Weathervane: A Climate Policy Blog from Resources for the Future

May25

Don’t Hate the Clean Air Act: Why EPA Climate Regulation Isn’t as Bad as You Think

Pricing vs. Regulation

The prevailing view among economists and policy people is that a broad carbon price set by new legislation is vastly superior in efficiency terms to EPA regulation under the existing Clean Air Act (CAA). This is especially true if the CAA is assumed to be a tool for traditional command-and-control regulation, but the perception seems to hold even if you suggest limited market-based approaches under the CAA.

The reasons for this are relatively simple, and familiar to most people with some understanding of policy economics. Markets are a more efficient tool for getting policy results where the players have different ways of contributing to the desired result, and where regulators don’t know that much about these players. In technical terms, markets are superior where opportunities for reaching the goal most cheaply are heterogeneous, and where regulators lack information about those opportunities.

To illustrate this, imagine you, your spouse, and your kids are at the state fair. Having spent the afternoon playing carnival games, everyone is hungry. You want everyone to enjoy their dinner as much as possible while spending the smallest amount of your family’s money you can. There are lots of stands selling all kinds of tasty food, but everyone wants something different. Since you’re carrying the wallet, you could just pick one of the many food stands. You could also ask everyone what they each want, and try to fashion a compromise. But neither of these options is going to result in everyone being happy, and might cost more too.

One solution is to give each member of the family some money and let them each buy their own dinner – and let them keep the change. Since everyone knows what they want for dinner, and has an incentive to spend less, the result should be the maximum satisfaction for the lowest cost to the family. You can then all sit down together and enjoy the meal – some of you will have corn dogs, some will have barbecue, etc. One of the kids might end up with a stick of cotton candy and lots of money left over, but that’s OK (if it’s not, you can limit the available choices in advance – though with a reduction in the level of satisfaction).

This analogy isn’t perfect since you aren’t really creating a market, but it does illustrate the value of pushing decisions down and creating incentives. At the state fair, you are like the regulator in climate policy: you know the results you want, but your family has varying preferences about which you have little good information. In climate policy, there are countless opportunities to reduce carbon emissions which vary greatly in cost. The EPA, with all its expertise, knows relatively little about what these opportunities are, much less about how much they cost. A price on carbon – just like giving money to your family members – allows those with the best information to make the decisions.

In the long run, these conditions are certainly true for climate policy. An economywide carbon price is undoubtedly the most efficient way to achieve a reduction in emissions. This is what makes legislation so much more appealing than regulation under the CAA. Even the most creative forms of CAA regulation can’t create an economywide carbon price, and many of them won’t result in any kind of carbon price at all – they’ll just be blanket requirements to do (or not do) something specific, regardless of whether it’s the cheapest method of reducing emissions. The result is higher costs per unit of emissions reduction… in the long run.

The Short Run

But this might not necessarily be true in the short run. Let’s briefly return to our analogy. You don’t know what each family member wants for dinner – that’s why you sent them off to make their own choices. But you aren’t completely clueless. You do know there are some things that everybody is going to want when they have dinner. Everyone will want a seat at the picnic table. Everyone will want some napkins. You might also have pretty good information about what some people in the family want. Even if you don’t know what your spouse wants for dinner, you can probably make a very good guess about what he or she wants to drink. You can take care of all of these things yourself without any appreciable change in anyone’s enjoyment of dinner. Grab a table, get some napkins and plastic silverware, and get a beer for you and your spouse. Everyone will be just as happy (maybe even better off, since you saved some time). This works because in these cases, preferences are similar (homogeneous) and/or you have relatively good information. Might the same conditions sometimes hold for climate policy?

In some cases, they might. Some industries have fewer participants and are more homogenous than others. Regulators also might have more information about them. Take coal power plants, for example. Reducing emissions from coal in the long run will require major changes: either carbon capture and storage (CCS) or large-scale switching to cleaner fuels. But in the short run, some things are clear. Many coal plants aren’t as efficient as they could be – the EPA estimates that the existing fleet could be made 2-5% more efficient on average. Many coal plants could also burn biomass, reducing their net carbon emissions. The EPA estimates doing so would mean another 2-5% reduction in emissions from coal. We don’t know exactly how much either of these moves would cost, but we can be pretty sure that neither would be as expensive as CCS or switching to natural gas. We’ve written here at RFF on policies the EPA could use under the CAA to reach these emissions reductions from coal.

If there were a price on carbon, we can therefore be relatively sure that coal plants would make these moves. They might not be the very first emissions-reducing moves the plants make, but they might be, and they would certainly be among the earliest. In these cases, therefore, the basic conditions under which a market is superior don’t hold: opportunities are relatively homogenous, and the regulator has decent information. Therefore the efficiency advantages of a market aren’t there or at least aren’t as large. Just like with your family’s dinner at the fair, there are certain more-or-less obvious choices that can be made in the short run with little or no penalty.

Of course, this doesn’t hold true in the long run or for all sectors of the economy. Carbon emissions are simply too pervasive in our society for any regulator to hope to be able to force their reduction in any efficient way without a price. But in the short term, there are real opportunities – low-hanging-fruit, to use the cliché – that regulators can go after with the CAA or other tools, without a big efficiency penalty.

The Good, the Perfect, and the Clean Air Act

This is an observation worth making because in reality we don’t have a carbon price, however economically attractive it is. Getting one will be politically difficult and will take time. In the long run, we will have a price – it’s the only reasonable outcome. But there is still a short term worth worrying about. Doing nothing to reduce emissions during that time is making the perfect the enemy of the good. Saying we shouldn’t use the CAA because it’s less efficient than a carbon price is also a false dichotomy – it’s possible to do one now and the other as soon as possible. Moreover, action under the CAA is legally required – the Supreme Court made that clear in Massachusetts v. EPA. The EPA tried to argue then that better policies were coming, and that Congress, not the EPA, had to decide what to do about carbon. The Court rejected those arguments.

In short, the distaste among economists and some policy people for climate regulation under the CAA is somewhat misplaced. So long as the CAA is viewed not as a replacement for a carbon price, but as a short-term supplement to it, it is relatively appealing. We realize that taking this position goes somewhat against the trend in economic and policy thought over the past few decades towards market-based solutions to environmental problems. But we don’t suggest unearthing and reanimating the corpse of command-and-control regulation. Rather, we think that under certain, limited conditions regulation short of an economywide price on carbon can achieve similar results at similar cost. Just as importantly, the CAA, unlike a carbon price, is a tool we actually have. The policy community should help the EPA identify opportunities to use the statute effectively, rather than dismiss it as useless or counterproductive. It need not be either.

Dallas Burtraw is a Senior Fellow, and Nathan Richardson a Visiting Scholar at RFF.

Published: May-25-10 | 6 Comments

May17

How Kerry-Lieberman Stacks Up

Congress, Cap and Trade, Waxman-Markey, Carbon Market, Cap and Dividend

Wondering how the recently-released Senate climate bill stacks up to the rest of this Congress' market-based legislative efforts? RFF's Danny Morris has this side-by-side comparison chart to shed some light on that question.

Click to Enlarge

Daniel F. Morris is a Research Associate with Resources for the Future. He’s a regular contributor over at the Progressive Fix and has been know to write a thing or two for Common Tragedies

Published: May-17-10 | 0 Comments

Feb17

Standing Behind Market-Based Reductions

Cap and Trade, Carbon Market, Obama Administration

Smokestack image courtesy Squeaky Marmot via Flickr Despite ample conjecture that another approach may be more politically palatable, the president’s top economic advisors are endorsing a market-based approach to emissions reductions as an engine for positive environmental and economic change. As part of the 2010 Economic Report of the President, the Council of Economic Advisors (CEA) suggests the president work to implement a cap-and-trade system to control greenhouse gas (GHG) emissions as a means to provide a solid economic footing to push toward a low-carbon future.

Citing the work of RFF researchers, among others, the CEA report underscored the importance of putting a price on carbon. A price, they write, allows firms to decide the best and most-affordable ways for them to reduce their emissions.

Still, given current and projected economic conditions, it will be important to ensure a cap on emissions is put in place with minimal harm to firms’ bottom lines. According to CEA officials, policymakers have a number of tools at their disposal to keep cap and trade costs under control and help firms transition to a low-carbon future:

Banking and Borrowing: Policymakers can allow firms to purchase and save emissions permits, as suggested in the House’s Waxman-Markey bill, giving purchasers the flexibility to decide when it’s most prudent to use the allowance and when another path could help them meet their reductions targets.

Price Ceilings and Floors: Provisions to keep market fluctuations in check could also help firms keep costs contained. Where banking would allow emitters to even out costs over time, limits on maximum and minimum permit price—ceilings and floors, respectively—could provide some framework for cost projections. Combing price ceilings and floors to create what’s known as a price collar could significantly reduce costs when compared to a cap-and-trade program without such mechanisms, according to recent RFF research cited in the CEA report.

Offsets: Allowing reductions from a sector not subject to the U.S. emissions cap is yet another way to help find the lowest-cost approach to reductions. While the authors of the CEA report say offsets can be a useful tool, they are quick to point out the importance of ensuring any offsets are real and can be verified. Absent verification, could emitters simply be paying for reductions that never occur and undermining the integrity of the cap.

The CEA report went on to point out that global cooperation will be essential to addressing climate concerns and that while the U.S. can’t act alone to address the problem, it must act.

Tiffany Clements is managing editor of Weathervane.

Published: Feb-17-10 | 0 Comments

Oct13

Looking Upstream to Streamline Carbon Regulation

Carbon Market, Congress, Price Collar

Sen. Maria Cantwell, D-Wash., is poised to add some spice to the Senate’s consideration of climate and energy legislation. She’s drafted a yet-to-be-introduced bill she’s calling CLEAR— Carbon Limits and Energy for America’s Renewal.

The bill is a “blessedly brief” 32 pages that could prove to be a game-changer in the climate debate, according to David Morris who lauds the bill with praise in a post at AlterNet.

He says Cantwell’s plan is fundamentally different from the legislation passed by the House last May. Instead of regulating carbon output it would regulate carbon input.

By shifting the responsibility upstream to the wellhead or mine or port of entry, the bill slashes administrative costs to a fraction of what they will be under Waxman-Markey. Only a few thousand energy-producing or importing firms would be covered, versus the hundreds of thousands or more entities covered under Waxman-Markey.

The bill calls for a 100 percent auction of carbon emissions permits, offers direct consumer refunds to help cushion the blow of energy price increases, and proposes strict trading structures that would keep speculation and hoarding in check.

Cantwell’s CLEAR bill would also place an upper and lower limit on auction prices, $21 and $7 respectively in 2012, which increases at an aggregate rate calculated from the rate of inflation and the rate of return on capital investments. This provision effectively places a price collar on auction prices, a mechanism popular with some climate and energy policy observers: see here, here, and of course here.

Tiffany Clements is managing editor of Weathervane.

Published: Oct-13-09 | 0 Comments

Sep10

Thursday's Reads

International, Waxman-Markey, Carbon Market, RGGI, Morning Reads

WSJ: The Regional Greenhouse Gas Initiative, RGGI, held its fifth permit auction Wednesday. An excess of permits and low electricity demand are expected to keep permit auction prices extremely low.

Reuters: Senate rumblings suggest climate may not make it through this session.

WSJ: The CTFC wants to be the agency in charge of regulating greenhouse gas credit markets. Meanwhile the EIA says it will expand its data collecting and analysis of energy and financial markets to aid Congress and the White House in meeting their goal of greater transparency.

Reuters: President Nicolas Sarkozy announced his plans to implement a carbon tax in France.

Reuters: The EU pledges more than $15 billion a year by 2020 to help developing nations combat climate change.

And what the Senate should consider as the top six priorities in the Waxman-Markey energy bill.

Did we miss something today? Let us know, leave a comment or email clements@rff.org.

Published: Sep-10-09 | 0 Comments

Aug26

Wednesday's Reads

Cap and Trade, Carbon Market, Climate Science, International, Biofuels

WSJ: The top official for the Intergovernmental Panel on Climate Change, considered the global authority on climate science, says he supports changing the scientific goal of an international agreement. Rajenda Pachauri says we should aim to lower the atmospheric concentration of carbon dioxide to 350 parts per million, instead of the IPCC’s 2007 goal of 450 parts per million.

NYT: The White House and CBO released updated budget numbers Tuesday; estimates put the nation’s 10 year deficit around $9 trillion. Meanwhile Reuters reports the numbers still count on raising some $627 billion in revenue between 2012 and 2019 through a cap-and-trade auction of emissions permits.

Reuters: The European Commission says some 4,000 airlines must find a way to reduce their carbon emissions or they will be unable to fly in the E.U.

NYT: A new report from The Nature Conservancy suggests that by 2030 energy production—specifically the pursuit of renewable domestically-produced energy—will occupy a land mass the size of Minnesota. Researchers hope to draw attention to habitat destruction and illustrate just how much land is used in the production of biofuels.

COP-15: Is it time to think about putting the global community on a carbon budget?

And, will wireless electricity change the world?

Published: Aug-26-09 | 0 Comments

Aug17

Lessons from the E.U.'s Emissions Trading Program

Border Adjustments, International, Cap and Trade, Carbon Market, Allocations

Image courtesy IFCCI Since 2005 major power generation and industrial emitters in the European Union have been monitoring their emissions and paying for the right to release CO₂ and other greenhouse gasses into the atmosphere. While a landmark moment in multi-national environmental cooperation, observers have found that in its early years the E.U.‘s emissions trading scheme (ETS) has not been without its flaws.

Most observers agree that excessive distribution of free allocation permits has led to windfall profits for some entities, and there have been inadequate measures in place to curb price volatility. But according to RFF Senior Fellow Dallas Burtraw in this Weekly Policy Commentary, many of those early problems have been addressed and will be changed in later phases of the program. And, importantly, substantial shifting of industrial production and jobs overseas—as has been feared by many under a U.S. system—has not occurred in the European Union.

Hopeful that U.S. policymakers could learn from the early missteps of the E.U.’s program—especially in the critical areas of allowance allocation and industrial competitiveness—the German Marshall Fund recently released this report offering 10 key lessons from the E.U. ETS.

The paper makes as strong a case for moving quickly from free allowances to full auctioning in the electricity generation sector. By handing out free allowances, the government has a choice between windfall profits if it allows costs to be passed through (which the E.U. initially chose), and a distortion of incentives for consumers to conserve energy if it does not (which the U.S. has essentially chosen with its allocation to local distribution companies). Burtraw made a similar argument in his recent testimony before the Senate Finance Committee, calling for auctioning permits and returning these revenues to protect low-income consumers in vulnerable regions of the United States that face energy price increases.

The report also addresses one of the hottest debates in climate policy design— border adjustments:

Discussion of border adjustments in Europe has been accompanied by extreme nervousness about their potential political impact, both on the world trade system and on the international climate negotiations. The issue was greatly down played in the negotiation of the EU ETS Phase III in favor of free allocation to exposed sectors (though a clause in the E.U. Directive could provide a basis for enacting border adjustments in the future). However, recognizing the imperfections of free allocation as a solution, the French government in particular has raised the issue again, particularly as a way of protecting the integrity of an international environmental treaty.

Although the European Union may not strictly need border adjustments to protect industry at the current low price of carbon, given their seeming inevitability in the U.S. bill, it may be worth considering whether they could be part of a “transatlantic climate partnership” for creating leverage in international negotiations.

As the details of U.S. domestic schemes and an international plan emerging, experience with emissions trading is clearly becoming a “public good” that will be of great value around the world.

Tiffany Clements is managing editor of Weathervane.

Published: Aug-17-09 | 1 Comment

Aug03

Ecosystem Service Stacking: Can Money Grow on Trees?

Carbon Market, Congress, Forests, Offsets

Future commodity traders may look back on June 26, 2009 as the day that the Congress officially backed ecosystem service markets as the prominent vehicle of environmental conservation in the 21^st Century. It was then that the sweeping American Clean Energy and Security Act of 2009 (H.R. 2454)—legislation in which carbon offset markets play a huge role—passed the House 219-212. Estimates from the EPA suggest by 2030, the U.S. offset market could be worth $4 billion. Forest offsets will likely constitute a large portion of the total market but agricultural lands will also have some significance.

While the ultimate fate of the bill remains uncertain, H.R. 2454 indicates that ecosystem service markets have a critical role in both the fight to slow climate change and the future of ecosystem conservation. In fact, reduced emissions from deforestation and degradation (REDD) and other forestry issues will likely be integral to an eventual agreement at the COP negotiations in Copenhagen this December.

Ecosystem Service Markets

While carbon markets are currently dominating discussions, they are certainly not the only type of ecosystem service market being utilized for environmental benefits. Other examples include water quality or nutrient trading, conservation easements, and habitat banking for endangered species. Section 404 of the Clean Water Act led to the establishment of wetland mitigation banks, which proved to be a successful conservation device. By 2005, 450 wetland banks had been established, with 59 selling out of credits completely.

Current ecosystem service markets have just scratched the surface. Robert Costanza and others estimated the global annual value of ecosystem services was $33 trillion. The voluntary carbon market in 2008 was estimated to be worth about $705 million. The forest carbon offset markets in H.R. 2454 provide an opportunity to expand and refine ecosystem service markets aggressively and incorporate them into the larger economic system domestically and worldwide.

Stacking

Widespread acceptance of carbon-related ecosystem services may present a vehicle for the expanded usage of other types of ecosystem services. Combining the value of these different services is called bundling or stacking, and it allows landowners and indigenous communities expanded opportunities to be compensated for maintaining and enhancing ecosystem functions. It is important to note that services will be stacked or bundled in a single ecosystem, but must be well-defined enough to separate into autonomous markets. The markets themselves will not necessarily be stacked.

One can imagine eventually linking carbon offsets with water quality credits or habitat credits. With a network of robust, functional ecosystem service markets a landowner could manage an entire portfolio on his/her land, balancing forest offsets with increased stream buffers that generate water quality market credits, understory clearing to generate endangered species habitat credits, and other types of natural capital. Such opportunities are a prospective avenue for alleviating poverty among rural or indigenous populations.

Oversight

Stacked but separate ecosystem service markets could possibly create incentives (though not guarantees) for landowners to take a more holistic management approach, looking at the functionality of entire natural systems rather than one specific usage. A fully integrated and functional ecosystem marketplace is currently far from becoming a reality, however. There are a number of issues that must be addressed to ensure the markets are robust and effective. Major concerns include:

Valuation: One advantage carbon has over other ecosystem services is that there are straightforward mechanisms for valuing tons of CO2. Determining accurate values for endangered species habitat credits or water filtration on a chunk of land will require better research and better valuation techniques than are currently available. Significant investments in scientific assessments and monitoring are needed before these markets can be established effectively.

Additionality: One of the major questions carbon markets must answer is how they can establish additionality, or proof that sequestration activities would not have occurred in the absence of the offset project investment. If other ecosystem markets link up with the carbon market on a piece of land, the landowners will likely need to show that actions that can earn other types of credits would not have occurred without additional investment.

Double-counting: If landowners hope to obtain multiple revenue streams, then they must manage for multiple ecosystem services. Selling water quality credits from land that is only being managed for carbon will not generate the correct incentives for landowners and will undercut the effectiveness of the water quality market. Added value of different services must be well-established enough to avoid multiple payments go to one specific type of action.

Capacity-building: International forest carbon offsets will be a sizable chunk of the total offset market, the vast majority of which will come from developing countries that currently lack the capacity to effectively establish, monitor, and certify offset projects. To ensure the veracity and efficacy of the market, massive capacity-building efforts are needed in places like the Congo Basin, Indonesia, and Central America. Other ecosystem service markets will also need similar building efforts, though they may be able to piggyback on the efforts to establish carbon-related infrastructure.

Permanence: What is the value of an ecosystem service credit if the ecosystem is damaged or destroyed soon after investment? This question will need a solid answer for markets to work properly. While permanence is currently a big concern in carbon markets, it will correspondingly affect other ecosystem markets. In order for these markets to grow and thrive, solid governance structures will be needed to establish appropriate risk premiums and other tools that can mitigate the problems related to permanence.

Stacked ecosystem services could prove to be a powerful conservation tool, but are not a silver bullet for protecting natural systems. They are designed to create incentives for people to manage land carefully. If carbon, water quality, endangered species, and other services simply morph into commodities to be traded back and forth without any robustness checks or on-the-ground coordination, then the transformative power of stacked ecosystem services will be lost. Moreover, regional issues will play a key role in determining which markets work and how. Carbon is a global good that can be traded across countries and continents; water quality and species habitat are very region-specific and will require smaller-scale markets that may or may not be trans-national.

Despite these challenges, ecosystem service markets are an innovative and potentially useful approach to conserving and restoring damaged and sensitive parts of the biosphere. The emphasis on forest carbon in H.R. 2454 may provide an opportunity to refine and expand these markets to the benefit of both ecosystems and the people who depend on them.

Daniel F. Morris is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Aug-03-09 | 0 Comments

Jun15

Experts Explore Challenges in Offset Market Design

Carbon Market, Waxman-Markey, Offsets

As the American Clean Energy and Security Act makes its way through the House Agriculture and Ways and Means Committees, offsets continue to crop up as a major point of contention. While understanding of offset markets matures, RFF continues to identify and address important economic and logistical issues of concern.

Last month, RFF hosted a joint workshop with the EPA entitled “Modeling the Costs and Volumes of GHG Offsets.” Experts in forest, non-CO2 gas, and agriculture offsets came gathered for a technical discussion about the state of offset modeling and how it can contribute to the design and implementation of offset policy. The presentations from each panel are available here. Some of the major themes highlighted by the panelists include:

Forestry

• Forest offsets show huge potential to sequester carbon and control costs, but there are many challenges to implementation.
• Threats to the integrity of offsets include tracking and measuring emissions leakage, establishing clear additionality, and assuring reliable levels of permanence.
• Heavy use of forest offsets suggest major land use changes both in the U.S. and in other countries, though land conditions could substantially affect the potential for offset usage.
• Contracts may be useful in some situations for dealing with leakage, permanence and other issues, but national standards may be needed in other contexts.

Non-CO2 gases

• Non-CO2 gases are major climate forcings and their mitigation costs are often lower than energy-related CO2.
• The economics of individual projects are relatively well-understood, but the sectoral cost curves are less clear.
• More guidance from government is necessary to reduce investment risk and encourage early action on offset opportunities.

Agriculture

• Models indicate that agriculture offsets will not play as big a role domestically as forestry-related offsets, but higher prices will bring more agriculture offsets into the market.
• Agriculture offset opportunities may exist in areas where afforestation or other types of offsets are not realistic.
• Technology may play a key role in providing more offsets.

Daniel Morris is a research assistant at Resources for the Future and regular contributor to Common Tragedies.

Published: Jun-15-09 | 0 Comments

Jun11

Perspectives From Bonn: EU-U.S. Leadership in International Emissions Trading

Carbon Market, COP-15, International

In a side event at the most recent round of negotiations of a comprehensive international climate agreement a panel of negotiators, policy experts and researchers gathered to discuss the framework of a global carbon trading market and opportunities for leadership from the U.S. and European Union in the design and implementation of such a scheme.

At “Forging an EU-US Alliance: What Does a Comparable Effort in a Global Carbon Market Mean?,” (sponsored by the Mistra Foundation Climate Policy Research Program) panelists discussed roles for the EU and U.S. broadly in global markets for emissions and specifically examined offsets and sectoral crediting mechanisms.

The Bonn event followed an Earth Day workshop in Washington (sponsored by CLIPORE, RFF, and the Embassy of Sweden) that highlighted specific research issues like competitiveness, leakage, and offsets and facilitated broader discussions of the relationship between the European Union and the U.S. in climate change negotiations.

In her remarks RFF Fellow Shalini Vajjhala said international market design presents, “… a Russian doll of issues—from the international, to the national, to the regional, to the sectoral.”

She pointed out that many market mechanisms are intended to be transitional. “Yet,” Vajjhala said, “there is very little consensus on how and when to make that transition.”

Underscoring key points from the Earth Day event, Vajjhala said forging a renewed trust between the EU and U.S., based on sound domestic action and specific targets, will be key to successful implementation of any international climate change agreement and determining just what transitional instruments might transition toward.

Find a full event recap from the UNFCC here, and video coverage of the panel discussion here.

RFF Fellow Shalini Vajjhala was in Bonn, Germany for the most recent round of UNFCCC negotiations. She’ll share an update on adaptation in the most recent treaty draft here Friday.

Published: Jun-11-09 | 0 Comments

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