Power Plant Emissions, Carbon Tax and Cap and Trade Legislation

 
 
 
 
 
 
 
 
 
 
 
 
 

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Brookings Explores Carbon Pricing Mechanisms

At a recent Washington conference sponsored by the Hamilton Project of the Brookings Institution, economists debated the relative merits of a carbon tax versus a cap-and-trade mechanism as a means to bring down our emissions of CO² into the atmosphere. The relative arguments pro and con are summarized below, but the major conclusion of the conference was that there are fewer differences between the two pricing measures than there are between the concept of pricing carbon and the idea of command-and-control mechanisms as a means of reducing greenhouse gas emissions.
     Either pricing mechanism, in the opinion of the conference presenters, would be more effective than efforts to regulate particular energy uses or selections, such as through CAFÉ standards on the automotive fleet or specific renewable fuel standards for the electric utilities. Their judgment was that a more balanced outcome would occur by building an appropriate price into the energy sources—coal, oil or natural gases—in proportion to their carbon content, and then allowing the market to select measures to minimize the cost.
     This contention argues that once a set level of carbon emissions is established through the cap-and-trade system, all decisions about where to achieve reductions will be made by the market within that set level of emissions. If consumption of gasoline is a higher cost to the consumer than electricity, that’s where reduced consumption will occur, and vice versa. Others may agree that if the goal is energy security, which really implicates petroleum imports rather than use of energy generally, measures such as CAFÉ might be required as supplements to the emissions permits. Closest to Source Is Best Another area of concurrence was the view that either the tax on carbon or the issuance of permits should be as far “upstream” as possible, built into the price of the energy source before it entered the market. The effort in the European Union to intervene at later “downstream” stages was cited as reason for many of the problems encountered in their cap-and-trade system.
     Another important factor to be considered in implementing either a carbon tax or a cap-and-trade system is that their design is primarily focused on reducing emissions of CO². It is not necessarily the case that any effective system of gas emission reduction will be equally effective in addressing the issue of energy security. It may be necessary to implement selective additional measures to optimize progress on that goal.
     Some further useful observations were provided by former Treasury Secretary Lawrence Summers, who compared the current state of play with respect to greenhouse gases with the apparent consensus in 1992 that “something had to be done about health care.” He argued that unless some critical decisions were made, the agreement about global warming will unravel. Specifically, we need to structure a plan in a way that minimizes the impacts on the “losers,” who are the ones most likely to oppose actively. The plan needs a vision that will sustain it through the debate, and a clear picture of what uncertainties exist and how they will be managed. We need to be able to do a good job of quantifying expected costs and benefits. Summers noted that as a society we tend to underestimate the costs of public works projects but overestimate the costs required of the private sector to meet regulatory requirements. Finally, he stressed the importance of thinking through the issue of international competitiveness—we will not achieve our global goals if high costs in the United States lead to outsourcing production to counties with even greater output of CO² in their industrial processes.
     The cap-and-trade paper was authored by Robert N. Stavins of Harvard’s Kennedy School of Government while the carbon tax paper was done by Gilbert E. Metcalf of Tufts University. Summaries follow.       - MLD

CARBON TAX

The Metcalf proposal would put a tax on carbon content in “upstream” energy sources, beginning at $15 per ton of CO², and rising gradually. An offset would be provided for energy purchasers who had plans to sequester the CO². It was argued that this approach would be substantially simpler than the management of a cap-and-trade system..
     In terms of its overall impact, the major effect of the carbon tax would be that it would determine the price of carbon, but there would be uncertainty as to the quantity of greenhouse gases that it would prevent, since each energy source and each end user would react differently to that price.
     Unmitigated, a carbon tax would be quite regressive in its economic impact, but as part of the taxation system, it would be feasible to pass back much of the revenue in a progressive way to minimize these impacts through an earned income tax credit or similar subsidy measures for non-wage earners. Professor Metcalf’s paper was primarily devoted to the design of this system for rebating revenues.
     It was also noted that there was significant risk that the political process would intervene and create a system of exemptions to protect certain industries and users, thus reducing the effectiveness of this strategy.

CAP-AND-TRADE

The cap-and-trade mechanism presented by Professor Stavins was described as a pragmatic approach to bring market economy principles to the issue. He described it as designed to satisfy decision-makers in Washington rather than academics in Cambridge or Berkeley. The classic approach in cap-and-trade is the allocation of permits for use of carbon-bearing energy sources, with the amount of permits being reduced over time until the desired emission targets have been met. As with the carbon tax proposal, rebates would be available for those who commit to sequestration of CO² emissions..
     In contrast to the carbon tax, the cap-and-trade mechanism will achieve the desired emissions level, but the uncertainty exists as to the price that will have to be paid. If the market works effectively, this price level could be lower than that under a carbon tax. While Stavin’s paper describes the possible feature of a “safety valve,” a mechanism in which new permits would be issued to keep prices from rising above a predetermined price, he argued that this would not necessarily be effective. In a sense, such a policy would convert the trading mechanism into a tax at that target level..
     Stavins also noted that continued application of various command-and-control regulatory mechanisms such as renewable energy requirements will not affect the total emissions level but simply reallocate the use of various emission-reduction strategies, not necessarily to the best net outcome..
     In the debate between allocating permits at no charge and auctioning, Professor Stavins offered a middle course, with an increasing proportion of permits being auctioned each year, but holding back the balance to be used to offset the impacts on those industries who face the greatest burden in implementing emission reductions..
     Among the benefits cited for the cap-and-trade strategy was the fact that it could be harmonized with internationally recognized trading schemes. Additionally, it would be feasible to require imports with significant embedded carbon emissions, such as steel, cement or aluminum, to obtain permits at the market price, thus offsetting their possible competitive advantage of being produced in a less carbon constrained environment..
     

How One Utility Struggles to Meet California’s
Tough Standards

                            And So Goes the Nation…Eventually?

For a preview of what power companies may be doing as soon as the end of this decade, consider the array of steps being undertaken by one of the most forward-thinking and innovative utilities in the USA, namely California's Pacific Gas and Electric (PG&E).
    In late summer 2006, the California Assembly passed AB 32, a law that calls for 25% reduction of greenhouse gases by 2020. Under pressure to meet the deadline, and a state mandate to generate 20% of their electricity from renewables by 2010, California’s major public utilities are scrambling to meet these targets through conservation, the development of new renewable energy sources, and customer funded emissions reduction projects.

PG&E’s Power Mix Through a combination of hydroelectric and nuclear sources, PG&E, which serves Northern California, already generates 50% of its electric power in a normal year with zero carbon emissions. Renewables, which amount to 12% of this power mix, include biomass and waste, geothermal, small hydroelectric, solar and wind, while natural gas provides 47%, and coal 4% of the electricity produced and distributed by PG&E.

Climate Smart Through its “Climate Smart” program, PG&E customers can now enroll in a program whereby the utility calculates the amount
                Click to continue

We Debate: Which Is Best, a CARBON TAX or CAP-AND-TRADE?

There's movement in Congress to impose a cost on emitting greenhouse gases into the atmosphere. No less than seven bills would introduce a cap-and-trade scheme, whereas only a couple propose a tax.
     What's the difference? How would a carbon tax be applied? What does cap-and-trade mean? Which is better? This is critical legislation, and we attempt to answer those questions with arguments on both sides below.
     Decide for yourself, and then watch what Congress does (or doesn't) do.

Carbon Tax: It's Simpler
and Will Have Immediate
Effect

The carbon tax approach to reducing emissions would charge industry and other entities for greenhouse gases they emit into the atmosphere. For all six greenhouse gases, converted to their CO2 equivalents in environmental damage, a levy of $10 to $15 a metric ton is often given as an example, at least in early years.
     It is the most straightforward scheme: It says, if you continue to pollute, you pay a penalty for doing so, and the cost is likely to cause you to take steps to reduce emissions to reduce the tax — exactly the desired effect. And if that doesn’t do it, increases in the tax will.
     The money raised could be directed to research and development of clean energy technology and renewable energy alternatives to oil, or other useful purposes — even rebates to low income earners hurt by the passed-on costs.
     Under a cap-and-trade program, allowances to emit carbon dioxide could be sold or auctioned to polluters such as the power utilities to provide the inducements to cut emissions, but the Lieberman-Warner bill now working its way through Congressional committee — the cap-and-trade plan extending from 2012 to 2050 that seems to have won the most favor — would give away half of its allocations free, the other half by auction.
     What’s wrong with that? At least the utilities, cement, paper and steel companies will be paying for half, would they not?
     Only eventually, because, at first, almost all the allocations are free: 82% in the 2012 start up year would be simply given away to companies to use or trade for profit. The percentage then declines, to 27% by 2050, but for years, free permits to pollute will give industry little inducement to make any changes. The Windfall      The allocations, often referred to as credits, are bound to have tremendous value. The Congressional Budget Office estimates that emission permits could rise in value from $5 to $65 per metric ton between now and 2050; the Environmental Protection Agency (EPA) estimates $14 to $78.
     The U.S. economy currently emits 7.3 billion metric tons of greenhouse gases annually. If the cap is set at current levels for the 73% of the economy that Lieberman-Warner covers, that would lead to allocations for 5.2 billion tons. As we just saw, 82% of those would be giveaways. Splitting the difference between the early-year estimates above, that’s a handout to industry of over $40 billion in the first year alone. Using its price estimates and the sliding percentage schedule, the EPA calculates that 66 billion pollution permits valued at $1.5 trillion will be handed out free of charge under Lieberman-Warner. Too Susceptible to Gaming      Even under an auction format, there are structural flaws with cap-and-trade. Swayed by campaign contributions, Congress will more than likely set an initial cap that matches the nation’s current levels of pollution — or possibly higher, to allow industry an early-year cushion. With plenty of credits to go around, they will trade at low prices — as happened in Europe’s implementation of Kyoto. Cheaply purchased credits will undercut inducements to cut costs by making infrastructure improvements, and that will lead to a long delay before the year-to-year declining schedule of allocations forces emission reductions.
     A carbon tax, even if low at first, would at least impose a cost for emissions. Penalizing the Pacesetters      Moreover, awarding allocations equal to current emissions gives no credit to companies that have already spent heavily to cut back pollution, while at the same time rewarding the worst offenders who have resisted for decades the Clean Air mandates to install controls. That is what is assumed to have prompted TXU to announce plans in early 2007 to hurriedly build eight coal-fired plants: they wagered that pollution levels would probably be “grandfathered” by any cap-and-trade bill.
     Additionally, cap-and-trade is likely to prove vulnerable to political tampering. Lobbyists and corporate campaign contributions will constantly press for adjusting the caps and percentages as the years pass and costs rise. Trading will need to be closely regulated to thwart market manipulation. A tax, on the other hand, is highly visible and less susceptible to camouflage. The Competition Question      An argument against a carbon tax is that higher costs will make American goods less competitive. So would an auction-based cap-and-trade program, whereas Lieberman-Warner imposes no appreciable costs for years. Nevertheless, in an attempt to eliminate the cost advantages of countries that refuse to penalize emissions such as China and India, and as a concession to labor, this bill sets up a second, parallel cap-and-trade mechanism for imports. That doubles its complexity and presages a still more bloated bureaucracy.
     Much simpler would be a tax imposed at port of entry, based on the amount of emissions imputed to have been released in making the incoming goods.
     There is no point imagining that China or India might someday agree to a cap-and-trade alliance to replace this border contrivance. They would insist on a population-based carbon allowance, and America would find itself paying itself into penury to buy credits to sate its much higher per-capita energy consumption.
      Charging non-compliant nations could lead to a tariff war will be the obvious cry. Yes, it could. But it is time to realize that all such human affairs of the moment – trade pacts, costs, profits, jobs — become petty trifles when at issue is the future of planet Earth. Any scheme adopted should anticipate international application, and a carbon tax works best.       - SCW

Cap-and-Trade: Market Incentives Will Spur Innovation

This article presents the view that a system of "cap-and-trade" would be more effective than a carbon tax as a way to bring about reductions in greenhouse gas (GHG) emissions — primarily, but not exclusively, CO2. GHG's are products of burning carbon-based fuels which appear to be changing the heat retention characteristics of our atmosphere and risking significant damage by warming the climate.
     What is cap-and-trade? In the simplest terms, it means that an absolute upper limit on CO2 equivalent emissions is set, based on what is currently taking place, and then the limit is steadily reduced, forcing emitters to a) reduce emissions, or b) buy at market prices certificates of other entities that have provable reductions in excess of their quota, or c) suffer crippling fines. It uses market mechanisms to reduce CO2 in the quickest and cheapest manner. It is hard to implement because the starting position has to be negotiated in a political environment. Also, it needs to be adopted by virtually every country, or it loses its effect. Many prefer it over carbon tax because it cannot as easily be circumvented or changed, as can be a tax. But a tax is easier to implement.
     A key issue when introducing a cap-and-trade system is whether: a) the initial allowances should be "granted" to emitters at near their current levels of emission, giving rise to complaints of rewarding bad behavior, or b) they should be auctioned by the issuing government. The preference is the latter as it provides immediate value for allowances, generates revenue to support clean energy research and defends the government against accusations of offering "giveaways" to big polluters.
     It is important to note that either approach has the potential to be effective, and even both might work well, but if the choice must be one or the other, cap-and-trade is the better alternative. Why? The Profit IncentiveFirst, because it is likely to bring about the largest amount of GHG emissions reduction in the shortest period of time and at the least cost to the economy. When the stakes are as large as they are in this matter, issues of "fairness" and "equity" may need to take a back seat to "effectiveness". Cap-and-trade causes the easiest and least costly reductions to take place early because those who produce such reductions can sell at a profit their surplus carbon allocations to others who are having trouble meeting the reduction targets that are imposed on them.
     In a war where winning is essential, a winning policy employs the most effective available strategies and tactics, not the least expensive or the most fair and balanced. The same logic applies here. Cap-and-trade harnesses the forces of markets to achieve cost-effective environmental protection. Markets can achieve superior environmental protection by giving businesses both flexibility and a direct financial incentive to find faster, cheaper and more innovative ways to reduce pollution.
     Markets provide greater effectiveness than command-and-control regulation because they turn pollution reductions into marketable assets. In doing so, this system creates tangible financial rewards for environmental performance.
     Carbon caps (or taxes) need to be applied as far as possible "upstream" in the supply chain, so that carbon emitted in making gasoline, for example, is capped along with the carbon emissions potential of the gasoline itself when consumed. Europe has learned that capping carbon emissions where the energy is used, such as for an individual car, is not effective. There's Already Proof That It Works Second, cap-and-trade was designed, tested and proven here in the United States, as a program within the 1990 Clean Air Act Amendments. The success of this program led The Economist magazine to crown it "probably the greatest green success story of the past decade." (July 6, 2002).
A Spur to InnovationThird, because cap-and-trade gives pollution reductions a value in the marketplace, the system prompts technological and process innovations that reduce pollution down to or beyond required levels. This point is not theoretical; experience has shown these results.
     Lastly, and perhaps most importantly, a cap on carbon emissions provides a relatively predictable outcome in terms of GHG reductions, with the cost of allocations being unknown and floating with market forces, whereas a carbon tax provides known increases in costs, but allows the reduction in GHG to float with market forces. We need maximum focus on achieving specific end results, rather than concentrating on taxes and revenues. Summary      An active cap-and-trade market enables those who can reduce pollution cheaply to earn a return on their pollution reduction investment by selling extra allowances. It enables those who can’t reduce pollution as cheaply to purchase allowances at a lower cost than the cost of reducing their own emissions. It enables all participants to meet the total emissions cap cost-effectively. And it gives all emitters incentives to innovate to find the least-cost solutions for total pollution control.      - DLA

How One Utility Struggles to Meet California’s
Tough Standards

  Click to return to beginning
needed to make your home energy greenhouse gas emissions “neutral” and adds that amount to your monthly bill. This voluntary arrangement will cost the average homeowner around $5.00 more a month, which will be invested in restoring and conserving greenhouse gas-absorbing forests in Mendocino and Santa Cruz counties, or capturing methane gas from landfills and dairy farms to generate electricity. This allows customers to offset their home’s carbon emissions and become “carbon neutral”. These offsets count toward PG&E’s meeting the state requirements.

Solar Thermal Power PG&E encourages homeowners to convert to solar power and heating, as well as wind turbines, and the state of California, through the California Solar Initiative, currently provides incentives for installing solar electric systems on homes and businesses. PG&E also has plans to develop its own unique solar generating facility. Instead of a series of photovoltaic panels mounted on a roof or on ground facing the sun, this will be a solar thermal project in which thousands of mirrors will focus sunlight on towers in which water will be heated to 750 degrees to generate steam that turn turbines to produce electricity. While using groundwater, plans call for cooling and reusing the water to generate more power.
     These facilities will be built in the Mojave Desert, noted for its intense summer heat, which coincides with the peak power demand for air conditioning. Several solar thermal projects have already been generating power in the Mojave by using oil-filled tubes to generate steam for turbines.
     This $2 billion dollar project will generate 553 megawatts, enough to power 400,000 homes, and will be completed by 2011. It is estimated that solar thermal will produce electricity at about one third the cost for photovoltaic panels -- 10 cents per kilowatt hour compared to 30 cents per kilowatt hour. However, while this system requires direct sun, solar panels can generate power on cloudy days. Other California utilities plan to purchase power from an as yet untested system in which mirrors reflect the sun to heat hydrogen gas which expands and drives a piston.
     Although the Mojave project will not bring PG&E into full compliance with the target of 20% of power from renewables, and will not be on line until 2011, it will increase the 12% already generated from renewables to a respectable 14%, with other projects to make up the difference. One of these is a federally-approved research project to explore generating electricity from ocean waves off the north coast of California.

Not in My Back Yard In spite of the state mandates and consumer support of cleaner and hopefully cheaper energy, all of these projects face local opposition. On the north coast, the fishing and tourist industries, along with some environmentalists, oppose the wave-generating project, while county supervisors want a piece of the action in terms of creating a publicly-owned utility and generating their own electricity. Given PG&E’s less than sterling environmental record, locals fear the worst.
     Despite its record as the smoggiest area of the country, there is also opposition to the Mojave Desert solar thermal project in Southern California, not to the method of generating clean power per se, but to the high voltage transmissions lines that will have to be built through densely populated areas. Despite studies that have found no connection, many public groups believe there are power transmission poses potential health hazards.

Think Tank Meanwhile, in an effort to counteract global warming, the California Public Utilities Commission has announced the creation of a $600 million think tank -- the California Institute for Climate Solutions -- to bring academic and private laboratories together to find ways to cut greenhouse gas emissions. The funding will be derived from a $.25 to $.35 surcharge on gas and electric bills.      - DAW