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Kelly, the former president of Enron Cogeneration Company and the executive responsible for forming and building Enron Renewable Energy Company, has extensive experience in dealing with the issue of climate change in the commercial arena.

"I've been in both the fossil fuel and renewable energy markets for 20 years, and this issue has been a vigorously contested aspect of energy policy throughout that time," Kelly said.  "Given the current stalemate between the United States and the rest of the world on the greenhouse gas issue, I decided it was time to conduct a rigorous review, offer a solution and enter the debate."

Analyzing Three Scenarios to Confront Global Warming

Moving from prehistoric times to current and future periods, Kelly, who holds a Ph.D. in economics from Harvard University, analyzes three scenarios to deal with global warming:  the Kyoto Protocol scenario (KPS), the business as usual scenario (BAU), and the Optimal Carbon Path scenario (OPT).
The Kyoto Protocol to the United Nations Framework Convention on Climate Change in 1997 calls for significant reductions in the emissions of carbon from the burning of fossil fuels in developing countries over the next several decades.  The United States has refused to ratify the Protocol.  Kelly notes that the Bush Administration has good reason for its exceptions to the Kyoto Protocol.
"The Kyoto Protocol strives to provide a solution to the global warming problem by limiting the emissions of fossil fuels in developed countries at or below the levels that existed in 1990," Kelly said.  "But, there are no limits set on developing countries, and these countries will be the world's largest emitters of CO2 in less than 20 years.  If the 1990 emissions limit is imposed globally, however, as in the KPS scenario, the reduction in the use of fossil fuels will impose costs on the world economic system, especially on the United States, that far outweigh the benefits," Kelly said.  "It would attempt to fix the emissions problem at a significant cost relative to the BAU case."

The BAU scenario outlines a baseline climate trajectory, which is projected to occur in the absence of implementing the Kyoto Protocol or any other incremental policy designed to mitigate the growth in greenhouse gases.

"In the BAU scenario, market forces will ultimately drive the economic system to a new, less threatening energy regime at a cost significantly less than that which would be imposed under the KPS scenario," Kelly said.  "The BAU scenario, however, is not economically efficient and is fraught with future political risk.  Because the polluter emitting carbon does not bear the associated climate change costs, too much carbon tends to be emitted.  This will result in more damage to the global economic and environmental systems from increasing temperatures and rising sea levels, than would occur with the proper pricing of CO2."


The OPT scenario uses an integrated assessment model to select a carbon emissions trajectory that balances the costs of imposing a price on CO2 through a carbon tax, with the benefits of reducing climate change damage.  In the OPT scenario, a carbon tax of $26 per ton (in $U.S. 2000) is instituted beginning in 2015 and increases to $89 per ton by 2055.  The carbon tax would ultimately be phased out as carbon-based fuels are displaced.  Under the OPT scenario, consumers would see a net economic benefit of $13 trillion from reduced climate change costs, including reduced insurance and medical costs.

Attaining Global Participation and Resolution Through an International Carbon Fund

Kelly contends that one of the key requirements of dealing with global warming is to have a mechanism, which is both cost effective and provides all nations an incentive to join.  To be effective, the mechanism should achieve, through either a carbon tax or a permit trading mechanism, an effective price for carbon emissions.  To provide all members an incentive to join requires designing a policy that results in an equitable sharing of the burden both for developed and developing countries.  Kelly proposes that these results can be achieved by instituting a comprehensive International Carbon Fund (ICF).  The ICF would be an organization similar to the International Monetary Fund and the World Trade Organization.  It would initially include all developed countries, and all developing countries would be given an invitation to join. Each country that becomes a member would agree to adhere to six principles: 1) To price carbon, via the institution of a carbon tax surcharge, at a level determined by the fund based on the principles outlined in the OPT scenario; 2) To impose the optimal carbon tax using the taxation systems of their central governments; 3) 50 percent of the revenues would be kept by the member governments and used for income tax relief or other equivalent purposes as determined by each central government; 4) 50 percent of the revenues would be contributed to the fund, which would use the proceeds to finance clean development projects in the developing countries; 5) The carbon tax surcharge would be re-evaluated by the fund based on new information with a new carbon tax being set every 10 years; 6) The fund would institute methods to insure compliance by member countries.
Under the ICF proposal, the initial value of the carbon tax surcharge in 2015 would be approximately $2.58 per barrel of oil or 6.1 cents per gallon at the pump.  The end result of imposing this type of taxation would be to reduce the consumption of carbon based energy to a point where the long-run net benefits to consumers would be maximized.

Acknowledging the Unappealing Aspects of a Tax Increase  

"It could be tempting to skirt around the issue by simply appealing to a permit trading system," Kelly said.  "However, in either case, carbon-based energy prices will increase.  Implementation of a tax would be easier than that of a trading system, where the initial allocation of permits would need to be determined and a trading framework would need to be instituted, not just for industrial energy users but also for retail consumers."

Kelly admits that there are a number of thorny issues to resolve when imposing a carbon tax.  These include what type of tax to utilize, such as specific or ad-valorem, and at what level in the value chain to place the tax -- at the production or the consumption end.  Kelly suggests that the most direct way to levy the tax would be as a specific per ton surcharge on the cost of purchasing the quantities of carbon by end users.  This could generally be implemented through existing sales tax structures on the purchase of energy in most countries with little or no change in the administrative procedures that are in place to collect such taxes.  This type of tax would also directly change the cost of carbon-based energy to final users and most effectively allow the price effect to operate on demand.  If the tax is imposed as a distinct surcharge attributable to the ICF, then the political impact can be somewhat deflected from the national to the international community.


The present value of the revenue, which could be collected under the ICF proposal, would be $27.5 trillion in year 2000 U.S. dollars.  Under the proposal, 50 percent of this amount would be redistributed to countries from which it was collected to reduce income taxes.  The other one-half would be redistributed to developing countries to fund clean development projects.
"An offsetting income tax reduction should soften the blow and lessen the political opposition to the carbon tax," Kelly said.  "The fact that this measure was also taken by an international group of nations as part of a worldwide effort to combat the effects of global warming would help with the political fallout from the tax."


Moving the Global Warming Issue From Impasse to Resolution

The most controversial aspect of the International Carbon Fund is the provision that allocates 50 percent of the revenues collected from each member to developing countries to finance clean development activities.  Kelly admits there are several associated issues, including whether the proposal is politically sellable, how much money goes to which developing countries and thirdly, what projects are funded.

"From a sellable standpoint, the carbon tax under the Kyoto Protocol scenario is more than three times the present value of the carbon tax envisioned under the OPT scenario," Kelly said.  "The net economic benefit of the OPT Scenario is more than $39 trillion greater than that of the Kyoto Protocol Scenario."

Kelly proposes that the revenue be distributed to developing countries in the proportion to which they pay the carbon tax compared to their peers.  To further mitigate the burden faced by developed countries, Kelly suggests that some of the funds they had contributed could be recycled to their private sector entities for construction of projects in developing countries.

"Current efforts to resolve global warming are at an impasse," Kelly said. "If no action is taken to reduce carbon emissions, mankind will most likely survive, but the economic, political and environmental effects will be significant.  I believe it is time to bring the debate back to the forefront, and I think The Carbon Conundrum offers that opportunity."

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08/01/2002 08:02 EDT