linkage of cap-and-trade systems Archives - Page 14 of 17

Good News from the Regulatory Front

As each day passes, the upcoming November 2012 general elections produce new stories about potential Republican candidates for President, as well as stories about President Obama’s anticipated re-election campaign. At the same time, the 2012 elections are already affecting Congressional debates, where each side seems increasingly interested in taking symbolic actions and scoring political points that can play to its constituencies among the electorate, rather than working earnestly on the country’s business.

The new Tea Party Republicans in the House of Representatives decry the “fact” that the U.S. Environmental Protection Agency (EPA) continues to promulgate “job-killing regulations” for made-up non-problems. And Democrats in the Congress – not to mention the Administration – are eager to talk about “win-win” policies that will produce “clean energy jobs” and protect Americans from the evils of imported oil and gas.

Neither side seems willing to admit that environmental regulations bring both good news – a cleaner environment – and bad news – costs of compliance that affect not only businesses but consumers as well. Sometimes the cost-side of proposed regulations dominates. Those regulatory moves are – from an economic perspective – fundamentally unwise, since they make society worse off. In other cases, the benefits of a proposed regulation more than justify the costs that will be incurred. Such regulations are – to use a word now favored by President Obama – a wise investment. They make society better off. Failure to take action on such opportunities is imprudent, if not irresponsible. Just such an opportunity now presents itself with EPA’s Clean Air Transport Rule.

In an op-ed that appeared on April 25, 2011, in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I assess this opportunity. Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with my co-author, Richard Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007. Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991. By the way, in previous blog posts, I’ve featured other op-eds that Dick and I have written in The Huffington Post (“Renewable Irony”) and The Boston Globe (“Beware of Scorched-Earth Strategies in Climate Debates”).

—————————————————————————————————————————————-

An Opportunity for Timely Action: EPA’s Transport Rule Passes the Test

by Richard Schmalensee and Robert Stavins

The Huffington Post, April 25, 2011

At a time when EPA regulations are under harsh attack, one new environmental regulation – at least – stands out as an impressive winner for the country. Studies of the soon-to-be-finalized Clean Air Transport Rule have consistently found that the benefits created by the rule would far outweigh its costs. By reducing sulfur dioxide and nitrogen oxide emissions from power plants in 31 states in the East and Midwest, the Transport Rule will create substantial benefits through lower incidence of respiratory and heart disease, improved visibility, enhanced agricultural and forestry yields, improved ecosystem services, and other environmental amenities. According to EPA, these benefits will be 25 to 130 times greater than the associated costs. We document this in our new report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation.

Despite the benefits offered by the Transport Rule, some argue that it – and other EPA regulations – will stifle economic growth and threaten the reliability of our electric power system. However, a careful look at the evidence reveals that the Transport Rule is unlikely to create such risks. Analyses of the Transport Rule have found that it need not lead to significant plant retirements. Robust regulatory and market mechanisms ensure that the nation can meet emission targets while reliably meeting customer demand.

While compliance with the Transport Rule would – in some cases – require installation of new pollution control equipment, the capital expenditures required would comprise a small fraction of aggregate capital spending by the power industry. In fact, because of the Transport Rule’s unique legal circumstances, in which the Courts have mandated that EPA replace a stringent predecessor, utilities have already begun to make pollution control investments needed to comply with the Transport Rule.

The Rule’s timing can also contribute to lowering its cost and supporting other policy goals. Installation of the pollution control technologies needed to comply with the Rule could increase short-term employment. Although the longer term job impacts are less clear, these short-term employment effects would complement other policy initiatives aimed at supporting the nation’s economic recovery.

EPA analysis estimates modest impacts on regional electricity rates, but reductions in health care expenditures could partially or fully offset these effects. Expanded supplies of low-cost natural gas can also help lower the Transport Rule’s cost by providing a less costly substitute for power generated from coal.

Most importantly, actions taken to reduce emissions would create substantial health benefits. Tens of thousands of premature deaths would be eliminated annually, as would millions of non-fatal respiratory and cardiovascular illnesses. A diverse set of studies find that these health improvements will create $20 to over $300 billion in benefits annually. And, while the Transport Rule is designed to reduce the impact of upwind emissions on downwind states, upwind states would also receive substantial health benefits from the cleaner air brought about by the Rule. These upwind states have much to gain, because states with the highest emissions from coal-fired power plants are also among those with the greatest premature mortality rates from these emissions.

Along with these health benefits, the largest shares of short-term improvements in employment and regional economies are likely to accrue to the regions that are most dependent on coal-fired power, as they invest in new pollution control equipment. Thus, while designed to help regions downwind of coal-fired power plants, the Transport Rule also offers substantial benefits to upwind states.

As the U.S. economy emerges from its worst recession since the Great Depression of the 1930s and faces an increasingly competitive global marketplace, regulation such as the Transport Rule that creates positive net benefits and allows industry flexibility in creating public goods can complement strategies intended to foster economic growth. Such regulations are best identified by careful analyses to ensure that benefits truly exceed costs and avoid unfair impacts on particular groups or sectors. The Transport Rule has undergone a series of such thorough assessments, and the results consistently indicate that it would create benefits that far exceed its costs. Failure to take timely action on this opportunity would seem to be imprudent, if not irresponsible.

————————————————————————————————–

*Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology, a research associate of the National Bureau of Economic Research, and a fellow of the Econometric Society and the American Academy of Arts and Sciences. He served as a member of the Council of Economic Advisers with primary responsibility for environmental and energy policy from 1989 through 1991. Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School, a university fellow of Resources for the Future, a research associate of the National Bureau of Economic Research, and a fellow of the Association of Environmental and Resource Economists. He served as chairman of the EPA’s Environmental Economics Advisory Committee from 1997 through 2002. Their report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation, can be downloaded at: http://www.analysisgroup.com/uploadedFiles/Publishing/Articles/2011_StavinsSchmalansee_TransportRuleReport.pdf

A Wave of the Future: International Linkage of National Climate Change Policies

The latest rage in Washington policy discussions these days (that’s relevant to climate change) is renewed interest in renewable electricity standards, this time in the form of so-called “clean energy standards.” I’ve written about this policy approach recently at this blog (Renewable Energy Standards: Less Effective, More Costly, but Politically Preferred to Cap-and-Trade?, January 11, 2011), and will do so again in the near future, but for today I want to turn to an important issue – for the long term – on the related topic of the international dimensions of climate change policy.

The Current State of Affairs

Despite the death in the U.S. Senate last year of serious consideration of an economy-wide cap-and-trade system for carbon dioxide (CO₂) emissions – and the apparent political hiatus of such consideration at least until after the November 2012 elections – a major cap-and-trade system for greenhouse gas (GHG) emissions is in place in the European Union; similar systems are in place or under development in New Zealand, California, and several Canadian provinces; systems are being considered at the national level in Australia, Canada, and Japan; and a global emission reduction credit scheme – the Clean Development Mechanism (CDM) – has an enthusiastic and important constituency of supporters in the form of the world’s developing countries.

So, despite the fact that there has been an undeniable loss of momentum due to recent political developments in Australia, Japan, and the United States, it remains true that cap-and-trade is still the most likely domestic policy approach for CO₂ emissions reductions throughout the industrialized world, given the rather unattractive set of available alternative approaches. This makes it important to think about the possibility of linking these national and regional cap-and-trade systems in the future. Such linking occurs when the government that maintains one system allows regulated entities to use allowances or credits from other systems to meet compliance obligations.

Thinking About Linkage

In 2007, with support from the International Emissions Trading Association (IETA) and the Electric Power Research Institute (EPRI), Judson Jaffe and I analyzed the opportunities and challenges presented by linking tradable permit systems. Jaffe was then at Analysis Group in Boston, and is now at the U.S. Department of the Treasury. We presented our findings at the thirteenth Conference of the Parties of the U.N. Framework Convention on Climate Change in Bali, Indonesia, in December, 2007. In 2010, Matthew Ranson (a Ph.D. student in Public Policy at Harvard), Jaffe, and I expanded on these ideas in an article that was published in Ecology Law Quarterly, “Linking Tradable Permit Systems: A Key Element of Emerging International Climate Policy.” In today’s blog post, I summarize the highlights of this complex, yet important topic.

First, for anyone new to this territory, let me review the basic facts. Tradable permit systems fall into two categories: cap-and-trade and emission reduction credits. Under cap-and-trade (CAT), the total emissions of regulated sources are capped and the sources are required to hold allowances equal to their emissions. Under a credit system, entities that voluntarily undertake emission reduction projects are awarded credits that can be sold to participants in cap-and-trade systems.

The Merits of Linking

By broadening markets for allowances and credits, linking increases the liquidity and improves the functioning of markets. Linking can reduce the costs of the linked systems by making it possible to shift emission reductions across systems. Just as allowance trading within a system allows higher-cost emission reductions to be replaced by lower-cost reductions, trading across systems allows higher-cost reductions in one system to be replaced by lower-cost reductions in another system.

Other Implications

Along with the cost savings it can offer, linking has other implications that warrant serious consideration. Under some circumstances, linked systems collectively will not achieve the same level of emission reductions as they would absent linking. This can result either from a link’s impact on emissions under the linked systems, or from its impact on emissions leakage from those systems. Linking also has distributional impacts across and within systems. And linking can reduce the control that a country has over the impacts of its tradable permit system. In particular, when a domestic CAT system is linked with another CAT system, decisions by the government overseeing the other system can influence the domestic system’s allowance price, distributional impacts, and emissions.

By the way, linkage can also occur among a heterogeneous set of domestic policy instruments, including carbon taxes and various types of regulation, although the linking is more challenging under such circumstances. On this, see “Linking Policies When Tastes Differ: Global Climate Policy in a Heterogeneous World,” a discussion paper by Gilbert Metcalf, Department of Economics, Tufts University, and David Weisbach, University of Chicago Law School, for the Harvard Project on Climate Agreements.

Concerns About Linking

Importantly, trading brought about by unrestricted links between CAT systems will lead to the automatic propagation of certain design elements, including: offset provisions and linkages with other systems; banking and borrowing of allowances across time; and safety-valve provisions. If these provisions, sometimes characterized as cost-containment measures, are present in one of the linked systems, they will automatically be made available to participants in the other system.

In the near-term, some links will be more attractive and easier to establish than others. Given the design-element propagation implications of two-way links between cap-and-trade systems, to facilitate such links it may be necessary to harmonize some design elements. And in some cases, it may be necessary to establish broader international agreements governing aspects of the design of linked cap-and-trade systems beyond mutual recognition of allowances.

An Emerging De Facto International Climate Policy Architecture?

Whereas some two-way links between cap-and-trade systems may thus take more time to establish, in the near-term one-way links between cap-and-trade and credit systems likely will be more attractive and easier to establish. A one-way link with a credit system may offer a cap-and-trade system greater cost savings than a two-way link with another cap-and-trade system. Also, such one-way links can only reduce allowance prices in the cap-and-trade system, giving a government greater control over its system than if it established a two-way link with another cap-and-trade system. The additionality problem is an important concern associated with such links, but it can be managed – to some degree – through the criteria established for awarding or recognizing credits.

Most important, if emerging cap-and-trade systems link with a common credit system, such as the CDM, this will create indirect links among the cap-and-trade systems. Through the indirect links that they create, such one-way linkages can achieve much of the near-term cost savings and risk diversification that direct two-way links among cap-and-trade systems would achieve. And they can do this without requiring the same foundation that likely would be needed to establish direct two-way links, such as harmonization of cost-containment measures. Such linkage may well emerge as part of the de facto post-Kyoto international climate policy architecture, and is fully consistent with the bottom-up, decentralized approach of the Cancun Agreements.

——————————————————————————————————–

For much more detailed discussions, here are some publications available on the web that describe various aspects of linkage:

Jaffe, Judson, Matthew Ranson, and Robert Stavins. “Linking Tradable Permit Systems: A Key Element of Emerging International Climate Policy Architecture.” Ecology Law Quarterly 36(2010):789-808.

Jaffe, Judson, and Robert Stavins. “Linkage of Tradable Permit Systems in International Climate Policy Architecture.” The Harvard Project on International Climate Agreements, Discussion Paper 08-07, Cambridge, Massachusetts, September, 2008.

Jaffe, Judson, and Robert Stavins. Linking a U.S. Cap-and-Trade System for Greenhouse Gas Emissions: Opportunities, Implications, and Challenges. Washington, D.C.: AEI-Brookings Joint Center for Regulatory Studies, January 2008.

Jaffe, Judson, and Robert Stavins. Linking Tradable Permit Systems for Greenhouse Gas Emissions: Opportunities, Implications, and Challenges. Prepared for the International Emissions Trading Association, Geneva, Switzerland. November, 2007.

Also, this issue of linkage among tradable permit systems has come up previously in a number of my essays at this blog:

AB 32, RGGI, and Climate Change: The National Context of State Policies for a Global Commons Problem

The Real Options for U.S. Climate Policy

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Only Private Sector Can Meet Finance Demands of Developing Countries

Approaching Copenhagen with a Portfolio of Domestic Commitments

Worried About International Competitiveness? Another Look at the Waxman-Markey Cap-and-Trade Proposal

Defining Success for Climate Negotiations in Cancun

International climate negotiations will continue in Cancun, Mexico, during the first two weeks of December, 2010. These will be the Sixteenth Conference of the Parties (COP-16) of the United Nations Framework Convention on Climate Change (UNFCCC). The key challenge is to continue the process of constructing a sound foundation for meaningful, long-term global action, not necessarily some notion of immediate, highly-visible triumph. Some of the gloom-and-doom predictions we’ve been hearing about these upcoming negotiations are therefore misguided, because they are based upon unreasonable – and fundamentally inappropriate – expectations (despite the fact that expectations have been lowered dramatically since COP-15 in Copenhagen last year).

Keeping Our Eyes on the Prize

Why do I say that the best goal for the Cancun climate talks is to make real progress on a sound foundation for meaningful, long-term global action, not some notion of immediate triumph? This is because of some basic scientific and economic realities.

First, the focus of scientists (and policy makers) should be on stabilizing concentrations at acceptable levels by 2050 and beyond, because it is the accumulated stock of greenhouse gas emissions — not the flow of emissions in any year — that are linked with climate consequences.

Second, the cost-effective path for stabilizing concentrations involves a gradual ramp-up in target severity, to avoid rendering large parts of the capital stock prematurely obsolete.

Third, massive technological change is the key to the needed transition from reliance on carbon-intensive fossil fuels to more climate-friendly energy sources. Long-term price signals (most likely from government policies) will be needed to inspire such technological change.

Fourth and finally, the creation of long-lasting international institutions is central to addressing this global challenge.

For all of these reasons, international climate negotiations will be an ongoing process, not a single task with a clear end-point. Indeed, they may well proceed much as international trade talks have done, that is, with progress over many years, building the institutions (the GATT, the WTO), but moving forward in fits and starts, at times seeming to move backward, but making meaningful progress in the long term.

So, the bottom-line is that a sensible goal for the international negotiations in Cancun is progress on a sound foundation for meaningful long-term action, not some notion of immediate “success.”

Don’t Sacrifice Valuable Long-Term Achievements for Minor Short-Term Gains

It might be relatively easy, but actually quite unfortunate, for countries to achieve what some people might define as “success” in Cancun: a signed international agreement, followed by glowing press releases. I say it would be unfortunate, because such an agreement could only be the Kyoto Protocol on steroids: more stringent targets for the original list of industrialized countries (Annex I) and no meaningful commitments by the key rapidly-growing emerging economies, such as China, India, Brazil, Korea, Mexico, and South Africa.

Such an agreement could — in principle — be signed, but it would not reduce global emissions, and it would not be ratified by the U.S. Senate (just like Kyoto). Hence, there would be no real progress on climate change.

What Would Constitute Real Progress in Cancun?

If it’s not reasonable to expect that a comprehensive post-Kyoto policy architecture will be identified and enacted in Cancun, what would constitute real progress?

1. Embracing Parallel Processes

A significant step forward would be for the UNFCCC to embrace the parallel processes that are carrying out multilateral discussions (and in some cases, negotiations) on climate change policy: the Major Economies Forum or MEF (a multilateral venue for discussions – but not negotiations – outside of the UNFCCC, initiated under a different name by the George W. Bush administration in the United States, and continued under a new name by the Obama administration, for the purpose of bringing together the most important emitting countries for candid and constructive discussion and debate); the G20 (periodic meetings of the finance ministers – and sometimes heads of government – of the twenty largest economies in the world); and various other multilateral and bilateral organizations and discussions.

By the way, the MEF includes Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, South Africa, the United Kingdom, and the United States. The membership of the G20 is the same as the membership of the MEF, plus Argentina, Saudi Arabia, and Turkey.

The previous leadership of the UNFCCC seemed to view the MEF, the G20, and most other non-UNFCCC forums as competition – indeed, as a threat. Fortunately, the UNFCCC’s new leadership under Executive Secretary Christiana Figueres (appointed by UN Secretary-General Ban Ki-moon in May of this year) has displayed a considerably more positive and pragmatic attitude toward these parallel processes.

2. Consolidating Negotiations Tracks

There are now three major, parallel processes operative: first, the UNFCCC’s KP track (negotiating national targets for a possible second commitment period – post-2012 – for the Kyoto Protocol); second, the LCA track (the UNFCCC’s negotiation track for Long-term Cooperative Action, that is, a future international agreement of undefined nature); and third, the Copenhagen Accord, negotiated and noted at COP-15 in Copenhagen, Denmark, in December, 2009. Consolidating these three tracks into two tracks (or better yet, one track) would be another significant step forward.

One way this could happen would be for the LCA negotiations to take as their point of departure the existing Copenhagen Accord, which itself marked an important step forward by blurring for the first time (although not eliminating) the unproductive and utterly obsolete distinction in the Kyoto Protocol between Annex I and non-Annex I countries. (Note that more than 50 non-Annex I countries now have greater per capita income than the poorest of the Annex I countries.)

In particular, the UNFCCC principle of “common but differentiated responsibilities” could be made meaningful through the dual principles that: all countries recognize their historic emissions (read, the industrialized world); and all countries are responsible for their future emissions (think of those rapidly-growing emerging economies).

This would represent a great leap beyond what has become the “QWERTY keyboard” (that is, unproductive path dependence) of international climate policy: the distinction in the Kyoto Protocol between the small set of Annex I countries with quantitative targets, and the majority of countries in the world with no responsibilities. Various policy architectures could subsequently build on these dual principles and make them operational, beginning to bridge the massive political divide which exists between the industrialized and the developing world.

At the Harvard Project on Climate Agreements — a multi-national initiative with some 35 research projects in Australia, China, Europe, India, Japan, and the United States — we have developed a variety of architectural proposals that could make these dual principles operational. (See, for example: “Global Climate Policy Architecture and Political Feasibility: Specific Formulas and Emission Targets to Attain 460 PPM CO2 Concentrations” by Valentina Bosetti and Jeffrey Frankel; and “Three Key Elements of Post-2012 International Climate Policy Architecture” by Sheila M. Olmstead and Robert N. Stavins.)

3. Productive Steps in Narrow, Focused Agreements, such as REDD+

A third area of success at the Cancun negotiations could be realized by some productive steps with specific, narrow agreements, such as on REDD+ (Reduced Deforestation and Forest Degradation, plus enhancement of forest carbon stocks). Other areas where talks are moving forward, although somewhat more slowly, are finance and technology.

4. Maintaining Sensible Expectations and Developing Effective Plans

Finally, it is important to go into the Cancun meetings with sensible expectations and thereby effective plans. Again, negotiations in this domain are an ongoing process, not a single task with a clear end-point. The most sensible goal for Cancun is progress on a sound foundation for meaningful long-term action, not some notion of immediate triumph. The key question is not what Cancun accomplishes in the short-term, but whether it helps put the world in a better position five, ten, and twenty years from now in regard to an effective long-term path of action to address the threat of global climate change.

Further Reading

A number of previous essays I have written and posted at this blog will be of interest to those who wishe to follow developments at the Sixteenth Conference of the Parties of the UN Framework Convention on Climate Change in Cancun. Here are links, in chronological order:

Three Pillars of a New Climate Pact

Can Countries Cut Carbon Emissions Without Hurting Economic Growth?

Approaching Copenhagen with a Portfolio of Domestic Commitments

Defining Success for Climate Negotiations in Copenhagen

Only Private Sector Can Meet Finance Demands of Developing Countries

Chaos and Uncertainty in Copenhagen?

What Hath Copenhagen Wrought? A Preliminary Assessment of the Copenhagen Accord

Another Copenhagen Outcome: Serious Questions About the Best Institutional Path Forward

Opportunities and Ironies: Climate Policy in Tokyo, Seoul, Brussels, and Washington