United States Senate Committee on Energy and Natural Resources

Good morning Chairman Domenici and Members of the Committee and thank you for holding this hearing to advance our understanding of both the risks of climate change and the impacts of different emission reduction approaches. I speak to you today on behalf of the National Commission on Energy Policy, a diverse and bi-partisan group of energy experts that first came together in 2002 and last December issued a comprehensive set of consensus recommendations for future U.S. energy policy.

I would like to begin by commending Chairman Domenici and Senator Bingaman and many others on this Committee for their leadership in winning Senate adoption of a landmark resolution recognizing the importance of the climate problem and, for the first time, putting this body on record in support of the need for mandatory efforts to reduce greenhouse gas emissions. I believe that in years to come, passage of this resolution will come to be seen as a pivotal moment in the evolution of our collective response to the risks posed by climate change.

The resolution marks a turning point, but it also represents a logical next step for the Senate on this issue. When the Senate last expressed its views on climate change — in the Byrd-Hagel resolution of 1998 — it set out two basic criteria for future U.S. climate policy that continue to serve as critical guideposts for our discussions today. The first criterion is that any efforts to combat climate change must not compromise the vitality or competitiveness of the U.S. economy. The second criterion is that all nations, and particularly developing nations with rapidly growing emissions, must also act to address this problem. As we heard in the previous panel, the scientific consensus about climate change has steadily strengthened over the last decade. A majority of Senators have now agreed that it is time to act — the challenge before us is devising ways to do so that satisfy the criteria articulated in both the Byrd-Hagel and the more recent Bingaman-Domenici resolutions.

Our group, the National Commission on Energy Policy, has developed an approach that we believe can meet the twin tests of economic responsibility and international equity.

But before outlining key elements of that approach, let me say a few additional words about the Commission itself. The Commission was formed in 2002 by the Hewlett Foundation and several other private, philanthropic foundations. Its ideologically and professionally diverse 16-member board included recognized energy experts from business, government, academia, and the non-profit sector. Our final recommendations, which are described in a report that was released on December 8, 2004, were informed by intense discussions over several years, by dozens of analyses contained in a 2,800 page Technical Appendix, and by extensive outreach to over 200 other groups. Those recommendations, I should stress, deal with a comprehensive set of energy policy issues including (in addition to climate change) our nation’s dependence on oil and the need for increased investment in new energy technologies and critical energy infrastructure.

As a group, however, we recognized from the outset that climate change presented one of the central energy challenges of our time and so we devoted considerable energy to developing a detailed set of recommendations for addressing this issue. I would like to begin my remarks by summarizing the Commission’s view that volunteerism and tax-payer supported incentives alone do not provide an effective or economically efficient response to this challenge. After explaining our support for mandatory market-based limits to slow, stop and ultimately reverse the growth of greenhouse gas emissions, I will focus on the attributes of a mandatory program that are needed to protect our economy.

The Imperative of Mandatory Action — Our Commission strongly supports the need for continued government efforts to accelerate the development and early deployment of low and non-carbon energy sources. We applaud the Administration’s efforts in this regard. However, in a competitive market-economy, where companies are encouraged and in some cases obligated to maximize shareholder value, it is contrary to the rules of free-market competition to expect companies to invest scarce resources absent a profit motive. While there are numerous cases where a combination of good will, good public relations, and positive ulterior motives (like reduced energy bills), create an adequate basis to reduce greenhouse gas emissions, these cases will remain limited if the financial value of reducing a ton of GHG emissions remains zero.

It is somewhat ironic that the English, French, and Germans are actively implementing market-based regulatory approaches developed here in the Unites States while we pursue a top-down program of government-directed, tax-payer funded research and deployment incentives. Developing and commercializing new technologies will cost money. The question is who is best positioned to secure and effectively spend these resources. While there is certainly a role for public funding and government incentives, the Commission believes that there must also be a role for those who emit greenhouse gases to share in the costs of developing solutions. As we have learned over the last twenty years, given a rational reason to invest, the private sector is far better than the government in developing technological solutions. The success of the acid rain program demonstrates that the most effective way to engage the ingenuity of the private sector is to place a monetary value on a ton of reduced emissions thus creating a real economic incentive to develop cleaner forms of energy. By imposing a modest market signal to pull private sector technology investment forward in combination with continued tax-payer supported investment to push longer-term solutions, the Commission believes we can significantly reduce GHG emissions without hampering economic growth or prosperity. Moreover, by auctioning a small fraction of the emission permits, government can raise the revenue needed to support technology innovation without burdening the general tax base.

Overview of Commission Proposal — Specifically, the Commission recommends that the United States adopt a mandatory, economy-wide, tradable-permits system for reducing greenhouse gas emissions, with a safety valve designed to limit costs. This approach is similar to the successful acid rain program in the United States, but differs in one very critical respect. Rather than proposing a hard cap on emissions, we have proposed an absolute cap program costs.

The aim of the Commission’s proposal is to slow growth in U.S. emissions over the 2010-2020 timeframe as a prelude to stopping and eventually reversing current emissions trends in the 2020s and beyond. We also explicitly designed our approach to recognize the importance of participation by major trading partners like China and India. Our program includes a regular 5-year review of progress which is intended to assess both the performance of the U.S. program and progress by other countries. If major U.S. trading partners and competitors (including China, India, Mexico, and Brazil) fail to implement comparable emission control programs, further U.S. efforts — including the gradual increase in stringency built into our program — could be suspended or adjusted. Conversely, the U.S. program could be strengthened if international progress, technology advances, or scientific developments warrant.

International participation and other issues will be the subject of future hearings, so I want to return now to the main focus of this panel: economic impacts.

Two key policy choices: 1) a modest reduction target; 2) the cost–cap or “safety-valve” enable the Commission to propose a mandatory, economy-wide GHG reduction program that according to EIA does not “materially affect,” the U.S. economy. I will describe each of these design features in turn.

Modest Reduction Target — The Commission believes that if we begin now, there is time to gradually phase-in GHG reductions across the economy. Like the Administration, we believe that reducing the GHG intensity of the economy is an effective means of slowing, stopping and ultimately reducing U.S. GHG emissions. Over the first decade of the program, we propose to set an economy-wide emission limit based upon a 2.4% decrease in GHG emission intensity. If achieved, this target would slow annual emissions growth by roughly 2/3 from business as usual allowing actual emissions to increase by 0.5% per year instead of by the currently projected 1.5% annual increase in total emissions. Absent Congressional intervention to adjust the target, the intensity decline would increase to 2.8% after a decade effectively stopping emissions growth. Many have argued that this reduction pathway is too slow and criticize the Commission plan for explicitly allowing emissions to increase for a decade after implementation. We acknowledge this critique, but believe that a modest and low-cost reduction pathway is critical to achieving the near-term consensus needed for timely action. The Commission believes that it is critical for the United States to move forward now to implement a robust regulatory architecture that can adjust over time as our understanding of climate impacts and the costs of solutions matures.

Cost-Certainty (the “Safety-Valve”) — Under a traditional cap and trade program the reduction target is fixed in statute or regulation while the costs are “best guesses” of what will be necessary to achieve the fixed targets. While our experience in the acid rain program suggests that projected costs are more likely to be exaggerated than understated, there remains a real possibility that costs for meeting any target will be higher than expected or desired. Under the safety-valve, regulated entities are allowed to buy additional permits from the government at a pre-determined price. This feature of the Commission’s proposal ensures that program compliance costs will not exceed estimates. If technology fails to progress at the projected rate, the program will reduce less emissions than desired but compliance costs will not increase.

EIA’s analysis and the work of Charles River and others reveal that expectations of technological progress are by far the most significant assumptions affecting the costs of achieving a particular emissions target. Under EIA’s base-case average technology assumptions achieving the Commissions modest 2.4% annual intensity reduction will begin to cost more than the safety-valve price beginning in 2015 causing firms to avail themselves of safety-valve permits. However, when EIA projects costs using more optimistic assumptions about technology progress that seek to capture the Commission’s “recycling” of auction revenue back into technology incentives, the target is met throughout the first decade with the safety-valve never being triggered at all. Under the more optimistic technology assumptions, a $7/ton incentive results in nearly double the reductions, but the overall cost of the program is the same.

The Commission’s decision to place a priority on cost-certainty over emissions certainty reflects our appreciation of strongly held and fundamentally irresolvable disagreements about technological progress and the ultimate costs of emission reductions. Rather than spending several more years paralyzed by differing climate change modeling assumptions, the safety-valve allows us to begin, albeit cautiously, to reduce U.S. greenhouse gas emissions while protecting our economy, affording time for key industries to adjust and maintaining America’s global competitiveness.

The safety valve also gives businesses the planning certainty they need to make wise long-run investments that will minimize the costs of achieving greenhouse gas emissions reductions over time. We chose an initial safety valve level of $7 per metric ton of carbon dioxide equivalent because analyses suggest that it roughly reflects the mid-point in the scientific literature of the expected harm that can presently be attributed to a ton of GHG emissions given current scientific understanding. Equally if not more important, the $7 figure is low enough to ensure that valuable, long-lived energy assets won’t be prematurely retired, yet also high enough to send a meaningful market signal for future investment in clean, low-carbon energy alternatives. In our proposal, the safety valve price increases gradually over time, at a nominal rate of 5 percent per year, to generate a steadily stronger market signal for reducing emissions.

Overall Economic Impacts — To assure ourselves that we had successfully addressed potential economic concerns, we subjected our proposal to detailed economic analysis. The analysis indicated that the impacts of the program on businesses and households would be modest. Our own modeling results were subsequently supported by an independent analysis of our proposal by the Department of Energy’s Energy Information Administration (EIA).

EIA’s analysis indicates that the impacts of the program on businesses and households are likely to be modest. Projected annual GDP growth would decline by less than .02% against a baseline average growth or 3.1%. This impact equate to an average annual cost of $78 per household between program inception and 2025. Assessed cumulatively between 2005 and 2025, overall, predicted GDP growth would change from 80.8 percent to 80.6 percent, or a difference of 0.2 percent. In the EIA’s own words: “the overall growth rate of the economy between 2003 and 2025, in terms of both real GDP and potential GDP, is not materially altered.” Put another way, the nation would be as wealthy on January 15, 2025 with the program in place, as it would have been on January 1, 2025 under business as usual. At the relatively minor cost of slowing economic growth by two weeks twenty years hence, we can make a significant start to address global climate change.

Because the models predict that a large share of reductions in the early years of the program would come from industrial greenhouse gases such as HFCs, PFCs, and SF6, total energy consumption would be expected to decline by only 1 percent below forecast levels for 2020, while still growing 14 percent in absolute terms over the first decade of program implementation (i.e., 2010–2020). Also noteworthy, natural gas demand is barely affected by the Commission’s climate proposal increasing by less than 1% over business as usual. When additional proposals to increase energy efficiency and support coal gasification are modeled, total natural gas demand actually declines against business as usual projections. Finally, while coal use grows more slowly than under BAU, significant growth in coal is projected by both the Commission and EIA’s analysis even when excluding new markets that will be created by IGCC.

Of course, a very small fraction of a very large economy can still look like a lot of money if taken out of context. You will undoubtedly hear from critics that our proposal will cost $313 billion in lost GDP between 2005 and 2025. What the critics are less likely to mention is that this is just a tiny fraction of the $323 trillion of cumulative growth in GDP the economy is expected to generate over the same time period. Similarly, those who oppose any action on climate change are likely to point to EIA’s estimate of 140,000 lost jobs by 2020 as a result of the tradable permits program. Again, this number needs to be viewed in context. EIA’s estimate of job losses comes to just 0.4 percent of the 36 million new jobs that the economy is expected to create between 2005 and 2025.

At Chairman Inhofe’s request, EIA also recently examined the impacts of the program assuming higher natural gas prices and higher costs for reducing emissions of non-CO2 greenhouse gas emissions. EIA found that the costs of the Commission’s proposal would actually be less if natural gas prices turned out to be higher than projected. Higher natural gas prices under business-as-usual assumptions would tend to lower total demand for energy, thus making it somewhat easier to meet the Commission’s proposed emission target. While more pessimistic assumptions regarding the costs of controlling non-CO2 greenhouse gas emissions would result in lower total reductions of greenhouse gas emissions, they would not materially affect program costs. This recent analysis makes clear the value of the safety-valve both as a substantive protection in case 2005 economic assumptions are not borne out over time and as a political device to set aside some of the more contentious and unknowable “what if” arguments that have undermined our ability to forge a consensus for mandatory actions to reduce GHG emissions.

The trade-off for low cost is a program that also achieves relatively modest emission reduction benefits, at least in its early stages. We believe that a flexible, gradual, market-based approach that provides cost certainty is appropriate at a time when uncertainties remain about the pace of actual warming and about the speed with which we can develop and commercialize lower-carbon alternatives. While this program will necessarily need to evolve as other nations join in the reduction effort and as our understanding of the climate induced impacts continues to improve. We believe that it is the right approach to get us started.

In fact, the importance of getting started is exactly what I hope you will not lose sight of as the inevitable debate about numbers and dollars and tons and jobs unfolds in the months to come. A war of numbers too easily leads to paralysis. And right now it matters less which numbers you choose than that you recognize the essential principle at the core of our proposal: Strictly voluntary, seemingly costless approaches will not enable the marketplace to attach a known value to carbon reductions. Only when reductions have real value — however small — can companies justify long-term investments in new, low-carbon energy alternatives and only then will we unleash the ingenuity and innovation of the private sector in addressing the climate change problem and in developing the clean technologies that will be in global demand for decades to come.

Finally, the Commission firmly recognizes that climate change is a global problem requiring an effective and equitable global solution. The United States can not meaningfully mitigate the risks of climate change absent commensurate efforts by the rest of the world. Similarly, the rest of the world can not solve the climate problem absent leadership from the United States. The Commission believes that undertaking mandatory domestic reduction efforts here at home is a condition precedent to achieving a truly global solution. This recognition that actions in the developing world will inevitably follow those of the United States provides further impetus to take action now so that we can work more effectively to encourage similar actions overseas.

Thank you for this opportunity to testify. I speak on behalf of the entire Commission in offering whatever further support and information we can provide to assist your deliberations in the months to come.

Summary of Key Features of the National Commission on Energy Policy’s Proposal for Reducing Greenhouse Gas Emissions

Mandatory, economy-wide, tradable-permits system would go into effect in 2010. This would allow U.S. companies adequate lead time to plan and make needed adjustments or investments. The program would cover carbon dioxide (CO2) and other major greenhouse gases (including methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride).

Environmental target based on annual reductions in emissions intensity, where intensity is measured in tons of CO2-equivalent emissions per dollar of GDP. Between 2010 and 2019 the Commission recommends a target emissions intensity decline of 2.4 percent per year. Based on current GDP forecasts, achieving this target would reduce projected emissions growth from a business-as-usual rate of 1.5 percent per year to 0.5 percent per year. Starting in 2020 and subject to the Congressional review described below, the Commission proposes raising the target intensity decline to 2.8 percent per year (the “stop phase” in the figure).

Cost cap is achieved by making additional permits (beyond the quantity of permits established through the target intensity decline described above) available for purchase from the government at a pre-determined price. The Commission proposes an initial cost cap or “safety valve” permit price of $7 per metric ton of CO2-equivalent. This price would increase by 5 percent per year in nominal terms.

Permit allocation for a given year would be calculated well in advance based on available GDP forecasts. For the first three years of program implementation, the Commission recommends that 95 percent of initial permits be issued at no cost to emitting sources. The remaining 5 percent would be auctioned. Starting in 2013 and every year thereafter, an additional 0.5 percent of the target allocation would be auctioned, up to a limit of 10 percent of the total permit pool.

Congressional review in 2015 and every five years thereafter to assess the U.S. program and evaluate progress by other countries. If major U.S. trading partners and competitors (including China, India, Mexico, and Brazil) fail to implement comparable emission control programs further U.S. efforts (including continued escalation of the safety valve price and permit auction, as well as more aggressive intensity reduction target in 2020) could be suspended. Conversely, the U.S. program could be strengthened if international progress, technology advances, or scientific developments warrant.