Cap-and-Trade Programs: Lessons for California’s Carbon Regulations James Bushnell University of California Energy Institute

Quantity Mechanisms Standards vs. cap-and-trade Under what conditions would command and control approaches achieve environmental goals at the same total cost as a permit program? Every source has the same cost of clean-up –The problem of costly retrofitting and technology innovation More generally: when potential gains from shifting clean-up across sources (or technologies) are outweighed by the transaction costs of the program

Hypothetical marginal cost of abatement curve for NOx Abatement (`000s tons) Dollars per unit of abatement $1000 $1200 $ Low NOx burners for power plants with steam turbines ($1000/ton) 3. Low NOx burners for power plants with gas turbines ($1500/ton) 2. Mid-kiln firing for cement manuf ($1200/ton)

Standards can produce large differences in compliance costs Abatement (tons) $/unit Abatement (tons) $/unit Refineries Power Plants MCA Q standard MCAv MCApp

Trades Reduce Emissions at less costly sources Abatement (tons) $/unit Refineries Power Plants MCA Q pollution MCAv MCApp Q pollution Pollution (tons) Abatement (tons) Pollution (tons) Q trade Q pollution

Trades Reduce Emissions at less costly sources Abatement (tons) $/unit Refineries Power Plants MCA Q pollution MCAv MCApp Q pollution Pollution (tons) Abatement (tons) Pollution (tons) Q trade Q pollution

“Gains” from Emissions Trade Abatement (tons) $/unit Refineries Power Plants MCAv MCApp Pollution (tons) Abatement (tons) Pollution (tons) Q trade Q pollution Costs Savings Q trade

Factors that favor cap-and-trade Significant variation in mitigation costs across sources –Large uncertainty about cost heterogeneity –potential for innovation in mitigation alternatives Pollution effects are comparable across sources –Damage is not completely localized –upwind/downwind problem Low Monitoring Costs –To date programs limited to stationary sources –Continuous monitoring costs $124,000/plant –All current programs targeted at sources Not much experience with offsets (negative emissions) Regulatory jurisdiction captures the relevant market –“Leakage” from regulated to unregulated sources or regions Firms have comparable incentives to reduce compliance costs

Monitoring Issues: We’re pretty good at measuring output from stationary sources It is not possible to meaningfully measure the “sources” of physical electricity consumed –Load-based must focus on financial transactions It is easier to deceive regulators about financial transactions than physical emissions –MRTU and the “common” pool –Assignment of output from plants via accounting –“Exports” from within California (MW greenwashing)

Firm Incentives and Cap-and-Trade Basic model assumes all firms have equivalent incentives to reduce emissions costs Firms can face differing incentives –Regulatory treatment of firms Merchant vs. cost-of-service –Market power In permits or in the product produced –Allocation mechanisms can distort incentives The problem with endogenous allocations These factors can lead to a distortion in who mitigates emissions, and by how much.

Nox control summary statistics Regulated electricity markets (87,828 MW; 286 Units) Restructured electricity markets (88,370 MW; 302 Units) Data sources: EPA CEMS, EIA 767/860, ICAC, MJ Bradley and Associates.

Cap-and-Trade and coverage areas Regions must be “big” enough –Induce liquidity in trades, take advantage of cost differences –Limit market power (RECLAIM problems) –Reduce leakage problems (GHG problems) Regions must not be too big –Coverage should match damage or else “hot spots” can form Pollution migrates up wind (or clean-up happens “downwind”) –East-coast Nox SIP-call program

Nox Flow Patterns and Concentrations hour standard: 80 ppb

Concluding Thoughts In several ways, carbon is an ideal candidate for cap- and-trade, if applied on a sufficiently large scale These policies will be interacting with other more directed regulations –These may lmit the scope for cap-and-trade to influence choices Focusing on getting “real” reductions from California may miss the point –California is a drop in the carbon bucket –Leakage may not matter that much in the big picture Must have a program that extends beyond California and the US What policies would most impact other states and Countries?