Energy Economics 31 (2009) S223–S234

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Energy Economics
j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / e n e c o

A top–down bottom–up modeling approach to climate change policy analysis

Sugandha D. Tuladhar ⁎, Mei Yuan, Paul Bernstein, W. David Montgomery, Anne Smith
CRA International, Washington DC, United States

a r t i c l e i n f o a b s t r a c t

Article history: This paper analyzes macroeconomic impacts of U.S. climate change policies for three different emissions
Received 3 April 2009 pathways using a top–down bottom–up integrated model. The integrated model couples a technology-rich,
Received in revised form 17 July 2009 bottom–up model of the U.S. electricity sector with a fully dynamic, forward-looking general equilibrium
Accepted 19 July 2009
model of the U.S. economy. Our model provides a unique and consistent modeling framework for climate
Available online 27 July 2009
change analysis. Because of the model's detail and flexibility, we use it to examine additional scenarios to
Keywords:
analyze many of the major uncertainties surrounding the implementation and impact of climate change
General equilibrium model policies — the role of command-and-control measures, loss in flexibility mechanisms such as banking, limits
Climate change on low-emitting technology, and availability of offsets. The results consistently demonstrate that those
Top–down policies that combine market-oriented abatement incentives with full flexibility are the most cost-effective.
Bottom–up © 2009 Elsevier B.V. All rights reserved.
Low carbon fuel standard

1. Introduction complete representation of the economy and the omission of market

In the face of ever-growing concern about the effects of climate
change, the United States seems on the brink of implementing policies
to limit its emissions of greenhouse gases (GHGs).
The details of such climate change policies, however, remain highly
uncertain. Of primary interest are the targets and timetables of the
emission reductions or caps. But the many details of the regulations are
also extremely important since they will ensure compliance with the
desired caps.
In this paper, we employ a fully integrated top–down and bottom–up
model to analyze climate change policies based on three core scenarios
that purport to restrict cumulative emissions over the 40 year model
horizon to 287 billion metric tons (bmt) or gigatons, of carbon dioxide
equivalent (CO2-e) greenhouse gas emissions (GtCO2-e), 203 GtCO2-e ,
and 167 GtCO2-e. The top–down model, Multi-Region National Model
(MRN), represents the entire economy at a macro level but lacks the
necessary technological detail since the model is not designed to
represent technologies from an engineering perspective. The bottom–
up model, North American Electricity and Environment Model (NEEM),
on the other hand, represents a subsystem of the economy–the
electricity sector–but does so in elaborate technological detail.
Bottom–up models' greatest strength is the richness of their representa-
tion of technology. It allows them to simulate the actual sector in a
partial equilibrium setting. However, bottom–up models constrained by
only partial economic representation cannot endogenously account for
macro-economic feedbacks from the rest of the economy. Their lack of
⁎ Corresponding author. 1201 F Street NW, Suite 700, Washington, DC 20004, United
States. Tel.: +1 202 662 3871; fax: +1 202 662 3910.
E-mail address: stuladhar@crai.com (S.D. Tuladhar).
responses exclude their use for any macro-economic analysis. Despite
their differences, the two paradigms have a complementary role to play
in policy analysis. If appropriately coupled, they can generate a wide
range of mutually consistent detailed results and high-level macro-
economic results. The top–down model's weaknesses are well compen-
sated by the bottom–up model's strengths, and vice versa. As the only
model combining two large scale models, the MRN–NEEM integrated
modeling approach provides a unique and consistent modeling frame-
work for climate change analysis.
Over the past few years, U.S. legislators have proposed a number of
different emission caps. Detailed discussion of Congressional bills that
have passed through the legislative discussion floor is provided in an
MIT report (Paltsev et al., 2007). The Environmental Protection
Agency (EPA) recently conducted a preliminary economic analysis of
the Waxman–Markey Discussion Draft (EPA, 2009). CRA International
used the MRN–NEEM to analyze the potential economic impacts of the
proposed energy and climate legislation released by Reps. Waxman
and Markey (American Clean Energy and Security Act of 2009, ACESA
or H.R.2454)1 currently being considered in the House Energy and
Commerce Committee (Montgomery et al., 2009).
In an effort to span these proposals, we consider three alternative
emission pathways. We assume that emission reductions are achieved in
the most cost-effective manner2; hence, we assume the U.S. imple-
ments a market-based approach. For this analysis, we choose to model
a cap-and-trade program as opposed to a tax policy program. To keep
1
The bill was released on May 15, 2009.
2
The benefits of reducing emission in the United States helps reduce global
concentrations of greenhouse gases, and the damages from climate change that these
reduced concentrations would avoid. In this paper we do not attempt to quantity the
benefits. We only provide costs of meeting the emission targets.

0140-9883/$ – see front matter © 2009 Elsevier B.V. All rights reserved.
doi:10.1016/j.eneco.2009.07.007
S224 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234
the analysis simpler and free of excessive implementation details of a
real program, we assume perfect efficiency of the program (e.g.,
costless monitoring of emissions, full compliance with the caps, etc.).
We do not concern ourselves with the actual operational details of
concerning the fungibility and availability of allowances. Rather, we
assume that the allowances may be traded among all sectors. For some
scenarios, we allow allowances to be banked and/or borrowed. Apart
from the policy decisions on the trading of allowances, we consider
uncertainty about the following: (i) the role of command and control
measures; (ii) the presence of flexibility mechanisms such as offsets;
and (iii) the availability and cost of low-emitting technologies and
fuels. This paper provides insights on such issues surrounding the
current climate change debate.
The paper is organized as follows. Section 2 briefly describes the
models used for the analyses and the integrated approach that combines
the top–down with the bottom–up model. Section 3 describes the model
calibration and the Reference case. Section 4 defines the model
assumptions that were used to generate the Reference case for each of
the three emissions pathways and Section 5 provides model results for
each of them. Section 6 examines the results of additional alternative
scenarios based on the three pathways and explores the impacts of some
climate change policy instruments. Section 7 highlights several insights
and contributions from the paper's analyses.
2. Model description3
The MRN–NEEM model combines two economic models: the MRN
model and the NEEM. MRN as a top–down model characterizes the
production technology and consumption preference in the economic
system with smooth functions and captures the economy-wide effects
through interrelated markets. NEEM as a bottom–up model represents
the electricity sector at the unit level and models the evolution of the
North American power system taking account of the electricity demand
growth, available generation, environmental technologies and environ-
mental regulations both present and future.
2.1. Overview of the MRN model
The MRN is a forward-looking, dynamic computable general
equilibrium model of the United States (U.S.). In it, the U.S. is divided
into 9 regions (see Fig. 1) with a single representative household and
state government in each region. The intertemporal budget constraint
of the households equates the present value of consumption gross of
tax with the present value of income earned in the labor market and
the value of the initial capital stock minus the value of post-terminal
capital. The infinitely lived representative agent optimally distributes
wealth over the horizon by choosing how much output in a given
period to consume and how much to save. The income-balance and
zero-profit conditions ensure that the infinitely lived economic agent
makes intertemporal decisions to optimize consumption, production,
and investment in every period.
The model includes 11 sectors: 5 energy sectors and 6 non-energy
sectors.4 All sectors except the electricity and coal sectors are modeled
as a nested Constant Elasticity of Substitution (CES) functions in the
MRN model. The electricity and coal sectors are characterized by
detailed supply structures in the NEEM model.
The model also includes four different types of low-carbon fuels for
personal transportation that are used for blending gasoline: aggregate
refined petroleum products or oil (blends of gasoline and diesel),
3
For detailed explanation of each of the models and the model integration
methodology, see Smith (2007).
4
Energy sectors include: (i) Electricity; (ii) Coal; (iii) Refined petroleum products;
(iv) Natural gas; and (v) Crude oil. Non-energy sectors include: (i) Agriculture; (ii)
Energy-intensive sectors; (iii) Manufacturing; (iv) Services; (v) Commercial transpor-
tation; and (vi) Motor vehicles.
Fig. 1. Regional definition.
conventional corn-based ethanol, low-GHG bio-fuel (blends of bio-
diesel and cellulosic and sugar-based ethanol), and a carbon-free
transportation fuel. Each fuel is characterized by its emission factor,
cost, and maximum allowable penetration (see Fig. 2). Corn-based
ethanol production is associated with an emission factor of 76% that of
gasoline measured in grams of CO2 per mega joule (gCO2/MJ), while
for the low-GHG the emission factor is 20% of conventional gasoline.
The zero-carbon transportation fuel, as the name suggests, embodies
no carbon.
2.2. Overview of the NEEM model
NEEM fills the need for a flexible, partial equilibrium model of the
North American electricity market that can simultaneously model both
system expansion and environmental compliance over a 50-year time
frame. The model employs detailed unit-level information on all large
generating units in the United States and large portions of Canada, and
it dispatches load based on a 20 period load duration curve. NEEM
models the evolution of the North American power system, taking
account of demand growth, available generation, environmental
technologies, and both current and future environmental regulations.
The North American interconnected power system is modeled as a set
of regions connected by a network of transmission paths.
NEEM features a rich representation of 24 electric power genera-
tion technologies. These are characterized in terms of capital cost,
operating cost, and heat rates, all of which are assumed to improve
over time. New technologies like Integrated Gasification Combined
Cycle (IGCC) with carbon capture and storage (CCS) are characterized
by dates of availability and introduction constraints.5 Since coal is the
primary fuel used by the electricity sector, a detailed representation of
the supply structure of this fuel is important. NEEM captures the coal
market through 21 supply curves that represent different regional
sources, ranks, sulfur, and mercury content. Technology costs and
characteristics used in the model are shown in Fig. 3.
2.3. MRN–NEEM integration methodology
Following the approach outlined by Bohringer–Rutherford (Bohringer
and Rutherford, 2006), the MRN–NEEM integration methodology follows
an iterative procedure to link top–down and bottom–up models. The
method utilizes an iterative process whereby the MRN and NEEM models
are solved in succession, reconciling the equilibrium prices and quantities
between the two models. The solution procedure, in general, involves an
iterative solution of the top–down general equilibrium model given the
net supplies from the bottom–up energy sector sub-model followed by
the solution of the energy sector model based on a locally calibrated set of
linear demand functions for the energy sector outputs. The two models
are solved independently using different solution techniques, but they are
linked through iterative solution points.
Specifically, the NEEM model passes the electricity supply, the non-
electric coal supply, and the electric natural gas demand to the MRN
model. The MRN model optimizes and returns to the NEEM model the
5
CCS is only available for IGCC coal generation units.
 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234 S225

Fig. 2. Relative cost ratio of alternative transportation fuel to refined petroleum products.

electricity prices, natural gas prices, and the coal demand from the non-
electric sectors. The iterative process involves the NEEM's resolving
given MRN feedbacks. The iteration continues until energy prices and
quantities converge. The same procedure applies in a carbon policy
analysis in which carbon allowances are passed between the two models
until both models' marginal abatement costs are equalized.
3. Model calibration and reference scenario
The core component of the MRN dataset is based on the Social
Accounting Matrix (SAM) developed by the Minnesota IMPLAN
Group, Inc. (MIG), which represents the economic flows of the 50
United States and the District of Columbia for the year 2002. The SAM
provides data on employment, industry output, value added, institu-
tional demand, national input–output structural matrices (use and
make tables), and inter-institutional transfers. We calibrate the energy
and economic dataset such that the resulting input–output tables for
each state balance and the energy values in the dataset line up with
the Energy Information Administration Annual Energy Outlook's
(AEO) physical energy quantities and prices.
The baseline energy use, carbon emissions from fossil fuels for the
non-electric sectors, natural gas price, world price of crude oil, and
petroleum price are all calibrated to the AEO 2008 Early Release
forecasts (EIA, 2008). The AEO 2008 Early Release, however, does not
include the provisions mandated by the Energy Independence and
Security Act of 2007 (EISA). The Act includes appliance efficiency
standards, an increase of the renewable fuel standard (RFS) to
36 billion gallons by 2022, and calls for an increase of the combined
corporate average fuel economy (CAFE) standards to 35 miles per
gallon (mpg) by 2020. We imposed these provisions on the baseline
calibrated to the AEO 2008 to generate a Reference case against which
the scenario results are compared.
As described in the previous section, the electricity sector is treated
differently. The characteristics of the power system are built up from
several data sources such as the North American Electric Reliability
Corporation (NERC) and the Energy Information Agency (EIA). Fig. 3
provides a snapshot of the technology cost assumptions.
4. Core policy scenario definitions and assumptions
The EMF 22 policy scenarios specify three U.S. emission targets
through 2050 along with the options of limited sectoral coverage and
limited banking/borrowing. The three emission pathways follow the
MIT cumulative emission trajectories (Paltsev et al., 2007) as: (i) a flat
allowance pathway from 2012 through 2050 held at 2008 emissions
levels; (ii) an allowance pathway starting at 2012 levels and
decreasing linearly to a 50% reduction in emissions below 1990 levels
by 2050; and (iii) an allowance pathway starting at 2012 levels and
decreasing linearly to an 80% reduction in emissions below 1990 levels
by 2050.

Fig. 3. New generation technology costs and characteristics (all dollar values are in 2007$).
S226 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234

The allowance pathways can be interpreted as cumulative emission

reductions over the model horizon. This provides flexibility in making
emission caps in the MRN–NEEM model, which operates in 5-year time
steps with 2010 as the first model year and 2015 as the first policy
year.6
The three emission pathways assume the cumulative emissions
over the model horizon to be 287 GtCO2-e, 203 GtCO2-e, and 167
GtCO2-e. Under the 287 GtCO2-e (“287 bmt”) pathway the emissions
cap is held constant at 7.19 GtCO2-e from 2015 to 2050. This represents
a reduction of 9% in 2015 and 34% in 2050 from the reference pathway
and total cumulative emissions of 287 GtCO2-e from 2015 to 2050.
Under the 203 GtCO2-e (“203 bmt”) total greenhouse emissions are
capped at 7.19 GtCO2-e (a reduction of 9% below the reference) in 2015
and declines linearly to 3.06 GtCO2-e (a reduction of 72%) in 2050. The
emissions target in the most stringent case, the 167 GtCO2-e
(“167 bmt”) pathway, is set at 1.22 GtCO2-e in 2050, which represents
a reduction of 89% from the reference level.7 These three emissions Fig. 4. Total GHG emissions and allowance pathways.
pathways plotted as dotted-lines in Fig. 4 span the emissions targets
under various climate change proposals in the U.S. (Paltsev et al., 5. Scenario results
2007).
The emission targets cover carbon emissions from fossil fuel We analyzed the impacts on the U.S. under the three core scenarios
combustion and emissions from the other five Kyoto GHGs (methane with different assumptions about borrowing and sectoral coverage. In
(CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluoro- addition, we considered sensitivities to other policy-relevant issues–
carbons (PFCs), and sulfur hexafluoride (SF6))8, which are grouped as banking, low-carbon fuel standards, and offsets–and one sensitivity of
landfill methane, coal mine methane, methane natural gas, other technology development where we severely constrained the U.S.'s
methane, other process carbon emissions, agricultural nitrous oxides, ability to build new nuclear units. Table 1 summarizes these fourteen
mobile nitrous oxides, other nitrous oxides, and high global warming scenarios whose results are discussed in the following sections.
potential gases.9
Based on the three emissions pathways, the “core” scenarios cover
all sectors of the economy with full flexibility in banking and 5.1. Core scenario results
borrowing. For all scenario cases, allowances are distributed for free,
which is equivalent to recycling them back to the representative The three core scenarios assume full flexibility of banking and
household in the model on a lump sum basis. Offsets provide an borrowing and include all sectoral emissions under the cap. Therefore,
opportunity to reduce the costs of the policy if designed properly. an emissions allowance must accompany each ton of GHG emitted.
Emission reduction costs can therefore be lowered by expanding the Because of this, the total price of these fuels increases. The allowance
available pool of offsets. Given the potential benefit and availability of price of these allowances for the three scenarios (EMF_1 287, EMF_1
offsets, we assume that only 20% of the cap can be satisfied by 203, and EMF_1 167 — see Fig. 5) starts at $12, $37, and $67 per ton of
purchasing bio-sequestration offsets.10 The MRN–NEEM model does CO2-e in 2015 and rises by the rate of interest of 5% to reach $67, $200,
not explicitly represent the rest of the world and hence the terms-of- and $370 by 2050, respectively.13 The allowance prices for these
trade impacts are only weakly modeled as an exogenous feedback scenarios are shown in Fig. 5. The flexibility of the banking and
from the impact observed in the international model, MS-MRT.11 The borrowing provision allows emitters to either save allowances for
international energy price feedback due to the policy change is future use when the emission targets are more stringent or borrow
simulated in the MS-MRT model and imposed in all scenarios from the pool of future allowances to reduce near-term costs.
(Bernstein et al., 1999b).12 Allowing banking and borrowing causes the present value of the
Besides the three core scenarios, we discuss the results of limited allowances to be equalized across all time periods, and the flexibility
coverage and no borrowing scenarios. In addition, we provide model of fully tradable allowances across sectors results in prices being
results for five additional sensitivities (a nuclear build constraint, a equalized across all sectors.
low-carbon fuels standard, an expansion of availability of offsets, a no Under the less stringent emission target of EMF_1 287, the emissions
banking case, and a no bio-sequestration offset case) using the are above the emissions target for the first two policy years (2015 and
“203 bmt” pathway. The full description of the assumptions, the 2020). This implies that it is cost effective to emit more than the target
corresponding emissions pathway, and the labels used throughout the level in the short run by borrowing allowances from the future. This is
paper are provided in Table 1. only possible because the long-run target does not require large
abatement. Therefore, it is beneficial to borrow allowances in the
6
short-run under this policy. However, for the other two core cases, the
Most of the climate change proposals start emissions target in 2012. For modeling
emission targets tighten quickly, such that near-term reductions appear
purposes in the MRN-NEEM model we start the emissions target in 2015.
7
See Fawcett et al. (forthcoming) for detailed discussion of the scenarios. less costly than longer-term reductions. Therefore, banking occurs under
8
The Global Warming Potentials (GWPs) values for these gases are calculated over these policies, and the actual emissions are below the emission targets in
100 year time horizon (IPCC, 1995). the near-to medium-term and above the allowance path in the long-run.
9
The baseline levels for the non-CO2 emissions are based on the EIA's S1766
In these more stringent cases, allowances need to be borrowed from the
Analysis (2008). The underlying MAC curves for the non- CO2 and bio-sequestration
offsets are described in Smith (2007).
future when lower-cost technology options are exhausted and the cost
10
Bio-sequestration offsets include soil sequestration, afforestration, and forest of abatement increases. Fig. 5 shows that under EMF_1 167, more
management activities. banking occurs in the short-run to cover the expected high allowance
11
Multi-sector, Multi-region Trade (MS-MRT) model is a forward looking dynamic price in the future. The sensitivity to the banking and borrowing
computable general equilibrium model of the world developed by CRA International.
12 assumptions will be discussed in the subsequent sections.
In the model we only take change in energy price feedback. This means that for the
non-energy goods we assume that the international price remains the same as in the
13
Reference case. All prices throughout the paper are expressed in 2005 dollars.
 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234 S227

Table 1
Scenario definitions.

Cumulative emission target International terms of Sectoral Banking Borrowing New nuclear Domestic offsets as a share of LCFS
(BMTCO2-e) trade feedback coverage capacity allowance submission
EMF_1 287 287 Yes Full Yes Yes 100 GW 20% availability No
EMF_1 203 203 Yes Full Yes Yes 100 GW 20% availability No
EMF_1 167 167 Yes Full Yes Yes 100 GW 20% availability No
EMF_2 287 287 Yes Limited⁎ Yes Yes 100 GW 20% availability No
EMF_2 203 203 Yes Limited⁎ Yes Yes 100 GW 20% availability No
EMF_2 167 167 Yes Limited⁎ Yes Yes 100 GW 20% availability No
EMF_3 287 287 Yes Full Yes No 100 GW 20% availability No
EMF_1 287NoSink 287 Yes Full Yes Yes 100 GW 20% availability⁎⁎⁎ No
EMF_1 203NoSink 203 Yes Full Yes Yes 100 GW 20% availability⁎⁎⁎ No
EMF_1 167NoSink 167 Yes Full Yes Yes 100 GW 20% availability⁎⁎⁎ No
EMF_1_203NoBnk 203 Yes Full Yes Yes 100 GW 20% availability No
EMF_1_203LCFS 203 Yes Full Yes Yes 100 GW 20% availability Yes⁎⁎
EMF_1_203Offset 203 Yes Full Yes Yes 100 GW 100% availability No
EMF_1_203Nuke 203 Yes Full Yes Yes 25 GW 20% availability No

⁎Limited sectoral coverage exempt agriculture, services, motor vehicles and manufacturers.
⁎⁎California low carbon fuel standard (LCFS) applied nationwide.
⁎⁎⁎No afforestration, soil sequestration, and forest management offsets.

Each sector's response to a carbon policy depends upon the
carbon intensity of the sector and its abatement options. The dif-
ferences in the percentage sectoral emission reductions reflect the
great differences in abatement costs across sectors (see Table 2
below). That is, in 2030, the marginal cost of abatement between the
electricity and household sectors is equalized once the electricity
and household sectors have reduced their emissions by 50% and 15%,
respectively.
In the absence of administrative costs, an efficient cap-and-trade
system would even cover sectors with a relatively small potential for
near-term emission cuts. Even though the electricity sector is the largest
single source of emission reductions, other sectors' cumulative
contributions are nearly equal to the reduction in the electric sector.14
It should be recognized that a great quantity of reductions come from
offsets whose availability and costs are uncertain. In the absence of these
offsets, the burden would increase for the electricity sector and others.
5.2. Impacts on energy price and use
energy than other fossil fuels, is adversely impacted. Consequently,
the demand for coal falls sharply, declining by 20%, 58%, 83% for EMF_1
287, EMF_1 203, and EMF_1 167, respectively in 2025. From today's
production of 1161 million tons, coal production falls to a low of
260 millions of tons by 2025 for the most stringent case. During this
time period, emission reductions are driven by price-induced energy
conservation and a massive replacement of coal by natural gas in
power generation. By 2025 almost all existing coal-fired power plants
are retired and, thereafter, the trends reverse as technologies for
advanced coal technologies with CCS become available. Advanced coal
with CCS replaces natural gas for power generation. If the industry
remains capable of such recovery, coal production may again increase
(see Fig. 7). The impact on the coal market can be observed from the
change in the technology portfolios for electricity generation (see
Fig. 8).
As the emission targets tighten, the role of CCS along with
renewables becomes more important and viable at the expense of coal
in the short-run and natural gas in the long-run.

The delivered cost of energy (inclusive of the carbon cost) will rise 5.4. Impacts on the transportation fuel markets
and induce energy users to change their behavior either by reducing
energy consumption or substituting with relatively cheaper forms of As the emission targets tighten, more and more emission
energy. Regional energy price impacts differ as costs of delivering reductions are required. Because of its lower marginal cost of
energy vary by region. At the national level, electricity rates for abatement, the electricity sector initially undertakes the greatest
households rise by 14%, 35%, and 58% in the years 2025 for the three percentage of reductions. But as this sector becomes increasingly
core cases — EMF_1 287, EMF_1 203, and EMF_1 167 (Fig. 6a), decarbonized, the marginal cost of abatement rises quickly, making it
respectively. In the EMF_1 167 case, advanced technology such as coal- cost-effective to undertake a greater amount of emission reductions in
fired generation with CCS becomes available in 2030 and displaces gas
in the electricity sector. As a result, gas demand in the economy and
gas price decreases. The reduction in gas price in 2030 compared to
2025, in the most stringent case, also translates into lower electricity
price in 2030. Hence we see a dip in 2030 in the natural gas and
electricity prices. However, as the allowance price continues to rise as
the abatement level becomes more stringent, electricity prices also
increases over time. In the short run, natural gas prices rise (net of the
allowance price) because of the greater demand for natural gas in the
electricity sector, as it is the most cost-effective reduction option in
the near-term.

5.3. Impacts on the coal and gas markets

As already noted, the carbon policy operates primarily through

raising energy prices. Coal, which contains more carbon per unit of

14
This includes reduction from non-CO2 offsets and sink sources. Fig. 5. Allowance prices.
S228 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234

Table 2
Percent change in emissions by scenario and sector in 2020 and 2050.

Scenario and sector Reference emissions Scenario emissions Reduction from reference Sectoral share of
(MtCO2-e) (MtCO2-e) reduction
2025 2050 2025 2050 2025 2050 2025 2050
EMF_1 287
Agriculture 166 220 158 179 − 5.0% − 18.8% 0.7% 1.1%
Households 1261 1785 1233 1710 − 2.2% − 4.2% 2.5% 1.9%
Energy intensive sectors 981 1379 920 1066 − 6.2% − 22.7% 5.3% 8.0%
Electricity 3055 4197 2546 2297 − 24.0% − 86.5% 44.7% 48.7%
Government 58 67 57 64 − 1.6% − 3.8% 0.1% 0.1%
Motor vehicle 20 21 20 18 − 3.8% − 14.0% 0.1% 0.1%
Manufacturing 81 94 79 83 − 2.8% − 12.4% 0.2% 0.3%
Refined petroleum products 133 162 127 137 − 4.8% − 15.3% 0.6% 0.6%
Services 199 241 191 207 − 4.3% − 14.1% 0.7% 0.9%
Commercial transportation 787 1129 772 1063 − 1.9% − 5.8% 1.3% 1.7%
NonCO2 1530 1530 1290 1158 − 15.7% − 24.3% 21.1% 9.5%
Bio-sequestration − 259 − 1061 22.8% 27.2%

EMF_1 203
Agriculture 166 220 145 150 − 12.7% − 31.7% 0.8% 1.1%
Households 1261 1785 1189 1439 − 5.7% − 19.4% 2.7% 5.5%
Energy intensive sectors 981 1379 840 872 − 14.4% − 36.8% 5.3% 8.0%
Electricity 3055 4197 1695 386 − 74.5% − 180.1% 50.8% 60.4%
Government 58 67 55 60 − 5.2% − 10.1% 0.1% 0.1%
Motor vehicle 20 21 18 15 − 10.5% − 26.5% 0.1% 0.1%
Manufacturing 81 94 74 71 − 9.0% − 24.4% 0.3% 0.4%
Refined petroleum products 133 162 115 99 − 13.8% − 38.9% 0.7% 1.0%
Services 199 241 177 179 − 11.1% − 25.6% 0.8% 1.0%
Commercial transportation 787 1129 738 844 − 6.3% − 25.2% 1.8% 4.5%
NonCO2 1530 1530 1159 1009 − 24.3% − 34.1% 13.9% 8.3%
Bio-sequestration − 607 − 611 22.7% 9.7%

EMF_1 203 NoSink

Agriculture 166 220 139 135 − 16.2% − 38.7% 1.0% 1.3%
Households 1261 1785 1165 1028 − 7.6% − 42.4% 3.5% 11.4%
Energy intensive sectors 981 1379 806 782 − 17.8% − 43.3% 6.4% 9.0%
Electricity 3055 4197 1156 265 − 62.2% − 93.7% 69.8% 59.3%
Government 58 67 54 57 − 6.9% − 14.7% 0.1% 0.1%
Motor vehicle 20 21 18 14 − 13.3% − 33.5% 0.1% 0.1%
Manufacturing 81 94 71 65 − 12.0% − 31.5% 0.4% 0.4%
Refined petroleum products 133 162 109 67 − 17.8% − 58.8% 0.9% 1.4%
Services 199 241 170 163 − 14.6% − 32.3% 1.1% 1.2%
Commercial transportation 787 1129 724 614 − 8.1% − 45.7% 2.3% 7.8%
NonCO2 1530 1530 1139 1009 − 25.6% − 34.1% 14.4% 7.9%
Bio-sequestration

EMF_1 167
Agriculture 166 220 134 129 − 19.4% − 41.3% 0.8% 1.2%
Households 1261 1785 1147 701 − 9.0% − 60.7% 2.9% 14.6%
Energy intensive sectors 981 1379 780 748 − 20.4% − 45.8% 5.1% 8.5%
Electricity 3055 4197 820 232 − 117.2% − 184.9% 56.6% 53.4%
Government 58 67 53 56 − 8.4% − 16.8% 0.1% 0.2%
Motor vehicle 20 21 17 13 − 16.1% − 36.0% 0.1% 0.1%
Manufacturing 81 94 69 62 − 14.7% − 33.9% 0.3% 0.4%
Refined petroleum products 133 162 104 49 − 21.5% − 70.0% 0.7% 1.5%
Services 199 241 166 151 − 16.7% − 37.5% 0.8% 1.2%
Commercial transportation 787 1129 703 495 − 10.7% − 56.1% 2.1% 8.5%
NonCO2 1530 1530 1139 1009 − 25.6% − 34.1% 9.9% 7.0%
Bio-sequestration − 813 − 244 20.6% 3.3%

other sectors. In terms of emission reduction opportunities, the
transportation sector is the next sector to undertake substantial
reductions. The availability and cost of the low-carbon transportation
fuels–the zero-carbon alternative transportation fuel along with the
low-carbon transportation fuel (e.g., cellulosic ethanol)–play an
important role in mitigating the cost of the policy. Fig. 9 below
shows how in particular the zero-carbon fuel, which is much more
costly than gasoline, and the low-GHG fuel, with an emission factor
20% that of gasoline's, would start displacing conventional gasoline in
vehicle transportation. Under the EMF_1 287 scenario, even in 2050
with an allowance price of $71 per ton of CO2-e, the zero-carbon fuel is
not viable; however, with tighter targets in EMF_1 203 and EMF_1 167,
the production and consumption of low-carbon and zero-carbon
transportation fuels occur. The zero-carbon transportation fuel
becomes viable in 2040 in the EMF_1 203 case; while under the
EMF_1 167, the zero-carbon fuel comes online much earlier (in 2030)
and supplies about 16.4 EJ of the transportation fuel demand by 2050.
Under the EMF_1 203 case, by contrast, the demand for it in 2050 is
only 4.8 EJ. The transportation sector is 70% decarbonized by 2050 in
the EMF_1 167 case.
5.5. Macro-economic impacts
The overall economic cost of a policy can be measured in different
ways. It can be defined as an equivalent variation in income, a welfare
measure, over the infinite horizon which provides a money-metric value
of the efficiency of a policy change (Rutherford, 1999; Bernstein et al.,
1999a; Pizer and Koop, 2003). The welfare impact (Fig. 10a) losses in the
 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234
Fig. 6. Percent change in residential energy prices (%).
EMF_1 287 are quite small; however, in the EMF_1 167 welfare losses
increase from 0.74% in 2015 to an excess of 2% by 2050. Qualitatively GDP
also mirrors the welfare impact (Fig. 10b). GDP declines by 0.35%, 0.90%,
and 1.51% in 2025 for EMF_1 287, EMF_1 203, and EMF_1 167,
respectively.15
A more common policy cost measure is the change in household
expenditures, which represents the overall change in the standard of
living of a typical American family induced by the policy. It can be
15
Factoring in the loss in investment makes the GDP loss to be smaller than
consumption loss as the stringency of the policy increases. For example, in 2025,
consumption (with a share of about 65% of GDP) declines by 2.1% and investment
(with a share of about 20 %) declines by 1.4 %.Hence, GDP loss declines by 1.5 %; which
is lower than consumption loss in 2025 for EMF_1 167 case.
S229
Fig. 7. Coal demand in the electricity sector.
thought of as the amount of compensation that would have to be paid to
the average household to make them as well off as they would be if the
policy were not enacted. This measure takes into account changes in
wages and other income, increases in the cost of energy and other goods
and services purchased by the household, and changes in employment
and hours worked. It is the most comprehensive and accurate
representation of what the policies mean to an average American
family. To make the monetary losses more meaningful, the cost per
household is calculated by multiplying percentage changes in con-
sumption in future periods by current consumption expenditures.16 The
loss in consumption for a typical household in 2025 for the three core
cases is estimated to be $350, $940, and $1700 (see Fig. 10c and d).
6. Alternate scenario results
6.1. Limited sectoral coverage scenario results17
Climate change bills such as Lieberman–McCain (S280), Lieber-
man–Warner markup (S2191), and Bingaman–Specter (S1766) have
proposed caps that limit emissions in some sectors of the economy
and exempt others. In general, covered sectors tend to be the electric
power, transportation, and industry sectors, which together account
for 80% of U.S. GHG emissions. For example, some of the following
provisions appear in the afore-mentioned proposals: exempting
electric power units smaller than 10 MW; exempting facilities that
refine petroleum or coal-based fuels for the transportation sector and
emit less than 10 GtCO2-e per year; exempting methane; or simply
providing a different trading regime for HFCs.
This section assumes limited sectoral coverage and discusses
results for the three emission pathways. Emissions from agriculture,
manufacturing, motor vehicle manufacturing, and service sectors are
assumed to be exempted from the carbon constraint cost. However,
emissions from these sectors are counted towards the cap. This
provides a second best solution, as the non-exempted sectors incur
even a more disproportionate share of the burden. As a result, the
16
This yields a dollar figure for the loss in consumption per household that can be
interpreted with reference to today’s income levels rather than to 2050's income
levels.
17
In this scenario, we recycle lump-sum the carbon cost applied to the exempted
sectors back to the household and maintain the same emissions target. This means that
the sectors are only exempted from the carbon cost, but the emissions are counted
towards the cap. An alternative method would have been to reduce the cap by the
baseline emissions of the exempted sectors and not have any carbon cost associated in
these sectors. This scenario differs from a policy case where the emission target is
applied to the covered sectors only, which would produce a lesser impact than the
scenario discussed in this section.
S230 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234

Fig. 8. Electricity generation by type.

allowance price and the macro impact are higher than the corre- of this constraint (see Fig. 5, EMF_3 287 series). The allowance price in
sponding core case results. 2015 rises from $12 to $27 and in 2020 it increases from $16 to $20.
The allowance prices under the limited sectoral coverage increase This rise in short-run allowance prices increases the welfare loss from
by $5 in 2015 and $26 in 2050 for the EMF_1 167 case, whereas the 0.29% to 0.34% (EMF_1 287 vs. the EMF_3 287).
increase in allowance prices for the EMF_1 203 case are $2 in 2015 and
$11 per ton of CO2-e in 2050. The welfare loss in the limited sectoral 6.3. Sensitivity run results for EMF_1 203 core case
coverage for the least stringent case (EMF_1 287) is quite mild.
However, the intertemporal welfare measure loss for the EMF_1 167 Besides the timing and level of emission caps, uncertainty
increases from 1.44% to 1.53%, and for EMF_1 203 the welfare loss surrounds other provisions that might appear in any future climate
increases from 0.78% to 0.81%. change policy. This section considers and analyzes some of these
uncertainties, mostly ones pertaining to the core EMF_1 203 case. The
section first analyzes the impacts of disallowing banking. Next, it
6.2. No borrowing for EMF_1 287 results
analyzes sequentially the imposition of an LCFS provision, and
expanding the amount of offsets available, and the impacts of limiting
As discussed in the core case results section, we observe borrowing
the amount of nuclear generation, in that order.
in the flat emissions target scenario, EMF_1 287. Although borrowing
can provide flexibility in optimizing emission reductions, there is also
6.3.1. The effect of disallowing banking
the danger of it being used to manipulate the allowance market (e.g.,
Even though most of the climate change proposals include
defaulting on obligations to repay borrowed allowances) or inducing
banking, climate change bills such as Sanders–Boxer 2007 opted to
unintended economic consequences. By shifting emission reductions
forego this provision. Allowing banking improves economic efficiency
to the future, borrowing may potentially cause under-investment in
as it enables the use of allowances when the emission targets are
new technologies in the near-term. In addition, deferring reductions
severe. Hence, prohibiting banking would increase the economic
to the future may also distort the allowance auction market in the
costs.
long-run. Also, there is risk associated with enforcement in the future.
This section explores the consequences of prohibiting banking in
To address these pitfalls of borrowing, we disallow borrowing in all
the EMF_1 203 core case scenario. With no banking, the marginal cost
years in the EMF_1 287 core scenario.18 Under the no borrowing case,
of abatement is equalized across sectors but not time periods such that
the rise in the allowance price in these years captures the shadow cost
the total emission reduction equals the corresponding year's emission
18
allowances. Hence, in the short-run, the allowance price would be
It should be noted that there is no borrowing observed in the EMF_1 203 and
EMF_1 167 core scenarios. Hence, there is no need to disallow banking for those runs.
lower than it would be with banking; and in the long-run when the
The EMF_3 287 case represents the no borrowing case corresponding to the EMF_1 287 policy calls for drastic reductions, allowance prices would rise to a
core case. much higher level than in the corresponding case with banking.
 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234
Fig. 9. Demand for transportation fuels.
With banking, emissions are reduced below the emission caps in
2015 through 2040, banking the difference for use in the 2045 and
2050 period. The infinite welfare loss increases from 0.78% (EMF_1
203) to 0.89% (EMF_1 203noBnk). Likewise, GDP change in the short-
run is smaller as a result of contraction in the economy while in the
long-run the GDP losses increases from 1.47% to 3.06% in 2050 (see
Fig. 11a). Therefore, not having banking provisions exacerbates the
long-run impact while mitigating the short-run impact. The long-run
negative impacts have unintended consequences in the short-run. We
see that the tight constraints in the future determine investment
choices being made today. Comparison of the no banking case with
the banking core case shows an additional 12 gigawatts (GW) of
additional IGCC with CCS in the banking case till 2040.
6.3.2. The effects of low-carbon fuel standard (LCFS)
Some policy makers argue that price signals are insufficiently large
to induce behavioral change needed for a reduction in transportation
fuel demand. They have argued for command-and-control measures
(e.g., CAFE or LCFS) to augment market-based policies for reducing
emissions from the transportation sector. This section considers the
impact of an LCFS policy layered on top of a cap-and-trade policy.
California's initiative to proceed with an LCFS has prompted federal
lawmakers to consider similar standards to address emissions from
the transportation sector.19 Following the California's LCFS proposal,
we impose a national LCFS which calls for a reduction of at least 10% in
19
Executive Order S-1-07, the Low Carbon Fuel Standard (LCFS) (January 18, 2007),
calls for a reduction of at least 10 % in the carbon intensity of California’s transportation
fuels by 2020.We apply the mandate to cover only transportation fuel use for personal
transportation.
S231
the carbon intensity of transportation fuels in 2020. We assume that
the LCFS starts in 2015 with a mandate for a 5% reduction in GHG
intensity, increases to 10% by 2020, and maintains this level of 10% till
2050. The LCFS can be met by either increasing the share of low-
carbon biofuels (corn-based ethanol, cellulosic ethanol, or zero-
carbon fuel) or by decreasing the quantity of gasoline in the blend or
both. The penetration and expansion constraint on these biofuel limits
its use in the short-run in the model to reflect the fact that ethanol
fuels cannot be produced in large quantities. The LCFS requirement
goes beyond what can be accomplished with gasoline, and the
available low-carbon transportation fuels which have very high near
term costs. Therefore, the effective delivered pump price of gasoline
must rise sufficiently to choke off the gasoline demand, induce the
purchase of lower carbon fuels, reduce vehicle miles traveled (VMT),
and increase the fuel economy of new cars. The shadow price of the
constraint is reflected in 2015 and 2020 where the LCFS is binding in
the model. The gasoline price rises in excess of 100% in the binding
years which, adds to the economic cost (see Fig. 11b). Beyond 2020,
LCFS is not binding because the allowance price from is high enough to
induce reduction in gasoline use which make the LCFS non-binding. In
this scenario, we see the clear operation of the economic principle that
regulatory programs leading to inefficient outcomes different from
the market response will increase costs. The increase in costs as a
result of LCFS is shown in the graph by the reduction in GDP in year
2015 and 2020.
6.3.3. The effects of increased availability of offsets for allowance
submission
Offsets can contribute to cost reductions by expanding the
opportunities for emissions reduction, thus lowering the marginal
abatement costs of a policy and lowering economic cost. In the core
scenario, we assumed that offsets were limited to 20% of the
S232 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234
Fig. 10. Macro-economic impacts.
allowance submissions requirement. The Offsets scenario examines
the economic impacts of removing this limitation. Fig. 11c illustrates
the reduction in allowance price as well as economic impact this
additional flexibility brings. Allowance prices in this scenario decline
by $5 in 2015 and by $22 in 2050 compared to the EMF_1 203 case. The
GDP impacts for this sensitivity also indicate that having more offsets
does improve macro-economic indicators.
6.3.4. The effects of nuclear capacity sensitivity
Policy impacts will depend greatly on the availability and cost of
low-emitting technologies such as nuclear power. Of the many
sensitivities that demonstrate this, we consider one representative
case to show the importance of technology costs and availability on
the impact of climate change policy. In order to capture this view, we
reduce the total cumulative new nuclear builds from 100 GW to
25 GW in this sensitivity run.
The recent increase in gas prices along with the possibility of some
form of carbon policy has renewed interest in nuclear power
construction, with utilities expressing interest to build 30 new
reactors (Parker and Hold, 2007). Since nuclear power emits no
GHGs, it has more cost advantages relative to coal-fired and gas-fired
generating units under a carbon policy. In view of the fact that no new
reactors in the United States have started up since 1996, expectations
of the number of additional reactors that can be built in the
foreseeable future are modest. The difficulty in securing Department
of Energy (DOE) loan guarantees, obtaining state commission up-front
prudence reviews such as guaranteed recovery of capital cost,
continuing uncertainties regarding final costs, as well as “not-in-my-
backyard” (NIMBY) issues restrain optimistic forecasts of future
nuclear builds.
Reducing the availability of nuclear capacity puts additional
pressure on the electricity sector to rely on other technologies to
reduce GHG emissions. New gas units increase in the short-run,
pushing up the gas demand and hence gas price in the absence of a
viable nuclear option. Over 100 GW of additional IGCC with CCS are
built to replace the loss of 75 GW of nuclear power (see Fig. 11d). The
infinite welfare loss increases from 0.78% (EMF_1 203) to 0.82% under
the constrained nuclear case (EMF_1 203Nuke).
6.3.5. The effects of unavailability of bio-sequestration offsets20
Bio-sequestration offsets (afforestration, soil sequestration, and
forest management) are important sources of emission reductions. In
the EMF_1 203 case, these sources alone provide a reduction of 607
and 611 million metric tons of CO2-e (MtCO2-e) in 2025 and 2050,
respectively (see Table 2). In the absence of these cheap reduction
sources, the allowance prices increase all three core cases (see Fig. 12).
For the EMF_1 203 case without these offsets, the initial allowance
price increases from $35 to $55 metric ton of CO2-e and hence
increases the cost of the policy. The welfare loss in EMF_1 203
increases from 0.78% to 1.09% while GDP losses in 2025 increase from
0.9% to 1.2% (see Table 3). The burden of abatement on the electricity
sector under the EMF_1 203 case increases from 51% to 70% by 2025. In
the long-run, though, the abatement burden shifts to the transporta-
tion sector as new technologies in the electric sector are either
exhausted or are no longer cost-effective.
20
A similar sensitivity was conducted in the CRA International's ACESA analysis.It
showed that the costs estimated would be much higher were it not for the use of
international offsets authorized by the bill (see Montgomery et al., 2009).
 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234 S233

Fig. 11. EMF_1 203 case sensitivity. Dotted lines in the panels (a), (b), and (c) refer to the alternative scenario results; while the bold line is the EMF_1 203 case results.

7. Conclusion a complementary role to play in climate change policy analysis. The

This paper uses a top–down, bottom–up integrated model to
analyze the macroeconomic impacts of U.S. climate change policies
that restrict cumulative emissions over the model horizon to 287, 203,
and 167 GtCO2-e. The integrated model couples a technology-rich,
bottom-up model of the U.S. electricity sector with a fully dynamic,
forward-looking general equilibrium model. Despite the differences in
the model structures, the two paradigms employed in this paper have
analyses in the paper show that if the models are coupled
appropriately, they can generate a wide range of both detailed results
and high-level macroeconomic results that are mutually consistent.
The results of our four sensitivity cases can provide some insights
for policy makers as they begin crafting climate change policies. The
sensitivity cases that prohibit banking and expand the availability of
offsets further demonstrate how compliance costs can be reduced by
including flexibility mechanisms. Offsets do face regulatory challenges
to ensure that they are permanent, independently verifiable, enforce-
able, measurable, and transparent. To the extent that any particular
offset fits these criteria, the results of the expanded offset sensitivity
strongly suggest that they should be pursued.
The compliance cost of any climate change policy depends critically
on the cost and availability of low-emitting technologies. The ‘limited
nuclear expansion’ scenario illustrates this point. Overall costs increase
by 5% when nuclear builds are limited to 25 GW from a 100 GW

Table 3
GDP and welfare impacts.

Scenario GDP Welfare

2025 2050
EMF_1 287 − 0.35% − 0.60% − 0.29%
EMF_1 287NoSink − 0.47% − 0.78% − 0.40%
EMF_1 203 − 0.90% − 1.47% − 0.78%
EMF_1 203NoSink − 1.15% − 2.25% − 1.09%
EMF_1 167 − 1.51% − 2.51% − 1.44%
EMF_1 167NoSink − 1.78% − 3.09% − 1.96%
Fig. 12. Allowance prices.
S234 S.D. Tuladhar et al. / Energy Economics 31 (2009) S223–S234
baseline. Viewing this result in the opposite direction suggests the
value of prudent R&D funding. Regulators should look at opportunities
to promote R&D in technologies that have a great potential to mitigate
the costs of complying with climate change policy.
The use of market-based mechanisms is far from being universally
accepted as the best means of achieving GHG reductions. Many people
advocate command-and-control measures. These policies make sense
if they are designed to correct pre-existing market failures. If not, they
can create unnecessary costs. The LCFS sensitivity shows that they can
have large hidden costs, unlike market-based mechanisms. The great
increase in near-term costs from adding the LCFS provision demon-
strates the risks inherent in implementing command-and-control
measures. Regulators need to be extremely careful not to put forward
an efficiency target that faces enormous technological hurdles.
Standards must be set with regard to the likelihood of developing
necessary technological solutions; otherwise, compliance costs will be
quite high.
As the climate change legislative debate gets underway in the
United States, it is imperative for decision makers and the public to
understand some of the impacts the legislation could have on the U.S.
economy and energy markets. In turn, these costs need to be compared
to the benefits of the specific proposal, and to the costs and benefits of
alternatives, in order to make an informed policy choice.
Three key and fairly intuitive conclusions emerge from the analyses
of the seven cap-and-trade scenarios around the three core emissions
pathways : (i) policies that combine market-oriented abatement
incentives with full flexibility are the most cost-effective; (ii) all else
being equal, for an emission control policy based on market-oriented
mechanisms, marginal abatement costs increase with the stringency of
the emission reduction targets; and (iii) real economic costs are likely
to be associated with climate change policies.
Acknowledgements
The authors would like to acknowledge the modeling contribution
of Professor Thomas F. Rutherford while at CRA International and two
anonymous referees for helpful comments and suggestions on the
draft version of this paper.
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