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Market News

 January 03, 2017
Cap and trade today for a better tomorrow

 The United States, along with at least 34 other countries, is succeeding in reducing carbon dioxide emissions while growing its economy. Moreover, according to the International Energy Agency, total emissions tied to energy usage worldwide remained flat in 2014 and 2015, even while the global economy grew more than 3 percent annually. Decoupling economic growth from carbon emission is both possible and necessary as diversified sources of clean energy reduces global warming, improves public health, creates jobs, and enhances national security.

To this end, nearly 40 nations have carbon pricing policies, and even China is designing a cap and trade program. But with President-elect Donald Trump's pledge to rescind the Clean Power Plan (CPP) and withdraw from the Paris Agreement, continued progress in the United States will likely fall on states and municipalities. The Reginal Greenhouse Gas Initiative (RGGI), the nation's first mandatory cap and trade program for carbon emissions, provides an example of state and regional leadership.

Cap and trade is a market-based mechanism where a cap is set on a particular pollutant and emission permits are bought and traded. The cap is reduced each year, calculated to raise the price of pollution. Both the cap and ability to sell and trade permits create incentives to innovate and reduce beyond what is required. Using market incentives to combat pollution traces back to Ronald Reagan's use of cap and trade to phase out lead in gasoline and the George H.W. Bush administration's successful effort to reduce acid rain. The RGGI has several notable features, including quarterly emission allowance auctions where proceeds are reinvested into complimentary efficiency and clean energy programs.

The RGGI, which took effect in January 2009, involves nine states: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island and Vermont (Gov. Chris Christie pulled New Jersey out of the RGGI in 2011.). The program covers carbon dioxide emissions from approximately 168 electric power plants with capacities to generate 25 megawatts or more. Based on estimates made in 2005, the original goal was to stabilize Co2 emissions at expected 2009 levels, and then require gradual reductions.

Due to the unexpected drop in natural gas prices, actual Co2 emissions declined below the cap level, creating an oversupply of pollution permits. This illustrates certain challenges in designing a cap and trade program: estimating emission levels and price fluctuations. In January 2014, the RGGI substantially tightened the emission cap by 45 percent, with 2.5 percent annual decreases scheduled between 2015 and 2020. The RGGI is currently undergoing its quadrennial program review, which will likely result in even more ambitious reduction targets.

Despite the disparity between the cap and emissions, the program still imposed a price on carbon and generated revenues for clean energy investments. The results have been striking. Since 2005, when the program was first announced, RGGI states have experienced a reduction of more than 45 pecent in affected power plant Co2 emissions, while enjoying higher than average economic growth rates and lower electricity bills.

Skeptics point to three other explanations for the sharp reduction in emissions: (1) the slowdown in economic growth caused by the 2008 financial crisis, (2) the increased availability of natural gas, and (3) other energy efficient initiatives such as renewable portfolio standards, which require that a certain share of electrical power be generated by renewable sources. To be sure, these factors have all impacted emission levels, particularly the shift to natural gas. But measuring the progress of RGGI states against that of other states tells a broader story.

According to Acadia Center, from 2008 to 2015 Co2 emissions dropped 30 percent in RGGI states compared to 14 percent in the rest of the country, excluding California, which has its own cap and trade program. During the same period, economic growth totaled 24.9 percent in RGGI states, compared to 21.3 percent in other states. According to a 2015 study, Co2 emissions would be 24 percent higher in RGGI states without the program. In addition, the auction proceeds have generated over $2.58 billion used to support investments in energy efficiency, renewables, greenhouse gas abatement and direct bill assistance. These reinvestments have contributed to lower utility bills and job creation.

There is concern over the increased reliance on natural gas, which still requires the purchase of allowances for emission under the RGGI. This underscores the role of complimentary clean energy programs supported by RGGI proceeds. According to the Natural Resources Defense Council, between 2012 and 2014 energy efficient investments helped reduce customer electricity bills by $341 million and natural gas bills by $118 million. Thermal efficiency programs funded by RGGI proceeds have resulted in substantial energy savings. Moreover, use of renewable energy has doubled in RGGI states. Indeed, solar and wind power are getting cheaper each year.

The RGGI demonstrates the ability to reduce carbon emissions while simultaneously growing the economy. It also illustrates a key economic principal: incentives matter. A combination of carbon pricing and complimentary investments in clean energy can spur market activity. Complimentary state and local policy tools include portfolio standards, energy aggregation, efficiency targets, utility regulations, building codes, land use and transportation. RGGI states are now leaders in clean energy, with New York committed to a 50 percent renewable supply by 2030 .

The RGGI was widely seen as a model for state compliance with the CPP. While the future of CPP is now uncertain, the experience and success of RGGI still provides a useful playbook for state level action. The prospect of decoupling carbon emissions from economic growth has never been more promising. Now is not the time to retreat on climate change.