Addressing California cap and trade concerns

California’s cap-and-trade program received court affirmation this month that the state has authority to auction allowances. But questions remain about the program’s future.

California lawmakers are evaluating ways to achieve the state’s 2030 greenhouse gas reduction goal. One option, championed by Governor Brown, is to extend its cap-and-trade program. But some lawmakers are concerned the program isn’t delivering the expected revenues for state clean energy programs. Others worry it doesn’t do enough to provide equitable environmental co-benefits.

Could the single step of extending the program address these concerns? To some extent, yes.

The debate in Sacramento

Under California’s cap-and-trade program, operating since 2013, emissions are down and economic productivity is up.

But there are some areas of concern. Auction revenues are down. As I’ve noted before, low carbon prices don’t mean a cap-and-trade program isn’t working. They just mean the required emissions reductions are cheap. But California legislators want to use auction revenue to fund other projects like planting trees in urban areas and putting rooftop solar panels in disadvantaged communities. More importantly, a recent analysis shows emitters are more likely to be near disadvantaged communities, raising concern Californians won’t enjoy the co-benefits, like cleaner air, equally.

Legislators have proposed extending the cap-and-trade program through 2030, although they are debating restricting how it operates. Discussion continues about replacing cap-and-trade with a carbon tax approach. This tax proposal would seek to address the first concern, that allowance prices are too low to fund desired programs. Other debate centers around restrictions to force more emissions reductions to occur inside the state. Current rules allow for reductions at sources of electricity outside California, or at limited offset project sites in the U.S. and Canada.

Economic theory tells us that limiting emissions through a cap-and-trade program will achieve the environmental objective at the least cost, through business innovation. Could lowering the cap address other key concerns as well?

Tighter cap = higher revenues

The California Air Resources Board’s (CARB) 2017 Climate Change Scoping Plan Update (Scoping Plan) evaluates policy options to achieve the 2030 goal. The regulator’s preferred approach is to keep existing programs (like the state’s aggressive 50 percent Renewable Portfolio Standard), extend the cap-and-trade program, and require extra emissions reductions at in-state refineries. Its analysis concludes this would meet the 2030 goal, using market-based approaches to minimize costs while prioritizing in-state reductions.

Using the information in the Scoping Plan, let’s examine how CARB’s preferred policy approach would address concerns about revenue and equity.

First, compare actual auction revenue in 2016 with projections of how revenue might change if the cap-and-trade program were extended (see Table 1). Making some conservative assumptions, revenues could double by 2020, from $2 billion without an extended cap to $4 billion with an extended cap. The increase comes mostly from increased allowance demand that would be expected if the business community receives a long-term policy signal in favor of cap-and-trade. Auction revenue could reach $5 billion in 2025, even as the cap (and the number of allowances sold) declines.

Table 1. Relationship between allowance supply and state revenue.
2016 values are calculated from CARB data. Projections for 2020 are based on CARB’s projected auction volumes and our conservative price estimates. Projections for 2025 are estimated assuming a linear cap decline and no significant changes to program allocation rules. Current program rules set a minimum auction price of $15.40 in 2020. The minimum price would be $19.70 in 2025 under the current escalation rate.

Illustrative scenario

Annual allowance sales at auction (tons, all vintages*)

Annual average auction clearing price ($/ton)

Annual state revenue ($)

2016 actual values

168,076,078

$12.73

$2,139,608,473

2020 projection, BAU policy**

133,632,293

$15.40

$2,057,937,311

2020 projection, extended cap-and-trade policy***

259,197,485

$16.00

$4,147,159,760

2025 projection, extended cap-and-trade policy***

211,618,003

$25.00

$5,290,450,075

*The vintage is the first year in which the allowance is eligible for compliance. California currently auctions a small number of allowances three years in advance (“future vintages”), to promote price discovery and liquidity in the market.
**Assumes auctions are subscribed at same level as 2016, but no future vintages offered.
***Assumes current and future vintage auctions are fully subscribed
Source: CARB data and C2ES calculations.

These calculations are based on the observation that allowance demand (and prices) increase when businesses receive policy signals that buying allowances will be a good long-term investment. Experience in both Europe and the U.S. Northeast’s Regional Greenhouse Gas Initiative has borne this out. Each of those markets has had periods of low prices. When rulemakers responded by tightening the cap, allowance prices increased.

A key point from those experiences is that the market didn’t wait to respond after the agreed cuts took place – prices increased as soon as the legislation was passed. Legislators can boost state revenue for greenhouse gas reduction programs today by committing to the market through 2030.

Tighter cap = greater co-benefits

But what about concerns that the trading provision doesn’t allow disadvantaged communities to enjoy equal co-benefits, like fewer criteria air pollutants (SO2, NOx, PM 2.5), from the regulation?

It is worth noting that the cap-and-trade program is not the state’s sole policy measure aimed at reducing greenhouse gases. Figure 1 shows the reductions each measure in CARB’s preferred plan is expected to produce. The total reductions needed to meet the 2030 target are estimated at 680 million tons (Mt). CARB expects other policies will reduce at least 339 Mt and potentially 489 Mt (the figure shows the high value). The cap-and-trade program is expected to make up the difference, or 28-50 percent of the required reductions.

While a detailed analysis is required to estimate cap-and-trade compliance pathways, it is reasonable to assume that improved energy efficiency and substituting cleaner fuels would play a major role. These actions also reduce criteria air pollutants as a co-benefit. A potential 50 percent cut in these pollutants would make a big difference in the air quality near covered sources.

Figure 1. Projected emissions reductions from the policies included in the Scoping Plan analysis. 

Solid black dashes show historic statewide emissions. The dotted line shows a trajectory to meet California’s 2020 and 2030 targets. The colored areas show the reductions from each policy measure, including the potential new refinery reduction measure. The blue dashed area shows the reductions that the cap-and-trade program would need to achieve to meet the 2030 goal.
Source: California Air Resources Board

While cap-and-trade is not a perfect policy tool, it provides emissions certainty while minimizing costs to society. Economic theory and experience show that extending (and lowering) the cap can cause near- and long-term market impacts. These include increased auction revenue and reduced criteria air pollutant emissions, and help address concerns about revenue and equity through the existing cap-and-trade program alone. Other policy options are available – such as modifying the trading rules or creating additional location-specific reduction targets. But legislators may have a simpler option that takes advantage of the flexibility of market mechanisms: Cut the cap, and let businesses respond.

(Ashley Lawson is a Senior Solutions Fellow at C2ES. Next on the Climate Compass blog: How carbon capture could play a greater role in the ARB Scoping Plan.)

 

It's certain: The Earth is getting warmer, and human activity is largely to blame

The case for climate action is having a hard time in Washington these days. While public officials acknowledge the climate is changing, they’re not necessarily saying why or what should be done about it.

Let’s clear up a few points.

 

1.The Earth is heating up.

Scientists have measured global temperatures for over a hundred years and see that the Earth is getting hotter. The trend can be best visualized by comparing each year’s average temperature with the long-term average. This figure shows observations of the world’s annual average temperature made by the National Oceanic and Atmospheric Administration (NOAA). It compares each year’s temperature to the average over the entire century. Blue bars are years that were cooler than average and red bars are years that were warmer than average. In recent decades, the years have always been hotter. If there were no long-term temperature trend, you would expect a mix of red and blue bars throughout the record. That’s not what we see.

Source: The National Oceanic and Atmospheric Administration (NOAA)

 

2. Human activity is largely responsible for this warming.

Over geologic time, the Earth’s average temperature has changed as a result of the sun’s output, the tilt and position of the Earth in its orbit, and the concentration of greenhouse gases. Scientists have developed a good understanding of the natural variations in these factors by examining different proxies for ancient temperatures. Observations tell us that these natural factors have not been changing over the last hundred years or so in a way that would explain the observed temperature increases.

In contrast, greenhouse gases have been changing in a way that can explain the observed temperature increases. The pre-eminent record of modern atmospheric carbon dioxide (CO2) concentrations is based at the Scripps Institute of Oceanography. Researchers there have been sampling pristine air from a mountaintop in Hawaii every month since 1958 and analyzing its composition. Their observations show that both the concentration and isotopic composition of CO2 is changing, and is consistent with manmade sources, including the carbon emissions from burning fossil fuels.

Moreover, physics tells us how different climate variables will change the temperature of the atmosphere at different heights. For example, changes in solar output will heat the atmosphere uniformly, while changes due to greenhouse gases will warm the surface but cool the higher part of the atmosphere (the stratosphere).

The National Centers for Environmental Information, run by NOAA, conduct monthly observations of atmospheric temperatures at different levels. Its 39-year record shows that the temperature change is not uniform. This is consistent with the effect of greenhouse gases, and inconsistent with other types of natural effects (e.g., changes in the sun’s output).

 

3. The impacts of climate change are growing, and we need to stop adding to the problem.

The result of this buildup of greenhouse gases is that we’re trapping heat within the climate system. The basic physics behind this has been establish for over 100 years. But climate change isn’t just a matter of the air temperature being a few degrees warmer.

Some observed climate changes are not bad. For example, growing seasons are lengthening in some parts of the country and costs for winter heating go down when temperatures are mild. But the overall impacts are estimated to be negative and costly.

The good news is that we’re making progress, and that we have many of the tools right now to make a difference, including expanding use of renewable power; zero-carbon nuclear power, carbon capture, use and storage; energy efficiency technologies, and electric vehicles. Many businesses, cities, and states are pursuing clean energy and clean transportation to improve public health, save money, and create jobs.

The question is not whether climate change is happening, but what we want to do about it.

Making the Clean Power Plan work with city energy goals

Cities often lead the way on greenhouse gas reductions, even though they rarely control the operation of the power plants that supply their energy. So how can city initiatives work together with the federal Clean Power Plan to reduce carbon emissions from power plants?

One option is the Clean Energy Incentive Program (CEIP). The U.S. Environmental Protection Agency (EPA) included this early-action program as part of the Clean Power Plan and recently released program design details.

The program is voluntary. If a state chooses to participate, then certain renewable and energy efficiency projects can receive early action credits, including a federal match from EPA. These credits can be used for complying with the Clean Power Plan, so they provide additional financial incentives for clean energy projects.

While we can’t know the full value of the CEIP without knowing how many states participate and how power plants in those states comply with the Clean Power Plan, C2ES estimates the CEIP could drive up to $7.4 billion of private spending on clean energy projects across the country.

A key aspect of the CEIP is its support of project development in low-income communities. Solar and energy efficiency projects in these communities receive double credit, and a special reserve pool is created to make sure these projects can compete with large renewables for credits. This type of project development can support four key goals of city leaders:

1.     Taking action to fight climate change;

2.     Reducing energy bills for low-income residents;

3.     Bringing jobs and investment to the community; and

4.     Delivering co-benefits of renewable energy like cleaner air and water.

City leaders have the know-how to channel CEIP credits to their communities, but they will need to partner with their states and businesses to succeed.

Once states choose to participate, city leaders can help articulate the benefits of the CEIP. Cities can also provide data and support to project developers to streamline CEIP projects, especially low-income community projects that often face more hurdles. For example, they could help businesses locate communities that would host projects, work with utilities to identify potential projects, and build public-private partnerships to finance renewable energy.

How does it work?

Step 1: EPA creates a matching pool for each state. The amount of CEIP match available is limited, and EPA will divide the total pool among the states before the program gets started. If a state does not use its full share of the match, those credits will be retired. In other words, the CEIP is use it or lose it. Half of each state’s pool is reserved for low-income community projects and the other half for renewable projects like wind, solar, geothermal, or hydroelectricity.

Step 2: Interested states include the CEIP as part of their implementation approach. States must submit a plan to EPA that details how they will implement the Clean Power Plan. States that opt-in to the CEIP would have to declare that as part of their plan, and then they could receive the EPA match. If states opt out, then clean energy projects within their borders would not be eligible.

Step 3: New clean energy projects are developed in participating states. CEIP credits go only to new projects – renewable projects that start generating electricity on or after Jan. 1, 2020 or low-income energy-efficiency projects that start delivering energy savings on or after Sept. 6, 2016.

Step 4: New clean energy projects benefit the community. CEIP credits are awarded for electricity generated (renewables) or saved (energy efficiency) in 2020 and 2021. Starting in 2022, these projects are eligible for other financing opportunities under the Clean Power Plan.

Step 5: CEIP projects receive tradeable credits. States will verify how much clean energy a project is producing, then distribute the appropriate amount of CEIP credits (half from the state’s pool and half from EPA) to eligible projects. The project developers that receive the credits can sell them to power plants that need them to comply with the Clean Power Plan. CEIP projects don’t need the credits themselves because only fossil fuel-fired power plants are covered by the regulation. The value of CEIP credits will be determined by how power plants reduce their emissions.

The dates in the CEIP design details may change, depending upon the outcome of the legal challenge against the Clean Power Plan.

Conclusion

The CEIP will be open for public comment this summer. Once finalized, it will help promote new clean energy development in communities across the country. Its focus on low-income communities aligns it with other city priorities in addition to fighting climate change. The short timeframe of the program will make public-private collaboration a key to success in attracting CEIP projects.

C2ES, through our Alliance for a Sustainable Future with The U.S. Conference of Mayors, can be a valuable resource on climate policies like the CEIP. By communicating technical information in a meaningful way and facilitating the conversations between cities and businesses, we can advance clean and efficient energy.

California-Quebec auction hits a record low (and that's probably a good thing)

What if you held a sale and customers bought hardly any of your product? You might conclude that your product wasn’t very popular. If your product happened to be carbon allowances, essentially permission slips to emit carbon pollution, that lack of popularity sounds like a good thing for the climate.

This is essentially what happened last week when California and Quebec, who have joined their carbon markets, announced the results of their most recent auction of allowances. Companies who must buy allowances decided they didn’t need the full amount being offered, presumably because their emissions are declining.

California and Québec began their carbon markets in 2013, and the partners have held joint auctions of allowances every three months since November 2014. Each jurisdiction sets a limit on nearly all fossil fuel combustion at an amount that declines each year (the cap). Businesses responsible for that fossil fuel combustion have to buy allowances at auction to cover their emissions.

Historically, businesses have bought more than 90 percent of the allowances offered. But at the most recent auction, only about 10 percent of the allowances were sold.

This is great news. It means that carbon emissions are going down, and at a faster rate than the policy requires. If emissions were going up, prices at auction would be high. If emissions were going down at the same rate as the cap, then prices might be low but the auction would still sell out.

Market forces, like declining costs of renewable power, are part of the reason why emissions are declining. Businesses can use cost-effective alternatives to fossil fuels in their operations.

Also factoring into the results are the numerous other policies California and Québec have in place to drive down emissions, including ones aimed at increasing energy efficiency. That means businesses use less energy overall.

Is there any reason this might be considered bad news? Well, if you were counting on the money from the sale, it’s a problem.

California has anticipated generating billions in revenue through 2020 from the allowance auctions. But with few allowances sold, that state revenue source drops dramatically. California’s auction revenue is directed to various clean energy programs across the state, which means those programs could be in jeopardy if auction sales remain low.

So, is this an example of cap-and-trade working or not working? I would argue this is how cap-and-trade is supposed to work. The government sets a cap based upon its climate goals, the cap creates a price in the market, and companies incorporate the carbon price into their business decisions. If emissions are low (more accurately, if they are lower than the cap), then businesses don’t buy carbon allowances, pure and simple. Both California and Québec agreed upon rules for handling unsold allowances before their programs started, so businesses know what to expect.

A larger and more difficult question is whether this is an example of carbon pricing working. In both jurisdictions, the cap-and-trade program is only one of many policies aimed at reducing emissions. It’s unclear at the moment to what extent the carbon price is driving down emissions (and allowance demand) versus other policies. A sophisticated statistical analysis is required to answer that question, and as the cap-and-trade program continues there will be observations to enable just such an analysis. 

There is often a heated debate around implementing new policies, and it is not unusual to hear predictions that regulating carbon emissions will cause economic doom. But time and again, experience has shown that businesses adapt quickly to new conditions and keep doing what they’re good at – giving us the products and services we want to buy. That they’re doing this while keeping their carbon emissions below a set level is something to celebrate.

2015 was the warmest year on record

Image courtesy NOAA

This visualization from NOAA shows much warmer than average or record warm temperatures across much of the globe in 2015, the warmest year on record.

The data are in, and 2015 was officially the warmest year globally ever recorded. We’ve been keeping temperature records since 1880. The last time the record was broken? 2014.

What’s interesting is just how much warmer 2015 was. The observed annual average surface temperature was more than 1.8° F (1° C) above the 19th century average, according to the National Oceanic and Atmospheric Administration (NOAA) and the National Aeronautics and Space Administration (NASA). That’s already half the warming countries have agreed to as the international limit.

And 2015 was about a quarter of a degree Fahrenheit warmer than 2014. That might seem small, but it’s actually huge when compared to the year-to-year differences observed in the record.

A strong El Niño, when the surface ocean in the Eastern Pacific basin warms, contributed to the record warmth of 2015. But even compared to other El Niño years, 2015 set records. The agencies reporting the data attribute this to the long-term warming trend due to the increase of greenhouse gases in the atmosphere.

As with all climate and weather data, the 2015 data shows some variability. Not all locations set high temperature records, and parts of the North Atlantic Ocean actually set a cold temperature record.

In the contiguous United States, 2015 was the second warmest year on record, with 2012 still holding the top spot. It was the 19th consecutive year that the annual average U.S. temperature was more than the 20th century average.