Complementary Policies for Climate Change: Basis, Design, Strategy January 23, 2009 Holmes Hummel, PhD hummel@stanfordalumni.org www.holmeshummel.net/ClimatePolicyDesign 1

Complementary Policies Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Title XIII) 2

U.S. Approach: Cap-and-Trade Declining Cap Covered Entities

Polluters Compete for Scarce Permits

Carbon Price Established by Market Activity So, is it more profitable to: buy a permit, OR reduce my own emissions? Profit opportunities are a main driver for innovation and investment, and the climate challenge needs both.

Carbon Price Established by Market Activity $40 Would anyone accept $40 for your permit?

Carbon Costs Passed to Consumers $40 $40 $40 $40 $40 35¢ per gallon 2.5 ¢ per kWh 0.6 ¢ per therm People Respond…?

Achieving Reduction Targets To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy. 5000 4000 3000 2000 1000 6000 7000 $100 $80 $60 $40 $20 $120 $150 $250 $200 $150 $100 $50 $300 $350 $?? What price trajectory would be sufficient to drive people away from fossil fuels? Modeling results are highly uncertain Annual U.S. Emissions (MtCO2) Carbon Price ($/MtCO2) 2000 2100 2050 8

Moving to Clean Energy 2030 2020 2010 2050 2040 $100 $50 $200 $30 $150 Players seek better options as costs rise. Cap-and-trade lets players choose at what price they leave the game – and how they want to make that change. Rail Transport Hybrid vehicle Nuclear power $100 Solar power Wind power $50 Green buildings $200 $30 $150 $20

Achieving Reduction Targets 2050 Who will be the last greenhouse gas polluters left in the game? Unlike the familiar game of Musical Chairs, the last players still vying for pollution permits are not exactly winners… 10

Achieving Reduction Targets 2050 The last ones remaining in the game are those who: can afford to pay the most, or have the least flexibility to change games. The underlying assumption is that the most valuable uses of fossil fuels must be the ones for which people are willing to pay the most. To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy. 11

Market Conditions Perfect Competition Many small buyers and sellers Perfect freedom of entry and exit from the industry. Homogeneous products are supplied to the markets that are perfect substitutes. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market SELLERS BUYERS

Market Conditions Perfect Competition Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market

Market Conditions Perfect Competition Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market

Market Conditions Perfect Competition Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

Market Conditions Perfect Competition Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

Market Conditions Perfect Competition Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Low transaction costs No externalities arising from production and/or consumption which lie outside the market $/Btu? $??

Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Persistent transaction costs No externalities arising from production and/or consumption which lie outside the market $?? $/Btu?

Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Persistent transaction costs Many, Very Large Externalities – climate change is just one… $?? $/Btu?

Complementary Policies Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Title XIII) 24

#1 Complementary Policies Reduce the Cost of Price-Based Policies Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors

#1 Complementary Policies Reduce the Cost of Price-Based Policies ($/tonCO2) Abatement costs <$50/ton 100 90 80 70 60 50 40 30 20 10 -10 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

#1 Complementary Policies Reduce the Cost of Price-Based Policies ($/tonCO2) Abatement costs <$50/ton 100 90 A price on carbon will not address all the non-price barriers to reducing GHGs – or the price insensitive reasons people consume fossil fuels. 80 70 Residential electronics Residential buildings - Lighting Fuel economy packages – Cars Cellulosic biofuels Industry – Combined heat and power Conservation tillage Fuel economy packages – Light trucks Coal mining – Methane mgmt Industrial process improve-ments Commercial buildings – New shell improvements 60 50 40 30 20 10 -10 0.2 0.4 0.6 0.8 1.0 1.2 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 Commercial electronics -100 -110 -120 -230 Mid-range case, McKinsey 2007

#1 Complementary Policies Reduce the Cost of Price-Based Policies ($/tonCO2) Abatement costs <$50/ton 100 Natural gas and petroleum systems mgmt Afforestation of pastureland Reforestation Winter cover crops New coal power plants with CCS for EOR Biomass power – Cofiring Industry – CCS new builds on carbon-intensive processes Shift dispatch of existing plants from coal to natural gas Car hybridi-zation 90 80 70 Commercial electronics Residential electronics Residential buildings - Lighting Fuel economy packages – Cars Cellulosic biofuels Industry – Combined heat and power Conservation tillage Fuel economy packages – Light trucks Coal mining – Methane mgmt Industrial process improve-ments Commercial buildings – New shell improvements 60 50 40 30 20 10 -10 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

#1 Complementary Policies Reduce the Cost of Price-Based Policies ($/tonCO2) Abatement costs <$50/ton Reduction Target: 1 GtCO2e 100 Natural gas and petroleum systems mgmt Afforestation of pastureland Reforestation Winter cover crops New coal power plants with CCS for EOR Biomass power – Cofiring Industry – CCS new builds on carbon-intensive processes Shift dispatch of existing plants from coal to natural gas Car hybridi-zation 90 80 70 60 $40 / tonCO2 50 40 30 20 10 -10 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

#1 Complementary Policies Reduce the Cost of Price-Based Policies ($/tonCO2) Abatement costs <$50/ton Reduction Target: 1 GtCO2e 100 New coal power plants with CCS for EOR Shift dispatch of existing plants from coal to natural gas New coal power plants with CCS for EOR Shift dispatch of existing plants from coal to natural gas 90 80 70 60 $40 / tonCO2 50 40 $10 Billion 30 20 10 Residential buildings -Lighting Fuel economy packages – Cars packages – Light trucks -10 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

#2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels COST ($/tonCO2) Abatement costs <$50/ton 100 New coal power plants with CCS for EOR 90 80 70 60 50 40 30 20 10 Residential buildings -Lighting Fuel economy packages – Cars packages – Light trucks -10 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 Messages: This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton The opportunities are reported in increasing cost order BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured Almost a quarter of these measures, 7 Gton) are at negative or zero cost The opportunities are highly fragmented cross regions and sectors -80 -90 -100 Shift dispatch of existing plants from coal to natural gas -110 -120 -230 Mid-range case, McKinsey 2007

#2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels 32

#2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Carbon Price: $0/tCO2 $20/tCO2 Nuclear Coal Power Natural Gas Sets Price Sets Price Market Price Market Price Profit Profit Profit Profit Profit Dispatch Price per MWh Profit Dispatch Price per MWh 33

#2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Carbon Price: $0/tCO2 $20/tCO2 Nuclear Coal Power Natural Gas Sets Price Sets Price Market Price Market Price Profit Profit Profit Profit Profit Dispatch Price per MWh Profit Dispatch Price per MWh 34

#2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Gasoline Consumption Price of Gasoline ~$150/tCO2

World Resources Institute; 2003 data #3 Stabilization Requires Reducing Emissions Outside a Managed Cap of Measurable Sources CAP OFFSETS World Resources Institute; 2003 data

Complementary Policies Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Annex XIII) 38

Market Conditions Perfect Competition Energy Sector Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Persistent transaction costs Many, Very Large Externalities – climate change is just one…

Complementary Policies Market Conditions Energy Sector Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Persistent transaction costs Many, Very Large Externalities – climate change is just one… Complementary Policies Price-Based Policies

Market Conditions Energy Sector Price-Based Policies Few sellers, many buyers Homogeneous products are supplied to the markets that are perfect substitutes. High capital requirements and regulatory barriers to entry Lack of transparency Persistent transaction costs Many, Very Large Externalities – climate change is just one… Curing market failures Coping with market failures Covering emissions by sector Price-Based Policies

Designing Complementary Policies An “economy-wide” cap-and-trade policy does not distinguish between sectors End-Use CAP U.S. GHG Emissions U.S. Sources OFFSETS INSIDE U.S. World Resources Institute; 2003 data

Designing Complementary Policies End-Use Transportation Distance Mode Fuel Source Fuel Economy U.S. GHG Emissions U.S. Sources World Resources Institute; 2003 data

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Vehicle GHG Standards

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Vehicle GHG Standards

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards

Designing Complementary Policies End-Use Transportation Electric Power Sector U.S. GHG Emissions U.S. Sources World Resources Institute; 2003 data

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Million Solar Roofs

Designing Complementary Policies End-Use U.S. GHG Emissions U.S. Sources Industrial Gases World Resources Institute; 2003 data

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 u Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Million Solar Roofs F-Gases & Refrigerants

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 u Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Million Solar Roofs Sustainable Forests F-Gases & Refrigerants

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 u Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Other Million Solar Roofs Sustainable Forests F-Gases & Refrigerants

California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 u Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Cap-And-Trade Market Response Million Solar Roofs Sustainable Forests F-Gases & Refrigerants

Designing Complementary Policies End-Use U.S. GHG Emissions U.S. Sources CAP OFFSETS INSIDE U.S. World Resources Institute; 2003 data

Energy Intensive Industries Most of the Industrial GHG Emissions Covered by a Cap-and-Trade Policy are in 5 Sub-Sectors Energy Intensive Industries Capped

Most of the Industrial GHG Emissions Covered by a Cap-and-Trade Policy are in 5 Sub-Sectors ISO 50001: Int’l Energy Management Std. Capped

Complementary Policies for EE & RE National Action Plan for Energy Efficiency recommendations Renewable Portfolio Standard; Renewable Fuel Standard Generation performance standards; Low Carbon Fuel Standard Requiring efficiency to be an alternative in power plant EIS studies Remove barriers to grid access (“Free the Grid” report) Green power purchases and marketing Combined heat and power (CHP) standards, incentives, and/or barrier removal Public Benefits Charge – and all that it could fund

Policy Horizon On the Books: EPAct 2005 EISA 2007 Existing executive authorities across all departments Looking ahead: New Energy for America SAFETEA-LU (Transportation Reauthorization) Cap-and-Trade legislation Mass vs. EPA regulations

Complementary Policies Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Title XIII) 61

Supplemental questions on Smart Grid What does Smart Grid do? What characterizes a Smart Grid? What does Smart Grid deliver? … as specified in the Energy Independence and Security Act of 2007

What does a Smart Grid do? (EISA Title XIII) Dynamic optimization of grid operations and resources, with full cyber-security. Development and incorporation of demand response, demand-side resources, and energy-efficiency resources. Provision to consumers of timely information and control options.

What characterizes a Smart Grid? (EISA TitleXIII) Increased use of digital information and controls technology to improve reliability, security, and efficiency of the electric grid. Deployment and integration of distributed generation (e.g. renewable resources) Deployment and integration of advanced electricity storage and peak-shaving technologies, including plug-in electric and hybrid electric vehicles, and thermal- storage air conditioning. Deployment of `smart' technologies (real-time, automated, interactive technologies that optimize the physical operation of appliances and consumer devices) for metering, communications concerning grid operations and status, and distribution automation. Integration of `smart' appliances and consumer devices. Development of standards for communication and interoperability of appliances and equipment connected to the grid, including grid infrastructure. Identification and lowering of unreasonable or unnecessary barriers to adoption of smart grid technologies, practices, and services.

What does a Smart Grid deliver? (EISA Title XIII) The ability to measure or monitor electricity use as a function of time of day, power quality characteristics such as voltage level, current, cycles per second, or source or type of generation and to store, synthesize or report that information by digital means. The ability to sense and localize disruptions or changes in power flows on the grid and communicate such information instantaneously and automatically for purposes of enabling automatic protective responses to sustain reliability and security of grid operations. The ability to detect, prevent, communicate with regard to, respond to, or recover from system security threats, including cyber-security threats and terrorism, using digital information, media, and devices. The ability of any appliance or machine to respond to such signals, measurements, or communications automatically or in a manner programmed by its owner or operator without independent human intervention. The ability to use digital information to operate functionalities on the electric utility grid that were previously electro-mechanical or manual. The ability to use digital controls to manage and modify electricity demand, enable congestion management, assist in voltage control, provide operating reserves, and provide frequency regulation.

Complementary Policies for Climate Change: Basis, Design, Strategy January 23, 2009 Holmes Hummel, PhD hummel@stanfordalumni.org www.holmeshummel.net/ClimatePolicyDesign 66