Achieving Low Cost Emission Reductions in Six US States: Carbon Pricing Policy Considerations
1) In a recent report, Resources for the Future (RFF) modeled policy options to further reduce carbon dioxide emissions from the electricity sector in six US states: North Carolina, Pennsylvania, Minnesota, Wisconsin, Illinois, and Michigan.
2) A hybrid carbon pricing program design translates low compliance costs into additional emission reductions.
3) There are inherent benefits to states working together, and policy levers such as targeted allowance revenue allocation and companion policies such as renewable requirements can be used to achieve specific desired outcomes not delivered by a price on carbon alone.
In the absence of robust federal policy to mitigate greenhouse gas emissions in the US, states have been at the forefront of climate action. Twenty nine states plus Washington DC have requirements for renewable energy generation, with several states this year announcing new ambitious goals to move towards 100% renewable or carbon-free electricity by mid-century. Ten states currently have carbon pricing policies – California and nine in the northeastern Regional Greenhouse Gas Initiative (RGGI) – with New Jersey joining RGGI in 2020 and other states considering similar pathways. And twenty-four states have pledged, through the US Climate Alliance, to meet the Paris Agreement goals of reducing emissions by 26-28% below 2005 levels by 2025.
In a recent report, Resources for the Future (RFF) modeled policy options to further reduce carbon dioxide emissions from the electricity sector in six states: North Carolina, Pennsylvania, Minnesota, Wisconsin, Illinois, and Michigan. In our report, State Policy Options to Price Carbon from Electricity, we examine various design options for carbon pricing and compare them with renewable energy requirements.
A hybrid program design can translate low compliance costs into additional emission reductions
Conventional thinking around carbon pricing asks policy makers to decide whether to implement a carbon tax or a cap-and-trade mechanism. More recently, programs in the US (and abroad) have begun including features of both cap and price mechanisms, a so-called “hybrid” approach in which the quantity of emission allowances available in the market (the cap) depends on the allowance price. An example of this is an auction price floor, a minimum price at which allowances will be sold, which is used in both cap-and-trade programs in California and RGGI.
Each state carbon pricing policy we model has key features borrowed from RGGI. These include:
A nominal emissions cap that declines by three percent per year from projected 2020 levels to achieve a thirty percent reduction over ten years;
A price floor and emissions containment reserve (ECR) – the latter withholds up to 10% of allowances below a certain price (tightening the cap);
A cost containment reserve, which introduces additional allowances above a certain price (raising the cap).
Under the current landscape of low natural gas prices and declining renewables costs, we find that power sector emissions will fall over time without any additional policies. In this setting, achieving further emissions reductions required by the caps is relatively inexpensive in most states. We observe this outcome in part through low program allowance prices – a measure of compliance cost. As a result, we find that the low prices activate the ECR and price floor, which accelerate emissions reductions beyond what the nominal cap would have achieved – often by about 10% annually.
Targeted use of program revenue can mitigate context-specific undesirable outcomes
An appeal of carbon pricing over alternatives such as renewable or clean energy standards is that revenue is raised through the sale of emission allowances in auctions that can then be re-invested or allocated in any number of ways. We compare three options for allocating program revenue: allocation to (1) electricity producers; (2) electricity consumers; and (3) outside the power sector. We find that allocation to producers mitigates the shifting of emissions to jurisdictions outside the program – a phenomenon known as leakage that compromises overall program effectiveness - by incentivizing in-state generation over imports. In fact, this form of allocation can even lead to negative leakage – achieving emission reductions both within and outside the program. Allocation to consumers has little effect on leakage but can further mitigate costs to consumers through reduced consumption and a direct subsidy in retail rates. Allocation outside of the power sector brings societal benefits but does not directly affect power markets.
Working together provides benefits of trade and program stability, can result in regional transfers
We explore options for each state to link with RGGI and compare them to a “go-it-alone” approach. The former would allow trading of allowances under a combined program to achieve an aggregate emissions goal. While linking has relatively small effects in our analysis – because of already low costs of compliance in the six states and RGGI – working together can provide important market stability and adopting the RGGI framework leverages nearly a decade of program experience. We also find that linking can result in transfers within the capped region if allowance prices would otherwise differ in the two regions.
Carbon pricing and renewables mandates; are they complements?
Lastly, we compare the carbon pricing programs to a requirement for in-state renewable (wind and solar) generation – a “renewable technology standard,” or RTS. We find that both a carbon price and RTS achieve additional wind and solar generation. However, an RTS is less effective at reducing emissions because it does not penalize higher-emitting generation more than lower-emitting sources as a carbon price does. When we apply both a carbon price and RTS together, the carbon price in some cases achieves more renewable generation than required under the RTS, rendering the RTS “non-binding.” Ultimately the relative stringencies of the programs will determine which drives additional renewable generation, but an RTS is a backstop that will guarantee renewable infrastructure that can help achieve emission reductions in the future. Allocating revenue from a carbon pricing program to renewables is another way to further incentivize renewable generation. However, the current policy landscape suggests that renewable and clean energy requirements will continue to play a role in the foreseeable future.
Carbon pricing is an effective mechanism to reduce emissions, and the specific design of the program is critical to a program’s success. Nevertheless, in each case we model, emission reductions are achieved at a low cost, and cost management features lead to additional emission reductions. The carbon pricing policy shifts generation from dirtier, emitting sources to cleaner sources such as renewables and nuclear power. There are inherent benefits to working together, and policy levers such as targeted allowance revenue allocation and companion policies such as renewable requirements can be used to achieve specific desired outcomes not delivered by a price on carbon alone.
The views expressed are those of the author and should not be attributed to Resources for the Future (RFF). RFF does not take institutional positions.
About the Author
Paul Picciano is a Senior Research Assistant at RFF. His research focuses on energy and climate policies in the electricity sector. At RFF, he primarily develops and applies simulation tools used for power system planning, policy analysis, and projections. These models include RFF’s Engineering, Economic, and Environmental Electricity Simulation Tool (E4ST) and Haiku Electricity Market Model. Previously, he evaluated energy and environmental regulations at NERA Economic Consulting and researched wind and solar energy integration as an Ernest F. Hollings Scholar with the National Oceanic and Atmospheric Administration.