Price Collars and Cost Containment in Cap-and-Trade Legislation
The Senate climate debate continues this month as Senator Barbara Boxer (D-Calif.) prepares to release her long-awaited carbon cap-and-trade legislation at the beginning of October. One of the major questions for the Senate bill is its approach to price volatility and cost containment. The issue took center stage last week in a hearing at the Senate Energy and Natural Resources Committee, as well as in news reports about price collar provisions in Boxer’s forthcoming bill and an alternative cap-and-trade bill released by Senator Maria Cantwell (D-Wash.).
Mechanisms to reduce short-term cost volatility and long-term costs are key components of a successful greenhouse gas (GHG) cap-and-trade program. Reducing energy consumption through energy efficiency is one of the most reliable and long-lasting forms of cost containment, and the House-passed American Clean Energy and Security Act (ACES) contains several provisions to establish and fund energy efficiency programs. In addition, ACES contains several direct cost-control mechanisms, including a strategic reserve for the borrowing of future allowances, unlimited banking and trading of carbon credits, and, most importantly, allowing emitters to offset up to two billion tons of GHG emissions by investing projects to reduce emissions outside the cap. The offsets were the single largest cost-containment measure in ACES; international offsets alone would reduce the price of allowances by nearly half in 2030, about $20 per ton, according to an analysis by the U.S. Environmental Protection Agency.
On September 15th, the Senate Energy and Natural Resources Committee hosted a full-committee hearing to examine measures to reduce energy costs and price volatility resulting from a cap on GHG emissions. The five witnesses represented a range of governmental, academic and public interest organizations, but all agreed that, while offsets provide some cost-containment potential, it would be nearly impossible to produce the number of offsets prescribed in Waxman-Markey without making unacceptable compromises to the integrity of the offsets - and thus to the environmental goals of the bill. Citing the experiences of the Clean Development Mechanism (CDM) in the Kyoto Protocol, the panelists outlined the various shortcomings of offset verification and enforcement. ACES would present an even greater challenge, they said, as the number of allowable offsets in ACES amounts to twenty to fifty times those in the CDM. Michael Wara of Stanford University concluded that “the twin objectives of copious offsets and high environmental integrity are fundamentally incompatible.”
Among the proposed alternatives, Eileen Claussen of the Pew Center on Global Climate Change favored a strategic reserve like the one in ACES, which would allow borrowing of permits from future years to cover emissions, providing the environmental integrity of a carbon cap while ensuring price stability similar to a price collar. In ACES, allowances from the strategic reserve would become available if allowance prices rose quickly above average prices from previous years, constituting a $24 “safety valve” in 2012, rising to $34 in 2030 and $90 in 2050, according to EPA price estimates. In addition to a strategic reserve, Claussen advocated in the hearing for banking of allowances, multi-year compliance schemes, and multi-year allowance schemes to mitigate short-term volatility.
The remaining witnesses held that a price collar, including a price floor to ensure sustained investment and a price ceiling to guarantee cost containment, would offer the most cost certainty in a cap-and-trade system. Jason Grumet, of the National Commission on Energy Policy, posited that a price collar would “allow policymakers to agree to disagree” on the differing cost estimates for a cap-and-trade program, while setting parameters for negotiation.
The price-certainty benefits of the price collar are clear: the floor would ensure a long-term minimum investment in clean energy and the ceiling would prevent dramatic price increases. Price certainty comes at the expense of emissions certainty, however, and the key challenge will be ensuring that the collar does not undermine the environmental goals of the bill. A price collar with a high ceiling would reduce incentives to invest in clean energy and degrade environmental integrity by allowing firms to purchase allowances in excess of the cap. A price collar with a low ceiling would have limited efficacy in cost-containment and could hinder Senate negotiations.
Following the hearing, reports surfaced that Barbara Boxer would likely include a price collar in her climate bill. According to Energy News, the Boxer price collar would limit the allowance price to a range between an $11 price floor and a $28 price ceiling in 2012; the floor and ceiling would increase at an unspecified rate over time. Similarly, Senator Maria Cantwell last week released a draft of an alternative climate bill, the CLEAR Act, which would create a price collar of $7 to $21 in 2012, rising at a rate of 6 percent plus inflation each year thereafter. The collar would limit allowance prices to a maximum of $60 in 2030 and $190 in 2050, before inflation, prices substantially higher than EPA’s projected allowance prices under ACES.
Perhaps the true efficacy of a price collar will depend on whether it is additional to or in place of other proposed cost-containment mechanisms. The Alliance, along with many others, has expressed serious concerns about the size and workability of the offset program in ACES. As suggested in the Senate hearing last week, the environmental uncertainty created by the price collar may actually prove an improvement over an environmentally uncertain offset program.
In the coming weeks, the Alliance will continue to monitor progress in the discussion of cost containment mechanisms, and to advocate for energy efficiency provisions throughout the Senate climate bill.
