CapandTrade 101

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Cap-and-Trade 101
Judi Greenwald Director of Innovative Solutions
Franz LitzSenior Fellow
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Overview

• Some Key Considerations for Climate Policy
• Why Market Mechanisms What Role Do They Play
  in a Comprehensive Climate Change Policy?
• Examples of Market Mechanisms
• Building Blocks of Cap-and-Trade
• How can other policies interact with
  Cap-and- Trade?
• Key Design Considerations

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Key Climate Policy Considerations

• Global problem needs global solution
• Location of GHG reduction doesnt matter
• Thousands of sources, thousands of solutions
• We know how to get significant GHG
  reductions-- challenge is to get the vast
  reductions we need over time, cost-effectively
• Markets can be effective at addressing these
  considerations

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Why Market Mechanisms?

• Enable linkage with the rest of the world
• Take advantage of gains from trade
• Drive innovation
• Create a price for greenhouse gas emissions,
  and allow market forces to
• minimize the cost of making substantial
  reductions
• Help find most efficient path to compliance
• Stimulate technological innovation and lead to
  further cuts in the future
• Identify solutions regulators cannot anticipate

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The Role of Market Mechanisms

• Market mechanisms are important, but are
  just one part of reaching overall emissions
  reduction goals
• Additional means of reducing GHG emissions
  should be included
• regulatory standards
• tax incentives
• public-private technology initiatives, etc.

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The Role of Market Mechanisms

• Standards (e.g., GHG standards for vehicles,
  fuels, etc.)
• can be complementary to markets either covering
  different sources or as baselines
• can be implemented through markets (e.g., LCFS)
• can be integrated with broader market through use
  of tradeable standards
• Pros and cons of economy-wide vs.
  sector-specific markets

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Examples of Market Mechanisms

• Emissions Cap-and-Trade
• Carbon Tax or Per Ton Emissions Charge
• Renewable Portfolio Standard (RPS) with
  Certificates Trading
• Low Carbon Fuel Standard (LCFS) with
  Certificates Trading
• Individual Transferable Quotas in Fisheries

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Renewable Portfolio Standard with Trading

• Government says minimum amount of electricity
  will come from renewable sources
• Renewable energy providers compete to supply
  the load- serving entity with certificates
• Objective market will be created in
  certificates, ensuring that the lowest cost
  renewable energy is obtained
• Achievement of goal is certain (given
  sufficient time for development and no cap on
  cost)

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Low Carbon Fuel Standard with Trading

• Government says all fuel must meet a low
  carbon fuel standard by a certain date, i.e.
  carbon attributable to fuel (on a life-cycle
  basis) must be reduced by X by date.
• Instead of making all producers meet the
  standard, producers can buy credits from other
  producers that are able to exceed the standard.
• Objective overall average of fuel delivered in
  the covered area will meet or exceed the LCFS.
  
• Achievement of low carbon average is certain,
  but amount of total carbon is not limited.

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Carbon Tax

• Government assesses per unit charge for
  pollution
• Pollution charge results in reduced pollution,
  because pollution costs the firms money
• Firms would reduce pollution as long as it is
  cheaper to reduce rather than pay the charge
• Emission reductions uncertain--reductions
  proceed until the marginal cost of reduction
  tax or charge
• Emphasis is therefore on cost, or revenue, not
  reductions

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Carbon Tax vs. Cap-and-Trade
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BASIC BUILDING BLOCKS OF CAP-AND-TRADE
ENFORCEMENT PENALTIES FOR NON-COMPLIANCE
SOURCES TRUE UP AT END OF EACH COMPLIANCE PERIOD
ESTABLISH COMPLIANCE PERIOD FOR SOURCES
DISTRIBUTE OR AUCTION ONE ALLOWANCE FOR EACH
TON IN BUDGET
DETERMINE THE REDUCTION OVER TIME (i.e.,
SUCCESSIVE BUDGETS REDUCED)
ESTABLISH ANNUAL EMISSIONS CAP (OR ANNUAL
ALLOWANCE BUDGET)
ESTABLISH AGGREGATE EMISSIONS BASELINE FOR
SOURCES
REQUIRE SOURCES TO MEASURE, MONITOR REPORT
EMISSIONS
IDENTIFY SOURCES TO BE COVERED IN ONE OR MORE
SECTORS
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ADDITIONAL DESIGN ISSUES
BASIC BUILDING BLOCKS OF CAP-AND-TRADE
ENFORCEMENT PENALTIES FOR NON-COMPLIANCE
SOURCES TRUE UP AT END OF EACH COMPLIANCE PERIOD
ESTABLISH COMPLIANCE PERIOD FOR SOURCES
DISTRIBUTE ONE ALLOWANCE FOR EACH TON IN
ALLOWANCE BUDGET
DETERMINE THE REDUCTION OVER TIME (i.e.,
SUCCESSIVE BUDGETS REDUCED)
PROVISION FOR NEW SOURCES?
ESTABLISH ANNUAL EMISSIONS CAP (OR ANNUAL
ALLOWANCE BUDGET)
LINKING TO OTHER PROGRAMS?
ESTABLISH AGGREGATE EMISSIONS BASELINE FOR
SOURCES
CREDIT FOR EARLY ACTION?
REQUIRE SOURCES TO MEASURE, MONITOR REPORT
EMISSIONS
OFFSETS?
IDENTIFY SOURCES TO BE COVERED IN ONE OR MORE
SECTORS
FLEXIBILITY COST-CONTAINMENT?
MANDATORY EMISSIONS REPORTING
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What is an Offset Credit?

• An offset credit is a project-based reduction
  that is demonstrated outside the capped sector.
• To receive credit, most existing programs
  require the reduction be real, surplus (or
  additional), verifiable, permanent, and
  enforceable (RSVP E).
• Examples of offset projects are land to forest
  sequestration project sulfur hexafluoride
  (SF6) leak prevention landfill gas capture and
  destruction.
• Offsets expand the cap on covered sources in
  exchange for reductions outside the sector.

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From the Perspective of a Source

• A cap-and-trade program consists of two basic
  requirements
• Source must measure, monitor and report its
  emissions to sources central registry account
  and
• At the end of the compliance period, source must
  hold sufficient allowances in its allowance
  account to cover all emissions in that compliance
  period.
• Allowances are freely tradable among sources.
• A covered entity can comply by reducing its
  emissions buying allowances from auction or
  another source that has reduced its emissions or
  buying offset credits.

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Regional Cap-and-Trade Programs

• Mechanics
• Each state gets a annual allowance budget
• Regional effort produces model program that
  states must then propose individually
• Each state recognizes the allowances of other
  states as long as the other state is in good
  standing and
• State registries are linked (or a regional
  registry is established) to allow for seamless
  trading across states.

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Regional Trading

• Sources in one state may buy or sell
  allowances to sources in another state
• Cap is maintained
• Aggregate total of emissions remains the sum
  of participating states allowance budgets,
  plus offsets.

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Potential for Leakage

• On the Potential for Emissions Leakage
• Addressing out-of-state leakage concerns (e.g.,
  cement manufacturing, electricity)
• Leakage depends on coverage and the cost of doing
  business
• Best way to avoid leakage is to expand coverage,
  minimize costs, and link with other systems
• Allocation can help on leakage
• Traditional regulation can drive leakage too

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Key Considerations

• Market Fundamentals most effort should be in set
  up
• Good emissions data measurement, monitoring and
  reporting
• Allowance tracking
• Consistent and transparent rules
• Good enforcement
• Minimize transaction costs

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Key Considerations (continued)

• Who should be covered, and who should not?
• Including more sources and gases in the program
  offers a broader range of opportunities for
  low-cost reductions
• But including too many small sources can make the
  program administratively complex
• Put what works well in the market
• Economy wide Cover all GHGs in all major
  emitting sectors
• Downstream at point of emission
• Upstream at point where fuels enter market
• Hybrid Large point sources downstream others
  covered upstream
• Electric power generators, first sellers or LSEs
• Coverage can expand over time

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Key Considerations (continued)
Create Model that Others will Emulate or Link to

• Ends
• Reduce GHGs
• Minimize costs
• Stimulate innovation
• Link efforts with others
• Achieve co-benefits
• Equity

• Means
• Markets are part of a comprehensive approach
• Get the market fundamentals right
• Careful design based on past lessons and analysis
• Complement and build on relevant state policies
  address state-specific issues

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Questions?
Judi Greenwald Director of Innovative Solutions
Franz T. Litz Senior Fellow
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