Federal Climate Change Legislation : Key Issues for Commissions Andy Keeler John Glenn School of Public Affairs The Ohio State University

Outline Legislative specifics that matter Issues for Commission Decision-making Cap-and-trade in Perspective

Legislative specifics that matter Allowance price Allowance allocation and use of resources Exemptions and special treatment Specifics on Interaction with State Programs

Allowance Price Matters Directly determines the costs and incentives Tighter targets => higher prices Lieberman-Warner / Boxer has tighter short-term targets than Bingaman- Specter

How big will price effects be? Predictions are highly imperfect Economic assumptions Technology assumptions Institutional assumptions – offsets, state programs, etc. Predicted effects in 2020 are good research but highly uncertain

EIA Model Predictions for 2020 Lieberman – Warner (L-W) ~ $0.17 / gallon gasoline ~.81 cents / kwh electricity (coal) Bingaman - Specter ~ $0.12 / gallon gasoline ~.28 cents / kwh electricity (coal) Inherent uncertainty is huge - but much lower for Bingaman than LW because of the safety valve

Cost Containment (Price Risk) in Legislation What happens if reducing CO2 is more difficult and expensive than predicted? Tradeoff between environmental certainty and economic certainty Economic risk – high prices, shortages, economic dislocation (political backlash) Environmental risk – “Busting the Cap” – not meeting GHG reduction goals

Emergency-Metaphor Policies—safety valves, circuit breakers, and emergency off-ramps Reduce the price of allowances by making additional allowances available Crucial distinctions Relax the long-term cap, or all released allowances made up in the future (borrowing) Price certainty, trigger certainty, or additional allowances released without certainty

Emergency-Metaphor Policies Safety Valve – unlimited allowances available at a known price Circuit Breaker – annual cap is frozen (stops declining) as long as prices are above a known price Emergency Off-Ramp – a reserve of future-year allowances is auctioned annually with a (known) minimum price

Cap Neutrality The safety valve is not cap-neutral – additional allowances sold at the safety valve price represent additional emissions The circuit breaker is not cap-neutral – but there are limits to the quantity of emissions above the cap The “allowance reserve” is cap-neutral (in theory)

Triggers A safety valve works off a known, pre- announced price Reserves, circuit breakers, and other borrowing mechanisms can be designed to work off announced triggers or at the discretion of regulators (e.g. Carbon Market Efficiency Board)

Carbon Market Efficiency Board The “Carbon Fed” would have discretion to change Offset quantities Borrowing restrictions ???? There are positive and negative consequences of building such discretion into a cap-and-trade system

Cost Containment in Legislative Proposals Emergency off-ramp (Boxer / L-W) – price effects are not certain, cap- neutral, has a pre-announced minimum price (starts at $22-30 per ton CO2) Safety valve (Bingaman-Specter) – certain, pre-announced (current version $12 per ton CO2), excess emission above the cap

What’s the price? Discussions about the safety valve in particular, and about all of these mechanisms, should focus more on the price at which they kick in A $12 safety valve is very different than a $50 safety valve

Cost containment: short-term and long-term Well-managed borrowing mechanisms are likely to be a good tool for short- term price volatility Long-run price uncertainty would be better managed by safety valve mechanisms (with accompanying drawbacks)

Long-term Targets and Prices Targets in most federal legislation are set through 2050 Common sense says that targets that far in the future could be changed Setting long-term targets does Create a status quo Concretize aspirational goals May have significance in IRP processes

Allowance Allocation: Who Gets the Money? $20 allowances for year 1 of Lieberman- Warner => $115 billion in allowance value Allowances can technically be allocated to just about anyone. Who gets them is a lot of politics with a little bit of equity and public policy thrown in for good measure.

Allocation to LDCs L-W gives about 10% of total allowances to LDCs (Bingaman punts on this point) and 3% to gas distributors Use to keep prices low Use to reduce energy use Use for GHG-reducing generation and transmission investments The use of these allowances is under state commission regulation – but may also have legislative direction

Allocation to Generation Owners L-W gives generation owners 18% of allowance pool to start, then shrinks that over time (Bingaman roughly 25%) Wholesale competition generators receive windfall Embedded cost regulation generators face commission regulation in using allowance value (public uses vs. shareholder equity) This potentially creates a significant equity issue

Individual Allocations to LDCs and generation owners For LDCs, L-W allocates initially based on electricity volume (favors areas with low-GHG sources like hydro or nuclear) For generation owners, L-W allocation is based on emissions history (favors coal) Future allocations could be based on these same criteria, or be updated by output, alternative energy progress, or some other criterion

Special Treatment and Exceptions Exemptions from the system Special treatment through bonus allowances Special treatment through other mechanisms

Exemptions from the System There has been a move to exempt gas used directly for home heating from a federal cap- and-trade system The argument goes that gas is more GHG- efficient, and so should be encouraged This is bad public policy – all fossil energy sources should be covered to avoid leakage and create correct long-term incentives Exemptions are the wrong tool to provide special treatment

Bonus Allowances Can be used to increase the returns to specific technologies Example – carbon capture and storage in L-W gets rewarded twice – once through reducing allowance needs, and again through bonus allowances with cash value Bonus allowances are really no different than cash payments, but do not require a direct budget allocation

Additional Incentives for Alternative Energy Renewable portfolio standards Inslee feed-in tariff bill Production Tax credits, etc

Federal Legislation and State Programs Model of CAA and tailpipe standards – states can be more stringent than federal regulation – does not apply well A state with a more stringent cap will take on more emissions reduction effort, but national emissions will be unchanged States can be rewarded for aggressive programs through allowance allocation

Commission Decisions Allowance prices and ratemaking End user prices vs. public investments in conservation Managing Conservation Programs Commissions and the public interest

Allowance prices and ratemaking What is prudent behavior with respect to allowance prices with respect to the decisions of regulated generation? Example – if allowance prices turn out to be higher than expected, was a coal plant a prudent expenditure This works both ways – if allowance prices turn out to be lower than expected, was a nuclear plant a prudent expenditure?

End user prices vs. public investments in conservation Commissions will have to determine how to allocate allowance value (that they control) to Reduce revenue requirements and prices Target assistance to low-income consumers and vulnerable industries Fund conservation and other GHG reduction activities

Managing Conservation Programs L-W has significant funding through allowance allocation for state-run conservation programs Coordination and emphasis of commission programs and other pubic programs Potential dramatic expansion of programs presents quality and accountability challenges

The Public Interest How do commissions treat state and national goals for GHG reduction relative to more traditional elements of their view of the public interest As a constraint As something to actively pursue beyond the letter of climate legislation

Is cap-and-trade the right policy? Would a tax be better? Does it really solve the climate change problem – or should we just be investing in technology?

Tax vs. Cap-and-trade A tax is an excellent policy from a technical standpoint Transparent Avoids wrangling over allowances Taxes have political liabilities “people hate taxes” NGOs hate lack of quantitative certainty Industry hates the lack of free allowances

Does cap-and-trade “solve climate change” NO - but nothing else does, either Massive investment in a portfolio of technologies, worldwide action, behavioral change, etc. are all required Pricing GHG emissions is necessary (but not sufficient)

Does cap-and-trade “solve climate change” Will increase R&D and innovation Will reward conservation investments and behavior All reductions in emissions lessen climate change risks – it’s not 0/1– and buy time for technology and adaptation

Does cap-and-trade “solve climate change” US action is a necessary step in international progress Pricing carbon does not preclude technology or standards – based policies – and generally tends to reinforce them