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A Golden Opportunity to Please Conservatives and Liberals Alike

The U.S. Environmental Protection Agency (EPA) has a golden opportunity to opt for a smart, low-cost approach to fulfilling its mandate under a Supreme Court decision to reduce carbon dioxide (CO₂) and other greenhouse gas (GHG) emissions linked with global climate change.

Such an approach would provide maximum compliance flexibility to private industry while meeting mandated emission reduction targets, would achieve these goals at the lowest possible cost, would work through the market rather than against it, would be consistent with the Obama Administration’s pragmatic approach to environmental regulation, and ought to receive broad political support, including from conservatives, who presumably want to minimize the cost burden of any policy on businesses and consumers.

Background and Context

By now, it is well known that the 2007 U.S. Supreme Court (5-4) decision in Massachusetts v. EPA found that EPA has the authority to regulate GHGs under the existing provisions of the Clean Air Act (CAA). This, combined with EPA’s “endangerment finding” in 2009 that GHGs threaten public health and the environment, led first in January, 2011, to new motor vehicle fuel efficiency standards, and soon will lead to regulations affecting new and modified stationary sources of emissions (under Section 111b of the CAA) via so-called New Source Performance Standards, and regulations for existing stationary sources (under Section 111d).

In quantitative terms, this last set of regulations – for existing stationary sources – will be key, and by far the most important affected sector will be electricity generation, which accounts for fully 40 percent of U.S. CO₂ emissions (and a third of national GHG emissions). Within this sector, coal-fired power plants will be the most drastically affected.

EPA could, in principle, promulgate a regulatory approach that incorporates compliance flexibility, such as through various types of credit, offset, or cap-and-trade mechanisms. It could do this, but may it do so under the legal authority of the Clean Air Act?

Call the Lawyers!

Over the past year, there has been a considerable amount of discussion and no small degree of hand-wringing over whether the relevant parts of the Clean Air Act authorize the use of such flexibility mechanisms. In the midst of this, a new report from Resources for the Future by Gregory Wannier (Columbia Law School) and others makes a compelling, but nuanced case in the affirmative. (See “Prevailing Academic View on Compliance Flexibility under §111 of the Clean Air Act”).

Their conclusion, in a nutshell: “EPA has the tools under §111 of the CAA to implement relatively flexible and efficient GHG regulation. The agency could use a range of compliance flexibility options itself, or facilitate state implementation plans that adopt such measures at the state or regional level.” Included are the market-based, economic-incentive instruments mentioned above.

We should take note, by the way, that Section 111d gives states considerable latitude when choosing their actions to follow EPA guidelines, an approach that is consistent with conservatives’ promotion of the primacy of state authorities in tailoring rules for individual state-by-state circumstances.

Now, for Some Economics

Even if the EPA has the legal authority to adopt a progressive, market-based approach to fulfilling this regulatory mandate, would it really make sense to do this? That is, what would be the consequences of adopting a flexible approach, compared with a conventional, inflexible regulatory scheme? Key issues include the implications for environmental performance, aggregate social cost, and consumer impacts via electricity prices.

Another new study, this one by Dallas Burtraw, Anthony Paul, and Matt Woerman (all at RFF), provides the analysis that is needed, using RFF’s well-regarded Haiku model of the U.S. electricity market, to examine the effect of alternative CAA policies on investment and operation of the nation’s electricity system over a 25-year time horizon in 21 interlinked regions. (See: “Retail Electricity Price Savings from Compliance Flexibility in GHG Standards for Stationary Sources”)

Four scenarios which would achieve the same environmental benefits are examined:

(1) a conventional approach in which the operating efficiency of individual coal-fired power plants would be regulated (labeled an “inflexible performance standard”).

(2) a “flexible performance standard,” under which plants that exceeded the standard could transfer a credit (in exchange for payment) to plants that found it more difficult to achieve the standard. The researchers call these “generation efficiency credit offsets.”

(3) cap-and-trade with auctioned CO₂ emission allowances, where the revenue generated for government simply displaces the need for other revenue sources on a one-for-one basis (that is, there is no assumption of a double-dividend through increased efficiency of the tax code).

(4) cap-and-trade with free allocation of allowances to Local Distribution Companies (LDCs), which are regulated and hence assumed to pass the benefits of the free allocation on to consumers.

The results are striking. In terms of aggregate social costs, the inflexible standard would bring with it total costs of about $5 billion per year, whereas – at the other extreme – cap-and-trade with free allocation would involve total costs of only $500 million annually, a 90 percent cost savings!

If – despite its legal authority – EPA believes it is politically unable to adopt a cap-and-trade approach (because of last year’s successful tarnishing of that phrase by Congressional conservatives), then it could opt for a second-best approach, the “flexible-performance standard,” above, which would involve total annual costs of about $1.4 billion, still a 70 percent cost savings compared with the conventional, inflexible standard.

Of course, political consideration of such policy alternatives is more frequently driven by estimates of consumer impacts than by overall social costs (which include consumer costs, industry costs, and costs to government). Here, the analysis is also striking. Consumer costs – due to higher electricity prices – under the inflexible standard would increase by 7 percent, while consumer costs under the flexible performance standard would increase by less than 2 percent. With the cap-and-trade regime with free allowances, consumer costs would actually fall by nearly 1 percent, due to lower electricity prices. [For complete numerical results with all of the scenarios, see the RFF discussion paper.]

The Bottom Line

Clearly, much is to be gained – and virtually nothing lost – by adopting a more flexible approach to meeting a court-ordered mandate that, one way or another, will have a regulation promulgated and eventually finalized. It would be foolish to turn away from a potential 90 percent cost savings for the country’s economy, particularly when the same approach yields lower electricity prices for consumers. All this, while meeting national obligations to reduce greenhouse gas emissions.

It’s too soon to forget that a year ago the Senate abandoned its attempt to pass climate legislation that would limit CO₂ emissions. In the process, conservative Republicans dubbed cap-and-trade “cap-and-tax.’’ But, as I’ve said before, regardless of what they think about climate change, conservatives should resist demonizing market-based approaches to environmental protection and reverting to pre-1980s thinking that saddled business and consumers with needless costs.

Market-based approaches to environmental protection should be lauded, not condemned, by political leaders, no matter what their party affiliation. Otherwise, there will be severe and perverse long-term consequences for the economy, for business, and for consumers.

Canada’s Step Away From the Kyoto Protocol Can Be a Constructive Step Forward

Canada confirmed this week that it will not take on a target under an extension of the Kyoto Protocol following the completion of the first commitment period, 2008-2012. Given that Canada is likely to miss by a wide margin its current target under the first commitment period, this decision may not be surprising, but it is nevertheless important. More striking, it may actually turn out to be a positive and constructive step forward in the drive to address global climate change through meaningful international cooperation. Why do I say that?

The Current Situation

The Kyoto Protocol, which essentially expires at the end of 2012, divides the world into two competing economic camps. Emission reductions are required for only the small set of “Annex I countries” (essentially those nations that used to be thought of as comprising the industrialized world). Such reductions will not reduce global emissions, and whatever is achieved would be at excessive cost, because of having left so many countries and so many low-cost emissions-reduction opportunities off the table. Furthermore, that dichotomous distinction is by no means fair: more than 50 non-Annex I countries now have higher per capita incomes than the poorest of the Annex I countries. (I have written about this and other issues surrounding the Kyoto Protocol in the past: Defining Success for Climate Negotiations in Cancun; Defining Success for Climate Negotiations in Copenhagen; Three Pillars of a New Climate Pact).

The United States did not ratify the Kyoto Protocol, and has made it clear that it will not take on a target under a second commitment period. The U.S. position continues to be that a considerably broader agreement is necessary – one that includes commitments not only from the Annex I (industrialized) countries, but also from the key emerging economies, such as China, India, Brazil, Korea, Mexico, and South Africa.

For much the same reason, Russia and Japan announced last year that they would not take on post-2012 commitments under the Kyoto Protocol. Further, it is unlikely that Australia will take on such a commitment under Kyoto, essentially leaving the European Union on its own.

On the other hand, the Kyoto Protocol is enthusiastically embraced by the non-Annex I countries (sometimes inaccurately characterized as the “developing countries”), because it holds out the promise of emissions reductions by the wealthiest nations without any responsibilities (costs) borne by others, including the emerging economies.

The Path from Copenhagen to Cancun to Durban

Year after year, the Conference of the Parties to the United Nations Framework Convention on Climate Change has failed to reach agreement on a second commitment period for the Kyoto Protocol. Most recently, in December, 2010, the issue was punted from the annual conference held in Cancun, Mexico, to the next conference, scheduled for December, 2011, in Durban, South Africa.

Because Durban provides the last opportunity to set up post-2012 targets (with time remaining for national ratification actions), it has been anticipated that the negotiations in Durban will re-ignite the divisiveness and recriminations that highlighted the Copenhagen negotiations in 2009 – with verbal hostilities between Annex I countries and non-Annex I countries dominating the discussions at the expense of any other considerations or meaningful actions.

A Positive and Constructive Step Forward

The decision just announced at meetings in Bonn, Germany, by the Canadian delegation that Canada will not take on a target in a second commitment period of the Kyoto Protocol can be a very constructive step forward. This is because it greatly reduces the risk that this year’s annual meeting of the Conference of the Parties in Durban will be dominated by acrimonious debates about a second commitment period for the Kyoto Protocol.

On the contrary, this announcement should encourage the non-Annex I (“developing”) countries, which have been insisting on a second commitment period, to begin to accept the reality that with the United States, Japan, Russia, and now Canada on record as not endorsing a second commitment period for the Kyoto Protocol, it is infeasible for the European Union to go it alone. (Indeed, one might suspect that Australia and most European nations are privately pleased by Canada’s announcement.)

The reality is that the world will be better off by focusing on sensible alternatives under the Long-Term Cooperative Action track of the UN negotiations and by “getting real” about post-Kyoto international climate policy architecture for the long term, such as by putting some additional meat on the Cancun Agreements and by considering any supplemental and sensible architectures the various parties wish to discuss. (For previous posts on the Cancun Agreements, see: Why Cancun Trumped Copenhagen; What Happened (and Why): An Assessment of the Cancun Agreements; Defining Success for Climate Negotiations in Cancun. For descriptions of a wide range of potential global climate policy architectures — ranging from top-down to bottom-up — see the diverse publications of the Harvard Project on Climate Agreements.)

Next Steps

At Cancun, it was encouraging to hear fewer people holding out for a commitment to another phase of the Kyoto Protocol, but it was politically impossible to spike the idea of extending the Kyoto agreement entirely. Instead, it was punted to the next gathering in Durban. Otherwise, the Cancun meeting could have collapsed amid acrimony and recriminations reminiscent of Copenhagen.

Usefully, the Cancun Agreements recognize directly and explicitly two key principles: (1) all countries must recognize their historic emissions (read, the industrialized world); and (2) all countries are responsible for their future emissions (think of those with fast-growing emerging economies). In important ways, this helps move beyond the old Kyoto divide.

The acceptance of the Cancun Agreements last December suggested that the international community may have begun to recognize that incremental steps in the right direction are better than acrimonious debates over unachievable targets. Canada’s announcement should help advance that recognition, and can thereby lead to vastly more productive talks this year in Durban.

Misguided Objection to Progressive Policy: The EJ Lawsuit Against Implementation of California’s AB 32 Climate Policy

On May 20th, San Francisco Superior Court Judge Ernest Goldsmith ruled that the California Air Resources Board had not adequately explained its choice of a market-based mechanism — a cap-and-trade system — to achieve approximately 20 percent of targeted emissions reductions by 2020 under Assembly Bill 32, the Global Warming Solutions Act of 2006.

The ruling was in response to a lawsuit brought by a set of “environmental justice” groups, who fear that the cap-and-trade system will hurt low-income communities. These groups hope — at a minimum — to delay implementation of the system, scheduled for January 2012. Their preferred outcome would be for California Governor Jerry Brown to abandon the approach altogether in favor of conventional regulatory mechanisms.

I’ve written about this controversy before, but the potential importance of Judge Goldsmith’s ruling suggests that it’s important to revisit this territory.

The National Context

As far as we know, Governor Jerry Brown plans to move forward with the implementation of Assembly Bill 32, the Global Warming Solutions Act, under which California seeks to take dramatic steps to reduce its greenhouse gas emissions. Questions have been raised about the wisdom of a single state trying to address a global commons problem, but with national climate policy developments having slowed dramatically in Washington, California is now the focal point of meaningful U.S. climate policy action. Indeed, for this reason, Nature Magazine recently labeled Mary Nichols, the Chairman of the California Air Resources Board, “America’s top climate cop.”

California’s Plan

A key element of the mechanisms to be used for achieving California’s ambitious emissions reductions will be cap-and-trade, a promising approach with a successful track record, despite its recent demonization as “cap-and-tax” by conservatives and other opponents in the U.S. Congress.

Under this approach, regulators restrict emissions by issuing a limited number of emission allowances, with the number of allowances ratcheted down over time, thus assuring ever-larger reductions in overall emissions. Pollution sources such as electric power plants and factories are allowed to trade allowances, and as a result, sources able to reduce emissions least expensively take on more of the pollution-reduction effort. Experience has shown that cap-and-trade programs achieve emissions reductions at dramatically lower cost than conventional regulation.

Concerns

Some groups in California have been very uneasy about the prospect of cap-and-trade. In particular, the Environmental Justice movement has long opposed this approach, citing concerns that it would hurt low-income communities. Professor Lawrence Goulder of Stanford University and I addressed such concerns in an article in The Sacramento Bee in March of 2008.

One expressed concern has been that a cap-and-trade policy might increase pollution in low-income or minority communities. The apprehension is not about greenhouse gases (the focus of AB 32), since these gases spread evenly around the globe and thus would have no discernible impact in the immediate area. Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide, and particulates, which can be emitted alongside greenhouse gases.

Because a cap-and-trade system would reduce California’s overall greenhouse gas emissions, it would also lower the state’s emissions of co-pollutants. Still, it’s possible, though unlikely, that co-pollutant emissions would increase in a particular locality. But here it’s crucial to recognize that existing air pollution laws address such pollutants, and so any greenhouse gas allowance trades that would violate local air pollution limits would be prohibited.

If current limits for co-pollutants are thought to be insufficient, the best response is not to scuttle a statewide system that can achieve AB 32’s ambitious targets at minimum cost. Rather, the most environmentally and economically effective way to address such pollution is to revisit existing local pollution laws and perhaps make them more stringent.

While much attention has been given to the effects of potential climate policies on environmental conditions in low-income communities, it’s also important to consider their economic impacts on these communities. Reducing greenhouse gas emissions will require greater reliance on more costly energy sources and more costly appliances, vehicles and other equipment. Because low-income households devote greater shares of their income to energy and transportation costs than do higher-income households, virtually any climate policy will place relatively greater burdens on low-income households. But because cap-and-trade will minimize energy-related and other costs, it holds an important advantage in this regard over conventional regulations.

Moreover, a cap-and-trade system gives the public a tool for compensating low-income communities for the potential economic burdens: If some emission allowances are auctioned, revenues can be used to mitigate economic burdens on these communities.

The Way Forward

All in all, cap-and-trade serves the goal of environmental justice better than the alternatives. This progressive policy instrument merits a central place in the arsenal of weapons California employs. Beyond helping the state meet its emissions-reduction targets at the lowest cost, it offers a promising way to reduce economic burdens on low-income and minority communities. For these reasons, the EJ lawsuit is not only misguided, but — if ultimately successful — will be counter-productive.