Federal Climate Change Legislation : Key Issues for Commissions

1. Federal Climate Change Legislation : Key Issues for Commissions Andy Keeler John Glenn School of Public Affairs The Ohio State University

2. Outline • Legislative specifics that matter • Issues for Commission Decision-making • Cap-and-trade in Perspective

3. Legislative specifics that matter • Allowance price • Allowance allocation and use of resources • Exemptions and special treatment • Specifics on Interaction with State Programs

4. Allowance Price Matters • Directly determines the costs and incentives • Tighter targets => higher prices • Lieberman-Warner / Boxer has tighter short-term targets than Bingaman-Specter

5. How big will price effects be? • Predictions are highly imperfect • Economic assumptions • Technology assumptions • Institutional assumptions – offsets, state programs, etc. Predicted effects in 2020 are good research but highly uncertain

6. EIA Model Predictions for 2020 • Lieberman – Warner (L-W) • ~ $0.17 / gallon gasoline • ~.81 cents / kwh electricity (coal) • Bingaman - Specter • ~ $0.12 / gallon gasoline • ~.28 cents / kwh electricity (coal) Inherent uncertainty is huge - but much lower for Bingaman than LW because of the safety valve

7. Cost Containment (Price Risk) in Legislation • What happens if reducing CO2 is more difficult and expensive than predicted? • Tradeoff between environmental certainty and economic certainty • Economic risk – high prices, shortages, economic dislocation (political backlash) • Environmental risk – “Busting the Cap” – not meeting GHG reduction goals

8. Emergency-Metaphor Policies—safety valves, circuit breakers, and emergency off-ramps • Reduce the price of allowances by making additional allowances available • Crucial distinctions • Relax the long-term cap, or all released allowances made up in the future (borrowing) • Price certainty, trigger certainty, or additional allowances released without certainty

9. Emergency-Metaphor Policies • Safety Valve – unlimited allowances available at a known price • Circuit Breaker – annual cap is frozen (stops declining) as long as prices are above a known price • Emergency Off-Ramp – a reserve of future-year allowances is auctioned annually with a (known) minimum price

10. Cap Neutrality • The safety valve is not cap-neutral – additional allowances sold at the safety valve price represent additional emissions • The circuit breaker is not cap-neutral– but there are limits to the quantity of emissions above the cap • The “allowance reserve” is cap-neutral (in theory)

11. Triggers • A safety valve works off a known, pre-announced price • Reserves, circuit breakers, and other borrowing mechanisms can be designed to work off announced triggers orat the discretion of regulators (e.g. Carbon Market Efficiency Board)

12. Carbon Market Efficiency Board • The “Carbon Fed” would have discretion to change • Offset quantities • Borrowing restrictions • ???? • There are positive and negative consequences of building such discretion into a cap-and-trade system

13. Cost Containment in Legislative Proposals • Emergency off-ramp (Boxer / L-W) – price effects are not certain, cap-neutral, has a pre-announced minimum price (starts at $22-30 per ton CO2) • Safety valve (Bingaman-Specter) – certain, pre-announced (current version $12 per ton CO2), excess emission above the cap

14. What’s the price? • Discussions about the safety valve in particular, and about all of these mechanisms, should focus more on the price at which they kick in • A $12 safety valve is very different than a $50 safety valve

15. Cost containment: short-term and long-term • Well-managed borrowing mechanisms are likely to be a good tool for short-term price volatility • Long-run price uncertainty would be better managed by safety valve mechanisms (with accompanying drawbacks)

16. Long-term Targets and Prices • Targets in most federal legislation are set through 2050 • Common sense says that targets that far in the future could be changed • Setting long-term targets does • Create a status quo • Concretize aspirational goals • May have significance in IRP processes

17. Allowance Allocation: Who Gets the Money? • $20 allowances for year 1 of Lieberman-Warner => $115 billion in allowance value • Allowances can technically be allocated to just about anyone. Who gets them is a lot of politics with a little bit of equity and public policy thrown in for good measure.

18. Allocation to LDCs • L-W gives about 10% of total allowances to LDCs (Bingaman punts on this point) and 3% to gas distributors • Use to keep prices low • Use to reduce energy use • Use for GHG-reducing generation and transmission investments • The use of these allowances is under state commission regulation – but may also have legislative direction

19. Allocation to Generation Owners • L-W gives generation owners 18% of allowance pool to start, then shrinks that over time (Bingaman roughly 25%) • Wholesale competition generators receive windfall • Embedded cost regulation generators face commission regulation in using allowance value (public uses vs. shareholder equity) • This potentially creates a significant equity issue

20. Individual Allocations to LDCs and generation owners • For LDCs, L-W allocates initially based on electricity volume (favors areas with low-GHG sources like hydro or nuclear) • For generation owners, L-W allocation is based on emissions history (favors coal) • Future allocations could be based on these same criteria, or be updated by output, alternative energy progress, or some other criterion

21. Special Treatment and Exceptions • Exemptions from the system • Special treatment through bonus allowances • Special treatment through other mechanisms

22. Exemptions from the System • There has been a move to exempt gas used directly for home heating from a federal cap-and-trade system • The argument goes that gas is more GHG-efficient, and so should be encouraged • This is bad public policy – all fossil energy sources should be covered to avoid leakage and create correct long-term incentives • Exemptions are the wrong tool to provide special treatment

23. Bonus Allowances • Can be used to increase the returns to specific technologies • Example – carbon capture and storage in L-W gets rewarded twice – once through reducing allowance needs, and again through bonus allowances with cash value • Bonus allowances are really no different than cash payments, but do not require a direct budget allocation

24. Additional Incentives for Alternative Energy • Renewable portfolio standards • Inslee feed-in tariff bill • Production Tax credits, etc

25. Federal Legislation and State Programs • Model of CAA and tailpipe standards – states can be more stringent than federal regulation – does not apply well • A state with a more stringent cap will take on more emissions reduction effort, but national emissions will be unchanged • States can be rewarded for aggressive programs through allowance allocation

26. Commission Decisions • Allowance prices and ratemaking • End user prices vs. public investments in conservation • Managing Conservation Programs • Commissions and the public interest

27. Allowance prices and ratemaking • What is prudent behavior with respect to allowance prices with respect to the decisions of regulated generation? • Example – if allowance prices turn out to be higher than expected, was a coal plant a prudent expenditure • This works both ways – if allowance prices turn out to be lower than expected, was a nuclear plant a prudent expenditure?

28. End user prices vs. public investments in conservation • Commissions will have to determine how to allocate allowance value (that they control) to • Reduce revenue requirements and prices • Target assistance to low-income consumers and vulnerable industries • Fund conservation and other GHG reduction activities

29. Managing Conservation Programs • L-W has significant funding through allowance allocation for state-run conservation programs • Coordination and emphasis of commission programs and other pubic programs • Potential dramatic expansion of programs presents quality and accountability challenges

30. The Public Interest • How do commissions treat state and national goals for GHG reduction relative to more traditional elements of their view of the public interest • As a constraint • As something to actively pursue beyond the letter of climate legislation

31. Is cap-and-trade the right policy? • Would a tax be better? • Does it really solve the climate change problem – or should we just be investing in technology?

32. Tax vs. Cap-and-trade • A tax is an excellent policy from a technical standpoint • Transparent • Avoids wrangling over allowances • Taxes have political liabilities • “people hate taxes” • NGOs hate lack of quantitative certainty • Industry hates the lack of free allowances

33. Does cap-and-trade “solve climate change” • NO - but nothing else does, either • Massive investment in a portfolio of technologies, worldwide action, behavioral change, etc. are all required • Pricing GHG emissions is necessary (but not sufficient)

34. Does cap-and-trade “solve climate change” • Will increase R&D and innovation • Will reward conservation investments and behavior • All reductions in emissions lessen climate change risks – it’s not 0/1– and buy time for technology and adaptation

35. Does cap-and-trade “solve climate change” • US action is a necessary step in international progress • Pricing carbon does not preclude technology or standards – based policies – and generally tends to reinforce them