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Kristin Eberhard’s Blog

California is leading the nation to join the emerging global clean energy economy

Kristin Eberhard

Posted December 16, 2010 in Curbing Pollution

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The California Air Resources Board today approved, by a vote of 9-1, the first economy-wide carbon market to reduce pollution in the nation. This comes just over a month after California voters overwhelmingly rejected Proposition 23, signaling strong support for clean energy and policies that will help the state reduce global warming pollution. The ARB action also comes just a week after nations around the world agreed on the urgent need to tackle the challenge of climate change (see my colleague Jake Schmidt’s blog on Cancun here).   

This newly adopted carbon market is one small but key part of California’s comprehensive clean energy law, AB 32.  It accounts for roughly one quarter of the overall emissions reduction programs that will be accomplished by the package of policies developed under the landmark legislation to put California on a clear path to reducing emissions to 1990 levels by 2020. 

The program sets a cap on global warming pollution for facilities in the industrial, electricity, transportation, and natural gas sectors and saves the overall economy money by letting facilities (such as power plants, refineries and industrial plants), use a market to find the cheapest ways to reduce pollution.

Let me illustrate with an example: if facility A and B need to reduce their emissions by a combined total of 20 tonnes, and facility A has a cheap way to reduce emissions (let’s say by $10/tonne reduced), but it will cost facility B twice as much ($20/tonne), facility A can reduce its emissions by 20 tonnes for a total cost of $200 (20 tonnes x $10/tonne) and then sell its extra allowances to facility B who will not need to reduce at all. If A sells its 10 extra allowances to B at a price slightly higher than what A paid to reduce emissions, but lower than the price B itself could have achieved (say $15/tonne), A will have spent $50 and B will have spent $150 to reduce global warming pollution overall by 20 tonnes.  In other words, the program will have reduced emissions at the lowest price in this market ($10/tonne), to the financial benefit of the cleanest emitter – A.

By contrast, as the chart below diagrams, if the government simply required facilities A and B to each reduce emissions by 10 tonnes, the overall cost of the program would rise. Under this scenario, facility A would pay a total of $100 (10 tonnes x $10/tonne) and facility B would pay a total of $200 (10 tonnes x $20/tonne) for a total cost of $300 – or $100 more than the cost of getting the same pollution reductions under a cap and trade program.

KGE CT (cropped) chart.PNG

How Cap-and-Trade Works in California:

The program sets a limit on pollution, and requires facilities to submit to the Air Board one pollution allowance for every tonne of pollution they emit. There are a limited number of allowances available (similar to taxi medallions). Facilities are free to find the cheapest ways of reducing emissions and the Air Board only monitors whether facilities have enough allowances to match the pollution they emit, not how they reduced their emissions.

Every facility has three options for meeting pollution limits:

1)      Reduce pollution by making facilities more efficient or finding alternative fuel sources

2)      Get a pollution allowance either by getting it for free, buying it in an auction, or buying it from another facility that has an extra allowances

3)      Buy an offset.  An offset represents a pollution reduction from outside the program.  A facility inside the program can invest in reductions elsewhere to offset their emissions.

There are many design elements of this program that we consider to be strong, and some that we believe should be improved over time.

DESIGN ELEMENTS THAT ARE STRONG:

A hard limit on pollution

This program sets a limit on how much pollution facilities in California can emit.  The limit starts at projected 2012 emission levels, and reduces pollution 15% from 2012 through 2020.

Tough Penalty Provisions

If a facility emits more than allowed, the Air Board will require it to submit four “compliance instruments” for every one missed, and could also impose monetary fines that accumulate up to $25,000/day. This gives a strong incentive for facilities to stay within their limit.

A steady price signal to encourage clean energy

The program contains a floor price of $10 per tonne, escalating at 5% per year to reach $15 per tonne by 2020, below which ARB will not auction allowances. This is considerably higher than RGGI’s floor price of less than $2 per tonne, and it sends a clear market signal for facilities to continue finding innovative ways of decreasing emissions and developing clean energy technologies.

Auctioning in the Electricity and Transportation Sectors

The Air Board will auction 100% of pollution allowances in the transportation sector, almost all in the electricity sector, and some in the industrial sector. This means over half of all allowances issued in the program will be auctioned from the start and will increase to roughly three-quarters of all allowances by 2020. Economists and environmentalists agree that auctioning is the most efficient and fairest way of distributing allowances because it maintains the “polluter pays” principle by requiring facilities to buy the right to pollute (see the Economic and Allocation Advisory Committee report from 16 noted economists).

KGE CT chart 2 (cropped).PNG

Auction money will be used to help Californians and keep costs down

Money from auctioning in the electricity sector will be used to help customers keep their electricity bills low through programs such as rebates and other energy efficiency incentives, and achieve low cost pollution reductions.

Continual Improvement is Built in to the Program

The Air Borad is establishing an annual review of the program to allow it to reassess and continually improve. California is embarking on a first of its kind program; building in the flexibility to review its performance and make improvements in a timely fashion is an excellent design element that will help California succeed.

AREAS THAT NEED IMPROVEMENT:

Set the industrial benchmark at industry best practices, not industry average

One of the factors for determining how many allowances an industrial facility will receive for free is its emissions per unit of output. This factor is currently tied to average industrial performance. This means that an industrial facility that puts out the average amount of pollution per widget produced could receive nearly all its pollution allowances for free. This factor should instead be tied to industry best practices, so that only those facilities using the cleanest technology available will be able to cover all of their pollution for free. This will encourage all facilities to adopt the best practices available in the industry.

Give the benefit of the doubt to the consumer, not to industry profits

The program errs on the side of caution for industrial sources by giving free allowances to any industry that might face competition from out-of-state sources that do not have to meet the same pollution limits that California emitters face.  However, in some cases the program may go too far in protecting these emitters at the expense of public health and welfare. We will be working with businesses and the ARB to ensure that California competitiveness is protected, but not at the expense of California consumers.

Today’s vote was a significant milestone for California in the State’s efforts to move forward towards a clean energy economy, cleaner air for Californians, and to recharge the economy while creating jobs in the fast-growing clean-tech sector.

There will be ongoing work on fleshing out the details of this program so we have the right solutions in place– see my colleague Alex Jackson’s blog to find out more about next steps for California.

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Comments

NickDec 20 2010 04:56 PM

I must admit I don't understand why NRDC is so supportive of this Californian Cap and Trade programme - as it all does is deliberately weaken the effectiveness of Californian climate change regulation.

It was clear from the Californian ARB hearing - that I attended earlier this week - that those who want this scheme are the corporations who are glad to finally get a loophole out of taking necessary action on climate change. The cap part is good, but the whole point of a trade scheme and why corporations are keen on it is to punch holes in the cap, which of course renders it useless.

You only need to look at the European experience to see that these schemes encourage fraud, provide huge windfall profits to polluting companies, and distract from the necessary work to transform our economies into low-carbon ones.

Don't believe me? Just read these articles which have popped in my reader this week:

1. The carbon detectives which details how cap and trade encourages companies to lie, and deliberately disguise emissions (http://www.nzherald.co.nz/world/news/article.cfm?c_id=2&objectid=10694702). Key quote by US scientist: "In a CO2 transaction, you can lie and both win. We're going to create a situation where both sides can win by cheating,"

2. Perverse carbon credits send flood of money to China (http://e360.yale.edu/feature/perverse_co2_payments_send_flood_of_money_to_china_/2350/), on how EU's carbon trading scheme is leading Chinese companies to make a highly toxic greenhouse gas, HFC, solely to destroy it and also illegally importing into US.

These are not exceptions - they define the whole rationale of a market response, where we turn air into a commodity - and should be rejected by organisations for NRDC as they won't work.

After such a good campaign to reject Prop 23, it is very sad that this trojan horse (which will undo all that work) is being snuck in, with the support even of top US environmental organisations.

For more on general problems with cap and trade and the European experience, I can highly recommend as an introduction Annie Leonard's Story of Cap and Trade http://www.storyofstuff.com/capandtrade/ and as an introductory primer, TNI/Carbon Trade Watch's How carbon trading works and why it fails http://www.tni.org/carbon-trade-fails.

Kristin EberhardDec 20 2010 06:31 PM

The resounding defeat of Prop 23 enabled the whole AB 32 program, including the carbon market (about 20% of the overall program) to move forward.

Market-based programs, like any regulation, sometimes suffer from design flaws. California has gone to great lengths to avoid the mistakes of the past. The two design flaws that you identify are:
1) Poor data. Poor accounting can undermine any attempt to reduce pollution, including a market system. California has been collecting high quality, reliable data for nearly four years, helping it avoid this potential pitfall.
2) Bogus offsets. The EU’s offsets program has been widely criticized for problems with its offsets in China. California has carefully and painstakingly developed strict offsets protocols, and only allowed 4 of them (none of them international) into the program at the start. The care with which these protocols have been developed gives every reason to believe they will result in real reductions.

NickDec 23 2010 12:54 AM

Thanks for the reply Kristin. It doesn't really answer my question though as to why NRDC would choose to support a market option, and not more effective regulatory measures or even alternative proposals like Cap and Dividend. I remain very dubious given that corporations like Chevron were there at CARB praising the deal that these market mechanisms will do anything except weaken the cap; they certainly won't provide the incentive to do a radical shift to a low carbon economy which is what climate change demands.

In terms of your two points:

1. On collecting data, does this look at emissions outputted rather than inputs as most evidence suggests that data collected on inputs is very inaccurate?

2. On offsets, there are huge problems with additionality, and counterfactuals of offsets. This already seems to be rearing its head with the timber issue it seems, allowing for clear cutting to be counted as an offset! See http://californiawatch.org/dailyreport/timber-companies-stand-benefit-new-climate-law-7469

Finally, I think I saw that the polluter permits are going to be given freely. That is exactly the same mistake the EU made and already shows how corporate lobbying ensures that market mechanisms do little to change behaviour. Instead we end up with an Enron-like market, in which a few people make lots of money and the environment ends up worse off

Kristin EberhardJan 4 2011 02:08 PM

Thanks for your comments, Nick. NRDC supports cap-and-trade because it is the only program that sets a hard cap on pollution. We think having a hard cap is a critical component of ensuring reductions, but it is by no means the only policy we support. As I mentioned, cap-and-trade is only 20% of the AB 32 program, and NRDC supports and works hard on the regulations comprising the other 80%, including improving energy efficiency, getting more electricity from renewable sources, making more efficient cars, finding cleaner fuels for our cars, and developing communities that make it easier to walk or bike and not have to drive a car at all.

These programs are all great and necessary, but we can’t know for sure how much pollution they will reduce. The cap and trade program layers on top of these other efforts to set a hard cap – so we know for sure we can reach our 2020 target.

I know we are so used to industry screaming bloody murder at any hint of regulation that we become suspicious if they don’t. But just because Chevron did not scream bloody murder doesn’t mean this is not an effective program – it means that it is a way of getting the pollution reductions we need while also giving industries the opportunity to find the most cost-effective ways of getting those reductions.

As to the free allowances: yes, CARB will be giving a lot of allowances for free in the industrial sector. Some of these are necessary to ensure that industries don’t simply go elsewhere and continue polluting (which undermines both our pollution reduction goals and our goals of growing a green economy), but we believe there are probably still too many and we will be working to reduce the free allocation over time.

However, in the other 3 sectors – electricity, transportation, and natural gas – CARB will be auctioning allowances. Again, we will be working to make sure that the money from the auctions is used to invest in things like energy efficiency, public transit, and renewable energy to help spur California towards a clean energy economy. We believe that that sort of “Cap and Invest” program will be more effective at achieving our goals than the “Cap and Dividend” you mentioned. Investing auction revenue into energy efficiency and other clean energy technologies helps not just reduce emissions and lower costs, but also to keep California on the cutting edge; something that simply cutting a check to each Californian does not do.

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