CHAPTER

2

Stimulating Technology to Slow Climate Change

by Raymond J. Kopp, Richard D. Morgenstern, Richard G. Newell and William A. Pizer

Sir, in order to effectively address the threat of global climate change, we urge you to adopt a flexible emissions trading program for greenhouse gases, and simultaneously to increase funding for related technology research and development. Such a program will place the United States on a path to address this serious environmental problem without risk to the nation’s economy.

The Problem and the Challenge

Climate change is a vexing problem for all nations. Emissions of greenhouse gases, notably carbon dioxide (CO₂), are associated with the combustion of coal, oil, and natural gas used to power much of the global economy. The accumulation of greenhouse gases in the atmosphere threatens to raise global temperatures and cause potentially damaging alterations in the earth’s climate.

For the United States and the world, the challenge is to make modest but meaningful changes in the energy system in the near term that set the stage for fundamental change in the long term. These changes therefore must include incentives both to reduce emissions now and, equally importantly, to develop and deploy new technologies necessary to make future reductions. A program involving flexible emissions trading coupled with a climate technology program has the potential to achieve significant results.

The Leading Proposal for Emissions Trading

A convenient starting point for describing such a program is the proposal introduced by Senators McCain and Lieberman in the 108th Congress (the Climate Stewardship Act, S. 139). Modeled after the successful 1990 acid rain emissions trading program, S. 139 would cap CO₂ emissions at year 2000 levels for most large emissions sources beginning in the year 2010. Under such a program, a limited number of emissions allowances are given out or sold, and emissions sources are required to obtain an allowance for each ton they emit. Whereas an ideal tradable permit program administered upstream on fossil fuel production would address 100 percent of national CO₂ emissions, the McCain–Lieberman proposal would cover more than 70 percent, excluding households, farms, and other small sources.

Central estimates by the Energy Information Administration, Massachusetts Institute of Technology, and Resources for the Future all suggest that the initial costs of S. 139 would be on the order of 0.05 percent of GDP, rising significantly in the future. Under alternate assumptions, costs could be much higher even in the near term.

In October 2003, S. 139 was defeated by a bipartisan vote of 55–43 with opponents stressing the potential high costs of the measure, along with the economic and environmental consequences of unilateral actions to reduce emissions. Others emphasized that the proposed emissions caps would barely make a dent in global emissions, instead pointing to the potential of technology, including the Bush administration’s $1 billion FutureGen program. Finally, the bill lacks a clear vision of where we need to go in the future.

A More Complete Solution

Because it already has a base of support and familiarity among stakeholders, we recommend using S. 139 as a platform for domestic climate policy, but with five crucial changes based on straightforward economics that also address the concerns voiced in the Senate:

Technology R&D

Effectively addressing the climate change problem requires large-scale changes in our energy system over many decades. Therefore, incentives to encourage the development, adoption, and utilization of a fundamentally transformed energy system are of primary importance for sound climate policy.

The federal government has a long history of supporting energy-related technology R&D, based in part on the positive economic spillovers associated with new, more efficient energy technologies and, more recently, on the global environmental benefit of avoiding climate change. However, this support has not kept pace with the increased need for technological solutions, nor has it always been consistent and well spent.

We propose, therefore, that federal expenditures on climate-related energy system technology R&D be significantly expanded to at least $3 billion annually, or about double current levels, and funded via proceeds from the sale of some emissions permits. Recognizing that federal energy R&D has a somewhat checkered past, thanks in part to a large degree of congressional earmarking and funding fluctuations, we propose that the allocation of these funds be subject to a multiyear integrated R&D planning process. An independent commission would have as its explicit purpose the best allocation of R&D funds for long-term cost-effective climate mitigation and would include experts from government, private, and academic circles. The commission would put forward multiyear R&D funding plans, which would be considered by Congress as a package and forward-funded for several years at a time.

Safety Valve

Technology R&D by itself is not enough to effectively reduce greenhouse gas emissions. Rather, a successful domestic policy must create incentives for the private sector to adopt and use available climate-friendly technologies. The price of permits associated with those emissions under an emissions trading system provides this desired incentive.

However, the price of permits under such a system should not be allowed to rise arbitrarily high in order to enforce a short-term emissions cap. The economics of global climate change suggest a focus on consistent long-term effort, not short-term targets. Yet a simple cap-and-trade system can face sudden permit shortages as a result of unexpected events, leading to skyrocketing permit prices and expensive efforts to reduce emissions. This happened in the NO_x RECLAIM market during the California energy crisis and in the leadup to implementation of the NO_x OTC market when program rules and participation were still uncertain.

The simple solution, and one advocated by chairmen of the Council of Economic Advisers under both Presidents Bill Clinton and George W. Bush, is to specify a price at which additional permits will be sold in order to avoid such a shortage—a “safety valve.” We recommend that the program start with a very modest price that rises over time—on the order of $30 per ton of carbon in 2010 with an annual increase of 5 percent per year. The price of $30 per ton of carbon works out to be $0.30 per million Btus of natural gas, $0.60 per million Btus of coal, and $0.07 per gallon of gasoline. The choice of a starting price for carbon on the order of $30 per ton is consistent with the range of estimated climate benefits reported in the literature. The 5 percent escalator reflects increases in climate benefits associated with economic growth.

Based on the emissions limits proposed under S. 139, it is almost assured that the permit prices will reach the recommended safety valve. Nonetheless, we believe this is smart policy: Set the target where you would like to go, and set the safety valve at the price you are willing to pay.

Domestic and International Offsets

Two necessary elements of a successful climate change policy are that it achieves its goals at an acceptable cost and that it engages developing countries, points made most forcibly by the Byrd–Hagel Resolution (S. 98, 105th Congress). Offsets address both elements. They allow participants in an emissions trading system the opportunity to purchase additional permits from sources outside the emissions trading system that have achieved verified emissions reductions. These offsets might come from other domestic sources, agricultural and forestry projects that absorb and sequester greenhouse gases from the atmosphere, or, most important, developingcountry efforts to reduce emissions.

We recommend allowing unlimited verified offsets because it will both lower program costs and engage developing countries that have low-cost opportunities to reduce emissions. Although there are other ways we can and should engage developing countries in climate change mitigation activities, the purchase of offsets from these sources creates the institutional foundation for full emissions trading in the future.

Long-Term Vision

As signatory to the United Nations Framework Convention on Climate Change (UNFCCC), the United States has an acknowledged long-run climate policy that is meant to lead to the global “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system.”

At this point, it is not known what greenhouse gas concentrations are consistent with this stated policy aim. At the same time, setting a near-term policy without a long-term vision leaves many people wondering why we should do anything. For that reason, we believe it is crucial to place near-term action in the context of a long-term vision of stabilization.

Because of its centrality in the literature, we recommend a 550-parts-per-million global target—a doubling since the start of the industrial revolution. Based on estimated domestic emissions paths consistent with such a target, we translate this into a 2 percent annual decline in the initial 2000-level emissions cap beginning in 2030, so long as the permit price remains below the safety valve. In this way, the cap proceeds as planned if prices are “safe.” If it rises above the safety valve, the cap stops declining, and additional permits are sold to keep the price from rising any further.

Appropriate Action by Other Nations

Climate change is a global problem and requires a global response. The domestic proposal we recommend can be effective only if it spurs additional international action. This could come in the form of trading systems or commensurate policies and measures in other countries. Developing countries should gradually move toward mitigation policies, even if part of the cost of these policies is borne by industrialized countries.

We recommend that any increase in U.S. effort beyond 2015—including continued escalation of the safety valve price—be conditional on substantive actions by all of the nations that are major contributors to greenhouse gas emissions and all countries with whom the U.S. has significant trade relations. Currently, many countries, including the European Union, Canada, and Japan, are pursuing domestic actions to meet their obligations under the Kyoto Protocol. Most developing countries have avoided any climate change obligations and policies. Some developing countries, including China, have pursued policies based on other priorities—such as energy security and local air pollution—that have led to reductions of greenhouse gas emissions. All of these measures should be considered in evaluating further U.S. action.

R.J.K.

R.D.M.

R.G.N.

W.A.P.