In recent years, US climate plans have changed abruptly. In a new RFF discussion paper, with RFF Center Fellow Anthony Paul and Research Assistant Sophie Pan, we examine the challenges for progress—specifically, of coordination among jurisdictions—that presently face policymakers in both the United States and around the world.
The current centerpiece of US policy is the Obama administration's Clean Power Plan, which would regulate greenhouse gas emissions from the power sector. Regulations are due this summer under the Clean Air Act that will establish a performance standard for emissions reductions—but that will leave states with significant flexibility for implementation, including the option of building regional cap-and-trade programs. This change in the US approach—away from cap and trade at a national level—mirrors, to a degree, shifts seen on the stage of international climate negotiations. There, observers see reason for optimism in the prospects for a bottom-up process to realize nationally determined reduction amounts.
Can this type of bottom-up approach meet the inevitable coordination challenges necessary to achieve an effective outcome? We looked at domestic data from the electricity industry and conclude that current design options can provide real opportunities to advance climate goals effectively—if states can learn new strategies and engage in coalition building.
A defining characteristic of the US Environmental Protection Agency’s (EPA’s) Clean Power Plan proposal is the establishment of emissions rate (carbon intensity) standards for individual states. This feature has led observers to speculate that states or power companies that have less stringent emissions rate targets relative to other states may be able to capture market share in electricity markets. This concern has been taken a step further in the comparison of an emissions rate standard with cap and trade. An emissions rate standard has an implicit production incentive, and units with emissions rates below the standard actually receive a net subsidy for electricity generation under the program.
Some authors have observed that this feature could lead states with emissions rate standards to capture market share from neighboring states if the neighbors transition to mass-based cap-and-trade programs. They suggest this could invite strategic behavior in the development of state policies that might seriously erode environmental outcomes or raise costs, or both. We look in our new paper at the possibility of emissions and generation leakage away from states that adopt mass-based policies under 111(d). Our findings validate that concern, but we also show that states have available a policy design that can remedy the problem.
The target assigned to each state by EPA is an emissions rate standard that might be implemented with a tradable emissions rate policy, which is essentially emissions rate averaging over a group of generators. Compared to usual approaches to cap and trade, this policy provides a production incentive for electricity generation because each megawatt hour (MWh) of generation earns emissions credits at the emissions rate standard (tons/MWh). When states have different rates, they may provide different production subsidies and those with less stringent standards may attract generation and investment. The differences among states may be especially pronounced if some states choose to convert their emissions rate standards to mass-based emissions budgets and others do not. This difference might lead not only to movement of generation among states, but also to an increase in emissions overall relative to a scenario where all states use one approach or the other, because emissions are not capped in states that adopt an emissions rate standard.
We demonstrate a policy approach that addresses this problem and potentially reverses the outcome. Targeted output-based allowance allocation under an emissions budget can mimic the production incentive associated with an emissions rate standard by distributing allowances according to the same formula embodied in an emissions rate. Such an approach would thereby avoid the potential negative interaction of emissions rate standards in some states with cap and trade in others. Beyond that, we show that targeting allocation to provide a production incentive to selected technologies can result in a greater total reduction in carbon dioxide emissions than would have occurred otherwise.
We are less excited about targeted output-based allocation as a policy outcome than as a policy option. We don’t promote this outcome because states may feel they have more valuable ways to use the revenue that might be available from auctions under cap and trade than using it as a production incentive. However, we note in the paper that under the cap-and-trade program in force among states in the Northeast (RGGI), about two-thirds of allowance value is used as a production incentive, in effect, for energy efficiency. We detail similar uses of allowance revenues as a production incentive and how they can be effective at solving leakage.
The value of this policy option is not in its use but in its existence. Game theory tells us that if states recognize that others can use this approach to allocation under a budget-based policy, they will be less inclined toward a rate-based approach as a means of attracting investment. We anticipate that recognition of the option may alleviate concerns about potential predatory behavior among states and enable broader cooperation—which is an outcome that would help achieve the overall goals of the Clean Power Plan.
The paper frames the US coordination problem among states as an analogue to the international coordination problem. In that context, if we can find approaches that can overcome emissions leakage, they may have broader applications on a global scale.
The good news is that this option—targeted output-based allocation—allows states to consider policies that can capture the administrative advantages of cap and trade without undermining the overall policy objective.