Use Market Pricing to Cut CO2 Emissions

Kaye_Loren_2012_4x6_CMYKNobody should be surprised that California’s cap-and-trade program is the most cost-effective strategy to reduce carbon emissions. What’s astonishing is that policymakers insist on pursuing other more expensive options.

The existing mandate to reduce greenhouse gas (GHG) emissions to 1990 levels by 2020 is apparently on an achievable path, helped by the historic recession, national automobile fuel economy standards, and the cap-and-trade program, which covers about 80% of emission sources.

Since November 2013, the Air Resources Board has held 13 auctions that set the price for GHG emission allowances. These auctions have revealed market prices ranging from $10 to $14 per ton of CO2, with an overall average for all auctions of $12.11 per ton.

More Expensive Strategies

But the market-based approach has not been sufficient for California’s elected leaders and regulators. And not surprisingly, regulatory and “state investment” strategies are far more expensive than the market.

The most ambitious command-and-control program is the low carbon fuel standard (LCFS), which requires fuel refiners to reduce the carbon intensity of gasoline, which in turn would reduce carbon emissions.

Until refiners figure out how to produce a less carbon-intensive hydrocarbon fuel, they are allowed to purchase emission credits. These credits are supplied by ethanol and biodiesel refiners, and electric utilities (that provide energy for electric vehicles).

Credit prices have recently shot up since the carbon intensity mandate was tightened without a similar increase in availability of credits.

A recent report by Oil Price Information Service found that the cost to refiners of purchasing gasoline credits will increase to 4.67 cents a gallon, and to 3.29 cents for diesel fuel. The additional cost for annual fuel use in California is $770 million.

In its regulatory package, the Air Board estimated that the LCFS would reduce GHGs by 6 million tons in 2016, rising to 20.7 million tons in 2020. Assuming no change in the cost of these reductions, this results in a carbon price ranging from $37 to $128 per ton.

In short, the LCFS regulation is three to 10 times more expensive in reducing GHGs than the cap-and-trade system.

Investments made by spending revenues from cap-and-trade are not any better.

The ARB’s 2015 annual report on projects funded in 2013 and 2014 shows poor cost-effectiveness for most projects, especially compared with the cap-and-trade benchmark.

Based on ARB estimates for lifetime GHG reductions of these projects:

• $83.4 million for rebates for “clean vehicles” will result in a reduction of about 2.2 million tons of carbon, for a cost-per-ton of $37.23, or three times more costly than cap-and-trade.

• Investment in the hybrid and zero- emission truck and bus program is even worse, with a cost-per-ton of $139, or 11 times most costly than cap-and-trade.

• Grants for water efficiency and water-energy efficiency projects ranged from $26 to $84 per ton of GHG reduced.

CalChamber Lawsuit

The revenue source for the spending on these and many other projects may be fatally flawed. The California Chamber of Commerce has sued the ARB over the legality of the auction, which has raised billions since 2013, arguing that the Air Board’s auction regulation went beyond the scope authorized by AB 32, and that the auction is an illegal tax under Proposition 13. The case is awaiting hearing in the 3rd District Court of Appeal.

However, the legal infirmity of the auction does not undermine the basic legal, policy and economic soundness of the cap-and-trade mechanism, which can and has operated efficiently without an auction component.

Overlaps More Costly

Why should the state not use its entire toolbox to reduce GHG emissions? After all, if cap and trade is good, why isn’t additional command and control and project spending even better?

As discussed in a seminal paper by Rob Stavins and Todd Schatzki, “these overlapping programs can produce perverse policy outcomes,” which make overall emission reductions more expensive and less effective.

They argue that creating a uniform, low-cost incentive to reduce carbon emissions is the best strategy “not only for maintaining the health of the California economy, but also for providing incentives for adoption of climate commitments by other governments.”

A specific risk they point to is the harmful interaction between policies:

“When complementary policies [e.g. LCFS – LK] impose incremental requirements on emission sources already covered by cap-and-trade, these policies fail to generate net emission reductions, but raise the costs of achieving emission targets by requiring more costly actions that would otherwise happen under cap-and-trade. Emission reductions from complementary policies also drive down allowance prices, thereby reducing incentives for technological change.”

Cap-and-Trade Best

As they consider the present and future prospect of achieving California’s climate change goals, the Legislature and administration have an opportunity to revisit the market, regulatory and investment approaches to emission reduction.

While reducing emissions will remain the overarching goal, achieving this goal in the least economically damaging and most effective way should be a top priority. A broad, if not exclusive, reliance on cap-and-trade will best achieve these goals.

Loren Kaye is president of the California Foundation for Commerce and Education, a nonprofit think tank affiliated with the California Chamber of Commerce.