Lots of economists and analysts on both sides of the aisle prefer a carbon tax to a cap-and-trade system, but political reality is such that the former is exceedingly unlikely and the latter has become all but inevitable. So it's time to focus on doing it well.
One question that came up in the panel Q&A was this: what makes for a good cap-and-trade system? This subject is both enormously complex and enormously relevant to current politics. We need the grassroots to be engaged, pushing back against the many half-ass measures on offer, lobbying on behalf of good measures.
To engage, people need some simple guidelines. So at the panel, I chose three markers of a good cap-and-trade system. Obviously there could be others, but these seem to me to be points where pressure could create positive movement:
- Auction rather than give away permits. As Europe painfully discovered, when you give away emissions credits, it's a financial windfall for the biggest polluters and creates no incentive for them to change. Permits to pollute should be sold, and the market should decide their initial price. Edwards and Obama, at least, are on record supporting this approach; several bills leave it up in the air, or punt it to the EPA. It should be made explicit.
- Spend the revenue wisely. Auctioning credits will produce a great deal of revenue -- by some estimates, up to $50 billion. That revenue will provide a crucial tool to accomplish two goals:
- Spur the development and deployment of clean energy: do things markets don't do well, like investing in infrastructure (e.g., public transit), basic research, and protecting carbon sinks.
- Drum up political support: produce tangible benefit for voters, either by reducing other taxes (e.g., payroll) or by returning the revenue directly to citizens, as with Alaska oil revenue. (It's worth noting that auctioned permits with revenue returned to citizens is functionally equivalent to a revenue-neutral carbon tax.)
- No "safety valves." Some cap-and-trade bills (e.g. Bingaman's) contain measures that would allow unlimited selling of permits at a pre-set price per ton of CO2 (e.g., $12 for Bingaman's). The idea is to prevent the program from becoming "too expensive," but the practical effect is to sacrifice one of cap-and-trade's great benefits: predictability. The emissions cap will ratchet down in set intervals, at set times, and the price of carbon will steadily rise, allowing private actors to plan ahead. If the market is sporadically thrown open when prices get too high, businesses have incentives to hold out on needed long-term changes, or to game the system by manipulating prices. Note: this leaves open the possibility of reasonable cost-containment measures like the one contained in the Lieberman-Warner bill, which hold tight to long-term targets while allowing some short-term flexibility. There are ways to contain costs that don't screw up the whole system.
So: auction permits, spend the resulting revenue wisely, and don't short-circuit the system with safety valves.
We can all remember that, right?
N.Y. Sen. Kirsten Gillibrand answers Grist’s questions on the Kerry-Boxer bill
Ask Umbra on buying carbon offsets
Comments
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Sean Casten Posted 1:50 am
08 Aug 2007
Thank you for bringing this up - the devilish details are absent from much of the carbon conversation, even amongst the good guys, and critically important to start thinking about them BEFORE we get bad language buried in the minutiae of an omnibus carbon bill.
That said, I would add one more really important provision to your list of 3: Make it Economy-wide.
As many arguments around "leakage" have shown, carbon is slippery. If you put a price on it in one market but not in another, you can end up pushing it over rather than down. Thus, RGGI spends a lot of time worrying about whether the non-RGGI coal-fired generators in Pennsylvania will suddenly be able to sell below-market coal-fired generation into the RGGI states, causing the RGGI framework to simply push coal emissions one state over.
This idea is generally understood at the geographic level (witness the same core debate in the should-the-developing-world-pay fights in Kyoto). It is equally important - but less well understood - in the affected carbon markets themselves. Thus, for all the thought that went into Pennsylvannia coal in RGGI, comparably little went into the fact that it only covers power plants >25 MW, and therefore ~2/3s of the total emissions (those from transportation, thermal energy production and smaller power plants) are unaffected. This can create a leakage problem, since - at the right carbon price - we create incentives for businesses to shift from electric motors to mechanical drives fueled on site. It also removes many otherwise good choices from the electric side since - to take just one example - the generator who decides to recover their waste heat gets no carbon incentive to do so, since that recovery is in an unaffected market.
The counter in this particular case is that those projects can theoretically engage through offset markets, but those are hugely inefficient, and at the very least cannot be relied on to provide equivalent pricing to all carbon increases/decreases, and therefore will encourage economically and environmentally inefficient arbitrage.
Enough rant. Make them economy wide.
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Gar Lipow Posted 2:34 am
08 Aug 2007
An upstream cap-and-trade system along the lines outlined above is a good policy architecture. It will be effective, ensuring comprehensive control of carbon emissions. It will be cost-effective, allowing maximum flexibility for market responses and providing continuing incentives for development of alternative energy and energy efficiency technologies. It will be relatively easy to administer and enforce. It will provide ample opportunities to ensure fairness. It is politically viable. It links readily to domestic and international offset programs. It deals effectively with the problem of energy subsidies.
The advantages of an upstream system have been recognized by public and private policy research groups, including the Congressional Budget Office, Resources for the Future, and the Climate Policy Center.
The National Commission on Energy Policy has also endorsed a comprehensive nation-wide cap-and-trade program, implying an upstream approach. However, all these envisage price caps and other features that would make the architecture less effective and less cost-effective.
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Sean Casten Posted 2:50 am
08 Aug 2007
However, there is a separate and equally important question as to where the decision to deploy capital will occur. Put the price too far upstream of this point, and you end up diluting the effect of the price over those who would use it.
Again, RGGI is a useful example. As a practical matter, there is nothing significant that a remote power plant can do to reduce their carbon emissions. Once I have built and own a big coal plant, I can't shift it to gas. Once I have built a big gas turbine, I can't retrofit it to run on wind. And for all central power plants, I have consciously designed them to be far from electricity users, which means that I cannot economically recover the waste heat (and even if I could, they're far too large to serve single thermal users). So in this upstream market we end up with the price being charged upstream, but the guy downstream - be he a lumber mill who can use his sawdust waste to make power or a cogen developer who can size his power plant to a local thermal load - who can make significant (>50%) reductions in carbon emissions associated with power gen can't realize direct value from that investment. Yes, their avoided power price is a bit higher because of those upstream carbon fees, but those fees are spread across all customers. Mathematically, the carbon reduction caused by the local guy who is downstream of the RGGI regulatory framework is vastly less on a $/ton basis than is charged by the market. (Consider: if I'm downstream of the regulatory point, I get a benefit from avoiding purchased power based on the kWh I reduce rather than by the CO2 I reduce.)
In the parlance of the trade, this specific problem can be addressed with an "allocation to load" (as opposed to "allocation to generation") methodology, but it is specific. Smarter people than me can probably point out interesting wrinkles on other sectors of the economy.
Note that I'm not disagreeing that in general, upstream is better. Simply making sure we don't ignore the specifics that sometimes require exceptions to that rule.
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David Roberts Posted 2:58 am
08 Aug 2007
As Sean says, many of the upstream carbon sources are somewhat fixed -- they can't do much to reduce carbon. They can just raise prices, but those price-jumps will be so spread out and diluted that I'm not sure they'll be enough for any given downstream source to change behavior -- as opposed to just shrugging and paying a little more.
Make sense? Somebody point me to a 150-page PDF I can read about this!
grist.org
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Gar Lipow Posted 3:38 am
08 Aug 2007
Let's take the lumber mill guy who can produce electricity from waste sawdust vs. the coal plant.
To the extent he produces electricity for his own use, he recovers the full carbon price.
To the extent the coal utility is required to purchase the electricity at the same price the sawmill would have paid the coal company he also recovers the full the price.
So upstream provides the same incentive as downstream--provided the regulatory environment is right.
Incidentally, it is not a true that coal power plant cannot be converted into a natural gas one. Natural gas boilers are added to coal plants all the time worldwide.
Pure efficiency (and conservations)have exactly the same incentives under upstream and downstream systems. Cut your use, an you cut your (now more expensive) electric bill. Or maybe get "free" heat as side effect of producing electricity. Or get "free" (or salable) electricity as a side effect of that heat you are producing anyway.
It seems like only case where upstream permit can cause problems is in the case of small low carbon producers of electricity. (Large low carbon producers can compete directly for consumers with large high carbon producers.) And there is a simple regulatory fix for that. Whereas downstream permit levying takes away incentives for some of the biggest carbon producer.
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KiraMarch Posted 4:45 am
08 Aug 2007
Sean, cheers for the economy-wide provision.
And I have two more for the list:
Include a standard for biofuels. America's farmers can be a huge part of slowing global warming, but not all biofuels make the cut.
Make sure the government doesn't prop up particular technologies. We need inventiveness, flexibility and results, not favored technologies picked by Congressmen with consituents to please.
(More on the Environmental Defense Web site, if you care for more! http://www.environmentaldefense.org/page.cfm?tagID=1003)
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Gar Lipow Posted 8:18 am
08 Aug 2007
Mathematically, the carbon reduction caused by the local guy who is downstream of the RGGI regulatory framework is vastly less on a $/ton basis than is charged by the market. (Consider: if I'm downstream of the regulatory point, I get a benefit from avoiding purchased power based on the kWh I reduce rather than by the CO2 I reduce.)
If the downstream electricity user is buying permits, how is the charge calculated? Per kWh or per kWh with time of day considerations are the only alternatives I can see. Thus the avoided cost is exactly same per kWh regardless of whether it is levied upstream or down, other than transaction costs and game playing available in downstream transactions. Maybe I'm missing something...
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Sean Casten Posted 9:12 am
08 Aug 2007
The issue in RGGI is that the downstream user doesn't buy permits. He's not a generator over 25 MW and his other carbon-related purchases (fuel, etc.) aren't electricity and therefore don't reflect a carbon price. Thus, in one scenario, he lowers his load through efficiency and saves a penny with every kWh which equates to $10/ton and your math works. But now let's suppose instead that he installs a gas-fired generator to make power, but his power output is <25 MW. Again, every kWh of reduction gets a penny credit, but there's no adjustment for the marginal carbon emissions from his generator, since gas markets aren't covered in the RGGI model (and he's under the 25 MW threshold for electric sector participation). We may well still be lowering carbon emissions in this model if his efficient gas plant displaces an inefficient coal plant, but it is clearly less than the 100% reduction in the first case. BUT - his total savings are the same. Thus, we end up with a proportionally greater "credit" per ton of carbon reduction.
It's tempting to generalize that the biggest carbon value in this scenario is given to the worst actors, but it's actually even more complicated. Consider now that the guy has a carbon-neutral, biomass-fired power plant but
he recovers the waste heat to displace heat that otherwise would have come from a gas-fired boiler. Clearly, there is an additional carbon reduction there, but there is no differential benefit from that reduction since the boiler wasn't covered in the RGGI framework - and in this case, he could have an incentive NOT to recover heat and generate power if in so doing he reduces his generation output and there is a sufficiently high credit on the electric side that doesn't factor into the thermal side.
Make sense?
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msandler Posted 9:39 am
08 Aug 2007
Good job to Mr. Roberts for explaining things simply and correctly. I agree with his recommendations.
I think a carbon tax could be a price floor in a cap and trade system, and could help with the problem of price volatility.
Also, another way to compensate consumers would be to distribute Shares of the cap on a per capita basis, then let people sell their shares to the companies via banks. More information is at http://www.carbonshare.org.
-Mike
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Gar Lipow Posted 10:01 am
08 Aug 2007
The issue in RGGI is that the downstream user doesn't buy permits. He's not a generator over 25 MW and his other carbon-related purchases (fuel, etc.) aren't electricity and therefore don't reflect a carbon price. Thus, in one scenario, he lowers his load through efficiency and saves a penny with every kWh which equates to $10/ton and your math works. But now let's suppose instead that he installs a gas-fired generator to make power, but his power output is <25 MW. Again, every kWh of reduction gets a penny credit, but there's no adjustment for the marginal carbon emissions from his generator, since gas markets aren't covered in the RGGI model (and he's under the 25 MW threshold for electric sector participation
OK - but the problem here is not upstream vs. downstream, but the fact that some emissions are not captured. In fact the problem is that here you have a midstream, not an upstream permitting system. In a true upstream system the permit fees would be levied as fossil fuel was extracted or refined or imported. So your big >25MW producers would be paying permit fees with their fuel purchase as would your small <25MW producers.
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Sean Casten Posted 11:19 pm
08 Aug 2007
Sorry. I got lost in the thread and responded to an issue separate from the one you raised. Mea culpa. My point - which I think you correctly picked up on - is that if you don't go economy-wide you end up treating different tons differently, but this is not directly responsive to your point about going upstream.
As I think through your logic, I think I agree with the math, but need to think a bit about the details. In an idealized model where all upstream signals pass costs perfectly through the system, I think you're right. The question then becomes whether or not that idealized model is likely to come to pass. And on this, I just need to think a bit. My hesitation in saying categorically yes or no is that regulated utilities exist to subsidize. A true pass through that emerges unscathed through the sausage grinder of a utility is damn rare. But certainly possible (a case can be made that it's been done for wholesale power prices in the restructured states, but note that this has in part been via a utility bypass, where the end user buys kWh from one supplier and distribution from the utility).
Those implementation concerns aside, I take your point that if you get the details right, this could work. Now to those details...
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GreyFlcn Posted 11:39 pm
08 Aug 2007
What ya bet this means wasting it all on
"Clean" Coal
"Bio" Fuels
"Sustainable" Nuclear
Rather than real alternatives like:
Wind/Solar/Wave/Geothermal
No "safety valves."
Would banking be allowed?
Because this is one method I've heard of which would smooth over investment costs to make them much less erratic.
Would allow companies to plan ahead better.
Include a standard for biofuels. America's farmers can be a huge part of slowing global warming, but not all biofuels make the cut.
Correct.
Virtually none make the cut.
If it uses freshwater and farmland it's automatically disqualified from offering any greenhouse reductions.
Algae is about the only one left standing after that, and we don't even know if that one's going to work.
Biomass is an amazingly inefficient way to harvest sunlight.
http://greyfalcon.net/ethanol.png
http://greyfalcon.net/sugarsolar
Besides which, generic commodity farming never benefits small farmers.
http://greyfalcon.net/farmers2
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