While much attention in the discussion of the new draft of the Waxman-Markey energy bill (H.R. 2454) will be devoted to the gratis allowance allocations, don’t overlook the economic importance of a new provision establishing a floor on the price of allowances (Sec. 791(d)). 

 

 

Short-run demand and supply conditions can lead to significant allowance price volatility, as we have seen in the European Union’s carbon market.  Very low allowance prices may not provide the needed incentives for conservation, and the development and deployment of new technology. H.R. 2454 adopts and minimum price auction ($10 reserve price in 2012) to set an allowance price floor.  To the extent the Strategic Reserve Auction can act as a credible price ceiling, the bill now contains a price “collar,” the combination of a floor and ceiling designed to minimize allowance price volatility. 

 

RFF researchers Dallas Burtraw and Karen Palmer (in this paper), and Harrison Fell and Richard Morgenstern (in this paper) have been developing the price collar for the past 24 months.  Recent work by these scholars reveals the considerable economic advantages attaching to a collar over a standard cap & trade program or a program with only ceiling price (often known as a safety valve).