Cost containment: Options for managing the costs of cap-and-trade
On June 29, the German Marshall Fund hosted an all-morning workshop on Capitol Hill for congressional staff titled "Cost Containment: Options for Managing the Costs of Cap-and-Trade." Three days earlier the House had passed a comprehensive climate and energy bill, and with Senate action being the next step in the Hill climate and energy debate, Senate staff were ready to dive into the details of designing a cap and trade program. The workshop panel included experts with a range of views on how to manage the costs of a cap and trade program, setting the stage for a lively debate. Featured panelists included Terry Dinan of the Congressional Budget Office, Dallas Burtraw of Resources for the Future, Nat Keohane of the Environmental Defense Fund, Cédric Philibert of International Energy Agency, and Peter Zapfel of the European Commission. Cathleen Kelly moderated.
The event was an opportunity to focus on one of the most contentious issues of the U.S. cap-and-trade debate: how to prevent carbon allowance prices that are too high, too low, or too volatile. Cap-and-trade is generally seen as the most economically efficient way of reducing emissions, but if emissions permit prices are too high, some businesses argue that the system could become too costly for firms and affect competitiveness. On the other hand, some environmentalists contend that prices that are too low may fail to deliver a market signal that will stimulate investments in clean technologies and innovation. Meanwhile, too much volatility may reduce confidence in the system and affect firms' decisions to invest in emissions-reducing technology. This meeting was an opportunity to examine a number of policy tools that are available to help reduce costs and offer more certainty for producers, consumers, and regulators under a cap-and-trade program. Terry Dinan opened the discussion with a survey of options, including: • banking and borrowing, where firms can accumulate unused emissions allowances for the future • a strategic public reserve of allowances that firms could access if allowance costs rise too much • a price collar, which allows allowance prices to fluctuate only between a set floor and ceiling • managed allowance prices, whereby the government would set the price at which allowances would be sold. The panelists drew out the economic, environmental, and political consequences of each of these, in terms of both the U.S. debate as well as the possibility of linking a U.S. cap-and-trade program with the EU Emissions Trading scheme. Like many engaged in the U.S. carbon emissions trading debate, Dallas Burtraw looked to the example of the U.S. SO2-trading scheme implemented in 1990.
He noted that the price of permits in that market was much lower than anticipated, so a price floor would have created more revenues to government. He also distinguished between cost-containment measures that were rules-based and discretion-based (i.e., vulnerable to short-term political decisions). Cedric Philibert, presenting his recently-published research for the IEA, proposed that a price collar (e.g., with $80 as the price floor and $260 as the ceiling - both significantly higher than proposals being discussed in the U.S. debate) could dramatically reduce costs compared to a system with a fixed cap and unconstrained prices, and asserted that the effect on the environment would be minimal. In contrast, Peter Zapfel and Nat Keohane said that trading itself was an important way of containing costs, and that the market was by far the best way of identifying the appropriate carbon price. Zapfel also suggested that, in Europe, a stable regulatory environment is seen as the most important element to avoid undue price volatility. Both Zapfel and Keohane asserted that some cost-containment measures, like a price cap, would reduce the environmental integrity of the system but, more importantly, they said a price cap could send a political signal that the emissions target is negotiable or of secondary importance.
During the Q & A session, panelists discussed implications these measures may have for the linking of the U.S. and EU trading schemes. Zapfel suggested that price floors or caps could be a serious impediment to the formation of a transatlantic carbon market because, unlike other design issues, there is a wide divergence in both analytical and political debate across the Atlantic. Some suggested that linking the U.S. and European trading markets could create the "magnetic force" necessary to draw other economies (including major emitters in the developing world) into an emissions trading scheme.