[Economic Report of the President (2009)]
[Administration of Barack H. Obama]
[Online through the Government Printing Office, www.gpo.gov]

 
CHAPTER 3

Energy and the Environment

Although fossil fuels will continue to compose a large share of the
U.S. energy portfolio for some time, the Federal Government has taken
major steps to increase and diversify the Nation's energy supply and
improve the environment. Since 2001, the Government has made significant investments to develop cleaner and more reliable energy sources. Several regulatory changes are expected to deliver dramatic improvements in air quality nationwide. The President has signed two major pieces of energy legislation, the Energy Policy Act (EPACT) of 2005 and the Energy
Independence and Security Act of 2007 (EISA). EISA was enacted in
response to the President's Twenty in Ten goal, issued in the 2007
State of the Union Address, of reducing U.S. gasoline usage by 20
percent in the next 10 years by improving fuel economy and increasing
the production of alternative fuels. EISA also includes numerous
energy efficiency mandates that are projected to result in substantial reductions in greenhouse gas (GHG) emissions. In addition, the Nation
is on track to meet and currently projected to exceed; the President
2002 goal of reducing U.S. GHG intensity (emissions per unit of GDP)
by 18 percent by 2012. This spring, the President set a new goal of
stopping the growth in total U.S. GHG emissions by 2025 and to begin decreasing them thereafter. The Administration has also recently led
efforts to encourage wider international action on addressing GHGs,
including action in developing countries.
Despite these steps by the Administration to address the problems
associated with the country's reliance on fossil fuel-based energy
sources, major challenges remain. For public health and environmental
reasons, the United States must continue to improve air quality by
ensuring that State and local areas come into compliance with Clean
Air Act (CAA) requirements. Additional steps should be taken to
mitigate the global problem of rising GHG emissions associated with
fossil fuel-based energy consumption. Furthermore, diversifying the
Nation's portfolio of energy sources and increasing domestic
production may reduce vulnerabilities associated with the U.S.
dependence on imported fossil fuels.
This chapter discusses policies for addressing the Nation's energy
needs in the context of both global climate change and the
reduction of local and regional pollution associated with fossil
fuel-based energy use. It reviews some of the steps this
Administration has taken to advance the transition to new sources of
energy with fewer environmental and security concerns, and to find
cleaner, more efficient methods of using existing energy sources. It
also identifies some of the overarching challenges that lie ahead in
developing any comprehensive energy policy.
The key points in this chapter are:
[BULLETS] Because of innovative regulations promulgated under this
Administration, there should be substantial improvements
in air quality over the next few decades. Two rules that
implemented cap-and-trade programs in the electricity
sector represent a significant step in using cost-
effective, market-oriented policy instruments to
dramatically reduce power plant's emissions of sulfur
dioxide, nitrogen oxide, and mercury.
[BULLETS] Despite widespread support for increased use of
market-based approaches to achieve our environmental and
energy policy goals going forward, challenges remain in
realizing the full potential of these approaches.
[BULLETS] There is an increasing need to reassess how well existing
laws can address the environmental problems associated
with fossil fuel use in more cost-effective ways. For
example, it may become increasingly costly to make
additional reductions in traditional air pollutants, and
existing statutes were not meant to regulate global
problems such as GHG emissions.
[BULLETS] Substantial reductions in global GHG emissions will require
participation by all large emitters (countries and sectors
within countries).


U.S. Energy Use and Policy Goals

Fossil fuels continue to satisfy the majority of the Nation's
demand for energy. Petroleum accounts for about 40 percent of total
energy consumption; 70 percent of this petroleum is used for
transportation. Coal and natural gas are the next most commonly used
fuel types, representing 22 percent and 23 percent of consumption,
respectively. Coal is used almost exclusively for electricity
production; approximately a third of natural gas consumption is also
used in electricity production, with the remaining two-thirds being
used directly by residential, commercial, and industrial sources.
Finally, nuclear power and renewable energy sources such as
hydropower, biomass, geothermal, wind, and solar power remain a small
but growing share of our energy consumption, with nuclear power
accounting for approximately 8 percent of U.S. energy consumption in
2007 and renewable energy accounting for approximately 7 percent. (See
the 2008 Economic Report of the President for more details on U.S.
energy sources.)
The Nation's current patterns of energy use pose a number of
problems that warrant government involvement in energy markets. One
is the concern over the public health and environmental effects of
fossil fuel-based energy production and use. In particular, the
emission of many common air pollutants that are created by the
combustion of fossil fuels increases the risk of premature mortality
and numerous acute and chronic health conditions. Additionally,
these emissions damage ecosystems, impair visibility, and have a
substantial impact on water and soil quality. In this chapter, common
air pollutant refers to the so-called criteria pollutants
(particulate matter (PM), ozone, nitrogen oxides (NOx), sulfur
dioxide (SO2), carbon monoxide (CO), and lead), although much that
is written about the criteria pollutants also applies to hazardous air pollutants or air toxics.
As in many other countries, anthropogenic (human-made) U.S. GHG
emissions continue to increase. Because of the environmental risks
posed by climate change and the national security implications of
events like droughts and rising sea levels, many countries have grown
more aware of the need to slow and reverse the growth of global
emissions of carbon dioxide (CO2) and other greenhouse gases. In 2007,
total U.S. GHG emissions were 7,282 million metric tons of
COequivalent (MMTCO2e), a 3-percent increase over 2000 levels; this
increase is mainly attributable to energy use. Energy-related CO2
emissions account for 98 percent of U.S. CO2 emissions and 2 more
than 80 percent of total U.S. GHG emissions. The United States
represented about 17 percent of world GHG emissions in recent years.
For energy security reasons, concerns also remain about the U.S.
reliance on imported fossil fuels. Net oil imports to the United
States account for a substantial share of national oil consumption,
which many argue makes the United States economy more vulnerable to
oil price shocks that are the result of supply disruptions in unstable
exporting regions. However, as economists have pointed out, it is
important to remember that it is primarily U.S. oil dependence, rather
than U.S. dependence on imported oil, that exposes the country to
turmoil in world oil markets. Given the integrated nature of the oil
market, a supply disruption in one region still removes oil from the
world market causing the price of oil to rise regardless of where it
was produced.
Despite a weak economic outlook for 2009, projections indicate that
energy consumption in the United States and around the world will
continue to grow in the long run. Thus, we will need to continue to
determine how to meet these needs while both addressing energy
security concerns and improving environmental protection. It is clear
that long-term policies aimed at reducing the Nation’s overall
reliance on fossil fuels can help to advance both goals. However,
taking intermediate steps that help us use fossil fuels in more
responsible ways during the transition to alternative sources of
energy is still consistent with this long-term objective. For example,
this Administration has supported removing regulatory impediments to
bringing domestic energy sources, including fossil fuels, to market,
to advance energy security objectives. It has also supported finding
cleaner ways of using fossil fuels. Some of the Administrations
efforts on each of these fronts are covered later in this chapter.
Before that, the next section provides a brief overview of policy
approaches for addressing these objectives.


The Promise of Market-Oriented
Policy Approaches

This section reviews the advantages of market-oriented policies,
while noting some of the challenges that must be overcome to use them
most effectively in tackling some policy objectives such as climate
change. This section also discusses the role for policies supporting
research and development and widespread adoption of new technologies
that pose fewer environmental or security concerns.

Market-Oriented Environmental Regulation

Regulatory approaches for addressing the policy goals outlined above
are often grouped roughly into two categories: conventional, or
command and control approaches, and market-oriented approaches.
Conventional approaches to reducing pollution, for example, tend to
involve policy instruments that mandate the amount individual entities
can emit or prescribe which abatement behaviors or technologies should
be adopted. These types of policies are often called command and
control approaches because they offer little flexibility about how a
particular environmental goal may be met (although, among command and
control approaches, performance-based standards can offer a bit more
flexibility in achieving abatement goals than do technology-based
standards). Market-oriented approaches, by contrast, encourage
behavior through price signals rather than with explicit standards on
pollution-control levels or methods. Policy tools such as tradeable
permits or taxes, for example, offer firms an incentive to reduce
their pollution by placing a price on each ton of pollutant emitted.
The primary advantage of market-oriented policies is that, if they
are designed well and properly implemented, they have the potential to
achieve environmental goals at a lower cost to society than
traditional command and control policies. This is because of the
greater flexibility they offer in determining how to reduce emissions.
If emitters can choose the method of pollution reduction, they have an
incentive to find the lowest-cost way to meet the regulatory
requirement. For example, policymakers could require producers and
consumers to take into account the environmental and public health
effects of a criteria pollutant like sulfur dioxide by imposing a tax
on emissions that is equal to the incremental damage caused by a unit
of emissions or by establishing a cap-and-trade program, under which
policymakers set an overall cap on emissions but allow regulated
entities to trade rights (called allowances) to those limited
emissions. Since the cost of reducing emissions may vary across firms
and sectors, what may be the least expensive approach for one firm may
be a relatively high-cost approach for another firm. Emitters that can
reduce emissions most inexpensively will do so and then sell
allowances to those who face much higher abatement costs. As a result,
the most economically efficient allocation of the pollution-control
burden among emitters can be achieved without requiring the
policymaker to make assumptions about how compliance costs may vary
across firms.
Another significant advantage of market-oriented approaches is that
they can provide a greater incentive to develop new ways to reduce
pollution than can command and control approaches. Command and control
policies often offer incentives to abate only to the level of the
standard, whereas a pricing approach encourages emitters to continue
to innovate as long as they find it relatively cheap to do so. Well-
designed pricing of CO2 emissions through a tax or cap-and-trade
program, for example, would give firms a direct incentive to invest in
developing new low- or zero-carbon technologies based on their
expectations of the increases in the costs of emissions. It would also
encourage competition in making incremental innovations in existing
emission reduction options. Of course, it will be important to address
hurdles in providing the infrastructure necessary to allow large-scale
deployment of new technologies, a point to which we return below.
Both of these advantages have created widespread support among
economists for greater use of emission pricing policies to address
environmental problems, including those problems associated with
fossil fuel–based energy use. However, it is important to
emphasize that challenges remain in realizing the full potential of
market-oriented policy approaches. This is especially true in the
context of climate change. Carbon pricing through a cap-and-trade
system or, closely related, by taxing fossil fuels in proportion to
their carbon content, will require broad-based participation to be
effective in addressing global GHG concentrations. Limited action that
does not result in emissions reductions from countries that contribute
a significant share of world emissions will not lead to significant
progress on climate change goals, since the majority of the future
growth in emissions will come from developing nations. Absent action
by all major emitting countries, it will be impossible to have a
meaningful impact on the problem. Also, without similar policies
across these countries, firms in energy-intensive industries that face
high regulatory costs in the U.S. could have an incentive to move
their operations to unregulated foreign markets. These issues and
other challenges in implementing more economically efficient policies
are discussed in greater detail below.

The Role for Technology Inducement Policies

Another method policymakers often use to give incentives for taking
into account the environmental or security consequences of a
particular behavior is to subsidize behavior that poses fewer
environmental or security concerns.
For example, similar to the way a business reacts to a price signal
such as an emissions tax, a profit-maximizing business will abate
pollution or invest in research and development (R&D) in cleaner
technologies up to the point where the cost is more than the subsidy
or reward earned for doing so. This is not to imply that a tax and
subsidy are equivalent policies. A tax generates revenue that can be
used to offset other preexisting distortionary taxes (such as payroll
taxes) in the economy, whereas a subsidy requires that revenue be
raised by increasing existing taxes or requires reducing spending in
other areas. Still, many economists maintain that, as a complement to
any pricing policy, governments will need to support R&D for
alternative energy sources and ensure that any R&D support is managed
efficiently and effectively. These policies may be justified on
economic grounds primarily because the process of generating and
diffusing new energy technologies is characterized by imperfect market
outcomes. The most significant of these is the general underinvestment
in innovation due to the pure public-good nature of R&D. Because
devoting a firm’s resources to innovation may yield knowledge
spillovers—benefits to society that do not translate into
profits for the innovating firm—there may be an inefficient, low
level of R&D in alternative energy technologies. This problem has long
been recognized in all industries, and there are numerous policies in
place to help innovators reap the rewards of their innovations (for
example, patents, copyright laws, funding for general science
research).
In assessing the desirability of public sector support for research
and development, one might consider the extent to which private sector
incentives for R&D already exist. Private incentives for R&D
investment may vary across categories of prospective R&D:

[BULLETS] Emission control for currently regulated pollutants. In
this case, there are regulatory incentives for the private
sector to develop technologies that control emissions, but
there will only be incentives to develop technologies that
reduce emissions in ways captured by regulation.

[BULLETS] Energy efficiency, new energy sources, and alternative
energy. Since energy is an expensive input, there are
strong private sector incentives to develop new or improved
technologies even without any government regulation.
Support for public sector R&D in this area would be
specifically justified if individual producers and consumers
do not account for the broader value of energy security
or of positive spillovers to others from the technology that
goes with the new alternative.

[BULLETS] Emissions from pollutants that are not currently regulated.
In this case, the incentive for private sector R&D is very
limited, because prospective developers are not only
uncertain about whether their new invention will work, but
also must consider if or when the pollutant will be
regulated, and whether their technology will be acceptable
under future regulations. Technologies to reduce emissions
of non-CO2 greenhouse gases are among those that are not
currently regulated, as are technologies that would capture
and store such gases to prevent them from entering the
atmosphere.

It is important to highlight that domestic R&D support for
alternative technologies may also help create incentives for action
on climate change by other major emitting countries that are
unwilling or unable to adopt GHG-reducing regulations. For example,
investment in developing low-cost, low-carbon technologies could
lead to inventions that such countries would adopt voluntarily.
Additionally, it is often argued that production costs of new,
unproven technologies fall as manufacturers gain production
experience. If the gains from such learning by doing experience
can be captured by other producers without compensating the early
adopters, then there may be inefficient, low deployment of new
technologies.
The difficulty in promoting technology adoption through subsidies and
other tools lies in designing policies that are neutral across all
alternative technologies. Weighting the size of a subsidy by the
degree to which each technology reduces environmental and security
concerns would help to ensure that the Government is not in the
position of picking winners. In April 2008, the President called
for a reform of the existing low-carbon technology deployment tax
incentives into a single, expanded incentive with such features.
We return to this issue below. Overall, there is less agreement
among economists about the justification for these types of policies
that target the commercial use of a technology than those that
target the R&D stage of the technology innovation process. Many
argue that once fundamental research is no longer necessary, the
market should decide how widely a new technology is adopted.


Increasing Use of Alternative Energy Sources

There are many alternatives to fossil fuels available for meeting
our energy needs in the electricity, transportation, and other
sectors. Electricity may be generated using renewable sources
(such as wind, solar, geothermal, biomass, and hydropower) or
nuclear power. In the transportation sector, solutions range from
finding new fuels for traditionally gas-powered vehicles to designing
different types of vehicles such as those that run on electricity
or hydrogen. Policy tools used under this Administration to promote
the transition to some of these alternatives can be grouped into
two categories: technology policies that provide incentives to
encourage R&D and deployment of new technologies, and mandates
that require increases in alternative energy use.

Generating Electricity

In the electricity sector, the Administration has supported
development of alternative energy technologies through a mix of
incentives, including both basic research investment and technology
deployment policies. Department of Energy funding for electricity-
related R&D, for example, totaled $11.5 billion (2007 dollars) from
fiscal year 2002 through fiscal year 2007. This section reviews some
of the existing incentives for promoting electricity generation from
renewable energy sources and nuclear power.

Renewable Energy

Renewable sources of energy such as wind, solar, and geothermal power
are desirable for generating electricity because, despite their high
initial fixed costs, they are domestic sources of power with no fuel
costs or emissions except those involved in building the
infrastructure required to generate the power. Biomass-fired
electricity, which is derived from sources such as wood, waste, and
alcohol fuels, is also a renewable source. While not technically a
zero-emission process, biomass energy produces fewer common air
pollutants than coal and, depending on the feedstock and firing
process, has the potential to create fewer GHG emissions than either
conventional coal or natural gas. This Administration has encouraged
deployment of renewable energy technologies in electricity generation
primarily through tax incentives. For example, the renewable energy
production tax credit (PTC) has been important in encouraging the
growing market for wind power. Although wind still provides only 1
percent of the United States’s electricity, wind generation has
grown by about 400 percent since 2001 and, in 2007, made up 10 percent
of electricity generation from renewable energy sources (see Chart
3-1). This growth is in part because, in some areas, the PTC makes the
cost of wind more competitive with other energy sources such as
natural gas. Incentives and requirements for renewable energy use in
numerous States are also contributing to the increase. The Federal PTC
has been renewed and expanded several times since its original
enactment in 1992, including by EPACT 2005 and again in October 2008.
It is currently available for a broad range of renewable sources such
as solar power; certain geothermal, landfill-gas, and biomass
projects; ocean energy; and livestock methane-based power.
Renewable energy deployment is also encouraged through tax credits for
investments in renewable energy equipment and property. For example,
the Energy Policy Act of 2005 (EPACT) increased the solar investment
tax credit (ITC), which offers businesses a tax credit for investments
in solar energy equipment and installations. The 21-percent increase
in solar powered electricity generation capacity between 2006 and 2007
may indicate that the solar ITC is having some effect. In order to
provide clear and consistent incentives for technology investment,
policies such as the PTC should be maintained for




a reasonable length of time but be phased out once they are no
longer warranted to address barriers associated with the early
commercialization of a technology.
It is worth noting that renewable energy sources, especially wind
and solar, face infrastructure obstacles because many large-scale
renewable energy installations are most likely to be built in remote
areas. Also, neither wind nor solar can currently be relied on as a
consistent means to produce energy 24 hours a day. The challenges of
bringing these resources to market and finding better ways to store
energy are discussed in more detail later in the chapter.

Nuclear Power

In addition to renewable energy sources, the Administration has
promoted increased use of nuclear power as a clean, efficient energy
source to meet the Nation’s growing need for electricity.
Nuclear power is not a new technology. Currently, 104 commercial
nuclear generating units (reactors) in the United States supply
approximately 20 percent of the country’s electricity. Nuclear
power generation makes no contribution to global CO2 emissions and
produces no notable emissions of SO2, NOx, and particulates. In
addition, nuclear plants have low operating costs and are able to
operate at close to full capacity all the time, thus providing a
reliable, constant supply of electricity. Despite these advantages,
high construction costs, investment risks, long-term management of
spent fuel generated by nuclear plants, and regulatory hurdles have
deterred any new commercial reactors from being ordered and approved
for construction since 1978. The last new nuclear plant came on line
in 1996.
The Administration has taken several steps to address some of the
concerns that are barring greater use of nuclear energy. EPACT 2005
provided a new production tax credit to reward investments in the
latest developments in advanced nuclear power generation. Since then,
the Nuclear Regulatory Commission has received 17 applications for
combined construction permit and operating licenses for 26 new nuclear
generating units.
As part of EPACT, the President also authorized the creation of loan
guarantee programs to encourage commercial use of new or significantly
improved energy related technologies, including nuclear power. In 2008, Congress authorized loan guarantees worth over $18 billion to support construction of new plants and enable nuclear plant owners to reduce
their interest costs. A loan guarantee is a promise by the Government
to take responsibility for a certain portion of a loan in case the
debtor defaults. By assuming some of the risk associated with loans
for new projects, these guarantees are implicit subsidies for new
nuclear energy projects. If priced appropriately, loan guarantees
can help to encourage early commercial use of new technologies that
had been hampered by informational asymmetries between project
developers and lenders. However, such guarantees should be used
with caution. If the Government assumes too much of the financial
or political risk associated with a new project, investors may
attempt to embark on speculative projects that could end up being
costly for taxpayers. This same caution applies to loan guarantee
programs available to support other energy sources such as
renewable and/or energy-efficient systems, cleaner coal-based power,
and other technologies.

Alternative Transportation Fuels

Petroleum use in road travel dominates energy consumption in
transportation. In recent years, tax incentives have increased the use
of some alternatives to petroleum, especially corn-based ethanol, but
there has been an increasing emphasis on promoting alternatives that
do not rely on food crops and have greater promise for significantly
reducing GHG emissions. The Administration’s efforts in this
area have focused on providing incentives and funding to develop new
vehicle technologies and reliable, low-cost alternative fuels to
conventional gasoline and on mandating increased use of renewable
fuels, including biofuels from non-food sources.

Incentive-Based Promotion of Alternative Fuels

Federal R&D support for alternative fuels has been led by a $1.2
billion investment (over 5 years) in hydrogen-based fuel cell vehicles
and about $1 billion since 2001 in cellulosic ethanol—an ethanol
produced from wood, grasses, or the nonedible parts of plants. These
fuels face significant cost hurdles which currently prevent them from
being commercially viable. The benefits of R&D in hydrogen vehicles
will take a long time to be realized because the vehicles still face
formidable technological obstacles that may take decades to resolve.
The projected cost of cellulosic ethanol, however, has dropped by more
than 60 percent since 2001. If these cost reductions continue,
cellulosic ethanol may become a viable transportation fuel more
quickly than alternatives like hydrogen. Aided by the Corporate
Average Fuel Economy (CAFE) credit given to manufacturers for
producing flex-fuel vehicles that can run on either all
gasoline or up to 85 percent ethanol, the number of light-duty
vehicles that can accommodate large amounts of ethanol has grown by
more than 5 million since 2001 (see Chart 3-2). However, as with other
types of biofuels, significant economic, scientific, environmental,
and logistical challenges remain with incorporating nationally
significant volumes of cellulosic ethanol into the market. Fuel
distributors and gas station owners will need to make significant
investments in the infrastructure for new fuel distribution and
manufacturers will need to make changes to vehicles to accommodate
substantially larger biofuel volumes; existing gas station
infrastructure and non-flex-fuel vehicles are currently only
compatible with gasoline blends consisting of up to 10 percent
ethanol.



Another alternative technology that shows more near-term promise in
reducing gasoline consumption is electricity for powering vehicles.
The consumer tax credits created under EPACT in 2005 for purchasing
electric; gasoline hybrid vehicles have helped to encourage
hybrid sales, and there are now more than 1 million hybrid vehicles on
the road. The so-called plug-in hybrid design takes this
technology a step further by using the gas engine only for back-up
status and letting the electric motor do most of the work. This is
possible because the large battery pack of the plug-in hybrid can be
recharged using a standard household outlet. The cost of the battery
pack is a major hurdle to widespread commercialization of these
vehicles. Between 2001 and 2008, the Department of Energy helped to
advance battery technology with about $230 million in funding for
energy storage R&D.
Replacing gasoline with electric power helps address energy security
concerns by increasing the use of domestic, non-petroleum energy
sources to meet our transportation needs. It does not eliminate GHG
concerns or emissions of many local pollutants if the electricity is
generated using fossil fuels, but it does reduce these concerns as
well. Electric vehicles with more efficient alternating current
systems would produce fewer CO2 emissions per mile than most
conventional gasoline vehicles if powered by electricity from a coal-
fired power plant. CO2 emissions per mile driven would be
significantly lower than with gasoline if the electricity were
generated with natural gas. This would also result in fewer emissions
than powering a car directly with natural gas, which has shown greater
use as an alternative to diesel in heavier trucks or buses. It will
still be necessary to modernize and expand the electricity grid to
accommodate substantial increases in electric power usage in the
transportation sector. The challenge of expanding electricity
transmission is discussed in more detail below.

Renewable Fuels Standard

In addition to using incentives to promote alternative fuels, the
Administration has also acted to mandate increased use of alternatives
to petroleum in transportation. In 2007, the President announced the
Twenty in Ten goal to reduce U.S. gasoline use by 20 percent in 10
years. The passage of the Energy Independence and Security Act of 2007
(EISA) represents a major step toward this goal by requiring
substantial increases in light-duty vehicle fuel economy standards and
an increase in the production of renewable fuels.
The renewable fuels standard (RFS) portion of EISA is an expansion of
the first RFS the President signed into law as part of Energy Policy
Act of 2005 (EPACT), which required a minimum volume of renewable fuel
to be sold or blended with gasoline in the United States. EISA raises
the 2008 standard from 5.4 billion gallons to 9 billion gallons and
increases the requirement each year thereafter, until reaching 36
billion gallons of renewable fuel by 2022. Beginning in 2009, about 5
percent of the RFS must be met with advanced biofuels such as
cellulosic ethanol made from switchgrass or wood chips or biodiesel
made from leftover restaurant grease. By 2022, nearly 60 percent of
the RFS-mandated volume must come from advanced biofuels. These
advanced biofuels hold greater potential for reducing GHG emissions
than current U.S. biofuels and are also less likely to affect future
food prices because they are not reliant on food crops as feedstock,
although some advanced biofuels may compete for land and other inputs
with food crops. However, minimizing the negative environmental
impacts (for example, on soil, water quality, forest cover, habitat
diversity, and increased GHG emissions from land-use changes) of
biofuel production is likely to remain a significant challenge
regardless of the type of feedstock. Furthermore, while the RFS will
lead to an increase in the use of biofuels, the expected reduction in
gasoline consumption (and associated emissions) will likely be
dampened due to unintended consequences. For example, gasoline
consumption may increase in other countries due to a rebound effect
from lower demand in the United States.
The risk of food-price spikes resulting from a binding RFS mandate
could be mitigated by establishing a safety valve mechanism that
would effectively cap the cost of meeting the mandate. With such a
mechanism, a refiner or fuel blender would be allowed to purchase
credits from the Government to satisfy its RFS requirement if
biofuel prices exceeded a predetermined safety-valve price. This would
prevent drastic shocks in food prices and also offer more regulatory
certainty to refiners, blenders, and biofuel producers. Despite the
Administration’s support for a safety valve in the RFS mandate,
the final version of EISA did not include such a provision.


Harnessing Existing Energy Sources More Responsibly

Given the economy’s overwhelming reliance on fossil fuels, it
is reasonable to assume that it will take some time to transition to
alternative sources of energy. Therefore, in addition to supporting
the development of alternatives described above, the Administration
has led a parallel effort to promote cleaner, more efficient, and more
reliable use of existing sources, including fossil fuels.

Increasing Efficiency

Efforts to use existing energy sources more efficiently have focused
on improving efficiency in vehicle fuel use and in electric energy
consumption through fuel economy standards on new cars and light
trucks and through various lighting and appliance standards.

Vehicle Fuel Economy Standards

The EISA Vehicle Fuel Economy Mandate builds on the Department of
Transportation’s 2003 and 2006 fuel economy rules for light-duty
trucks and requires that the light-duty vehicle fleet (new cars and
light trucks) meet a Corporate Average Fuel Economy (CAFE) standard
average of 35 miles per gallon (mpg) by 2020. The 2003 rulemaking
increased fuel economy standards of new light trucks by 7 percent
between 2004 and 2007 model-years, and the 2006 rulemaking required an
additional 8 percent increase, bringing fuel economy of new light
trucks to 24 mpg by model year 2011. The 2020 requirement represents
approximately 40-percent increase in miles per gallon over 2008
standards: 27.5 mpg for passenger cars, and 22.5 mpg for light trucks.
Several new credit trading and banking provisions will help reduce the
cost to manufacturers of meeting the new standards and are an example
of the use of market-based mechanisms. Under EISA, manufacturers whose
vehicles exceed minimum CAFE standards can sell credits to other
manufacturers below the standards, and companies can transfer credits
between their car and light truck fleets. Companies are also permitted
to carry credits forward for 5 years (instead of the current 3 years),
which should encourage earlier introduction of new technologies and
overcompliance in the initial years. In addition, EISA provides $25
billion in loans to the auto industry to assist in meeting the new
CAFE standards. In April 2008, the Department of Transportation issued
a proposal to raise fuel economy standards more rapidly than required
by EISA.
In addressing potential energy security concerns, the advantage of
CAFE over some other policies is that it encourages reductions in
gasoline consumption, thus reducing not only oil imports but also the
economy’s overall reliance on oil. However, increased CAFE
standards do nothing to reduce externalities related to miles driven
(congestion, accidents, noise, local pollution) and will in fact
increase these slightly as the per mile cost of driving falls. In
addition, since regulations like CAFE standards that differentiate
based on a vehicle’s age make new vehicles less attractive than
existing vehicles, the regulation may delay the turnover of the
vehicle fleet and reduce the realized environmental benefits of the
tighter standards. For such reasons, many economic analyses suggest
that higher fuel taxes may be a more efficient solution to the
negative externalities related to fuel consumption. As noted in
Chapter 9, congestion pricing may also be a better way than CAFE to
address many of the negative externalities associated with driving.
In the absence of other policies, increasing fuel economy standards
will help reduce gasoline consumption and greenhouse gas emissions. It
is also likely, as recent trends suggest, that higher fuel prices may
persuade consumers to buy more fuel-efficient vehicles even before the
higher mileage standards take full effect.
In addition to increasing the fuel economy of our vehicles, fuel
efficiency may be increased by targeting inefficiencies at other
points in the transportation network. For example, municipalities have
saved millions of gallons of fuel and abated associated COemissions by
monitoring and retiming 2 their traffic signals and have seen
significant returns on their signal-management investments
(see Chapter 9).

Electric Energy Efficiency

The final set of mandates included in EISA is aimed at improving
energy efficiency in electricity use. The Lighting Efficiency Mandate
will essentially phase out the sale of incandescent light bulbs by
2014 and improve lighting efficiency by more than 65 percent by 2020.
The Appliance Efficiency Mandate sets over 45 new standards for
appliances. The Federal Government Operations Mandate requires Federal
agencies to reduce the energy intensity of their facilities by 30
percent from 2003 levels by 2015 (an increase over the 20 percent
reduction requirement set by EPACT 2005). EISA also revised the
Federal Building Energy Efficiency Performance Standards so that
fossil fuel-generated energy use is phased out of new Federal building
designs by 2030. While these requirements will undoubtedly deliver
efficiency improvements, reductions in fossil fuel use through these
and other types of efficiency standards will be dampened by population
and economic growth. In fact, the Energy Information Administration
projects that net electricity consumption will still increase nearly
30 percent by 2030 even after accounting for the EISA efficiency
standards. Furthermore, as in the case of vehicles, it is important to
remember that improvements in electric efficiency will reduce energy
cost per kilowatthour, resulting in some increased use of lighting,
air conditioning, and other electricity-using activities. This rebound
effect thus dampens somewhat the overall impact of the EISA mandates.
There are numerous other promising opportunities to make our
electricity generation, distribution, and consumption more efficient
and reliable. According to the Energy Information Administration, the
U.S. electricity-generation system converts only one-third of total
energy inputs into usable electricity, and about 9 percent of this
electricity is lost during transmission and distribution. One way to
increase the efficiency of the system would be through the use of a
so-called smart electricity grid. A smart grid could be able to
receive power back from clients. It would thereby allow greater
integration of renewable generation resources and facilitate
distributed electricity generation from small-scale sources such as
home photovoltaic panels and micro-turbines during peak demand times.
Using a two-way communications system, a smart grid would also allow
consumers in areas where electricity prices rise and fall based on
real-time demand to shift energy consumption from high-priced peak
demand periods to low-priced off-peak periods. Finally, by enabling
near real-time monitoring of electricity use, a smart grid would give
utility companies more time to detect faults and take steps to prevent
the possibility of a blackout. These steps could include alerting
consumers about reducing energy consumption during emergency periods
of peak energy usage. Recent estimates suggest that deployment of
smart-grid technologies could potentially reduce America's annual
electricity usage by up to 4.3 percent by 2030.
The Department of Energy is undertaking many smart-grid planning,
implementation, and awareness activities. EISA also authorized up to
$100 million per year over the next 5 years for a smart-grid
demonstration initiative to demonstrate the potential benefits of
advanced grid technologies; to facilitate commercial transition from
the current system to advanced technologies; and to improve system
performance, power flow control, and reliability.

Cleaner Use of Fossil Fuels

The recent mandates for increased energy efficiency have been further
supported by policies promoting cleaner use of fossil fuels, including
numerous regulations targeting local and regional air pollution and
technology deployment incentives, such as tax incentives for advanced
coal technologies.

Regulating Local and Regional Air Pollutants

Regulations directed at local and regional air quality problems are
and will continue to be linked to policies to reduce GHG emissions.
These policies often provide co-benefits to each other. For example,
to the extent that regulations that target common air pollutants in
the transportation sector lower fossil fuel use and make fossil energy
cleaner, they also contribute to more secure energy with less
environmental harm. Similarly, significant air quality benefits can be
expected from climate change mitigation policies. (Note that the
reverse may not be true, since pollution-control equipment consumes
power, which requires greater fossil fuel use (and CO2 emissions) to
generate the same amount of usable energy.) There may be additional
savings from reduced investment in local air pollution controls (such
as equipment to reduce the amount of nitrous oxide (NOx) and sulfur
dioxide (SO2) released into the air from coal-burning power plants)
under a future GHG emission pricing policy that reduces the use of
fossil fuels.
According to a number of indicators, air quality has improved
dramatically over the past few decades. As shown in Chart 3-3,
emissions of many common air pollutants have decreased, and these
trends have continued through this Administration. For example,
between 2000 and 2007, NOx and volatile organic compounds (VOC)
emissions (the primary precursors to ground-level ozone) fell by 23
percent and 12 percent, respectively, and SO2 emissions fell by 19
percent.



Over the past decade, the Environmental Protection Agency (EPA) has
finalized and is implementing a suite of regulations on light-and
heavy-duty vehicles and engines and nonroad mobile sources
(such as construction, agricultural, industrial equipment,
locomotives, and marine engines) that are transforming the diesel
engine. The 2004 Clean Air Nonroad Diesel Rule, for example, is
expected to reduce emissions from new nonroad diesel equipment (such
as tractors and bulldozers) by over 90 percent from 2004 levels by
2014 and to reduce sulfur levels in nonroad diesel fuel by 99 percent
from 2004 levels by 2010. The Administration has also strengthened the
National Ambient Air Quality Standards (NAAQS) for three out of the
six common air pollutants: fine particulate matter (PM2.5), ground-
level ozone (the primary component of smog), and lead. Emissions of
these pollutants stem from a wide range of sources and State plans for
complying with the new standards will vary. Unfortunately, several
areas, such as parts of California, remain grossly out of compliance
with current NAAQS, and it will be difficult for some of them to reach
compliance within the next couple of decades.
The President 2002 Clear Skies Initiative called for using
cost-effective, market-based policy instruments to dramatically reduce
power plants; emissions of sulfur dioxide, nitrogen oxide, and
mercury. Although Clear Skies legislation did not pass the Congress,
in 2005 the EPA took a major step toward a more efficient
multipollutant policy in the electricity sector by finalizing two
rules, the Clean Air Interstate Rule (CAIR) and the companion Clean
Air Mercury Rule (CAMR), which echoed many features of the Clear Skies
Initiative.
The Clean Air Interstate Rule (CAIR) received broad support from
economists, environmental groups, states, policymakers, and the
regulated industry for promoting significant environmental
improvements at a lower cost to society than a traditional command and
control type of regulation. CAIR was designed to provide states with a
solution to the problem of pollution that crosses State boundaries.
Covering 28 eastern States and the District of Columbia, the rule
requires the steepest emissions cuts from coal-fired power plants
required in over a decade implemented in two phases by 2015. When
fully implemented, caps on annual NOx and SOemissions 2 would
permanently reduce NOx and SO2 from coal-fired power plants in
the eastern United States by more than 60 percent and 70 percent,
respectively, from 2003 levels. The rule is projected to achieve over
$100 billion in net benefits by 2015 (see Table 3-1). In addition to
the cost savings from using a more market-based approach, CAIR
cap-and-trade program has other beneficial effects. For example, the
cap on NOx would prevent any increases in aggregate NOx emissions in
the East that might otherwise arise from electricity sector
restructuring.
In February 2008, the United States Court of Appeals ruled CAMR to be
unlawful because the EPA had not taken the appropriate steps to
regulate mercury emissions from power plants under a more flexible
portion of the Clean Air Act (CAA) that allows for a cap-and-trade
program. Then in July 2008, the Court ruled that the CAIR rule was
fundamentally flawed, and it vacated the entire rule. The ruling was
based on several issues, including that the cap-and-trade program was
too focused on regionwide emission reductions and did not adequately
factor in each State’s significant contribution to air pollution
issues. For example, the Court deemed that CAIR did not provide
adequate protection for downwind areas. While both rulings have been
appealed through the courts and contested and debated on many fronts,
their invalidation would have substantial consequences because the
underlying requirements of the Clean Air Act remain in place. For
example, all States would have to redo their State Implementation
Plans (SIPs) to demonstrate compliance with CAA requirements and would
not be able to rely on the cost-effective controls built into CAIR.
The thousands of premature deaths avoided annually and other
significant health and environmental gains would come at a higher
price, if at all, in the absence of a fix for these rules that retains
their trading provisions. After receiving petitions from a range of
industry groups, States, and the Administration, in December 2008 a
Federal appeals court reversed the earlier decision on CAIR, allowing
for the

======================================================================
Table 3-1 Projected Net Benefits from Selected 2001-08
EPA Clean Air Regulations

* Lists pollutants whose reductions are monetized in the benefit
calculations. There may be additional cobenefits resulting from
reductions in other pollutants that are not quantified in the
rulemaking analysis.
** The table shows net benefits expected in 2015 for CAIR and CAVR and
2016 for lead NAAQS.
Note: Consistent with OMB and EPA guidelines, net benefits are
calculated using both a 3 percent and 7 percent discount rate for
valuing future impacts (although net benefits using the 7 percent
discount rate are not available from the revised 2006 CAMR analysis).
Note that the assumptions and methods used in each of the Regulatory
Impact Analyses (RIAs) are not necessarily consistent across the rules
listed.
Source: Environmental Protection Agency (Regulatory Impact Analyses).
======================================================================

reinstatement of the rule until EPA crafts a replacement. This
reversal helps to avoid a prolonged period of regulatory uncertainty
that may result in the reduction or elimination of pollution-control
construction projects.

Developing Cleaner Fossil Fuel Technology

In addition to regulating local and regional air pollutants, the
Administration has promoted cleaner ways to use our domestic fossil
fuels through the use of tax incentives. For example, EPACT broadened
the scope of the investment tax credits (ITCs) for renewable energy
production to apply to investments in certain clean coal facilities,
such as Integrated Gasification Combined Cycle (IGCC) power plants,
which rely on a two-stage process in which pollutants are removed
before combustion occurs. Recent research shows that the 20 percent
ITC for new IGCC plants potentially could make this technology cost-
competitive with new conventional coal plants. Because of their
inherently higher operating efficiency, IGCC plants are estimated to
produce up to 8 percent fewer CO2 emissions per megawatt hour (mWh)
than conventional coal plants. Furthermore, capturing and store the
CO2 emissions underground (known as carbon capture and sequestration,
or CCS) would be less expensive in an IGCC plant than in a
conventional power plant. Also, the IGCC process produces very low
levels of common air pollutants (NOx, SO2, and PM) and volatile
mercury, which reduces the cost of compliance with regulations of
these emissions. To date, two 260–290 megawatt (mW) IGCC power
plants are in operation in the United States and others are in the
pipeline. A third, larger facility (with 630 mW capacity) received
approval in January 2008.

Removing Regulatory Impediments to Domestic Production

Finally, the Administration has worked to remove regulatory
impediments to bringing domestic energy sources, including fossil
fuels, to market. In July 2008, the President lifted the Executive
restriction on offshore exploration and requested that the Congress
also lift its ban. On September 30, 2008, the ban on offshore domestic
exploration of natural gas and oil was allowed to expire, a decision
that would allow open access to an estimated 14 billion barrels of oil
and nearly 55 trillion cubic feet of gas off the Atlantic and Pacific
coasts. These previously restricted areas represent a sizable portion
of the estimated 101 billion barrels of oil and 480 trillion cubic
feet of natural gas untapped on the outer continental shelf. While we
strive toward the long-term goal of reducing the economy’s
overall reliance on oil for environmental and security reasons,
expanded domestic oil and gas production in these areas will help
reduce the $300 billion Americans spend each year on net petroleum
imports.

Overarching Challenges

Despite widespread support for increasing the use of market-oriented
approaches to achieve our environmental and energy policy goals going
forward, numerous challenges remain in realizing the full potential of
these types of policies.

Balancing Local, Regional and Global Goals

First, any future comprehensive national energy policy will need to
address potential tradeoffs between environmental and security goals,
as well as tradeoffs between competing environmental goals. As noted
earlier, policies aimed at mitigating local air pollution can at times
reduce GHG and vice versa. For example, the clean diesel programs may
provide climate change benefits by reducing black carbon (soot), the
climate change effects of which require further study but many argue
could be quite substantial. (The clean diesel rules will also likely
become more significant if there is an increase in the number of
diesel vehicles due to policies aimed at improving fuel economy and
reducing GHG emissions from mobile sources.) However, some air quality
policies may result in “technology lock-in” that could
cause major delays in the implementation of GHG control technologies
because of the investment in capital and other resources to meet the
air quality control requirements. Policies aimed at GHG mitigation may
also at times increase emissions of traditional pollutants. For
example, technology standards that require increasing the thermal
efficiency of engines may lead designers to achieve the regulatory
objective by raising combustion temperatures, a strategy that would
tend to increase NOx emissions unless countered by other control
methods. The challenge going forward will be to design comprehensive
policies that enhance synergies and reduce the degree to which
policies may work at odds with one another.
There are additional conflicts that will continue to arise in
achieving long term environmental goals. For example, in the
transition to alternative energy sources, where will new facilities
and transmission infrastructure for different types of electricity
generation be built? This issue is especially contentious when talking
about new nuclear facilities, large scale CCS facilities, and
renewable sources such as off-shore wind turbines. Renewable energy
facilities generally face greater siting hurdles than their
conventional counterparts because they can only be located at certain
sites. The most highly valued renewable resources are often in
pristine, isolated parts of the country (like mountain ridges, open
plains, and coastal waters) with significant environmental and
aesthetic value. Siting hurdles are compounded by the additional
transmission and distribution infrastructure that is needed to bring
the electricity from remote generation sites to population centers.
States will have to balance renewable energy goals with other
environmental concerns in deciding whether to support investment in
new transmission infrastructure, such as new regional transmission
corridors. Similarly, there are significant challenges that must be
faced in expanding or reconfiguring existing fuel distribution systems
to accommodate the large volumes of ethanol and other biofuels
required by EISA.
Obstacles to increased nuclear power generation extend beyond the
hurdles of siting power plants. There is also a concern about the lack
of long-term storage for the spent fuel generated by nuclear plants.
To reduce the amount of spent fuel that must be properly contained for
centuries, efforts may also be made to increase recycling of this fuel
within the generation process, but without producing weapons-grade
material. The Administration has laid the groundwork for tackling this
issue through efforts such as the Global Nuclear Energy Partnership
(GNEP) and the Nuclear Power 2010 joint government– industry
effort to develop advanced nuclear plant technology and reduce
technical, regulatory, and institutional barriers to nuclear
deployment.

Efficient R&D Support for Alternative Energy Sources

Technology policies will continue to be an important component of any
energy policy portfolio going forward. Many economists maintain that,
as a complement to any pricing policy directed at environmental
problems, governments will need to support R&D for alternative energy
sources. The challenge will be to ensure that any R&D support is
managed efficiently and effectively.
As discussed above, an emission pricing policy is a key step in
inducing technological change at low cost because the emissions price
provides the private sector with a direct incentive to invest in and
deploy new environ-ment-friendly innovations. Well-targeted technology
policy can reinforce these incentives for private R&D and thus reduce
future costs. Basic and applied energy-related research as well as the
education of the next generation of researchers will continue to be in
particular need of government support, because these areas are the
least likely to be undertaken by the private sector. It will also be
crucial to expand the use of more flexible research policy instruments
that allow the market, rather than government, to pick technology
winners. For example, the Government could award prizes for basic
research advancements in energy storage, which would help to spur
innovation in a wide range of low-carbon technologies. Efforts are
already underway to expand the use of prizes in some areas. EISA
provided authorization for an L-prize for high-efficiency solid-state
lighting products and an H-prize for advancements in hydrogen
technology.
Current policies that target the adoption or deployment phase of the
technological development process also need reviewing. Many of the
existing tax credits have been found to be costly ways of making
renewable sources competitive with fossil fuel sources. However, if
technology deployment incentives are needed, they should be applied in
a way that is neutral across all alternatives. Existing subsidies such
as the ethanol blender’s tax credit, flex-fuel vehicle credits,
and subsidies for alternative electricity generation, in combination
with the growing use of existing residential deductions and credits
for energy-efficient home improvements, have created a patchwork of
incentives that send an inconsistent message about how much the
abatement of a ton of carbon is worth. In addition, there are
opportunity costs associated with resources devoted to any area of
research or deployment support. For example, in the context of
renewable fuels, additional support for first-generation biofuels such
as corn ethanol reduces the amount of funding available for the
development of other alternatives and could make it more difficult for
second-generation biofuels (with potentially significantly lower GHG
emissions) to become viable.
Going forward, it will be important to reform these subsidies so as to
minimize market distortions. One way existing tax incentives could be
simplified is to offer a single subsidy in which the payment is
weighted by the extent to which petroleum consumption and/or carbon is
reduced relative to a baseline technology. In April 2008, the
President voiced strong support for such a reform of the current
complicated mix of incentives to make the commercialization and use of
new, lower emission technologies more competitive. Another policy
instrument that could encourage commercial use of new energy-efficient
technology at a lower cost to the taxpayer is the reverse auction, in
which would-be subsidy recipients (such as a renewable energy project
developer) submit proposals for new projects and bid the minimum price
they would accept for zero- or low-carbon electricity generation.
However, such technology adoption policies may still favor what are
currently the least expensive technologies, rather than technologies
that may have greater potential to reduce cost and improve
environmental performance through learning by doing.

Economically Efficient Regulation Under Existing Statutes

Another significant challenge in realizing the full potential of
market-oriented policy approaches is likely to be the ability of
existing laws to address old and new environmental problems in more
efficient ways.

Local and Regional Air Pollutants

Although there have been great gains in reducing common air
pollutants under the Clean Air Act, air pollution will continue to
be a problem in the future, and the importance of finding
economically efficient ways to further improve air quality will only
increase. As seen in the 2008 National Ambient Air Quality Standard
(NAAQS) for ozone, stricter standards have moved the private sector
up the marginal cost-of-control curve. That is, it is becoming more
costly to reduce each additional ton of NOx and VOC emissions
(the precursors to ground-level ozone). Upcoming reviews of the
NAAQS for other pollutants will undoubtedly reveal a similar trend.
These trends do not shed light on the relative cost of controlling
one pollutant over others, due to the sequential nature of the
individual NAAQS reviews. However, it is likely to spark debate
about the benefits of moving either toward a more integrated
multipollutant approach to controlling emissions of pollutants
that pose the most significant risks or toward a more goal-
oriented standard setting, as there may be no level that adequately
protects human health and the environment for some pollutants (for
example, lead), and currently costs cannot be considered in setting a
NAAQS.
A multipollutant approach can help reduce the costs of meeting
standards in regulated industries, such as the electricity sector,
in which power plants face an increasingly complex set of requirements
under the current Clean Air Act (CAA) (see Chart 3-4). The
Presidents Clear Skies Initiative was an important first step
in establishing a multipollutant approach. It is important that the
market-oriented aspects of the CAIR and CAMR rules not be lost upon
being remanded to the EPA for revision. The Administration has also
made efforts to reform the complex requirements for upgrading or
building new power plants under the New Source Review provisions of
the Clean Air Act. Such age differentiated regulations can create a
disincentive to invest in energy efficiency improvements, thus slowing
turnover in the capital stock (equipment and facilities) and pollution
abatement. The debate over how best to reduce such counterproductive
incentives will undoubtedly continue in the future.

[GRAPHIC(S) NOTot AVAILABLE IN TIFF FORMAT]

Greenhouse Gas Emissions

Existing statutes are not well suited to tackling problems that were
not considered when the original laws were written. In the context of
climate change, the unique characteristics of GHGs and the ubiquity of
GHG emission sources present significant challenges for economically
efficient regulatory design under the existing Clean Air Act or other
statutes. Unlike most traditional air pollutants, GHG emissions become
well mixed throughout the global atmosphere, so a unit of GHG
emissions has the same effect on environmental quality regardless of
where it comes from, and, once emitted, GHGs can remain in the
atmosphere for decades to centuries. Therefore, while policies can
control the flow of GHG emissions, the ultimate concern is the
stock—the cumulative concentration of GHGs in the atmosphere.
These characteristics suggest that GHGs are particularly well suited
to market-oriented policies that do not dictate the exact location and
timing of emission reductions as opposed to the command and control
type of regulation under the CAA that is used for some other
pollutants.
There are examples of CAA regulations in which market-oriented
approaches have been used for groups of mobile or stationary sources,
such as in the Acid Rain Control Program, and even some cases in which
multi-sector trading programs have been established. However,
economists have demonstrated that taking a more integrated approach to
control GHGs, such as through a common cap or price on emissions
across sectors, would allow the market to identify a combination of
methods to reduce the cost of achieving a given emission reduction.
For example, expanding the coverage of such a market-oriented policy
to include the industrial, electricity, and transportation sectors has
been found to substantially decrease the cost of achieving a given
emission reduction compared to one that is limited to the electricity
and transportation sectors. However, if a policymakers goal is
to transform technology in a single area to the point where developing
countries would voluntarily adopt the new low-carbon technology, then
the advantage of a sector-specific approach is that it may help to
ensure that technology investment remains within that sector.
It is unclear whether it would be legally possible to implement an
economy-wide system for GHGs under the CAA. However, any economy-wide
program under one provision of the CAA would likely trigger additional
source-specific or sector-based requirements as a result of other CAA
provisions, thus resulting in multiple programs affecting a particular
sector, source category, or GHG. With multiple market-oriented
policies focused on the same problem, the overall emissions reductions
may not be achieved in the least costly way because there would not be
a common price of pollution across all activities that directly result
in GHG emissions. Without such a common price, full trading
opportunities to reduce control costs will not be realized. In
addition, emissions leakage across sectors and countries can occur
when the cost of reducing one ton of emissions differs across them.
When faced with a high cost of complying with new environmental
regulations, a firm may move its operations to a jurisdiction with
less stringent (and less costly) emissions controls. Current
requirements under the CAA do not consider the actions (or inaction)
of other countries or allow for consideration of unequal treatment of
emissions across different types of emitters.
The Clean Air Act is also not designed to implement any carbon-pricing
policy so that it operates in an efficient and transparent manner. For
example, economists suggest that it would be economically efficient to
employ a broad-based emissions tax, using the proceeds to decrease
distortionary taxes. A well designed cap-and-trade system can have
much in common with a well designed tax, but policy considerations
should weigh heavily on how emissions allowances would be distributed
under such a program. The economic literature broadly finds that there
are significant efficiency advantages to auctioning emissions
allowances, particularly if the revenues are used for reducing
existing distortionary taxes. Also, cost-containment provisions in a
cap-and-trade program, such as a safety valve allowance price, help to
prevent caps from resulting in allowance prices that are higher than
the social cost of the emissions. However, the CAA does not authorize
the EPA to impose taxes or to administer a broad cap-and-trade program
with auctioning and cost-containment provisions, making the Act ill
suited to address the unique challenges posed by GHG emissions.
The globalized nature of GHG emissions is also likely to create
difficulties in other statutes, such as the Endangered Species Act
(ESA) and the National Environmental Policy Act (NEPA), which were
designed to address local or regional concerns. For example, the ESA
requires consultation between Federal agencies when a Federal action
is likely to cause effects that pose a threat to a listed species.
However, because the effects of GHG emissions have global
repercussions, any causal connection between the effects of any
particular action and the loss of a listed animal or its habitat is
not discernible, or at least not significant or proximate enough to
warrant such consultation. Similarly, the types of environmental
impacts included in NEPA analyses are local or regional in nature and
do not fit into the complexities related to global climate change
effects.
Given the difficulties in applying existing statutes to the unique
problems presented by GHGs, policymakers should seek new approaches
for enacting comprehensive and market-oriented solutions. The
scientific debate over the specific GHG concentrations needed to
affect global temperatures and the probability of catastrophic damages
will continue for some time, and the policy debate over tough
questions such as to how to value future emissions reductions is far
from settled. In the face of such uncertainty and discussion of
numerous other policy design issues, flexibility and transparency will
be vital to the success of any policy designed to address global
climate change.

Global Action on Climate Change

Finally, perhaps the most significant challenge in tackling climate
change is developing broad-based global action to make meaningful
progress in reducing GHG emissions.
As shown in Chart 3-5, U.S. greenhouse gas intensity (as measured by
GHG emissions per unit of GDP) has been improving over time. In 2002,
the President set a goal of reducing U.S. GHG intensity by 18 percent
by 2012, and the Nation is on track to meet and exceed this target.
Between 2002 and 2007, both energy-related CO2 emissions per unit of
GDP and total GHG emissions per unit of GDP declined by about 10
percent. In the spring of 2008, the President also set a new goal to
stop U.S. growth in total GHG emissions by 2025. Despite U.S. action
toward meeting these or future domestic GHG reduction targets, it is
important to understand that U.S. action alone will not reverse global
emission growth or stabilize global atmospheric GHG concentrations.
Many assert that it is the responsibility of developed countries to
reduce GHG emissions, since they have a longer historical record of
emissions and therefore are responsible for most of the existing
atmospheric concentrations. This formulation does not account for the
reduction in the




natural absorption of CO2 (for example, in forests)
due to land-use change that has occurred throughout the world. More
important, actions by developed countries alone will not stabilize
atmospheric concentrations given the recent and projected emissions
growth in large rapidly developing economies.
Chart 3-6 provides one example of why it is important for all
countries, particularly major economies involved in negotiations, to
limit GHG emissions. The chart shows the future path of global CO2
concentrations if the United States takes action to reduce GHG
emissions under various cap-and-trade bills recently debated in
Congress. One of the main reasons why future global concentrations do
not decrease substantially compared to the reference case (which is a
business-as-usual case that includes current international efforts to
address climate change) is that major emerging economies represent a
large and growing share of global GHG emissions. In addition,
international emissions leakage may reduce global mitigation if only a
handful of countries take action. Just as sector-based regulation of
GHG emissions under the CAA raises worry about potential leakage of
emissions across source categories, there are concerns about potential
shifts in GHG emissions to countries where GHGs face no regulations.
Energy-intensive industries in which domestic firms would face
significantly higher costs due to regulation may move operations to
unregulated foreign markets where costs are lower. International
sectoral agreements in energy-intensive industries can help alleviate
some of these competitiveness concerns.



It is clear from the projections above, as well as other recent
analyses of climate mitigation scenarios, that climate change
requires a global solution, with participation by all major
economies. The Administration has recently taken several steps to
encourage wider international action to address GHGs, including
promoting consensus toward commitments in developing countries. In
2007, the Administration launched the Major Economies Meeting (MEM)
process, involving those of the world’s major economies that
use the most energy and emit the most GHGs, to help promote
international action to slow, stop, and eventually reverse the
growth of GHGs. This process is intended to support the United
Nations Framework Convention on Climate Change (UNFCCC)
negotiations by elaborating on areas of shared understanding among
the major GHG emitters. At the July 2008 MEM meeting in Japan,
leaders issued a Leaders Declaration that emphasizes ambitious,
realistic, and achievable” steps toward achieving these
goals and agreement to take near-term actions. Leaders agreed to
continue to work together to promote the success of the negotiations
under the UNFCCC.
In addition to achieving commitments by all major economies,
accelerating the deployment of clean energy technology in emerging
economies is critical to mitigating climate change. To this end, the
United States has taken several steps to form international
partnerships to support national climate change efforts. In 2007, the
Administration led efforts to produce an international agreement to
accelerate the phase-out of the hydrochlorofluorocarbon (HCFC)
refrigerants—a potent GHG—under the Montreal Protocol on
Substances that Deplete the Ozone Layer. Under this agreement, both
developed and developing countries explicitly agreed to accept binding
and enforceable commitments that have climate change benefits. In
2008, the President launched the Clean Technology Fund to help bridge
the gap between current technology and cleaner, more efficient ways of
fueling the world’s growth. The President has asked Congress for
an initial U.S. commitment of $2 billion, and many other nations have
pledge support. Altogether, the United States, the United kingdom,
Japan, France, Germany, Sweden, Australia, and Spain have pledged over
$5 billion to the Fund, which will be housed at and overseen by the
World Bank.
To be eligible for funding, a project must be consistent with the
recipient country’s national low-carbon growth strategy and must
help move the relevant industry or sector toward a clean-energy path.
Competition is intended to be technology-neutral, with projects
competing for financing based on lifetime GHG reductions compared to
the baseline technology and relative to the Fund’s investment.
The recipient country would contribute public and/ or private capital
to meet the project’s baseline costs. The Clean Technology Fund
would help finance the cost difference between the clean energy
technology and the standard baseline, higher-emissions technology.
In partnership with the European Union, the United States also
proposed the Environmental Goods and Services Agreement in the World
Trade Organization (WTO) to eliminate tariff and non-tariff barriers
to environmental technologies and services. This proposal included an
agreement in the WTO to eliminate tariffs worldwide on 43 climate-
friendly technologies identified by the World Bank. It also included a
higher level of commitment from developed and most advanced developing
countries to eliminate trade barriers across a broader range of goods
and services. Global trade in the environmental goods covered by the
proposal totaled approximately $613 billion in 2006, and global
exports of these goods have grown annually by an average of 15 percent
since 2000. The World Bank suggests that by removing trade barriers on
key technologies, trade could increase by an additional 7 to 14
percent annually.
Other international partnerships to pursue development and diffusion
of clean energy include the 21-member Global Nuclear Energy
Partnership (GNEP) and the 7-country Asia-Pacific Partnership on Clean
Development and Climate (APP). These are primarily sectoral efforts to
support national climate change efforts. The GNEP, announced by the
President in 2006, focuses on promoting technology breakthroughs to
support the long-term expansion of clean, safe, proliferation-
resistant nuclear power here and abroad. As mentioned earlier, safer
ways to deal with storage of nuclear waste are crucial to this effort.
The APP has a somewhat broader mission. It aims to promote
coordination among different sectors to create new investment
opportunities, build local capacity, and remove barriers to the
introduction of a wide range of cleaner, more efficient technologies.

Conclusion

Energy policy will continue to be one of the major challenges facing
the United States for many years to come. As the Federal Government
moves toward a more integrated approach in confronting energy
security, climate change, and other environmental challenges, we will
need to ensure that we consider the economic efficiency of future laws
and regulations. In addition to advancing clean and renewable energy
technologies, a key challenge going forward will be leading all
countries to work cooperatively to achieve global climate goals with
meaningful participation by all major economies.