Overly Optimistic Outlook Drives White House Model

Overly Optimistic Outlook Drives White House Model
November 1, 1998



Citing several flaws in the Clinton administration's assessment of the impact of the Kyoto climate-change treaty, a new study by an outside consulting firm argues that the annual costs to the U.S. economy of complying with the treaty could be $100 billion, or 10 times greater than the White House estimates.

Entitled "How Much Could Kyoto Really Cost? A reconstruction and reconciliation of administration estimates," the report was written by PhD economist W. David Montgomery of Washington-based Charles River Associates, for the American Petroleum Institute.

Montgomery accepted the same assumptions and economic model used by Janet Yellen, the White House's chief economic advisor, in her March 1998 study.

"Given her assumptions, Dr. Yellen's analysis is internally consistent and compatible with mainstream economic analysis," said Montgomery. "However, her cost estimates include only direct costs, not the full impacts to the economy of implementing the Kyoto Protocol, and very optimistic assumptions are made about the economy's ability to reduce emissions at low cost."

According to Montgomery, Yellen's study is flawed by its excessive optimism about the emergence of an efficient trading system for emission credits and the ability of investor-owned utilities to retrofit its plants with natural-gas burning generators.



Excessive Optimism on Trading

Recognizing that the United States would not be able to meet the tough reduction requirements of greenhouse gasses-- mainly carbon dioxide -- imposed by the treaty without causing serious damage to the economy, the White House is counting on the unrestricted purchase of emissions credits. Yellen assumes the credits would be purchased from other countries whose emissions are below Kyoto standards to produce the desired level of carbon dioxide gas reductions. Instead of reducing its own emissions, the United States instead would be transferring its wealth to other countries that actually are producing fewer greenhouse gases than they were in 1990.

Montgomery calculates that the United States would need to purchase 82 to 88 percent of its 550 million metric ton emissions reductions from abroad, with Russia being the primary seller.

He notes two flaws with that scenario, however. First, the White House is estimating the purchase price of such allowances at no higher than $23 a ton, when the consensus of several other independent economists is at least at $170 a ton.

Second, the White House plans for industry to achieve over 50 percent of US reductions through purchasing emissions credits -- something that European Union and other countries find unacceptable. These developed countries have reduction targets far lower than the U.S., and insofar as the United States can buy emission credits abroad, it can maintain its level of business activity, depriving the developed European nations an opportunity to pick up market share that U.S. firms would otherwise have to surrender.

Furthermore, developing nations, which have no reduction targets, have stated their intentions not to approve any final Kyoto document that allows emissions-credit trading. Like their developed-nations colleagues, they, too, hope to scoop up market share from constrained U.S. firms.

In fact, however, Montgomery says the White House economist believes that the United States can convince other treaty states to accept an unrestricted system that "will work as efficiently as the New York Stock Exchange."

Failure to acquire these credits, even at Yellen's unrealistic target of $23 a ton, would result in economic losses that would have a serious impact on families, jobs and businesses. Montgomery faulted Yellen for measuring only part of the costs that would be attributable to rising energy prices. For example, the Charles River study predicts that the average household's energy bill would jump by $850 a year, and gasoline prices would increase by 50 cents a gallon, as energy suppliers pass along the cost of buying emission credits to their customers.



Excessive Optimism about Utilities

Coal-fired electric utility companies, among the largest emitters of carbon dioxide emissions, would be compelled to retrofit their operations to run on natural gas.

But Montgomery says it's unreasonable to accept Yellen's assumption that coal- fired electric utilities can switch to natural gas in the short time remaining until 2008. On the other hand, if the price of energy as measured by carbon remains below Yellen's $25 figure, then utility management has no economic incentive to retrofit: Management would find it cheaper to buy emission credits.

Said Montgomery, "Dr. Yellen's estimate constitutes, in a sense, the best case analysis for the United States," but it's based on an optimism that no other economist shares.