1. Initial Allocations in the Regional Greenhouse Gas Initiative: Alternatives and Implications Presented by David Harrison, Jr., Ph.D. Senior Vice President Regional Greenhouse Gas Initiative Stakeholder Group Meeting New York City June 24, 2004

2. 1 NERA Experience in Emissions Trading NERA staff have been involved in the design or analysis of nearly all of the major emissions trading programmes implemented to date NERA involvement in EU ETS –March 2002 report prepared for the Commission on initial allocation alternatives. –Assisting UK government in developing its NAP –Evaluating UK CO2 program (for UK government) –Helping various private clients understand allocation effects Of course, this presentation represents personal views, and should not be taken as indicative of the opinions of NERA’s clients

3. 2 Outline 1. Overview of Allocation Alternatives 2. NERA Allocation Study: Evaluation Criteria and General Conclusions 3. Three Specific Issues from EC Experience 4. Conclusions

4. 3 Allowance Allocation: Alternative Methodologies The table below summarises some basic allocation alternatives

5. 4 Some Additional Allocation Elements Set asides –For specific installations or technologies –For all new entrants (form of “updating”) Projections could be used rather than past data –Business as Usual projections without CO 2 trading –Regulatory targets –Feasibility (marginal costs) “Indirect emissions” could be reflected –Range from zero to 100% Credits or additional allowances could be provided to recognize “early action”

6. 5 Summary of Allocations in Previous Emissions Trading Programs Most existing programs use non-updated (“grandfathering”) –No major auctions in U.S. but UK CO 2 program uses an auction –Some examples of updating in NOx Budget program Many variations in metric for grandfathering (input, output, emissions, years) –No existing examples of indirect emissions Recipients are facilities covered in the program –Some early action credits

7. 6 NERA Allocation Study—Two Major Types of Evaluation Criteria Efficiency: –Compliance cost minimization –Administrative cost minimization –Transaction cost minimization –Product market distortions –Removal of tax distortions Distributional: –Sector burden –Reduces stranded costs –Taxpayer burden –Consumer and labor market burden –Rewards early action

8. 7 NERA Allocation Study—Key Qualitative Conclusions Grandfather vs. auction –Same efficiency effects in allowance and product markets  Differences if electricity markets are not deregulated  Potential tax efficiency gains from auction –Different distributional effects Updating has several potential inefficiencies –Compliance costs may not be minimized –Product markets and trade may be distorted

9. 8 NERA Allocation Study—Key Empirical Conclusions Need to develop plant-level information –No single EU database for plant-specific information  Proxies sometimes inaccurate and need verification –Member States differ greatly in plant-level data (emissions, fuel inputs, production) Sector impacts vary –Sectors fare quite differently under alternatives considered (historical, least-cost emissions, +indirect) Plant impacts vary –Plants fare very differently under alternatives considered (grandfathering with emissions, inputs, outputs and grandfathering with auction phase-in)

10. 9 1. Data availability 2. Confusion over incentives created by allocation approaches 3. Interactions among State programs Three Specific Issues from EC Experience

11. 10 Data Availability Sometimes limits feasible approaches –E.g., UK, only very limited data available (initially) at the installation level before 1998. –Limits on types of data, with output and inputs not readily available (other than power sector). Some facilities may have no historical data –E.g., 20 MW-50 MW facilities Implications –May need to obtain/verify additional data from individual installations –Limit allocation alternatives to those for which adequate data are available

12. 11 Framework for Considering Allocation Incentives for Firms CO 2 Emissions $/Ton Market Allowance Price AllocationMarginal Abatement Cost Curve Baseline Emissions Controlled Emissions

13. 12 Why Grandfathered Allocations Don’t Affect Firm Decisions on Emissions Two different allocation levels… –…but facility emissions levels are the same Controlled Emissions $/ton

14. 13 Interactions Among State Allocations General issue: which features of a multi-State trading program should be the same in all States? –Raised in previous multi-jurisdiction programs (e.g., NOx Budget Program) –General conclusion: allocations can differ Potential problems can arise; e.g., allocation to “new entrants” –Single State trying to attract investment could use allocation as “carrot” to new entrants –If one State adopts, and no others, creates an incentive for investment in that State. Implications: all States will allocate to new entrants –A kind of “prisoner’s dilemma” –In the end, could raise costs to everyone

15. 14 General Conclusions and Recommendations Importance of detailed analyses by governments and participating sectors/firms –Data availability (may include collection of confidential/verified company information) –Determine “what is at stake” under major alternatives –Consider implications of additional details (e.g., credits for early action, credits for renewables) –Provide the basis for informed decision-making process Sound initial allocation is both important and possible –Encourage cost savings from trading –Avoid competitive product market distortions –Avoid serious adverse distributional impacts

16. For more information, contact David.Harrison@nera.com 617.621.2612