Good and bad options for changing California’s cap-and-trade program

California has been an environmental leader for decades, but still numerous cities in the state struggle with air quality. As state lawmakers debate the future of the cap-and-trade program to reduce greenhouse gas emissions, can they also find ways to reduce other air pollutants -- like ozone and particulate matter -- that make people sick?

The answer is yes. But some options are better than others.

Analysis of California’s climate policy shows that big cuts are needed to meet the state’s 2030 greenhouse gas reduction goal – and these cuts to carbon emissions will probably reduce other pollutants as well. By modifying the cap-and-trade program, California can improve the likelihood that criteria air pollutants get cut, too. Some of these options would reduce the flexibility businesses now have to comply with the program. This includes the ability to trade allowances, bank (save allowances for future years if you don’t need them now), and use offsets (verified reductions that happen at approved projects in California or elsewhere; the state sets strict rules on what counts as an offset).

The problem with eliminating these compliance options is that the program would lose elements that provide cost containment. In other words, it would likely get more expensive overall to achieve the same greenhouse gas reductions.

For example, eliminating the ability to bank allowances might backfire. Since the program is oversupplied right now (that is, there are more allowances available than emissions), banking is one of the main drivers of allowance demand and prices. If that option goes away, businesses will lose a big price signal to reduce greenhouse gas emissions, and emissions might increase in the near-term.

Another option is to add regulations on top of the cap-and-trade program. The state could regulate greenhouse gas emissions from refineries, which are also a large source of criteria air pollutants. The state could also enhance existing regulations for those other pollutants. It’s hard to predict how much pollution reduction either of these options would deliver compared to extending the cap-and-trade program as is, but they would at least increase certainty about criteria air pollution (though they might miss a big source of these emissions in the form of cars and trucks).

Yet another option is to create a price ceiling for allowances so that if auction prices reach a specific level, they can go no higher. This option does not address concerns about air pollutants, but does address concerns that future prices will be too high. The program already includes a version of this feature in how its allowance price containment reserve (APCR) operates. In the APCR, the reserve of allowances is built by pulling forward allowances from future years. If auction prices reach a specific price, allowances from the reserve are auctioned into the market; if they reach a higher price, more are released. The reserve has not yet been used by California businesses. A "hard" price ceiling similarly provides more allowances to the market when prices are high, but has an unlimited number of allowances. The downside to a hard price ceiling is that if too many allowances enter the market, the state might miss its greenhouse gas target.

There’s also talk about replacing the cap-and-trade program altogether. It could be replaced with a tax-and-dividend approach (a direct tax on greenhouse gas emissions with the revenue returned in part or in full to consumers) or just direct regulation of greenhouse gases. The tax might not be able to achieve the 2030 reduction goal, and regulations would be more expensive and eliminate some programs that reinvest carbon dollars into projects that reduce emissions.

Eliminating the cap-and-trade program could actually increase emissions over the near-term for the same reason that eliminating banking would. Some businesses are investing today in clean technologies and processes to avoid future long-term carbon costs. If that long-term certainty goes away, those businesses might postpone or abandon their plans.

So what are the good options?

One idea is to expand the APCR with more allowances borrowed from the future. This would give additional confidence to market participants about prices while keeping the program’s climate ambition intact.

Another option is to add a surcharge or tax on the use of offsets. This would still let offsets serve their cost-containment function, but would make businesses think twice about using them and make sure that all other ways to directly reduce greenhouse gases had been explored first.

While there is some uncertainty about how a new regulation would perform (and interact with the cap-and-trade program), directly regulating the criteria air pollutants of concern is probably the simplest policy option to improve air quality.

Cities and businesses can make more resilient communities by working together

The impacts of climate change are being felt today – including more frequent and intense storms, heat waves, droughts, and rising sea level. These impacts take a human and economic toll on cities and the businesses operating in them. Despite the common threat, little guidance exists for how the public and private sectors can work together to prepare.

To address that gap, C2ES, in partnership with Bank of America created a Guide to Public-Private Collaboration on City Climate Resilience Planning. The guide outlines 13 recommended actions for city planners to invite and promote collaboration with businesses on climate resilience.

Working together makes sense because both public and private stakeholders want to see economic growth in their communities. Extreme weather events have caused more than $1 trillion in damage to the U.S. economy since 1980, and the intensity of these events is expected to worsen because of manmade climate change.

Storms can be particularly devastating for small businesses. The Hartford found 52 percent of small businesses affected by Hurricane Sandy in 2012 lost sales or revenue, and 25 percent of these businesses had to slow down or stop hiring.

C2ES brought together local government and business officials in Kansas City, Mo.; Miami Beach, Fla.; Phoenix; and Providence, R.I., to assess each city’s climate preparedness and prioritize resilience needs. Despite differences in each city’s geography, size, climate threats, and economic make-up, we found common insights into how to best foster city-business collaboration.

  • Resilience planning should be an extension of existing programs and partnerships. It requires involvement of officials in multiple city departments.
  • If cities demonstrate to businesses that climate resilience planning is a key priority, it’s more likely businesses will devote the resources to collaboration.
  • Businesses respond to data. By working with partners to find localized data on climate threats and vulnerabilities, cities can help articulate the business case for climate resilience planning.
     
  • ‘Business’ is not a monolith, and city climate resilience planners will need to tailor their approach. Small businesses, in particular, have unique needs.
     
  • Innovative financing can help promote collaboration. While not all climate resilience strategies will require additional funds, some will. The private sector is more likely to collaborate when they see that the city is committed to exploring all options for financing the steps in the climate resilience plan.

As the diagram below shows, business collaboration can be a part of every step of existing climate resilience planning frameworks.

 

Our recommendations supplement existing climate resilience planning frameworks.

 

City-business collaboration in times of disaster isn’t new. When Hurricane Sandy knocked out electricity to millions, American Water, the largest publicly traded U.S. water company, had more than 400 generators ready to keep providing clean water to its customers. The only problem was, the company didn’t have any place to store the fuel to run them. Local towns had fuel storage tanks, but no fuel. So, they worked together to move and store fuel to run not only the water pumps but also fire and police vehicles.

What’s needed is more collaboration before the fact, in light of new and increased threats. Providence, Rhode Island, faces increased flooding with sea level projected to rise as much as 2 feet by 2050. At our workshop, state officials, city departments, local businesses, universities, hospitals, utilities, and others started examining the risks and ways to respond. As Mayor Jorge Elorza put it, “We simply can’t afford to kick the can down the road.”

We hope this report will be a first step toward a climate resilience planning paradigm where cities and businesses work together to find the best ways to protect their communities from climate change impacts. We believe these important partners can achieve better results by working together.

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.