Cap and Trade in Perspective: Carbon Trading in the Northeast

Part II of a three-part series on cap-and-trade looking at the successes, failures and lessons the U.S. government can learn from three programs already in place.

The Regional Greenhouse Gas Initiative, a program to regulate carbon dioxide emissions in 10 Northeastern and Mid-Atlantic states, is proving a mandatory cap-and-trade program to address greenhouse gas emissions can work in the United States.

The program’s goals are modest — only one greenhouse gas is regulated and only power plants of at least 25 megawatts are covered. Emissions are capped at current levels through 2014, then the cap is reduced by 2.5 percent annually for four years until emissions are cut 10% by 2018.

Still, the fact 10 states overcame their differences to create a single compliance market to reduce carbon dioxide emissions is a “remarkable achievement,” says Judi Greenwald, vice president for innovative solutions at the Pew Center on Global Climate Change.

Also significant is that the system is working; the market has established a price for carbon dioxide emissions and power companies are willing to pay for allowances to emit.

“From a political perspective, it demonstrates that you actually can design and implement a cap-and-trade program in the U.S.,” Greenwald says. “A lot of people want to see a home-grown example. I think it’s very important that it’s working well and it’s working here.”

It took five years for seven states — Connecticut, Delaware, Maine, New Hampshire, New Jersey, New York and Vermont — to devise a system for regulating carbon emissions.
Massachusetts, Rhode Island and Maryland joined in 2007, after a model rule laying out how the program would work was approved by the initial states.

A unique feature of RGGI is that each state establishes its share of the regional emissions cap and controls the number of allowance issued to power plants. Each allowance gives a plant the right to emit one ton of carbon dioxide. Power plants that reduce emissions below the cap can sell allowances on the secondary market to plants that exceed the emissions cap.

Most RGGI allowances are sold in quarterly auctions, so states earn money for energy efficiency and renewable energy programs, further reducing carbon emissions.

So far, the RGGI states have raised $366.5 million.

“It’s a mini exercise in federalism,” says Christopher Davis, a partner at the law firm Goodwin Procter in Boston. “Each state adopted a flavor and approach that meets its regulatory structure.”

Although the price per allowance has been relatively small — $3.23 at the last auction, compared with about $23 for emission allowances in the European Union — the dollars already are fueling transformation of the regional energy economy, Davis says.

“The auctions have been viewed by most participants as successful and effective,” he says. “It’s generated a lot of money for the 10 states.”

The lawmakers who crafted RGGI decided allowances should be purchased through auctions instead of given away for free so the value of the allowances, or the cost and benefit of complying with a cap on emissions, was visible to consumers.

Unlike RGGI, the national economy-wide cap-and-trade program proposed in the American Clean Energy and Security Act (ACES) legislation that passed the U.S. House of Representatives in late June, would allow for a significant percentage of allowances to be granted for free.

While the idea of free allowances has been controversial, Greenwald at Pew Climate doesn’t view it as problematic.

“We think whether you auction or freely allocate is less important than what you do with the value of allowances,” she says.

The value of the allowance is the market price, which a utility can receive if it sells the allowance. ACES protects consumers, Greenwald says, because it requires the proceeds to go to lowering consumers’ costs and it channels many of the free allowances to Local Distribution Companies, which are regulated by state Public Utility Commissions.

“Public utility commissions will ensure that those savings will be passed on to consumers,” she says. “Whether the utility owns generation or not, the utility can sell allowances and use the proceeds to fund energy efficiency, for example through utility-run consumer efficiency programs.”

One element of RGGI being considered in a federal program is the use of offsets. A project can generate offset allowances by reducing greenhouse gas emissions that otherwise might not have been reduced, for example, by capturing and destroying methane at landfills that are not already subject to federal regulatory laws.

Power plants under RGGI can meet their compliance obligations by purchasing offset allowances representing up to 3.3 percent of emissions. Critics of offset programs say they let polluters off the hook, but Greenwald at Pew believes the RGGI program provides a “nice example of a small but robust offsets program.”

One reason it works is RGGI narrowly defines offsets to five categories of projects that must be found within the RGGI states. To qualify, any carbon reductions from the offset project must be real, verifiable, enforceable, permanent and additional to emission reductions that would have taken place otherwise.

The offset categories are: landfill methane capture recovery and destruction, reduction of sulfur hexafluoride emissions from electricity transmission and distribution, carbon sequestration on lands converted to forests, reduction of carbon emissions from “end-use” efficiencies in the building sector, and agricultural methane capture and destruction from animal manure and organic food waste.

Under ACES, an Offsets Integrity Advisory Board would decide what kinds of domestic and international offsets qualify, and would ensure their validity.

RGGI takes a “walk before you run approach” says Davis at Goodwin Procter, giving the states and power plants time to work with a cap-and-trade program. In that sense, it has been a good trial run for a broader, national program.

“It was kind of assumed that after 2012 [RGGI] could be expanded, depending on what happens at the federal level to more greenhouse gases and potentially more facilities,” Davis says, noting that compromises had to be made in creating the program. “It was kind of challenging to get those 10 states on board.”

ACES is more ambitious, proposing an economy-wide program that covers seven greenhouse gas emissions, including methane, nitrous oxide and hydrofluorocarbons, which are more potent than CO2. The legislation would also apply to industrial sources, refiners, and natural gas distribution companies, as well as power plants.

Greenwald doesn’t believe the U.S. needs to take RGGI’s “walk before you run” approach. An economy-wide program will not only allow for more reductions, it will create a more efficient, and therefore less costly, system, she says.

A Pew Climate study on multi-gas contributors to global climate change in 2003 found that including high-potency non-CO2 gases in an emissions reductions strategy can reduce the cost of cutting overall greenhouse gas emissions. Allowing non-CO2 gases in a program simply would deliver more bang for the buck.