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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

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    1. 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

    2. TOPICS • The Essentials of Emission Caps • Within-system Flexibility • Off-system Flexibility • Mutual recognition • System extension • Off-system credits • Concluding Points

    3. 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

    4. 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

    5. 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

    6. 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

    7. 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

    8. 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

    9. 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

    10. 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

    11. 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

    12. 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

    13. 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

    14. 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