Cap-and-Trade 101

1. WORLD RESOURCES INSTITUTE Cap-and-Trade 101 Judi Greenwald Director of Innovative Solutions Franz LitzSenior Fellow

2. WORLD RESOURCES INSTITUTE • Webinar #1: Introduction to Cap-and-Trade • Webinar #2: Program Scope and Point of Regulation • Webinar #3: Electricity Sector Options • Webinar #4: Cap-and-Trade Design Issues In-Depth: Part I-- Lessons from the U.S./Canadian Acid Rain Programs/Northeast NOx Budgets • Webinar #5: Cap-and-Trade Design Issues In-Depth: Part II Lessons from the European Union Emissions Trading Scheme and Northeast RGGI Webinar Series 2

3. WORLD RESOURCES INSTITUTE • Webinar #6: Design Elements in Federal Cap-and-Trade Proposals • Webinar #7: Distributing Allowances • Webinar #8: Offsets • Webinar #9: Linking Cap-and-Trade Programs • Webinar #10: Emissions Trading Market Fundamentals Webinar Series 3

4. WORLD RESOURCES INSTITUTE • Some Key Considerations for Climate Policy • Why Market Mechanisms & What Role Do They Play in a Comprehensive Climate Change Policy? • Examples of Market Mechanisms • Building Blocks of Cap-and-Trade • How can other policies interact with Cap-and- Trade? • Key Design Considerations Overview 4

5. WORLD RESOURCES INSTITUTE • Global problem; needs global solution • Location of GHG reduction doesn’t matter • Thousands of sources, thousands of solutions • We know how to get significant GHG reductions-- challenge is to get the vast reductions we need over time, cost-effectively • Markets can be effective at addressing these considerations Key Climate Policy Considerations 5

6. WORLD RESOURCES INSTITUTE • Enable linkage with the rest of the world • Take advantage of “gains from trade” • Drive innovation • Create a price for greenhouse gas emissions, and allow market forces to: • minimize the cost of making substantial reductions • Help find most efficient path to compliance • Stimulate technological innovation and lead to further cuts in the future • Identify solutions regulators cannot anticipate Why Market Mechanisms? 6

7. WORLD RESOURCES INSTITUTE • Market mechanisms are important, but are just one part of reaching overall emissions reduction goals • Additional means of reducing GHG emissions should be included: • regulatory standards • tax incentives • public-private technology initiatives, etc. The Role of Market Mechanisms 7

8. WORLD RESOURCES INSTITUTE • Standards (e.g., GHG standards for vehicles, fuels, etc.) • can be complementary to markets; either covering different sources or as baselines • can be implemented through markets (e.g., LCFS) • can be integrated with broader market through use of “tradeable standards” • Pros and cons of economy-wide vs. sector-specific markets The Role of Market Mechanisms 8

9. WORLD RESOURCES INSTITUTE • Emissions Cap-and-Trade • Carbon Tax or Per Ton Emissions Charge • Renewable Portfolio Standard (RPS) with Certificates Trading • Low Carbon Fuel Standard (LCFS) with Certificates Trading • “Individual Transferable Quotas” in Fisheries Examples of Market Mechanisms 9

10. WORLD RESOURCES INSTITUTE • Government says: minimum amount of electricity will come from renewable sources • Renewable energy providers compete to supply the load- serving entity with certificates • Objective: market will be created in certificates, ensuring that the lowest cost renewable energy is obtained • Achievement of goal is certain (given sufficient time for development and no cap on cost) Renewable Portfolio Standard with Trading 10

11. Government says: all fuel must meet a low carbon fuel standard by a certain date, i.e. carbon attributable to fuel (on a life-cycle basis) must be reduced by X% by date. • Instead of making all producers meet the standard, producers can buy credits from other producers that are able to exceed the standard. • Objective: overall average of fuel delivered in the covered area will meet or exceed the LCFS. • Achievement of low carbon average is certain, but amount of total carbon is not limited. Low Carbon Fuel Standard with Trading 11

12. WORLD RESOURCES INSTITUTE • Government assesses per unit charge for pollution • Pollution charge results in reduced pollution, because pollution costs the firms money • Firms would reduce pollution as long as it is cheaper to reduce rather than pay the charge • Emission reductions uncertain--reductions proceed until the marginal cost of reduction = tax or charge • Emphasis is therefore on cost, or revenue, not reductions Carbon Tax 12

13. Carbon Tax vs. Cap-and-Trade 13

14. BASIC BUILDING BLOCKS OF CAP-AND-TRADE ENFORCEMENT & PENALTIES FOR NON-COMPLIANCE SOURCES “TRUE UP” AT END OF EACH COMPLIANCE PERIOD ESTABLISH COMPLIANCE PERIOD FOR SOURCES DISTRIBUTE OR AUCTION ONE “ALLOWANCE” FOR EACH TON IN BUDGET DETERMINE THE REDUCTION OVER TIME (i.e., SUCCESSIVE BUDGETS REDUCED) ESTABLISH ANNUAL EMISSIONS CAP (OR ANNUAL ALLOWANCE BUDGET) ESTABLISH AGGREGATE EMISSIONS BASELINE FOR SOURCES REQUIRE SOURCES TO MEASURE, MONITOR & REPORT EMISSIONS IDENTIFY SOURCES TO BE COVERED IN ONE OR MORE SECTORS 14

15. BASIC BUILDING BLOCKS OF CAP-AND-TRADE ADDITIONAL DESIGN ISSUES ENFORCEMENT & PENALTIES FOR NON-COMPLIANCE SOURCES “TRUE UP” AT END OF EACH COMPLIANCE PERIOD ESTABLISH COMPLIANCE PERIOD FOR SOURCES DISTRIBUTE ONE “ALLOWANCE” FOR EACH TON IN ALLOWANCE BUDGET DETERMINE THE REDUCTION OVER TIME (i.e., SUCCESSIVE BUDGETS REDUCED) PROVISION FOR NEW SOURCES? ESTABLISH ANNUAL EMISSIONS CAP (OR ANNUAL ALLOWANCE BUDGET) LINKING TO OTHER PROGRAMS? ESTABLISH AGGREGATE EMISSIONS BASELINE FOR SOURCES CREDIT FOR EARLY ACTION? REQUIRE SOURCES TO MEASURE, MONITOR & REPORT EMISSIONS OFFSETS? IDENTIFY SOURCES TO BE COVERED IN ONE OR MORE SECTORS FLEXIBILITY & COST-CONTAINMENT? MANDATORY EMISSIONS REPORTING 15

16. An offset credit is a project-based reduction that is demonstrated outside the capped sector. • To receive credit, most existing programs require the reduction be real, surplus (or additional), verifiable, permanent, and enforceable (RSVP & E). • Examples of offset projects are: land to forest sequestration project; sulfur hexafluoride (SF6) leak prevention; landfill gas capture and destruction. • Offsets expand the cap on covered sources in exchange for reductions outside the sector. What is an Offset Credit? 16

17. WORLD RESOURCES INSTITUTE • A cap-and-trade program consists of two basic requirements: • Source must measure, monitor and report its emissions to source’s central registry account; and • At the end of the compliance period, source must hold sufficient allowances in its allowance account to cover all emissions in that compliance period. • Allowances are freely tradable among sources. • A covered entity can comply by: reducing its emissions; buying allowances from auction or another source that has reduced its emissions; or buying offset credits. From the Perspective of a Source 17

18. WORLD RESOURCES INSTITUTE • Mechanics: • Each state gets a annual allowance budget; • Regional effort produces model program that states must then propose individually; • Each state recognizes the allowances of other states as long as the other state is in good standing; and • State registries are linked (or a regional registry is established) to allow for seamless trading across states. Regional Cap-and-Trade Programs 18

19. Regional Trading • Sources in one state may buy or sell allowances to sources in another state; • Cap is maintained; • Aggregate total of emissions remains the sum of participating states’ allowance budgets, plus offsets. 19

20. WORLD RESOURCES INSTITUTE • On the Potential for Emissions Leakage: • Addressing out-of-state “leakage” concerns (e.g., cement manufacturing, electricity) • Leakage depends on coverage and the cost of doing business • Best way to avoid leakage is to expand coverage, minimize costs, and link with other systems • Allocation can help on leakage • Traditional regulation can drive leakage too Potential for Leakage 20

21. WORLD RESOURCES INSTITUTE • Market Fundamentals: most effort should be in set up • Good emissions data: measurement, monitoring and reporting • Allowance tracking • Consistent and transparent rules • Good enforcement • Minimize transaction costs Key Considerations 21

22. WORLD RESOURCES INSTITUTE • Who should be covered, and who should not? • Including more sources and gases in the program offers a broader range of opportunities for low-cost reductions • But including too many small sources can make the program administratively complex • Put what works well in the market • Economy wide: Cover all GHGs in all major emitting sectors • Downstream: at point of emission • Upstream: at point where fuels enter market • Hybrid: Large point sources downstream; others covered upstream • Electric power: generators, first sellers or LSEs • Coverage can expand over time Key Considerations (continued) 22

23. WORLD RESOURCES INSTITUTE Create Model that Others will Emulate or Link to • Ends: • Reduce GHGs • Minimize costs • Stimulate innovation • Link efforts with others • Achieve co-benefits • Equity • Means: • Markets are part of a comprehensive approach • Get the market fundamentals right • Careful design based on past lessons and analysis • Complement and build on relevant state policies; address state-specific issues Key Considerations (continued) 23

24. WORLD RESOURCES INSTITUTE Questions? Judi Greenwald Director of Innovative Solutions Franz T. Litz Senior Fellow 24