January 23, 2009 Holmes Hummel, PhD hummel@stanfordalumni

1. January 23, 2009 Holmes Hummel, PhD hummel@stanfordalumni.org www.holmeshummel.net/ClimatePolicyDesign Complementary Policies for Climate Change: Basis, Design, Strategy

2. Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Title XIII) Complementary Policies

3. U.S. Approach: Cap-and-Trade Declining Cap Covered Entities

4. Polluters Compete for Scarce Permits

5. Carbon Price Established by Market Activity So, is it more profitable to: buy a permit, OR reduce my own emissions? Profit opportunities are a main driver for innovation and investment, and the climate challenge needs both.

6. Carbon Price Established by Market Activity $40 Would anyone accept $40 for your permit?

7. Carbon Costs Passed to Consumers $40 $40 $40 $40 $40 35¢ per gallon 2.5 ¢ per kWh 0.6 ¢ per therm People Respond…?

8. Achieving Reduction Targets 7000 $150 $350 $?? 6000 $300 $120 5000 $250 $100 $?? 4000 $200 $80 3000 $150 $60 $?? 2000 $100 $40 1000 $50 $?? $20 2050 2100 2000 What price trajectory would be sufficient to drive people away from fossil fuels? Modeling results are highly uncertain Carbon Price ($/MtCO2) Annual U.S. Emissions (MtCO2) To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy.

9. Moving to Clean Energy 2010 2020 2030 2050 2040 Rail Transport Hybrid vehicle Nuclear power Solar power Wind power Green buildings $100 $50 $200 Players seek better options as costs rise. Cap-and-trade lets players choose at what price they leave the game – and how they want to make that change. $30 $20 $150

10. Achieving Reduction Targets 2050 Who will be the last greenhouse gas polluters left in the game? Unlike the familiar game of Musical Chairs, the last players still vying for pollution permits are not exactly winners…

11. Achieving Reduction Targets 2050 The last ones remaining in the game are those who: • can afford to pay the most, or • have the least flexibility to change games. The underlying assumption is that the most valuable uses of fossil fuels must be the ones for which people are willing to pay the most. To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy.

13. Market Conditions Many small buyers and sellers Perfect freedom of entry and exit from the industry. Homogeneous products are supplied to the markets that are perfect substitutes. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market Perfect Competition SELLERS BUYERS

14. Market Conditions Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market Perfect Competition

15. Market Conditions Many small buyers and sellers Homogeneous products are supplied to the markets that are perfect substitutes. Perfect freedom of entry and exit from the industry. Perfect knowledge Low transaction costs No externalities arising from production and/or consumption which lie outside the market Perfect Competition

16. Market Conditions Perfect Competition • Many small buyers and sellers • Homogeneous products are supplied to the markets that are perfect substitutes. • Perfect freedom of entry and exit from the industry. • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

17. Market Conditions Perfect Competition • Many small buyers and sellers • Homogeneous products are supplied to the markets that are perfect substitutes. • Perfect freedom of entry and exit from the industry. • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

18. Market Conditions Perfect Competition • Many small buyers and sellers • Homogeneous products are supplied to the markets that are perfect substitutes. • Perfect freedom of entry and exit from the industry. • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

19. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • Perfect freedom of entry and exit from the industry. • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

20. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $3.99 $3.99 $3.20

21. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market $/Btu? $??

22. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Persistent transaction costs • No externalities arising from production and/or consumption which lie outside the market $?? $/Btu?

23. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Persistent transaction costs • Many, Very Large Externalities – climate change is just one… $?? $/Btu?

24. Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Title XIII) Complementary Policies

25. #1 Complementary Policies Reduce the Cost of Price-Based Policies

26. #1 Complementary Policies Reduce the Cost of Price-Based Policies Abatement costs <$50/ton COST ($/tonCO2) 100 90 80 70 60 50 40 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 Potential Gigatons/year IN 2030 -20 -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

27. Fuel economy packages – Light trucks Industrial process improve-ments Coal mining – Methane mgmt Residential electronics Residential buildings - Lighting Industry – Combined heat and power Cellulosic biofuels Commercial electronics Conservation tillage Commercial buildings – New shell improvements Fuel economy packages – Cars #1 Complementary Policies Reduce the Cost of Price-Based Policies Abatement costs <$50/ton COST ($/tonCO2) 100 90 A price on carbon will not address all the non-price barriersto reducing GHGs – or the price insensitive reasons people consume fossil fuels. 80 70 60 50 40 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 Potential Gigatons/year IN 2030 -20 -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

28. Fuel economy packages – Light trucks Industrial process improve-ments Coal mining – Methane mgmt Residential electronics Residential buildings - Lighting Industry – Combined heat and power Industry – CCS new builds on carbon-intensive processes Biomass power – Cofiring Car hybridi-zation Cellulosic biofuels New coal power plants with CCS for EOR Commercial electronics Conservation tillage Commercial buildings – New shell improvements Natural gas and petroleum systems mgmt Shift dispatch of existing plants from coal to natural gas Winter cover crops Reforestation Fuel economy packages – Cars Afforestation of pastureland #1 Complementary Policies Reduce the Cost of Price-Based Policies Abatement costs <$50/ton COST ($/tonCO2) 100 90 80 70 60 50 40 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 Potential Gigatons/year IN 2030 -20 -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

29. Industry – CCS new builds on carbon-intensive processes Biomass power – Cofiring Car hybridi-zation New coal power plants with CCS for EOR Natural gas and petroleum systems mgmt Shift dispatch of existing plants from coal to natural gas Winter cover crops Reforestation Afforestation of pastureland #1 Complementary Policies Reduce the Cost of Price-Based Policies Abatement costs <$50/ton COST ($/tonCO2) Reduction Target: 1 GtCO2e 100 90 80 70 60 $40 / tonCO2 50 40 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -230 Mid-range case, McKinsey 2007

30. New coal power plants with CCS for EOR New coal power plants with CCS for EOR Fuel economy packages – Light trucks Fuel economy packages – Cars Residential buildings -Lighting #1 Complementary Policies Reduce the Cost of Price-Based Policies Abatement costs <$50/ton COST ($/tonCO2) Reduction Target: 1 GtCO2e 100 90 80 70 60 $40 / tonCO2 50 40 $10 Billion 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 -80 -90 -100 Shift dispatch of existing plants from coal to natural gas Shift dispatch of existing plants from coal to natural gas -110 -120 -230 Mid-range case, McKinsey 2007

31. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels New coal power plants with CCS for EOR Fuel economy packages – Light trucks Fuel economy packages – Cars Residential buildings -Lighting Abatement costs <$50/ton COST ($/tonCO2) 100 90 80 70 60 50 40 30 20 10 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 -10 -20 Potential Gigatons/year IN 2030 -30 -40 -50 -60 -70 -80 -90 -100 Shift dispatch of existing plants from coal to natural gas -110 -120 -230 Mid-range case, McKinsey 2007

32. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels

33. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Nuclear Coal Power Natural Gas Power Nuclear Coal Power Natural Gas Power $20/tCO2 Carbon Price: $0/tCO2 Sets Price Sets Price Market Price Market Price Profit Profit Profit Profit Profit Profit Dispatch Price per MWh Dispatch Price per MWh

34. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Nuclear Coal Power Natural Gas Power Nuclear Coal Power Natural Gas Power $20/tCO2 Carbon Price: $0/tCO2 Sets Price Sets Price Market Price Market Price Profit Profit Profit Profit Profit Profit Dispatch Price per MWh Dispatch Price per MWh

35. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels Gasoline Consumption Price of Gasoline ~$150/tCO2

36. #3 Stabilization Requires Reducing Emissions Outside a Managed Cap of Measurable Sources CAP OFFSETS World Resources Institute; 2003 data

37. Seeking a Price Response in Failed Markets Making the Case for Complementary Policies Considering a Federal Climate Action Plan Annex: Smart Grid (EISA Annex XIII) Complementary Policies

38. Market Conditions Perfect Competition Energy Sector • Many small buyers and sellers • Homogeneous products are supplied to the markets that are perfect substitutes. • Perfect freedom of entry and exit from the industry. • Perfect knowledge • Low transaction costs • No externalities arising from production and/or consumption which lie outside the market • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Persistent transaction costs • Many, Very Large Externalities – climate change is just one…

39. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Persistent transaction costs • Many, Very Large Externalities – climate change is just one… Complementary Policies Price-Based Policies

40. Market Conditions Energy Sector • Few sellers, many buyers • Homogeneous products are supplied to the markets that are perfect substitutes. • High capital requirements and regulatory barriers to entry • Lack of transparency • Persistent transaction costs • Many, Very Large Externalities – climate change is just one… • Curing market failures • Coping with market failures • Covering emissions by sector Price-Based Policies

41. Designing Complementary Policies An “economy-wide” cap-and-trade policy does not distinguish between sectors End-Use CAP U.S. GHG Emissions U.S. Sources OFFSETS INSIDE U.S. World Resources Institute; 2003 data

42. Designing Complementary Policies End-Use Transportation Distance Mode Fuel Source Fuel Economy U.S. GHG Emissions U.S. Sources World Resources Institute; 2003 data

43. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Vehicle GHG Standards

44. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Vehicle GHG Standards

45. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards

46. Designing Complementary Policies End-Use Transportation Electric Power Sector U.S. GHG Emissions U.S. Sources World Resources Institute; 2003 data

47. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs

48. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020

49. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below 2002-2004 Low Carbon Fuel Standard Transportation & Other Vehicle Measures Vehicle GHG Standards Efficiency Standards & Incentive Programs Renewable Portfolio Standard: 33% by 2020 Million Solar Roofs

50. Designing Complementary Policies End-Use U.S. GHG Emissions U.S. Sources Industrial Gases World Resources Institute; 2003 data