Federal Cap-and-Trade Policy: Overview of Design Options Ray Hammarlund, KCC Energy Programs Division Director

1. Federal Cap-and-Trade Policy: Overview of Design OptionsRay Hammarlund, KCC Energy Programs Division Director Presentation to Kansas Energy Council Greenhouse Gas Policy Committee, May 13, 2007

2. Point of Regulation • Accurate accounting for emissions requires understanding the chain of economic activity and selecting one point in the chain to be responsible for tracking emissions. • Point of regulation options (carbon): • Upstream: on entities that produce or extract fossil fuels (mining, drilling) • Midstream: on entities that process, transport fossil fuels • Downstream: on entities that actually emit CO2 KEC GHG Policy Committee May 13, 2008

3. Chain of Economic Activity Extraction Processing, transport Major direct emitters Other direct/indirect emitters Mine, drilling Refinery, pipeline Power plants, factories Residential, vehicles UPSTREAM MIDSTREAM DOWNSTREAM KEC GHG Policy Committee May 13, 2008

4. upstream downstream FIRST SELLERS/ LSEs electricity generation Extracted coal Coal prep large industrial and commercial sources Natural gas processors and importers Extracted natural gas Transmission small industrial and commercial sources, residential sources LDC/ Distribution Petroleum refiners and importers Extracted crude petroleum Vehicle Manufacturers transportation Point of Control (Detail) KEC GHG Policy Committee May 13, 2008

5. Natural Gas “upstream” “downstream” electricity generation Extracted natural gas large industrial and commercial sources Natural gas processors and importers Transmission small industrial and commercial sources, residential sources LDC/ Distribution KEC GHG Policy Committee May 13, 2008

6. Upstream • Most comprehensive coverage (leads to most cost-effective emissions reduction) • Fewest entities to regulate: ~2,000 permit holders • Easiest to monitor, enforce • Lower administrative costs • Reduce risk of leakage KEC GHG Policy Committee May 13, 2008

7. Downstream • More familiarity, experience (e.g., Acid Rain Trading Program) • More gradual phase in of regulation • Less comprehensive coverage; therefore less efficient • More entities to regulate • More expensive to monitor, enforce • Increased risk of leakage KEC GHG Policy Committee May 13, 2008

8. Upstream or Downstream? • Some contend that downstream regulation is more likely to change emitter behavior; sends more direct signal to emitters to achieve reductions and invest in technology • Others contend that emitters will respond to higher price signal regardless of who holds the permit—e.g., residential customers will respond to higher electric or natural gas bills KEC GHG Policy Committee May 13, 2008

9. Allocation of Permits Advantages of giving away for free • Politically expedient: gift of valuable asset encourages buy-in from powerful interests; gets cap-and-trade started. Disadvantages of giving away for free • Government loses revenue from permit sales, which could be used to mitigate economic impacts, fund R&D, etc. KEC GHG Policy Committee May 13, 2008

10. Allocation of Permits Advantages of auctioning some, or all • Regulated entities compete equally for allowances • Simplified program design • Government receives revenue which can be used to mitigate economic impacts on consumers, fund R&D, etc. Disadvantages of auctioning • Political support may diminish if regulated entities lose windfall KEC GHG Policy Committee May 13, 2008

11. Uses of Revenue Uses for revenue from permit sales: • Cut other taxes (on all or low-income) to offset economic impact of regulation • Fund climate adaptation, mitigation efforts • Fund ongoing climate research • Reduce national debt • Fund R&D on alternative technologies ... KEC GHG Policy Committee May 13, 2008

12. Emissions Offsets • Defined as a project (or program)-based emission reduction achieved outside the cap-and-trade program’s covered sources. • An offset “credit” is granted by a regulatory agency for each “ton” of demonstrated actual reductions that meet a set of established requirements. KEC GHG Policy Committee May 13, 2008

13. Offsets: Advantages • May reduce cost of compliance with cap by giving access to wider range of emission reduction opportunities • Allows entities not included in the cap to participate in the market by investing in or developing offset projects • Expands linkages between regional, national, and international carbon markets KEC GHG Policy Committee May 13, 2008

14. Offsets: Disadvantages • Viewed by some as undermining effectiveness of cap. • Reduce incentive for reductions • Strict monitoring and enforcement requirements add to implementation costs. • Lack of integrity or legitimacy • Problems with U.N. Clean Development Mechanism KEC GHG Policy Committee May 13, 2008

15. Offset requirements • R - Real • S - Surplus/Additional • V - Verifiable • P - Permanent • E - Enforceable KEC GHG Policy Committee May 13, 2008

16. Offsets: Sequestration • Three types • Terrestrial (agriculture and forestry) • Aquatic • Geologic KEC GHG Policy Committee May 13, 2008

17. Sources Climate Change Legislation Design White Paper: Scope of a Cap-and-Trade Program, Committee on Energy and Commerce Staff, October 2007 (http://energycommerce.house.gov/Climate%5FChange/). Potential Reductions through Offsets in the Midwest: Introduction to Offsets, Climate Change Capital, Presentation at MGA Cap-and-Trade Workshop, Detroit, March 13, 2008. Scope and Point of Regulation in a Cap-and-Trade Program, Judi Greenwald Presentation at MGA Cap-and-Trade Workshop, Detroit, March 13, 2008. Downstream Regulation: Design Options, Robert R. Nordhaus, Presentation at Point of Regulation Workshop, National Commission on Energy Policy, September 16, 2005 (http://www.energycommision.org/ht/a/GetDocumentAction/i/2790). KEC GHG Policy Committee May 13, 2008