California Public Utilities Commission

1. Session 4: Managing Allowance Price Volatility Different Policy Mechanisms and their Emissions and Price Impact California Public Utilities Commission Greenhouse Gas Cap & Trade Systems: Symposium on Flexible Compliance Mechanisms San Francisco, CA April 20, 2007 Derek K. Murrow Director of Policy Analysis Environment Northeast

2. Environment Northeast • Who We Are: Environment Northeast is a nonprofit research and advocacy organization focusing on the Northeastern United States and Eastern Canada. Our mission is to address large-scale environmental challenges that threaten regional ecosystems, human health, or the management of significant natural resources. We use policy analysis, collaborative problem solving, and advocacy to advance the environmental and economic sustainability of the region. • Where We Are: Rockport, ME / Portland, ME Boston, MA / Providence, RI / Hartford, CT New Haven, CT • Primary Project Areas: energy & climate policy in New England and Eastern Canada • Cap & Trade Experience: one of 24 RGGI stakeholders, actively engaged in regional negotiation and program design as well as New England implementation • Development of Comprehensive Policy Recommendations: see Climate Change Roadmap for New England and Eastern Canada for recent policy work CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

3. Background • ENE is NOT endorsing any of these price control mechanisms • We have experience thinking through options because of our participation in the development of RGGI • We would encourage CA to avoid the use of price control mechanisms • We do think it’s important to understand different mechanisms and their implications CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

4. Outline:Managing Allowance Price Volatility • It is critical to define the goal for the policy before considering options – setting the price vs. limiting volatility • Carbon cap & trade vs. a carbon tax • Many price control mechanisms have the potential to transform the system into something like a carbon tax • Carbon cap & trade: environmental certainty, price floats • Carbon tax: price certainty, environmental outcome floats • Price and cap control mechanisms to discuss: offsets quantity limits, circuit breakers, accelerators, safety valve, and borrowing safety valve • Discussion of the level of a price control – setting the price vs. limiting extended periods of high price or excessive price spikes CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

5. OffsetsLimits Offsets Limit Triggered Emissions from the Sector Increase • Background: Offsets allow the regulated entity to purchase emissions reductions outside the regulated system and continue to emit – the offset quantity must be limited to ensure change within the regulated sector • Description: At a set price point, the state allows a larger percent of a facility’s compliance obligation to be met through offsets (this is the RGGI mechanism) • Environmental Implication: the total emissions (sector and offsets combined) will still achieve the cap but likely with more offsets and less change in the sector • Price Implication: Prices are not capped, but assuming a supply of lower cost offsets, additional offsets allowance supply should reduce costs • Comments: this mechanism is seen by some as okay from an environmental perspective but it creates tremendous uncertainty in the offsets market (level of demand) and may lead to less innovation in the electric or regulated sector CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

6. Circuit Breaker Circuit Breaker Triggered • Description: At a set price point, the state does not reduce the cap level but keeps the allocation of allowances fixed until prices come back down • Environmental Implication: the rate of cap decline can be delayed but emissions will not rise and the long term trajectory should return to a downward slope • Price Implication: Prices are not capped but if the event happens, the supply of allowances expected in the market increases • Comments: This mechanism ensures in the worst case that emissions are kept stable and likely will lead to achievement of the target but potentially at a later point in time (price point dependent) CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

7. Accelerator Accelerator Triggered • Description: Below a price point, the state increases the rate of cap decline and issues less allowances until prices rise above the price point again (a floor price in an auction could also achieve this outcome) • Environmental Implication: the rate of cap decline can be accelerated if the cost of program turns out to be lower than anticipated • Price Implication: Prices are not capped but if the event happens, the supply of allowances in the market decreases and prices will likely rise • Comments: A mechanism like this that can compensate for conservative modeling and the kinds of innovation we have seen in other cap & trade programs that have led to lower costs than anticipated CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

8. Safety Valve Safety Valve Triggered Any trajectory is possible • A safety valve is also known as a firm price cap • Description: At a set price point, the state sells allowances to regulated entities • Environmental Implication: the cap can be inflated indefinitely, loosing the environmental benefit • Price Implication: Prices have an absolute cap (price point may rise over time) • Comments: A safety valve or price cap can have the effect of transitioning the program to a carbon tax-like system by setting the market price; an exception to this would be in the case of a very high price point (see subsequent discussion) CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

9. Borrowing Safety Valve Safety Valve Triggered Any trajectory is possible • Description: At a set price point, the state sells allowances to regulated entities but deducts those allowances from the subsequent compliance period budget • Environmental Implication: the cap can be inflated indefinitely, loosing the environmental benefit, but IF prices come back down the emissions may end up close to the original cap level or back on the right trajectory • Price Implication: Prices have an absolute cap (price point may rise over time) • Comments: Another option would be to including a borrowing provision only in the first compliance period CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

10. Setting the Price Point:Low vs. High & Change Over Time • Price control mechanism should be based on average prices over a compliance period • Low Price Point - $7 to 20 per ton CO2 • Will likely set the price for allowances and inflate the cap • A bad precedent that would reduce the likelihood of achieving environmental goals • High Price Point - $100 to 500 per ton CO2 • Much like in an energy market (ISO-NE at $1,000/MWh), a high price would be set to avoid runaway prices that could be due to speculation or a short-term market imbalance (end of compliance period) • A better precedent could assist with market stability • Change in Price Over Time • We should be willing to pay more with time to address the problem • Consider a phase out of any price controls • The price point should rise significantly in every compliance period by a set percent plus inflation CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

11. Summary • Avoid manipulation of the market through price controls • If price controls are considered, weigh the mechanism carefully – they are very different • Carefully consider any price point chosen and ensure it rises significantly over time • Let the program function as cap and trade program rather than transforming it into a carbon tax CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007

12. Derek K. Murrow Director of Policy Analysis 101 Whitney Ave. New Haven, CT 06510 (203) 495-8224 dmurrow@env-ne.org Environment Northeast Rockport, ME / Portland, ME / Boston, MA Providence, RI / Hartford, CT / New Haven, CT www.env-ne.org Contact Information CPUC - GHG Cap & Trade Systems - Session 4 - April 120, 2007