This analysis was undertaken at the request of the U.S. House of Representatives Committee on Science, following the earlier study by the Energy Information Administration (EIA), Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity.¹ That report, also responding to a request from the Committee on Science, was published in October 1998. The committee subsequently requested that EIA analyze the impacts of an earlier phased-in start date for U.S. carbon emissions reductions to comply with the Kyoto Protocol, based on the same assumptions and cases of the earlier study.

The Kyoto Protocol calls for binding limits on greenhouse gas emissions by the developed nations during the period 2008 through 2012. Some analysts suggest that an earlier start date could allow for a more gradual, and therefore easier and less expensive, transition in energy markets to achieve specific reduction targets. Earlier carbon reductions could lead to the purchase of more efficient or less carbon-intensive equipment at an earlier date, making it easier to meet greenhouse gas emissions targets. This report describes EIA’s analysis of the impacts of an early start, using the same methodology as in the previous study, with only those changes in assumptions caused by the early start date. The analysis results are summarized in Chapter 2, and Appendix A provides detailed tables of the projections. The remainder of this chapter summarizes the provisions of the Kyoto Protocol and the results of EIA’s 1998 study.

From December 1 through 11, 1997, representatives from more than 160 countries met in Kyoto, Japan, at the third session of the Conference of the Parties to the 1992 Framework Convention on Climate Change. The goal of the Conference was the negotiation of binding limits for greenhouse gas emissions for developed nations. In the resulting Kyoto Protocol to the Framework Convention, targets for greenhouse gas emissions were established for these nations, the Annex I countries,² relative to their emissions levels in 1990. The targets are to be achieved, on average, from 2008 through 2012, the first commitment period in the Protocol.

The overall emissions reduction target for the Annex I countries is 5.2 percent below 1990 levels. Relative to 1990, the individual targets range from an 8-percent reduction for the European Union (EU) to a 10-percent increase for Iceland. Australia and Norway are also allowed increases of 8 and 1 percent above 1990 levels, respectively, while New Zealand, the Russian Federation, and the Ukraine are held to their 1990 levels. Other Eastern European countries undergoing transition to a market economy have reduction targets of between 5 and 8 percent below 1990 levels. The reduction targets for Canada and Japan are 6 percent and, for the United States, 7 percent, compared to 1990. Non-Annex I countries have no targets under the Protocol, although the Protocol reaffirms the commitments of the Framework Convention by all parties to formulate and implement climate change mitigation and adaptation programs.

The Protocol was opened for signature on March 16, 1998, for a 1-year period. It will enter into force 90 days after 55 Parties, including Annex I countries accounting for at least 55 percent of the 1990 carbon dioxide emissions from Annex I nations, have deposited their instruments of ratification, acceptance, approval, or accession. By March 15, 1999, 84 countries had signed the Protocol, including all but two of the Annex I countries, Hungary and Iceland. To date, only 10 countries have ratified or acceded to the Protocol—Panama, El Salvador, Trinidad and Tobago, Antigua and Barbuda, the Maldives, Tuvalu, Fiji, Bahamas, Niue, and Georgia—none of which is an Annex I country.

Although the Protocol does not prescribe specific steps to be taken, a number of potential actions are enumerated. They include energy efficiency improvements, enhancement of carbon-absorbing sinks, research and development of sequestration technologies, phasing out of fiscal incentives and subsidies that may inhibit the goal of emissions reductions, and reduction of methane emissions in waste management and in energy production, distribution, and transportation. Sources of emissions include energy combustion, fugitive emissions from fuels, industrial processes, solvents, agriculture, and waste management and disposal.

The Kyoto Protocol includes a number of flexibility measures for compliance—often referred to as what, where, and when flexibility. What flexibility refers to the source of the emissions. Although carbon dioxide is the major greenhouse gas in terms of the level of emissions, the Protocol includes methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride,³ in addition to carbon dioxide. The aggregate target is established using the carbon dioxide equivalent of each of the greenhouse gases, based on the global warming potential of each gas. Carbon-absorbing sinks—forests, other vegetation, and soils—are also included in what flexibility. Net changes in emissions by direct anthropogenic land-use changes and forestry activities will be used in meeting the commitment, limited to afforestation, reforestation, and deforestation since 1990. Specific guidelines and rules for the accounting of land-use and forestry activities must be resolved by the Conference of the Parties.

Where flexibility includes a variety of international activities, which would allow a country to meet its emissions target by taking action with or within other countries. Emissions trading among the Annex I countries is permitted. Groups of Annex I countries, such as the EU, may also jointly meet the total commitment of all the member nations either by allocating a share of the total reduction to each member or by trading emissions rights. Joint implementation projects are also allowed among the Annex I countries, allowing a nation to take emissions credits for projects that reduce emissions or enhance emissions-absorbing sinks in other Annex I countries. It is specifically indicated in the Protocol that trading and joint implementation are supplemental to domestic actions.

The Protocol also establishes a Clean Development Mechanism (CDM), a program under which Annex I countries can earn credits for projects that reduce emissions in non-Annex I countries. Such projects must lead to measurable, long-term benefits. Reductions from projects occurring from 2000 up to the beginning of the first commitment period can be used to assist in compliance in the commitment period. An executive board will be established to supervise the CDM, and an unspecified share of the proceeds from certified project activities will be used to cover administrative expenses and to assist developing country Parties that are particularly vulnerable to adverse effects of climate change to meet the costs of adaptation.

At the fourth session of the Conference of the Parties in Buenos Aires, in November 1998, a plan of action was adopted to finalize a number of the implementation issues at the sixth Conference of the Parties, which is likely to be held late in 2000 or early in 2001. Also at issue is the possibility of limiting credits for international actions that may be used to meet a country’s target.

Under when flexibility, the targets can be achieved on average over the first commitment period of 2008 to 2012 rather than in each individual year. Averaging emissions over the 5-year period smooths out short-term fluctuations that might result from economic cycles or weather conditions. No targets are established for periods after 2012, although the Conference of the Parties will initiate consideration of future commitments at least 7 years before the end of the first commitment period. Banking—carrying over emissions reductions that go beyond the target from one commitment period to a subsequent commitment period—is allowed. The Protocol indicates that each Annex I country must have made demonstrable progress in achieving its commitments by 2005.

At the request of the U.S. House of Representatives Committee on Science, EIA analyzed the likely impacts of the Kyoto Protocol on U.S. energy prices, energy use, and the economy in the 2008 to 2012 period. The analysis was published in Impacts of the Kyoto Protocol on U.S. Energy Markets and Economic Activity, with an accompanying briefing report, What Does the Kyoto Protocol Mean to U.S. Energy Markets and the U.S. Economy?⁴

The request specified that the 1998 analysis use the same methodologies and assumptions as the Annual Energy Outlook 1998  (AEO98),⁵ which was the latest AEO at the time, using the National Energy Modeling System with no changes in assumptions regarding policy, regulatory actions, or funding for energy and environmental programs. The Committee also specified that the construction of new nuclear plants should not be assumed but that economic life extensions of nuclear plants should be permitted.

Energy use is naturally a focus of greenhouse gas reductions. In 1990, total greenhouse gas emissions in the United States were 1,633 million metric tons carbon equivalent, of which carbon emissions from the combustion of energy comprised 1,346 million metric tons, or 82 percent. By 1997, total greenhouse gas emissions had risen to 1,791 million metric tons carbon equivalent, with 1,480 million metric tons (83 percent) from energy combustion.⁶ Because energy-related carbon emissions constitute such a large percentage of total greenhouse gas emissions, any action or policy to reduce emissions will impact U.S. energy markets.

Carbon Targets

Because of the uncertainties surrounding the final implementation of the Kyoto Protocol, EIA’s analysis included a range of six cases with different levels of reductions for domestic energy-related carbon emissions (Figure 1).

Figure 1. Projected Carbon Emissions, 1990-2020  [source]

• Reference Case. Carbon emissions from energy increase to 33 percent above 1990 levels in 2010, reaching 1,791 million metric tons compared to 1,346 million metric tons in 1990. Between 2008 and 2012, annual carbon emissions average 1,792 million metric tons.

• 24 Percent Above 1990 Levels (1990+24%). Carbon emissions increase to an annual average of 1,670 million metric tons between 2008 and 2012, 24 percent above the 1990 levels.

• 14 Percent Above 1990 Levels (1990+14%). Carbon emissions average 1,539 million metric tons annually between 2008 and 2012, approximately at the level estimated for 1998 in AEO98, 1,533 million metric tons.

• 9 Percent Above 1990 Levels (1990+9%). Carbon emissions increase to an annual average of 1,467 million metric tons between 2008 and 2012, 9 percent above 1990 levels.

• Stabilization at 1990 Levels (1990). Carbon emissions reach an annual average of 1,345 million metric tons during the commitment period of 2008 through 2012, stabilizing approximately at the 1990 level of 1,346 million metric tons.

• 3 Percent Below 1990 Levels (1990-3%). Carbon emissions are reduced to an annual average of 1,307 million metric tons between 2008 and 2012.

• 7 Percent Below 1990 Levels (1990-7%). Carbon emissions are reduced to an annual average of 1,250 million metric tons in the period 2008 to 2012. This case essentially assumes that the 7-percent target in the Kyoto Protocol for reducing emissions below 1990 levels must be met by energy-related carbon emissions with no net offsets from sinks, other greenhouse gases, or international activities.

EIA assumed that the United States would reach its goal of a 7-percent reduction in net greenhouse gas emissions in each of the carbon reduction cases, but each case implicitly assumed different levels of forestry and agricultural sinks, reductions from other greenhouse gases, international trading, and other international activities, which may offset the domestic reductions required from carbon. EIA's 1990-3% case was based on a fact sheet issued by the U.S. Department of State on January 15, 1998, which estimated that the method of accounting for sinks and the flexibility of using 1995 as the base year for the synthetic greenhouse gases could change the U.S. target for energy-related carbon emissions to a level analogous to 3 percent below 1990 levels, before accounting for sinks, reductions in other greenhouse gases, or international activities. Each of the cases with higher carbon targets (smaller reductions) assumed more contribution from sinks, other gases, and international activities to offset carbon reductions. In the 1990+24% case, for example, sinks, reductions in other greenhouse gases, and international activities account for nearly 80 percent of the total net greenhouse gas reduction.

In each of the carbon reduction cases, the target is achieved on average for each of the years in the first commitment period, 2008 through 2012. The target is assumed to be constant from 2013 through 2020, the end of the forecast horizon, because the Protocol does not specify any targets beyond the first commitment period (although consideration of commitments for subsequent periods will be initiated at least 7 years before the end of the first commitment period). In the 1998 study, the target was assumed to be phased in over a 3-year period beginning in 2005, because the Protocol indicates that demonstrable progress toward reducing emissions must be shown by 2005. The 2005 start date for compliance activities would allow energy markets to begin adjustments to meet the reduction targets prior to 2008.

Carbon Prices

In its 1998 analysis of the Kyoto Protocol, EIA assumed that a carbon price would be applied to each of the energy fuels at its point of consumption, relative to its carbon content. The carbon price would not be applied directly to electricity but would be applied to the fossil fuels used for electricity generation and reflected in the delivered price of electricity. The analysis assumed that a carbon permit trading system would function as a Federal Government auction, and that the revenues collected by the Government would be recycled to the economy through either a lump sum rebate in personal income taxes or a reduction in social security tax rates.

In 2010, the carbon price necessary to achieve the targets ranges from $67 per metric ton (1996 dollars) in the 1990+24% case to $348 per metric ton in the 1990-7% case. In the more restrictive cases, the carbon price escalates rapidly to achieve the more stringent reductions but then declines over the next 10 years of the forecast horizon. Cumulative investments in more energy-efficient and lower-carbon equipment, particularly for electricity generation, reduce the cost of compliance in the later years (Figure 2).

Figure 2. Projected Carbon Prices, 1996-2020  [source]

The carbon prices represent the marginal cost of reducing domestic carbon emissions, reflecting the price the United States would be willing to pay to purchase carbon permits from other countries or to induce carbon reductions in other countries. They do not represent the international market-clearing price of carbon permits or the price at which other countries would be willing to offer permits.

Energy Prices

Because coal has the highest carbon content per thermal output of all the fossil fuels, a carbon price would have the largest impact on coal prices (Figure 3). Across all the EIA carbon reduction cases, the average delivered price of coal in 2010 is higher by between 152 and nearly 800 percent relative to the reference case. Average electricity prices in 2010 are higher by between 20 and 86 percent compared to the reference case, and average delivered natural gas prices are between 25 and 148 percent higher. On average, the price of petroleum products is higher by between 12 and 62 percent, and the price of gasoline is higher by between 11 and 53 percent in 2010, reaching $1.91 a gallon in the most stringent reduction case compared to $1.25 a gallon in the reference case.

Figure 3. Projected Changes in Average Delivered Prices for energy Fuels in the 1990+9% Case Relative to the Reference Case, 1996-2020  [source]

Energy Consumption and Fuel Mix

The imposition of carbon prices and the resulting increase in fossil fuel prices would lead to reduced demand for energy services, more rapid adoption of higher-efficiency equipment, and increased use of either noncarbon or less carbon-intensive fuels. As carbon prices raised the delivered price of energy, the overall intensity of energy use would decline. In the reference case, energy intensity, measured as primary energy consumed per dollar of gross domestic product (GDP), declines at an average annual rate of about 1 percent between 2005 and 2010. Across the carbon reduction cases, the rate of the intensity decline in the same period ranges from 1.6 percent a year in the 1990+24% case to 3.0 percent a year in the 1990-7% case (Figure 4).

Figure 4. Projections of U.S. Energy Intensity, 1970-2020  [source]

Carbon emissions would be reduced in each of the end-use sectors—residential, commercial, industrial, and transportation. Higher energy prices would encourage investments in more efficient equipment, building shells, and vehicles and reduce the demand for energy services. The impact of higher energy prices on the economy would also lower industrial output and overall travel requirements. Finally, relative changes in the prices of energy fuels as a result of the carbon prices would encourage a shift to less carbon-intensive fuels and renewable energy.

Across the carbon reduction cases, electricity generation accounts for between 68 and 75 percent of the total carbon reductions in 2010. As energy prices increase, electricity consumption is reduced and more efficient, less carbon-intensive technologies are used for electricity generation. Fuel switching accounts for most of the carbon reductions from electricity (Figure 5) as generators shift from coal to new natural-gas-fired generating plants, extend the operating lives of existing nuclear plants, and increase the use of renewable energy—particularly, biomass and wind. Electricity generators respond more strongly than end-use consumers to higher energy prices because generation in the reference case is highly dependent on coal, fuel prices play a more significant role in fuel choice decisions, and there are more economically viable technologies available that can be used to shift generation from coal to natural gas or renewable sources as the carbon price increases.

Figure 5. Projected Reductions in Carbon Emissions From the Electricity Supply Sector, 1990+9% Case, 1996-2020  [source]

Overall, U.S. coal consumption is significantly lower in the carbon reduction cases, between 18 and 77 percent in 2010, than in the reference case. As a result, its share of total U.S. energy consumption is reduced to between 6 and 19 percent across the carbon reduction cases, compared to a 22-percent share in the reference case (Figure 6). Consumption of petroleum is also lower, although its share of the total fuel mix increases slightly because the transportation sector remains highly dependent on oil. Natural gas, nuclear power, and renewable energy consumption all increase, primarily because of increased use for electricity generation.

Figure 6. Projections of Fuel Shares of Total U.S. Energy Consumption, 2010  [source]