State and Local Climate Policy under a National Emissions Floor

This paper describes the nature of inter-jurisdictional relations as they may exist under a federal cap-and-trade program and provides background on the current climate-related activities by state and local governments. State and local governments are uniquely positioned to implement many aspects of an overall climate strategy, and an important question is whether the price signal from a cap-and-trade program (or a tax) would be a sufficient incentive to do so. The paper examines alternative types of relationships between different levels of government when an agency problem exists, wherein information or incentives for action are not perfectly aligned.environmental federalism, emissions cap, cap and trade, incentives, subsidiarity

Tradable Rights to Emit Air Pollution

The use of cap-and-trade to regulate air pollution promises to achieve environmental goals at lower cost than traditional prescriptive approaches. Cap-and-trade has been applied to various air pollutants including sulfur dioxide, nitrogen oxides, and volatile organic compounds in the United States and carbon dioxide in the European Union. This corresponds to what is likely to become the most expensive environmental undertaking in history—the effort to reduce the heating of the planet. However, the efficacy of a cap-and-trade policy for carbon dioxide depends in large part on the design of the program. In addition to the level of the cap, the most important decision facing policymakers will be the initial allocation of emissions allowances. The method used to allocate tradable emissions allowances will have significant influence on the distributional impact and efficiency of the program.cap-and-trade, emission allowances, allocation, auction, grandfathering, climate change, global warming, carbon dioxide

Nitrogen Trading in Lake Taupo: An Analysis and Evaluation of an Innovative Water Management Strategy

This paper provides a concise introduction to and evaluation of the Lake Taupo nitrogen cap and trade program established as part of Waikato Regional Council?s recent Regional Plan Variation Five. The policy establishes a catchment-wide cap on nitrogen losses by allocating farmers individual nitrogen discharge allowances and allowing those farmers flexibility to trade allowances amongst themselves and to sell allowances to a public fund while remaining within the overall catchment cap. This paper seeks to explain the structure and evolution of the nitrogen trading market and to analyse its impact thus far by drawing on a wide variety of relevant perspectives. Research drawn from written material and basic quantitative data provide the basis for analysing the policy, while interviews with relevant stakeholders provide insight into the successful, surprising and contentious issues which arose throughout its development and implementation

Federalism in the Greenhouse: Defining a Role for States in a Federal Cap-and-Trade Program

Reviews arguments for federal- and state-led action to reduce greenhouse gas emissions. Argues for a hybrid approach with options to enable states to implement innovations and more aggressive reductions to complement a federal cap-and-trade program

The SO2 Allowance Trading System and the Clean Air Act Amendments of 1990: Reflections on Twenty Years of Policy Innovation

The introduction of the U.S. SO2 allowance-trading program to address the threat of acid rain as part of the Clean Air Act Amendments of 1990 is a landmark event in the history of environmental regulation. The program was a great success by almost all measures. This paper, which draws upon a research workshop and a policy roundtable held at Harvard in May 2011, investigates critically the design, enactment, implementation, performance, and implications of this path-breaking application of economic thinking to environmental regulation. Ironically, cap and trade seems especially well suited to addressing the problem of climate change, in that emitted greenhouse gases are evenly distributed throughout the world’s atmosphere. Recent hostility toward cap and trade in debates about U.S. climate legislation may reflect the broader political environment of the climate debate more than the substantive merits of market-based regulation.

How Can One Allocation Provision Undermine a Cap-and-Trade Program? Section 3902 of the Lieberman-Warner Bill Offers a Warning about Risks in the Allowance Allocation Debate

As the debate over the design of a federal greenhouse gas cap-and-trade program unfolds, the distribution (or allocation) of emission allowances will be one of the most difficult issues to resolve. The distributional implications of allocation decisions have long been appreciated. However, various proposals in Congress have made it increasingly clear that these decisions also could have a profound effect on how emissions are reduced under a cap-and-trade program, and could thereby have a substantial effect on the program's societal cost. This paper describes an important exception to the conventional wisdom that allocation decisions do not affect a cap-and-trade program's societal cost. While this wisdom holds for many types of allocations, it does not apply to conditional allocations in which the number of allowances that a firm receives is conditioned on the firm's future operational or investment decisions. To demonstrate this point, this paper examines an allocation provision in the draft of the Lieberman-Warner Climate Security Act of 2008 that was reported out of the Senate Environment and Public Works Committee in December 2007 (the Lieberman-Warner bill). This provision, Section 3902, would distribute allowances to new fossil-fuel-fired power plants on the basis of their future output. In so doing, it would dramatically reduce, and in certain cases reverse, some of the most important emission reduction incentives that a cap-and-trade program would create. Section 3902's new entrant provision would counteract the incentive that a cap-and-trade program otherwise would create for firms to shift some investments in new electric generating capacity toward non-emitting renewable or nuclear plants. The provision's effects would be so significant that, for several years, the Lieberman-Warner bill's cap-and-trade program would actually create incentives for firms to invest in low-emitting fossil-fuel-fired plants instead of non-emitting renewable or nuclear plants. Section 3902's new entrant provision also would reduce the marginal cost of generation from new fossil-fuel-fired plants relative to existing plants. As a result of this provision, electricity generation from some existing plants would be economically displaced by generation from new plants even in cases where the new plants have higher emission rates and fuel costs. An examination of Section 3902's effects highlights the need to carefully analyze the incentives that any conditional allocation provisions would create, regardless of whether those provisions are designed with the intention of creating particular incentives, or are instead designed to achieve certain distributional objectives. Otherwise, there is a real risk that much of the emission reduction measures achieved under a cap-and-trade program will be driven by allocation decisions made in the halls of Congress, rather than by the market-based incentives that a cap-and-trade program is intended to create. Such an outcome would invariably increase the cost of reducing U.S. greenhouse gas emissions.

Impact of the allowance allocation on prices and efficiency

Successful cap and trade programs for SO2 and NOx in the US allocate allowances to large emitters based on a historic base line for a period of up to thirty years. National Allocation Plans in Europe allocate CO2 allowances in an iterative approach first for a three then for a five-year period. The potential updating of the base line creates perverse incentives for operation and investment. Some allowances are also reserved for new entrants further distorting the scheme. We use analytic models and numeric simulations for the UK power sector to illustrate and quantify how these effects contribute to an inflation of the allowance price while reducing utilisation and investment in efficient technologies. The inflated allowance prices are likely to increase the European allowance budget and emissions, e.g. through the Linking Directive. As a result opportunity costs of emitting CO2 are reduced relative to an efficient cap and trade program

Nitrogen Trading in Lake Taupo: An Analysis and Evaluation of an Innovative Water Management Strategy

This paper provides a concise introduction to and evaluation of the Lake Taupo nitrogen cap and trade program established as part of Waikato Regional Council's recent Regional Plan Variation Five. The policy establishes a catchment-wide cap on nitrogen losses by allocating farmers individual nitrogen discharge allowances and allowing those farmers flexibility to trade allowances amongst themselves and to sell allowances to a public fund while remaining within the overall catchment cap. This paper seeks to explain the structure and evolution of the nitrogen trading market and to analyse its impact thus far by drawing on a wide variety of relevant perspectives. Research drawn from written material and basic quantitative data provide the basis for analysing the policy, while interviews with relevant stakeholders provide insight into the successful, surprising and contentious issues which arose throughout its development and implementation.Environmental Economics and Policy, Land Economics/Use,

California Carbon Market Watch: A Comprehensive Analysis of the Golden State's Cap-and-Trade Program, Year One - 2012-2013

January 1, 2014 marked one year since the start of California's landmark cap-and-trade program, a market-based system to reduce greenhouse gas (GHG) pollution. The program will be the second-largest carbon market in the world, after the European Union's, and will cover 85% of all carbon pollution in the state by 2015. It is the most discussed program in a suite of strategies being deployed to achieve the goal of California's Global Warming Solutions Act -- also known as Assembly Bill 32 (AB 32) -- a 2006 law requiring the state to reduce GHG emissions to 1990 levels by 2020. California is the eighth-largest economy in the world and the first state in the nation to employ an economy-wide cap-and-trade program. While no state or country can stop climate change alone, California's environmental policies have a history of success and replication. The importance of California's program is thus magnified by the example it sets, and the world is watching to see whether the state's carbon market will succeed.One year into the program, the outlook is positive. California's cap-and-trade system weathered legal challenges and demonstrated a successful launch and viability during its initial year. In the first five auctions, all of the offered emission allowances usable for compliance in 2013 were sold. Similarly, the secondary market for carbon allowances has shown stability, and carbon prices close to the floor indicate the long-term possibility of low marginal abatement costs for regulated entities. Contrary to some predictions of harsh economic damage, capping carbon pollution in California has occurred amidst sustained and promising economic recovery and growth, including a stronger housing market and lower unemployment rate.This report provides an overview and analysis of California's carbon market after one year in operation. Included are a background on the cap-and-trade program, an account of the carbon market's progress to date, and an analysis of what the market's performance means for California's environmental and economic goals. This analysis includes in-depth summaries and trends observed from the quarterly auctions and secondary market activity, along with evaluations of market performance by industry experts and academics. Updates regarding litigation, proposed regulatory amendments, and international agreements are also discussed

The Effect of Allowance Allocations on Cap-and-Trade System Performance

We examine an implication of the “Coase Theorem” which has had an important impact both on environmental economics and on public policy in the environmental domain. Under certain conditions, the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights. That is, the overall cost of achieving a given aggregate emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation. We call this the independence property. This property is very important because it allows equity and efficiency concerns to be separated in a relatively straightforward manner. In particular, the property means that the government can establish the overall pollution-reduction goal for a cap-and-trade system by setting the cap, and leave it up to the legislature – such as the U.S. Congress – to construct a constituency in support of the program by allocating the allowances to various interests without affecting either the environmental performance of the system or its aggregate social costs. Our primary objective in this paper is to examine the conditions under which the independence property is likely to hold – both in theory and in practice. A number of factors can call the independence property into question theoretically, including market power, transaction costs, non-cost-minimizing behavior, and conditional allowance allocations. We find that, in practice, there is support for the independence property in some, but not all cap-and-trade applications.Cap-and-Trade System, Tradable Permits, Coase Theorem, Allowance Allocation