Weathervane: A Climate Policy Blog from Resources for the Future

Apr09

A Matter of Semantics: Hard vs. Soft Price Collars

Like all climate nerds, I’m eagerly anticipating the upcoming release of the Kerry-Lieberman-Graham Tri-Partisan-Super-Moderate-Climate/Energy Cavalcade, currently scheduled to grace my computer screen around Earth Day. Since first announcing they would be working together on a new way forward on climate legislation in December, the three senators have been stingy with details, letting them dribble out from time to time. The last blast of info came in mid-March and provided enough titillating details to show that this bill won’t be massively different from Waxman-Markey (17 percent reductions of ’05 emissions levels by 2020, consumer rebates, regulating facilities that emit more than 25,000 tons of CO2).

In my excitement over this modicum of information about the bill, I missed a small phrase that probably doesn’t mean much to anyone who doesn’t take a daily swim in a metaphorical pool of climate economics. Quoth Darren Samuelsohn:

Additional layers of certainty for industry come via a "hard price collar" that limits greenhouse gas allowances to between $10 and $30 per ton tagged to inflation, with an increase at a to-be-determined "fixed rate" over time. The legislation would also set aside a "strategic reserve" of 4 billion greenhouse gas credits that could be released into the market to help control price volatility fluctuations.

See anything wrong with that statement? Allow me to help with a brief discussion of price collars from an economist’s perspective.

A hard price collar in the world of environmental economics is one with a firm price floor and ceiling where once the market hits the price ceiling, emissions allowances are released into the market to maintain the ceiling until the price drops back down below it. There is no limit to how many allowances are released, the point is simply to drop the price.

Contrast that with a soft price collar, which is a collar that draws allowances from a pre-established reserve of allowances once the market hits the ceiling price. Again, the goal is to drop the price below the ceiling, but there is a limit on how many allowances can enter the market (the amount available in the reserve).

Now look at the quote again. It claims the bill has a hard collar, but then also says it has a strategic reserve, which would clearly make it a soft collar. The difference between the two is subtle, but it has important implications. A market with a hard collar is less desirable from an emissions control perspective because once the market hits the price ceiling, there is no way of knowing how many credits will enter, meaning the amount of extra emissions allowed is unpredictable. A hard collar puts a premium on price certainty. Conversely, a soft collar has more emissions certainty because once the reserve is exhausted, no more allowances enter the system, regardless of the allowance price. Environmentalists prefer this approach because it maintains the emissions cap.

If the KLG bill does truly have a soft collar, then it will have to take allowances from somewhere (presumably the initial allocation) to fill the strategic reserve. It will also have to develop mechanisms to replenish the reserve if it gets drawn down, possibly in a similar way to Waxman-Markey, which uses revenue from the reserve auctions and international forestry offsets. Bottom line: there will be slightly fewer allowances available to regulated firms both at the beginning of the program and throughout the life of the program than there would be with a hard collar.

So, what do the good senators mean when they (through Darren) say a “hard price collar?” Well, if I could read legislators’ minds, I would probably have a different job. Based on the context of the statement, however, my guess is that they are using hard collar to mean that the collar prices will increase at some fixed rate over time. This is a different approach from Waxman-Markey, which keeps collar prices 60 percent above a rolling 36-month average of daily allowance prices. Increasing the price collar at a fixed rate is better for firms as it provides more price certainty over time and protects against a steeply rising price ceiling. It’s a good idea, but it’s not a hard price collar.

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: Apr-09-10 | 0 Comments

Mar18

Keeping Climate Policy Costs in Check

Price Collar

A major concern with cap-and-trade proposals to reduce greenhouse gas emissions is the uncertainty over the future costs of compliance. Indeed, those who had the chance to see an eight-page overview of the forthcoming Senate climate legislation say the bill will take steps to mitigate cost uncertainty and ease volatility. From Darren Samuelsohn of GreenWire:

Layers of certainty for industry come via a "hard price collar" that limits greenhouse gas allowances to between $10 and $30 per ton tagged to inflation, with an increase at a to-be-determined "fixed rate" over time. The legislation would also set aside a "strategic reserve" of 4 billion greenhouse gas credits that could be released into the market to help control price volatility fluctuations.

According to a new Weekly Policy Commentary from RFF’s Harrison Fell and Richard Morgenstern, price collars, that is to say adding a floor and a ceiling to emissions prices can go a long way toward curbing price volatility in a cap-and-trade system:

With the introduction of a price collar, the expected total cost of compliance was lower and the range of cost outcomes was narrower, yet expected emissions increased only slightly. Importantly, we also found that the range of possible cumulative emissions outcomes could actually be smaller with a price collar compared to a no-collar policy if both the offset supply shock was highly persistent and the negative correlation between offset uncertainty and abatement cost uncertainty was large. As expected, the range of possible price paths was smaller than with no-collar policies.

Read more about the effectiveness of price collars and its functionality as a complement to other cost containment strategies in Fell and Morgenstern’s, Collaring Price Volatility in a Carbon Offset Market, here.

Published: Mar-18-10 | 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

Sep15

What’s Driving the Senate Debate?

Congress, Waxman-Markey, Price Collar, Allocations

With action punted deeper into the year by Senate leaders, the future of climate and energy legislation in this congressional session seems uncertain at best. And though the wildly-popular (and widely-debated) Cash for Clunkers vehicle retirement program kept the whisper of energy policy on America’s lips, health care reform dominated the public discourse this summer and threatens to keep it up well into the fall.

Will looming Post-Kyoto Protocol treaty negotiations and the EPA’s preparations to regulate greenhouse gas emissions if Congress fails to pass its own plan motivate action this session? The factors listed below could well determine the answers to those questions and provide insight into what’s on the horizon for U.S. climate legislation.

Industry Interests: Natural gas could be the loser in the Senate as lawmakers concede it is coal-state votes that will swing legislation to passage but the future of coal has its own uncertainties, as Rob Stavins explains. And oil industry leaders have been accused of mobilizing astroturf campaigns to drum up discontent, unhappy with their share of emissions allowances in the House version of the bill.

Oversight and Regulation: Creating a new marketplace for carbon emissions permit trading undoubtedly calls for new structures to oversee its functions. The bill that passed the House in June would give oversight to the Federal Energy Regulatory Commission but another bill has been introduced in the Senate to give that control to the Commodities Futures Trading Commission.

Allowance Distribution: Just who got what out of Waxman-Markey made for plenty of horse trading in House negotiations of the bill. It’s clear allowance distribution (and the mechanisms used) will be the subject of Senate debate. For her part Sen. Maria Cantwell, D-Wash., is drafting a proposal calling for a 100 percent auction of allowances.

Cost Containment: Senators will search for the best mechanisms to ensure that a plan avoids some of the pricing pitfalls of the E.U.’s ETS or RGGI. The House bill opts for a “safety valve” to take effect when and if permit prices hit a certain threshold. Sen. Barbara Boxer, chair of the Environment and Public Works Committee, said she would consider utilizing a price collar, to keep price volatility in check. A Natural Resources Committee hearing today is scheduled to tackle this issue, exploring these tools and others as members work on their contribution to the Senate’s bill.

EPA: While Congress has been working out the details of its plan for climate change and energy, the Environmental Protection Agency was working on its own plan to regulate the emissions of carbon dioxide, which a 2007 Supreme Court ruling says can be covered under the Clean Air Act. The agency has spent recent months sketching out the specifics of a plan to cover emissions from the electricity and transportation sectors if Congress fails to pass legislation.

Trade & Tariffs: Suggestions to preserve border adjustment provisions—included in the legislation approved by the House and called for by ten Democratic senators in this letter–in the Senate’s version of the bill sent some searching for the right ratio of carrots to sticks and led others to wonder whether an international treaty could be negotiated without U.S. legislation.

At the Negotiating Table: Bringing commitments on emissions reductions, approved by the president and Congress to Copenhagen could make the task ahead of U.S. climate negotiators easier to tackle and provide a strong leg to stand on when asking other nations to take action. Leaders in India, one of several nations expected to factor prominently in negotiations, say if the U.S. commits to action they would be hard pressed not too as well.

Of course, whether these or any other factors come to bear will depend heavily on the amount of political capital (and time) President Obama and Congressional leaders are forced to use on health care reform and other legislative priorities.

Are there other factors lawmakers should take into account as they work on their plan?

Tiffany Clements is managing editor of Weathervane. Contact her at clements@rff.org.

Published: Sep-15-09 | 0 Comments

Sep11

What Can We Learn from RGGI Auction Prices?

RGGI, Safety Valve, Price Collar, Waxman-Markey

Regional Greenhouse Gas Initiative auction prices hit their lowest mark since the program began selling polluting rights last year.

The auction to disperse CO₂ emissions permits in ten northeastern states sold allowances for the 2009 vintage at a price of $2.19/each—down 32 percent from June—and allowances for the 2012 vintage at a price of $1.87/each—down 9 percent from June.

As Keith Johnson pointed over at Environmental Capital earlier this week, three things likely sent prices plunging:

First, state authorities appear to have made a similar mistake as European authorities did when they started their own cap-and-trade program. That is, they over-estimated the amount of permits that power companies would need to cover their emissions requirements. The result is a surplus of pollution permits, which pushes their price down.

Second, the recession whacked demand for electricity, which means that power plants emitted even less than they thought they would.

Third, cheap natural gas over the last year has made it easier for power companies to switch to the cleaner-burning fuel, which again means fewer emissions of greenhouse-gases.

Lawmakers plodding through a discussion of a national plan to cap CO₂ emissions would be wise to learn a thing or two from RGGI. Namely, finding the right balance of permits and pricing is crucial to realizing environmental benefits with the least amount of economic woe. A “price collar,” like the one included in the bill passed by the House in June, may be one way to strike that right balance, as Ray Kopp points out in this post:

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.

Tiffany Clements is managing editor of Weathervane. Contact her at clements@rff.org.

Published: Sep-11-09 | 1 Comment

May18

Waxman-Markey and the Important Price Collar

Cap and Trade, Congress, United States, Safety Valve, Price Collar, Waxman-Markey

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)).

“(d) RESERVE AUCTION PRICE.—The minimum reserve auction price shall be $10 for auctions occurring in 2012. The minimum reserve price for auctions occurring in years after 2012 shall be the minimum reserve auction price for the previous year increased by 5 percent plus the rate of inflation (as measured by the Consumer Price Index for all urban consumers).”

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).

Raymond J. Kopp is a senior fellow and director of Resources for the Future’s Climate Policy Program.

Published: May-18-09 | 2 Comments