Highlights

Introduction

This analysis of Senate Bill 139 (S.139), the Climate Stewardship Act of 2003, was requested by Senator James M. Inhofe, Chairman of the Senate Environment and Public Works Committee, and by Senators John McCain and Joseph I. Lieberman, who introduced the bill. The analysis responds to both requests.

Highlights of S.139

• S.139 would establish regulations to limit U.S. emissions of greenhouse gases, primarily through a system of tradable emission allowances and related emissions reporting requirements.
• The bill covers emissions of six greenhouse gases: carbon dioxide, methane, nitrous oxide, and three gases with high global warming potential (GWP)—hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride. The bill’s allowance requirements cover about 75 percent of direct emissions in the United States. Covered sources include entities in the commercial, industrial, and electric power sectors with annual greenhouse gas emissions above a threshold level of 10,000 metric tons carbon dioxide equivalent;¹ transportation uses of petroleum products; and producers and importers of high-GWP gases.
• Emissions sources excluded are entities in the residential and agriculture sectors with direct emissions and entities with annual emissions below 10,000 metric tons carbon dioxide equivalent (based on GWP). Noncovered entities are affected by the bill, however, because emissions from the electricity they use are subject to the bill’s allowance program, and because prices for natural gas are expected to rise as demand for the low-carbon fuel increases under the program.
• Emissions allowance caps are introduced in two phases. Phase I allowance caps, in effect from 2010 to 2015, are based on the emissions from covered sources in 2000. The Phase II caps, in effect after 2015, are based on 1990 emissions. The bill provides incentives and flexibility measures to spur early action and give credit for past emission reduction efforts, including:
• A banking provision that allows entities to save allowances for future use, providing an incentive to overcomply early, when the allowance limit is relatively low, easing the transition to more stringent limits in Phase II, beginning in 2016
• Emission allocation rules that reward past reductions with increases in the initial allocation of allowances
• Allocation of emission-based marketable credits to automotive manufacturers for corporate average fuel economy (CAFE) improvements that are more than 20 percent over the relevant standard
• A Climate Change Credit Corporation, funded by allowance sales, with authority to provide programs for transition assistance and to reduce economic impacts, which could take the form of rebates for purchases of efficient appliances and other transfer payments.

Summary of the S.139 Analysis and Results

Total Greenhouse Gas Emissions Reach 2000 Levels by 2025. Total greenhouse gas emissions are estimated to reach 2000 levels by 2025, with the gradual decline in U.S. greenhouse gas emissions starting in 2010. Covered entities are expected to overcomply in Phase I, in order to bank allowances. Beginning in 2016, when the more stringent Phase II allowance caps go into effect, covered entities would use previously banked allowances, enabling them to reduce their emissions (about 75 percent of the total) to near 1990 levels over the next decade. Emissions from noncovered entities grow moderately through 2025. Total emissions (covered and noncovered) reach 2000 levels by 2025. These changes in emissions do not reflect increases in carbon sequestration and purchases of emissions reductions abroad that are also used to comply with the targets in the legislation.

Allowance Values Grow Over Time. Prices in the emission allowance program are expected to increase gradually from $79 per metric ton carbon equivalent in 2010 ($22 per metric ton carbon dioxide equivalent) to $221 per metric ton carbon equivalent in 2025 ($60 per metric ton carbon dioxide equivalent).² The S.139 provisions to allow banking of emissions allowances are expected to moderate price increases as arbitrage occurs in allowance trading and banking.

A Supplementary Market for Tradable Offsets Develops. The bill provides an incentive for noncovered entities to make reductions and register them, so that they can be sold to covered entities for use in place of allowances. An organized market for offsets is expected to develop, and covered entities are assumed to take advantage of the maximum allowable amount of offsets (15 percent of the allowance requirement in Phase I and 10 percent in Phase II). The offset limits, combined with the generally lower costs of initial reductions from offset sources, are expected to result in a lower market price for offsets than for allowances. Estimated prices of offsets in 2025 are $52 per metric ton carbon equivalent, well below the price of allowances ($221 per metric ton carbon equivalent).³

2025 End-Use Prices Increase by 27 Percent for Motor Gasoline and 46 Percent for Electricity. In the S.139 analysis case, gasoline prices increase by 19 cents per gallon in 2010 and by 40 cents per gallon in 2025 relative to the prices projected in the reference case. Electricity costs increase by 0.6 cents per kilowatthour in 2010 (9 percent) and by 3 cents in 2025 (46 percent). The average household’s energy bill, including the fuel cost of personal transportation, is expected to increase by $444 dollars per year in 2025 (13 percent) relative to the reference case.

Allowance Proceeds Offset Consumer Impacts. The increase in the average household’s energy expenses is significantly mitigated by appliance rebates, transition assistance, and other transfer payments provided by the Climate Change Credit Corporation, a new nonprofit organization created under the bill and funded with revenues from emission allowance sales.

By 2025, Average Delivered Prices to Covered Entities Increase by 31 Percent for Petroleum Products,
79 Percent for Natural Gas, and 485 Percent for Coal. Covered entities must hold allowances for their greenhouse gas emissions. The costs of the allowances add to the effective price of fossil fuels delivered to the covered sectors. The large percentage increase in the cost of coal reflects both its high carbon content and its relatively low initial price. On a dollar-per-Btu basis, coal remains the lowest cost fossil fuel under the bill, but its use is expected to be greatly reduced as a direct consequence of the allowance program.

Macroeconomic Impacts Reduce Gross Domestic Product (GDP). The economy’s adjustment to increasing energy costs through 2025 under the bill is expected to reduce real GDP and disposable income, with the degree and timing of the impacts determined in part by how proceeds from allowance sales are distributed. Assuming that the amount of auctioned allowances grows over time, the maximum percentage reduction in projected GDP compared to the reference case in any year is 0.7 percent.⁴ The projected average annual growth rate of GDP from 2001 to 2025 is 3.02 percent with the bill and 3.04 percent without it. Expressed in dollar terms, the reduction in the present discounted value of GDP over the forecast period is $507 billion (in 1996 dollars). In 2025, when the adjustment to the S.139 regime is largely complete, actual GDP in the S.139 case is $106 billion (0.6 percent) lower than in the reference
case.

Personal Disposable Income Is Also Reduced. Reductions in disposable income are similar in magnitude to the reductions in GDP, with the greatest changes occurring in the 2010-2015 time frame, when the assumed percentage of allowances allocated to the Climate Change Credit Corporation and rebated to consumers is the lowest. Over the 22-year time frame of the analysis, the cumulative difference in discounted disposable income relative to the reference case is $1,037 per capita, or about $47 per person per year (1996 dollars). Without discounting, the cumulative difference in disposable income relative to the reference case is $2,459 per capita, or $112 per person per year.

The Electric Power Sector Dominates Emission Reductions. The electric power sector is expected to provide by far the greatest share of emissions reductions, mainly through fuel substitution on the supply side but also through demand changes from higher electricity prices. Total energy-related carbon dioxide emissions in 2025 are reduced by 752 million metric tons carbon equivalent relative to the reference case, with the electricity sector’s reduction amounting to 663 million metric tons. The electricity sector is more flexible in reducing emissions because of its potential to substitute towards lower carbon fuels, adopt emission-free alternatives, and implement carbon sequestration technology for fossil-fueled plants. To a great extent, these options can reduce emissions at a lower per-ton cost than in other energy-consuming sectors.

Coal Use Declines Sharply; New Nuclear Power Plants Are Added; Use of Renewable Energy Increases. The use of coal, particularly for electric power, is expected to decline rapidly, with generators substituting capacity fueled by natural gas, nuclear, and renewable fuels, and building plants equipped with carbon sequestration technology. Geological sequestration of carbon dioxide for coal and natural gas plants is expected to become economical, resulting in 140 gigawatts of capacity equipped with this technology (38 gigawatts using coal) by 2025. Nuclear power, which produces no greenhouse gas emissions, becomes more economical under S.139. Nuclear generation is expected to increase by 50 percent by 2025, with investments in a new generation of advanced plants beginning as early as 2012. Renewable energy use increases under S.139, particularly in the electricity sector, as additions of biomass and wind capacity, along with more modest increases in geothermal and landfill gas capacity, increase relative to the reference case. The estimated share of generation supplied by renewables, including hydroelectricity, increases from 8 percent in the reference case in 2025 to 23 percent in the S.139 case.

Transportation Energy Use Falls. Transportation petroleum use declines by 0.3 quadrillion Btu (1 percent) in 2010 and 4.1 quadrillion Btu (10 percent) in 2025 under the bill, compared to the reference case level, as the prices of travel-related emission allowances are passed on to consumers, who respond by buying more fuel-efficient vehicles and traveling less. Automotive manufacturers, who are given incentives under the bill to exceed fuel economy standards by at least 20 percent, are expected to respond gradually to the incentives, while continuing to maintain vehicle comfort, safety, and performance. By 2025, new light vehicle fuel economy (cars and light trucks together) reaches 29.0 miles per gallon, compared with 26.4 miles per gallon in the reference case.

Petroleum Imports Decline. U.S. petroleum demand is estimated to fall by 0.3 million barrels per day in 2010 and by 2.7 million barrels per day in 2025 compared to the reference case, reducing projected oil import dependence in 2025 from 67.8 percent to 64.7 percent of total U.S. oil supply.

Allowance Values and GDP Impacts Are Lower Under High Technology Assumptions. Under more optimistic assumptions about the future availability, costs, and performance of advanced energy-using technologies, the cost of compliance for S.139 is lower. In a high technology sensitivity case, allowance prices in 2025 are reduced by 28 percent compared to the S.139 case. The reduction in the size of the economy in 2025 is $106 billion in the S.139 case and $95 billion in the S.139 high technology case (1996 dollars).

A Lower Natural Gas Supply Outlook and Higher Natural Gas Prices Result in Greater Adoption of Nuclear and Renewable Technologies and Increase the Use of Coal with Carbon Sequestration. More pessimistic assumptions for natural gas supplies, including recoverable reserves and undiscovered resources, result in projected wellhead prices in 2025 that are 40 percent higher than in the reference case. An S.139 sensitivity case with higher gas prices results in changes in compliance strategies, particularly in the electricity sector. Generating capacity substituted for natural gas additions includes coal-fired plants with carbon sequestration, as well as nuclear and renewables. As a result, overall coal consumption in this sensitivity case is 237 million tons higher than in the S.139 case in 2025, but at 543 million tons it is significantly lower than in the reference case (1,466 million tons). The overall cost of compliance, as indicated by the allowance prices, is about 6 percent higher in the S.139 high gas price case than in the S.139 case.

The Results Are Inherently Uncertain. An assessment of the impact of S.139 over a 25-year period is subject to considerable uncertainty. The baseline forecast (which is itself uncertain) affects the amount of change needed to meet an emissions target, as do the modeling methodology and assumptions. Alternative assumptions about the cost, performance, and market acceptance of these technologies affect the results, as do other assumptions, including the distribution of emission allowances to covered entities, the availability and cost of international offsets, future policy changes affecting energy use, and the extent of coverage and reduction potential of emissions sources. Sensitivity analysis is used to address some of these issues but does not necessarily encompass the full range of plausible energy and economic outcomes that might follow from enactment of the bill.

Notes and Sources