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Regional Carbon Trading Programs, Explained

By Brandon Lorenz, Senior Editor - June 2008 - Energy Efficiency


“We and the other nations of the world must get serious about substantially reducing greenhouse gas emissions in the coming years or we will hand off a much-diminished world to our grandchildren.”

The speech from Arizona Sen. John McCain, shows just how much of a lame duck President George W. Bush has become in the debate on climate change. Even the presumptive Republican presidential candidate has a contrary position.

Environmentalists have savaged Bush for seven years for refusing to tackle the issue. But that criticism never seemed to hit home. And so, rather than try to move the administration, or wait it out, governors, businesses and environmentalists took another approach — the end run. As the years of federal inaction stretch on, the real work to combat climate change is occurring at the state and regional level.

“What the states are really doing is taking leadership and trying to find out what works in different regions,” says Patrick Cummins, project manager for the Western Climate Initiative (WCI).

That activity hasn’t been lost on Congress, which has borrowed features from the various regional programs to offer its own options for a federal cap-and-trade program to control greenhouse gas (GHG) emissions.

McCain is among several senators who have sponsored legislation to reduce emissions. Sen. Barack Obama of Illinois, the front-runner for the Democratic nomination, has released a detailed plan to cut greenhouse gas emissions. So has his opponent, New York Sen. Hillary Clinton.

Though a range of proposals are floating about in Congress, action isn’t likely this year. Even if action is taken, it faces an almost certain veto from President Bush. Nevertheless, today’s regional GHG programs stand in stark contrast to the picture even five years ago. As these programs mature, they have the ability to further shape the direction of federal policy after the November election — and for facility executives, energy costs.

There are currently three regional initiatives dedicated to reducing greenhouse gases. Each differs in scope and methodology. The Regional Greenhouse Gas Initiative (RGGI) was launched first. RGGI includes Connecticut, Delaware, Maine, New Hampshire, New Jersey, Maryland, New York and Vermont. The District of Columbia, Massachusetts, Pennsylvania, Rhode Island, the Eastern Canadian Provinces and New Brunswick are observers in the process. They can join later as participants.

An analysis last year by the World Resources Institute concluded these states (excluding observers) are responsible for emitting 695 million metric tons of carbon dioxide, an amount equal to 10 percent of the nation’s total.

The goal of RGGI is to stabilize carbon dioxide emissions from power plants by 2014 at the 2004 level. Following that, the goal would be to decrease the sector’s carbon dioxide emissions by 2.5 percent annually from 2015 to 2018. That would mark a 10 percent decline from 2009.

RGGI aims to drive down emissions by using a cap-and-trade program. Under the program, each state has agreed to an emissions budget in the form of carbon dioxide allowances. The budget is based on recent past emissions. Each allowance represents 1 short ton of carbon dioxide emissions. For example, Connecticut has an emissions budget of 10.6 million short tons and gets an equal number of allowances. Connecticut, along with the other RGGI states, will auction the allowances to utilities that fall under the scope of the program in September.

Any power plant over 25 megawatts that uses more than 50 percent fossil fuel requires regulation and must buy enough allowances at auction to cover its emissions.

Under RGGI, the 2009 emissions cap is set at 120 million tons of carbon dioxide annually during the stabilization period from 2009 to 2014. Each state has its own emissions budget — collectively the allowances add up to the 120 million tons.

Cutting carbon dioxide emissions from power plants isn’t the same as curbing acid rain or other pollutants, which can be reduced easier than carbon dioxide by adding emissions control equipment called scrubbers, says Chris James, senior associate with consulting firm Synapse Energy. James formerly served as the staff representative from Connecticut to RGGI.

A cap-and-trade program makes sense in part because there are few direct ways to reduce carbon dioxide emissions at the stack, James says. Instead, the most cost-effective way to reduce utility emissions is through indirect means such as reducing demand, he says.

Utilities buy allowances to cover their emissions up to the cap level. If a utility emits less than the cap, it is allowed to sell the surplus allowances. In other words, utilities that can reduce emissions at a lower cost sell their allowances to utilities that face higher costs to reduce emissions. A dual-fuel plant could potentially switch fuels, for relatively low cost to lower emissions, for example.

Power producers that can’t meet the cap can also buy offsets to cover emissions in excess of the cap. Offset prices are market-based. Like allowances, they are priced as dollars per ton of carbon dioxide. One example of an offset under RGGI would be a program to capture and combust landfill gas.

Under RGGI, facilities aren’t directly affected because the program only regulates utilities. Nevertheless, as ratepayers, facility executives are clearly in a position to be affected if costs are passed on as the program unfolds.

Fortunately, RGGI is designed to mitigate some of the cost to ratepayers. The agreement signed by the states requires at least 25 percent of the revenue from the auction of allowances be used to reduce the cost impact. Programs to mitigate the financial impact are still being formed but could take shape in a number of ways — energy efficiency programs and incentives or programs to develop carbon sequestration or promote renewable energy. Some states have pledged to devote 100 percent of the revenue from the auction of allowances to such programs.

In Connecticut, the revenue from RGGI will add an extra $30 million to $50 million each year to the state’s $87 million energy efficiency fund, James says. “Energy efficiency is one of the most cost-effective resources anywhere in the country for reducing greenhouse gas emissions,” he says. By law, three of every four dollars of revenue Connecticut receives from RGGI will be dedicated to energy efficiency projects. The remainder will be used to stimulate renewable energy, says James.

RGGI is making changes in other ways. Connecticut has taken a page from California’s playbook and now requires that utilities demonstrate that they have pursued all cost-effective energy efficiency measures before any new generation is approved. Maine, Vermont and Rhode Island are among the states with similar rules. “That’s really a trend that I think you’re going to see taking hold in many other parts of the country,” says James.

Another Approach

Announced two years after RGGI, the Western Climate Initiative (WCI) is taking a more aggressive approach to capping GHG emissions. The target, for example, is to reduce emissions 15 percent below 2005 levels by 2020.

WCI was formed in February 2007 by the governors of Arizona, California, New Mexico and Oregon. It has since grown to include Utah, Montana and the Canadian Provinces of British Columbia, Manitoba and Quebec.

While it would take two years longer than RGGI, WCI aims for a larger GHG reduction. WCI also targets a broader sector of the economy. Though RGGI focuses solely on the electricity sector, WCI plans on going much further.

“RGGI’s goal was never really to do a broad, sweeping program over time,” says Pat Hogan, solutions fellow with the Pew Center on Climate Change. As the first program of its kind in the U.S., RGGI was meant to be modest, says Hogan.

The March 2008 draft of the WCI cap-and-trade program cites a range of emissions sources as possible targets for regulation, in addition to electric utilities.

“I think people realize that some of the cap-and-trade approaches that are out there work not only for the electricity market but for other sectors,” says Cummins. “With the kind of cuts we need to make, everybody needs to be in the program. We’re not going to get the reductions we need by focusing on a single sector.”

Compared to years of federal inaction, programs like RGGI and WCI represent a heady start. But they are just that — a start. Most experts believe that much larger greenhouse gas cuts need to be made over the long term to have a meaningful impact. “I don’t think any of these states are embarking on these programs thinking it will be the final answer,” Hogan says.

Most states in WCI have established emissions-reductions goals for the period after 2020, which is the deadline for greenhouse gas cuts under WCI. And those long-term goals are aggressive. By 2050, California aims to reduce emissions by 80 percent below 1990. New Mexico is aiming for 75 percent below 2000 over the same period. While it’s not yet clear how those targets will be achieved, it is evident that WCI and its counterparts aren’t feel-good green programs, but part of a long-term strategy to reduce emissions.

“A lot of these states have mid-century reductions goals that put them where the science says they need to be,” Hogan says. “These programs allow them to see how it’s working and adjust their timetables accordingly.”

New Kid on the Block

The Midwestern Greenhouse Gas Accord (MGA) is the newest of the three regional programs. Iowa, Illinois, Kansas, the Province of Manitoba, Michigan, Minnesota and Wisconsin signed on as participants. Indiana, Ohio (both are major coal burning states) and South Dakota have signed on as observers.

Signed in November 2007, the founding memorandum of understanding doesn’t include a concrete reductions goal. Instead, it calls on the states to develop a goal for reductions and a model cap-and-trade program within one year. Implementation is slated to begin by July 2010.

MGA should have a range of target reductions identified by July, says Jesse Heier, director of the Midwest Governors Association. “We’re putting together a model of where the emissions are coming from and what it would take to reduce them,” says Heier. “Once we have that model up and running, we can see where the emissions are coming from and how much each sector contributes.”

Although MGA hasn’t yet identified a target, the initiative is significant because MGA states have the highest carbon dioxide emissions of the three programs. The World Resources Institute analysis of emissions estimates that MGA states are responsible for 14 percent of the nation’s carbon dioxide emissions, compared to 13 percent for WCI and 10 percent for RGGI. Ranked as a nation, the analysis says that MGA’s emissions are the seventh largest in the world.

While the specifics aren’t developed, MGA’s target of having a model cap-and-trade program completed in a year is aggressive, particularly compared to RGGI and WCI. “We started after RGGI and WCI, so we’re a little behind the pace,” Heier says. “But at the same time, we are building on and learning from and running with their ideas.”

Part of the reason for the urgency is a belief in the importance of combating climate change, says Heier. But it’s also a recognition that federal legislation is on the horizon. When the debate comes, MGA member states want to have a seat at the table. “We’ll have a lot more ground to stand on when the federal system is put together,” he says.

Putting the Pieces Together

Though the passage of federal legislation could be more than a year away, the three regional programs offer some hints at its potential shape. When Congress does pass climate change legislation, cap-and-trade will likely be part of the mix. Several of Congress’ cap-and-trade proposals have borrowed features from the regional programs.

The Bingaman-Specter bill, for example, includes a “safety valve” to control costs if the price of carbon offsets exceeds a certain limit. It also includes the ability to bank offsets. Both of those elements are part of RGGI.

Like WCI and MGA, many of the Senate bills aim to create a cap-and-trade program with a cap that includes as many emissions sources as possible. McCain-Lieberman, along with two other bills, aims to set the cap at about 87 percent of all carbon emissions.

While most programs call for gradual emissions reductions, at least one bill, Oliver-Gilchrest, includes a stabilization period where emissions would be held flat before the cap would be lowered. RGGI uses a similar model.

Though final details of federal legislation are far from clear, this is a key time for stakeholders, such as facility executives, to engage in the process. One reason: Policy details are still being formulated for the MGA and WCI programs. Cap-and-trade programs that focus on electricity could raise rates. How incentives are handed out to mitigate the impact of a cap-and-trade program is one area up for grabs. “The rules are being made now,” says James. “If you’re not at the table, you’re going to miss out.”

While all programs have procedures in place for gathering input from stakeholders, MGA has made an especially strong effort to gather input from a diverse group of voices, Hogan says.

“It’s definitely time to be getting a seat at the table and to be talking about these policies,” he says.

 

The three regional greenhouse gas initiatives include the Midwestern Greenhouse Gas Accord (MGA), Western Climate Initiative (WCI) and the oldest program — the Regional Greenhouse Gas Initiative (RGGI).

TAKING ACTION
The Importance of Efficiency

Regional cap-and-trade programs may seem far afield for facility executives because the programs focus on utilities. But the local utility has a direct pipeline to a facility’s budget.
“It’s very hypothetical at this point, but I think any program to reduce greenhouse gas emissions is going to lead to some increase in the cost to produce electricity,” says Patrick Cummins, project manager for the Western Climate Initiative (WCI).

The bottom line: Cap-and-trade programs give facility executives yet another reason to think about energy efficiency.

“Fuel costs are not going to go down,” says Chris James, senior associate with consulting firm Synapse Energy. “All the factors we see that have driven oil to $120 a barrel and coal prices to increase are going to continue.”

An analysis conducted for the Regional Greenhouse Gas Initiative (RGGI) found that aggressive energy efficiency measures are the most cost effective way for states to meet their GHG reductions, James says.

“I think a lot of people are starting to recognize that energy efficiency offers the best opportunity for short term, low-cost emissions reductions simply because there is quite a bit you can do,” says Pat Hogan, solutions fellow for the Pew Center on Climate Change.

— Brandon Lorenz

 

LOOKING AHEAD
And on the Federal Level

Though any federal legislation to cap and reduce greenhouse gas emissions would face an almost certain veto from President Bush, that hasn’t stopped Congress from exploring the options.

There are no fewer than seven proposals circulating in the House and Senate to regulate greenhouse gas emissions. The makeup of each proposal varies. Some aim to reduce emissions gradually over time. Others take a “stair step” approach. The size and scope of the cap varies also, as does the way offsets are handled.

Other policy considerations are also up in the air. For example, would a federal policy preempt regional greenhouse gas programs? Or would it set a minimum, with states given flexibility to reduce emissions even more?

“What’s going to be the appropriate division of responsibility?” asks Pat Hogan, solutions fellow for the Pew Center on Climate Change. “That’s one of the million dollar questions at the federal level.”

For example, a federal cap-and-trade program might make sense because it offers the broadest market and more opportunities for low cost reductions, says Hogan.

But a regional approach would allow states to take into account variations like growth factors, says Patrick Cummins, project manager for the Western Climate Initiative.

“The states are more nimble. They are closer to the emissions sources,” says Chris James, senior associate with consulting firm Synapse Energy. “They can adopt and implement a more cost effective program to achieve reductions more quickly and have a history of doing so.”

And while most observers expect some kind of federal legislation to be passed after a new president takes office, implementation could still be years away, if the experiences of developing regional programs offer a guide.

“While a lot of important discussions are happening at the regional level, the rubber is really going to hit the road with a new administration and new congress,” Cummins says.

— Brandon Lorenz





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