Welfare Decomposition of a Clean Technology Standard: 3 Steps to a Carbon Tax by Anthony Paul, Karen Palmer, Matt Woerman

2 Policy Context for a Clean Technology Standard Federal energy policy debate has addressed climate and GHGs for more than a decade. Several proposals for CO 2 cap-and-trade in the early 2000s, then Waxman-Markey passed the House in Focus has shifted to EPA regulation of CO 2 emissions and policies to encourage clean technologies in the electricity sector. President Obama’s 2011 State of the Union address proposed a Clean Technology Standard. Senator Bingaman proposed the Clean Energy Standard Act of Behind the scenes discussion of a carbon tax continues in the context of federal fiscal issues.

3 What is a Clean Technology Standard? Minimum percentage of electricity from clean sources. –Minimum grows over time –Clean Energy Credits used for compliance –Credits are tradable and could be bankable Similar to renewable portfolio standards (RPS), but includes more technologies: –Nuclear and Hydro –Fossil with CCS and Natural Gas earn partial credit Partial crediting based on technology –Natural Gas earns ½ credit per MWh

4 Three Inefficiencies in a Clean Technology Standard CO 2 emissions mitigation not harvested on 3 margins –Emissions rate heterogeneity in natural gas fleet –Emissions rate heterogeneity in coal fleet –Demand reductions A Bingaman-style Clean Energy Standard that credits natural gas based on emissions rates addresses the natural gas heterogeneity margin. A Carbon Intensity Standard (cap-and-trade with output-based allowance allocation) addresses the coal heterogeneity margin. A Carbon Tax addresses the demand margin by raising electricity prices.

5 Clean Energy Standard: NG Heterogeneity Crediting under Clean Technology Standard –1 credit/MWh for non-emitting technologies –½ credit/MWh for natural gas –0 credit/MWh for coal Crediting under Clean Energy Standard –Max(0, 1 – CO 2 emissions rate / 0.82 ) –0.82 metric tons CO2 / MWh is between natural gas and coal Clean Energy Standard harvests emissions reductions from natural gas emissions rate heterogeneity, but not from coal emissions rate heterogeneity or demand reductions.

6 Carbon Intensity Standard: Coal Heterogeneity Clean Energy 1.5 metric tons CO 2 / MWh –Every generator credited => coal heterogeneity harvested. –Large subsidy drives down energy price to very negative. Carbon Intensity Standard = Clean Energy 1.5 –Cap-and-trade with output-based allowance allocation –Allowance allocation at fleet average emissions rate. –Not just subsidy to generation, also tax on emissions => Energy prices do not plummet –Incentive structures, quantity outcomes identical (generation by source, emissions, etc) Carbon Intensity Standard harvests emissions reductions from natural gas and coal emissions rate heterogeneity, but not from demand reductions.

7 Carbon Tax: Demand Reductions Carbon Intensity Standard is a tax and a subsidy –Tax on emissions, subsidy to generation Carbon Intensity Standard without subsidy is Carbon Tax –Carbon Tax yields: higher electricity prices => lower demand => less generation => fewer emissions reductions => cheaper emissions reductions Carbon Tax harvests emissions reductions from natural gas and coal emissions rate heterogeneity and from demand reductions. Tax revenues modeled as lump-sum rebate to consumers Public finance literature shows that using tax revenues to offset existing distortionary taxes creates “double dividend”.

8 Modeling Approach: Baseline + 4 Scenarios Haiku Electricity Market Model simulates –Baseline –4 Policies for CO 2 Emissions Mitigation o Clean Technology Standard (CTS) o Clean Energy Standard (CES) o Carbon Intensity Standard (CIS) o Carbon Tax (CTax) Baseline (BL) includes existing policies –Federal: Title IV for SO 2 ; CAIR for NO x ; MATS for Hg, HCl, SO 2 ; PTC/ITC for renewables –States: 29 RPSs; RGGI for CO 2 ; PTC/ITC, Hg standards CTS, CES, CIS, CTax: identical CO 2 emissions –Compare policies on economic welfare

9 Haiku Model Covers only electricity sector in contiguous 48 states Calibrated to AEO 2011 Endogenous capacity investment and retirement, dispatch, electricity demand, fuel prices. All prices are in 2009 $. Modeling horizon is

10 National CO 2 Emissions (B short tons)

11 National Average Electricity Price ($/MWh)

12 National Generation Profile in 2035 (TWh)

13 Cumulative Economic Welfare (B$)

14 Conclusions A Clean Technology Standard fails to harvest some economic CO 2 emissions reductions because it misses 3 margins: emissions rate heterogeneity in the natural gas and coal fleets, and demand reductions. A Carbon Tax picks up all 3 margins. Natural gas emissions rate heterogeneity can be addressed by crediting based on emissions rates instead of technology. Coal emissions rate heterogeneity can be addressed by crediting all generators based on emissions rates. Demand reductions can harvested by removing the subsidy component of the policy, allowing retail prices to rise. Harvesting emissions abatement efficiency on all 3 margins saves about 40% of the cumulative economic welfare costs of a Clean Technology Standard through 2035.

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