Getting More for Four Principles for Comprehensive Emissions Trading

1. Getting More for FourPrinciples for Comprehensive Emissions Trading Jan Mazurek, Director Center for Innovation and the Environment 2002 Environmental Innovations Summit Washington, D.C. September 18-20 Based on PPI policy report with Byron Swift

2. Overview Advancing principles for Environmental Legislation in the Power Sector Background Emissions from the electricity generating sector Cap and Trade features Benefits of Cap and Trade Three “E” Approaches Four “E” Approach Six Principles for Comprehensive Emissions Trading Conclusion

3. Emissions from the Electricity-Generating Sector This sector produces high percentage of our nation’s air pollution 1/3 of total U.S. emissions of nitrogen oxide and mercury Even higher share of sulfur dioxide and carbon dioxide Emissions linked to pressing environmental problems Acid rain Exposure to fine particles Smog Regional haze Global climate change

4. Cap and Trade Key Features Replace rates on individual sources with a single, industry-wide limit or “cap;” the cap is set lower than historical emissions to reduce emissions Rate levels are replaced with allowances– an authorization to emit a fixed amount of a pollutant Sources can choose how to reduce emissions, including whether to buy additional allowances from other sources that reduce emissions Sources can buy or sell allowances on the open market System depends on accurate monitoring, measurement Each source must own at least as many allowances as its emissions or face penalty

5. Benefits of Cap and Trade Protects the environment Reduces compliance cost Promotes Innovation

6. Cap and Trade Protects the Environment Same or greater total emissions reduction: as economy grows, sources must find ways to keep emissions below the cap Complete and consistent emissions measurement and reporting by all sources guarantees that total emissions do not exceed the cap and that individual sources’ emissions are no higher than their allowances

7. Cap and Trade Reduces Compliance Costs Rate-based methods dictate specific technologies firms must use for controlling emissions Cap-and-trade allows firms to select cost-effective abatement option Reductions can then be achieved cost effectively, versus requiring reductions at high-cost sources

8. Cap and Trade Promotes Innovation Market-based systems replace rate levels on individual sources with flexible approaches that impose a single industry-wide limit. Sources are free to use the most cost-effective strategy to reduce emissions. Sources that reduce emissions below allocated levels can sell allowances to firms that find emissions control more costly—creating incentives for firms to find cheaper, cleaner technologies. Rate-based standards can distort firms’ investment and prevent them from lowering costs and achieving greater environmental quality

9. The Acid Rain Example Acid rain largely caused by sulfur dioxide emissions from utility industry In 1989 former Bush Administration proposed cap and trade system — a cleaner environment not inordinately expensive Acid Rain Program sets single tonnage limit or “cap” on SO2 Combining an emissions cap with allowance trading, a stringent environmental result was achieved at lower cost Case of acid rain– rate-based approaches were estimated to cost about $4.5 billion to control sulfur dioxide. Under cap-and-trade, cost was a little over $1 billion.

10. “Three-E” Approaches White House “Clear Skies” plan harnesses cap and trade for three pollutants (SO2, NOx, mercury) Excluding carbon dioxide (CO2) is costly and could cause emissions to increase 3-P rate based approach promotes costly “scrubbers” Scrubbers make plants burn more fuel and release more CO2 Encourages dirty old plants to keep running

11. The “Four-E” Approach Caps carbon dioxide Cap promotes fuel switching, plant retirement, innovation Cap and trade makes rate-based approach redundant

12. Make the strategy comprehensive Cap carbon now Use emissions caps, not end-of-pipe rate standards Establish phased reduction targets Replace redundant requirements Distribute trading allowances equitably Principles for a Four-Pollutant Approach

13. Principle 1 – Make the Strategy Comprehensive If 4Es not addressed by one strategy, EPA will address individually EPA will tighten existing SO2 cap 4.5 mmt by 2008 EPA has proposed to control mercury from power generators by 2008 Array of programs to address NOx, probably will be tightened CO2 eventually will be capped Makes it harder for generators to develop a coherent investment strategy Does nothing to promote development of new, clean, and efficient multi-pollutant technologies

14. Principle 2 –Cap Carbon Now 3E does nothing to reduce carbon 4E will reduce carbon emissions by 50 percent or more for equal power output 4E costs only a fraction of a cent per kilowatt meter more than 3E Promotes a clean energy future

15. Principle 3 –Use Emissions Caps, Not End-of-Pipe Rate Standards Rate standards encourage use of technologies to control “just enough” Provide few incentives to invest in better technologies when they come along Caps encourage experimentation to go “beyond compliance” Under Acid Rain Program firms were free to experiment and switch to cleaner fuels

16. Principle 4 – Adopt Stringent Levels with a Phased Approach

17. Principle 5 –Replace Redundant Requirements to Sources With a Four-E Cap Emissions caps should be integrated with the NSR NSR requires installation of pollution controls on new plants and on major modifications NSR provides an incentive to keep dirty, old plants running so as to avoid NSR Once Congress establishes an emissions cap, any form of rate standard loses its capability to reduce emissions overall

18. Principle 6 – Distribute Trading Allowances Equitably Can give allowances away, based on historic fuel use Can allocate on the basis of recent power generated Can auction allowance and use revenues to offset the cost of regulation or for other social goods Start with a partial auction (20-30 percent of allowances) and gradually increase to a full auction over time

19. Conclusion Cap and trade is efficient 3E strategies only perpetuate old, end of pipe controls and old plants Capping carbon now is less costly in economic and environmental terms A Four-E, market-friendly approach can put us on the road to a clean energy future