MODELING THE ECONOMICS OF GREENHOUSE GAS MITIGATION

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K. John Holmes, Rapporteur Division on Engineering and Physical Sciences

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THE NATIONAL ACADEMIES PRESS 500 Fifth Street, N.W. Washington, DC 20001 NOTICE: The project that is the subject of this report was approved by the Governing Board of the National Research Council, whose members are drawn from the councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. This study was supported by funding from the U.S. Department of Energy under contract DE-AM01-04PI45013/­DE- DT0000010/­002. Any opinions, findings, conclusions, or recommendations expressed in this publication are those of the author(s) and do not necessarily reflect the views of the organizations or agencies that provided support for the project. International Standard Book Number-13: 978-0-309-16235-7 International Standard Book Number-10: 0-309-16235-1 Copies of this report are available from the National Academies Press, 500 Fifth Street, N.W., Lockbox 285, Washington, DC 20055; (800) 624-6242 or (202) 334-3313 (in the Washington metropolitan area); Internet, http:/­/­www.nap.edu. Copyright 2011 by the National Academy of Sciences. All rights reserved. Printed in the United States of America

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The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. Upon the authority of the charter granted to it by the Congress in 1863, the Academy has a mandate that requires it to advise the federal government on scientific and technical matters. Dr. Ralph J. Cicerone is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of outstanding engineers. It is autonomous in its administration and in the selection of its members, shar- ing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages education and research, and rec - ognizes the superior achievements of engineers. Dr. Charles M. Vest is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The Institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Harvey V. Fineberg is president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad com - munity of science and technology with the Academy’s purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the Council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the gov - ernment, the public, and the scientific and engineering communities. The Council is administered jointly by both Academies and the Institute of Medicine. Dr. Ralph J. Cicerone and Dr. Charles M. Vest are chair and vice chair, respectively, of the National Research Council. www.national-academies.or g

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PLANNING COMMITTEE FOR THE WORKSHOP ON ASSESSING ECONOMIC IMPACTS OF GREENHOUSE GAS MITIGATION JOHN WEYANT, Stanford University, Chair MARILYN BROWN, Georgia Institute of Technology WILLIAM NORDHAUS, Yale University KAREN PALMER, Resources for the Future RICHARD RICHELS, Electric Power Research Institute STEVEN SMITH, Pacific Northwest National Laboratory Project Staff K. JOHN HOLMES, Responsible Staff Officer, Board on Energy and Environmental Systems JAMES J. ZUCCHETTO, Director, Board on Energy and Environmental Systems LaNITA JONES, Administrative Coordinator, Board on Energy and Environmental Systems E. JONATHAN YANGER, Senior Program Assistant, Board on Energy and Environmental Systems iv

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BOARD ON ENERGY AND ENVIRONMENTAL SYSTEMS ANDREW BROWN, JR., NAE,1 Delphi Technologies, Troy, Michigan, Chair RAKESH AGRAWAL, NAE, Purdue University, West Lafayette, Indiana WILLIAM BANHOLZER, NAE, Dow Chemical Company, Midland, Michigan MARILYN BROWN, Georgia Institute of Technology, Atlanta MICHAEL CORRADINI, NAE, University of Wisconsin, Madison PAUL DeCOTIS, Long Island Power Authority, Albany, New York CHRISTINE EHLIG-ECONOMIDES, NAE, Texas A&M University, College Station WILLIAM FRIEND, NAE, Bechtel Group, Inc. (retired), McLean, Virginia SHERRI GOODMAN, CNA, Alexandria, Virginia NARAIN HINGORANI, NAE, Independent Consultant, Los Altos Hills, California ROBERT J. HUGGETT, Independent Consultant Seaford, Virginia DEBBIE NIEMEIER, University of California, Davis DANIEL NOCERA, NAS,2 Massachusetts Institute of Technology, Cambridge MICHAEL OPPENHEIMER, Princeton University, Princeton, New Jersey DAN REICHER, Stanford University, Stanford, California BERNARD ROBERTSON, NAE, Daimler-Chrysler (retired), Bloomfield Hills, Michigan ALISON SILVERSTEIN, Independent Consultant, Pflugerville, Texas MARK THIEMENS, NAS, University of California, San Diego RICHARD WHITE, Oppenheimer & Company, New York Staff JAMES J. ZUCCHETTO, Director, Board on Energy and Environmental Systems DUNCAN BROWN, Senior Program Officer DANA CAINES, Financial Associate ALAN CRANE, Senior Program Officer K. JOHN HOLMES, Senior Program Officer LaNITA JONES, Administrative Coordinator MADELINE WOODRUFF, Senior Program Officer E. JONATHAN YANGER, Senior Project Assistant 1 NAE, National Academy of Engineering. 2NAS, National Academy of Sciences. v

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Preface The 2010 National Research Council (NRC) workshop “Modeling the Economics of Greenhouse Gas Mitiga - tion” was initiated by the Department of Energy (DOE) to help address the agency’s need for improved economic modeling tools to use in the development, analysis, and implementation of policies to address greenhouse gas mitigation. As understanding improves of the issues addressed by and the relationships among the climate sci - ences, economics, and policy-making communities, techniques and modeling tools currently being used will have to be improved or modified. Critical elements in these activities include the understanding and modeling of new technologies as they move from demonstration to deployment. This is the second NRC workshop organized with a focus on economic modeling issues. The first such work - shop, “Assessing Economic Impacts of Greenhouse Gas Mitigation,” was held on October 2-3, 2008, in Washing - ton, D.C., with the goal of gaining a broader view of the variables to be accounted for and techniques used when attempting this type of modeling.1 As a follow-up, the current workshop sought to delve more deeply into some of the key issues discussed in 2008. As with the first workshop, the second was an effort to engage leaders from the policy, economic, and analytical communities in helping to define the frontiers of and provide insight into the opportunities for enhancing the capabilities of existing models to assess the economic impacts of efforts to reduce greenhouse gas emissions. This summary captures the major topics discussed at the second workshop. It does not include any consensus views of the participants or the planning committee, does not contain any conclusions or recommendations on the part of the National Research Council, and does not offer any advice to the government, nor does it represent a viewpoint of the National Academies or any of its constituent units. No priorities are implied by the order in which ideas are presented. The workshop itself was divided into four major sessions (see Appendix A), each including a moderator, a number of distinguished speakers, and a panel of discussants who provided comments and additional perspectives on the speakers’ presentations. The workshop was planned by a committee of experts who identified the major topics for discussion and selected speakers and participants well respected in their fields (see Appendix B for short biographical sketches). Papers submitted by the workshop speakers are reprinted essentially as received in Appendix C. 1 NRC (National Research Council). 2009. Assessing Economic Impacts of Greenhouse Gas Mitigation: Summary of a Workshop. The National Academies Press, Washington, D.C. vii

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viii PREFACE I would like to thank John Weyant, Marilyn Brown, William Nordhaus, Karen Palmer, Rich Richels, and Steven Smith for their extensive work in planning and executing this project. I also extend my gratitude to each presenter and discussant who contributed to this event. Jim Zucchetto and Peter Blair of the Division on Engineering and Physical Sciences provided valuable program direction, for which I am grateful. Jonathan Yanger also deserves special recognition for his program support on this project. This workshop would not have been possible without the financial support of its sponsor: the U.S. Department of Energy’s Office of Policy and International Affairs. Inja Paik and Bob Marlay of the Department of Energy provided the planning committee with useful input which helped it to develop a workshop that proved both timely and valuable to the various policy, economic, and analytic communities engaged in the many aspects of greenhouse gas mitigation. This workshop summary has been reviewed in draft form by individuals chosen for their diverse perspectives and technical expertise, in accordance with procedures approved by the NRC’s Report Review Committee. The purpose of this independent review is to provide candid and critical comments that will assist the institution in making its published report as sound as possible and to ensure that the report meets institutional standards for quality and objectivity. The review comments and draft manuscript remain confidential to protect the integrity of the review process. Thanks are extended to the following individuals for their review of this workshop summary: Paul DeCotis, Long Island Power Authority Robert W. Fri, Resources for the Future Charles Goodman, Southern Company (retired) William Nordhaus, Yale University Karen Palmer, Resources for the Future Although the reviewers listed above provided many constructive comments and suggestions, they were not asked to endorse the content of the summary, nor did they see the final draft before its release. Responsibility for the final content of this report rests entirely with the author and the institution. K. John Holmes K. Rapporteur

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Contents 1 INTRODUCTION 1 2 USES AND ABUSES OF MARGINAL ABATEMENT SUPPLY CURVES 4 3 USES AND ABUSES OF LEARNING, EXPERIENCE, AND KNOWLEDGE CURVES 9 4 OFFSETS—WHAT’S ASSUMED, WHAT IS KNOWN/­NOT KNOWN, AND WHAT DIFFERENCE THEY MAKE 13 5 STORY LINES, SCENARIOS, AND THE LIMITS OF LONG-TERM SOCIO-TECHNO-ECONOMIC FORECASTING 19 6 REFLECTIONS ON THE WORKSHOP 22 REFERENCES 25 APPENDIXES A Workshop Announcement and Agenda 29 B Biographical Sketches of Planning Committee Members, Speakers, and Discussants 33 C Papers Submitted by Workshop Speakers 41 Paradigms of Energy Efficiency’s Cost and Their Policy Implications: Déjà Vu All Over Again—Mark Jaccard, 42 —Mark Mark ix

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x CONTENTS Energy Efficiency Cost Curves: Empirical Insights for Energy-Climate Modeling—Jayant Sathaye and —Jayant Jayant Amol Phadke, 52 The Perils of the Learning Model for Modeling Endogenous Technological Change— — William William D. Nordhaus, 69 Uncertainties in Technology Experience Curves for Energy-Economic Models— — Sonia Sonia Yeh and Edward Rubin, 76 Roles of Offsets in Global and Domestic Climate Policy—Raymond J. Kopp, 92 —Raymond Raymond Carbon Offsets in Forest and Land Use—Brett Sohngen, 100 —Brett Brett Measurement and Monitoring of Forests in Climate Policy Design—Molly K. Macauley, 109 —Molly Molly International Offsets Usage in Proposed U.S. Climate Change Legislation—Allen A. Fawcett, 111 —Allen Allen The Politics and Economics of International Carbon Offsets—David G. Victor, 132 —David David Developing Narratives for Next-Generation Scenarios for Climate Change Research and Assessment—Richard Moss, 143 —Richard Richard