Cost Containment in a Federal GHG Cap and Trade Program

1. Cost Containment in a Federal GHG Cap and Trade Program NARUC Webcast May 30, 2008 Andy Keeler John Glenn School of Public Affairs The Ohio State University

2. Cost Containment – Overview of mechanisms and issues • What does “cost containment” mean? • Why is it important for program design? • What are the options for cost containment that are under consideration? • What are the key issues for policy design?

3. Cost Containment • A “textbook” cap-and-trade program will result in some allowance price that affects all covered entities • Cost containment refers to modifications of the “textbook” policy that (may) lower the allowance price • Under all conditions • When “emergency” criteria are met

4. Why is cost containment important in program design? • High allowance prices increase economic risk • Volatility and uncertainty create investment choice problems • Bad economic outcomes increases the political risk for long-term climate policy

5. Protecting against the unexpected and/or bad luck • There is enormous uncertainty about both the demand and supply sides of a national GHG allowance market • Economic • Technological • Institutional • And the uncertainty is greatest in the early years of a new program

6. Offsets – Engaging Non-covered sectors • Emissions reductions from entities outside the cap-and-trade systems can offsetincreased emissions within the cap • In theory, this has the twin benefits of • Lowering allowance prices • Encouraging long-term GHG reductions by the sectors producing the offsets • Changes in the limits or terms of offsets are a cost containment policy

7. Banking and Borrowing • Banking means holding over allowances for use in the future – this reduces future allowance prices and increases current prices • Borrowing means using allowances allocated for use in future years now -- this increases allowance supply and reduces prices now, while increasing prices in the future

8. Borrowing • Policy proposals limit borrowing to specific circumstances and to maximum amounts • Changes in the limits or terms of borrowing are a cost containment policy

9. Emergency-Metaphor Policies—safety valves, circuit breakers, and emergency off-ramps • Reduce the price of allowances by making additional allowances available • Crucial distinctions • Relax the long-term cap, or all released allowances made up in the future (borrowing) • Price certainty, trigger certainty, or additional allowances released without certainty

10. Emergency-Metaphor Policies • Safety Valve – unlimited allowances available at a known price • Circuit Breaker – annual cap is frozen (stops declining) as long as prices are above a known price • Emergency Off-Ramp – a reserve of future-year allowances is auctioned annually with a (known) minimum price

11. Cap Neutrality • The safety valve is not cap-neutral – additional allowances sold at the safety valve price represent additional emissions • The circuit breaker is not cap-neutral– but there are limits to the quantity of emissions above the cap • The “allowance reserve” is cap-neutral (in theory)

12. Triggers • A safety valve works off a known, pre-announced price • Reserves, circuit breakers, and other borrowing mechanisms can be designed to work off announced triggers orat the discretion of regulators (e.g. Carbon Market Efficiency Board)

13. Carbon Market Efficiency Board • The “Carbon Fed” would have discretion to change • Offset quantities • Borrowing restrictions • ???? • There are positive and negative consequences of building such discretion into a cap-and-trade system

14. Two Current Proposals • Emergency off-ramp (Boxer / L-W) – price effects are not certain, cap-neutral, has a pre-announced minimum price (starts at $22-30 per ton CO2) • Safety valve (Bingaman-Specter) – certain, pre-announced (current version $12 per ton CO2), excess emission above the cap

15. What’s the price? • Discussions about the safety valve in particular, and about all of these mechanisms, should focus more on the price at which they kick in • A $12 safety valve is very different than a $50 safety valve

16. Summary • Cost containment is a key part of program design • Debate on this issue has a long way to go • Big issues • Price certainty • Emissions neutrality • Extent of discretion • What’s the price?