What is cap and trade? What do legislative proposals currently in Congress say about it? Brent Sohngen Department of Agricultural, Environmental & Development Economics

“Cap-and-Trade” System Sets a limit on CO2 emissions Allows large emitters to trade CO2 amongst themselves Allows additional supply from land based sources… CO 2 Overall cap set Individual cap set (Firms get permits) Firms can trade permits depending on their emissions. Init Em 1000 t CO t CO 2 Initial Emission = 3000 t CO 2 Total Cap = 2700 t CO 2 Cap 900 t CO t CO 2 Emit 700 t CO t CO 2 Trade sell 200buy 200

3 CO 2 $ $ $ $ “Cap-and-Trade” System Credits for sale = 200 t CO 2 CO 2 Init Em 1000 t CO t CO 2 Initial Emission = 3000 t CO 2 Total Cap = 2700 t CO 2 Cap 900 t CO t CO 2 Emit 700 t CO t CO 2 Trade sell 200buy 200 Sets a limit on CO2 emissions Allows large emitters to trade CO2 amongst themselves Allows additional supply from land based sources…

Debate on land-based credits Role of land-based options and importation of credits – Scientific uncertainties have been resolved. – Land-based can provide 30% of carbon abatement – Can reduce costs by 40%. – National land-based program and international component are complements, not substitutes. National program will be less efficient without an international program.

Cap and Trade Pros and Cons Pros – A cap actually will limit emissions. – Establishes clear price signal ($/ton CO2). – Imposes stringency of market on abatement decisions (investments will flow to “best” alternatives). – Reduces costs.** Cons – Creates a difficult negotiation over “rights” for permits Auction or free allocation? Who gets free permits? – Can be very stringent – May be too costly if it turns out that abatement costs are high.

Climate Policy Update United Nations Process Continues…. – In the Kyoto Protocol commitment period now ( ) Markets active in Europe & Australia International trading through Clean Development Mech. – Continuing negotiation over successor treaty Still much debate about what will emerge from Copenhagen… US is working hard to reduce expectations…. US Policy is very active – Regional initiatives (CA, RGGI) – Supreme Court decision (Massachusetts vs. US EPA) and EPA response – Energy legislation – We have moved from 95-0 on Byrd-Hagel in 1997 to Waxman-Markey (h.r. 2454) passing the House last spring.

Key issues in Waxman-Markey (HR 2454) Carbon Cap and Trade System % % % Permit Allocation – Designed to limit electricity price increases Offsets – Up to 2 billion t CO2, with 1 billion t from outside the US Renewable Portfolio Standards – 20% of electricity from renewables by 2020

Senate Action: Kerry-Boxer Introduced recently for discussion this fall Not clear if the “stars” will align, but renewed hope after Kerry-Graham Op-Ed in the NY Times this past Sunday – Nuclear – Clean coal – Border tax adjustments**

Summary Cap and Trade works by limiting overall emission (e.g., putting a cap in place) – Reduces costs relative to other methods of achieving the same goal. Land based offsets are likely to be part of the system in the US, both domestic and international. – Scale differs between House and Senate so far. Policy is moving forward with or without federal legislation. Important future questions about the role of nuclear, coal, renewables, and border tax adjustments.