Climate Change: Comparison and Analysis of S. 1151 and the Draft "Climate and Economy Insurance Act of 2005"
Released: 2005-07-18T00:00:00

Introduction

Climate change is generally viewed as a global issue, but proposed responses generallyrequire action at the national level. In 1992, the United States ratified the United Nations'Framework Convention on Climate Change (UNFCCC) which called on industrialized countries totake the lead in reducing the six primary greenhouse gases to 1990 levels by the year 2000. (1) Over the past decade, a varietyof voluntary and regulatory actions have been proposed or undertaken in the United States, includingmonitoring of power plant carbon dioxide emissions, improved appliance efficiency, and incentivesfor developing renewable energy sources. But carbon dioxide emissions have continued to increase.

In 2001, President George W. Bush rejected the Kyoto Protocol, which called for legallybinding commitments by developed countries to reduce their greenhouse gas emissions. (2) He also rejected the conceptof mandatory emissions reductions. Since then, the Administration has focused U.S. climate changepolicy on voluntary initiatives to reduce the growth in greenhouse gas emissions. This focus isparticularly evident in the Administration's 2002 Climate Action Report (CAR) submitted under theprovisions of the UNFCCC. Of the over 50 programs summarized in the 2002 CAR, only six aredescribed as "regulatory." (3) These regulatory programs were generally implemented to achieve energy or environmental goalsother than the reduction of greenhouse gas emissions, but produced a concomitant greenhouse gasemissions reduction. In this sense, they could be considered the results of a "no regrets" (4) policy where climate changeeffects resulting from related air quality and energy policies are included in the decision-makingprocess on new or modified rules.

A number of congressional proposals to advance programs designed to reduce greenhousegases have been introduced in the 109th Congress. These have generally followed one of three tracks. The first is to improve the monitoring of greenhouse gas emissions -- in order to provide a basis forresearch and development and for any potential future reduction scheme. The second is to enact amarket-oriented greenhouse gas reduction program along the lines of the trading provisions of thecurrent acid rain reduction program established by the 1990 Clean Air Act Amendments. The thirdis to enact energy and related programs that would also have the added effect of reducing greenhousegases; an example would be a requirement that electricity producers generate a portion of theirelectricity from renewable resources (a renewable portfolio standard). This report focuses on thesecond category of bills, specifically comparing the major provisions of two proposals that receivedattention during the Senate's debate on its version of H.R. 6 -- The Energy Policy Actof 2005.

Proposed Senate Legislation: A Comparison of Two Proposals

In February 2005, Senators McCain and Lieberman introduced S. 342 , theClimate Stewardship Act of 2005. (5) The primary focus of the proposed legislation is to reduce U.S.emissions of greenhouse gases through the use of flexible, market-based mechanisms. In May 2005,Senators McCain and Lieberman introduced S. 1151 , an expanded version of S.342 that includes a new title designed to encourage innovation and deployment of lesscarbon intensive technologies, sequester carbon emissions, or mitigate the effects of climate change.The bill's emission reduction provisions are very similar to S.Amdt. 2028 (to S. 139 ) of the 108th Congress, which the Senate debated in 2003. That amendment failedon a 43-55 vote. During the debate on the Energy Policy Act of 2005, S. 1151 wasintroduced as S.Amdt. 826 and defeated on a 38-60 vote.

As summarized in Table 1 , S. 1151 would require mandatory andeconomy-wide emission reductions. Using a flexible, market-based implementation strategy, the billwould require economy-wide reductions, but permits participation in pre-certified internationaltrading systems and in carbon sequestration programs to achieve part of the reduction requirement. The bill excludes residential and agricultural sources of greenhouse gases, along with entities thatdo not own a single facility that emits more than 10,000 metric tons of carbon dioxide equivalentsannually. (6)

A draft amendment, (7) announced by Senator Bingaman, is based on the report of theNational Commission on Energy Policy (NCEP) that called for a mandatory, economy-widetradeable permit program to begin limiting greenhouse gases. (8) The Climate and EconomyInsurance Act of 2005 (hereafter referred to as the "draft amendment") would mandate an acceleratedreduction in the greenhouse gas intensity of the country's economy. (9) Between 2010 and 2019, thedraft amendment would require a 2.4% annual reduction in greenhouse gas emissions per dollar ofprojected gross domestic product (GDP). After 2019, this reduction would increase to 2.8%annually.

Implementation would be through a flexible, market-oriented allowance trading program. The total number of allowances each year would be calculated based on the mandated decline ingreenhouse gas intensity, and projected GDP growth. However, the draft amendment includes acost-limiting safety valve that allows covered entities to make a payment to DOE in lieu of reducingemissions. The initial price of such payments would be $7 a ton in 2010. (10) Thus, if a covered entitychooses, it may make payments to DOE at a specific price rather than make any necessary emissionsreductions.

The most notable difference between the two proposals is their approach to controlling emissions of greenhouse gases. Both would cover the majority of U.S. greenhouse gas emissions. However, while S. 1151 would place an absolute cap on emissions from coveredentities, the draft amendment aims to reduce greenhouse gas intensity. Under S. 1151,while emissions from covered entities would be capped, uncovered emissions would be expected tocontinue to rise: ultimately, overall U.S. emissions would be expected to grow. Under the draftamendment, if it is assumed that all U.S. emissions are covered, economic growth would determinewhether total U.S. emissions grow or decline: if economic growth outpaces the scheduled reductionsin emissions intensity, or the proposal's safety valve is invoked, emissions could continue togrow. (11)

A second key difference is the establishment of a cost-limiting "safety valve" in the draftamendment. Under this proposal, covered entities in need of extra tradeable allowances maypurchase them on an open market, or they can make a payment to DOE at a set price (i.e., the safetyvalve). (12) Under S. 1151 , there is no provision to limit the price per allowance that a covered entitywould be required to pay.

In addition, the two proposals differ in other ways, as well, including which entities arecovered, which agency has primary responsibility for the program, how credits for early action andother activities can be generated, and how proceeds from the sale/auction of allowances will beutilized. Table 1 compares key topics covered by the two proposals.

Table 1. Comparison of Key Topics Covered by S.1151 and the Draft Amendment

Results: Emission Reductions

As discussed in the next section, emission reduction estimates under both options involveat least some uncertainty, particularly for the draft amendment. Thus the estimates provided in Table2 should be considered "ballpark" in nature.

In 2004, The Energy Information Administration (EIA) analyzed an earlier version of S. 1151 . (13) Under EIA's analysis, S. 1151 would achieve a 6.7% reduction in overall greenhouse gasemissions in 2010 compared with its projected business-as-usual scenario, but would not returngreenhouse gas emissions to their 2000 or 1990 levels. This result contrasts with CRS's estimate thatthe draft amendment would result in a 2.5% reduction in overall greenhouse gas emissions in 2010compared with EIA's business-as-usual scenario. (14)

CRS did not estimate longer term reductions from either S. 1151 or the draftamendment because of the inherent uncertainty involved in such projections. Qualitatively, it canbe stated that emissions of greenhouse gases would likely continue to increase under both options,although somewhat more slowly than business-as-usual. In the case of S. 1151, thepercentage of greenhouse gases not covered by the bill would increase and would be uncontrolledby the reduction program. Thus, the initial reduction in emissions achieved in 2010 would be slowlyeaten up over time. In the case of the draft amendment, covered emissions would continue to growto the extent that projected economic growth outstripped the 2.4% annual reduction in carbonintensity (2.8% beginning in 2020), and to the extent that increased costs drove covered entities toinvoke the safety valve rather than further reduce emissions. In the longer term, emissions couldpotentially rise faster under the draft amendment than under S. 1151.

Table 2. Projected Emissions Under S. 1151 and DraftAmendment

(billions of metric tons of carbon dioxide equivalents)

Sources: 1990 and 2000 data: U.S. submission to the United Nations Framework Convention onClimate Change, 2010 projections. For S.Amdt. 2028: Energy InformationAdministration, Analysis of Senate Amendment 2028, the Climate Stewardship Act of 2003 (May2004). S.Amdt. 2028 is very similar to S. 1151 and is used as a surrogate here. However, the number of covered entities may be more or less under S. 1151 then assumedhere, so the estimates may understate or overstate actual reductions that would be achieved underS. 1151. For the draft amendment, calculations by CRS are based on projected GDP andcarbon intensity improvements by Energy Information Administration, Annual Energy Outlook 2005 ,DOE/EIA-0383(2005), February 2005. See text for discussion of uncertainties surrounding the draftamendment's estimate. Estimates do not take into account the potential for carbon sequestration.

Analysis: Addressing the Price versus Quantity Issue

Uncertainty in Emission Reductions

The projected emission reductions under the draft amendment are more uncertain than under S. 1151 . The primary source of uncertainty for S. 1151 is the precise numberof covered entities that must meet the reduction requirements. In EIA's analysis of previous versionsof S. 1151, the assumed coverage is about 75%; supporters of the bill have suggested thecoverage is about 85%. The difference is significant as higher coverage means more reductions thanestimated by EIA and more certainty about their quantity; lower coverage means lower compliancecosts, but greater uncertainty about quantity.

Table 3. Factors Potentially Affecting EmissionReductions

As indicated in Table 3 , the draft amendment has several uncertainties with respect to emissions reductions. Unlike S. 1151 , which defines a historic emissions baselinewhich covered entities must achieve, the draft amendment calculates a future baseline fromprojections of 2009 GDP growth and carbon intensity improvement. Both of those variables areuncertain. In EIA's current projections, economic growth to 2010 is assumed under its threescenarios to range from 2.5% annually (low case) to 3.6% annually (high case) with its referencecase set at 3.1% annually. CRS calculations presented in Table 2 assume the reference caseassumption of 3.1% annual GDP growth. However, as indicated here, this estimate could be off by20%, or more.

Likewise, the carbon intensity improvement projection is uncertain. Based on EIAprojections, CRS estimated a 2009 carbon intensity of 165 million metric tons carbon equivalent permillion dollars GDP (MMTCE/M$GDP) for its calculations. However, based on the President'sClimate Change Initiative, the targeted 2009 carbon intensity is in the range of 159MMTCE/M$GDP). (15) Likewise, improvement could be less than projected, as current intensity levels are considerablyhigher than those projected under the initiative. The 2002 estimate of carbon intensity is 183MMTCE/M$GDP.

Like S. 1151 , the draft amendment raises some questions as to the exact extentof its coverage. The CRS estimate in Table 2 assumes 100% coverage. However, there arepotentially entities not covered under the draft amendment.

The final uncertainty affecting emissions reductions achieved under the draft amendment isthe safety valve. All analysis done of previous versions of S. 1151 indicate that a $7per ton of carbon dioxide safety valve would be triggered immediately. (16) In contrast, the EnergyInformation Administration's analysis projects the safety valve would be triggered around the year2015. (17) As the degreeto which reductions could be achieved before the safety valve would be triggered is disputed, anotherlayer of uncertainty is added to the emission reductions achieved under the draft amendment,particularly in the longer term.

Uncertainty in Cost Estimates

The projected cost under S. 1151 is more uncertain than under the draftamendment. A major source of uncertainty for S. 1151 is future growth in greenhouse gasemissions by covered entities. Because S. 1151 establishes a firm cap on greenhouse gasemissions based on the year 2000, any increased emissions resulting from continuing economicgrowth would have to be offset. The more robust the economic growth, the greater potential formore emissions that would have to be offset to maintain the cap. In general, more emissionreductions probably means higher costs. If economic growth is less robust, fewer reductions wouldhave to be made and costs would be less.

S. 1151 cost estimates are affected by several other uncertainties. In threestudies conducted on the cost of previous versions of S. 1151, two studies placed the potential permit price in 2010 at $9 a ton (2001$), and one at $15 a ton (2001$). The sources of thediffering estimates are different assumptions about the availability of the following: (1) cost effectiveenergy efficiency improvements, (2) cost-effective non-CO 2 greenhouse gas reductions, (3)cost-effective carbon sequestration and international credits, and (4) future natural gas supply. Witha program designed to achieve a least-cost solution through a market-based allowance tradingsystem, restricting the availability of options increases projected costs. The range between the twostudies indicating $9 a ton and the one indicating $15 a ton illustrates the sensitivity and uncertaintysurrounding S. 1151's potential costs. (18)

The draft amendment's cost estimates are not as sensitive to the factors identified above. Partly this is by design, and partly this is because the draft amendment requires less emissionreductions than S. 1151 . Unlike S. 1151, the draft amendment incorporateseconomic growth into its emissions limitation target, permitting some increase in future emissionsif projected economic growth exceeds the mandated improvement in greenhouse gas intensity. Fewer offsets required translates into lower costs.

Like S. 1151 , the draft amendment's projected cost is affected by the assumedavailability of cost-effective control measures, such as those noted above -- energy efficiencyimprovements, cost-effective carbon sequestration and non-CO 2 greenhouse gas reductions, alongwith assumed future natural gas supply. However, the draft amendment does not extend its flexiblemarket implementation program to international credits in the manner that S. 1151 does.Thus, no uncertainty (or possible lower costs) is introduced by the potential for international trading.

The National Commission on Energy Policy placed the permit price of its proposal (on whichthe draft amendment is based) at $5 a ton in 2010 (2004$). Although there are uncertainties in thedraft amendment's potential costs, its safety valve puts a firm limit on its upside risk -- $7 a ton(nominal 2010$). Converting these estimates to 2001 dollars, the projected permit price for the draftamendment would be $4.8 - $5.9 a ton (2001$). (19) Besides putting a ceiling on upside cost, the draft amendment'ssafety valve narrows the band of potential costs substantially. The remaining cost uncertainty is withrespect to the lower bound of costs.

Price versus Quantity: The Safety Valve

The purpose of a safety valve is to bound the costs of any climate change control program(price) at the expense of reductions achieved (quantity). (20) In general, market-based mechanisms to reduce CO 2 emissionsfocus on specifying either the acceptable emissions level (quantity), or compliance costs (price), andallowing the marketplace to determine the economically efficient solution for the other variable. Forexample, a tradeable permit program sets the amount of emissions allowable under the program (i.e.,the number of permits available caps allowable emissions), while letting the marketplace determinewhat each permit will be worth. Likewise, a carbon tax (or the safety valve contained in the draftamendment) sets the maximum unit (per ton of CO 2 ) cost that one should pay for reducingemissions, while the marketplace determines how much actually gets reduced. In one sense,preference for a pure tradeable permit system or inclusion of a safety valve depends on how oneviews the uncertainty of costs involved and benefits to be received.

For those confident that achieving a specific level of CO 2 reduction will yield significantbenefits -- enough so that even the potentially very high end of the marginal cost curve does notbother them -- a pure tradeable permit program may be most appropriate. CO 2 emissions would bereduced to a specific level, and in the case of a tradeable permit program, the cost involved wouldbe handled efficiently, though not controlled at a specific cost level. This efficiency occurs becausethrough the trading of permits, emission reduction efforts concentrate at sources at which controlscan be achieved at least cost.

However, if one is more concerned about the potential downside risk of substantial controlcosts to the economy than of the benefits of a specific level of reduction, then including a safetyvalve may be most appropriate. In this approach, the level of the safety valve effectively caps themarginal cost of control that affected entities would pay under the reduction scheme, but the preciselevel of CO 2 achieved is less certain. Emitters of CO 2 would spend money controlling CO 2 emissions up to the level of the safety valve. However, since the marginal cost of control amongmillions of emitters is not well known, the overall emissions reductions for a given safety valve levelon CO 2 emissions cannot be accurately forecast. In essence, the safety valve on the draft amendmentcould be seen as a contingent carbon tax.

Hence, a major policy question is whether one is more concerned about the possibleeconomic cost of the program and therefore willing to accept some uncertainty about the amount ofreduction received (i.e., a safety valve); or one is more concerned about achieving a specific emissionreduction level with costs handled efficiently, but not capped (i.e., pure tradeable permits). S. 1151 leans toward the quantity (total emissions) side of the equation; the draftamendment leans more toward the price side.

Conclusion

The two proposals -- S. 1151 and the draft amendment -- would establishmarket-based systems to limit emissions of greenhouse gases. However, the proposals differ in howthose systems would work. S. 1151 would establish an absolute cap on emissions fromcovered entities, and would allow entities to trade emissions under that cap. The draft amendmentwould limit greenhouse gas emissions intensity and establish a cost-limiting safety valve to protectagainst high compliance costs. Under both proposals, short-term U.S. emissions would likely bebelow a business-as-usual scenario, although reductions under S. 1151 are likely to belarger and more certain. In contrast, the cost of the draft amendment is likely to be less and morepredictable. However, under both proposals, total U.S. emissions could be expected to continue theirupward trend, albeit at a slower rate than currently forecasted.