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Cap and Trade Revisited


Cap and Trade Revisited  

Tom Markowitz - Wednesday, November 14, 2012

Welcome to Enerhope

Cap-and-Trade Revisited:

(How to Build a Successful Cap-and-Trade System for Greenhouse Gas Emissions in the United States, without falling off the Fiscal Cliff)

(c)Enerhope.com November, 2012

Congratulations, Barack Obama, on being re-elected President of the USA for another four years! You face a daunting task, re-establishing public confidence in the US Government, uniting the USA around common goals, solving serious economic problems, and, yes, restoring a sustainable environment.

At this time, the global struggle against climate change should still be a priority US Government policy. 

The USA can and must implement a Cap-and-Trade system, to reduce greenhouse gas ("GHG") emissions from large industrial emitters, without causing economic problems. You have the opportunity to learn from the mistakes of the past. 

It is true that the US Government is facing a "Fiscal Cliff," with considerable opposition to tax increases and to increased government spending. Can the USA implement a successful Cap-and-Trade system without increased taxes or subsidies? Read on, my friend!

A successful Cap-and-Trade system should not be a repeat of the Waxman-Markey Bill in the House of Representatives in 2010, which contained serious mistakes, and never arrived on the floor of the Senate.

What were these mistakes in the Waxman-Markey Bill? 

1.Too Big

The Waxman-Markey Bill proposed a Cap-and-Trade system that would eventually cap 85% 0f USA GHG emissions. This Cap is much too large. The Cap should be limited to large, direct emitters, e.g. coal-fired electricity generators, petroleum refineries, cement kilns. Each of these large, direct emitters emits over 100,000 tonnes per year of CO2e  into the atmosphere. These large, direct emitters are responsible for about 40% - 50% of the USA’s total greenhouse gas emissions. A 20% reduction in GHG emissions from this sector would reduce the USA's total emissions by 8% - 10%. 

The proposed Waxman-Markey Cap-and-Trade system placed “under the Cap” every direct emitter of greenhouse gases over 25,000 tonnes per year of CO2e.

The “threshold” of 25,000 tonnes/year is so small that many thousands of medium-sized enterprises with no knowledge of emissions reporting, trading or reductions would be required to report their emissions and retire Allowances and Offsets at the end of the year. Supervising this massive number of Capped facilities would place a huge administrative burden on the US Government.

Waxman-Markey proposed that producers, distributors and importers of petroleum products and natural gas would be under the Cap for the emissions by their customers. Capping fuel distributors for their indirect emissions, i.e. for emissions by their customers, is a serious mistake. Motorists who buy and consume gasoline from service stations would not be under any regulatory obligation to reduce their greenhouse gas emissions. Instead, the motorists would see a price increase of about 5% in the price of gasoline, varying with the week-by-week price of Allowances. The motorists would resent this price increase but would not reduce their emissions. If the government made Allowances so scarce that the price of gasoline increased by a large percentage, e.g. 70%, motorists would begin to reduce their fuel consumption, but many vulnerable people would be hurt. Most people do not understand Cap-and-Trade! Imposing Cap-and-Trade, directly or indirectly, on individual motorists would be resented. 

Non-large, non-direct emitters should not be under the Cap. The US Government and State Governments should use other programs and policies to encourage emission reductions in these other sectors. 

2. Allowance Allocation: Too Complicated, and an Economic Burden

During the 2008 Presidential Election campaign, the Obama team promised a Cap-and-Trade system with 100% auction of all Allowances. Revenue from auction would be used to finance various worthy programs.  

In 2012, facing the "Fiscal Cliff," the US Government would not dare to propose any new,large program which increased government spending.  

The Waxman-Markey Bill changed the proposed Allocation system to free Allocation of Allowances to 30 different recipient groups, including electricity and natural gas retailers, tax rebates for homeowners, coal-fired generators, and motor vehicle research.

The complex free Allocation scheme described in the Waxman-Markey Bill would burden the Capped facilities (and their customers) with the cost of subsidizing 30 different recipient groups, as well as the cost of emission reductions. Cap-and-Trade is a fragile program that should not be endangered by extraneous financial burdens or political causes. 

3. Don't Auction Allowances

Auction of Allowances or free Allocation to non-Capped organizations would create a long, circuitous path for the Allowances to be traded by their original owners, through various brokers, to the Capped facilities. This long, circuitous path would add cost, complexity, and the risk of price speculation to the purchase of Allowances by Capped facilities.

The experience of the RGGI Cap-and-Trade system in the northeastern US States illustrates the pitfalls of Allowance auction. RGGI allocates 90% of its Allowances by auction. How does a Capped facility in an RGGI state obtain Allowances? The Capped facility must buy these Allowances from RGGI Inc., the Cap-and-Trade operator, in a secret auction, or buy the Allowances from a third party during the year. The auction revenues are paid to the State Governments of the RGGI states by RGGI Inc., a private company. The whereabouts of each Allowance are a secret.

Auctioning of Allowances adds to the price of electricity and other products from the Capped facilities, and is perceived as an unfair and onerous tax by opponents of Cap-and-Trade. The customers of the Capped facility must pay the price of the facility's products, plus the price of emission reductions, plus the auction price, plus the price of speculation by investors.

Proponents of RGGI Allowance auctions reply that the states’ revenue from Cap-and-Trade is used to finance emission reduction projects. However, in at least one RGGI state, some of these revenues have been used to pay down the state deficit, instead of financing emission reductions.

The most serious flaw with Allowance auction is that an auction requires secrecy, to avoid bid-rigging and collusion. The public does not learn who is the owner of which Allowance. This secrecy violates one of the fundamental principles of Cap-and-Trade, the need for vigilant, transparent public registry of Allowance ownership. 

Free Allocation of Allowances

The best Allocation system is free Allocation to Capped facilities, according to a fair scheme, under a hard Cap.

Free Allocation has the following advantages:

•    Minimum cost to customers of the Capped facilities: The only cost is the cost of emission reductions. The market for Allowances and Offsets quickly purchases the lowest cost emission reductions.

•    The Capped facilities hold most of the Allowances in their own accounts until retirement. A few Allowances are traded before retirement.

•    Wealthy polluters cannot easily buy their way out of their regulatory obligations.

•    No taxes, no fees, no subsidies

•    No auction-rigging, no hoarding, no scalping

•    Allocations are visible to the public: “Transparency”

•    By controlling the Allocation of Allowances to Capped facilities, the Government can discourage “leakage” of emission activities outside the Capped facilities. 

4. Offsets

Waxman-Markey's attempt to place 85% of US greenhouse gas emissions under the Cap meant that only 15% of emissions would be from facilities that could plan Offset projects. This shortage of Offsets would prevent the creation of a lively Offset market. The absence of a lively Offset market would place additional risk on the Allowance system. If too many Allowances were available, the price of each Allowance would sink to a trivial amount. If not enough Allowances were available, the Capped facilities would not be able to meet their regulatory obligations.  

The best solution to this Offset dilemma would be to limit the Allowance Cap to large, direct emitters, which represent 40% - 50% of total US greenhouse gas emissions. The other sectors would be free to create a lively Offsets market, which would supplement the Allowance market under a rigorous, “hard” Cap. The most obvious opportunity for Offset creation would be energy efficiency improvements. 

Waxman-Markey proposed authorizing the US Federal Department of Agriculture to create and award Offsets for agricultural projects. The responsibility for creating and awarding Offsets for any sector should remain with the US EPA, not with another department which does not have environmental protection as its major goal.  

Cap-and-Trade is a fragile environmental management system, which could easily be damaged, if it were required to provide subsidies to any economic sector.

The Offsets System should not be used to provide extra subsidies for expensive wind turbine, photovoltaic, ethanol, or fuel cell projects. These projects could be eligible for Offsets, but would need to compete in the Offset market against low-cost energy efficiency projects, which are more necessary. Let the Offsets marketplace find the lowest-cost emission reduction projects and activities, without government bias toward expensive renewable energy technologies. 

5. Registry

Waxman-Markey proposed authorizing the US Government to create and allocate 4,500,000,000 Allowances in 2012, one Allowance representing one tonne of CO2e. Too many Allowances to register and track! Suggestion: Create one Allowance (or Offset) for each kilotonne of CO2e, not each tonne. Result: a smaller, manageable number of Allowances.

How to Overcome Congressional Difficulties

Although the President is a Democrat, the majority of Congressional Representatives are Republicans. The US Senate has a slight Democratic majority, but not enough to overcome filibuster opposition to a new Cap-and-Trade bill.

Within Congress, some of the fiercest opponents of Cap-and-Trade are Democrats from so-called "Blue Dog" States, where much of the economic activity is in industries which produce or consume fossil fuels. (e.g. Pennsylvania, Michigan). The support of these Blue Dog Senators and Congressional Representatives cannot be bought with massive federal government spending, especially in the era of the Fiscal Cliff.

The best way to obtain support for Cap-and-Trade within the fossil fuel states would be to concentrate the USA Offsets system in the fossil fuel states. While it is true that Cap-and-Trade would reduce coal production (and coal industry jobs) in (e.g.) Pennsylvania, the Offsets system would create new jobs in Pennsylvania, and would produce a Pennsylvania with the world's best public transit systems, the world's best inter-city transportation system, and the world's most energy-efficient industries and buildings. These improvements would strengthen, not weaken, the state economy. 

The President has the power to enact Cap-and-Trade by regulation. A US Supreme Court decision in 2007 (Massachusetts vs EPA) held that the Environmental Protection Administation already has statutory power to regulate greenhouse gas emissions under the Clean Air Acts. Reacting to the Supreme Court ruling, in March, 2009, the EPA cleared the way for a possible regulation by publishing a finding that greenhouse emissions endanger human health by causing climate change. However, implementing a Cap-and-Trade system by regulation instead of legislation may still be challenged in the US courts, and could be a political liability for the Obama administration.

 And now,a quick review of the Basics of a Successful Emissions Trading (Cap-and-Trade) System


The Government passes a Regulation.


Specific Capped Facilities – must participate in emissions trading – major direct GHG emitters, each emitting more than 100,000 tonnes CO2e per year– will be “under the Cap.” (e.g. coal-fired electricity generators, petroleum refineries, cement kilns)


The Cap – a specific, regulated maximum tonnes of GHG emissions from the total of the Capped Facilities in each specified year, e.g. 2015, 2016, 2017…..The Cap will decrease from year to year.


Registry – like a bank ledger. Each Capped Facility will have an Account on the Registry. The Government will have its own Account on the Registry. Brokers are allowed to open Accounts on the Registry. The Retirement Account on the Registry will be the “graveyard” for Allowances which have been used up. The Registry must be visible to the public. The ownership history of every Allowance must be visible to the public.


Allowances – An Allowance is a permit to emit something into the environment. Each year, in January, the Government will create Allowances for GHGs, one Allowance for each tonne or kilotonne of GHG in the Cap.  Each Allowance will have a certificate with a unique serial number. At the beginning of the year, (starting in e.g. 2015) the Government will deposit the new Allowances in its own Account.


Allocation – At the beginning of each year, beginning in e.g. 2015, the Government will distribute the new Allowances to the Capped Facilities, according to a fair scheme. The government will transfer the allocated Allowances from its own Account to the Accounts of the Capped Facilities. (“Free Allocation to Capped Facilities”)


Monitoring and Reporting – Each Capped Facility must monitor its direct GHG emissions during the year, completely, accurately and honestly. At the end of the year, each Capped Facility must report its total direct GHG emissions for the year.The monitored total emissions for each facility should be reported on the Registry.


Offsets – An Offset is a reward for emission reductions outside the Capped Sector. An organization which is not a Capped Facility can complete an emission reduction project and apply to the Government  for creation of Offsets, to reward the emission reductions. If the Government agrees that the emission reductions were real and satisfy program requirements, the Government will create a specific number of kilotonnes of Offsets and transfer these new Offsets to the applicant’s Account in the Registy.


Offsets and Allowances are both Tradeable Units in the Registry.


Trading – At any time, any Account holder can buy Tradeable Units from, or sell Tradeable Units to, any other Account holder. (exception – The Tradeable Units in the Retirement Account never leave the Retirement Account.) The transfer of Tradeable Units from one Account to another must be recorded in the Registry, with the serial numbers.


Retirement – At the end of the year, each Capped Facility must Retire (transfer to the Retirement Account) enough Tradeable Units to equal its reported annual direct GHG emissions. 

For more information about how a Cap-and-Trade system should work, please look at www.enerhope.com 

Good luck, President Obama!


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