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Numerical Example of the Cost Savings Associated with Cap-and-Trade Systems
Firms Historical Emissions(Tons/Yr)
Marginal Abatement Cost ($/Ton)
Alkyone 600 50
Merope 600 100
Kelaino 600 100
Elektra 600 150
Sterope 800 200
Taygete 800 250
Maia 800 400
Industry Total
4,800 ---
In this example, could Alkyone make a profit by selling an allowance to Maia for $200? How much?
Is this purchase advantageous for Maia? By how much?
Acid Deposition Process
Source: EPA
Acid Deposition Process
Sulfur dioxide (SO2) and nitrogen oxides (NOx) are the primary causes of acid rain. In the US, About 2/3 of all SO2 and 1/4 of all NOx comes from electric power generation that relies on burning fossil fuels like coal.
Acid rain occurs when these gases react in the atmosphere with water, oxygen, and other chemicals to form various acidic compounds. Sunlight increases the rate of most of these reactions. The result is a solution of sulfuric acid and nitric acid.
Has Acid Rain Cap and Trade Worked?
SO2 Environmental Results: The Cap and Trade Platform
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Ind
ex
: 1
98
7 =
1.0
U.S. Gross Domestic Product
Total net electricity generation
SO2 emissions from electric utilities
(Sources: DOC, DOE and EPA, respectively)
*
* ARP units only
Proposed Approach
• Replace inefficient command and control regulation with an appropriate cap and trade program.
• Design cap and trade program to:– Better encourage diverse mix of clean
technologies and efficiency.– Promote technology development.– Ensure better environmental performance.
Cap and Trade Programs
• Cap provides greater environmental certainty than command and control.
• Provides greater flexibility and lower compliance cost.
• With proper design, can encourage efficiency and new technology.
Historical Problems With Caps• Difficult to find the right cap level.• Allocation favors historic big polluters.• Doesn’t include/support new, efficient
generators.• Under a cap, command and control programs
provide no environmental value since total emissions will remain the same.– Command and control defeats the trading
program benefit of reducing costs.
Critical Design Elements
• Setting cap levels and timing
• Applicability
• Allocation of Allowances
Cap and Trade Program Basics
• Set an emissions tonnage limit (cap or budget) for a class of sources in a region.
• Allocate the right to emit tons (allowances) to individual sources.
• At the end of the season, each source must have allowances equal to actual emissions.
• Sources can control, overcontrol, sell, bank, buy allowances to comply.
Historical Approach to Caps
• Fixed levels
• Large, step reductions
• Allocation based on historic heat input
• Participation limited to fossil generators
• New and clean units treated less favorably
Traditional Emission Cap Profile
0
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10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Year
MM
Ton
s
Non-Title IV Sources
Example of Declining Cap on SO2
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10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
MM
Ton
s
Declining Cap10%/yr
Jeffords
BAU
Non-Title IV Sources
Bush
Illustration of Declining Cap
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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Year of Program
0
100
200
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400
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600
Cap Level(Tons/year) Circuit Breaker Value
($/ton)
Allowance Price
Declining Cap/Circuit breaker
• Each cap decreases by fixed percent each year. Glide slope defined in advance.
• Decline for each pollutant stops if annual average allowance cost exceeds predetermined cost threshold ($/ton).
• Decline starts again when the annual average cost is below threshold.
Declining NOx Cap
0
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2
3
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
MM
Ton
s
Declining Cap12%/yr
JeffordsBAU
SIP Call/126
Non-Title IV Sources
Bush
Allocation
• The most controversial issue after levels and timing.
• Critical to encouraging efficiency and clean technology.
• It is distributional.
• Distribution is key to influencing policy goals.
Allocation Principles
• Avoid creating artificial winners and losers.
• Promote policy goals.
• Keep it simple.
• Be politically viable.
Allocation Options
• Grandfathering primarily rewards old, high emitting plants.
• Auction has theoretical benefits but is politically difficult.
• Output-based, reallocating program provides maximum reward for efficiency, low emissions, new plants.
Effects of Output-Based Allocation
• Concern expressed that output-based allocation will be too negative for coal.
• In the near-term, base load coal plants are among the most efficient in the mix.
• 24 of the top generating companies, accounting for 50 percent of affected generation do better under output than input, including coal-heavy companies.
Allocation Effects on Companies
Do Better Under Output* Do Worse Under Output
Southern Co.AEPTVAReliantCinergyProgress EnergyDuke EnergyAllegheny EnergyDTE EnergyDomminionFirstEnergyFPLPPL
XcelTXUEntergyEdison InternationalScottish PowerAmerenLG&EMidAmerican EnergyPinnacle West
*Within 1%
Value of Allowances
• Implications of allowance allocation to clean or non-emitting sources are not simple.
• Does not directly change dispatch order. Does increase profitability.
• Theoretically causes reduced bid/electricity price. Actual effect likely to be lower than theoretical due to uncertainties.
• Alternatives need to be defined.
The CO2 Approach Must:
• Limit economic risk• Limit large structural
or lifestyle changes• Not pick winners• Be market-based
• Show a commitment• Be gradual• Promote new
technology• Lead to commitments
from other countries
Congressional Cap and Trade
• Bingaman-Specter (S 1766)• Udall-Petri (Draft, May 2007)• Lieberman-McCain (S 280)• Kerry-Snowe (S 485)• Waxman (HR 1590)• Sanders-Boxer (S 309)• Feinstein-Carper (S 317)• Alexander-Lieberman (S 1168)• Stark (HR 2069)• Larson (HR 3416)
John Dingell Cap-and-Trade Program
John Dingell (D-MI-Auto)
John Dingell Hybrid Carbon and Petroleum Tax Bill
• $50-per-ton tax on carbon
• 50 cents per gallon tax on gasoline and jet fuel
• Indexed to inflation• “No New Taxes”
Regressivity/Rebates
John Dingell (D-MI-Auto)
Arguments for a Carbon Tax
Effectiveness and Efficiency
Wide Array of Support
• .
Control on Price Not Quantity
• “Specifically, a carbon tax equal to the damage per ton of CO2 will lead to exactly the right balance between the cost of reducing emissions and the resulting benefits of less global warming.” William Pizer
• “Corrective taxes are superior to direct regulation of harmful externalities when the state's information about control costs is incomplete."
AEI, Climate Change: Caps vs. Taxes, 2007
What is the Behavioral Impact on Firms and Consumers?
Why the Changs?
Impact of Carbon Tax on Emissions and Revenue
Equity Implications
• Who gets hit hardest by Carbon Tax?
Reduction in Taxes
Double Dividend
• Mitigate economic costs of tax– Lower capital/corporate taxes– Lower payroll taxes, offset regressive effects– Invest in energy efficiency
Predictability
• No fluctuation in prices
Caveats
• India and China
• US can only impose a national system
• "no regrets" principle
Political Support for Cap and Trade
Earth Blog
• no one has the ‘right’ to emit greenhouse gases in reality – we share the biosphere with all other living organisms, and no organism except for humans expects any rights, especially not to put agents of global warming into the air. Non-human organisms just live, and die. However, at least with a mechanism like C&C the amount of carbon dioxide, methane, nitrous oxide and so on, that is emitted, is not dictated by the amount of money you have in the bank, or how many tanks or missiles you have.
