Billy Pizer Rethinks Three Issues Regarding the Clean Power Plan and Carbon Markets

Billy Pizer, a faculty fellow at Duke’s Nicholas Institute for Environmental Policy Solutions and professor in the Sanford School of Public Policy, was among the Duke representatives at the Navigating the American Carbon World Conference in Los Angeles, California, this week. Pizer, who led a panel on the Opportunities and Challenges for Carbon Markets under the Clean Power Plan, reflects on three issues brought up at the conference.

Some states and utilities are viewing the rate-based state compliance approach as more accommodating of growth than a mass-based approach. 

At first blush, this would seem to be an obvious truth. A rate-based compliance approach means you have to hit a tons-of-CO₂-per-megawatt-hour rate—but you can produce as many megawatt-hours and tons of CO₂ as you want under that rate. A mass-based approach stipulates a certain number of tons, regardless of how much power you generate. But consider the underlying basis of the regulation—an emissions rate among existing sources. Growth is much more about new sources than existing sources. If new emissions sources—which are always going to be low-emissions sources given new source standards—are included under a rate-based approach, rate improvements driven by new plants cannot be used to allow existing sources to go above their EPA-mandated emissions limit. Ultimately, a rate-based approach, including new and existing sources, would require a reduction in the required rate to maintain compliance. Now consider that it entirely possible for a mass-based approach to include a mechanism to increase the cap as new sources are brought into the system—as long as existing emissions sources do not exceed the EPA-set rate. One would want to be careful that any increased allowances under the cap are not directly given to new sources. That would potentially distort the incentives to build new plants versus dispatch existing plants. But unless I am missing something about how various state approaches will necessarily mesh with the EPA regulations, growth accommodation is probably not a good reason to embrace a rate-based approach.  

Another concern I heard at the conference was that mass-based approaches tend to raise wholesale electricity prices a lot more than rate-based policies.  In order to address concerns about electricity price increases, states may therefore lean towards rate-based approaches.

This price result actually comes out of a lot of research, including some of our own work at the Nicholas Institute. But all of this hinges on particular assumptions about allowance allocation and it need not be the case. In another context, namely concern about trade-exposed industries, a lot of work has been done on the idea of output-based allocations. Within the confines of an emission cap, these types of allocations operate like a tradable performance standard (e.g., rate-based approach) in terms of their influence on prices. Much of the economic literature has harped on these allocations from the standpoint of failing to raise prices and encourage conservation. But if you want to depress electricity prices, output-based allocations are a way to do it without the additional complexities of a rate-based approach.
 

A final puzzle that came up was how different types of regional trading may or may not interact.

Our discussions clarified that at least three different models of regional trading are likely to emerge. Under a "minimal compatibility" or "common elements" system—so named because of the few requirements or elements required to ensure the system’s workability—states would set up their trading programs and allow regulated entities to use allowances from other states for compliance. Alternatively, under a system like the Northeast’s Regional Greenhouse Gas Initiative, states would negotiate a more elaborate collaboration. Finally, under a system like the California Cap-and-Trade Program, states might include sectors beyond the power sector, allow for offsets, and regulate imported electricity.
That last characteristic—regulation of imported electricity—most sets this system apart from other trading systems. California has, in essence, switched from a "production-based” approach to a "consumption-based” approach. That is, it has chosen to regulate emissions associated with electricity consumed—rather than electricity produced—in California. 

This reflects a concern in California that reductions in the state not occur at the expense of emissions increases elsewhere. These concerns are not fully mitigated by the Clean Power Plan—states still face no absolute limit on emissions when new sources are included. Therefore, it is hard to see how California will trade with another jurisdiction unless it takes the same or a similar approach by not only capping their emissions, but also addressing electricity imports. All of this leads me to believe that we are in for at least these three different trading systems for the foreseeable future.

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Billy Pizer is available for comment by contacting Erin McKenzie, erin.mckenzie@duke.edu or 919.613.3652.