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Emission Caps and Flexibility Mechanisms. A. Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology http://web.mit.edu/ceepr Regional Greenhouse Gas Initiative Boston, Massachusetts May 20, 2004. TOPICS. The Essentials of Emission Caps

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Emission Caps and Flexibility Mechanisms

A. Denny Ellerman

Center for Energy and Environmental Policy Research

Massachusetts Institute of Technology

http://web.mit.edu/ceepr

Regional Greenhouse Gas Initiative

Boston, Massachusetts

May 20, 2004


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TOPICS

  • The Essentials of Emission Caps

  • Within-system Flexibility

  • Off-system Flexibility

    • Mutual recognition

    • System extension

    • Off-system credits

  • Concluding Points


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Essentials of an Emissions Cap

  • Decision on an emissions cap and allocation of equivalent rights to emit (allowances)

  • Monitoring and reporting of emissions

  • Periodic reconciliation of emissions and allowances

    • Surrender of allowances

    • Penalties for non-compliance


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Redefining Compliance

  • A very simple compliance requirement

    • One ton  One allowance

    • Plus monitoring and reporting

  • No specific instruction to abate for any source

  • Strict accountability and complete flexibility

    • A “no excuse” system

  • Only issue is allowance availability and cost


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Within-system Flexibility

  • The sine qua non: No review of trades

    • But trades are tracked or recorded

  • Spatial flexibility within a compliance period is always accepted

  • Temporal flexibility (banking/borrowing) between periods is less so

    • No reason to prohibit banking

    • Ditto for borrowing, but more problematic


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More on Borrowing

  • Remember system is enforced, now and in the future

    • Using more now means fewer later

  • Cannot allow infinite borrowing

    • Limit to x years forward

  • Or, apply discount to future vintage allowances surrendered in current reconciliation

  • Objective is reducing price volatility


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Off-system Flexibility

  • No environmental reason (for GHGs) to limit abatement to within-system sources

  • Only requirement is that off-system “rights” be as good as within-system allowances

    • Or, that they be “real” or “additional”

  • Implies effective extension of system to off-system sources


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Mutual Recognition Option

  • Some other equivalent system exists

  • Both may recognize similarity and allow trading (as with any commodity)

  • Main criterion is “integrity” of other system

  • Note, however, that any trading inevitably

    • “Loosens” one cap and

    • “Tightens” the other cap


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System Extension Option

  • Off-system source is brought within the system

    • Baseline is established and allowances issued

    • Emissions are monitored and reported

    • Emissions and allowances are reconciled

  • Easy to see for within-jurisdiction opt-in sources

    • Example: US SO2 emissions trading

  • Cap is “loosened,” but scope is extended


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Off-system Credit Option

  • “Real” abatement is credited and traded

  • Recognition of “credit” implies

    • Definition of a baseline for off-system source

    • Monitoring of emissions and implicit reconciliation to determine quantity of credits

  • Only difference is system allowances not issued and required to be surrendered for emissions

    • Recognize only the “surplus” allowances


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Problems with Off-system Credits

  • “Anyway tons:” Adverse selection and information assymmetry are unavoidable problems

    • The same problem is faced (and solved) in within-system allocation

    • Various ways to minimize problem (e.g., no in-and-out opt-ins)

  • Transaction costs are likely to be high

  • Can be delegated: CDM or other certifying agency


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How to Treat Off-system Credits

  • The Wrong Approach: Arbitrary limits

    • Assumes off-system credits are worthless or not equivalent

    • Pointless loosening of the cap

  • The Right Approach: Open but tough

    • Problems of off-system credits can be solved

    • “The customer is always right”

  • Always an extension of the system


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Off-system Flexibility in Perspective

  • Initial caps are unlikely to be very demanding

    • This implies relatively low prices

  • Low prices do not encourage extensive off-system reliance (unless they are free!)

    • Transaction costs of open but tough system will limit reliance on off-system credits

  • No more “loosening” of cap than in recognizing another system with a lower price


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Concluding Points

  • Flexibility is the way to success and low cost

  • Flexibility is possible only with strictly enforced binding caps

  • All provisions for off-system flexibility must involve the application of within-system standards

  • RGGI will be successful only if it sets an example and induces others to follow by adoption of simple, practical, and effective rules


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