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Instrument ChoiceBob WymanApril 9, 2010

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Regulation One Way or Another• International diplomacy has stalled

• Increased interest in sectoral programs• This coincides with California’s focus

• Congress has stalled• But EPA will play a resurgent role

• Endangerment Finding December 2009• Light Duty Vehicle Rule to be Final as of March 31, 2010• New and Modified Stationary Source GHG Controls as of April 2010

• State programs will likely not be preempted• State and regional efforts continue to develop on schedule

• California’s AB32 and Other Programs (AB1493, SB1368, SB375, low carbon fuel standard, 33% RPS by 2020): economy-wide program

• Western Climate Initiative (WCI)• Midwest Greenhouse Gas Accord• Regional Greenhouse Gas Initiative (RGGI) already governs electricity sector

• Courts are plugging the gap• 2nd and 5th Circuits – recognize federal common law of nuisance• NEPA, CEQA, ESA claims challenging individual projects based on climate

impacts

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How Tough Will This Be?

Year US Population Per Capita Emissions

GDP Total Emissions

2050 420 Million (projected)

2.4 Tons (to meet target)

? 1 Billion Tons (BT)

2005 (Base) 303 Million 20.3 Tons $ 14 Trillion 6 BT

1910 92 Million 10.9 Tons $ 572 Billion 1 BT

1887 45 Million 2.4 Tons $ 147 Billion

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Caveat

• A carbon price signal is not enough• Infrastructure gaps are material

• Example – transmission lines• Technology gaps are material

• Example – energy storage limitations• Regulatory barriers are material

• Examples – California Environmental Quality Act (CEQA), National Environmental Policy Act (NEPA) reviews substantially delay and often stop even new, low-carbon investment (e.g., cogeneration increases local emissions despite reducing regional emissions)

• A state (or nation) that cares seriously about addressing climate change needs to identify strategic energy investments and clear the way

• Stimulus package is directionally correct, but sorely deficient

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Types of Market Programs

• Cap and trade/allowance-based• Sources must surrender allowances for their emissions• Traded commodity is certified in advance• Examples: acid rain program, EU ETS, RECLAIM

• Averaging/performance-based• Sources average to a performance standard and must make up any

shortfall by purchasing credits• Credits/debits generated automatically by reference to credit line• Performance standard can be periodically adjusted, if necessary• Examples: lead phase-out from gasoline, low carbon fuel standard, EPA

recreational marine engine standards• Discrete emission reductions (Offsets)

• Requires case-by-case certification• Credits generated for surplus reductions relative to baseline• Examples: ERCs, Clean Development Mechanism (CDM)

• Emissions Charges and Financial Vehicles• Examples: carbon tax, clean air investment fund (e.g., AQIP)• Encourages demand-side reductions

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Potential Benefits from Market Programs• Minimize costs (typically 25+% savings)• Preserve operational flexibility• Deliver price signal• Encourage conservation• Encourage innovation• Plug gaps in legal authority• Provide source of financing• Increase penetration of clean fuels and products through

cost signal and monetary reward• Preserve political will for ambitious environmental goals

by minimizing cost impact and preserving economic opportunity

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Desirable Elements of Market Program• Large scale and diversity of market• Banking (and borrowing when appropriate)• Safety valve/transitional safe harbor

• Ceiling price payment to investment fund until market matures

• Transparency• Confidence in estimation or quantification methods• Select a market design that takes into account the

variability or uncertainties regarding sector activity levels• Offsets (cost and liquidity benefits)• Clear and consistent enforcement• Provision for mid-course corrections• Linkage to and ultimate integration with other jurisdictions

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Challenges and Specific Problems

• Gaps in legal authority• No binding international agreement• Incomplete Congressional action• Legal impediments (in addition to policy concerns) for state action

• Mixed and somewhat inconsistent goals• Desired technology outcomes • Cost minimization

• Leakage and Competitive Issues• Narrow market – price spikes• Distributional impacts

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Gaps in Legal Authority

• In absence of Congressional action, and following Mass v. EPA, if EPA’s endangerment finding is upheld, then it is likely to regulate GHG emissions under the Clean Air Act

• CAA Title II – motor vehicle standards• EISA – renewable fuels standards• Stationary sources

• Preconstruction permit program• Potential section 111 new and existing source performance standards• Other authorities may be available (e.g., NAAQS, hazardous air

pollutants, stratospheric ozone protection, international measures), but are not likely to be used

• State role (Compact Clause and policy concerns)• International

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Mixed Goals

• Strategic technology development• Cost minimization – reducing GHG tons at least cost

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Structure of Markets – Possible Hybrid Approach

• Targeted technology markets – sector-specific performance standard plus averaging and trading

• “Siloed (or Closed)” Categories• Renewable electricity standard• Low carbon fuel standard• Motor vehicle standards

• Possible accelerator - Innovative technology credits (ITCs): forward-generated

• Open Sectors – tonnage reductions at lowest cost

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Leakage and Energy Balance Concerns

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Source: Sweeney/Weyant Draft Analysis of Measures to Meet the Requirements of California’s Assembly Bill 32

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At Stake for California Development• If California’s program remains its own

• Each GHG ton could be 2-5 times more expensive in CA than in other states and regions

• CA marginal cost ~ $100+/ton GHG in 2020• ~$18-22/ton for other regions of the country

• Significant cost differences will drive investment (even low carbon investment) outside of the state, partially thwarting the state’s GHG reduction goals AND distorting the state’s energy balance

• Climate stabilization requires that we bring energy supply close to energy demand to minimize transmission losses and transportation emissions

• A national program avoids these problems, but also could reward CA investment if the national program provides a mechanism to monetize the low carbon characteristics

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Distributional Concerns

• Different starting points among sources• Fuel differences• Technology differences

• Difference in entity’s ability to recover costs• Power sector – differences between utilities and merchant plants• Commodity manufacturers – need to compete in international

markets

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Illustration of Potential Challenges – Starting and End Points,Rates of Reduction

2012 2020

A

B

Common start, common end, common rate

A starts in the hole

T/MWH

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Illustration – Separate Credit Trading Line for Performance-Based System

2012 2020

A

BCredit generation line

T/MWH

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OPENMARKET

TECHNOLOGYMARKETS

innovative technology

credits (ITC)

CAP AND TRADE

P-B AVERAGING AND TRADING

Deliverers of electric power

Refineries

Glass Plants

Cement Plants

Landfills

Other

Transition to cap and trade or integrate with national program

ONE-WAY TRADING

+ OFFSETS

TONS

TONS

Internal Trading and Banking Only; No Safety Valve Unrestricted Trading, Banking; No Safety Valve IF Program Linked at Outset; Otherwise Transitional Safety

Valve

renewable portfolio standard

Advanced battery,

advanced combustion, other vehicle and engine advances

Renewable power

low carbon fuel

standard

motor vehicles

Other qualified advanced low carbon technologies and programs

low-carbon biomass fuels

(cellulosic ethanol,

biodiesel), carbon

capture and sequestration