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The Center for Climate and Energy Solutions seeks to inform the design and implementation of federal policies that will significantly reduce greenhouse gas emissions. Drawing from its extensive peer-reviewed published works, in-house policy analyses, and tracking of current legislative proposals, the Center provides research, analysis, and recommendations to policymakers in Congress and the Executive Branch. Read More
 

Climate-Friendly Energy Policy: Options For The Near Term


In Brief, Number 5

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The majority of U.S. greenhouse gas (GHG) emissions—84 percent—are in the form of carbon dioxide (CO2), resulting almost entirely from the combustion of fossil fuels. As a result, energy policies that reduce fossil fuel use will reduce GHG emissions. Fossil fuel use can be reduced by: (1) deploying technologies that increase energy efficiency (e.g., more efficient power plants, cars, and appliances) and (2) employing non-fossil fueled energy sources (e.g., solar, wind, geothermal, biomass, hydroelectric, nuclear energy, or renewables-based hydrogen). CO2 emissions also can be reduced by shifting from high-carbon to lower-carbon fuels (e.g., shifting from coal to natural gas in the electricity sector), and by employing carbon capture and sequestration technologies.

A “climate-friendly” energy policy can advance climate objectives while serving energy policy goals. However, a climate-friendly energy policy is not a substitute for climate policy. More significant GHG emissions reductions would be necessary in order to address climate change than can be justified solely on the basis of traditional energy policy objectives. The energy policy options outlined in this brief represent sensible and important first steps in U.S. efforts to reduce GHG emissions.

 

Introduction

Energy use and climate change are inextricably linked. The majority of U.S. greenhouse gas (GHG) emissions—84 percent—are in the form of carbon dioxide (CO2), resulting almost entirely from the combustion of fossil fuels.1  Choices made today in the current national energy policy debate will directly impact U.S. greenhouse gas emissions far into the future. Decision-makers face the challenge of crafting policies that allow the United States to meet its energy needs while acting responsibly to reduce GHG emissions.

Often, these objectives are thought of as competing goals—that energy policy and energy security issues are in conflict with environmental objectives and vice versa. In reality, there is a substantial convergence between the goals of energy policy and climate policy, and many feasible and beneficial policies from supply and security perspectives can also reduce future U.S. greenhouse gas emissions. This brief considers near-term energy policies that can be adopted in the context of the energy policy debate, short of adopting a GHG reduction program now, to best position the United States to reduce GHG emissions and to implement future climate change policies. These options make up a “climate-friendly energy policy.” This brief is drawn from a Pew Center report: Designing a Climate-friendly Energy Policy: Options for the Near Term.2

It is important to note that a climate-friendly energy policy is not a substitute for a mandatory climate policy. More significant GHG emissions reductions would be necessary in order to address climate change than can be justified solely on the basis of traditional energy policy objectives. A previous Pew Center policy brief outlines potential programs aimed specifically at GHG abatement,3  and Pew Center reports discuss options for designing a mandatory U.S. GHG reduction program4  and reducing GHG emissions from U.S. transportation.5

The Link Between Energy and Climate

Because the vast majority of GHG emissions are in the form of CO2 resulting from fossil fuel combustion, energy policies that reduce fossil fuel use will reduce GHG emissions.6  Fossil fuel use can be reduced by: (1) deploying technologies that increase energy efficiency (e.g., more efficient power plants, cars, and appliances) and (2) employing non-fossil fueled energy sources (e.g., solar, wind, geothermal, biomass7, hydroelectric, nuclear energy, or renewables-based hydrogen). CO2 emissions also can be reduced by shifting from high-carbon to lower-carbon fuels (e.g., shifting from coal to natural gas in the electricity production sector), and by employing carbon capture and sequestration technologies. Conversely, energy policies that increase fossil fuel consumption, discourage or miss opportunities for efficiency improvements, and expand reliance on high-carbon fuels will increase CO2 emissions and thereby exacerbate climate change.

Given this close relationship between energy use and GHG emissions, near-term energy policy choices have significant future implications for climate change. Climate-friendly energy policies fall into one of three general categories—policies that: 

(1) Reduce GHG emissions now;

(2) Promote technology advancement or infrastructure development that will reduce the costs of achieving GHG emissions reductions in the future; and

(3) Minimize the amount of new capital investment in assets that would be substantially devalued (or “stranded”) if a GHG program were implemented.

Energy Policy Context

A discrete and unified U.S. energy policy does not exist. Rather, policies affecting energy production and use in the United States have many sources and take a multitude of forms. For example, while this brief focuses primarily on federal energy policies, state and local governments also play a key role in regulating energy-related activities. In addition, while there are federal policies aimed directly at achieving energy objectives, there are also federal policies aimed at achieving other objectives—ranging from environmental protection to easing traffic congestion—that have indirect but nevertheless substantial impacts on energy production and use. Finally, even those policies aimed squarely at achieving energy-related objectives are shaped by other policy concerns, such as labor and foreign policy issues. Energy policy, in short, operates in multiple dimensions.

Historically, most major shifts in U.S. energy policy have been triggered by interruptions, and subsequent price increases, in crude oil supply. Such events occurred in 1973 (Arab oil embargo), 1979–80 (triggered by the Iranian revolution), and 1990 (associated with the Persian Gulf War). The policy prescriptions for reducing supply vulnerability have included increasing U.S. production of conventional and alternative fuels, emphasizing market forces, reducing demand through efficiency measures, establishing and maintaining the strategic petroleum reserve (SPR),8  and maintaining international arrangements under the International Energy Program (IEP) to coordinate petroleum stock drawdowns. Over the years, the United States has reduced its vulnerability to a physical interruption of crude oil supplies but economic vulnerability remains. U.S. oil imports continue to grow, and the OPEC countries continue to be the source of significant oil imports, leaving the transportation sector in particular—and the economy in general—exposed to supply and price risk.

Today’s energy policy debate confronts a mixture of old and new issues. The United States remains vulnerable to concerted action by oil-producing nations to curtail production and increase prices. Conflicts in Central Asia and the Middle East have brought fuel supply concerns again to the fore. Moreover, the events of September 11, 2001, have given rise to a new energy policy priority: Securing domestic energy facilities from terrorist attack. In addition, sharply increased rates of U.S. economic growth in the late 1990s exposed energy supply shortages, as well as transportation and transmission bottlenecks. The deregulation of the electric power industry in some states has created regulatory idiosyncrasies that have sharply increased prices of electricity in some regions.9  Furthermore, current U.S. energy policy is much more market-oriented, less focused on cost-based price regulation, and more focused on environmental regulation than it was in the 1970s.

Current U.S. Energy Picture

The United States supplies about three-quarters of its energy needs from domestic sources. The nation has ample sources of coal and, indeed, is a modest coal exporter. The United States also supplies about 84 percent of its own natural gas; imports, mostly from Canada, account for about 16 percent of U.S. natural gas consumption.10 Oil presents a very different picture, however. The United States imported about 55 percent of the petroleum it consumed in 2001, and imports are projected to increase.11

The United States consumes a tremendous amount of energy each year, at considerable expense. In 2001, it consumed about 97 quadrillion British Thermal Units (or “quads”) of energy, at a cost of nearly $700 billion.12 Figure 1 indicates end uses of energy by sector, with the primary energy13 used for electricity generation allocated to each sector in proportion to its electricity consumption.

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The bulk of U.S. primary energy comes from fossil fuels. Fossil fuels provided 86 percent of U.S. primary energy in 2001.14 (See Figure 2.) Non-fossil sources provided the remaining 14 percent, of which nuclear energy represented approximately 8 percent and renewable energy resources accounted for approximately 6 percent (about 40 percent of the renewable energy is hydropower). The amount of energy provided by nuclear sources is expected to increase slightly over the next few decades, but DOE does not anticipate any new nuclear facilities being built in the United States during that period.15 Hydropower output is expected to be static. Other renewable sources (biomass, wood, municipal solid waste, ethanol, geothermal, wind, and solar) now supply only 3.4 percent of total U.S. energy consumption and only 2.1 percent of total U.S. electricity generation.16 DOE projects slow growth for non-hydro renewables because of the relatively lower costs of fossil fuels for electricity generation, and because less capital-intensive natural gas technologies have an advantage in competitive electricity markets over coal and baseload renewables for new capacity.17

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Current Greenhouse Gas Emissions Picture

Greenhouse gas emissions from U.S. energy use and production are primarily CO2 emissions from the combustion of fossil fuels in the electricity generation, buildings, industrial processes, and transportation sectors.18 (See Figure 3.) CO2 from fossil fuel combustion accounts for 82 percent of total U.S. GHG emissions.19  Figure 4 shows U.S. CO2 emissions broken down by fuel source. 

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One way to view the broad relationship between energy use and CO2 missions is to examine shifts in two indices: energy intensity (measured by energy used per dollar of gross domestic product (GDP) created) and carbon intensity (measured by CO2 emissions per dollar of GDP created). The first value indicates the economy’s overall energy efficiency, while the second is a function of the fuel mix and generation technologies used to meet the nation’s energy needs. With regard to fuel mix, it is important to understand that different types of fossil fuels have different levels of carbon content. (See Figure 5.) Both energy intensity and carbon intensity are influenced by energy policy choices.

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As the U.S. economy has grown, CO2 emissions have increased, although at a slower rate than conventional measures of economic output. During the 1990s, the divergence between CO2 and GDP growth was primarily a result of lower energy intensity. From 1990 to 2001, GDP grew by about 2.9 percent per year, while CO2 from energy grew by about 1.3 percent per year, i.e., CO2 grew at about half the rate of GDP. Energy use per dollar of GDP fell by 1.7 percent per year, while CO2 emissions per unit of energy consumed have remained at roughly the 1990 level.20  This decrease in the U.S. economy’s energy intensity since the early 1990s has resulted in large part from an increase in non-energy-intensive economic sectors (e.g., computer equipment and semiconductor manufacturing) relative to traditional energy-intensive manufacturing industries (e.g., steelmaking), as well as from energy efficiency improvements.21

The primary CO2 growth components during the 1990s were electricity generation and transportation. CO2 emissions from the electric power sector grew by 24 percent between 1990 and 2001, and CO2 emissions from transportation increased 19 percent during this period.22 The demand for electricity has grown with the U.S. economy and with substantial increases in the market penetration of electricity-consuming electronic equipment, consumer appliances, and manufacturing technologies. In the transportation sector, an increasing proportion of vehicles on the road (e.g., minivans, sport utility vehicles, and light trucks) are not subject to the passenger car Corporate Average Fuel Economy (CAFE) standards, but instead are subject to the significantly less stringent “light-duty truck” CAFE standards. CAFE standards established in 1975 required new passenger car fuel economy to reach 27.5 mpg in 1985, where the standard remains today. Less was required of light trucks; standards set by the U.S. Department of Transportation increased to 20.5 mpg in 1987 and stand at 20.7 mpg today.23  The actual fuel economy of new passenger cars and light trucks has closely followed the standards, and has not increased since 1988; indeed, today’s combined fleet of passenger cars and light trucks gets fewer mpg than the vehicles sold fifteen years ago because of the growth in the proportion of light trucks in the fleet.24  Finally, all vehicles are being driven more miles as a result of relatively low gasoline prices and land-use patterns characterized by sprawl.

Economic Analysis of Energy Policy

The body of economic work on energy and climate change contains several important themes to be considered in any effort that aims to identify “climate friendly” energy policies. These key themes include:

  • Energy use in the U.S. economy is largely a function of the current equipment (or “capital stock”) used to extract, produce, convert, and use energy (e.g., machinery used in longwall coal mining, technology used to explore for and produce oil and natural gas, boilers and turbines used to convert fossil fuel to electric power, and automobiles and trucks used to transport people and goods).
  • New energy technologies usually take time to develop, mature, and find broad acceptance in the market.
  • The market penetration of improved equipment reflects economic behavior, not just technological potential.
  • Energy or fuel prices can play a substantial role in energy use and emissions outcomes, apart from long-run technology choices.
  • To the extent that policy actions alter the market supply or demand of specific fuels or energy types, such policies can change energy prices. As a consequence, future energy use decisions would be based on a new set of prices, which may affect the expected level and cost of eventual emissions reductions.
  • Expectations regarding future prices, technologies, and policies can play a large role in shaping current investment decisions. Thus, the form and direction of policy enacted in the near term can encourage market participants to alter longer-term decisions even before regulatory compliance deadlines or other milestones occur.
  • It is critical to assess the impact of today’s energy policy choices in terms of the future cost of pursuing future GHG reduction policies.

 

Policy Objectives

While U.S. energy policy has many sources, forms, and influences, it is nevertheless possible to identify four traditional objectives on which U.S. energy policy has focused: 

  1. a secure, plentiful, and diverse primary energy supply; 
  2. a robust, reliable infrastructure for energy conversion and delivery; 
  3. affordable and stable energy prices; and 
  4. environmentally sustainable energy production and use.

The policy options considered in this brief serve one or more of these objectives.

Climate-friendly energy policies fall into one of three general categories—policies that: 

  1. reduce GHG emissions now; 
  2. promote technology advancement or infrastructure development that will reduce the costs of achieving GHG emissions reductions in the future; and 
  3. minimize the amount of new capital investment in assets that would be substantially devalued (or “stranded”) if a GHG program were implemented. 

Using the criteria outlined above, the following elements of a climate-friendly energy policy have been identified:

Fossil Fuels 

Expand natural gas transportation infrastructure. Encouraging expansion of the natural gas transportation system in North America through, for example, rate incentives, streamlined permitting for pipeline and liquefied natural gas (LNG) facilities, and expedited approvals needed for construction of an Alaska natural gas pipeline, will increase the delivery capability for natural gas and lower the price of the delivered product. This will facilitate the use of gas as a substitute for coal in electricity production and thus reduce GHG emissions. 

Increase natural gas production. Encouraging increased production of natural gas in North America through, for example, tax incentives, royalty relief, and access to public land for resource development will lower the price and increase the availability of natural gas. This will, in turn, permit the use of gas as a substitute for coal in electricity production and thus reduce GHG emissions.

Electricity 

Encourage deployment of efficient electricity production technologies
. Encouraging developers of new generation capacity to employ very efficient generation technologies—with tools such as tax incentives for combined heat and power and high-efficiency distributed generation—can significantly increase the amount of useful energy gleaned from fuels, and thus reduce both energy costs and emissions. Moreover, support for repowering existing plants with technology that improves the efficiency of electricity generation can reduce electricity prices and reduce fuel consumption per kilowatt-hour (kWh), with corresponding GHG reduction benefits. Conversely, policies that discourage such investments in improved efficiency, and instead result only in energy-consuming pollution control retrofits (e.g., scrubbers to reduce conventional air pollutants), may be counterproductive from a climate perspective. Incentives for investment in advanced technologies such as carbon capture and sequestration would allow future use of coal resources without net GHG emissions.

Maintain role for nuclear and hydroelectric power. Policies that allow the safe continued use of nuclear power plants—such as granting license extensions, approving plant upratings where warranted, and finding new solutions to the nuclear waste problem—preserve diversity of energy supply, may reduce electricity prices, and avoid very substantial coal consumption for electricity generation. Likewise, maintaining or expanding hydroelectric capacity in a way that protects natural resources provides low-cost electricity without GHG emissions.

Encourage development of renewable energy resources. Policies that encourage the development of renewable energy resources—such as production tax credits, a renewable portfolio standard, electricity transmission policies that do not discriminate against intermittent renewable resources such as solar and wind, and net metering for small distributed renewable resources—can help diversify our energy portfolio and are environmentally attractive. Wind, solar, geothermal, and hydropower generation produce no GHG emissions, and use of biomass produces no net GHG emissions.

Buildings End-Use Efficiency

Promote use of efficient technologies and green design in buildings. Policies that require increased efficiency of energy end-use (such as building codes or appliance efficiency standards), and policies that encourage use of highly efficient equipment and technologies (such as tax incentives, product efficiency labeling, and Energy Star™ programs) can significantly reduce energy consumption, consumer operating costs over a product’s or building’s lifecycle, the need for investment in new power plants, and emissions related to energy use.

Industrial End-Use Efficiency

Promote the use of more efficient processes and technologies in industry. Policies that provide incentives for investment in efficient processes and combined heat and power technologies, expand coverage of efficiency standards to standard-design industrial equipment, and provide more information on efficient technologies to industrial consumers can lead to further emissions reductions in the industrial sector.

Transportation

Enhance end-use efficiency of automobiles and light trucks. Regulatory and tax policies—such as more stringent CAFE standards, reforms to the “gas guzzler” tax, efficiency standards for tires, and tax or other incentives for the purchase of highly efficient hybrid vehicles—can significantly reduce fuel consumption per mile, thus reducing oil consumption and mitigating reliance on oil imports. Very significant energy and climate policy benefits can be gained in this area. According to a recent National Research Council study, if lead times are long enough, automakers can produce substantially more fuel-efficient vehicles without increasing net consumer costs or compromising safety.25 Moreover, fundamental redesigns such as hybrid vehicles (already commercially available in some Honda and Toyota vehicles) and fuel-cell vehicles offer important additional benefits.

Research and Development

Promote research and development on efficient electricity production technologies. Federal funding or tax incentives for R&D on improving the efficiency of the electricity generation process, regardless of fuel source, can provide options to reduce future energy prices and reduce future fuel consumption per kWh, with corresponding GHG benefits.

Promote research and development on efficient end-use technologies. Federal funding or tax incentives for R&D on improving transportation, building, and industrial end-use efficiency can provide options to reduce future energy costs to consumers and to reduce future energy consumption, with corresponding GHG benefits. Support for R&D is particularly important in areas where fundamental changes are possible, such as the widespread use of hydrogen in fuel cells to power vehicles.

Promote research and development on non-fossil fuels and carbon sequestration. Federal funding or tax incentives for R&D on alternatives to fossil fuels, such as biofuels and hydrogen, can provide future viable alternatives to oil. Development of economical carbon sequestration technologies could enable continued reliance on coal consistent with a GHG regulatory regime.

 

Conclusions

A “climate-friendly” energy policy can advance climate objectives while serving energy policy goals. However, a climate-friendly energy policy is not a substitute for climate policy. More significant GHG emissions reductions would be necessary in order to address climate change than can be justified solely on the basis of traditional energy policy objectives. In the long run, we can only curb climate change by weaning ourselves of our reliance on fossil fuels. The energy policy options outlined in this brief represent sensible and important first steps in U.S. efforts to reduce GHG emissions.

 


 

Endnotes


1 CO2 from fossil fuel combustion represents 82% of U.S. GHG emissions. Only 2% of U.S. GHG emissions are CO2 released from other activities. Although most methane emissions (the second-largest GHG emissions source) come from landfills and agricultural sources, about one-third are attributable to production of natural gas or coal, or to transportation of natural gas. See U.S. DOE, EIA. 2003. Emissions of Greenhouse Gases in the United States 2001. Available at http://www.eia.doe.gov/oiaf/ggrpt .
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2 Smith, Douglas W., Robert R. Nordhaus, Thomas C. Roberts, Marc Chupka, Shelley Fidler, Janet Anderson, Kyle Danish, and Richard Agnew. Designing a Climate-friendly Energy Policy: Options for the Near Term. Pew Center on Global Climate Change. Arlington, VA. July 2002.
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3 The U.S. Domestic Response to Climate Change: Key Elements of a Prospective Program. In Brief, Number 1. Pew Center on Global Climate Change. Arlington, VA.
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4 Nordhaus, Robert R. and Kyle W. Danish. Designing a Mandatory Greenhouse Gas Reduction Program for the U.S. Pew Center on Global Climate Change. Arlington, VA. May 2003. This report identifies issues that must be addressed in the design of a mandatory U.S. GHG reduction program. Three options are specifically evaluated: (1) cap-and-trade programs, (2) GHG taxes, and (3) a “sectoral hybrid” program that combines efficiency standards for automobiles and consumer products with a cap-and-trade program applicable to large sources of greenhouse gases.
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5 Greene, David L. and Andreas Schafer. Reducing Greenhouse Gas Emissions from U.S. Transportation. Pew Center on Global Climate Change. Arlington, VA. May 2003.
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6 CO2 makes up the lion’s share of U.S. GHG emissions, but other gases also play a role in enhancing the greenhouse effect. Non-CO2 greenhouse gases account for roughly 18% of the global warming potential of U.S. GHG emissions. Some of them have a very weak effect; options to control GHG emissions have focused on the five with the strongest impact. Methane (CH4) and nitrous oxide (N2O) are created through decomposition, chemical processes, fossil fuel production and combustion, and many smaller sources. Sulfur hexafluoride (SF6) is used as an insulating gas in large-scale electrical equipment. The remaining two are hydrofluorocarbons (HFCs) used as refrigerants and perfluorocarbons (PFCs) released during aluminum smelting and used in the manufacture of semiconductors. When compared using 100-year global warming potentials, their weighted emissions are as follows: CH4, 9%;  N2O, 5%; HFC/PFC/SF6, 2%. For further discussion of non-CO2 greenhouse gases, see Reilly, John M., Henry D. Jacoby, and Ronald G. Prinn. Multi-gas Contributors to Global Climate Change. Pew Center on Global Climate Change. Arlington, VA. February 2003.
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7 CO2 emissions from the combustion of biomass are offset by CO2 removed from the atmosphere by the plants.
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8 Crude oil in the SPR plus private company stocks would cover approximately 150 days without imports.
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9 For more information about deregulation in the electric power sector, see U.S. DOE, EIA. Electric Power Industry Restructuring Fact Sheet. Available at http://www.eia.doe.gov/cneaf/electricity/page/fact_sheets/restructuring.html.  
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10 U.S. DOE, EIA. 2002. Annual Energy Review 2001. Available at http://www.eia.doe.gov/aer/contents.html.
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11 U.S. DOE, EIA. 2003. Annual Energy Outlook 2003, p. 83. Available at http://www.eia.doe.gov/oiaf/aeo . This number reflects net imports.
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12Ibid., Tables A2 and A3.
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13 “Primary energy” consists of the sum of “site energy” (the energy directly consumed by end users) and the energy consumed in the production and delivery of energy products to end users. See http://www.eia.doe.gov/emeu/consumptionbriefs/cbecs/cbecs_trends/primary_site.html.
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14 U.S. DOE, EIA. 2002. Annual Energy Review 2001, Table 1.3.
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15 U.S. DOE, EIA. 2003. Annual Energy Outlook 2003, pp. 5-6.
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16 U.S. DOE, EIA. 2002. Annual Energy Review 2001, Tables 1.3 and 8.2a.
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17 U.S. DOE, EIA. 2003. Annual Energy Outlook 2003, p. 6.
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18 In addition to CO2 emissions, energy production and use contributes two other greenhouse gases: CH4, primarily from natural gas systems and coal mining, and N2O from fuel combustion.
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19 See Endnote 1.
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20 See U.S. DOE, EIA. 2003. Emissions of Greenhouse Gases in the United States 2001, p. 26.
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21Ibid.
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22Ibid., pp. 24 and 21 (respectively).
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23 A rulemaking by the Department of Transportation, in progress at time of writing, calls for the light truck standard to be raised to 22.2 mpg by 2008.
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24 Greene and Schafer.
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25 National Research Council. 2002. Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards. Available at http://www.nap.edu/books/0309076013/html/.
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Press Release: Climate Change and the U.S. Transportation Sector

For Immediate Release
May 29, 2003

Contact:   Katie Mandes
               703-516-0606

Climate Change and the U.S. Transportation Sector: New Report Reveals Available Policy Options to Reduce GHG Emissions

Washington, DC —Transportation sources in the U.S. account for nearly a third of our nation's greenhouse gas (GHG) emissions, and are rising faster than in any other sector. It is critical that an effective climate change policy for the U.S. address these emissions. A new report released today by the Pew Center on Global Climate Change, Reducing Greenhouse Gas Emissions from U.S. Transportation, written by David L. Greene of Oak Ridge National Laboratory and Andreas Schafer of the Massachusetts Institute of Technology, identifies a number of policies and technologies that can achieve GHG reductions of the necessary scale.

"The U.S. is the owner of the world's largest transportation system, and reducing emissions from this system is critical to an effective GHG reduction strategy," said Eileen Claussen, President of the Pew Center on Global Climate Change. The U.S. transportation system emits more CO2 than any other nation’s total economy, except that of China, and presently accounts for seven of ten barrels of oil this nation consumes. Many of the actions that would reduce emissions from transportation would also address other national priorities, including U.S. dependence on imported oil.

If we start now with existing technologies and investments, it will be possible to reduce carbon emissions by about 20 percent by 2015, and almost 50 percent by 2030, compared to ‘business as usual.’ Some of the reports recommendations are:
Fuel economy for new cars and light trucks can be increased by 25-33% over the next 10-15 years using market-ready technologies. Emerging technologies, including advanced diesel engines and hybrid-electric vehicles are likely to reap fuel savings of 50-100% by 2030. These technologies could be adopted without reducing the size or performance of the vehicles.

R & D and voluntary efforts are necessary but not sufficient, mandatory policies are essential to pull technological improvements into the marketplace. Fuel economy has gotten worse, not because of lack of technology, but lack of policy.

Fuel cells and hydrogen hold out the tantalizing promise of eliminating GHG emissions from this sector, but government must provide clear policy direction in order to drive massive private investment by the fuel and vehicle industries.

The report concludes that a cost-effective portfolio of policy options to address transportation’s GHG emissions exists, but the long lead time required to turn over an entire fleet of vehicles and the supporting infrastructure mean that policies must be implemented now to create the impetus for change. "The transportation sector in the U.S. offers a myriad of choices for near-term gains in efficiency," says Eileen Claussen, "and since many are affordable and available, it is inexcusable that we are not taking advantage of them. Action needs to begin today in order to start us down the path to a low-carbon transportation future."

Solutions Series
This report is part of the Solutions series, which is aimed at providing individuals and organizations with tools to evaluate and reduce their contributions to climate change. Other Pew Center series focus on domestic and international policy issues, environmental impacts, and the economics of climate change.

A complete copy of this report-and previous Pew Center reports-is available on the Pew Center's web site, www.c2es.org/projects. An abbreviated version of this report written specifically for policy-makers, Taking Climate Change into Account in U.S. Transportation, is also available.

The Pew Center was established in May 1998 by The Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is an independent, nonprofit, and non-partisan organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.

Press Release: Two New Reports Examine Options for a Mandatory GHG Reduction Program

For Immediate Release
May 15, 2003

Contact:   Katie Mandes, 703-516-0606

DESIGNING U.S. POLICY TO ADDRESS CLIMATE CHANGE:
Two New Reports Examine Options for a Mandatory GHG Reduction Program

Washington, DC - The Pew Center on Global Climate Change today released two new reports examining design options for a U.S. greenhouse gas emissions reduction program. One report reviews lessons of emissions trading; the other evaluates multiple options for program design. "With growing Congressional interest in policy to address climate change-including the recent introduction of economy-wide cap-and-trade legislation controlling greenhouse gas emissions-the analysis of potential U.S. greenhouse gas reduction programs is timely," said Pew Center President Eileen Claussen. "These reports draw from previous experience with environmental regulation, examining the strengths and weaknesses of various policy approaches, and providing critical guidance for policy-makers."

In recent decades, emissions trading has become an important element of programs to control air pollution both domestically and internationally. In Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases, report authors A. Denny Ellerman and Paul L. Joskow of MIT, and David Harrison, Jr. of NERA review six diverse U.S. emissions trading programs, drawing general lessons for the development of greenhouse gas reduction programs. The report finds that an emissions trading program, if designed and implemented effectively, can achieve environmental goals faster and at lower costs than traditional command-and-control alternatives. The analysis suggests that a cap-and-trade program is especially attractive for controlling greenhouse gases because the warming effects of greenhouse gases are the same regardless of where they are emitted, the costs of reducing emissions vary widely by source, and the cap ensures that the environmental goal is attained.

The second Pew Center report released today - Designing a Mandatory Greenhouse Gas Reduction Program for the U.S., written by Robert R. Nordhaus and Kyle W. Danish-examines options for designing a domestic greenhouse gas reduction program. In addition to cap-and-trade programs, this report evaluates greenhouse gas taxes and a "sectoral hybrid" program that combines efficiency standards for automobiles and consumer products with a cap-and-trade program applicable to large sources of greenhouse gases. Each option is evaluated according to the following criteria: environmental effectiveness, cost-effectiveness, administrative feasibility, distributional equity, and political acceptability. The report's analysis suggests that the comprehensive, upstream cap-and-trade (or similar) approach and the sectoral hybrid approach are the most viable alternatives for a domestic program.

"In order for the United States to achieve the greenhouse gas reductions necessary to address climate change, it must implement a mandatory greenhouse gas reduction program," said Claussen. "Careful design of a domestic program is pivotal to the ultimate success of achieving greenhouse gas reductions in a cost-effective manner."

 


The Pew Center was established in May 1998 by The Pew Charitable Trusts, one of the United States' largest philanthropies and an influential voice in efforts to improve the quality of the environment. The Pew Center is an independent, nonprofit, and non-partisan organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.

Designing a Mandatory Greenhouse Gas Reduction Program for the U.S.

US Gas Report Cover

Designing a Mandatory Greenhouse Gas Reduction Program for the U.S.

Prepared for the Pew Center on Global Climate Change
May 2003

By:
Robert R. Nordhaus
Kyle W. Danish

Press Release

Download Entire Report (pdf)

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

In response to the goal of the U.N. Framework Convention on Climate Change to stabilize greenhouse gas concentrations at a level that would prevent dangerous human interference with the climate system, the United States has instituted a number of programs since 1992. These include voluntary greenhouse gas mitigation programs, research and development, and a subset of energy policies that focus on energy efficiency and renewable energy. More than a decade of experience with these programs shows that while they have at times inspired significant action on the part of individual companies, these measures have not succeeded in reducing, or even stabilizing, total U.S. emissions. U.S. greenhouse gas emissions increased roughly 12 percent between 1990 and 2001, and are projected to increase another 12 percent by 2012. In order for the United States to achieve the significant greenhouse gas reductions necessary to address climate change, it must implement a mandatory greenhouse gas reduction program.

The Pew Center asked report authors Robert Nordhaus of Van Ness Feldman, P.C., and George Washington University Law School, and Kyle Danish of Van Ness Feldman to examine options for designing a mandatory U.S. greenhouse gas reduction program. Three options are specifically evaluated: (1) cap-and-trade programs, (2) greenhouse gas taxes, and (3) a “sectoral hybrid” program that combines efficiency standards for automobiles and consumer products with a cap-and-trade program applicable to large sources of greenhouse gases. In addition to identifying design issues unique to each type of program, the authors evaluate the options according to the following criteria: environmental effectiveness, cost-effectiveness, administrative feasibility, distributional equity, and political acceptability.

The analysis suggests that a comprehensive, upstream cap-and-trade approach (or a workable variation) and the sectoral hybrid approach are the most viable alternatives for a domestic greenhouse gas reduction program. While an economy-wide cap-and-trade approach may present the best option for low-cost greenhouse gas reductions, a sectoral hybrid approach building on existing programs may evolve. Whatever approach is taken, policy-makers should attempt to reach their environmental goal in a way that incorporates market mechanisms and minimizes administrative complexity.

With growing Congressional interest in programs to address climate change—including the recent introduction of economy-wide cap-and-trade legislation controlling greenhouse gas emissions—the analysis of U.S. greenhouse gas reduction program options is timely. In addition to this review, the Pew Center is simultaneously releasing a complementary report, Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases, which examines six diverse U.S. emissions trading programs, drawing general lessons for future applications and discussing considerations for controlling greenhouse gas emissions.

The Pew Center and the authors would like to thank Joe Goffman, Granger Morgan, Tom Wilson, Ev Ehrlich, and Billy Pizer for providing comments on a previous draft of this report, Anne Smith for reviewing the description of modeling results, and William Nordhaus for his useful insights. The views expressed in this report are the authors’ and not those of the reviewers, Van Ness Feldman, or its clients.

Executive Summary

This report identifies issues that must be addressed in the design of a mandatory, domestic greenhouse gas (GHG) reduction program. Three options are specifically evaluated: (1) cap-and-trade programs, (2) GHG taxes, and (3) a “sectoral hybrid” program that combines efficiency standards for automobiles and consumer products with a cap-and-trade program applicable to large GHG emission sources.

Criteria for Evaluating Options

In order to compare various approaches to GHG reductions, each option is evaluated using the following criteria:
 

  • Environmental Effectiveness. How effective is the program in meeting its emissions reduction target?
     
  • Cost-Effectiveness. Will the program design permit cost-effective compliance?
     
  • Administrative Feasibility. Can the program be administered effectively and does it minimize administrative and transaction costs?
     
  • Distributional Equity. Are the burdens of compliance fairly apportioned?
     
  • Political Acceptability. Are there elements of the program’s design that affect its political acceptability?


Analysis of Options

1. Cap-and-Trade Programs

A conventional cap-and-trade program establishes an economy-wide or sectoral “cap” on emissions (in terms of tons per year or other compliance period), and allocates or auctions tradable “allowances” (the right to emit a ton of greenhouse gases) to GHG emission sources or fuel distributors. The total number of allowances is equal to the cap. A “downstream” cap-and-trade program applies to sources of GHG emissions and requires them to surrender allowances equal to their emissions. An “upstream” program applies to fuel suppliers and requires them to surrender allowances equivalent to the carbon content of fossil fuels they distribute. The primary focus of a cap-and-trade program would be on sources of emissions that can be readily measured and monitored; these include almost all sources of carbon dioxide (CO2) emissions from fossil-fuel combustion as well as many sources of other GHG emissions. Sources not amenable to regulation through a cap-and-trade program can be covered on an “opt in” or project basis or addressed through supplemental regulation. Four major issues should be considered in the design of such a cap-and-trade program:
 

1) Flexibility. To what extent can firms satisfy their obligations by purchasing allowances (either from within or outside the United States), by sequestering carbon, by controlling greenhouse gases other than CO2, or by banking or borrowing allowances?

2) Downstream vs. Upstream. Does the program regulate firms that emit greenhouse gases (“downstream”) or does it regulate their fuel suppliers (“upstream”)?

3) Allowance Allocation. Does the program distribute free allowances to firms affected by GHG regulation, does it auction them to the highest bidder, or is some combination of approaches involved? If free allowances are distributed, what allocation formula is used? If allowances are auctioned, how are the revenues used? How might the allocation process change over time?

4) Cost Cap. Does the program incorporate a “safety valve” in which additional allowances are made available at a pre-set price?

Evaluation of the Cap-and-Trade Approach

Upstream cap-and-trade. An economy-wide upstream cap-and-trade program would be environmentally effective, could attain cost-effective compliance if it incorporates flexibility measures, and would be administratively feasible. Its distributional consequences would depend on how allowances were allocated and, if auctioned, how the auction revenues were recycled back into the economy. These allocation and recycling decisions can also affect overall compliance costs, because some methods of allocating allowances may be less economically efficient than an auction, and according to some economists, using auction revenues to reduce “distortionary” taxes on capital or labor can reduce the net costs of the program. Finally, because an economy-wide upstream cap-and-trade program will drive up the cost of gasoline and home heating fuels, it is likely to present a political challenge.

All-source downstream cap-and-trade. An economy-wide downstream cap-and-trade program—because it implies the regulation of literally millions of individual GHG sources, including cars and homes—would be difficult and costly to administer, and therefore is not a viable prospect for a domestic GHG regulatory program.

Large-source downstream cap-and-trade. A large-source downstream program (i.e., one applicable only to electricity generators and large industrial sources of greenhouse gases) is administratively feasible and could be environmentally effective with respect to the sectors it covered. To be fully effective, however, such an approach would have to be coupled with a program to cover other sectors. A large-source downstream program might be more acceptable politically than an upstream economy-wide program because it would not result in price increases for gasoline and home heating fuels (though it still would result in price increases for electricity).




2. GHG Tax

A GHG tax is a tax on emissions of greenhouse gases or on the carbon content of fossil fuel. Many of the design issues discussed in connection with cap-and-trade programs are also present—though in somewhat different form—in the design of a GHG tax.

Evaluation of the GHG Tax Approach

An upstream GHG tax program could be environmentally effective, but would not provide certainty in meeting a particular emissions target. It would allow for adoption of least-cost mitigation strategies, would offer cost certainty, and would be administratively feasible. The ultimate distributional consequences of a GHG tax would depend on how policy-makers distributed revenues from the tax. Again, according to some economists, using revenues from allowance auctions or emissions taxes to reduce “distortionary” taxes can reduce the net costs of the program. However, political acceptability is likely to be a major obstacle, since the GHG tax combines both new taxes and fuel price increases. A GHG tax could have better prospects as a part of a larger tax reform effort.




3. Sectoral Hybrid Programs (Product Efficiency Standards Plus Large Source Cap-and-Trade)

One way to increase the environmental effectiveness and cost-effectiveness of a domestic program that relies on a large-source downstream cap-and-trade policy is to regulate uncapped sectors through product efficiency standards. Such a “sectoral hybrid” program would combine a large source cap-and-trade program with product efficiency standards. The product efficiency standard component would be similar to current automobile and appliance efficiency standards, and would be designed to limit GHG emissions from new automobiles and consumer products.

Issues in designing the product efficiency standards component of the sectoral hybrid include: the scope of the program (which products are regulated); the extent to which standards are made “tradable” (i.e., whether manufacturers can trade between product lines within the firm, with other manufacturers, or with facilities regulated under the cap-and-trade program); and whether the program “caps” projected lifetime emissions from use of the product (“capped tradable standards”).

Evaluation of the Sectoral Hybrid Approach

A sectoral hybrid program consisting of a large-source downstream program coupled with product efficiency standards would be more environmentally effective than a downstream program alone (or standards alone), because standards could address emissions from sources (such as automobiles and appliances) that could not feasibly be covered by the downstream cap-and-trade program. Building on existing standards programs, such a hybrid program could attain coverage of about 80 percent of U.S. energy-related CO2 emissions. However, product efficiency standards would not address the intensity of product use or the replacement rate of new products for old, less-efficient products. A hybrid program would be a more costly means of achieving any particular emissions target than an economy-wide upstream cap-and-trade or tax program, though making the standards “tradable” would reduce the disparity. Incorporating tradable standards would present significant administrative challenges, however, because of the need to prevent double-counting of emission reductions and the technical issues in setting and revising standards. Finally, a sectoral hybrid program may score better on political acceptability because it constrains domestic GHG emissions while largely shielding consumers from
fuel price increases.




Summary of Analysis

The paper’s analysis would argue against an economy-wide downstream cap-and-trade program (as unadministrable), a stand-alone large-source cap-and-trade program (as incomplete), and a GHG tax program (as unviable politically, unless coupled with structured tax reform). The paper’s analysis indicates that at least two major alternatives appear to be feasible: (1) an economy-wide upstream cap-and-trade program, or (2) a sectoral hybrid program under which product efficiency standards complement a large-source downstream cap-and-trade program.

The first alternative (a comprehensive upstream cap-and-trade program) may be the best one if it can be put in place. However, U.S. energy policy experience over the past three decades suggests that putting it in place may be extraordinarily difficult. Even in times of most compelling national circumstances, such as the 1973 Arab oil embargo, Congress was unwilling to use energy price increases to rein in consumer demand. The second alternative—a sectoral hybrid program—may be all that can be implemented in the near term. If policy-makers take that course, careful attention will have to be given to minimizing economic costs and administrative complexity, and assuring that the program can be effectively enforced.

Kyle W. Danish
Robert R. Nordhaus
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Emissions Trading in the U.S.: Experience, Lessons, and Considerations for Greenhouse Gases

Emissions Trading Report Cover

Emissions Trading in the U.S.: Experience, Lessons and Considerations for Greenhouse Gases

Prepared for the Pew Center on Global Climate Change
May 2003

By:
A. Denny Ellerman and Paul L. Joskow, Massachusetts Institute of Technology
David Harrison, Jr., National Economic Research Associates, Inc.

Press Release

Download Entire Report (pdf)

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

In recent years, emissions trading has become an important element of programs to control air pollution. Experience indicates that an emissions trading program, if designed and implemented effectively, can achieve environmental goals faster and at lower costs than traditional command-and-control alternatives. Under such a program, emissions are capped but sources have the flexibility to find and apply the lowest-cost methods for reducing pollution. A cap-and-trade program is especially attractive for controlling global pollutants such as greenhouse gases because their warming effects are the same regardless of where they are emitted, the costs of reducing emissions vary widely by source, and the cap ensures that the environmental goal is attained.

Report authors Denny Ellerman and Paul Joskow of the Massachusetts Institute of Technology and David Harrison of National Economic Research Associates, Inc. review six diverse U.S. emissions trading programs, drawing general lessons for future applications and discussing considerations for controlling greenhouse gas emissions. The authors derive five key lessons from this experience. First, emissions trading has been successful in its major objective of lowering the cost of meeting emission reduction goals. Second, the use of emissions trading has enhanced—not compromised—the achievement of environmental goals. Third, emissions trading has worked best when the allowances or credits being traded are clearly defined and tradable without case-by-case certification. Fourth, banking has played an important role in improving the economic and environmental performance of emissions trading programs. Finally, while the initial allocation of allowances in cap-and-trade programs is important from a distributional perspective, the method of allocation generally does not impair the program’s potential cost savings or environmental performance.

With growing Congressional interest in programs to address climate change—including the recent introduction of economy-wide cap-and-trade legislation controlling greenhouse gas emissions—the application of lessons learned from previous emissions trading programs is timely. In addition to this review, the Pew Center is simultaneously releasing a complementary report, Designing a Mandatory Greenhouse Gas Reduction Program for the U.S., which examines additional options for designing a domestic climate change program.

The authors and the Pew Center are grateful to Dallas Burtraw and Tom Tietenberg for reviewing a previous draft of this report. The authors also wish to acknowledge Henry Jacoby, Juan-Pablo Montero, Daniel Radov, and Eric Haxthausen for their contributions to various parts of the report, and James Patchett and Warren Herold for their research assistance.

Executive Summary

Emissions trading has emerged over the last two decades as a popular policy tool for controlling air pollution. Indeed, most major air quality improvement initiatives in the United States now include emissions trading as a component of emissions control programs. The primary attraction of emissions trading is that a properly designed program provides a framework to meet emissions reduction goals at the lowest possible cost. It does so by giving emissions sources the flexibility to find and apply the lowest-cost methods for reducing pollution. Emission sources with low-cost compliance options have an incentive to reduce emissions more than they would under command-and-control regulation. By trading emission credits and allowances to high-cost compliance sources, which can then reduce emissions less, cost-effective emission reductions are achieved by both parties. When inter-temporal trading is allowed, sources can also reduce emissions early, accumulating credits or allowances that can be used for compliance in future periods if this reduces cumulative compliance costs. Accordingly, cap-and-trade programs achieve the greatest cost savings when the costs of controlling emissions vary widely across sources or over time. In practice, well-designed emissions trading programs also have achieved environmental goals more quickly and with greater confidence than more costly command-and-control alternatives.

Emissions trading has achieved prominence beyond the United States largely in the context of discussions regarding implementation of the Kyoto Protocol, a proposed international agreement to control emissions of carbon dioxide (CO2) and other greenhouse gases. The Kyoto Protocol provides for the use of various emissions trading mechanisms at the international level. Some countries already are developing emissions trading programs while the process of ratifying the Protocol moves forward. Both the United Kingdom and Denmark have instituted greenhouse gas (GHG) emissions trading programs, and, in December 2002, the European environment ministers agreed on the ground rules for a European Union trading program that would begin in 2005 for large sources of CO2 emissions (and later for other GHG emissions). Indeed, proposals to control GHG emissions in the United States also include the use of emissions trading.

The theoretical virtues of emissions trading have been recognized for many decades—the basic elements were outlined in Coase (1960) and elaborated in Dales (1968)—but actual emissions trading programs have been brought from the textbook to the policy arena mostly in the last decade. It is important to recognize, however, that while properly designed emissions trading programs can reduce the cost of meeting environmental goals, experience does not indicate that significant emissions reductions can be obtained without costs. Emissions trading can be an effective mechanism for controlling emissions by providing sources with the flexibility to select the lowest-cost opportunities for abatement, but it does not make costs disappear. Moreover, emissions trading programs must be designed properly in order to realize their potential cost-reduction and environmental compliance goals. As with any emissions control program, poor design is likely to lead to disappointing results.

Experience with emissions trading, including both the design and operation of trading programs, provides a number of general lessons for future applications. This report reviews the experience with six emissions trading programs with which one or more of the authors have considerable experience:

  • The early Environmental Protection Agency (EPA) Emissions Trading programs that began in the late 1970s;
  • The Lead Trading program for gasoline that was implemented in the 1980s;
  • The Acid Rain program for electric industry sulfur dioxide (SO2) emissions and the Los Angeles air basin (RECLAIM) programs for both nitrogen oxides (NOx) and SO2 emissions, all of which went into operation in the mid-1990s;
  • The federal mobile source averaging, banking, and trading (ABT) programs that began in the early 1990s; and
  • The Northeast NOx Budget trading program, which began operations in the late 1990s.

Based on this experience, this report identifies and discusses five general lessons concerning the design and implementation of emissions trading programs, and two considerations of particular relevance for GHG applications.



General Lessons from Experience with Emissions Trading

Emissions trading has been successful in its major objective of lowering the cost of meeting emission reduction goals. Experience shows that properly designed emissions trading programs can reduce compliance costs significantly compared to command-and-control alternatives. While it is impossible to provide precise measures of cost savings compared to hypothetical control approaches that might have been applied, the available evidence suggests that the increased compliance flexibility of emissions trading yields costs savings of as much as 50 percent.

The use of emissions trading has enhanced—not compromised—the achievement of environmental goals. While some skeptics have suggested that emissions trading is a way of evading environmental requirements, experience to date with well-designed trading programs indicates that emissions trading helps achieve environmental goals in several ways.

For one thing, the achievement of required emission reductions has been accelerated when emission reduction requirements are phased-in and firms are able to bank emissions reduction credits. The Lead Trading program for gasoline, the Acid Rain program for the electric industry, the federal mobile source ABT programs, and the Northeast NOx Budget programs each achieved environmental goals more quickly through these program design features. Moreover, giving firms with high abatement costs the flexibility to meet their compliance obligations by buying emissions allowances eliminates the rationale underlying requests for special exemptions from emissions regulations based on “hardship” and “high cost.” The reduction of compliance costs has also led to instances of tighter emissions targets, in keeping with efforts to balance the costs and benefits of emissions reductions. Finally, properly designed emissions trading programs appear to provide other efficiency gains, such as greater incentives for innovation and improved emissions monitoring.

Emissions trading has worked best when allowances or credits being traded are clearly defined and tradable without case-by-case pre-certification. Several different types of emissions trading mechanisms have been implemented. Their performance has varied widely, and these variations illuminate the key features of emissions trading programs that are most likely to lead to significant cost savings while maintaining (or exceeding) environmental goals.

The term “emissions trading” is used, often very loosely, to refer to three different types of trading programs: (1) reduction credit trading, in which credits for emission reductions must be pre-certified relative to an emission standard before they can be traded; (2) emission rate averaging, in which credits and debits are certified automatically according to a set average emission rate; and (3) cap-and-trade programs, in which an overall cap is set, allowances (i.e., rights to emit a unit) equal to the cap are distributed, and sources subject to the cap are required to surrender an allowance for every unit (e.g., ton) they emit.

The turnaround in perception of emissions trading over the last decade—from a reputation as a theoretically attractive but largely impractical approach to its acceptance as a practical framework for meeting air quality goals in a cost-effective manner—largely reflects the increased use of averaging and cap-and-trade type programs. The performance of the early EPA reduction credit programs was very poor and gave “emissions trading” a bad name. These early EPA programs emphasized case-by-case pre-certification of emission reductions and were characterized by burdensome and time-consuming administrative approval processes that made trading difficult. The averaging and cap-and-trade programs have been much more successful. While the use of cap-and-trade or averaging does not guarantee success, and the problems with the reduction credit-based approach can be reduced by good design, avoiding high transaction costs associated with trade-by-trade administrative certification is critical to the success of an emissions trading program. The success of any emissions trading program also requires several additional elements: emissions levels must be readily measured, legal emissions rates or caps must be clearly specified, and compliance must be verified and enforced aggressively.

Banking has played an important role in improving the economic and environmental performance of emissions trading programs. Early advocates of emissions trading tended to emphasize gains from trading among participants (i.e., low-cost compliance sources selling credits and allowances to high-cost compliance sources) in the same time period. The experience with the programs reviewed here indicates that inter-temporal trading also has been important. The form that inter-temporal trading most often takes is credit or allowance banking, i.e., reducing emissions early and accumulating credits or allowances that can be used for compliance in future periods. Banking improves environmental performance and reduces cumulative compliance costs. Moreover, it has been particularly important in providing flexibility to deal with many uncertainties associated with an emissions trading market—production levels, compliance costs, and the many other factors that influence demand for credits or allowances. Indeed, the one major program without a substantial banking provision, the Los Angeles RECLAIM program, appears to have suffered because of its absence.

The initial allocation of allowances in cap-and-trade programs has shown that equity and political concerns can be addressed without impairing the cost savings from trading or the environmental performance of these programs. Because emissions allowances in cap-and-trade programs are valuable, their allocation has been perhaps the single most contentious issue in establishing the existing cap-and-trade programs. However, the ability to allocate this valuable commodity and thereby account for the economic impacts of new regulatory requirements has been an important means of attaining political support for more stringent emissions caps. Moreover, despite all the jockeying for allowance allotments through the political process, the allocations of allowances to firms in the major programs have not compromised environmental goals or cost savings. The three cap-and-trade programs that have been observed so far all have relied upon “grandfathering,” i.e., distributing allowances without charge to sources based upon historical emissions information, which generally does not affect firms’ choices regarding cost-effective emission reductions and thus the overall cost savings from emissions trading. There are other methods of allocating initial allowances—such as auctioning by the government and distributing on the basis of future information—that can affect cost savings and other overall impacts; but the major effects of the initial allocation are to distribute valuable assets in some manner and to provide effective compensation for the financial impacts of capping emissions on participating sources.



Considerations for Greenhouse Gas Control Programs

Emissions trading seems especially well-suited to be part of a program to control greenhouse gas emissions. The emissions trading programs reviewed for this report generally have spatial or temporal limitations because sources of the pollutants included in these programs—such as lead, SO2, and NOx—may have different environmental impacts depending on the sources’ locations (e.g., upwind or downwind from population centers) and the time of the emissions (e.g., summer or winter). The concerns of trading programs associated with climate change are different because greenhouse gases are both uniformly mixed in the earth’s atmosphere and long-lived. The effects of GHG emissions thus are the same regardless of where the source is located and when the emissions occur (within a broad time band). This means that emissions trading can be global in scope as well as inter-temporal, creating an opportunity for the banking of emission credits, which allows emissions to vary from year to year as long as an aggregate inter-temporal cap is achieved.

Emissions trading is also well suited for GHG emissions control because the costs of reducing emissions vary widely between individual greenhouse gases, sectors, and countries, and thus there are large potential gains from trade. While other market-based approaches, such as emissions taxes, also would provide for these cost savings, the cap-and-trade version of emissions trading has the further advantage of providing greater certainty that an emission target will be met. Moreover, GHG emissions generally can be measured using relatively inexpensive methods (e.g., fuel consumption and emission factors), rather than the expensive continuous emissions monitoring required for some existing trading programs.

Furthermore, emissions trading provides important incentives for low-cost compliance sources initially outside the program to find ways to participate, and thereby further reduce costs. This opt-in feature is useful because an environmentally and cost-effective solution for reducing concentrations of greenhouse gases should be comprehensive and global, whereas initial controls on GHG emissions will—for political reasons—likely be limited, if not to certain sectors and greenhouse gases, then almost certainly to a restricted number of countries. Therefore, an important criterion for initial measures is that they be able to induce participation by sources not yet controlled. The markets created by cap-and-trade programs provide incentives for sources outside the trading program to enter if they can provide reductions more cheaply than the market prices—a common feature of any market. Although, as discussed below, the voluntary nature of these incentives can create some problems, the ability to induce further participation is an important reason to include a market-based approach initially. Indeed, it is hard to imagine how command-and-control regulations or emissions taxes could provide similar incentives to non-participants to adopt new measures to reduce greenhouse gas emissions.

Opt-in or voluntary features have a strategic role that is likely to warrant their inclusion despite the potential problems associated with them. Experience with allowing sources not covered by mandatory emissions trading programs to “opt-in,” i.e., to voluntarily assume emissions control obligations and to participate in the emissions market, has revealed a trade-off. Setting clear baselines for opting-in lowers transactions costs and thus encourages participation; but some of this participation consists of credits for calculated “reductions” that are unrelated to the trading program and actually lead to increased emissions. For example, in the Acid Rain Program, evidence indicates that many of the voluntary participants received credits for having emissions below the pre-specified baseline even though they took no abatement actions. The simple emissions baseline had been set higher than these facilities’ actual emissions, so at least some of the credits they received did not represent real emissions reductions.

This experience suggests that the decision whether or not to include opt-in provisions should be determined by weighing the cost-saving benefits against the emissions-increasing potential. For greenhouse gases, the potential cost-savings benefits of including a voluntary element in the mandatory program are large because initial efforts are not likely to be comprehensive and global, as they must be eventually to achieve their environmental goals and be cost-effective. Opt-in provisions also have value in improving measurement and monitoring techniques, in familiarizing participants with the requirements of emissions trading, and more generally with inducing participation of sources outside the trading program that can offer cheaper abatement. As a result, allowing participants outside the mandatory GHG emissions control program to opt-in has a strategic value that has not been prominent in other opt-in programs. Indeed, it should be possible to learn from existing experience with opt-in programs how to reduce adverse effects while achieving cost-savings.

Viewed from a broad historical perspective, emissions trading has come a long way since the first theoretical insights forty years ago and the first tentative application almost a quarter of a century ago. Although still not the dominant form of controlling pollution in the United States or elsewhere, emissions trading is being included in an increasing number of programs and proposals throughout the world, and its role seems likely to expand in the future.

Conclusions

Emissions trading has emerged as a practical framework for introducing cost-reducing flexibility into environmental control programs and reducing the costs associated with conventional command-and-control regulation of air pollution emissions. Over the last two decades considerable experience with various forms of emissions trading has been gained, and today nearly all proposals for new initiatives to control air emissions include some form of emissions trading. This report has attempted to summarize that experience and to draw appropriate lessons that may apply to proposals to limit GHG emissions. In doing so, we hope that the reader has gained a better understanding of emissions trading and the reasons for its increasing importance as an instrument for addressing environmental problems.

Six diverse programs constitute the primary U.S. experience with air emissions trading. The EPA’s early attempts starting in the late 1970s to introduce flexibility into the Clean Air Act through netting, offsets, bubbles, and banking were not particularly encouraging. Most of the potential trades, and economic gains from trading, in these early systems were frustrated by the high transaction costs of certifying emission reductions. The first really successful use of emissions trading occurred in the mid-1980s when the lead content in gasoline was reduced by 90 percent in a program that allowed refiners to automatically earn credits for exceeding the mandated reductions in lead content and to sell those credits to others or bank them for later use.

The Acid Rain or SO2 allowance trading program for electricity generators, which has become by far the most prominent experiment in emissions trading, was adopted in 1990 and implemented beginning in 1995. This innovative program introduced a significantly different form of emissions trading, known as cap-and-trade, in which participants traded a fixed number of allowances—or rights to emit—equal in aggregate number to the cap, instead of trading on the differences from some pre-existing or external standard as had been the case in the early EPA trading programs and the lead phase-down program.

Another cap-and-trade program, the RECLAIM program for both SO2 and NOx emissions, was developed and implemented at the same time as the Acid Rain program by the regulatory authority in the Los Angeles Basin as part of its efforts to bring that area into attainment with National Ambient Air Quality Standards. The RECLAIM program is the first instance of emissions trading both supplementing and supplanting a pre-existing command-and-control structure that theoretically was capable of achieving the same environmental objective. The standards of the pre-existing command-and-control system largely determined the level of the cap, and the program’s ten-year phase-in design and trading provided the flexibility that led to the achievement of environmental goals that had been previously elusive. RECLAIM also introduced trading among different sectors.

The 1990 Amendments to the Clean Air Act also provided enabling legislation for two other emissions trading programs. Emissions from mobile sources were more effectively and efficiently controlled by the introduction of mobile source averaging, banking, and trading programs. The mobile source programs followed the example of the lead phase-down program by allowing firms to create credits automatically for any reductions beyond a required uniform emission standard and to use these credits in lieu of more costly reductions elsewhere or later within the company and to sell them. The 1990 Amendments also provided the mechanism that encouraged states in the Northeastern United States to adopt cap-and-trade programs to control NOx emissions that contributed to ozone non-attainment in that region of the country. As was the case in the RECLAIM program, emissions trading was adopted as a means to attain environmental objectives more quickly and cost-effectively than had proved possible through conventional command-and-control regulation.

There are many lessons to be gained from the experience with these six programs, but the five most important lessons can be summarized as follows. First, the major objective of emissions trading, lowering the cost of meeting emission reduction goals, has been achieved in most of these programs. Second, emissions trading has not compromised the achievement of the environmental goals embodied in these programs. If anything, and this is perhaps surprising, the achievement of those goals has been enhanced by emissions trading. Third, emissions trading has worked best in reducing costs and achieving environmental goals when the credits being traded are clearly defined and readily tradable without case-by-case certification. Fourth, temporal flexibility, i.e., the ability to bank allowances, has been more important than generally expected, and the ability to bank has contributed significantly to accelerating emission reductions and dampening price fluctuations. Fifth, the initial allocation of allowances in cap-and-trade programs has shown that equitable and political concerns can be met without impairing either the cost savings from trading or the environmental performance of these programs. In addition, the success of any emissions trading program requires that emissions levels can be readily measured and compliance verified and enforced.

All of these five lessons are relevant when considering the use of emissions trading in a program aimed at reducing GHG emissions. In fact, emissions trading seems especially appropriate for this environmental problem. Greenhouse gas emissions mix uniformly and remain in the atmosphere for a long time. Thus, it matters little where or when the emissions are reduced, as long as the required cumulative reductions are made. These specific characteristics of GHG emissions eliminate two of the concerns that have limited the scope of emissions trading in many other programs.

Although an effective GHG mitigation program must eventually be global in scope and comprehensive in its coverage of pollutants and economic sectors, the likelihood that control efforts will be limited initially to the richer countries, the more easily measurable gases, and perhaps to certain sectors of the economy introduces another consideration. The ability to induce initially uncapped sources to participate voluntarily in the early efforts will reduce costs and prepare the way for extending the caps. Thus, providing opportunities to opt-in for uncapped sources that can reduce emissions at lower cost than those within the cap has a strategic value beyond the potential cost savings. Although some existing programs with voluntary provisions have revealed opportunities for misuse, these problems can be managed more successfully now with the benefit of experience. The strategic value of opt-in provisions in any GHG emission control program makes their inclusion highly desirable.

Emissions trading has come a long way since the first theoretical insights forty years ago and the first tentative application almost a quarter of a century ago. Since then, the use of emissions trading has expanded steadily and significant experience has been gained. Although not the dominant form of controlling pollution in the United States or elsewhere, emissions trading now seems firmly established as a valuable instrument and its future use seems sure to increase. Our review of experience over the past quarter century suggests that this trend toward greater use of emissions trading will improve the performance of environmental regulation, including efforts to control GHG emissions.

About the Authors

A. Denny Ellerman, Massachusetts Institute of Technology

Dr. Ellerman is a Senior Lecturer with the Sloan School of Management at the Massachusetts Institute of Technology, where he also serves as the Executive Director of the Center for Energy and Environmental Policy Research and of the Joint Program on the Science and Policy of Global Change. His former employment includes Charles River Associates, the National Coal Association, the U.S. Department of Energy, and the U.S. Executive Office of the President. He served as President of the International Association for Energy Economics for 1990. Dr. Ellerman received his undergraduate education at Princeton University and his Ph.D. in Political Economy and Government from Harvard University. His current research interests focus on emissions trading, climate change policy, and the economics of fuel choice, especially concerning coal and natural gas.


Paul L. Joskow, Massachusetts Institute of Technology

Paul L. Joskow is Elizabeth and James Killian Professor of Economics and Management at MIT and Director of the MIT Center for Energy and Environmental Policy Research. He received a B.A. from Cornell University in 1968 and a Ph.D. in Economics from Yale University in 1972. Professor Joskow has been on the MIT faculty since 1972 and served as Head of the MIT Department of Economics from 1994 to 1998.

At MIT he is engaged in teaching and research in the areas of industrial organization, energy and environmental economics, and government regulation of industry. Professor Joskow has published five books and over 100 articles and papers in these areas. He has been studying the behavior and performance of the SO2 allowance trading program created by the Clean Air Act Amendments of 1990 for several years and is a co-author of the book Markets for Clean Air: The U.S. Acid Rain Program (Cambridge University Press).

Professor Joskow has served as a consultant on regulatory and competitive issues to organizations around the world. He served on the EPA’s Acid Rain Advisory Committee from 1990-1992 and was a member of the Environmental Economics Advisory Committee of the EPA’s Science Advisory Board from 1998-2002. He is a Director of the National Grid Transco Group and the Whitehead Institute for Biomedical Research and a Trustee of the Putnam Mutual Funds. He is a Fellow of the Econometric Society and the American Academy of Arts and Sciences.


David Harrison, Jr. , National Economic Research Associates, Inc.

David Harrison is a Senior Vice President at National Economic Research Associates (NERA), an international firm of 500 consulting economists operating in 16 offices on five continents and a Marsh & McLennan company. Dr. Harrison is co-chair of NERA’s energy and environmental economics practice.

Before joining NERA in 1988, Dr. Harrison was an Associate Professor at the John F. Kennedy School of Government at Harvard University, where he taught microeconomics, environmental and energy policy, transportation policy, and benefit-cost analysis. He was a member of the Faculty Steering Committee of Harvard’s Energy and Environmental Policy Center. Dr. Harrison earlier served as a Senior Staff Economist on the President’s Council of Economic Advisors, where his areas of responsibility included environmental regulation, natural resource policy, transportation policy, and occupational health and safety.

Dr. Harrison has consulted for private firms, trade associations, and government agencies in the U.S. and abroad on many energy and environmental issues. Dr. Harrison has been active in the development of major emissions trading programs, including serving on the advisory committee to develop RECLAIM, an author of proposals for averaging, banking, and trading programs for mobile sources and for NOx trading proposals for the Northeast, and a consultant to the European Commission (EC) with regard to aspects of its proposed greenhouse gas emissions trading program. He is currently advising the UK government with regard to aspects of its EU program and the EC with regard to trading programs for non-greenhouse gas emissions.

Dr. Harrison holds a Ph.D. in Economics from Harvard University, a M.Sc. in Economics from the London School of Economics, and a B.A. in Economics from Harvard University.

 

A. Denny Ellerman
David Harrison, Jr.
Paul L. Joskow
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Tackling Climate Change: 5 Keys to Success

Tackling Climate Change: 5 Keys to Success

Remarks by Eileen Claussen
President, Pew Center on Global Cliamte Change

4th Annual Dartmouth Student Science Congress

May 2, 2003

Thank you very much.  It is a pleasure to be here at Dartmouth for the Fourth Annual Student Science Congress.  I understand that as part of these proceedings, students will be voting on a series of ballot questions.  I have not yet seen these questions, but tonight I am nevertheless going to try to influence your answers.  

For example, if one of the questions is “How serious a problem is global warming?” I encourage you to answer that it is a very serious problem indeed.  And, if one of the questions is “Who was your favorite speaker during the Congress?” . . . well, just keep in mind that Claussen sort of rhymes with awesome. 

Seriously, I appreciate this opportunity to address your Student Science Congress, and I applaud the organizers of this event for taking on a topic of such pressing importance.  Whether we like it or not, global warming is shaping up as one of the most important  challenges of the 21st century.  It is going to drive far-reaching changes in how we live and work, how we power our homes, schools, factories and office buildings, how we get from one place to another, how we manufacture and transport goods, and even how we farm and manage forests.  It touches every aspect of our economy and our lives, and to ignore it is to live in a fantasy land where nothing ever has to change – and where we never have to accept what the science tells us about what is happening to our world.

My goal tonight is to give you a clear idea of where we stand today in the effort against global climate change. To do that, I’d first like to offer you an insider’s look at how the world and the United States have responded to this challenge over the last decade.

Then, after the history lesson – and don’t worry, there will not be a test – I want to look forward.  And I’d like to suggest to you five keys to success – five things we need to do if were are to successfully meet the challenge of climate change.

So, to begin with, let’s travel back in time to 1992, when another George Bush was our President, and when the nations of the world gathered in sunny Rio de Janeiro for the United Nations Conference on Environment and Development, affectionately known as the Earth Summit.  This was the event, you may recall, where more than 150 countries signed an agreement called the United Nations Framework Convention on Climate Change. 

The UNFCCC, as it is known, set an ambitious long-term objective: to stabilize greenhouse gas concentrations in the atmosphere at a level that would – and I quote – “prevent dangerous anthropogenic (or human-caused) interference with the climate system.”  This is a goal that the United States, and virtually every other nation, has embraced.  

As a first step, industrialized countries agreed to a voluntary emissions target:  they aimed to reduce their greenhouse gas emissions to 1990 levels by the year 2000.  Before long, however, it became clear that the targets would not be met and that voluntary commitments could not deliver genuine action.  So the United States and others countries began to negotiate a new agreement, one with binding targets, and they agreed at the outset that these new commitments would extend only to the industrialized countries, which so far have contributed the most to the problem. 

The result, negotiated five years after the Rio summit in Kyoto, Japan, is the Kyoto Protocol.  The Protocol requires countries to reduce or limit their emissions of greenhouse gases in relation to 1990 levels, with different countries agreeing to different targets.  The agreement also includes a number of features advocated by the United States to ensure countries a high degree of flexibility as they work to achieve their targets.  They can make actual emission reductions at home, trade emission credits with others who have made reductions, and use “sinks” such as farms and forests to remove carbon from the atmosphere. 

During the negotiations in Kyoto, Vice President Al Gore flew to the ancient Japanese capital to help hammer out the deal.  And what the U.S. negotiators ultimately agreed to was a binding 7-percent reduction in emissions below 1990 levels by 2012. 

The problem was that it was already 1997, and U.S. emissions had already risen over 1990 levels by more than 8 percent.  In other words, we had pledged to reduce our emissions by nearly 14 percent and we didn’t have any kind of program in place to do this, nor any will to put such a program into place. 

Another problem was that the United States Senate, under the Byrd-Hagel resolution, had recently voted unanimously that the United States should not sign any climate treaty that – quote – "would result in serious harm to the economy of the United States" or that did not impose some type of commitment on developing countries as well. 

Of course Kyoto did not include commitments for developing countries, because the parties, including the United States, agreed at the outset that it would not.  And the target agreed to by the United States was portrayed by those who wished to kill the treaty as clearly harmful to our economy, a charge that was not effectively countered by the Administration.  So the fact of the matter is that the Kyoto Protocol negotiated by the Clinton administration was about as welcome in the Senate as the proverbial skunk at a lawn party – and senators had no intention of holding their noses so they could tolerate this thing.  They just plain didn’t want it anywhere near them. 

The Clinton administration, for its part, did nothing to try to bring about the ratification of this treaty that its people had made such a big deal of signing.  Granted, the President at the time was caught up in a scandal, and Vice President Gore was gearing up for a presidential run of his own and surely wanted to avoid being publicly associated with anything that could be said to pose a threat the economy.  But still, the whole episode of U.S. participation in Kyoto -- and, before that, the UNFCCC -- was enough to recall the line from Shakespeare: “full of sound and fury, signifying nothing.”  The bottom line: We clearly were not prepared to deliver at home what we were promising abroad. 

But the story does not end there.  To fast forward to 2000, American voters elected another President – another Bush – and within months of entering office his administration made a unilateral decision to reject the Kyoto Protocol out of hand, instead of working to change it and make it better.  Needless to say, this decision was not received warmly by other nations that had persevered through years of difficult negotiations and that had acceded to U.S. demands early on that the treaty include trading and other business-friendly mechanisms. 

As an aside, I think it is interesting to note that in the recent run-up to the war in Iraq, it was hard to find an article about other countries’ perceptions of the United States that did not mention the impolitic way in which this Administration rejected Kyoto.  It was perceived as a real slap in the face – a confirmation of global fears that the United States, which is responsible for almost one-fourth of global greenhouse has emissions, had no intention of acting seriously on this issue.

As if to confirm these fears, the Bush administration last year announced a climate strategy that was big on rhetoric but not-so-big on results.   Here is what this strategy does: It sets a voluntary “greenhouse gas intensity” target for the nation.  The idea is to reduce the ratio of greenhouse gas emissions to U.S. economic output, or GDP.  But the funny thing about the White House target – an 18 percent reduction in greenhouse gas intensity by 2012 – is that it would allow actual emissions to grow by 12 percent over the same period.

What’s more, the Administration’s strategy relies entirely on voluntary measures.  This despite the fact that U.S. climate policy has consisted primarily of voluntary measures for more than a decade.  And what have these voluntary measures achieved?  As of 2001, U.S. greenhouse gas emissions were up 11.9 percent over their 1991 levels.  And so now we are more than ten years removed from the Earth Summit, and we still – still – have no real plan in place to reduce the U.S. contribution to the problem that we and other countries identified back then as – quote – “a common concern of humankind.”

The reason I have presented this history lesson is to show that, as the world has set out in the last decade to respond to the problem of climate change, the United States has been both a driver and a drag on the process, a driver in terms of development of a framework for action, a drag because we have made no serious attempt to implement that framework.  We are like the boyfriend or girlfriend who says sweet things all the time but will never truly commit.  And lately we aren’t even saying sweet things any more. 

The reality is that it is long past the time for playing these sorts of games.  We should have committed long ago to serious action on this issue and, having failed, it is all the more urgent that we get serious now.  What does that mean?  What principles should guide these efforts?  I’d like to offer five – five keys to success in meeting the challenge of climate change. 

Key Number One: We must forge a global response to the problem of  climate change.  As I already said, the United States is responsible for one-fourth of global greenhouse gas emissions.  The 15 countries of the European Union are responsible for another one-fourth.  The remainder is divided among other developed nations and rapidly developing countries such as China and India.  And, while developed countries clearly are responsible for a majority of these emissions, that will not be the case in the future as emissions continue to grow more rapidly in developing countries than anywhere else.

It is one of the most contentious issues in the debate over global climate change – that is, the perceived divide between the interests and obligations of developed and developing countries.  Equity demands that the industrialized world—the source of most past and current emissions of greenhouse gases—act first to reduce emissions. This principle is embedded in both the UNFCCC and the Kyoto Protocol, which sets binding emission targets for developed countries only. However, with the Protocol expected to enter into force sometime this year or next, it is now time to turn our attention to what happens next.  And as we do this, we need to think broadly of a framework that will include not only the countries that will be implementing the Kyoto protocol, but also the United States, Australia, and the major emitting countries in the developing world.   

I do not claim to know what form this framework should take.  But here’s what I do know:  It must be effective; over the coming decades, it must significantly reduce global emissions of greenhouse gases.  It also must be fair.  We must recognize who bears responsibility for climate change, and who will bear the brunt of its impacts; and we must arrive at an equitable sharing of responsibility for addressing it.  That probably means different kinds of measures for different countries at different times, but all the major emitting countries must do their part.  Finally, this new framework must marry our environmental goals with our economic and development objectives.  In the developing world in particular, commitments that are not consistent and compatible with raising standards of living and promoting sustainable economic growth have little chance of success.  And even in the developed world, all countries will have to be convinced that the environmental goals they agree to, the carbon limits they accept, will not impede their efforts to sustain economic growth.  This will mean not only ensuring that countries are given flexibility in how they meet their goals, but also that they can turn over the existing capital stock and acquire more climate friendly technology at prices that they can afford.    

This brings us to the second Key to Success in our efforts to address the climate issue: We need to think in terms of both short-term and long-term actions.  There is a great deal we can do now to reduce our emissions.  At the same time, we need to be looking ahead to longer-term, and potentially more far-reaching, reductions in the years and decades to come. 

At the Pew Center, we are developing a plan we call the 10/50 Solution.  The idea is to think ahead to where we need to be 50 years from now if we are going to meet the challenge of climate change, and then to figure out decade by decade how to do it.

Why look 50 years out?  Because achieving the necessary reductions in our greenhouse gas emissions will ultimately require innovation on a level never before seen.  It will require a massive shift away from fossil fuels to climate-friendly sources of energy.  And, as I said at the start of my remarks, it will require fundamental changes in how we live and work and grow our economies. 

The 10-50 approach doesn’t just look long-term, though.  It recognizes that in order to realize that 50-year vision, we have to start right now.  We can start with the low-hanging fruit – the countless ways we can reduce greenhouse emissions at little or no cost by simply being more efficient: everything from more fuel-efficient cars and trucks, including hybrids, to energy-efficient appliances and computers, efficiency improvements in industry, and even better management of animal wastes.

In the medium to long term, the challenge is to begin what we have called a second industrial revolution.  The Pew Center is just now completing a scenario analysis that identifies several technologies as essential to our ability to create a climate-friendly energy future for the United States.  Among them:

· Number one: natural gas.  Substituting natural gas for coal results in approximately half the carbon emissions per unit of energy supplied, but we need policies to encourage the expansion of natural gas supply and infrastructure.
· Number two: energy efficiency.  We have the ability to dramatically improve the fuel economy of cars and light trucks right now and in the very near future through a combination of advances in the internal combustion engine or through hybrid electric vehicles.
· Number three: renewable energy and distributed generation.  The potential here is enormous, but policy support will be essential in promoting investment and breaking barriers to market entry for these technologies.
· Number four: nuclear power.  Despite its problems, the fact remains that our carbon emissions would be much higher without nuclear power.
· Number five: geological sequestration.  Sequestration holds the potential of allowing for the continued production of energy from fossil fuels, including coal, even in the event of mandatory limits on carbon emissions. 
· And number six: hydrogen and fuel cells.  The President’s recent announcement of a new federal commitment to fuel cell research was a welcome one, but we must have policies that will help pull these vehicles into the market.

Looking down this list, it is hard not to see that most, if not all, of these technologies would be important even in a world where we did not have this pressing obligation to reduce the amount of greenhouse gases in the atmosphere.  For energy security and economic growth reasons, and a wide range of environmental reasons as well, these are simply smart things to do.  The second industrial revolution is not just about responding to the challenge of climate change; it’s about creating a common-sense energy future. 

And, in order to create that energy future, we are going to have to keep in mind Key to Success Number Three: Industry must be a partner in shaping and implementing climate solutions.   The Pew Center serves as a convenor of leading businesses that are taking practical steps to reduce their contribution to the climate problem. The 38 members of our Business Environmental Leadership Council represent nearly 2.5 million employees and have combined revenues of $855 billion.  They include mostly Fortune 500 firms, and they are deeply committed to climate solutions:

· There is DuPont, for example, which made a voluntary pledge to reduce its global emissions of greenhouse gases by 65 percent by the year 2010.  And guess what?  Late last year, they announced they had achieved this target eight years ahead of schedule.
· Also ahead of schedule in meeting its target is BP, which in 2002 announced it had reduced global greenhouse emissions by 9 million metric tons in just four years.  This marked a 10-percent reduction in the company’s emissions – and, like DuPont, BP had originally intended to achieve this goal in 2010.

Over the past several years, it has become clear that there are three types of companies when it comes to the issue of climate change: those that do not accept the science; those that accept the science and are working internally to reduce their contribution to the problem; and those that accept the science, are working internally and are advocating for strong government action to address this issue. 

BP, DuPont and the other companies we are working with at the Pew Center clearly fall into this latter group.  And I hope that our government – as well as other governments throughout the world – will take full advantage of their expertise and commitment.

The benefits of active involvement by industry in environmental policy making first became clear to me during negotiations on the Montreal Protocol – the agreement that set out to address the man-made threat to the Earth’s protective ozone layer.   An important reason for the success of that agreement, I believe, is that the companies that produced and used ozone-depleting chemicals—and that were developing substitutes for them—were very much engaged in the process.  As a result, there was a factual basis and an honesty about what we could achieve, how we could achieve it, and when. And there was an acceptance on the part of industry, particularly U.S. companies, that the depletion of the ozone layer was an important problem and that multilateral action was needed.  

I am happy to report that we are seeing the same kind of acceptance and determination to act on the climate issue among the companies we work with at the Pew Center.  Their involvement should serve as a reminder that it is industry that will develop the technologies and the strategies that will reduce global emissions of greenhouse gases.  It is industry that will have to deliver on government requirements and goals.  To ignore this as we try to structure a global response to this enormous challenge is to fail.

Speaking of government, let me introduce a fourth Key to Success in responding to climate change: We have to adopt real, mandatory goals.  Voluntary approaches, as I have said, simply have not worked to address this problem.  In order to engage the full spectrum of industry and society, we need to set clear, mandatory goals for emission cuts, and at the same time provide sensible, business-friendly rules that give companies the flexibility they need to help meet those goals as cost-effectively as possible. 

This is the approach embodied in recent legislation introduced by the bipartisan duo of Senators John McCain and Joe Lieberman.  This landmark measure for the first time brings together several features that would be critical to the success of a national climate change strategy.  The bill would establish ambitious and binding targets for reducing U.S. greenhouse gas emissions.  Equally important, it would provide companies with the flexibility to reduce emissions as cost-effectively as possible – thanks to the creation of a rigorous nationwide system allowing emissions trading and providing some credit for carbon storage.  Last but not least, the bill would recognize those reductions that are being made now by the companies that are taking the lead on this issue and provide additional flexibility for these early actors. 

Of course, the McCain-Lieberman measure has little chance of becoming law any time soon, but it is an encouraging development nonetheless to see our policymakers in Washington finally coming to grips with exactly what it is going to take to yield real progress toward a climate-friendly future.  And what it is going to take is a set of real, enforceable commitments.

This leads us finally, and forgive me if this seems redundant, to Key to Success Number Five: The United States must be an integral part of the climate solution.   Despite having 4 percent of the world’s population, we have contributed nearly a third of worldwide emissions of greenhouse gases in the last century, and we continue to be the largest source of these emissions worldwide.  And still, we have decided to sit on the sidelines while the world moves forward with a plan to begin addressing this challenge.  Even worse, we have yet to develop anything resembling a domestic program to reduce our own emissions and protect the climate.  

This problem, quite simply, will not be solved without us.  We owe it to ourselves, we owe it to other nations, and we owe it to future generations, to commit American ingenuity and American leadership to meeting this challenge.  I think the job begins at home: We must achieve a national consensus on how best to reduce our greenhouse gas emissions.  And from there, we must engage constructively with other nations in the searching for a lasting global solution. 

So there you have it.  Five keys to success:  We need to address this issue globally.  We need to think and act both short-term and long-term.  We need to involve industry.  We need mandatory goals.  And we need the United States to do its part both at home and abroad. 

Yet another key to success, as I have learned over the years, is to keep your remarks to a reasonable length.  So I will stop there, and I welcome your questions. 

Thank you very much. 

Press Release: New Report: Climate Change Poses Challenges for U.S. Forestry

For Immediate Release: 
February 26, 2003

Contact:  Katie Mandes
(703) 516-0606

NEW REPORT: Climate Change Poses Challenges for U.S. Forestry


Washington, DC - One-third of U.S. lands are covered by forests, making forest ecosystems one of the nation's most prominent natural resources. In addition to their contribution to biodiversity, water quality, and recreation, forests also play a significant role in the U.S. economy, and forestry or forestry-related enterprises are the dominant industries in many U.S. communities. According to a new study by the Pew Center on Global Climate Change, the U.S. forestry sector will face a number of challenges in the next century due to the impacts of climate change.

The Pew Center report, Forests and Global Climate Change: Potential Impacts on U.S. Forest Resources, explores the challenges climate change will pose to forest ecosystems and related economic enterprises over the next century.

"Changes in forest productivity, the migration of tree species, and potential increases in wildfires and disease could cause substantial changes to U.S. forests," said Eileen Claussen, President of the Pew Center on Global Climate Change. "Moreover, these ecological impacts will have direct implications for our economy. The timber industry in the southern United States is particularly vulnerable."

The key conclusions of the report include:


Forest location, composition, and productivity will be altered by changes in temperature and precipitation. Climate change is virtually certain to drive the migration of tree species, resulting in changes in the geographic distribution of forest types and new combinations of species within forests. In addition, climate change is likely to alter forest productivity depending upon location, tree species, water availability, and the effects of carbon dioxide (CO2) fertilization.


Changes in forest disturbance regimes, such as fire or disease, could further affect the future of U.S. forests and the market for forest products. Increased temperatures could increase fire risk in areas that experience increased aridity, and climate change could promote the proliferation of diseases and pests that attack tree species.


U.S. economic impacts will vary regionally. Overall, economic studies indicate that the net impacts of climate change on the forestry sector will be small, ranging from slightly negative to positive impacts; however, gains and losses will not be distributed evenly throughout the United States. The Southeast, which is currently a dominant region for forestry, is likely to experience net losses, as tree species migrate northward and tree productivity declines. Meanwhile, the North is likely to benefit from tree migration and longer growing seasons.


As a managed resource, the implications of climate change for the forestry sector are largely dependent upon the actions taken to adapt to climate change. The United States currently has vast forest resources, and more timber grows within the United States than is consumed each year. If professional foresters take proactive measures, the sector may minimize the negative economic consequences of climate change.


A number of challenges currently limit our understanding of the effects of climate change on forestry. Existing projections for future changes in temperature and precipitation span a broad range making it difficult to predict the future climate that forests will experience, particularly at the regional level. Thus, current projections could fail to accurately predict the actual long-term impacts of climate change for the forestry sector.

Part of "Impacts" Series

Forests and Global Climate Change: Potential Impacts on U.S. Forest Resources, was prepared for the Pew Center by Herman Shugart (University of Virginia), Roger Sedjo (Resources for the Future), and Brent Sohngen (The Ohio State University). It is the ninth in a series of Pew Center reports examining the potential impacts of climate change on the U.S. environment. Other Pew Center reports focus on domestic and international policy issues, climate change solutions, and the economics of climate change.

Click here for a complete copy of this report and previous Pew Center reports.

Multi-Gas Contributors to Global Climate Change

multigas7

Multi-Gas Contributors to Global Climate Change: Climate Impacts and Mitigation Costs of Non-CO2 Gases

Prepared for the Pew Center on Global Climate Change
February 2003

By:
John M. Reilly, Henry D. Jacoby, and Ronald G. Prinn
Massachusetts Institute of Technology

Press Release

Download Entire Report (pdf)

 

Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

In the effort to understand and address global climate change, most analysis has focused on rapidly rising emissions of carbon dioxide (CO2) and options for reducing them. Indeed, carbon dioxide, a byproduct of fossil fuel combustion, is the principal greenhouse gas contributing to global warming. However, other greenhouse gases including methane, nitrous oxide, and a number of industrial-process gases also are important contributors to climate change. From both an environmental and an economic standpoint, effective climate strategies should address both carbon dioxide and these other greenhouse gases.

Non-CO2 gases account for 17 percent of total greenhouse gas emissions in the United States and a much larger percentage in developing countries such as India and Brazil. In addition, a host of local and regional air pollutant emissions interact in the atmosphere’s complex chemistry to produce either additional warming or cooling effects. Understanding how these gases interact—and how to craft policies that address a range of environmental impacts—is vital to addressing both local and global environmental concerns.

In this report, authors John Reilly, Henry Jacoby, and Ronald Prinn of M.I.T. unravel some of the complexities associated with analyzing the impacts of these multiple gases and opportunities for reducing them. Emissions originate from a wide range of sectors and practices. Accurate calculation of emissions and emission reductions is easier for some sources than for others. For policy purposes, various greenhouse gases are compared on the basis of “global warming potentials,” which are based on the atmospheric lifetime of each gas and its ability to trap heat. However, these do not yet accurately capture the climatic effects of all the substances contributing to climate change and so must be used with some caution. While scientists have recognized the various roles of non-CO2 gases and other substances that contribute to climate change for some time, only recently have the various pieces of the puzzle been fit together to provide a more complete picture of the critical role these gases can play in a cost-effective strategy to address climate change.

Using M.I.T.’s general equilibrium model, the authors demonstrate that including all greenhouse gases in a moderate emissions reduction strategy not only increases the overall amount of emissions reductions, but also reduces the overall cost of mitigation: a win-win strategy. In fact, due to the high potency of the non-CO2 gases and the current lack of economic incentives, this analysis concludes that control of these gases is especially important and cost-effective in the near term. The policy implications are clear: any attempt to curb warming should include efforts to reduce both CO2 and non-CO2 greenhouse gases.

The Center and the authors are grateful to James Hansen, Keith Paustian, Ev Ehrlich, Francisco Delachesnaye, and Dina Kruger for their helpful comments on previous drafts of this report. The authors also acknowledge support, through the M.I.T. Joint Program on the Science and Policy of Global Climate Change, and the research assistance provided by Marcus Sarofim.

Executive Summary

 

Most discussions of the climate change issue have focused almost entirely on the human contribution to increasing atmospheric concentrations of carbon dioxide (CO2) and on strategies to limit its emissions from fossil fuel use. Among the various long-lived greenhouse gases (GHGs) emitted by human activities, CO2 is so far the largest contributor to climate change, and, if anything, its relative role is expected to increase in the future. An emphasis on CO2 is therefore justified, but the near-exclusive attention to this single contributor to global warming has had the unintended consequence of directing attention away from the other GHGs, where some of the most cost-effective abatement options exist. The non-CO2 GHGs emitted directly by human activities include methane (CH4) and nitrous oxide (N2O), and a group of industrial gases including perfluorocarbons (PFCs), hydrofluorocarbons (HFCs), and sulfur hexafluoride (SF6). When taken together with the already banned chlorofluorocarbons (CFCs), their climate significance over the past century is roughly equivalent to that of CO2. Looking to likely emissions over the next half-century, it is also the case that feasible reductions in emissions of methane and other non-CO2 gases can make a contribution to slowing global warming that is as large as or even larger than similar reductions in CO2 emissions. To effectively limit climate change, and to do so in a cost-effective manner, thus requires that climate policies deal with CO2 and non-CO2 gases alike.

There are several reasons why attention has been focused so heavily on CO2 even though the full list of GHGs has been targeted for control under international climate agreements. Emissions of CO2 from fossil sources can be readily estimated from market data on fuel use, whereas the other gases present measurement difficulties. Also, the analysis of abatement options for fossil emissions benefits from decades of research on energy markets, energy efficiency, and alternative energy supply technologies—work that was spurred by concerns about the security of supply and prices of fossil fuels. The analytical capability developed to study energy markets was then readily applied to the climate issue. Now that the capability to measure and assess the non-CO2 GHGs has improved, it is clear that their control is also an essential part of a cost-effective climate policy.

In addition to the main non-CO2 GHGs identified above, there are other emissions from human activities that are not included in existing climate policy agreements but that nonetheless retard or enhance the greenhouse effect. Tropospheric ozone (O3) is a natural greenhouse constituent of the atmosphere. Emissions of carbon monoxide (CO), nitrogen oxides (NOX), aerosols, non-methane volatile organic compounds (NMVOCs), and ammonia (NH3) all affect the chemistry of tropospheric ozone and methane. Black carbon or soot, though not well-understood, is thought to contribute to warming as well. Other human emissions have the opposite of a greenhouse effect. Sulfur dioxide (SO2) and nitrogen oxides (NOx), mainly from fossil fuel combustion, are converted by chemical processes in the atmosphere into cooling aerosols. These various gases and aerosols are related to one another by their common generation in industry and agriculture as well as by their interaction in the chemistry of urban areas, the lower atmosphere, and the stratosphere. Thus, policies that reduce CO2 also may affect emissions of SO2, NOx, and CO, as well as the non-CO2 greenhouse gases.

Designing a cost-effective approach for control of these multiple substances requires some way of accounting for the independent effects of each on climate. The current method for doing so is a set of indices or weights known as global warming potentials (GWPs). These have been developed for the main GHGs, but not for SO2 and other local and regional air pollutants. By design, the GWP for CO2 is 1.0 and the values for other GHGs are expressed in relation to it. These indices attempt to capture the main differences among the gases in terms of their instantaneous ability to trap heat and their varying lifetimes in the atmosphere. By this measure, for example, methane is ton for ton more than 20 times as potent as CO2, while N2O is about 300 times as potent, and the industrial gases are thousands of times as potent when taking into account the atmospheric effects of these gases over the next 100 years.

The relative value of controlling non-CO2 gases, as expressed by these GWPs, is one key reason that inclusion of the non-CO2 gases in policies to address climate change can be so effective in lowering implementation costs, particularly in the early years. Given the high carbon-equivalent values of the non-CO2 gases, even a small carbon-equivalent price on these gases would create a huge incentive to reduce emissions. Another reason is that, historically, economic instruments (i.e., prices, taxes, and fees) have not been used to discourage or reduce emissions of non-CO2 gases, whereas price signals via energy costs exist to curb CO2 emissions from fossil fuels.

If, for example, the total GHG emissions reduction required to meet a target were on the order of 10 or 15 percent, as would be the case if total GHG emissions in the United States were held at year 2000 levels through 2010, nearly all of the cost-effective reductions would come from the non-CO2 greenhouse gases. Compared to a particular reduction achieved by CO2 cuts alone, inclusion of the non-CO2 abatement options available could reduce the carbon-equivalent price of such a policy by two-thirds. This large contribution of the non-CO2 gases, and their potential effect on lowering the cost of a climate policy, is particularly surprising because it is disproportionate to their roughly 20 percent contribution to total U.S. GHG emissions. In developing countries like India and Brazil, non-CO2 gases currently account for well over one-half of GHG emissions. Any cost-effective effort to engage developing countries in climate mitigation will, therefore, need to give even greater attention to the non-CO2 gases.

Of course, these gases are only part of an effective response to the climate threat. Even if they were largely controlled, we would still be left with substantial CO2 emissions from energy use and land-use change. Over the longer term, and as larger cuts in GHGs are required, the control of CO2 will increase in its importance as an essential component of climate policy.

There remain a number of uncertainties in calculating the climatic effects of non-CO2 gases, and one is the accuracy of global warming potentials. Analysis has shown that the GWPs currently in use significantly underestimate the role of methane, and any correction of this bias would amplify the importance of the non-CO2 greenhouse gases. This error is due in part to omitted interactions, such as the role of methane in tropospheric ozone formation. The GWPs also fail to adequately portray the timing of the climate effects of abatement efforts. Because of its relatively short lifetime in the atmosphere, abatement efforts directed at methane have benefits in slowing climate change that take effect over the next few decades, whereas the benefits of CO2 abatement are spread out over a century or more. To the extent one is concerned about slowing climate change over the next 50 years, therefore, the control of methane and HFCs—the gases that last a decade or so—has an importance that is obscured when 100-year GWPs are used to compare the contributions of the various gases. Economic formulations of the GWP indices have been proposed that would address these concerns, but calculations using these economic-based formulae are bedeviled by a variety of deeper uncertainties, such as how to monetize the damages associated with climate change.

A still more difficult issue is whether and how to compare efforts to control other substances that affect the radiative balance of the atmosphere, such as tropospheric ozone precursors, black carbon, and cooling aerosols. The main issue with these substances is that, even though their climatic effects are important, a more immediate concern is that they cause local and regional air pollution that affects human health, crop productivity, and ecosystems. Moreover, their climatic effects are mainly regional, or even local, and this feature creates difficulties for the use of a single index to represent their effects across the globe. In the end, it is essential to consider these substances as part of climate policy, but more research and analysis is needed to quantitatively establish their climate influence and to design policies that take account of their local and regional pollution effects.

Putting aside the local and regional air pollutants, the quantitative importance of the other non-CO2 greenhouse gases has now been relatively well-established. One of the major remaining concerns in including them in a control regime is whether their emissions can be measured and monitored accurately so that, whatever set of policies are in place, compliance can be assured. In fact, the ability to monitor and measure has less to do with the type of greenhouse gas than with the nature of its source. It is far easier to measure and monitor emissions from large point sources, such as electric power plants, than from widely dispersed non-point sources, such as automobile and truck tailpipes or farmers’ fields. Methane released from large landfills can be easily measured, and is in the United States. But, it is impractical to directly measure the methane emitted from each head of livestock, or the N2O from every farmer’s field. The difficulty of monitoring and measuring emissions implies that a different regulatory approach may be desirable for different sources, at least initially.

Scientists have long recognized the various roles of non-CO2 greenhouse gases and other substances that contribute to climate change. It is only in the past few years, however, that the various pieces of this complex puzzle have been fit together to provide a more complete picture of just how critical the control of these gases can be in a cost-effective strategy to slow climate change. Control of non-CO2 greenhouse gases is a critical component of a cost-effective climate policy, and particularly in the near term these reductions can complement early efforts to control carbon dioxide.

Henry D. Jacoby
John M. Reilly
Ronald G. Prinn
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Congressional Testimony of Eileen Claussen: Regarding the Draft American Investments for Reduction of Emissions Act of 2003

TESTIMONY

STATEMENT BY EILEEN CLAUSSEN, PRESIDENT
PEW CENTER ON GLOBAL CLIMATE CHANGE

Before the Senate Committee on
Commerce, Science and Transportation

Washington, DC
January 8, 2003

Mr. Chairman and members of the Committee, thank you for this opportunity to testify regarding the draft American Investments for Reduction of Emissions Act of 2003. My name is Eileen Claussen, and I am the President of the Pew Center on Global Climate Change.

The Pew Center on Global Climate Change is a non-profit, non-partisan, and independent organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. Since 1998 the Pew Center has published 43 peer-reviewed reports - aimed primarily at policy-makers and opinion-leaders - on the science and environmental impacts of climate change, the economic costs and benefits of climate change policies, domestic and international policy alternatives for addressing climate change, and technology options for reducing greenhouse gas emissions. Thirty-eight major companies in the Pew Center's Business Environmental Leadership Council (BELC), most included in the Fortune 500, work with the Center to educate the public on the risks, challenges, and solutions to climate change. The BELC companies do not contribute financially to the Center.

The Pew Center accepts the view of the great majority of scientists that enough is known about the science and environmental impacts of climate change for us to take action now. As noted in 2001 by the National Research Council of the National Academy of Sciences, "greenhouse gases are accumulating in Earth's atmosphere as a result of human activities, causing surface air temperature and subsurface ocean temperature to rise." 1 The potential consequences of this warming include sea-level rise and increases in the severity or frequency (or both) of extreme weather events, including heat waves, floods, and droughts, with potentially major impacts to U.S. water resources, coastal development, infrastructure, agriculture, and ecological systems.2  We consider the risk of these and other consequences sufficient to justify action to reduce greenhouse gas emissions significantly. Moreover, much of this action must occur in the United States, which produces 24% of global emissions, making it the world's largest greenhouse gas emitter. U.S. greenhouse gas emissions are expected to grow by 12% by 2012 under current Administration policy.3

The Pew Center also believes that the cost to the United States of meeting a given emissions target can vary substantially depending on the policy approach taken. In general, the most cost-effective approaches allow emitters flexibility in deciding how to meet a target; provide early direction so targets can be anticipated and factored into major capital and investment decisions; and employ market-based mechanisms, such as emissions trading, to achieve reductions where they cost the least.

The Pew Center welcomes this opportunity to share its views on the draft American Investments for Reduction of Emissions Act of 2003, which, when introduced, will be the most significant piece of climate change legislation ever put before Congress. To provide some context for the Committee's review of this draft legislation, I would like to begin with an overview of climate change efforts already being undertaken by other countries, as well as by states and industry here in the United States.

Because climate change is a global challenge that requires a global solution, I think it is important that a discussion of U.S. policy start with a full understanding of how the issue is being addressed elsewhere in the world. I would like to emphasize two points: virtually all industrialized nations have now committed themselves to reducing their greenhouse gas emissions; and most view emissions trading as an essential component of their climate change strategies.

More than ten years ago, at the Earth Summit in Rio de Janeiro, the United States joined other nations in approving the United Nations Framework Convention on Climate Change. Recognizing that additional efforts were necessary to effectively address climate change, the parties subsequently negotiated the Kyoto Protocol, which sets binding emission targets for industrialized countries. While far from perfect, the Protocol represents a significant diplomatic achievement. Largely at the insistence of the United States, the Protocol includes several innovative mechanisms to ensure that emissions are reduced as cost-effectively as possible, chief among them an international system of emissions trading.

The present U.S. Administration has made clear it will not submit the Kyoto Protocol to the Senate for ratification. Nevertheless, other countries, including the United States' closest allies, continue to support the Protocol and have moved forward with ratification. Last month, Canada became the 100th country to ratify the agreement. Apart from the United States, Australia is the only country to state explicitly that it is not prepared to ratify the Kyoto Protocol. However, the Australian government remains committed to meeting its Kyoto emissions target and has not ruled out ratifying the treaty at a future date. The Protocol still must be ratified by Russia in order for it to enter into force. Russia has announced its intention to ratify the treaty, and is expected to do so later this year.

On a parallel track, governments are deeply engaged in developing and implementing domestic policies to meet their Kyoto targets. Japan, for instance, has set national targets for carbon dioxide and for other greenhouse gases, and is developing more than 100 measures to improve energy efficiency, promote renewable energy, enhance carbon sequestration and advance other efforts to reduce emissions. In addition, the Canadian government recently adopted a comprehensive plan that calls for binding emission reduction agreements with industry, increased government support for technology research, and targeted measures such as energy efficiency standards.

Some countries are contemplating emission reductions well beyond those required under the Kyoto Protocol. The German government has said it is prepared to reduce emissions 40 percent below 1990 levels by 2020, provided other countries agree to steeper cuts as well. In the United Kingdom, the Royal Commission on Environmental Pollution is recommending a 60 percent reduction in U.K. emissions by 2050, and Prime Minister Blair has called for a similar reduction worldwide.

Each of these countries is pursuing a strategy tailored to its national circumstances, such as its energy mix, regulatory culture, and economic profile. And each, it is worth noting, is looking to emissions trading to help meet its target. Some may rely primarily on the international trading system established under the Kyoto Protocol, while others are developing domestic systems of their own. The European community, which at first viewed U.S. arguments for emissions trading with deep skepticism, is now leading the way in establishing greenhouse gas markets. In Denmark, a cap-and-trade system regulating carbon emissions from the power sector was enacted in 1999. Last year, the U.K. became the first country to introduce a broad-based greenhouse gas trading system. While voluntary in nature, the U.K. system provides strong incentives for companies to take on binding emission targets. These and other systems are still in their early stages, but the volume of trading is rapidly increasing. A recent World Bank study projected that the number of greenhouse gas credits traded worldwide would increase four-fold from 2001 to 2002. In the first trade under the Kyoto system, a Japanese firm last month purchased 200,000 credits from Slovakia, which intends to invest the proceeds in domestic emission reduction projects.

One of the most significant steps in the development of the greenhouse gas market came last month when the European Council reached agreement on the establishment of a European trading system for carbon dioxide. This system, which is subject to final approval by the European Parliament, will encompass all the member states of the European Union (including the ten approved for new membership in 2004), which have a combined economy larger than that of the United States. In its initial phase, the system will cover six sectors - including electric utilities, steel producers, and oil refiners - which together account for nearly half of Europe's carbon dioxide emissions. Individual member states will set targets and allocate allowances among their emitters, and facilities that fail to meet their targets will face significant penalties. The system is designed to be compatible with the Kyoto system and with other national systems, but trading will be permitted only with countries that have ratified the Kyoto Protocol. Member states overcame strong political differences to reach agreement on this system, and its operation will provide valuable lessons for the future of greenhouse gas emissions trading.

I would like to offer one final note on what is happening internationally. As you know, one of the chief criticisms of the Kyoto Protocol is that it does not establish greenhouse gas emission limits for developing countries. Whether or not one believes the Kyoto Protocol is fair in this respect - and I happen to believe it is - I think the more important question is whether or not developing countries are in fact taking steps to limit their emissions. The Pew Center recently undertook an analysis of climate change mitigation in six developing countries, including China, India, Mexico, and Brazil.4  We identified many measures underway in those countries that, while not necessarily motivated by climate concerns, are significantly reducing the growth of their greenhouse gas emissions. We calculated that these measures - which include market and energy reforms, fuel switching, and pollution controls - have reduced the growth of these countries' combined greenhouse gas emissions by nearly 300 million tons a year. These findings suggest significant opportunities to further reduce emissions growth in developing countries while helping them to achieve stronger economic growth and other development priorities.

Clearly, significant greenhouse gas reduction activities are occurring abroad, but U.S. states are undertaking important activities as well. In fact, the recent state leadership in addressing climate change has been striking. At least two-thirds of the states have programs that, while not necessarily directed at climate change, are achieving real greenhouse gas emission reductions. Measures that have proven controversial at the federal level, such as renewable portfolio standards and mandatory reporting of greenhouse gas emissions, have been implemented at the state level, often with bipartisan support and little controversy.

The Pew Center recently published a report on state initiatives to reduce greenhouse gas emissions.5  This report found that Texas and eleven other states have enacted legislation that requires utilities to provide a certain amount of renewable power as part of their total offering of electricity. Texas has also established a Renewable Energy Credits (RECs) Trading Program that gives utilities considerable flexibility in meeting the requirement. Under this market-based program, every certified renewable energy project in Texas produces one credit for every kilowatt-hour of electricity that it generates. These credits can be purchased by electricity providers to meet any shortfall in their own generation of renewable energy. A carbon cap-and-trade program would work on the same principle.

Important work is being done in other states, as well. New Hampshire and Massachusetts have recently started directly regulating carbon dioxide emissions from power plants. Nebraska, Illinois, North Dakota, Oklahoma, and Wyoming are linking agricultural policy with greenhouse gas reduction, and are taking steps to allow agricultural interests to sell stored, or "sequestered," carbon as a commodity. California has enacted a law to require reduction of greenhouse gases emitted from cars, sport utility vehicles (SUVs), and light-duty trucks. And the New England governors have joined with the premiers of the five eastern provinces of Canada in committing to reduce regional greenhouse gas emissions to 1990 levels by 2010 and to ten percent below 1990 levels by 2020.

There are similar examples of leadership in industry. A growing number of companies are voluntarily committing themselves to greenhouse gas reduction targets. At last count, the Pew Center had identified more than 40, most either based in the United States or with significant U.S. operations. BP, for example, has reduced greenhouse gas emissions to 10 percent below 1990 levels - eight years ahead of target - and now has pledged to keep them there at least until 2010. Alcoa is working to reduce its greenhouse gas emissions by 25 percent below 1990 levels by 2010. DuPont is aiming for a 65 percent reduction below 1990 levels, also by 2010.

The Pew Center recently studied several companies that have taken on targets and found they are motivated by several things.6  They believe the science of climate change is compelling. They know in time the public will demand strong climate protections, and they can get ahead of the curve by reducing their emissions now. They want to encourage government policies that will work well for business. They also cite one other important motivation: To improve their competitive position in the marketplace. That, in fact, has been the result. The companies are finding that reducing emissions also helps to improve operational efficiencies, reduce energy and production costs, and increase market share - all things that contribute to a healthier bottom line. While addressing climate change is not necessarily profitable, the evidence so far suggests it is certainly affordable.

To summarize: Other countries are moving forward to address climate change, and, in the United States, states and companies are exercising leadership to fill the void left by inaction at the federal level. In this context, I believe the draft American Investments for Reduction of Emissions Act of 2003 represents an important milestone in the effort to ensure that the United States does its part to address global climate change. Its enactment would establish a comprehensive national framework that would put the United States on a path toward significant long-term emissions reduction.

The draft Act incorporates several features that would be critical to the success of a national climate change strategy. First, it would establish ambitious environmental goals through binding caps on greenhouse gas emissions. Recognizing the need for reductions from all the major sectors, the Act would apply this cap economy-wide, providing an important signal to key players throughout the economy to increase energy efficiency and develop alternative fuels and technologies to reduce greenhouse gas emissions.

Second, the Act would provide companies with the flexibility they need to reduce emissions as cost-effectively as possible. It would establish a rigorous nationwide system allowing emissions trading across sectors, gases, and national borders, and would provide reasonable credit for carbon storage through sequestration.

Third, the Act would take a phased approach that respects economic realities. As mentioned, our work has demonstrated that there are many cost-effective - in fact, cost-saving - opportunities to reduce emissions in the short- and perhaps medium-term. However, achieving the emission cuts ultimately needed to avert the most adverse consequences of climate change is not a cost-free proposition. The Act's phased approach would take advantage of the relatively easy steps now readily available, while allowing time for the capital and technology investments needed to achieve deeper emissions cuts over the long term.

Finally, the Act would seek to treat all affected parties fairly. It would recognize the real and verifiable reductions of those who have taken the lead in reducing their emissions, and would provide assistance to consumers, workers, and communities affected by climate change policy.

As with any legislation this far-reaching and complex, there is significant room for debate on the specifics, even among those who share the Act's objectives and would support its broad approach. Nonetheless, we believe the draft Act offers a solid foundation for crafting an effective national climate policy that draws on America's strengths and begins to fulfill its responsibility to protect our global climate. We appreciate the vision and leadership shown by Senators McCain and Lieberman in drafting the American Investments for Reduction of Emissions Act of 2003 and look forward to providing any assistance that might be useful to the Committee as it acts on the bill.

--------------------------------------------------------------------------------

Footnotes

1. "Climate Change Science: An Analysis of Some Key Questions," Committee on the Science of Climate Change, National Research Council, 2001.

2. Wigley, T.M.L., 1999, The Science of Climate Change: Global and U.S. Perspectives, Pew Center on Global Climate Change; Neumann, J.E., G. Yohe, R. Nicholls, and M. Manion, 2000, Sea-Level Rise & Global Climate Change: A Review of Impacts to U.S. Coasts, Pew Center on Global Climate Change; Frederick, K.D. and P.H. Gleick, 1999, Water and Global Climate Change: Potential Impacts on U.S. Water Resources, Pew Center on Global Climate Change.

3. "Pew Center Analysis of President Bush's February 14th Climate Change Plan," Pew Center on Global Climate Change, 2002, available online.

4. Chandler, W., R. Schaeffer, Z. Dadi, P.R. Shukla, F. Tudela, O. Davidson, and S. Alpan-Atamer, 2002, Climate Change Mitigation in Developing Countries, Pew Center on Global Climate Change.

5. Rabe, B., 2002, Greenhouse & Statehouse: The Evolving State Government Role in Climate Change, Pew Center on Global Climate Change.

6. Margolick, M. and D. Russell, 2001, Corporate Greenhouse Gas Reduction Targets, Pew Center on Global Climate Change.

Capital Cycles and the Timing of Climate Change Policy

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Capital Cycles and the Timing of Climate Change Policy

Prepared for the Pew Center on Global Climate Change
October 2002

By:
Robert J. Lempert, Steven W. Popper, and Susan A. Resetar, RAND
Stuart L. Hart, Kenan-Flagler Business School, University of North Carolina at Chapel Hill

Press Release

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Foreword

Eileen Claussen, President, Pew Center on Global Climate Change

Patterns of capital investment by businesses can have a major impact on the success and cost-effectiveness of climate change policies. Due to the high cost of new capital, firms often are reluctant to retire old facilities and equipment. Thus, capital investment decisions made today are likely to have long-term implications for greenhouse gas (GHG) emissions. Because businesses consider a range of factors when making capital stock decisions, policy-makers need to understand and focus on these factors in order to craft effective climate change policies.

The Pew Center commissioned this report to gain an understanding of the actual patterns of capital investment and retirement, or “capital cycles.” Authors Robert Lempert, Steven Popper, and Susan Resetar of RAND, with Stuart Hart of the Kenan-Flagler Business School at UNC-Chapel Hill combine analysis of the literature on investment patterns with in-depth interviews of top decision-makers in leading U.S. firms. Their work provides important insights into the differing patterns of capital investment across firms and sectors, and what factors spur those investments.

The authors found that capital has no fixed cycle. In reality, external market conditions often drive a firm’s decision whether to invest or disinvest in large pieces of physical capital stock, and a firm often invests in new capital only to capture new markets. In the absence of policy or market incentives, expected equipment lifetimes and the availability of more efficient technologies are not significant drivers of capital stock decisions. With regular maintenance, capital stock often lasts decades longer than its rated lifetime, and the availability of new technology rarely influences the rate at which firms retire older, more polluting plants.

The authors suggest certain policies that can stimulate more rapid turnover of existing capital stock. These include putting in place early and consistent incentives that would assist in the retirement of old, inefficient capital stock; making certain that policies do not discourage capital retirement; and pursuing policies that shape long-term patterns of capital investment. For example, piecemeal regulatory treatment of pollutants rather than a comprehensive approach could lead to stranded investments in equipment (e.g., if new conventional air pollutant standards are put in place in advance of carbon dioxide controls at power plants). The authors also note that even a modest carbon price could stimulate investment in new capital equipment. Ultimately, any well-crafted policy to address climate change must consider and harness market factors and policies that drive capital investment patterns.

The authors and the Pew Center wish to acknowledge members of the Center’s Business Environmental Leadership Council, as well as Byron Swift, Ev Ehrlich, Mark Bernstein, Debra Knopman, Alan Sanstad, and David Victor for their advice and comments on previous drafts of this report. We also thank the individuals who gave their time in interviews with the project team.

Executive Summary

One important source of climate-altering greenhouse gas (GHG) emissions is the capital equipment that supports the world’s economic activity. Capital stock, such as electricity generation plants, factories, and transportation infrastructure, is expensive and once built can last for decades. Such capital also presents important and conflicting constraints on policy-makers attempting to reduce society’s GHG emissions. On the one hand, attempts to reduce emissions too quickly may create a drag on the economy if they force the premature retirement of capital. On the other hand, delaying reductions may raise the cost of future actions because the facilities built today can still be polluting decades from now.

This report aims to help policy-makers navigate between these conflicting tensions by providing an understanding of the actual patterns of capital investment and capital retirement and the key factors that affect these patterns. “Capital cycles” have been studied extensively in the empirical and theoretical literature. Nonetheless, the topic remains poorly understood in the debates over climate change policy. In part, there are few good summaries available of the voluminous and complex literature. In addition, the differing patterns of capital investment across firms and sectors can have important implications for climate change policy. Such heterogeneity is not well-captured by the existing theoretical and empirical literature.

This report begins with a brief overview of the existing theoretical and empirical literature on capital cycles. It then turns to its main focus—the results of a small number of in-depth interviews with key decisionmakers in some leading U.S. firms. In the course of the study, nine interviews, designed to illuminate the key factors that influence firms’ capital investment decisions, were conducted with firms in five economic sectors. The firms interviewed are mostly members of the Center’s Business Environmental Leadership Council (BELC). Based on the information gathered during the interviews, this report closes with some observations regarding the implications for the timing of climate change policy.

This is a small study with limited scope. Nonetheless, several consistent and clear findings emerged from the firm interviews:

Capital has no fixed cycle. Despite the name, there is no fixed capital cycle. Rather, external market conditions are the most significant influence on a firm’s decision to invest in or decommission large pieces of physical capital stock. In particular, firms strive to invest in new capital only when necessary to capture new markets. Firms most commonly retire capital when there is no longer a market for the products they produce and when maintenance costs of older plants become too large.

Capital investments may have long-term implications. Today’s capital investment decisions can have implications that extend for decades. Capital stock is expensive, and firms often have little economic incentive to retire existing plants. The environmental performance of capital stock is not fixed over time and can improve as a firm makes minor and major upgrades. Nonetheless, there are limits to such upgrades, so that investment decisions made today may shape U.S. GHG emissions well into the 21st century.

Equipment lifetime and more efficient technology are not significant drivers in the absence of policy or market incentives. It is often assumed that the engineering and nominal service lifetimes of physical equipment are important determinants of the timing of capital investment. The phrase “capital cycle” derives at least in part from the notion that capital equipment in each sector has some fixed lifetime, which drives the industry’s capital investment decisions. This study finds that the physical lifetime of equipment does drive patterns of routine maintenance in different economic sectors, but it appears to be a less significant driver of plant retirement or for investment in new facilities. With regular maintenance, capital stock can often last decades longer than its rated lifetime.

In addition, discussions of climate change policy often highlight the potential of new technology to enable low-cost reductions in GHG emissions. This study finds that however beneficial such technology may be, it will likely have little influence on the rate at which firms retire older, more polluting plants in the absence of policies promoting technology or requiring emissions reductions. New process technology, that is, technology that improves the efficiency and cost-effectiveness of a factory or power plant, requires performance improvements of an exceptional magnitude to induce a firm to retire existing equipment whose capital costs have already been paid. Firms do adopt new process technology, but only when other factors, particularly changes in demand for their products or regulatory requirements and other government policies, drive them to invest in new capital stock.

Firms focus investment towards key corporate goals. Although manifested differently across firms and economic sectors, all the firms we interviewed followed the same basic decisionmaking process for capital investment. Each year a firm’s leadership allocates the funds available for capital investment—first to must-do investments, then to discretionary investments. The former are required to maintain equipment and to meet required health, safety, and environmental standards. The latter are prioritized according to their ability to address key corporate goals. In particular, firms’ capital investment is often driven by the desire to capture new markets. Uncertainty was a recurring theme in all our interviews. Capital investment decision processes are shaped by the desire to reduce the potential regret due to adverse or unforeseen events over the long lifetime of capital stock.

These results are based on interviews with a small number of firms and are by no means definitive. Nonetheless, they suggest that climate policy should combine modest, near-term efforts to reduce emissions and more aggressive efforts to shape capital investment decisions over the long term. In particular:

The long lifetime of much capital stock may slow the rate at which the United States can obtain significant GHG emission reductions. Firms are often reluctant to retire capital and attempts to force them to do so on a short-term timetable can be costly. Sporadic and unpredictable waves of capital investment make it more difficult for climate policy to guarantee low-cost achievement of fixed targets and timetables for GHG emissions reductions. Reductions may be more rapid during periods of significant capital turnover and less rapid otherwise.

Policy-makers should consider early and consistent incentives for firms to reduce GHGs. Incentives ranging from early action credits to emissions trading can take advantage of those rare times when firms make major investments in new capital. Relatively low-cost opportunities for GHG emissions reductions are often available during such periods of investment. This analysis suggests that introducing a relatively low carbon price could serve as a consistent incentive to reduce GHG emissions.

Policy-makers should avoid regulations and other rules that discourage capital retirement. The retirement of older facilities often provides the opportunity for low-cost deployment of new, emissions-reducing technologies. The grandfathering provisions of the Clean Air Act and other environmental regulations may delay the retirement of older plants by exempting them from the environmental regulations governing new plants. At the same time, regulations governing some pollutants may provide an opportunity to address GHGs simultaneously while these investments are being made.

Policy-makers should pursue policies that shape long-term patterns of capital investment. While policy may only make small perturbations in near-term decisions regarding the composition of U.S. capital stock, over the long term, policy may significantly shape the market forces and opportunities perceived by firms. Government-sponsored research and development on new, emissionsreducing technologies and policies such as a cap-and-trade program may have a profound effect on the direction of long-term investments in new capital stock. Overall, the dynamics of capital investment and retirement suggest that policy-makers can set ambitious long-term climate goals, but should allow firms a great deal of flexibility in the timing with which they will respond to them.

Robert J. Lempert
Steven W. Popper
Stuart L. Hart
Susan A. Resetar
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