Cost Containment in a Federal GHG Cap and Trade Program NARUC Webcast May 30, 2008 Andy Keeler John Glenn School of Public Affairs The Ohio State University

Cost Containment – Overview of mechanisms and issues What does “cost containment” mean? Why is it important for program design? What are the options for cost containment that are under consideration? What are the key issues for policy design?

Cost Containment A “textbook” cap-and-trade program will result in some allowance price that affects all covered entities Cost containment refers to modifications of the “textbook” policy that (may) lower the allowance price Under all conditions When “emergency” criteria are met

Why is cost containment important in program design? High allowance prices increase economic risk Volatility and uncertainty create investment choice problems Bad economic outcomes increases the political risk for long-term climate policy

Protecting against the unexpected and/or bad luck There is enormous uncertainty about both the demand and supply sides of a national GHG allowance market Economic Technological Institutional And the uncertainty is greatest in the early years of a new program

Offsets – Engaging Non-covered sectors Emissions reductions from entities outside the cap- and-trade systems can offset increased emissions within the cap In theory, this has the twin benefits of Lowering allowance prices Encouraging long-term GHG reductions by the sectors producing the offsets Changes in the limits or terms of offsets are a cost containment policy

Banking and Borrowing Banking means holding over allowances for use in the future – this reduces future allowance prices and increases current prices Borrowing means using allowances allocated for use in future years now -- this increases allowance supply and reduces prices now, while increasing prices in the future

Borrowing Policy proposals limit borrowing to specific circumstances and to maximum amounts Changes in the limits or terms of borrowing are a cost containment policy

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

Two Current 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

Summary Cost containment is a key part of program design Debate on this issue has a long way to go Big issues Price certainty Emissions neutrality Extent of discretion What’s the price?