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Climate and Environment

CBO analyzes proposed policies for limiting damage resulting from pollution that affects the atmosphere, land, and water resources. Of particular concern to many policymakers are the increasingly large quantities of greenhouse gases, especially carbon dioxide, that are being emitted as a result of human activities, and CBO has studied a range of policies for reducing such emissions.

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  • Budgetary and Economic Effects of Climate Change Proposals
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Federal Financial Support for the Development and Production of Fuels and Energy Technologies

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March 6, 2012

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Highlights

Federal Support for Developing and Producing Fuel and Energy Technologies Totaled $24 Billion in 2011

  • Tax preferences totaled $20.5 billion, or about 85 percent of the total.
  • Funding for the Department of Energy’s (DOE’s) spending programs totaled $3.5 billion, or about 15 percent of the total.

Tax Preferences Were Mostly for Renewable Energy and Energy Efficiency in 2011, but Many of Them Have Expired or Will Expire Soon

The budgetary costs of tax preferences aimed at encouraging energy efficiency and energy produced from renewable sources (such as wind and the sun) increased considerably in 2006, when several new preferences came into effect. Some of those preferences have expired or will expire soon.

  • Four major preferences, each costing at least $500 million, expired in 2011.
  • Those expiring preferences accounted for about 60 percent of the total cost of tax preferences in 2011.
  • Credits for energy from renewable sources available under another preference are scheduled to expire by the end of 2013.

Only four major energy tax preferences are permanent: three are for fossil fuels and one is for nuclear energy.

Tax Preferences Are Generally an Inefficient Way to Reduce Environmental Costs of Producing and Consuming Energy

  • They may reward businesses for investments and actions they intended to take anyway.
  • They target only specific technologies, which may not be the least expensive technology in many cases.
Energy-Related Tax Preferences, by Type of Fuel or Technology

DOE's Spending Supports Direct Investments and Subsidized Credit Programs

  • Over 50 percent of the $3.3 billion in 2012 funding for direct investments by DOE is for energy efficiency and renewable energy programs.
  • Between 2009 and 2012, DOE provided an estimated $4.0 billion in subsidies for about $25 billion in loans, primarily to producers of advanced vehicles, generators of solar power, and manufacturers of solar equipment.
  • Federal support for energy research and development has often yielded benefits greater than costs; however, DOE's spending on large demonstration projects has produced mixed results.
  • Despite some R&D successes, the use of technologies aimed at improving energy efficiency and producing energy from renewable sources has been limited in part because consumers and businesses do not have to pay for the environmental damage or other costs to the nation from the use of fossil fuels and those fuels retained their commercial advantage as their prices fell.


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  • Deforestation and Greenhouse Gases

    January 06, 2012
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Deforestation and Greenhouse Gases: Infographic

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January 6, 2012

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  • Deforestation and Greenhouse Gases: Infographic

    January 06, 2012
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Deforestation and Greenhouse Gases

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January 6, 2012

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Highlights

Human activities produce large amounts of greenhouse gases (GHGs), primarily carbon dioxide (CO2), and thus contribute to global warming. The use of fossil fuels is the primary source of CO2 emissions, but the removal of trees from forested land has also contributed.

Mature forests, having absorbed CO2 from the atmosphere while growing, store carbon in wood, leaves, and soil. That carbon is released when people clear forested land and destroy the wood. From 2000 to 2005, the loss of forests, primarily in tropical developing countries, accounted for approximately 12 percent of global GHG emissions.

Slowing or halting deforestation in developing countries is a potentially low-cost way to help reduce global GHG emissions. For that potential to be realized, however, substantial challenges would need to be addressed—by providing technical and financial assistance to governments, by creating demand from private markets, or both.

Challenges in Reducing Forest-Based Emissions

If actions to support forest preservation are to play a cost-effective role in a significant international effort to reduce global GHG emissions, three broad challenges would have to be met:

  • Obtaining useful measurements of changes in the amount of carbon stored in forests,
  • Structuring incentives to reduce total forest-based emissions, and
  • Improving governance in developing countries.
Measuring Changes in Carbon Storage

Establishing programs to reduce emissions of greenhouse gases and assessing the effectiveness of those programs require methods for measuring emissions. In some cases, measuring them is easy—the electric power industry, for example, can use systems that directly, continuously, and accurately monitor CO2 emissions.

Measuring emissions resulting from deforestation is more complicated, however, because such emissions depend on the amount of deforestation and the carbon content of the wood that has been destroyed. Researchers can combine remote-sensing data about the amount of deforestation with information about the carbon content of the wood gleaned from on-the-ground inventories of the number and size of trees in sample areas to make such measurements. Most developing countries would need to improve their technical capabilities to process remote-sensing data and conduct inventories in order to effectively implement any program aimed at reducing carbon emissions from deforestation.

Structuring Incentives to Reduce Total Forest-Based Emissions

To reduce total forest-based emissions worldwide, the design of preservation programs must consider not only how much additional preservation would result but also how much “leakage” would occur—that is, how much of a forest program’s direct reductions in GHG emissions would be negated by additional GHG releases elsewhere. For example, a program that compensates people for preservation in one location might prompt a decline in the clearing of forested land for agriculture or timber production in that area, thus reducing supplies of those commodities and raising their prices. Higher prices, in turn, could encourage uncompensated landowners elsewhere to clear forests to produce agricultural products or timber to sell at the higher prices. Consequently, programs might need to compensate not only new preservation efforts aimed at threatened forests but also the continued preservation of forests that would not be threatened in the program’s absence. Leakage reduces a program’s cost-effectiveness, and significant leakage might negate the cost advantages that using forest preservation has in comparison with other approaches to achieving GHG reductions.

Improving Governance in Developing Countries

Weak governance—the inability to successfully design and implement policies to achieve stated objectives—undermines any efforts to use forest preservation programs to produce verifiable reductions in greenhouse gases. Even if they are motivated to participate in such programs, agencies in some developing countries may have inadequate authority for that task and may lack effective mechanisms for negotiating and distributing compensation to those who preserve forests. Also, the rights to any potential benefits from preserving forest resources may be poorly defined, making the gains from deforestation for agricultural and timber production and the use of wood for fuel more certain than the gains from preserving forests. Finally, government corruption and political instability can undermine laws that promote preservation.

Improving governance may be the most intractable of the three challenges. Of the 25 countries with the largest forest-based emissions in recent years, which together produced 95 percent of such emissions globally, nearly three-quarters rank in the bottom half of all countries on a key indicator of a country’s ability to govern—government effectiveness. That indicator measures, for example, the quality of policy formulation and implementation and the credibility of the government’s commitments to its policies. The World Bank, which tracks and reports measures of governance, rates the two largest emitters of forest-based CO2—Brazil and Indonesia—at roughly the 50th percentile in terms of government effectiveness.

Policy Approaches for Reducing Forest-Based Emissions

Approaches the United States and other developed countries could take to encourage forest preservation in developing countries fall into two broad categories:

  • Providing financial and technical assistance to governments interested in preserving forests and
  • Creating demand in private markets for reductions in forest-based greenhouse gas emissions.

The two types of policies might work best together. The viability of markets, for example, may depend on having in place a reliable program for achieving measurable reductions in forest-based emissions—the type of program that financial and technical assistance can help establish.

Assistance to Governments

Financial and technical assistance can help overcome some of the challenges of pursuing forest preservation. It can help support advances in measuring and monitoring changes in forest carbon, help ensure that developing countries have access to the technologies for doing so, and also help counter leakage by offering incentives for achieving global reductions in forest-based emissions. Given uncertain funding and the challenges of improving governance in developing countries, the United States and other developed countries could consider focusing efforts on selected countries—for example, Brazil and Indonesia—that have relatively reliable governance, that are rich in remaining forest resources, and whose experiences could inform subsequent policy development.

Markets for Forest-Based Emissions

The United States and other developed countries could also generate resources for reducing forest-based GHG emissions by creating demand in private markets for such reductions. They could do that by establishing cap-and-trade programs or by taxing GHG emissions and providing tax credits for those who fund forest preservation activities. The potential for forest preservation in developing countries to lower the private-sector costs of achieving a goal for global GHG reductions might motivate substantial funding from private sources.



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Deforestation and Greenhouse Gases

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January 6, 2012


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Response to Questions About Estimating the Budgetary Impact of a Bill Similar to S.2877, The Carbon Limits and Energy for America's Renewal (CLEAR) Act

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September 29, 2011

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Federal Loan Guarantees for the Construction of Nuclear Power Plants

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August 3, 2011

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Abstract

CBO's analysis examines the main factors that influence the cost to the federal government of providing loan guarantees for the construction of nuclear power plants. It includes illustrative cost estimates using the methodology specified by the Federal Credit Reform Act of 1990, which determines the budgetary cost of the program, and also estimates prepared on a fair-value basis, which provide a more comprehensive measure of cost. CBO found that the expected cost to the federal government of guaranteeing a nuclear construction loan varies greatly depending on a project's characteristics. Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates. However, because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee, either under credit reform or on a fair-value basis.


Highlights

Among the goals often posited for federal energy policy are to enhance energy security by diminishing the nation's reliance on foreign oil, to meet a growing demand for electricity, and to reduce greenhouse gas emissions by encouraging investment in clean energy production and technologies. To help further such objectives, the Energy Policy Act of 2005 (Public Law 109-58) established incentives to encourage private investment in innovative technologies, including advanced nuclear energy facilities. Much of the support for such investment is provided under title XVII of that legislation, which offers federal loan guarantees for the construction of nuclear power plants and other types of "alternative" energy facilities.

Administered by the Department of Energy (DOE), the loan guarantee program encourages private investment in nuclear energy by lowering the cost of borrowing and possibly increasing the availability of credit for project sponsors—usually an individual utility, a consortium of utilities, or a merchant power producer. In exchange for providing a loan guarantee, DOE is authorized to charge sponsors a fee that is meant to recover the guarantee's estimated budgetary cost.

However, budgetary cost estimates—which are calculated as required under the Federal Credit Reform Act of 1990 (FCRA)—are not a comprehensive measure of the cost to taxpayers of those guarantee commitments. Specifically, FCRA estimates do not recognize that the government's assumption of financial risk has costs for taxpayers that exceed the average amount of losses that would be expected from defaults; those additional costs arise because a borrower is most likely to default on a loan and fail to make the promised payments of principal and interest during times of economic stress, when the losses are especially painful for taxpayers. Consequently, the estimated budgetary cost of a guarantee is generally lower than its estimated "fair-value" cost, which approximates the market price that a private guarantor would charge for an obligation with similar risk and expected returns.

Because budgetary cost estimates are not a comprehensive measure of the taxpayer resources committed, and because of concerns about the accuracy of the methods and assumptions that DOE uses to forecast default rates and recovery values, some commentators have suggested that federal loan guarantees for the construction of nuclear power plants are being systematically underpriced, whereas others believe they are being overpriced.

For this study, the Congressional Budget Office (CBO) reviewed the many factors that can influence the cost to the government of guaranteeing loans for the construction of advanced nuclear facilities; developed a model to estimate guarantee costs for a representative loan using both FCRA-based and fair-value methodologies; performed a sensitivity analysis of those estimated costs to changes in assumptions about key drivers of cost; and explored the challenges inherent in attempting to charge borrowers the full cost of a loan guarantee. CBO's findings are as follows:

  • The expected cost to the federal government of guaranteeing a nuclear construction loan will vary greatly depending on a project's characteristics and on the economic and regulatory environment in which the project will operate. Important considerations include capital structure (the mix of debt and equity used to finance the project); ownership structure (whether it is a stand-alone project or part of a diversified company); whether construction costs may be passed on to utility ratepayers or local taxpayers; the regulatory environment; the degree of uncertainty about construction costs; the cost of competing generation technologies; and the demand for electricity. Although a serious nuclear accident could entail extremely large costs to investors and society, that risk has a small effect on the direct cost to the government of providing a guarantee because liability under the guarantee is limited to the amount of the debt, and the probability that such an accident will occur is low.
  • Default rates and recovery rates are likely to vary considerably, both across projects and over the lifetime of a given project. CBO does not have enough information to independently estimate an average recovery rate for nuclear construction loans. However, assigning a similar expected recovery rate as a starting point for all projects—which is DOE's current practice—does not appear to make full use of the information available to DOE through its detailed project assessment process. For example, when sponsors of stand-alone projects cannot pass on construction costs to rate-payers, very low recoveries may result if bankruptcy occurs during the construction phase. By contrast, recovery rates may be considerably higher once projects become operational.

    Using a single recovery rate tends to increase the variability of estimated guarantee costs relative to their true values, which increases the government's exposure to a phenomenon known as adverse selection. Adverse selection occurs when borrowers are better able than the government to assess the value of a guarantee offer and take advantage of their superior information at the government's expense. For nuclear construction loans, borrowers will tend to turn down a guarantee if they believe the fee set by DOE is too high but go forward if they consider it fair or underpriced, which increases the likelihood that DOE's portfolio will include more projects for which the subsidy fee has been underestimated than overestimated.
  • When credit ratings are used to assess default probabilities, cost estimates will vary widely with the assigned ratings category, the assumed recovery rate, and whether Treasury interest rates or estimated market interest rates are used for discounting. CBO relied on the information in historical credit ratings to impute default probabilities (as does DOE) and considered a range of recovery rates that might apply to different projects depending on their characteristics. As required under FCRA, budgetary estimates use Treasury interest rates for discounting future cash flows; fair-value estimates rely on estimates of the applicable market interest rates for discounting.
  • Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates, which provide a more comprehensive measure of the cost to taxpayers. CBO used the credit rating associated with a project to derive the discount rate the market would most likely assign to the loan cash flows. For example, if the risks associated with a guaranteed loan are in the range of those posed by bonds rated A (less risky) and bonds rated BB (riskier), and if 55 percent of the amount owed is expected to be recovered in the event of a default, the budgetary cost, measured on a FCRA basis, ranges from 1 percent to 6 percent of the principal loaned. In contrast, the fair value of the guarantee ranges from 9 percent to 21 percent of the principal loaned.
  • Because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee. When adverse selection is severe, attempts to offset expected losses with an increase in fees can backfire because the higher fees drive away creditworthy borrowers, making it impossible to provide a loan guarantee that does not involve a subsidy.

CBO relied on a credit-ratings-based approach to evaluate the probability of default rather than on the historical experience of the nuclear industry, for which not enough data exist to draw quantitative inferences. However, historical experience suggests that investing in nuclear generating capacity engenders considerable risk. One study found that of the 117 privately owned plants in the United States that were started in the 1960s and 1970s and for which data were available, 48 were canceled, and almost all of them experienced significant cost overruns. As a consequence, most of the utilities that undertook nuclear projects suffered ratings downgrades—sometimes several downgrades—during the construction phase.

However, bondholders experienced losses from defaults in only a few instances. Losses for the most part were borne by the projects' equity holders, the regions' electricity ratepayers, and the government. Supporters of nuclear power argue that newer plant designs and changes in the regulatory environment make nuclear investments less risky now, but recent experience abroad suggests that cost overruns and delays are still common phenomena, and concerns remain about an uncertain regulatory environment and changes in demand for electricity.

Finally, although the federal budget is intended to account for the costs of federal activities, it does not account for the benefits of such activities. As is the case with other types of federal spending, loan guarantees for the construction of nuclear plants might increase well-being by supporting activities that are valuable to society but that are unlikely to be economically viable without governmental support. In assessing the value of the program, such benefits must be weighed against the costs of those activities. However, an analysis of the benefits of loan guarantees for nuclear construction is beyond the scope of this study.



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Federal Loan Guarantees for the Construction of Nuclear Power Plants

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August 3, 2011


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The Effects of Renewable or Clean Electricity Standards

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July 26, 2011


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The Effects of Renewable or Clean Electricity Standards

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July 26, 2011

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Brief Comparison of Cost Estimates for Mandates as Prepared by CBO and by Federal Agencies for Selected Regulatory Rules

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May 20, 2011

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