Creating Winners Through Climate Change Policy --A Look at a Federal & State Policy Options--

1. Creating Winners Through Climate Change Policy--A Look at a Federal & State Policy Options-- Ned Helme, Executive Director * * * NGA Center for Best Practices February 28, 2002 Washington, DC

2. Center for Clean Air Policy • Non-profit research-advocacy group founded in 1985 by state governors to find market-based solution to acid rain • Applying similar approaches to ozone, greenhouse gases, and air toxics at state, regional, nat’l, int’l levels • Leader in OTAG process and in international climate change policy negotiations. • Proponent of states as “laboratory of democracy”

3. Presentation Outline • CCAP’s State Projects • Highlights of CCAP state initiatives • Lessons from state experience • Impacts of allowance allocation on national cap-and-trade approach • CCAP study • Studies on electricity sector caps

4. CCAP’s Vision for State Action Statewide Target Policy Mechanisms Emissions Trading Negotiated Agreements Regulatory Approaches Funding Mechanisms Voluntary Programs Example: MA electricity sector 4-P Example: NJ Silver/Gold Track Example: Building Codes Example: Public Benefit Charges Example: Transportation Education  Targets and Mechanisms for each sector 

5. CCAP’s State Roundtable on Global Climate Change • Launched in December 1998 to discuss and advance state action on climate change. • Participants include senior environmental, energy, transportation, and land-use officials from 14 states. • Forum for sharing ideas, building motivation & momentum, and developing coordinated strategies for reducing GHG emissions. • Moving from specific innovative ideas to broader multi-sector approaches, including statewide caps, inventories, and mechanisms.

6. State Actions: Lessons from New York CCAP’s Role: • Developing recommendations for NY on state actions to reduce GHG emissions. Key Insights: • Important to develop an overarching strategy that: • Looks at options in all sectors • Utilizes a variety of policy mechanisms (i.e., emissions trading, negotiated agreements, regulatory approaches, funding mechanisms, and voluntary mechanisms)

7. CCAP’s Transportation and Climate Change Roundtable CCAP’s Transportation & Climate Change Initiative: • Forum where Roundtable States discuss opportunities to reduce transportation emissions. Key Lessons: • Many options offer co-benefits, such as reducing air pollution, mitigating congestion, and improving “quality of life”. • Important to look at VMT as well as vehicle technology. • Quantification of reductions is difficult, but not impossible.

8. Using Funding Mechanisms: Public Benefit Funds CCAP’s Public Benefit Charge Fund Project: • Seeking to develop & implement criteria that target energy-efficiency (EE) & renewable energy (RE) technologies that maximize reductions in various emissions. Key Lessons: • Results will be applicable to any “pot” of money specifically set aside for EE/RE. • 19 states have public benefit funds • Other states have funds specifically set aside for EE & RE projects

9. Emissions from Electricity Generation: Distributed Generation CCAP’s Distributed Generation Project: • Analyzing the impacts of distributed generation on net emissions from electricity sector using in-house model. • Initially looked at short-term impacts on New England, but long-term impacts on NE and other regions can be done. Key Preliminary Findings: • In short-term: • Existing diesel DG may pose NOx emissions problem. • Little impact on CO2 emissions.

10. Assessing & Controlling Emissions from Distributed Generation CCAP’s Distributed Generation Project: • Analyzing the impacts of distributed generation on net emissions from electricity sector using in-house model. • Initially looked at short-term impacts on New England, but long-term impacts on NE and other regions can be done. Key Preliminary Findings: • In short-term: • Existing diesel DG may pose NOx emissions problem. • Little impact on CO2 emissions.

11. Future CCAP State Projects • Working with additional states. • More focused discussion on inventories and policy mechanisms. • Continued evaluation of state policy opportunities to reduce GHG emissions.

12. CCAP / CRA Study: Upstream Carbon Trading  Project goal was to identify winners and losers, look at alternative ways to design program to support domestic climate policy. • Key insights on design of cap-and-trade program that balances equity & efficiency. • Provide better understanding of program costs.

13. Applicability of Study to States • A number of states have developed or are considering cap-and-trade approaches for emissions trading. • Others developing framework for potential trading through state registries. • Opportunities for state input into national policy design discussions, including multi-pollutant cap and economy-wide proposals.  Method for allocating allowances under cap-and-trade is key question for policy design.

14. Project Overview • Collaborative modeling effort between CCAP, Charles River Associates (CRA) and modeling team. • Work grew out of CCAP’s GHG Emissions Trading Braintrust. • Used CGE model to look at alternative designs of upstream, economy-wide cap-and-trade program for carbon dioxide.

15. CRA: Modeling Background • Dynamic, computable general equilibrium (CGE) model. • Upstream, economy-wide cap-and-trade program for carbon dioxide. • Model assumes Kyoto target with Annex B trading. • Economy is on the economic efficiency frontier (except for taxes)—i.e., no free efficiency. • Does not capture technology detail, including energy efficiency & technological improvements. • Compliance occurs through substitutions among energy sources as well as substitutions between goods and services, labor and energy. • Output includes overall costs to economy, impacts on prices, employment, production & stock value.

16. Main Findings/Insights • Cost of economy-wide CO2 control program can be substantially reduced if allowances are auctioned and revenues are recycled as marginal tax rate reductions instead of grandfathering most allowances • Conventional wisdom suggests energy industry would suffer loss in shareholder value from implementation of Kyoto accord. • Study suggests that design of the trading system can create winners as well as losers. • Grandfathering heavily to emitting sources can overcompensate those sources to the detriment of other affected parties and the larger economy.

17. Implications for Policy • Can design program so that energy sector stock values are held harmless (no declines or windfalls). • Depending on program design, revenues may be available for a variety of beneficial uses. • Results apply to an economy-wide trading program, but not necessarily a single-sector trading program.

18. Design Issues Investigated in CRA Study Allowance Allocation • Grandfathering—allowances given to trading system participants based on historical emissions in 3 scenarios: • g/f equal to 93% of 1990 emissions • g/f equal to 25% of 1990 emissions • g/f to energy industry to protect BAU equity value • Auction—participating companies purchase allowances to cover emissions. Revenues recycled.

19. Design Issues Investigated in CRA Study Cont. Revenue Recycling • Cover government revenue losses • Reduce marginal tax rates • Payments to losing companies, consumers • Payments to labor, communities (didn’t evaluate but also possible)

20. Economic Efficiency • Most efficient approach = 100% auction allocation in which revenues are used first to compensate government for revenue losses with remaining revenues distributed through personal income tax (PIT) recycling • In this scenario, allowances are used as follows: • 56% to maintain government revenues • 44% distributed through PIT recycling

21. Equity Value • An auction allocation results in moderate equity losses (4-6%) in the oil, gas and power sectors, and larger (64%) losses in the coal sector. • Depending on the amount given to affected industries, grandfathering based on past emissions can result in protection of current stock value, or significant gains or losses for particular sectors: • Providing 93% of 1990 emissions (Kyoto target) to electric utilities would increase stock value by 50% over BAU • Same historic allocation formula would cut coal by 56% because of low direct emissions from coal mines,etc.

22. Change in Equity Value

23. Balancing Efficiency and Equity • Grandfathering just 9% of total allowances would be sufficient to preserve current equity value of major energy companies • 91% of allowances could be auctioned under this scenario with revenues recycled through tax redux • This combined auction/grandfather approach cuts cost to economy by 40% below cost of pure grandfather • Note: the 9% figure compensates only shareholders; additional allowances would need to be provided to compensate labor and communities.

24. Balancing Efficiency and Equity

25. Economic Efficiency Welfare Loss Under Different Allocation & Recycling Scenarios (Percentage loss relative to BAU)

26. RFF Study of Electricity Sector Study • Resources for the Future evaluated the impact of allocation decisions under national carbon cap on electricity sector Main Findings • Allocation through an auction is roughly one-half the cost to society of Grandfathering or GPS • Under auction, net change in the value of existing assets across the industry is 6% of the net present value of allowances (2001-2020).

27. Change in Value of Assets: National Aggregation(1997 $/MW in 2001 under Limited Restructuring; 35 million mtC)

28. Electricity Sector Cap: ICF Study • Emission allocation can increase a companies value, especially prominent for carbon. • Grandfathering carbon allowances to a company provides assets that can rival the value of their generating assets. • Carbon value of permits is greater than NOx and SO2 values.

29. Value of Allowance Book – Grandfathered Allocation

30. Summary of Results of CCAP Economy-Wide Modeling • An auction allocation with government compensation and PIT recycling is the most efficient approach—about half the cost of pure grandfathering allocation. • Traditional grandfathering of allowances may overcompensate the electricity sector while other sectors and interests still lose. • Energy industry shareholders can be made whole with only 9% of the total allowances, while minimizing adverse impacts on program efficiency.

31. Implications for State & FederalTrading System Design • Tees up a discussion of different approaches to allowance allocation/revenue recycling. • Is it desirable to compensate (or overcompensate) affected industry sectors? • Recycling revenues to taxpayers can be very efficient. What is the best approach? • To what extent should other affected interests (communities, labor) be compensated? • What about compensating government for revenue losses? • Other uses for revenues might include contributions to state EE/RE funds (e.g., PBC programs)

32. For more information • Study on allocation impacts see: Allowance Allocation: Who Wins and Loses Under a Carbon Dioxide Control Program • CCAP’s website: www.ccap.org