Report#:SR/OIAF/99-01

Preface

Executive Summary

Introduction

CCTI Tax Initiatives

Research and Development Support

Energy-Efficient Appliances and Equipment

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In February 1999, the Administration sent its fiscal year 2000 budget request to the U.S. Congress. The Administration's budget includes more than $4 billion in programs related to climate change. Nearly $1.8 billion of the funding consists of tax incentives, research, development, and deployment, and other spending for the Climate Change Technology Initiative (CCTI). CCTI includes tax credits to serve as incentives for deploying energy efficiency improvements and renewable technologies for buildings, light-duty vehicles, industry, and electricity generation. Other funding covers research, development, and deployment for energy-efficient and renewable technologies, appliance standards, and carbon sequestration research. One focus of these programs is climate change, but they often have additional benefits for improved air quality due to reductions in other emissions, energy security, and international competitiveness. Although the tax incentives are largely new initiatives, many of the other programs are continuations or expansions of ongoing research, development, and deployment programs. The total budget request for CCTI programs for all Federal agencies comprises almost $1.4 billion for research, development, and deployment (representing an increase of $347 million over the estimated fiscal year 1999 budget) and nearly $400 million for tax incentives.

The analysis described in this report examines all the CCTI programs with the exception of $4 million proposed for electricity restructuring programs at the U.S. Environmental Protection Agency (EPA); $14 million for management, planning, and analysis programs at the U.S. Department of Energy (DOE) and EPA; $3 million for EIA; and $10 million for carbon sequestration programs within EPA and the U.S. Department of Agriculture (USDA). The most detailed analysis in this report is for the tax incentives proposed in CCTI, which are new initiatives or extensions of current tax credits. Generally, we are not able to link research and development expenditures directly to program results or to separate the impacts of incremental funding requested for fiscal year 2000 from ongoing program expenditures.

Other programs related to climate change include the U.S. Global Change Research Program, international assistance, and programs with climate change co-benefits--for example, weatherization and State energy grants. There are additional initiatives supported by the Administration that have a primary or ancillary purpose in reducing emissions. These include, but are not limited to, establishing a program for early action in reducing emissions, industry consultations, electricity restructuring, and changes in Federal procurement to increase energy efficiency and the use of renewable energy technologies in the Federal Government. With the exception of electricity restructuring, the impacts of these programs are difficult to quantify and are not discussed in this analysis.

Tax Incentives

The proposed CCTI tax incentives include investment tax credits--for buildings, vehicles, and industry--that would lower the initial costs of more energy-efficient and renewable technologies and production tax credits for renewable generation technologies. The revenue impacts of the proposed tax credits, as estimated by the Administration, total $383 million in fiscal year 2000 and $3.6 billion from fiscal years 2000 through 2004. Although the tax credits would be short term in nature, their longer term purpose is to encourage the use of energy-efficient and renewable energy technologies, reducing their production costs and creating a more mature market for them.

Some past tax incentives have been able to accelerate substantially the introduction of new technologies into the market. For example, natural gas production from coal seams has grown dramatically since the late 1980's, largely because of tax credits that provide an incentive for the production of high-cost gas supplies. In 1997, 1,090 billion cubic feet, or 6 percent of total U.S. production, came from coal seams, compared with only 41 billion cubic feet in 1988. The tax credit has also contributed to sustained development of natural gas from coal seams by promoting an improved understanding of unconventional gas reservoirs, leading to new and lower cost technologies for its recovery. Other tax credits have had little impact, including the current biomass tax credit and the solar tax credit which was enacted in 1978 and expired in 1985.

Important factors in the success of tax incentives include the timing, duration, and magnitude of the credits. Compared to some earlier tax credits, including the 40-percent solar tax credit, the incentives currently proposed are of small to modest magnitude and of relatively short duration. Other factors include the definition of qualifying entities and the different incentives provided by investment and production tax credits. Investment tax credits provide a return to the investor at the time a capital investment is made, while production tax credits provide a return during the life of the credit.

The proposed incentives are summarized below:

• Buildings

- Tax Credits for Energy-Efficient Homes--new graduated tax credits for the purchase of new homes that are at least 30 percent more energy efficient than the 1998 International Energy Conservation Code (IECC). Specifically, the proposal is for a $1,000 tax credit for new homes built between 2000 and 2001 that are at least 30 percent more efficient, a $1,500 credit for homes built between 2000 and 2002 that are at least 40 percent more efficient, and a credit of $2,000 for homes built between 2000 and 2004 that are at least 50 percent more efficient than the IECC standard.

- Tax Credits for Energy-Efficient Equipment in Existing Homes and Buildings--new tax credits, subject to caps, for electric heat pump and natural gas water heaters, electric and natural gas heat pumps, advanced central air conditioners, and fuel cells. A credit of 10 percent, up to $250 per unit, is proposed for electric heat pumps, central air conditioners, and advanced natural gas water heaters purchased in 2000 and 2001 meeting specified efficiency levels. A 20-percent credit is proposed for purchases between 2000 and 2003 of fuel cells, electric heat pump hot water heaters, electric heat pumps, central air conditioners, advanced natural gas water heaters, and natural gas heat pumps meeting specified efficiency levels. The cap is $500 per kilowatt for fuel cells, $1,000 per unit for natural gas heat pumps, and $500 per unit for all other equipment.

- Tax Credits for Rooftop Solar Systems--a new 15-percent tax credit, subject to a cap, is proposed for rooftop photovoltaic systems installed between 2000 and 2006 and solar water heating systems installed from 2000 and 2004 but not applicable to solar-heated swimming pools. The cap is $2,000 for photovoltaic systems and $1,000 for solar water heating systems.

• Transportation

- Tax Credits for Electric Vehicles and Fuel Cell Vehicles--the current 10-percent tax credit, subject to a $4,000 cap, for the purchase of qualified electric vehicles and fuel cell vehicles is scheduled to begin to phase down in 2002, phasing out by 2005; however, the proposal would extend the credit at its full level through 2006.

- Tax Credits for Highly Fuel-Efficient Hybrid Vehicles--new graduated tax credits for qualifying hybrid vehicles, including cars, minivans, sport utility vehicles, and pickup trucks. The proposed credits are $1,000 for vehicles purchased from 2003 to 2004 that are at least one-third more fuel efficient than a comparable vehicle in the same class; $2,000 for vehicles from 2003 to 2006 that are at least two-thirds more efficient; $3,000 for vehicles from 2004 to 2006 that are at least twice as efficient; and $4,000 for vehicles from 2004 to 2006 that are at least three times as efficient.

• Industry

- Tax Credits for Combined Heat and Power Systems--a new 8-percent tax credit is proposed for qualified combined heat and power systems larger than 50 kilowatts, installed between 2000 and 2002. Qualified systems would produce at least 20 percent thermal and at least 20 percent electrical or mechanical power. Systems with electrical capacity higher than 50 megawatts would need a total efficiency exceeding 70 percent to qualify, and smaller systems would need at least a 60-percent efficiency.

• Renewable Energy Electricity Generation

- Tax Credits for Wind Generation--the current tax credit of 1.5 cents per kilowatthour, which is adjusted for inflation from a 1992 base, for systems placed in service after December 31, 1993, and before July 1, 1999, would be extended to systems placed in service before July 1, 2004.

- Tax Credits for Biomass Generation--the current tax credit of 1.5 cents per kilowatthour, which is adjusted for inflation from a 1992 base, for systems using dedicated energy crops, placed in service after December 31, 1992, and before July 1, 1999, would be extended to systems placed in service before July 1, 2004; the definition of biomass systems eligible for the credit would be extended to include certain forest-related, agricultural, and other biomass sources; a new 1.0-cent-per-kilowatthour tax credit, adjusted for inflation from a 1999 base, would be added for biomass-fired electricity generated by coal plants using biomass co-firing through June 30, 2004.

Research, Development, and Deployment

In addition to tax incentives, CCTI includes nearly $1.4 billion of funding in the fiscal year 2000 budget request for research, development, and deployment of energy-efficient equipment and renewable energy and for research into carbon sequestration. Some of the research and development programs aim to reduce the costs and improve the operating characteristics of existing technologies, making them more economically competitive with conventional technologies. Others are directed toward inventing and developing new technologies. Some of the proposed technologies are speculative and may achieve benefits in a very long time frame or may not achieve success at all.

Past research and development programs have contributed to improved energy efficiency and therefore lower carbon emissions. For example, there has been considerable impact on cost reductions and efficiency improvements for natural gas-fired, combined-cycle electricity generating plants. In the Annual Energy Outlook 1987, it was assumed that these plants would cost $855 per kilowatt (1997 dollars) and have an efficiency of 41 percent. By AEO99, these assumptions were revised to a cost of $445 per kilowatt and an efficiency of 49 percent. Less conductive windows and improved ballasts for lighting are additional examples of more efficient technologies as a result of research and development. Other benefits, such as improved quality of life and increased economic growth, may also result from research and development. It is difficult, however, to quantify the impacts of research and development on specific improvements. In the reference case of AEO99, which projects that carbon emissions in 2010 will increase by 33 percent over 1990 levels, it is assumed that research and development continue at current levels. Reductions in these programs would likely lead EIA to increase its projections of carbon emissions, while new or expanded programs could lead EIA to lower its carbon projections.

Successful development of new technologies does not guarantee market acceptance. Low prices for fossil energy and conventional technologies, unfamiliarity with the use and maintenance of new products, and uncertainties about the reliability and further development of new technologies, among other factors, can work to slow technology penetration. Since some of the benefits may be long term, caution should be applied in using research and development to address short-term problems.

Other initiatives include programs to encourage the deployment of new technologies, such as consultations, partnerships, and voluntary programs. These programs usually have low costs, but the benefits of past efforts are difficult to quantify and also difficult to quantify for the future. Successful programs that have contributed to the adoption of improved technologies include efficiency improvements in buildings, televisions, and computers, among others. However, results reported under many voluntary programs include efforts that would have been taken without the program. Therefore, there may be a tendency to overestimate the impacts of deployment programs on energy consumption and carbon emissions.

In CCTI, more than $1.1 billion is requested for research, development, and deployment programs within DOE, with additional funding for EPA and the Departments of Housing and Urban Development (HUD), Commerce, and USDA. The energy-related programs include buildings, transportation, industry, and electricity generation initiatives, as summarized below:

• Buildings

- Partnership for Advancing Technology in Housing--a cooperative effort by DOE, HUD, EPA, and the Federal Emergency Management Agency with the building industry to improve the energy efficiency of new and existing homes, with the goal of building 2,000 highly energy-efficient and cost-effective houses. The goals are to make new homes 50 percent more efficient within a decade and to retrofit 15 million homes to make them 30 percent more efficient.

- Energy-Efficient Appliances and Equipment--DOE and EPA programs to develop new Energy Star products and increase funding for the development of energy-efficient technologies.

- Energy-Efficient Commercial Buildings--DOE and EPA partnership with industry for research, development, and deployment of technologies and practices to improve the energy efficiency of commercial buildings.

- Energy Smart Schools--programs to improve the energy efficiency of school buildings.

• Transportation

- Partnership for a New Generation of Vehicles (PNGV)--an ongoing government partnership with industry to develop a prototype mid-size automobile with an efficiency of 80 miles per gallon by 2004.

- Light and Heavy Trucks--government and industry partnerships to develop advanced diesel-cycle engine technologies for pickup trucks, vans, and sport utility vehicles with a 35-percent efficiency improvement by 2002 and engine and vehicle technologies to improve the fuel efficiency of new heavy trucks to 12 miles per gallon from an average of 5.3 miles per gallon.

- Biofuels--continuing programs with USDA to develop the technologies to convert agricultural products to ethanol and other biofuels.

• Industry

- Industries of the Future--DOE partnership programs with the most energy-intensive industries to develop more energy-efficient technologies.

- Industrial Cogeneration--continuing DOE programs for the development of cogeneration systems and combined efforts with EPA to eliminate barriers to the dissemination of combined heat and power technologies.

• Electricity Generation

- Renewable Technologies--continuing research and development for solar energy, biomass power, wind energy, geothermal power, and hydropower.

- Deployment--funding for the Renewable Energy Production Incentive, renewable energy demonstration projects, and the International Solar Program.

- Transmission and Distribution--development of storage and power quality systems to improve the quality and reliability of power service, and continuing development of distributed generation.

- Hydrogen--acceleration of research on hydrogen production and storage.

- High-Temperature Superconductivity--continuing support for the development of superconducting technology.

- Nuclear Energy--funding for programs to extend the useful life of nuclear power plants.

- Fossil Energy--programs to improve the efficiency of coal- and natural-gas-fired electricity generation.

• Carbon Sequestration--research into the capture and storage of carbon dioxide by enhancing the natural capacity of terrestrial ecosystems and oceans to take up and store carbon dioxide in underground geological structures and the deep ocean.

Efficiency Standards

Within the building technologies program, additional funding is provided to DOE to accelerate the lighting and appliance efficiency standards program in order to encourage the deployment of more energy-efficient appliances and equipment. It is proposed that new standards be developed for fluorescent lamp ballasts, water heaters, and clothes washers, as well as test procedures for residential central air conditioners and heat pumps, distribution transformers, commercial heating, ventilation, and air conditioning, and water heaters. Historically, efficiency standards have been successful in improving energy efficiency. For example, refrigerators will use less energy and create fewer carbon emissions in 2010 than in 1990 even with population growth and performance enhancements. The most recent refrigerator standards adopted in 1993 and coming into effect in 2001 are aggressive enough to not only take inefficient units off the market but also accelerate the introduction of new technologies.

Methods of Analysis

At the request of the U.S. House of Representatives Committee on Science, the Energy Information Administration (EIA) conducted an analysis of the likely impacts of CCTI. The analysis was conducted primarily using the National Energy Modeling System (NEMS),⁽⁴⁾ the energy-economic modeling system of domestic energy markets developed and maintained by the Office of Integrated Analysis and Forecasting within EIA. With some minor modifications and ongoing enhancements, the version of NEMS used for this analysis was that used to develop the projections published in EIA's Annual Energy Outlook 1999 (AEO99)⁽⁵⁾ in December 1998. Additional offline analysis employed a building code model and building simulation model, both developed by DOE, to evaluate the tax credits for new energy-efficient homes.

For most of the energy-consuming and producing sectors of the economy, NEMS includes individual technologies, characterizing them by capital and operating costs, efficiencies, years of availability, and other relevant attributes. Therefore, NEMS can directly analyze the penetration of new technologies and the impacts of changes in the characteristics of technologies.

For this CCTI analysis, the tax credits for energy-efficient homes and buildings equipment; rooftop solar systems; electric, fuel cell, and hybrid vehicles; and combined heat and power systems were assumed to reduce the initial costs of purchasing the applicable equipment over the years specified in the proposals. The wind and biomass tax credits provide an incentive for these technologies through a production tax credit. Also, in analyzing the impact of the tax credit for fuel cell vehicles, the assumed date of commercial availability of the vehicles was advanced from 2010 to 2006 as a result of the credit, based on the announcement of a prototype vehicle in 2004.

With the exception of some reduction in the costs of advanced technologies for electricity generation, the analysis did not include ancillary benefits that might accrue from cost reductions with increasing market penetration. It is recognized that cost is not the only factor in consumer decisionmaking; however, this analysis assumes that consumer behavior will remain similar to that derived from empirical evidence, because there is no basis for assuming a fundamental change in consumer behavior. Consumer behavior has worked against the adoption of more fuel-efficient technologies in the past, because of the value placed on attributes other than lowering energy consumption. Future consumer behavior could shift to favor novel technologies or technologies that would benefit the climate if there were widespread acceptance of a need to improve energy efficiency or reduce greenhouse gas emissions; however, the incentives and programs in CCTI are unlikely to produce such changes, given their immediate timing and overall level of funding.

The portion of CCTI that includes funds for research, development, and deployment of new technologies is more difficult to quantify. In general, a direct link has not been established between levels of funding for research and development and specific improvements in the characteristics and availability of energy technologies. Similarly, it is difficult to quantify a link between information programs and other programs for voluntary initiatives and partnerships for technology development with realized technology development and deployment. As a result, the analysis of the research and development components of CCTI uses a different approach.

Many of the proposed research and development programs are addressed in qualitative terms in this analysis, discussing the current state of development of the relevant technologies and the economics of their development and deployment. For other programs the potential impacts are analyzed by assuming that certain program goals are achieved or through the impact of ongoing technology improvement in the AEO99 reference case. EIA analyzed the buildings program for energy-efficient appliances and equipment, which includes acceleration of lighting and appliance efficiency standards and new Energy Star products, by evaluating the impacts of the standards proposed in a study by the American Council for an Energy-Efficient Economy, Approaching the Kyoto Targets: Five Key Strategies for the U.S.,⁽⁶⁾ in combination with the new Energy Star programs for televisions and video cassette recorders and the goal of the Million Solar Roofs program. The program for the development of more energy-efficient technologies for light and heavy trucks is evaluated by assuming that the program goals for advanced diesel technologies for light trucks and for a variety of fuel-saving technologies for heavy trucks will be achieved and by evaluating the economics of their penetration. In a similar fashion, the Partnership for Advancing Technology in Housing (PATH), which has a goal of improving the energy efficiency of homes, is analyzed by assuming that the goals for new housing construction will be fully realized; however, the costs of achieving those highly efficient homes are not evaluated or incorporated into a decisionmaking process.

For each tax incentive or other program evaluated quantitatively, the impacts were analyzed by using the relevant sector of NEMS in a standalone mode. The results are presented in terms of energy savings and reductions in carbon emissions from the sector, relative to the reference case, along with other key indicators from the sector. Where possible, an estimate of the tax revenue losses is also provided and compared with the Administration's estimates in the budget submission. It is important to recognize that all results are presented as incremental changes to the reference case. Where CCTI encompasses ongoing research, development, and deployment programs already included in the reference case for AEO99, the impacts of the proposed funding additions are not evaluated.

It is also possible that some of the more efficient technologies included in the CCTI tax incentives would penetrate even in the absence of the incentives. The tax incentives are applied to both the units that are added incrementally as a result of the incentives and the units that would be added even in the baseline, which become unintended beneficiaries of the tax incentives. Where applicable, this analysis identifies the incremental units that are projected to be introduced as a result of the CCTI provisions. Another unintended effect of an investment tax credit is that part of the value of the credit accrues to equipment manufacturers and suppliers. Because the credit increases the demand for capital equipment, higher equilibrium prices for the equipment result. This effect could result in as much as 70 percent of the tax credit being passed on to equipment suppliers in the form of higher equipment prices.⁽⁷⁾ If this situation were to occur, the impact of a tax credit on capital equipment additions could be quite modest. This effect has not been incorporated in the analysis.

The presentation of the results focuses on the year 2010, because it is the midpoint of the first commitment period in the Kyoto Protocol, and also on 2005, because none of the tax credits extends beyond 2006. Some of the CCTI programs may have benefits in the longer term. Because of stock turnover, which can be slow, energy efficiency improvements and standards may take a long time to produce significant changes in the average stock of equipment. In addition, some of the research and development programs may have results later in, or beyond, the 2020 horizon of the analysis. The results are presented primarily in terms of energy savings and carbon reductions. Additional benefits that may occur, but are not evaluated, include improvements in air quality due to reductions in other emissions, energy security from lower energy imports, international opportunities for American companies as a result of improved technologies, and revenues from the deployment of more advanced technologies to other countries.

As noted above, the PATH program is evaluated by assuming that program goals will be met, even though the resulting technologies may not be economical within the time frame of the analysis. New equipment evaluated for the analysis of energy efficiency standards may similarly be unable to penetrate consumer markets on their own. The additional costs that could be required to make the technologies competitive are not addressed. In addition, there may be others, such as the full private sector costs of developing and manufacturing new technologies, infrastructure costs, and social costs, that are not captured in the analysis.

Uncertainties

It is possible that a standalone analysis of energy efficiency policies may overstate somewhat the potential energy and carbon savings that would be seen in a fully integrated analysis of U.S. energy markets. In other words, the individual energy sector savings are not necessarily additive. As an example, some policies may encourage the development and deployment of more energy-efficient and/or less carbon-intensive technologies for electricity generation. If concurrent policies encourage energy efficiency in the end-use demand sectors and reduce the demand for electricity, however, there may be less opportunity for the generation sector to grow and invest in the new generation technologies. Therefore, evaluating the combined impacts in an integrated model may be important. In this analysis, however, the individual impacts of the CCTI programs are projected to be relatively small, and it is unlikely that an integrated evaluation would provide additional information.

One of the key uncertainties in analyzing the impacts of new, more efficient technologies is consumer price elasticity--the extent to which, and how quickly, energy consumers will react to changes in energy prices or to improvements in the energy efficiency of equipment by purchasing the more efficient technologies. The EIA analysis relies on empirically derived estimates of price elasticities and consumer preferences to evaluate technology penetration; however, models cannot predict shifts in consumer tastes or market transformations associated with rapid adoption of new technologies. The pace of technology development is also a major uncertainty. EIA relies on engineering evaluations of the availability, costs, and characteristics of new technologies assuming continuing patterns of research and development. It is acknowledged, however, that the future development paths of energy-using technologies cannot be foreseen with certainty.

Market Barriers

Although some programs in the CCTI are aimed at the basic research and development of more efficient or renewable technologies, others are focused on the diffusion and deployment of the technologies. There are a number of reasons why new technologies may be slow to penetrate, the foremost of which is cost-effectiveness. Much of the research in new energy technologies, such as photovoltaic and wind generation, is aimed at reducing their costs.

The lack of penetration of technologies that do appear to be cost-effective is often termed "market failure." More recently, analysts have attempted to separate true market failure from other market barriers. Market failures may result from lack of information about the characteristics of new technologies, which may be helped through a variety of information programs. Another difficulty is exemplified by the difference between the incentives of builders and homeowners. To the extent that newer technologies may be more expensive, it may be difficult for builders or landlords to recover their additional costs from buyers or tenants who may not value energy efficiency as highly as other characteristics. Conversely, the buyer or tenant who will be paying the energy costs may not readily have the option of making equipment choices. Finally, artificially lower prices for energy, through subsidies or regulated prices for example, may hamper the penetration of technologies, because even lower technology costs would be necessary for them to appear cost-effective.

Other items may be viewed as market barriers, not failures. Energy consumers may be fully aware of potential cost savings from a more efficient technology but have a preference for other characteristics of equipment they purchase. The current trend for larger, more powerful vehicles is a prime example, but there are many examples of characteristics for vehicles, appliances, and equipment that compete with energy efficiency. New technology also tends to have a naturally slow penetration for a variety of reasons, including uncertainty as to the reliability and benefits of the new product; lack of familiarity with new techniques for installing and maintaining the equipment; uncertainty about the future availability of the next generation of the technology, which could represent a major improvement; and apprehension about the infrastructure for support and maintenance of the technology.

Perceptions about the payback periods for new equipment purchases may also vary among consumers. A technology may appear cost-effective when the potential fuel cost savings are estimated over a long period of time, but many consumers appear to want a more immediate payback for their higher initial purchase costs. Also, the tendency for homeowners to move frequently works against the purchase of equipment with long payback periods. Finally, uncertainty about future fuel prices and the likely duration of occasional price spikes may discourage consumers from investing in energy-saving equipment.

Market failures can be addressed by a number of programs, including those in the CCTI. Information programs, collaborative efforts for development and diffusion, research and development to improve the technologies and reduce costs, and incentives to enhance the cost-effectiveness of new technologies all may help to encourage earlier penetration of technologies. Subsequently, the initial penetration may have the additional impact of reducing costs through learning, establishing the infrastructure, and increasing familiarity with new technologies. Finally, equipment standards and other mandates, such as renewable portfolio standards, can also accelerate the market penetration of advanced technologies. No attempt was made in this analysis to evaluate the costs of such standards.

File last modified: April 14, 1999

URL: http://www.eia.doe.gov/oiaf/archive/climate99/introduction.html

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