Global Climate Change: Lowering Cost Estimates through Emissions Trading -- Some Dynamics and Pitfalls

Global Climate Change: Lowering Cost Estimates through Emissions Trading -- Some Dynamics and Pitfalls

Order Code RL30285
CRS Report for Congress
Received through the CRS Web
Global Climate Change:
Lowering Cost Estimates through Emissions
Trading — Some Dynamics and Pitfalls
August 20, 1999
(name redacted)
Specialist in Energy and Environmental Policy
Resources, Science, and Industry
Congressional Research Service ˜ The Library of Congress

ABSTRACT
With the negotiation of the Kyoto Protocol, international emissions trading has become the
centerpiece of efforts to minimize costs of reducing greenhouse gas emissions. A review of
existing cost analyses of U.S. compliance with the Kyoto Protocol indicates consensus that
the potential for international emission trading to reduce compliance cost is substantial and
indisputable. However, this report also indicates that potential for turning that potential into
fact is problematic and that other alternatives may deserve a hearing. Further information on
global climate change is available from the CRS Electronic Briefing Book at
http://www.congress.gov/brbk/html/ebgcc1.html. This report will be updated as circumstances
warrant.

Global Climate Change: Lowering Cost Estimates through
Emissions Trading — Some Dynamics and Pitfalls
Summary
A major element in the debate about global climate change has been how to
minimize costs by selecting the most economically efficient strategies to reduce
greenhouse gases. With the negotiation of the Kyoto Protocol, international
emissions trading has become a focal point of attention. Indeed, the Administration
believes that the goals of the Kyoto Protocol can not be achieved without effective
emissions trading. International emissions trading is one of four “flexibility
mechanisms” contained in the Kyoto Protocol (article 17).
A review of existing cost analyses of U.S. compliance with the Kyoto Protocol
indicates consensus that the potential for international emission trading to reduce U.S.
compliance cost under the Kyoto Protocol is substantial and indisputable. However,
whether the potential for international emissions trading can be turned into fact is
more problematic. This analysis suggests that implementing international emissions
trading under Kyoto would represent uncharted territory for U.S. environmental
policy.
First, an international emissions trading scheme has to function very efficiently
to achieve the savings projected by analyses. For example, the Administration’s
analysis relies on an unprecedented amount of international trading to achieve the
substantial cost reduction it projects. Under its most aggressive scenario, 82%-88%
of the U.S. reduction requirement would be bought from foreign sources. The
magnitude of transactions not only raises questions of its feasibility, but also may
conflict with the intent of the Kyoto Protocol, which states that international
emissions trading is to be “supplemental” to domestic actions.
Second, besides the amount of trading estimated, the sources of these reductions
raise additional questions. For example, according to an analysis by Charles River
Associates, half the estimated savings from international emissions trading would
come either from so-called “hot air” credits that countries of the former Soviet Union
have available because of their economic difficulties, or from transactions with Third
World countries that are not required to participate in the program.
Third, while the U.S. acid rain emissions trading program is cited as a model for
international carbon trading, in fact, unlike an international carbon trading program,
the acid rain program does not have to operate particularly efficiently to achieve
substantial cost savings. The simplest trades — those between a company’s own
plants — achieve the greatest cost savings under the acid rain program. Thus, the
U.S. acid rain emissions trading program provides little guidance to any future
international carbon trading program.
The complexity presented by international emissions trading suggests that
alternatives may deserve a hearing.

Contents
Overview: Importance of Emission Trading to Kyoto Compliance . . . . . . . 1
Review of Analyses: the Dynamics of Trading . . . . . . . . . . . . . . . . . . . . . . 5
Implementation Pitfalls: Comparison with Acid Rain . . . . . . . . . . . . . . . . . 9
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
List of Tables
Table 1: Climate Change Perspectives and Policy Parameters . . . . . . . . . . . . . . 3

Global Climate Change: Lowering Cost
Estimates through Emissions Trading — Some
Dynamics and Pitfalls
Overview: Importance of Emission Trading to Kyoto Compliance
United States concerns about implementing the Kyoto Protocol focus on three
interlinked issues: (1) the considerable uncertainty and risk of substantial cost from
carbon dioxide (CO ) abatement; (2) the competitive impacts of compliance, both
2
domestically and internationally; and (3) the comprehensiveness of the Protocol’s
scope, in particular, the exclusion of third world countries from any CO reduction
2
program.1 These implementation concerns, along with perceived scientific
uncertainty, have prevented any serious effort by the Administration to seek Senate
ratification of the Kyoto Protocol.
Removal of any one of the three interlinked issues might significantly improve
the prospects for approval of the Kyoto Protocol, or some other regime to control
greenhouse gas emissions. For example, if the cost of Kyoto compliance could be
shown to be not as burdensome as some have suggested, the competitive impact
would be weakened and the concern about comprehensiveness would lessen. Such
concerns, along with scientific doubt, would not be eliminated; however, they would
be attenuated.
Such a task would not be easy. Estimates of costs to reduce CO emissions vary
2
greatly, and focus attention on an estimator’s basic view about the problem and the
future, rather than on simple, technical differences, in economic assumptions.2 Some
of these “lenses” through which people view the problem and their effects on cost
analysis are summarized in Table 1. Based on these perspectives, the cost of
complying with Kyoto can appear to range from “none” (or indeed, a positive
benefit”) to an estimate so high as to potentially bankrupt the economy. For example,
the American Petroleum Institute, in summarizing the results of several studies
concludes that Kyoto compliance would require “heavy taxes or high carbon permit
prices” to be achieved, resulting in “sharp declines in domestic demand”, “encourage
1For a analysis of U.S. policy, see Larry B. Parker and John E. Blodgett, Global Climate
Change Policy: From “No Regrets” to S. Res. 98, CRS Report RL30024, January 12, 1999.
For a summary of the Kyoto Protocol, see (name redacted), Global Climate Change Treaty:
The Kyoto Protocol, CRS Report 98-2 ENR, updated June 23, 1999.
2For a further discussion, see: (name redacted) and (name redacted),
Global Climate Change:
Three Policy Perspectives, CRS Report 98-738, August 31, 1998. It identifies three “lenses”
through which people can view the global climate change issue, and their influence on cost
analysis.

CRS-2
imports and reduce exports,” and a “significant loss of jobs” in energy related
industries.
3 In contrast, a study by a coalition of public interest groups concludes that
new energy policies can “cut energy costs, increase employment, and protect the
environment.” Such a path is seen as reducing energy costs by $530 a household
while exceeding the reduction requirements of Kyoto.4 None of the perspectives on
which these analysis are based is inherently more “right” or “correct” than another;
rather, they overlap and to varying degrees complement and conflict with each other.
People hold to each of the lenses to some degree. The uncertainties about the risk of
global climate change and the critical impacts of differing assumptions about the
nature of the problem effectively preclude predictions of the ultimate costs of
reducing greenhouse gases.

As a result, attention has focused on how to minimize costs by selecting the most
economically efficient strategies to reduce CO emissions. With the negotiation of the
2
Kyoto Protocol, the mechanism that has become the centerpiece of this attention is
emissions trading. Indeed, Janet Yellen, Chair of the President Council of Economic
Advisors has stated that the “promise of Kyoto can not be achieved without effective
emissions trading.”
5
Emissions trading is one of four “flexibility mechanisms contained in the Kyoto
Protocol (article 17).6 Under the Kyoto Protocol, developed countries are given
greenhouse gas emissions “budgets” for the compliance period 2008-2012 based on
a percentage of their 1990 or 1995 emissions levels (depending on the particular
greenhouse gas). If a country determined that it would exceed its emissions limit
during the compliance period, emissions trading would permit it to purchase emissions
reductions (i.e., “credits” ) from another country that determined it would hav
7
e
achieved more emissions reductions than necessary to comply. With emissions
trading, countries that can make relatively inexpensive emissions reductions have an
incentive to reduce emissions below the level required by the Kyoto Protocol, and sell
the extra credits to other countries whose emissions control costs are more
Rayola
3
Dougher, The Impact of the Kyoto Protocol on Allied Industry Output, Employment,
and Trade, American Petroleum Institute, 1999. For a rebuttal of the type of studies on which
the API conclusions are based, see Howard Geller, “On Impacts of the Kyoto Protocol on
U.S. Energy Markets and Economic Activity.” Testimony before the House Science
Committee, October 9, 1998.
4Alliance to Save Energy, American Council for an Energy-Efficient Economy, Natural
Resources Defense Council, Tellus Institute, and Union of Concerned Scientists, Energy
Innovations: A Prosperous Path to a Clean Environment, Tellus Institute, June 1997. For
a rebuttal of the type of studies on which these conclusions are based, see Ronald J.
Sutherland, The Feasibility of “No Cost” Efforts to Reduce Carbon Emissions in the U.S.,
American Petroleum Institute, Issue Analysis #106, May 1999.
5Statement of Janet Yellen, Chair, President’s Council of Economic Advisers, House
Committee on Commerce, Subcommittee on Energy and Power, March 4, 1998.
6 The other mechanisms are Bubbles (Article 4), Joint Implementation (Article 6), and the
Clean Development Mechanism (Article 12).
A
7
credit would generally represent the reduction of one metric ton of carbon equivalent
emissions.

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Table 1: Climate Change Perspectives and Policy Parameters
Seriousness of
Risk in developing
Approach
Problem
mitigation program
Costs
Technology
Is agnostic on the
Believes any reduction
Viewed from the
merits of the
program should be
bottom-up. Tends to
problem. The focus
designed to maximize
see significant
is on developing
opportunities for new
energy inefficiencies
new technology that
technology. Risk lies
in the current
can be justified
in not developing
economic system
from multiple
technology by the
that currently (or
criteria, including
appropriate time.
projected) available
economic,
Focus on research,
technologies can
environmental and
development, and
eliminate at little or
social perspectives.
demonstration; and on
no overall cost to the
removing barriers to
economy.
commercialization of
new technology.
Economic
Understands issue
Believes that
Viewed from the top-
in terms of
economic costs should
down. Tends to see
quantifiable cost-
be examined against
a gradual
benefit analysis.
economic benefits in
improvement in
Generally assumes
determining any
energy efficiency in
the status quo is the
specific reduction
the economy, but
baseline from which
program. Risk lies in
significant costs
costs and benefits
imposing costs in
(quantified in terms
are measured.
excess of benefits.
of GDP loss)
Unquantifiable
Any chosen reduction
resulting from global
uncertainty tends to
goal should be imple-
climate change
be ignored.
mented through eco-
control programs.
nomic measures such
Typical loss
as tradeable permits
estimates range from
or emission taxes.
1-2% of GDP.
Ecological
Issue understood in
Rather than economic
Views costs from an
terms of potential
costs and benefits or
ethical perspective in
threat to basic
technological
terms of the
values, including
opportunity, effective
ecological values
ecological viability
protection of the
that climate change
and the well-being
planet’s ecosystems
threatens. Values
of future gener-
should be the primary
such as intergene-
ations. Values
criteria in determining
rational equity
reflect ecological
the specifics of any
should not be con-
and ethical consid-
reduction program.
sidered commodities
erations; attempts
Focus of program
to be bought and
to convert them into
should be on altering
sold. Costs include
commodities to be
values and broadening
aesthetic and en-
bought and sold
consumer choices.
vironmental values
seen as trivializing
that economics can-
the issue.
not readily quantify
and monetize.

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expensive. Thus, both the seller and the buyer would have lower costs by virtue of
the seller’s profit and the buyer’s savings.
This mechanism, however, comes with significant restrictions under the Kyoto
Protocol. First, emissions trading is restricted to countries that have legally binding
greenhouse gas emission limitations. Commonly called Annex 1 parties, only
developed, industrialized countries are included.8 This restriction also applies to two
of the other three mechanisms — bubbles and joint implementation projects. Only the
Clean Development Mechanism (CDM) can be employed for transactions between
Annex 1 countries and countries without legally binding requirements — i.e.,
developing countries. The specifics of this mechanism are yet to be defined.
A second restriction to trading is the requirement that it “be supplemental to
domestic actions for the purpose of meeting quantified emission limitations and
reduction commitments...” However, the Protocol is vague as to wha
9
t
“supplemental” means, and the term is subject to continuing negotiation.
Some parties have suggested a third restriction on trading with respect to how
reductions are accomplished. Specifically, some have argued that trading be restricted
to transactions where the traded carbon credits are the result of explicit controls that
reduce greenhouse gases, and not because of economic downturns or other events
separate from the Protocol. This issue arises as several countries of the former Soviet
Union are projected to have sizeable amounts of credits available for sale because of
current economic difficulties. Proponents of trading restrictions argue that such “hot
air” reductions would have occurred anyway and would weaken the Protocol’s
targets. These concerns are heightened by the failure of Russia and seven other
members of the former Soviet Union countries to comply with the Montreal
Protocol because of “economic difficulties” — the same difficulties that woul
10
d
create the hot air credits. However, the Kyoto Protocol places no restriction on the
means countries may use to comply with reduction requirements; thus, this position
may be difficult to sustain in negotiation.

Because trading is a central feature of costs analyses of the Kyoto Protocol, this
paper analyzes some of the dynamics and pitfalls of carbon trading, based on various
analyses done on U.S. compliance with the Kyoto Protocol. As the analysis
conducted by the Administration has become the focus of much of the cost debate,
it receives special emphasis here.
Although
8
called “Annex 1" countries in reference to Annex 1 of the Framework Convention
on Climate Change (FCCC), the correct reference is to Annex B of the Kyoto Protocol. The
lists of countries in Annex 1 and Annex B are very similar, but not identical. CRS uses the
common usage term, Annex 1, in this report.
Article 17, Kyoto Protocol.
9
10The Montreal Protocol is an international environmental treaty designed to protect the
stratospheric ozone layer by phasing out the global production of ozone-depleting chemicals,
such as chlorofluorocarbons.

CRS-5
Review of Analyses: the Dynamics of Trading
Several attempts have been made to estimate the cost of U.S. compliance with
the terms of the Kyoto Protocol. Seventeen estimates by eight different organizations
are shown in Figure 1. In terms of the discussion in table 1, these estimates are the
11
result of “top-down” analyses, although some have more aggressive assumptions
about market penetration rates for new, more energy efficient technologies than
others. Several “bottom-up”, technology-oriented analyses of potential carbon
reductions under various scenarios have been conducted. However, these analyses
rely on assumed availability and penetration of various energy-efficient and low
carbon technologies, not international emissions trading, to achieve their cost savings,
and so are not reviewed here. Indeed, a recently released “bottom-up” analysi
12
s
conducted by the Tellus Institute expresses concern that the flexibility mechanisms
contained in the Kyoto Protocol could threaten environmental integrity and result in
misguided policies that could actually increase costs in the long term.
13
Most analyses of the Kyoto Protocol either exclude emissions trading or limit
trading to the developed countries covered by the Protocol (Annex 1 countries). The
latter assumption is consistent with the intent and language of the Protocol —
developing countries’ participation in emission trading is restricted to a “Clean
Development Mechanism,” the parameters of which are yet to be sorted out. Only
14
three estimates incorporated a global trading scenario. Despite the wide range of
estimates plotted in Figure 1 for each trading scenario, the differences between the
three trading scenarios strongly suggest that emission trading would significantly
The
11
organizations are the Energy Information Administration (EIA), WEFA, Inc., Charles
River Associates (CRA), Pacific Northwest National Laboratory (PNNL), Massachusetts
Institute of Technology (MIT), Electric Power Research Institute (EPRI), Data Resources
Institute (DRI), and the Clinton Administration. A summary of the first seven analyses can
be found in Energy Information Administration, Impacts of the Kyoto Protocol on U.S.
Energy Markets and Economic Activity, prepared for the U.S. House, Committee on Science,
U.S. Govt. Print. Office, SR/OIAF/98-03, October 1998, pp. 137-151. Additional scenarios
from the CRA analysis are available in Paul M, Bernstein and W. David Montgomery, How
Much Could Kyoto Really Cost? A Reconstruction and Reconciliation of Administration
Estimates, prepared for the American Petroleum Institute, 1998. The Administration’s
analysis is contained in The Kyoto Protocol and the President’s Policies to Address Climate
Change: Administration Economic Analysis, July 1998.
Indeed,
12
the best known of these studies, the “Five-Lab Study,” used carbon taxes of $25 and
$50 a ton in developing its scenarios. It should also be noted that the “Five-Lab Study
examined technology-oriented strategies to achieve stabilization of U.S. carbon emissions at
1990 levels — not the 7% below 1990 levels required under Kyoto. See: Interlaboratory
Working Group on Energy-Efficient and Low-Carbon Technologies, Scenarios of U.S.
Carbon Reductions: Potential Impacts of Energy-Efficient and Low Carbon Technologies
by 2010 and Beyond, September 1997. For a critique of the analysis, see: Energy Information
Administration, Impacts of Kyoto Protocol on U.S. Energy Markets and Economic Activity,
prepared for the House Committee on Science, October 1998, pp. 146-151.
13Tellus Institute, America’s Global Warming Solution, a study prepared for the World
Wildlife Fund and Energy Foundation, August 1999, pp. 18-20.
The EPRI analysis included above includes some participation in the CDM.
14

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reduce the projected costs of U.S. compliance with the Kyoto Protocol. The
“promise” of international emissions trading appears to be indisputable, based on
existing analyses.
Figure 1
Cost Estimates for Kyoto Compliance
(Year 2010)
400
350
348
300
295
280
266
250
265
221
200
193
175
171
150
119
114
100
110
100
61
50
50
23
14
0
No Trading
Annex 1 Trading
Global Trading
Source: U.S. Energy Information Administration, Charles River Associates, Administration Economic Analysis.
To examine this a little further, two organizations conducted cost analyses for
three different trading scenarios. Those estimates, calculated by the Administration
and by Charles River Associates (CRA) are provided in Figure 2. As indicated,
moving from a no trading posture to an Annex 1 trading posture lowered the cost
estimates by 60% (CRA) to 68% (Administration). According to these analyses, if
the Kyoto Protocol permitted full global trading, the costs would be lowered by 83%
(CRA) to 88% (Administration). These analyses agree on the potential cost
reductions presented by emissions trading; a potential that increases as the pool of
potential participants increase. This agreement on trading’s effect on costs is evident
despite the significant disagreement on what the actual compliance costs under the
Kyoto Protocol might be.15
The
15
difference in costs between the Administration’s and CRA’s analyses is primarily the
result of two factors. First, the Administration assumes a higher energy efficiency
improvement rate than CRA. Second, the Administration assumes a higher elasticity of
substitution between coal and natural gas. These more aggressive assumptions by the
Administration are consistent with its “technological view” of Kyoto implementation. For
more on that view, see Table 1.

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Figure 2
Another important dynamic with respect to trading illustrated in figure 2 is the
importance of “hot air” credits to reducing costs. As noted earlier, “hot air” credits
is a rather pejorative term used to describe a potentially large pool of CO credits
2
available from the former Soviet Union. This pool of perhaps 200 million metric tons
of carbon, according to DOE estimates, results from the substantial reduction in
economic activity in the former Soviet Union since 1990 (the baseyear for the Kyoto
Protocol). If these credits are dumped on the market during the five-year compliance
period (2008-2012), credit prices would be depressed, reducing compliance costs as
indicated in the CRA analysis. Likewise, without the availability of these credits, the
cost of U.S. compliance under Kyoto could be substantially higher.
This substantial cost savings projected under the CRA analysis illustrates why
the Administration opposes any restriction on hot air credits. An increase in the
available pool of credit for sale would tend to reduce the price of credits in the trading
market. For a country like the United States, which is projected to be very active in
the trading market, lower credit prices would translate into lower compliance costs,
all else being equal.
Indeed, the lower cost estimates of the Administration’s analysis is partially the
result of a trading system that is assumed to be very free and unconstrained. In

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essence, the Administration assumes the trading system will work very well indeed.
Just how well is indicated by Figure 3. In order to gain the 68% cost reduction from
emission trading between Annex 1 countries discussed above, 61% of the necessary
carbon credits must be bought from other Annex 1 countries. In order to gain the
88% reductions in costs from global trading, 82% of the necessary carbon credits
must be bought from other countries. In a maximum trading scenario developed by
the Administration, up to 88% of carbon credits would be purchased from other
countries.
Figure 3
This scale of potential trading may put any resulting U.S. implementation
strategy in conflict with restrictions contained in the Kyoto Protocol, and with the
negotiating position of other parties to the Protocol. As noted earlier, according to
the Protocol, international emissions trading is to be a “supplemental” implementation
tool to domestic efforts. According to the latest European Union position,
supplemental means no more than 50%. If the European standard was adopted in
negotiation, the estimated savings from trading would be substantially reduced.
Two conclusions emerge from this review. First, there is little debate among the
analyses that emission trading could reduce U.S. compliance cost under Kyoto.
Indeed, the percentage reductions resulting from increased trading do not differ

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greatly. Rather, the dispute is over how well such a program would work. Second,
it is the assumption of the Administration’s analysis that trading will work extremely
well, resulting in substantially lower costs for the United States. This possibility may
be difficult to achieve given restrictions contained within the Kyoto Protocol, the
negotiating position of some of the other parties, and the sources from which many
of the credits are projected to come. Moreover, current efforts to devise a workable
trading system suggest that it will be a difficult and lengthy process, at best.
Implementation Pitfalls: Comparison with Acid Rain
The importance of trading to cost estimates, and the scope to which it is
employed by the Administration in its analysis has no direct parallel in any existing
environmental program. The closest example of such a trading program is the acid
rain program under title IV of the 1990 Clean Air Act Amendments. However,
significant differences between acid rain and possible global warming limit the
usefulness of title IV as an analogy for an international carbon trading system. For
example, the acid rain program involves up to 3,000 new and existing electric
generating facilities that contribute two-thirds of the country’s sulfur dioxide (SO )
2
and one-third of its nitrogen oxide (NOx) emissions (the two primary precursors of
acid rain). This concentration of sources makes the logistics of emissions trading
manageable and enforceable. However, CO emissions are not so concentrated.
2
Although over 95% of the CO generated comes from fossil fuel combustion, only
2
about 33% comes from electricity generation. Transportation accounts for about
33%, direct residential and commercial use about 12%, and direct industrial use about
20%. Thus, small dispersed sources in these other areas are far more important in
controlling CO emissions than they are in controlling SO emissions. This creates
2
2
significant administrative and enforcement problems for an international emissions
trading program if it attempts to be comprehensive. These concerns multiply as the
global nature of the program is considered, along with the number of greenhouse
gases that would be included in it.
In addition to the substantive differences in the problems, the trading dynamics
of national SO trading and international CO trading are different. As indicated by
2
2
Figure 4, the largest projected saving from emission trading under the SO program
2
is from permitting relatively simple and uncomplicated trading between a utility’s own
facilities. An additional ten percent can be gained by permitting intrastate trading.
However, expanding the boundaries of the trading to interstate trading does not result
in as dramatic cost reductions as for intra-company trading. For implementation
policy, this is very significant, as it suggests that the SO trading program does not
2
have to work very efficiently to achieve a large proportion of the economic benefits
that have been estimated. Given the increasing regulatory and administrative
complexity of expanding the scope of trading to regional levels, the trading dynamics
suggest that such complexity can be avoided at little loss of economic efficiency.16
For
16
a further discussion, see: Larry B. Parker, Robert D. Poling, and John L Moore, “Clean
Air Act Allowance Trading,” 21 Environmental Law, 4, 1991, pp. 2023-2068,

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Figure 4
However, although the positive effects of trading have been borne out in the first
few years of the SO program, it is not necessarily a harbinger of the potential cost
2
savings from an international carbon trading program. First, the baselines for
measuring cost savings are different. For the acid rain program, a unit-by-unit
allocation of reduction with absolutely no trading is the baseline from which cost
savings from trading are measured. For a carbon trading program, the baseline is an
interstate (or intra-country) trading scenario from which cost savings from
international trading is measured. Thus, the maximum trading scenario estimated
under the acid rain program (interstate trading) is the baseline scenario for measuring
the effect of inter-country trading under carbon trading. In essence, the “no trading”
scenario of the carbon trading program is the “interstate trading” scenario of the acid
rain program. Thus, the scope of international carbon trading is well beyond that of
the title IV program.
Second, the trading dynamic under the SO program discussed above contrasts
2
strongly with that projected under an international carbon trading program. As
indicated in Figure 5, under an international carbon trading program, only half the
anticipated savings from trading occur in transactions between developed Annex 1
countries. About a fifth of the savings projected by Charles River Associates is the
result of “hot air” credits. Finally, about a quarter to a third of the anticipated savings

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results from transactions with countries not currently covered by the Protocol. Thus
about half the total savings from trading would come from sources whose credits are
either contested in some quarters, or from countries who are not required to
participate in the reduction program at all.17
Figure 5
Conclusion
The potential for international emission trading to reduce U.S. compliance cost
under the Kyoto Protocol is substantial and indisputable. Whether that potential can
be turned into fact is more problematic. The analysis presented here suggests that
implementing international emissions trading under Kyoto would represent uncharted
territory for U.S. environmental policy.
Indeed,
17
it is not clear that developing countries can participate in the CDM unless they
assume reduction obligations. For more on the CDM, see United Nations Development
Programme, Issues & Options: The Clean Development Mechanism, United Nations
Publications, 1998.

CRS-12
First, an international emissions trading scheme has to function very efficiently
to achieve the savings projected by analyses. For example, the Administration’s
analysis relies on an unprecedented amount of international trading to achieve the
substantial cost reduction its projects. Under its most aggressive trading scenario,
82%-88% of the U.S. reduction requirement would be bought from foreign sources,
resulting in domestic CO reductions of only 66 to 99 million metric tons, compared
2
with an estimated 550 million metric tons if all reduction were achieved
domestically.
18 Even restricting trading to Annex 1 countries results in 61% of the
country’s reduction requirement coming from foreign sources. The magnitude of
transactions not only raises questions of its feasibility, but may also conflict with the
intent of the Kyoto Protocol — and with the positions of some other countries —
which states that international emissions trading is to be “supplemental” to domestic
actions.
Second, besides the amount of trading estimated, the sources of these reductions
raise additional questions. For example, according to analysis by Charles River
Associates, half the estimated savings from international emissions trading would
come from either “hot air” credits from the former Soviet Union, or from transactions
with Third World countries that are not required to participate in the program.
Trading with these sources does not have the certainty that trading with most Annex
1 countries would have in terms of monitoring, enforcement, and integrity of
transactions. With respect to the former Soviet Union, current problems with
achieving compliance with the Montreal Protocol, a far simpler international treaty,
does not bode well for the Kyoto Protocol. That “economic difficulties” are
proffered by these countries as grounds for non-compliance and non-enforcement of
the Montreal Protocol is particularly disturbing, as those same difficulties are the
source of the “hot air” credits.
The situation may be more uncertain with Third World transactions as
developing countries generally have neither the incentive of a binding obligation under
the Protocol, nor the infrastructure to monitor, enforce, and protect the integrity of
transactions. In addition, there may be complications resulting from the Kyoto
Protocol itself. As currently written, transactions with Third World countries are to
be funneled through a “Clean Development Mechanism,” an institution whose role
and parameters have yet to be worked out. How much this “middle man” mechanism
would affect trades is unclear.
Third, the situation with international carbon trading is not analogous to the acid
rain program, often cited as a model. The acid rain program involves domesti
19
c
trading in one pollutant from about 3,000 relatively large stationary sources. As such,
it has been administratively manageable, enforceable, and successful. The Kyoto
Protocol involves 6 pollutants, millions of small, medium, and large sources, and
18For further information on the projected U.S. reduction requirement under the Kyoto
Protocol, see: (name redacted) and (name redacted),
Global Climate Change: Reducing
Greenhouse Gases — How Much from What Baseline? CRS Report 98-235 ENR, March
11, 1998
For
19
example, see: Council of Economic Advisors, Economic Report of the President, U.S.
Govt. Print. Off., February 1997, pp. 208-213.

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international trading. The maximum trading scenario under the acid rain program —
interstate trading — is the baseline for international trading under the Kyoto Protocol.
While electric generating facilities — the focus of the acid rain trading program —
account for two-thirds of U.S. sulfur dioxide emission, they account for only 29% of
the six greenhouse gases emitted in the U.S. (mostly carbon dioxide). Other more
dispersed energy uses, such as transportation, make up most of the rest. Add the
international scope of carbon trading to this mix, and it is clear that implementation
challenges would be on a different level than that encountered with the acid rain
program, a level to which the implementation of the acid rain program provides little
guidance.
Besides questions raised by the scale of carbon trading, the trading dynamics of
carbon trading differ from those of the acid rain program. Unlike an international
carbon trading program that must operate very efficiently to achieve much of its cost
savings, the acid rain program does not have to do so. The simplest trades — those
between a company’s own plants — achieve the greatest cost savings under the acid
rain program, not interstate trades between unassociated parties. That there have
been relatively few interstates trades so far under the acid rain program means once
again that the program provides little guidance to any future international carbon
trading program.
In short, to expect trading to reduce costs by the 80%-90% suggested by some
analyses seems at the current time to be unrealistic. Indeed, the complexity presented
by international emissions trading suggest that alternatives may deserve a hearing.

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