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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

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
TOPICS
  • The Essentials of Emission Caps
  • Within-system Flexibility
  • Off-system Flexibility
    • Mutual recognition
    • System extension
    • Off-system credits
  • Concluding Points
essentials of an emissions cap
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
redefining compliance
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
within system flexibility
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
more on borrowing
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
off system flexibility
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
mutual recognition option
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
system extension option
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
off system credit option
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
problems with off system credits
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
how to treat off system credits
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
off system flexibility in perspective
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
concluding points
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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