Markets for the Environment and Renewable Energy

A. Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology http://web.mit.edu/ceepr/www/ Perspectives from Abroad Colloquia Sustainable Energy Ireland Dublin, Ireland May 21, 2003 Massachusetts Institute of Technology Center for Energy and Environmental Policy Research Markets for the Environmentand Renewable Energy

Introducing environmental & renewable markets The US Experience with Emissions Trading The UK Experience with Renewable Energy Interactions among markets Concluding Comments Outline

Societies, governments, and markets From Locke’s social contract to Lincoln’s “of the people, by the people, and for the people” Natural markets, banned markets, and constructed markets Decisions reflect societal values Non-appropriability as the underpinning for constructed markets Some Preliminaries

Basic requirement: one ton = one allowance Demand has been created, but non-specific Radical refocusing of the government role: from specific mandate to accounting Measuring instead of inspecting Simultaneous recognition and issuance of tradable “rights to emit” Simplicity, strict accountability, & flexibility An Environmental Market:U.S. Cap and Trade Programs

Basic requirement: ROCs = % obligation Creates demand for certificates (ROCs) Producers of renewable energy earn ROCs Specific mandate abandoned, market will take care of supply Unbundling of electricity and “renewability” Like in environmental markets Allows separate markets to operate No build requirements for utilities Also, subtle shift from capacity to generation A Renewable Energy Market:Renewable Obligation Certificates

The Acid Rain (SO2 allowance trading) Program Nationwide, single source beginning in 1995 RECLAIM Programs for NOx and SO2 in the Los Angeles Basin Multi-source, local program starting in 1994 The Northeastern NOx Budget Program Seasonal program (May-Sept) enacted by coordinated individual state action beginning in 1999 Expanded by federal action to include all eastern U.S. in 2003 U.S. Cap-and-Trade Programs

Cost savings have been achieved 50% savings in the Acid Rain Program Markets have emerged in all programs and significant trading has been observed Better environmental performance than conventional regulatory alternatives 1st year effect with & without banking Big, dirty units reduce the most 100% (real) compliance because of treatment of high abatement cost facilities What are the Results?

First Year Effect in “Big Dirties”

First Year Effect in Other Units

Deep abatement technology is capital intensive Economics depends on units of output over which the (large) fixed costs can be spread Cap & Trade Programs pay per unit of abatement, while conventional regulatory programs do not Why Did the “Big, Dirties” Reduce the Most?

Cost heterogeneity implies C & C rule will not fit all…imposes unique hardship on some Leads to administrative appeal and equitable exception that relaxes or delays requirement One-sided process…those facing less cost than others never offer to do more Fine line between equity and special pleading Why 100% Compliance?Exception and Equity

Cheaper to buy an offset than seek exception Trading provides for automatic off-setting Also, harder to claim unique hardship in a market with many buyers… highest cost is price of an allowance Easier to enforce allowance-emissions matching than prescriptive rules Flexibility, simplicity & strict accountability Special Pleading Has Been Made Uneconomic

How has Renewable Energy Procurement Fared?

NFFO and RO Capacity(England & Wales)

ROC Performance to date(England, Wales, & Scotland)

Emissions Trading RECLAIM and NOx programs superseded conventional programs with ample authority Too complicated to implement by regulation Acid Rain Program was “de novo” Renewables: Market replaces direct procurement Separability, decentralization & specialization Avoiding pitfalls of informational asymmetries and the political uses of administrative discretion More general than environment and renewables Another Similarity:Markets Supplant Regulation?

Many markets interact Substitution and budget constraints Environmental markets are similar Caps are independent & costs are additive But sometimes, abatement of one pollutant reduces/increases another pollutant If both capped, markets are interdependent Renewable energy markets will interact with CO2 markets, for instance the EU Trading Scheme Market Interactions

Renewable energy emits no CO2 and is often seen as an instrument of climate policy Any CO2 market will provide some impetus to renewable energy production If CO2 and ROC markets co-exist Tighter CO2 caps will reduce ROC prices, and Larger ROs will reduce CO2 prices Potentially one could drive the other price to zero The ROC/CO2 Interaction

Something unique and non-appropriable about renewables? Set the RO at the right level Don’t worry about interactions If the RO is a surrogate carbon policy, Justified only as a 2nd best instrument Interaction is appropriate if CO2 price is rising Otherwise, an RO is superfluous or inefficient Is There Something Wrong with this Interaction?

Technological Trends Information revolution has greatly reduced cost of monitoring, reporting and processing Societal Trends Greater willingness to rely on “markets” and less faith in “government” and “experts” Environmental Problems are Different Blunt tools work only on big obvious problems Why Markets Now?

Exciting new world of constructed markets Reflecting broad underlying trends Not besotted market ideology More intelligent use of government Sorting out government and market roles by equal application of market and public failure Adapting to diminishing supply of civil servants The right attitude for policy… Some Concluding Thoughts

“If it is feasible to establish a market to implement a policy, no policy-maker can afford to do without one.” Pollution, Property and Prices J. H. Dales (1968)

Markets for the Environment and Renewable Energy