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What Does the Kyoto Protocol Mean to U.S. Energy Markets and the U.S. Economy?

October 1, 1998

Economic Effects of a Complex Agreement Depend on Many Assumptions

The Kyoto Protocol, negotiated by more than 160 nations in December 1997, aims to reduce net emissions of certain greenhouse gases (primarily carbon dioxide (CO2 )). Each of the participating developed countries must decide how to meet its respective reduction goal during a five-year period (2008-2012); but specific ground rules remain to be worked out at future negotiating sessions. The next meeting is in Buenos Aires (November 1998).

In a study entitled Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity, the Energy Information Administration (EIA), an independent statistical and analytical agency in the U.S. Department of Energy, has projected that meeting the U.S. targets under the Protocol will call for significant market adjustments:

  • Reductions in CO2 emissions will result in between 18 and 77 percent less coal use than projected in the EIA Reference Case in 2010, particularly affecting electricity generation, and between 2 and 13 percent less petroleum use, mainly affecting transportation.
  • Energy consumers will need to use between 2 and 12 percent more natural gas in 2010 and between 2 and 16 percent more renewable energy, and extend the operating life of existing nuclear units.
  • To achieve these ends via market-based means, average delivered energy costs (in inflation-adjusted 1996 dollars) must be between 17 and 83 percent higher than projected in 2010.
  • The amount prices must rise is uncertain. Accounting procedures and international trading rules for greenhouse gases are not finalized. Forecasting technological change and public response to it under various pricing scenarios is an inexact science. The more stringent the need for domestic emission reductions, however, the more costly the adjustment process will be.

EIA undertook this study in response to a request by the Chairman and Ranking Minority Member of the House Committee on Science that it analyze impacts of the Protocol (which the President has not yet submitted to the U.S. Senate for ratification) on U.S. energy use, prices, and the general economy in the 2008-2012 time frame. That is when this country is supposed to reach an average level of net greenhouse gas emissions 7 percent lower than they were in 1990—having shown demonstrable progress toward that goal by 2005. At the Committee’s request, EIA assumed that actions begin in 2005.

EIA was asked to do the study for several reasons. More than 80 percent of the human-originated greenhouse gas emissions are energy-related. EIA’s National Energy Modeling System (NEMS) is perhaps the most complete, integrated, regional computer model available to simulate all elements of U.S. energy supply and demand in the context of the full U.S. macroeconomy. NEMS presents year-by-year projections over a 20-year horizon, accounting for capital stock turnover and the availability and penetration of specific energy-consuming technologies. Its annual "Reference Case" assumes no change from existing laws and regulations, and so it provides a base from which to evaluate policy options or alternative assumptions.

EIA analyzed six cases to investigate the uncertain range of impacts which could result from the Kyoto Protocol. Differences among the cases analyzed arise from three facts: 1) The Protocol gives credit for "CO2- equivalent” reductions in five gases other than CO2 —methane, nitrous oxide, and three synthetic gases—as well as for certain actions that take carbon out of the atmosphere (such as preserving or extending forests); 2) participating developed countries are allowed to sell excess "permits” (e.g., because of economic problems since 1990 in the participating countries of the former Soviet Union, they may have about 165 million metric tons of carbon permits easily available); and 3) support for effective programs in other countries can earn permits. Details of this last process (called "Joint Implementation” among developed countries and the "Clean Development Mechanism,” or CDM, for developing countries) are unsettled.

EIA’s six cases cover a range of reductions in energy-linked carbon emissions from an annual average of 122 million metric tons below the expected baseline emissions (1990+24% Case) to 542 million metric tons (1990-7% Case) in 2008-2012. In the 1990+24% Case, domestic actions may furnish about one-fifth of all reductions, with the rest coming from international activities (including trading), offsets of other gases, and carbon sinks in the U.S., while the 1990+9% Case assumes that nearly 60 percent of the reductions result from such domestic initiatives as fuel-switching, improved technology, and cutbacks in energy use. EIA did not separately calculate the contributions of international activities, offsets or sinks for any case. The 1990-3% Case assumes all reductions are from domestic actions, with a 4 percentage point contribution from sinks and offsets from other gases. In the 1990-7% case, all reductions mus

The Kyoto Protocol does not specify targets for greenhouse gases after the period 2008-2012. At the Committee’s request, EIA held the target for energyrelated carbon emissions in the commitment period constant to 2020, the end of the forecast horizon. Targets following the 2008-2012 period will be a topic at future negotiating sessions.

To reduce carbon emissions, EIA assumes that a "carbon price” is added to the price of delivered energy fuels based on their carbon content. For example, coal prices rise more than petroleum and natural gas prices; and the cost of generating electricity from non-carbonemitting nuclear and renewable fuels is not increased due to the carbon price. Although electricity does not have the carbon price directly added to it, its price is increased due to the higher cost of fossil fuels used for generation.

The price increases encourage a reduction in the use of energy services (heating, lighting, and travel, for example), the adoption of more energy-efficient equipment, and a shift to less carbon-intensive fuels. The carbon price reflects the amount fossil fuel prices in the U.S., adjusted for the carbon content of the fuel, must rise to achieve the removal of the last ton of carbon emissions that meets the carbon reduction target in each case.

In most of the cases, the carbon price peaks early in the 2008-2012 period, reaching between $67 and $348 per metric ton in 2010, and then declines as energy markets adjust and more efficient, new technologies become available and gradually penetrate the market. In the least stringent reduction cases, the increase is more gradual throughout the period because less severe reductions need to be made. Looking at average carbon prices over the commitment period 2008 to 2012 shows how the cost of compliance increases with increasingly stringent targets.

Differences in the cost of energy will affect the outlook for U.S. jobs, consumer prices, investment, technical change, and economic growth. Whenever use of a factor of production such as energy is restricted, economic performance falls for some period of time, the price of energy and other goods and services rises, and consumption and employment decline. Hence the various cases affect the national economy to varying degrees.

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