States move to price carbon
The debate in the United States about whether to put a price on carbon emissions overlooks the fact that states covering a quarter of the US population and a third of the US economy already put a price on such emissions.
Washington State enacted a new "cap-and-invest" plan in May that is supposed to reduce carbon emissions in the state by 45% by 2030, 70% by 2040 and 95% by 2050.
The plan will take effect in 2023, provided the state enacts a separate transportation-spending package that increases the gas tax by at least 5¢ a gallon.
Washington is now the third US state effort to tackle carbon emissions without waiting for the US government to act. The other two are a 16-year old regional effort by the New England and mid-Atlantic states called the Regional Greenhouse Gas Initiative—or RGGI—and an ambitious eight-year old California program that is linked to Quebec.
The state efforts give factories that generate their own electricity using natural gas, coal or types of biomass that satisfy eligibility requirements an incentive to buy electricity instead from renewable sources rather than have to pay for allowances to cover their carbon emissions.
Carbon emission allowances cleared the latest RGGI auction on June 2 at $7.97 a ton and were priced in California at $18.80 a ton as the NewsWire went to press. The price for allowances in Washington state is still unknown, but the state is projecting revenue from allowance auctions of approximately $480 million in the first year of trading in 2023 and up to $580 million by 2040.
Companies that generate electricity using fossil fuels or certain types of biomass spent $416.3 million in 2020, the most recent year for which such data is available, on allowances to cover their carbon emissions in the 11-state area covered by RGGI.
The figure for California was $1.7 billion in 2020.
A monitoring report released by RGGI in March 2021 showed that the annual average carbon emissions rate among RGGI electric generation sources decreased by 31.4% between 2016 and 2018 as compared to the base period of 2006 to 2008. A 2020 report on the California program showed that the state reduced annual greenhouse gas emissions by 4.98% in 2018 as compared to 2013 when the cap-and-trade plan took effect.
The details of the new Washington state plan are in the "Climate Commitment Act," also known as SB 5126.
The governor and state legislature acted after voters failed in a ballot initiative in 2018 to impose a fee on carbon emissions.
The carbon reductions will be helped by two other state laws — one that requires a phase-out of carbon pollution from state power generation by 2045 and another that creates a clean fuels standard for marketers of gasoline and diesel.
There is no sunset or time limit on the Climate Commitment Act. It will stay in place until the state achieves net-zero emissions, which will avoid political battles over reauthorization.
The main feature of the new plan is a mechanism being called "cap and invest." The plan sets annual pollution and allowance limits for entities that emit at least 25,000 tons of energy, process or landfill emissions per year. This threshold covers roughly the state's 100 largest greenhouse gas emitters.
The number of allowances is linked to electricity supply and demand forecasts. The overall pool of carbon allowances will be gradually reduced over time in order for the state to achieve its 2050 net-zero emissions goal. A declining cap should force emission reductions. The theory is that as allowances become more scarce and expensive, emitters will have an incentive to make investments to reduce their emissions rather than have to pay more for allowances to cover their emissions.
The state will distribute allowances in three ways: auctions, direct allocation to industrial companies and direct allocation to utilities.
Most of the allowances will be auctioned to emitters and auctions will occur four times a year. The state will set a floor-to-ceiling price range for auction bids in order to protect the program from price shocks.
The ceiling will take the form of an allowance price containment reserve. This means that if the allowance price hits the ceiling, unlimited allowances at that price can be released from a reserve until prices go back down.
There will also be an emissions containment reserve, set to a trigger price that will allow the state to withdraw subsets of allowances from the system if the emission targets are not being met. The state will set the floor, ceiling and trigger prices through rulemakings and revisit pricing on certain predetermined milestone dates. However, the state can also revisit pricing and the number of allowances in the system at its discretion.
At the outset of the allowance program, a regulated source will have to hold one emission allowance in order to emit one ton of carbon dioxide equivalent. Large emitters may engage in secondary trading of pollution allowances.
Certain electricity generators, like smelters or factories that are considered vulnerable to out-of-state competition, will get most of their allowances for free, at least through 2035.
Free distribution of allowances to industrial emitters is being done to prevent leakage of businesses and pollution to other states with more lax regulation of greenhouse gas emissions.
Consumer-owned and investor-owned utilities in the state will be given allowances in an effort to prevent ratepayers from having to pay more for electricity.
If utilities reduce emissions ahead of schedule, they can auction off the remainder of their allowances. Local gas distribution companies will get free allowances equal to their emissions for the first year of the program, after which the number of allowances they are issued will decline by about 6.5% a year through 2030, which is the rate at which the carbon emissions cap drops annually. Starting in 2023, local gas distribution companies must make auction sales of 65% of their free allowances, with that figure rising by 5% a year until it reaches 100%.
The state Department of Ecology will collect annual, verified greenhouse gas emissions data from each covered entity to verify compliance. The data will be used to determine how many allowances each entity needs to turn in for compliance purposes. Entities will turn in any allowances they have been given or purchased to cover their emissions. An entity that fails to turn in the required amount of allowances will be required to turn in four allowances for each ton of greenhouse gases it emitted during the relevant period. This penalty is a strong incentive to buy the right amount of allowances.
The auction proceeds collected by the state will be deposited in new accounts set up to direct cash toward greenhouse gas reduction initiatives. These initiatives are wide ranging. They cover measures related to reducing transportation-related greenhouse gas emissions, financial support for biofuels, biomass and manure digesters at dairy farms, energy storage, energy conservation, other measures to reduce emissions in the agriculture sector, electrification and decarbonization of buildings, support for workers to transition to new jobs in the clean energy and decarbonization sectors, carbon sequestration, mitigating the impact of climate change on the state's forests, estuaries, oceans, fisheries and other ecosystems, and reducing pollution and health disparities in disadvantaged communities.
The Washington state plan also allows a small number of "offsets" to be used for compliance purposes.
An offset is a credit for activities that reduce greenhouse gas emissions outside of capped sectors.
Covered emitters may meet 8% of their compliance obligations through carbon offsets in the first compliance period that runs from 2023 through 2026. From then on, the offset cap is 6%. In order to receive an offset, the emission reductions must be permanent, verifiable and proven to have not otherwise happened.
The state will reduce the total amount of allowances issued each year to make up for the allowed level of offsets to ensure that the overall amount of allowances and offsets together does not exceed the level of the emissions cap.
The use of offsets is fairly constrained, requiring that at least half of offsets come from activities that provide direct environmental benefits to Washington state, and the law includes specific set-asides for offsets from Indian tribes.
RGGI is a regional effort by Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Virginia to reduce greenhouse gas emissions by the power sector. The initiative started in 2005 and auctioned its first group of emission allowances in 2008.
Virginia joined last year and Governor Tom Wolf is pressing for Pennsylvania, the biggest energy producer on the East Coast, to join RGGI as early as 2022. However, opponents in the Republican-controlled general assembly are currently pushing through legislation that, if passed, would effectively block Pennsylvania from joining RGGI.
RGGI requires fossil-fuel-fired electricity generators with a capacity of 25 megawatts or greater to hold at least one allowance for each short ton of CO2 aggregate emissions over each three-year control period. More specifically, these generators must hold allowances equal to at least 50% of their emissions during each of the first two calendar years of each three-year control period. Compliance is evaluated at the end of each three-year control period.
New York requires RGGI compliance by electricity generators with capacities of 15 megawatts or greater if a generating unit is located near one or more other generating units under common ownership with capacities of 15 megawatts or greater.
The total number of available allowances is determined based on the emission reduction goals for the RGGI region as a whole. RGGI plans on reducing the total number of allowances by 30% between 2020 and 2030.
Generators may acquire allowances either through quarterly allowance auctions or on secondary markets.
Quarterly auctions are sealed-bid, uniform-price auctions that are open to all qualified participants and result in a single, quarterly clearing price. Secondary markets include both over-the-counter trades and exchanges, such as the Nodal Exchange and the ICE NGX and Intercontinental Exchange.
Similar to the Washington state plan, RGGI auctions are subject to both a price ceiling, in the form of an allowance price cost containment reserve that releases additional allowances as a safety valve to hold down prices, and a price floor, in the form of an emissions containment reserve that withdraws allowances when the price has fallen too far to leave much incentive to control emissions.
In 2021, the price trigger for the containment reserve is $13 and the price trigger for the emissions containment reserve is $6. These thresholds will increase by 7% a year. The emissions containment reserve price floor does not currently apply to power producers in Maine or New Hampshire.
Generators in Connecticut, Delaware, Maine, Maryland, New Jersey, New York and Vermont may also obtain a limited amount of allowances through permitted offsets. These offsets give credit toward a generator's available emission allowances in a specific RGGI state for its emission reductions in another RGGI state.
An important caveat is that the offsetting power plant must be located within a RGGI state that also awards offset allowances. For example, a New York power producer cannot take advantage of emission reductions for its other projects in Massachusetts, New Hampshire, Rhode Island or Virginia. Moreover, offset allowances are capped at 3.3% of a power plant's emissions for any applicable control period. Few generators actually use these offsets due to the relatively low price of allowances available through the quarterly auctions.
The California program launched in 2013 and limits emissions of six types of greenhouse gas emissions in the power and industrial sectors. It was expanded in 2015 to cover transportation fuels and natural gas.
The California Air Resources Board enforces the program. Any electricity generator that emits at least 25,000 metric tons of greenhouse gases a year is covered. Electricity that a generator imports into California counts toward the 25,000.
The approach of capping emissions in multiple sectors makes the program broader than RGGI and more akin to the Washington state program.
Like RGGI, the compliance evaluation for California generating sources takes place at the end of each three-year control period. California's overall goal is to reduce its greenhouse gas emission cap by 5% a year from 2021 through 2030.
Emission allowances are distributed through a mix of free allocation and quarterly auctions. The portion of emissions covered by free allowances varies by sector. The number of free allowances is set by regulation and often function to grandfather politically sensitive industries that might otherwise relocate to other states. The portion of emissions covered by these free allowances also depends on the efficiency of the relevant facility when compared to industry benchmarks.
California's auction mechanics are similar to the mechanics in Washington state and RGGI: they include a sealed-bid, uniform-price auction that is subject to both a price ceiling and a floor.
At the beginning of 2021, a hard price ceiling of $65 per metric ton was set and will increase by 5% annually (plus an inflation adjustment), and an unlimited supply of allowances will be available at this price.
California's program is linked with Quebec whereby offsets and allowances can be traded across the two jurisdictions, providing greater liquidity for these assets.
Similar to the Washington state and RGGI programs, California allows emitters to use certain offsets to make up emissions allowance shortfalls. These offsets are capped 4% of an electricity generator's total emissions for 2021 through 2025 and 6% for 2026 through 2030. Beginning in 2021, at least half the offsets used for compliance must come from projects that directly benefit California.