Report#:SR/OIAF/98-03(S) Kyoto
Testimony Electricity & Coal Industries Face Major Adjustments All Sectors Need to Adjust; Motor Vehicles Face Main Non-Electric Impact Rising Price Could Level Off or Lower Gasoline Use Industrial Energy Efficiency, Already Rising, Would Further Improve Energy Efficiency Could Improve in the Building Sectors with Rising Prices Shift Toward Natural Gas and Renewables Characterizes New Energy Mixes Output and Cost-of-Living Impacted During the Transition Period Would Some Changes in Assumptions Revise These Projections? How? How Much? What Are Some of the Issues in Reducing Carbon Emissions in the United States Completed
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Output and Cost-of-Living Impacted During the Transition Period Even though energy represents only about 7 percent of our Gross Domestic Product (GDP), it is a crucial factor in virtually all the goods and services we produce and consume. The effects of alternative carbon scenarios can be expressed in terms of their impacts on the economy as a whole (e.g., GDP, capital investment, prevailing interest rates, inflation rates) as well as their impacts on individual families and enterprises (e.g., increased expenditures on energy, disposable income). When energy costs rise, other factors of production--including labor and capital--become relatively less expensive. Energy price increases encourage adjustments in which labor and capital are substituted for more expensive energy to the extent practicable. In the process however, some economic potential is lost. This reduces the "potential" GDP for the Nation. EIA calculates that such losses would range from $13 billion to $72 billion in 2010 (1992 dollars). In an economy today of over $7 trillion, which is expected to grow to over $9.4 trillion (1992 dollars) in 2010, the percentage loss in output ranges from 0.1 percent to 0.8 percent. In this context, the economy continues to grow, but at a slower rate. Because it takes time to adjust to a new set of factor-costs, however, there are, in addition to losses in potential GDP, transitional costs--which probably cannot be avoided entirely. Such short-run costs arise whenever price increases disrupt capital or employment markets. The transitional costs are very uncertain, but possibly very significant. They impact the "actual" GDP. Hence, the actual GDP losses are greater than the "potential" losses. The transitional costs can be softened to the extent that price changes are anticipated and appropriate compensatory adjustments can be made to Federal monetary and fiscal policies. Annual Growth Rates in Potential and Actual Gross Domestic Product, 2005-2010 This analysis assumes a carbon-permit trading system is introduced in the form of an auction run by the Federal Government (to focus on the most economically efficient means of reducing carbon emissions). The domestic auction would produce substantial revenue. This study assumes that the revenues would be recycled back into the economy to bolster disposable income and encourage both consumption and investment, counteracting the adverse short-term effects on the economy associated with higher energy prices and speeding the transition to equilibrium. Taking money out of the economy through a carbon price and then returning it encourages a shift in priorities that accomplishes the goal of achieving a carbon emissions reduction while moderating the impacts on the economy. It modifies the national energy mix and makes the overall economy less energy-intensive, while partly compensating consumers and business for the loss in income resulting from higher energy prices. EIA evaluates two illustrative recycling cases: one providing rebates via reductions in the personal income tax, and the other through the social security tax. EIA projects the loss in actual GDP in 2010 to range between $61 billion and $183 billion if revenues are recycled via a reduction in social security taxes, and between $96 billion and $397 billion if they are recycled via a reduction in personal income taxes (1992 dollars). Again, the economy grows even during the period of adjustment but does not reach the levels of growth in potential GDP. Although there is a definite slowing of economic growth during the transition period, actual GDP returns to its potential path, so the effects on the economy are almost totally muted over the longer term. The total cost to the economy can be estimated as the loss in actual GDP (the loss in potential GDP plus the macroeconomic adjustment cost) plus the purchase of international permits. It is assumed that the U.S. will purchase international permits at the marginal abatement cost in the U.S., i.e., the domestic carbon price. Total costs range from an average annual level for the period 2008 to 2012 of $77 billion to $338 billion 1992 dollars depending on the carbon reduction case and how funds are recycled back to the economy. Annual Cost of Carbon Reductions to the U.S. Economy, 2008-2012 As energy prices rise in the United States, downstream prices for all goods and services are affected. A rule of thumb for the year 2010 is that each 10-percent increase in the level of aggregate energy prices may lead to a 1.5- percent increase in producer prices and a 0.7- percent increase in consumer prices. Final prices for goods and services in the 1990+9% case, as shown by the CPI, are approximately 3.5 percent higher than the Reference Case by 2010 if carbon permit revenues are recycled through a personal income tax rebate, and 2.0 percent higher if revenues are recycled through a social security tax rebate. Throughout these cases, the role of monetary policy is critical. Higher energy prices place upward pressure on interest rates. Based on past behavior of the Federal Reserve Board, it is assumed that they will adjust interest rates to moderate the impact on the economy and return it to its long-run path. For Reference: A Matrix of Variables for Cases Analyzed by EIA Would Some Changes In Assumptions Revise These Projections? How? How Much? The House Science Committee asked EIA to determine how sensitive the results of its analysis might be to changes in three basic assumptions made for the Reference Case. These were analyzed against the 1990+9% Case, except for the changes in nuclear power assumptions. The changes can be framed as three questions. Suppose . . . underlying economic growth of the nation were higher (or lower)? If higher or lower growth is assumed in such factors as population, the labor force, and productivity, there would be differences in industrial output, inflation rates and interest- rate levels. Assuming a range of annual GDP growth between 1996 and 2020 from 1.3 to 2.4 percent, compared to 1.9 percent in the Reference Case, total U.S. energy consumption would be lower/higher in 2010 by about 2.2 quadrillion Btu. (A quadrillion Btu is equivalent to consuming about 500,000 barrels of oil per day for one year). To meet the same level of carbon reductions with higher (or lower) energy consumption, the "carbon price" would also be higher (or lower)--as shown on the adjoining graph. With a higher carbon price, less coal and more natural gas, renewables, and nuclear power are used. Suppose . . . technology advanced more rapidly as a result of increased national emphasis on research and development (or suppose--technology choices stayed as they were in 1998)? The technology assumptions in the main cases in the EIA report reflect expert engineering opinion of likely technological advances--i.e., they are not technologically pessimistic. Nevertheless, to analyze the effects of even more advanced technology, assumptions were developed by energy technology experts for the end-use and generation sectors, considering possibilities based on increased Research and Development. This could mean earlier introduction of products and processes, lower costs, and higher efficiencies than assumed in the Reference Case. It was also assumed that technology for extracting and storing carbon emissions from coal and natural gas-fired electric generators might become available. A "low tech" sensitivity assumes all future choices are made from today's technology. The range of energy consumption differences was similar to the GDP growth sensitivity. Higher technology lowers energy consumption in 2010 by 2.1 quadrillion Btu; freezing technological progress forces consumption to grow by an extra 1.5 quadrillion Btu. The related graph compares carbon price changes. In the residential and commercial sectors, lower carbon prices encourage higher consumption and balance the effect of advanced technology. Efficiency improvements and lower carbon prices allow coal use in generation to be about 40 percent higher in 2010. With low technology, converse trends prevail; more natural gas, nuclear energy, and renewables are needed to meet carbon reduction targets. The industrial and transportation sectors are more sensitive to technology changes than to price changes. Suppose . . . building of nuclear power plants resumed in this country? Because new nuclear plants did not compete economically with fossil and renewable plants in the 1990+9% Case, this sensitivity was analyzed against 1990-3% Case (with a carbon price of $294 in 2010). Some of the extra costs assumed for "first of a kind" advanced-design plants were also relaxed. Under these conditions, 1 to 2 new 600- megawatt nuclear plants would be added by 2010; and 2020 could see about 68 new plants. Because most would start up after the 2008-2012 period, carbon prices in 2010 would be relatively unchanged. By 2020, however, the 1990-3% Case carbon price of $240 per metric ton would be reduced to $199. Because of the lower carbon price in this sensitivity, all sectors have higher energy consumption. 2010 Carbon Prices in Three 1990+9% Cases 2010 Carbon Prices in Three 1990+9% Cases
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