Market Mechanisms to Curb Greenhouse Gases: Challenges and

Future Directions

Market Mechanisms to Curb Greenhouse Gases: Challenges and

Future Directions

Joe Kruger

February 20, 2007

Joe Kruger

February 20, 2007

OverviewOverview

• Taxes vs. cap and trade

• The evolution of cap and trade from SO2 to greenhouse gases

• New cap and trade programs in Europe and states

• Conclusions

• Taxes vs. cap and trade

• The evolution of cap and trade from SO2 to greenhouse gases

• New cap and trade programs in Europe and states

• Conclusions

Emissions TradingEmissions Trading

• Set a target or cap• Distribute tradable permits (allowances) to industry• Companies choose emission reduction strategies

and may trade allowances• Government measures emissions and assesses

penalties if emissions exceed allowances• Cap provides certainty that a quantity of emissions

will not be exceeded but leaves uncertainty about price

• Set a target or cap• Distribute tradable permits (allowances) to industry• Companies choose emission reduction strategies

and may trade allowances• Government measures emissions and assesses

penalties if emissions exceed allowances• Cap provides certainty that a quantity of emissions

will not be exceeded but leaves uncertainty about price

TaxesTaxes

• Set a price for carbon or carbon dioxide

• Measure emissions (or fuel use) and collect fee

• Creates certainty about price of policy (but not quantity of emissions)

• What about the revenues?

• Set a price for carbon or carbon dioxide

• Measure emissions (or fuel use) and collect fee

• Creates certainty about price of policy (but not quantity of emissions)

• What about the revenues?

Lessons from SO2 for GHGLessons from SO2 for GHG• General lessons:

– Emissions trading is an effective instrument– May be even more appropriate for ghgs because no

“hotspots”

• Specific elements:– Hands-off role of regulators– Flexibility of timing important (banking)– Importance of monitoring and verification– Political importance of allowance distribution

• General lessons:– Emissions trading is an effective instrument– May be even more appropriate for ghgs because no

“hotspots”

• Specific elements:– Hands-off role of regulators– Flexibility of timing important (banking)– Importance of monitoring and verification– Political importance of allowance distribution

What might be different in a ghg system?What might be different in a ghg system?• Scope and point of regulation• Higher stakes for distribution of allowances:

auction vs. free allocation• Mechanisms to limit price uncertainty (safety

valve) • Additional incentives for R&D, technology

deployment• Global dimensions of problem

• Scope and point of regulation• Higher stakes for distribution of allowances:

auction vs. free allocation• Mechanisms to limit price uncertainty (safety

valve) • Additional incentives for R&D, technology

deployment• Global dimensions of problem

Scope & Point of RegulationScope & Point of Regulation

High stakes for allowance distributionHigh stakes for allowance distribution• Huge asset value of allowances

• In a competitive market, “opportunity cost” of free allowances passed on– Special issues for power sector; competitive

markets vs cost of service regulation

• How much compensation is needed?

• Allocation need not be tied to point of regulation

• Huge asset value of allowances

• In a competitive market, “opportunity cost” of free allowances passed on– Special issues for power sector; competitive

markets vs cost of service regulation

• How much compensation is needed?

• Allocation need not be tied to point of regulation

Mitigating Price UncertaintyMitigating Price Uncertainty• Climate change is a long-term problem• Fuel markets and other factors can cause price

uncertainty/spikes• Price uncertainty makes long-term technology

investment difficult• Safety valve mechanisms may improve political

feasibility for first mandatory step• But ultimately we will need transition from price

certainty to emissions certainty

• Climate change is a long-term problem• Fuel markets and other factors can cause price

uncertainty/spikes• Price uncertainty makes long-term technology

investment difficult• Safety valve mechanisms may improve political

feasibility for first mandatory step• But ultimately we will need transition from price

certainty to emissions certainty

Additional incentives for R&D, technology deploymentAdditional incentives for R&D, technology deployment• In the short-term, technologies not available

to make the ecologically necessary reductions (e.g., carbon capture and storage)

• Is it possible to incentivize by the carbon price alone?

• Most legislative proposals provide additional incentives for R&D, technology deployment

• In the short-term, technologies not available to make the ecologically necessary reductions (e.g., carbon capture and storage)

• Is it possible to incentivize by the carbon price alone?

• Most legislative proposals provide additional incentives for R&D, technology deployment

Global dimension of problemGlobal dimension of problem

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Summary of the EU Trading SystemSummary of the EU Trading System• Participants: 25 Member States (MS) • Timing: Periods are 2005-2007 and 2008-

2012• Coverage:

– Sectors: Energy activities (including electric power), iron & steel, minerals, pulp and paper

– ~12,000 installations covering 46% of CO2 emissions

• Links to Kyoto mechanisms

• Participants: 25 Member States (MS) • Timing: Periods are 2005-2007 and 2008-

2012• Coverage:

– Sectors: Energy activities (including electric power), iron & steel, minerals, pulp and paper

– ~12,000 installations covering 46% of CO2 emissions

• Links to Kyoto mechanisms

EU MarketEU Market• Active trading

– $9 billion in transactions in 2005

– $19 billion in the first 9 months of 2006

• Volatility– Poor market information?– Fuel prices?– Too many allowances?

• New caps and allocations are under discussion for 2008-2012 period

• Active trading– $9 billion in transactions in

2005– $19 billion in the first 9

months of 2006

• Volatility– Poor market information?– Fuel prices?– Too many allowances?

• New caps and allocations are under discussion for 2008-2012 period

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Regional Greenhouse Gas Initiative (RGGI)Regional Greenhouse Gas Initiative (RGGI)• Seven states signed MOU

in December; three additional states to join

• Program covers power sector

• Cap at current levels by 2009; 10% reduction by 2019;

• At least 25% of allowances for “public benefit”

• Seven states signed MOU in December; three additional states to join

• Program covers power sector

• Cap at current levels by 2009; 10% reduction by 2019;

• At least 25% of allowances for “public benefit”

CaliforniaCalifornia

• Economy-wide cap on emissions– 1990 emissions by 2020– Likely to include

trading program in some sectors

– Explornig links to RGGI, EU trading programs

• Economy-wide cap on emissions– 1990 emissions by 2020– Likely to include

trading program in some sectors

– Explornig links to RGGI, EU trading programs

Conclusions/PredictionsConclusions/Predictions

• Trading programs are evolving to address climate change• U.S. will benefit from the European and RGGI experiences• Ultimately, we will have a mandatory program with

– Economy-wide approach– A safety valve for price certainty– Less free allocation and a transition to auctions over time– Cap and trade increasingly seen as part of policy mix with

technology policies/R&D– Strengthening of cap will be tied to actions by trade partners (e.g.,

China)

• Trading programs are evolving to address climate change• U.S. will benefit from the European and RGGI experiences• Ultimately, we will have a mandatory program with

– Economy-wide approach– A safety valve for price certainty– Less free allocation and a transition to auctions over time– Cap and trade increasingly seen as part of policy mix with

technology policies/R&D– Strengthening of cap will be tied to actions by trade partners (e.g.,

China)