Nov/Dec 2009

State News: August 2009


cap and trade 101

Cap and trade, some say, is the least complex method of lowering carbon emissions. While many agree the program may help address the problem of greenhouse gases, some in the industry have concerns about the cost of allowances proposed in legislation currently in Congress as well as the timeline for lowering emission levels.
By Mary Branham
In 2003, nine Northeastern states’ governors signed on to an effort to address the problem of carbon emissions.
The states worked through 2005 to iron out the details of a cap and trade program—the first of its kind in the country—that addressed carbon emitted by power plants.
“Carbon is a much bigger issue than just power plants, but we wanted to start someplace,” said Phillip Cherry, director of Policy and Planning for the Delaware Department of Natural Resources and Environmental Control.
The result, the Regional Greenhouse Gas Initiative, set a cap on CO2 emissions based on what the plants were emitting in the most recent past. RGGI, as the initiative is known, set the cap on plants that produce 25 megawatts of power or more. It calls for carbon emissions to remain stable through 2015. After that, power plants must reduce carbon emissions by 10 percent by 2019, according to Cherry.
RGGI also set a price for the allowances that allow a certain amount of emissions, and sells those allowances at auction. The idea, said Cherry, is to incentivize companies to make their power plants more energy efficient, fine-tuning them by switching fuel or moving toward more carbon neutral fuels like biomass.
“Cap and trade is about driving the least cost solution for lowering carbon emissions,” said Cherry.
While RGGI is still in its infancy, Cherry and others hope its successes will help steer the debate in Congress. The House approved the American Clean Energy and Security Act, which contains a cap and trade plan, in June; the Senate’s version, the Boxer-Kerry bill, was introduced in late September.
The goals of the federal legislation are similar to those of RGGI and other regional initiatives—to reduce greenhouse gas emissions over time. The difference comes in price: RGGI allowance prices have been around $3 a ton at auction; the federal legislation forecasts prices of between $20 and $30 a ton in a couple of decades.

Understanding Cap and Trade

Striving for that goal will be a huge undertaking. Thousands of different activities create greenhouse gas emissions, said Judi Greenwald, vice president of Innovative Solutions for the Pew Center on Global Climate Change, a nonpartisan organization formed to address climate change. That creates a complicated problem calling for a myriad of solutions—and setting up an effective and cost-effective program is complex, she said.
“Our view is that cap and trade is the least complex of the various ways you could attack this problem, but it’s a complicated problem and will have complicated solutions,” she said.
Here’s how a cap and trade program for power plants works:
First, the amount of allowable carbon emissions for power plants above a certain size threshold is decided based on emissions in previous years. That’s the cap.
“Because we need to see emissions reduced, we would make that cap smaller and smaller so those power plants over time would have to emit less and less,” said Franz Litz, a senior fellow at the World Resources Institute, an environmental think tank in Washington, D.C.
To accomplish that goal, the government—either nationally or regionally—issues allowances, each of which would cover one metric ton of emissions of a particular pollutant, in this case carbon, Litz said. Plants must measure and report their emissions annually, then surrender enough allowances to cover those emissions, he said.
Traditionally, the U.S. controlled pollutions under a command and control system, according to Daniel Chartier, director of Environmental Markets and Air Quality Programs for Edison Electric Institute, an association of shareholder-owned electric companies. That involved a specific rule and regulation on the amount of pollutant a plant could emit, and could be as specific as the amount per hour, Chartier said.
“Those were very effective,” he said. “Pollutions were coming down, permits were being met.”
But the program was expensive and cumbersome, said Chartier. “It was very labor intensive and required the regulator to know a lot more about a particular company’s operations than probably a regulator should know,” he said.
Researchers in the 1960s advocated a cap and trade system that would serve the same purpose, but at a much lower cost, Chartier said.
Such a system became part of the 1990 amendments to the Clean Air Act for controlling sulfur dioxide emissions—acid rain, he said. The allocation formula in the first phase represented a 25 percent reduction from historic levels, according to Chartier.
Companies would get those allowances based on a specific formula for the pollutant. They could comply with the regulation, Chartier said, in a number of ways: They could reduce emissions by installing technology, cut the utilization of a unit or burn a cleaner fuel, for instance.
Regardless, companies had to have allowances to cover their emissions. If any were still needed, they could turn to the marketplace to buy allowances from someone else. That’s the trade.
“The underlying economic theory in cap and trade is to make it more expensive to emit these pollutants,” Litz said.

Reaching for a Goal

Cost could eventually be an issue. While most everyone involved in the debate agrees something needs to be done to reduce carbon emissions, some are concerned with the economic impact of the pending legislation.
Under the House bill, for example, companies are given some allowances at no cost. But those free allowances are phased out by 2025, according to Chartier. Meanwhile, the reductions sought under the legislation grow over time, meaning companies need to continue to make reductions in carbon emissions.
That requires new technologies that haven’t been developed yet, Chartier said.
Greenwald of the Pew Institute said the House bill includes subsidies for development of technology like carbon capture and sequestration. That’s on top of the market that would be created for such technology because of the federal legislation, she said.
“Basically, when you have a cap and trade program, that creates demand for low carbon technology because there’s now a cost of emitting,” Greenwald said. “Everybody has an incentive to develop and sell technology that reduces emissions.”
But the industry is concerned about the short timeframe for developing technology that will help it cut emissions before they must buy all their allowances at auction.
The most promising technology, Chartier said, is carbon capture and sequestration, which has been tested in limited trials.
“Things that work at pilot scale, it’s not always, let’s just make it bigger,” Chartier said. “(Industry researchers) are dealing with, ‘how do we go from these small plants to actually demonstrating that it can be done 24/7 at the thousand megawatt level?’”
And that’s just the capture part. Sequestration demonstration projects are even more limited, Chartier said.
He said experts believe by 2020 there may be a full-scale demonstration project of both technologies. Deployment, he said, could then take another five to 10 years, well past the point companies are paying for their carbon emission allowances.
“The targets ought to be achievable,” said Chartier. “Finding the reduction targets that match with the technologies available today as well as matching with the availability of commercial technologies is extremely important.”
But Litz said a small portion of free allowances for entities working on technology deployment extends to 2050. The U.S. Department of Energy, Litz said, also receives allowances and is instructed to use the value of those to stimulate technology.

Mitigating an Economic Hit

Others fear a hit to consumers—and the overall economy.
West Virginia Gov. Joe Manchin, CSG’s current president, is worried about the hit his coal-rich state will take if the price of allowances gets too high. A $20 to $30 cost of allowance could double the price of coal per ton, putting coal-fired plants at a competitive disadvantage, he said. A much lower amount—such as $5 or $6 a ton for CO2 emissions—would mitigate the hit to consumers and the overall economy, he said. (See 10 Questions on Page 12.)
“If the rest of the world doesn’t follow suit, their energy is going to be much cheaper, especially the coal-fired units that’s in China and India and all these developing nations,” Manchin said. “We’re concerned that we’re going to lose more jobs.”
The House bill, Greenwald said, addresses that concern. It gives energy-expensive, trade-exposed industries free allowances until competitive nations set their own reduction targets.
“That particular problem about competitiveness is a pretty narrow problem because there are only a few industries for which energy is such a big part of their costs that they’re exposed to international competition,” she said.
Pennsylvania Rep. Chris Ross, chair of CSG’s Energy and Environment Task Force, said states must come up with new ways to address those lost jobs, if that happens.
“For states like Pennsylvania that have a large coal industry, and a lot of industries that are generating a lot of the greenhouse gases, we need to be thinking hard about how to reduce our greenhouse gases without negatively affecting our economic health,” he said.
That means investment in new cleaner energy and an alternative energy portfolio, and drawing manufacturers involved in the renewable energy sector, like windmill and solar technology production, he said.
Greenwald said in the economic modeling she has seen, the consumer won’t see much of a hit in the power sector until years later because of the early free distribution of some allowances. In fact, the Congressional Budget Office estimates the House bill would in 2020 have an average annual cost of $175 per household, the Pew Web site reports.
The cap and trade proposals in Congress cover the greenhouse gases in all sectors of the economy, not just power plant emissions like RGGI covers.
That means while the consumer won’t see an immediate impact in the power sector from the carbon reduction efforts set in cap and trade, they may see it elsewhere. The price of gasoline would likely rise by as much as 9 cents per gallon for every $10 added to a cost of the allowances, according to Litz.
By 2020, modeling forecasts an allowance price as much as $30 a ton for CO2 emissions. That would tack another 27 cents onto the price of a gallon of gas.
“As taxes go, it’s not huge,” Litz said, “but 27 cents might be enough to make some people unhappy.”
The idea, he said, is to create an incentive for people to emit less pollution. For drivers, that could mean using a more fuel-efficient vehicle or driving the same gas guzzler less, he said.
“The goal is to either change behavior or change technology, and probably a little of both,” Litz said.
—Mary Branham is managing editor of State News.
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