California is leading the nation to join the emerging global clean energy economy
Posted December 16, 2010 in Curbing Pollution
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.
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).
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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