1. Complementary Policies
for Climate Change:
Basis, Design, Strategy
January 23, 2009
Holmes Hummel, PhD 1

2. Complementary Policies
Seeking a Price Response in Failed Markets
Making the Case for Complementary Policies
Considering a Federal Climate Action Plan
Annex: Smart Grid (EISA Title XIII) 2

3. U.S. Approach: Cap-and-Trade
Declining Cap
Covered Entities

4. Polluters Compete for Scarce Permits

5. Carbon Price Established by Market Activity
So, is it more profitable to:
buy a permit, OR
reduce my own emissions?
Profit opportunities are a main
driver for innovation and investment,
and the climate challenge needs both.

6. Carbon Price Established by Market Activity
$40
Would anyone accept
$40 for your permit?

7. Carbon Costs Passed to Consumers
$40
$40
$40
$40
$40
35¢
per gallon
2.5 ¢
per kWh
0.6 ¢
per therm
People
Respond…?

8. Achieving Reduction Targets
To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy.
5000
4000
3000
2000
1000
6000
7000
$100
$80
$60
$40
$20
$120
$150
$250
$200
$150
$100
$50
$300
$350
$??
What price trajectory
would be sufficient to drive
people away from fossil fuels?
Modeling results are
highly uncertain
Annual U.S. Emissions (MtCO2)
Carbon Price ($/MtCO2)
2000
2100
2050 8

9. Moving to Clean Energy 2030 2020 2010 2050 2040 $100 $50 $200 $30 $150
Players seek better options as costs rise.
Cap-and-trade lets players choose at what price they leave the game
– and how they want to make that change.
Rail Transport
Hybrid vehicle
Nuclear power
$100
Solar power
Wind power
$50
Green buildings
$200
$30
$150
$20

10. Achieving Reduction Targets
2050
Who will be the last greenhouse gas polluters left in the game?
Unlike the familiar game of Musical Chairs, the last players
still vying for pollution permits are not exactly winners… 10

11. Achieving Reduction Targets
2050
The last ones remaining in the game are those who:
can afford to pay the most, or
have the least flexibility to change games.
The underlying assumption is that the most valuable uses of fossil fuels must be the ones for which people are willing to pay the most.
To stabilize global warming, most uses of coal, oil, and gas will have to move to a different game: the clean energy economy. 11

13. Market Conditions Perfect Competition Many small buyers and sellers
Perfect freedom of entry and exit from the industry.
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
SELLERS
BUYERS

14. Market Conditions Perfect Competition Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market

15. Market Conditions Perfect Competition Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market

16. Market Conditions Perfect Competition Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$3.99
$3.99
$3.20

17. Market Conditions Perfect Competition Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$3.99
$3.99
$3.20

18. Market Conditions Perfect Competition Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$3.99
$3.99
$3.20

19. Market Conditions Energy Sector Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$3.99
$3.99
$3.20

20. Market Conditions Energy Sector Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$3.99
$3.99
$3.20

21. Market Conditions Energy Sector Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
$/Btu?
$??

22. Market Conditions Energy Sector Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Persistent transaction costs
No externalities arising from production and/or consumption which lie outside the market
$??
$/Btu?

23. Market Conditions Energy Sector Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Persistent transaction costs
Many, Very Large Externalities – climate change is just one…
$??
$/Btu?

24. Complementary Policies
Seeking a Price Response in Failed Markets
Making the Case for Complementary Policies
Considering a Federal Climate Action Plan
Annex: Smart Grid (EISA Title XIII) 24

25. #1 Complementary Policies Reduce the Cost of Price-Based Policies
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors

26. #1 Complementary Policies Reduce the Cost of Price-Based Policies
($/tonCO2)
Abatement costs <$50/ton
100 90 80 70 60 50 40 30 20 10
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
-100
-110
-120
-230
Mid-range case, McKinsey 2007

27. #1 Complementary Policies Reduce the Cost of Price-Based Policies
($/tonCO2)
Abatement costs <$50/ton
100 90
A price on carbon will not address all the non-price barriers to reducing GHGs –
or the price insensitive reasons people consume fossil fuels. 80 70
Residential electronics
Residential buildings - Lighting
Fuel economy packages – Cars
Cellulosic
biofuels
Industry – Combined heat and power
Conservation tillage
Fuel economy packages – Light trucks
Coal mining – Methane mgmt
Industrial process improve-ments
Commercial buildings – New shell improvements 60 50 40 30 20 10
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
Commercial electronics
-100
-110
-120
-230
Mid-range case, McKinsey 2007

28. #1 Complementary Policies Reduce the Cost of Price-Based Policies
($/tonCO2)
Abatement costs <$50/ton
100
Natural gas and petroleum systems mgmt
Afforestation of pastureland
Reforestation
Winter cover crops
New coal
power plants
with CCS
for EOR
Biomass power – Cofiring
Industry – CCS new builds on carbon-intensive processes
Shift dispatch of existing plants from coal to natural gas
Car hybridi-zation 90 80 70
Commercial electronics
Residential electronics
Residential buildings - Lighting
Fuel economy packages – Cars
Cellulosic
biofuels
Industry – Combined heat and power
Conservation tillage
Fuel economy packages – Light trucks
Coal mining – Methane mgmt
Industrial process improve-ments
Commercial buildings – New shell improvements 60 50 40 30 20 10
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
-100
-110
-120
-230
Mid-range case, McKinsey 2007

29. #1 Complementary Policies Reduce the Cost of Price-Based Policies
($/tonCO2)
Abatement costs <$50/ton
Reduction
Target:
1 GtCO2e
100
Natural gas and petroleum systems mgmt
Afforestation of pastureland
Reforestation
Winter cover crops
New coal
power plants
with CCS
for EOR
Biomass power – Cofiring
Industry – CCS new builds on carbon-intensive processes
Shift dispatch of existing plants from coal to natural gas
Car hybridi-zation 90 80 70 60
$40 / tonCO2 50 40 30 20 10
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
-100
-110
-120
-230
Mid-range case, McKinsey 2007

30. #1 Complementary Policies Reduce the Cost of Price-Based Policies
($/tonCO2)
Abatement costs <$50/ton
Reduction
Target:
1 GtCO2e
100
New coal
power plants
with CCS
for EOR
Shift dispatch of existing plants from coal to natural gas
New coal
power plants
with CCS
for EOR
Shift dispatch of existing plants from coal to natural gas 90 80 70 60
$40 / tonCO2 50 40
$10 Billion 30 20 10
Residential
buildings -Lighting
Fuel economy
packages – Cars
packages –
Light trucks
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
-100
-110
-120
-230
Mid-range case, McKinsey 2007

31. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels
COST
($/tonCO2)
Abatement costs <$50/ton
100
New coal
power plants
with CCS
for EOR 90 80 70 60 50 40 30 20 10
Residential
buildings -Lighting
Fuel economy
packages – Cars
packages –
Light trucks
-10
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
-20
Potential
Gigatons/year
IN 2030
-30
-40
-50
-60
-70
Messages:
This is a summary of our conclusions; the curve represents a simplified view of all the abatement opportunities identified in the 6 sectors and 6 geographies at a cost lower or equal to 40 EUR/ton
The opportunities are reported in increasing cost order
BAU emissions 2030 could be reduced by 27 Gton (46% compared to BAU) if all measures below 40 EUR/ton are captured
Almost a quarter of these measures, 7 Gton) are at negative or zero cost
The opportunities are highly fragmented cross regions and sectors
-80
-90
-100
Shift dispatch of existing plants from coal to natural gas
-110
-120
-230
Mid-range case, McKinsey 2007

32. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels32

33. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels
Carbon Price: $0/tCO2
$20/tCO2
Nuclear
Coal
Power
Natural Gas
Sets
Price
Sets
Price
Market Price
Market Price
Profit
Profit
Profit
Profit
Profit
Dispatch Price per MWh
Profit
Dispatch Price per MWh 33

34. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels
Carbon Price: $0/tCO2
$20/tCO2
Nuclear
Coal
Power
Natural Gas
Sets
Price
Sets
Price
Market Price
Market Price
Profit
Profit
Profit
Profit
Profit
Dispatch Price per MWh
Profit
Dispatch Price per MWh 34

35. #2 People May Reject a Carbon Price Signal Before They Reject Fossil Fuels
Gasoline Consumption
Price of Gasoline
~$150/tCO2

36. World Resources Institute; 2003 data
#3 Stabilization Requires Reducing Emissions Outside a Managed Cap of Measurable Sources
CAP
OFFSETS
World Resources Institute; 2003 data

37. Complementary Policies
Seeking a Price Response in Failed Markets
Making the Case for Complementary Policies
Considering a Federal Climate Action Plan
Annex: Smart Grid (EISA Annex XIII) 38

38. Market Conditions Perfect Competition Energy Sector
Many small buyers and sellers
Homogeneous products are supplied to the markets that are perfect substitutes.
Perfect freedom of entry and exit from the industry.
Perfect knowledge
Low transaction costs
No externalities arising from production and/or consumption which lie outside the market
Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Persistent transaction costs
Many, Very Large Externalities – climate change is just one…

39. Complementary Policies
Market Conditions
Energy Sector
Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Persistent transaction costs
Many, Very Large Externalities – climate change is just one…
Complementary Policies
Price-Based Policies

40. Market Conditions Energy Sector Price-Based Policies
Few sellers, many buyers
Homogeneous products are supplied to the markets that are perfect substitutes.
High capital requirements and regulatory barriers to entry
Lack of transparency
Persistent transaction costs
Many, Very Large Externalities – climate change is just one…
Curing market failures
Coping with market failures
Covering emissions by sector
Price-Based Policies

41. Designing Complementary Policies
An “economy-wide” cap-and-trade policy does not distinguish between sectors
End-Use
CAP
U.S. GHG Emissions
U.S. Sources
OFFSETS INSIDE U.S.
World Resources Institute; 2003 data

42. Designing Complementary Policies
End-Use
Transportation
Distance
Mode
Fuel Source
Fuel Economy
U.S. GHG Emissions
U.S. Sources
World Resources Institute; 2003 data

43. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Vehicle GHG
Standards

44. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Low Carbon
Fuel Standard
Vehicle GHG
Standards

45. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards

46. Designing Complementary Policies
End-Use
Transportation
Electric Power Sector
U.S. GHG Emissions
U.S. Sources
World Resources Institute; 2003 data

47. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs

48. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020

49. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020
Million Solar Roofs

50. Designing Complementary Policies
End-Use
U.S. GHG Emissions
U.S. Sources
Industrial
Gases
World Resources Institute; 2003 data

51. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below u
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020
Million Solar Roofs
F-Gases &
Refrigerants

52. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below u
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020
Million Solar Roofs
Sustainable
Forests
F-Gases &
Refrigerants

53. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below u
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020
Other
Million Solar Roofs
Sustainable
Forests
F-Gases &
Refrigerants

54. California’s Strategy to Reduce Emissions to 1990 by 2020 = 174 MMTCO2E below baseline = 10% below u
Low Carbon
Fuel Standard
Transportation
& Other Vehicle
Measures
Vehicle GHG
Standards
Efficiency Standards
& Incentive Programs
Renewable Portfolio
Standard:
33% by 2020
Cap-And-Trade
Market Response
Million Solar Roofs
Sustainable
Forests
F-Gases &
Refrigerants

55. Designing Complementary Policies
End-Use
U.S. GHG Emissions
U.S. Sources
CAP
OFFSETS INSIDE U.S.
World Resources Institute; 2003 data

56. Energy Intensive Industries
Most of the Industrial GHG Emissions Covered by a Cap-and-Trade Policy are in 5 Sub-Sectors
Energy Intensive Industries
Capped

57. Most of the Industrial GHG Emissions Covered by a Cap-and-Trade Policy are in 5 Sub-Sectors
ISO 50001:
Int’l Energy Management Std.
Capped

58. Complementary Policies for EE & RE
National Action Plan for Energy Efficiency recommendations
Renewable Portfolio Standard; Renewable Fuel Standard
Generation performance standards; Low Carbon Fuel Standard
Requiring efficiency to be an alternative in power plant EIS studies
Remove barriers to grid access (“Free the Grid” report)
Green power purchases and marketing
Combined heat and power (CHP) standards, incentives, and/or barrier removal
Public Benefits Charge – and all that it could fund

59. Policy Horizon On the Books: EPAct 2005 EISA 2007
Existing executive authorities across all departments
Looking ahead:
New Energy for America
SAFETEA-LU (Transportation Reauthorization)
Cap-and-Trade legislation
Mass vs. EPA regulations

60. Complementary Policies
Seeking a Price Response in Failed Markets
Making the Case for Complementary Policies
Considering a Federal Climate Action Plan
Annex: Smart Grid (EISA Title XIII) 61

61. Supplemental questions on Smart Grid
What does Smart Grid do?
What characterizes a Smart Grid?
What does Smart Grid deliver?
… as specified in the Energy Independence and Security Act of 2007

62. What does a Smart Grid do? (EISA Title XIII)
Dynamic optimization of grid operations and resources, with full cyber-security.
Development and incorporation of demand response, demand-side resources, and energy-efficiency resources.
Provision to consumers of timely information and control options.

63. What characterizes a Smart Grid? (EISA TitleXIII)
Increased use of digital information and controls technology to improve reliability, security, and efficiency of the electric grid.
Deployment and integration of distributed generation (e.g. renewable resources)
Deployment and integration of advanced electricity storage and peak-shaving technologies, including plug-in electric and hybrid electric vehicles, and thermal- storage air conditioning.
Deployment of `smart' technologies (real-time, automated, interactive technologies that optimize the physical operation of appliances and consumer devices) for metering, communications concerning grid operations and status, and distribution automation.
Integration of `smart' appliances and consumer devices.
Development of standards for communication and interoperability of appliances and equipment connected to the grid, including grid infrastructure.
Identification and lowering of unreasonable or unnecessary barriers to adoption of smart grid technologies, practices, and services.

64. What does a Smart Grid deliver? (EISA Title XIII)
The ability to measure or monitor electricity use as a function of time of day, power quality characteristics such as voltage level, current, cycles per second, or source or type of generation and to store, synthesize or report that information by digital means.
The ability to sense and localize disruptions or changes in power flows on the grid and communicate such information instantaneously and automatically for purposes of enabling automatic protective responses to sustain reliability and security of grid operations.
The ability to detect, prevent, communicate with regard to, respond to, or recover from system security threats, including cyber-security threats and terrorism, using digital information, media, and devices.
The ability of any appliance or machine to respond to such signals, measurements, or communications automatically or in a manner programmed by its owner or operator without independent human intervention.
The ability to use digital information to operate functionalities on the electric utility grid that were previously electro-mechanical or manual.
The ability to use digital controls to manage and modify electricity demand, enable congestion management, assist in voltage control, provide operating reserves, and provide frequency regulation.

65. Complementary Policies
for Climate Change:
Basis, Design, Strategy
January 23, 2009
Holmes Hummel, PhD 66