2 48
38.05
-38.05
0.00
Total Cost ($billion)
36.50
16.96
25.21
11.50
4.38
94.55
-25 32
69.23
Gains from trade ($billion)
1 12
17.41
5.08
1.31
0.29
25.21
25 32
50.53
TABLE F: World trading
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
182
12
73
59
52
378
101
723
1202
51
437
102
42
2
89
'Hot air' (Mton)
0
111
0
111
Market Price of Permits (S/ton)
$24
$24
$24
$24
$24
$24
$24
$24
$24
$24
S24
$24
$24
$24
$24
Cost of Abatement ($billion)
1.66
0 14
071
041
0.43
3.36
0.81
6 99
11 15
0 54
422
0.95
0 44
0 03
0.81
Permits exp(-)/imp(+) (Mton)
390
132
234
112
66
935
-211
-723
0
-51
-437
-102
-42
-2
-89
i.e % of commitment (import)
68°.
92%
76%
6€°c
56%
71%
Flows exp(-)/imp(+) ($billion)
9.27
315
5.57
2 67
1.57
22.24
-5.03
-17.21
0.00
-1.21
-10.40
-2.44
-0.99
-0 06
-2.12
Total Cost ($billion)
10.94
3.29
6.29
3.09
2.01
25.60
-4.22
-10.22
11.15
-0.68
-6 17
-1.49
-0.55
-0.03
-1.31
Gains from trade ($billion)
26.69
31.08
24.00
9.73
2.66
94 16
4.22
10.22
108.61
0.68
6.17
1.49
0.55
0.03
1.31
THE EFFECTS ON DEVELOPING COUNTRIES
OF THE KYOTO PROTOCOL AND CO₂ EMISSIONS TRADING
A. Denny Ellerman, Henry D. Jacoby and Annelène Decaux¹
Joint Program on the Science and Policy of Global Change
Massachusetts Institute of Technology
I
Ellerman is Senior Lecturer at the Sloan School of Management and Executive Director of the Joint Program; Jacoby
is the William F. Pounds Professor of Management at the Sloan School and Co-Director of the Joint Program; and
Decaux is a candidate for a master's degree from MIT's Technology and Public Policy Program and a research assistant
with the Joint Program. Funding for this paper from the World Bank is gratefully acknowledged. We are also very
much indebted to Ian Sue Wing and David Reiner for modeling support and comments on this paper.
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TABLE OF CONTENTS
1. INTRODUCTION
3
2. THREE BASIC CASES: NO TRADING, ANNEX B TRADING AND FULL GLOBAL TRADING
6
a) The Autarkic. No-Trading Case (Fig. 1, Table A)
6
b) Annex B Trading (Figs. 2 and 3. Table A)
6
c) Full Global Trading (Figure 4. Table C)
7
3. THE EFFECT OF IMPORT LIMITATIONS
8
4. EFFECT OF CDM "SURCHARGES" AND CARTELIZATION OF SUPPLY
10
CDM surcharges
10
Cartelization of supply
12
5. INEFFICIENT SUPPLY
13
6. EFFECTS OF KYOTO AND EMISSIONS TRADING THROUGH TRADE IN GOODS
15
a) Effects of Kyoto through trade in goods in the no emissions trading case
16
b) Comparing no-trading case effects with full global trading case effects
17
c) Summary
18
7. CONCLUDING OBSERVATIONS
19
REFERENCES
21
APPENDIX A: MARGINAL ABATEMENT CURVES
22
a) What are Marginal Abatement Curves and what do they represent? (Fig. Al)
22
b) How can MACs be used for Trade Studies? (Fig. A2)
22
c) How can MACs be generated from CGE Models? (Fig. A3, A4 and A5)
24
d) Assessing the 'Robustness' of MACs with regard to the Policy applied (Fig. A6)
25
e) Analytical Approximations: a Simple Tool for Trade Studies (Fig. A7)
26
f) Construction of Aggregate Supply and Demand Curves (Fig. A8)
27
APPENDIX B: DATA TABLES
29
BASIC CASES
29
IMPORT LIMITATIONS
30
CDM SURCHARGES
31
MONOPOLISTIC BEHAVIOR
32
INEFFICIENT SUPPLY
33
COMBINED CASES WITH 50% EFFICIENT SUPPLY
34
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1. INTRODUCTION
The Kyoto Protocol recognizes a strong linkage between CO₂ emission reduction goals, emissions
trading, and the role of developing economies. Annex B parties, generally the industrialized
nations, have set targets that, for most, imply a significant reduction of CO2-equivalent emissions
by 2010. The ability and even willingness of Annex B parties to achieve these targets will depend
on the cost of abatement. The cheapest sources of CO₂ emission reductions are found, not in the
Annex B countries, but in the developing economies or non-Annex B parties, which for historic and
equity reasons are not presently expected to contribute to the global reduction in greenhouse gas
emissions. Since the location of CO₂ emissions does not matter from a global warming
perspective, the achievement of the Kyoto targets will depend in large part upon the ability of
Annex B countries to substitute cheaper emission reductions in non-Annex B parties for equivalent
abatement at home. In providing a mechanism for this exchange, emissions trading not only
reduces the cost of meeting the Kyoto goals for Annex B parties, but also provides a new source of
export earnings for non-Annex B parties.
Developing country interest in emissions trading is not limited to the potential for new export
earnings. Achieving the goals set at Kyoto will change patterns of consumption and production
within the Annex B nations; and these changes will have inevitable effects on the flows of
internationally traded goods. As a result, developing countries will be affected through
conventional trade linkages with the Annex B countries; however, these effects, both favorable and
unfavorable, will be diminished to the extent that emissions trading reduces the cost of achieving
the Kyoto targets.
In examining the effects of the Kyoto Protocol upon non-Annex B parties, we assume that the
Annex B goals are met, and we focus in particular on how emissions trading would affect the
developing countries. We refer to emissions trading generically, to include bubbles, joint
implementation, allowance or credit systems, and perhaps other forms yet to be devised. The
chief practical distinction among these forms concerns the transaction cost involved in effecting an
individual trade.
The paper relies heavily upon the use of marginal abatement curves (MACs). These curves
represent the marginal cost of reducing carbon emissions by different amounts within an economy.
The details of their construction, and the elaboration of the aggregate demand and supply curves
for carbon permits which are drawn from them, are explained in Appendix A. The MACs used here
are generated using MIT's Emissions Prediction and Policy Assessment (EPPA) model (Yang et
al. 1996). This is a multi-sectoral, multi-regional, computable general equilibrium (CGE) model of
global economic activity, energy use and carbon emissions. The underlying model simulates real
emission reductions, so that our analysis implicitly assumes that the "additionality" criterion
established in the Kyoto Protocol [Arts. 6.1(b) and 12.5(c)] is satisfied. We do not attempt to
address the considerable political and practical problems of measurement and verification that are
associated with this criterion, but we will account for the effect of these problems in a subsequent
section.
2
The main body of the paper consists of five sections. Section 2 uses the MACs to analyze three
basic cases: no emissions trading, emissions trading limited to Annex B parties (including the
FSU), and full global trading. Results are presented in graphical form in the text, and the regional
2
UNCTAD 1998 contains an excellent discussion of these issues.
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detail--in terms of abatement, costs, emission permit trade and prices for all the cases discussed--
is presented in tabular form in Appendix B.
The next three sections address the effects of various departures from the three basic cases. The
first departure, in Section 3, is the effect of limitations on imports of emission permits, as might
correspond to the "supplementarity" criterion included in the Kyoto Protocol [Arts. 6.1(d) and 17] or
to the recent call by the EU environmental ministers for a "concrete ceiling" on emissions trading.
Section 4 evaluates the effect of surcharges on emission permits generated under the Clean
Development Mechanism (CDM), as also provided in the Kyoto Protocol [Art. 12.8], and of
monopolistic pricing. The third departure, discussed in Section 5 is the effect of a smaller supply of
permits from the non-Annex B regions than is indicated by EPPA's assumptions of complete
economic rationality and zero transaction costs, which we term "inefficient supply."
In Sections 2 through 5, the measure of welfare used is the total direct resource cost required to
meet the emissions constraint. As explained in Appendix A, for any country this cost is the area
under its marginal abatement curve up to any point of constraint, corrected for any purchase or
sale of emissions permits. This is the conventional measure which is generated using the MAC
approach. However, because the MACs are generated at the country level, they are not able to
take account of effects that are mediated through international trade in energy or other goods. As
shown in Appendix A, the MAC results themselves are not sensitive to these effects. They may
influence other types of welfare measures, however, and they will effect sub-national details, such
as patterns of trade in particular goods and activity at the sectoral level. To explore these effects,
we depart from the MAC analysis in Section 6, and present results taken directly from the EPPA
model.
In Section 7 we offer some concluding observations.
In conducting our analysis, we will make frequent reference to the twelve regions represented in
EPPA, which are listed below with the model's acronyms.
ANNEX B REGIONS:
NON-ANNEX B REGIONS:
USA: USA
EEX: Energy Exporting Countries
JPN: Japan
CHN: China
EEC: European Union (12 countries)
IND: India
OOE: Other OECD Countries
DAE: Dynamic Asian Economies
EET: Eastern Economies in Transition
BRA: Brazil
FSU: Former Soviet Union
ROW: Rest Of World
Definition of Regions in the EPPA Model
The CO₂ emission reductions required of Annex B regions are calculated as the differences
between EPPA's predicted emissions for these regions in 2010 and the goals established at Kyoto
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for the constituent parties, which are generally stated as a percentage of 1990 emissions, as
indicated in Table 1 below. 3
USA
JPN
EEC
OOE
EET
FSU
Non An. B
Ref emissions 1990 (Mton)
1362
298
822
318
266
891
2022
Ref emissions 2010 (Mton)
1838
424
1064
472
395
763
4142
Kyoto commitments 1 1990
93%
94%
92%
94.5%
104%
98%
NA
Hence Emissions Target in
1267
280
756
301
273
873
NA
2010 (Mton)
i.e. Reduction / ref (Mton)
571
144
308
171
118
0
NA
i.e. Reduction / ref (in %)
31%
34%
29%
36%
30%
0
NA
'hot air'
0
0
0
0
0
110
0
Table 1: Emissions Levels corresponding to Kyoto Commitments
Only five of the six EPPA regions encompassing Annex B countries are constrained by the
commitment made at Kyoto, 5 and these five will subsequently be termed the Kyoto-constrained
regions. For the sixth Annex B region, the FSU, emissions are predicted to be below the
aggregate level to which the principal nations constituting the FSU-Russia, the Ukraine, and the
Baltics- committed at Kyoto. The difference between the FSU commitment and predicted
emissions is controversially called 'hot air,' but in our analysis we assume that it constitutes a "right
to emit" that can be exported. For the non-Annex B regions, as well as for the FSU, any reduction
from 2010 reference emissions also generates a permit for export to the Kyoto-constrained
regions.
3
Under Kyoto Protocol accounting, as best it is understood, this procedure involves the implicit assumption that all
other GHGs are also reduced by the same percentage below the appropriate baseline value. No costs are included for
these controls in our study, nor is any account taken of possible carbon sinks.
4
The countries constituting the EET committed to targets at Kyoto that were from 5% to 8% below baseline emissions,
however, these countries were allowed to choose an alternative year to 1990. Based on the national communications of
these countries to date, the change of baseline year appears to translate to a limitation that is 4% above 1990 emissions
for the region as a whole.
5 The Kyoto Protocol refers to the targets established for Annex B parties as "legally binding commitments," although
neither the legal structure nor the sanctioning mechanism are evident. In this paper, we use the terms "goals,"
"targets," and "commitments" more or less interchangeably.
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2. THREE BASIC CASES: NO TRADING, ANNEX B TRADING AND FULL
GLOBAL TRADING
Three basic cases are used to illustrate the effects of the Kyoto Protocol and the role of emissions
trading. The first case is an autarkic one in which Annex B parties meet their Kyoto commitments
without any emissions trading. As a result, the FSU and non-Annex B regions are affected only
through the prices and quantities of goods traded with the Kyoto-constrained regions. In the
second case, Annex B parties (notably including the former Soviet Union) trade emission permits
among themselves. Emissions trading within Annex B reduces the costs of the Kyoto commitment
for the constrained regions, and the former Soviet Union finds a new source of export revenue; but
non-Annex B countries will continue to be affected only through conventional trade linkages. The
third basic case examines emissions trading on a global scale in which non-Annex B countries join
the former Soviet Union in earning export revenue from supplying permits to Annex B countries.
Further variations on these basic cases will be developed in subsequent sections, but these three
frame the salient alternatives.
a) The Autarkic, No-Trading Case (Fig. 1, Table A)
Fig. 1 presents the MACs and the costs associated with the carbon emission reductions required
of each of the Kyoto-constrained regions (excluding the FSU) when there is no emissions trading.⁶
The black diamonds on the MACs indicate, on the horizontal axis, the quantity of abatement
required of each region (cf. Table 1), and, on the vertical axis, the shadow price of carbon for the
region. The shadow price is the marginal cost for the last ton abated. The autarkic marginal cost
of abatement for Japan ($584/ton) is much higher than the marginal costs for the EEC ($273), the
OOE ($233), the USA ($186), or the EET ($116). The areas under the curves represent the total
costs of abatement for each region, which sum to $120 billion.
With no emissions trading, there are no export earnings for the FSU or the non-Annex B regions.
None of these regions would have any incentive to abate in order to generate 'rights to emit' for
export; and, of course, the FSU would not be able to export its "hot air." Nevertheless, these
regions would be affected through trade in conventional goods (excluding emissions permits), as
will be subsequently discussed. The details of these results are presented in Appendix B, Table A.
b) Annex B Trading (Figs. 2 and 3, Table A)
Fig. 2 shows the effect of Annex B trading on the Kyoto-constrained regions. At the market
clearing price of $127/ton, the OECD regions (USA, EEC, JPN, OOE) are importers of permits and
the EET and FSU are exporters. As an unconstrained Annex B party, the FSU accounts for
virtually all of the exports (98%). As shown in Fig. 3, about a third of these consist of 'hot air,' with
a cost of zero; but the remaining exports are generated by abatement undertaken to earn
additional export profits up to the point where marginal abatement cost equals the market price. It
costs the FSU $10 billion to abate the 234 megatons (Mton), but the permits can be sold for $30
billion for a net gain of $20 billion. When added to the $14 billion earned for exporting 111 Mton
of the unused Kyoto entitlement, the FSU's total gain from emissions trading is $34 billion.
6 The MACs for the OOE and EET are virtually identical and are therefore superimposed in Fig. 1.
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P
FSU
$127
Emissions
HOT AIR
Reduction
(111 Mton)
(234 Mion)
Q
Optimal quantity of permits traded (345 Mton)
Fig. 3: Trade with FSU: the 'hot air' effect
For the five Kyoto-constrained regions depicted on Fig 2, the cost of meeting the Kyoto
commitment is reduced by $32 billion. This is the area of the hatched triangles, which represent
costly domestic abatement avoided by importing permits for the four OECD regions and the export
earnings for the EET. From the standpoint of world resource use, the aggregate cost of meeting
the Kyoto commitments is much lower with Annex B trade ($54 billion) than without ($120 billion).
The total gains from emissions trading are $66 billion, split about evenly between the FSU ($34
billion) and the OECD + EET ($32 billion).
The distribution of the reduction in cost, that is, the gains from emissions trading for the Kyoto-
constrained regions, is distributed roughly in proportion to autarkic marginal cost. The two regions
with the highest autarkic marginal costs, Japan and the EEC, benefit the most from traded permits.
Japan imports 66% of its reduction requirement and reduces its cost by $19 billion. The EEC
imports 35% of its reduction requirement and reduces its cost by $7 billion. These two regions
account for about one-third of the total emission reduction requirement for the five Kyoto-
constrained regions, and about five-sixths of the gains from emissions trading for these regions
accrue to them. The other three regions are characterized by autarkic marginal costs much closer
to the Annex B market price; consequently, they trade much less. The USA and OOE are
importers for 19% and 25% of their respective requirements, and the EET reduces emissions by
5% more than required in order to export permits. The gains for these regions, which account for
two-thirds of the total reduction requirement, total $5 billion, about a sixth of the gains from trading
for the Kyoto-constrained regions.
This distribution of the gains from trade reflects an important feature of emissions trading. Regions
with autarkic marginal cost farther from the trading equilibrium will import or export more (and
benefit more) than those regions with autarkic marginal cost closer to the trading equilibrium.
Thus, Japan and the EEC benefit most from emissions trading among the importers, as does the
FSU, not just because of the 'hot air,' but also because its autarkic marginal cost ($0/ton) is far
from the market price.
c) Full Global Trading (Figure 4, Table C)
To illustrate full global trading, we rely on aggregate supply and demand curves for emissions
permits (not abatement), as explained in the Appendix A and illustrated in Fig. 4. These curves
indicate the total quantities of permits that would be supplied or demanded at various price levels
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in a given market. In Figure 4, there is only one demand curve because the Kyoto-constrained
regions are the same in both the Annex B and the global markets. Only the supply changes,
reflecting the huge amounts of potentially cheap carbon abatement that becomes available as non-
Annex B regions take full advantage of new export earnings opportunities. The ample supply of
permits from non-Annex B regions results in a market price that is much lower ($24/ton) than in
the Annex B trading case. The total cost of reducing global CO₂ emissions to achieve the Kyoto
goals is astonishingly low: $11 billion vs. $54 billion or $120 billion in the other two cases!
At this price, the Kyoto-constrained regions depend far more on imports than when trading was
restricted to Annex B regions only. In the aggregate, 71% of OECD + EET commitments are met
by importing emission permits from non-constrained regions; and the percentage reliance upon
imports reflects autarkic marginal cost: Japan, 92%; EEC, 76%; USA, 68%; OOE, 66% and EET,
56%. On the suppliers' side, three countries account for the bulk of exports: China (47%), the FSU
(23%) and India (11%), hence 81% altogether. Whether because of relatively small size or high
relative abatement costs, the remaining four non-Annex B regions are small suppliers of emission
permits to the Annex B regions.
With full global trading, the gains from emissions trading are much greater for the Kyoto-
constrained regions ($94 billion vs. $32 billion with Annex B trading). The non-Annex B regions
gain $10 billion by exporting permits, but their gains are markedly less than those of the Kyoto-
constrained regions. The FSU is the only party that is worse off by this widening of the market. At
$24/ton, the FSU abates about half as much as before, (101 Mton), and the 'hot air' is worth much
less. As a result, the FSU's net gain ($4 billion) in the global market is much less than its $34
billion gain when it does not compete with the non-Annex B regions.
The distribution of the gains from emissions trading in the global market illustrates again the
feature of emissions trading we just noted: regions whose autarkic marginal cost is further from the
equilibrium price benefit more than regions whose marginal cost is closer to that price. In this
global trading case, the clearing price is much closer to the suppliers' autarkic marginal cost
($0/ton) than it is to the autarkic marginal cost of any of the importers.
3. THE EFFECT OF IMPORT LIMITATIONS (Figure 5, Tables D-F)
The three basic cases presented earlier are based on several assumptions:
Potential participants in emissions trading are not impeded by restrictions on trading,
All parties participate to the extent warranted by the economics,
Trading is conducted efficiently with low or non-existent transactions costs, and
There is no monopolistic behavior.
Such assumptions simplify exposition and the analysis of emissions trading, but they are not
necessarily realistic. One of the possible departures from this theoretical ideal is a limit on the
extent to which an Annex B party can rely on emission permits to reduce what otherwise would be
its domestic abatement requirement. The 'supplementarity' provisions of the Kyoto Protocol
suggest such a limit, although no specific number has been agreed upon. More recently, the EU
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environmental ministers have called for a 'concrete ceiling' that would establish a firm limit on
permit imports.
To illustrate this effect, we consider limits of 75%, 50% and 25% on any Annex B party's ability to
meet its emission reduction requirement through imported permits.⁷ From the full global trading
case without restrictions, we know that Japan would optimally realize 92% of its Kyoto commitment
through imports, so that with a 75% limit, it would have to abate more domestically. The EEC
would also be affected, but to a very slight extent since it would otherwise import 76% of its
emission reduction requirement; but none of the other importing regions would be affected. With a
50% limit, all regions would be limited and forced to abate more domestically at higher cost; and at
a 25% limit, the reliance on higher cost domestic abatement would be even greater.
Fig. 5 shows how the demand curve is shifted inward by such limitations, and Table 2 summarizes
the effects on prices, quantities and costs. The "No Limit" case is the same as full global trading,
and it is provided for comparison.
TABLE 2: Effects of Import Limits on Global Emissions Trading
No Limit
75% Limit
50% Limit
25% Limit
Market Price (85US$/tonC)
$24
$23
$13
$3
Quantity Traded (Mton C)
935
913
656
328
FSU (Mton)
211
209
183
148
Non Annex B (Mton)
723
704
473
180
World Cost (Billion US85$)
$11.2
$11.9
$21.7
$55.3
OECD+EET Cost
$25.6
$25.4
$27.1
$56.1
FSU Gain
$4.2
$4.0
$2.0
$0.5
Non Annex B Gain
$10.2
$9.5
$3.4
$0.3
The 75% limit significantly restricts only Japan and the overall effect is relatively slight: world cost
increases slightly (6.5%), the quantity traded is 2% less, and the price falls by 4.1%. The effect of
input limits upon the exporting regions is predictable. With less demand, the market price falls,
fewer 'rights to emit' are produced and exported, and there is a drop in the gains to exporters. The
effects on importers are twofold. Importers that are not affected by the limitation import more, and
at a cheaper price; thus they realize more savings. They are better off because the limitation
removes some of the demand by higher cost abaters from the market. Importers who are affected
by the limitation also benefit from this lower market price on their imports, but they incur more
domestic abatement cost. For the EEC the net balance between these two opposing effects is
positive (+1.14% gains) but for Japan it is negative (-1.94%). Overall, the cost to importers is
slightly less with the 75% limit on imports than without it.
7
The Kyoto Protocol specifies only that "trading shall be supplemental to domestic actions." We define this potential
limitation as a percentage relative to the emission reduction implied by the Kyoto commitment, given EPPA's
prediction of reference emissions.
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With a 50% or 25% limit on imported permits, all the importing regions are restricted, and the price
of imports is much lower, $12.54 and $3.39, respectively. Among the importing regions, the effects
of this tighter limit depend upon the balance between higher domestic abatement costs and
cheaper import costs. At 50%, this balance is now negative for both EEC and Japan, but the
benefit of the much cheaper imports continues to outweigh the higher domestic abatement costs
for the other three importing regions. With a 25% limit, all the importing regions are worse off than
they would be without any limit on imports, and the percentage increases in cost are greatest for
the higher cost producers of abatement among the importing regions (JPN, +425%; EEC, +123%;
OOE, +73%; USA, +58%; EET, +5%).
From the standpoint of the suppliers, the effect of a limitation on imports is to skew the distribution
of gains from trading even more heavily in favor of the importing regions. It can be seen in Table 2
that, as the limit becomes more stringent, greater domestic abatement by the importing regions
causes world costs to rise, but at least up to the 50% limit, the total cost for the importing regions
remains relatively constant, at $25-27 billion. In contrast, for the exporting regions, the gains from
emissions trading diminish. The global efficiency losses due to the import limit are effectively
shifted to the exporting regions through the lower price of imported permits. Only when the limit
becomes very tight and the price of permits is very low, for instance within 25% limit, do the
increases in domestic abatement costs outweigh the benefits of cheaper imports, and the
importing regions start to absorb the efficiency losses.
The effect of a quantitative limit on imports can be summarized quickly. To the extent that it is
binding, it redistributes the gains from trading among the importing regions from those facing the
highest abatement costs to those facing the lowest costs. Furthermore, and at least initially, it
shifts the increase in global cost caused by a binding import limit onto the suppliers.
4. EFFECT OF CDM "SURCHARGES" AND CARTELIZATION OF SUPPLY
Departures from the theoretical ideal can also arise on the supply side. The Kyoto Protocol
provides for a Clean Development Mechanism (CDM) by which non-Annex B emissions reductions
would be certified and made available as emission permits for Annex B countries. The exact role
of the CDM has yet to be defined, but the Protocol does provide that the CDM would apply a
surcharge to cover its administrative expense and to collect funds to assist countries "to meet the
cost of adaptation" (Article 12.8). Also, because of the inelasticity of demand at low market prices,
there is a possibility that suppliers could increase their gains significantly by colluding to limit
supply, instead of competing among themselves.
a) CDM surcharges
CDM surcharges would create a wedge between the price paid by consumers of emission permits
and that received by producers, as illustrated in Fig. 6 for surcharges of 25%, 50% and 100%.
Table 3 provides details concerning prices, quantities and gains. Surcharges of 50% or 100% are
beyond any level being discussed currently, but they do illustrate the effects of inelastic demand.
Since FSU exports would not be surcharged, we treat the FSU as a competitive supplier in all
these cases.
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TABLE 3. PRICES, FLOWS AND GAINS WITH A CDM SURCHARGE
LEVEL OF CDM SURCHARGE
None
25%
50%
100%
Market Price (85$)
$23.80
$27.44
$30.55
$35.88
Producers Marginal Cost (85$)
$23.80
$21.95
$20.37
$17.94
CDM Net profit (billion $)
$10.2
$12.6
$14.4
$17.0
Profit to producers
$10.2
$8.9
$7.9
$6.3
Surcharge Proceeds
$0
$3.7
$6.6
$10.7
CDM Exports (MtonC)
723
687
654
602
FSU Exports (MtonC)
211
219
225
235
FSU Gains (billion $)
$4.2
$5.0
$5.7
$6.9
OECD+EET Cost (")
$25.6
$28.9
$31.7
$36.3
World Cost (")
$11.2
$15.0
$18.2
$23.0
The most notable feature of Table 3 is that CDM net profit, defined as revenue minus abatement
cost, increases as the surcharge is raised even though importers reduced demands in response to
the higher prices. This phenomenon reflects the price inelasticity of demand over this portion of
the aggregate demand curve. As would be true of any tax, there is a welfare loss, equal to the
increase in world cost as a result of the more expensive abatement undertaken by importers.
The second notable feature of Table 3 is that producer profit decreases. Of course, the distribution
of the proceeds raised by the surcharge would be a matter for the producers to decide. With
inelastic demand, it would be theoretically possible to devise distributions that would keep
producers whole and still make funds available for other purposes such as adaptation.
Nevertheless, any redistribution of funds for such purposes will reduce what the non-Annex B
producers might otherwise receive.
The implicit conflict between producer interests and re-distributive goals has larger implications for
the evolution of the global climate regime. It will be readily evident to all non-Annex B producers
that the producer that benefits the most from CDM surcharges is the FSU. As a competitive
supplier, the FSU benefits directly from the increase of the market price and the increase of its
exports. It is able to benefit doubly because, having accepted an Annex B limit on emissions, its
exports are not surcharged. The example will be compelling for many non-Annex B producers,
who will come to see Annex B accession as a way to by-pass the CDM. Proponents of the CDM
will not be pleased, but such action is essential both to the creation of a more efficient global
trading system and to achieving the stabilization of atmospheric concentrations of GHGs. 8
Accession logically implies a transitional role for the CDM. So long as the CDM provides an
essential service-certification and verification-for converting non-Annex B emission reductions
into tradable emission permits, a reasonable fee can be charged. But that service, and the
8
See Yang and Jacoby (1997) for a discussion of the relation between accession and stabilization.
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attendant role for the CDM, would no longer be needed as non-Annex B parties accept limits and
arrange for their own certification and verification as part of the global emissions trading regime.
b) Cartelization of supply
The ability to raise surcharges without diminishing net profit to non-Annex B producers may inspire
thoughts of a cartel, not so much because of the CDM which might serve as a coordinating
mechanism, but because of the inelasticity of demand that characterizes the global emissions
market.⁹ This potential is explored in Table 4 which compares the trade effects for a fully
competitive market and two alternative assumptions about non-competitive behavior:
1) A CDM cartel in which the FSU is a competitive supplier, and
2) A full supplier monopoly in which the FSU and the non-Annex B countries cooperate
through the CDM or an alternative mechanism.
In calculating the gains for the FSU and the non-Annex B regions, we assume that the monopoly
rent, the difference between market price and marginal cost, is shared in proportion to the quantity
of abatement provided at marginal cost. In effect, we assume a highly efficient monopoly in which
in which only the lowest cost sources of permits are produced (including the FSU's hot air).
TABLE 4. EFFECT OF MONOPOLY ON
GAINS FROM TRADE, COSTS AND PRICES
Competitive
Non-Annex B
Non-Annex B
case
cartel
+ FSU cartel
Market Price ($/metric ton C)
$23.8
$62.7
$108.2
World Cost (Billion 85US$)
$11.2
$20.0
$32.2
Non-Annex B Gains (")
$10.2
$22.4
$30.1
FSU Gains (")
$4.2
$13.8
$17.4
OECD+EET Savings (")
$94.2
$63.6
$39.2
Successful monopolization has the expected effects: the market price is higher, as is world
resource cost, and the gains from trade are shifted substantially to the suppliers. In the case of the
CDM cartel for example, the importing regions lose $32 billion: the $9 billion increase in global
costs plus a $23 billion transfer of income to the suppliers. With the full supply monopoly, the
importing regions lose another $25 billion, $12 billion in increased resource cost and another $13
billion transfer to the suppliers. Even though this is a dramatic change in the distribution of the
gains from permit trade, the Kyoto-constrained regions are still better off (by $7 billion) than if
there were no supply from the non-Annex B regions. The FSU is, however, always worse off, even
when the suppliers successfully create an efficient monopoly.
The incentive to collude would be even greater if limits were placed on import demands, since the
effect of such limits is to make demand more inelastic. Table 5 makes the point. It shows the effect
of the full monopoly on price, world cost and gains when there is no limit on permit imports and
when a 50% limit is set.
9
In contrast, there is little potential for cartelization in the Annex B case because of the higher price and more price
elastic demand, as discussed in Ellerman and Decaux.
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TABLE 5. EFFECT OF MONOPOLY ON
GAINS FOR SUPPLIERS WHEN LIMIT ON PERMIT IMPORTS
Limit on
Competitive
Non-Annex B +
imports
case
FSU cartel
Market Price ($/metric ton C)
No limit
$23.8
$108.2
50% limit
$12.5
$103.4
World Cost (Billion 85US$)
No limit
$11.2
$32.2
50% limit
$21.7
$37.6
Non-Annex B Gains (")
No limit
$10.2
$30.1
50% limit
$3.4
$26.2
FSU Gains (")
No limit
$4.2
$17.4
50% limit
$2.0
$16.3
OECD + EET Savings (")
No limit
$94.2
$39.2
50% limit
$92.6
$39.8
The effect of successful monopoly is much the same whether or not there are import limits. The
market price rises to about the same level, $103 vs. $108, world cost increases, and the exporting
regions gain significantly at the expense of the importing regions. The 50% import limit reduces the
price, increases world cost and diminishes producer gains in both the competitive and monopoly
cases, but by much less in the latter.
5. INEFFICIENT SUPPLY
Full global trading is an appealing case, to importers for the great reductions in cost and to
exporters for the possibilities of non-competitive pricing, but both should remember that CGE
models indicate a potential given complete economic rationality and negligible transactions cost. 10
The more likely contour of global emissions trading is that this potential will not spring forth full
blown once trading is allowed and appropriate modalities devised, but that it develop only slowly as
experience is gained. Fig 7 depicts several possibilities for less than fully efficient supply in which it
is assumed that 5%, 10%, 15%, 25%, and 50% of the supplies from the FSU and non-Annex B
regions are available at every price. The lowest line is fully efficient global trading, as previously
discussed.
Inefficient supply could result from several causes. The most serious and most likely is transaction
cost, particularly that involved in meeting the 'additionality' criterion. Past experience with credit-
based emissions trading systems applied to other environmental problems and with Joint
Implementation pilot projects has shown these costs to be large and the quantities traded to be
small. 11 Alternatively, a general failure to take full advantage of economic opportunities presented
10 EPPA 2.6 is not alone in making such forecasts. The recent analysis provided by the U.S. Council of Economic
Advisors to support Chairman Janet Yellen's earlier testimony obtains a similar permit price for a comparable market,
albeit in 1996 dollars.
II See UNCTAD 1978 for a discussion of the relative efficiency of allowance and credit based trading systems. These
costs will be greatly reduced to the extent that non-Annex B regions accept emission caps that remove the concern
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by emissions trading would also limit the amount of credits available from the non-Annex B regions
and the FSU. Finally, some non-Annex B countries have expressed considerable antipathy to
emissions trading as a concept; and they may decide not to participate in an emissions trading
regime, whether through the CDM or otherwise, for political or other reasons. It would be
impossible to assess beforehand to what extent these causes might operate in a global market, but
they will certainly be present.
If the supplies from the global market are very small initially, say 5% of the full global potential,
then the market price for permits would be relatively high ($181) and the quantities traded small
(170 Mton). As experience is gained and supplies become more ample, the quantities traded
would increase and prices fall. The gains from emissions trading increase with improved efficiency
of supply and they become quite large well before attaining 100% efficiency. As shown in Fig 8,
total gains increase steadily, but those for exporters increase only up to a point a little above15%.
Thereafter, the relatively inelastic demand causes the gains to exporters to decline, while those to
the importers increase dramatically.
When supply is very inefficient, the market distortions considered earlier have little effect. For
example, as severe a limitation on demand as a 25% ceiling would affect only Japan if supplies
from the FSU and non-Annex B regions were only 5% of the full potential. And at the prices
reflecting very inefficient supply, there would be no gain to monopoly. Nevertheless, as supply
becomes more efficient and prices decrease, a limitation on imports would become more binding;
and as the market clearing price moved into the inelastic range (below about $110), monopoly
could become more of a concern.
The effect of CDM surcharges will also depend on the elasticity of demand. In the inelastic range,
corresponding to greater supply from the non-Annex B regions, the surcharge can result in greater
gains, so that it is at least possible to keep producers whole (compared to no surcharge) and
generate funds for other purposes. However, when supply is very inefficient and the price for
permits falls in the elastic range, any surcharge will reduce the total gain to be shared between
producers and other claimants.
As would be expected, inefficient supply implies a higher market price, greater world cost and
fewer gains from trade, but the gains will still be substantial and decidedly worth pursuing. The
effects of distortions, such as import limitations and non-competitive pricing, are the same as with
fully efficient supply, but the magnitude of the effect is less because there is less to lose. Perhaps
the most notable feature of inefficient supply is that the gains to early entrants in the global
emissions market will be very large. Thereafter, as is true for any innovator, the large initial reward
will dissipate as imitators follow.
about additionality and the necessity to establish a counterfactual baseline. Curiously, the Kyoto Protocol also asserts
'additionality' as a criterion for joint implementation projects within Annex B countries (cf. Art. 6).
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6. EFFECTS OF KYOTO AND EMISSIONS TRADING THROUGH TRADE
IN GOODS
MACs provide a simple and direct way to study emissions trading, but they do not indicate the
effect of abatement actions on the prices and quantities of goods in international trade. The effects
of emissions reductions may not be restricted to the countries undertaking the abatement actions.
Through trade they may be transmitted to countries that made no commitment. In this section, we
abandon the use of MACs and examine these other effects using the EPPA results directly.
The central feature driving these trade-in-goods effects is the shadow price for carbon that is faced
by the Kyoto-constrained regions and the effect of that shadow price on the world price for oil and
natural gas. Table 6 provides a quick summary of those prices for the 2010 reference case and our
three basic emissions trading scenarios. Carbon prices are shown in 1985 dollars; oil and gas
prices are shown as an index with the 2010 price in the reference case set to 1.0.
TABLE 6. CARBON AND ENERGY PRICES IN 2010 for Kyoto-constrained regions
Reference
No Trading
Annex B
Global
Carbon Price
$0
$116-584
$127
$24
Oil Price
1.0
0.90
0.95
0.99
Natural Gas Price
1.0
0.83
0.86
0.96
Oil and natural gas are treated as Hecksher-Ohlin goods in EPPA, which means that there is
complete freedom of trade among regions and a single world price. As a result, restrictions on
carbon emissions in Annex B countries lead to (equally) lower oil and natural gas prices for
producers and consumers throughout the world. In contrast, coal is an Armington good, which
means that there is no single world price but a series of regional prices that can be affected by
changes in trade flows. Consequently, actions by the Annex B regions will affect coal prices in
these regions, but generally not elsewhere, or only through the quantities traded which are not
great.
As the scope of emissions trading expands and the price of carbon declines, and the effect on
energy prices diminishes. This effect occurs because one of the cheapest forms of carbon
abatement is the reduction of and substitution away from the use of coal. Emissions trading makes
it possible to substitute cheaper carbon abatement by reducing coal use in non-Annex B regions
for more expensive abatement by reducing oil and natural gas use in Annex B regions.
The effects on trade patterns of the Kyoto commitments and emissions trading are most usefully
observed by comparing the no trading case with full global trading. The former can be viewed as a
relatively inefficient way of achieving the goals set at Kyoto, while the latter represents the
absolutely most efficient way. Emissions trade limited to Annex B is an intermediate case, which
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we omit because its effects are midway between what occurs with no emission trading and with full
global trading. 12
a) Effects of Kyoto through trade in goods in the no emissions trading case
The starting point for the no emissions trading case is the effect of the carbon price on domestic
demand in the Kyoto-constrained regions. Table 7 provides the percentage change from the
reference prediction for domestic use of sectoral output (production less exports plus imports) by
Kyoto-constrained region. The sectoral breakdown in EPPA includes five energy sectors (oil, gas,
coal, electricity and refined oil) and three non-energy sectors (agriculture, energy intensive
industries, and other industries).
TABLE 7. % CHANGE IN DOMESTIC USE BY SECTOR AND REGION
DUE TO KYOTO COMMITMENT WITHOUT EMISSIONS TRADING
USA
JPN
EEC
OOE
EET
OIL
-3.5%
-19.6%
-4.0%
-7.6%
-3.4%
GAS
-11.1%
-24.8%
-10.3%
-14.1%
-12.1%
COAL
-54.5%
-48.8%
-52.1%
-63.2%
-49.4%
ELEC
-11.1%
-11.3%
-12.2%
-13.1%
-19.7%
REFOIL
-6.5%
-20.3%
-7.7%
-10.6%
-7.7%
AGR
-0.7%
-2.2%
-0.2%
-0.9%
-0.4%
ENINTSV
-0.5%
-5.1%
-2.6%
-1.7%
-2.2%
OTHIND
+0.1%
-1.1%
-0.2%
-0.4%
-0.6%
With one insignificant exception, all the signs are negative, and they are greatest in magnitude for
the energy sectors. Coal is hit hardest with domestic use declining by about half in all regions;
however, coal, like electricity and refined oil, is mostly a domestic good so that the international
trade effect of this reduction in demand is not particularly great. Oil and gas are more traded
internationally, and the effect of the reduction in Annex B demand is a world-wide fall in the price of
oil and gas: by 10% and 17%, respectively, as was shown above in table 6. 13 This reduction in
price reduces the income of oil and gas producers throughout the world; and the effect will be
particularly large on the two oil and gas exporting regions, the EEX and the FSU. Interestingly, oil
and gas quantities exported and traded internationally do not change much, but there is a shift in
the destination of energy exports away from the Kyoto-constrained regions towards the non-
constrained regions, as illustrated below through trade in energy-intensive goods.
The domestic use of energy-intensive goods declines in all Kyoto-constrained regions; however,
the most significant effects show up in the trade balances and domestic output for these goods, as
shown in Table 8.
12 The FSU is the one exception. With Annex B trading, its demand for energy declines in the same manner as the
Kyoto-constrained Annex B regions, as does its production and export of energy-intensive goods.
13 The greater effect upon natural gas results from the greater responsiveness to price changes in the industrial and
residential sectors, where natural gas is mostly used, than in the transportation sector, where petroleum products
dominate. Both oil and natural gas gain share in electricity generation at the expense of coal, but electricity demand also
shrinks. In the end, the balance between the losses in non-electricity sectors and the gains in electricity generation are
less favorable for natural gas than for oil.
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TABLE 8. CHANGES IN EXPORT, IMPORT AND OUTPUT
OF ENERGY INTENSIVE GOODS: NO EMISSIONS TRADING
Absolute
USA
JPN
EEC
OOE
EET
FSU
EEX
CHN
IND
DAE
BRA
ROW
Change in:
Net trade
-2.57
-30.96
-26.20
-6.29
-1.61
+7.93
+22.8
+6.78
+1.13
+6.07
+1.86
+21.1
Output
-6.90
-61.68
-42.25
-9.31
-4.99
+9.81
+21.1
+15.3
+2.74
+15.8
+3.46
+22.9
The patterns are very clear. The Kyoto-constrained regions reduce production and net exports of
energy-intensive goods, while the non-constrained regions increase output and net exports of
them. The Kyoto-constrained regions increase imports of these goods, and of the non-taxed
carbon that is embodied in them.
b) Comparing no-trading case effects with full global trading case effects
Meeting the Kyoto commitments with full global trading has much less effect on Annex B demand
for oil and gas and on the trade in energy-intensive goods than was the case with no emissions
trading, as shown in Table 9 and Table 10.
TABLE 9. % CHANGE IN DOMESTIC USE BY SECTOR AND REGION
DUE TO KYOTO COMMITMENT WITH FULL GLOBAL TRADING
USA
JPN
EEC
OOE
EET
OIL
-0.2%
-0.2%
-0.2%
-0.3%
-0.5%
GAS
-0.5%
-0.5%
-0.7%
-0.04%
-0.9%
COAL
-21.5%
-5.0%
-13.2%
-25.0%
-15.4%
ELEC
-2.5%
-0.3%
-1.6%
-2.3%
-5.0%
REFOIL
-1.0%
-0.8%
-0.6%
-1.2%
-1.5%
AGR
-0.1%
-0.1%
-0.03%
-0.1%
+0.2%
ENINTSV
-0.1%
-0.1%
-0.1%
-0.1%
+0.02%
OTHIND
-0.1%
-0.1%
-0.1%
-0.1%
-0.1%
The effects of the Kyoto Protocol remain negative, but the magnitudes are much attenuated. Coal
use is reduced by at most a quarter; and the effect on other goods is generally less than 1%. The
world prices for oil and natural gas are reduced by only 1.3% and 3.5%, respectively, instead of
10% and 17% in the no trading case.
TABLE 10. CHANGES IN EXPORT, IMPORT AND OUTPUT
OF ENERGY INTENSIVE GOODS: FULL GLOBAL TRADING
Absolute
USA
JPN
EEC
OOE
EET
FSU
EEX
CHN
IND
DAE
BRA
ROW
Change In:
Net trade
+0.37
+0.30
-0.09
+0.16
+0.19
-0.71
+1.61
-2.60
-0.94
+0.53
-0.02
+1.22
Output
-0.59
-0.18
-0.93
-0.02
+0.21
-1.81
+0.45
-8.90
-2.25
+0.10
-0.01
+1.24
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The changes in trade and output of energy-intensive goods are all relatively small; and there is no
consistent pattern as in Table 8, because the price of carbon is the same in all countries. Output
and the net trade position is most adversely affected in China, India and FSU because their
production of energy intensive goods is more dependent on coal, which is the fuel most adversely
affected by any positive price on carbon emissions.
c) Summary
The effects of the Kyoto Protocol and of emissions trading on non-Annex B regions consist of three
analytically separate elements, which can be summarized by the following simple matrix.
TABLE 11: EFFECT OF KYOTO AND EMISSIONS TRADING
KYOTO EFFECT
No Emissions
Global Emissions
Trading
Trading
Permit Revenues
0
+
Oil & Gas Export Revenue
- -
-
Energy Intensive Goods Trade
+
0
Whether there is emissions trading or not, the effect of the Kyoto commitments on non-Annex B
countries is mixed. Without emissions trading, there will be no permit exports, but an increase in
the production and export of energy intensive goods can be expected, assuming no protective
trade measures are enacted by the Kyoto-constrained regions. With global emissions trading,
there will be permit export revenues, but no significant increase in production and exports of
energy intensive goods. The revenues of Non-Annex B regions that export oil and gas will be
adversely affected in either case, but much less so with the lower carbon price associated with a
broadened market for emissions permits. In effect, oil and gas exporters benefit as emissions
trading makes it possible for Kyoto-constrained regions to substitute reduced coal use in non-
Annex B regions for reduced oil and natural gas use at home.
The temptation is almost overwhelming to produce a single aggregate number to indicate the
extent to which particular countries and regions are better or worse off as a result of some policy
intervention. Although EPPA produces such a number, as does any CGE model, we have chosen
not to cite it here for several reasons.¹⁴ Some of the abstractions used in EPPA, such as a single
representative consumer and full employment of resources, seem particularly inappropriate in the
context of an economically developing country. Then, such numbers lend themselves to
inappropriate cardinal comparisons and they detract from the fundamental story at the sectoral
level. The effects of meeting the Kyoto commitments will not be evenly felt across all sectors,
either in the constrained or the non-constrained regions. To take an obvious example, coal
producers in non-Annex B regions will lose some market to cheaper oil and gas even with no
14 See Jacoby et al. 1997 does present such a number but it is a discounted sum over many periods for a somewhat
more stringent Annex B reduction. This estimate is slightly negative for all non-Annex B regions.
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emissions trading, but they will lose much more with emissions trading. Oil and gas producers will
be in exactly the opposite position, as will coal producers in Kyoto-constrained regions.
In any case, the amounts involved are not large when viewed in the context of the entire economy.
The earnings from the export of permits or the increased export of energy intensive goods is
always less than 2% of GDP for the non-Annex B regions, and typically less than 1%.
7. CONCLUDING OBSERVATIONS
The effect on developing countries of Annex B actions to comply with the Kyoto Protocol will
depend on the particular country and on the success of emissions trading. All developing
economies will have an interest in emissions trading as a source of new export earnings, but their
interest will extend beyond this new commercial possibility. In particular, oil and gas exporters will
have a strong interest in emissions trading as a means to reduce the cost for Annex B parties
generally, and specifically to allow Annex B parties to substitute reduced coal emissions abroad for
reduced oil and gas emissions at home. It is possible that some countries and sectors would be
adversely affected by emissions trading. For instance, the advantage enjoyed by producers of
energy-intensive goods will be greater with no emissions trading, assuming that the embodied
carbon imports would be permitted by the Annex B regions. The net balance will be different for
various countries, but in general it seems likely that developing countries will benefit from
emissions trading.
The gains from emissions trading are potentially very large, fully sufficient to give potential buyers
and sellers an economic incentive to support such a system. Most studies of permit trade suggest
ample supplies would be offered by non-Annex B regions, at commensurately low prices, yielding
large cost reductions for the Kyoto-constrained regions and substantial benefits to non-Annex I
regions. The actual supply is likely to be somewhat less, at least initially, due to transactions cost
and less than complete participation in the market by all non-Annex B regions. Nevertheless,
whatever the initial extent of the market and its subsequent development, both importing and
exporting parties will gain.
As in any market, the potential for welfare damaging distortions is always present. Given the
undefined meaning of "supplemental" in the Kyoto Protocol, a particularly alarming distortion from
the developing country standpoint is a limitation on Annex B imports of emission permits. Not only
will such limits depress permit prices and the export earnings of non-Annex B parties, but they will
have perverse effects on importing countries. Annex B parties with relatively high domestic
abatement costs, and thus higher imports, would be penalized, while those with relatively low
domestic abatement costs, and fewer imports, would find the cost of meeting their Kyoto
commitments reduced.
The ability of the CDM to impose surcharges to help countries meet the costs of adaptation will
depend upon the elasticity of demand, which depends in turn on the supply available from non-
Annex B regions. Ironically, the greater the supply and the lower the price, the greater the ability to
impose surcharges without fear of losing revenue. Still, there is an unavoidable conflict between
the interests of the producers of the permits and redistributive goals. The same price inelasticity of
demand that makes it possible to impose the surcharge while keeping producers whole will likely
also inspire attempts at cartelizing the global market for emission permits.
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The FSU and the non-Annex B countries appear as clear rivals to each other in the stylized cases
we have presented, but casting this rivalry in geopolitical terms obscures its more practical aspect.
The stylized Annex B or global emissions markets typically posited in modeling exercises will not
spring into life as soon as appropriate institutional arrangements are made. Rather these markets
will develop, probably slowly, over time. As is true of any new market, the first to enter, whether
from the FSU or from the developing countries, will enjoy large gains that will be dissipated as
others follow.
The FSU does however have one large advantage: its acceptance of an Annex B emission
limitation, which removes the high costs associated with the certification and verification of
emission reductions that will be required in non-Annex B countries. This example will encourage
the most enterprising non-Annex B countries to accede to Annex B to capture more of the large
gains of early emissions trading. In doing so, these parties will foster more efficient emissions
trading and promote the ultimate goals of the Kyoto Protocol, but they will also necessarily reduce
the ability of the CDM to act as a re-distributive mechanism.
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REFERENCES
Ellerman, A. Denny and Annelene Decaux, 1998, "Analysis of Post-Kyoto Emissions Trading Using
forthcoming, Cambridge, MA.
Marginal Abatement Curves," MIT Joint Program on the Science and Policy of Global Change,
Jacoby, H.D. et al. 1997. "CO₂ Emissions Limits: Economic Adjustments and the Distribution of
Burdens," The Energy Journal, 18/3, 31-58.
Jacoby, H.D., R.G. Prinn and R. Schmalensee 1998. "Kyoto's Unfinished Business," Foreign
Affairs 77/4, 54-66, July/August.
Prinn, R.G. et al. 1998. "Integrated Global System Model: Feedbacks and Sensitivity Studies,"
Climatic Change, forthcoming.
United Nations Conference on Trade and Development (UNCTAD) 1998, "Greenhouse Gas
Emissions Trading: Defining the Principles, Modalities, Rules and Guidelines for Verification,
Reporting and Accountability," Geneva, Switzerland, Draft of July 1998.
United Nations Framework Convention on Climate Change, Kyoto Protocol, 1997.
Yang et al. 1996. "The MIT Emissions Prediction and Policy Analysis (EPPA) Model," MIT Joint
Program on the Science and Policy of Global Change, Report No. 6, Cambridge, MA.
Yang, Zili and Henry D. Jacoby, "Necessary Conditions for Stabilization Agreements," MIT Joint
Program on the Science and Policy of Global Change, Report No. 26, Cambridge, MA.
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APPENDIX A: MARGINAL ABATEMENT CURVES1
a) What are Marginal Abatement Curves and what do they represent? (Fig. A1)
A CGE model will produce a shadow
price for any constraint on carbon
emissions for a given region R at time
T. An example would be a 10%
Shadow price of carbon
Region R, time T
reduction below the reference case for
USA in 2010. This price indicates the
= Total cost of abatement
marginal cost of reducing the last ton
under constraint: q abated
of carbon required to meet the
p
constraint; and, as might be expected
MAC
in a proper CGE model, the shadow
prices corresponding to constraints of
plot
increasing severity rise as an
increasing function of emissions
reduction.
A Marginal Abatement Curve is
described by generating the plots of
the shadow prices corresponding to
q
CO₂ abated
constraints of increasing severity at
time T, then drawing a line joining the
plots, as in Fig. A1. Each plot on the
Fig. Al: Marginal Abatement Curves
curve for region R at time T represents
the marginal cost (p) of abating an
additional unit of carbon emissions at quantity q. The integral under the curve (hatched area)
represents the total abatement cost associated with each level of abatement, that is, the resources
re-allocated to abatement because of the constraint. 16 This area is not the same as the welfare
loss that is calculated by most CGE models, although it is closely related.
b) How can MACs be used for Trade Studies? (Fig. A2)
If several regions commit to achieve emission reductions at the same time and there is some
prediction of what emissions would be without the commitment, the abatement required can be
represented as a point on each region's marginal abatement curve. Moreover, if the marginal costs
associated with those reductions are different across regions, the aggregate cost of meeting the
commitments will be less to the extent that a region with higher marginal costs can induce a region
with lower marginal costs to abate more on its behalf. 17 By abating more, the lower cost region
produces 'rights to emit,' or emission permits, which it can sell to the higher cost region which
15 This section of the paper draws heavily on Ellerman and Decaux, 1998.
16 As is true of any CGE model, full employment of resources is always assumed.
17
As typically assumed in such analyses, and as is the case here, the environmental goal pursued - reducing
atmospheric concentrations of greenhouse gases - is not affected by the location of the emission reduction.
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would thereby avoid a like amount of higher cost domestic abatement. Thus, the difference in the
marginal costs associated with each region's commitment in the absence of trade creates a
potential gain to be shared in some manner between the two regions. The aggregate emission
reduction will be achieved at least cost when the regions trade until their marginal abatement costs
are equal at what will then be the market clearing price for the 'right to emit' carbon.
Fig. A2 illustrates the gains from trading for 2
regions R₁ and R₂, subject to the constraints:
CO₂ abated = q₁ for R₁ and q₂ for R₂, and
Shadow price of
carbon
Time T
Table A1 below displays the cost calculations
R₁
in the no trading and trading cases.
A
p₁
These cost calculations can easily be
generalized to N regions, and they constitute
R₂
A'
8'
the basis of this study: we will calculate,
1,
1₂
under various trading assumptions, the
p'
B
volume of trade and the resulting savings for
P₂
the regions.
O
2
Q₁
à
2
q1
q₂
q'2
CO₂
abated
Fig. A2: MACs used for Trade Studies
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No Trade
Trade between R₁ and R₂
Constraints
R₁: q₁ abated
R₁ and R₂: q₁ + q₂ abated
R₂: q₂ abated
Marginal Cost / Market Price
R₁: p₁
R₁ and R₂: p' such that p',(q'₁) = p'₂(q'₂) = p'
R₂: P₂
and q'₁ + q'2 = q₁ + q₂
Abatement Cost
R₁: area AOQ1
R₁: area A'OQ'₁
R₂: area BOQ₂
R₂: area B'OQ'₂
Emission Permits Trading
NA
R₁: buys right to emit q1-q'₁
R₂: sells right to emit q'2-q₂ = q1-q'₁
Imports (+) / Exports (-) Flows
NA
R₁: pays p' (q₁-q'₁) = area A'I₁Q₁Q'₁ to R₂
R₂: receives p' * (q'2-q₂) = area B'I₂Q₂Q'₂ from R₁
Total Cost
R₁: area AOQ1
R₁: area A'OQ'₁ + area A'I₁Q₁Q'₁ < area AOQ₁
R₂: area BOQ₂
R₂: area B'OQ'2 area B'I₂Q₂Q'₂ < area BOQ₂
Savings from Trading
NA
R₁: area AI₁A' (hatched)
R₂: area BI₂B' (hatched)
Table Al: Basics of Trade Studies
c) How are MACs generated from CGE Models? (Fig. A3, A4 and A5)
The CGE model we use to generate MACs is the MIT Emissions Prediction and Policy
Assessment (EEPA) model. It is a multi-sectoral, multi-regional global model of economic activity,
energy use and greenhouse gas (GHG) emissions that is part of MIT's larger Integrated Global
Systems Model. 18 As such, EPPA is frequently used to predict emissions and to assess the costs
associated with constraints on carbon emissions. Although EPPA predicts emissions and assesses
costs through the year 2100, this study takes the year 2010 as representative of the first
commitment period, which includes the years 2008 through 2012. The model keeps track of five
vintages of capital. Version 2.6 of the model incorporates two backstop technologies; however,
because these energy sources will not play a substantial role in 2010, they are omitted from the
calculations presented here.
To build the MACs, we run the EPPA model under different constraints corresponding to different
levels of carbon abatement, such as 10%, 20%, or 30% of reference emissions in the year 2010.
For each set of constraints, the corresponding, regional shadow prices of carbon are an output of
the model (in 1985 US$). 19 The shadow prices for each region can then be plotted as a function of
the level of abatement, and a line can be fitted to the plots to get the MAC for that region and time.
18 See Yang et. al, 1996, for a description of EPPA and Prinn et. al., 1998, for a description of the IGSM.
19 Although we often refer to CO₂ emissions, all prices and quantities are in terms of carbon. Each ton of carbon
corresponds to 3.67 tons of carbon dioxide.
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As an example, Fig. A3 shows the results obtained for the four OECD regions in 2010 when the
policies applied are: proportional reductions by all OECD regions (1, 5, 10, 15, 20, 30 and 40% of
reference 2010 emissions), and no reduction by other regions. Here, the shadow prices have been
plotted in function of the percentage of carbon emission reduction (and not the absolute
quantities), in order to show the variations across regions without taking into account the size of
the economy. We can see that, for any equal percentage reduction among the OECD regions, the
abatement of the corresponding quantities would cost most in Japan, then in EEC, and least in
USA and OOE.
Similar curves can be obtained for all regions. For example, we can apply the same proportional
reductions, but to all of EPPA's twelve regions at the same time.²⁰ Fig. A4 displays the marginal
abatement curves thus obtained. It shows where it is the cheapest to abate carbon emissions
(India and China) and where it is the most expensive (Japan and Brazil).
Now, to allow trade studies like in Fig. A2, we need to re-scale the x-axis of these curves to actual
absolute quantities instead of percentages, and it is the way MACs will be represented from now
on. Stating marginal cost in terms of the proportional reduction, as above, reveals the relative cost
of carbon abatement among the twelve EPPA regions, but it does not indicate the importance of
various regions in an emissions trading market. For example, as shown in figure A4, both China
and India are relatively low cost suppliers of abatement. However, China is a significantly greater
potential supplier of abatement than India by the simple fact that its reference emissions are 3.5
times as large (1,792 vs. 486 Mton). China is about 70% more carbon intensive than India, its
economy is predicted to be about twice the size of India's in 2010. Thus, as can be seen on Fig.
A5, which represents on the quantitative scale the marginal curves of the six non-Annex B regions
and the USA (for comparison), the MAC for China is much lower than the other non-Annex B
MACs. China is the largest potential source of emissions permits from the non-Annex B regions.
To illustrate, if the market price for emissions permits were $50, China would provide about 700
Mton of emissions reduction, while the five other regions combined would provide only 400 Mton.
d) Assessing the 'Robustness' of MACs with regard to the Policy applied (Fig. A6)
One question that arises immediately is how the location of a MAC is influenced by events in other
regions. More specifically, how is the cost associated with any given level of carbon abatement for
one region affected by differing levels of abatement in other regions? For instance, one can notice
in Table 1 (see body of the text) that the levels of implied abatement corresponding to the Kyoto
commitment are not strictly proportional, e.g. 29% for EEC, 36% for OOE. 21 Also, with emissions
trading, we would not expect the reductions among regions to be proportional. Will MACs
generated by assumptions other than proportional reductions in all regions look the same?
This fundamental question is that of the robustness of the MACs. And indeed, a drawing like Fig.
A2, and the simple method we have deduced from it assume this robustness (one curve for each
region, whatever the reductions in other regions). The answer is: they are robust. In all the runs we
have done, whatever the reduction schemes assumed (we went as far as one region reducing its
20
In doing so, we do not imply that non-Annex B countries assume constraints, but only that they choose to abate
emissions in the proportions indicated, as they might to pursue the export earnings implicit with trading when a positive
price for carbon emissions is being paid by Annex B regions.
21
In addition, different assumptions about economic and emissions growth between 1990 and 2010 from those used in
this model prediction can yield even greater variation.
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emissions by 60% while the others keep reference emissions), the plots obtained are all located on
or very close to the curves we have generated using proportional abatement scenarios.
For example, Fig. A6 shows simultaneously the two sets of MACs corresponding to varying levels
of OECD abatement assuming no emissions trading and fully efficient emissions trading. The
curves in both sets are similar, thus showing that the MACs are robust with regard to this change
of policy. We have made similar comparisons for other assumptions-no trading, Annex B trading
and world trading-and each time we have found the same fundamental result: whatever the
trading scheme, whatever the extent of the market, the marginal abatement curves are almost
identical.
Our conclusion is that MACs, and more generally, the costs associated with a given level of
domestic abatement, are sufficiently insensitive to different levels of abatement among regions and
the scope of emissions trading to justify the analytic method applied here.
e) Analytical Approximations: a Simple Tool for Trade Studies (Fig. A7)
Robustness implies that each region at time T has a unique marginal abatement curve. This result
allows independent use of marginal abatement curves, once generated from CGE model, and
makes trade analysis straightforward and simple. Now, such an analysis can be even more
simplified if each curve could be described by a single mathematical expression because, once we
have the equations of the MACs, the cost calculations (i.e. integration under the curves) are
extremely simple and rapid.
Fig. A7 shows, for the OECD regions, that we can fit very simple analytical curves to the sets of
plots resulting from the EPPA runs, and that those fits are very good (for each curve, R² very close
to 1). This result holds for all the other regions as well. The curves that best fit the EPPA-
generated plots are of the form: P = aQ² + bQ, where Q is the amount of carbon abatement in
Mton and P is the marginal cost, or shadow price, of carbon in 1985 US$. By integration, the total
cost of abatement is C = 1/3*aQ³ + 1/2*bQ². The table below displays the coefficients a and b for
each region in 2010, as well as the coefficient of determination R².
Region
a
b
R²
Region
a
b
R²
USA
0.0005
0.0398
0.9923
EEX
0.0032
0.3029
0.9983
JPN
0.0155
1.816
0.9938
CHN
0.00007
0.0239
0.9992
EEC
0.0024
0.1503
0.9951
IND
0.0015
0.0787
0.9970
OOE
0.0085
- 0.0986
0.9981
DAE
0.0047
0.3774
0.9996
EET
0.0079
0.0486
0.9973
BRA
0.5612
8.4974
0.9997
FSU
0.0023
0.0042
0.9938
ROW
0.0021
0.0805
0.9967
Table A2: Coefficients of the Approximations of the MACs of the Form: P = aQ² + bQ
In using these approximations, analysts should keep in mind that the price of this simplicity is
abandonment of the general equilibrium features of the underlying model. The robustness of the
22 Note that, compared to figs. 3 and 4, the x-axis has been re-scaled to quantities.
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curves assures us that the relation between price and quantity of abatement is relatively fixed, but
the curves do not capture all the effects of emissions trading. Since the EPPA model remains our
primary analysis tool, we have run the model in every policy case we studied in order both to
ensure that the approximations are not misleading and to capture any possible side effects. The
prices and quantities for abatement were all very close to the approximations, but there is a side
effect that the MAC approach does not capture: "leakage." When carbon emissions are
constrained for only a sub-set of regions, carbon emissions tend to "leak" to non-constrained
regions. These effects are not an essential feature of the present analysis; however, the analytical
approximations are a powerful computational shortcut. They also provide a convenient way to
represent graphically the results of the trading analysis, and we use them extensively for that
purpose in the remaining sections.
f) Construction of Aggregate Supply and Demand Curves (Fig. A8)
Marginal abatement curves are the basis for determining the demand and supply for emission
permits in any given market. Emission permits represent 'rights to emit' and these rights can be
produced by some party abating more than it is required to do, or undertaking some abatement
when not required to do so. The willingness of any party to produce these permits is a function of
the underlying cost relationships represented by the MAC, of the amount the party is otherwise
required to abate, and of the price of permits. The demand for 'rights to emit' is a function of the
same three factors. Given the MACs and a set of reduction requirements,²³ aggregate supply and
demand can be calculated by adding the (positive) quantities supplied or demanded at every price
across regions.
If a region is unconstrained (non-Annex B regions, or FSU in this case), then it is always a seller of
permits. At any market price, it will be willing to sell a quantity of permits equal to the amount of
abatement it would undertake when the marginal cost on its MAC equals the market price. And, for
the FSU, the quantity of 'hot air' (111 Mton here) can be added, on the assumption that trade in
such "hot air" will be allowed under the Kyoto Protocol.
If a region is constrained by its Kyoto commitment, then its position in the market, as seller or
buyer, depends on the market price.
If the market price is lower than its autarkic marginal abatement cost, this region would be
willing to buy emission permits corresponding to the quantity difference between the reduction
implied by its Kyoto commitment and the domestic abatement it would provide at the market
price.
Conversely, if the market price is higher than its autarkic marginal abatement cost, it would be
willing to undertake more abatement and supply the market with the 'right to emit' for the
corresponding quantity.
Now, for each price (y-axis) and each market we are considering (Annex B, or the world, for
instance), we simply add up the quantities (x-axis) potentially supplied and those potentially
demanded. As we vary the price, we describe the demand and the supply curves for this market,
23 A reduction requirement depends both on the Kyoto commitment and an estimate of what emissions would otherwise
be (e.g., reference or business-as-usual emissions).
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and their intersection indicates the market clearing price on the y-axis and the total quantity traded
on the x-axis.
Fig. A8 shows the aggregate demand and supply curves obtained in the Annex B and world
trading cases. The aggregate demand curve is the same in both the Annex B and the global
market because both include all Kyoto-constrained, i.e. potentially importing, regions. This single
demand curve intersects the horizontal axis at the quantity equal to the sum of the emission
reductions required to meet the Kyoto commitments, which is 1.31 Gton. This is the 'Kyoto cap'
represented by a vertical dotted line on the figure; it is also the quantity of emission permits that
would be demanded if the price were $0/ton. At this price, the aggregate supply is the quantity of
permits available at no cost. This is the FSU's 111 Mton of "hot air".
As the price increases, the demand for permits diminishes, as more and more domestic abatement
is undertaken, and the supply of permits increases as more abatement is justified in the
unconstrained, exporting regions. As long as the market price is less than the lowest autarkic
marginal cost for the Kyoto-constrained regions, these regions are always on the demand side;
and the unconstrained regions are on the supply side. When the price reaches $116, the marginal
cost for EET, this region switches from the demand side to the supply side, resulting in a 'kink' on
the demand and supply curves (which happens to be almost indiscernible because of the small
economic size of this region). Such a kink can readily be seen on both supply and demand curves
when the price reaches $186, the autarkic marginal cost for USA. There would be similar kinks at
$233 when OOE becomes a supplier and at $273 when the EEC does. At $584, the autarkic
marginal cost for Japan meeting the commitment, the demand for permits would be zero.
APPENDIX B: DATA TABLES
NB: all the prices in the following tables are in 1985$
BASIC CASES
TABLE A: Kyoto no trading
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
Reductions / ref 2010 (Mton)
571 58
144.19
307.21
171 38
118.04
1312 41
0 00
0.00
1312 41
Marginal Costs ($/ton)
$186.10
$584.12
$272.68
$232.76
$115.82
\
\
\
\
Cost of Abatement ($billion)
37.62
34.37
30 29
1281
467
119.76
0.00
0 00
11976
TABLE B: Annex B trading
USA
JPN
EEC
OOE
EET
oacd+eet
FSU
World
Reductions / ref 2010 (Mton)
465 77
49 24
200.85
128.18
123.76
967.80
234 08
1201.88
'Hot air (Mton)
\
\
\
\
\
0.00
110 53
110 53
Marginal Costs ($/ton)
$127.01
$127.01
$127.01
$127.01
$127.01
$127.01
$127.01
$127.01
Cost of Abatement ($billion)
21.16
2 82
9.51
5 16
5.36
44 01
9 95
53 96
Permits exp(-)/imp(+) (Mton)
105.81
94 95
106.36
4321
-571
344.61
-344.61
0 00
1.6 % of commitment (import)
18.51%
65 85%
34.62%
2521% 1
26 26%
1
1
Flows exp(-)/imp(+) ($billion)
13.44
12 06
13.51
5 49
-073
43 77
-43 77
0 00
Total Cost ($billion)
34 60
14 88
23.02
10.64
4 64
87 78
-33 82
53.96
Gains from trade ($billion)
3.03
19.49
7.27
2.17
0.03
31.99
33 82
65.81
TABLE C: World trading
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
181.96
11 90
73.07
59 03
5189
377 84
100 81
723 23
1201.88
51.04
436 81
102 42
41 55
2 42
88 99
'Hot air' (Mton)
\
\
\
\
\
0.00
110.53
0.00
11053
\
\
\
\
\
Marginal Costs ($/ton)
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
$23.80
Cost of Abatement ($billion)
1.66
0.14
0.71
0.41
0.43
3.36
0.81
6 99
11 15
0 54
4.22
0.95
0 44
0 03
081
Permits exp(-)/imp(+) (Mton)
389 63
132 30
234 14
112.36
66.15
934.57
-211 34
723 23
0 00
-51 04
-436 81
-102 42
-41 55
-242
-88 99
i.e % of commitment (import)
6817%
9175%
76 22%
65 56%
5604%
7121%
1
1
\
1
1
1
\
\
1
Flows exp(-)/imp(+) ($billion)
9 27
3 15
5.57
267
157
22 24
-5.03
-17 21
0.00
-121
-1040
-2 44
-0 99
0 06
-212
Total Cost ($billion)
10 94
3 29
6 29
3 09
2.01
25 60
-422
-1022
11.15
-0.68
-6 17
149
.0 55
-0 03
131
Gains from trade ($billion)
26.69
31.08
24.00
9.73
2.66
94.16
4.22
10 22
108.61
0 68
6.17
1.49
0 55
0 03
131
29
IMPORT LIMITATIONS
TABLE D: 75%
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
177.53
36.05
76.80
57.94
50 76
399.09
98.71
704 08
1201.88
49.48
425.28
99 88
40 28
2.33
86.83
'Hot air' (Mton)
\
\
\
\
0.00
110.53
0.00
110.53
\
\
\
Marginal Costs ($/ton)
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
$22.82
Cost of Abatement ($billion)
1.56
1.42
0.81
0.39
0.41
4.58
0.76
6.54
11.88
0.50
3.96
0.89
0.41
0 03
0.76
Permits exp(-)/imp(+) (Mton)
394.05
108.14
230.41
113.44
67 28
913.32
-209.24
-704.08
0.00
-49 48
-425 28
-99.88
40.28
-2.33
-86.83
i.e % of commitment (import)
68.94%
75.00%
75.00%
66.19%
5700%
68.07%
1
1
1
1
1
1
1
1
I
Flows exp(-)/imp(+) ($billion)
8.99
2.47
5.26
2.59
1.54
20.84
-4.77
-16.07
0 00
-1.13
-9.70
-228
0.92
-0.05
-1.98
Total Cost ($billion)
10.55
3.89
6.06
2.97
1.94
25.42
-4.02
-9.52
11.88
-0.63
-5.75
-1 39
-051
-0.03
-122
Gains from trade ($billion)
27.07
30.48
24 22
9.84
2.73
94.34
4.02
9.52
107.88
0.63
5.75
139
051
0 03
122
delta gain in % / no limit (table C)
1.44%
-1.94%
0.93%
1.14%
2.46%
0.19%
-4.88%
-6.84%
-0.67%
-7.26%
-6.85%
-6.66%
-7.28%
-7.73%
-6.60%
TABLE E: 50%
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
285.79
72.10
153.60
85.69
59.02
656.20
72.93
472.75
1201.88
31.15
285.65
68 88
25.27
1.35
60.45
'Hot air' (Mton)
\
\
\
\
0.00
110.53
0.00
110.53
\
\
\
\
\
\
Marginal Costs ($/ton)
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
Cost of Abatement ($billion)
5.52
6.66
4.67
1 42
0.63
18.89
0.31
2.50
21.70
0.18
152
0.35
0 15
0.01
0.30
Permits exp(-)/imp(+) (Mton)
285.79
72.10
153 60
85 69
59.02
656 20
-183.46
-472.75
000
-31.15
-285-65
-68.88
-25.27
-1.35
60.45
i.e % of commitment (import)
50.00%
50.00%
50.00%
50.00%
50.00%
48.91%
1
1
1
1
1
1
I
1
1
Flows exp(-)/imp(+) ($billion)
3.58
0.90
1.93
1.07
0.74
8.23
-2.30
-5.93
0.00
-0 39
-3 58
-0 86
-0.32
-0.02
-0 76
Total Cost ($billion)
9.10
7.56
6.60
2.50
1.37
27.12
-1.99
-3 42
21.70
021
2.06
-051
-017
001
-0.46
Gains from trade ($billion)
28.53
26.81
23.69
10.32
3.30
92.64
1 99
3.42
98.06
0.21
2.06
0.51
0.17
0.01
0.46
delta gain In % / no limit (table C)
6.88%
-13.75%
-1.30%
6.06%
24.10%
-1.61%
-52.83%
-66.51%
-9.71%
-68.83%
-66.57%
-65.47%
-68.93%
-70.98%
-65.06%
TABLE F: 25%
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
428.69
108.14
230.41
128.54
88.53
984.31
37.51
180.06
1201.88
10.12
107 92
28.09
8.16
0.39
25.37
'Hot air' (Mton)
\
\
\
0.00
110.53
0.00
110.53
\
\
\
Marginal Costs ($/ton)
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
$3.39
Cost of Abatement ($billion)
16.79
17.15
13.77
5 20
2.02
54.94
0.04
0.28
55.26
0 02
0 17
004
0.01
0.00
0.04
Permits exp(-)/imp(+) (Mton)
142.90
36.05
76.80
42.85
29.51
328.10
-148.04
-180.06
0.00
-10 12
-107.92
-28.09
-8 16
-0.39
-25 37
i.e % of commitment (import)
25.00%
25.00%
25.00%
25.00%
25.00%
24.45%
1
I
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
0.48
0.12
0.26
0.15
0.10
1.11
-0 50
-0.61
0.00
-0.03
-0.37
-0.10
-0.03
0.00
0 09
Total Cost ($billion)
17.27
17.28
14.04
5.35
2.12
56.05
-0.46
-0.33
55.26
-0.02
-0.20
-0 05
-001
0.00
-0.05
Gains from trade ($billion)
20.35
17.09
16.25
7.47
2.55
63.72
0.46
0 33
64.51
0 02
0.20
0.05
0.01
0 00
0 05
delta gain In % / no limit (table C)
-23.74%
-45.01%
-32.29%
-23.26%
-4.13%
-32.33%
-89.14%
-96.76%
-40.61%
-97.39%
-96.80%
-96.43%
-97.41%
-97.79%
-96.27%
30
CDM SURCHARGES
TABLE G: 25% CDM Surcharge
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
197.82
13.54
80.10
62.91
55.94
410.32
108 32
686.52
1205.17
48.06
414.70
97.55
39.11
2.25
84.85
'Hot air' (Mton)
\
\
\
0.00
110.53
0.00
110.53
\
\
\
\
Marginal Costs ($/ton)
$27.44
$27.44
$27.44
$27.44
$27.44
$27.44
$27.44
$21.95
\
$21.95
$21.95
$21.95
$21.95
$21.95
$21.95
Cost of Abatement ($billion)
2.07
0.18
0 89
051
0 54
419
1.00
6.15
11.34
047
3.72
0.81
038
0.02
072
Permits exp(-)/imp(+) (Mton)
373.76
130.65
227.10
108.47
62.10
902.09
-218.85
686.52
-3 29
48.06
414.70
97.55
39.11
-2.25
-84.85
1.8 % of commitment (import)
65.39%
9061%
73.92%
63.29%
52.61%
6724%
1
1
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
10.26
3.58
6.23
2.98
1.70
2475
-6.01
-15 07
3 68
-1.05
-9.10
244
0.86
0.05
-1.86
Total Cost ($billion)
12.32
3.76
7.13
349
224
28.94
5.01
-8 92
15.02
-0.59
538
130
0.48
0.03
-115
Gains from trade ($billion)
25.30
30.60
23.16
9.33
2.43
90.82
5.01
8 92
104.75
0.59
5.38
1.30
0.48
0.03
115
delta gain in % / no limit (table C)
-5.20%
-1.54%
-3.50%
-4.13%
-8.76%
-3.55%
18.54%
-12.76%
-3.56%
-13.52%
-12.77%
-12.44%
-13.55%
-14.35%
-12.32%
TABLE H: 50% CDM Surcharge
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
210.57
14.92
85.78
66.03
59.19
436.48
114 34
653.99
1204.81
45.44
395.10
93 22
36 96
2.10
81 17
'Hot air' (Mton)
\
0.00
110.53
0.00
110.53
\
Marginal Costs ($/ton)
$30.55
$30.55
$30.55
$30.55
$30.55
$30.55
$30.55
$20.37
$20 37
$20.37
$20.37
$20.37
$20.37
$20.37
Cost of Abatement ($billion)
2.44
0.22
1.06
0.60
0.63
4 95
1.17
5.46
11.58
0.41
3.30
075
0.31
0.02
0.64
Permits exp(-)/imp(+) (Mton)
361.01
129.27
221.43
105.35
58.86
875.93
-224.87
-653.99
-2.93
-45.44
395.10
-93 22
-36.96
2.10
-81.17
i.e % of commitment (import)
63.16%
89.65%
72.08%
61.47%
49.86%
65.29%
1
1
1
1
1
1
I
1
Flows exp(-)/imp(+) ($billion)
11.03
3.95
6.76
3.22
1.80
26.76
-6.87
-13.32
6.57
-0.93
-8.05
-1.90
-0.75
-0.04
-165
Total Cost ($billion)
13.47
4.17
7.82
3.82
2.43
31.71
-5.70
-7.86
18.15
-0.51
474
-1.15
-042
0.02
-1.01
Gains from trade ($billion)
24.16
30.20
22.46
9.00
2.24
88.06
5.70
7.86
101.61
0.51
474
1.15
0.42
0.02
1.01
delta gain In % / no limit (table C)
-9.48%
-2.84%
-6.40%
-7.55%
-15.83%
-6.48%
34.88%
-23.12%
-6.44%
-24.41%
-23.13%
-22.57%
-24.46%
-25.80%
-22.36%
TABLE I: 100% CDM Surcharge
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
231.02
17.23
94.90
71.03
64.39
478.57
123.99
601.66
1204.22
41.25
363 54
86.23
33.53
1.88
75.23
'Hot air' (Mton)
0.00
11053
0.00
110.53
\
\
Marginal Costs ($/ton)
$35.88
$35.88
$35.88
$35.88
$35.88
$35.88
$35.88
$17.94
$17.94
$17.94
$17.94
$17.94
$17.94
$17.94
Cost of Abatement ($billion)
3.12
0.30
1.36
0.77
0.80
6.34
1.49
4.46
12.30
0.33
270
061
027
0 02
0.53
Permits exp(-)/imp(+) (Mton)
340.56
126.97
212.31
100 35
53.66
833.84
-234 52
-601.66
-2.34
-41.25
-363.54
8623
-33.53
-1.88
75 23
i.e % of commitment (import)
59.58%
88.05%
69.11%
58.56%
45.45%
62.15%
1
1
1
I
1
1
1
Flows exp(-)/imp(+) ($billion)
12.22
4.56
7.62
3.60
1.93
29.92
-8.41
-10 79
10.71
-0.74
-6.52
-1.55
-060
-0.03
-1.35
Total Cost ($billion)
15.34
4.85
8.98
4.37
2.73
36.26
-6.92
-6.33
23.01
041
-3.82
-0.93
0.33
0.02
0.82
Gains from trade ($billion)
22.29
29.52
21.31
8.45
1.94
83.50
6.92
6.33
96.76
0.41
3.82
0.93
0.33
0.02
0.82
delta gain In % / no limit (table C)
-16.49%
-5.04%
-11.22%
-13.18%
-27.08%
-11.32%
63.88%
-38.04%
-10.91%
-39.94%
-38.08%
-37.23%
-40.02%
-41.90%
-36.92%
31
MONOPOLISTIC BEHAVIOR
TABLE J: CDM cartel with FSU as competitive supplier
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
Reductions / ref 2010 (Mton)
DAE
BRA
ROW
316.67
27.90
133.38
91.91
86.10
655.97
164 26
381.65
1201.88
24.25
230.46
'Hot air' (Mton)
5646
19.64
\
\
1.02
\
49.83
\
\
0.00
110.53
0.00
110 53
\
\
Marginal Costs ($/ton)
\
\
$62.74
$62.74
\
$62.74
$62.74
$62.74
$62.74
$62.74
$62.74
$62.74
$62.74
Cost of Abatement ($billion)
$62.74
$62.74
$62.74
7.29
$62.74
0.82
$62.74
3.24
1.78
1.86
14 99
3.45
1.52
19 96
0.10
0.92
Permits exp(-)/imp(+) (Mton)
0.22
0.08
254.91
0 00
116.29
0 19
173.83
79.47
31.95
656.44
274.79
381.65
000
24.25
230.46
i.e % of commitment (Import)
-56-46
19.64
44.60%
-102
80.65%
-49.83
56.58%
46.37%
27.06%
50.02%
1
1
1
I
1
1
Flows exp(-)/imp(+) ($billion)
1
1
15.99
1
7.30
1091
4.99
200
41.19
17 24
-23 94
0.00
-1.52
-14.46
Total Cost ($billion)
-3.51
1.23
23.28
-0 06
8.12
-313
14.14
6.77
386
5617
13.79
-22.43
19.96
-1.42
-1354
Gains from trade ($billion)
-3.33
115
14.34
26.25
-0.06
-2.94
16.15
6 05
0.80
63.59
13.79
2243
99.81
142
13.54
3 33
TABLE K: CDM+FSU monopoly
115
0.06
2.94
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
Reductions / ref 2010 (Mton)
BRA
ROW
417.36
42.03
178.91
116.41
111.54
866.25
50.86
284.77
1201.88
17.22
171.62
43.03
'Hot air' (Mton)
13.92
\
0.69
\
38.30
\
\
\
0.00
110.53
0.00
110.53
\
\
\
Marginal Costs ($/ton)
\
\
$108.24
\
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
$108.24
Cost of Abatement ($billion)
$108.24
$108.24
15.58
$108.24
1.99
6.99
3.80
3.96
32.31
0 11
0.77
33 20
0.05
0 47
011
Permits exp(-)/imp(+) (Mton)
0.04
0.00
154.22
0.10
102.16
128.30
54.97
6.50
446.16
-161 39
-284.77
0.00
-17.22
-171.62
13.03
i.e % of commitment (import)
13.92
-0 69
26.98%
-38.30
70.85%
41.76%
32.08%
5.51%
34.00%
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
1
1
16.69
11.06
13.89
5.95
0.70
48.29
-17 47
-30.82
0 00
-1 86
-18 58
466
Total Cost ($billion)
-151
-0.08
32.28
-415
13.05
20.87
9.75
4.66
80.61
-17.36
-30 05
33.20
-181
-18 11
-4.54
Gains from trade ($billion)
-1-17
007
5.35
21.32
-4 05
9.41
3.06
0.01
39.16
17.36
30.05
86.57
181
18 11
154
14/
007
TABLE L: CDM+FSU monopoly and 50% Import Limitation
4.05
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
416.71
72.10
178.61
116.25
111.38
895.04
47.70
259.14
1201.88
1542
156.03
39.42
1246
'Hot air' (Mton)
061
35 19
\
\
\
\
\
0.00
110.53
0.00
110.53
\
\
\
:
\
Marginal Costs ($/ton)
\
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
$103.41
Cost of Abatement ($billion)
$103.41
$103.41
15.52
6.66
6.96
3.78
3.94
36.85
0.09
0.63
37.56
0.04
0 38
0.09
0.03
Permits exp(-)/imp(+) (Mton)
0.00
0.08
154.87
72.10
128.60
55.13
6.67
417.37
-158.23
-259.14
0 00
-1542
-156.03
-39.42
-12.46
i.e % of commitment (import)
-0.61
-35.19
27.10%
50 00%
41.86%
32.17%
5.65%
31.11%
1
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
1
16.02
7.46
13.30
5.70
0.69
43.16
-16.36
-26 80
0.00
-1.60
-16.14
4.08
-129
Total Cost ($billion)
-0.06
-3.64
31.53
14.11
20.25
9.49
4.63
8001
-16.27
-26 17
37.56
-1.56
-15.76
-3.98
-1 26
Gains from trade ($billion)
-0.06
-3.56
6.09
20.26
10.03
3.33
0.04
39.75
16.27
26 17
82.20
1.56
15.76
3 98
126
0.06
3.56
delta gain In % / no limit (table C)
-77.17%
-34.83%
-58.20%
-65.79%
-98.46%
-57.78%
285.37%
155.99%
-24.32%
129.23%
155.30%
167.85%
128.13%
105.89%
172.51%
32
INEFFICIENT SUPPLY
TABLE M: 50% of Potential FSU and non-Annex B Supply
USA
JPN
EEC
00E
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
286 14
23 93
11963
84 48
7837
592 54
74 96
589 64
1257 14
44 51
355.29
8119
36 37
235
69.92
'Hot air' (Mton)
\
\
\
\
\
0 00
5527
000
55 27
\
\
\
\
Marginal Costs ($/ton)
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
$52.33
Cost of Abatement ($billion)
5 53
0 59
2 45
136
1 42
11 34
1 32
11 98
24 63
0 98
7 20
1 59
080
0 06
1 35
Permits exp(-)/imp(+) (Mton)
285 44
120 26
187 58
8691
39 67
719 86
130.23
589 64
001
44 51
355.29
8119
3637
2 35
69.92
i.e % of commitment (import)
4994%
8341%
6106%
5071%
3361%
5185%
\
1
\
1
1
1
1
Flows exp(-)/imp(+) ($billion)
14 94
6 29
9 82
455
2 08
3767
6 82
30 86
0.00
233
18.59
425
190
012
365
Total Cost ($billion)
2047
6.88
12.26
590
3 49
4901
550
18 88
24.63
-1.35
1139
-266
110
00/
24
Gains from trade ($billion)
17 15
27.48
18.03
691
1.18
70 75
5 50
1888
95.13
1 35
11 39
266
110
007
231
delta gain In % / no limit (table C)
-35.73%
-11.58%
-24.90%
-28.97%
-55.78%
-24.86%
30.23%
84.65%
-12.41%
99.43%
84.56%
78.77%
100.19%
120 66%
7676%
TABLE N: 25% of Potential FSU and non-Annex B Supply
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
394 93
38 77
168 75
11095
105 88
819 27
5023
41527
1284.78
32 55
249.70
5627
26.66
185
18.21
'Hot air (Mton)
\
\
\
\
\
0.00
2763
0.00
27 63
1
\
\
\
Marginal Costs ($/ton)
$93.70
$93.70
$93.70
$93.70
$93 70
$93.70
$93.70
$93.70
$93.70
$93.70
$93.70
$93.70
$93.70
$93.70
$93.70
Cost of Abatement ($billion)
13 37
167
5.98
3 26
3 40
27.68
1 58
1467
43 92
123
8.79
192
101
0 08
163
Permits exp(-)/imp(+) (Mton)
176.65
105 42
138 46
60.43
12.17
493.13
-77 86
415 27
0 00
32 55
-249.70
56 27
26.66
-185
48.23
je % of commitment (import)
3091%
73.11%
4507%
35 26%
1031%
37.57%
1
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
16 55
9.88
12.97
5.66
1.14
46.21
-7 30
-38 91
0 00
-3 05
-2340
527
-2.50
-0 17
4.52
Total Cost ($billion)
29 92
11.54
18 96
8 93
4 54
73 89
-572
-24 24
43.92
-1 82
-14 60
3 35
1.49
0 10
289
Gains from trade ($billion)
7.70
22.82
11.33
3 89
0 13
45 88
5.72
24 24
75 84
1 82
14 60
3 35
149
0 10
289
delta gain In % / no limit (table C)
-71.14%
-26.57%
-52.80%
-60.03%
-95.04%
-51.28%
35.44%
137.12%
-30.17%
168.21%
136.65%
125.11%
169.93%
220.09%
121 16%
TABLE O: 15% of Potential FSU and non-Annex B Supply
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
464 53
49 05
200 29
127.87
123 44
965 19
35 03
295 61
1295 83
23 54
177 56
39.78
1930
1 39
-
3404
'Hot air' (Mton)
\
\
\
\
0 00
16 58
0.00
1658
\
\
\
\
Marginal Costs ($/ton)
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
$126.38
Cost of Abatement ($billion)
2100
2 79
9.44
5.12
5 32
43 68
0 54
6.04
5026
0 56
360
075
0.46
0.04
0.63
Permits exp(-)/imp(+) (Mton)
107 05
95 14
106 92
43 51
-5 40
347 22
51 60
295 61
0 00
-23 54
-177 56
39 78
-19.30
-1 39
3404
1.0 % of commitment (import)
1873%
65 98%
3480%
25 39%
458%
26.46%
1
1
1
1
1
1
1
I
1
Flows exp(-)/imp(+) ($billion)
1353
12.02
13.51
5.50
-0 68
43 88
-6 52
37 36
000
2 98
-2244
503
244
0 18
430
Total Cost ($billion)
34 53
1482
22.96
10.62
4.64
87 56
5 98
31 32
50.26
2 42
-18 84
427
-198
013
367
Gains from trade ($billion)
3 09
19.55
7.33
2 20
0.03
32 20
5 98
31 32
69.51
2 42
18 84
427
1 98
0 13
367
delta gain In % / no limit (table C)
-88.40%
-37.10%
-69.45%
-77.41%
-98.92%
-65.80%
41.71%
206.35%
-36.00%
256 28%
205.34%
187.36%
259.13%
347 47%
181.28%
TABLE P: 10% of Potential FSU and non-Annex B Supply
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
509.14
55.88
220.54
13871
134.70
1058.96
25 44
216.96
1301.36
17 42
13024
29 09
1429
104
2487
'Hot air (Mton)
\
\
\
\
0 00
11 05
0.00
1105
\
\
\
\
\
\
Marginal Costs ($/ton)
$149 87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
$149.87
Cost of Abatement ($billion)
27.16
3 74
12 24
6.61
6 88
56.62
021
2.76
59 59
0.27
1 64
0 33
023
0 02
0 27
Permits exp(-)/imp(+) (Mton)
62 44
88 31
86 67
32.67
-16 65
253 45
-36 49
-216.96
0 00
-17 42
-130 24
29 09
-1429
-1 04
2487
% of commitment (import)
10 92%
6125%
2821%
19 06%
-14.11%
1931%
1
1
1
1
1
1
1
1
1
Flows exp(-Vimp(+) ($billion)
9 36
1324
12 99
4.90
2 50
37 98
-5 47
-32 52
0 00
261
-19 52
4 36
214
0 16
373
Total Cost ($billion)
36 51
16 97
25.23
11.51
4 38
94 60
-5.26
-29.75
59.59
-2.34
-17 88
403
191
013
3.46
Gains from trade ($billion)
1.11
17 40
5 06
1.30
0 29
25.16
5 26
29 75
60.18
2 34
17 88
4 03
191
0 13
3.46
delta gain In % / no limit (table C)
-95.84%
-44.03%
-78.91%
-86.59%
-89.12%
-73.28%
24.58%
191.03%
-44.59%
244.45%
189.80%
170.91%
247.56%
50%
164.57%
TABLE Q: 5% of Potential FSU and non-Annex B Supply
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
563 01
6431
245 01
151 80
148 28
1172 41
13 98
120 50
1306 88
9 75
72 29
1610
801
0.60
1375
'Hot air (Mton)
\
\
1
0 00
553
0.00
5.53
\
\
\
\
\
Marginal Costs ($/ton)
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
$180.90
Cost of Abalement ($billion)
36.05
5 13
16 28
8.77
9 12
75 35
0.04
067
76.05
0 07
0 39
0 07
006
001
0.06
Permits exp(-)/imp(+) (Mton)
8 57
79 88
62 20
19 58
-30 24
140 00
-19 50
-120 50
0 00
-9 75
72 29
16 10
-801
060
1375
10 % of commitment (import)
1.50%
55.40%
20.25%
11.43%
-2561%
10.67%
-
1
I
1
1
1
1
I
1
Flows exp(-)/imp(+) ($billion)
1 55
14.45
1125
3 54
-547
2533
353
-21 80
0 00
-176
13 08
291
145
011
249
Total Cost ($billion)
37 60
1958
27 53
12 32
365
100 68
3.49
-21 13
76.05
169
-12 69
284
139
0.10
243
Gains from trade ($billion)
0 02
14 79
2 76
0 50
102
19 09
349
21.13
43.71
169
12.69
284
139
0.10
243
delta gain In % / no limit (table C)
-99.92%
-52.42%
-88.51%
894 89%
-61.67%
-79.73%
-17 29%
106.69%
-59.75%
149.29%
105.58%
90.81%
151.83%
236.29%
8588%
"
COMBINED CASES with 50% Efficient Supply
TABLE R: CDM cartel, No Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
385 25
37.38
164 36
108.60
103 43
799 03
98 20
359 92
1257 14
25 38
217.38
50 99
20 66
1 20
4431
'Hot air' (Mton)
\
1
0.00
55.27
0 00
55.27
\
\
\
\
\
Marginal Costs ($/ton)
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89.54
$89 54
Cost of Abatement ($billion)
12.48
1.54
5 58
3.05
3.17
25 83
2 04
3.45
32 22
0 26
2 09
0 47
022
0.01
0 40
Permits exp(-)/imp(+) (Mton)
186.33
106 81
142 84
62 78
14.61
513 38
-15347
-359 92
-001
25 38
217 38
-50 99
20 66
120
-4431
i.e % of commitment (import)
32 60%
7408%
46 50%
36 63%
12 38%
39 12%
1
1
1
1
1
\
1
-
Flows exp(-)/imp(+) ($billion)
16.68
9 56
12 79
562
131
45 97
-13 74
32 23
0 00
-2 27
-1946
-4 57
-185
-011
391
Total Cost ($billion)
29 17
11 10
18.37
8 67
4 48
71.79
-10 80
-28.77
32.22
2.01
-17 38
410
163
-0.09
35/
Gains from trade ($billion)
8 46
23.27
1191
4.15
0.19
47 97
10.80
28 77
87.54
2.01
17.38
410
163
0 09
3 57
delta gain In % I no limit (table C)
-68.31%
-25.15%
-50.36%
-57.39%
-92.94%
-49.06%
155.67%
181.42%
-19.40%
195.96%
181.57%
175.31%
196.64%
212.37%
173.04%
TABLE S: CDM+FSU monopoly, No Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
434 50
44.56
186 67
120 58
11587
902 17
44 75
31023
1257 15
21 38
187 44
44 37
17 38
0 98
38 68
'Hot air (Mton)
\
1
\
\
0 00
55 27
0.00
55.27
-
\
\
\
\
\
Marginal Costs ($/ton)
$111.69
$111.69
$111.69
$111.69
$111.69
$111.69
$111.69
$111.69
$111.69
$111.69
$111 69
$111.69
$111.69
$111.69
$111 69
Cost of Abatement ($billion)
17 43
2 26
7.82
4.25
4.42
36 18
0 28
2 40
38.87
0 18
145
0.33
0 15
001
0 28
Permits exp(-)/imp(+) (Mton)
137 08
99.64
120.54
5081
2 18
410.24
-100.02
-310 23
-001
-21 38
187 44
-4437
-17 38
0 98
38 68
i.e % of commitment (import)
23.98%
69.10%
39 24%
29 65%
184%
3126%
1
1
1
1
1
1
1
1
-
Flows exp(-)/imp(+) ($billion)
15.31
11 13
13.46
567
0.24
45 82
-11 17
-34.65
0.00
-2 39
-20 94
.4 96
-1 94
-011
-4 32
Total Cost ($billion)
32.74
13 39
21.29
9.92
4.67
82.00
-10 89
-32.25
38.87
-221
-19 48
4 63
-179
-0 10
-4 04
Gains from trade ($billion)
4.89
20.98
900
2.89
0 00
37.76
10.89
32 25
80.90
2.21
19 48
463
1.79
0 10
4 04
delta gain In % I no limit (table C)
-81.69%
-32.50%
-62.49%
-70.30%
-99.83%
-59.90%
157.81%
215.41%
-25.52%
225.38%
215.68%
210.98%
225.80%
234.41%
209.21%
TABLE T: No cartel or monopoly, 50% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
285.79
72 10
153.60
85 69
70.55
667.73
67.71
521.71
1257.14
38 78
314 58
72.30
31 66
1 99
62 39
'Hot air' (Mton)
\
\
0 00
55 27
0 00
55.27
\
\
Marginal Costs ($/ton)
$42.75
$42 75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42.75
$42 75
Cost of Abatement ($billion)
5 52
6 66
467
1 42
105
1931
0.97
8 75
29 03
0 70
527
117
0 58
0 04
0.99
Permits exp(-)/imp(+) (Mton)
285 79
72 10
153 60
85.69
47.50
644 68
-122 98
-521 71
001
38 78
-314 58
-72 30
31 66
-199
62.39
i.e % of commitment (import)
50.00%
50 00%
50.00%
50 00%
40.24%
49 12%
-
1
1
1
1
-
1
1
Flows exp(-)/imp(+) ($billion)
12.22
3 08
6 57
3.66
203
27.56
-5 26
-22.30
0.00
-1 66
-1345
3 09
-1 35
0 09
-267
Total Cost ($billion)
17 73
9 74
11 24
5 08
3 08
46 87
-429
-13 55
29 03
-0 95
-8 18
-192
-0 78
-0 05
-167
Gains from trade ($billion)
1989
24.63
19.05
7.73
1 59
72 89
4.29
13 55
90.73
0 95
8 18
1 92
0 78
0 05
167
delta gain In % / no limit (table C)
-25.47%
-20.76%
-20.64%
-20.55%
-40.12%
-22.59%
1.49%
32.53%
-16.46%
40.55%
32.51%
29.30%
40.96%
51.43%
28.17%
TABLE U: CDM cartel, 50% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
378 74
72 10
161 42
107 02
10179
821.06
96 68
339 41
1257.14
23 72
205 03
48 26
1930
1.11
4199
'Hot air' (Mton)
\
\
1
\
0 00
55.27
0.00
55 27
\
\
\
Marginal Costs ($/ton)
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86.80
$86 80
$86.80
$86.80
Cost of Abatement ($billion)
1191
6.66
5.32
2.91
3 03
29 82
281
2.99
35 63
0.23
181
0.41
0 19
001
0 35
Permits exp(-)/imp(+) (Mton)
192.84
72.10
145 79
64 37
16 25
491 35
-151.95
-339.41
-001
-23 72
-205.03
-48 26
-1930
-111
-41 99
% of commitment (import)
3374%
50.00%
47.46%
37 56%
13.77%
37.44%
1
1
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
16.74
6 26
12 65
5.59
141
42 65
-13 19
-29 46
0 00
-2 06
-17 80
-4 19
-168
010
364
Total Cost ($billion)
28.65
12.91
17.98
8 49
4 44
72.47
-10 38
-2647
35.63
-1.83
-15 99
-3 78
-1 49
-0 08
-3 30
Gains from trade ($billion)
8 98
21 45
1231
4 32
0.23
47 29
10.38
26 47
84.14
1.83
15.99
3 78
149
0.08
3 30
delta gain In % / no limit (table C)
-66.36%
-30.98%
-48.71%
-55.60%
-91.36%
-49.78%
145.76%
158.90%
-22.53%
169.98%
159.06%
154.16%
170 48%
181.67%
152.35%
34
TABLE V: CDM+FSU monopoly, 50% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
432 45
7210
185 74
120 08
115.35
925 72
42 39
289.04
1257 14
19 69
174.65
4154
16.00
0 89
36 27
'Hot air' (Mton)
\
\
0 00
55 27
0 00
55 27
\
1
\
\
\
Marginal Costs ($/ton)
$110.72
$110.72
$110.72
$110.72
$110.72
$110 72
$110.72
$110.72
$110.72
$110.72
$110.72
$110 72
$110.72
$110.72
$110.72
Cost of Abatement ($billion)
17.20
666
7 72
4 19
4 36
40 14
0 24
2 02
42 40
0 15
1 23
028
0 12
001
024
Permits exp(-)/imp(+) (Mton)
139 13
72.10
121 47
5131
2 69
386.69
97 66
-289 04
-001
-19 69
174 65
-41 54
-16 00
0 89
-3627
i.e % of commitment (import)
2434%
50 00%
39 54%
29.94%
2 28%
29 46%
1
1
1
1
1
1
1
Flows exp(-)/imp(+) ($billion)
15 40
7.98
13 45
5 68
0.30
4281
-1081
32 00
0 00
-2 18
-19 34
4 60
-177
010
-4 02
Total Cost ($billion)
32 61
14.64
21.17
988
4 66
82.95
-1057
29 98
42 40
-203
-18 11
4 32
165
0 09
378
Gains from trade ($billion)
5 02
19.73
9 12
2.94
0.01
36.81
10 57
29 98
77.36
2.03
18.11
432
1.65
0.09
3 /8
delta gain In % / no limit (table C)
-81.19%
-36.52%
-62.01%
-69.79%
-99.74%
-60.90%
150.34%
193.21%
-28.77%
199.23%
193.48%
190.38%
199.46%
203.43%
189.17%
TABLE W: No cartel or monopoly, 25% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
428 69
108 14
230.41
128.54
88.53
984 31
36 46
236 37
1257 14
15 57
142 82
34 44
12 64
0 68
30 22
'Hot air (Mton)
0 00
55 27
0 00
55 27
\
\
\
Marginal Costs ($/ton)
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
$12 54
$12.54
$12.54
$12.54
$12.54
$12.54
$12.54
Cost of Abatement ($billion)
16.79
17 15
13.77
5.20
2 02
54 94
0 15
125
56 34
0 09
0 76
0 18
007
0 00
0 15
Permits exp(-)/imp(+) (Mton)
142 90
36.05
76 80
42 85
29.51
328 10
9173
-236 37
-001
-15 57
-142.82
34 44
-12 64
-0 68
-30 22
1.0 % of commitment (import)
2500%
25.00%
25.00%
25.00%
2500%
2500%
1
1
1
1
1
1
1
I
1
Flows exp(-)/imp(+) ($billion)
1.79
0.45
0.96
0.54
0.37
4.11
-1 15
-2 96
0 00
-020
-1.79
-0 43
-0 16
0.01
-0 38
Total Cost ($billion)
18 58
17.61
14.74
5 74
2 39
59.05
-100
-171
56.34
-0.11
-103
-0 26
-0 09
0 00
-023
Gains from trade ($billion)
19.05
1676
15.55
7.07
2.28
60.71
1 00
171
63.42
011
1.03
0 26
0 09
0 00
023
delta gain In % / no limit (table C)
-28.64%
-46.07%
-35.21%
-27.29%
-14.27%
-35.52%
-76.41%
-83.25%
-41.61%
-84.42%
-83.28%
-82.74%
-84.47%
-85.49%
-82.53%
TABLE X: CDM cartel, 25% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
428.69
108.14
230.41
128.54
114 40
1010.17
108.37
138 60
1257.14
8.34
83.51
20 98
6 74
0 33
18 69
'Hot air (Mton)
\
\
0 00
55 27
0 00
55 27
\
Marginal Costs ($/ton)
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
$108.95
Cost of Abatement ($billion)
16 79
17.15
1377
5 20
4 26
57 18
3.95
0 36
61.49
0 02
0.22
0 05
0 02
0 00
0 05
Permits exp(-)/imp(+) (Mton)
142.90
36 05
76.80
42.85
364
302.23
-163.64
-138 60
0 00
-8 34
-8351
-20 98
-6 74
033
1869
% of commitment (import)
25.00%
2500%
2500%
2500%
3.09%
23.03%
-
1
1
1
1
1
-
1
1
Flows exp(-)/imp(+) ($billion)
15.57
3 93
8 37
467
0 40
32 93
-17.83
-15 10
0 00
-091
9 10
-2 29
-073
-004
2 04
Total Cost ($billion)
32.36
21.08
22 14
9.87
4 66
90.11
-13.88
-1474
61 49
-0 89
-8 88
-223
-0 72
-0.04
-1 99
Gains from trade ($billion)
5 27
1329
8.14
2.94
0.01
29.66
13 88
1474
58.27
0 89
8.88
2 23
0 72
0 04
1 99
delta gain In % / no limit (table C)
-80.26%
-57.25%
-66.07%
-69.74%
-99.53%
-68.50%
228.58%
44.14%
-46.35%
30.50%
43.85%
50.10%
29.93%
18.13%
52.39%
TABLE Y: CDM+FSU monopoly, 25% Import Limitation
USA
JPN
EEC
OOE
EET
oecd+eet
FSU
NAB
World
EEX
CHN
IND
DAE
BRA
ROW
Reductions / ref 2010 (Mton)
447.47
108.14
230.41
128.54
119 14
1033.70
31.36
192.08
1257 14
12 22
115.99
28 40
9 90
051
25 06
'Hot air" (Mton)
\
\
0 00
55.27
0.00
55.27
\
\
Marginal Costs ($/ton)
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
$117.93
Cost of Abatement ($billion)
18.92
17.15
13.77
5.20
4.80
59 85
0.10
077
60.72
0.05
0 47
0 11
0 04
0 00
0 09
Permits exp(-)/imp(+) (Mton)
124.11
36 05
76.80
42.85
-1 10
278.70
-86 63
-192 08
-001
-12 22
-115.99
-28.40
-9 90
-051
-25 06
i.e % of commitment (import)
21.71%
2500%
25.00%
25.00%
1
21.24%
1
1
1
1
1
1
I
Flows exp(-)/imp(+) ($billion)
14 64
4 25
9.06
5.05
-0 13
32 87
-1022
-22.65
0 00
-144
-13.68
3 35
-1 17
-0 06
2 96
Total Cost ($billion)
33.55
21 41
2283
10.26
4.67
92.71
-10 12
-21.88
60.71
-1 39
-1321
-324
-112
-0 06
286
Gains from trade ($billion)
4.07
12 96
7.46
2.56
0 00
27 05
10 12
21 88
59.05
1 39
1321
3 24
1 12
0 06
2 86
delta gain In % / no limit (table C)
-84.75%
-58.29%
-68.94%
-73.70%
-99.95%
-71.27%
139.58%
114.03%
-45.63%
104.56%
114.08%
117.82%
104.10%
93.50%
119.08%
35
Fig. 1: Annex B meeting their Kyoto commitment, no trading
700
JPN
OOE
Abatement Cost
Total Cost:
Abatement Cost
$34 billion
$120 billion
600
$13 billion
Shadow Price of Carbon ($/ton)
500
EET
Abatement Cost
EEC
-
$5 billion
Abatement Cost
USA
400
$30 billion
JPN
EEC
300
OOE
USA
-
EET
Abatement Cost
200
$38 billion
Kyoto
100
0
0
100
200
300
400
500
600
700
Carbon Emissions Reductions (Mton)
Fig. 2: Annex B meeting their Kyoto commitment, no trading / trading
700
Total Savings for Kyoto
JPN
00E
EET
constrained regions:
Savings:
Savings:
Savings:
$32 billion
600
$19 billion
$2 billion
$0 billion
-
USA
Shadow Price of Carbon ($/ton)
500
EEC
JPN
Savings:
EEC
$7 billion
400
OOE
-
EET
USA
Kyoto
300
Savings:
Trading
$3 billion
200
$127.01
100
0
0
100
200
300
400
500
600
700
Carbon Emissions Reductions (Mton)
Fig. 4: Aggregated Supply and Demand Curves - Kyoto - 2010
Annex B Trading / World Trading
Kyoto Cap
$200
Demand
Supply Annex B
I
$180
trading
638
8
$160
8
28
$140
E
8
Allowance price
$120
8
$100
*
8
$80
8
8
$60
a
$40
Supply World
Trading
#
$20
8
*
$-
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
Figure 5: World Supply and Demand - Kyoto - 2010
Limitations on demand: 75%, 50%, 25%
Kyoto Cap
$140
I
$120
Demand
XXI
200
XX
$100
=
Supply Annex I
XXR
Allowance price
$80
Trading
8
8
$60
XXR
-
$40
Supply World
-
Trading
288
-
$20
-
-
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
Figure 6: CDM surcharges: 25%, 50%, 100%
Kyoto Cap
$50
Demand to
à
Supply from Non
$45
Non-Annex B
1300
Annex B through CDM
*
$40
*
*
$35
*
*
Allowance price
$30
&
$25
8
%
$20
*
*
$15
8
*
$10
R
$5
&
*
$0
0
200
400
600
800
1,000
1,200
Quantity (Mton)
Demand 506 RX Kyoto cap
Supply World Trading
25%
50%
100%
Fig. 7: World Permit Supply and Demand - Kyoto - 2010
Limitation on Supply: Supply = 50% - 25% - 15% - 10% - 5% Total
Kyoto Cap
$200
5%
10%
15%
-
$180
Supply = 25%
-
of Total
$160
$140
Supply = 50%
&
of Total
Allowance Price
$120
$100
Demand
XRR
$80
-
$60
Supply
$40
-
-
$20
**
$0
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
fig8
Fig. 8: Gains from More Efficient Global Trading
120
100
Importers
Exporters
80
Billion 85$US
60
40
20
0
5%
10%
15%
25%
50%
100%
% of Full Potential
WBpaper3.xls
Fig. A3: EPPA-generated Marginal Abatement Curves - 2010
OECD Regions, Proportional Reductions, No Trading
$800
JPN
$700
$600
Shadow price of carbon ($/ton)
EEC
$500
$400
OOE
$300
$200
USA
$100
**
$0
0%
5%
10%
15%
20%
25%
30%
35%
40%
Carbon emissions reduction
Fig. A4: EPPA-generated Marginal Abatement Curves - 2010
All Regions, Proportional Reductions, No Trading
$350
JPN
EEC
BRA
EEX
USA
$300
OOE
$250
Shadow price of carbon ($/ton)
$200
EET
FSU
DAE
$150
ROW
$100
IND
$50
CHN
$0
0%
5%
10%
15%
20%
25%
30%
35%
40%
Carbon emissions reduction
Fig. A5: EPPA-generated Marginal Abatement Curves - 2010
Non-Annex B regions, Proportional Reductions, No Trading
$100
BRA DAE
EEX ROW
USA
$90
IND
$80
$70
Shadow price of carbon ($/ton)
$60
$50
CHN
$40
$30
$20
$10
$0
0
100
200
300
400
500
600
700
Carbon emissions reduction (Mton)
Fig. A6: EPPA-generated Marginal Abatement Curves - 2010
OECD Proportional Reductions - No Trading / OECD Trading
$500
#
JPN
EEC
$450
$400
$350
Shadow price of carbon ($/ton)
USA - No trading
JPN - No trading
$300
OOE
EEC - No trading
$250
00E - No trading
- USA - Trading
$200
JPN - Trading
EEC - Trading
$150
00E - Trading
$100
USA
$50
$0
0
100
200
300
400
500
Carbon emissions reduction (Mton)
Fig. A7: Marginal Abatement Curves - 2010
OECD Regions - Polynomial Approximations
$500
OOE
EEC
$450
JPN
y = Q.0085x² - 0.0986x
y If 0.0024x² + 0.1503x
$400
R² = 0.9981
R² = 0.9951
y = 0.0155x² + 1.816x
R² = 0.9938
Shadow price of carbon ($/ton)
$350
$300
$250
$200
USA
$150
y = 0.0005x² + 0.0398x
R² = 0.9923
$100
$50
$0
0
100
200
300
400
500
Carbon emissions reduction (Mton)
Fig. A8: Aggregated Supply and Demand Curves - Kyoto - 2010
Annex B Trading / World Trading
Kyoto Cap
$200
Demand
Supply Annex B
#
$180
trading
-
I
$160
$140
I
$
Allowance price
$120
-
8
$100
1
8
$80
#
I
$60
202
$40
Supply World
Trading
$
$20
*
8
$-
0
200
400
600
800
1,000
1,200
1,400
Quantity (Mton)
APICRATP.MA
Page 1
Curbing Carbon Emisions and the Kyoto Protocol:
Perspective from the Administration
Jeffrey A. Frankel
Member, Council of Economic Advisers
The White House
Washington Policy Seminar
Macroeconomic Advisers, LLC
Georgetown Conference Center, Thursday, Sept. 10, 1998
I will make some general comments about the Administration position on the Kyoto
Agreement, before responding to the two panelists who have gone before me.
The key bottom line of the economic analysis that we released in July was as follows, in
qualitative terms: Given key elements of the Agreement and of Administration policy (including
tradeable permits and other flexibility features), the U.S. economic impacts are likely to be
modest.
Those key features are of several sorts. The Administration insisted that the design of the
agreement be market-based, flexible, and global. The flexibility comes in three categories:
"When" flexibility
1st-period reductions less drastic than some countries wanted
targets phrased as multi-year averages
banking
"What" flexibility
6 gases included, not just carbon dioxide
sinks
"Where" flexibility
international trading in emission permits
CDM
Finally, we require a global solution, to address a global problem.
Without meaningful LDC participation, the President will not
submit the Treaty for Senate ratification
Economic analysis of climate change policy is difficult for many reasons, which again fall
into three categories.
It is impossible to put a single monetary number on the benefits of averting Global Climate
Change. Putting numbers on the economic costs of a 2-to-6 degree F increase in
temperature or a 6-inch to 3-foot rise in sea level, which is what the IPCC scientists are
forecasting for the next 100 years, is difficult enough. But that difficulty pales next to the
uncertainties surrounding the appropriate discount rate, danger of catastrophic climate
events, and appropriate risk aversion.
Some terms of the international agreement are still uncertain.
APICRATP.MA
Page 2
Later
sopacific
Northwest,
Laboratories
Econometric models are subject to inevitable limitations. Some are good at some things,
other at others. No one model does it all.
Despite these difficulties, we used some estimates based on Battelle Labs' SGM, which is
well-designed to handle international trading. The most important quantitative findings,
supporting the qualitative finding that I led with, were as follows.
Full and successful implementation of Annex I trading would reduce costs by one-half,
relative to a situation where each country had to satisfy its commitment domestically.
Full and successful implementation of global trading (including developing countries)
would reduce costs by 80-87%.
Global trading would reduce resource costs by an estimated $7-$12 b/yr in 2010, which is
0.1% GDP in 2010. This is a cost that I would describe as, if anything, less than modest.
The effect on the price of carbon is estimated at $14-$23/ton.
Д price of natural gas = 3-5%
Д price of fuel oil
= 5-9%
Д price of gasoline
= 4-6¢ / gal.
A price of electricity = 3-4%
In one respect, these estimates are optimistic: we cannot be sure of getting full
developing-country participation in the near future. But in other respects they are conservative.
They omit some factors that would reduce the net costs of the agreement:
The Administration proposal for Federal electricity restructuring, which we consider part
of our energy-and-environment policy, would save approximately $20 billion in costs
emission reductions substantially. THANK celog. sins. The Kyoto Prof. explicity
Allowance for sinks, such as land forestation, would potentially reduce the need for
recognizes sinks
The President's proposal to allocate $6.3 billion over the next five years in Research and
Development and tax breaks to develop and disseminate carbon-saving technologies could
further reduce costs if it were enacted and if some of the technological payoff were to
come in the next ten years. To be conservative, we assumed that it did not.
Ancillary non-climate benefits, such as the health benefits of reduced air pollution could
reduce net costs by an estimated one-quarter.
Of course, the most important factor that has been left out of the above assessment is the
benefit of mitigating climate change itself. (A full cost-benefit analysis would include
mitigation in the benefits column. The only reason we have not done so, explained
repeatedly above, is the difficulty in coming up with a number to capture the monetary
APICRATP.MA
Page 3
benefits.) But nobody should lose sight of our ultimate objective -- keeping our planet the
hospitable home that we enjoy today.
General comments on the other two panelists
We, as economic modelers, all have one important goal in common (among others). That
is to avoid giving non-economists grounds to confirm their prejudices that models are of little use
-- that they all say different things, depending on the inclinations of the modeler. It is true that if
you listen to one-sentence summaries of the conclusions of different studies, the predicted effects
of the Kyoto Protocol will appear to vary over a wide range. But for the most part the numbers
pertain to different experiments. The questions vary, and so the answers vary -- as they should.
It is important to be clear and explicit about the question that is being asked. We at the CEA
have tried to do this in our public reports (the congressional testimony that Janet Yellen presented
last last spring and the recent Administration Economic Analysis). Fortunately I think that the
two papers that have been presented are also very clear and explicit.
Unfortunately, the experiments to which which the central Jones and Montgomery
conclusions pertain are not the experiments that correspond to real aspects of the Kyoto Protocol
and essential elements of the President's Climate Change policy:
1) Their main conclusions do not allow for Annex I trading;
2) They do not allow for LDC participation (no CDM or "growth targets"); and
3) They do not include the role of other gases and sinks.
When these studies are interpreted so as to take into account these factors, they reinforce and
underscore our own analysis and negotiating position that flexible mechanisms are essential to
responding to climate change. I am particularly pleased that David Montgomery has
approximately replicated the results of the Administration Economic Analysis when allowing for
full trading of emission rights. These results in part underly our judgment that the economic
costs of complying with the Kyoto Agreement are likely to be modest.
Russell Jones Analysis
Jones and Dougher use the "Kaya Identity" (emissions = carbon intensity of energy *
energy intensity of output * per capita output * population) to look at historical changes in the
factors contributing to our emissions to show that the changes necessary to meet Kyoto
commitments are "unprecedented". This approach offers a useful perspective. Attaining
Kyoto-sized reductions in domestic emissions will not be completely effortless for the United
States, or for other industrialized countries. Anyone who thinks otherwise -- e.g., that
"technology will save us," even without price signals or any other government actions -- ought to
think seriously about the Kaya identity.
But it does not follow that complying with Kyoto is impossible or even that it will impose
large economic costs on us. There are two very crucial steps separating the analysis in this paper
from a negative verdict on Kyoto.
APICRATP.MA
Page 4
The analysis assumes commitment is met entirely at home. The Kyoto Protocol
includes various flexibility mechanisms that enable us to reduce emissions elsewhere at
lower cost. Our estimate is that international trading can reduce the costs by as much as
80-87 percent. After taking into account trading, the required domestic reductions are
within the range of historical efforts as viewed in the Kaya framework.
The United States has never tried to reduce carbon intensity of energy. Looking at
historical changes in the carbon intensity of energy is misleading. The oil shocks of the
1970s raised the prices of oil (moderately high carbon content) and natural gas (low
carbon content), far more than it raised the price of coal (highest carbon content). While
we have tried to improve our economy's energy intensity in the past, we have never tried
to improve our carbon intensity of energy. Therefore, looking at our historical experience
in this field will not be indicative of what we may expect in the future.
Charles River Associates (Montgomery) Analysis
The model used by Charles River Associates' (CRA) is capable of analyzing the effects
of changes in the price of carbon that go outside our historical experience. Their capsule
assessment of the Administration's economic analysis of Kyoto says that the costs would be
higher than the Administration's estimates. Again, this verdict leaves out central elements of the
Kyoto Protocol and of the Administration's policy.
"Realistic" Trading Assumptions. CRA argues that without trading, the costs of
complying with our Kyoto target would be higher. We have no disagreement here. This
is precisely why the Administration advocated and won international trading and other
flexibility mechanisms in the Kyoto Protocol and is insisting on meaningful participation by
developing countries. Assessments purportedly of the Kyoto Protocol that exclude
trading, or assume trading constraints, are neither analyses of the Protocol nor of the
Administration's position on implementing the Protocol. As I already mentioned, we are
pleased to see that the CRA model, given the relevant assumptions, does generally
replicate the low price effects estimated with Pacific Northwest Laboratories SGM Model
and in the Administration's economic analysis. 1
"Rapid" replacement of coal plants with natural gas plants. CRA claims that the
Administration assumes extremely rapid replacement of coal-fired plants with natural gas
plants by 2008. I don't believe this is right. The Administration's estimates of natural gas
consumption and coal consumption, relative to what they would be without any efforts to
reduce greenhouse gas emissions, rebut this claim. With permit prices of $14 to $23/ton,
natural gas consumption is roughly equal to what it is projected to be otherwise, while
coal consumption, though somewhat lower than it would otherwise be, is still higher than
present consumption. Thus there is no rapid reduction of coal-fired capacity.
APICRATP.MA
Page 5
Measurement of Economic Costs. CRA claims that the Administration's assessment of
economic costs underestimates the true costs to the whole economy (by a factor of 2-4).
First, it should be noted that this claim only concerns the definition and
calculation of total resource costs given a specific permit price -- the argument
does not address the estimated effects on prices. Prices seem to be the area of
greatest interest to many in Congress, business, and the political process more
broadly, as opposed to theoretical economists. [On price there is much less
disagreement, once the experiment is specified carefully.]
Second, I have checked the references given, and can't find there anything like
this proposition regarding indirect costs.
Third, CRA does not provide any specific demonstration or intuition as to what
the indirect costs are, or why the total (direct and indirect costs) would be several
times higher than what is evident in the measurement of direct costs. I am aware
of several arguments, incorporated in some models, as to why the indirect effects
might operate to reduce total resource costs, but not to add to them.
The first is that, if tradeable permits were auctioned off to generate
revenue, which was then recycled as pro-investment reductions in
distortionary taxes, then the real resouce cost would be reduced. We have
never included this effect; the Administration has not yet decided whether
even to distribute permits by auction.
But the second argument is potentially more relevant: raising the price of
energy has auxiliary benefits, such as reducing SO2 pollution and thus
reducing health costs. (Our estimates are that these benefits offset roughly
1/4 of the economic costs of meeting the Kyoto targets.)
Third, because the US is large in the world, we have some monopsony
power. Policies to reduce the domestic demand for oil will thus work to
reduce the price on world oil markets, improving our national terms of
trade.
We have not included this effect either. But these are the indirect effects I
can think of. I would like to hear from David Montgomery what are the indirect effects in his
model that go the other way.
In the absence of more information, I can only think of two possibilities.
The first possibility is that he is looking at indirect effects on industries
that are more energy-intensive than the average, neglecting the indirect
effects on industries that are less energy-intensive than the average.
APICRATP.MA
Page 6
The second possibility is that he is generalizing from historical studies of
command-and-control policies, which do indeed tend to have costs that go
beyond the increase in price of the commodity directly effected. This
would be inappropriate, however, because the Administration's oft-stated
plan is to implement its reductions through efficient market-oriented
policies, not inefficient command-and-control policies. I offer these two
possible hypotheses only as questions.
Technology Assumption. Finally, I would like to highlight that in the Administration
Economic Analysis we did not give in to the temptation of assuming that technology
would bail us out, without help from price signals or other government policies.2 Rather,
we adopted the default assumption about energy efficiency improvement used by the
modelers who developed the Second Generation Model (AEEI =.96% a year).3
SR/OIAF/98-03
Distribution Category UC-950
Impacts of the Kyoto Protocol
on U.S. Energy Markets
and Economic Activity
- DRAFT REPORT-
September 8, 1998
NOT FOR QUOTATION OR CITATION
Energy Information Administration
Office of Integrated Analysis and Forecasting
U.S. Department of Energy
Washington, DC 20585
This report was prepared by the Energy Information Administration, the independent statistical and
analytical agency within the Department of Energy. The information contained herein should be
attributed to the Energy Information Administration and should not be construed as advocating or
reflecting any policy position of the Department of Energy or of any other organization.
Contacts
This report was prepared by the staff of the Office
[email protected]), Director of the Demand and
of Integrated Analysis and Forecasting of the Energy
Integration Division; James M. Kendell (202/586-9646,
Information Administration. General questions con-
[email protected]), Director of the Oil and Gas Divi-
cerning the report can be directed to Mary J. Hutzler
sion; Scott B. Sitzer (202/586-2308, [email protected]),
(202/586-2222, [email protected]), Director of the
Director of the Coal and Electric Power Division; and
Office of Integrated Analysis and Forecasting; Arthur
Andy S. Kydes (202/586-2222, [email protected]),
T. Andersen (202/586-1441, [email protected]),
Senior Modeling Analyst. Specific questions about the
Director of the International, Economic, and Green-
report can be directed to the following analysts:
house Gas Division; Susan H. Holte (202/586-4838,
Executive Summary, Chapter 1
Susan H. Holte
202/586-4838
[email protected]
Chapter 2
Daniel H. Skelly
202/586-1722
[email protected]
Chapter 3 Residential
John H. Cymbalsky
202/586-4815
[email protected]
Commercial
Erin E. Boedecker
202/586-4791
[email protected]
Industrial
T. Crawford Honeycutt
202/586-1420
[email protected]
Transportation
David M. Chien
202/586-3994
[email protected]
Chapter 4
Electricity
J. Alan Beamon
202/586-2025
[email protected]
Renewables
Thomas W. Petersik
202/586-6582
[email protected]
Chapter 5
Natural Gas and Oil
James M. Kendell
202/586-9646
[email protected]
Coal
Edward J. Flynn
202/586-5748
[email protected]
Chapter 6
Ronald F. Earley
202/586-1398
[email protected]
Chapter 7
Andy S. Kydes
202/586-2222
[email protected].
ii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Preface
From December 1 through 11, 1997, more than 160
generation sector, and the fossil fuel supply markets,
nations met in Kyoto, Japan, to negotiate binding limita-
respectively. Chapter 6 provides the results of EIA's
tions on greenhouse gases for the developed nations,
analysis of the macroeconomic impacts of carbon reduc-
pursuant to the objectives of the Framework Convention
tion under different monetary and fiscal policy assump-
on Climate Change signed on May 4, 1992. The outcome
tions. Chapter 7 compares the results of this study with
of the meeting was the Kyoto Protocol, in which the
those from other studies of the costs of carbon reduction,
developed nations agreed to limit their greenhouse gas
with accompanying tables in Appendix C. Appendix B
emissions, relative to the levels emitted in 1990. The
includes the detailed energy market results from the
United States agreed to reduce emissions from 1990
carbon reduction cases.
levels by 7 percent during the period 2008 to 2012.
Within its Independent Expert Review Program, EIA
The analysis in this report was undertaken at the request
arranged for leading experts in the fields of energy and
of the Committee on Science of the U.S. House of Repre-
economic analysis to review earlier versions of this
sentatives. In its request, the Committee asked the
analysis and provide comment. The assistance of the fol-
Energy Information Administration (EIA) to analyze the
lowing reviewers in preparing the report is gratefully
Kyoto Protocol, "focusing on U.S. energy use and prices
acknowledged:
and the economy in the 2008-2012 time frame," as noted
in the first letter in Appendix D. The Committee speci-
Joseph Boyer
fied that EIA consider several cases for energy-related
Yale University
carbon reductions in its analysis, with sensitivities
Lorna Greening
evaluating some key uncertainties: U.S. economic
Consultant to Hagler Bailly Services, Inc.
growth, the cost and performance of energy-using tech-
nologies, and the possible construction of new nuclear
William Hogan
power plants.
Harvard University
William Nordhaus
The energy projections and analysis in this report were
conducted using the National Energy Modeling System
Yale University
(NEMS), an energy-economy model of U.S. energy
Dallas Burtraw
markets designed, developed, and maintained by EIA.
Resources for the Future
NEMS is used each year to provide the projections in the
Richard Newell
Annual Energy Outlook (AEO). In its second letter, in
Resources for the Future
Appendix D, the Committee requested that the analysis
use the same general methodologies and assumptions
William Pizer
underlying the Annual Energy Outlook 1998 (AEO98),
Resources for the Future
published in December 1997; however, some minor
Michael Toman
modifications were made to allow greater flexibility in
Resources for the Future
NEMS in response to higher energy prices and to
incorporate some methodologies that were formerly
John Weyant
represented offline. These differences are outlined in
Stanford University Energy Modeling Forum.
Appendix A. The macroeconomic analysis used the Data
The legislation that established EIA in 1977 vested the
Resources, Inc. (DRI) Macroeconomic Model of the U.S.
organization with an element of statutory independ-
Economy, which is also used for the economic analysis
in the AEO.
ence. EIA does not take positions on policy questions. It
is the responsibility of EIA to provide timely, high-
Chapter 1 of this report provides background discussion
quality information and to perform objective, credible
of the Kyoto Protocol and the framework and methodol-
analyses in support of the deliberations of both public
ogy of the analysis. Chapter 2 summarizes the energy
and private decisionmakers. This report does not pur-
market results from the various carbon reduction cases.
port to represent the official position of the U.S. Depart-
Chapters 3, 4, and 5 analyze in more detail the issues and
ment of Energy or the Administration.
results for the end-use demand sectors, the electricity
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
iii
Other EIA reports on the topic of greenhouse gases
Emissions of Greenhouse Gases in the United States 1996,
include the following annual reports:
published in October 1997, with an inventory of all
Annual Energy Outlook 1998, published in December
domestic greenhouse gas emissions
1997, with projections of domestic energy carbon
Mitigating Greenhouse Gas Emissions: Voluntary
emissions through 2020
Reporting, published in October 1997, reporting vol-
International Energy Outlook 1998, published in April
untary actions in 1995 to reduce greenhouse gases in
the United States
1998, with projections of international energy carbon
emissions through 2020
Greenhouse Gases, Global Climate Change, and Energy,
an information brochure on greenhouse gases.
iv
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Contents
Executive Summary
xi
1. Scope and Methodology of the Study
1
Background
1
Methodology of the Analysis
5
Use of Models for Analysis
16
2. Summary of Energy Market Results
19
Carbon Reduction Cases
19
Sensitivity Cases
29
3. End-Use Energy Demand
33
Background
33
Residential Demand
34
Commercial Demand
42
Industrial Demand
50
Transportation Demand
59
4. Electricity Supply
71
Introduction
71
Trends in Fuel Use and Generating Capacity
73
Electricity Prices
88
Sensitivity Cases
91
5. Fossil Fuel Supply
95
Natural Gas Industry
95
Oil Industry
103
Coal
110
6. Assessment of Economic Impacts
119
Objectives of the Macroeconomic Analysis
119
The U.S. Permit System and International Trading of Permits.
120
Summary of Macroeconomic Impacts
120
Estimating The Unavoidable Impact on the Economy
123
Energy Prices and the Role of Monetary and Fiscal Policy
124
7. Comparing Cost Estimates for the Kyoto Protocol
137
Introduction
137
Summary of Comparisons
137
The "Five-Lab Study"
146
Appendixes
A. Modifications to the Reference Case
153
B. Results for the Carbon Reduction Cases
159
C. Summary Comparions of Analyses.
213
D. Letters from the Committee on Science
223
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
V
Tables
ES1. Selected Variables in the Carbon Reduction Cases, 1996 and 2010
XV
ES2. Selected Variables in the Carbon Reduction Cases, 1996 and 2020
xvi
ES3. Energy Market Assumptions for the Macroeconomic Analysis of Three Carbon Reduction Cases,
Average Annual Values, 2008 through 2012
xxi
ES4. Macroeconomic Impacts in Three Carbon Reduction Cases, Average Annual Values, 2008-2012
xxii
ES5. Projected Impacts on Gross Domestic Product, 2005 and 2010
xxiii
ES6. Projected Impacts on Gross Domestic Product, 2005 and 2020
xxiii
ES7. Projected Losses in Potential and Actual GDP per Capita, Average Annual Values, 2008-2012
XXV
1. Carbon Emissions Factors for Major Energy Fuels and Calculated 1996 Delivered Energy Prices
With a Carbon Price of $100 per Metric Ton
12
2. Summary Comparison: Reference, 1990+24%, 1990+9%, and 1990-3% Cases, 2010 and 2020
21
3. Primary and End-Use Energy Consumption by Sector, 1996
33
4. Change in Projected Average Efficiencies of Newly Purchased Residential Equipment
in Carbon Reduction Cases Relative to the Reference Case, 2010.
38
5. Cost and Efficiency Indexes of Best Available Technologies for Selected Residential Appliances, 2015
40
6. Change in Projected Penetration Rates for Selected Technologies in the Commercial Sector
Relative to the Reference Case, 2010
46
7. Projected Carbon Prices and Average Fuel Prices for the Commercial Sector in Technology Sensitivity
Cases, 2010
49
8. Projected Highest Available and Average Efficiencies for Newly Purchased Equipment
in the Commercial Sector, 2015
49
9. Projected Energy Intensities for Industrial Process Steps and End Uses
55
10. Projected Average Transportation Energy Intensities by Mode of Travel, 2010
60
11. Projected Penetration of Selected Technologies for Domestic Compact Cars, 2010.
63
12. Projected Penetration for Selected Advanced Technologies for Aircraft, 2010
65
13. Projected Penetration of Selected Technologies for Freight Trucks, 2010
66
14. Projected Fuel Consumption Shares in the Transportation Sector by Fuel and Travel Mode, 2010
67
15. Projected Alternative-Fuel Vehicle Shares of New Light-Duty Vehicle Sales by Type
in the High Technology Cases, 2010.
70
16. Cost and Performance Characteristics of New Fossil, Renewable, and Nuclear Generating Technologies
73
17. Carbon Emissions From Fossil Fuel Generating Technologies
75
18. Hypothetical Examples of Levelized Plant Costs at Various Carbon Prices
76
19. Projected U.S. Electricity Generation From Renewable Fuels
80
20. Projected U.S. Electricity Generation Capacity From Renewable Fuels
81
21. U.S. Biomass Resources
85
22. Components of Differential Petroleum Product Prices Relative to the Reference Case, 2010.
108
23. Projected Number of Coal Mining Jobs by Region, 2010
114
24. Coal Industry Wages and Employment
115
25. Energy Market Assumptions for the Macroeconomic Analysis of Three Carbon Reduction Cases,
Average Annual Values, 2008 through 2012
121
26. Macroeconomic Impacts in Three Carbon Reduction Cases, Average Annual Values, 2008-2012
122
27. Projected Losses in Potential and Actual GDP per Capita, Average Annual Values, 2008-2012
123
28. Average Projected Annual Losses in Economic Output, 2008-2012
124
29. Projected Economic Impacts of Carbon Reduction Cases Assuming Personal Income Tax Rebate
131
30. Comparison of Results for Reducing Carbon Emissions to 7 PercentBelow 1990 Levels Without Trading,
Sinks, Offsets, or Clean Development Mechanism
139
31. Comparison of Results for Reducing Carbon Emissions to 7 Percent Below 1990 Levels
With Annex I Trading, Sinks, and Offsets
140
32. Comparison of Energy Consumption, Gross Domestic Product, and Energy Intensity Results
for EIA and Five-Lab Study Analyses
147
33. Comparison of Carbon Emissions Results for EIA and Five-Lab Study Analyses
147
vi
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Figures
ES1. Projections of Carbon Emissions, 1990-2020
xiii
ES2. Projections of Carbon Prices, 1996-2020
xvii
ES3. Average Projected Carbon Prices and Annual Carbon Emission Reductions, 2008-2010
xvii
ES4. Projections of U.S. Electricity Generation, 1990-2020
xvii
ES5. Projected Reductions in Carbon Emissions From the Electricity Supply Sector, 1990-3% Case, 1996-2020
xvii
ES6. Projected Reductions in Carbon Emissions by End-Use Sector Relative to the Reference Case, 2010
xviii
ES7. Projected Changes in Average Delivered Prices for Energy Fuels in the 1990+9% Case
Relative to the Reference Case, 1996-2020
xviii
ES8. Projections of Fuel Shares of Total U.S. Energy Consumption, 2010
xix
ES9. Projections of U.S. Coal Consumption, 1970-2020
xix
ES10. Projections of U.S. Petroleum Consumption, 1970-2020
xix
ES11. Projections of U.S. Natural Gas Consumption, 1970-2020
xx
ES12. Projections of U.S. Nuclear Energy Consumption, 1970-2020
XX
ES13. Projections of U.S. Renewable Energy Consumption, 1990-2020
xx
ES14. Projected Changes in Consumer Price Index Relative to the Reference Case, 1998-2020
xxii
ES15. Total Projected Costs of Carbon Reductions to the U.S. Economy, 2008-2012
xxiii
ES16. Projected Dollar Losses in Potential GDP Relative to the Reference Case, 1998-2020.
xxiv
ES17. Projected Changes in Potential and Actual GDP in the 1990+9% Case Relative to the Reference Case
Under Different Fiscal Policies, 1998-2020.
xxiv
ES18. Projected Annual Growth Rates in Potential and Actual GDP, 2005-2010
XXV
ES19. Projected Annual Growth Rates in Potential and Actual GDP, 2005-2020
XXV
ES20. Projected Carbon Prices in the 1990+9% High and Low Economic Growth and
High and Low Technology Sensitivity Cases, 2010
xxvi
1. Projections of Carbon Emissions, 1990-2020
19
2. Projections of Carbon Prices, 1996-2020
20
3. Average Annual Carbon Emission Reductions and Projected Carbon Prices, 2008-2012
22
4. Average Delivered Prices for Energy Fuels in the 1990+24% Case, 1996-2020
23
6. Average Delivered Prices for Energy Fuels in the 1990-3% Case, 1996-2020
23
5. Average Delivered Prices for Energy Fuels in the 1990+9% Case, 1996-2020
23
7. Projected Changes in Average Delivered Prices for Energy Fuels in the 1990+9% Case
Relative to the Reference Case, 1996-2020
23
8. Projections of Fuel Shares of Total U.S. Energy Consumption, 2010
24
9. Projections of U.S. Coal Consumption, 1970-2020
24
10. Projections of U.S. Natural Gas Consumption, 1970-2020
24
11. Projections of U.S. Petroleum Consumption, 1970-2020
25
12. Projections of U.S. Nuclear Energy Consumption, 1970-2020
25
13. Projections of U.S. Renewable Energy Consumption, 1990-2020
25
14. Projections of U.S. Electricity Generation, 1990-2020
26
15. Projections of U.S. Carbon Emissions per Unit of Primary Energy Consumption, 1990-2020
26
16. Projected Reductions in Carbon Emissions by End-Use Sector Relative to the Reference Case, 2010
27
17. Projections of U.S. Industrial Energy Intensity, 1996-2020
27
18. Projections of U.S. Light-Duty Vehicle Travel, 1996-2020
27
19. Projections of Average Fuel Efficiency for the Light-Duty Vehicle Fleet, 1996-2020
28
20. Projections of U.S. Motor Gasoline Consumption, 1996-2020
28
21. Projected Fuel Use for Electricity Generation by Fuel in the 1990+24% Case, 1996-2020
29
22. Projected Fuel Use for Electricity Generation by Fuel in the 1990+9% Case, 1996-2020
29
23. Projected Fuel Use for Electricity Generation by Fuel in the 1990-3% Case, 1996-2020
29
24. Projected Carbon Prices in the 1990+9% High and Low Economic Growth and
High and Low Technology Sensitivity Cases, 2010
30
25. Projections of Primary Energy Consumption, 1990-2020
33
26. Index of Residential Sector Delivered Energy Consumption, 1970-2020
35
27. Index of Residential Sector Delivered Energy Intensity, 1970-2020
36
28. Residential Sector Carbon Emissions, 1990, 1996, and 2010
36
29. Delivered Energy Consumption in the Residential Sector by Major Fuel, 1970, 1980, 1996, and 2010
37
30. Residential Sector Energy Use per Household, 1996
37
31. Average Projected Annual Growth in Residential Sector Energy Consumption by End Use, 1996-2010
37
32. Index of Residential Sector Energy Prices, 1970, 1980, 1996,and 2010
38
33. Projected Stocks of Ground-Source Heat Pumps, 1995-2020
40
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
vii
34. Average Residential Sector Energy Prices, 1995-2020
40
35. Projected Energy Expenditures in the Residential Sector, 1995-2020
41
36. Changes From Reference Case Projections of Energy Intensity for Residential Water Heating
in Three Sensitivity Cases, 1995-2020.
42
37. 1995-2020 Changes From Reference Case Projections of Residential Energy Consumption in Three Sensitivity Cases,
42
38. Index of Commercial Sector Delivered Energy Consumption, 1970-2010
45
39. Commercial Sector Carbon Emissions, 1990, 1996, and 2010
45
40. Real Prices for Delivered Energy in the Commercial Sector by Fuel, 1970, 1980, 1996, and 2010
45
41. Index of Delivered Energy Intensity in the Commercial Sector, 1970-2020
46
42. Delivered Energy Use and Electricity-Related Losses in the Commercial Sector, 1970, 1980, 1996, and 2010
46
43. Projected Fuel Expenditures in the Commercial Sector in Low and High Technology Cases, 1996-2020
49
44. Index of Industrial Sector Energy Prices, 2000-2020
51
45. Index of Delivered Energy Consumption in the Industrial Sector, 1970-2020
52
46. Industrial Sector Carbon Emissions, 1990, 1996, and 2010
53
47. Industrial Sector Energy Consumption by Fuel, 1970, 1980, 1996, and 2010
53
48. Projected Energy Intensity in the Industrial Sector, 1995-2020
53
49. Projected Change in Industrial Sector Energy Intensity, 1996-2010
54
50. Structural and Efficiency/Other Effects on Industrial Energy Intensity, 1980-1985, 1980-1996, and 1996-2010
54
51. Change From Projected Reference Case Energy Expenditures in the Industrial Sector
for Alternative Carbon Reduction Cases, 2010
54
52. Natural-Gas-Fired Cogeneration and Biomass Consumption in the Industrial Sector
in Alternative Carbon Reduction Cases, 2010.
57
53. Light-Duty Vehicle Energy Intensity, 1996 and 2010
60
54. Carbon Emissions in the Transportation Sector, 1990, 1996, and 2010
60
55. Fuel Consumption in the Transportation Sector, 1970-2020
60
56. Light-Duty Vehicle Travel, 1970-2020
61
57. Projected New Car and Light Truck Fuel Economy, 2010
62
58. Projected Shares of Automobile Sales by Size Class, 2010
63
59. Projected Reductions From Reference Case Projections of Car and Light Truck Horsepower
in the Carbon Reduction Cases, 2010 and 2020
64
60. Projected Fuel Consumption in the Transportation Sector by Mode in the Reference Case, 2010
64
61. Projected Fuel Consumption in the Transportation Sector by Fuel Type, 2010
64
62. Projected New and Stock Aircraft Fuel Efficiency, 2010
65
63. Projected New and Stock Freight Truck Fuel Efficiency, 2010
66
64. Projected Reductions From Reference Case Projections of Transportation Sector Fuel Consumption
in High and Low Technology Sensitivity Cases, 2010
69
65. Electricity Generation by Fuel in the Reference Case, 1949-2020
71
66. Projections of Electricity Sales, Carbon Emissions, Fossil Fuel Use, and Fossil-Fired Generation, 1997-2020
72
67. Projections of Carbon Emissions From the Electricity Supply Sector, 1996-2020
74
68. Projected Reductions in Carbon Emissions From the Electricity Supply Sector, 1990-3% Case, 1996-2020
74
69. Electricity Generation by Fuel, 1990+9% Case, 1949-2020
74
70. Electricity Generation by Fuel, 2010
74
71. Projections of Coal-Fired Electricity Generation, 2000-2020
75
72. Operating Costs for Coal-Fired Electricity Generation Plants, 1981-1995
76
73. Projections of Coal-Fired Generating Capacity, 2000-2020
76
74. Electricity Generation Capacity by Fuel, 2010
76
75. Projections of Natural-Gas-Fired Electricity Generation, 2000-2020
77
76. Natural-Gas-Fired Electricity Generation, 1990-3% Case, 1996-2020
77
77. Projections of Natural-Gas-Fired Electricity Generation Capacity, 2010
77
78. Projections of Nonhydroelectric Renewable Electricity Generation, 2000-2020
79
79. Projections of Wind-Powered Electricity Generation Capacity, 2000-2020
80
80. Projected Shares of Most Economical Wind Resources Developed by Region, 1990-7% Case, 1996-2020
82
81. Estimated Biomass Resource Availability and Projected Generating Capacity in 2020 by Region
83
82. Projections of Nuclear Electricity Generation, 2000-2020
88
83. Projections of Nuclear Electricity Generation Capacity, 2000-2020
88
84. Projected Changes in Electricity Sales Relative to the Reference Case, 2000-2020
88
85. Projections of Electricity Prices, 1996-2020
89
86. Projected Electricity Prices in Regulated and Competitive Electricity Markets, 2000-2020
90
viii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Enerav Markets and
87. Projected Carbon Prices in Regulated and Competitive Electricity Markets, 2000-2020
90
88. Projected Percentage of Time for Different Plant Types Setting National Marginal Electricity Prices,
2010 and 2020
90
89. Projected Percentage of Time for Interregional Trade Setting Marginal Electricity Prices, 2020
91
90. 1996-2020 Projections of Average Heat Rates for Natural-Gas-Fired Power Plants in High and Low Technology Cases,
92
91. Projected Electricity Prices in High and Low Technology Cases, 1996-2020
92
92. Projections of Nuclear Generating Capacity in the 1990-3% Nuclear Sensitivity Case, 2000-2020
92
93. Natural Gas Consumption, 1996-2020
96
94. Increases in Natural Gas Production, 1983-1984 and 2005-2006
97
95. Index of Natural Gas Reserve-to-Production Ratios, 1990-2020
98
96. Natural Gas Wellhead Prices, 1970-2020
102
97. Delivered Natural Gas Prices in the Residential Sector, 1970-2020
102
98. Petroleum Consumption, 1970-2020
104
99. Lower 48 Crude Oil Reserve Additions, 1990-2020
104
100. Net Expenditures for Imported Crude Oil and Petroleum Products, 1974-2020
105
101. Consumption of Ethanol in the Transportation Sector, 1992-2020
106
102. Gasoline Prices in the Transportation Sector, 1990-2020
107
103. Retail Gasoline Prices by Region, Average of All Grades, 1996 and 2010
108
104. Projected Wholesale Gasoline Margins, 1996-2020
109
105. U.S. Coal Production, 1970-2020
111
106. Western Share of U.S. Coal Production, 1990-2020
112
107. Average U.S. Minemouth Coal Prices, 1970-2020
113
108. Coal Prices to Electricity Generators, 1970-2020
113
109. Coal Mine Employment, 1970-2020
114
110. Total Projected Costs of Carbon Reductions to the U.S. Economy, 2008-2012
122
111. Projected Annual Growth Rates in Potential and Actual GDP, 2005-2010
122
112. Projected Annual Growth Rates in Potential and Actual GDP, 2005-2020
122
113. Projected Dollar Losses in Potential GDP Relative to the Reference Case, 1998-2020
123
114. Average Carbon Reductions and Projected Carbon Prices, 2008-2012
123
115. Comparison of Average U.S. Economic Losses Projected by the NEMS and DRI Models, 2008-2012
124
116. Projected Changes in Wholesale Price Index for Fuel and Power Relative to the Reference Case, 1998-2020
125
117. Projected Changes in Producer Price Index Relative to the Reference Case, 1998-2020
125
118. Projected Changes in Consumer Price Index Relative to the Reference Case, 1998-2020
126
119. Total Projected U.S. Payments for Domestic and International Carbon Emissions Permits,
1998-2020
126
120. Projected Destinations of Funds Paid for Carbon Emissions Permits, 2010 and 2020
127
121. Projected Changes in U.S. Inflation Rate Relative to the Reference Case, 1998-2020
128
122. Projected Changes in U.S. Unemployment Rate Relative to the Reference Case, 1998-2020
128
123. Projected Changes in U.S. Federal Funds Rate Relative to the Reference Case, 1998-2020
128
124. Projected Changes in Potential and Actual U.S. Gross Domestic Product in the 1990+9% Case
Relative to the Reference Case, 1998-2020
129
125. Projected Changes in Potential and Actual U.S. Gross Domestic Product in the 1990-3% Case
Relative to the Reference Case, 1998-2020
130
126. Projected Changes in Potential and Actual U.S. Gross Domestic Product in the 1990+24% Case
Relative to the Reference Case, 1998-2020
130
127. Projected Changes in Real Consumption in the U.S. Economy Relative to the Reference Case, 1998-2020
130
128. Projected Changes in Real Investment in the U.S. Economy Relative to the Reference Case,
1998-2020
130
129. Consumption and Investment Growth Rates
132
130. Projected Changes in U.S. Federal Funds Rate in the 1990-3% Case Relative to the Reference Case
Under Different Fiscal Policies, 1998-2020
133
131. Projected Changes in U.S. Federal Funds Rate in the 1990+9% Case Relative to the Reference Case
Under Different Fiscal Policies, 1998-2020
133
132. Projected Changes in U.S. Federal Funds Rate in the 1990+24% Case Relative to the Reference Case
Under Different Fiscal Policies, 1998-2020
133
133. Projected Changes in Potential and Actual U.S. Gross Domestic Product in the 1990+9% Case
Relative to the Reference Case Under Different Fiscal Policies, 1998-2020
133
134. Projected Changes in Real Consumption in the U.S. Economy Relative to the Reference Case, 1998-2020,
Assuming a Social Security Tax Rebate
134
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
135. Projected Changes in Real Investment in the U.S. Economy Relative to the Reference Case, 1998-2020,
Assuming a Social Security Tax Rebate
134
136. Projected Sectoral Growth Rates in Real Economic Output in the 1990+9% Case, 2005-2010
135
137. Projected Sectoral Growth Rates in Real Economic Output in the 1990-3% Case, 2005-2010
136
138. Projected Sectoral Growth Rates in Real Economic Output in the 1990+24% Case, 2005-2010
136
X
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Enerav Markets and Activity
Executive Summary
Greenhouse Gases
The first and second Conference of the Parties in 1995
and the Kyoto Protocol
and 1996 agreed to address the issue of greenhouse gas
emissions for the period beyond-2000, and to negotiate
Over the past several decades, rising concentrations of
quantified emission limitations and reductions for the
greenhouse gases have been detected in the Earth's
third Conference of the Parties. On December 1 through
atmosphere. It has been hypothesized that the continued
11, 1997, representatives from more than 160 countries
accumulation of greenhouse gases could lead to an
met in Kyoto, Japan, to negotiate binding limits on
increase in the average temperature of the Earth's sur-
greenhouse gas emissions for developed nations. The
face and cause a variety of changes in the global climate,
resulting Kyoto Protocol established emissions targets
sea level, agricultural patterns, and ecosystems that
for each of the participating developed countries-the
could be, on net, detrimental.
Annex I countries²-relative to their 1990 emissions lev-
els. The targets range from an 8-percent reduction for the
The Intergovernmental Panel on Climate Change (IPCC)
European Union to a 10-percent increase allowed for Ice-
was established by the World Meteorological Organiza-
tion and the United Nations Environment Programme
land. The target for the United States is 7 percent below
1990 levels.
in 1988 to assess the available scientific, technical, and
socioeconomic information in the field of climate
Although atmospheric concentrations of greenhouse
change. The most recent report of the IPCC concluded
gases are thought to have the potential to affect the
that: "Our ability to quantify the human influence on
global climate, the Protocol establishes targets in terms
global climate is currently limited because the expected
of annual emissions. Non-Annex I countries have no tar-
signal is still emerging from the noise of natural variabil-
gets under the Protocol, but the Protocol reaffirms the
ity, and because there are uncertainties in key factors.
commitments of the Framework Convention by all par-
These include the magnitudes and patterns of long-term
ties to formulate and implement climate change mitiga-
variability and the time-evolving pattern of forcing by,
tion and adaptation programs.
and response to, changes in concentrations of green-
house gases and aerosols, and land surface changes.
Should the Protocol enter into force, the emissions tar-
Nevertheless, the balance of evidence suggests that
gets for the developed countries would have to be
there is a discernable human influence on global cli-
achieved on average over the commitment period 2008
mate."¹
to 2012. The greenhouse gases covered by the Protocol
are carbon dioxide, methane, nitrous oxide, hydro-
The Framework Convention on Climate Change was
fluorocarbons, perfluorocarbons, and sulfur hexafluo-
signed by more than 160 countries in Rio de Janeiro, Bra-
ride. The aggregate target is based on the carbon dioxide
zil, on May 4, 1992. The objective of the Framework Con-
equivalent of each of the greenhouse gases. For the three
vention was to
achieve
stabilization of the
synthetic greenhouse gases, countries have the option of
greenhouse gas concentrations in the atmosphere at a
using 1995 as the base year.
level that would prevent dangerous anthropogenic
interference with the climate system." The signatories
Several provisions of the Protocol allow for some flexi-
agreed to formulate programs to mitigate climate
bility in meeting the emissions targets. Net changes in
change, and the developed country signatories agreed to
emissions by direct anthropogenic land-use changes
adopt national policies to return anthropogenic emis-
and forestry activities may be used in meeting the com-
sions of greenhouse gases to their 1990 levels.
mitment, but they are limited to afforestation, reforesta-
tion, and deforestation since 1990. Emissions trading
1 Intergovernmental Panel on Climate Change, Climate Change 1995: The Science of Climate Change (Cambridge, UK: Cambridge University
Press, 1996).
²Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, European Community, Finland, France,
Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, Monaco, Netherlands, New Zea-
land, Norway, Poland, Portugal, Romania, Russian Federation, Slovakia, Slovenia, Spain, Sweden, Switzerland, Ukraine, United Kingdom
of Great Britain and Northern Ireland, and United States of America. Turkey is an Annex I nation but did not commit to a quantifiable emis-
sions target.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xi
among the Annex I countries is also allowed. According
economy in the 2008 to 2012 time frame. The request
to estimates presented by the Energy Information
specified that the analysis use the same methodologies
Administration (EIA) in its International Energy Outlook
and assumptions employed in the AEO98, with no
1998,3 there may be 165 million metric tons of carbon
changes in assumptions about policy, regulatory
permits available from the Annex I countries of the
actions, or funding for energy and environmental pro-
former Soviet Union in 2010. Greenhouse gas emissions
grams.
for those countries as a group are expected to be 165 mil-
lion metric tons below 1990 levels in 2010 as a result of
the economic decline that has occurred in the region
during the 1990s. Additional carbon permits may also be
Methodology
available, depending on the "carbon price" that is estab-
The international provisions of the Kyoto Protocol,
lished in international trading.
including international emissions trading between
Joint implementation projects are permitted among the
Annex I countries, joint implementation projects, and
Annex I countries, allowing a nation to take emissions
the CDM, may reduce the cost of compliance in the
credits for projects that reduce emissions or enhance
United States. Guidelines for those provisions, however,
emissions-absorbing sinks, such as forests and other
remain to be resolved at future negotiating meetings,
vegetation, in other Annex I countries. The Protocol also
and rules and guidelines for the accounting of emissions
establishes a Clean Development Mechanism (CDM),
and sinks from activities related to agriculture, land use,
under which Annex I countries can take credits for proj-
and forestry activities must be developed. The specific
ects that reduce emissions in non-Annex I countries. In
guidelines may have a significant impact on the level of
addition, any group of Annex I countries may create a
reductions from other sources that a country must
bubble or umbrella to meet the total commitment of all
undertake. Reductions in the other greenhouse gases
the member nations. In a bubble, countries would agree
may also offset the reductions required from carbon
to meet their total commitment jointly by allocating a
dioxide. A fact sheet issued by the U.S. Department of
share to each member. In an umbrella arrangement, the
State on January 15, 1998, estimated that the method of
total reduction of all member nations would be met col-
accounting for sinks and the flexibility to use 1995 as the
lectively through the trading of emissions rights. There
base year for the synthetic greenhouse gases may reduce
is potential interest in the United States in entering into
the target to 3 percent below 1990 levels.⁶ A similar
an umbrella trading arrangement with Annex I coun-
estimate was cited by Dr. Janet Yellen, Chair, Council of
tries outside the European Union.
Economic Advisers, in her testimony before the House
Committee on Commerce, Energy and Power Sub-
In 1990, total greenhouse gas emissions in the United
committee, on March 4, 1998.7
States were 1,618 million metric tons carbon equivalent.⁴
Of this total, 1,346 million metric tons, or 83 percent, con-
Because the exact rules that would govern the final
sisted of carbon emissions from the combustion of
implementation of the Protocol are not known with cer-
energy fuels. By 1996, total U.S. greenhouse gas emis-
tainty, the specific reduction in energy-related emissions
sions had risen to 1,753 million metric tons carbon
cannot be established. This analysis includes cases that
equivalent, including 1,463 million metric tons of carbon
assume a range of reductions in energy-related carbon
emissions from energy combustion. EIA's Annual Energy
emissions in the United States. Each case was analyzed
Outlook 1998 (AEO98)5 projects that energy-related car-
to estimate the energy and economic impacts of achiev-
bon emissions will reach 1,803 million metric tons in
ing an assumed level of reductions.
2010, 34 percent above the 1990 level. Because energy-
A reference case and six carbon emissions reduction
related carbon emissions constitute such a large percent-
cases were examined in this report. The cases are
age of the Nation's total greenhouse gas emissions, any
defined as follows:
action or policy to reduce emissions will have significant
implications for U.S. energy markets.
Reference Case (33 Percent Above 1990 Levels).
This case represents the reference projections of
At the request of the U.S. House of Representatives
Committee on Science, EIA performed an analysis of the
energy markets and carbon emissions without any
enforced reductions and is presented as a baseline
Kyoto Protocol, focusing on the potential impacts of
for comparisons of the energy market impacts in the
the Protocol on U.S. energy prices, energy use, and the
reduction cases. Although this reference case is
³Energy Information Administration, International Energy Outlook 1998, DOE/EIA-0484(98) (Washington, DC, April 1998).
⁴Energy Information Administration, Emissions of Greenhouse Gases in the United States 1996, DOE/EIA-0573(96) (Washington, DC, Octo-
ber 1997).
⁵Energy Information Administration, Annual Energy Outlook 1998, DOE/EIA-0383(98) (Washington, DC, December 1997).
⁶See web site www.state.gov/www/global/oes/fs_kyoto_climate_980115.html.
See web site www.house.gov/commerce/database.htm.
xii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
based on the reference case from AEO98, there are
emissions during that period. This case essentially
small differences between this case and AEO98, in
assumes that the 7-percent target in the Kyoto Proto-
order to permit additional flexibility in response to
col must be met entirely by reducing energy-related
higher energy prices or to include certain analyses
carbon emissions, with no net offsets from sinks,
previously done offline directly within the modeling
other greenhouse gases, or international activities.
framework, such as nuclear plant life extension and
generating plant retirements. Also, some assump-
In each of the carbon reduction cases, the target is
tions were modified to reflect more recent assess-
achieved on average for each of the years in the first
ments of technological improvements and costs. As a
commitment period, 2008 through 2012 (Figure ES1).
result of these modifications, the projection of
Because the Protocol does not specify any targets
energy-related carbon emissions in 2010 is slightly
beyond the first commitment period, the target is
reduced from the AEO98 reference case level of 1,803
assumed to hold constant from 2013 through 2020, the
million metric tons to 1,791 million metric tons.
end of the forecast horizon (although more or less
24 Percent Above 1990 Levels (1990+24%). This case
stringent requirements may be set by future
assumes that carbon emissions can increase to an
Conferences of the Parties). The target is assumed to be
average of 1,670 million metric tons between 2008
phased in over a 3-year period, beginning in 2005,
because the Protocol indicates that demonstrable
and 2012, 24 percent above the 1990 levels. Com-
pared to the average emissions in the reference case
progress toward reducing emissions must be shown by
carbon emissions are reduced by an average of 122
2005. The phase-in allows energy markets to begin
million metric tons each year during the commit-
adjustments to meet the targets in the absence of
ment period.
complete foresight; however, a longer or more delayed
phase-in could lower the adjustment costs-an option
14 Percent Above 1990 Levels (1990+14%). This case
that is not considered here. In this analysis, some carbon
assumes that carbon emissions average 1,539
reductions are expected to occur before 2005 as the result
between 2008 and 2012, approximately at the level
of capacity expansion decisions by electricity generators
estimated for 1998 in AEO98, 1,533 million metric
that incorporate their expectations of future increases in
tons. This target is 14 percent above 1990 levels and
energy prices.
represents an average annual reduction of 253 mil-
lion metric tons from the reference case.
Figure ES1. Projections of Carbon Emissions,
1990-2020
9 Percent Above 1990 Levels (1990+9%). This case
Million Metric Tons
assumes that energy-related carbon emissions can
2,000 -
Reference
increase to an average of 1,467 million metric tons
between 2008 and 2012, 9 percent above 1990 levels,
1990+24%
an average annual reduction of 325 million metric
1,500 -
1990+14%
1990+9%
tons from the reference case projections.
1990
Stabilization at 1990 Levels (1990). This case
1990-7%
assumes that carbon emissions reach an average of
1,000 -
1,345 million metric tons during the commitment pe-
riod of 2008 through 2012, stabilizing approximately
at the 1990 level of 1,346 million metric tons. This is
500 -
an average annual reduction of 447 million metric
tons from the reference case.
History
Projections
3 Percent Below 1990 Levels (1990-3%). This case
0
assumes that energy-related carbon emissions are
1990
1995
2000
2005
2010
2015
2020
reduced to an average of 1,307 million metric tons
Sources: History: Energy Information Administration, Emissions of
between 2008 and 2012, an average annual reduction
Greenhouse Gases in the United States 1996, DOE/EIA-0573(96) (Washington,
DC, October 1997). Projections: Office of Integrated Analysis and Forecasting,
of 485 million metric tons from the reference case
National Energy Modeling System runs KYBASE.D080398A, FD24ABV
projections.
D080398B, FD1998.D080398B, FD09ABV.D080398B, FD1990.D080398B,
FD03BLW.D080398B, and FD07BLW.D080398B.
7 Percent Below 1990 Levels (1990-7%). In this case,
energy-related carbon emissions are reduced from
There are three ways to reduce energy-related carbon
the level of 1,346 million metric tons in 1990 to an
emissions: reducing the demand for energy services,
average of 1,250 million metric tons in the commit-
adopting more energy-efficient equipment, and switch-
ment period, 2008 to 2012. Compared to the refer-
ing to less carbon-intensive or noncarbon fuels. To
ence case, this is an average annual reduction of 542
reduce emissions, a carbon price is applied to the cost of
million metric tons of energy-related carbon
energy. The carbon price is applied to each of the energy
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xiii
fuels relative to its carbon content at its point of con-
consumers would have more incentive to purchase
sumption. Electricity does not directly receive a carbon
them.
fee; however, the fossil fuels used for generation receive
the fee, and this cost, as well as the increased cost of
In addition, for new generating technologies, the elec-
investment in generation plants, is reflected in the deliv-
tricity sector accounts for technological optimism in the
ered price of electricity. In practice, these carbon prices
capital costs of first-of-a-kind plants and for a decline in
could be imposed through a carbon emissions permit
the costs as experience with the technologies is gained
system.
both domestically and internationally. In each of these
sectors, equipment choices are made for individual tech-
In this analysis, the carbon prices represent the marginal
nologies as new equipment is needed to meet growing
cost of reducing carbon emissions to the specified level,
demand for energy services or to replace retired equip-
reflecting the price the United States would be willing to
ment. In the other sectors-industrial, oil and gas sup-
pay in order to purchase carbon permits from other
ply, and coal supply-the treatment of technologies is
countries or to induce carbon reductions in other coun-
somewhat more limited due to limitations on the avail-
tries. In the absence of a complete analysis of trade and
ability of data for individual technologies; however,
other flexible mechanisms to reduce carbon emissions
technology progress is represented by efficiency
internationally, the projected carbon prices do not neces-
improvements in the industrial sector, technological
sarily represent the international market-clearing price
progress in oil and gas exploration and production
of carbon permits or the price at which other countries
activities, and productivity improvements in coal pro-
would be willing to offer permits.
duction.
The projections in AEO98 and in this analysis were
developed using the National Energy Modeling System
(NEMS), an energy-economy modeling system of U.S.
Carbon Reduction Cases
energy markets, which is designed, implemented, and
maintained by EIA.⁸ The production, imports, conver-
Carbon Prices
sion, consumption, and prices of energy are projected
In 2010, the carbon prices projected to be necessary to
for each year through 2020, subject to assumptions on
achieve the carbon emissions reduction targets range
macroeconomic and financial factors, world energy
from $67 per metric ton (1996 dollars) in the 1990+24%
markets, resource availability and costs, behavioral and
case to $348 per metric ton in the 1990-7% case (Table
technological choice criteria, costs and performance
ES1 and Figure ES2). In the 1990+24% case, carbon prices
characteristics of energy technologies, and demograph-
generally increase from 2005 through 2020 (Table ES2
ics. NEMS is a fully integrated framework, capturing the
and Figure ES2). In the 1990+14% and 1990+9% cases,
interactions of energy supply, demand, and prices
the carbon prices increase through 2013 and then
across all fuels and all sectors of U.S. energy markets.
essentially flatten.
NEMS provides annual projections, allowing the repre-
sentation of the transitional effects of proposed energy
In the three other carbon reduction cases, the carbon
policy and regulation.
price escalates more rapidly in order to achieve the more
stringent carbon reductions in the commitment period.
NEMS includes a detailed representation of capital stock
The carbon price then declines as cumulative
vintaging and technology characteristics, capturing the
investments in more energy-efficient and lower-carbon
most significant factors that influence the turnover of
equipment, particularly in the electricity generation
energy-using and producing equipment and the choice
sector, reduce the marginal cost of compliance in the
of new technologies. The residential, commercial, trans-
later years of the forecast. These investments reduce the
portation, electricity generation, and refining sectors of
demand for carbon permits over an extended period of
NEMS include explicit treatments of individual known
time, offsetting growth in energy demand and
technologies and their characteristics, such as initial
moderating the carbon prices. Figure ES3 shows the
cost, operating cost, date of commercial availability, effi-
average carbon prices required to achieve the average
ciency, and other characteristics specific to the sector.
carbon reductions.
Unknown technologies are not likely to be developed in
time to achieve significant market penetration within
Sectoral Impacts
the time frame of this analysis. Higher energy prices, as a
result of carbon prices, for example, do not alter the
As a result of the carbon prices and higher delivered
characteristics or availability of energy-using technolo-
energy prices, the overall intensity of energy use
gies. However, higher prices induce more rapid adop-
declines in the carbon reduction cases. Energy intensity,
tion of more efficient or advanced technologies, because
measured in energy consumed per dollar of gross
⁸Energy Information Administration, The National Energy Modeling System: An Overview 1998, DOE/EIA-058 (Washington, DC, Feb-
ruary 1998).
xiv
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Table ES1. Selected Variables in the Carbon Reduction Cases, 1996 and 2010
2010
1990
1990
1990
1990
1990
Varlable
1996
Reference
+24%
+14%
+9%
1990
-3%
-7%
U.S. Carbon Emissions
(Million Metric Tons)
1,463
1,791
1,668
1,535
1,462
1,340
1,300
1,243
Emissions Reductions
(Percent Change From Reference Case)
-
-
6.9
14.3
18.4
25.2
27.4
30.6
Total Energy Consumption
(Quadrillion Btu).
93.8
111.2
106.5
101.9
99.6
95.2
93.9
91.7
(Percent Change From Reference Case)
-
-
-4.2
-8.4
-10.4
-$4.4
-15.6
-17.5
Carbon Price
(1996 Dollars per Metric Ton)
-
-
67
129
163
254
294
348
Carbon Revenueᵃ
(Billion 1996 Dollars)
-
-
110
195
233
333
374
424
Gasoline Price
(1996 Dollars per Gallon)
1.23
1.25
1.39
1.50
1.55
1.72
1.80
1.91
(Percent Change From Reference Case)
-
-
11.2
20.0
24.0
37.6
44.0
52.8
Average Electricity Price
(1996 Cents per Kilowatthour)
6.8
5.9
7.1
8.2
8.8
10.0
10.5
11.0
(Percent Change From Reference Case)
-
-
20.3
39.0
49.2
69.5
78.0
86.4
Actual Gross Domestic Productᵇ
(Billion 1992 Dollars)
6,928
9,429
9,333
9,268
9,241
9,137
9,102
9,032
(Percent Change From Reference Case)
-
-
-1.0
-1.7
-2.0
-3.1
-3.5
-4.2
(Annual Percentage Growth Rate, 2005-2010)
-
2.0
1.8
1.7
1.6
1.4
1.3
1.2
Potential Gross Domestic Product
(Billion 1992 Dollars)
6,930
9,482
9,469
9,455
9,448
9,429
9,420
9,410
(Percent Change From Reference Case)
-
-
-0.1
-0.3
-0.4
-0.6
-0.7
-0.8
(Annual Percentage Growth Rate, 2005-2010)
-
2.0
2.0
1.9
1.9
1.9
1.9
1.9
Change in Energy Intensity
(Annual Percent Change, 2005-2010)
-
-1.0
-1.6
-2.0
-2.1
-2.7
-2.8
-3.0
(Percent Change From Reference Case)
-
-
55.6
96.4
108.2
161.8
177.0
199.0
ᵃThe carbon revenues do not include fees on the nonsequestered portion of petrochemical feedstocks, nonpurchased refinery fuels, or industrial
other petroleum.
b Carbon permit revenues are assumed to be returned to households through personal income tax rebates.
Source: Office of Integrated Analysis and Forecasting, National Energy Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B,
FD09ABV.D080398B, FD1990.D080398B, FD03BLW.D080398B, FD07BLW. D080398B.
domestic product (GDP), declines (i.e., improves) at an
end-use consumers to higher prices because this indus-
average annual rate of 1 percent between 2005 and 2010
try has traditionally been cost-minimizing, factoring
in the reference case due to the availability and adoption
future energy price increases into investment decisions.
of more efficient equipment. In the carbon reduction
In contrast, the end-use consumers are assumed to con-
cases, higher rates of improvement are projected-from
sider only current prices in making their investment
1.6 percent a year in the 1990+24% case to triple the refer-
decisions and to consider additional factors, not only
ence case rate at 3.0 percent a year in the 1990-7% case.
price, in their decisions. In addition, there are a number
In 2010, reductions in carbon emissions from electricity
of more efficient and lower-carbon technologies for elec-
tricity generation that become economically available as
generation account for between 68 and 75 percent of the
the cost of generating electricity from fossil fuels
total carbon reductions across the cases. Electricity con-
increases.
sumption is projected to be lower than in the reference
case, with more efficient, less carbon-intensive technolo-
Total electricity generation is lower in the carbon reduc-
gies used for electricity generation. In all the carbon
tion cases because electricity sales range from 4 to 17 per-
reduction cases except the 1990+24% case, carbon emis-
cent below the reference case in 2010 (Figure ES4).
sions from electricity generation in 2010 are lower than
Reduction in electricity demand in response to higher
the actual 1990 level of 477 million metric tons of carbon
electricity prices is somewhat mitigated by the change in
emissions from the electricity supply sector. Electricity
relative prices. In 2010, electricity prices are between
generators are expected to respond more strongly than
20 and 86 percent above the reference case across the
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
XV
Table ES2. Selected Variables in the Carbon Reduction Cases, 1996 and 2020
2020
1990
1990
1990
1990
Variable
1990
1996
Reference
+24%
+14%
+9%
1990
-3%
-7%
U.S. Carbon Emissions
(Million Metric Tons)
1,463
1,929
1,668
1,535
1,468
1,347
1,303
Emissions Reductions
1,251
(Percent Change From Reference Case)
-
-
13.5
20.4
23.9
30.2
32.5
35.1
Total Energy Consumption
(Quadrillion Btu)
93.8
117.0
108.6
105.6
103.8
100.9
(Percent Change From Reference Case)
99.9
98.8
-
-
-7.2
-9.7
-11.3
43.8
-14.6
Carbon Price
-15.6
(1996 Dollars per Metric Ton)
-
-
99
123
141
200
240
Carbon Revenueᵃ
305
(Billion 1996 Dollars)
-
-
162
184
202
263
306
372
Gasoline Price
(1996 Dollars per Gallon)
1.23
1.24
1.42
1.45
1.49
1.60
(Percent Change From Reference Case)
1.67
1.80
-
-
14.5
16.9
20.2
29.0
34.7
45.2
Average Electricity Price
(1996 Cents per Kilowatthour)
6.8
5.6
7.3
7.8
8.1
8.7
(Percent Change From Reference Case)
8.9
9.3
-
-
30.4
39.3
44.6
55.4
58.9
Actual Gross Domestic Productᵇ
66.1
(Billion 1992 Dollars)
6,928
10,865
10,815
(Percent Change From Reference Case)
10,808
10,796
10,799
10,793
10,782
-
-
-0.5
-0.5
-0.6
-0.6
-0.7
(Annual Percentage Growth Rate, 2005-2020)
-0.8
-
1.6
1.6
1.6
1.6
1.6
1.6
1.6
Potential Gross Domestic Product
(Billion 1992 Dollars)
6,930
10,994
10,968
10,961
10,954
10,940
10,933
10.925
(Percent Change From Reference Case)
-
-
-0.2
-0.3
-0.4
-0.5
-0.6
-0.6
(Annual Percentage Growth Rate, 2005-2020)
-
1.7
1.6
1.6
1.6
1.6
1.6
1.6
Change In Energy Intensity
(Annual Percent Change, 2005-2020)
-
-0.9
-1.4
-1.4
-1.5
-1.6
(Percent Change From Reference Case)
-1.7
-1.7
-
-
46.3
54.0
55.7
72.1
76.9
80.9
The carbon revenues do not include fees on the nonsequestered portion of petrochemical feedstocks, nonpurchased refinery fuels, or industrial
other petroleum.
Carbon permit revenues are assumed to be returned to households through personal income tax rebates.
FD09ABV.D080398B, FD1990.D080398B, FD03BLW.D080398B, FD07BLW. D080398B.
Source: Office of Integrated Analysis and Forecasting, National Energy Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B,
carbon reduction cases; however, delivered natural gas
dramatically increase the use of renewables in the more
prices are higher by between 25 and 147 percent. With a
stringent reduction cases, particularly biomass and
smaller percentage price increase, electricity becomes
wind energy systems, which become more economical
more attractive in those end uses where it competes with
with higher carbon prices.
natural gas, such as home heating.
Assuming that carbon emissions from the generation of
Although reduced demand for electricity and efficiency
electricity are shared to each of the end-use demand
improvements in the generation of electricity contribute
sectors, based upon their consumption of electricity, the
to the total reductions in carbon emissions from
industrial and residential end-use demand sectors
electricity generation, fuel switching accounts for most
account for most of the carbon reductions, and the
of the reductions (Figure ES5). The delivered price of
transportation sector accounts for the least (Figure ES6).
coal to generators in 2010 is higher by between 153 and
In response to higher energy prices, consumers have an
nearly 800 percent in the carbon reduction cases relative
incentive to reduce demand for energy services, switch
to the reference case. As a result, coal-fired generation,
to lower-carbon energy sources, and invest in more
which accounts for about half of all generation in 2010 in
energy-efficient technologies.
the reference case, has a share between 42 percent and 12
percent in 2010 in the carbon reduction cases. To replace
Because coal is the most carbon-intensive of the fossil
coal plants, generators build more natural gas plants,
fuels, delivered coal prices are most affected by the
extend the life of existing nuclear plants, and
xvi
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activitv
Figure ES2. Projections of Carbon Prices,
1996-2020
Figure ES4. Projections of U.S. Electricity
Generation, 1990-2020
1996 Dollars per Metric Ton
400
Billion Kilowatthours
4,800
-
350 -
1990-7%
4,000 -
300 -
250 -
3,200 -
Reference
1990
200 -
- 1990+24%
2,400 -
#-
- 1990+14%
150 -
1990+9%
- 1990+9%
1,600 -
100 -
1990+14%
-
1990
1990+24%
50 -
800 -
- 1990-7%
0
History
Projections
0
1995
2000
2005
2010
2015
2020
1990
1995
2000
2005
2010
2015
2020
Source: Office of Integrated Analysis and Forecasting, National Energy
Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD1998.
Sources: History: Energy Information Administration, Annual Energy Review
D080398B, FD09ABV.D080398B, FD1990.D080398B, FD03BLW.D080398B,
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
and FD07BLW.D080398B.
Integrated Analysis and Forecasting, National Energy Modeling System runs
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
Figure ES3. Average Projected Carbon Prices and
D080398B.
Annual Carbon Emission Reductions,
2008-2010
Figure ES5. Projected Reductions in Carbon
Average Carbon Price (1996 Dollars per Metric Ton)
350
Emissions From the Electricity Supply
-
1990-7%
Sector, 1990-3% Case, 1996-2020
Million Metric Tons
300 -
600 -
250
1990
500 -
200 -
Demand Reductions
400
150 -
1990+9%
Fuel Switching
1990+14%
300 -
100
50
1990+24%
200 -
Reference
0
0
100
100 - -
200
300
400
500
600
Average Carbon Reductions (Million Metric Tons)
Source: Office of Integrated Analysis and Forecasting, National Energy
0
Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD1998.
1995
2000
2005
2010
2015
2020
D080398B, FD09ABV.D080398B, FD1990.D080398B, FD03BLW.D080398B,
and FD07BLW.D080398B.
Source: Office of Integrated Analysis and Forecasting, National Energy
Modeling System runs KYBASE.D080398A, FD03BLW.D080398B.
carbon prices (Figure ES7). Higher electricity prices
Total carbon emissions from the industrial sector are
reflect the increased costs of fossil fuels for generation
lower by between 7 and 28 percent in 2010 in the carbon
and the incremental cost of additional investments,
reduction cases, relative to the reference case. Total
although the increase is mitigated by generation from
industrial output is lower because of the impact of
renewables and nuclear power, because their fuel prices
higher energy prices on the economy. As energy prices
are not affected by carbon prices. Although the average
increase, industrial consumers accelerate the replace-
carbon content of petroleum products is higher than that
ment of productive capacity, invest in more efficient
of natural gas, the percentage increase in the price of
technology, and switch to less carbon-intensive fuels. In
natural gas is higher than that of petroleum. Higher
2010, industrial energy intensity is reduced from 7.6
prices for petroleum are partially offset by lower world
thousand British thermal units (Btu) per dollar of output
oil prices, and Federal and State taxes on gasoline also
in the reference case to between 7.4 and 7.1 thousand Btu
serve to mitigate the percentage increase.
in the carbon reduction cases.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xvii
Figure ES6. Projected Reductions in Carbon
Figure ES7. Projected Changes in Average
Emissions by End-Use Sector Relative
Delivered Prices for Energy Fuels in
to the Reference Case, 2010
the 1990+9% Case Relative to the
Million Metric Tons
160
-
Reference Case, 1996-2020
1990+24%
1990+9%
1990-3%
Percent
400
120
Coal
300 - -
80
Electric
40
200 -
0
Residential
Commercial
Industrial
100 -
Transportation
Residential
Commercial
Industrial
Transportation
Residential
Commercial
Industrial
Transportation
Natural Gas
Electricity
0
Note: Electricity emissions are from the fuel used to generate elec-
1995
2000
2005
2010
2015
2020
tricity and are attributed to the sectors relative to their shares of elec-
Source: Office of Integrated Analysis and Forecasting, National Energy
tricity consumption.
Modeling System runs KYBASE.D080398A and FD09ABV.D080398B.
Source: Office of Integrated Analysis and Forecasting, National Energy
Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD09ABV.
D080398B, and FD03BLW. D080398B.
percent, primarily as the result of reduced travel and the
In both the residential and commercial sectors, higher
purchase of more efficient vehicles. The relatively low
carbon reductions for transportation result from the
energy prices encourage investments in more efficient
equipment and building shells and reduce the demand
continued dominance of petroleum, although some
increase in market share is projected for alternative-fuel
for energy services. Total carbon emissions in the resi-
dential sector are reduced by 11 percent in the 1990+24%
vehicles. Improvements in average fuel efficiency are
case and by 45 percent in the 1990-7% case, relative to the
slowed by vehicle turnover rates. Although new car
reference case. Because of reduced demand for energy
efficiency in 2010 improves from 30.6 miles per gallon in
and improved end-use efficiencies, total energy use in
the reference case to between 32.0 and 36.4 miles per
2010 ranges from 145 to 173 million Btu per household in
gallon in the carbon reduction cases, total light-duty
the carbon reduction cases, compared with 184 million
fleet efficiency rises only from 20.5 miles per gallon to
between 20.7 and 21.7 miles per gallon. The impact of
Btu per household in the reference case. Space heating
carbon prices on the economy lowers light-duty vehicle
and cooling account for the largest share of the change in
and airline travel and freight requirements while
energy demand; however, energy demand for a variety
inducing some efficiency improvements.
of miscellaneous appliances, such as computers, televi-
sions, and VCRs, is also reduced.
Impacts by Fuel
In the commercial sector, total carbon emissions are
In order to achieve carbon emission reductions, the slate
lower by between 12 and 51 percent in the carbon reduc-
of energy fuels used in the United States is projected to
tion cases, compared to the reference case. Total energy
change from that in the reference case (Figure ES8).
use per square foot of commercial floorspace, which is
Because of the higher relative carbon content of coal and
206 thousand Btu in 2010 in the reference case, is
petroleum products, the use of both fuels is reduced,
reduced to between 148 and 192 thousand Btu across the
and there is a greater reliance on natural gas, renewable
cases. Similar to the residential sector, most of the reduc-
energy, and nuclear power. Although the use of
tion occurs for space conditioning-heating, cooling,
petroleum declines relative to the reference case, it
and ventilation; however, more efficient lighting and
increases slightly as a share because most petroleum is
office equipment and reduced miscellaneous electricity
used in the transportation sector, where fewer fuel
use-for example, for vending machines and telecom-
substitutes are available.
munications equipment-also contribute to lower
energy consumption.
Because of the high carbon content of coal, total
domestic coal consumption is significantly reduced in
The average price of gasoline in 2010 across the carbon
the carbon reduction cases, by between 18 and 77
reduction cases is between 11 and 53 percent higher than
percent relative to the reference case in 2010 (Figure
the projected reference case price. Carbon reductions in
ES9). Most of the reductions are for electricity
the transportation sector in 2010 range from 2 to 16
generation, where coal is replaced by natural gas,
renewable fuels, and nuclear power; however, demand
xviii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activitv
Figure ES8. Projections of Fuel Shares of Total U.S. Energy Consumption, 2010
Reference
1990+24%
(111.2 Quadrillion Btu)
39.4%
(106.5 Quadrillion Btu)
40.2%
Natural Gas
Coal
Nuclear
Renewable
0.7%
26.1%
-0.3%
Other
6.6%
27.8%
6.9%
41.3%
41.4%
5.6%
6.3%
21.7%
18.5%
-0.2%
0.2%
-7.7%
-8.7%
32.0%
34.6%
1990+9%
7.0%
7.9%
1990-3%
(99.6 Quadrillion Btu)
11.8%
7.1%
(93.9 Quadrillion Btu)
Note: "Other" includes net electricity imports, methanol, and liquid hydrogen.
FD03BLW.D080398B Source: Office of Integrated Analysis and Forecasting, National Energy Modeling System runs KYBASE.D080398A, FD24ABV.D080398B, FD09ABV.D080398B, and
Figure ES9. Projections of U.S. Coal Consumption,
in new mines, which are primarily in the West. Because
1970-2020
of lower coal production, coal mine employment in 2010
Quadrillion Btu
is projected to be 15 to 63 percent lower than in the
30 -
reference case; however, employment in the energy
History
Projections
industry related to the production of natural gas and
25
Reference
renewable fuels is likely to increase.
20 -
Petroleum consumption is lower in all the carbon
reduction cases than in the reference case, by between 2
and 13 percent (Figure ES10). Because most of the
15 -
1990-24%
petroleum is used for transportation, between 68 and 82
percent of the total reduction is in the transportation
10
1990+14%
sector, as travel and freight requirements are reduced
1990+9%
and higher-efficiency vehicles are used. Because of
5 -
lower petroleum demand in the United States and in
1990
0
1990-7%
Figure ES10. Projections of U.S. Petroleum
1970
1980
1990
2000
2010
2020
Consumption, 1970-2020
Sources: History: Energy Information Administration, Annual Energy Review
Quadrillion Btu
50
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
Integrated Analysis and Forecasting, National Energy Modeling System runs
45 -
History
Projections
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
D080398B.
40 - -
for industrial steam coal and metallurgical coal is also
35 -
reduced because of a shift to natural gas in industrial
30
Reference
boilers and a reduction in industrial output. Coal
- 1990+24%
25 -
exports are also lower in the carbon reduction cases, by
- 1990+14%
between 21 and 32 percent, due to lower demand for
20 -
-
1990+9%
coal in the Annex I nations.
15 -
1990
10 -
Although total U.S. coal production is reduced, the
- 1990-7%
average minemouth coal price rises in the carbon
5 - -
reduction cases, by between 3 and 28 percent in 2010,
0
because a larger share of production is from higher-cost
1970
1980
1990
2000
2010
2020
eastern coal mines that tend to serve the remaining
Sources: History: Energy Information Administration, Annual Energy Review
markets. Production of western coal is further
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
discouraged by the higher cost of fuels used for rail
Integrated Analysis and Forecasting, National Energy Modeling System runs
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV.
transportation and by reduced incentive for investment
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
D080398B.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xix
Figure ES11. Projections of U.S. Natural Gas
Consumption, 1970-2020
Figure ES12. Projections of U.S. Nuclear Energy
Quadrillion Btu
Consumption, 1970-2020
40
Quadrillion Btu
8 -
History
Projections
35
1990-7%
7-
1990
30
6 -
1990+9%
1990+14%
25 - -
Reference
5- -
1990+248
- 1990+24%
20 -
4 -
- 1990+14%
a
Reference
15
- 1990+9%
3-
- 1990
10 -
2-
5 -
- 1990-7%
History
Projections
0
0
1970
1980
1990
2000
2010
2020
1970
1980
1990
2000
2010
2020
Sources: History: Energy Information Administration, Annual Energy Review
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
Sources: History: Energy Information Administration, Annual Energy Review
Integrated Analysis and Forecasting, National Energy Modeling System runs
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV.
Integrated Analysis and Forecasting, National Energy Modeling System runs
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV.
D080398B.
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
D080398B.
other developed countries that are committed to reduc-
ing emissions under the Kyoto Protocol, world oil prices
Figure ES13. Projections of U.S. Renewable
are lower by between 4 and 16 percent in 2010, relative to
Energy Consumption, 1990-2020
the reference case price of $20.77 per barrel. In 2010, net
Quadrillion Btu
14
crude oil and petroleum product imports are lower by a
1990-7%
range of 3 to 22 percent relative to the reference case.
12 - -
Consequently, the dependency of the United States on
1990
imported petroleum is reduced from the reference case
10 -
1990+9%
level of 59 percent to as little as 53 percent in 2010.
1990+14%
8 - -
1990+24%
In 2010, natural gas consumption is higher than in the
Reference
reference case, by a range of 2 to 12 percent across the
6-
carbon reduction cases (Figure ES11). Increased use of
natural gas in the generation sector is only partially
4-
offset by reductions in the end-use sectors. Later in the
forecast period, continued growth in natural gas
2-
consumption for electricity generation is mitigated by
History
Projections
the increasing use of renewables and nuclear power,
0
particularly in the more stringent carbon reduction
1990
1995
2000
2005
2010
2015
2020
cases. As a result, in 2020, natural gas use does not
Sources: History: Energy Information Administration, Annual Energy Review
necessarily increase with higher levels of carbon
1997, DOE/EIA-0384(97) (Washington, DC, July 1998). Projections: Office of
Integrated Analysis and Forecasting, National Energy Modeling System runs
reductions. As the result of higher demand, the average
KYBASE.D080398A, FD24ABV.D080398B, FD1998.D080398B, FD09ABV
wellhead price of natural gas in 2010 is higher in all the
D080398B, FD1990.D080398B, FD03BLW.D080398B, and FD07BLW.
D080398B.
carbon cases than in the reference case, by a range of 2 to
30 percent. Although meeting the levels of production
assumed to be built in the carbon reduction cases,
that may be required will be a challenge for the industry,
extending the lifetimes of existing plants is projected to
sufficient natural gas resources are available. The
become more economical with higher carbon prices. In
potential increases in both drilling and pipeline capacity
the more stringent carbon reduction cases, most existing
are within levels achieved historically (or about to be
nuclear plants are life-extended through 2020, in
achieved) and are not likely to be a constraint, given
contrast to the gradual retirement of approximately half
appropriate incentives and planning.
of the nuclear plants projected in the reference case.
Nuclear power, which produces no carbon emissions,
Consumption of renewable energy, which results in no
increases with carbon reduction targets by between 8
net carbon emissions, is projected to be significantly
and 20 percent in 2010, relative to the reference case
higher with carbon reduction targets (Figure ES13).
(Figure ES12). Although no new nuclear plants are
Across the carbon reduction cases, renewable energy
XX
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
consumption increases by between 2 and 16 percent in
income tax lump sum rebate and, second, lowering
2010 and by between 9 and 70 percent in 2020. Most of
social security tax rates as they apply to both employers
this increase occurs in electricity generation, primarily
and employees. The two policies are meant only to be
with additions to wind energy systems and an increase
representative of a set of possible fiscal policies that
in the use of biomass (wood, switchgrass, and refuse). In
might accompany an initial carbon mitigation policy.
the carbon reduction cases, the share of renewable
generation is as much as 14 percent in 2010, compared
The second flow of funds is associated with U.S.
with 10 percent in the reference case, increasing to as
purchases of international carbon permits and assumes
high as 22 percent in 2020, compared with 9 percent in
that the carbon price determined in the U.S. energy
the reference case. Because additional renewable tech-
market analysis is the international price at which
nologies become available and economical later in the
permits would be traded. The differences between the
forecast period, the share of renewable generation con-
reduction level in the 1990-3% case and those in the other
tinues to increase through 2020.
cases are assumed to be met by purchases of permits in
international markets. Table ES3 shows average carbon
Macroeconomic Impacts
reductions, purchases of international permits, and the
In the energy market analyses, the projected carbon
carbon price for the three cases considered in the
prices reflect the prices the United States would be will-
macroeconomic assessment for the 2008-2012 period.
ing to pay to achieve the Kyoto targets, without address-
The energy market analysis in this report does not
ing the international trade in carbon permits. The
address the international implications of achieving a
macroeconomic analysis assumes that the carbon permit
particular target at the projected carbon price. For the
trading system would function as an auction run by the
macroeconomic assessment, the simplifying assumption
Federal Government, and that the United States would
is made that in each case the domestic carbon price is the
be free to purchase carbon permits in an international
same as the international permit price when different
market at the marginal abatement cost in the United
levels of trading are used to achieve the Kyoto target,
States. The U.S. State Department's assessment of the
implying that different international supplies of permits
accounting of carbon-absorbing sinks and offsets from
would be available in the alternative cases considered.
reductions in other greenhouse gases is assumed to
This is an important simplifying assumption, and the
reduce the U.S. emissions target to 3 percent below 1990
value placed on the overseas transfer of funds to
levels. The 3-percent target is then achieved through a
purchase international permits is subject to considerable
combination of domestic actions and the purchase of
uncertainty. However, this element must be considered
permits on the international market. Thus, two flows of
a key factor in performing any assessment of the impacts
funds occur-domestic and international.
on the economy, and therefore it is explicitly factored
On the domestic side, U.S. permits are sold in a competi-
into the analysis.
tive auction run by the Federal Government, raising
As a direct consequence of the carbon price, aggregate
large sums of funds. In the 1990-3% case, where the reve-
energy prices in the U.S. economy are expected to rise.
nues come entirely from the domestic market, the reve-
One way to measure this effect is to look at the
nue collected in 2010 is projected to total $585 billion
percentage change in prices in the economy. For
nominal dollars and $317 billion and $128 billion in the
example, in the 1990+9% case, energy prices are 56
1990+9% and 1990+24% cases, respectively. The collec-
percent higher than the reference case projection in 2010
tion of this money necessitates a careful consideration of
and remain more than 50 percent above the reference
appropriate fiscal policy to accompany the permit auc-
case over the rest of the forecast period. The projected
tion. Two approaches are considered: first, returning
energy price increases would also affect downstream
collected revenues to consumers through a personal
prices for all goods and services in the economy as
Table ES3. Energy Market Assumptions for the Macroeconomic Analysis of Three Carbon Reduction Cases,
Average Annual Values, 2008 through 2012
Binding
Average U.S.
Value of
Carbon
Carbon
U.S. Purchases
Purchased
Emissions
Emissions
of International
Carbon Price
International
Reduction Target
Reductions
Permits
Permits
(Million
(Million
(Million
1996 Dollars per
1992 Dollars per
(Billion
Analysis Case
Metric Tons)
Metric Tons)
Metric Tons)
Metric Ton
Metric Ton
1992 Dollars)
1990-3%
485
485
0
290
263
0
1990+9%
485
325
160
159
144
23
1990+24%
485
122
363
65
59
I
21
Source: Office of Integrated Analysis and Forecasting, National Energy Modeling System.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xxi
Figure ES14. Projected Changes in Consumer
Price Index Relative to the Reference
the extent that they do not rise at the rate of domestic
Case, 1998-2020
prices because non-Annex I countries do not face carbon
Percent Change From Reference Case
constraints, would dampen the price effects as lower-
7 -
priced imports find their way into U.S. markets.
Assuming Social Security
7-
Tax Rebate
6
6-
Because energy resources are used to produce most
5.
4-
goods and services, higher energy prices can affect the
5 -
3-
economy's production potential. Long-run equilibrium
2-
1.
costs are associated with reducing reliance on energy in
4
0
favor of other factors of production-including labor
1995
2005
2015
and capital, which become relatively cheaper as energy
3 -
1990+9%
costs rise. Short-run adjustment costs, or business cycle
costs, can arise when price increases disrupt capital or
2-
employment markets. Long-run costs are considered
unavoidable. Short-run costs might be avoidable if price
1 -
1990+24%
changes can be accurately anticipated or if appropriate
compensatory monetary and fiscal policies can be
0
1995
2000
2005
2010
2015
implemented. The economic assessment in this analysis
2020
considers both the short-run and long-run costs to the
Note: Carbon permit revenues are assumed to be returned to
households through reductions in personal income taxes.
economy and focuses on the 1990-3%, 1990+9%, and
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
1990+24% carbon reduction cases.
of the U.S. Economy.
measured by the producer price index. The projected
The possible impacts on the economy are summarized in
increase in producer prices relative to the reference case
Table ES4, which shows average changes from the
in 2010 is 9 percent in the 1990+9% case. Final prices for
reference case projections over the period from 2008
goods and services in 2009, as shown by the consumer
through 2012 in the three carbon reduction analysis
price index (CPI) series, are about 4 percent higher in the
cases. The loss of potential GDP measures the loss in
1990+9% case (Figure ES14). Expressed as a rate of
productive capacity of the economy directly attributable
change, CPI inflation rises by 0.7 percentage points
to the reduction in energy resources available to the
between 2005 and 2010, as the reference case CPI rises by
economy. The macroeconomic adjustment cost reflects
3.6 percent a year and the 1990+9% case rises by 4.3 per-
frictions in the economy that may result from the higher
cent a year. These figures suggest the following rule of
prices of the carbon mitigation policy. It recognizes the
thumb for the year 2010: each 10-percent increase in
possibility that cyclical adjustments may occur in the
aggregate prices for energy may lead to a 1.5-percent
short run. The loss in actual GDP for the economy is the
increase in producer prices and a 0.7-percent increase in
sum of the loss in potential and the adjustment cost. The
consumer prices.
purchase of international permits represents a claim on the
productive capacity of domestic U.S. resources.
One aspect of the CPI is particularly noteworthy. The
Essentially, as funds flow abroad, other countries have
CPI measures the prices that consumers face, regardless
an increased claim on U.S. goods and services. The loss
of the country of origin of the product. Import prices, to
Table ES4. Macroeconomic Impacts in Three Carbon Reduction Cases, Average Annual Values, 2008-2012
(Billion 1992 Dollars)
Purchases of
Loss In
Macroeconomic
Loss in
International
Total Cost
Analysis Case
Potential GDP
Adjustment Cost
Actual GDP
Permits
to the Economy
1990-3%
Personal Income Tax Rebate
58
225
283
0
283
Social Security Tax Rebate
58
70
128
0
128
1990+9%
Personal Income Tax Rebate
32
137
169
23
192
Social Security Tax Rebate
32
59
91
23
114
1990+24%
Personal Income Tax Rebate
12
76
88
21
109
Social Security Tax Rebate
12
44
56
21
77
Note: Loss in potential GDP plus the macroeconomimc adjustment cost equals the loss in actual GDP. The actual GDP loss plus purchases of
international permits equals the total cost to the economy.
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model of the U.S. Economy.
xxii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
of potential GDP plus the purchase of international
Figure ES15. Total Projected Costs of Carbon
permits represent the long-run, unavoidable impact on
Reductions to the U.S. Economy,
the economy. The total cost to the economy is represented
2008-2012
by the loss in actual GDP plus the purchase of interna-
Billion 1992 Dollars
300
-
tional permits (Figure ES15). These costs need to be put
Loss in Potential GDP
in perspective relative to the size of the ecomomy, which
averages $9,425 billion between 2008 and 2012. Tables
250 -
Macroeconomic Adjustment Cost
ES5 and ES6 summarize the macroeconomic impacts
Assuming Personal Income
projected for the years 2010 and 2020.
200
Tax Rebate
In the long run, higher energy costs would reduce
the use of energy by shifting production toward less
150 -
Assuming Social Security
energy-intensive sectors, by replacing energy with labor
Tax Rebate
and capital in specific production processes, and by
100 -
encouraging energy conservation. Although reflecting a
more efficient use of higher-cost energy, the gradual
50
-
reduction in energy use would tend to lower the
productivity of other factors in the production process.
0
The derivation of the long-run equilibrium path of the
1990-3%
1990+9%
1990+24%
economy can be characterized as representing the
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
of the U.S. Economy.
Table ES5. Projected Impacts on Gross Domestic Product, 2005 and 2010
2010
2005
Refer-
1990
1990
1990
1990
1990
Variable
1996
Reference
ence
+24%
+14%
+9%
1990
-3%
-7%
Potential GDP
(Billion 1992 Dollars)
6,930
8,585
9,482
9,469
9,455
9,448
9,429
(Percent Change From Reference Case)
9,420
9,410
-
-
-
-0.1
-0.3
-0.4
-0.6
-0.7
-0.8
(Annual Growth Rate, 2005-2010, Percent)
-
-
2.0
2.0
1.9
1.9
1.9
1.9
1.9
Actual GDP, Assuming Personal Income Tax Rebate
(Billion 1992 Dollars)
6,928
8,525
9,429
9,333
9,268
9,241
9,137
(Percent Change From Reference Case)
9,102
9,032
-
-
-
-1.0
-1.7
-2.0
-3.1
-3.5
-4.2
(Annual Growth Rate, 2005-2010, Percent)
-
-
2.0
1.8
1.7
1.6
1.4
1.3
1.2
Actual GDP, Assuming Social Security Tax Rebate
(Billion 1992 Dollars)
6,928
8,525
9,429
9,369
9,337
9,326
(Percent Change From Reference Case)
9,291
9,281
9,247
-
-
-
-0.6
-1.0
-1.1
-1.5
-1.6
-1.9
(Annual Growth Rate, 2005-2010, Percent)
I
-
2.0
1.9
1.8
1.8
1.7
1.7
1.6
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model of the U.S. Economy.
Table ES6. Projected Impacts on Gross Domestic Product, 2005 and 2020
2020
2005
Refer-
1990
1990
1990
1990
1990
Variable
1996
Reference
ence
+24%
+14%
+9%
1990
-3%
-7%
Potential GDP
(Billion 1992 Dollars)
6,930
8,585
10,994
10,968
10,961
10,954
10,940
(Percent Change From Reference Case)
10,933
10,925
-
-
-
-0.2
-0.3
-0.4
-0.5
-0.6
-0.6
(Annual Growth Rate, 2005-2020, Percent)
I
-
1.7
1.6
1.6
1.6
1.6
1.6
1.6
Actual GDP, Assuming Personal Income Tax Rebate
(Billion 1992 Dollars)
6,928
8,525
10,865
10,815
10,808
10,796
(Percent Change From Reference Case)
10,799
10,793
10,782
-
-
-
-0.5
-0.5
-0.6
-0.6
-0.7
-0.8
(Annual Growth Rate, 2005-2020, Percent)
-
-
1.6
1.6
1.6
1.6
1.6
1.6
1.6
Actual GDP, Assuming Social Security Tax Rebate
(Billion 1992 Dollars)
6,928
8,525
10,865
10,840
10,832
10,828
(Percent Change From Reference Case)
10,833
10,835
10,842
-
-
-
-0.2
-0.3
-0.3
-0.3
-0.3
-0.2
(Annual Growth Rate, 2005-2020, Percent)
-
I
1.6
1.6
1.6
1.6
1.6
1.6
1.6
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model of the U.S. Economy.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xxiii
Figure ES16. Projected Dollar Losses in Potential
Figure ES17. Projected Changes in Potential and
GDP Relative to the Reference Case,
Actual GDP in the 1990+9% Case
1998-2020
Relative to the Reference Case Under
Billion 1992 Dollars
10
Different Fiscal Policies, 1998-2020
Billion 1992 Dollars
50
0
Potential GDP
-10 -
0
1990+24%
-20 -
-50
-30 -
1990+9%
-100
-40
Actual GDP,
Reference Case
Social Security
-50 -
Potential GDP:
Tax Rebate
-150 -
Reference Case
1996 = $ 6,930
Potential GDP:
-60
2010 = $ 9,482
2020 = $10,994
1996 = $ 6,930
-200
2010 = $ 9,482
Actual GDP,
-70
Personal Income
2020 = $10,994
1995
2000
2005
2010
Tax Rebate
2015
2020
-250
Note: Carbon permit revenues are assumed to be returned to
1995
2000
2005
2010
2015
2020
households through reductions in personal income taxes.
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
of the U.S. Economy.
of the U.S. Economy.
"potential" output of the economy when all
levels. The personal income tax cut essentially returns
resources-labor, capital, and energy-are fully
collected revenues to consumers, helping to maintain
employed. As such, potential GDP is equivalent to the
personal disposable income. Like the personal income
full employment concept in other analyses that focus on
tax cut, the social security tax cut returns collected funds
long-run growth while abstracting from business cycle
to the private sector of the economy, ameliorating the
behavior. Figure ES16 shows the losses in the potential
near-term impacts of higher energy prices. Although
economic output, as measured by potential GDP, for the
consumers and businesses still would face much higher
three carbon reduction cases. The shapes of the three tra-
relative prices for energy than for other goods and serv-
jectories mirror the carbon price trajectories.
ices, disposable income is maintained near reference
case values to the extent that funds flow back to consum-
The ultimate impacts of carbon mitigation policies on
ers.
the economy will be determined by complex interac-
tions between elements of aggregate supply and
In the fiscal policy settings, higher prices in the economy
demand, in conjunction with monetary and fiscal policy
place upward pressure on interest rates. The Federal
decisions. As such, cyclical impacts on the economy are
Reserve Board seeks to balance the consequences of
bound to be characterized by uncertainty and contro-
higher energy prices on the economy and possible
versy. However, raising the price of energy and down-
adverse effects on output and employment by making
stream prices in the rest of the economy could introduce
adjustments to the Federal funds rate. The adjustments
cyclical behavior in the economy, resulting in employ-
would be designed to moderate the possible impacts on
ment and output losses in the short run. The measure-
both inflation and unemployment, and to return the
ment of losses in actual output for the economy, or
economy to its long-run growth path.
actual GDP, represents the transitional cost to the aggre-
gate economy as it adjusts to its long-run path.
Figure ES17 shows the projected impacts on both actual
Resources may be less than fully employed, and the
and potential GDP for the two hypothetical fiscal poli-
economy may move in a cyclical fashion as the initial
cies (income tax and social security tax cuts) in the
cause of the disturbance-the increase in energy
1990+9% case. The figure indicates that, in the 2008 to
prices-plays out over time.
2012 period, the short-run cyclical impact on actual GDP
is larger than the long-run impact on potential GDP;
Collection of money from a permit auction system
however, the two output concepts begin to converge by
necessitates a careful consideration of appropriate fiscal
2015, and by 2020 they have merged into a steady-state
policy to accompany the carbon reduction policy. Two
path reflected by potential GDP. Monetary policy is
alternative fiscal policies are analyzed, both returning
instrumental in balancing inflation and unemployment
collected revenue back to agents in the economy: a cut in
impacts through the adjustment period, acting in a man-
personal income taxes and a cut in social security taxes
ner to bring the economy back to its long-run growth
as they apply to both employers and employees. In both
path.
cases, the Federal deficit is maintained at reference case
xxiv
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Figure ES18. Projected Annual Growth Rates in
Figure ES19. Projected Annual Growth Rates in
Potential and Actual GDP, 2005-2010
Potential and Actual GDP, 2005-2020
Percent per Year
2.5 -
Percent per Year
2.5
-
Reference
1990+24%
1990+9%
Reference
1990+24%
1990+9%
2.0
2.0 -
1.5
1.5 -
1.0
1.0 -
0.5
0.5 -
0
0
Potential GDP
Actual GDP,
Actual GDP,
Potential GDP
Actual GDP,
Actual GDP,
Assuming
Assuming
Assuming
Assuming
Personal Income
Social Security
Personal Income
Social Security
Tax Rebate
Tax Rebate
Tax Rebate
Tax Rebate
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model
of the U.S. Economy.
of the U.S. Economy.
Table ES7. Projected Losses in Potential and Actual GDP per Capita, Average Annual Values, 2008-2012
(1992 Dollars per Person)
Loss in Actual GDP
Loss in Actual GDP
Loss In Potential GDP
per Capita,
per Capita,
Analysis Case
per Capita
Personal Income Tax Rebate
Social Security Tax Rebate
1990-3%
193
947
428
1990+9%
106
567
305
1990+24
40
294
187
Source: Simulations of the Data Resources, Inc. (DRI) Macroeconomic Model of the U.S. Economy.
The choice of the accommodating fiscal policy is also key
year when the social security tax rebate is assumed.
to the assessment of the ultimate impacts on the econ-
However, through 2020, with the economy rebounding
omy. While the personal income tax option moderates
back to the reference case path, there is no appreciable
the impacts through a return of funds to consumers, the
change in the projected long-term growth rate. The
social security tax option has cost-cutting aspects of
results for the 1990+24% and 1990-3% cases are similar.
lowering the employer portion of the tax, which serves
to reduce inflationary pressures in the aggregate econ-
Aggregate impacts on the economy, as measured by
omy. On the employer side, the reduction in employer
potential and actual GDP, are shown in Table ES7 in
contributions to the social security system would lower
terms of losses in GDP per capita. In the 1990+9% case,
costs to the firm and, thereby, moderate the near-term
the loss in potential GDP per capita is $106; however, the
price consequences to the economy. Since it is the price
loss in actual GDP for in the 1990+9% case is $567
effect that produces the predominately negative effect
assuming the personal income tax rebate and $305
on the economy, any steps to reduce inflationary
assuming the social security tax rebate. Again, the lower
pressures would serve to moderate adverse impacts on
value (loss in potential GDP) represents an unavoidable
the aggregate economy.
loss per person, and the higher values (loss in actual
GDP) reflect the highly uncertain, but significant,
Another way to view the macroeconomic effects is by
impacts that individuals could experience as the result
looking at the effects of the carbon reduction cases on the
of frictions within the economy. To provide perspective,
growth rate of the economy, both during the period of
actual GDP per capita averages $31,528 in the reference
implementation from 2005 through 2010 and then over
case between 2008 and 2012.
the entire period from 2005 through 2020 (Figures ES18
and ES19). In the reference case, potential and actual
GDP grow at 2.0 percent per year from 2005 through
2010. In the 1990+9% case, the growth rate in potential
Sensitivity Cases
GDP slows to 1.9 percent per year, and the growth rate
This analysis includes several sensitivity cases designed
in actual GDP slows to 1.6 percent per year when the
to examine alternative assumptions that may have
personal income tax rebate is assumed or 1.8 percent per
significant impacts on energy demand and carbon
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
XXV
emissions over the next 20 years, including higher and
energy demand grows faster, as higher manufacturing
lower economic growth, faster and slower availability
output and higher income increase the demand for
and rates of improvement in technology, and the con-
energy services, resulting in higher carbon emissions.
struction of new nuclear power plants. The sensitivity
Assumptions of lower growth in population, the labor
cases illustrate how such factors influence the results of
force, and labor productivity result in an average annual
the carbon reduction cases. With the exception of the
growth rate of 1.3 percent in the low economic growth
nuclear power case, the sensitivity cases are analyzed
case, resulting in lower carbon emissions.
relative to the 1990+9% case.
Because each sensitivity case is constrained to the same
With higher economic growth, both industrial output
and energy service demand are higher. As a result,
level of carbon emissions as the case to which it is
carbon prices must be correspondingly higher to attain a
compared, the primary impact is not on the carbon
given carbon emissions target. In the high
emissions levels, or even on aggregate energy
macroeconomic growth case, the carbon price in 2010 is
consumption, but rather on the carbon price required to
$215 per metric ton, $52 per metric ton higher than the
meet the emissions target. For example, in the high
carbon price of $163 per metric ton in the 1990+9% case
technology case, projected carbon emissions during the
with reference growth assumptions (Figure ES20). In the
compliance period are the same as in the corresponding
low macroeconomic growth case, the carbon price in
reference technology case. What differs is the cost of
2010 is $128 per metric ton. The higher carbon prices
meeting the target, as reflected in the required carbon
price.
necessary to achieve the carbon reductions with higher
economic growth have a negative impact on the
Macroeconomic Growth
economy and the energy system. Nevertheless, total
energy consumption in 2010 is higher with higher
The assumed rate of economic growth has a strong
economic growth, by 2.2 quadrillion Btu relative to the
impact on the projection of energy consumption and,
1990+9% case, which assumes the same economic
therefore, on the projected levels of carbon emissions.
growth rate as the reference case. In the low economic
Two sensitivity cases explore the effects of higher
growth case, total energy consumption is lower by 2.2
and lower economic growth on the cost of reducing car-
quadrillion Btu in 2010.
bon emissions to the 1990+9% level. Higher eco-
nomic growth results from higher assumed growth in
In order to meet the carbon reduction targets with
population, the labor force, and labor productivity,
higher economic growth, there is a shift to less carbon-
resulting in higher industrial output, lower inflation,
intensive fuels and higher energy efficiency. On a secto-
and lower interest rates. As a result, GDP increases at an
ral basis, higher economic growth affects total energy
average rate of 2.4 percent a year through 2020, com-
consumption in the industrial and transportation sectors
pared with a growth rate of 1.9 percent a year in the ref-
more significantly than in the other end-use sectors.
erence case. With higher macroeconomic growth,
Total consumption of both renewables and natural gas is
higher, primarily for electricity generation but also in
Figure ES20. Projected Carbon Prices in the
the industrial sector. Coal use for generation is lower,
1990+9% High and Low Economic
and the use of nuclear power is higher as a result of the
Growth and High and Low
higher carbon prices. Petroleum consumption is also
Technology Sensitivity Cases, 2010
higher with higher economic growth, both in the trans-
1996 Dollars per Metric Ton
portation and industrial sectors.
250 -
243
215
Total energy intensity is lower in the high economic
200 -
growth case, partially offsetting the increases in the
163
163
demand for energy services caused by the higher
150
growth assumption. With higher economic growth,
128
121
there is greater opportunity to turn over and improve
the stock of energy-using technologies. In addition, the
100
higher carbon price induces more efficiency improve-
ments and some offsetting reductions in energy service
50 -
demand, moderating the impacts of higher economic
growth. With higher economic growth, aggregate
0
energy intensity declines at an average annual rate of 1.9
Low Reference High
Low Reference High
percent through 2010, compared to 1.6 percent with ref-
Growth Growth Growth
Tech-
Tech-
Tech-
erence economic growth. The opposite effects on energy
nology nology nology
intensity occur with lower economic growth, with the
Source: Office of Integrated Analysis and Forecasting, National Energy
Modeling System runs FD09ABV.D080398B, LMAC09.D080698A, HMAC09.
decline in energy intensity slowing from 1.6\percent to
D080598A, FREEZE09. D080798A, and HITECH09.D080698A.
1.3 percent between 1996 and 2010.
xxvi
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
Technological Progress
nology assumptions, the carbon price increases to $243
The rates of development and market penetration of
per metric ton in 2010.
energy-using technologies have a significant impact on
In the high technology sensitivity case, total energy con-
projected energy consumption and energy-related car-
sumption in 2010 is lower by 2.1 quadrillion Btu, or
bon emissions. Faster development of more energy-
about 2 percent, than in the 1990+9% case with reference
efficient or lower-carbon-emitting technologies than
technology. Delivered energy consumption in both the
assumed in the reference case could reduce both con-
industrial and transportation sectors is lower as effi-
sumption and emissions; however, because the refer-
ciency improvements in industrial processes and most
ence case already assumes continued improvement in
both energy consumption and production technologies,
transportation modes outweigh the countervailing
effects of lower energy prices. In the residential and
slower technological development is also possible.
commercial sectors, the effect of lower energy prices bal-
To analyze the impacts of technology improvement,
ances the effect of advanced technology, and consump-
high technology assumptions were developed by
tion levels are at or near those in the reference
experts in technology engineering for each of the
technology (1990+9%) case. In the generation sector, coal
energy-consuming sectors, considering the potential
use for generation is 40 percent higher than with refer-
impacts of increased research and development for
ence technology assumptions, due to efficiency
more advanced technologies. The revised assumptions
improvements and the lower carbon price.
included earlier years of introduction, lower costs,
In the low technology sensitivity case, the converse
higher maximum market potential, and higher efficien-
trends prevail. In 2010, total energy consumption is
cies than assumed in the reference case.⁹ Also, this
higher by 1.5 quadrillion Btu than in the 1990+9% case
sensitivity case assumed the availability of carbon
with reference technology assumptions. Delivered
sequestration technology for coal- and natural-gas-fired
energy consumption is higher in the industrial and
power plants, which would remove carbon dioxide and
transportation sectors and lower in the residential and
store it in underground aquifers; however, the technol-
commercial sectors, suggesting that industry and trans-
ogy is uneconomical relative to other technologies
portation are more sensitive to technology changes than
because of its high operating and storage costs.
to price changes, and the residential and commercial
These technological improvements were developed
sectors are more sensitive to price changes. With the
under the assumption of increased research and devel-
higher carbon prices in the low technology case, coal use
opment, and they are distinct from the more rapid adop-
is further reduced in the generation sector, and more
tion of advanced technologies that occurs with higher
natural gas, nuclear power, and renewables are used to
energy prices in the carbon reduction cases. It is possible
meet the carbon reduction targets.
that further technology improvements could occur
Nuclear Power
beyond those in the high technology sensitivity case if a
very aggressive research and development effort were
In the reference case, nuclear electricity generation
established. The low technology sensitivity case
declines significantly because 52 percent of the total
assumes that all future equipment choices are made
nuclear capacity available in 1996 is assumed to be
from the end-use and generation equipment available in
retired by 2020. A number of units are retired before the
1998, with new building shell and industrial plant effi-
end of their 40-year operating licenses, as suggested by
ciencies frozen at 1998 levels. Comparing this sensitivity
industry announcements and analysis of the age and
case to a case with reference technology assumptions
operating costs of the units. In the carbon reduction
demonstrates the importance of technology improve-
cases, life extension of the plants can occur if it is eco-
ment in the reference case.
nomical; and there is an increasing incentive to invest in
nuclear plant refurbishment with higher carbon prices.
Because faster technology development makes
However, these cases do not allow the construction of
advanced energy-efficient and low-carbon technologies
new nuclear power plants, given continuing high capital
more economically attractive, the carbon prices required
investment costs and institutional constraints associated
to meet carbon reduction levels are significantly
with nuclear power. A nuclear power sensitivity case
reduced. Conversely, slower technology improvement
examines the impact of allowing new plants to be con-
requires higher carbon prices (Figure ES20). With high
structed. Because nuclear plants still are not economi-
technology assumptions, the carbon price in 2010 is $121
cally competitive with fossil and renewable plants in the
per metric ton, $42 per metric ton lower than the carbon
1990+9% case, the nuclear power sensitivity case was
price of $163 per metric ton in the 1990+9% case with the
analyzed against the 1990-3% case. In addition to allow-
reference technology assumptions. With the low tech-
ing new nuclear plants, the higher costs assumed in the
⁹The design of the high technology sensitivity case differs from the high technology cases in AEO98, which generally did not include an
analysis of improvements for specific technologies.
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
xxvii
reference case for the first few advanced nuclear plants
In addition to the uncertainties concerning the final
were reduced in this sensitivity.
interpretation and implementation of the Kyoto Proto-
col, specific actions that might be taken to reduce green-
Relative to the 1990-3% case, 1 gigawatt of new nuclear
house gas emissions in the United States have not been
capacity is added by 2010 in the nuclear power sensitiv-
formulated. Actions taken by other Annex I countries to
ity case, and 41 gigawatts, representing about 68 new
reduce emissions, future growth in worldwide energy
plants of 600 megawatts each, are added by 2020. With
consumption and emissions, and the opportunities for
most of the impact from the new nuclear plants coming
reducing emissions through joint implementation and
after the commitment period of 2008 through 2012, there
the CDM are unknown, and they are likely to have
is little impact on carbon prices in 2010. By 2020, how-
important impacts on the international trade of carbon
ever, carbon prices are $199 per metric ton with the
permits and the carbon permit price. This analysis
assumption of new nuclear plants, as compared with
assumes that auctioned permits will constrain carbon
$240 per metric ton in the 1990-3% case with the refer-
emissions and raise the price of fossil fuels, with reve-
ence nuclear assumptions. In 2010, total energy con-
nues from the auction recycled to consumers either
sumption is about the same in this sensitivity case as in
through personal income tax or social security tax
the 1990-3% case, but in 2020 it is about 1.8 quadrillion
rebates. Alternative carbon reduction programs and fis-
Btu higher. Somewhat lower energy prices induce
cal policies would be likely to change the cost of carbon
higher consumption in all sectors, and the availability of
reduction from the costs in this analysis. The timing of
more carbon-free nuclear generation allows the carbon
carbon reduction programs and the amount of adjust-
reduction target to be met with higher end-use con-
ment time allowed could also be important in determin-
sumption.
ing costs.
Future technology development also cannot be known
Uncertainties in the Analysis
with certainty and may have a significant effect on the
cost of achieving carbon reductions. The technology sen-
The reference case projections in both AEO98 and this
sitivity cases in this analysis explore some of the poten-
analysis represent business-as-usual forecasts, given
tial impacts, but even the high technology sensitivity
known trends in technology and demographics, current
does not include possible breakthrough or speculative
laws and regulations, and the specific methodologies
technologies. On the other hand, even the reference case
and assumptions used by EIA. Because EIA does not
technology assumptions include continued develop-
include future legislative and regulatory changes in its
ment of more energy-efficient and renewable technolo-
reference case projections, the projections provide a
gies, which serve to mitigate the costs of carbon
policy-neutral baseline against which the impacts of pol-
reduction. Those technology improvements are likely,
icy initiatives can be analyzed.
but not certain.
Results from any model or analysis are highly uncertain.
Finally, consumer response to carbon initiatives is
By their nature, energy models are simplified represen-
uncertain. Because energy price changes that have
tations of complex energy markets. The results of any
occurred in the past may not provide sufficient evidence
analysis are highly dependent on the specific data,
about the reaction of consumers to sustained high
assumptions, behavioral characteristics, methodologies,
energy prices, changes in demand as a result of the
and model structures included. In addition, many of the
higher carbon fees cannot be projected with confidence.
factors that influence the future development of energy
In addition to price-induced changes, consumers might
markets are highly uncertain, including weather, politi-
also respond to climate change initiatives and a national
cal and economic disruptions, technology development,
commitment to reduce emissions by adopting more
and policy initiatives. Recognizing these uncertainties,
energy-efficient or renewable technologies sooner than
EIA has attempted in this study to isolate and analyze
expected. Finally, public acceptance of large-scale
the most important factors affecting future carbon emis-
renewable technologies or the continuation of nuclear
sions and carbon prices. The results of the various cases
power-both of which make important contributions to
and sensitivities should be considered as relative
the achievement of the carbon emissions reductions at
changes to the comparative baseline cases.
the costs projected in this analysis-cannot be known
with certainty.
xxviii
Energy Information Administration / Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity
09/24/98 THU 17:41 FAX 202 6222633
1
001
Office of Economic Policy
Department of the Treasury
Washington, D.C. 20220
ac: Jy
FAX
5AA
Date:
9 1/24/98 124
OF
Number of pages including cover sheet: 9
cong
Name
Fax Number
Phone Number
To:
David Doniger 260-5155
David Sandalow 456-2710
David Gardiner 260-0275
Dirk Forrister 395-2311
Mark Mazur
586-9626
Janet Anderson 395-2311
Jeff Frankel 395-6947
Jeremy Symons 565-2134
Joe Aldy/Steve Polasky 395-6870 Laurence Campbell 482-0325
Victoria Greenfield 647-5713
From: Bob Cumby
202-622-2633
202-622-0572
REMARKS:
Urgent
For your review
Reply ASAP
Please comment
zoranne>
2
fix
2318
09/24/98 THU 17:41 FAX 202 6222633
002
September 24, 1998
To:
Early Action Group
From: Bob Cumby
Subject: Latest Draft, etc.
I have attached the latest draft of the early action memo. The following parts are new:
1. Guiding Principles these were provide by Dirk. Let me know if they are agreeable
and if it needs some prose to go along with the bullets.
2. The section on no penalty for early action and the section on credit for early action
have been separated and the no penalty part is largely new.
3. The caps section is new. Please let me know if you think that this accurately reflects
the view and if it does so in a way that is appropriate for this document.
4. The one size fits all section is new.
Please have a look, especially at the new pieces and let me know what further changes you would
like to make. Fax (622-2633), phone (622-0572) or e-mail ([email protected]) are
all fine.
In our discussion of caps at the last meeting, the need for some analysis of the potential size of an
early credit program came up. I have also attached some analysis that was done by the EPA.
Please have a look. I will schedule another meeting to see what kind of consensus we can reach.
I believe that we reached consensus at our last meeting on only two issues: That if we have caps,
first-come-first-served is better than true-up and that setting a setting a benchmark as change
from BAU is the worst option among those listed.
09/24/98 THU 17:42 FAX 202 6222633
0
003
Principles and Design Issues for an Early Credit Mechanism
President Clinton promised in his October 1997 speech that companies that "showed the way" in
reducing emissions early would receive appropriate credit for their efforts. The Administration is
committed to assuring that firms will not be penalized for acting early and is exploring ways to
provide positive incentives to reduce emissions through voluntary, cost-effective measures. An
early credit mechanism, while complementing efforts to reduce emissions through a cap and
trade program during the commitment period, should not restrict or pre-judge the design of the
cap and trade program.
Why Early Credit?
To reduce the costs to the U.S. economy of compliance with the Kyoto Protocol.
Economic costs are minimized when firms adjust more slowly over time to their required
changes in production patterns, rather than suddenly in 2008. By acting early, firms can
incorporate carbon considerations into their natural pattern of capital turnover.
To provide the environmental benefit of earlier emissions reductions. The ultimate
concentration of greenhouse gasses in the atmosphere determines global warming, SO
there benefits to reducing the flow of emissions in years prior to the commitment period.
To the extent that an early credit mechanism reduces pre-2008 emissions below what they
would otherwise have been, we reap these benefits.
Guiding Principles for Early Action Mechanisms
Any mechanism for providing credit for early action should:
be market driven
be simple and straightforward
provide fair reward for real environmental gain
have broad appeal to both historic and future emitters
minimize free riders
be transparent to the public
avoid prejudging the design of a future domestic cap-and-trade system
1
09/24/98 THU 17:42 FAX 202 6222633
004
No Penalty for Early Action
There are at lcast three ways to make sure that those acting early to reduce greenhouse gas
emissions will not be penalized. It would not be necessary to specify what means would be
chosen, but only to provide assurances that the approach ultimately adopted will not penalize
early action.
Baseline protection. If emissions allowances were allocated according to a formula based
on past emissions, we could choose a reference year for the formula (the baseline) early
enough so as not to penalize early action.
The exact year is subject to discussion. But it is worth noting that choosing a year
before 1999 could lead to potentially large data difficulties, as there are not
comprehensive and comparable data on emissions for all entities to whom permits
may be allocated.
Performance standards. If emissions allowances were allocated according to some
performance-based benchmark, that standard could be set without reference to historical
performance or the reference year for the standard could be set early enough so as not to
penalize early action.
Auction. If emissions allowances are auctioned in 2008, there would be no penalty for
early action.
Credits for Early Action
Credits for early actions. Explicit credits could be allocated for actions taken before
2008. These credits could be redeemed in some fashion for permits in 2008.
The total amount of permits that are given away through an early credit
mechanism would be subtracted from the amount of permits allocated in 2008
through other mechanisms. But it is important to recognize that an early credit
mechanism would not affect our assigned amount for the first commitment period.
It would it only affect the distribution of the assigned amount by shifting some
permits from those who would otherwise have been allocated permits in 2008 to
those who took early actions.
Credit for early action and allocation mechanism that do not penalize early action could
be combined in some way.
A Two Part Early Credit System
We could implement a two part early action system.
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005
In the first part, we could give credit for actions taken before the system is announced.
There could be a separate cap for credits for this period. This part would rely on the best
available data from firms for the past, and could involve auditing firm-specific reports on
emissions.
In the second part, we could give credit for actions taken after the mechanism has been
announced but before 2008. This part could have its own cap, but the value of that cap
may depend on the level of early credits claimed for the first period. Before the
beginning of the second part, we could establish a consistent data reporting system to ease
the monitoring and measurement of early credit.
Issues with an Early Credit System
Caps vs. an Open-Ended System
We could establish a cap for the total quantity (measured in tons of assigned amount) of early
action credits or we could leave the quantity the could be allocated unspecified.
Caps would limit the quantity of "anyway tons" that are allocated in an early credit
system both by restricting the total quantity allocated and by reinforcing a rigorous set of
criteria for allocating early credit. A capped system would also reduce the risk that the
early credit system would prejudge the ultimate allocation mechanism.
On the other hand, a capped system-especially if only a relatively small fraction of
available units are allocated to those seeking credit for early action-might create the
mistaken impression that the system is not serious.
First Come First Served V.S. "Truing Up" at End of Period
If caps are adopted, there could be at least two alternatives for allocating credits.
One alternative would provide credits that have a set, predetermined value (such as one
credit equals one ton of emissions) and would allocate the credits on a first-come-first-
served basis. This approach provides firms certainty over the value of their actions, but
could create substantial inequities across firms.
An alternative would "true up" the quantity of credits at the end of the period, by
comparing the number of credits claimed with the level of the cap. The credits could, for
example, be worth up to one ton each, and perhaps less if there are more credits claimed
than the size of the cap. This doesn't create inequities but does create uncertainty over
the value of early action credits.
What is the Appropriate Measure for Early Credit?
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006
Emissions Levels: This is the ultimate metric for meeting our Kyoto targets. But this approach
could reward firms for shrinking and penalize firms for growing, potentially creating difficulties
with mergers or divestitures, and firm definition.
Emissions Rates (e.g. carbon per unit of output): This approach could appropriately adjust for
changes in scale of business to reward firm efforts to reduce carbon intensity. But it doesn't
solve problems with firm definition and could create additional difficulties with aspects of
measurement (e.g. what is a unit of output?).
Project-by-Project Evaluation (akin to JI): This approach could limit problems with defining the
firm, since it doesn't require firm-wide baseline measurement and emissions tracking (as project
is evaluated assuming no change in other firms' behavior). But it could be administratively
unwieldy and non-comprehensive (if, for example, firms are able to claim credits for their
activities that reduce emissions without claiming debits for activities that increase emissions).
Options for Defining the Baseline
Changes from Starting Point (reductions in emissions levels or rates from some base year
credited for early action): This approach could provide relatively easy administration of the early
action system, and it may make it relatively easy for firms to qualify because, for example, there
is a naturally occurring level of emissions rate reductions over time.
Changes from Projected Reduction Schedule (e.g. firms only rewarded for early action if they
reduce emissions rates by more than 1% per year): This remains relatively straightforward to
administer, and could more tightly reward those firms that are truly increasing efficiency. But it
may, for steep reduction schedules, limit the breadth of participation in an early action system
and therefore potentially limit the economic and environmental gains.
Changes from Business As Usual (project business as usual trajectories for emissions levels or
rates, and reward only improvements from those business as usual projections): This approach
could account for changes in firm size and other developments over time that naturally affect
emissions levels or rates. But it would likely introduce substantial administrative complexities.
Predefined set of eligible actions or technologies (set up a menu of actions that would be eligible
to receive credit, e.g. improving the carbon efficiency of a boiler by a prespecified amount): This
approach may be the easiest to administer, particularly for early action credits given for past
actions. But it could run into potential administrative difficulties with "picking winners"
(eligible actions or technologies), and may exclude legitimate but harder to define activities.
The Scope of Emissions Measurement
Direct and Indirect Emissions from Production: Firms are responsible for both direct emissions
(those coming out of their stacks) and indirect emissions (those emissions occurring beyond the
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007
boundary of the firm as a result of the firm's activity). The question of whether to include these
indirect emissions raises a tradeoff between comprehensiveness (including only direct emissions
may preclude cost-effective indirect reduction opportunities) and administrative tractability
(reporting indirect emissions could be very burdensome). It also raises difficult issues of double-
counting across firms.
Emissions From Production vs. Consumption: On the one hand, firms could qualify for credits
for emissions reduction related to their own energy use in production. On the other hand, firms
may want credits for reducing the carbon intensity of their products, or for activities such as
demand side management. Once again, there is a tradeoff here between comprehensiveness and
administrative tractability. Double counting is also a concern.
One Size Fits All vs. Industry-Specific Programs
An early credit mechanism could allow for industry-specific programs with potentially different
measures, choices of baseline, and scope of emissions measurement or it could adopt a common
set of choices on these design issues.
Data and Measurement Issues
Defining a Firm: Firm level, rather than plant level, measurement could provide a more
comprehensive system of accounting for early action. If, for example, the full range of a firm's
activities are not taken into account, early credit might be granted to units that are performing
well on emissions or efficiency but not subtracted for units that are not. But environmental
regulation is traditionally focused at the plant level, and firm-level measurement raises a host of
new issues such as joint ownership of plants and mergers and divestitures.
Measuring Carbon Efficiency: The basic concept of carbon efficiency is to compare carbon
utilization to production. If production is measured by dollars of sales, this is fairly
straightforward; but dollars of sales has a number of problems, such as the fact that changes in
market prices which have nothing to do with energy or carbon efficiency will change the
measured efficiency. For example, how would we account for the fact that auto prices are rising
over time while computer prices are falling. If production is measured by units of sales or
production, we face a new issue of how to measure units when a company's product mix may be
changing.
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Calculations of Potential Size of Early Credits
Several calculations are presented below to give a feel for how much credit might be
given under a policy to reward early action, depending on how the program is structured. This
paper compares the amount of claimed credit against an approximation of the first budget under
the Kyoto Protocol (7700 mmice from 2008-2012), although this estimate of the budget period
does not include the impact of sinks or the Clean Development Mechanism. Note that the below
analysis is based on the United States Climate Action Report 1997, which is calibrated 10 major
cconomic assumptions in the Annual Energy Outlook 1997. The Annual Energy Outlook 1998
projects significantly higher growth in U.S. greenhouse gas emissions.
U.S. Greenhouse Gas Emissions
All 6 Greenhouse Gases (Does Not Include Sinks)
2500
Total Credits (Shawn
as % of First Budget)
30% (Anyway Tons)
2000
15% (CCAP)
30% (New)
1500
MUTCE
Frozen C/GDP Intensity (in energy sector)
Business As Usual
1000
Current Policy (CCAP)
Straight Line to 7% Below 1990 Levels
500
0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Year
Notes: Does not Include updated N20 estimates based on revised IPCC guidelines
Source: Based on U.S. Climate Action Report, 1997
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September 24, 1998
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If credit is limited to reductions beyond normal intensity improvements. This calculation
illustrates the importance of designing a system so that it encourages additional actions over
bascline projections. Significant intensity improvements are forccasted to occur in bascline
energy forecasts. If one assumes a frozen carbon intensity (c/gdp) in the energy sector at 1990
levels, then U.S. greenhouse gas emissions would be 2,380 mmtce higher than in the baseline
(business-as-usual) scenario between 1990 and 2008. Thus, actions and structural changes that
would have occurred in the economy anyway could account for up to 30% of the first budget
period it the early credit system is not designed to account for bascline intensity improvements.
If credit were given for actions under the Climate Change Action Plan. Between 1990 and 2008,
CCAP programs are expected to reduce cumulative U.S. greenhouse gas emissions by 1,160
mmtce, about 15% of the first budget period.
If credit were given for all actions beyond CCAP (assuming U.S. emissions declined on a straight
line traicctory toward Kyoto). If, in the aggregate, the U.S. economy approaches the Kyoto target
via a straight line reduction from 1998 levcls, then these reductions would generate additional
credits of about 2,300 mmice, about 30% of the first budget. This is an outside estimate. Other,
less aggressive pathways of U.S. emissions reductions are more likely to occur.
If credit were given only for actions taken beyond a straight Kyoto trajectory. Some proposals
have suggested only giving credit for reductions beyond a Kyoto trajectory. The amount of
credits awarded would depend on the dynamics of how individual firms respond to the credit.
Regardless, the amount of credit would be much smaller than for other options.
Voluntary Reporting Under 1605(b)
Section 1605(b) of the 1992 Energy Policy Act created a database in which firms may
report voluntary actions that reduced greenhouse gas emissions. Many firms have already
reported voluntary reductions under this system. Through 1995, for example, 142 organizations
have reported 967 projects. Amounts of reductions reported under these filings were calculated
according to a variety of methodologics and were not subject to detailed government review.
Nonethelcss, they totaled about 20 MMTCE per year in 1994 and grew to 50 MMTCE per year
in 1995 and in 1996. Because most projects already claimed will continue to deliver pollution
reductions, projects already claimed could account for about 670 mmice through 2007, or about
9% of the expected budget. Assuming the filings continued to increase, especially since there
would be a policy of rewarding credit, the actual total might be many times that amount. To the
extent that credits are awarded under 1605(b), they would likely fall into one of the three
categories alroady explored above: some have already been anticipated in the business-as-usual
baseline forecast, some have been counted towards the Climate Change Action Plan's impact,
and additional credits might contribute to a Kyoto straight-line pathway scenario.
Additional Factors Affecting the Amount of Credits Claimed
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Impacts of an "Onen" Crediting System. The numbers presented in this analysis are
based on cconomy-wide averages and therefore understate the potential credits that could
be claimed by individual companies. Additional actions that reduce emissions and could
be claimed for credit are disguised in economy-wide averages by actions that increase
carbon intensity (for example, ALO 1998 forecasts that coal generation will increase by
18% between 1996 and 2008). To the extent that firms with increasing cmissions don't
participate in the early credit program, then the credits that are claimed by other firms
may exceed what economy-wide averages would suggest.
Transaction Costs. The numbers presented in this analysis are based on "potential"
claims against an early crcdit system. However, improvements in greenhouse gas
intensity are widely dispersed throughout the economy. The scope of the early credit
system, as well as transaction costs related to claiming and redeeming credits, would limit
the number of credits that are actually claimed.
*** DRAFT -- DO NOT QUOTE OR CITE ***
September 24, 1998
1333 New Hampshire Ave., NW
Suite 1070
The
Washington, DC 20036
Aspen
(202) 736-5820
Fax (202) 293-0525
Institute
Program on Energy, the Environment, and the Economy
E-mail: [email protected]
August 31, 1998
John A. Riggs
Director
Advisory Committee
Dr. Jeffrey Frankel
James R. Schlesinger, Chairman
Member
Chairman of the Board
The MITRE Corporation
Council of Economic Advisors
Vicky A. Bailey
17th & Pennsylvania Ave., NW
Commissioner
Federal Energy Regulatory Commission
Room 314
Stephen D. Ban
Washington, DC 20502
President and CEO
Gas Research Institute
John E. Brvson
Chairman and CEO
Edison International
Dear Jeff:
Charles B. Curtis
Hogan 3 Hartson
Wilfried Czernie
At this summer's Energy Policy Forum, the members of
Senior General Manager
our Advisory Committee who attended suggested that a more
Ruhrgas
John H. Gibbons
aggressive dissemination of our results would improve our
Former Assistant to the President
likelihood of affecting policy. In response, we tried to condense
for Science and Technology
the highlights of our discussions, and particularly the
Kenneth L. Lay
Chairman and CEO
agreements reached at our final session, into a concise list of
Enron Corporation
conclusions.
Henry R. Linden
Director, Energy and Power Center
Illinois Institute of Technology
Enclosed is a copy of that list, along with a copy of a
Amory B. Lovins
Director of Research and
transmittal letter to the President and the Congressional
Vice President
Rocky Mountain Institute
leadership that was signed by several of the participants.
J. Michael McCloskey
Chairman. Sierra Club
While I believe that the conclusions are an accurate
William McCormick. Jr.
Chairman and CEO
representation of the sense of the Forum, obviously not all 100
CMS Energy Corporation
participants approved the list as written. This is noted directly
James E. Rogers. Jr
Vice Chairman. CEO and President
in the disclaimer at the end of the list and indirectly in the
Cinergy Corp.
introductory sentence of the transmittal letter.
Roger W. Sant
Chairman, The AES Corporation
Irwin M. Stelzer
We are also preparing the traditional report on the
Director, Regulatory Policy Studies
American Enterprise Institute
Forum, which will be sent to you when it is printed.
Linda G. Stuntz
Stuntz, Davis & Staffier
Clinton A. Vince, Esq.
Sincerely,
Co-Chairman
Verner. Lüpfert, Bernhard, McPherson
5 Hand
Kurt E. Yeager
President
Jack
Electric Power Research Institute
Eric R. Zausner
Jack Riggs
President, Energy Asset Management
September 1, 1998
The Honorable William Jefferson Clinton
President
The White House
Washington, DC 20500
Dear Mr. President:
We write on our own behalf as individuals and to convey what we consider to be the
conclusions of 100 energy experts convened recently by the Aspen Institute to discuss
global climate change. We are sending a virtually identical letter to the Speaker and
Minority Leader of the House and the Majority Leader and Minority Leader of the
Senate.
Preventing or limiting global climate change is a marathon, not a sprint. It requires a
long-term approach and a national consensus that will not change with the results of
every election. We recommend a high priority effort to increase public understanding
of the issues, to moderate the political aspects of the debate, and to develop public
consensus. One option for doing so would be the establishment, in consultation with
Congressional leaders, of a bi-partisan, very high level, Blue Ribbon Commission.
This educational effort, and the subsequent policy actions, should be focused primarily
on the long-term threat - unsustainable concentrations of greenhouse gases in the
atmosphere. The Aspen group agreed not to debate the science of climate change, and
many disagreed about the value and cost of substantial early emissions reductions, but
we agreed on the importance of preventing unsustainable concentrations and of the
need to begin action now.
We urge that the Kyoto Protocol not be submitted to the Senate in the near future,
where pre-emptive rejection would remove the U.S. from a political leadership role and
put America at a competitive disadvantage as the world develops a sustainable energy
system in the 21st century.
This is not, however, a call for inaction. Pending submission of the treaty, the U.S.
should move quickly to establish bilateral carbon reduction programs with key
developing countries; to increase research and development on lower carbon and
carbon-free fuels, technologies, and systems; to establish the rules for crediting early,
voluntary emission reductions; and to remove environmental, tax, and regulatory
barriers to the adoption of less carbon intensive technologies.
As these steps are being taken, national and international mechanisms and policies for
achieving long-term goals must be developed and tested. These should be sufficiently
flexible to adapt to changing scientific knowledge and to experience with
implementation.
The participants in the Aspen dialogue were a diverse group with very different
backgrounds and different views on climate change. We were encouraged to speak for
ourselves and not to be bound by our organizations' positions, and we were surprised
at the level of consensus we achieved. We believe a broad bi-partisan majority of
Americans could also agree on these positive steps. The Aspen recommendations are
attached.
Sincerely,
Jad Adam
Bennett Johnston
Chairman and CEO
Johnston & Associates
Black & Veatch
Former Chairman
Energy and Natural Resources Committee
U.S. Senate
Thomas R. Castum
Thomas R. Casten
JonathmDash Jonathan Lash
President and CEO
President
Trigen Energy Corporation
World Resources Institute
Crandes Charles B. Curtis B. Cuiter knoth74 Kenneth L. Lay
Partner, Hogan & Hartson
Chairman and CEO
Former Deputy Secretary of Energy
Enron Corporation
Clinton Administration
John H fibborn
any B.J.
John H. Gibbons
Amory B. Lovins
Former Assistant to the President
Director of Research and Vice President
for Science and Technology
Rocky Mountain Institute
Clinton Administration
Jon W Jan W. Mares W. mores
Philip PlilSharp R. Sharp
EOP Group
Lecturer in Public Policy
Former Assistant Secretary of Energy
Harvard University
Reagan Administration
Former Chairman
Energy and Power Subcommittee
U.S. House of Representatives
Persant
Roger W. Sant
Eric az R. Zausner
Chairman, The AES Corporation
President
Chairman, World Wildlife Fund
Energy Asset Management, L.L.C.
Former Deputy Federal Energy
Administrator, Ford Administration
Enclosure: Conclusions of the 1998 Aspen Institute
Energy Policy Forum on Global Climate Change
Participant List
Conclusions of the
1998 Aspen Institute Energy Policy Forum
on Global Climate Change
1.
Take a long term focus.
Climate change is a long term problem, and the focus should be on achieving
sustainable levels of greenhouse gas concentrations at the least cost, not only on near-
term emission reductions. Nevertheless, certain early actions, based on industry and
other public suggestions, are desirable to develop institutions, mechanisms,
technologies, and domestic and international support for long-term programs.
2.
Do not reject the Kyoto Protocol nor submit it for ratification now.
Submission to the Senate and pre-emptive rejection of the Protocol would
remove the U.S. from a political leadership role and put America at a competitive
disadvantage in the continuing development of a sustainable energy system.
3.
De-politicize the issue and educate the public.
U.S. political and intellectual leadership should undertake a high priority effort
to increase public understanding of the issues, moderate the political aspects of the
debate, and develop public consensus. One option for the Administration to consider
is the establishment, in consultation with Congress, of a bi-partisan, very high level,
Blue Ribbon Commission to lead in the development of a national consensus.
4.
Establish bilateral programs with developing countries.
The Administration should work aggressively and quickly to establish bilateral
carbon reduction programs with key developing countries such as China, India, and
Brazil, stressing an early start toward a cost-effective long-term reduction in the
dependence on fossil fuels.
5.
Increase R & D.
To reduce the cost of eventual stabilization of greenhouse gas concentrations,
public and private spending for research and development of lower carbon and
carbon-free fuels, technologies, and systems, including sequestration and end-use
efficiency, should be increased significantly now. Coordination between public and
private efforts should be enhanced. Commercial deployment should be left to market
choices.
6.
Set the rules for crediting early voluntary reductions.
The government, with broad industry and other public involvement, should
quickly establish rules for crediting voluntary emissions reductions against any future
standards.
7.
Review barriers to innovation.
Many lower carbon technologies and more efficient systems are available now,
but long-standing laws and regulations often discourage their adoption. These barriers
should be reviewed and, where more valuable objectives are not being served, should
be removed promptly.
8.
Ensure that policies are flexible.
Any governance mechanisms and policies should be sufficiently flexible to adapt
to changing scientific knowledge and experience with implementation.
These conclusions are issued under the auspices of The Aspen Institute and its Program on
Energy, the Environment, and the Economy. They reflect agreements reached during the
Energy Policy Forum, but the participants were not asked to sign off on the final wording.
Individuals at the Forum were asked to speak for themselves, not for their organizations, and
their participation should not imply the endorsement of their organizations.
The Aspen Institute is a non-profit, non-partisan educational organization that convenes people
of diverse perspectives and views to seek new approaches to contentious policy issues. Except as
a reflection of its participants' views, the Institute takes no position on policy issues.
how would we implanment
Pre-decisional draft. Do not cite or quote. October 1, 1998
the caps?
Seller Plus Plus - Net seller with continuous monitoring (theoretical case)
ASSIGNED AMOUNT
SELLER PLUS
BOUNDARY
NET SALES
CUMULATIVE
EMISSIONS
TIME
END OF
START OF COMMITMENT
COMMITMENT PERIOD
PERIOD
Trading restriction:
Net Sales + Cumulative Emissions > Boundary Line
Party cannot sell.
Pre-decisional draft. Do not cite or quote. October I, 1998
Seller Plus Plus -
Net seller with annual emissions reporting
(no reporting lag)
ASSIGNED AMOUNT
SELLER PLUS
BOUNDARY
NET SALES
CUMULATIVE (reported)
EMISSIONS
TIME
END OF
START OF COMMITMENT
COMMITMENT PERIOD
PERIOD
these In
Trading restriction:
Net Sales + Cumulative Reported Emissions > Boundary Line
Party cannot sell.
Pre-decisional draft. Do not cite or quote. October 1, 1998
Seller Plus Plus -
Net seller with annual emissions reporting
(6 month reporting lag & seller plus boundary shifted 6 months)
ASSIGNED AMOUNT
SELLER PLUS
BOUNDARY
NET SALES
CUMULATIVE (reported)
EMISSIONS
TIME
END OF
START OF COMMITMENT
COMMITMENT PERIOD
PERIOD
Trading restriction:
Net Sales + Cumulative Reported Emissions > Boundary Line
=>
Party cannot sell.
PRESS RELEASE
PRESS OFFICE, UNITED STATES INFORMATION SERVICE
AMERICAN EMBASSY, TOKYO TEL. 3224-5264/5265/5266 FAX. 3586-3282
"
JY
SP
UA
Remarks by Stuart E. Eizenstat
Cong. QF -Under Secretary for Economic, Business and
Agricultural Affairs
September 18, 1998
Tokyo, Japan
(As prepared for delivery)
U.S. LAUDS TOKYO MINISTERIAL
from China and Indonesia to Japan and
AND SHARES VIEWS ON COP4
the United Kingdom -- made clear their
concern about climate change and
The informal Ministerial on
described national policies and programs
climate change held in Tokyo on
that help address climate change.
September 17-18 proved very positive,
and the United States thanked our
Discussion of the Clean
Japanese hosts for putting together the
Development Mechanism, or CDM,
meeting. Among the twenty-plus
which shows real promise as a bridge
countries invited to attend, there was a
between the developed and developing
strong spirit of cooperation and shared
countries in their efforts to address the
responsibility to continue the progress on
global problem of climate change, was
climate change begun in Kyoto last
especially productive. Attendees
December. There was interest in
recognized that the projects to be covered
developing a work plan with timetables on
by the CDM can create emissions
the flexibility mechanisms - emissions
reductions with environmental benefits for
trading, Joint Implementation and the
us all. The Ministers and their
Clean Development Mechanism.
representatives generally acknowledged
CDM's potential to promote investments
An active discussion took place the
in clean growth in developing countries
domestic actions being taken by individual
and to help developed countries meet their
nations. The United States set forth in
Kyoto goals, cost-effectively, through
detail its ongoing and planned efforts,
project-generated credits against their
which include existing programs for
targets.
energy labeling on major appliances, solar
energy promotion and model energy
The Ministerial sparked a frank
conservation programs in the federal
and lively discussion of emissions trading.
government itself, $1 billion in climate-
It reflected an uncommonly clear sènse of
related assistance to some 44 developing
the balance needed between ensuring the
countries over the next five years, as well
trading system's integrity through strong
as President Clinton's $6.3 billion
rules, and maximizing its ability to
proposal for new, climate-related tax
generate emissions reductions worldwide
incentives and R&D measures. Both
by making it simple and transparent and
developing and developed countries --
allowing its full and flexible use. Trading
98-56R
September 18, 1998
is a complex issue and countries have
Kyoto mechanisms and processes will
different views on precisely how it should
work.
work. The Ministerial reflected this, yet
also made clear that trading is greatly
The United States will encourage
valued as an innovative and powerful
all countries - both developed and
approach to addressing climate change
developing -- to reiterate at COP4 the
cost-effectively. On that basis, the group
need for concerted, cooperative action to
was quite positive on balance about the
address this global problem. A concrete
prospects for progress on trading at the
step in this regard would be for Parties to
Fourth Conference of the Parties - COP4
renew their commitment to taking actions
- coming up in November in Buenos
in the context of the Framework
Aires. Based upon improved
Convention, which recognizes both the
understanding with the EU, we hope that
"common, but differentiated
emissions trading will not be a divisive
responsibilities" of developed and
issue at COP4.
developing countries and the need for a
global effort.
The Ministerial gave the twenty-
plus attendees an opportunity to consider
The United States would like to
what can be achieved at COP4 and
see greater evidence at COP4 of
beyond, but no formal conclusions were
developed and developing countries
reached. A very business-like attitude
working together on climate change. We
was taken by the Ministers and their
are encouraging discussion of a broad
representatives, with a strong focus in
array of developing country participation
discussions on identifying common
activities and acknowledgment of the
interests and feasible results for COP4.
specific contributions to limiting
In our meetings, the United States made
greenhouse gases many have made. We
clear that developing countries must be
may also be able to build confidence and
part of the solution. Meaningful
shared perspectives by engaging at COP4
participation by key developing countries
with the private sector and the NGOs.
is central, with their degree of
These groups have many skills and
commitment dependent upon their
insights to contribute, and can help us
emissions level and state of development.
move forward on issues that are
technically complex and politically
The United States sees COP4 as an
sensitive.
opportunity to renew momentum on both
the UN Framework Convention on
The key to success will be to
Climate Change and the historic Kyoto
establish COP4 as a stepping stone to the
Protocol. There seems to be a solid basis
future of our efforts on climate change,
for developing an approach to completing
one which is both credible and effective.
the elaboration of the flexibility
mechanisms - emissions trading, the
JAPAN MUST PLAY STRONG ROLE
Clean Development Mechanism.
AS GLOBAL ECONOMIC PARTNER
Our goal is to engage in frank
Over the last few days I have met
discussions on the areas of shared interest,
with a number of senior Japanese
to develop a consensus on next steps in
Government officials, businesspeople and
key areas, and to avoid unproductive
academics. I have come away from those
arguments on issues that cannot be
meetings with a fresh sense that Japanese
resolved at COP4. The United States
leaders understand the severity of Japan's
hopes that at COP4, Parties will signal
economic problems and the urgency of
clearly their commitment to move
effective action. My message is that
forward, and their understanding of the
Japan and the U.S. must be global
need for greater certainty among our
economic partners to help the world avert
people and private firms about how the
a financial crisis. I have also detected a
2
growing recognition within Japan that
In order for our global partnership
such effective action is important not only
to be fully effective, we need to resolve
for Japan, but for the region and the
bilateral differences in a spirit of
world.
cooperation and mutual respect - as
friends. We are deeply concerned about
There appears to be an increasing
Japan's rising trade surplus with the U.S.
sense of confidence that Japan will take
and the world. Our trade deficit with
actions in the three critical areas we have
Japan is likely to hit historic highs in
identified: maintaining, and
1998. It is critical that Japan's recovery
supplementing when necessary, fiscal
be, as the government of Japan itself has
stimulus; strengthening and reforming the
insisted, domestic demand-led, not export-
banking system; and deregulating and
led. Rising deficits threaten a
opening its economy. In particular, I
protectionist backlash. Japan is in a far
would like to reiterate Secretary Rubin's
different position than its East Asian
appeal two days ago, when he called on
neighbors, who must not only restructure
both opposition and majority parties to
their economies, but also increase exports
work out their differences over the
to grow.
banking bills to achieve a result that we
hope will include provisions for
We also call on Japan to resolve
substantial funding to deal with the bad
outstanding issues in insurance, film, flat
debt and address the problem of weak but
glass, and autos and auto parts in order to
solvent banks.
reduce tensions, to open its economy to
foreign investment, and its government
The U.S.-Japan partnership has
procurement and public investments to
never been more important, as the world
U.S. participation. Opening up to the
faces this looming crisis. The US will
know-how, capital and valuable
continue to do its part to strengthen the
technology and services of U.S. and other
world financial and trading system. We
foreign firms will improve the growth and
will continue to pursue policies to
productivity of Japan's once vibrant
maintain strong growth. We will continue
economy. These actions would be in tune
to keep our markets open to the goods of
with Japan's needs into the 21st century.
East Asian emerging-market countries in
distress. We will seek support for the full
Our country is committed to a
funding of our IMF package. And
positive course. My visit here has given
together with Japan and our other G-7
me renewed hope that Japan is equally up
colleagues, we will step up our efforts to
to the task.
foster a strong, viable international
financial and trade regime.
* *
But Japan, as the largest economy
in the region, must play its part. Plainly -
- the recovery of Asia depends on the
recovery of Japan, which in turn depends
upon fiscal stimulus as long as needed
until growth resumes, genuine
deregulation and dealing with Japan's
serious banking problems. This means
Japan must absorb more of the exports
from South Korea, Thailand, Indonesia,
and other countries in the region. The
burden cannot rest on our shoulders
alone.
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