1. Background and Scope of the Analysis

This service report was prepared by the Energy Information Administration (EIA), in response to an October 20, 2005, request from Senator Ken Salazar (see Appendix A). Senator Salazar requested that EIA assess the impacts of alternative greenhouse gas intensity5 reduction goals and permit safety-valve prices. He requested that the analysis build on an earlier EIA Report that analyzed the policies recommended by the National Commission on Energy Policy (NCEP), a nongovernmental, privately-funded entity, in its December 2004 report entitled, Ending the Energy Stalemate: A Bipartisan Strategy to Meet America's Energy Challenges.^6,7

Among the policies recommended by the NCEP was a greenhouse gas (GHG) reduction program with a goal to reduce GHG intensity in two phases beginning in 2010. The NCEP recommended a GHG intensity reduction goal of 2.4 percent per year in the first phase between 2010 and 2019, and a goal of 2.8 percent per year in the second phase beginning in 2020. The NCEP proposed meeting the reduction targets with an emission cap-and-trade program with a safety-valve⁸ permit price of $7 per metric ton of carbon dioxide equivalent in 2010 (nominal dollars rising at 5 percent per year).

This report examines the impacts of alternative GHG intensity reduction goals on greenhouse gas emissions, energy demand, supply and prices, together with the economic impacts using the National Energy Modeling System (NEMS).⁹ Specifically, Senator Salazar requested "analysis of additional intensity-improvement/safety-valve combinations with intensity improvements ranging from 2.6 to 4.0 percent per year and safety-valve values ranging from $10 to $35 (in 2010 nominal dollars, rising five percent per year)."

Pursuant to Senator Salazar��s request, this report considers variations in the greenhouse gas intensity reduction program originally recommended by the NCEP. It does not evaluate the impacts of other programs suggested by the NCEP. The impacts of the GHG intensity reduction goals analyzed are compared with the reference case results published by EIA in the Annual Energy Outlook 2006 (AEO2006) in February 2006.¹⁰ Since the earlier report was based on the AEO2005, a brief discussion is provided of the key differences between the AEO2005 and AEO2006 that impact greenhouse gas emissions.

This report, like other EIA analyses of energy and environmental policy proposals, focuses on the impacts of those proposals on energy choices made by consumers in all sectors and the implications of those decisions for the economy. This focus is consistent with EIA's statutory mission and expertise. The study does not account for any possible health or environmental benefits that might be associated with curtailing GHG emissions.

Greenhouse Gas Intensity Reduction Cases

Table 1 summarizes the greenhouse gas intensity improvement rates and permit safetyvalve prices for the analysis cases in this report. The Cap-Trade 1 through Cap-Trade 4 cases, which incorporate progressively larger rates of targeted intensity improvements and progressively higher safety-valve prices, are the main focus of this report. The GHG
intensity reduction goals used in these cases were chosen to span the ranges in the analysis request. In addition, permit safety-valve prices for each case were selected from the range of safety-valves requested by Senator Salazar. The permit safety-valve prices shown in Table 1 are in 2004 dollars while the requested $10 to $35 range was given in 2010 dollars. In 2010 dollars, the $8.83 value shown would be $10 while the $30.92 value would be $35. As requested, the safety-valves are assumed to increase 5 percent annually in nominal dollars from 2010 through 2030.

The report also discusses three additional cases based on the intensity reduction goals in the Cap-Trade 3 case, but with alternative assumptions about the permit safety-valve price, the abatement opportunities for other greenhouse gases, and the rate of technological change. The Cap-Trade 3 Low Safety case is the same as the Cap-Trade 3 case, except that it uses a lower GHG permit safety-valve price to illustrate how the safety-valve can impact the results actually achieved. The Cap-Trade 3 High Tech case examines the impacts of alternative technology improvement assumptions. It includes the same greenhouse gas targets and safety-valves as the Cap-Trade 3 case, but incorporates the technology assumptions from the High Integrated Technology case in the AEO2006.¹¹ The Cap-Trade 3 Low Other case addresses uncertainty about the emissions reductions that might occur in non-energy-related greenhouse gases. NEMS does not explicitly represent consumer and producer behavior with respect to the nonenergy-related greenhouse gases. Instead, engineering-based emissions abatement curves for these other gases were derived from work done by the Environmental Protection Agency (EPA) and were used to represent how consumers and producers might respond to a GHG cap and trade program. However, markets often do not respond as rapidly as some engineering-based analyses would suggest, so the Cap-Trade 3 Low Other case assumes a 50-percent reduction in the quantity available on the other greenhouse gas abatement curves.

Figure 1 illustrates the GHG intensity reduction goal and safety-valve price combinations examined. The Cap-Trade 1 case represents the program recommended by the NCEP. Starting from this case, the Cap-Trade 2, Cap-Trade 3 and Cap-Trade 4 cases (throughout the rest of this report referred to as the "Cap-Trade" cases) pair increasingly stringent GHG intensity reduction goals with increasing permit safety-valve prices, defining the dotted ellipse in Figure 1. Combinations of intensity rate reduction targets and safetyvalve prices below and to the right of the dotted ellipse in Figure 1 pair relatively stringent intensity rate reduction goals with relatively low safety-valve prices. These combinations, such as the Cap-Trade 3 Low Safety case, tend to produce energy model results similar to those for combinations within the dotted ellipse with less stringent intensity goals and the same safety-valve, as shown in the next chapter.

Combinations of relatively modest intensity rate reduction goals with relatively high safety-valve prices, above and to the left of the dotted ellipse in Figure 1, are not explicitly addressed in this report. However, once the safety-valve price is set at a level where the safety-valve is not triggered, further increases in the safety-valve price have no impact on the energy model or economic model results. Model results for combinations in the region above and to the left of the dotted ellipse in Figure 1 are generally close to those that would result from policies that set intensity rate reduction targets without a safety-valve price mechanism. However, even a non-binding safety-valve price would continue to provide some degree of economic and energy system protection in a situation where the cost of emissions abatement proves to be significantly higher than technologies and behavior as modeled in NEMS for energy-related CO2 or by EPA for other greenhouse gases would suggest. Such an outcome could occur if technologies that penetrate the market significantly in the modeled program cases, for example new nuclear power plants, run into unanticipated technical or siting problems.

Methodology

The analysis of energy sector and energy-related economic impacts of the various GHG emission reduction proposals in this report is based on NEMS results. NEMS projects emissions of energy-related CO2 emissions resulting from the combustion of fossil fuels, representing about 84 percent of total GHG emissions today. For this analysis, the AEO2006 reference case emissions for energy-related CO2 were augmented with baseline emissions projections for other covered GHGs to create a baseline for total covered GHG emissions. Projections of non-CO2 GHG emissions, including the covered non-CO2 gases, are derived from an unpublished Environmental Protection Agency (EPA) "nomeasures" case, a recent update to the "business-as-usual" case cited in the White House Greenhouse Gas Policy Book Addendum¹² released with the Climate Change Initiative. The projections from the Policy Book were based on several EPA-sponsored studies conducted in preparation of the U.S. Department of State's Climate Action Report 2002.¹³ The no-measures case was developed by EPA in preparation for a planned 2006 "National Communication" to the United Nations in which a "with-measures" policy case is to be published.¹⁴

Simulations of the emissions cap-and-trade policy in NEMS were used to estimate the price of GHG permits over time and resulting changes in the energy system. First, starting from the projected level of energy-related CO2 emissions in 2010 from the AEO2006 reference case and the EPA projection for emissions of other GHGs in 2010, the GHG intensity rate reduction targets for each of the analysis cases were translated into annual emissions targets for the 2011 to 2030 period.

NEMS endogenously calculates changes in energy-related CO2 emissions in the analysis cases. The cost of using each fossil fuel includes the costs associated with the GHG permits needed to cover the emissions produced when they are used. These adjustments influence energy demand and energy-related CO2 emissions. The GHG permit price also determines the reductions in the emissions of other GHGs based on the abatement cost relationships supplied by EPA, as discussed above. With emission permit banking, NEMS solves for the time path of permit prices such that cumulative emissions match the cumulative target, provided the permit price remains below the safety-valve permit price.

Once the safety-valve permit price is attained and the previously-banked permits are exhausted, actual GHG emissions can exceed the calculated annual emissions target, as fossil fuel users and other GHG emitters can purchase an unlimited number of emissions permits from the government at the safety-valve price. NEMS, like all models, is a simplified representation of reality. Projections are dependent on the data, methodologies, model structure, and assumptions used to develop them. Since many of the events that shape energy markets are random and cannot be
anticipated (including severe weather, technological breakthroughs, and geopolitical developments), energy markets are subject to uncertainty. Moreover, future developments in technologies, demographics, and resources cannot be foreseen with certainty. Nevertheless, well-formulated models are useful in analyzing complex policies, because they ensure consistency in accounting and represent key interrelationships, albeit imperfectly, to provide insights.

EIA's projections are not statements of what will happen, but what might happen, given technological and demographic trends and current policies and regulations. EIA's reference case is based on current laws and regulations. Thus, it provides a policy-neutral starting point that can be used to analyze energy policy initiatives. EIA does not propose, advocate, or speculate on future legislative or regulatory changes within its reference case. Laws and regulations are generally assumed to remain as currently enacted or in force (including sunset or expiration provisions); however, the impacts of scheduled regulatory changes, when clearly defined, are reflected.

Background and Scope of the Analysis Tables

Notes and Sources