Federal Cap-and-Trade Policy: Overview of Design Options Ray Hammarlund, KCC Energy Programs Division Director Presentation to Kansas Energy Council Greenhouse Gas Policy Committee, May 13, 2007

KEC GHG Policy Committee May 13, Point of Regulation  Accurate accounting for emissions requires understanding the chain of economic activity and selecting one point in the chain to be responsible for tracking emissions.  Point of regulation options (carbon):  Upstream: on entities that produce or extract fossil fuels (mining, drilling)  Midstream: on entities that process, transport fossil fuels  Downstream: on entities that actually emit CO2

KEC GHG Policy Committee May 13, Refinery, pipeline Mine, drilling Extraction UPSTREAM Processing, transport Power plants, factories Residential, vehicles Major direct emitters Other direct/indirect emitters MIDSTREAM DOWNSTREAM Chain of Economic Activity

KEC GHG Policy Committee May 13, Point of Control (Detail) downstream electricity generation Petroleum refiners and importers transportation large industrial and commercial sources Extracted coal upstream Transmission small industrial and commercial sources, residential sources Natural gas processors and importers Coal prep FIRST SELLERS/ LSEs LDC/ Distribution Extracted natural gas Extracted crude petroleum Vehicle Manufacturers

KEC GHG Policy Committee May 13, Natural Gas “downstream” electricity generation large industrial and commercial sources “upstream” Transmission small industrial and commercial sources, residential sources Natural gas processors and importers LDC/ Distribution Extracted natural gas

KEC GHG Policy Committee May 13, Upstream Most comprehensive coverage (leads to most cost-effective emissions reduction) Fewest entities to regulate: ~2,000 permit holders Easiest to monitor, enforce Lower administrative costs Reduce risk of leakage

KEC GHG Policy Committee May 13, Downstream More familiarity, experience (e.g., Acid Rain Trading Program) More gradual phase in of regulation Less comprehensive coverage; therefore less efficient More entities to regulate More expensive to monitor, enforce Increased risk of leakage

KEC GHG Policy Committee May 13, Upstream or Downstream? Some contend that downstream regulation is more likely to change emitter behavior; sends more direct signal to emitters to achieve reductions and invest in technology Others contend that emitters will respond to higher price signal regardless of who holds the permit—e.g., residential customers will respond to higher electric or natural gas bills

KEC GHG Policy Committee May 13, Allocation of Permits Advantages of giving away for free Politically expedient: gift of valuable asset encourages buy-in from powerful interests; gets cap-and-trade started. Disadvantages of giving away for free Government loses revenue from permit sales, which could be used to mitigate economic impacts, fund R&D, etc.

KEC GHG Policy Committee May 13, Allocation of Permits Advantages of auctioning some, or all Regulated entities compete equally for allowances Simplified program design Government receives revenue which can be used to mitigate economic impacts on consumers, fund R&D, etc. Disadvantages of auctioning Political support may diminish if regulated entities lose windfall

KEC GHG Policy Committee May 13, Uses of Revenue Uses for revenue from permit sales: Cut other taxes (on all or low-income) to offset economic impact of regulation Fund climate adaptation, mitigation efforts Fund ongoing climate research Reduce national debt Fund R&D on alternative technologies...

KEC GHG Policy Committee May 13, Emissions Offsets Defined as a project (or program)-based emission reduction achieved outside the cap-and-trade program’s covered sources. An offset “credit” is granted by a regulatory agency for each “ton” of demonstrated actual reductions that meet a set of established requirements.

KEC GHG Policy Committee May 13, Offsets: Advantages May reduce cost of compliance with cap by giving access to wider range of emission reduction opportunities Allows entities not included in the cap to participate in the market by investing in or developing offset projects Expands linkages between regional, national, and international carbon markets

KEC GHG Policy Committee May 13, Offsets: Disadvantages Viewed by some as undermining effectiveness of cap. –Reduce incentive for reductions Strict monitoring and enforcement requirements add to implementation costs. Lack of integrity or legitimacy –Problems with U.N. Clean Development Mechanism

KEC GHG Policy Committee May 13, Offset requirements R - Real S - Surplus/Additional V - Verifiable P - Permanent E - Enforceable

KEC GHG Policy Committee May 13, Offsets: Sequestration Three types –Terrestrial (agriculture and forestry) –Aquatic –Geologic

KEC GHG Policy Committee May 13, Sources Climate Change Legislation Design White Paper: Scope of a Cap-and-Trade Program, Committee on Energy and Commerce Staff, October 2007 ( Potential Reductions through Offsets in the Midwest: Introduction to Offsets, Climate Change Capital, Presentation at MGA Cap-and-Trade Workshop, Detroit, March 13, Scope and Point of Regulation in a Cap-and-Trade Program, Judi Greenwald Presentation at MGA Cap-and-Trade Workshop, Detroit, March 13, Downstream Regulation: Design Options, Robert R. Nordhaus, Presentation at Point of Regulation Workshop, National Commission on Energy Policy, September 16, 2005 (